Filed
Pursuant to Rule 424(b)(5)
Registration No. 333-108039
The information in this preliminary prospectus supplement is not complete and may be changed. This preliminary prospectus
supplement is not an offer to sell these securities, and is not soliciting an offer to buy these securities, in any state where the offer or sale is not permitted.
Subject to completion, dated September 22, 2003
Preliminary prospectus supplement
(To Prospectus dated September 17, 2003)
16,000,000 Shares
GrafTech International Ltd.
Common stock
This is an offering of common stock by GrafTech International Ltd.
Our common stock is traded on the New York Stock Exchange, or NYSE, under the trading symbol "GTI." On September 19, 2003, the last reported sale price of our common stock on the NYSE was $8.94 per share.
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We have granted the underwriters an option for a period of 30 days to purchase up to 2,400,000 additional shares of our common stock at the public offering price less the underwriting discounts and commissions to cover over-allotments.
Investing in our common stock involves a high degree of risk. See "Risk factors" beginning on page S-12.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus supplement or the accompanying prospectus. Any representation to the contrary is a criminal offense.
JPMorgan
CIBC World Markets
RBC Capital Markets
Jefferies Quarterdeck
, 2003.
About this prospectus supplement
This document consists of two parts. The first part is this prospectus supplement, which describes the specific terms of the securities that we are offering and also changes, adds to and updates information contained in the accompanying prospectus and the documents incorporated by reference in this prospectus supplement and the accompanying prospectus. The second part, the accompanying prospectus, gives more general information about securities we may offer from time to time, including securities other than those that we are offering by this prospectus supplement. If information contained in this prospectus supplement is inconsistent with information contained in the accompanying prospectus, you should rely on the information contained in this prospectus supplement.
It is important for you to read and consider all of the information contained in this prospectus supplement and the accompanying prospectus in making your investment decision. You should also read and consider the information contained in the documents we have incorporated by reference as described in "Where you can find more information" and "Incorporation of certain documents by reference" in this prospectus supplement.
We include cross references in this prospectus supplement and the accompanying prospectus to captions under which you can find additional related discussions. The table of contents in this prospectus supplement provides the pages on which these captions are located.
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Preliminary notes | S-ii | |
Where you can find more information | S-v | |
Incorporation of certain documents by reference | S-v | |
Forward looking statements | S-vii | |
Summary | S-1 | |
Risk factors | S-12 | |
Use of proceeds | S-26 | |
Price range of common stock and dividend policy | S-27 | |
Capitalization | S-29 | |
Selected consolidated financial data | S-31 | |
Management's discussion and analysis of financial condition and results of operations |
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Business | S-75 | |
Management | S-103 | |
Shares eligible for future sale | S-106 | |
Material U.S. federal tax consequences for non-U.S. investors | S-107 | |
Underwriting | S-110 | |
Notice to Canadian residents | S-112 | |
Legal matters | S-114 | |
Experts | S-114 | |
Index to financial statements | F-1 |
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About this prospectus | 2 | |
Where you can find more information | 3 | |
Incorporation of certain documents by reference | 3 | |
Forward looking statements | 4 | |
The company | 6 | |
Ratio of earnings to fixed charges | 8 | |
Use of proceeds | 8 | |
Risk factors | 9 | |
Description of common stock and preferred stock | 9 | |
Description of debt securities and guarantees |
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Description of depositary shares | 36 | |
Description of warrants | 39 | |
Description of global securities | 41 | |
Plan of distribution | 44 | |
Legal matters | 48 | |
Experts | 48 |
Important terms
We use the following terms to identify various companies or groups of companies or other matters. These terms help to simplify the presentation of information in this prospectus supplement and the accompanying prospectus.
"GTI" refers to GrafTech International Ltd. only. GTI is our public parent company and the issuer of the publicly traded common stock offered by this prospectus supplement. GTI is a guarantor of the Senior Notes and the Senior Facilities. Prior to our Annual Meeting of Stockholders for 2002, GTI was named UCAR International Inc.
"GrafTech Global" refers to GrafTech Global Enterprises Inc. only. GrafTech Global is a direct, wholly owned subsidiary of GTI and the direct or indirect holding company for all of our operating subsidiaries. GrafTech Global is a guarantor of the Senior Notes and the Senior Facilities. Prior to June 7, 2002, GrafTech Global Enterprises Inc. was named UCAR Global Enterprises Inc.
"UCAR Carbon" refers to UCAR Carbon Company Inc. only. UCAR Carbon is our wholly owned subsidiary through which we conduct most of our U.S. operations. UCAR Carbon is a guarantor of the Senior Notes and the Senior Facilities.
"GrafTech Finance" refers to GrafTech Finance Inc. only. GrafTech Finance is a direct, wholly owned special purpose finance subsidiary of GTI and the borrower under our senior secured bank credit facilities (as amended, the "Senior Facilities"). GrafTech Finance is the issuer of our 10.25% senior notes due 2012 (the "Senior Notes"). The Senior Notes were issued under an Indenture dated February 15, 2002, as supplemented on April 30, 2002 (as supplemented, the "Indenture"). Prior to June 7, 2002, GrafTech Finance was named UCAR Finance Inc.
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"AET" refers to Advanced Energy Technology Inc. only. AET is our 97.5% owned (wholly owned, prior to June 2001) subsidiary engaged in the development, manufacture and sale of natural graphite products. Prior to January 1, 2003, AET was named Graftech Inc.
"Carbone Savoie" refers to Carbone Savoie S.A.S. and its subsidiaries. Carbone Savoie is our 70% owned subsidiary engaged in the development, manufacture and sale of cathodes.
"Subsidiaries" refers to those companies that, at the relevant time, are or were majority owned or wholly owned directly or indirectly by GTI or its predecessors to the extent that those predecessors' activities related to the graphite and carbon business. All of GTI's subsidiaries have been wholly owned (with de minimis exceptions in the case of certain foreign subsidiaries) from at least January 1, 2000 through June 30, 2003, except for:
Our 100% owned Brazilian cathode manufacturing operations were contributed to Carbone Savoie and, as a result, became 70% owned on March 31, 2001.
"We," "us" or "our" refers to GTI and its subsidiaries collectively or, if the context so requires, GTI, GrafTech Global or GrafTech Finance, individually.
Presentation of financial, legal and market data
We present our financial information on a consolidated basis. This means that we consolidate financial information for all subsidiaries where our ownership is greater than 50%. 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, including our 25% owned joint venture in China with Jilin Carbon Co., Ltd. (together with its affiliates, "Jilin").
All financial information contained herein has been restated to reflect changes in accounting for reportable segments (as required by SFAS No. 131 to reflect changes in the organization of our businesses effective January 2003), accounting for discontinued operations (as required by SFAS No. 144 to reflect the sale of our non-strategic composite tooling business in June 2003) and reclassification of extraordinary items and corresponding adjustments to provisions for income taxes (as required by SFAS No. 145, which we adopted effective January 2003), except for financial information at and for the quarter ended March 31, 2003 and at and for the quarter and half year ended June 30, 2003, which was originally reported on the same basis as the restated financial information. The restatement does not change previously reported consolidated net income, basic or diluted earnings per share, consolidated total assets or liabilities, or consolidated cash flows from operating activities, investment activities or financial activities.
References to cost in the context of our low cost advantages and strategies do not include the impact of special or non-recurring charges, expenses or credits, such as those related to investigations, lawsuits, claims, restructurings or impairments, or the impact of changes in accounting principles.
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All cost savings and reductions relating to our 1998 enhanced global restructuring and rationalization plan are estimates based on a comparison, with respect to provision for income taxes, to costs in 1998 or, for all other costs, to costs in the 1998 fourth quarter (annualized). Calculation of cost savings under the 1998 plan includes the effects of changes in currency exchange rates and production levels. All cost savings and reductions relating to our 2002 major cost savings plan are estimates or targets based on a comparison to costs in 2001. For purposes of calculating the cost savings related to the 2002 plan, savings relating to graphite electrode production costs per metric ton are determined based on annual graphite electrode production volume of about 180,000 metric tons and certain other savings are determined based on annual overhead costs (together with research and development costs) of $90 million, annual interest expense of $60 million and an effective income tax rate of 45% before taking into account the realignment of our subsidiaries. These amounts approximate actual amounts in 2001. Calculation of cost savings under the 2002 plan excludes the effects of the changes in currency exchange rates between the euro and the dollar, but includes the effects of changes in currency exchange rates between other currencies, and includes the effects of changes in production levels.
Neither any statement made in this prospectus supplement and the accompanying prospectus nor any charge taken by us relating to any legal proceedings constitutes an admission as to any wrongdoing.
Unless otherwise specifically noted, market and market share data in this prospectus supplement and the accompanying prospectus are our own estimates. Market data relating to the steel, aluminum, electronics, semiconductor, transportation, petrochemical and other metals industries, our general expectations concerning such industries and our market position and market share within such industries, both domestically and internationally, are derived from trade publications relating to those industries and other industry sources as well as assumptions made by us, based on such data and our knowledge of the industries. Market data relating to the fuel cell power generation industry, our general expectations concerning such industry and our market position and market share within such industry, both domestically and internationally, are derived from publications by securities analysts relating to Ballard Power Systems, other industry sources and public filings, press releases and other public documents of Ballard Power Systems as well as assumptions made by us, based on such data and our knowledge of the industry. Market and market share data relating to the graphite and carbon industry as well as cost information relating to our competitors, our general expectations concerning such industry and our market position and market share within such industry, both domestically and internationally, are derived from the sources described above and public filings, press releases and other public documents of our competitors as well as assumptions made by us, based on such data and our knowledge of the industry. We are not aware of any misstatements regarding any industry or market share data and our estimates related to this data are based on assumptions that we believe to be reasonable. However, our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under "Forward looking statements" and "Risk factors" in this prospectus supplement. We cannot guarantee the accuracy or completeness of this market and market share data and have not independently verified it. None of the sources mentioned above has consented to the disclosure or use of data in this prospectus supplement.
Unless otherwise noted, when we refer to dollars, we mean U.S. dollars.
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Unless otherwise noted, references to "market shares" are based on sales volumes in 2002, to "major product lines" mean graphite electrodes, cathodes and natural graphite products and to "natural graphite products" does not include mined natural graphite flake.
Where you can find more information
We are required to file periodic reports, proxy statements and other information relating to our business, financial and other matters with the SEC under the Securities Exchange Act of 1934. Our filings are available to the public over the Internet at the SEC's web site at http://www.sec.gov. You may also read and copy any document we file with the SEC at, and obtain a copy of any such document by mail from, the SEC's public reference room located at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed charges. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room and its charges. Our reports and proxy statements and other information relating to us can also be read and copied at the NYSE located at 20 Broad Street, New York, New York 10005, (212) 656-5060.
We have filed with the SEC a registration statement on Form S-3 under the Securities Act of 1933 with respect to our securities described in this prospectus supplement, as well as securities other than those we are offering in this prospectus supplement. References to the "registration statement" or the "registration statement of which this prospectus is a part" mean the original registration statement (including any related registration statement relating thereto filed pursuant to Rule 462(b) under the Securities Act) and all amendments, including all schedules and exhibits. This prospectus supplement and the accompanying prospectus do not contain all of the information in the registration statement because we have omitted parts of the registration statement in accordance with the rules of the SEC. Please refer to the registration statement for any information in the registration statement that is not contained in this prospectus supplement or the accompanying prospectus. The registration statement is available to the public over the Internet at the SEC's web site described above and can be read and copied at the locations described above.
Each statement made in this prospectus supplement or the accompanying prospectus concerning a document filed as an exhibit to the registration statement is qualified in its entirety by reference to that exhibit for a complete description of its provisions.
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 Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file them with or furnish them to the SEC. We maintain a web site at http://www.graftech.com. The information contained on our web site is not part of this prospectus supplement, the accompanying prospectus or the registration statement.
Incorporation of certain documents by reference
The SEC allows us to "incorporate by reference" the information we file with it, which means that we can disclose important information to you by referring you to those documents. The information incorporated by reference is an important part of this prospectus supplement and the accompanying prospectus, and information that we file later with the SEC will automatically update and supersede this information. We incorporate by reference the
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documents listed below and any future filings made by us with the SEC under Sections 13(a), 13(c), 14, or 15(d) of the Securities Exchange Act of 1934 until this offering is completed.
Any statement contained in a previously filed document incorporated by reference in this prospectus supplement or the accompanying prospectus is modified or superseded to the extent that a statement contained in this prospectus supplement or the accompanying prospectus modifies or supersedes such statement. Any statement contained in this prospectus supplement or the accompanying prospectus or in a document incorporated by reference in this prospectus supplement or the accompanying prospectus is modified or superseded to the extent that a statement contained in any subsequently filed document which is or is deemed to be incorporated by reference in this prospectus supplement or the accompanying prospectus modifies or supersedes such statement. Only the modified or superseded statement shall constitute a part of this prospectus supplement or the accompanying prospectus.
You may request a copy of these filings, other than their exhibits, at no cost, by oral or written request to: GrafTech International Ltd., Brandywine West, 1521 Concord Pike, Suite 301, Wilmington, Delaware 19803, Attention: Elise A. Garofalo, Director of Investor Relations, Telephone (302) 778-8227.
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This prospectus supplement and the accompanying prospectus contain forward looking statements. In addition, from time to time, we or our representatives have made or may make forward looking statements orally or in writing. These include statements about such matters as: future production and sales of steel, aluminum, electronic devices, fuel cells and other products that incorporate our products or that are produced using our products; future prices and sales of and demand for graphite electrodes and our other products; future operational and financial performance of our businesses; strategic plans; impacts of regional and global economic conditions; interest rate management activities; restructuring, realignment, strategic alliance, raw material and supply chain, technology development and collaboration, investment, acquisition, joint venture, operating integration, tax planning, rationalization, financial and capital projects; legal matters and related costs; consulting fees and related projects; potential offerings, sales and other actions regarding debt or equity securities of us or our subsidiaries; and future costs, working capital, revenues, business opportunities, values, 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 performance, 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 or cash flows.
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.
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This summary highlights information contained elsewhere in this prospectus supplement and the accompanying prospectus. It does not contain all of the information that you should consider before making a decision to invest in our common stock. You should read carefully the entire prospectus supplement, the accompanying prospectus and the documents incorporated by reference, including "Risk factors" and the Consolidated financial statements and notes thereto included elsewhere in this prospectus supplement.
Unless otherwise stated, the information contained in this prospectus supplement is based on the assumption that the underwriters' over-allotment option will not be exercised.
GrafTech International Ltd.
We are one of the world's largest manufacturers and providers of high quality synthetic and natural graphite and carbon products and related technical and research and development services. We manufacture graphite electrodes and cathodes, products essential to the production of electric arc furnace steel and aluminum. We also manufacture thermal management, fuel cell and other specialty graphite and carbon products for, and provide services to, the electronics, power generation, semiconductor, transportation, petrochemical and other metals markets. We have 13 state-of-the-art manufacturing facilities strategically located on four continents, in more diverse locations than the facilities of any of our competitors. We have customers in more than 70 countries, including industry leaders such as Arcelor, Nucor and Bao Steel in steel, Alcoa, Pechiney and Alcan in aluminum, Cisco, IBM and Intel in electronics, MEMC Electronic Materials in semiconductors and Ballard Power Systems in fuel cells.
We have the largest share of the worldwide market for electrodes and cathodes. We have a uniquely positioned global manufacturing network, which we believe cannot be replicated by any of our competitors due to the capital investment, technology and process know-how required to do so. We believe that our network has the largest manufacturing capacity, has the lowest manufacturing cost structure of all of our major competitors and delivers the highest quality products. Over the last few years, we have rationalized our graphite electrode and cathode facilities and redeployed capacity to larger facilities in lower cost countries. This allows us to achieve significant increases in productivity and output from our existing assets, including economies of scale and other cost savings that we believe will increase as we grow our sales. We believe that our network provides us with the operational flexibility to source customer orders from the facility that optimizes our profitability and, with the continuing consolidation in the steel and aluminum industries, provides us a significant growth opportunity in serving larger multi-plant global customers.
We believe that we are the industry leader in graphite and carbon materials science and high temperature processing know-how and that we operate the premier research, development and testing facilities in our industry. We have over 100 years of experience in the research and development of these technologies. Our intellectual property portfolio is extensive, with over 350 U.S. and foreign patents and 290 U.S. and foreign pending patent applications, which we believe is more than any of our major competitors. About 86% of these patents were granted within the past four years.
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We believe that our technological capabilities for developing products with superior thermal, electrical and physical characteristics provide a differentiating advantage. These capabilities have enabled us to accelerate development and commercialization of our technologies to exploit markets with high growth potential for us, including products for electronic thermal management and fuel cell applications.
We have developed, over the past two years, natural graphite electronic thermal management products and secured product approvals and purchase commitments from a wide range of industry leaders, such as Cisco, IBM and Intel, based on superior thermal performance, weight, adaptability and cost characteristics as compared to alternative products. Thermal management products are designed to dissipate heat generated by electronic devices. We expect demand for our products to grow as industry trends continue toward smaller, more powerful electronic devices which generate more heat and require more advanced thermal management solutions. We estimate that the market for our current products is about $300 million and expect it to grow at an annual rate in excess of 20% over the next three years. Sales of our products are growing, from about $500,000 in 2002 to an estimated $2 million in 2003 and an estimated $8 million in 2004, based on orders received to date.
We are the leading manufacturer of natural graphite products for PEM fuel cells and fuel cell systems. Fuel cells provide environmentally friendly electrical power generation. We expect continued commercialization of fuel cells, encouraged by current governmental programs and driven by concerns relating to the U.S. electrical power grid, environmental protection, foreign oil dependency and other factors. We estimate that the market for our fuel cell products in 2012 will exceed $500 million. About 85% of the 175 fuel cell vehicles expected to be operational worldwide in 2003 and 2004 are or will be powered by Ballard Power Systems fuel cells. Our products are essential components of those fuel cells. Ballard Power Systems, the world leader in PEM fuel cells, is our strategic partner under an exclusive product supply agreement that continues through 2016 and an exclusive collaboration agreement that continues through 2011.
Lines of business
We have three lines of business: synthetic graphite; natural graphite; and advanced carbon materials. We had net sales of $657 million and gross profit of $153 million for the twelve months ended June 30, 2003. Synthetic graphite, which constitutes its own reportable segment, had net sales of $589 million and gross profit of $137 million for the twelve months ended June 30, 2003. Natural graphite and advanced carbon materials, which together constitute our other reportable segment, had net sales of $68 million and gross profit of $16 million for the twelve months ended June 30, 2003.
Synthetic graphite. Our synthetic graphite line of business manufactures and delivers high quality graphite electrodes, cathodes and advanced synthetic graphite products as well as related services. Electrodes and cathodes are key components of the conductive power systems used to produce steel, aluminum and other non-ferrous metals. Advanced synthetic graphite products include primary and specialty products for transportation, semiconductor and other markets. We believe there is currently no commercially viable substitute for graphite electrodes in electric arc furnace steel production or for cathodes in aluminum smelting.
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Graphite electrodes are consumed primarily in electric arc furnace steel production, the steel making technology used by all "mini-mills," typically at a rate of one graphite electrode every eight to ten operating hours ("a stick a shift"). Mini-mills constitute the higher long term growth sector of the steel industry.
Cathodes are used in aluminum smelting furnaces, and demand for cathodes is driven by construction of new smelters and relines and upgrades of existing smelters. We operate our cathode business through a 70% owned joint venture with Pechiney, the world's recognized leader in aluminum smelting technology.
Natural graphite. We invented natural graphite products, consisting of advanced flexible graphite and flexible graphite. Advanced flexible graphite products include highly engineered thermal interface products, heat spreaders and heat sinks for electronic device applications. We also manufacture highly engineered flow field plates, gas diffusion layers and other advanced flexible products for PEM fuel cells and fuel cell systems for use in the power generation and transportation markets. Flexible graphite products include gasket and sealing material for high temperature and corrosive environments in automotive, petrochemical and other applications. We are one of the world's largest manufacturers of natural graphite products for all of these uses and applications.
Advanced carbon materials. Our advanced carbon materials line of business includes carbon electrodes and refractories as well as related services. Carbon electrodes are used in the production of ferro-alloys and silicon metal, a raw material primarily used in the manufacture of aluminum. Refractories are used primarily as submerged arc and other furnace hearth walls and bottoms.
Building sustainable competitive advantages
Over the past few years through late 2002, adverse global and regional economic conditions negatively impacted many of our markets. Our management team responded to these challenges and transformed our operations, building sustainable competitive advantages that enable us to compete successfully in our major product lines regardless of changes in economic conditions, to realize enhanced performance as economic conditions improve and to exploit growth opportunities from our intellectual property portfolio.
During this period, we successfully implemented the following initiatives:
Repositioned global manufacturing network. We repositioned our global manufacturing network by, among other things, shutting down four of our higher cost graphite electrode manufacturing facilities and redeploying capacity to our six remaining larger, lower cost, strategically located facilities. The repositioning of our network allows us to deliver the same graphite electrode sales volume that we delivered over the past few years with a significantly lower fixed cost base. With these actions and our proprietary process and technological improvements, we now have the capability, depending on product demand and mix, to manufacture more than 220,000 metric tons of graphite electrodes from our existing assets.
We also shutdown cathode and advanced synthetic graphite products manufacturing capacity and redeployed it to lower cost facilities and expanded our advanced flexible graphite manufacturing capacity. Together, since 1998, these repositioning actions resulted in a
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headcount reduction of over 30% and contributed a majority of the achieved cost savings described below.
We believe that there are significant barriers to entrants to our industry, including the need for extensive product and process know-how and other intellectual property and a high initial capital investment. There have been no entrants in the synthetic graphite industry for more than 50 years.
Redesigned global manufacturing, marketing and sales processes. We have evaluated virtually every aspect of our global supply chain, and we have redesigned and implemented changes to our global manufacturing, marketing and sales processes to leverage the strengths of our repositioned network. Among other things, we have eliminated manufacturing bottlenecks, improved product and service quality and delivery reliability, expanded our range of products, and improved our global sourcing and product mix for our customers. Over the past three years, we have reduced annual customer compensation for graphite electrode quality claims from $3 million to less than $1 million. We also redirected marketing and sales activities to better service the needs of both existing and new customers. Over the past several years, we estimate that we have increased our share of the worldwide market for graphite electrodes by more than 10%, from 19% in 2001 to about 21% in 2003.
Accelerated technology development. We analyzed our intellectual property portfolio to identify new product opportunities in markets with high growth potential for us, redirected research to enhance and exploit our portfolio and accelerated development of products for those markets. Among other things, we developed patented advanced pin technology for graphite electrodes, patented processing technology for high performance graphite cathodes, products for PEM fuel cells that are enabling fuel cell commercialization, and new electronic thermal management technologies with over 130 product approvals from industry leading strategic partners, customers and others.
In September 2003, we received R&D Magazine's prestigious R&D 100 Award, granted to identify the 100 most technologically significant products and advancements each year, for our achievements in electronic thermal management heat sink products.
Achieved cost savings. From 1998 through December 2001, we achieved recurring annual pre-tax cost savings of $132 million. From January 2002 through August 31, 2003, we achieved additional recurring pre-tax cost savings of $20 million. In addition to the rationalization of our facilities, we have, among other things, redesigned benefit plans, completed information technology outsourcing, and consolidated and streamlined administration and other activities. This has enabled us to mitigate the impact of significant declines in pricing of our products from 1998 into 2002 and adverse economic conditions. This has also enabled us to achieve the lowest manufacturing cost structure of all of our major competitors.
Business strategies
Our goal is to create stockholder value by maximizing cash flow from operations, and our business strategies are designed to expand upon the competitive advantages that our initiatives have created.
Leveraging our unique global manufacturing network. We believe that our unique global manufacturing network provides us with significant competitive advantages in costs and
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product quality, proximity to customers, timely and reliable delivery and operational flexibility to adjust product mix to meet the diverse needs of a wide range of customers. We believe we can further exploit this advantaged manufacturing network by redirecting our marketing and sales efforts toward and focusing our superior technical and customer service capabilities on:
Delivering exceptional and consistent quality. We believe that our products are among the highest quality products available in our industry. We have been awarded preferred or certified supplier status by many major steel and aluminum companies and have received numerous technological innovation and other awards by industry groups, customers and others. Using our technological capabilities, we continually seek to improve the consistent overall quality of our products and services, including the performance characteristics of each product, the uniformity of the same product manufactured at different facilities and the expansion of the range of our products. We believe that improvements in overall quality create significant efficiencies for us, provide us the opportunity to increase sales volumes and market share, and create market opportunities for us and production efficiencies for our customers.
Providing superior technical service. We believe that we are the recognized industry leader in providing value added technical services to customers for our major product lines. We believe that we have the largest customer technical service and related supporting engineering and scientific organizations in our industry, with more than 245 engineers, scientists and specialists around the world. Our employees assist key steel and other metals customers in furnace design, operation and upgrade to reduce energy consumption, improve raw material costs and increase output. In addition, our employees assist customers and others who design, develop or produce electronic devices to integrate our advantaged flexible graphite product solutions into their new devices.
Accelerating commercialization of advantaged technologies. We believe that our leading technological and manufacturing capabilities and strengths provide us with a significant growth opportunity as well as a competitive advantage. We seek to exploit these capabilities across all of our businesses, to improve existing products, such as supersize graphite electrodes used in the most demanding electric arc steel production furnaces and high performance graphite cathodes that have become the preferred technology in the industry, and to develop and commercialize new products for markets with high growth potential for us.
Pursuing cost savings. In January 2002, we announced a major cost savings plan that we believe is the most aggressive cost reduction plan being implemented in our industry. We are targeting cumulative recurring annual pre-tax cost savings of $30 million in 2003, $60 million in 2004 and $80 million in 2005. In addition, we are also targeting $50 million of additional asset
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sales by the end of 2004. We believe that these savings and asset sales will further enhance our performance.
As part of the 2002 plan, we are continuing to implement global work process changes, including consolidation and streamlining of our order fulfillment, purchasing, finance and accounting and human resource processes, and identification and implementation of outsourcing opportunities. These activities are targeted for completion by the end of 2004.
Outlook
We believe that our initiatives have well positioned us to increase earnings and cash flow from operations under current economic conditions and to leverage additional increases in earnings and cash flow from operations from improvements in economic conditions.
Synthetic graphite. The graphite electrode supply/demand balance has improved, and supply remains tight primarily due to graphite electrode industry-wide rationalization, including bankruptcies of competitors, and, to a lesser extent, increased electric arc furnace steel production. Capacity utilization at our graphite electrode manufacturing facilities remains high.
Since September 2002, we have successfully implemented graphite electrode price increases around the world. The average sales revenue per metric ton of our graphite electrodes in the 2003 first half was $2,311. Current spot prices per metric ton for graphite electrodes in our major markets are about $2,600. Among others, we recently implemented graphite electrode price increases in South Africa, which are the first price increases contracted for 2004 as the annual contract period in South Africa runs from July 1 to June 30. Because our graphite electrode capacity is virtually sold out for 2003, we do not expect price increases announced in mid-2003 to materially impact results of operations until 2004.
Demand for our cathodes continues to be strong and we expect long term growth in the aluminum industry. Our cathode capacity is virtually sold out for 2003, and we expect it to be virtually sold out in 2004 due to construction of new aluminum smelters as well as relines of existing smelters. Our strategic alliance with Pechiney, which is a 30% owner of our cathode business and purchases cathodes from us under a requirements contract that remains in effect through 2006, continues to position us as the leading supplier of cathodes to the aluminum industry.
Other. We expect growing net sales of our electronic thermal management products, due to the strengthening of the electronics industry and the development of new, higher performance electronic devices as well as our continuing successful product development and commercialization initiatives. We also expect demand for our advanced carbon materials products to improve, due primarily to the strengthening of the steel industry and our marketing and sales initiatives.
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Recent developments
On September 22, 2003, we announced that we were reaffirming 2003 third quarter and full year earnings guidance and establishing 2004 earnings guidance. For 2004, we expect earnings per diluted share to be $0.60 to $0.75, after giving effect to the issuance of the shares offered by this prospectus supplement.
The GRAFTECH logo, GRAFCELL®, eGraf, GRAFOIL®, GRAFGUARD® and GRAFSHIELD®, are our trademarks and trade names. This prospectus supplement and the accompanying prospectus also contain trademarks and trade names belonging to other parties.
We are a Delaware corporation. Our principal executive offices are located at Brandywine West, 1521 Concord Pike, Suite 301, Wilmington, Delaware 19803, and our telephone number at that location is (302) 778-8227. We maintain a web site at http://www.graftech.com. The information contained on this web site is not part of this prospectus supplement or the accompanying prospectus.
S-7
Common stock offered | 16,000,000 shares, par value $0.01 per share | |
Over-allotment option |
We have granted the underwriters an option to purchase up to 2,400,000 shares of common stock solely to cover over-allotments. |
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Common stock outstanding after this offering |
83,515,504 shares, excluding: |
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12,233,215 shares issuable upon exercise of options outstanding at September 18, 2003 under our equity incentive plans, at a weighted average exercise price of $12.84; |
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505,847 shares held at September 18, 2003 in employee benefits protection and deferred compensation plan trusts, which are not considered outstanding for calculations of basic or diluted earnings per share; and |
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up to 2,400,000 shares that may be issued to the underwriters upon exercise of their over-allotment option. |
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At September 18, 2003, 1,324,037 shares were available for future awards under our equity incentive plans. |
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Use of net proceeds |
We intend to use: |
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$81 million to repay term loans outstanding under the Senior Facilities; and |
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the balance of $54 million to reduce the principal amount outstanding under our revolving credit facility and other short-term debt, pending use for a specific corporate purpose. To the extent that there are net proceeds in excess of such amounts, the excess would be added to cash and cash equivalents. |
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NYSE symbol |
GTI |
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Dividend policy |
We have not paid cash dividends on our common stock and do not intend to do so in the foreseeable future. |
S-8
Summary consolidated financial data
The following Summary consolidated financial data at and for the years ended December 31, 1998, 1999, 2000, 2001 and 2002 have been derived from our audited annual Consolidated financial statements. The following Summary consolidated financial data at and for the six months ended June 30, 2002 and 2003 have been derived from our quarterly Consolidated financial statements, which are unaudited but in the opinion of our management reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of our consolidated financial condition, results of operations and cash flows for such periods. Results of operations for interim periods are not necessarily indicative of results to be expected for full fiscal years. You should read this data in conjunction with the "Preliminary notesPresentation of financial, legal and market data," "Selected consolidated financial data," "Management's discussion and analysis of financial condition and results of operations" and the Consolidated financial statements and notes thereto included elsewhere in this prospectus supplement and the accompanying prospectus.
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Year Ended December 31, |
Six Months Ended June 30, |
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(dollars in millions, except per share data) |
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1998 |
1999 |
2000 |
2001 |
2002 |
2002 |
2003 |
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Statement of operations data: | |||||||||||||||||||||||||
Net sales | $ | 928 | $ | 818 | $ | 763 | $ | 634 | $ | 596 | $ | 291 | $ | 351 | |||||||||||
Gross profit | 336 | 256 | 214 | 179 | 135 | 65 | 82 | ||||||||||||||||||
Selling, administrative and other expenses | 99 | 84 | 84 | 75 | 76 | 42 | 42 | ||||||||||||||||||
Restructuring charges (credit) (a) | 86 | (6 | ) | 6 | 12 | 6 | 5 | 20 | |||||||||||||||||
Impairment loss on long-lived and other assets (b) | 60 | 35 | 3 | 80 | 17 | 13 | | ||||||||||||||||||
Antitrust investigations and related lawsuits and claims (c) | | | | 10 | | | | ||||||||||||||||||
Interest expense | 73 | 84 | 75 | 60 | 60 | 30 | 27 | ||||||||||||||||||
Provision for (benefit from) income taxes | 27 | 1 | 2 | 14 | (16 | ) | (11 | ) | 1 | ||||||||||||||||
Income (loss) from continuing operations (a)(b)(c)(d)(e)(f) | (40 | ) | 42 | 10 | (89 | ) | (19 | ) | (12 | ) | (4 | ) | |||||||||||||
Net income (loss) (a)(b)(c)(d)(e)(f)(g) | (37 | ) | 42 | 10 | (87 | ) | (18 | ) | (11 | ) | (2 | ) | |||||||||||||
Basic income (loss) per common share: |
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Income (loss) from continuing operations | $ | (0.89 | ) | $ | 0.94 | $ | 0.22 | $ | (1.79 | ) | $ | (0.35 | ) | $ | (0.21 | ) | $ | (0.06 | ) | ||||||
Income from discontinued operations | 0.06 | | | 0.04 | 0.02 | 0.01 | 0.02 | ||||||||||||||||||
Net income (loss) | $ | (0.83 | ) | $ | 0.94 | $ | 0.22 | $ | 1.75 | $ | (0.33 | ) | $ | (0.20 | ) | $ | (0.04 | ) | |||||||
Weighted average common shares outstanding (in thousands) | 44,972 | 45,114 | 45,224 | 49,720 | 55,942 | 55,848 | 56,829 | ||||||||||||||||||
S-9
Diluted income (loss) per common share: | |||||||||||||||||||||||||
Income (loss) from continuing operations | $ | (0.89 | ) | $ | 0.91 | $ | 0.22 | $ | (1.79 | ) | $ | (0.35 | ) | $ | (0.21 | ) | $ | (0.06 | ) | ||||||
Income from discontinued operations | (0.06 | ) | | | 0.04 | 0.02 | 0.01 | 0.02 | |||||||||||||||||
Net income (loss) | $ | (0.83 | ) | $ | 0.91 | $ | 0.22 | $ | (1.75 | ) | $ | (0.33 | ) | $ | (0.20 | ) | $ | (0.04 | ) | ||||||
Weighted average common shares outstanding (in thousands) | 44,972 | 46,503 | 45,813 | 49,720 | 55,942 | 55,848 | 56,829 | ||||||||||||||||||
Balance sheet data (at period end): | |||||||||||||||||||||||||
Cash and cash equivalents | $ | 58 | $ | 17 | $ | 47 | $ | 38 | $ | 11 | $ | 51 | $ | 8 | |||||||||||
Total assets | 1,137 | 933 | 908 | 797 | 859 | 869 | 919 | ||||||||||||||||||
Short-term debt | 19 | | 3 | 7 | 18 | 17 | 23 | ||||||||||||||||||
Total debt | 804 | 722 | 735 | 638 | 731 | 717 | 709 | ||||||||||||||||||
Stockholders' deficit | (287 | ) | (293 | ) | (316 | ) | (332 | ) | (381 | ) | (348 | ) | (349 | ) | |||||||||||
Working capital | 198 | 101 | 99 | 112 | 115 | 137 | 109 | ||||||||||||||||||
Other financial data: |
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Gross profit margin | 36.3 | % | 31.3 | % | 28.1 | % | 28.2 | % | 22.7 | % | 22.3 | % | 23.4 | % | |||||||||||
Depreciation and amortization | 50 | 44 | 42 | 35 | 28 | 15 | 15 | ||||||||||||||||||
Capital expenditures | 52 | 56 | 52 | 40 | 50 | 20 | 20 | ||||||||||||||||||
Net cash provided by (used in) operating activities from continuing operations | (29 | ) | 77 | 92 | 14 | (60 | ) | (36 | ) | (25 | ) | ||||||||||||||
Cash flow used in investing activities | (31 | ) | (39 | ) | (50 | ) | (39 | ) | (50 | ) | (20 | ) | (5 | ) | |||||||||||
Cash flow provided by (used in) financing activities | 62 | (80 | ) | (13 | ) | 15 | 79 | 66 | 27 | ||||||||||||||||
Other operating data: |
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Quantity of graphite electrodes sold (in thousands of metric tons) | 211 | 206 | 217 | 174 | 180 | 87 | 98 | ||||||||||||||||||
Quantity of cathodes sold (in thousands of metric tons) | 33 | 31 | 35 | 33 | 37 | 19 | 20 | ||||||||||||||||||
Pro forma data (i): |
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Interest expense | $ | 48 | $ | 24 | $ | 22 | |||||||||||||||||||
Basic and diluted earnings per share: | |||||||||||||||||||||||||
Income (loss) from continuing operations | $ | (0.14 | ) | $ | (0.10 | ) | $ | (0.01 | ) | ||||||||||||||||
Discontinued operations | 0.01 | 0.01 | 0.02 | ||||||||||||||||||||||
Net income (loss) | (0.13 | ) | (0.09 | ) | 0.01 | ||||||||||||||||||||
Weighted average common shares outstanding (in thousands) | 80,541 | 79,135 | 82,635 | ||||||||||||||||||||||
S-10
The footnotes to the preceding table, except for footnote (i) below, appear on pages S-32 and S-33.
(i) These pro forma financial data assume that (i) this offering had occurred, and the initial application of the estimated net proceeds therefrom had been made, as of January 1, 2002 and (ii) exchanges in the 2003 second and third quarters of an aggregate principal amount of $55 million of Senior Notes issued in February 2002, plus accrued interest, for an aggregate of about 9.9 million shares of common stock had occurred as of February 15, 2002. These pro forma financial data are based upon assumptions that we believe to be reasonable, and available information that we reasonably believe to be accurate, under the circumstances. This pro forma financial data should be read in conjunction with the other financial information included elsewhere in this prospectus supplement and the accompanying prospectus. These pro forma financial data do not purport to represent what our actual interest expense or basic or diluted earnings per share would have been if, in fact, such transactions had been completed on such dates or to project our interest expense or basic or diluted earnings per share for any future period or date. The following tables set forth, for the periods indicated, the calculation of these pro forma financial data.
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Year Ended December 31, |
Six Months Ended June 30, |
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(dollars in millions) |
2002 |
2002 |
2003 |
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Interest expense, as reported | $ | 60 | $ | 30 | $ | 27 | |||||
Less: Interest expense on debt repaid with estimated net proceeds from this offering (1) | (8 | ) | (4 | ) | (3 | ) | |||||
Less: Interest expense on Senior Notes exchanged for common stock (2) | (4 | ) | (2 | ) | (2 | ) | |||||
Pro forma interest expense | $ | 48 | $ | 24 | $ | 22 | |||||
(1) Uses the weighted average debt outstanding for each period. Assumes that (i) net proceeds from this offering are $135 million, (ii) $81 million of the net proceeds was applied to repay term loans under the Senior Facilities, and the balance of $54 million was applied to reduce the principal amount outstanding under our revolving credit facility and to repay other short-term debt and (iii) the annual interest rate on the debt was the same as the weighted average interest rate on the Senior Facilities, which was 5.6% for 2002, 5.6% for the 2002 first half and 5.1% for the 2003 first half.
(2) Uses the annual interest on the Senior Notes exchanged after taking into account the effect of interest rate swaps relating to the Senior Notes exchanged, which results in an effective annual interest rate thereon of 6.28% for 2002, 6.12% for the 2002 first half and 6.58% for the 2003 first half. Assumes that none of the additional Senior Notes issued in May 2003 at a price of 104.5% of principal amount, plus accrued interest, resulting in an effective annual interest rate thereon of 9.5%, was exchanged.
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Year Ended December 31, |
Six Months Ended June 30, |
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(dollars in millions) |
2002 |
2002 |
2003 |
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Income (loss) from continuing operations, as reported | $ | (19 | ) | $ | (12 | ) | $ | (4 | ) | ||
Less: difference between interest expense, as reported, and pro forma interest expense, net of related tax effect | 8 | 4 | 3 | ||||||||
Pro forma income (loss) from continuing operations | (11 | ) | (8 | ) | (1 | ) | |||||
Discontinued operations | 1 | 1 | 2 | ||||||||
Pro forma net income (loss) | $ | (10 | ) | $ | (7 | ) | $ | 1 | |||
S-11
An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below before purchasing our common stock. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our financial condition, results of operations, cash flows or business. If any of the following risks actually occur, our financial condition, results of operations, cash flows or business could be harmed. In that case, the trading price of our common stock could decline, and you could lose part or all of your investment.
Risks relating to us
We are dependent on the global steel and aluminum industries and also sell products to the transportation, semiconductor, petrochemical and other metals industries. Our results of operations may deteriorate during global and regional economic downturns.
We sell graphite electrodes, which accounted for about 63% of our total net sales in 2002, primarily to the electric arc furnace steel production industry. We also sell cathodes, which accounted for about 15% of our total net sales in 2002, to the aluminum industry. Many of our other products are sold primarily to the transportation, semiconductor, petrochemical and other metals industries. These are global basic industries, and customers in these industries are located in every major geographic market. As a result, our customers are affected by changes in global and regional economic conditions. This, in turn, affects overall demand for and prices of our products sold to these industries. Accordingly, we are directly affected by changes in global and regional economic conditions. These conditions are affected by events and circumstances beyond our control such as geopolitical events (such as the war on terror and the circumstances involving Iraq and North Korea), changes in demand by consumers, businesses and governments, and policy decisions by governments, and central banks. As a result of changes in economic conditions, demand and pricing for our products sold to these industries has fluctuated significantly.
Demand for our products sold to these industries may be adversely affected by improvements in our products as well as in the manufacturing operations of customers, which reduce the rate of consumption or use of our products for a given level of production by our customers. In the case of graphite electrodes, we estimate that the average rate of consumption of graphite electrodes per metric ton of steel produced in electric arc furnaces (called "specific consumption") declined from about 4.3 kilograms of graphite electrodes per metric ton of steel produced in 1990 to about 2.4 kilograms per metric ton in 2002. While we believe that the rate of decline of specific consumption over the long term has slowed, we believe that there was a slightly more significant decline in 2001 than would otherwise have been the case due to the accelerated shutdown of older, less efficient electric arc furnaces as a result of global and regional economic conditions.
Sales volumes and prices of our products sold to these industries are impacted by the supply/demand balance as well as overall demand and growth of and consolidation within the end markets for our products. In addition to the factors mentioned above, the supply/demand balance is affected by factors such as business cycles, rationalization within our industry, and
S-12
output and productivity within our industry and the end markets for our products, some of which factors are affected by decisions by us. In the case of graphite electrodes, although our volume of graphite electrodes sold has increased significantly since early 2002, we have in the past experienced significant fluctuations in volume. In addition, although we implemented significant graphite electrode price increases in the 2002 second half and 2003, prices have declined significantly since 1998.
Over the past few years through late 2002, we faced extremely challenging business and industry conditions. Adverse global and regional economic conditions negatively impacted many of the end markets for our products, with many customers in these markets reducing production, becoming less creditworthy or being acquired due to consolidation within their industries. Industry-wide capacity for most of our products exceeded demand, and competition has been intense. Our net sales and net income have declined significantly since 1999.
We cannot assure you that the electric arc furnace steel production industry will continue to be the higher long term growth sector of the steel industry, that the aluminum industry will continue to experience long term growth or that any of the industries to which we sell products will experience strong recovery from current economic conditions affecting them. Accordingly, we cannot assure you that there will be stability or growth in demand for or prices of graphite electrodes or our other products sold to these industries. An adverse change in global or certain regional economic conditions could materially adversely affect us.
Any substantial growth in net sales, cash flow from operations or net income from our natural graphite line of business depends on successfully developing, manufacturing and selling new products on a profitable basis. If we are not successful, we will not achieve our planned growth.
Our planned growth of our natural graphite line of business depends on successful and profitable development, manufacture and sale primarily of thermal management products for electronic devices and products for PEM fuel cells and fuel cell systems.
Successful and profitable commercialization of products is subject to various risks, including risks beyond our control such as:
S-13
These risks could be impacted by factors such as adoption of new laws and regulations, changes in governmental programs, failure of necessary supporting systems (such as fuel delivery infrastructure for fuel cells) to be developed, and consumer perceptions about costs, benefits and safety.
Our financial condition could suffer if we experience unanticipated costs as a result of antitrust investigations and related lawsuits and claims.
Since 1997, we have been subject to antitrust investigations and related lawsuits and claims. We have recorded pre-tax charges of $350 million against results of operations as a reserve for estimated potential liabilities and expenses in connection with antitrust investigations and related lawsuits and claims. At June 30, 2003, $94 million remained in the unfunded reserve. The balance of the reserve is available for the $52.5 million balance of the fine payable by us to the U.S. Department of Justice (the "DOJ") that was imposed in 1998, the €50.4 million fine assessed against us by the Directorate GeneralCompetition of the Commission of the European Communities (the "EU Competition Authority") in July 2001 and other antitrust related matters. We have filed an appeal to the Court of First Instance In Luxembourg with respect to, among other things, the amount of the EU fine. The DOJ fine does not bear interest prior to April 2004 and bears interest at the statutory rate (which was 1.09% annually at June 30, 2003) after April 2004. The EU fine bears interest at the statutory rate of 6.04% annually.
The reserve does not cover interest on the DOJ fine (including interest that, for accounting purposes, is imputed on the DOJ fine and which, for the period from July 2003 through April 2004, is nil). Such interest is recorded in interest expense on the Consolidated statements of operations.
The reserve will cover interest accrued on the EU fine for the period from July 2001 through the date of the court's decision on our appeal. Due to the accumulation of interest as a result of the delay in the court's decision as well as changes in currency exchange rates which impact the translation of the amount of the EU fine into dollars, we may be required to record a charge at the time of the court's decision to increase the reserve, even if the amount of the EU fine is reduced on appeal. Interest accruing on the EU fine after the date of the court's decision will be recorded in interest expense on the Consolidated statements of operations and will not be covered by any reserve.
Our insurance has not and will not materially cover liabilities that have or may become due in connection with antitrust investigations or related lawsuits or claims.
We cannot assure you that remaining liabilities and expenses in connection with antitrust investigations, lawsuits and claims will not materially exceed the remaining uncommitted balance of the reserve or that the timing of payment thereof will not be sooner than anticipated. If such liabilities or expenses materially exceed such balance or if the timing of payment thereof is sooner than anticipated, we may not be able to comply with the financial covenants under the Senior Facilities. In such event, we could experience the material adverse consequences described, and be forced to take the unfavorable actions referenced, in the risk factor relating to restrictive covenants under the Senior Facilities and Senior Notes on pages S-15 through S-16.
S-14
We are highly leveraged and our substantial debt and other obligations could limit our financial resources and ability to compete and may make us more vulnerable to adverse economic events.
We are highly leveraged, and we have substantial obligations in connection with antitrust investigations, lawsuits and claims. At June 30, 2003, after giving affect to our exchanges of Senior Notes for shares of common stock after July 1, 2003 as well as this offering and the initial application of the estimated net proceeds therefrom, we would have had total debt of $558 million and a stockholders' deficit of $177 million. See "Capitalization" in this prospectus supplement. In addition, we typically discount or factor a substantial portion of our accounts receivable and use the proceeds to reduce our debt. During the 2003 first half, certain of our subsidiaries sold receivables totaling $96 million. If we had not sold such receivables, our accounts receivable and our debt would have been about $48 million higher at June 30, 2003. A significant majority of our debt is or has effectively been converted into variable rate debt. We believe that we will have a net use of cash in operating and investing activities in 2003. We are dependent on our revolving credit facility, the availability of which depends on continued compliance with the financial covenants under the Senior Facilities, for liquidity.
Our high leverage and antitrust related obligations could have important consequences, including the following:
Our ability to service our debt and meet our other obligations depends on certain factors beyond our control.
Our ability to service our debt and meet our other obligations as they come due is dependent on our future financial and operating performance. This performance is subject to various factors, including factors beyond our control such as changes in global and regional economic conditions, developments in antitrust investigations, lawsuits and claims involving us, changes
S-15
in our industry or the end markets for our products, changes in interest or currency exchange rates, and inflation in raw materials energy and other costs.
If our cash flow and capital resources are insufficient to enable us to service our debt and meet these obligations as they become due, we could be forced to: reduce or delay capital expenditures; sell assets or businesses; limit or discontinue, temporarily or permanently, business plans or operations; obtain additional debt or equity financing; or restructure or refinance debt.
We cannot assure you as to the timing of such actions or the amount of proceeds that could be realized from such actions. Accordingly, we cannot assure you that we will be able to meet our debt service and other obligations as they become due or otherwise.
We are subject to restrictive covenants under the Senior Facilities and the Senior Notes. These covenants could significantly affect the way in which we conduct our business. Our failure to comply with these covenants could lead to an acceleration of our debt.
The Senior Facilities and the Senior Notes contain a number of covenants that, among other things, significantly restrict our ability to: dispose of assets; incur additional indebtedness; repay or refinance other indebtedness or amend other debt instruments; create liens on assets; enter into leases or sale/leaseback transactions; make investments or acquisitions; engage in mergers or consolidations; make certain payments and investments, including dividend payments and stock repurchases; make capital expenditures; or engage in certain transactions with subsidiaries and affiliates.
The Senior Facilities also require us to comply with specified financial covenants, including minimum interest coverage and maximum leverage ratios. In addition, pursuant to the Senior Facilities, we cannot borrow under our revolving credit facility:
Further, substantially all of our assets in the U.S. are pledged to secure guarantees of the Senior Facilities by our domestic subsidiaries. In addition, our principal foreign operating subsidiaries are obligors under intercompany term notes and guarantees of those notes issued to GrafTech Finance that are pledged to secure the Senior Notes. Our Swiss subsidiary is an obligor under an intercompany revolving note and our principal foreign subsidiaries are guarantors of that note that are pledged to secure the Senior Facilities. Most of the assets of the obligors under the intercompany revolving note and the related guarantees, which constitute a majority of our assets outside the U.S., are pledged to secure that note and those guarantees.
S-16
We are currently in compliance with the covenants contained in the Senior Facilities and the Senior Notes. However, our ability to continue to comply may be affected by events beyond our control. The breach of any of the covenants contained in the Senior Facilities, unless waived by the lenders, would be a default under the Senior Facilities. This would permit the lenders to accelerate the maturity of the Senior Facilities. It would also permit the lenders to terminate their commitments to extend credit under our revolving credit facility. This would have an immediate material adverse effect on our liquidity. An acceleration of maturity of the Senior Facilities would permit the holders of the Senior Notes to accelerate the maturity of the Senior Notes. A breach of the covenants contained in the Senior Notes would be a default under the Senior Notes. This would also permit the holders of the Senior Notes to accelerate the maturity of the Senior Notes. Acceleration of maturity of the Senior Notes would permit the lenders to accelerate the maturity of the Senior Facilities and terminate their commitments to extend credit under our revolving credit facility. If we were unable to repay our debt to the lenders and holders or otherwise obtain a waiver from the lenders and holders, we could be forced to take the actions described in the preceding risk factor and the lenders and holders could proceed against the collateral securing the Senior Facilities and the Senior Notes and exercise all other rights available to them. We cannot assure you that we will have sufficient funds to make these accelerated payments or that we will be able to obtain any such waiver on acceptable terms or at all.
We are subject to risks associated with operations in multiple countries.
A substantial majority of our net sales are derived from sales outside of the U.S., and a substantial majority of our operations and our total property, plant and equipment and other long-lived assets are located outside the U.S. As a result, we are subject to risks associated with operating multiple countries, including:
S-17
We cannot assure you that such risks will not have a material adverse effect on us in the future.
In general, our results of operations and financial condition are affected by inflation in each country in which we have a manufacturing facility. We maintain operations in Brazil, Russia and Mexico, countries which have had in the past, and may have now or in the future, highly inflationary economies, defined as cumulative inflation of about 100% or more over a three calendar year period. We cannot assure you that future increases in our costs will not exceed the rate of inflation or the amounts, if any, by which we may be able to increase prices for our products.
Our ability to grow and compete effectively depends on protecting our intellectual property. Failure to protect our intellectual property could adversely affect us.
We believe that our intellectual property, consisting primarily of patents and proprietary know-how and information, particularly the intellectual property relating to electronic thermal management and fuel cell power generation, is important to our growth. Failure to protect our intellectual property may result in the loss of the exclusive right to use our technologies. We rely on patent, trademark, copyright and trade secret laws and confidentiality and restricted use agreements to protect our intellectual property. Some of our intellectual property is not covered by any patent or patent application or any such agreement.
We own, and have obtained exclusive and non-exclusive licenses to, various domestic and foreign patents related to our technologies. These patents and licenses expire at various times over the next two decades. When such patents and exclusive licenses expire, we will no longer have the right to exclude others from making, using or selling the claimed inventions.
Patents are subject to complex factual and legal considerations. Accordingly, there can be uncertainty as to the validity, scope and enforceability of any particular patent. Therefore, we cannot assure you that:
S-18
We cannot assure you that agreements designed to protect our proprietary know-how and information will not be breached, that we will have adequate remedies for any such breach, or that our strategic alliance partners, consultants, employees or others will not assert rights to intellectual property arising out of our relationships with them.
In addition, effective patent, trademark and trade secret protection may be limited, unavailable or not applied for in the U.S. or in any of the foreign countries in which we operate.
Moreover, we cannot assure you that the use of our patented technology or proprietary know-how or information does not infringe the intellectual property rights of others.
Intellectual property protection does not protect against technological obsolescence due to developments by others or changes in customer needs.
Our ability to establish and maintain our competitive advantage through our technology and any intellectual property rights may be achieved, in part, by prosecuting claims against others whom we believe have misappropriated our technology or have infringed upon our intellectual property rights, as well as by defending against misappropriation or infringement claims brought by others against us. Our involvement in litigation to protect or defend our rights in these areas could result in a significant expense to us, adversely affect the development of sales of the related products, and divert the efforts of our technical and management personnel, regardless of the outcome of such litigation.
If necessary, we may seek licenses to intellectual property of others. However, we can give no assurance to you that we will be able to obtain such licenses or that the terms of any such licenses will be acceptable to us. Our failure to obtain a license from a third party for its intellectual property that is necessary for us to make or sell any of our products could cause us to incur substantial liabilities and to suspend the manufacture or shipment of products or use of processes requiring the use of such intellectual property.
Our current and former manufacturing operations are subject to increasingly stringent health, safety and environmental requirements.
We use and generate hazardous substances in our manufacturing operations. In addition, both the properties on which we currently operate and those on which we have ceased operations are and have been used for industrial purposes. Further, our manufacturing operations involve risks of personal injury or death. We are subject to increasingly stringent environmental, health and safety laws and regulations relating to our current and former properties and neighboring properties and our current operations. These laws and regulations provide for substantial fines and criminal sanctions for violations and sometimes require the installation of costly pollution control or safety equipment or costly changes in operations to limit pollution or decrease the likelihood of injuries. In addition, we may become subject to potentially material liabilities for the investigation and cleanup of contaminated properties and to claims alleging personal injury or property damage resulting from exposure to or releases of hazardous substances or personal injury as a result of an unsafe workplace. In addition, noncompliance with or stricter enforcement of existing laws and regulations, adoption of more stringent new laws and regulations, discovery of previously unknown contamination or imposition of new or increased requirements could require us to incur costs or become the basis of new or increased liabilities that could be material.
S-19
We are dependent on supplies of raw materials and energy at affordable prices. Our results of operations could deteriorate if that supply is substantially disrupted for an extended period.
We purchase raw materials and energy from a variety of sources. In many cases, we purchase them under short term contracts or on the spot market, in each case at fluctuating prices. We purchase a majority of our requirements for petroleum coke, our principal raw material, at variable prices, from multiple plants of a single supplier under a supply agreement that continues through the end of 2006. The availability and price of raw materials and energy may be subject to curtailment or change due to:
Petroleum and coal products, including petroleum coke and pitch, our principal raw materials, and energy, particularly natural gas, have been subject to significant price fluctuations. Over the past several years, we have mitigated the effect of price increases on our results of operations primarily through our cost reduction efforts. We cannot assure you that such efforts will successfully mitigate future increases in the price of raw materials or energy. A substantial increase in raw material or energy prices which cannot be mitigated or passed on to customers or a continued interruption in supply, particularly in the supply of petroleum coke or energy, would have a material adverse effect on us.
Our results of operations could deteriorate if our manufacturing operations were substantially disrupted for an extended period.
Our manufacturing operations are subject to disruption due to extreme weather conditions, floods and similar events, major industrial accidents, strikes and lockouts, adoption of new laws or regulations, changes in interpretations of existing laws or regulations or changes in governmental enforcement policies, and other events. We cannot assure you that no such events will occur. If such an event occurs, it could have a material adverse effect on us.
We have significant non-dollar-denominated intercompany loans and significant interest rate swaps and may in the future have significant foreign currency financial instruments. Translation gains and losses due to changes in currency exchange rates or interest rates have in the past resulted and may in the future result in significant gains or losses.
We have non-dollar-denominated intercompany loans between GrafTech Finance and some of our foreign subsidiaries. At June 30, 2003, the aggregate principal amount of these loans was $464 million. These loans are subject to translation 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, translation gains and losses on these loans are recorded in accumulated other comprehensive income (loss) on the Consolidated balance sheets. The balance of these loans are deemed to be temporary and, as a result, translation gains and losses on these loans are recorded as unrealized gains or losses in other expense (income), net, in the Consolidated statements of operations. We have the ability to replace each intercompany loan with a
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substantially identical new intercompany loan. When we replace such a loan, we record net cumulative realized translation gains or losses with respect to that loan in other expense (income), net. Those realized gains or losses are, however, non-cash gains or losses. In the 2003 first half, we recorded a gain of $16 million with respect to these loans.
We have interest rate swaps that effectively convert fixed rate debt (represented by the Senior Notes) into variable rate debt in order to seek to minimize interest expense and optimize our portfolio of fixed and variable interest rate obligations. Although we had no swaps at June 30, 2003, in July 2003, we entered into swaps, a portion of which we sold in September 2003. At September 18, 2003, we had swaps for a notional amount of $485 million. Our swaps are designated as hedging the exposure to changes in the fair value of the related debt (called a fair value hedge). The swaps are marked-to-market daily, and we are required to provide cash collateral to the counterparty to the extent that the negative mark-to-market exceeds $15 million. At September 18, 2003, the negative mark-to-market was $15 million. The fair value of the hedge at the end of a quarterly or annual period is recorded on the Consolidated balance sheets on the line entitled "fair value of hedged debt obligation." When we sell swaps, the gain or loss realized is amortized as a credit or charge to interest expense over the remaining term of the Senior Notes. In the 2003 first half, we realized proceeds of $31 million with respect to the sale of swaps, which will be amortized as a credit to interest expense over the remaining term of the Senior Notes.
We have foreign currency financial instruments to attempt to limit our risks associated with changes in currency exchange rates by attempting to hedge existing exposures, firm commitments and, potentially, anticipated transactions. At June 30, 2003, we held instruments with an aggregate net notional amount of $17 million. These instruments are marked-to-market monthly. Gains and losses are recorded as unrealized gains or losses in other expense (income), net. When we sell the instruments, we record net cumulative realized gain or loss with respect to the instruments in other expense (income), net. In the 2003 first half, we recorded a loss of $3 million with respect to the instruments.
We cannot assure you that we will have gains, or will not have losses, of the type described above. Incurrence of material losses, and provision of material cash collateral, could materially adversely affect our ability to comply with the financial covenants under the Senior Facilities.
Our results of operations for any quarter are not necessarily indicative of our results of operations for a full year.
Sales of graphite electrodes and other products fluctuate from quarter to quarter due to such factors as changes in economic conditions, changes in competitive conditions, scheduled plant shutdowns by customers, national vacation practices, changes in customer production schedules in response to seasonal changes in energy costs, weather conditions, strikes and work stoppages at customer plants and changes in customer order patterns in response to the announcement of price increases. We have experienced, and expect to continue to experience, volatility with respect to demand for and prices of graphite electrodes and other products, both globally and regionally.
We have also experienced volatility with respect to prices of raw materials and energy, and it has frequently required several quarters of cost reduction efforts to mitigate increases in those prices. We expect to experience volatility in such prices in the future. We have experienced
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translation gains and losses in the past, some of which have been significant, and expect to experience translation gains and losses in the future.
Accordingly, results of operations for any quarter are not necessarily indicative of the results of operations for a full year.
The graphite and carbon industry is highly competitive. Our market share, net sales or net income could decline due to vigorous price and other competition.
Competition in the graphite and carbon products industry (other than with respect to new products) is based primarily on price, product quality and customer service. Graphite electrodes, in particular, are subject to rigorous price competition. Price increases by us or price reductions by our competitors, decisions by us or our competitors with respect to prices, volumes or profit margins, technological developments, changes in the desirability or necessity of entering into long term supply contracts with customers or other competitive or market factors or strategies could adversely affect our market share, net sales or net income.
Competition with respect to new products is, and is expected to be, based primarily on product innovation, performance and cost effectiveness as well as customer service.
Competition could prevent implementation of price increases, require price reductions or require increased spending on research and development, marketing and sales that could adversely affect us.
We may not be successful in the lawsuit against our former parents initiated by us.
We have initiated a lawsuit against our former parents. Successful prosecution of this lawsuit is subject to risks, including:
We cannot predict the ultimate outcome of this lawsuit, including the possibility, timing or amount of any recovery of damages by us or any liability we may have in connection with any counterclaims or cross claims. In addition, we cannot assure you as to the possibility, timing or amount of any settlement or the legal expenses to be incurred by us or as to the effect of this lawsuit on management's focus and time available for our ongoing operations.
Litigation such as this lawsuit is complex. Complex litigation can be lengthy and expensive. This lawsuit is in its earliest stages. The ultimate outcome of this lawsuit is subject to many uncertainties. We may at any time settle this lawsuit.
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We may not be able to complete our planned asset sales.
We intend to continue to sell real estate, non-strategic businesses and certain other non-strategic assets. We cannot assure you if or when we will be able to complete these sales or that we will realize proceeds therefrom that meet our current expectations.
We may not achieve the cost savings targeted under our 2002 major cost savings plan.
We are targeting, under the 2002 plan, cumulative annual recurring pre-tax cost savings of $30 million in 2003, $60 million in 2004 and $80 million in 2005. We recorded an aggregate of $33 million of restructuring charges and $41 million of impairment losses on long-lived and other assets and expect to record an additional $6 million of restructuring charges (primarily for severance associated with further global business and work process changes). These charges include payments through June 30, 2003 of $7 million of cash costs and expected payments of an additional $20 million of cash costs.
Our targeted cost savings are based on assumptions regarding activities undertaken and to be undertaken as part of the 2002 plan. We cannot assure you that these assumptions are correct or that we will be able to implement these activities. If we are unable to implement these activities as and when we have assumed or if the costs associated with these activities are higher than anticipated, we may not be able to meet our cost savings targets.
Risks relating to an investment in our common stock
Our stock price may be volatile due to the nature of our business as well as the nature of the securities markets, which could affect the short-term value of your investment.
Many factors may cause the market price for our common stock to decline or fluctuate, perhaps substantially, following this offering, including:
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The stock markets in general have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of our common stock.
In the past, companies that have experienced volatility in the market price of their stock have been the subject of securities class action litigation. We could be involved in a securities class action litigation in the future. Such litigation could result in substantial costs and a diversion of management's attention and resources.
There are provisions in some of our important documents that could have the effect of preventing a change in control.
GTI's Certificate of Incorporation and By-Laws contain provisions concerning voting, issuance of preferred stock, removal of officers and directors and other matters that may have the effect of discouraging, delaying or preventing a change in control of GTI. See "Description of Common Stock and Preferred StockCertain Charter and Statutory Provisions" and "Description of Common Stock and Preferred StockPreferred Share Purchase Rights" in the accompanying prospectus. In addition, GTI's Board of Directors has adopted a stockholder rights plan that may have the same effect. See "Description of Common Stock and Preferred StockPreferred Share Purchase Rights" in the accompanying prospectus. Further, the Senior Facilities restrict certain events that would constitute a change of control and provide that certain events which would constitute a change in control would also constitute an event of default. See Note 5 to the interim Consolidated financial statements and Note 5 to the annual Consolidated financial statements in this prospectus supplement.
We are required to repay the Senior Facilities and offer to repurchase the Senior Notes upon a change in control. We may not have sufficient funds to do so.
The occurrence of certain events could constitute a change in control of GTI for purposes of the Senior Facilities or the Senior Notes, or both. Such events would constitute an event of default under the Senior Facilities, which could require us to repay the Senior Facilities, and would require us to offer to repurchase the outstanding Senior Notes at a purchase price equal to 101% of the principal amount, plus accrued and unpaid interest, if any, to the date of purchase. We cannot assure you that we would have sufficient funds to make such repayment and to pay such purchase price, and we expect that we would require third party financing to do so. We cannot assure you that we would be able to obtain this financing on favorable terms or at all. If we fail to make such repayment or such purchases as required, this would constitute a default under the Senior Facilities or the Senior Notes. In such event, we could experience the material adverse consequences described, and be forced to take the unfavorable actions referenced, in the risk factor relating to restrictive covenants under the Senior Facilities and Senior Notes on page S-16.
Future sales of our common stock in the public market may depress our stock price.
After this offering, 83,515,504 shares of our common stock will be outstanding (85,915,504, if the over-allotment option is exercised), excluding:
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At September 18, 2003, 1,324,037 shares were available for future awards under our equity incentive plans.
All of the outstanding shares of our common stock, the shares of our common stock to be sold in this offering and any shares of our common stock issued under our equity incentive and employee benefit plans will be freely transferable by persons other than our affiliates. The outstanding shares of our common stock held by, and any shares of our common stock issued under our equity incentive and employee benefit plans to, our affiliates are restricted securities and may not be sold other than pursuant to an effective registration statement or Rule 144 or another exemption from registration under the Securities Act.
We, subject to certain limitations, and certain of our directors and executive officers have agreed that, for a period of 90 days after the date of this prospectus supplement, we and they will not sell or otherwise dispose of any shares of our common stock without the prior written consent of J.P. Morgan Securities Inc.
We have granted and intend to grant options to employees and directors annually in the ordinary course. We have filed and intend, consistent with past practice, to file with the SEC registration statements relating to the issuance of shares of common stock under our equity incentive and employee benefit plans and resale of shares of our common stock held by our directors and executive officers.
No prediction can be made as to the effect, if any, that future sales of shares, or the availability of shares for future sales, will have on the market price of our common stock prevailing from time to time. Sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, could adversely affect prevailing market prices for our common stock and could impair our ability to raise capital through an offering of our equity securities. The market price of our common stock could decline as a result of sales by our existing stockholders of a large number of shares of our common stock in the market after this offering, or the perception that these sales may occur. These sales might also make it more difficult for us to sell equity securities in the future and at a price that we deem appropriate.
We will experience immediate dilution in earnings per share as a result of this offering. In addition, to the extent that outstanding options to purchase shares of our common stock are exercised, there will be further dilution in our earnings per share.
Our ability to pay cash dividends and repurchase our common stock is restricted.
The Senior Facilities and the Senior Notes substantially restrict the payment of cash dividends and repurchase of our common stock by us.
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The net proceeds to us from this offering are estimated to be about $135 million (about $156 million, if the underwriters' over-allotment option is exercised in full), after deducting underwriting discounts, commissions and other expenses payable by us and assuming that the public offering price is the last reported sale price of our common stock on the NYSE on September 19, 2003. We intend to use the net proceeds to us from this offering as follows:
The outstanding term loans under the Senior Facilities consist entirely of Tranche B Term Loans. At September 18, 2003, the outstanding principal amount of the Tranche B Term Loans was $137 million and the annual interest rate thereon was 5.0%. The Tranche B Term Loans mature in 2007.
Pending use for a specific general corporate purpose, we intend to initially use the balance of the net proceeds to reduce the outstanding principal amount under our revolving credit facility and, to the extent that at the time there is no such amount outstanding, to reduce the outstanding principal amount under other short-term debt (consisting principally of local lines of credit established by our foreign subsidiaries for working capital purposes) and, thereafter, to invest in short-term, investment quality, interest-bearing securities or deposits. We estimate that, at September 30, 2003, before giving effect to this offering, based on currency exchange rates in effect on September 18, 2003, our cash and cash equivalents will be about $5 million to $10 million, the outstanding balance under our revolving credit facility will be about $60 million to $70 million and our other short-term debt will be about $15 million to $20 million. Our revolving credit facility matures in 2006.
J.P. Morgan Securities Inc., or its affiliates, are lenders under the Senior Facilities and will receive their proportionate shares of the repayment of amounts under the Senior Facilities as described above.
We do not currently have any pending commitments or agreements to make any acquisitions.
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Price range of common stock and dividend policy
Our common stock trades publicly on the NYSE under the trading symbol "GTI." The following table sets forth on a per share basis the high and low closing sale prices for our common stock as reported on the NYSE for the periods indicated.
|
High |
Low |
||||
---|---|---|---|---|---|---|
2001 | ||||||
First Quarter | $ | 13.85 | $ | 9.19 | ||
Second Quarter | 15.14 | 10.36 | ||||
Third Quarter | 13.30 | 8.35 | ||||
Fourth Quarter | 10.89 | 7.00 | ||||
2002 |
||||||
First Quarter | 14.30 | 9.80 | ||||
Second Quarter | 14.05 | 11.00 | ||||
Third Quarter | 11.85 | 7.05 | ||||
Fourth Quarter | 7.60 | 3.82 | ||||
2003 |
||||||
First Quarter | 5.89 | 2.57 | ||||
Second Quarter | 6.30 | 2.39 | ||||
Third Quarter (through September 19, 2003) | 8.94 | 5.50 | ||||
At September 18, 2003, there were 138 holders of record of outstanding shares of our common stock and we estimate that there were about 3,500 stockholders represented by nominees.
Our common stock is included in the Russell 2000 Index.
Dividend Policies and Restrictions
It is the current policy of GTI's Board of Directors to retain earnings to finance strategic and other plans and programs, conduct business operations, fund acquisitions, meet obligations and repay debt. Any declaration and payment of cash dividends or repurchases of common stock will be subject to the discretion of GTI's Board of Directors and will be dependent upon our financial condition, results of operations, cash requirements and future prospects, the limitations contained in the Senior Facilities and the Senior Notes and other factors deemed relevant by GTI's Board of Directors. We do not intend to pay cash dividends in the foreseeable future.
GTI is a holding company that derives substantially all of its cash flow from GrafTech Global and GrafTech Finance. GTI's ability to pay dividends or repurchase common stock from earnings or cash flow from operating or investing activities is dependent upon the earnings and cash flow from operating or investing activities of GrafTech Global and its subsidiaries and the distribution of those earnings and cash flows by GrafTech Global to GTI.
Under the Senior Facilities, GTI is permitted to pay dividends on common stock and repurchase common stock only in an annual aggregate amount of $25 million, plus up to an additional $25 million if certain leverage ratio and excess cash flow requirements are satisfied. We are also permitted to repurchase common stock from present or former directors, officers or
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employees in an aggregate amount of up to the lesser of $5 million per year (with unused amounts permitted to be carried forward) or $25 million on a cumulative basis since February 22, 2000. In addition, GrafTech Global is permitted to pay dividends to GTI for those purposes and also in respect of GTI's administrative fees and expenses and to fund payments in connection with antitrust, securities and stockholder derivative investigations, lawsuits and claims. The total amount of dividends to fund those payments (in each case, excluding certain imputed interest), plus the total amount paid on intercompany debt owed to GTI for the same purpose (in each case, excluding certain imputed interest), plus the amount of additional reserves created with respect to these investigations, lawsuits and claims may not exceed $340 million by more than $75 million (which $75 million is reduced by the amount of certain debt, other than the Senior Notes, incurred by us that is not incurred under the Senior Facilities ($12 million of which debt was outstanding at June 30, 2003)).
Under the Senior Notes, GTI is permitted to pay dividends on common stock and repurchase common stock only in a cumulative (from February 15, 2002) amount of $25 million (subject to reduction if we make other restricted payments), plus, if certain leverage ratio requirements are satisfied, an amount of up to the sum of 50% of certain cumulative (from April 1, 2002) consolidated net income, 100% of net cash proceeds from certain sales of common stock (subsequent to February 15, 2002) and certain investment returns. We are also permitted to repurchase common stock from present or former directors, officers or employees of up to the lesser of $5 million annually or $10 million on a cumulative basis from February 15, 2002. GrafTech Global is permitted to pay dividends to GTI for those and other purposes.
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The following table sets forth our capitalization at June 30, 2003 (i) on an actual basis and (ii) as adjusted to reflect:
You should read this table in conjunction with "Use of proceeds," "Selected consolidated financial data," "Management's discussion and analysis of financial condition and results of operations" and the Consolidated financial statements and notes thereto included elsewhere in this prospectus supplement or the accompanying prospectus.
|
June 30, 2003 |
||||||||
---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) |
Actual |
As Adjusted |
|||||||
Cash and cash equivalents (a) | $ | 8 | $ | 27 | |||||
Short-term debt (a) | $ | 23 | $ | | |||||
Long-term debt: | |||||||||
Carrying value (b) | $ | 680 | $ | 552 | |||||
Fair value of hedged debt obligation | | | |||||||
Unamortized bond premium | 6 | 6 | |||||||
Total long-term debt (b)(c) | $ | 686 | $ | 558 | |||||
Stockholders' deficit: | |||||||||
Preferred stock, par value $.01, 10,000,000 shares authorized, none issued (d) | | | |||||||
Common stock, par value $.01, 150,000,000 shares authorized, 64,338,211 shares issued actual and 86,426,323 shares, as adjusted (e)(f) | 1 | 1 | |||||||
Additional paid-in capital | 662 | 834 | |||||||
Accumulated other comprehensive (loss) (g) | (299 | ) | (299 | ) | |||||
Accumulated deficit | (622 | ) | (622 | ) | |||||
Less: cost of common stock in treasury, 2,451,035 actual and as adjusted (f) | (85 | ) | (85 | ) | |||||
Less: common stock held in employee benefits protection trust, 426,400 actual and as adjusted (f) | (6 | ) | (6 | ) | |||||
Total stockholders' deficit (f) | (349 | ) | (177 | ) | |||||
Total capitalization (h) | $ | 360 | $ | 381 | |||||
(a) We estimate that, at September 30, 2003, before giving effect to this offering, based on currency exchange rates in effect on September 18, 2003, actual cash and cash equivalents will be about $5 million to $10 million and other short-term debt will be about $15 million to $20 million.
(b) We estimate that, at September 30, 2003, before giving effect to this offering, based on currency exchange rates in effect on September 18, 2003, the outstanding balance under our revolving credit facility will be about $60 million to $70 million.
(c) Assumes that $81 million of net proceeds is applied to repay term loans under the Senior Facilities, $12 million of net proceeds is applied to repay the principal amount outstanding under our revolving credit facility and $23 million
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of net proceeds is applied to reduce the outstanding principal amount of other short-term debt, with the remaining $19 million of net proceeds added to cash and cash equivalents. See "Use of proceeds" in this prospectus supplement.
(d) Excludes preferred stock purchase rights attached to our common stock, including the shares of our common stock offered by this prospectus supplement, pursuant to our stockholder rights plan.
(e) Excludes shares issuable upon the exercise of options outstanding under our equity incentive plans.
(f) After giving effect to the exchange of $35 million aggregate principal amount of Senior Notes, plus accrued interest, for shares of common stock after July 1, 2003 and grants, exercises and contributions of shares after July 1, 2003 in connection with equity incentive and employee benefit plans in the ordinary course, at September 18, 2003:
(g) Accumulated other comprehensive (loss) represents, predominantly, translation losses relating to our foreign operations.
(h) Based on the last reported sale price of our common stock on September 19, 2003, our market equity capitalization was about $600 million and our total market capitalization, consisting of the sum of our estimated long-term debt at September 30, 2003 and such market equity capitalization, was about $1.3 billion.
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Selected consolidated financial data
The following selected consolidated financial data at and for the years ended December 31, 1998, 1999, 2000, 2001 and 2002 have been derived from our audited annual Consolidated financial statements. The following selected consolidated financial data for the six months ended June 30, 2002 and 2003 have been derived from our quarterly Consolidated financial statements, which are unaudited but in the opinion of our management reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of our consolidated financial condition, results of operations and cash flows for such periods. Results of operations for interim periods are not necessarily indicative of results to be expected for full fiscal years. You should read this information in conjunction with "Preliminary notesPresentation of financial, legal and market data," "Management's discussion and analysis of financial condition and results of operations" and the Consolidated financial statements and notes thereto elsewhere in this prospectus supplement and the accompanying prospectus.
|
Year Ended December 31, |
Six Months Ended June 30, |
||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions, except per share data) |
1998 |
1999 |
2000 |
2001 |
2002 |
2002 |
2003 |
|||||||||||||||||
Statement of operations data: | ||||||||||||||||||||||||
Net sales | $ | 928 | $ | 818 | $ | 763 | $ | 634 | $ | 596 | $ | 291 | $ | 351 | ||||||||||
Gross profit | 336 | 256 | 214 | 179 | 135 | 65 | 82 | |||||||||||||||||
Selling, administrative and other expenses | 99 | 84 | 84 | 75 | 76 | 42 | 42 | |||||||||||||||||
Restructuring charges (credit) (a) | 86 | (6 | ) | 6 | 12 | 6 | 5 | 20 | ||||||||||||||||
Impairment loss on long-lived and other assets (b) | 60 | 35 | 3 | 80 | 17 | 13 | | |||||||||||||||||
Antitrust investigations and related lawsuits and claims (c) | | | | 10 | | | | |||||||||||||||||
Securities class action and stockholder derivative lawsuits (d) | | 13 | (1 | ) | | | | | ||||||||||||||||
Corporate realignment and related expenses (e) | | | | 2 | 3 | 3 | | |||||||||||||||||
Other expense (income), net (f) | 20 | (9 | ) | 20 | 1 | (12 | ) | (9 | ) | (10 | ) | |||||||||||||
Interest expense | 73 | 84 | 75 | 60 | 60 | 30 | 27 | |||||||||||||||||
Provision for (benefit from) income taxes | 27 | 1 | 2 | 14 | (16 | ) | (11 | ) | 1 | |||||||||||||||
Income (loss) from continuing operations (a)(b)(c)(d)(e)(f) | (40 | ) | 42 | 10 | (89 | ) | (19 | ) | (12 | ) | (4 | ) | ||||||||||||
Income from discontinued operations (less applicable income tax expense) (g) | 3 | | | 2 | 1 | 1 | 1 | |||||||||||||||||
Net income (loss) (a)(b)(c)(d)(e)(f)(g) | (37 | ) | 42 | 10 | (87 | ) | (18 | ) | (11 | ) | (2 | ) | ||||||||||||
Basic income (loss) per common share: |
||||||||||||||||||||||||
Income (loss) from continuing operations | $ | (0.89 | ) | $ | 0.94 | $ | 0.22 | $ | (1.79 | ) | $ | (0.35 | ) | $ | (0.21 | ) | $ | (0.06 | ) | |||||
Income from discontinued operations | 0.06 | | | 0.04 | 0.02 | 0.01 | 0.02 | |||||||||||||||||
Net income (loss) | $ | (0.83 | ) | $ | 0.94 | $ | 0.22 | $ | 1.75 | $ | (0.33 | ) | $ | (0.20 | ) | $ | (0.04 | ) | ||||||
Weighted average common shares outstanding (in thousands) | 44,972 | 45,114 | 45,224 | 49,720 | 55,942 | 55,848 | 56,829 | |||||||||||||||||
Diluted income (loss) per common share: | ||||||||||||||||||||||||
Income (loss) from continuing operations | $ | (0.89 | ) | $ | 0.91 | $ | 0.22 | $ | (1.79 | ) | $ | (0.35 | ) | $ | (0.21 | ) | $ | (0.06 | ) | |||||
Income from discontinued operations | (0.06 | ) | | | 0.04 | 0.02 | 0.01 | 0.02 | ||||||||||||||||
Net income (loss) | $ | (0.83 | ) | $ | 0.91 | $ | 0.22 | $ | (1.75 | ) | $ | (0.33 | ) | $ | (0.20 | ) | $ | (0.04 | ) | |||||
Weighted average common shares outstanding (in thousands) | 44,972 | 46,503 | 45,813 | 49,720 | 55,942 | 55,848 | 56,829 | |||||||||||||||||
S-31
|
Year Ended December 31, |
Six Months Ended June 30, |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions, except per share data) |
1998 |
1999 |
2000 |
2001 |
2002 |
2002 |
2003 |
|||||||||||||||
Balance sheet data (at period end): | ||||||||||||||||||||||
Cash and cash equivalents | $ | 58 | $ | 17 | $ | 47 | $ | 38 | $ | 11 | $ | 51 | $ | 8 | ||||||||
Total assets | 1,137 | 933 | 908 | 797 | 859 | 869 | 919 | |||||||||||||||
Short-term debt | 19 | | 3 | 7 | 18 | 17 | 23 | |||||||||||||||
Payments due within one year on long-term debt | 63 | 82 | 27 | | | | | |||||||||||||||
Long-term debt carrying value | 722 | 640 | 705 | 631 | 699 | 686 | 680 | |||||||||||||||
Fair value of hedged debt obligation | | | | | 8 | 7 | | |||||||||||||||
Unamortized bond premium | | | | | 6 | 7 | 6 | |||||||||||||||
Total debt | 804 | 722 | 735 | 638 | 731 | 717 | 709 | |||||||||||||||
Other long-term obligations (excluding the reserve for antitrust investigations, lawsuits and claims) (h) | 149 | 120 | 126 | 132 | 163 | 128 | 181 | |||||||||||||||
Balance of reserve for antitrust investigations, lawsuits and claims | 195 | 131 | 107 | 101 | 98 | 101 | 94 | |||||||||||||||
Other long-term obligations | 266 | 224 | 209 | 231 | 258 | 229 | 275 | |||||||||||||||
Stockholders' deficit | (287 | ) | (293 | ) | (316 | ) | (332 | ) | (381 | ) | (348 | ) | (349 | ) | ||||||||
Working capital | 198 | 101 | 99 | 112 | 115 | 137 | 109 | |||||||||||||||
Other financial data: |
||||||||||||||||||||||
Gross profit margin | 36.3 | % | 31.3 | % | 28.1 | % | 28.2 | % | 22.2 | % | 22.3 | % | 23.4 | % | ||||||||
Depreciation and amortization | $ | 50 | $ | 44 | $ | 42 | $ | 35 | $ | 28 | $ | 15 | $ | 15 | ||||||||
Capital expenditures | 52 | 56 | 52 | 40 | 50 | 20 | 20 | |||||||||||||||
Net cash provided by (used in) operating activities from continuing operations | (29 | ) | 77 | 92 | 14 | (60 | ) | (36 | ) | (25 | ) | |||||||||||
Net cash provided by (used in) operating activities from discontinued operations | | 3 | 2 | 3 | | | 1 | |||||||||||||||
Net cash provided by (used in) operating activities | (29 | ) | 80 | 94 | 17 | (60 | ) | (36 | ) | (24 | ) | |||||||||||
Cash flow used in investing activities | (31 | ) | (39 | ) | (50 | ) | (39 | ) | (50 | ) | (20 | ) | (5 | ) | ||||||||
Cash flow provided by (used in) financing activities | 62 | (80 | ) | (13 | ) | 15 | 79 | 66 | 27 | |||||||||||||
Other operating data: | ||||||||||||||||||||||
Quantity of graphite electrodes sold (in thousands of metric tons) | 211 | 206 | 217 | 174 | 180 | 87 | 98 | |||||||||||||||
Quantity of cathodes sold (in thousands of metric tons) | $ | 33 | $ | 31 | $ | 35 | $ | 33 | $ | 37 | $ | 19 | $ | 20 | ||||||||
(a) For 1998, represents a charge in connection with closing graphite electrode operations in Canada and Germany and the consolidation of certain corporate administrative offices. These costs consisted primarily of severance, write-offs of fixed assets and environmental and other shutdown costs. The cash portion of these restructuring charges was $57 million. For 1999, represents a net reduction in the estimate of shutdown costs recorded in 1998. For 2000, represents a $2 million cash charge in connection with the restructuring of our advanced synthetic graphite products (then called advanced graphite materials) business and a $4 million cash charge in connection with a corporate restructuring involving a workforce reduction. These costs consisted primarily of severance. For 2001, represents a $5 million charge in connection with the closure of graphite electrode manufacturing operations in Tennessee and coal calcining operations in New York and relocation of corporate headquarters, which consisted primarily of severance, and a $7 million charge in connection with the mothballing of graphite electrode operations in Italy, which consisted primarily of shutdown costs. The cash portion of these charges was $10 million. For 2002, represents a $6 million net increase in the estimate of costs in connection with the mothballing of graphite electrode operations in Italy. These costs consisted primarily of severance. For the 2002 first half, represents a $5 million cash charge in connection with the mothballing of graphite electrode operations in Italy. For the 2003 first half, represents a $9 million charge for organizational changes, which consisted primarily of severance, and a $11 million net non-cash actuarial charge for closure of benefit plans.
(b) For 1998, represents impairment loss on long-lived Russian assets. For 1999, represents impairment loss on long-lived advanced synthetic graphite products business assets. For 2000, represents impairment loss on long-lived cathode assets. For 2001, represents a $51 million impairment loss related to long-lived graphite electrode assets in Tennessee, a $1 million impairment loss related to long-lived coal calcining assets in New York, a $1 million impairment loss related to the corporate realignment of our subsidiaries, a $24 million impairment loss related to long-lived graphite electrode assets in Italy and a $3 million impairment loss related to available-for-sale securities. For 2002, represents a $12 million impairment loss related to long-lived carbon electrode assets in Tennessee, a $2 million impairment loss related to available-for-sale securities, and a $3 million related to our joint venture with Jilin in China. For the 2002 first half, represents a $12 million impairment loss related to long-lived carbon electrode assets in Tennessee and a $1 million impairment loss related to available-for-sales securities.
(c) Represents additional estimated potential liabilities and expenses in connection with antitrust investigations and related lawsuits and claims.
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(d) Represents estimated liabilities and expenses in connection with securities class action and stockholder derivative lawsuits, $1 million of which was reversed in 2000.
(e) Represents costs in connection with the corporate realignment of our subsidiaries.
(f) Includes: for 1998, a $12 million write-off of capitalized bank fees and other costs resulting from early extinguishment of debt in connection with a debt refinancing; for 2000, a $21 million write-off of capitalized bank fees and other costs resulting from early extinguishment of debt in connection with a debt recapitalization; for 2002, $21 million of gains from currency translation on intercompany loans and translation of financial statements of foreign subsidiaries which use the dollar as their functional currency and a $4 million write-off of capitalized bank fees and other costs in connection with retirement of debt and issuance of Senior Notes; for the 2002 first half, $20 million of gains from currency translation; and, for the 2003 first half, $19 million of gains from currency translation.
(g) Represents income of our non-strategic composite tooling business that was sold in the 2003 second quarter.
(h) Represents pension, post-retirement and related benefits, employee severance liabilities and miscellaneous other long-term obligations.
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The following quarterly selected consolidated financial data have been derived from the Consolidated financial statements for the periods indicated, which have not been audited. The selected quarterly consolidated financial data set forth below should be read in conjunction with "Preliminary notesPresentation of financial, legal and market data," "Management's discussion and analysis of financial condition and results of operations" and the Consolidated financial statements and notes thereto included elsewhere in this prospectus supplement.
(dollars in millions, except per share data) |
First Quarter |
Second Quarter |
Third Quarter |
Fourth Quarter |
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---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2001 | ||||||||||||||
Net sales | $ | 167 | $ | 165 | $ | 153 | $ | 149 | ||||||
Gross profit | 48 | 50 | 42 | 39 | ||||||||||
Income (loss) from continuing operations | 3 | (40 | ) | 4 | (56 | ) | ||||||||
Income from discontinued operations (less applicable income tax expense) | | 1 | | 1 | ||||||||||
Net income (loss) (a)(b)(c) | $ | 3 | $ | (39 | ) | $ | 4 | $ | (55 | ) | ||||
Basic income (loss) per common share: | ||||||||||||||
Income (loss) from continuing operations | $ | 0.07 | $ | (0.88 | ) | $ | 0.07 | $ | (1.00 | ) | ||||
Income from discontinued operations | | 0.01 | | 0.02 | ||||||||||
Net income (loss) per share | $ | 0.07 | $ | (0.87 | ) | $ | 0.07 | $ | (0.98 | ) | ||||
Diluted income (loss) per common share: | ||||||||||||||
Income (loss) from continuing operations | $ | 0.07 | $ | (0.88 | ) | $ | 0.07 | $ | (1.00 | ) | ||||
Income from discontinued operations | | 0.01 | | 0.02 | ||||||||||
Net income (loss) per share | $ | 0.07 | $ | (0.87 | ) | $ | 0.07 | $ | (0.98 | ) | ||||
2002 | ||||||||||||||
Net sales | $ | 133 | $ | 157 | $ | 150 | $ | 156 | ||||||
Gross profit | 30 | 35 | 33 | 37 | ||||||||||
Income (loss) from continuing operations | (5 | ) | (7 | ) | (5 | ) | (2 | ) | ||||||
Income from discontinued operations (less applicable income taxes expense) | 1 | | | | ||||||||||
Net income (loss) (d)(e)(f)(g) | $ | (4 | ) | $ | (7 | ) | $ | (5 | ) | $ | (2 | ) | ||
Basic income (loss) per common share: | ||||||||||||||
Income (loss) from continuing operations | $ | (0.08 | ) | $ | (0.15 | ) | $ | (0.09 | ) | $ | (0.04 | ) | ||
Income from discontinued operations | 0.02 | 0.01 | 0.01 | | ||||||||||
Net income (loss) per share | $ | (0.06 | ) | $ | (0.14 | ) | $ | (0.08 | ) | $ | (0.04 | ) | ||
Diluted income (loss) per common share: | ||||||||||||||
Income (loss) from continuing operations | $ | (0.08 | ) | $ | (0.15 | ) | $ | (0.09 | ) | $ | (0.04 | ) | ||
Income from discontinued operations | 0.02 | 0.01 | 0.01 | | ||||||||||
Net income (loss) per share | $ | (0.06 | ) | $ | (0.14 | ) | $ | (0.08 | ) | $ | (0.04 | ) | ||
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(dollars in millions, except per share data) |
First Quarter |
Second Quarter |
|||||
---|---|---|---|---|---|---|---|
2003 | |||||||
Net sales | $ | 170 | $ | 181 | |||
Gross profit | 39 | 43 | |||||
Income (loss) from continuing operations | (10 | ) | 6 | ||||
Income from discontinued operations (less applicable income tax expense) | 1 | | |||||
Net income (loss) (a)(b) | $ | (9 | ) | $ | 7 | ||
Basic income (loss) per common share: | |||||||
Income (loss) from continuing operations | $ | (0.17 | ) | $ | 0.11 | ||
Income from discontinued operations | 0.01 | 0.01 | |||||
Net income (loss) per share | $ | (0.16 | ) | $ | 0.12 | ||
Diluted income (loss) per common share: | |||||||
Income (loss) from continuing operations | $ | (0.17 | ) | $ | 0.11 | ||
Income from discontinued operations | 0.01 | 0.01 | |||||
Net income (loss) per share | $ | (0.16 | ) | $ | 0.12 | ||
(a) The 2001 second quarter includes a restructuring charge of $5 million related to graphite electrode operations in Tennessee and coal calcining operations in New York, a charge of $53 million related to the impairment of long-lived graphite electrode assets in Tennessee and long-lived coal calcining assets in New York, and a charge of $10 million related to antitrust investigations and related lawsuits and claims.
(b) The 2001 third quarter includes a restructuring charge of $1 million related to coal calcining operations in New York, a charge of $1 million related to the impairment loss of long-lived assets related to relocation of corporate headquarters and the corporate realignment of our subsidiaries, and reversal of prior restructuring charges of $2 million based on revised lower estimates of costs.
(c) The 2001 fourth quarter includes a restructuring charge of $7 million related primarily to graphite electrode operations in Italy, a charge of $24 million related to the impairment of long-lived graphite electrode assets in Italy, a $3 million charge related to the impairment of available-for-sale securities, and a $29 million charge related to adjustments made to provision for income taxes in connection with the capitalization of foreign tax credits to investment in affiliates as well as settlement of audits and adjustments to reserves.
(d) The 2002 first quarter includes a restructuring charge of $5 million related to graphite electrode operations in Italy.
(e) The 2002 second quarter includes a $12 million charge related to the impairment of long-lived carbon electrode assets in Tennessee and a $1 million charge related to impairment of available-for-sale securities.
(f) The 2002 third quarter includes a $1 million charge related to the impairment of available-for-sale securities.
(g) The 2002 fourth quarter includes a charge of $3 million charge related to the impairment of our investment in our joint venture in China with Jilin and an additional restructuring charge of $1 million related to graphite electrode operations in Italy.
(h) The 2003 first quarter includes a restructuring charge of $19 million related to organizational and benefit plan changes.
(i) The 2003 second quarter includes an additional restructuring charge of $1 million related to organizational changes.
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Management's discussion and analysis of financial condition and results of operations
We are one of the world's largest manufacturers and providers of high quality synthetic and natural graphite and carbon products and technical and related research and development services, with customers in more than 70 countries. We manufacture graphite electrodes and cathodes, products essential to the production of electric arc furnace steel and aluminum. We also manufacture thermal management, fuel cell and other specialty graphite and carbon products for, and provide services to, the electronics, power generation, semiconductor, transportation, petrochemical and other metals markets. We have 13 state-of-the-art manufacturing facilities strategically located on four continents, in more diverse locations than the facilities of any of our competitors.
Our businesses are organized around three lines of business:
We have successfully rationalized and repositioned our unique global manufacturing network, redesigned and implemented changes to our manufacturing, marketing and sales processes, accelerated technology development and new product commercialization, achieved cost savings, reduced debt and other obligations, and managed antitrust liabilities.
Repositioning our global manufacturing network and other initiatives
GTI's Board of Directors adopted a global restructuring and rationalization plan in September 1998 that delivered cumulative recurring annualized run rate pre-tax cost savings of $132 million by the end of 2001. In January 2002, we announced a major cost savings plan that we believe is the most aggressive cost reduction plan being implemented in our industry.
The key elements of the 2002 plan consist of:
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Under the 2002 plan, we are targeting cumulative recurring annual pre-tax cost savings of $30 million in 2003, $60 million in 2004 and $80 million in 2005. Savings achieved under the 2002 plan are additive to those which we achieved by the end of 2001 under the 1998 plan. All cost savings described below under this section entitled "Repositioning our global manufacturing network and other initiatives" are included in the aggregate amounts set forth above.
We recorded an aggregate of $91 million of restructuring charges and $154 million of impairment losses on long-lived and other assets, of which $48 million were cash costs, in connection with the 1998 plan. We do not expect to pay any additional material cash costs in connection with the 1998 plan. We recorded an aggregate of $33 million of restructuring charges and $41 million of impairment losses on long-lived and other assets, and expect to record an additional $6 million of restructuring charges (primarily for severance associated with further global business and work process changes), in connection with the 2002 plan. These charges include payments through June 30, 2003 of $7 million of cash costs, and expected payments of an additional $20 million of cash costs, in connection with the 2002 plan. Remaining actions associated with the 2002 plan that could result in additional restructuring charges relate primarily to the implementation of global work process changes and additional overhead cost reductions.
Rationalization of our global manufacturing network. We have repositioned our global manufacturing network by rationalizing our higher cost manufacturing facilities and redeploying capacity to our remaining larger, lower cost, strategically located facilities.
Graphite electrodes. In 1999 and 2000, we shut down the high cost graphite electrode manufacturing operations at our facilities in Canada and Germany and rationalized the graphite electrode manufacturing operations at the facilities in Russia that we had acquired in 1997. In 2001, we shut down the high cost graphite electrode manufacturing operations at our facilities in Tennessee. In 2001, we recorded a $5 million restructuring charge and a $53 million impairment loss on long-lived assets primarily relating to the shutdown in Tennessee. In addition, in 2001, we incrementally expanded graphite electrode manufacturing capacity at our lower cost facilities in Mexico, Spain and South Africa for a capital investment of about $3 million.
In the 2002 first quarter, we mothballed the high cost graphite electrode manufacturing operations at our facility in Italy. In 2001, we recorded a $7 million restructuring charge and a $24 million impairment loss on long-lived assets in connection with the mothballing. In 2002, we recorded an additional $6 million restructuring charge related to the mothballing as well as changes in the estimates for the restructuring charge previously recorded. These operations had the capacity to manufacture 26,000 metric tons of graphite electrodes annually.
During the 2002 second quarter, we launched the expansion of our graphite electrode manufacturing facility in Mexico from about 40,000 metric tons to about 60,000 metric tons annually. We completed 10,000 metric tons of expansion at this facility by the end of 2002. We completed the remaining 10,000 metric tons of expansion during the 2003 first quarter. The 2003 second quarter was the first full quarter of operation of the fully expanded capacity. In 2002 and 2003, we also incrementally expanded graphite electrode manufacturing capacity at our other facilities. The expansions required capital investments of about $15 million.
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The repositioning of our network allows us to deliver the same graphite electrode sales volume that we delivered over the past few years with a significantly lower fixed cost base. With these actions and our proprietary process and technological improvements, we now have the capability, depending on product demand and mix, to manufacture more than 220,000 metric tons of graphite electrodes from our existing assets.
Other products. In 1999 and 2000, we restructured our advanced synthetic graphite products (then called advanced graphite materials) business in West Virginia. The key elements of the restructuring included elimination of unprofitable product lines and rationalization of operations of the remaining product lines. In 1999, we recorded a $35 million impairment loss on long-lived assets and, in 2000, we recorded a restructuring charge of $2 million in connection with these actions.
In 2000, we re-sourced high cost cathode manufacturing operations in the U.S. to our lower cost facilities in France and Brazil. In 2000, we recorded a $3 million impairment loss on long-lived assets in connection with the re-sourcing.
In 2001, we shut down our coal calcining operations in New York primarily because we entered into a five-year agreement to purchase calcined coal from a third party at a competitive cost.
In 2001, we also launched operations on our new advanced natural graphite production line, which was financed with a portion of the net proceeds from our public offering of common stock in July 2001.
In 2002, we recorded a $12 million impairment loss on our carbon electrode assets in Tennessee.
Redesign and implementation of changes to global manufacturing, marketing and sales processes. We have evaluated virtually every aspect of our global supply chain, and we have redesigned and implemented changes to our global manufacturing, marketing and sales processes to leverage the strengths of our repositioned network. Among other things, we have eliminated manufacturing bottlenecks, improved product and service quality and delivery reliability, expanded our range of products, and improved our global sourcing and product mix for our customers. Over the past three years, we have reduced annual customer compensation for graphite electrode quality claims from $3 million to less than $1 million. We also redirected marketing and sales activities to better service the needs of both existing and new customers.
Redesign and implementation of changes to benefit plans. In the 2001 fourth quarter and the 2002 first quarter, we redesigned and implemented changes in our retiree medical insurance plan and our U.S. retirement and savings plans for active employees. Among other things, we froze our qualified defined benefit plan and established a new defined contribution plan for most of our U.S. employees. These changes resulted in annual cost savings of $2 million in 2001 and $11 million in 2002 and we expect these changes to result in recurring annual pre-tax cost savings of approximately $11 million in 2003 and later years.
On July 1, 2002, we amended our U.S. post-retirement medical coverage. Effective March 31, 2003, we discontinued the Medicare supplement plan (for retirees 65 years or older or those eligible for Medicare benefits). This change applies to all active employees except for some employees covered by a collective bargaining agreement, all current retirees who were not covered by a collective bargaining agreement when they retired and those retirees who retired under a former collective bargaining agreement. This change is expected to reduce our net
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post-retirement medical benefit obligation by about $7 million. The reduction is being amortized over the remaining life of the retiree population.
Effective March 31, 2003, we froze our qualified defined benefit plan for our remaining U.S. employees and closed our non-qualified U.S. defined benefit plan for the participating salaried workforce. The closure and settlement of our non-qualified U.S. defined benefit plan resulted in a $11 million restructuring charge in the 2003 first quarter.
On June 25, 2003, we announced the termination of the early retiree medical plan for retirees under age 65, effective December 31, 2005 and the limitation of the amount of retiree's life insurance after December 31, 2004. The change is expected to reduce our net post-retirement medical benefit obligation by about $8 million.
Implementation of changes to global business processes. We began to implement in 2000 and continue to implement global business and work process rationalization and transformation initiatives, including the streamlining of our organizational structure within our three major lines of business, the consolidation and streamlining of order fulfillment, purchasing, finance and accounting, and human resource processes, the identification and implementation of outsourcing opportunities, the improvement in performance through realignment and enterprise-wide standardization of supply chain processes and systems, and the improvement of interfaces and information technology infrastructures with trading partners. Under our organizational structure launched in January 2003, we are revising our compensation programs. A main component of our compensation programs is a direct link between incentive compensation and cash profitability of our businesses. Through June 30, 2003, our investment in these initiatives included about $11 million of consulting fees and internal costs and $13 million of capital expenditures, primarily for costs related to implementation of global information technology systems for advanced planning and scheduling software and for global treasury management systems.
We have also implemented and continue to implement an enterprise-wide risk management process whereby we assess the business risks to our goal of maximizing cash flow, using a structured and disciplined approach. This approach seeks to align our personnel and processes with our critical strategic risks so that our management team and GTI's Board of Directors may better evaluate and manage those uncertainties.
Effective April 2001, we entered into a ten year service contract with CGI Group Inc. valued at $75 million. Pursuant to this contract, CGI became the delivery arm for our global information technology service requirements, including the design and implementation of our global information and advanced manufacturing and demand planning processes, using J.D. Edwards software. Through this contract, we are seeking to transform our information technology service capability into an efficient, high quality enabler for our global supply chain initiatives as well as a contributor to our cost reduction activities. Under the outsourcing provisions of this contract, CGI manages our data center services, networks, desktops, telecommunications and legacy systems. Through this contract, we believe that we will be able to leverage the resources of CGI to assist us in achieving our information technology goals and our cost savings targets.
In the 2002 third quarter, we entered into a ten year outsourcing contract with CGI Group Inc. valued at $36 million. Pursuant to this contract, CGI became the delivery arm for our finance and accounting business process services, including accounts receivable and accounts payable activities. CGI also provides various related analytical services such as general accounting, cost
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accounting and financial analysis activities. Through this contract, we believe that we will be able to further leverage the resources of CGI to assist us in achieving our cost savings targets.
Severance programs. We have implemented and continue to implement business and voluntary and selective severance programs, designed to complement our global business and work process rationalization and transformation initiatives.
In 2000, in connection with corporate and business restructuring and management centralization activities, we implemented a workforce reduction of about 109 employees. The functional areas affected included finance, accounting, sales, marketing and administration. We recorded a $4 million restructuring charge in connection with these activities.
During the 2003 first quarter, we substantially completed U.S. voluntary and selective severance programs announced in December 2002, resulting in a reduction of 103 U.S. employees (or 27% of the U.S. salaried workforce). We recorded an $8 million restructuring charge in the 2003 first quarter in connection with these programs. These programs are expected to result in annual pre-tax cost savings of $6 million in 2003 and cumulative recurring annual pre-tax cost savings of $12 million in 2004 and later years.
From 1998 through the 2003 second half, we reduced our global workforce by about 1,700 employees, or over 30%. Current severance programs are expected to reduce our global workforce by more than an additional 110 employees (or about 3%) over the next 12 to 18 months.
Corporate realignment of our subsidiaries. The realignment of our foreign subsidiaries was substantially completed in the 2002 first half. Most of the operations and net sales of our synthetic graphite line of business are located outside the U.S. and, as a result of the realignment, are held by our Swiss subsidiary or its subsidiaries. Most of our technology is held by our U.S. subsidiaries.
The realignment of our foreign subsidiaries has resulted and is expected to result in substantial tax savings. We used opportunities created by the realignment to improve cash management and corporate services delivery and reallocate intercompany debt as well as reduce taxes. This reallocation of intercompany debt better matches intercompany debt with cash flow from operations. Debt service on our intercompany debt provides an important source of funds to repay our debt to third parties, including the Senior Facilities and the Senior Notes. We may in the future realign the corporate organizational structure of our U.S. subsidiaries.
The legal and tax restructuring and global realignment mentioned herein are part of the corporate realignment of our subsidiaries. The tax benefits from the realignment (which are called tax benefits from legal and tax restructuring) have been recorded separately in the Consolidated financial statements from expenses to implement the realignment (which are called global realignment and related expenses).
Sales of non-strategic assets. We sold our non-strategic composite tooling business based in California in June 2003 for approximately $17 million, including an approximately $2 million working capital adjustment. We received $15 million in cash prior to June 30, 2003. We have terminated our executive life insurance program and, in the 2003 second quarter, we liquidated our split dollar life insurance policies for executives for net cash proceeds of approximately $3 million. We intend to continue to sell real estate, non-strategic businesses and certain other non-strategic assets over the next eighteen months. We anticipate that the aggregate
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estimated pre-tax cash proceeds from sales of non-strategic assets will total $30 million in 2003 and $75 million by the end of 2004.
Recent strategic alliance initiatives
We have developed a strategic alliance in the cathode business with Pechiney, the world's recognized leader in aluminum smelting technology. To broaden our alliance, in March 2001, we contributed our Brazilian cathode manufacturing operations to Carbone Savoie. Pechiney, our 30% joint venture partner in Carbone Savoie, contributed approximately $9 million in cash to Carbone Savoie as part of this transaction. The cash contribution was used to upgrade manufacturing operations in Brazil and France, which was completed by the end of the 2002 first quarter. Ownership in Carbone Savoie remains 70% by us and 30% by Pechiney. Carbone Savoie holds our entire cathode manufacturing capacity.
In April 2001, we entered into a graphite electrode production joint venture with Jilin in China. We are required to make capital contributions of $6 million of cash ($2 million of which has been contributed to date) plus technical assistance ($1 million of which has been contributed to date) for our 25% ownership interest in the joint venture. During the 2002 fourth quarter, we recorded an impairment loss of $3 million associated with our investment in the joint venture. This impairment resulted from uncertainty about the completion and start-up of the joint venture facilities in China due to the effects that the challenging 2002 graphite electrode industry conditions had on Jilin. We continue to work closely with Jilin on production alternatives. However, we will make no further contributions to the joint venture until we have agreed upon production alternatives.
We have been working with Ballard Power Systems since 1992 on developing natural graphite-based materials for use in its PEM fuel cells. In June 2001, our subsidiary, AET, entered into an expanded exclusive development and collaboration agreement and an expanded exclusive long-term supply agreement with Ballard Power Systems. In addition, Ballard Power Systems became a strategic investor in AET in June 2001, investing at that time $5 million in shares of Ballard Power Systems common stock for a 2.5% equity ownership interest in AET.
Global economic conditions and outlook
We are impacted in varying degrees, both positively and negatively, as global, regional or country conditions fluctuate.
Over the past three years through late 2002, we faced extremely challenging business and industry conditions. Adverse global and regional economic conditions negatively impacted many of the end markets for our products. Many of the customers in these markets reduced production levels (which reduced demand and adversely impacted prices for products sold by us and our competitors), became less creditworthy, filed for bankruptcy protection or were acquired as part of the consolidation trends within their industries. In order to seek to minimize our credit risks, we reduced our sales of, or refused 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 was only 0.2% of global net sales during this period. In addition, industry-wide capacity for most of our products exceeded demand. We have been experiencing intense competition, particularly in the graphite electrode industry. Two of our competitors, one in the U.S. and one in Europe, filed for bankruptcy protection. The competitor in the U.S. announced in April 2003 that it sold a
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portion of its graphite electrode capacity to a third party bidder in a bankruptcy auction process.
2001. Economic weakening in North America continued and became more severe in 2001. This economic weakness was exacerbated by the impact on economic conditions of the terrorist acts in the U.S. in September 2001. Electric arc furnace steel production declined in 2001 as compared to 2000 by about 11% in the U.S.
Worldwide electric arc furnace steel production was stable in 2001 as compared to 2000, as declines in the U.S., Asia (excluding China) and South America were offset by gains in China. The decline of electric arc furnace steel production in South America was caused both by shortages of electricity brought on by a drought that reduced hydroelectric power generation in Brazil (that was largely relieved in 2002), and a currency, debt and related economic crisis in neighboring Argentina.
Worldwide electric arc furnace steel production in 2001 was 285 million metric tons, about 33% of total steel production, which was similar to 2000.
While electric arc furnace steel production was stable, weaker economic conditions resulted in reduced production and, in some cases, the closing of older, less efficient electric arc furnaces. This led to a decline in demand for graphite electrodes. We estimate that worldwide graphite electrode volume sold declined in 2001 as compared to 2000 by about 9%. Overall pricing worldwide was weak throughout most of this period. While we implemented increases in local currency selling prices of our graphite electrodes in 2000 and early 2001 in Europe, the Asia Pacific region, the Middle East and South Africa, we were not able to maintain all of these price increases. Our volume of graphite electrodes sold declined in 2001 as compared to 2000 by about 20% due primarily to the closing of older, less efficient electric arc furnaces as well as our efforts to implement and maintain local currency selling price increases and our efforts to seek to minimize credit risks.
The global and regional economic conditions that impacted demand and prices for graphite electrodes also impacted demand and prices for most of our other products. In general, demand was relatively stable and pricing remained relatively weak. Demand and prices for graphite cathodes remained relatively strong primarily due to construction of new aluminum smelters using graphite cathodes, even as old smelters using carbon cathodes are removed from service.
2002. Global economic conditions remained relatively weak into 2002. We estimate that worldwide electric arc furnace steel production increased by about 5% in 2002 (to a total of about 299 million metric tons, about 33% of total steel production) from 2001. This increase was primarily due to an increase in production in the U.S., Mexico, Brazil and Asia.
In March 2002, President Bush announced his decision to impose tariffs, of up to 30% initially and declining thereafter over a three year period, on most imported steel as part of a broader plan to rescue the financially troubled steel industry in the U.S. Several additional exemptions were granted in 2002 by the Bush administration. We believe that the tariffs have had a modest positive impact on electric arc furnace steel production in the U.S. While steel imported from Mexico is exempt from the tariffs, steel imported from Europe and Asia is not exempt. Steel production in those regions has been adversely impacted by the tariffs. The tariffs are expected to remain in place through March 2005. Import duties in China on both steel and
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graphite electrodes have declined as a result of the admission of China to the World Trade Organization. We cannot predict whether and to what extent these developments will impact our global business over the long-term.
Worldwide graphite electrode demand was very depressed in the 2002 first quarter, but rebounded from those depressed levels during the balance of 2002. During the last three quarters of 2002, we utilized virtually all of our graphite electrode manufacturing capacity. For the entire year 2002, our volume of graphite electrodes sold increased about 4% from 2001. We believe that worldwide graphite electrode demand increased by 3% in 2002 from 2001. We believe that graphite electrode pricing declined by about 10% in 2002 as compared to 2001, driven by global and industry economic conditions and the fact that the prices of graphite electrodes sold in 2002 were largely negotiated during the order book season in late 2001.
Demand and prices for cathodes remained strong primarily due to construction of new aluminum smelters using graphite cathodes, even as old smelters using carbon cathodes were removed from service. We used virtually all of our cathode manufacturing capacity during 2002 and our volume of cathodes sold increased about 10% in 2002 from 2001. Weak economic conditions in 2002 resulted in relatively low demand and weak pricing for most of our other products.
2003 first half. Global and regional economic conditions strengthened slightly in the 2003 first half. While steel production increased slightly globally and was particularly strong in China, certain end markets for steel, such as the automotive and construction industries, continued to be weak. We estimate that worldwide steel production was about 470 million metric tons in the 2003 first half. We estimate that total steel production in the 2003 second quarter was about 5% higher than in the 2003 first quarter, and in the 2003 first half was about 8% higher than in the 2002 first half. We estimate that electric arc furnace steel production increased correspondingly. We operated our graphite electrode manufacturing capacity at very high levels, and estimate that (excluding China, for which reliable information is not available) industry-wide graphite electrode manufacturing capacity utilization rate was over 95%, in the 2003 first half.
Graphite electrode price increases announced since September 2002 have been successfully implemented. In February 2003, we implemented graphite electrode price increases of €100 per metric ton in Europe, $200 per metric ton in Asia, the Middle East, North Africa and South America and $0.05 per pound in the U.S. In July 2003, we implemented graphite electrode price increases in South Africa, to an average price range of $2,500 to $2,600 per metric ton, which are the first price increases contracted for 2004 as the annual contract period in South Africa runs from July 1 to June 30. In July 2003, we implemented graphite electrode price increases in Asia (except China) and the Middle East of $500 per metric ton. Subsequently, in July 2003, we announced graphite electrode price increases in North and South America, to $2,600 per metric ton, effective August 1, 2003. In September 2003, we announced additional graphite electrode price increases in Europe of €100 per metric ton.
Demand for cathodes continued to remain strong during the 2003 first half due primarily to construction of new aluminum smelters using graphite cathodes. We used virtually all of our cathode manufacturing capacity in the 2003 first half. Demand for refractories was strong in the 2003 first half. Weak economic conditions resulted in relatively low demand and weak pricing in the 2003 first half for most of our other products.
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Outlook. We believe that our initiatives have well positioned us to increase earnings and cash flow from operations under current global and regional economic conditions and to leverage additional increases in earnings and cash flow from operations from improvements in economic conditions. We expect net sales to be about $700 million in 2003 as compared to $596 million in 2002.
The graphite electrode supply/demand balance has improved, and supply remains tight primarily due to graphite electrode industry-wide rationalization, including bankruptcies of competitors, and, to a lesser extent, increased electric arc furnace steel production. Since September 2002, we successfully implemented graphite electrode price increases around the world, as described above. Because our graphite electrode capacity is virtually sold out for 2003, we do not expect price increases announced in mid-2003 to materially impact results of operations until 2004. However, current spot prices per metric ton for graphite electrodes in our major markets are about $2,600.
Demand for our cathodes continues to be strong and we expect long term growth in the aluminum industry. Our cathode capacity is virtually sold out for 2003, and we expect it to be virtually sold out in 2004 due to construction of new aluminum smelters as well as relines of existing smelters.
Operation of our facilities at capacity is expected to positively impact graphite electrode and cathode cost of sales in 2003 as compared to 2002, offset by higher energy and freight costs and the negative impact of net changes in currency exchange rates on costs. In addition, we expect to benefit from our rationalization and other initiatives that allow us to achieve significant increases in productivity and output from our existing assets, including economies of scale and other cost savings that we believe will increase as we grow our sales. We believe that our network provides us with the operational flexibility to source customer orders from the facility that optimizes our profitability and, with the continuing consolidation in the steel and aluminum industries, provides us a significant growth opportunity in serving larger multi-plant global customers.
We expect growing net sales of our electronic thermal management products, due to the strengthening of the electronics industry and development of new, higher performance electronic devices as well as our continuing successful product development and commercialization initiatives. We have developed new electronic thermal management technologies with over 130 product approvals from industry leading strategic partners, customers and others. We are seeking to commercialize approximately 20 active eGRAF thermal management products under development programs that are currently underway. Approximately half of these programs are already in the product testing phase. Sales of our products are growing, from about $500,000 in 2002 to an estimated $2 million in 2003 and an estimated $8 million in 2004, based on orders received to date.
We expect most of our other businesses to continue to perform at current levels primarily due to weak economic conditions in the end markets for their products. In particular, demand for carbon electrodes in the U.S. and demand for advanced synthetic graphite products used in the semiconductor, telecommunications and electronics industries continues to be weak. Accordingly, we expect the financial performance of our businesses selling these products to remain at 2002 levels. However, demand for our refractories has strengthened as a result of our increased penetration of various markets, particularly Europe and China, and increased
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blast furnace construction and refurbishment. We continue to seek to drive productivity and cost improvements in all of these businesses.
Our total debt was $709 million and cash and cash equivalents were $8 million at June 30, 2003. We expect total debt to be about $705 million to $720 million and cash and cash equivalents to be about $5 million to $10 million at September 30, 2003, before giving effect to this offering. Total debt at September 30, 2003 or any subsequent date could be higher or lower due to changes in the fair value of hedges of debt obligations, which were nil at June 30, 2003. In the 2003 fourth quarter, we expect to generate cash flow from operating activities of up to $30 million, before capital expenditures of about $10 million. In addition, in the 2003 fourth quarter, we expect to generate net cash proceeds from the sale of non-strategic assets of about $10 million (which is about $5 million more than our previous estimates and is expected to bring our total net cash proceeds from sales of non-strategic assets in 2003 to about $30 million). As a result, before giving effect to this offering, we are targeting total debt to be about $675 million to $690 million and cash and cash equivalents to be about $5 million to $10 million at December 31, 2003.
We continue to implement interest rate management initiatives to seek to minimize interest expense and optimize our portfolio of fixed and variable interest rate obligations as described under "Quantitative and qualitative disclosures about market risks" in this prospectus supplement. After giving effect to this offering and the initial application of the estimated net proceeds therefrom, we are targeting interest expense of approximately $48 million for 2003.
As a result of, among other things, the successful completion of the corporate realignment of our subsidiaries, we are targeting an effective income tax rate of 40% for 2003 and 35% for 2004.
Our outlook could be significantly impacted by, among other things, changes in interest rates by the U.S. Federal Reserve Board and the European Central Bank, changes in tax and fiscal policies by the U.S. and other governments, developments in the Middle East, the occurrence of further terrorist acts and developments resulting from terrorist acts and the war on terrorism (including increases in security, insurance, data back-up, energy and transportation and other costs, transportation delays and continuing or increased economic uncertainty and weakness) and changes in global and regional economic conditions.
Financing transactions.
2002 senior note offerings. On February 15, 2002, we completed an offering of $400 million aggregate principal amount of Senior Notes at a price of 100% of principal amount. On May 6, 2002, we completed an offering of $150 million aggregate principal amount of additional Senior Notes at a price of 104.5% of principal amount, plus accrued interest from February 15, 2002. The Senior Notes bear interest at an annual rate of 10.25% and mature in 2012.
The net proceeds from the offering completed in February 2002 were $387 million. The net proceeds (excluding accrued interest paid by the purchasers of the Senior Notes) from the offering completed in May 2002 were $151 million. We used all of these net proceeds to reduce the principal amount outstanding under our revolving credit facility and to repay term loans under the Senior Facilities. We paid approximately $13 million of debt issuance costs related to the Senior Notes sold in February 2002 and $6 million related to the Senior Notes sold in May 2002. These costs are being amortized over the term of the Senior Notes. We
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recorded charges of $4 million in other expense (income), net, in 2002 for write-off of capitalized fees associated with the term loans under the Senior Facilities repaid with the net proceeds from the issuance of the Senior Notes.
The $7 million premium received upon issuance of the additional Senior Notes issued in May 2002 is classified as long-term liability on the Consolidated Balance Sheets and amortized (as a credit to interest expense) over the term of the additional Senior Notes. As a result of our receipt of such premium, the effective annual interest rate on the additional Senior Notes is about 9.5%.
In the 2003 second and third quarters, we exchanged $55 million aggregate principal amount of Senior Notes, plus accrued interest of $2 million, for approximately 9.9 million shares of common stock. Through June 30, 2003, these transactions resulted in a net gain of approximately $2 million, which has been recorded in other expense (income), net. These exchanges were based on prevailing market prices and are accretive to 2003 earnings.
At June 30, 2003, the Senior Facilities constituted $149 million of our total debt of $709 million (including $6 million for unamortized bond premium), of which $137 million was borrowings under term loans and all of the scheduled principal payments of which term loans are due in 2007.
2001 public equity offering. In July 2001, we completed a public offering of 10,350,000 shares of common stock at a public offering price of $9.50 per share. The net proceeds from that offering were $91 million.
2000 debt recapitalization. In February 2000, we completed a debt recapitalization and obtained the Senior Facilities. We recorded a charge of $21 million in other expense (income), net, in 2000 in connection with our debt recapitalization. The charge includes the redemption premium on our previously outstanding senior subordinated notes, bank, legal, accounting, filing and other fees and expenses, and write-off of deferred issuance costs.
Litigation against our former parent companies initiated by us
In February 2000, we commenced a lawsuit against our former parents, Mitsubishi Corporation and Union Carbide Corporation to recover certain payments made to them in connection with our leveraged equity recapitalization in January 1995, as well as certain unjust receipts by them from their investments in us and damages for aiding and abetting breaches of fiduciary duties owed to us by our former senior management in connection with illegal graphite electrode price fixing activities. We are seeking to recover more than $1.5 billion, including interest. The defendants have filed motions to dismiss this lawsuit. Oral hearings were held on those motions in the 2001 first quarter. The court has not ruled on these motions. We expect to incur $10 million to $20 million for legal expenses to pursue this lawsuit from the date of filing the complaint through trial. Through June 30, 2003, we had incurred about $6 million of these legal expenses. This lawsuit is in its earliest stages, and the ultimate outcome of this lawsuit is subject to many uncertainties.
Antitrust and other litigation against us
Since 1997, we and other producers and distributors of graphite and carbon products have been subject to antitrust investigations by antitrust authorities in the U.S., the European Union, Canada, Japan and Korea. In addition, civil antitrust lawsuits have been commenced and
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threatened against us and other producers and distributors of graphite and carbon products in the U.S., Canada and elsewhere. We recorded pre-tax charges against results of operations in the aggregate amount of $350 million as a reserve for estimated potential liabilities and expenses in connection with antitrust investigations and related lawsuits and claims.
In April 1998, GTI pled guilty to a one count charge of violating U.S. federal antitrust law in connection with the sale of graphite electrodes and was sentenced to pay a non-interest-bearing fine in the aggregate amount of $110 million, payable in six annual installments. The payment schedule has been revised periodically at our request. The payment schedule for the $52.5 million outstanding balance consists of quarterly payments ranging from $3.25 million to $5.375 million from April 2004 through January 2007. Beginning in 2004, the DOJ may ask the court to accelerate the payment schedule based on a change in our ability to make such payments. Interest will begin to accrue on the outstanding balance, commencing in April 2004, at the statutory rate of interest then in effect. At June 30, 2003, the statutory rate of interest was 1.09% per annum. Accrued interest will be payable together with each quarterly payment. Of the $110 million original aggregate amount, $90 million is treated as a fine and $20 million is treated as imputed interest for accounting purposes. At June 30, 2003, the aggregate amount of remaining committed payments payable to the DOJ for imputed interest was nil. In addition, in 1999, 2001 and 2002, investigations by the antitrust authorities in Canada, Japan and Korea were resolved.
In January 2000, the EU Competition Authority alleged that we and other producers violated European antitrust laws in connection with the sale of graphite electrodes. In July 2001, the EU Competition Authority issued its decision regarding the allegations and assessed a fine of €50.4 million ($58 million, based on currency exchange rates in effect at June 30, 2003) against GTI. As a result of our cooperation, this fine reflects a substantial reduction from the amount that otherwise would have been assessed. The EU fine bears interest at the statutory rate of 6.04% annually. It is the policy of the EU Competition Authority to negotiate appropriate terms of payment of antitrust fines, including extended payment terms. We have had discussions regarding payment terms. After an in-depth analysis of the decision, in October 2001, we filed an appeal to the Court of First Instance in Luxembourg challenging, among other things, the amount of the EU fine. The court has not yet issued its decision on our appeal. The EU Competition Authority decision establishes the maximum obligation with respect to our last major remaining antitrust liability.
Following assessment of the EU fine and during the pendency of an appeal, the fine or collateral security would typically be required to be paid or provided. Since the filing of our appeal in October 2001, we have negotiated with the EU Competition Authority regarding the appropriate form of collateral security during the pendency of the appeal. In September 2003, we filed an interim appeal to the court to waive the requirement for collateral security or to allow us to provide alternative security for payment. We cannot predict how or when the court would rule on such an interim appeal.
In the 2001 second quarter, we became aware that the Brazilian antitrust authority had requested written information from various steelmakers in Brazil. In April 2002, our Brazilian subsidiary received a request for information from that authority. We have provided that information.
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In May 2002, the EU Competition Authority alleged that we and other producers violated European antitrust laws in connection with the sale of specialty graphite. In December 2002, the EU Competition Authority issued its decision regarding the allegations. It assessed no fine against us due to our cooperation.
We are continuing to cooperate with the U.S., European and Canadian antitrust authorities in their continuing investigations of others. It is possible that antitrust investigations seeking, among other things, to impose fines and penalties could be initiated against us by authorities in Brazil or other jurisdictions.
We have settled, among others, virtually all of the actual and potential claims against us by customers in the U.S. and Canada arising out of alleged antitrust violations occurring prior to the date of the relevant settlement in connection with the sale of graphite electrodes. All settlement payments due have been timely made. None of the settlement or plea agreements contain restrictions on future prices of our graphite electrodes. There remain, however, certain pending claims as well as pending lawsuits in the U.S. relating to the sale of graphite electrodes sold to foreign customers. It is also possible that additional antitrust lawsuits and claims could be asserted against us in the U.S. or other jurisdictions.
Through June 30, 2003, we have paid an aggregate of $256 million of fines and net settlement and expense payments and $19 million of imputed interest on the DOJ fine. At June 30, 2003, $94 million remained in the reserve. The balance of the reserve is available for the balance of the DOJ fine, the EU fine and other matters. The reserve does not cover interest on the DOJ fine (including interest that, for accounting purposes, is imputed on the DOJ fine and which, for the period from July 2003 through April 2004 is nil). Such interest is recorded in interest expense. The reserve will cover interest accrued on the EU fine for the period from July 2001 through the date of the court's decision of our main appeal (which is separate from our interim appeal). Due to the accumulation of interest as a result of the delay in the court's decision as well as changes in currency exchange rates which impact the translation of the amount of the EU fine into dollars, we may be required to record a charge at the time of the court's decision to increase the reserve, even if the amount of the EU fine is reduced on appeal. Interest accruing on the EU fine after the date of the court's decision will be recorded in interest expense on the Consolidated statements of operations.
We cannot assure you that remaining liabilities and expenses in connection with antitrust investigations, lawsuits and claims will not materially exceed the remaining uncommitted balance of the reserve or that the timing of payment thereof will not be sooner than anticipated. In the aggregate, the fines and net settlements and expenses are within the amounts we used to evaluate the $350 million charge. To the extent that aggregate liabilities and expenses, net, are known or reasonably estimable, $350 million represents our estimate of these liabilities and expenses. The guilty pleas and the decisions by the antitrust authorities make it more difficult to defend against other investigations, lawsuits and claims. Our insurance has not and will not materially cover liabilities that have or may become due in connection with antitrust investigations or related lawsuits or claims.
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 69% of our net sales in 2000, 70% of our net sales in 2001, 71% of our net sales in 2002 and 70% of our net sales in the 2003 first half. Our
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customer base includes both steel makers and non-steel makers. In 2002, two of our ten largest customers were purchasers of non-graphite electrode products. In 2002, four of our ten largest customers were based in Europe, two were in the U.S., two were in South Africa and one was in each of Mexico and Brazil. No single customer or group of affiliated customers accounted for more than 6% of our net sales in 2002 or 4% of our net sales in the 2003 first half.
Results of operations
The following table sets forth, for the periods indicated, certain items in the Consolidated statements of operations and the increase or decrease (expressed as a percentage of such item in the comparable prior period) of such items:
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Percentage increase (decrease) |
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For the year ended December 31, |
For the six months ended June 30, |
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2000 to 2001 |
2001 to 2002 |
2002 First half to 2003 First half |
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(dollars in millions) |
2000 |
2001 |
2002 |
2002 |
2003 |
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Net sales | $ | 763 | $ | 634 | $ | 596 | $ | 291 | $ | 351 | (17 | )% | (6 | )% | 21 | % | ||||||
Cost of sales | 549 | 455 | 461 | 226 | 269 | (17 | ) | 1 | 19 | |||||||||||||
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Gross profit | 214 | 179 | 135 | 65 | 82 | (17 | ) | (24 | ) | 27 | ||||||||||||
Research and development | 11 | 12 | 13 | 6 | 5 | 8 | 10 | 17 | ||||||||||||||
Selling, administrative and other expenses | 84 | 75 | 76 | 42 | 42 | (10 | ) | | | |||||||||||||
Other expense (income), net | 20 | 1 | (12 | ) | (9 | ) | (10 | ) | N/M | N/M | N/M | |||||||||||
The following table sets forth, for the periods indicated, the percentage of net sales represented by certain items in the Consolidated statements of operations:
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For the year ended December 31, |
For the six months ended June 30, |
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2000 |
2001 |
2002 |
2002 |
2003 |
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Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | |
Cost of sales | 71.9 | 71.8 | 77.3 | 77.6 | 76.6 | ||||||
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Gross profit | 28.1 | 28.2 | 22.7 | 22.3 | 23.4 | ||||||
Research and development | 1.4 | 1.8 | 2.2 | 2.0 | 1.4 | ||||||
Selling, administrative and other expenses | 11.0 | 12.0 | 12.7 | 14.4 | 11.9 | ||||||
Other expense (income), net | 2.7 | 0.3 | (2.0 | ) | (3.0 | ) | (2.8 | ) | |||
Financial information discussed below omits our non-strategic composite tooling business, that was sold in June 2003 and has been accounted for as discontinued operations. The results of our discontinued operations were not material to our consolidated results of operations.
Three months ended June 30, 2003 as compared to three months ended June 30, 2002. Net sales of $181 million in the 2003 second quarter represented a $24 million, or 15%, increase from net sales of $157 million in the 2002 second quarter, primarily due to higher graphite electrode prices and higher sales volumes of synthetic graphite and advanced carbon materials. Cost of sales of $138 million in the 2003 second quarter represented a $16 million, or 13%,
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increase from cost of sales of $122 million in the 2002 second quarter, primarily due to the higher sales volumes. Gross profit of $43 million in the 2003 second quarter represented a $8 million, or 23%, increase from gross profit of $35 million in the 2002 second quarter.
Synthetic graphite segment. Net sales of $162 million in the 2003 second quarter represented a $20 million, or 14%, increase from net sales of $142 million in the 2002 second quarter, primarily due to higher average graphite electrodes sales revenue per metric ton and higher sales volumes of graphite electrodes. Volume of graphite electrodes sold was 50,600 metric tons in the 2003 second quarter as compared to 48,800 metric tons in the 2002 second quarter. The higher volume of graphite electrodes sold represented an increase of $4 million in net sales. The increase was a result of stronger demand for graphite electrodes primarily in the United States and Europe. Average sales revenue per metric ton of graphite electrodes in the 2003 second quarter was $2,347 as compared to the average in the 2002 second quarter of $2,095. The increase was primarily due to changes in currency exchange rates. The higher average sales revenue per metric ton represented an increase of $13 million in net sales. Net sales of cathodes increased in the 2003 second quarter by 11%, or $2 million, from net sales of $22 million in the 2002 second quarter.
Cost of sales of $123 million in the 2003 second quarter represented a $13 million, or 12%, increase from cost of sales of $110 million in the 2002 second quarter, primarily due to the higher volumes of graphite electrodes. Gross profit in the 2003 second quarter was $39 million, 21% or $7 million higher than in the 2002 second quarter. The increase in gross profit was primarily due to higher graphite electrode net sales and improved productivity throughout the production network. These improvements were partially offset by higher energy costs, higher freight costs and the negative impact of net changes in currency exchange rates on costs. Gross margin was 23.8% of net sales in the 2003 second quarter, higher than the 22.6% of net sales in the 2002 second quarter.
Other segment. Net sales of $19 million in the 2003 second quarter represented a $4 million, or 27%, increase from net sales of $15 million in the 2002 second quarter, primarily due to increased net sales in our advanced carbon materials line of business. Cost of sales of $15 million in the 2003 second quarter represented a $3 million, or 25%, increase from cost of sales of $12 million in the 2002 second quarter. The increase in cost of sales was primarily related to higher sales volumes sold in our advanced carbon materials line of business and higher energy costs, primarily natural gas. Gross profit in the 2003 second quarter was $4 million (a gross margin of 24.3% of net sales) as compared to gross profit in the 2002 second quarter of $3 million (a gross margin of 20.7% of net sales).
Items affecting us as a whole. Selling, administrative and other expenses were $21 million in the 2003 second quarter, a decrease of $3 million from the 2002 second quarter. This decrease resulted from cost savings associated with the redesign of benefit plans, the streamlining of our organizational structure and lower incentive compensation primarily due to the absence in the 2003 second quarter of an expense comparable to the accelerated vesting of restricted stock grants in the 2002 second quarter.
Other expense (income), net, was income of $6 million in the 2003 second quarter, primarily due to currency exchange benefits associated with euro-denominated intercompany loans, which were partially offset by other expenses, including an approximately $1 million fair value adjustment on $500 million notional amount of five-year interest rate caps. Other expense (income), net, was income of $10 million for the 2002 second quarter. Among other things,
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income of $14 million primarily associated with currency exchange benefits relating to euro-denominated debt was partially offset by the write-off of previously capitalized bank charges and operating costs related to the Italian shutdown.
In the 2003 second quarter, we recorded $1 million of restructuring charges. The $1 million charge was primarily related to employee severance programs and related benefits associated with a workforce reduction of several employees. In the 2002 second quarter, restructuring charges were nil.
In the 2003 second quarter, impairment loss on long-lived and other assets was nil. In the 2002 second quarter, we recorded $13 million of non-cash charges primarily related to the impairment of our long-lived carbon electrode assets in Tennessee as a result of a decline in demand and loss of market share. The primary end market for carbon electrodes is silicon metal, which was very depressed in the U.S. where our main customer base was located. This charge also included $1 million related to the impairment of available-for-sale securities.
Interest expense was $13 million in the 2003 second quarter as compared to $17 million in the 2002 second quarter. Average total debt outstanding was $761 million in the 2003 second quarter as compared to $708 million in the 2002 second quarter. The average annual interest rate was 5.9% in the 2003 second quarter as compared to 9.1% in the 2002 second quarter. These average annual rates include the benefits of our interest rate swaps and exclude imputed interest on the fine payable to the DOJ. Interest rate swaps reduced our interest expense by approximately $5 million during the 2003 second quarter, which includes a $2 million credit to interest expense from the acceleration of interest swap proceeds as a result of our debt for equity exchange during June 2003.
During the 2003 second quarter, we recorded a $1 million gain on the sale of our non-strategic composite tooling business as part of our asset sale program.
Provision for income taxes was a charge of $5 million in the 2003 second quarter as compared to a benefit of $5 million in the 2002 second quarter. The effective income tax rate was approximately 40% in the 2003 second quarter as compared to approximately 39% in the 2002 second quarter.
As a result of the changes described above, net income was $7 million in the 2003 second quarter as compared to a net loss of $7 million in the 2002 second quarter.
Six months ended June 30, 2003 as compared to six months ended June 30, 2002. Net sales of $351 million in the 2003 first half represented a $60 million, or 21%, increase from net sales of $291 million in the 2002 first half. Gross profit of $82 million in the 2003 first half represented a $17 million, or 27%, increase from gross profit of $65 million in the 2002 first half. Gross margin increased to 23.4% of net sales in 2003 first half from 22.3% in 2002 first half. The increase in net sales, gross profit and gross margin was primarily due to higher net sales in our synthetic graphite and advanced carbon materials lines of businesses.
Synthetic graphite segment. Net sales of $311 million in the 2003 first half represented a $51 million, or 20%, increase from net sales of $260 million in the 2002 first half, primarily due to higher sales volume of graphite electrodes and higher average graphite electrode sales revenue per metric ton. Volume of graphite electrodes sold was 97,700 metric tons in the 2003 first half as compared to 87,300 metric tons in the 2002 first half. The higher volume of graphite electrodes sold represented an increase of $22 million in net sales. Average sales revenue per metric ton of graphite electrodes in the 2003 first half was $2,311 as compared to
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the average in the 2002 first half of $2,090. The higher average sales revenue per metric ton represented an increase of $21 million in net sales. The increase was primarily due to changes in currency exchange rates. Net sales of cathodes increased in the 2003 first half by 19%, or $8 million, from net sales of $43 million in the 2002 first half.
Cost of sales of $238 million in the 2003 first half represented a $38 million, or 19%, increase from cost of sales of $200 million in the 2002 first half, primarily due to the higher volumes of graphite electrodes and cathodes sold. Gross profit in the 2003 first half was $73 million, or 22% or $13 million, higher than in the 2002 first half. The increase in gross profit was primarily due to higher graphite electrode net sales and higher operating levels throughout the production network. These improvements were partially offset primarily by higher energy costs, higher freight costs and the negative impact of net changes in currency exchange rates on costs. Gross margin was 23.3% of net sales in the 2003 first half, higher than the 22.9% of net sales in the 2002 first half.
Other segment. Net sales of $40 million in the 2003 first half represented a $9 million, or 27%, increase from net sales of $31 million in the 2002 first half, primarily due to increased net sales in our advanced carbon materials line of business. Cost of sales of $31 million in the 2003 first half represented a $5 million, or 15%, increase from cost of sales of $26 million in the 2002 first half. The increase in cost of sales was primarily related to higher sales volume sold in our advanced carbon materials line of business and higher energy costs, primarily natural gas. Gross profit in the 2003 first half was $9 million (a gross margin of 24.7% of net sales) as compared to gross profit in the 2002 first half of $5 million (a gross margin of 17.1% of net sales).
Items affecting us as a whole. Selling, administrative and other expenses were $42 million in the 2003 first half, unchanged from the 2002 first half. In the 2003 first half, we recorded higher variable compensation expense. In the 2002 first half, we recorded a one-time reduction in franchise and other taxes associated with the corporate realignment of our subsidiaries, and a $5 million non-cash charge to compensation expense associated with the accelerated vesting of restricted stock grants.
Other expense (income), net, was income of $10 million in the 2003 first half, primarily due to currency exchange benefits of $19 million, which were primarily associated with euro-denominated intercompany loans. These benefits were partially offset by other expenses, including an approximately $2 million fair value adjustment on $300 million notional amount of five-year interest rate caps and $4 million of bank fees and legal fees. Other expense (income), net, was net income of $12 million in the 2002 first half. Among other things, income of $20 million primarily associated with currency exchange benefits relating to euro-denominated intercompany loans was partially offset by the write-off of $4 million of previously capitalized bank charges.
In the 2003 first half, we recorded $20 million of restructuring charges, consisting of $9 million for organizational changes and $11 million for the closure and settlement of our U.S. non-qualified defined benefit plan for the participating salaried workforce. The $9 million charge for organizational changes related primarily to U.S. voluntary and selective severance programs and related benefits associated with a workforce reduction of 103 employees. The closure of our non-qualified U.S. defined benefit plan resulted in recognition of net non-cash actuarial losses of $11 million. Approximately half of the $9 million will involve cash outlays.
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In the 2002 first half, we recorded $5 million of restructuring charges related primarily to the mothballing of our graphite electrode operations in Caserta, Italy. This charge included estimated pension, severance and other related employee benefit costs for 102 employees and other cost related to the mothballing.
In the 2003 first half, impairment loss on long-lived and other assets and other special charges were nil. In the 2002 first half, we recorded $13 million of non-cash charges primarily related to the impairment of our long-lived carbon electrode assets in Columbia, Tennessee.
Interest expense was $27 million in the 2003 first half as compared to $30 million in the 2002 first half. Average total debt outstanding was $758 million in the 2003 first half as compared to $688 million in the 2002 first half. The average annual interest rate was 6.3% in 2003 first half as compared to 8.5% in the 2002 first half. These average annual rates include the benefits of our interest rate swaps and exclude imputed interest on the fine payable to the DOJ. Interest rate swaps reduced our interest expense by approximately $9 million during the 2003 first half, which includes $2 million credit to interest expense from acceleration of interest swap proceeds as a result of our debt for equity exchange during June 2003.
Provision for income taxes was a charge of $1 million in the 2003 first half as compared to a benefit of $11 million in the 2002 first half.
During the 2003 first half, we recorded a $1 million gain from the sale of our non-strategic composite tooling business. The discontinued business recorded a net income from operations of $1 million during both the 2003 first half and the 2002 first half.
As a result of the changes described above, net loss was $2 million in the 2003 first half as compared to net loss of $11 million in the 2002 first half.
2002 compared to 2001. Net sales in 2002 were $596 million, a decrease of $38 million, or 6%, from net sales in 2001 of $634 million. Gross profit in 2002 was $135 million, a decrease of $44 million, or 24%, from gross profit in 2001 of $179 million. Gross profit margin in 2002 was 22.7% of net sales as compared to gross profit margin in 2001 of 28.2% of net sales. The decrease in net sales and gross profit was primarily due to lower sales revenue per metric ton for our graphite electrodes, which reduced net sales by about $43 million.
Synthetic graphite segment. Net sales decreased 4%, or $22 million, to $538 million in 2002 from $559 million in 2001. The decrease was primarily attributable to a decrease in average sales revenue per metric ton of graphite electrodes, partially offset by higher sales volumes for graphite electrodes and cathodes sold. The volume of graphite electrodes sold increased 6,000 metric tons, or 4%, to 180,000 metric tons in 2002 as compared to 174,000 metric tons in 2001. The increase in volume of graphite electrodes sold represented an increase in net sales of about $16 million. The average sales revenue per metric ton (in U.S. dollars and net changes in currency exchange rates) of our graphite electrodes was $2,100 in 2002 as compared to $2,341 in 2001. The reduced average sales revenue per metric ton of graphite electrodes represented a decrease of about $43 million in net sales. Unfavorable changes in currency exchange rates represented a reduction of about $4 million in net sales of graphite electrodes. Volume of cathodes sold in 2002 was 10% higher than in 2001, with 36,900 metric tons in 2002 as compared to 33,400 metric tons in 2001, and net sales of cathodes in 2002 were 17% higher than in 2001. We completed the expansion of our cathode manufacturing capacity in Brazil in 2002 and were successful in selling virtually all of our cathode manufacturing capacity for 2002.
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Synthetic Graphite segment cost of sales increased 4%, or $15 million, to $413 million in 2002 from $398 million in 2001. The increase in cost of sales was primarily due to higher volume of graphite electrodes sold, partially offset by lower average graphite electrode cost of sales per metric ton. The reduction in average graphite electrode cost of sales per metric ton was primarily due to cost savings initiatives and lower average fixed cost per metric ton due to facility closures and, to lesser extent, changes in currency exchange rates.
Gross profit decreased 22%, or $36 million, to $125 million (23.2% of net sales) in 2002 from $161 million (28.8% of net sales) in 2001.
Other segment. Net sales decreased 23%, or $17 million, to $58 million in 2002 from $75 million in 2001. We had lower net sales in each of our product lines, especially in advanced carbon materials due to a cyclical decrease in the volume of refractories sold and in flexible graphite due to lower sales of sealing products sold to the transportation industry. Cost of sales decreased 17%, or $9 million, to $48 million in 2002 from $57 million in 2001. The decline was primarily due to lower volume of products sold. Gross profit decreased 41%, or $8 million, to $10 million (18.5% of net sales) in 2002 from $18 million (24.3% of net sales) in 2001.
Other items affecting us as a whole. Selling, administrative and other expense increased by $1 million to $76 million in 2002 from $75 million in 2001.
Other expense (income), net, was $12 million of income in 2002 as compared to $1 million of expense in 2001. We recorded both other income and other expense in both periods resulting from various non-operational activities, including gains from currency transactions and translation. In 2002, we had $28 million in currency gains, $21 million of which gain was due to currency translation on intercompany loans and translation of financial statements of foreign subsidiaries which use the dollar as their functional currency and $7 million of which related to transactions with third parties. These gains were offset by other expenses, including legal expenses and settlements, financing costs and costs associated with the curtailment of employee benefit plans.
In 2002, we recorded a total of $23 million in impairment losses and restructuring charges as described below:
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Caserta, Italy. These charges included estimated pension, severance and other related employee benefit costs.
In addition, in 2002, we recorded a $5 million charge related to the accelerated vesting of restricted stock and $3 million in corporate realignment and related expenses.
In 2001, we recorded a total of $92 million, net, in impairment losses and restructuring charges as described below:
In addition, in 2001, we recorded a $10 million charge for additional potential liabilities and expenses in connection with antitrust investigations and related lawsuits and claims as well as $2 million in corporate realignment and related expenses.
Interest expense was stable at $60 million in each of 2002 and 2001. Our average outstanding total debt was $701 million in 2002 as compared to $683 million in 2001 and our average annual interest rate was 8.5% in 2002 as compared to 8.1% in 2001. These average annual interest rates exclude imputed interest on antitrust fines, which decreased $3 million to $1 million in 2002 from $4 million in 2001.
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Benefit from income taxes was $16 million in 2002 as compared to provision for income taxes of $14 million for 2001. During both 2002 and 2001, the benefit from and provision for income taxes reflected an effective rate of about 35%, excluding the impact of impairment losses on long-lived and other assets, restructuring charges, the charge related to antitrust investigations and related lawsuits and claims, and the charge related to the corporate realignment of our subsidiaries.
As a result of the changes described above, net loss was $18 million in 2002, an improvement of $69 million from net loss of $87 million in 2001.
2001 compared to 2000. Net sales in 2001 were $634 million, a decrease of $129 million, or 17%, from net sales in 2000 of $763 million. Gross profit in 2001 was $179 million, a decrease of $35 million, or 17%, from gross profit in 2000 of $214 million. Gross profit margin in 2001 was 28.2% of net sales as compared to gross profit margin in 2000 of 28.1% of net sales. The decrease in net sales and gross profit was primarily due to lower sales volume of most of our products, particularly graphite electrodes, which reduced net sales by about $104 million, primarily due to depressed steel industry conditions. The increase in gross profit margin percentage was primarily due to the fact that the percentage decrease in net sales was less than the percentage decrease in cost of sales, due primarily to lower production levels and benefits from our cost savings activities.
Synthetic graphite segment. Net sales decreased 18%, or $122 million, to $559 million in 2001 from $681 million in 2000. The decrease was primarily attributable to a decrease in average sales revenue per metric ton of graphite electrodes and lower volumes of graphite electrodes and cathodes sold. The volume of graphite electrodes sold decreased 43,000 metric tons, or 20%, to 174,000 metric tons in 2001 from 217,000 metric tons in 2000. The decrease in volume of graphite electrodes sold represented a decrease in net sales of about $104 million. The decrease was primarily a result of continued lower North American steel production, weaker demand in Europe and Brazil and actions taken to manage credit risk. The average sales revenue per metric ton (in U.S. dollars and net changes in currency exchange rates) of our graphite electrodes was $2,341 in 2001 as compared to $2,379 in 2000. The reduced average sales revenue per metric ton of graphite electrodes represented a decrease of about $6 million in net sales. Unfavorable changes in currency exchange rates represented a reduction of about $15 million in net sales of graphite electrodes, more than offsetting the benefits of increases in selling prices in local currencies in certain foreign countries. Volume of cathodes sold was 33,000 metric tons in 2001 as compared to 35,000 metric tons in 2000.
Cost of sales decreased 17%, or $91 million, to $398 million in 2001 from $489 million in 2000. The decrease in cost of sales was primarily due to the lower volume of graphite electrodes sold and a lower average graphite electrode cost of sales per metric ton. The reduction in average graphite electrode cost of sales per metric ton was primarily due to cost savings initiatives and lower average fixed cost per metric ton due to facility closures and, to lesser extent, changes in currency exchange rates.
Gross profit decreased 17%, or $31 million, to $161 million (28.8% of net sales) in 2001 from $192 million (28.1% of net sales) in 2000. The increase in gross profit margin was primarily due to the fact that the percentage decrease in net sales was less than the percentage decrease in cost of sales.
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Other segment. Net sales decreased 8%, or $7 million, to $75 million in 2001 from $82 million in 2000. The decrease was primarily due to a reduction in the volume of flexible graphite sold for gasket applications due to lower demand from the automotive industry as well as a decrease in products sold to the semiconductor and industrial sectors, partially offset by an increase in volume of refractories sold and an increase in technical service and technology license fees. Cost of sales decreased 3%, or $3 million, to $57 million in 2001 from $60 million in 2000. The decline was primarily due to the lower volume of products sold. Gross profit decreased 19%, or $4 million, to $18 million (24.3% of net sales) in 2001 from $22 million (27.8% of net sales) in 2000. The decrease in gross profit margin percentage was primarily due to the fact that the percentage decrease in net sales was greater than the percentage decrease in cost of sales.
Other items affecting us as a whole. Selling, administrative and other expense declined $9 million to $75 million in 2001 from $84 million in 2000, primarily due to reduced corporate spending.
Other expense (income), net, was expense of $1 million in 2001 as compared to $20 million in 2000. The expense of $20 million in 2000 was primarily related to the write-off of capitalized bank fees and other costs resulting from early extinguishment of debt in connection with a debt recapitalization.
In 2001, we recorded a total of $92 million, net, in impairment losses and restructuring charges as described below:
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In addition, in 2001, we recorded a $10 million charge for additional potential liabilities and expenses in connection with antitrust investigations and related lawsuits and claims as well as $2 million in corporate realignment and related expenses.
In 2000, we recorded a total of $9 million, net, in impairment losses and restructuring charges as described below:
In addition, in 2000, we recorded a $2 million write-off of costs incurred in connection with a proposed initial public offering by AET that was subsequently withdrawn.
Interest expense decreased to $60 million in 2001 from $75 million in 2000. The decrease was due to lower average annual interest rates and lower average total debt outstanding. Our average outstanding total debt was $683 million in 2001 as compared to $780 million in 2000 and our average annual interest rate was 8.1% in 2001 as compared to 9.0% in 2000. These average annual interest rates exclude imputed interest on antitrust fines.
Provision for income taxes was $14 million for 2001 as compared to $2 million for 2000. For 2001, the provision for income taxes reflected an effective rate of about 35%, excluding the impact of impairment losses on long-lived and other assets, restructuring charges, the charge related to antitrust investigations and related lawsuits and claims, and the charge related to the corporate realignment of our subsidiaries. For 2001, the provision for income taxes included a $29 million charge related to adjustments made in connection with the capitalization of foreign tax credits to investment in affiliates as well as settlement of audits and adjustments to reserves. For 2000, the provision for income taxes reflected an effective rate of about 30%. The increase in the effective rate in 2001 was primarily due to a higher proportion of income from higher tax jurisdictions.
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As a result of the changes described above, net loss was $87 million in 2001, a decrease of $97 million from net income of $10 million in 2000.
Effects of inflation
We incur costs in the U.S. and each of the six non-U.S. countries in which we have a manufacturing facility. In general, our results of operations, cash flows and financial condition are affected by the effects of inflation on our costs incurred in each of these countries.
During the 2000 first half, the effects of inflation on our cost of sales in these countries (except for highly inflationary countries) were generally mitigated by a combination of improved operating efficiency and on-going cost savings. Accordingly, during that period, these effects were not material to us. From mid-2000 through mid-2001, we experienced higher energy and raw material costs primarily due to the substantial increase in the worldwide market price of oil and natural gas. During the latter part of that period, we were able to similarly mitigate the effects of those increases on our cost of sales. During 2002, the effects of inflation on our cost of sales globally (except for highly inflationary countries) were also generally mitigated by a combination of improved operating efficiency and on-going cost savings. Accordingly, during 2002, these effects were not material to us.
During the 2003 first half, we experienced higher energy and freight costs primarily due to the substantial increase in the worldwide market price of oil and natural gas. We attempt to mitigate certain increases in our natural gas costs by entering into fixed rate cost contracts with certain of our North American suppliers. The contracts expire at various times during the 2004 second and fourth quarters. During the 2003 first half, we did not experience significant inflation with respect to other costs. We cannot assure you that future increases in our costs will not occur or exceed the rate of inflation or the amounts, if any, by which we may be able to increase prices for our products.
Currency translation and transactions
We account for our non-U.S. subsidiaries under SFAS No. 52, "Foreign Currency Translation." Accordingly, except for highly inflationary countries, the assets and liabilities of our non-U.S. subsidiaries are translated into dollars for consolidation and reporting purposes. Foreign currency translation adjustments are generally recorded as part of stockholders' equity and identified as part of accumulated other comprehensive income (loss) in the Consolidated balance sheets until such time as their operations are sold or substantially or completely liquidated.
Prior to August 1, 2000, our Swiss subsidiary used the dollar as its functional currency. Beginning August 1, 2000, our Swiss subsidiary began using the euro as its functional currency because its operations became predominantly euro-denominated.
We have subsidiaries in Russia, Mexico, Brazil and other countries which have had in the past, and may have now or in the future, highly inflationary economies, defined as cumulative inflation of about 100% or more over a period of three calendar years. In general, the financial statements of foreign operations in highly inflationary economies have been remeasured as if the functional currency of their economic environments were the dollar and translation gains and losses relating to these foreign operations are included in other expense (income), net in the Consolidated statements of operations rather than as part of stockholders'
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equity in the Consolidated balance sheets. We also record foreign currency transaction gains and losses as part of other expense (income), net.
Currently, we account for our Mexican subsidiary using the dollar as its functional currency, irrespective of Mexico's inflationary status, because its sales and purchases are predominantly dollar-denominated. In addition, we account for our Russian subsidiary using the dollar as its functional currency because Russia is considered to have a highly inflationary economy.
Significant changes in currency exchange rates impacting us are described under "Effects of changes in currency exchange rates." Foreign currency translation adjustments decreased stockholders' equity by $35 million, including $23 million associated with our South African subsidiary, in 2000, $29 million, including $21 million associated with our South African subsidiary, in 2001 and $20 million, including $16 million associated with our Brazilian subsidiary, in 2002. Foreign currency translation adjustments increased stockholders' equity by $5 million in the 2003 first half.
Effects of changes in currency exchange rates
We incur costs in dollars and the currency of each of the six non-U.S. countries in which we have a manufacturing facility, and we sell our products in multiple currencies. In general, our results of operations, cash flows and financial condition are affected by changes in currency exchange rates affecting these currencies relative to the dollar and, to a limited extent, each other.
When the currencies of non-U.S. countries in which we have a manufacturing facility decline (or increase) in value relative to the dollar, this has the effect of reducing (or increasing) the dollar equivalent cost of sales and other expenses with respect to those facilities. This effect is, however, partially offset by the cost of petroleum coke, a principal raw material used by us, which is priced in dollars. In certain countries where we have manufacturing facilities, and in certain instances where we price our products for sale in export markets, we sell in currencies other than the dollar. Accordingly, when these currencies increase (or decline) in value relative to the dollar, this has the effect of increasing (or reducing) net sales. The result of these effects is to increase (or decrease) operating profit and net income.
Many of the non-U.S. countries in which we have a manufacturing facility have been subject to significant economic pressures, which have impacted inflation and currency exchange rates. As a result, many of the currencies in which we manufacture and sell our products weakened against the dollar. We seek to mitigate adverse impacts of changes in currency exchange rates on net sales by increasing local currency prices for some of our products in various regions as circumstances permitted.
During 2000, the South African rand declined about 19%, the euro declined about 6% and the Brazilian real declined about 8% relative to the dollar. During 2001, the euro declined about 5%, the Brazilian real declined about 16% and the South African rand declined about 36% relative to the dollar. During 2002, the Brazilian real declined about 35%, the South African rand increased about 38% and the euro increased about 18% relative to the dollar. During the 2003 first half, the average exchange rate of the euro and the South African rand increased about 24% and 37%, respectively, relative to the dollar, when compared to the average exchange rate for the 2002 first half. During the 2003 first half, the average exchange rate for the Brazilian real and the Mexican peso declined about 30% and 12%, respectively, relative to
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the dollar, when compared to the average exchange rate for the 2002 first half. In the case of net sales of graphite electrodes, the impact of these events was a reduction of about $36 million in 2000, a reduction of about $15 million in 2001, a reduction of about $4 million in 2002, a reduction of about $7 million in the 2002 first half and an increase of about $21 million in the 2003 first half. We seek to mitigate adverse impacts of changes in currency exchange rates on net sales by increasing local currency prices for some of our products in various regions as circumstances permit. We cannot predict changes in currency exchange rates in the future or whether those changes will have positive or negative impacts on our net sales or cost of sales. We cannot assure you that we would be able to mitigate any adverse effects of such changes.
We have non-dollar-denominated intercompany loans between GrafTech Finance and some of our foreign subsidiaries. At June 30, 2003, the aggregate principal amount of these loans was $464 million. These loans are subject to translation 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, translation gains and losses on these loans are recorded in accumulated other comprehensive income (loss) on the Consolidated balance sheets. The balance of these loans are deemed to be temporary and, as a result, translation gains and losses on these loans are recorded as unrealized gains or losses in other expense (income), net, in the Consolidated statements of operations. We have the ability to replace each intercompany loan with an identical new intercompany loan. When we replace such a loan, we record net cumulative realized translation gains or losses with respect to that loan in other expense (income), net. Those realized gains or losses are, however, non-cash gains or losses. Foreign currency translation gains and losses relating to these loans included in other expense (income), net, were a gain of $8 million in 2000, a loss of $4 million in 2001, a gain of $21 million in 2002, a gain of $18 million in the 2002 first half and a gain of $22 million in the 2003 first half.
To manage certain exposures to specific financial market risks caused by changes in currency exchange rates, we use various financial instruments as described under "Qualitative and quantitative disclosures about market risks."
Liquidity and capital resources
Our sources of funds have consisted principally of invested capital, cash flow from operations, debt financing and, since July 2001, net proceeds from our public offering of common stock. Our uses of those funds (other than for operations) have consisted principally of debt reduction, capital expenditures, payment of fines, liabilities and expenses in connection with investigations, lawsuits and claims and payment of restructuring costs.
We are highly leveraged, and we have substantial obligations in connection with antitrust investigations, lawsuits and claims. At June 30, 2003, after giving effect to our exchanges of Senior Notes for shares of common stock after July 1, 2003 as well as this offering and the initial application of the estimated net proceeds therefrom, we would have had total debt of $558 million and a stockholders' deficit of $177 million. See "Capitalization" in this prospectus supplement. In addition, we typically discount or factor a substantial portion of our accounts receivable and use the proceeds to reduce our debt. During the 2003 first half, certain of our subsidiaries sold receivables totaling $96 million. If we had not sold such receivables, our accounts receivable and our debt would have been about $48 million higher at June 30, 2003. We believe that we will have a net use of cash in operating and investing activities in 2003 and
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that we will generate positive cash flow from operating activities in 2004. At June 30, 2003, a substantial portion of our debt had variable interest rates. If we are required to pay or issue a letter of credit to secure payment of the EU fine, the payment would be financed by borrowing under (or secured by a letter of credit that would constitute a borrowing under) our revolving credit facility. Cash and cash equivalents were $8 million at June 30, 2003.
We are dependent on our revolving credit facility, the availability of which depends on continued compliance with the financial covenants under the Senior Facilities, for liquidity. We closely monitor compliance with the financial covenants and believe that we will remain in compliance for 2003.
Recent de-leveraging actions. We completed over $100 million in de-leveraging actions in the first three quarters of 2003. These actions consisted of the sale of our non-strategic composite tooling business for approximately $17 million, including a working capital adjustment of approximately $2 million, the sale of $400 million notional amount of interest rate swaps for cash proceeds of approximately $31 million and the exchange of $55 million aggregate principal amount of Senior Notes, plus accrued interest, for common stock. See also "Cash flows" in this prospectus supplement.
Long-term contractual, commercial and other obligations and commitments. The following tables summarize our long-term contractual obligations and other commercial commitments at June 30, 2003.
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Payment Due During |
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(dollars in millions) |
All Years |
Year Ending June 2004 |
Year Ending June 2005 |
Year Ending June 2006 |
Year Ending June 2007 |
Years Ending After June 2007 |
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Contractual and Other Obligations | |||||||||||||||||||
Long-term debt (a) | $ | 686 | $ | | $ | | $ | 12 | $ | 138 | $ | 536 | |||||||
Capital lease obligations | 2 | | | 1 | 1 | | |||||||||||||
Operating leases | 7 | 2 | 2 | 2 | 1 | | |||||||||||||
Unconditional purchase obligations | 50 | 8 | 8 | 8 | 6 | 20 | |||||||||||||
Total contractual obligations (a) | 745 | 10 | 10 | 23 | 146 | 556 | |||||||||||||
Estimated liabilities and expenses in connection with antitrust investigations and related lawsuits and claims | 94 | 3 | 23 | 27 | 25 | 16 | |||||||||||||
Postretirement, pension and related benefits | 131 | 14 | 10 | 10 | 11 | 86 | |||||||||||||
Other long-term obligations | 9 | | 2 | 1 | | 6 | |||||||||||||
Total contractual and other obligations (a) | $ | 979 | $ | 27 | $ | 45 | $ | 61 | $ | 182 | $ | 664 | |||||||
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Amount of Commitment |
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(dollars in millions) |
For All Years |
Expiring During Year Ending June 2004 |
Expiring During Year Ending June 2005 |
Expiring During Year Ending June 2006 |
Expiring During Year Ending June 2007 |
Expiring After June 2007 |
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Other Commercial Commitments | |||||||||||||||||||
Lines of credit | $ | 13 | $ | 13 | $ | | $ | | $ | | $ | | |||||||
Letters of credit | 16 | 16 | | | | | |||||||||||||
Guarantees | 1 | | | | 1 | | |||||||||||||
Total other commercial commitments | $ | 30 | $ | 29 | $ | | $ | | $ | 1 | $ | | |||||||
The first preceding table includes our reserve for estimated liabilities and expenses in connection with antitrust investigations and related lawsuits and claims, which includes the EU fine of €50.4 million. The timing of payment of the EU fine is not known and for purposes of this table is split between the columns captioned "payments due during year ending June 2005", "payments due during year ending June 2006", "payments due during year ending June 2007" and "payments due during years ending after June 2007" on the line entitled "estimated liabilities and expenses in connection with antitrust investigations and related lawsuits and claims." It is the policy of EU Competition Authority to negotiate appropriate terms of payment of antitrust fines, including extended payment terms. We have had discussions regarding such payment terms. We have also filed an appeal to the court challenging, among other things, the amount of the EU fine. We cannot predict how or when the court will rule on the appeal. While we cannot assure you that such will be the case, we believe the amount of the EU fine will be reduced on appeal and that, after such ruling, we will be permitted to pay the EU fine over an extended period. In addition, if we are required to pay (or issue a letter of credit to secure payment of) the EU fine, the payment would be financed by a borrowing under (or the letter of credit would constitute a borrowing under) our revolving credit facility. Such a requirement would result in a change in the manner in which such amount is reflected in the preceding tables.
Effective April 2001, we entered into a ten year service contract with CGI Group Inc. valued at $75 million. Pursuant to this contract, CGI provides a majority of our global information technology service requirements. We are dependent on CGI for these services. A failure by CGI to provide these services to us in a timely manner could have an adverse effect on our operations and results of operations. The first preceding table includes a line entitled "unconditional purchase obligations" that includes the minimum purchases under that contract. In September 2002, we entered into a ten year outsourcing contract with CGI to provide finance and accounting business process services valued at $36 million. That contract does not constitute an unconditional purchase obligation and therefore is not included in the first preceding table.
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The second preceding table includes a line entitled "lines of credit." These are local lines of credit established by our foreign subsidiaries for working capital purposes and are not part of our revolving credit facility.
Our pension benefit obligations were underfunded by about $70 million at June 30, 2003 as compared to $80 million at December 31, 2002. This decrease in underfunding was primarily due to the increase in asset values resulting from the increase in the capital markets in the U.S. in the first half of 2003. We value our pension assets and obligations for financial statement purposes on an annual basis.
Cash flow and plans to manage liquidity. As a result of our high leverage, our substantial obligations in connection with antitrust investigations, lawsuits and claims and our substantial other long-term contractual and commercial obligations and commitments, we have placed high priority on efforts to manage cash, generate additional cash flow and reduce debt. Our longer-term efforts include our 1998 major cost savings plan, our 2002 major cost savings plan and our other cost savings activities, our strategic alliances and our financing activities. Our shorter-term efforts include our interest rate management and working capital initiatives.
During the four years prior to 2002, we had positive annual cash flow from operations, excluding payments in connection with restructurings and investigations, lawsuits and claims. Typically, the first quarter of each year resulted in neutral or negative cash flow from operations (excluding payments in connection with restructurings and investigations, lawsuits and claims) due to various factors. Factors impacting seasonality included customer order patterns, customer buy-ins in advance of annual price increases, fluctuations in working capital requirements and payment of variable compensation with respect to the immediately preceding year. Typically, the other three quarters resulted in positive cash flow from operations (before such exclusions). The third quarter tended to produce relatively less positive cash flow primarily as a result of scheduled plant shutdowns by our customers for vacations. During 2002, we had negative cash flow from operations before such exclusions primarily due to negative net income before non-cash charges (credits) primarily from lower net sales and to a use of cash for working capital. We expect financial performance to improve in 2003 and to have positive cash flow from operations before such exclusions.
Our cash flow from operations (before such exclusions) in the first and third quarters is adversely impacted by the semi-annual interest payments on the Senior Notes. 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, collections, and accounts payable and payments thereof to seek to maximize our free cash at any given time and minimize accounts receivable losses. We typically discount or factor a portion of our accounts receivable. Certain of our subsidiaries sold receivables totaling $152 million in 2000, $223 million in 2001, $187 million in 2002, and $96 in the 2003 first half. Accounts receivable sold and remaining on the Consolidated balance sheets aggregated $1 million at December 31, 2002 and nil at June 30, 2003. If we had not sold such receivables, our accounts receivable and our debt would have been about $46 million higher at December 31, 2002 and about $48 million higher at June 30, 2003. If we were unable to factor our accounts receivable, our debt would increase, which could adversely affect our financial condition and compliance with the financial covenants under the Senior Facilities. In addition, careful management of credit risk over at least the past three years has allowed us to avoid
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significant accounts receivable losses notwithstanding the poor financial condition of many of our potential and existing customers. We cannot assure you that we will not be materially adversely affected by accounts receivable losses in the future.
We use, and are dependent on, funds available under our revolving credit facility as our primary source of liquidity. As a result, we are also dependent upon continued compliance with the financial covenants under the Senior Facilities. We believe that our cost savings and other initiatives will, over the next one to two years, continue to improve our cash flow from operations for a given level of net sales. Improvements in cash flow from operations resulting from these initiatives are being partially offset by associated cash implementation costs, while they are being implemented. We also believe that our planned sales of non-strategic assets 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 exchange or purchase Senior Notes in open market or privately negotiated transactions, opportunistically on terms that we believe to be favorable. These exchanges or purchases may be effected for cash (from cash on hand, borrowings under our revolving credit facility or new credit facilities, or proceeds from sale of debt or equity securities or assets), common stock or other equity or debt securities, or a combination thereof. We may at any time and from time to time seek and obtain consent from the lenders under the Senior Facilities with respect to any restrictions thereunder applicable to such transactions. 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.
Our high leverage and substantial antitrust related and other obligations could have a material impact on our liquidity. Cash flow from operations services payment of our debt and these obligations, thereby reducing funds available to us for other purposes. Our ability to service our debt as it comes due, including maintaining compliance with the financial covenants under the Senior Facilities, and to meet these and other obligations as they come due is dependent on our future financial and operating performance. This performance, in turn, is subject to various factors, including certain factors beyond our control. Our leverage and these obligations make us more vulnerable to economic downturns or in the event that these obligations are greater or timing of payment is sooner than expected.
We cannot assure you that our cash flow and capital resources will be sufficient to enable us to meet our obligations when due. Even if we are able to meet our obligations when due, we may not be able to comply with the covenants and other provisions under the Senior Facilities. These covenants and provisions include financial covenants relating to specified minimum interest coverage and maximum net senior secured debt leverage ratios that become more restrictive over time and representations regarding absence of material adverse changes affecting us. A failure to comply with these financial covenants and representations, unless waived by the lenders, would be a default under the Senior Facilities. This would permit the lenders to accelerate the maturity of the Senior Facilities. It would also permit the lenders to terminate their commitments to extend credit under our revolving credit facility. This would have an immediate material adverse effect on our liquidity. An acceleration of maturity of the Senior Facilities or a breach of the covenants contained in the Senior Notes would permit the holders of the Senior Notes to accelerate the maturity of the Senior Notes. Acceleration of
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maturity of the Senior Notes would permit the lenders to accelerate the maturity of the Senior Facilities and terminate their commitments to extend credit under our revolving credit facility. If we were unable to repay our debt to the lenders or holders, the lenders and holders could proceed against the collateral securing the Senior Facilities and the Senior Notes, respectively, and exercise all other rights available to them. At June 30, 2003, we were in compliance with the financial covenants under the Senior Facilities. Based on our current business plan, we believe we will remain in compliance with these covenants for 2003. 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. We cannot assure you that we would be able to obtain any such waiver or amendment on favorable terms or at all.
While our revolving credit facility provides for maximum borrowings of up to €200 million ($230 million, based on currency exchange rates in effect at June 30, 2003), our future ability to borrow under this 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 Senior Facilities. In addition, €25 million of the €200 million is reserved exclusively for use to pay or secure payment of the EU fine. At June 30, 2003, we had drawn $14 million under this facility with and the remaining $203 million (after consideration of outstanding letters of credit) was fully available. In addition, payment of the EU fine or issuance of a letter of credit to secure payment of the EU fine would significantly reduce the funds available under our revolving credit facility for operating and other purposes.
We believe that the long-term fundamentals of our business continue to be sound. Accordingly, although we cannot assure you that such will be the case, we believe that, based on our expected cash flow from operations, our expected resolution of our remaining obligations in connection with antitrust investigations, lawsuits and claims, and our existing capital resources, and taking into account our cost saving initiatives and working capital needs and our efforts to improve efficiencies and product quality, generate growth and cash flow and maximize funds available to meet our debt service and other obligations, we will be able to manage our liquidity to permit us to service our debt and meet our obligations when due.
Description of senior facilities, certain amendments thereto and senior notes. Descriptions of the Senior Facilities, certain amendments thereto and the Senior Notes are set forth in Note 5 to the interim Consolidated financial statements and Note 5 to the annual Consolidated financial statements contained in this prospectus supplement and are incorporated herein by reference.
Recent amendment to senior facilities. In September 2003, we obtained an amendment to the Senior Facilities which will become effective upon, among other things, completion of this offering (so long as the net proceeds therefrom exceed $75 million). The amendment provides us additional flexibility to, among other things, make investments and repurchase Senior Notes (up to a maximum of $35 million aggregate principal amount).
The amendment also provides for the exclusion from the calculation of the financial covenants the impacts of providing a letter of credit to secure payment of the EU fine and of additional charges against results of operations in connection with antitrust investigations and related lawsuits and claims due to accrued interest on the EU fine through the date of the court's decision on our appeal and translation of the EU fine (and accrued interest thereon) from
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euros into dollars. If this offering is not completed (or net proceeds therefrom do not exceed $75 million), we may obtain the benefit of, among other things, the provisions in the amendment described in this paragraph relating to the EU letter of credit and fine upon payment of an additional amendment fee.
Related party transactions. We have not, since January 1, 2000, engaged in or been a party to any material transactions with affiliates or related parties other than transactions with our subsidiaries (including Carbone Savoie and AET), compensatory transactions (including employee benefits, stock option and restricted stock grants, compensation deferral and executive employee loans and stock purchases) with directors or officers, and transactions with our 25%-owned joint venture with Jilin in China.
Special purpose entities. We have not been, since January 1, 2000, affiliated with or related to any special purpose entity other than GrafTech Finance.
Off-balance-sheet financings and commitments. We have not, since January 1, 2002, undertaken or been a party to any material off-balance-sheet financing arrangements or other commitments (including non-exchange traded contracts), other than:
Cash flows. In 2000, we generated cash from operating activities (including restructuring activities and antitrust-related payments) that exceeded the use of cash for capital expenditures. In general, during 2001, 2002 and the 2003 first half, we used cash in operating activities (including restructuring activities and antitrust-related payments) as well as for capital expenditures. Financing for these uses was provided primarily by net proceeds from our public offering of common stock in 2001 and our incurrence of long-term and short-term debt and, in the 2003 first half, the proceeds from sales of non-strategic assets and interest rate swaps.
Cash costs paid and expected to be paid in connection with the 1998 plan and the 2002 plan (including restructuring payments and severance costs) are described under "Repositioning our global manufacturing network and other initiatives" in this prospectus supplement. We believe that we will have a net use of cash in operating and investing activities in 2003 and that we will generate positive cash flow from operating activities in 2004.
Cash flow (used in) provided by operating activities. Cash flow used in operating activities was $25 million in 2003 first half as compared to $36 million in 2002 first half, an improvement of $11 million. The improvement was primarily due to a reduction of net losses from continuing
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operations. The net loss from continuing operations in the 2003 first half was $4 million as compared to a net loss in the 2002 first half of $12 million.
Cash flow used in operations was $60 million in 2002 as compared to cash flow provided by operations of $17 million in 2001, a decline of $77 million. This decline was primarily due to a decrease in net income before non-cash charges (credits) of $63 million from a positive $54 million in 2001 to a negative $9 million in 2002, primarily due to lower net sales. In addition, use of working capital increased $6 million.
Working capital was a use of $38 million of cash flow in 2002, an increase of $6 million from a use of $32 million of cash flow in 2001. The change in working capital occurred primarily due to a $38 million decrease in accounts payable and accruals, a $25 million increase in notes and accounts receivable and a $2 million increase in prepaid expenses and other current assets, largely offset by a $32 million decrease in inventories and a $27 million reduction in payments related to antitrust investigations and related lawsuits and claims and payments related to restructurings. Accounts payable and accruals declined primarily due to the mothballing of our Italian graphite electrode manufacturing operations, shutdown of our U.S. graphite electrode manufacturing operations and the high level of accounts payable at December 31, 2001. Accounts receivable increased primarily due to higher net sales in the 2002 fourth quarter as compared to the 2001 fourth quarter. Inventory levels decreased due to the mothballing and shutdown of our graphite electrode manufacturing operations.
Cash flow provided by operations was $17 million in 2001 as compared to cash flow provided by operations of $94 million in 2000. This decline of $77 million resulted primarily from an increase of $74 million in the use of cash flow for working capital. Net income before non-cash items charges (credits) and extraordinary items (net of tax) was stable at $55 million in each of 2000 and 2001.
Working capital was a use of $32 million of cash flow in 2001, a change of $74 million from a source of $42 million of cash flow in 2000. The change occurred primarily due to a $38 million increase in inventories, a $18 million increase in accounts payable, a $11 million increase in restructuring payments, and a $3 million increase in prepaid expenses, partially offset by a $7 million reduction in payments for antitrust fines and net settlements and expenses. Graphite electrode inventory levels increased primarily due to transitioning activities in connection with the shutdown of our U.S. graphite electrode manufacturing operations and lower than expected volume of graphite electrodes sold. Accounts payable increased primarily due to our cash management activities, partially offset by lower spending, including lower purchases of petroleum coke as excess inventories stockpiled following the explosion at one of ConocoPhillips' petroleum coke plants were reduced and lower production levels as demand for graphite electrodes and certain other products weakened during 2001.
Cash flow used in investing activities. Cash flow used in investing activities was $5 million in the 2003 first half as compared to $20 million in the 2002 first half. Capital expenditures in both the 2003 first half and the 2002 first half were $20 million. Capital expenditures in the 2003 first half related primarily to the expansion of graphite electrode manufacturing capacity, implementation of J.D. Edwards information systems and essential capital maintenance. In the 2003 first half, $15 million of cash was provided to investing activities from the sale of our non-strategic composite tooling business.
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We used $50 million of cash flow in investing activities during 2002 as compared to $39 million during 2001, in each case primarily for capital expenditures. The increase of $11 million was primarily due to an increase in capital expenditures. Capital expenditures in 2002 related primarily to expansion of manufacturing graphite electrode capacity in Mexico, expansion of cathode manufacturing capacity in France, J.D. Edwards information system implementation and essential maintenance.
We used $39 million of cash flow in investing activities during 2001 as compared to $50 million during 2000, in each case primarily for capital expenditures. The reduction of $11 million was primarily due to a reduction in capital expenditures that did not constitute strategic capital investments or essential maintenance.
Cash flow provided by financing activities. Cash flow provided by financing activities was $27 million during 2003 first half as compared to $66 million in 2002 first half. During the 2003 first half, we received proceeds of $31 million from the sale of interest rate swaps and $4 million from additional borrowings under our short-term debt facilities. We used these proceeds to fund, in part, the semi-annual interest payment on the Senior Notes, a dividend payment to minority stockholders in consolidated entities, a purchase of interest rate caps and a repayment of short-term debt borrowings. In the 2002 first half, we completed a private offering of $550 million of Senior Notes. Net proceeds were $538 million, which were used to repay term loans under the Senior Facilities, reduce the outstanding balance under our revolving credit facility and fund increased working capital.
Cash flow provided by financing activities was $79 million during 2002 as compared to cash flow provided by financing activities of $15 million in 2001. The increase of $64 million was primarily attributable to $557 million of proceeds from our sale of $550 million of Senior Notes in 2002, of which $392 million was used to repay other long term debt, $86 million was used to repay borrowings under our revolving credit facility and $21 million was used to pay financing costs. In addition, we received $10 million from the reset of interest rate swaps.
Cash flow provided by financing activities was $15 million during 2001 as compared to cash flow used in financing activities of $13 million in 2000. During 2001, we received net proceeds of $91 million from our public offering of common stock in July 2001, and $9 million from an additional minority investment in connection with the broadening of our strategic alliance in the cathode business with Pechiney, and made $84 million in net debt repayments. During 2000, we incurred $28 million of costs, fees and expenses in connection with our debt recapitalization in February 2000 and had an increase in net borrowing of $13 million.
Critical accounting policies
Critical accounting policies are those that require difficult, subjective or complex judgments by management, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.
Our significant accounting policies are described in Note 2 to the annual Consolidated financial statements. Not all of these significant accounting policies require management to make difficult, subjective or complex judgments. However, the following accounting policies could be deemed to be critical.
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Reliance on estimates. In preparing the Consolidated financial statements, we use and rely on estimates in determining the economic useful lives of our assets, obligations under our employee benefit plans, provisions for doubtful accounts, provisions for restructuring charges and contingencies, tax valuation allowances, evaluation of goodwill and other intangible assets, pension and post-retirement benefit obligations and various other recorded or disclosed amounts. Estimates require us to use our judgment. While we believe that our estimates for these matters are reasonable, if the actual amount is significantly different than the estimated amount, our assets, liabilities or results of operations may be overstated or understated.
Employee benefit plans. We sponsor various retirement and pension plans, including defined benefit, defined contribution plans and post retirement benefit plans that cover our employees worldwide. Accounting for these plans requires us to make judgments and assumptions about discount rates, expected return on plan assets, expected salary increases and health care cost trend rates. See Note 11 to the annual Consolidated financial statements for further detail on these rates and the effect of a change in these rates on our results of operations.
Financial instruments. Effective January 1, 2001, we adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and SFAS No. 138. The adoption did not have a significant impact on our consolidated financial position or results of operations. We are exposed to market risks primarily from changes in interest rates and currency exchange rates. We routinely enter into various transactions that have been authorized according to documented policies and procedures to manage well-defined currency exchange rate risks and interest rate risks. These transactions relate primarily to financial instruments described under "Quantitative and qualitative disclosures about market risks." 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. Accounting for financial instruments requires us to make judgments about the value of those instruments at specified dates. While we believe that our estimates of values are reasonable, if the actual values are significantly different than the estimated values, our assets, liabilities or results of operations may be overstated or understated.
Contingencies. We account for contingencies in accordance with SFAS No. 5, "Accounting for Contingencies." SFAS No. 5 requires that we record an estimated loss from a loss contingency when information available prior to issuance of the Consolidated financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the Consolidated financial statements and the amount of the loss can be reasonably estimated. Accounting for contingencies such as those relating to environmental, legal and income tax matters requires us to use our judgment. While we believe that our accruals for these matters are adequate, if the actual loss from a loss contingency is significantly different from the estimated loss, our results of operations may be overstated or understated.
Impairments of long-lived assets. We record impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted future cash flows estimated to be generated by those assets are less than the carrying amount of those assets. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated future net cash flows to be generated by the asset. If the asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the
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estimated fair value of the asset. Assets to be disposed are reported at the lower of the carrying amount or fair value less estimated costs to sell. If the actual value is significantly less than the estimated fair value, our assets may be overstated.
Inventories. We record the value of inventories at the lower of cost or market, and periodically review the book value of products and product lines to determine if they are properly valued. We also periodically review the composition of our inventories and seek to identify slow-moving inventories. In connection with those reviews, we seek to identify products that may not be properly valued and assess the ability to dispose of them at a price greater than cost. If it is determined that cost is less than market value, then cost is used for inventory valuation. If a write down to current market value is necessary, the market value cannot be greater than the net realizable value, sometimes called the ceiling (defined as selling price less costs to complete and dispose), and cannot be lower than the net realizable value less a normal profit margin, sometimes called the floor. Generally, we do not experience issues with obsolete inventory due to the nature of our products. If the actual value is significantly less than the recorded value, our assets may be overstated.
Accounting for income taxes. When we prepare the Consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. We record this amount as a provision for our taxes in accordance with SFAS No. 109, "Accounting for Income Taxes." This process requires us to make the following assessments:
If our estimates are incorrect, our assets or liabilities may be overstated or understated.
Recent accounting pronouncements
Descriptions of recent accounting pronouncements that affect us are set forth in Note 1 to the interim Consolidated financial statements and Note 2 to the annual Consolidated financial statements contained in this prospectus supplement and are incorporated herein by reference.
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Costs relating to protection of the environment
We have been and are subject to increasingly stringent environmental protection laws and regulations. In addition, we have an on-going commitment to rigorous internal environmental protection standards. Environmental considerations are part of all significant capital expenditure decisions. The following table sets forth certain information regarding environmental expenses and capital expenditures.
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Year Ended December 31, |
Six Months Ended June 30, |
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(dollars in millions) |
2000 |
2001 |
2002 |
2002 |
2003 |
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Expenses relating to environmental protection | $ | 14 | $ | 12 | $ | 10 | $ | 4 | $ | 4 | |||||
Capital expenditures related to environmental protection | 6 | 3 | 2 | $ | 1 | $ | 1 | ||||||||
Quantitative and qualitative disclosures about market risk
We are exposed to market risks primarily from changes in interest rates and currency exchange rates. We routinely enter into various transactions that have been authorized according to documented policies and procedures to manage well-defined currency exchange rate risks and interest rate 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. We implement interest rate management initiatives to seek to minimize our interest expense and optimize our portfolio of fixed and variable interest rate obligations. Use of these initiatives is allowed under the Senior Notes and Senior Facilities.
Our interest rate swaps described below are designated as hedging the exposure to changes in the fair value of the related debt (called a fair value hedge). The swaps are marked-to-market daily, and we are required to provide cash collateral to the counterparty to the extent that the negative mark-to-market exceeds $15 million. At September 18, 2003, the negative mark-to-market was $15 million. The fair value of the hedge at the end of a quarterly or annual period is recorded on the Consolidated balance sheets on the line entitled "fair value of hedged debt obligation." When we sell swaps, the gain or loss realized is amortized as a credit or charge to interest expense over the remaining term of the Senior Notes. In the 2003 first half, we realized proceeds of $31 million with respect to the sale of swaps, which will be amortized as a credit to interest expense over the remaining term of the Senior Notes.
In the 2002 second quarter, we entered into two ten-year interest rate swaps for a total notional amount of $250 million to effectively convert that amount of fixed rate debt (represented by Senior Notes) to variable rate debt. These swaps reduced our interest expense in 2002 by $6 million. In the 2002 third quarter, we sold the total notional of $250 million of swaps to allow the accelerated collection of $10 million in cash. We subsequently entered into two interest rate swaps for the total notional amount of $250 million to effectively convert that amount of fixed rate debt to variable rate debt.
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In the 2003 first quarter, we entered into an additional $200 million notional amount interest rate swap (bringing our total notional amount of swaps to $450 million) through the remaining term of the Senior Notes, effectively converting that amount of fixed rate debt to variable rate debt. Subsequently in the 2003 first quarter, we sold the entire $450 million notional amount of swaps for $10 million in cash. Following the sale of the swaps, in the 2003 first quarter, we entered into $350 million notional amount of interest rate swaps through the remaining term of the Senior Notes. Subsequently, in the 2003 second quarter, we entered into an additional $50 million notional amount interest rate swap (bringing our total notional amount of swaps to $400 million). The swaps reduced our interest expense by approximately $3 million during the 2003 second quarter and by approximately $6 million during the 2003 second half. Subsequently, we sold the total notional amount of $400 million of swaps to allow for the accelerated collection of $21 million in cash in the 2003 second quarter. The proceeds from the sale of the swaps are being amortized over the term of the Senior Notes and recorded as a credit against interest expense.
In July 2003, we entered into an additional interest rate swap for a notional amount of $500 million to effectively convert that amount of fixed rate debt to variable rate debt. In September 2003, we sold $15 million notional amount of swaps. At September 18, 2003, our interest rate swaps related to $485 million notional amount of debt in the aggregate.
In the 2003 first quarter, we entered into interest rate caps for a notional amount of $300 million. In the 2003 second quarter, we also entered into additional interest rate caps for a notional amount of $200 million (bringing our total notional amount of caps to $500 million through August 2007). The adjustment for the fair value of the hedged debt obligation was $8 million at December 31, 2002 and nil at June 30, 2003 and has been recorded as part of other assets in the Consolidated balance sheet. The adjustment for the fair value of the interest rate caps was $2 million for the 2003 first half, and has been recorded as a charge to other expense (income), net, in the Consolidated statements of operations.
Our exposure to changes in currency exchange rates results primarily from:
When we deem it appropriate, we may attempt to limit our risks associated with changes in currency exchange rates through both operational activities and financial instruments. Financial instruments may be used to attempt to hedge existing exposures, firm commitments and, potentially, anticipated transactions. We use these instruments to reduce risk by essentially creating offsetting currency exposures. These instruments include forward exchange contracts and purchased foreign currency option contracts, and are primarily used to attempt to hedge net global currency exposures relating to euro-denominated debt and identifiable foreign currency receivables, payables and commitments. Forward exchange contracts are agreements to exchange different currencies at a specified future date and at a specified rate. Purchased foreign currency option contracts 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
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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.
We held contracts against these risks with an aggregate net notional amount of about $56 million at December 31, 2002 and $17 million at June 30, 2003. All of our contracts mature within one year. All of our contracts are marked-to-market monthly. Gains and losses are recorded as unrealized gains and losses in other expense (income), net. When we sell the instruments, we record net cumulative realized gain or loss with respect to the instruments in other expense (income), net. Unrealized gains and losses on outstanding foreign currency contracts were not material at December 31, 2000, nil at December 31, 2001, a loss of $3 million at December 31, 2002, a loss of $2 million for the 2002 first half and a loss of $2 million for the 2003 first half.
We used a sensitivity analysis to assess the potential effect of changes in currency exchange rates and interest rates on reported earnings for the 2003 first half. 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 2002 by about $4 million and for the 2003 first half by about $2 million. A hypothetical increase in interest rates of 100 basis points across all maturities would have increased our interest expense for 2002 by about $7 million and for the 2003 first half by about $4 million.
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We are one of the world's largest manufacturers and providers of high quality synthetic and natural graphite and carbon products and related technical and research and development services. We manufacture graphite electrodes and cathodes, products essential to the production of electric arc furnace steel and aluminum. We also manufacture thermal management, fuel cell and other specialty graphite and carbon products for, and provide services to, the electronics, power generation, semiconductor, transportation, petrochemical and other metals markets. We have 13 state-of-the-art manufacturing facilities strategically located on four continents, in more diverse locations than the facilities of any of our competitors. We have customers in more than 70 countries, including industry leaders such as Arcelor, Nucor and Bao Steel in steel, Alcoa, Pechiney and Alcan in aluminum, Cisco, IBM and Intel in electronics, MEMC Electronic Materials in semiconductors and Ballard Power Systems in fuel cells.
We have the largest share of the worldwide market for electrodes and cathodes. We have a uniquely positioned global manufacturing network, which we believe cannot be replicated by any of our competitors due to the capital investment, technology and process know-how required to do so. We believe that our network has the largest manufacturing capacity, has the lowest manufacturing cost structure of all of our major competitors and delivers the highest quality products. Over the last few years, we have rationalized our graphite electrode and cathode facilities and redeployed capacity to larger facilities in lower cost countries. This allows us to achieve significant increases in productivity and output from our existing assets, including economies of scale and other cost savings that we believe will increase as we grow our sales. We believe that our network provides us with the operational flexibility to source customer orders from the facility that optimizes our profitability and, with the continuing consolidation in the steel and aluminum industries, provides us a significant growth opportunity in serving larger multi-plant global customers.
We believe that we are the industry leader in graphite and carbon materials science and high temperature processing know-how, and we operate the premier research, development and testing facilities in our industry. We have over 100 years of experience in the research and development of these technologies, and our intellectual property portfolio is extensive.
We believe that our technological capabilities for developing products with superior thermal, electrical and physical characteristics provide a differentiating advantage. These capabilities have enabled us to accelerate development and commercialization of our technologies to exploit markets with high growth potential for us, including products for electronic thermal management and fuel cell applications.
We have developed, over the past two years, natural graphite electronic thermal management products and secured product approvals and purchase commitments from a wide range of industry leaders, such as Cisco, IBM and Intel, based on superior thermal performance, weight, adaptability and cost characteristics as compared to alternative products. Thermal management products are designed to dissipate heat generated by electronic devices. We expect demand for our products to grow as industry trends continue toward smaller, more powerful electronic devices which generate more heat and require more advanced thermal management solutions.
We are the leading manufacturer of natural graphite products for PEM fuel cells and fuel cell systems. Fuel cells provide environmentally friendly electrical power generation. We expect
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continued commercialization of fuel cells, encouraged by current governmental programs and driven by concerns relating to the U.S. electrical power grid, environmental protection, foreign oil dependency and other factors. We estimate that the market for our fuel cell products in 2012 will exceed $500 million. About 85% of the 175 fuel cell products expected to be operational worldwide in 2003 and 2004 are or will be powered by Ballard Power Systems fuel cells. Our products are essential components of those fuel cells. Ballard Power Systems, the world leader in PEM fuel cells, is our strategic partner under an exclusive product supply agreement that continues through 2016 and an exclusive collaboration agreement that continues through 2011.
Our businesses are organized around three lines of business:
Business strategies
Our goal is to create stockholder value by maximizing cash flow from operations, and our business strategies are designed to expand upon the competitive advantages that our initiatives have created.
Leveraging Our Unique Global Manufacturing Network. We repositioned our global manufacturing network by, among other things, shutting down four of our higher cost graphite electrode manufacturing facilities and redeploying capacity to our six remaining larger, lower cost, strategically located facilities. We also shutdown cathode and advanced synthetic graphite manufacturing capacity and redeployed it to lower cost facilities and expanded our advanced flexible graphite manufacturing capacity.
We believe that our unique global manufacturing network provides us with significant competitive advantages in costs and product quality, proximity to customers, timely and reliable delivery and operational flexibility to adjust product mix to meet the diverse needs of a wide range of customers. We believe we can further exploit this advantaged manufacturing network by redirecting our marketing and sales efforts toward and focusing our superior technical and customer service capabilities on:
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Our activities have a customer driven focus, and we continually seek to identify customer needs and adjust our products and services to better service those needs. We believe that, in many cases, the growing larger global customer created by the continuing consolidation trend within the steel and aluminum industries are more creditworthy than other customers and that we are able to better manage our exposure to trade credit risk as we increase the percentage of our total net sales sold to these customers.
We believe that our graphite electrode and cathode businesses have the leading market shares in the world and we expect for 2003 our worldwide market share to be:
We sell these products in every major geographic market. Sales of these products outside the U.S. accounted for about 81% of our net sales in 2002 and about 64% in the 2003 first half. No single customer or group of affiliated customers accounted for more than about 6% of our total net sales in 2002 or about 4% in the 2003 first half.
We have a strategic alliance with Pechiney, the world leader in aluminum smelting technology. We believe that this alliance strengthens our position as the quality leader in the low cost production of high quality graphite cathodes. We believe that our advanced graphite cathode technology is enabling us to increase our market share of graphite cathodes sold upon the commencement of operation of the new, more efficient aluminum smelting furnaces that are being built, even as older furnaces are being shut down.
We believe that we are the manufacturer best positioned to supply natural graphite products to the electronic thermal management and fuel cell markets. We are one of the world's largest manufacturers of natural graphite for these markets as well as for automotive and petrochemical applications. We believe that, in 2002, our worldwide market share was 26%. We believe that we operate the most technologically sophisticated advanced natural graphite production line in the world. We have strategic alliances with leading chip makers and others in electronic thermal management and with Ballard Power Systems, the world leader in PEM fuel cell technology.
Delivering exceptional and consistent quality. We believe that our products are among the highest quality products available in our industry. We have been awarded preferred or certified supplier status by many major steel and aluminum companies and have received numerous technological innovation and other awards by industry groups, customers and others. Using our technological capabilities, we continually seek to improve the consistent overall quality of our products and services, including the performance characteristics of each product, the uniformity of the same product manufactured at different facilities and the expansion of the range of our products. We believe that improvements in overall quality create significant efficiencies for us, provide us the opportunity to increase sales volumes and market share, and create market opportunities for us and production efficiencies for our customers.
Providing superior technical service. We believe that we are the recognized industry leader in providing value added technical services to customers for our major product lines. We believe that we have the largest technical service and related supporting engineering and scientific organizations in our industry, with more than 245 engineers, scientists and specialists around
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the world. Our employees assist key steel and other metals customers in furnace design, operation and upgrade to reduce energy consumption, improve raw material costs and increase output. In addition, our employees assist customers and others who design, develop or produce electronic devices to integrate our advantaged flexible graphite product solutions into their new devices.
Accelerating commercialization of advantaged technologies. We believe that our leading technological and manufacturing capabilities and strengths provide us with a significant growth opportunity as well as a competitive advantage. We seek to exploit these capabilities across all of our businesses to improve existing products, such as supersize graphite electrodes used in the most demanding electric arc steel production furnaces and high performance graphite cathodes that have become the preferred technology in the industry, and to develop and commercialize new products for markets with high growth potential for us. We have analyzed our intellectual property portfolio to identify new product opportunities in markets with high growth potential for us, redirected research to enhance and exploit our portfolio and accelerated development of products for those markets. Among other things, we developed patented advanced pin technology for graphite electrodes, patented processing technology for high performance graphite cathodes, products for PEM fuel cells that are enabling fuel cell commercialization, and new electronic thermal management technologies with over 130 product approvals from industry leading strategic partners, customers and others.
We also believe that our strategic partners have entered into alliances with us due to, among other things, the strength of our technology and our research and development capabilities.
In September 2003, we received R&D Magazine's prestigious R&D 100 Award, granted to identify the 100 most technologically significant products and advancements each year, for our achievements in electronic heat sink products.
Pursuing cost savings. In January 2002, we announced a major cost savings plan that we believe is the most aggressive cost reduction plan being implemented in our industry. We are targeting cumulative recurring annual pre-tax cost savings of $30 million in 2003, $60 million in 2004 and $80 million in 2005. Savings achieved under the 2002 plan are additive to those which we achieved by the end of 2001 under the 1998 Plan. In addition, we are also targeting $50 million of additional asset sales by the end of 2004. We believe that these savings and asset sales will further enhance our performance.
As part of the 2002 plan, we are continuing to implement global work process changes, including consolidation and streamlining of our order fulfillment, purchasing, finance and accounting and human resource processes, and identification and implementation of outsourcing opportunities. These activities are targeted for completion by the end of 2004.
We intend to sell real estate, non-strategic businesses and certain other non-strategic assets over the next eighteen months. Through September 18, 2003, we have completed sales aggregating $20 million. We anticipate that the aggregate estimated pre-tax cash proceeds from these sales will total $30 million in 2003 and $75 million by the end of 2004.
Lines of business
Carbon is one of the fundamental elements and is capable of forming an enormous variety of compounds. As a result of these characteristics, carbon is one of the most widely used elements in manufacturing processes of all kinds. Graphite is the crystalline form of carbon. Graphite can
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be processed to be resistant to corrosive materials, withstand high temperatures and act as either a conductor of, or an insulator from, heat and electricity. Graphite is both manmade (called "synthetic graphite") and occurs naturally (called "natural graphite"). Synthetic graphite is made primarily from petroleum coke, a by-product of petroleum refining. Natural graphite is a mined mineral that is processed to increase its purity.
Synthetic graphite line of business
Our synthetic graphite line of business manufactures and delivers high quality graphite electrodes, cathodes and advanced synthetic graphite products as well as related services. Electrodes and cathodes are key components of the conductive power systems used to produce steel, aluminum and other non-ferrous metals. Advanced synthetic graphite products include primary and specialty products for transportation, semiconductor and other markets. Graphite electrodes accounted for about 72% of the net sales of this line of business in 2002 and about 73% in the 2003 first half. Cathodes are manufactured by our subsidiary, Carbone Savoie, and accounted for about 17% of the net sales of this line of business in 2002 and about 16% in the 2003 first half.
We estimate that, in 2002, the worldwide market for graphite electrodes and cathodes was about $2.5 billion. Customers for these products are located in all major geographic markets.
Graphite electrodes.
Use of graphite electrodes in electric arc furnaces. There are two primary technologies for steel making:
Graphite electrodes are consumed primarily in electric arc furnace steel production, the steel making technology used by all "mini-mills," typically at a rate of one graphite electrode every eight to ten operating hours ("a stick a shift"). Electric arc furnace steel makers are called "mini-mills" because of their historically smaller capacity as compared to basic oxygen furnace steel makers and because they historically served more localized markets. Mini-mills constitute the higher long term growth sector of the steel industry. Graphite electrodes are also consumed in the refining of steel in ladle furnaces and in other smelting processes such as production of titanium dioxide.
Electrodes act as conductors of electricity in the furnace, generating sufficient heat to melt scrap metal, iron ore or other raw materials used to produce steel or other metals. The electrodes are consumed in the course of that production.
Electric arc furnaces that produce steel typically range in size from those that produce about 25 metric tons of steel per production cycle to those that produce about 150 metric tons per production cycle. Electric arc furnaces operate using either alternating or direct electric current. The vast majority of electric arc furnaces use alternating current. Each of these furnaces typically uses nine electrodes (in three columns of three electrodes each) at one time. The other electric arc furnaces, which use direct current, typically use one column of three electrodes. The size of the electrodes varies depending on the size of the furnace, the size of the furnace's electric transformer and the planned productivity of the furnace. In a typical furnace using alternating current and operating at a typical number of production cycles per day, one of the
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nine electrodes is fully consumed (requiring the addition of a new electrode), on average, every eight to ten operating hours. The actual rate of consumption and addition of electrodes for a particular furnace depends primarily on the efficiency and productivity of the furnace. Therefore, demand for graphite electrodes is directly related to the amount and efficiency of electric arc furnace steel production.
Electric arc furnace steel production requires significant heat (as high as 5,000 degrees Fahrenheit, which we believe is the hottest operating temperature in any industrial or commercial manufacturing process worldwide) to melt the raw materials in the furnace, primarily scrap metal. Heat is generated as electricity (as much as 150,000 amps) passes through the electrodes and creates an electric arc between the electrodes and the raw materials.
Graphite electrodes are currently the only products available that have the high levels of electrical conductivity and the capability of sustaining the high levels of heat generated in an electric arc furnace producing steel. Therefore, graphite electrodes are essential to the production of electric arc furnace steel. We believe that there are currently no commercially viable substitutes for graphite electrodes in electric arc furnace steel making. We estimate that, on average, the cost of graphite electrodes represents about 3% of the cost of producing steel in a typical electric arc furnace.
Electric arc furnace steel production has, for many years, been the higher long term growth sector of the steel industry, at an estimated average annual growth rate of about 3%. Graphite electrode demand is expected to grow over the long term at an estimated average annual growth rate of about 1% to 2%. There are currently in excess of 2,000 electric arc steel production furnaces operating worldwide. Worldwide electric arc furnace steel production grew from about 90 million metric tons (about 14% of total steel production) in 1970 to about 285 million metric tons (about 34% of steel production) in 2000, 279 million metric tons in 2001 (about 33% of steel production) and 299 million metric tons (about 33% of total production) in 2002. We estimate that steel makers worldwide added net new electric arc furnace steel production capacity of about 13 million metric tons in 2000, about 11 million metric tons in 2001 and about 15 million metric tons in 2002. We believe that a portion of the new capacity added in the past three years has not yet become operational. We are aware of about 23 million metric tons of announced new electric arc furnace steel production capacity that is scheduled to be added in 2003 through 2005.
After an electric arc steel production furnace has been commissioned, the cost and time required to suspend and recommence production due to operational, economic or other factors is relatively low and short as compared to a basic oxygen steel production furnace. As a result, electric arc furnace steel producers are better able to reduce and increase production to respond to changes in demand and prices for steel. This ability has resulted in fluctuations in electric arc furnace steel production over the past five years, as economic conditions affecting demand for steel have fluctuated. The following table illustrates the growth in electric arc steel production since 1970.
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Worldwide steel production
(Millions of metric tons)
Sources: International Iron and Steel Institute and GTI estimates
We believe that, in a strong and sustained recovery in global economic conditions, electric arc furnace steel production will strengthen significantly.
Relationship between graphite electrode demand and electric arc furnace steel production. We believe that the worldwide growth in electric arc furnace steel production has been due primarily to improvements in the cost effectiveness and operating efficiency of electric arc furnace steel making. We believe that growth has also been due to the fact that, as a result of technical advances, electric arc furnace steel makers are capable of producing the majority of the product lines that are produced by basic oxygen furnace steel makers.
The improved efficiency of electric arc furnaces has resulted in a decrease in the average rate of consumption of graphite electrodes per metric ton of steel produced in electric arc furnaces. We estimate that specific consumption declined from about 4.3 kilograms of graphite electrodes per metric ton of steel produced in 1990 to about 2.4 kilograms per metric ton in 2002. We believe that, on average, as the costs (relative to the benefits) increase for electric arc furnace steel makers to achieve significant further efficiencies in specific consumption, the decline in specific consumption will continue at a more gradual pace. We further believe that the rate of decline in the future will be impacted by the addition of new electric arc furnace steel making capacity. To the extent that this new capacity replaces old capacity, it has the effect of reducing industry wide specific consumption due to the efficiency of new electric arc furnaces. To the extent that this new capacity increases industry wide electric arc furnace steel production capacity and that capacity is utilized, it creates additional demand for graphite electrodes. While we believe that the rate of decline of specific consumption over the long term has become lower, we believe that there was a slightly greater decline in 2001 than would otherwise have been the case due to the shutdown of older, less efficient electric arc furnaces primarily due to industry rationalization and weak global and regional economic conditions.
The fluctuations in electric arc steel production reflected in the preceding table resulted in corresponding fluctuations in demand for graphite electrodes. Other than in China, for which reliable information is generally not available, we believe that the graphite electrode industry
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manufacturing capacity utilization rate was about 94% in 2000, about 89% in 2001, about 90% in 2002 and about 95% in the 2003 first half. In 2002, we believe that graphite electrode manufacturing capacity worldwide (excluding China, for which reliable information is generally not available) was about 800,000 metric tons.
Production capacity. Currently, there is only one other global manufacturer and about ten other notable regional or local manufacturers of graphite electrodes. There have been no entrants in the synthetic graphite industry for more than 50 years.
Since 1998, we have reduced our graphite electrode manufacturing capacity by about 55,000 metric tons, net of the expansion of our facility in Mexico and incremental expansions in our other facilities. We shutdown four graphite electrode manufacturing facilities in Canada, Germany, the U.S. and Italy, and redeployed capacity to our six remaining larger, lower cost, strategically located facilities in Mexico, South Africa and Spain. In addition, from 1998 through 2002, two of our competitors reduced their annual graphite electrode manufacturing capacity. Their announced reductions totaled more than 35,000 metric tons. Two of our graphite electrode competitors, who had about 60,000 metric tons of annual graphite electrode manufacturing capacity, are subject to bankruptcy proceedings. The competitor in the U.S. announced in April 2003 that it sold a portion of its graphite electrode capacity to a third party bidder in a bankruptcy auction process. We believe that, since 1998, worldwide graphite electrode manufacturing capacity has been reduced by about 13%, assuming closure of the facilities of our bankrupt competitors.
During the 2002 second quarter, we launched the expansion of our facility in Mexico to increase its capacity from 40,000 metric tons to about 60,000 metric tons annually. We completed the expansion during the 2003 first quarter. We believe that this facility is now the largest graphite electrode manufacturing facility in the world and strengthens our ability to supply demand from the large NAFTA market on a low cost basis.
As a result of repositioning our global manufacturing network and other actions, as well as our proprietary process and technological improvements, we now have the capability, depending on product demand and mix, to manufacture more than 220,000 metric tons of graphite electrodes annually from our existing assets.
We believe that there are significant barriers to entrants to our industry, including the need for extensive product and process know-how and other intellectual property and a high initial capital investment. We are not aware of any "greenfield" construction of new graphite electrode manufacturing facilities. We believe that we can significantly expand our graphite electrode capacity at a cost that is less than 15% of the initial investment for "greenfield" capacity and which we believe is significantly less than any of our competitors would have to invest for comparable expansion.
Graphite electrode market share. We estimate that about 62% of the electric arc furnace steel makers worldwide (other than in China, for which reliable information is not generally available) and about 84% of the electric arc furnace steel makers in the U.S. and the markets where we have manufacturing facilities purchased all or a portion of their graphite electrodes from us in 2002. We further estimate that we supplied about 45% of all graphite electrodes purchased in the U.S. and the markets where we have manufacturing facilities and about 19% worldwide, in each case in 2002. We estimate that the worldwide market for graphite electrodes was about $2 billion in 2002.
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We estimate that, in 2002, sales in the U.S. accounted for about 19% of our total net sales of graphite electrodes and that we sold graphite electrodes in over 70 countries, with no other country accounting for more than 11% of our total net sales of graphite electrodes.
Over the past several years, we estimate that we increased our share of the worldwide market for graphite electrodes by more than 10%, from 19% in 2001 to about 21% in 2003. In addition to increased volumes, this shift in our customer base enables us to further optimize efficiencies and reduce costs.
We believe that, in many cases, the growing larger global customers created by the continuing consolidation trend within the steel and aluminum industries are more creditworthy than smaller producers and that we are able to better manage our exposure to trade credit risk as we increase the percentage of our total net sales sold to them.
Cathodes. Cathodes consist primarily of blocks used as floor lining for, and conductors of electricity in, furnaces (called "pots") used to smelt aluminum. Cathodes are made from either carbon or graphite. Cathodes are currently the only products available that have the high levels of electrical conductivity and the capability of surviving the highly corrosive high temperature environments in an aluminum smelting furnace. We believe that there are no current commercially viable substitutes for cathodes in aluminum smelting furnaces. In a typical aluminum smelting furnace operating at a typical rate and efficiency of production, the cathodes must be replaced every 5 to 8 years. Since cathodes are used in the construction of pots, demand for them is directly related to both the number of new aluminum smelting furnaces being built and the frequency with which existing furnaces are upgraded and relined.
We operate our cathode business through a 70% owned joint venture with Pechiney, the world's recognized leader in aluminum smelting technology. We have developed high performance graphite cathodes that have become the preferred technology in the industry. We are using Pechiney's smelting technology and our graphite technology and expertise in high temperature industrial applications to develop further improvements in graphite cathodes. We believe that use of graphite cathodes (instead of carbon cathodes) allows a substantial improvement in process efficiency.
We believe that worldwide demand for aluminum will continue to grow over the long term at an average annual rate of about 3% to 4%, primarily because of greater use of aluminum by the transportation industry and higher growth in demand in China. We also believe that, over the long term, new aluminum smelting furnaces will need to be built to meet the growth in demand. We believe, therefore, that demand for graphite cathodes will continue to grow, both for new smelting furnaces as well as for substitution for carbon cathodes in relines and upgrades of existing smelting furnaces. Demand for our cathodes continues to be strong.
We believe that we are the largest manufacturer of cathodes in the world. In 2002, we expanded the manufacturing capacity of our Brazilian facility, the only non-captive manufacturer of cathodes in the Americas. We estimate that we sold about 16% of the cathodes sold in the world in 2002. There are seven producers of cathodes in the world (excluding those located in Russia and China, about whom reliable information is generally not available, and captive producers who manufacture cathodes to meet a portion of the needs of their parent aluminum companies). We estimate that the worldwide market for cathodes was about $450 million in 2002.
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Advanced synthetic graphite products. Advanced synthetic graphite products include isomolded, molded and extruded products in a variety of shapes and grades, weighing from a few kilograms to ten metric tons, for diverse applications. These materials include primary products (such as bulk graphite blocks (called "billets") that are sold to customers for further processing or finishing for end users) and specialty products (such as pressure casting molds for steel railroad car wheels).
Our isomolded products are used in applications including continuous casting and hot press manufacturing processes and resistance heating elements. Our molded products are used in applications including high temperature furnaces and crucibles, chemical processing equipment and pressure and centrifugal casting equipment. Our extruded products are used in applications including fused refractories, diamond drill molds and semiconductor components as well as in applications in aluminum smelting.
We manufacture our advanced synthetic graphite products using raw materials, processes and technologies similar to those we use to make graphite electrodes and cathodes. We estimate the worldwide market for advanced synthetic graphite products was about $450 million in 2002.
Natural graphite line of business
Our natural graphite line of business manufactures natural graphite products and provides related services and technologies for both established markets and new markets with high growth potential for us. We invented natural graphite products, consisting of advanced flexible graphite products and flexible graphite products. We currently sell these products primarily to the electronic thermal management and fuel cell power generation markets. We provide cost effective engineering and other technical services and license our proprietary technology in markets where we do not anticipate engaging in manufacturing ourselves. Our natural graphite products are developed and manufactured by our subsidiary, AET.
Advanced flexible graphite products include highly engineered thermal interface products, heat spreaders and heat sinks for electronic device applications. They also include highly engineered flow field plates, gas diffusion layers and other advanced flexible graphite products for PEM fuel cells and fuel cell systems for use in the power generation and transportation markets. Flexible graphite products include gasket and sealing material for high temperature and corrosive environments in automotive, petrochemical and other applications. We are one of the world's largest manufacturers of natural graphite products for all of these uses and applications.
The versatility of our proprietary processes and equipment enables us to modify natural graphite products to meet a variety of customer needs. We work with our customers to develop technologically advanced solutions, utilizing our industry-leading technological and manufacturing strengths and capabilities.
Electronic thermal management products. Thermal management products are designed to dissipate heat generated by electronic devices. Electronics manufacturers are currently experiencing constraints in the development of ever more advanced devices because of the limitations of current thermal management products and technologies to dissipate the higher levels of heat generated. We have developed and are continuing to develop and introduce highly engineered advanced flexible graphite products that improve thermal management in
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electronic devices. We expect demand for our products to grow as industry trends continue toward smaller, more powerful electronic devices which generate more heat and require more advanced thermal solutions.
Advanced flexible graphite products include highly engineered thermal interface products, heat spreaders and heat sinks for current and next generation electronic device applications, including computers, servers, televisions, digital video devices, cell phones and other communications, industrial, military, office and automotive equipment. Thermal interface products reside between a chip set or other heat generating unit in a device and the remaining components in the heat dissipation system in the device. Heat sinks are finned units (similar to radiators) that dissipate heat via air movement into the surrounding environment. Heat spreaders are engineered plates or tubes that move or spread heat from hot spots, such as a processing chip, to other locations in the device for dissipation into the environment.
We expect that the superior ability of our products to manage heat will allow our customers and others to redesign electronic devices to reduce cost, size and weight while improving performance. Our products offer many advantages over competitive products, such as copper or aluminum. These advantages include:
Our product lines include eGRAF heat spreaders, heat sinks and other thermal management products and eGRAF Hi-Therm thermal interface materials. We can provide both custom and off-the-shelf products and sophisticated solutions for cooling complex electronic devices.
During 2002, we began commercializing our line of eGRAF thermal management products. Since then, we have obtained orders for eGRAF products from industry leading electronic companies such as Agilent, Cisco, Hitachi, IBM, Intel, Nortel, Nokia and Maxtor. In addition, we have over 130 product approvals from strategic partners, customers and others. Among others, we have obtained approvals in the 2003 first half from IBM for eGRAF heat spreaders for certain notebook computer applications, Sony for eGRAF heat spreaders in computer and television screen applications and Samsung for eGRAF products for its new plasma screen televisions. We also obtained approval from Intel for eGRAF Hi-Therm thermal interface materials for applications in several Intel® processors, including the Pentium®4 processor.
We estimate that the market for our current products is about $300 million and expect it to grow at an annual rate in excess of 20% over the next three years. Sales of our products are growing, from about $500,000 in 2002 to an estimated $2 million in 2003 and an estimated $8 million in 2004, based on orders received to date.
We believe that the thermal management component market for computers, servers, televisions, digital video devices, cell phones and other communications, industrial, military, office and automotive equipment was about $3 billion in 2001.
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Fuel cell products. We are the leading manufacturer of natural graphite products for PEM fuel cells and fuel cell systems. We manufacture highly engineered flow field plates, gas diffusion layers and other advanced flexible graphite products for PEM fuel cells and fuel cell systems for use in transportation and power generation applications.
Fuel cells were invented in 1839 and were first used in practical applications in the 1960s in NASA's Gemini and Apollo space programs to provide electricity aboard spacecrafts. Fuel cells provide environmentally friendly electrical power generation by combining hydrogen (which can be obtained from a variety of sources such as methanol, natural gas and other fuels) with oxygen (from air, not necessarily pure) to produce electricity through an electrochemical process without combustion. The only material by-products from this process are water and heat. We believe that PEM fuel cells have emerged as the leading fuel cell technology because they offer higher power, lower weight and lower costs relative to alternative fuel cell technologies. PEM fuel cells have the potential for use as replacements for existing power generation markets in:
We expect significant growth from this opportunity in the second half of this decade.
Ballard Power Systems, the world leader in PEM fuel cells, is our strategic partner under an exclusive product supply agreement that continues through 2016 and an exclusive collaboration agreement that continues through 2011. Our products are essential components of its fuel cells.
Transportation market. We believe that manufacturers of automobiles, buses and other vehicles are searching for a viable alternative to the internal combustion engine. We also believe that PEM fuel cells have the potential to provide the power of an internal combustion engine, to reduce or eliminate polluting emissions, and to lower vehicle operating costs through higher fuel efficiency and lower maintenance costs. Advanced flexible graphite products are used in PEM fuel cells and fuel cell systems. We market our advanced flexible graphite products for fuel cell applications under the GRAFCELL® name. In June 2002, according to PricewaterhouseCoopers, the use of fuel cell systems in the global transportation market was projected to reach 1.6 million units by 2011.
We believe, based on actual revenues and statements by Ballard Power Systems customers and other automobile manufacturers, that commercial sales of PEM fuel cells for use in automobiles began in late 2002 and have increased and will continue to increase in 2003. Ballard Power Systems has announced that about 85% of the 175 fuel cell vehicles expected to be operational worldwide in 2003 and 2004 are or will be powered by its fuel cells.
We believe that the significant market opportunities for fuel cell vehicles will be supported by governmental programs. In January 2002, the Bush administration launched a new program called FreedomCAR aimed at spurring the growth of hydrogen fuel cells for cars and trucks. In January 2003, the Bush administration launched FreedomFUEL, focusing on technologies and infrastructure needed to produce, distribute and store hydrogen for fuel cells. About $1.7 billion of funding is proposed over the next five years under these programs. The
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European Union and Japan have each announced similar initiatives, and the U.S. and the European Union have agreed to cooperate to overcome barriers to fuel cell commercialization.
In the 2003 first half, we received orders from Ballard Power Systems valued at more than $1 million for fuel cell products for use in Ballard Power Systems Mark 902 fuel cells. We estimate that the market for our fuel cell products in 2012 will exceed $500 million.
Stationary power market. Fuel cells have the potential to provide electric power for residential, commercial and industrial stationary applications. Long-term increases in electric power demand for these applications are expected, driven by continued growth of digital communications systems and infrastructures and industrialization of developing nations as well as continued population and personal income growth. We believe that demand for technologies such as fuel cells will be driven by requirements for uninterruptible electric power with a high degree of reliability and distributed power generation capability as well as environmental concerns. Commercial sales are expected to begin with residential and general stationary systems in 2003. In June 2002, PricewaterhouseCoopers estimated that the North American market for stationary fuel cells will be about $7 billion in 2011.
Portable power market. Fuel cells have the potential to provide electric power currently provided by rechargeable and nonrechargeable batteries in many portable electronic devices used in consumer, construction, marine and industrial applications. The fastest growing market opportunity is expected to be laptop computers, cell phones and personal digital assistants and other handheld devices. In June 2002, PricewaterhouseCoopers estimated that the North American market for portable devices is estimated to be 150 million units by 2011, with an estimated value of $3.7 billion. Commercial sales are expected to begin with small portable device applications in 2003.
Sealing products. Flexible graphite is lightweight, conformable, temperature-resistant and inert to most chemicals. Due to these characteristics, it is an excellent gasket and sealing material that to date has been used primarily in high temperature and corrosive environments in the automotive and petrochemical industries. For example, automotive applications for our flexible graphite products include head gaskets and exhaust gaskets as well as engine and exhaust heat shields. We market our flexible graphite products under the GRAFOIL® name.
Industrial thermal management products. Advanced flexible graphite products provide superior heat management solutions for insulation packages, induction furnaces, high temperature vacuum furnaces and direct solidification furnaces and other industrial thermal management applications. We market our advanced flexible graphite products for these applications under the GRAFSHIELD® name. We believe that the market for these products was about $200 million worldwide in 2001.
Advanced carbon materials line of business
Our advanced carbon materials line of business includes carbon electrodes and refractories as well as related services. We use proprietary "hot press" technology to manufacture our refractories.
Carbon electrodes. Carbon electrodes are used in the production of silicon metal, a raw material primarily used in the manufacture of aluminum. Carbon electrodes are also used in the production of ferro-alloys and thermal phosphorous. Carbon electrodes are used and consumed in a manner similar to that of graphite electrodes, although at lower temperatures
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and with different consumption rates. We believe that demand for carbon electrodes fluctuates based primarily on changes in production of silicon metal. We also believe that the silicon metal industry is directly impacted by changes in global and regional economic conditions. We estimate that demand for carbon electrodes was about 86,000 metric tons in 2000 and about 69,000 metric tons in each of 2001 and 2002.
We estimate that we sold about 26% of the carbon electrodes sold in the world in 2002. We estimate that the worldwide market for carbon electrodes was about $110 million in 2002. There are two significant manufacturers of carbon electrodes in the world. We are the only manufacturer of carbon electrodes in the Western Hemisphere.
Refractories. Refractories are made in a multitude of standard and custom shapes and sizes. Smaller refractories are sometimes called refractory bricks and larger ones are sometimes called refractory blocks. Graphite is added to some carbon refractories (called "semi-graphitic" refractories) to adjust performance characteristics. Carbon and semi-graphitic refractory bricks are used primarily as chemical industry tank and reactor linings and blast furnace and submerged arc furnace hearth walls. These refractory bricks have excellent resistance to corrosion and abrasion. Our carbon refractory brick is one of the established standards for North American blast furnaces. Our semi-graphitic refractory brick is used where higher conductivity is required or when additional abrasion resistance is desired.
We also manufacture graphite refractory bricks which are used primarily for their high thermal conductivity and the ease with which they can be machined to large or complex shapes. Common applications in blast furnace and submerged arc furnaces are cooling courses in the hearth bottoms for heat distribution and removal, backup linings in hearth walls for improved heat transfer and safety, and lintels over copper cooling plates where a single brick cannot span the cooling plate.
Carbon refractory blocks are used primarily as submerged arc and other furnace hearth walls and bottoms, for which they are machined to shape and assembled in a variety of designs. We also provide special shapes (such as sidewall blocks, tap blocks, tuyere surrounds and runner liners) for blast furnaces, submerged arc furnaces and cupola furnaces.
Production planning, product manufacturing and distribution
Over the last few years, we have rationalized our facilities and redeployed capacity to larger facilities in lower cost countries. The repositioning of our network allows us to achieve significant increases in productivity and output from our existing assets, including economies of scale and other cost savings that we believe will increase as we grow our sales. For example, we are able to deliver the same graphite electrode sales volume that we delivered over the past few years with a significantly lower fixed cost base. In addition, we believe that our network provides us with the operational flexibility to source customer orders from the facility that optimizes our profitability and, with the continuing consolidation in the steel and aluminum industries, provides us a significant growth opportunity in serving larger multi-plant global customers. We believe that our unique network provides us with significant competitive advantages in costs and product quality, proximity to customers, timely and reliable delivery and operational flexibility to adjust product mix to meet the diverse needs of a wide range of customers. We also believe that our products are among the highest quality products available in our industry.
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Planning.
We plan and source our graphite electrode and cathode production globally. We have evaluated virtually every aspect of our global supply chain, and we have redesigned and implemented changes to our global manufacturing, marketing and sales processes to leverage the strengths of our global manufacturing network. Among other things, we have eliminated manufacturing bottlenecks, improved product and service quality and delivery reliability, expanded our range of products, and improved our global sourcing and product mix for our customers. We continue to implement global work process changes, including the consolidation and streamlining of our order fulfillment and purchasing processes. These activities are targeted for completion by the end of 2004.
We deploy synchronous work processes at most of our manufacturing facilities. We have also installed and continue to install and upgrade proprietary process technologies at our synthetic graphite manufacturing facilities and use statistical process controls in our manufacturing processes.
We have developed, and begun installing, a global information system using J.D. Edwards One World information systems for both enterprise resource planning and advanced production planning for managing our supply chains. The advanced planning capabilities that we have developed for our global synthetic graphite manufacturing capacity allow us to use our modularized capacity to seek to optimize, under then current conditions, timely product delivery to customers and changes in variables affecting profitability, including variable production costs, changes in currency exchange rates and changes in product mix. These capabilities also enable us to seek to maximize capacity utilization at as many of our facilities as possible as well as minimize our average fixed production cost per unit produced. Our global manufacturing network also helps us to minimize risks associated with dependence on any single economic region.
Manufacturing.
Electrodes and cathodes. The manufacture of a graphite electrode takes, on average, about two months. Graphite electrodes range in size from three inches to 30 inches in diameter and two feet to nine feet in length and weigh between 20 pounds and 4,800 pounds (2.2 metric tons).
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The manufacture of graphite electrodes involves the six main processes described below:
Forming: | Calcined petroleum coke is crushed, screened, sized and blended in a heated vessel with coal tar pitch. The resulting plastic mass is extruded through a forming press and cut into cylindrical lengths (called "green" electrodes) before cooling in a water bath. | |
Baking: |
The "green" electrodes are baked at about 1,400 degrees Fahrenheit in specially designed furnaces to purify and solidify the pitch and burn off impurities. After cooling, the electrodes are cleaned, inspected and sample-tested. |
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Impregnation: |
Baked electrodes are impregnated with a special pitch when higher density, mechanical strength and capability to withstand higher electric currents are required. |
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Rebaking: |
The impregnated electrodes are rebaked to solidify the special pitch and burn off impurities, thereby adding strength to the electrodes. |
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Graphitizing: |
Using a process that we developed, the rebaked electrodes are heated in longitudinal electric resistance furnaces at about 5,000 degrees Fahrenheit to restructure the carbon to its characteristically crystalline form, graphite. After this process, the electrodes are gradually cooled, cleaned, inspected and sample-tested. |
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Machining: |
After graphitizing, the electrodes are machined to comply with international specifications governing outside diameters, overall lengths and joint details. Tapered sockets are machine-threaded at each end of the electrode to permit the joining of electrodes in columns by means of correspondingly double-tapered machine-threaded graphite nipples (called "pins"). |
Cathodes range in size from 5 feet to 12 feet and weigh between 800 pounds and 3,700 pounds. Graphite cathodes are manufactured by a comparable process. Carbon electrodes (which can be up to 55 inches in diameter) and carbon cathodes are manufactured by a comparable process (excluding impregnation and graphitization). Refractories are manufactured using a process comparable to that for carbon electrodes or a proprietary "hot press" process. We believe that we manufacture the broadest range of sizes in graphite electrodes and cathodes and that the quality of our electrodes and cathodes is competitive with or better than that of comparable products of any other major manufacturer.
We generally warrant to our customers that our electrodes and cathodes will meet our specifications. Electrode and cathode returns and replacements have aggregated less than 1% of net sales in each of the last three years.
As a result of repositioning our global manufacturing network and other actions, together with our proprietary process technology, we now have the capability, depending on product demand and mix, to incrementally manufacture more than 220,000 metric tons of graphite electrodes and more than 40,000 metric tons of cathode annually from our existing assets. We
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also have the capacity to manufacture about 30,000 metric tons of carbon electrodes annually. The following table sets forth certain information regarding our sales volumes:
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For the Year Ended December 31, |
For the Six Months Ended June 30, |
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(Metric tons) |
2000 |
2001 |
2002 |
2002 |
2003 |
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Volume of graphite electrodes sold | 217,000 | 174,000 | 180,000 | 87,000 | 98,000 | |||||
Volume of cathodes sold | 35,000 | 33,000 | 37,000 | 19,000 | 20,000 | |||||
Volume of carbon electrodes sold | 23,000 | 19,000 | 17,000 | 9,000 | 10,000 | |||||
Graphite electrodes are manufactured in Brazil, Mexico, South Africa, France, Spain and Russia. Cathodes are manufactured in France and Brazil. Carbon electrodes and refractories are manufactured in the U.S.
Advanced synthetic graphite products. Advanced synthetic graphite products are manufactured by a process comparable to that for graphite electrodes. Our facilities have the capability to process a wide range of raw materials, mill, mix and extrude or mold small to very large graphite blocks, impregnate, bake and graphitize the blocks, purify the blocks to reduce the impurities to parts per million levels, and machine the blocks using advanced machining stations to manufacture products finished to high tolerances and unique shapes. Advanced synthetic graphite products are manufactured in the U.S. and France.
Natural graphite. We use a proprietary process to convert mined natural graphite flake into expandable graphite, an intermediate product. During this process, we can manufacture expandable graphite with a number of specific properties. For example, we can change its sensitivity to temperature, modify its particle size and give it long term stability. We manufacture flexible graphite by further processing expandable graphite. We fabricate finished gasket and sealing products by fabricating flexible graphite into sheet, laminate and tape products. We manufacture advanced flexible graphite by subjecting expandable or flexible graphite to additional proprietary processing. These additional processing steps alter the properties and characteristics of the graphite to make materials with modified electrical, thermal and strength characteristics.
Our natural graphite line of business operates two state-of-the-art manufacturing facilities in the U.S. These facilities have the capability to chemically treat natural graphite flake, bake the flake in high temperature furnaces to expand the graphite flake, mechanically form and calender the expanded flake, and form and shape intermediate and finished products. We believe that we operate the world's most technologically sophisticated advanced natural graphite production line.
Quality standards and maintenance. Certain of our global manufacturing facilities are certified and registered to QS-9000, the U.S. quality standard, as well as ISO-9002, the international quality standard. Our natural graphite line of business has a quality assurance system designed to meet the most stringent requirements of its customers. Major maintenance at our facilities is conducted on an ongoing basis.
Raw materials and suppliers. The primary raw materials for electrodes and cathodes are engineered by-products and residues of the petroleum and coal industries. We use these raw materials because of their high carbon content. The primary raw materials for graphite electrodes and graphite cathodes are calcined petroleum cokes (needle coke for electrodes and
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regular grade cokes for cathodes), coal tar pitch and petroleum pitch. The primary raw materials for carbon electrodes and carbon cathodes are calcined anthracite coal and coal tar pitch and, in some instances, a petroleum coke-based material. The primary raw material for our natural graphite products is natural graphite flake.
We purchase raw materials and energy from a variety of sources. In many cases, we purchase them under short term contracts or on the spot market, in each case at fluctuating prices. We believe that adequate supplies of these raw materials are available at market prices. We entered into a strategic alliance with ConocoPhillips, the largest producer of petroleum coke, to improve the supply chain for our primary raw material and, since the beginning of 2001, we have purchased a majority of our requirements for petroleum coke, at variable prices, from multiple plants of ConocoPhillips under a supply agreement that continues through the end of 2006. In addition, in 2001, we shut down our coal calcining operations primarily because we entered into a five-year agreement to purchase calcined coal from a third party at a competitive cost. These agreements contain customary terms and conditions. We believe that the quality and cost of these raw materials on the whole is competitive with or better than those available to our major competitors and that, under current conditions, these raw materials are available in adequate quantities. We also believe that we are able to purchase these raw materials on a more cost efficient basis than our competitors who have more limited product lines and production volumes.
We purchase natural graphite flake from a variety of sources. We believe that adequate supplies of natural graphite flake are available at market prices. We entered into an arrangement with Mazarin Mining Corporation to develop and commercialize a natural graphite deposit in Canada. The initial phase of a feasibility study, relating to the quality of the natural graphite flake in the deposit, was completed in 2000 with favorable results. The second phase of the feasibility study is expected to be completed by the end of 2004. The feasibility study is expected to cost us about $2 million, for which we will receive a 25% interest in the mine. After completion of the study, we may decide to commence commercial production of the deposit with Mazarin, exercise an option to extend the period for the development decision for five one-year periods until 2009, or terminate the arrangement. In the case of extension, we will have to make option payments totaling Cdn. $800,000 if the option is extended for the full five years. We have the right to purchase the entire production of natural graphite flake from the deposit. We believe that at full capacity, if developed, the deposit should produce about 50,000 tons of natural graphite flake per year, which would make it one of the largest single sources of natural graphite flake in the world. We believe that, if developed, the deposit would have sufficient reserves to meet our projected needs for the next 10 to 15 years. Consummation of the arrangement is subject to, among other things, the receipt of any required governmental approvals.
Electric power or natural gas used in manufacturing processes is purchased from local suppliers primarily under short-term contracts or in the spot market. We have entered into fixed rate cost contracts with certain of our North American natural gas suppliers in order to mitigate certain increases in our natural gas costs. These contracts expire at various times during the 2004 second and fourth quarters.
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Distribution.
Our graphite electrode customers generally seek to negotiate prices and anticipated volumes on an annual basis. These customers then generally place orders for graphite electrodes three to six months prior to the desired delivery date. These orders are cancelable by the customer. Therefore, we manufacture graphite electrodes and seek to manage graphite electrode inventory levels to meet rolling sales forecasts. We generally seek to maintain an appropriately low level of finished graphite electrode inventories, taking into account these factors and the length of graphite electrode manufacturing cycles. Recently, we have entered into long term supply contracts with purchasers of our carbon electrodes. Our other products are generally manufactured or fabricated to meet customer orders. We may, however, from time to time in the future, enter into long term supply contracts with purchasers of graphite electrodes or our other products. Currently, we do not manage or operate based on backlog.
Finished products are generally stored at our manufacturing facilities. Limited quantities of some finished products are also stored at local warehouses around the world to meet customer needs. We ship our finished products to customers primarily by truck and ship, using "just in time" techniques where practical. Accordingly, inventory levels will vary with demand for finished products.
Proximity of manufacturing facilities to customers can provide a competitive advantage in terms of cost of delivery of electrodes and cathodes. The significance of these costs is affected by fluctuations in exchange rates, methods of shipment, import duties and whether the manufacturing facilities are located in the same economic trading region as the customer. We believe that our manufacturing facilities are uniquely located around the world to supply graphite electrodes and cathodes globally and that the locations of our facilities provide us with a significant competitive advantage.
Sales and customer service
We believe that we are the recognized industry leader in providing value added technical services to customers for our major product lines and that we have the largest customer technical service and related supporting engineering and scientific organizations in our industry, with more than 245 engineers, scientists and specialists around the world. As part of the redesign and implementation of changes to our global business and work processes, we have redirected marketing and sales activities to better service the needs of both existing and new customers.
Synthetic graphite business. Our synthetic graphite line of business sells products in every major geographic market primarily through its direct sales force, whose members are trained and experienced with our products. Its direct sales force operates from about 17 sales offices located around the world. It also sells products through independent sales agents and distributors.
Our synthetic graphite line of business has customer technical service personnel based around the world who assist customers to maximize their production and minimize their costs. It employs about 160 engineers and technicians to provide technical service and advice to key steel and other metals customers in furnace design, operation and upgrade to reduce energy consumption, improve raw material costs and increase output. In connection therewith, it recently developed and is now providing Virtual Monitor 2 to key electric arc furnace steel
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producers. Virtual Monitor 2 is a customizable, computer-based furnace data collection and analytic service with real time, online capabilities. It is a fully integrated, next generation service that we believe is not available from any other source and is particularly valuable to multi-plant customers. We believe that our synthetic graphite line of business has more technical service engineers located in more countries than any of its competitors.
The sales and service groups of our synthetic graphite line of business include those dedicated to cathodes who are employed by Carbone Savoie. Carbone Savoie's sales and service groups work closely with those of Pechiney, which is our 30% joint venture partner in Carbone Savoie, to maximize use of their respective products and technologies.
Natural graphite business. Our natural graphite line of business has eight direct field sales employees in the U.S. and two in Europe. It also sells products through independent sales agents and distributors. Its customer service personnel, supported by a staff of more than 40 development scientists and manufacturing engineers, assist customers in learning about and using our products, improving their manufacturing processes and operations, and solving their technical dilemmas. A particular focus is assisting customers and others who design, develop or produce electronic devices to integrate our advantaged flexible graphite product solutions into their new devices.
Advanced carbon materials business. Our advanced carbon materials line of business sells products through the direct global sales force of our synthetic graphite line of business, located in all of its major markets, as well as through independent agents and distributors. Its U.S. sales office coordinates the activities of an experienced sales staff and these agents and distributors. Our experienced engineering staff provides technical service to customers around the world. It provides specialized technical assistance to submerged arc and other furnace operators with regard to product performance, furnace monitoring and operations analysis. We believe that its customer technical service staff is highly regarded.
Technology
We believe that we are the industry leader in graphite and carbon materials science and high temperature processing know-how and that we operate the premier research, development and testing facilities in our industry. We have over 100 years of experience in the research and development of graphite and carbon technologies. Over the past several years, we have analyzed our intellectual property portfolio to identify new product opportunities in markets with high growth potential for us, redirected research to enhance and exploit our portfolio and accelerated development of products for those markets.
Research and development. We conduct our research and development both independently and in conjunction with our strategic partners, customers and others. We have two dedicated technology centers, one in Ohio, which is used by all of our lines of business, and the other in France, which is used by Carbone Savoie. We also have a pilot plant located in Ohio that has the capability to produce small or trial quantities of new or improved synthetic or natural graphite products. In addition, we have a state-of-the-art testing facility located in Ohio capable of conducting physical and analytical testing for those products as well as process technology. The activities at these centers and facilities are integrated with the efforts of our engineers at our manufacturing facilities who are focused on improving manufacturing processes.
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We believe that our technological and manufacturing strengths and capabilities provide us with a significant growth opportunity as well as a competitive advantage and are important factors in the selection of us by industry leaders and others as a strategic partner. Our technological capabilities include developing products with superior thermal, electrical and physical characteristics that provide a differentiating advantage. We seek to exploit these strengths and capabilities across all of our businesses, to improve existing products and to develop and commercialize new products for markets with high growth potential for us. In particular, we believe that our research and development capabilities were an important factor in the selection of us by Ballard Power Systems to enter into an exclusive long term product development and collaboration agreement.
Developments by us include larger and stronger graphite electrodes, new chemical additives to enhance raw materials used in the manufacture of graphite electrodes, patented advanced pin technology for graphite electrodes, improved supersize graphite electrodes for the most demanding electric arc steel producing furnaces, cold pastes with reduced environmental impact for use with cathodes, patented processing technology for high performance graphite cathodes which have become the preferred products in the industry, products for PEM fuel cells that are enabling fuel cell commercialization, and new electronic thermal management technologies with over 130 product approvals from industry leading strategic partners, customers and others. We have been awarded preferred or certified supplier status by many major steel and aluminum companies and have received numerous technological innovation and other awards by industry groups, customers and others. In September 2003, we received R&D Magazine's prestigious R&D 100 Award, granted to identify the 100 most technologically significant products and advancements each year, for our achievements in electronic thermal management heat sink products.
A significant portion of our research and development is focused on new product development, including achievement of the objectives of our strategic alliances with companies that use or specify the use of electronic thermal management technologies and our strategic alliance with Ballard Power Systems for PEM fuel cells.
Technology licensing and technical services. We offer, through licensing contracts, rights to use our intellectual property to other firms developing or manufacturing products. We also provide, through service contracts, research and development services, extensive product testing services (such as high temperature testing and analysis), high temperature heat treating services, graphite and carbon process and product technology consulting and development services, and information services to customers, suppliers and universities to assist in their development of new or improved process and product technology. Among other things, we provide cost-effective technical services for a broad range of markets and license our proprietary technology for a broad range of applications through our web site. The web site includes technical papers on graphite and carbon science, technical literature and search assistance, and industry news as well as access to our services.
Intellectual property. We believe that our intellectual property, consisting primarily of patents and proprietary know-how and information, particularly the intellectual property relating to electronic thermal management and fuel cell power generation, provides us with competitive advantages and is important to our growth opportunities. Our intellectual property portfolio is extensive, with over 350 U.S. and foreign patents and 290 U.S. and foreign pending patent applications, which we believe is more than any of our major competitors. Among our
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competitors, we hold the largest number of patents for flexible graphite as well as the largest number of patents relating to the use of natural graphite for PEM fuel cell applications. In addition, we have obtained exclusive and non-exclusive licenses to various U.S. and foreign patents relating to our technologies. These patents and licenses expire at various times over the next two decades. About 86% of our patents were granted within the past four years.
We own, and have obtained licenses to, various trade names and trademarks used in our businesses. For example, the trade name and trademark UCAR are owned by Union Carbide Corporation (which has been acquired by Dow Chemical Company) and are licensed to us on a worldwide, exclusive and royalty-free basis until 2015. This particular license automatically renews for successive ten-year periods. It permits non-renewal by Union Carbide commencing after the first ten-year renewal period upon five years' notice of non-renewal. The trade name and trademark CARBONE SAVOIE are owned by Carbone Savoie and are used in connection with cathodes manufactured by it. The trademark CARBONE SAVOIE is registered in many countries throughout the world.
We rely on patent, trademark, copyright and trade secret laws as well as appropriate agreements to protect our intellectual property. Among other things, we seek to protect our proprietary know-how and information, through the requirement that employees, consultants, strategic partners and others, who have access to such proprietary information and know-how, enter into confidentiality or restricted use agreements.
Strategic alliances
We pursue strategic alliances that strengthen our business, enhance our research and development initiatives or support our new product commercialization activities. Strategic alliances may be in the form of joint venture, licensing, supply or other arrangements.
Synthetic graphite business. We have a strategic alliance in the cathode business with Pechiney, the world's recognized leader in aluminum smelting technology. Pechiney uses its technology in its own smelting operations and licenses its technology to other aluminum producers. Under our alliance, Pechiney is a 30% joint venture partner in our subsidiary, Carbone Savoie, which holds our entire cathode manufacturing capacity. With this alliance, we believe that we are positioned as the quality leader in the low cost production of graphite cathodes, the preferred technology for deployment in new aluminum smelting furnaces due to their ability to provide substantial improvements in process efficiency. We are using Pechiney's smelting technology and our graphite technology and expertise in high temperature industrial applications to develop further improvements in graphite cathodes. Our cathodes are sold to Pechiney for use in its own plants under a requirements contract that remains in effect through 2006 and are marketed to Pechiney's licensees as to well as other aluminum producers.
In April 2001, we entered into a joint venture with Jilin to produce and sell high-quality graphite electrodes in China. If successfully implemented, the joint venture would utilize renovated capacity at Jilin's main facility in Jilin City and complete additions at another facility in Changchun that were begun by Jilin. During the 2002 fourth quarter, we wrote-off our investments associated with this joint venture as a result of uncertainty about the completion and start-up of the facilities due to the effects that the challenging 2002 graphite electrode industry conditions had on Jilin. We continue to work closely with Jilin on production alternatives.
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In the 2001 fourth quarter, we entered into a strategic alliance with AMI GE, S.A. de C.V., a Mexican company that is 50%-owned by General Electric. AMI GE is a supplier of furnace regulators and other furnace equipment. Based in Mexico, AMI GE is seeking to expand its services globally. Under the alliance, AMI GE will market our technical services to steel producers and others. We believe that the range and quality of our technical services will provide a competitive advantage to AMI GE, and AMI GE will provide us with opportunities to increase sales of our products and services to new and existing customers.
In December 2000, we entered into a license and technical services agreement with ConocoPhillips to license our technology for use at a carbon fiber manufacturing facility that ConocoPhillips was building in Oklahoma. In February 2003, ConocoPhillips announced that it would no longer be pursuing its carbon fiber initiative. Work under the agreement has been postponed until the parties have had an opportunity to discuss the implications of this announcement.
Natural graphite business. In May 2001, we entered into a product manufacturing services agreement with JBC Seals, Packing & Kits, which expands our ability to produce high volume, custom eGRAF thermal interface and other electronic thermal management products.
In July 2001, we entered into a thermal design joint development agreement with Menova Engineering relating to the design and development of thermal components and heat solution products for computer and communications applications using eGRAF thermal management products. Menova will work exclusively with us in the design and testing of new, graphite-based thermal solutions.
We have been working with Ballard Power Systems since 1992 on developing natural graphite products for use in its PEM fuel cells. In 2000, Ballard Power Systems launched its Mark 900 series fuel cell stack and announced that it was the foundation for future Ballard Power Systems' fuel cells for transportation, stationary and portable applications. The flow field plates used in the Mark 900 are made from our GRAFCELL® advanced flexible graphite products. In October 2001, Ballard Power Systems launched its most advanced PEM fuel cell platform to date, the Mark 902. GRAFCELL® advanced flexible graphite products are a strategic material for the Mark 902. Building upon the Mark 900, the advantages of the Mark 902 include lower cost, improved design for volume manufacturing, improved reliability, higher power density and enhanced compatibility with customer system requirements. The unit cell design of the Mark 902 allows scalable combinations to achieve a variety of power outputs ranging from 10 kilowatt to 300 kilowatt and is designed to allow configuration for stationary and transportation applications.
In June 2001, we entered into an exclusive development and collaboration agreement and an exclusive long term supply agreement with Ballard Power Systems, which significantly expand the scope and term of prior agreements. In addition, Ballard Power Systems became a strategic investor in AET, investing $5 million in shares of Ballard Power Systems' common stock for a 2.5% equity ownership interest, to support the development and commercialization of natural graphite products for PEM fuel cells. As an investor in AET, Ballard Power Systems has rights of first refusal with respect to certain equity ownership transactions, tag along and drag along rights, and preemptive and other rights to acquire additional equity ownership under certain limited circumstances.
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The scope of the current exclusive development and collaboration agreement includes natural graphite products, including flow field plates and gas diffusion layers, for use in PEM fuel cells and fuel cell systems for transportation, stationary and portable applications. The initial term of this agreement extends through 2011. Under the new supply agreement, we will be the exclusive manufacturer and supplier of natural graphite products for Ballard Power Systems' fuel cells and fuel cell systems, other than those natural graphite products which Ballard Power Systems elects in the future to manufacture for itself. The initial term of this agreement, which contains customary terms and conditions (including certain license and royalty provisions), extends through 2016. We have the right to manufacture and sell, after agreed upon release dates, natural graphite products for use in PEM fuel cells to other fuel cell producers.
Competition
Synthetic graphite and advanced carbon materials businesses. Competition in the graphite electrode, cathode, advanced synthetic graphite and advanced carbon materials businesses is based primarily on price, product quality and customer service.
There is only one other global manufacturer and about ten other notable regional or local manufacturers of graphite electrodes, including SGL Carbon, (whose facilities are located on only two continents, Europe and North America, virtually all of which are located in higher cost countries), and four manufacturers in Japan (one of whom, Showa Denko Carbon has a plant located in the U.S.).
Global and regional economic conditions and antitrust investigations, lawsuits and claims are having an impact on the graphite electrode industry. We believe that, at a minimum, these impacts include increased price competition and increased debt or cost burdens, or both, for most manufacturers in the industry. In October 2001, The Carbide/Graphite Group filed for bankruptcy protection and, in December 2002, ceased operations. In April 2003, it announced that it sold a portion of its graphite electrode capacity to a third party bidder in a bankruptcy auction process. In late 2002, a German competitor filed for bankruptcy protection and, in early 2003, ceased operations. It is possible that other competitors could make similar bankruptcy filings. It is not uncommon for companies subject to bankruptcy filings to enjoy, at least temporarily, a cost advantage as compared to their competitors. This advantage enables them to compete more aggressively on price. It is also possible that one or more of our competitors could divest graphite electrode manufacturing facilities. These divestitures could increase the number or change the capabilities of our competitors.
There are seven notable manufacturers of cathodes in the world. We believe that we and SGL Carbon are the largest manufacturers in the world. There are two significant manufacturers of carbon electrodes in the world, us and SGL Carbon. There are about five significant manufacturers of advanced synthetic graphite products in the world.
We believe that there are no current commercially viable substitutes for graphite electrodes in electric arc steel production furnaces or cathodes in aluminum smelting furnaces. We are aware of commercially viable technologies that are competitive with carbon electrodes.
We believe that there are significant barriers to entrants to our industry, including the need for extensive product and process know-how and other intellectual property and a high capital investment. It also requires high quality raw material sources and a developed energy supply infrastructure. There have been no entrants in the synthetic graphite industry for more than
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50 years. We are not aware of any "greenfield" construction of new graphite electrode manufacturing facilities and believe that it is unlikely that new "greenfield" graphite electrode manufacturing facilities will be built during the next several years by existing competitors or entrants due to, among other things, the relatively high initial capital investment. It is possible that one or more of our synthetic graphite competitors could incrementally expand their synthetic graphite manufacturing capacity.
Natural graphite business. Competition in the natural graphite business with respect to existing products is based primarily on quality and price. Competition with respect to services and new products is based primarily on product and service innovation, performance and cost effectiveness as well as customer service, with the relative importance of these factors varying among services, products and customers.
Competitors include companies located around the world that develop and manufacture natural graphite products, including SGL Carbon and Le Carbone, and companies that develop, manufacture or provide substitute or alternative materials, products, services or solutions. We are one of the largest manufacturers of natural graphite products in the world.
Our electronic thermal management products compete with a wide variety of materials, including copper and other metals, ceramics, conductive rubbers and greases. Our fuel cell products compete with other graphitic products, including fibers, composites and synthetic graphite, and metal products such as stainless steel. Our sealing and gasket products compete with various fiber products such as asbestos, cellulose and synthetic composites as well as stainless steel and other metals. Our fire retardant products compete with compounds containing phosphates, halogens and hydrated aluminas as well as many other materials. Our industrial thermal management products compete with a wide variety of materials, including natural and synthetic fibers, other carbon forms and metal products.
Environmental matters
We are subject to a wide variety of federal, state, local and foreign laws and regulations relating to the presence, storage, handling, generation, treatment, emission, release, discharge and disposal of hazardous, toxic and other substances and wastes governing our current and former properties and neighboring properties and our current operations. These laws and regulations (and the enforcement thereof) are periodically changed and are becoming increasingly stringent. We have experienced some level of regulatory scrutiny at most of our current and former facilities, and have been required to take remedial action and incurred related costs, in the past and may experience further regulatory scrutiny, and may be required to take further remedial action and incur additional costs, in the future. Although this has not been the case in the past, these costs could have a material adverse effect on us in the future.
The principal U.S. laws and regulations to which we are subject include the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, the Safe Drinking Water Act and similar state and local laws which regulate air emissions, water discharges and hazardous waste generation, treatment, storage, handling, transportation and disposal. In addition, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act of 1986 and the Small Business Liability Relief and Brownfields Revitalization Act of 2002, and similar state laws provide for responses to and liability for releases of hazardous substances into the environment. The Toxic
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Substances Control Act and related laws are designed to assess the risk of new products to health and to the environment at early developmental stages. Finally, laws adopted or proposed in various states impose or may impose, as the case may be, reporting or remediation requirements if operations cease or property is transferred or sold.
Our manufacturing operations outside the U.S. are subject to the laws and regulations of the countries in which those operations are conducted. These laws and regulations primarily relate to pollution prevention and the control of the impacts of industrial activities on the quality of the air, water and soil. Regulated activities include, among other things: use of hazardous substances; packaging, labeling and transportation of products; management and disposal of toxic wastes; discharge of industrial and sanitary wastewater; and emissions to the air.
We believe that we are currently in material compliance with the federal, state, local and foreign environmental laws and regulations to which we are subject. We have received and continue periodically to receive notices from the U.S. Environmental Protection Agency or state environmental protection agencies, as well as claims from others, alleging that we are a potentially responsible party (a "PRP") under Superfund and similar state laws for past and future remediation costs at hazardous substance disposal sites. Although Superfund liability is joint and several, in general, final allocation of responsibility at sites where there are multiple PRPs is made based on each PRP's relative contribution of hazardous substances to the site. Based on information currently available to us, we believe that any potential liability we may have as a PRP will not have a material adverse effect on us.
We have sold or closed a number of facilities that had solid waste landfills. In the case of virtually all of our sold facilities, we have retained ownership of the landfills. We have closed these landfills, and we believe that we have done so in material compliance with applicable laws and regulations. We continue to monitor these landfills pursuant to applicable laws and regulations. To date, the costs associated with the landfills have not been, and we do not anticipate that future costs will be, material to us.
We establish accruals for environmental liabilities where it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. We adjust accruals as new remediation and other commitments are made and as information becomes available which changes estimates previously made.
Estimates of future costs of environmental protection are necessarily imprecise due to numerous uncertainties, including the impact of new laws and regulations, the availability and application of new and diverse technologies, the extent of insurance coverage, the identification of new hazardous substance disposal sites at which we may be a PRP and, in the case of sites subject to Superfund and similar state laws, the ultimate allocation of costs among PRPs and the final determination of remedial requirements. Subject to the inherent imprecision in estimating such future costs, but taking into consideration our experience to date regarding environmental matters of a similar nature and facts currently known, we believe that costs and capital expenditures (in each case, before adjustment for inflation) for environmental protection will not increase materially over the next several years.
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Properties
We operate the following facilities, which are owned or leased as indicated.
Location of Facility |
Primary Use |
Owned or Leased |
|||
---|---|---|---|---|---|
U.S. | |||||
Wilmington, Delaware | Corporate Headquarters | Leased | |||
Lakewood, Ohio | Flexible Graphite Manufacturing Facility and Sales Office | Owned | |||
Parma, Ohio | Technology Center, Testing Facility, Pilot Plant and Flexible Graphite Manufacturing Facility | Owned | |||
Clarksville, Tennessee | Sales Office, Shared Service Center and Machine Shop | Owned | |||
Columbia, Tennessee | Carbon Electrode Manufacturing Facility and Sales Office | Owned | |||
Lawrenceburg, Tennessee | Advanced Carbon Materials Manufacturing Facility | Owned | |||
Clarksburg, West Virginia | Advanced Graphite Materials Manufacturing Facility and Sales Office | Owned | |||
Europe |
|||||
Calais, France | Electrode Manufacturing Facility | Owned | |||
Notre Dame, France | Electrode, Advanced Graphite Materials and Cathode Manufacturing Facility and Sales Office | Owned | |||
Vénissieux, France | Cathode Manufacturing Facility and Technology Center | Owned | |||
Caserta, Italy | Machine Shop | Owned | |||
Malonno, Italy | Machine Shop and Sales Office | Owned | |||
Saronno, Italy | Sales Office | Leased | |||
Moscow, Russia | Sales Office | Leased | |||
Vyazma, Russia | Electrode Manufacturing Facility | Owned | |||
Pamplona, Spain | Electrode Manufacturing Facility and Sales Office | Owned | |||
Etoy, Switzerland | Sales Office and European Headquarters | Owned | |||
Sheffield, United Kingdom | Machine Shop and Sales Office | Owned | |||
Other International |
|||||
Salvador Bahia, Brazil | Electrode and Cathode Manufacturing Facility | Owned | |||
Sao Paulo, Brazil | Sales Office | Leased | |||
Beijing, China | Sales Office | Leased | |||
Hong Kong, China | Sales Office | Leased | |||
Monterrey, Mexico | Electrode Manufacturing Facility and Sales Office | Owned | |||
Meyerton, South Africa | Electrode Manufacturing Facility and Sales Office | Owned |
We believe that our facilities, which are of varying ages and types of construction, are in good condition, are suitable for our operations and generally provide sufficient capacity to meet our requirements for the foreseeable future.
Employees
Since 1998, we have reduced our global workforce by about 1,700 employees, or over 30%. At June 30, 2003, we had 3,824 employees, of which 1,925 were in Europe (including Russia), 860 were in Mexico and Brazil, 372 were in South Africa, 4 were in Canada, 657 were in the U.S. and 6 were in the Asia Pacific region. At June 30, 2003, 2,753 of our employees were hourly employees.
At June 30, 2003, about 69% of our worldwide employees were covered by collective bargaining or similar agreements, which expire at various times in each of the next several
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years. At June 30, 2003, about 490 employees, or 13% of our employees, were covered by agreements, which expire, or are subject to renegotiation, at various times through December 31, 2003. We believe that, in general, our relationships with our unions are satisfactory and that we will be able to renew or extend our collective bargaining or similar agreements on reasonable terms as they expire. We cannot assure you, however, that renewed or extended agreements will be reached without a work stoppage or strike or will be reached on terms satisfactory to us.
Excluding our subsidiaries prior to the time when we acquired them, we have not had any material work stoppages or strikes during the past decade.
Insurance
We obtain insurance against civil liabilities relating to personal injuries to third parties, for loss of or damage to property and for environmental matters to the extent that it is currently available and provides coverage that we believe is appropriate upon terms and conditions and for premiums that we consider fair and reasonable. We believe that we have insurance providing coverage for claims and in amounts that we believe appropriate as described above. We cannot assure you, however, that we will not incur losses beyond the limits of or outside the coverage of our insurance. We currently believe that recovery under our insurance, if any, will not materially offset liabilities that have or may become due in connection with antitrust investigations, lawsuits or claims.
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The following table sets forth certain information concerning our executive officers and directors, including their ages as of June 30, 2003.
Name |
Age |
Position |
||
---|---|---|---|---|
Craig S. Shular | 50 | Chief Executive Officer, President and Director | ||
Scott C. Mason | 43 | President, Synthetic Graphite Line of Business | ||
John J. Wetula | 44 | President, Natural Graphite Line of Business | ||
Corrado F. De Gasperis | 37 | Vice President, Chief Financial Officer and Chief Information Officer | ||
Karen G. Narwold | 43 | Vice President, General Counsel, Human Resources and Secretary | ||
Gilbert E. Playford | 55 | Chairman of the Board | ||
R. Eugene Cartledge | 74 | Director | ||
Mary B. Cranston | 55 | Director | ||
John R. Hall | 70 | Director | ||
Harold E. Layman | 56 | Director | ||
Ferrell P. McClean | 56 | Director | ||
Michael C. Nahl | 60 | Director |
Executive Officers
Craig S. Shular became Chief Executive Officer and a director in January 2003 and has served as President since May 2002. From May 2002 through December 2002, he also served as Chief Operating Officer. From August 2001 to December 2002, he served as Executive Vice President of our former Graphite Power Systems Division. He served as Vice President and Chief Financial Officer from January 1999, with the additional duties of Executive Vice President, Electrode Sales and Marketing from February 2000. From 1976 through 1998, he held various financial, production and business management positions at Union Carbide, including the Carbon Products Division, from 1976 to 1979. We are the successor to the Carbon Products Division of Union Carbide.
Scott C. Mason became President of our synthetic graphite line of business in January 2003. From February 2001 through December 2002, he was Executive Vice President of our former Advanced Energy Technology Division. He served as Chief Financial Officer and Vice President of AET and our Director of Mergers and Acquisitions from April 2000 to March 2001. Prior to joining us, Mr. Mason was Vice President-Supply Chain Logistics for Union Carbide. From 1996 to 1999, Mr. Mason served as Director of Operations and then as Business Director for the Unipol Polymers Business of Union Carbide. Mr. Mason served from 1981 to 1996 in various financial, sales and marketing, operations and mergers and acquisition management positions at Union Carbide. He began his career in 1981 in the Chemicals and Plastics Division of Union Carbide.
John J. Wetula became President of our natural graphite line of business in January 2003. From July 1999 to December 2002, he served as President of AET. From July 1998 to June 1999, he served as our Director of Export Sales. From October 1996 to June 1998, he was General Manager of our GRAFOIL® product line. He is a chemical engineering and MBA graduate of Cleveland State University.
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Corrado F. De Gasperis became Chief Financial Officer in May 2001 in addition to his duties as Vice President and Chief Information Officer, which he assumed in February 2000. He served as Controller from June 1998 to February 2000. From 1987 through June 1998, he was with KPMG LLP, most recently as Senior Assurance Manager in the Manufacturing, Retail and Distribution Practice. KPMG had announced his admittance into their partnership effective July 1, 1998.
Karen G. Narwold became Vice President, General Counsel and Secretary in September 1999 and also assumed responsibility for the human resources department effective January 2002. She joined our Law Department in July 1990 and served as Assistant General Counsel from June 1995 to January 1999 and Deputy General Counsel from January 1999 to September 1999. She was an associate with Cummings & Lockwood from 1986 to 1990.
Directors
Gilbert E. Playford has been a director since 1998. Mr. Playford has served as the Chairman of the Board since September 1999. Mr. Playford served as Chief Executive Officer from June 1998 until January 2003 and as President from June 1998 until May 2002. Since January 2003, Mr. Playford had been serving as Chairman of the Board in an executive capacity. Mr. Playford retired in June 2003 upon the expiration of his amended employment agreement. His retirement does not affect the continuation of his service as a director or Chairman of the Board in a non-executive capacity. Mr. Playford joined Union Carbide in 1972 and held various management positions, including Treasurer and Principal Financial Officer, until he resigned in January 1996. In his capacity as Principal Financial Officer of Union Carbide, he also served as a nominee of Union Carbide on GrafTech's Board of Directors from 1992 until our leveraged equity recapitalization in January 1995. Mr. Playford is currently a director and non-executive Deputy Chairman of LionOre Mining International Ltd.
R. Eugene Cartledge has been a director since 1996. From 1986 until his retirement in 1994, Mr. Cartledge was the Chairman of the Board and Chief Executive Officer of Union Camp Corporation. Mr. Cartledge retired as Chairman of the Board of Savannah Foods & Industries Inc. in December 1997, and retired as a director of Delta Airlines, Inc. and Sunoco, Inc. in May 2002. He is currently a director of Formica Corporation and Blount International, Inc., and President of the Cartledge Foundation.
Mary B. Cranston has been a director since 2000. Ms. Cranston is a partner and has served since 1999 as Chairperson of Pillsbury Winthrop LLP, an international law firm. Ms. Cranston is based in San Francisco, California. Ms. Cranston has been practicing complex litigation, including antitrust, telecommunications and securities litigation, with Pillsbury Winthrop LLP since 1975. She is a director of the San Francisco Chamber of Commerce, the Bay Area Council and the Commonwealth Club, and a trustee of the San Francisco Ballet and Stanford University.
John R. Hall has been a director since 1995. Mr. Hall was Chairman of the Board and Chief Executive Officer of Ashland Inc. from 1981 until his retirement in January 1997 and September 1996, respectively. Mr. Hall had served in various engineering and managerial capacities at Ashland Inc. since 1957. He retired as Chairman of Arch Coal Inc. in 1998. He served as a director of Reynolds Metals Company from 1985 to 2000. Mr. Hall currently serves as a member of the Boards of Bank One Corporation, Humana Inc. and USEC Inc. Mr. Hall graduated from Vanderbilt University in 1955 with a degree in Chemical Engineering and later served as Vanderbilt's Board Chairman from 1995 to 1999. Mr. Hall also serves as Chairman of
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the Blue Grass Community Foundation and the Commonwealth Fund for Kentucky Educational Television, and as President of the Markey Cancer Center Foundation.
Harold E. Layman has been a director since March 2003. From 2001 until his retirement in 2002, Mr. Layman was President and Chief Executive Officer of Blount International, Inc. Prior thereto, Mr. Layman served in other capacities with Blount International, including President and Chief Operating Officer from 1999 to 2001, Executive Vice President and Chief Financial Officer from 1997 to 2000, and Senior Vice President and Chief Financial Officer from 1993 to 1997. From 1981 through 1992, he held various financial management positions with VME Group/Volvo AB. From 1970 to 1980, Mr. Layman held various operations and financial management positions with Ford Motor Company. He is currently a director of Blount International, Infinity Property and Casualty Corporation and Von Hoffman Holdings Inc.
Ferrell P. McClean has been a director since 2002. Ms. McClean was the Managing Director and Senior Advisor to the head of the Global Oil & Gas Group in Investment Banking at J.P. Morgan Chase & Co. from 2000 through the end of 2001. She joined J.P. Morgan & Co. Incorporated in 1969 and founded the Leveraged Buyout and Restructuring Group within the Mergers & Acquisitions Group in 1986. From 1991 until 2000, Ms. McClean was the Managing Director and co-headed the Global Energy Group within the Investment Banking Group at J.P. Morgan & Co. Ms. McClean is currently a director of Unocal Corporation.
Michael C. Nahl has been a director since 1999. Mr. Nahl is Senior Vice President and Chief Financial Officer of Albany International Corporation, a manufacturer of paper machine clothing, which are the belts of fabric that carry paper stock through the paper production process. Mr. Nahl joined Albany International Corporation in 1981 as Group Vice President, Corporate and was appointed to his present position in 1983. Mr. Nahl is a director of Lindsay Manufacturing Co. and a member of the Chase Manhattan Corporation Northeast Regional Advisory Board.
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Shares eligible for future sale
After this offering, 83,515,504 shares of our common stock will be outstanding (2,400,000, if the over-allotment option is exercised), excluding:
At September 18, 2003, 1,324,037 shares were available for future awards under our equity incentive plans.
All of the outstanding shares of our common stock, the shares of our common stock to be sold in this offering and any shares of our common stock issued under our equity incentive and employee benefit plans will be freely transferable by persons other than our affiliates. The outstanding shares of our common stock held by, and any shares of our common stock issued under our equity incentive and employee benefit plans to, our affiliates are restricted securities and may not be sold other than pursuant to an effective registration statement or Rule 144 or another exemption from registration under the Securities Act. We believe that the only persons who may be considered our affiliates are our executive officers and directors.
We have granted and intend to grant options to employees and directors in the ordinary course. We have filed and intend, consistent with past practice, to file with the SEC registration statements relating to the issuance of shares of our common stock under our equity incentive and employee benefit plans and resale of shares of our common stock held by our directors and executive officers.
In general, Rule 144 limits the number of shares that an affiliate of ours can sell within any three-month period to the greater of (i) one percent of the then outstanding shares of our common stock and (ii) the average weekly trading volume of our common stock during the four calendar weeks preceding the sale. Rule 144 sales are also subject to certain manner-of-sale provisions, notice requirements and the availability of current public information about us. Under Rule 144, however, a person who has held shares of our common stock that are restricted securities for a minimum of two years from the later of the date such securities were acquired from us or an affiliate of ours and who is not, and for the three months prior to the sale of such restricted securities has not been, an affiliate of ours, is free to sell such shares of our common stock without regard to the volume, manner-of-sale and the other limitations contained in Rule 144. The foregoing summary of Rule 144 is not intended to be a complete discussion thereof.
No prediction can be made as to the effect, if any, that future sales of shares, or the availability of shares for future sales, will have on the market price of our common stock prevailing from time to time. Sales of substantial amounts of our common stock in the public market, or the perception that such sales could occur, could adversely affect prevailing market prices for our common stock and could impair our ability to raise capital through an offering of our equity securities, at a price that we deem appropriate or at all. The market price of our
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common stock could decline as a result of sales by our existing stockholders of a large number of shares of our common stock in the market after this offering, or the perception that these sales may occur.
Material U.S. federal tax consequences for non-U.S. investors
The following is a summary of the material U.S. federal income and estate tax consequences of owning and disposing of our common stock that may be relevant to non-U.S. investors. In general, a "non-U.S. investor" is any person or entity that is, for U.S. federal tax purposes:
An individual generally may be deemed to be a resident alien, as opposed to a nonresident alien, by virtue of being present in the United States for at least 31 days in the current calendar year and for an aggregate of at least 183 days during a three-year period ending in the current calendar year. For these purposes, all the days present in the current year, one-third of the days present in the immediately preceding year and one-sixth of the days present in the second preceding year are counted. Resident aliens generally are subject to U.S. federal income tax as if they were U.S. citizens.
This summary does not address all of the U.S. federal tax considerations that may be relevant to a non-U.S. investor in light of its particular circumstances and does not discuss any state, local or foreign tax. This summary is based on current law, which is subject to change, possibly with retroactive effect, or different interpretations. This summary is limited to non-U.S. investors who are the initial purchasers of common stock and who hold the common stock as a capital asset.
PROSPECTIVE INVESTORS ARE ADVISED TO CONSULT WITH THEIR OWN TAX ADVISORS REGARDING THE U.S. FEDERAL TAX CONSEQUENCES RELATING TO THE OWNERSHIP AND DISPOSITION OF THE COMMON STOCK AS WELL AS THE EFFECT OF ANY STATE, LOCAL OR FOREIGN TAX LAWS.
Dividends
Dividends paid to a non-U.S. investor generally will be subject to withholding of U.S. federal income tax at a 30% rate or such lower rate as may be specified by an applicable income tax treaty. To claim a reduced treaty rate, a non-U.S. investor must furnish to us or our paying agent a completed Internal Revenue Service Form W-8BEN (or successor form) certifying that it qualifies for a reduced rate. In addition, if dividends are paid to a non-U.S. investor that is a partnership or other pass through entity, persons holding interests in the entity may need to provide certification claiming an exemption or reduction in withholding under the applicable treaty. A non-U.S. investor that is eligible for a reduced rate of U.S. withholding tax pursuant to an income tax treaty may obtain a refund of any excess amounts withheld by filing an appropriate claim for refund with the Internal Revenue Service.
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Dividends that are effectively connected with the conduct by a non-U.S. investor of a trade or business within the United States or, if a treaty applies, attributable to a permanent establishment of a non-U.S. investor within the United States, will be exempt from withholding tax, provided the non-U.S. investor provides us or our paying agent with an Internal Revenue Service Form W-8ECI (or successor form) containing the non-U.S. investor's taxpayer identification number. Non-U.S. investors will be subject to U.S. federal income tax on effectively connected dividend income as if they were U.S. citizens. Effectively connected dividend income of a non-U.S. investor that is a corporation may be subject to an additional branch profits tax at a rate of 30% or a lower rate specified by an applicable income tax treaty.
Non-U.S. investors must comply with the certification procedures described above, or, in the case of payments made outside the United States with respect to an offshore account, certain documentary evidence procedures, directly or under certain circumstances through an intermediary, to obtain the benefit of a reduced rate under an applicable income tax treaty with respect to dividends paid with respect to the common stock. In addition, if a non-U.S. investor is required to provide an Internal Revenue Service Form W-8ECI (or successor form), as discussed above, the non-U.S. investor must provide its taxpayer identification number.
Sale or other disposition of common stock
A non-U.S. investor generally will not be subject to U.S. federal income tax on any gain recognized on the sale or other disposition of our common stock, except in the following circumstances:
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Information reporting and backup withholding
We must report annually to the Internal Revenue Service and to each non-U.S. investor the amount of dividends paid to each such non-U.S. investor and the tax withheld with respect to those dividends, regardless of whether withholding was required. Copies of the information returns reporting those dividends and withholding may also be made available to the tax authorities in the country in which the non-U.S. investor resides under the provisions of an applicable income tax treaty or other applicable agreements.
Backup withholding is generally imposed on certain payments to persons that fail to furnish the necessary identifying information to the payor at the rate of 28% in calendar years 2003 through 2010, and at the rate of 31% in calendar years thereafter. A non-U.S. investor will be subject to backup withholding tax with respect to dividends paid on common stock unless the non-U.S. investor certifies his, her or its non-U.S. status.
The payment of proceeds of a sale of our common stock effected by or through a U.S. office of a broker is subject to both backup withholding and information reporting unless the non-U.S. investor certifies its non-U.S. status or otherwise establishes an exemption. In general, backup withholding and information reporting will not apply to the payment of the proceeds of a sale of our common stock by or through a foreign office of a broker. If, however, such broker is, for U.S. federal income tax purposes, a U.S. person, a controlled foreign corporation, a foreign person that derives 50% or more of its gross income for certain periods from the conduct of a trade or business in the United States, or a foreign partnership with certain connections to the United States, such payments will be subject to information reporting, but not backup withholding, unless such broker has documentary evidence in its records that the non-U.S. investor is a non-U.S. investor and certain other conditions are satisfied or the non-U.S. investor otherwise establishes an exemption.
Backup withholding is not an additional tax. Amounts withheld under the backup withholding rules are generally allowable as a refund or credit against the non-U.S. investor's U.S. federal income tax liability, if any, provided, that the required information is furnished to the Internal Revenue Service.
U.S. federal estate taxes
A non-U.S. investor that is an individual will have to include in his or her gross estate for U.S. federal estate tax purposes any of our common stock held at the time of such non-U.S. investor's death, and such non-U.S. investor may be subject to U.S. federal estate tax, unless an applicable estate tax treaty provides otherwise.
Recently enacted U.S. federal tax legislation provides for reductions in the U.S. federal estate tax through 2009 and the elimination of the estate tax entirely in 2010. Pursuant to the legislation, however, the estate tax will be fully reinstated, as in effect prior to the reductions, in 2011.
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Subject to the terms of the underwriting agreement, the underwriters named below have severally agreed to purchase from us the following respective numbers of shares of common stock:
Name |
Number of shares |
|
---|---|---|
J.P. Morgan Securities Inc. | ||
CIBC World Markets Corp. | ||
RBC Dain Rauscher Inc. | ||
Jefferies & Company, Inc. | ||
Jefferies/Quarterdeck, LLC | ||
Total | 16,000,000 | |
The underwriting agreement provides that the obligations of the underwriters are subject to certain conditions precedent, including the absence of any material adverse change in our business and the receipt of certain certificates, opinions and letters from us, our counsel and our independent auditors. The underwriters are committed to purchase all of the shares of common stock offered by us, other than those shares covered by the over-allotment option described below, if they purchase any shares of common stock.
Underwriting discounts and commissions
The following table shows the per share and total underwriting discounts and commissions we will pay to the underwriters. These amounts are shown assuming both no exercise and full exercise of the underwriters' over-allotment option to purchase additional shares of common stock from us.
Without over-allotment exercise |
With over-allotment exercise |
|||||
---|---|---|---|---|---|---|
Per Share | $ | $ | ||||
Total | $ | $ | ||||
We estimate that the total expenses of this offering, excluding underwriting discounts and commissions, will be about $ million.
The underwriters initially propose to offer the shares of common stock directly to the public at the public offering price set forth on the cover page of this prospectus and to certain dealers at that price less a concession not in excess of $ per share. The underwriters may allow and such dealers may reallow a concession not in excess of $ per share to certain other dealers. After the initial public offering, the underwriters may change the offering price and other selling terms.
We have granted to the underwriters an option, exercisable no later than 30 days after the date of this prospectus supplement, to purchase up to an additional 2,400,000 shares of common stock from us at the public offering price less the underwriting discounts and commissions set forth on the cover page of this prospectus. To the extent that the underwriters
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exercise this option, each underwriter will have a firm commitment to purchase approximately the same percentage thereof which the number of shares of common stock to be purchased by it shown in the table above bears to the total number of shares of common stock offered hereby. The underwriters may exercise this option only to cover over-allotments made in connection with the sale of shares of common stock offered hereby.
The offering of the shares of common stock is made for delivery when, as and if accepted by the underwriters and subject to prior sale and to withdrawal, cancellation or modification of this offering without notice. The underwriters reserve the right to reject an order for the purchase of shares of common stock in whole or in part.
We have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act, and to contribute to payments the underwriters may be required to make in respect of these liabilities.
We, subject to certain limited exceptions, and our executive officers and directors have agreed not to, without the prior written consent of J.P. Morgan Securities Inc., sell or otherwise dispose of any shares of our capital stock, options or warrants to acquire shares of our capital stock or securities exchangeable for or convertible into shares of our capital stock for a period of 90 days after the date of this prospectus supplement.
Persons participating in the offering may engage in transactions, including over-allotments, syndicate covering transactions, stabilizing bids, or imposition of penalty bids, that may have the effect of stabilizing or maintaining above, or otherwise affecting, the market price of shares of common stock at a level from that which might otherwise prevail in the open market.
A syndicate covering transaction is a bid for or the purchase of shares of common stock on behalf of the underwriters to reduce a syndicate short position incurred by the underwriters in connection with the offering. The underwriters may create a syndicate short position by making short sales of shares of common stock and may purchase shares of common stock on the open market to cover syndicate short positions created by short sales. Short sales involve the sale by the underwriters of a greater number of shares of common stock than they are required to purchase in this offering. Short sales can be either covered or naked. Covered short sales are sales made in an amount not greater than the underwriters' over-allotment option to purchase additional shares from us in the offering. Naked short sales are sales in excess of the over-allotment option. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of shares of common stock in the open market after pricing that could adversely affect investors who purchase in this offering. If the underwriters create a syndicate short position, they may choose to reduce or cover this position by either exercising all or part of the over-allotment option to purchase additional shares of common stock from us or by engaging in syndicate covering transactions. The underwriters may close out any covered short position by either exercising their over-allotment option or purchasing securities in the open market. The underwriters must close out any naked short position by purchasing securities in the open market. In determining the source of shares of common stock to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase securities through the over-allotment option.
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A stabilizing bid is a bid for or the purchase of shares of common stock on behalf of the underwriters for the purpose of fixing or maintaining the price of shares of common stock. A penalty bid is an arrangement that permits the representatives to reclaim the selling concession from an underwriter or a syndicate member for shares of common stock purchased by the underwriters in a syndicate covering transaction and therefore have not been effectively placed by the underwriter or syndicate member.
These transactions may be effected on the NYSE or otherwise and, if commenced, may be discontinued at any time. Similar to other purchase activities, these activities may have the effect of preventing or retarding a decline in the market price of shares of common stock. As a result, the price of shares of common stock may be higher than the price that might otherwise exist in the open market.
$81 million ($94 million, if the underwriters' over-allotment option is exercised in full) of the net proceeds from this offering will be used for repayment of term loans under the Senior Facilities, and the balance of the net proceeds may be used to reduce the outstanding balance under our revolving credit facility under the Senior Facilities pending use as otherwise described in this prospectus supplement. See "Use of proceeds" in this prospectus supplement. J.P. Morgan Securities Inc., or its affiliates, are lenders under the Senior Facilities and will receive their proportionate share of the repayment of the amounts under the Senior Facilities that we expect to make from the net proceeds of this offering.
In the ordinary course of their business, the underwriters or their affiliates have engaged, are engaged and may in the future engage in investment banking, financial advisory and/or commercial banking transactions with us and our affiliates.
This offering is being made in compliance with the requirements of Rule 2710(c)(8) of the Conduct Rules of the National Association of Securities Dealers, Inc. However, because a bona fide independent market exists for our common stock, this offering does not require the services of a qualified independent underwriter.
Resale restrictions
The distribution of our common stock in Canada is being made only on a private placement basis exempt from the requirement that we prepare and file a prospectus with the securities regulatory authorities in each province where trades of common stock are made. Any resale of our common stock in Canada must be made under applicable securities laws which will vary depending on the relevant jurisdiction, and which may require resales to be made under available exemptions or under a discretionary exemption granted by the applicable Canadian securities regulatory authority. Purchasers are advised to seek legal advice prior to any resale of our common stock.
Representations of purchasers
By purchasing our common stock in Canada and accepting a purchase confirmation, a purchaser is representing to us and the dealer from whom the purchase confirmation is received that:
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Rights of action (Ontario purchasers)
In the event that this prospectus supplement and the accompanying prospectus, together with any amendments or supplements hereto or thereto, delivered to a purchaser of securities contains a misrepresentation and it was a misrepresentation at the time of purchase of the securities, each purchaser in Ontario will be deemed to have relied upon the misrepresentation and will, subject as hereinafter provided, have a right of action against us for damages, or, while still the owner of the securities purchased by that purchaser, for rescission, in which case, if the purchaser elects to exercise the right of rescission, the purchaser will have no right of action for damages against us, provided that:
The rights discussed above are in addition to and without derogation from any other rights or remedies available at law to the purchaser.
Enforcement of legal rights
All of our directors and officers as well as the experts named in this prospectus supplement and the accompanying prospectus may be located outside of Canada and, as a result, it may not be possible for Canadian purchasers to effect service of process within Canada upon us or such persons. All or a substantial portion of our assets and the assets of such persons may be located outside of Canada and, as a result, it may not be possible to satisfy a judgment against us or such persons in Canada or to enforce a judgment obtained in Canadian courts against us or such persons outside of Canada.
Taxation and eligibility for investment
Canadian purchasers of our common stock should consult their own legal and tax advisors with respect to the tax consequences of an investment in our common stock in their particular circumstances and about the eligibility of our common stock for investment by the purchaser under relevant Canadian legislation.
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The legality of our common stock offered in this offering and certain other legal matters will be passed upon for us by Kelley Drye & Warren LLP, New York, New York, and Stamford, Connecticut, and for the underwriters by Cravath, Swaine & Moore LLP, New York, New York.
The Consolidated financial statements of GTI (formerly known as UCAR International Inc.) and subsidiaries as of December 31, 2001 and 2002 and for the years then ended included in this prospectus supplement and incorporated in the accompanying prospectus and the registration statement by reference from our current report on Form 8-K filed with the SEC as of August 18, 2003 have been audited by Deloitte & Touche LLP, independent auditors, as stated in their report, included herein and incorporated therein by reference (which report expresses an unqualified opinion and includes explanatory paragraphs relating to (i) our adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," effective January 1, 2002 and (ii) reclassification in the Consolidated financial statements to give retroactive effect to our discontinued operations, changes in segments and adoption of SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections), and has been so included and incorporated in reliance upon the report of such firm given upon their authority as experts in accounting and auditing.
The Consolidated statements of operations, stockholders' equity (deficit) and cash flows of GTI (formerly known as UCAR International Inc.) and subsidiaries for the year ended December 31, 2000 (before the restatements described in Note 19 to such Consolidated financial statements) have been included in this prospectus supplement and incorporated by reference in the accompanying prospectus and the registration statement in reliance upon the report of KPMG LLP, independent accountants, included in this prospectus supplement and incorporated by reference in the accompanying prospectus and the registration statement, and upon the authority of said firm in accounting and auditing.
GTI has agreed to indemnify and hold KPMG LLP harmless for and from any and all legal costs and expenses incurred by KPMG LLP in successful defense of any legal action or proceeding that arises as a result of KPMG LLP's consent to inclusion and incorporation by reference of its audit report on our past Consolidated financial statements included in this prospectus supplement and incorporated by reference in the accompanying prospectus and the registration statement.
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GrafTech International Ltd.
Index to financial statements
|
Page |
|
---|---|---|
Consolidated balance sheets at December 31, 2002 and June 30, 2003 (unaudited) | F-2 | |
Consolidated statements of operations for the three months and six months ended June 30, 2002 and 2003 (unaudited) |
F-3 |
|
Consolidated statements of cash flows for the six months ended June 30, 2002 and 2003 (unaudited) |
F-4 |
|
Consolidated statement of stockholders' deficit for the year ended December 31, 2002 and six months ended June 30, 2003 (unaudited) |
F-5 |
|
Notes to consolidated financial statements (unaudited) |
F-6 |
|
Independent Auditors' Reports |
F-38 |
|
Consolidated balance sheets at December 31, 2001 and 2002 |
F-40 |
|
Consolidated statements of operations for the years ended December 31, 2000, 2001 and 2002 |
F-41 |
|
Consolidated statements of cash flows for the years ended December 31, 2000, 2001 and 2002 |
F-42 |
|
Consolidated statements of stockholders' equity (deficit) for the years ended December 31, 2000, 2001 and 2002 |
F-43 |
|
Notes to consolidated financial statements |
F-44 |
F-1
GrafTech International Ltd. and Subsidiaries
Consolidated balance sheets
(Unaudited)
(Dollars in millions, except per share data) |
December 31, 2002 |
June 30, 2003 |
||||||
---|---|---|---|---|---|---|---|---|
ASSETS | ||||||||
Current Assets: | ||||||||
Cash and cash equivalents | $ | 11 | $ | 8 | ||||
Accounts and notes receivable, net | 104 | 119 | ||||||
Inventories: | ||||||||
Raw materials and supplies | 39 | 45 | ||||||
Work in process | 102 | 120 | ||||||
Finished goods | 30 | 29 | ||||||
Total inventories | 171 | 194 | ||||||
Prepaid expenses and deferred income taxes | 21 | 27 | ||||||
Assets of discontinued operations | 14 | | ||||||
Total current assets | 321 | 348 | ||||||
Property, plant and equipment | 995 | 1,070 | ||||||
Less: accumulated depreciation | 695 | 742 | ||||||
Net fixed assets | 300 | 328 | ||||||
Deferred income taxes | 171 | 187 | ||||||
Goodwill | 17 | 20 | ||||||
Other assets | 50 | 36 | ||||||
Total assets | $ | 859 | $ | 919 | ||||
LIABILITIES AND STOCKHOLDERS' DEFICIT | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 105 | $ | 105 | ||||
Short-term debt | 18 | 23 | ||||||
Accrued income and other taxes | 23 | 32 | ||||||
Other accrued liabilities | 57 | 76 | ||||||
Liabilities of discontinued operations | 3 | 3 | ||||||
Total current liabilities | 206 | 239 | ||||||
Long-term debt: | ||||||||
Carrying value | 699 | 680 | ||||||
Fair value of hedged debt obligation | 8 | | ||||||
Unamortized bond premium | 6 | 6 | ||||||
Total long-term debt | 713 | 686 | ||||||
Other long-term obligations | 258 | 275 | ||||||
Deferred income taxes | 33 | 39 | ||||||
Minority stockholders' equity in consolidated entities | 30 | 29 | ||||||
Commitments & contingencies | | | ||||||
Stockholders' deficit: |
||||||||
Preferred stock, par value $.01, 10,000,000 shares authorized, none issued | | | ||||||
Common stock, par value $.01, 100,000,000 and 150,000,000 shares authorized, respectively at December 31, 2002 and June 30, 2003, 59,211,664 shares issued at December 31, 2002, 64,338,211 shares issued at June 30, 2003 | 1 | 1 | ||||||
Additional paid-in capital | 636 | 662 | ||||||
Accumulated other comprehensive loss | (304 | ) | (299 | ) | ||||
Accumulated deficit | (620 | ) | (622 | ) | ||||
Less: cost of common stock held in treasury, 2,542,539 shares at December 31, 2002, 2,451,035 shares at June 30, 2003 | (88 | ) | (85 | ) | ||||
Less: common stock held in employee benefits trust, 426,400 shares at December 31, 2002 and June 30, 2003 | (6 | ) | (6 | ) | ||||
Total stockholders' deficit | (381 | ) | (349 | ) | ||||
Total liabilities and stockholders' deficit | $ | 859 | $ | 919 | ||||
See accompanying Notes to Consolidated Financial Statements.
F-2
GrafTech International Ltd. and Subsidiaries
Consolidated statements of operations
(Unaudited)
|
Three Months Ended June 30, |
Six Months Ended June 30, |
||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions, except per share data) |
2002 |
2003 |
2002 |
2003 |
||||||||||
Net sales | $ | 157 | $ | 181 | $ | 291 | $ | 351 | ||||||
Cost of sales | 122 | 138 | 226 | 269 | ||||||||||
Gross profit | 35 | 43 | 65 | 82 | ||||||||||
Research and development |
3 |
2 |
6 |
5 |
||||||||||
Selling, administrative and other expenses | 24 | 21 | 42 | 42 | ||||||||||
Other (income) expense, net | (10 | ) | (6 | ) | (9 | ) | (10 | ) | ||||||
Restructuring charges | | 1 | 5 | 20 | ||||||||||
Impairment loss on long-lived and other assets | 13 | | 13 | | ||||||||||
Interest expense | 17 | 13 | 30 | 27 | ||||||||||
47 | 31 | 87 | 84 | |||||||||||
Income (loss) from continuing operations before provision for income taxes | (12 | ) | 12 | (22 | ) | (2 | ) | |||||||
Provision (benefit) for income taxes | (5 | ) | 5 | (11 | ) | 1 | ||||||||
Income (loss) from continuing operations of consolidated entities before minority interest | (7 | ) | 7 | (11 | ) | (3 | ) | |||||||
Less: Minority stockholders' share of income | | 1 | 1 | 1 | ||||||||||
Income (loss) from continuing operations | (7 | ) | 6 | (12 | ) | (4 | ) | |||||||
Discontinued operations: | ||||||||||||||
Income from discontinued operations (less applicable income tax expense) | | | 1 | 1 | ||||||||||
Gain on sale of discontinued operations (less applicable income tax expense) | | 1 | | 1 | ||||||||||
Net income (loss) | $ | (7 | ) | $ | 7 | $ | (11 | ) | $ | (2 | ) | |||
Basic income (loss) per common share: | ||||||||||||||
Income (loss) from continuing operations | $ | (0.14 | ) | $ | 0.11 | $ | (0.21 | ) | $ | (0.06 | ) | |||
Discontinued operations | | 0.01 | 0.01 | 0.02 | ||||||||||
Net income (loss) per share | $ | (0.14 | ) | $ | 0.12 | $ | (0.20 | ) | $ | (0.04 | ) | |||
Weighted average common shares outstanding (in thousands) | 55,872 | 57,037 | 55,848 | 56,829 | ||||||||||
Diluted income (loss) per common share: | ||||||||||||||
Income (loss) from continuing operations | $ | (0.14 | ) | $ | 0.11 | $ | (0.21 | ) | $ | (0.06 | ) | |||
Discontinued operations | | 0.01 | 0.01 | 0.02 | ||||||||||
Net income (loss) per share | $ | (0.14 | ) | $ | 0.12 | $ | (0.20 | ) | $ | (0.04 | ) | |||
Weighted average common shares outstanding (in thousands) | 55,872 | 57,040 | 55,848 | 56,829 | ||||||||||
See accompanying Notes to Consolidated Financial Statements.
F-3
GrafTech International Ltd. and Subsidiaries
Consolidated statements of cash flows
(Unaudited)
|
Six Months Ended June 30, |
||||||||
---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) |
2002 |
2003 |
|||||||
Cash flow from operating activities: | |||||||||
Net loss | $ | (11 | ) | $ | (2 | ) | |||
Income from discontinued operations | 1 | 1 | |||||||
Gain on sale of discontinued operations | | 1 | |||||||
Loss from continuing operations | (12 | ) | (4 | ) | |||||
Non-cash charges to net loss: | |||||||||
Depreciation and amortization | 15 | 15 | |||||||
Deferred income taxes | (13 | ) | (10 | ) | |||||
Restructuring charges | 5 | 20 | |||||||
Impairment loss on long-lived and other assets | 13 | | |||||||
Other non-cash charges (credits), net | (20 | ) | (20 | ) | |||||
(Increase) decrease in working capital* | (24 | ) | (27 | ) | |||||
Long-term assets and liabilities | | | |||||||
Net cash used in operating activities from continuing operations | (36 | ) | (26 | ) | |||||
Net cash provided by operating activities from discontinued operations | | 1 | |||||||
Net cash used in operating activities | (36 | ) | (25 | ) | |||||
Cash flow from investing activities: | |||||||||
Capital expenditures | (20 | ) | (20 | ) | |||||
Proceeds from sale of discontinued operations | | 15 | |||||||
Net cash used in investing activities | (20 | ) | (5 | ) | |||||
Cash flow from financing activities: | |||||||||
Short-term debt borrowings, net | 10 | 4 | |||||||
Revolving credit facility borrowings (reductions), net | (95 | ) | 1 | ||||||
Long-term debt borrowings | 557 | | |||||||
Long-term debt reductions | (387 | ) | | ||||||
Proceeds from reset of interest rate swap | | 31 | |||||||
Purchase of interest rate caps | | (5 | ) | ||||||
Sale of common stock | 1 | | |||||||
Financing costs | (20 | ) | | ||||||
Dividends paid to minority stockholders | | (4 | ) | ||||||
Net cash provided by financing activities | 66 | 27 | |||||||
Net increase (decrease) in cash and cash equivalents | 10 | (3 | ) | ||||||
Effect of exchange rate changes on cash and cash equivalents | 3 | | |||||||
Cash and cash equivalents at beginning of period | 38 | 11 | |||||||
Cash and cash equivalents at end of period | $ | 51 | $ | 8 | |||||
Supplemental disclosures of cash flow information: | |||||||||
Net cash paid during the periods for: | |||||||||
Interest expense | $ | 17 | $ | 33 | |||||
Income taxes | $ | 4 | $ | 5 | |||||
*Net change in working capital due to the following components: | |||||||||
(Increase) decrease in current assets: | |||||||||
Notes and accounts receivable | $ | (18 | ) | $ | (6 | ) | |||
Inventories | 10 | (9 | ) | ||||||
Prepaid expenses and other current assets | (2 | ) | (3 | ) | |||||
Decrease in accounts payable and accruals | (12 | ) | (2 | ) | |||||
Payments in antitrust investigations and related lawsuits and claims, net | | (4 | ) | ||||||
Restructuring payments, net | (2 | ) | (3 | ) | |||||
(Increase) decrease in working capital | $ | (24 | ) | $ | (27 | ) | |||
See accompanying Notes to Consolidated Financial Statements.
F-4
GrafTech International Ltd. and Subsidiaries
Consolidated statement of stockholders' deficit
(Unaudited)
|
December 31, 2002 and June 30, 2003 |
||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions, except share data) |
Common Stock |
Shares of Common Stock |
Additional Paid-in Capital |
Accumulated Other Comprehensive Loss |
Accumulated Deficit |
Unearned Restricted Stock |
Treasury Stock |
Common Stock Held in Employee Benefits Trust |
Total Stockholders' (Deficit) |
||||||||||||
Balance at January 1, 2002 | $1 | 58,623,713 | $629 | $(269 | ) | $(602 | ) | $ | $(85 | ) | $(6 | ) | $(332 | ) | |||||||
Comprehensive loss: | |||||||||||||||||||||
Net loss | | | | | (18 | ) | | | | (18 | ) | ||||||||||
Other comprehensive loss: | |||||||||||||||||||||
Minimum pension liability | | | | (15 | ) | | | | | (15 | ) | ||||||||||
Foreign currency translation adjustments | | | | (20 | ) | | | | | (20 | ) | ||||||||||
Total comprehensive loss | | | | (35 | ) | (18 | ) | | | | (53 | ) | |||||||||
Issuance of restricted stock | | 412,200 | 6 | | | (6 | ) | | | | |||||||||||
Amortization of restricted stock | | | | | | 1 | | | 1 | ||||||||||||
Accelerated vesting of restricted stock | | | | | | 5 | | | 5 | ||||||||||||
Sale of common stock under stock options | | 175,751 | 1 | | | | | | 1 | ||||||||||||
Repurchase of treasury stock | | | | | | | (3 | ) | | (3 | ) | ||||||||||
Balance at December 31, 2002 | 1 | 59,211,664 | 636 | (304 | ) | (620 | ) | | (88 | ) | (6 | ) | (381 | ) | |||||||
Comprehensive income (loss): | |||||||||||||||||||||
Net loss | | | | | (2 | ) | | | | (2 | ) | ||||||||||
Other comprehensive income (loss): | |||||||||||||||||||||
Foreign currency translation adjustments | | | | 5 | | | | | 5 | ||||||||||||
Total comprehensive income (loss) | | | | 5 | (2 | ) | | | | 3 | |||||||||||
Senior Notes for common stock exchange | | 3,800,758 | 20 | | | | | | 20 | ||||||||||||
Treasury stock | | | (3 | ) | | | | 3 | | | |||||||||||
Issuance of common stock to savings and pension plans | | 1,325,789 | 9 | | | | | | 9 | ||||||||||||
Balance at June 30, 2003 | $1 | 64,338,211 | $662 | $(299 | ) | $(622 | ) | $ | $(85 | ) | $(6 | ) | $(349 | ) | |||||||
See accompanying Notes to Consolidated Financial Statements.
F-5
GrafTech International Ltd. and Subsidiaries
Notes to consolidated financial statements
(unaudited)
(1) Interim Financial Presentation
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, recurring nature) which are necessary for a fair presentation 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 related Notes, contained in our Annual Report on Form 10-K at and for the year ended December 31, 2002 (the "Annual Report"). Results of operations for the six months ended June 30, 2003 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, 2003.
Certain amounts in the Consolidated Financial Statements for the three months and six months ended June 30, 2002 have been reclassified as described in this Note 1 below.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the amounts reported in the financial statements and accompanying notes. The accounting estimates that require our management's most difficult and subjective judgments include those related to employee benefit plans, financial instruments, contingencies, impairments of long-lived assets, inventories and accounting for income taxes. Actual amounts may differ materially from our management's estimates.
Important Terms
We use the following terms to identify various companies or groups of companies in the Consolidated Financial Statements.
"GTI" refers to GrafTech International Ltd. only. GTI is our public parent company and the issuer of the publicly traded common stock covered by the Consolidated Financial Statements. GTI is a guarantor of the Senior Notes and the Senior Facilities. Prior to our Annual Meeting of Stockholders for 2002, GTI was named UCAR International Inc.
"GrafTech Global" refers to GrafTech Global Enterprises Inc. only. GrafTech Global is a direct, wholly owned subsidiary of GTI and the direct or indirect holding company for all of our operating subsidiaries. GrafTech Global is a guarantor of the Senior Notes and the Senior Facilities. Prior to June 7, 2002, GrafTech Global Enterprises Inc. was named UCAR Global Enterprises Inc.
"UCAR Carbon" refers to UCAR Carbon Company Inc. only. UCAR Carbon is our wholly owned subsidiary through which we conduct most of our U.S. operations. UCAR Carbon is a guarantor of the Senior Notes and the Senior Facilities.
F-6
"GrafTech Finance" refers to GrafTech Finance Inc. only. GrafTech Finance is a direct, wholly owned special purpose finance subsidiary of GTI and the borrower under our senior secured bank credit facilities (as amended, the "Senior Facilities"). GrafTech Finance is the issuer of our 10.25% senior notes due 2012 (the "Senior Notes"). The Senior Notes were issued under an Indenture dated February 15, 2002, as supplemented on April 30, 2002 (as supplemented, the "Indenture"). Prior to June 7, 2002, GrafTech Finance was named UCAR Finance Inc.
"AET" refers to Advanced Energy Technology Inc. only. AET is our 97.5% owned (wholly owned, prior to June 2001) subsidiary engaged in the development, manufacture and sale of natural graphite-based products. Prior to January 1, 2003, AET was named Graftech Inc.
"Carbone Savoie" refers to Carbone Savoie S.A.S. and its subsidiaries. Carbone Savoie is our 70% owned subsidiary engaged in the development, manufacture and sale of cathodes.
"Subsidiaries" refers to those companies that, at the relevant time, are or were majority owned or wholly owned directly or indirectly by GTI or its predecessors to the extent that those predecessors' activities related to the graphite and carbon business. All of GTI's subsidiaries have been wholly owned (with de minimis exceptions in the case of certain foreign subsidiaries) from at least January 1, 2000 through June 30, 2003, except for:
Our 100% owned Brazilian cathode manufacturing operations were contributed to Carbone Savoie and, as a result, became 70% owned on March 31, 2001.
"We," "us" or "our" refers to GTI and its subsidiaries collectively or, if the context so requires, GTI, GrafTech Global or GrafTech Finance, individually.
In 2002, we substantially completed the realignment of our foreign subsidiaries. Most of the operations and net sales of our synthetic graphite line of business are located outside the U.S. and, as a result of the realignment, are held by our Swiss subsidiary or its subsidiaries. Most of our technology is held by our U.S. subsidiaries. We may in the future realign the corporate organizational structure of our U.S. subsidiaries.
New Accounting Standards
In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150 establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company currently has no financial instruments which meet these requirements.
In April 2003, FASB issued SFAS No. 149 "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered
F-7
into or modified, and for hedging relationships designated, after June 30, 2003. Other provisions of SFAS No. 149 that related to SFAS No. 133 implementation issues should continue to be applied in accordance with their respective dates. We do not expect the adoption of SFAS No. 149 will have a significant impact on our results of operations or financial position.
In December 2002, FASB issued SFAS No. 148 "Accounting for Stock-Based CompensationTransition and Disclosure." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The adoption of SFAS No. 148 did not have a significant impact on our consolidated results of operations or financial position because the impact was limited to additional disclosure. The additional disclosure is set forth below.
No compensation expense has been recognized for our time vesting options granted with exercise prices at not less than market price on the date of grant. At June 30, 2003, all awards subject to performance conditions were fully vested. If compensation expense for our stock-based compensation plans was determined by the fair value method prescribed by SFAS No. 123, "Accounting for Stock Based Compensation," our net income (loss) and net income (loss) per share would have been reduced or increased to the pro forma amounts indicated in the following table.
|
Three Months Ended June 30, |
Six Months Ended June 30, |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2002 |
2003 |
2002 |
2003 |
|||||||||
Net income (loss) as reported | $ | (7) | $ | 7 | $ | (11) | $ | (2) | |||||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | (2) | (1) | (4) | (2) | |||||||||
Pro forma net income (loss) | $ | (9) | $ | 6 | $ | (15) | $ | (4) | |||||
Earnings per share: | |||||||||||||
Basicas reported | $ | (0.14) | $ | 0.12 | $ | (0.20) | $ | (0.04) | |||||
Basicpro forma | $ | (0.17) | $ | 0.11 | $ | (0.26) | $ | (0.07) | |||||
Dilutedas reported | $ | (0.14) | $ | 0.12 | $ | (0.20) | $ | (0.04) | |||||
Dilutedpro forma | $ | (0.17) | $ | 0.11 | $ | (0.26) | $ | (0.07) | |||||
In November 2002, FASB issued Financial Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others." The initial recognition and measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, and require that we record a liability, if any, for the fair value of such guarantees in the Consolidated Balance Sheet. The adoption of FIN No. 45 did not have a significant impact on our consolidated financial position or results of operations because the impact was limited to additional disclosure. The additional disclosure is set forth below.
F-8
Certain of our subsidiaries have guaranteed the Senior Facilities and the Senior Notes as described in Notes 5 and 8.
Under the charters, by-laws and other organizational documents of GTI and its subsidiaries as well as certain laws, we are obligated to indemnify our directors and officers for certain liabilities or expenses arising out of service to us, and we maintain insurance with respect to certain of those obligations. Under certain circumstances, we may be entitled to recover from them expenses advanced on their behalf. No amounts have been recorded in respect of such obligations.
We generally sell products with a limited warranty. We accrue for known warranty claims if a loss is probable and can be reasonably estimated, and accrue for estimated incurred but unidentified claims based on historical activity. The accruals were not significant for either the 2002 first half or the 2003 first half.
In June 2002, FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which is effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue No. 94-3, a liability for an exit cost as defined in Issue No. 94-3 is recognized at the date an entity commits to an exit plan. We adopted SFAS No. 146 effective January 1, 2003 and recorded $19 million ($12 million, net of tax) of restructuring charges in the 2003 first quarter, $8 million of which related to organization changes and $11 million of which related to the closure and settlement of our U.S. non-qualified defined benefit plan for the participating salaried workforce.
In April 2002, FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections." The provisions of SFAS No. 145 related to the rescission of SFAS No. 4 must be applied in fiscal years beginning after May 15, 2002. The provisions of SFAS No. 145 related to SFAS No. 13 are effective for transactions occurring after May 15, 2002. All other provisions of SFAS No. 145 are effective for financial statements issued on or after May 15, 2002. SFAS No. 145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and an amendment thereto, and SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." Previously, accounting principles generally accepted in the United States required that gains and losses from extinguishment of debt be classified as an extraordinary item, net of related income tax effect. Based on SFAS No. 145, gains and losses from extinguishment of debt are classified as extraordinary items only if they meet the criteria of Accounting Principle Boards Opinion 30 ("APB 30"), "Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." The provisions of APB 30 distinguish transactions that are part of an entity's recurring operations from those that are unusual or infrequent or that meet the criteria for classification as an extraordinary item. As such, those that do not meet the criteria of APB 30 are included in the statement of operations before income (loss) before provisions (benefits) for income taxes, minority interest and extraordinary items. All prior periods presented that do not meet the criteria in APB 30 for classification as an extraordinary item must be reclassified. SFAS No. 145 also rescinds SFAS
F-9
No. 44, "Accounting for Intangible Assets of Motor Carriers." SFAS No. 145 amends SFAS No. 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS No. 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings or describe their applicability under changed conditions. We adopted SFAS No. 145 relating to SFAS No. 4 effective January 1, 2003. The effect of the adoption was to require reclassification of certain write-offs of capitalized bank charges for the three months and six months ended June 30, 2002 in the amount of $1 million and $4 million, respectively, from extraordinary items to other (income) expense, net. Correspondingly, the provision for income taxes from continuing operations for the three months and six months ended June 30, 2002 was increased by nil and $1 million, respectively. The adoption of the provisions of SFAS No. 145 relating to SFAS No. 13 and the other provisions of SFAS No. 145, excluding the provisions relating to SFAS No. 4, did not have a significant impact on our consolidated financial position or results of operations.
In July 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. We adopted SFAS No. 143 effective January 1, 2003. The adoption of SFAS No. 143 did not have a significant impact on our consolidated financial position or results of operations.
(2) Earnings Per Share
Basic and diluted earnings per share are calculated using the following share data:
|
Three Months Ended June 30, |
Six Months Ended June 30, |
||||||
---|---|---|---|---|---|---|---|---|
|
2002 |
2003 |
2002 |
2003 |
||||
Weighted average common shares outstanding for basic calculation | 55,872,417 | 57,036,671 | 55,848,004 | 56,829,015 | ||||
Add: Effect of stock options | | 3,581 | | | ||||
Weighted average common shares outstanding for diluted calculation | 55,872,417 | 57,040,252 | 55,848,004 | 56,829,015 | ||||
Basic earnings (loss) per common share are calculated by dividing net income (loss) by the weighted average number of common shares outstanding, in each case for the same period. Diluted earnings (loss) per share are calculated by dividing net income (loss) 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 had been issued, in each case for the same period. As a result of the net loss reported for the three months and six months ended June 30, 2002, 1,709,758 and 1,409,850, respectively, of potential common shares underlying dilutive securities have been excluded from the calculation of diluted earnings (loss) per share because their effect would reduce the loss per share. As a result of the net loss for the six months ended June 30, 2003, 48,554 of potential common shares underlying dilutive securities have been excluded from the calculation of diluted earnings (loss) per share because their effect would reduce the loss per share.
F-10
In addition, the calculation of weighted average common shares outstanding for the diluted calculation excludes consideration of stock options covering 4,205,994 and 9,016,980 shares in the three months ended June 30, 2002 and 2003, respectively, and 4,267,546, and 9,114,280 shares in the six months ended June 30, 2002 and 2003, 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 following table summarizes information about stock options outstanding at June 30, 2003.
|
Options Outstanding |
Options Exercisable |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Range of Exercise Prices (Shares in thousands) |
Number Outstanding |
Weighted-Average Remaining Contractual Life |
Weighted-Average Exercise Prices |
Number Exercisable |
Weighted-Average Exercise Prices |
||||||
Time vesting options: | |||||||||||
$02.83 to $10.77 | 4,636 | 7 years | $8.39 | 3,451 | $8.34 | ||||||
$11.60 to $19.06 | 2,467 | 5 years | $16.57 | 2,215 | $16.92 | ||||||
$22.82 to $29.22 | 141 | 5 years | $25.71 | 135 | $25.85 | ||||||
$30.59 to $40.44 | 1,426 | 3 years | $34.33 | 1,236 | $34.15 | ||||||
8,670 | 7,037 | ||||||||||
Performance vesting options: | |||||||||||
$7.60 | 361 | 4 years | $7.60 | 361 | $7.60 |
The calculation of both basic and diluted earnings (loss) per share gives effect to, among other things, the grant of 412,200 shares of restricted stock to employees in March 2002. GTI's Board of Directors accelerated the vesting of all of these shares in June 2002. As a result, we recorded $5 million of compensation expense in the 2002 second quarter which amount has been included in selling, administrative and other expenses.
In September 1998, GTI's Board of Directors adopted an executive employee loan program and an executive employee stock purchase program. In the 2002 first quarter, the programs were closed. In the 2002 second quarter, all of the outstanding loans, an aggregate of $3 million, were repaid and discharged. GTI received an aggregate of 220,127 shares of common stock, valued at the closing sale price on the date of repayment, and cash as repayment of the loans. Those shares were added to common stock held in treasury.
(3) Segment Reporting
In 2002, our businesses were organized around two operating divisions, our Graphite Power Systems Division, which included our graphite electrode and cathode businesses, and our Advanced Energy Technology Division, which included our natural graphite and advanced synthetic graphite and carbon materials businesses.
F-11
In 2003, we further refined the organization of our businesses into the following three lines of business:
In accordance with SFAS No. 131, "Segment Reporting," we have segregated our businesses into three corresponding operating segments. "Other" in the table below includes Advanced Energy Technology and Advanced Carbon Materials.
F-12
We evaluate the performance of our reportable segments based on gross profit. Intersegment sales and transfers of goods and services are not material. The following tables summarize financial information concerning our reportable segments.
|
Three Months Ended |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) (Unaudited) |
March 31, 2002 |
June 30, 2002 |
September 30, 2002 |
December 31, 2002 |
March 31, 2003 |
June 30, 2003 |
||||||||
Net sales: | ||||||||||||||
Synthetic Graphite | $118 | $142 | $136 | $142 | $149 | $162 | ||||||||
Other | 16 | 15 | 14 | 13 | 21 | 19 | ||||||||
Total | $134 | $157 | $150 | $155 | $170 | $181 | ||||||||
Cost of sales: | ||||||||||||||
Synthetic Graphite | $90 | $110 | $105 | $108 | $115 | $123 | ||||||||
Other | 14 | 12 | 12 | 9 | 16 | 15 | ||||||||
Total | $104 | $122 | $117 | $117 | $131 | $138 | ||||||||
Gross profit: | ||||||||||||||
Synthetic Graphite | $28 | $32 | $31 | $34 | $34 | $39 | ||||||||
Other | 2 | 3 | 2 | 4 | 5 | 4 | ||||||||
Total | $30 | $35 | $33 | $38 | $39 | $43 | ||||||||
Depreciation and amortization: | ||||||||||||||
Synthetic Graphite | $6 | $7 | $6 | $7 | $6 | $7 | ||||||||
Other | 1 | 1 | 1 | 1 | 1 | 1 | ||||||||
Total | $7 | $8 | $7 | $8 | $7 | $8 | ||||||||
"Other" in the table above has been restated for the periods presented to exclude our composite tooling business that was sold in June 2003.
(4) Restructuring and Impairment Charges
In the 2003 second quarter, we recorded an additional $1 million (before and after tax) of restructuring charges that related to the organizational changes in the 2003 first quarter described below. The $1 million charge was primarily related to employee severance programs and related benefits associated with a workforce reduction of several employees.
In the 2003 first quarter, we recorded $19 million ($12 million, net of tax) of restructuring charges, consisting of $8 million for organizational changes and $11 million for the closure and settlement of our U.S. non-qualified defined benefit plan for the participating salaried workforce. The $8 million ($5 million, net of tax) charge for organizational changes related to U.S. voluntary and selective severance programs and related benefits associated with a workforce reduction of 103 employees. The closure of our non-qualified U.S. defined benefit
F-13
plan resulted in recognition of net non-cash actuarial losses of $11 million ($7 million, net of tax).
In the 2002 fourth quarter, we recorded $3 million ($2 million, net of tax) of impairment charges relating to our investment in our joint venture with Jilin Carbon Co. Ltd. (together with its affiliates, "Jilin"). The impairment resulted from uncertainty about the completion and start-up of the planned graphite electrode facility in Changchun, China due to the effects that the challenging 2002 graphite electrode industry conditions had on Jilin. We also recorded a $1 million (nil, net of tax) change in estimate for the restructuring charge for our graphite electrode operations in Caserta, Italy.
In the 2002 third quarter, we recorded a $1 million charge related to the impairment of available-for-sale securities.
In the 2002 second quarter, we recorded a $13 million ($8 million, net of tax) non-cash charge primarily related to the impairment of our long-lived carbon electrode assets in Columbia, Tennessee as a result of a decline in demand and loss of market share. The primary end market for carbon electrodes is silicon metal, which was very depressed in the U.S. where our main customer base was located. This charge also included $1 million related to the impairment of available-for-sale securities.
In the 2002 first quarter, we recorded a $5 million restructuring charge related primarily to the mothballing of our graphite electrode operations in Caserta, Italy. This charge included estimated pension, severance and other related employee benefit costs for 102 employees and other costs related to the mothballing.
The following table summarizes activity relating to the accrued expense in connection with the restructuring charges.
(Dollars in millions) |
Severance and Related Costs |
Plant Shutdown and Related Costs |
Total |
||||
---|---|---|---|---|---|---|---|
Balance at December 31, 2001 | $4 | $8 | $12 | ||||
Restructuring charges in 2002 |
6 |
|
6 |
||||
Payments in 2002 | (5 | ) | 1 | (4 | ) | ||
Balance at December 31, 2002 | 5 | 9 | 14 | ||||
Restructuring charges in 2003 |
20 |
|
20 |
||||
Payments in 2003 | (2 | ) | (1 | ) | (3 | ) | |
Balance at June 30, 2003 | $23 | $8 | $31 | ||||
The restructuring accrual is included in other accrued liabilities on the Consolidated Balance Sheets.
F-14
(5) Long-Term Debt and Liquidity
The following table presents our long-term debt:
(Dollars in millions) |
December 31, 2002 |
June 30, 2003 |
|||||
---|---|---|---|---|---|---|---|
Senior Facilities: | |||||||
Tranche A euro facility | $ | $ | |||||
Tranche A U.S. dollar facility | | | |||||
Tranche B U.S. dollar facility | 137 | 137 | |||||
Revolving credit facility | 10 | 12 | |||||
Total Senior Facilities | 147 | 149 | |||||
Other European debt | 2 | 1 | |||||
Senior Notes: | |||||||
Senior Notes due 2012 | 550 | 530 | |||||
Fair value of hedged debt obligations | 8 | | |||||
Unamortized bond premium | 6 | 6 | |||||
Total Senior Notes | 564 | 536 | |||||
Total | $713 | $686 | |||||
Debt for Equity Exchange
In June 2003, we exchanged $20 million aggregate principal amount of Senior Notes, plus accrued interest of approximately $1 million, for 3,800,758 shares of common stock. These exchanges resulted in a net gain of approximately $1 million in the 2003 second quarter which has been recorded in other (income) expense, net. As a result of these exchanges, we accelerated certain amortization of swap proceeds (see Note 6) and recorded approximately $2 million as a credit against interest expense. See Note 11 regarding additional debt for equity exchanges during July and August 2003.
Senior Notes
On February 15, 2002, GrafTech Finance issued $400 million aggregate principal amount of Senior Notes. Interest on the Senior Notes is payable semi-annually on February 15 and August 15 of each year, commencing August 15, 2002, at the rate of 10.25% per annum. The Senior Notes mature on February 15, 2012.
In April 2002, we obtained consent from the holders of the Senior Notes issued in February 2002 to amend the Indenture so as to waive the requirement to use the gross proceeds from the issuance of up to $150 million aggregate principal amount of additional Senior Notes to make intercompany loans to our foreign subsidiaries. On April 30, 2002, we entered into a Supplemental Indenture.
On May 6, 2002, GrafTech Finance issued $150 million aggregate principal amount of additional Senior Notes at a purchase price of 104.5% of principal amount, plus accrued interest from February 15, 2002, under the same Indenture pursuant to which it issued the Senior Notes in February 2002. All of the Senior Notes constitute one class of debt securities under the Indenture. The additional Senior Notes bear interest at the same rate and mature on
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the same date as the Senior Notes issued in February 2002. The $7 million premium received upon issuance of the additional Senior Notes was added to the principal amount of the Senior Notes shown on the Consolidated Balance Sheets and is amortized (as a credit to interest expense) over the term of the additional Senior Notes. As a result of our receipt of such premium, the effective annual interest rate on the additional Senior Notes is about 9.5%.
Except as described below, GrafTech Finance may not redeem the Senior Notes prior to February 15, 2007. On or after that date, GrafTech Finance may redeem the Senior Notes, in whole or in part, at specified redemption prices beginning at 105.125% of the principal amount redeemed for the year commencing February 15, 2007 and reducing to 100.00% of the principal amount redeemed for the years commencing February 15, 2010 and thereafter, in each case plus accrued and unpaid interest to the redemption date.
In addition, before February 15, 2005, GrafTech Finance is entitled at its option on one or more occasions to redeem Senior Notes in an aggregate principal amount not to exceed 35% of the aggregate principal amount of Senior Notes originally issued by GrafTech Finance at a redemption price of 110.25% of the principal amount redeemed, plus accrued and unpaid interest to the redemption date, with the net cash proceeds from one or more underwritten primary public offerings of common stock of GTI pursuant to an effective registration statement under the Securities Act so long as:
Upon the occurrence of a change of control, GrafTech Finance will be required to make an offer to repurchase the Senior Notes at a price equal to 101.00% of the principal amount redeemed, plus accrued and unpaid interest to the redemption date. For this purpose, a change in control occurs on:
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The Senior Notes rank senior to present and future subordinated debt and equally with present and future senior debt and obligations of GrafTech Finance. The Senior Notes are effectively subordinated to present and future secured debt and obligations of GrafTech Finance, to the extent of the value of the assets securing such debt and obligations, and are structurally subordinated to debt and obligations, including trade payables, of subsidiaries that are neither guarantors of the Senior Notes nor unsecured intercompany term note obligors.
GTI, GrafTech Global and UCAR Carbon and other U.S. subsidiaries holding a substantial majority of our U.S. assets have guaranteed the Senior Notes on a senior unsecured basis, except that the guarantee by UCAR Carbon is secured as described below. Additional information with respect to the guarantees is set forth in Note 8.
Unsecured intercompany term notes in an aggregate principal amount at June 30, 2003 equal to $485 million (based on currency exchange rates in effect at June 30, 2003) and guarantees of those unsecured intercompany term notes issued to GrafTech Finance by certain of our foreign subsidiaries have been pledged by GrafTech Finance to secure the Senior Notes, subject to the limitation that at no time will the combined value of the pledged portion of any foreign subsidiary's unsecured intercompany term note and unsecured guarantee of unsecured intercompany term notes issued by other foreign subsidiaries exceed 19.99% of the principal amount of the then outstanding Senior Notes. As a result of this limitation, the principal amount of unsecured intercompany term notes pledged to secure the Senior Notes at June 30, 2003 equals $391 million (based on currency exchange rates in effect at June 30, 2003), or about 74% of the principal amount of the outstanding Senior Notes. The remaining unsecured intercompany term notes held by GrafTech Finance in an aggregate principal amount at June 30, 2003 of $94 million (based on currency exchange rates in effect at June 30, 2003), and any pledged unsecured intercompany term notes that cease to be pledged due to a reduction in the principal amount of the then outstanding Senior Notes due to redemption, repurchase or other events, will not be subject to any pledge and will be available to satisfy the claims of creditors (including the lenders under the Senior Facilities and the holders of the Senior Notes) of GrafTech Finance, as their interests may appear. The Senior Notes contain provisions restricting, subject to certain exceptions, the pledge of those unsecured intercompany term notes to secure any debt or obligation unless they are equally and ratably pledged to secure the Senior Notes for so long as such other pledge continues in effect.
The guarantee by UCAR Carbon has been secured by a pledge of all of our shares of AET, but at no time will the value of the pledged portion of such shares exceed 19.99% of the principal amount of the then outstanding Senior Notes. The pledge of the shares of AET is junior to the pledge of the same shares to secure UCAR Carbon's guarantee of the Senior Facilities.
The unsecured intercompany term note obligations rank senior to present and future subordinated guarantees, debt and obligations of the respective obligors, and equally with present and future senior guarantees, debt and obligations of the respective obligors. The unsecured intercompany term note obligations are effectively subordinated to present and future secured guarantees, debt and obligations of the respective obligors, to the extent of the value of the assets securing such guarantees, debt and obligations, and are structurally subordinated to guarantees, debt and obligations, including trade payables, of subsidiaries of the respective obligors that are not also unsecured intercompany term note obligors.
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The Senior Notes contain a number of covenants that, among other things, restrict our ability to incur additional indebtedness, pay dividends, make investments, create or permit to exist restrictions on distributions from subsidiaries, sell assets, engage in certain transactions with affiliates or enter into certain mergers and consolidations.
In addition to the failure to pay principal and interest when due or to repurchase Senior Notes when required, events of default under the Senior Notes include: failure to comply with applicable covenants; failure to pay at maturity or upon acceleration indebtedness exceeding $10 million; judgment defaults in excess of $10 million to the extent not covered by insurance; and certain events of bankruptcy.
The Senior Notes contain provisions as to legal defeasance and covenant defeasance.
Senior Facilities
The Senior Facilities consist of:
We are generally required to make mandatory prepayments in the amount of:
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We may make voluntary prepayments under the Senior Facilities. There is no penalty or premium due in connection with prepayments (whether voluntary or mandatory).
GrafTech Finance has made and may make secured and guaranteed intercompany loans of the net proceeds of borrowings under the Senior Facilities to GrafTech Global's subsidiaries. The obligations of GrafTech Finance under the Senior Facilities are secured, with certain exceptions, by first priority security interests in all of these intercompany loans (including the related security interests and guarantees). We used the proceeds from the issuance of the Senior Notes in February 2002 to finance the repayment of all of these intercompany loans that were outstanding at that time, except for intercompany revolving loans to UCAR Carbon and our Swiss subsidiary.
GTI guarantees the obligations of GrafTech Finance under the Senior Facilities. This guarantee is secured, with certain exceptions, by first priority security interests in all of the outstanding capital stock of GrafTech Global and GrafTech Finance, all of the intercompany debt owed to GTI and GTI's interest in the lawsuit initiated by us against our former parents.
GTI, GrafTech Global and each of GrafTech Global's subsidiaries guarantees, with certain exceptions, the obligations of GrafTech Global's subsidiaries under the intercompany loans, except that our foreign subsidiaries do not guarantee the intercompany loan obligations of our U.S. subsidiaries.
The obligations of GrafTech Global's subsidiaries under the intercompany loans as well as these guarantees are secured, with certain exceptions, by first priority security interests in substantially all of our assets, except that no more than 65% of the capital stock or other equity interests in our foreign subsidiaries held directly by our U.S. subsidiaries, and no other foreign assets, secure obligations or guarantees of our U.S. subsidiaries.
Each of the guarantees is full, unconditional and joint and severable, except as otherwise required to comply with applicable non-U.S. laws. Payment under the guarantees could be required immediately upon the occurrence of an event of default under the Senior Facilities. If a guarantor makes a payment under its guarantee, it would have the right under certain circumstances to seek contribution from the other guarantors.
At June 30, 2003, the interest rate applicable to the Revolving Facility is, at our option, either euro LIBOR plus a margin ranging from 1.375% to 3.375% (depending on our leverage ratio) or the alternate base rate plus a margin ranging from 0.375% to 2.375% (depending on our leverage ratio). At June 30, 2003, the interest rate applicable to the Tranche B Facility is, at our option, either euro LIBOR plus a margin ranging from 2.875% to 3.625% (depending on our leverage ratio) or the alternate base rate plus a margin ranging from 1.875% to 2.625% (depending on our leverage ratio). The alternate base rate is the higher of the prime rate announced by JP Morgan Chase Bank or the federal funds effective rate, plus 0.50%. GrafTech Finance pays a per annum fee ranging from 0.375% to 0.500% (depending on our leverage ratio) on the undrawn portion of the commitments under the Revolving Facility. At June 30, 2003, the interest rates on outstanding debt under the Senior Facilities were: Tranche B Facility, 5.0%; and dollar-denominated borrowings under the Revolving Facility, 4.8%. The weighted average interest rate on the Senior Facilities was 5.1% during the 2003 second quarter and 5.5% during the 2002 second quarter and 5.1% during the 2003 first half and 5.6% during the 2002 first half.
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The Senior Facilities contain a number of significant covenants that, among other things, significantly restrict our ability to sell assets, incur additional debt, repay or refinance other debt or amend other debt instruments, create liens on assets, enter into sale and lease back transactions, make investments or acquisitions, engage in mergers or consolidations, make capital expenditures, make intercompany dividend payments to GTI, pay intercompany debt owed to GTI, engage in transactions with affiliates, pay dividends to stockholders of GTI or make other restricted payments and that otherwise significantly restrict corporate activities. In addition, we are required to comply with financial covenants relating to specified minimum interest coverage ratios and maximum net senior secured debt leverage ratios (which is the ratio of our net senior secured debt to our EBITDA (as defined in the Senior Facilities)), which become more restrictive over time, beginning September 30, 2003.
Under the Senior Facilities, GTI is permitted to pay dividends on, and repurchase, common stock in an aggregate annual amount of $25 million, plus up to an additional $25 million if certain leverage ratio and excess cash flow requirements are satisfied. We are also permitted to repurchase common stock from present or former directors, officers or employees in an aggregate amount of up to the lesser of $5 million per year (with unused amounts permitted to be carried forward) or $25 million on a cumulative basis since February 22, 2000.
In addition to the failure to pay principal, interest and fees when due, events of default under the Senior Facilities include: failure to comply with applicable covenants; failure to pay when due, or other defaults permitting acceleration of, other indebtedness exceeding $7.5 million; judgment defaults in excess of $7.5 million to the extent not covered by insurance; certain events of bankruptcy; and certain changes in control.
Certain Amendments to Senior Facilities
In February 2002, the Senior Facilities were amended to, among other things, permit us to issue up to $400 million aggregate principal amount of Senior Notes. The amendment also changed the manner in which net debt and EBITDA (as defined in the Senior Facilities) are calculated for financial covenant purposes with respect to certain expenses incurred in connection with the lawsuit initiated by us against our former parents and any letter of credit issued to secure payment of the antitrust fine assessed against us by the EU Competition Authority. In connection therewith, we paid an amendment fee of $1 million and the margin that is added to either euro LIBOR or the alternate base rate in order to determine the interest rate payable thereunder increased by 37.5 basis points.
In May 2002, the Senior Facilities were amended to, among other things, permit us to issue up to $150 million aggregate principal amount of Senior Notes. In connection with this amendment, our maximum permitted leverage ratio was changed to measure the ratio of net senior secured debt to EBITDA (as defined in the Senior Facilities) as against new specified amounts. Our interest coverage ratio was also changed. We believe that these changed ratios provide us with greater flexibility. In addition, the amendment reduced the maximum amount available under the Revolving Facility to €200 million from €250 million (€25 million of which can only be used to pay or secure payment of the fine assessed by the EU Competition Authority) and reduced the basket for certain debt incurred by us that is not incurred under the Senior Facilities (excluding the Senior Notes) to $75 million from $130 million ($11 million of which debt was outstanding at June 30, 2003). In connection with the amendment and a
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consent to amend the Senior Notes to permit such issuance, we paid fees and costs of $1 million.
Leverage
We are highly leveraged and, as discussed in Note 7, have substantial obligations in connection with antitrust investigations, lawsuits and claims (in respect of which we have an unfunded reserve totaling $94 million). We had total debt of $709 million (including $6 million for unamortized bond premium) and a stockholders' deficit of $349 million at June 30, 2003. A substantial portion of our debt has variable interest rates or has been effectively converted from a fixed rate obligation to a variable rate obligation pursuant to interest rate management initiatives. We typically discount or factor a portion of our accounts receivable. In the 2003 first half, certain of our subsidiaries sold receivables totaling $96 million. In addition, if we are required to pay or issue a letter of credit to secure payment of the fine assessed by the antitrust enforcement authority of the European Union (the "EU Competition Authority") pending resolution of our appeal regarding the amount of the fine, the payment would be financed by borrowing under, or the letter of credit would constitute a borrowing under, the Revolving Facility.
We use, and are dependent on, funds available under the Revolving Facility as well as monthly or quarterly cash flow from operations as our primary sources of liquidity. As a result, we are dependent upon continued compliance with the financial covenants under the Senior Facilities. In addition, while the Revolving Facility provides for maximum borrowings of up to €200 million ($230 million, based on currency exchange rates in effect at June 30, 2003), 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 Senior Facilities.
Our high leverage and substantial obligations in connection with antitrust investigations, lawsuits and claims could have a material impact on our liquidity. Cash flow from operations services payment of our debt and these obligations, thereby reducing funds available to us for other purposes. Our leverage and these obligations make us more vulnerable to economic downturns or in the event that these obligations are greater or timing of payment is sooner than expected.
Our ability to service our debt as it comes due, including maintaining compliance with the financial covenants under the Senior Facilities, and to meet these and other obligations as they come due is dependent on our future financial and operating performance. This performance, in turn, is subject to various factors, including certain factors beyond our control, such as changes in conditions affecting our industry, changes in global and regional economic conditions, changes in interest and currency exchange rates, developments in antitrust investigations, lawsuits and claims involving us and inflation in raw material, energy and other costs.
Even if we are able to meet our debt service and other obligations when due, we may not be able to comply with the covenants and other provisions under the Senior Facilities. These covenants and provisions include financial covenants and representations regarding absence of material adverse changes affecting us. A failure to so comply, unless waived by the lenders thereunder, would be a default thereunder. This would permit the lenders to accelerate the
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maturity of the Senior Facilities. It would also permit them to terminate their commitments to extend credit under the Revolving Facility. This would have an immediate material adverse effect on our liquidity. An acceleration of maturity of the Senior Facilities would permit the holders of the Senior Notes to accelerate the maturity of the Senior Notes. A breach of the covenants contained in the Senior Notes would also permit the holders of the Senior Notes to accelerate the maturity of the Senior Notes. Acceleration of maturity of the Senior Notes would permit the lenders to accelerate the maturity of the Senior Facilities and terminate their commitments to extend credit under the Revolving Facility. If we were unable to repay our debt to the lenders and holders or otherwise obtain a waiver from the lenders and holders, the lenders and holders could proceed against the collateral securing the Senior Facilities and the Senior Notes, respectively, and exercise all other rights available to them. If we were unable to repay our debt to the lenders or the holders, or otherwise obtain a waiver from the lenders or the holders, we could be required to limit or discontinue, temporarily or permanently, certain of our business plans, activities or operations, reduce or delay certain capital expenditures, sell certain of our assets or businesses, restructure or refinance some or all of our debt or incur additional debt, or sell additional common stock or other securities. We cannot assure you that we would be able to obtain any such waiver or take any of such actions on favorable terms or at all.
As described above, we are dependent on the Revolving Facility and continuing compliance with the financial covenants under the Senior Facilities for liquidity. The Senior Facilities require us to, among other things, comply with financial covenants relating to specified minimum interest coverage and maximum net senior secured debt leverage ratios that become more restrictive over time. At June 30, 2003, we were in compliance with the financial covenants under the Senior Facilities. Based on our current business plan, we believe we will remain in compliance with the financial covenants for 2003. If we were to believe that we would not continue to comply with the financial 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.
(6) Financial Instruments
We use derivative financial instruments for managing well-defined currency exchange rate risks and interest rate risks. We do not use derivative financial instruments for trading purposes.
Foreign Currency Contracts
The amount of foreign exchange contracts used by us to minimize foreign currency exposure was $56 million at December 31, 2002 and $17 million at June 30, 2003.
Sale of Receivables
Certain of our U.S. and foreign subsidiaries sold receivables of $96 million in the 2003 first half and $94 million in the 2002 first half. Receivables sold and remaining on the Consolidated Balance Sheets were $1 million at December 31, 2002 and nil at June 30, 2003.
Interest Rate Risk Management
We implement interest rate management initiatives to seek to optimize the risk profile of our portfolio of fixed and variable interest rate obligations and lower our effective interest costs. Use of these initiatives is allowed under the Senior Notes and the Senior Facilities.
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Our interest rate swaps described below are designated as hedging the exposure to changes in the fair value of our related debt obligation (referred to as a fair value hedge). The gain or loss on the fair value hedge is recorded, together with the offsetting gain or loss on the debt obligation (sometimes referred to as the short-cut method), in the Consolidated Statements of Operations in the period of change in value.
In the 2003 first quarter, we entered into an additional $200 million notional amount interest rate swap (bringing our total notional amount of swaps to $450 million) through the remaining term of the Senior Notes, effectively converting that amount of fixed rate debt to variable rate debt. Subsequently in the 2003 first quarter, we sold the entire $450 million notional amount of swaps for $10 million in cash. Following the sale of the swaps, in the 2003 first quarter, we entered into $350 million notional amount of interest rate swaps through the remaining term of the Senior Notes. Subsequently, in the 2003 second quarter, we entered into an additional $50 million notional amount interest rate swap (bringing our total notional amount of swaps to $400 million). The swaps reduced our interest expense by approximately $3 million during the 2003 second quarter and by approximately $6 million during the 2003 second half. Subsequently, we sold the total notional amount of $400 million of swaps to allow for the accelerated collection of $21 million in cash in the 2003 second quarter. The proceeds from the sale of the swaps are being amortized over the term of the Senior Notes and recorded as a credit against interest expense. See Note 11 regarding our interest rate swap transaction during July 2003.
In the 2003 first quarter, we entered into interest rate caps for a notional amount of $300 million. In the 2003 second quarter, we also entered into additional interest rate caps for a notional amount of $200 million (bringing our total notional amount of caps to $500 million through August 2007).
The adjustment for the fair value of the hedged debt obligation was $8 million at December 31, 2002 and nil at June 30, 2003 and has been recorded as part of other assets in the Consolidated Balance Sheets. The adjustment for the fair value of the interest rate caps was $2 million for the six months ended June 30, 2003, and has been recorded as a charge to other (income) expense, net, in the Consolidated Statements of Operations.
Fair Market Value Disclosures
SFAS No. 107, "Disclosure about Fair Market Value of Financial Instruments," defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. Such fair values must often be determined by using one or more methods that indicate value based on estimates of quantifiable characteristics as of a particular date. Values were estimated as follows:
Cash and cash equivalents, short-term notes and accounts receivables, accounts payable and other current payablesThe carrying amount approximates fair value because of the short maturity of these instruments.
DebtFair value of debt was approximately $586 million at December 31, 2002 and $669 million at June 30, 2003.
Foreign currency contractsForeign currency contracts are carried at market value. The market value of the contracts was a loss of approximately $3 million at December 31, 2002 and a loss of approximately $2 million at June 30, 2003.
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Interest rate swapsSee "Interest Rate Risk Management."
(7) Contingencies
Antitrust Investigations
In April 1998, pursuant to a plea agreement between the U.S. Department of Justice (the "DOJ") and GTI, GTI pled guilty to a one count charge of violating U.S. federal antitrust law in connection with the sale of graphite electrodes and was sentenced to pay a non-interest-bearing fine in the aggregate amount of $110 million. The plea agreement was approved by the U.S. District Court for the Eastern District of Pennsylvania (the "District Court") and, as a result, under the plea agreement, we will not be subject to prosecution by the DOJ with respect to any other violations of U.S. federal antitrust law occurring prior to April 1998. At our request, in January 2002, the payment schedule for the $60 million unpaid balance outstanding at that time was revised to require a $2.5 million payment in April 2002, a $5.0 million payment in April 2003 and, beginning in April 2004, quarterly payments ranging from $3.25 million to $5.375 million, through January 2007. Beginning in 2004, the DOJ may ask the District Court to accelerate the payment schedule based on a change in our ability to make such payments. Interest will begin to accrue on the unpaid balance, commencing in April 2004, at the statutory rate of interest then in effect. At June 30, 2003, the statutory rate of interest was 1.09% per annum. Accrued interest will be payable together with each quarterly payment. The revised payment schedule has been approved by the District Court. All payments due have been timely paid.
In October 1999, we became aware that the Korean antitrust authority had commenced an investigation as to whether there had been any violation of Korean antitrust law by producers and distributors of graphite electrodes. In March 2002, we were advised that the Korean antitrust authority had assessed a fine against us in the amount of 676 million KRW ($569,000, based on currency exchange rates in effect at the time of payment) and assessed fines against five other graphite electrode producers in amounts ranging up to 4,396 million KRW (approximately $3.3 million, based on currency exchange rates in effect at the time of the decision imposing the fine). Our fine, which represented 0.5% of our graphite electrode sales in Korea during the relevant time period and was the lowest fine as a percentage of sales imposed by the Korean antitrust authority, reflected a substantial reduction as a result of our cooperation with that authority during its investigation. In May 2002, we appealed the decision. In July 2002, the Korean antitrust authority affirmed its decision on appeal. We paid the fine together with accrued interest, an aggregate of $584,000, in August 2002.
In January 2000, the EU Competition Authority issued a statement of objections initiating proceedings against us and other producers of graphite electrodes. The statement alleges that we and other producers violated antitrust laws of the European Community and the European Economic Area in connection with the sale of graphite electrodes. In July 2001, the EU Competition Authority issued its decision regarding the allegations. Under the decision, the EU Competition Authority assessed a fine of €50.4 million (about $58 million, based on exchange rates in effect at June 30, 2003) against us and assessed fines against seven other graphite electrode producers in amounts ranging up to €80.2 million. From the initiation of its investigation, we have cooperated with the EU Competition Authority. As a result of our cooperation, our fine reflects a substantial reduction from the amount that otherwise would have been assessed. It is the policy of the EU Competition Authority to negotiate appropriate
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terms of payment of antitrust fines, including extended payment terms. We have had discussions regarding payment terms with the EU Competition Authority. After an in-depth analysis of the decision, in October 2001, we filed an appeal to the Court of First Instance of the European Communities in Luxembourg (the "Court") challenging the amount of the fine. In July 2003, the Court heard oral argument on this appeal and we are awaiting its decision. The fine or collateral security therefor would typically be required to be paid or provided at about the time the appeal was filed. We have had discussions with the EU Competition Authority regarding the appropriate form of collateral security during the pendency of the appeal. If the EU Competition Authority seeks to require payment of the fine or provision of collateral security therefor, we may file an interim appeal to the Court to waive or modify such requirement. We cannot predict how or when the Court would rule on such an interim appeal.
In May 2001, we became aware that the Brazilian antitrust authority had requested written information from various steelmakers in Brazil. In April 2002, our Brazilian subsidiary received a request for information from that authority. We have provided that information.
In May 2002, the EU Competition Authority issued a statement of objections initiating proceedings against us and other producers of specialty graphite. The statement alleges that we and other producers violated European antitrust laws in connection with the sale of specialty graphite. In December 2002, the EU Competition Authority issued its decision regarding the allegations. Under the decision, the EU Competition Authority assessed no fine against us and assessed fines against seven other producers in amounts ranging up to €28 million. We received a 100% reduction from the amount that otherwise would have been assessed against us due to our cooperation.
Except as described above, the antitrust investigations against us in the U.S., Canada, the European Union, Japan and Korea have been resolved. We are continuing to cooperate with the DOJ, the EU Competition Authority and the Canadian Competition Bureau in their continuing investigations of others. In October 1997, we were served with subpoenas by the DOJ to produce documents relating to, among other things, our carbon electrode and bulk graphite businesses. It is possible that antitrust investigations seeking, among other things, to impose fines and penalties could be initiated against us by antitrust authorities in Brazil or other jurisdictions.
To the extent that antitrust investigations involving us have been resolved with guilty pleas or by adverse decisions, such guilty pleas and decisions make it more difficult for us to defend against other investigations as well as civil lawsuits and claims. We have been vigorously protecting, and intend to continue to vigorously protect, our interests in connection with the investigations described above. We may, however, at any time settle any possible unresolved charges.
Antitrust Lawsuits
Through June 30, 2003, except as described in the following paragraphs, 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 by certain customers who negotiated directly with us. The settlements cover, among other things, virtually all claims against us by customers in the U.S. and Canada arising out of alleged antitrust violations occurring prior to the date of the relevant settlements in connection with the sale of graphite electrodes. One of the settlements
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also covers the actual and respective potential claims against us by certain foreign customers arising out of alleged antitrust violations occurring prior to the date of that settlement in connection with the sale of graphite electrodes sourced from the U.S. Although each settlement is unique, in the aggregate they consist primarily of current and deferred cash payments with some product credits and discounts. All payments due have been timely paid.
In 1999 and 2000, we and other producers of graphite electrodes were served with three complaints commencing three separate civil antitrust lawsuits in the District Court. In March 2002, we were served with another complaint commencing a separate civil antitrust lawsuit in the District Court. These lawsuits are called the "foreign customer lawsuits." The first complaint, entitled Ferromin International Trade Corporation, et al. v. UCAR International Inc., et al., was filed by 27 steelmakers and related parties, all but one of whom are located outside the U.S. The second complaint, entitled BHP New Zealand Ltd. et al. v. UCAR International Inc., et al. was filed by 4 steelmakers, all of whom are located outside the U.S. The third complaint, entitled Saudi Iron and Steel Company v. UCAR International Inc., et al., was filed by a steelmaker who is located outside the U.S. The fourth complaint, entitled Arbed, S.A., et al. v. Mitsubishi Corporation, et al., was filed by 5 steelmakers, all of whom are located outside the U.S. In each complaint, the plaintiffs allege that the defendants violated U.S. federal antitrust law in connection with the sale of graphite electrodes sold or sourced from the U.S. and those sold and sourced outside the U.S. The plaintiffs seek, among other things, an award of treble damages resulting from such alleged antitrust violations. We believe that we have strong defenses against claims alleging that purchases of graphite electrodes outside the U.S. are actionable under U.S. federal antitrust law. We filed motions to dismiss the first and second complaints. In June 2001, our motions to dismiss the first and second complaints were granted with respect to substantially all of the plaintiffs' claims. Appeals have been filed by the plaintiffs and the defendants with the U.S. Court of Appeals for the Third Circuit with regard to these dismissals. The U.S. Court of Appeals for the Third Circuit heard oral argument on these appeals on March 11, 2003, and we are awaiting its decision. The third complaint was dismissed without prejudice to refile pending the resolution of such appeals. We filed a motion to stay the lawsuit commenced by the fourth complaint pending resolution of appeals in the other foreign customer lawsuits and such motion was granted in July 2002.
In 1999 and 2000, we were served with three complaints commencing three civil antitrust lawsuits (the "carbon electrode lawsuits"). The first complaint, filed in the District Court, is entitled Globe Metallurgical, Inc. v. UCAR International Inc., et al. The second complaint, initially filed in the U.S. Bankruptcy Court for the Northern District of Ohio and subsequently transferred to the U.S. District Court for the Northern District of Ohio, Eastern Division, is now entitled Cohen & Co., Distribution Trustee v. UCAR International Inc., et al. (In re Simetco, Inc.). The third complaint, filed in the U.S. District Court for the Southern District of West Virginia, is entitled Elkem Metals Company Inc and Elkem Metals Company Alloy LLP v. UCAR Carbon Company Inc., et al. SGL Carbon AG is also named as a defendant in the first complaint and SGL Carbon Corporation is also named as a defendant in the first and third complaints. In the complaints, the plaintiffs allege that the defendants violated U.S. federal antitrust law in connection with the sale of carbon electrodes and seek, among other things, an award of treble damages resulting from such alleged violations. In October 2001, we settled the lawsuit commenced by the third complaint. In September 2002, we settled the lawsuit commenced by the first complaint. In January 2003, we settled the lawsuit commenced by the second complaint. The guilty pleas and decisions described above do not relate to carbon electrodes.
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In the 2002 first quarter, we and other producers of cathodes were served with a complaint commencing a civil antitrust lawsuit in the U.S. District Court for the District of Oregon entitled Northwest Aluminum Company, et al. vs. VAW Aluminum A.G., et al (the "carbon cathode lawsuit"). The complaint was filed by two producers of aluminum. In the complaint, the plaintiffs allege that the defendants violated U.S. federal antitrust law in connection with the sale of cathodes and seek, among other things, an award of treble damages resulting from such alleged violations. In November 2002, we settled this lawsuit. The guilty pleas and decisions described above do not relate to cathodes.
In December 2002 and January 2003, we and other producers of bulk graphite were served with two complaints commencing two civil class action antitrust lawsuits. The first complaint, filed in the U.S. District Court for the District of New Jersey, is entitled Industrial Graphite Products, Inc. v. Carbone Lorraine North America Corporation, et al. The second complaint, filed in the same court, is entitled Ceradyne, Inc. v. Carbone Lorraine North America Corporation, et al. In February 2003, we learned that a class action complaint commencing a civil class action antitrust lawsuit had been filed against us and other producers of bulk graphite in the District Court entitled General Refractories Company v. GrafTech International Ltd., et al. In March 2003, this lawsuit was dismissed by the District Court without prejudice. In March 2003, we learned that two complaints commencing civil class action antitrust lawsuits had been filed against us and other producers of bulk graphite in the U.S. District Court for the District of New Jersey entitled General Refractories Company v. GrafTech International Ltd., et al. and Midwest Graphite Co., Inc. v. SGL Carbon, LLC, et al., respectively. The lawsuits commenced by the first, second, fourth and fifth complaints, along with a lawsuit commenced by a sixth complaint filed only against SGL Carbon, LLC, SGL Carbon A.G. and SGI Carbon GmbH, were subsequently consolidated or are subject to consolidation into a single lawsuit in the United States District Court for the District of New Jersey entitled In re: Bulk [Extruded] Graphite Products Antitrust Litigation (the "bulk graphite lawsuits"). In the bulk graphite lawsuits, the plaintiffs allege that the defendants violated U.S. federal antitrust law in connection with the sale of bulk graphite and seek, among other things, an award of treble damages resulting from such alleged violations. In March 2003, we reached an agreement to settle the bulk graphite lawsuits. The guilty pleas and decisions described above do not relate to bulk graphite.
The foreign customer lawsuits are still in their early stages. We have been vigorously defending, and intend to continue to vigorously defend, against these remaining lawsuits as well as all threatened lawsuits and possible unasserted claims. We may at any time, however, settle these lawsuits as well as any threatened lawsuits and possible claims. It is possible that additional civil antitrust lawsuits seeking, among other things, to recover damages could be commenced against us in the U.S. and in other jurisdictions.
Antitrust Earnings Charges
We have recorded pre-tax charges of $350 million against results of operations as a reserve for potential liabilities and expenses in connection with antitrust investigations and related lawsuits and claims. The reserve of $350 million is calculated on a basis net of, among other things, imputed interest on installment payments of the DOJ fine. Actual aggregate liabilities and expenses (including settled investigations, lawsuits and claims as well as continuing investigations, pending appeals and unsettled pending, threatened and possible lawsuits and claims mentioned above) could be materially higher than $350 million and the timing of
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payment thereof could be sooner than anticipated. The fines and net settlements and expenses are within the amounts we used to evaluate the aggregate charge of $350 million. To the extent that aggregate liabilities and expenses, net, are known or reasonably estimable, at June 30, 2003, $350 million represents our estimate of these liabilities and expenses. Our insurance has not and will not materially cover liabilities that have or may become due in connection with antitrust investigations or related lawsuits or claims.
Through June 30, 2003, we have paid an aggregate of $256 million of fines and net settlement and expense payments and $19 million of imputed interest. At June 30, 2003, $94 million remained in the reserve. The balance of the reserve is available for the fine payable to the DOJ (excluding imputed interest thereon), the fine assessed by the EU Competition Authority and other matters. The aggregate amount of remaining committed payments payable to the DOJ for imputed interest at June 30, 2003 was nil.
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 us.
Lawsuit Initiated by Us Against Our Former Parents
In February 2000, at the direction of a special committee of independent directors of GTI's Board of Directors, we commenced a lawsuit in the U.S. District Court for the Southern District of New York against our former parents, Mitsubishi Corporation and Union Carbide Corporation. The other defendants named in the lawsuit include two of the respective representatives of Mitsubishi and Union Carbide who served on GTI's Board of Directors at the time of our 1995 leveraged equity recapitalization, Hiroshi Kawamura and Robert D. Kennedy. Mr. Kennedy, who was a director of GTI at the time the lawsuit was commenced, resigned as such on March 14, 2000.
In the lawsuit, we allege, among other things, that, in January 1995, Mitsubishi and Union Carbide had knowledge of facts indicating that GTI had engaged in illegal graphite electrode price fixing activities and that any determination of GTI's statutory capital surplus would be overstated as a result of those activities. We also allege that certain of their representatives knew or should have known about those activities. In January 2000, Mitsubishi was indicted by the DOJ on a one count charge of aiding and abetting violations of U.S. federal antitrust law in connection with the sale of graphite electrodes. Mitsubishi entered a plea of not guilty. In February 2001, a jury found Mitsubishi guilty of the charge. Mitsubishi entered into a sentencing agreement with the DOJ, which was approved by the District Court, pursuant to which Mitsubishi agreed to pay a fine of $134 million and not appeal its conviction. Mitsubishi has also been named as a defendant in several civil antitrust lawsuits commenced by electric arc furnace steel producers with respect to its alleged participation in those activities. In addition, we allege that, in January 1995, GTI did not have the statutory capital surplus required to lawfully authorize the payments that GTI made to its former parents. We also allege that Mitsubishi and Union Carbide were unjustly enriched by receipts from their investments in GTI and that they knowingly induced or actively and substantially assisted former senior management of GTI to engage in illegal graphite electrode price fixing activities in breach of their fiduciary duties to GTI.
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Based on the allegations summarized above, we are seeking to recover from Mitsubishi and Union Carbide more than $1.5 billion in damages, including interest. Some of our claims provide for joint and several liability; however, damages from our various claims would not generally be additive to each other.
The defendants have filed motions to dismiss this lawsuit and a motion to disqualify certain of our counsel from representing us in this lawsuit. Oral hearings were held on those motions in the 2001 first and second quarters. The court approved a motion to disqualify certain of our counsel in November 2002, and denied our motion to reconsider that decision. We do not believe that either that decision or the adverse ruling on such motion for reconsideration will adversely affect this lawsuit. The court has not ruled on the motions to dismiss.
We expect to incur $10 million to $20 million for legal expenses to pursue this lawsuit from the date of filing the complaint through trial. Through June 30, 2003, we had incurred about $5 million of these legal expenses. This lawsuit is in its earliest stages. The ultimate outcome of this lawsuit is subject to many uncertainties. We may at any time settle this lawsuit.
(8) Financial Information About the Parent, the Issuer, the Guarantors and the Subsidiaries Whose Securities Secure the Senior Notes and Related Guarantees
On February 15, 2002, GrafTech Finance (the "Issuer") issued $400 million aggregate principal amount of Senior Notes and, on May 6, 2002, $150 million aggregate principal amount of additional Senior Notes. The Senior Notes have been guaranteed on a senior basis by GTI (the "Parent") and GrafTech Global, UCAR Carbon and other subsidiaries holding a substantial majority of our U.S. assets, which subsidiaries are UCAR International Holdings Inc., UCAR International Trading Inc., UCAR Carbon Technology LLC, UCAR Composites Inc. and UCAR Holdings III Inc. The guarantors (other than the Parent) are collectively called the "U.S. Guarantors." The guarantees of the U.S. Guarantors are unsecured, except that the guarantee of UCAR Carbon has been secured by a pledge of all of our shares of AET, but in no event will the value of the pledged portion of such shares exceed 19.99% of the principal amount of the then outstanding Senior Notes. All of the guarantees are full, unconditional and joint and several, and the Issuer and each of the U.S. Guarantors are 100% owned by the Parent. If a U.S. Guarantor makes a payment under its guarantee, it would have the right under certain circumstances to seek contribution from the other U.S. Guarantors. Payment under the guarantees could be required immediately upon the occurrence of an event of default under the Senior Notes. AET and our other subsidiaries, which are not guarantors, are called the "Non-Guarantors." The following table sets forth condensed consolidating balance sheets at December 31, 2002 and June 30, 2003 and condensed consolidating statements of operations and cash flows for the three months and six months ended June 30, 2002 and 2003 of the Parent, the Issuer, the U.S. Guarantors and the Non-Guarantors. Provisions in the Senior Facilities restrict the payment of dividends by our subsidiaries to the Parent. At June 30, 2003, retained earnings of our subsidiaries subject to such restrictions were approximately $482 million. Investments in subsidiary companies are recorded on the equity basis.
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Condensed consolidating balance sheet
at June 30, 2003
(Unaudited)
|
June 30, 2003 |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) |
Parent |
Issuer |
U.S. Guarantors |
Non- Guarantors |
Eliminations |
Consolidated |
|||||||||
ASSETS | |||||||||||||||
Current Assets: | |||||||||||||||
Cash and cash equivalents | $ | $ | $2 | $5 | $1 | $8 | |||||||||
Notes and accounts receivable | 1 | 827 | 448 | 122 | (1,279 | ) | 119 | ||||||||
Inventories: | |||||||||||||||
Raw materials and supplies | | | 2 | 44 | (1 | ) | 45 | ||||||||
Work in process | | | 29 | 90 | 1 | 120 | |||||||||
Finished goods | | | 8 | 24 | (3 | ) | 29 | ||||||||
1 | | 39 | 158 | (3 | ) | 194 | |||||||||
Prepaid expenses and deferred income taxes | | 4 | 11 | 14 | (2 | ) | 27 | ||||||||
Assets of discontinued operations | | | 17 | | (17 | ) | | ||||||||
Total current assets | 1 | 831 | 517 | 299 | (1,300 | ) | 348 | ||||||||
Property, plant and equipment | | | 301 | 773 | (4 | ) | 1,070 | ||||||||
Less: accumulated depreciation | | | (260 | ) | (481 | ) | (1 | ) | (742 | ) | |||||
Net fixed assets | | | 41 | 292 | (5 | ) | 328 | ||||||||
Deferred income taxes and other assets | 21 | 24 | (77 | ) | 127 | 148 | 243 | ||||||||
Total assets | $22 | $855 | $481 | $718 | $(1,157 | ) | $919 | ||||||||
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) |
|||||||||||||||
Current liabilities: | |||||||||||||||
Accounts payable | $42 | $26 | $48 | $87 | $(98 | ) | $105 | ||||||||
Short-term debt | 389 | | 224 | 586 | (1176 | ) | 23 | ||||||||
Accrued income and other taxes | (8 | ) | 22 | (4 | ) | 22 | | 32 | |||||||
Other accrued liabilities | | | 74 | 39 | (37 | ) | 76 | ||||||||
Liabilities of discontinued operations | | | 5 | | (2 | ) | 3 | ||||||||
Total current liabilities | 423 | 48 | 347 | 734 | (1,313 | ) | 239 | ||||||||
Long-term debt | (20 | ) | 704 | | 2 | | 686 | ||||||||
Other long-term obligations | | 38 | 190 | 47 | | 275 | |||||||||
Deferred income taxes | | (12 | ) | | 37 | 14 | 39 | ||||||||
Minority stockholders' equity in consolidated entities | | | | 28 | 1 | 29 | |||||||||
Stockholders' equity (deficit) | (381 | ) | 77 | (56 | ) | (130 | ) | 141 | (349 | ) | |||||
Total liabilities and stockholders' equity (deficit) |
$22 | $855 | $481 | $718 | $(1,157 | ) | $919 | ||||||||
F-30
Condensed consolidating balance sheet
at December 31, 2002
|
December 31, 2002 |
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Dollars in millions) |
Parent |
Issuer |
U.S. Guarantors |
Non- Guarantors |
Eliminations |
Consolidated |
|||||||||
ASSETS | |||||||||||||||
Current Assets: | |||||||||||||||
Cash and cash equivalents | $ | $ | $4 | $7 | $ | $11 | |||||||||
Notes and accounts receivable, net | | 752 | 466 | 255 | (1,369 | ) | 104 | ||||||||
Inventories: | |||||||||||||||
Raw materials and supplies | | | 2 | 38 | (1 | ) | 39 | ||||||||
Work in process | | | 30 | 71 | 1 | 102 | |||||||||
Finished goods | | | 10 | 23 | (3 | ) | 30 | ||||||||
| | 42 | 132 | (3 | ) | 171 | |||||||||
Prepaid expenses and deferred income taxes |
| | 8 | 13 | | 21 | |||||||||
Assets of discontinued operations | | | 14 | | | 14 | |||||||||
Total current assets | | 752 | 534 | 407 | (1,372 | ) | 321 | ||||||||
Net fixed assets | | | 36 | 268 | (4 | ) | 300 | ||||||||
Deferred income taxes and other assets | 47 | 34 | (33 | ) | 120 | 70 | 238 | ||||||||
Total assets | $47 | $786 | $537 | $795 | $(1,306 | ) | $859 | ||||||||
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) |
|||||||||||||||
Current liabilities: | |||||||||||||||
Accounts payable | $21 | $26 | $30 | $89 | $(61 | ) | $105 | ||||||||
Short-term debt | 416 | | 231 | 668 | (1,297 | ) | 18 | ||||||||
Accrued income and other taxes | (24 | ) | (3 | ) | 36 | 18 | (4 | ) | 23 | ||||||
Other accrued liabilities | | | 36 | 39 | (18 | ) | 57 | ||||||||
Liabilities of discontinued operations | | | 3 | | | 3 | |||||||||
Total current liabilities | 413 | 23 | 336 | 814 | (1,380 | ) | 206 | ||||||||
Long-term debt | | 711 | | 2 | | 713 | |||||||||
Other long-term obligations | | 9 | 203 | 45 | 1 | 258 | |||||||||
Deferred income taxes | | (5 | ) | (1 | ) | 36 | 3 | 33 | |||||||
Minority stockholders' equity in consolidated entities | | | | 30 | | 30 | |||||||||
Stockholders' equity (deficit) | (366 | ) | 48 | (1 | ) | (132 | ) | 70 | (381 | ) | |||||
Total liabilities and stockholders' equity (deficit) | $47 | $786 | $537 | $795 | $(1,306 | ) | $859 | ||||||||
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