10-Q 1 graftech10qaug02.txt FORM 10-Q ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------- FORM 10-Q --------------- (MARK ONE) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ........TO......... --------------- COMMISSION FILE NUMBER: 1-13888 --------------- GRAFTECH INTERNATIONAL LTD. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 06-1385548 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) --------------- 1521 CONCORD PIKE BRANDYWINE WEST, SUITE 301 19803 WILMINGTON, DE (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (302) 778-8227 --------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] As of June 30, 2002, 55,829,730 shares of common stock, par value $.01 per share, were outstanding. ================================================================================ TABLE OF CONTENTS PART I. FINANCIAL INFORMATION: ITEM 1. FINANCIAL STATEMENTS: Consolidated Balance Sheets at December 31, 2001 and June 30, 2002........................... Page 2 Consolidated Statements of Operations for the Three Months and Six Months ended June 30, 2001 and 2002............................................................. Page 3 Consolidated Statements of Cash Flows for the Six Months ended June 30, 2001 and 2002........ Page 4 Consolidated Statement of Stockholders' Deficit for the Six Months ended June 30, 2002....... Page 5 Notes to Consolidated Financial Statements................................................... Page 6 INTRODUCTION TO PART I, ITEM 2, AND PART II, ITEM 1................................................. Page 36 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................................................. Page 42 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS................................ Page 74 PART II. OTHER INFORMATION: ITEM 1. LEGAL PROCEEDINGS......................................................................... Page 76 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS................................................. Page 81 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................................... Page 82 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.......................................................... Page 82 SIGNATURE .......................................................................................... Page 84
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ---------------------------- GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED)
DECEMBER 31, JUNE 30, ASSETS 2001 2002 ---- ---- CURRENT ASSETS: Cash and cash equivalents........................................................ $ 38 $ 51 Notes and accounts receivable.................................................... 95 117 Inventories: Raw materials and supplies..................................................... 33 41 Work in process................................................................ 111 102 Finished goods................................................................. 33 29 ----------- ----------- 177 172 Prepaid expenses and deferred income taxes....................................... 12 21 ----------- ----------- Total current assets........................................................... 322 361 ----------- ----------- Property, plant and equipment........................................................ 931 972 Less: accumulated depreciation...................................................... 650 684 ----------- ----------- Net fixed assets............................................................... 281 288 ----------- ----------- Deferred income taxes................................................................ 140 158 Goodwill............................................................................. 29 25 Less: accumulated amortization...................................................... 12 11 ----------- ----------- 17 14 Other assets......................................................................... 37 48 ----------- ----------- Total assets................................................................... $ 797 $ 869 =========== =========== LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES: Accounts payable................................................................. $ 101 $ 106 Short-term debt.................................................................. 7 17 Accrued income and other taxes................................................... 45 48 Other accrued liabilities........................................................ 57 59 ----------- ----------- Total current liabilities................................................... 210 230 Long-term debt....................................................................... 631 693 Unamortized bond premium............................................................. - 7 Other long-term obligations.......................................................... 231 229 Deferred income taxes................................................................ 32 31 Minority stockholders' equity in consolidated entities............................... 25 27 STOCKHOLDERS' EQUITY (DEFICIT): Preferred stock, par value $.01, 10,000,000 shares authorized, none issued....... - - Common stock, par value $.01, 100,000,000 shares authorized, 58,532,209 shares issued at December 31, 2001, 58,798,669 shares issued at June 30, 2002........ 1 1 Additional paid-in capital....................................................... 629 636 Accumulated other comprehensive loss............................................. (269) (278) Retained deficit................................................................. (602) (613) Unearned restricted stock........................................................ - - Less: cost of common stock held in treasury, 2,322,412 shares at December 31, 2001, 2,542,539 shares at June 30, 2002.................................. (85) (88) Less: common stock held in employee benefits trust, 426,400 shares at December 31, 2001 and June 30, 2002.................................................... (6) (6) ----------- ----------- Total stockholders' deficit...................................................... (332) (348) ----------- ----------- Total liabilities and stockholders' deficit.................................. $ 797 $ 869 =========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) (UNAUDITED)
THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, 2001 2002 2001 2002 ---- ---- ---- ---- $ $ $ $ Net sales............................................ 171 161 342 299 Cost of sales........................................ 120 125 242 232 ---------- ------------ --------- --------- Gross profit.................................... 51 36 100 67 Research and development............................. 3 3 6 6 Selling, administrative and other expenses........... 19 20 40 38 Compensation expense-stock grant..................... - 5 - 5 Global realignment and related expenses.............. - 2 - 3 Restructuring charge and impairment loss of long- lived and other assets.......................... 58 13 58 18 Antitrust investigations and related lawsuits and claims...................................... 10 - 10 - Other (income) expense, net.......................... - (13) - (16) Interest expense..................................... 16 17 35 30 ---------- ------------ --------- --------- 106 47 149 84 Loss before provisions (benefits) for income taxes, minority interest and extraordinary items........................ (55) (11) (49) (17) Benefit for income taxes............................. (16) (5) (14) (10) ---------- ------------ --------- --------- Loss of consolidated entities before minority interest and extraordinary items. (39) (6) (35) (7) Less: minority stockholders' share of income......... - - 1 1 ---------- ------------ --------- --------- Loss before extraordinary items............... (39) (6) (36) (8) Extraordinary items, net of tax...................... - 1 - 3 ---------- ------------ --------- --------- Net loss........................................ $ (39) $ (7) $ (36) $ (11) ========== ============ ========= ========= BASIC LOSS PER COMMON SHARE: Loss before extraordinary items................. $ (0.87) $ (0.12) $ (0.80) $ (0.15) Extraordinary items, net of tax................. - (0.02) - (0.05) ---------- ------------ --------- ---------- Net loss per share.............................. $ (0.87) $ (0.14) $ (0.80) $ (0.20) ========== ============ ========= ========== Weighted average common shares outstanding (IN THOUSANDS).............................. 45,346 55,872 45,284 55,848 ========== ============ ========= ========== DILUTED LOSS PER COMMON SHARE: Loss before extraordinary items................. $ (0.87) $ (0.12) $ (0.80) $ (0.15) Extraordinary items, net of tax................. - (0.02) - (0.05) ========== ============ ========= ========== Net loss per share.............................. $ (0.87) $ (0.14) $ (0.80) $ (0.20) ========== ============ ========= ========== Weighted average common shares 45,346 55,872 45,284 55,848 outstanding (IN THOUSANDS).................. ========== ============ ========= ==========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED)
SIX MONTHS ENDED JUNE 30, ------------------------- 2001 2002 ---- ---- CASH FLOW FROM OPERATING ACTIVITIES: Net loss .................................................................... $ (36) $ (1) Extraordinary items, net of tax.............................................. - 3 Non-cash charges to net loss: Depreciation and amortization............................................ 19 15 Deferred income taxes.................................................... (21) (13) Antitrust investigations and related lawsuits and claims................. 10 - Compensation expense - stock grant....................................... - 5 Restructuring charge and impairment loss on long-lived and other assets......................................... 53 18 Other non-cash charges................................................... (3) (28) Working capital *............................................................ (21) (25) Long-term assets and liabilities............................................. - - ------- ------ NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES................. 1 (36) ------- ------ CASH FLOW FROM INVESTING ACTIVITIES: Capital expenditures......................................................... (11) (20) Sale of assets............................................................... 4 - ------- ------ NET CASH USED IN INVESTING ACTIVITIES............................... (7) (20) ------- ------ CASH FLOW FROM FINANCING ACTIVITIES: Short-term debt borrowings (reductions), net................................. (1) 10 Revolving credit facility borrowings (reductions), net....................... 13 (95) Long-term debt borrowings.................................................... 1 557 Long-term debt reductions.................................................... (29) (387) Minority interest investment................................................. 9 - Sale of common stock under stock options..................................... 2 1 Financing costs.............................................................. - (20) ------- ------ NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ................ (5) 66 ------- ------ Net increase (decrease) in cash and cash equivalents.............................. (11) 10 Effect of exchange rate changes on cash and cash equivalents...................... (1) 3 Cash and cash equivalents at beginning of period.................................. 47 38 ------- ------ CASH AND CASH EQUIVALENTS AT END OF PERIOD........................................ $ 35 $ 51 ======= ====== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Net cash paid during the period for: Interest expense......................................................... $ 33 $ 17 ======= ====== Income taxes............................................................. $ 15 $ 4 ======= ====== * Net change in working capital due to the following components: (Increase) decrease in current assets: Notes and accounts receivable............................................ $ 18 $ (18) Inventories.............................................................. (26) 10 Prepaid expenses......................................................... (1) (2) Increase (decrease) in accounts payable and accruals......................... 1 (13) Antitrust investigations and related lawsuits and claims..................... (8) - Restructuring payments....................................................... (5) (2) ------- ------ WORKING CAPITAL..................................................... $ (21) $ (25) ======= ====== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4 PART I (CONT'D) CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT (DOLLARS IN MILLIONS) (UNAUDITED)
ACCUMULATED COMMON STOCK TOTAL ADDITIONAL OTHER UNEARNED HELD IN STOCKHOLDERS' COMMON PAID-IN COMPREHENSIVE RETAINED RESTRICTED TREASURY EMPLOYEE EQUITY STOCK CAPITAL LOSS DEFICIT STOCK STOCK BENEFITS TRUST (DEFICIT) ----- ------- ---- ------- ----- ----- -------------- --------- BALANCE AT DECEMBER 31, 2001....... $ 1 $ 629 $ (269) $ (602) $ - $ (85) $ (6) $ (332) Comprehensive loss: Net loss...................... - - - (11) - - - (11) Foreign currency translation adjustments............... - - (9) - - - - (9) ------- ------- ------- ------ ------ ------ ------- -------- Total comprehensive loss............. - - (9) (11) - - - (20) Issuance of restricted stock....... - 6 - - (6) - - - Amortization of restricted stock.. - - - - 1 - - 1 Accelerated vesting of restricted stock......................... - - - - 5 - - 5 Repurchase of treasury stock....... - (3) - (3) Sale of common stock............... - 1 - - - - - 1 ------- ------- ------- ------ ------ ------ ------- -------- BALANCE AT JUNE 30, 2002...........$ 1 $ 636 $ (278) $ (613) $ - $ (88) $ (6) $ (348) ======= ======= ======= ====== ====== ====== ======= ========
5 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (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. Results of operations for the six months ended June 30, 2002 are not necessarily indicative of the results of operations that may be expected for the entire year ending December 31, 2002. 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. 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. 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. "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"). Prior to June 7, 2002, GrafTech Finance was named UCAR Finance Inc. "GRAFTECH" refers to Graftech Inc. only. Graftech is our 97.5% owned (wholly owned, prior to June 2001) subsidiary engaged in the development, manufacture and sale of natural graphite-based products. "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 graphite and carbon cathodes. 6 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS "SUBSIDIARIES" refers to those companies which, 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, 2002, except for: o Carbone Savoie, which has been and is 70% owned; and o Graftech, which was 100% owned until it became 97.5% owned in June 2001. 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. We have realigned the corporate organizational structure of our foreign subsidiaries. As a result, most of the non-U.S. businesses of each of our two divisions are segregated into separate companies along divisional lines. In addition, because most of the operations, net sales and growth opportunities of our Graphite Power Systems Division are located outside the U.S., most of its operations 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 similarly realign the corporate organizational structure of our U.S. subsidiaries. FOREIGN CURRENCY TRANSLATION Generally, except for financial statements of our subsidiary in Russia where high inflation has existed, unrealized gains and losses resulting from translation of financial statements of our foreign subsidiaries from their functional currencies into dollars are accumulated in other comprehensive income (loss) on the Consolidated Balance Sheets until such time as the subsidiaries or their operations are sold or the subsidiaries are substantially or completely liquidated. Translation gains and losses relating to financial statements of foreign subsidiaries in countries where high inflation has existed or which predominantly use the dollar for their operations are included in other (income) expense, net in the Consolidated Statements of Operations. 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. Our Mexican subsidiary began using the dollar as its functional currency during 1999 because its sales and purchases are predominantly dollar-denominated. Prior to the 2002 first quarter, we had designated (euro)125 million of Tranche A Term Loans as a net equity hedge for our net investments in Europe. The currency effects associated with the 7 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS designated Tranche A Term Loans were reflected in accumulated other comprehensive income (loss) in the Consolidated Balance Sheets where they offset gains and losses recorded on our net investment in Europe. In the 2002 first quarter, a majority of the Tranche A Term Loans were repaid, the net equity hedge was eliminated and the resulting $1 million of loss in accumulated other comprehensive income (loss) was charged to other (income) expense, net in the Consolidated Statements of Operations. We have intercompany loans between GrafTech Finance and some of our subsidiaries. Some of these loans are denominated in currencies other than the dollar and, accordingly, are subject to translation gains and losses due to changes in currency exchange rates. Some of these intercompany loans are deemed to be essentially permanent and, as a result, translation gains and losses on these loans are reflected in accumulated other comprehensive income (loss). The remaining intercompany loans are expected to be repaid in the foreseeable future and, as a result, translation gains and losses on these loans are reflected in other (income) expense, net. NEW ACCOUNTING STANDARDS In June 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which is effective for financial statements issued for fiscal years beginning 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)." We are currently evaluating the impact of SFAS No. 146 on our consolidated financial position and results of operations. 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 shall be applied in fiscal years beginning after May 15, 2002. The provisions of SFAS No. 145 related to SFAS No. 13 shall be effective for transactions occurring after May 15, 2002 and all other provisions of SFAS No. 145 shall be 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." SFAS No. 145 also rescinds SFAS 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 are currently evaluating the impact of the provisions of SFAS No. 145 relating to SFAS No. 4 on our consolidated financial position and results of operations. The provisions of SFAS No. 145 relating to SFAS No. 13 and the other provisions of SFAS No. 145, 8 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS excluding the provisions relating to SFAS No. 4, did not have a significant impact on our consolidated financial position or results of operations. In August 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets, excluding goodwill and other intangible assets not being amortized pursuant to SFAS No. 142, and certain other assets. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001. We adopted SFAS No. 144 effective January 1, 2002. The adoption of SFAS No. 144 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. SFAS No. 143 will be effective for financial statements issued for fiscal years beginning after June 15, 2002. We anticipate that the adoption of SFAS No. 143 will not have a significant impact on our consolidated financial position or results of operations. In July 2001, FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets," both of which are effective for financial statements issued for fiscal years beginning after December 15, 2001. SFAS No. 141 and SFAS No. 142 establish accounting and reporting standards for business combinations, goodwill and intangible assets. We adopted SFAS No. 141 and SFAS No. 142 effective January 1, 2002. The adoption of SFAS No. 141 and SFAS No. 142 did not have a significant impact on our consolidated financial position or results of operations, except that we no longer amortize goodwill. Goodwill amortization was $1 million in the 2001 first half. (2) EARNINGS PER SHARE Basic and diluted earnings per share are calculated using the following share data:
THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, -------------- -------------- 2001 2002 2001 2002 ---- ---- ---- ---- Weighted average common shares outstanding for basic calculation............... 45,345,828 55,872,417 45,284,211 55,848,004 Add: Effect of stock options........................ - - - - ---------- ---------- ---------- ---------- Weighted average common shares outstanding for diluted calculation............. 45,345,828 55,872,417 45,284,322 55,848,004 ========== ========== ========== ==========
Basic earnings (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is 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. As a result of the net loss reported 9 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for the three months and six months ended June 30, 2001, 986,196 and 898,781, respectively, of potential common shares 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 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. In addition, the calculation of weighted average common shares outstanding for the diluted calculation excludes consideration of stock options covering 4,305,447 and 4,205,994 shares in each of the three months ended June 30, 2001 and 2002, respectively, and 4,311,847 and 4,267,546 shares in each of the six months ended June 30, 2001 and 2002, respectively, because the exercise of these options would not have been dilutive for those periods due to the fact that the exercise prices were greater than the weighted average market price of our common stock for each of those periods. The calculation of both basic and diluted earnings (loss) per share gives effect to, among other things, the grant of 412,300 shares of restricted stock to employees in March 2002. 50% of the shares granted to each employee were scheduled to vest on January 1, 2003 and 50% on January 1, 2004 if the employee was still employed on the vesting date. 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. 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 with shares of common stock, valued at the closing sale price on the date of repayment. Those shares were added to common stock held in treasury. (3) SEGMENT REPORTING We evaluate the performance of our operating 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. 10 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, -------- -------- 2001 2002 2001 2002 ---- ---- ---- ---- (DOLLARS IN MILLIONS) Net sales to external customers: Graphite Power Systems Division .................. $137 $133 $273 $244 Advanced Energy Technology Division .............. 34 28 69 55 ---- ---- ---- ---- Consolidated net sales ........................ $171 $161 $342 $299 ==== ==== ==== ==== Gross profit: Graphite Power Systems Division .................. $ 41 $ 30 $ 79 $ 55 Advanced Energy Technology Division .............. 10 6 21 12 ---- ---- ---- ---- Consolidated gross profit ..................... $ 51 $ 36 $100 $ 67 ==== ==== ==== ==== Depreciation and amortization: Graphite Power Systems Division .................. $ 8 $ 6 $ 17 $ 12 Advanced Energy Technology Division .............. 1 2 2 3 ---- ---- ---- ---- Consolidated depreciation and amortization .... $ 9 $ 8 $ 19 $ 15 ==== ==== ==== ====
4. RESTRUCTURING AND IMPAIRMENT CHARGES In the 2002 second quarter, we recorded a $13 million ($8 million after tax) non-cash charge primarily related to the impairment of our long-lived carbon electrode assets in Columbia, Tennessee, primarily due to a decline in demand and loss of market share. The primary end market for carbon electrodes is silicon metal, which remains very depressed in the U.S. where our main customer base is located. This non-cash charge also includes a $1 million impairment loss related to impairment of available-for-sale securities. In the 2002 first quarter, we recorded a $5 million restructuring charge that related primarily to the mothballing of our graphite electrode operations in Caserta, Italy. This charge includes estimated pension, severance and other related employee benefit costs for 102 employees and other costs related to the mothballing. In the 2001 fourth quarter, we recorded a $7 million restructuring charge and a $27 million impairment loss on long-lived and other assets. The restructuring charge related primarily to exit costs related to the mothballing of our graphite electrode operations in Caserta, Italy. $24 million of the impairment loss related to assets located at our facility in Caserta. The remaining $3 million of the impairment loss related to impairment of available-for-sale securities. In the 2001 third quarter, we recorded a $2 million restructuring charge and impairment loss on long-lived assets related to the restructuring and realignment of our businesses into our Advanced Energy Technology and Graphite Power Systems Divisions, the relocation of our corporate headquarters and the shutdown of our coal calcining operations located in Niagara Falls, New York. As part of the realignment, we centralized management functions of our Advanced Energy Technology Division in Cleveland, Ohio, and management functions of our 11 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Graphite Power Systems Division in Etoy, Switzerland. We relocated our corporate headquarters, consisting of approximately 10 employees, from Nashville, Tennessee, to Wilmington, Delaware. The relocation was substantially completed by the end of 2001. The charge includes severance and related benefits associated with a workforce reduction of 24 employees and impairment of leasehold improvement assets. In the 2001 third quarter, we reversed $2 million of prior restructuring charges based on revised lower estimates of workforce reductions and plant closure costs, and we reclassified $4 million of prior restructuring charges related to on-site waste disposal post monitoring costs to the other long-term obligations. In the 2001 second quarter, we recorded a $58 million charge for restructuring and impairment loss on long-lived assets related to the shutdown of our graphite electrode manufacturing operations in Clarksville and Columbia, Tennessee and our coal calcining operations in Niagara Falls, New York. The $58 million charge included restructuring charges of $2 million for severance and related benefits associated with a work force reduction of 171 employees and $3 million in plant shutdown and related costs. The remaining $53 million of the charge related to the impairment loss on long-lived assets. The shutdown was completed on schedule by the end of the 2001 third quarter. In the 2000 fourth quarter, we recorded a charge of $4 million in connection with a corporate restructuring, mainly for severance and related benefits associated with a workforce reduction of 85 employees. The functional areas affected included finance, accounting, sales, marketing and administration. In 2001, we paid about $1 million of these expenses. In the 2001 third quarter, we revised the workforce reduction estimate to 45 employees and reversed a portion of the $4 million charge. The reversal is part of the $2 million reversal described above. In the 2000 third quarter, we recorded an impairment loss on long-lived assets of $3 million in connection with the re-sourcing of our U.S. cathode production to our facilities in Brazil and France and the reduction of graphite electrode production capacity to accommodate such increased cathode production in Brazil and France. This non-cash charge related to the write-off of certain long-lived assets located at one of our facilities in the U.S. In the 2000 first quarter, we recorded a restructuring charge of $6 million in connection with a restructuring of our advanced graphite materials business. Key elements of the restructuring included elimination of certain product lines and rationalization of operations to reduce costs and improve profitability of remaining product lines. This rationalization included discontinuing certain manufacturing processes at one of our facilities in the U.S. that will be performed at our other facilities in the future. Based on subsequent developments in the 2000 third quarter, we decided not to demolish certain buildings. Therefore, in the 2000 third quarter, we reversed the $4 million of the charge related to demolition and related environmental costs. The $2 million balance of the charge included estimated severance costs for 65 employees. The restructuring was completed in 2000. 12 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes activity relating to the accrued expense in connection with the restructuring charges.
POST PLANT SHUTDOWN MONITORING SEVERANCE AND AND RELATED AND RELATED RELATED COSTS COSTS COSTS TOTAL (DOLLARS IN MILLIONS) BALANCE AT DECEMBER 31, 2000............. $ 13 $ 9 $ 4 $ 26 Restructuring charges in 2001............ 4 8 - 12 Payments in 2001......................... (13) (5) - (18) Non-cash write-offs in 2001.............. - (4) - (4) Reclassification of on-site disposal and monitoring costs..................... - - (4) (4) ------ ---- ----- ----- BALANCE AT DECEMBER 31, 2001............. $ 4 $ 8 $ - $ 12 Restructuring charges in 2002............ 5 - - 5 Payments in 2002......................... (3) 2 - (1) ------ ---- ----- ----- BALANCE AT JUNE 30, 2002................. $ 6 $ 10 $ - $ 16 ======= ====== ====== ======
The restructuring accrual is included in other accrued liabilities on the Consolidated Balance Sheets. (5) LONG-TERM DEBT AND LIQUIDITY The following table presents our long-term debt:
DECEMBER 31, JUNE 30, 2002 2002 ---- ---- (DOLLARS IN MILLIONS) Senior Facilities: Tranche A euro facility............................ $ 194 $ - Tranche A U.S. dollar facility..................... 23 - Tranche B U.S. dollar facility..................... 313 137 Revolving credit facility.......................... 95 - ---------- -------- Total Senior Facilities.......................... 625 137 Swiss mortgage and other European debt.................. 6 6 Senior Notes due 2012................................... - 550 ---------- -------- Total.............................................. $ 631 $ 693 ========== ========
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. 13 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. 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 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%. On June 5, 2002, GrafTech Finance offered to exchange new registered Senior Notes (and related guarantees) that are substantially identical to the previously outstanding Senior Notes (and related guarantees), except that certain transfer restrictions and registration rights relating to the previously outstanding Senior Notes would not apply to the new registered Senior Notes (and related guarantees). All of the previously outstanding Senior Notes (and related guarantees) were exchanged under the exchange offer. 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% 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 (which includes additional Senior Notes, if any) in an aggregate principal amount not to exceed 35% of the aggregate principal amount of the Senior Notes (which includes additional Senior Notes, if any) originally issued 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 offering of common stock of GTI pursuant to an effective registration statement under the Securities Act so long as: o at least 65% of such aggregate principal amount of Senior Notes (which includes additional Senior Notes, if any) remains outstanding immediately after each such redemption (other than Senior Notes held, directly or indirectly, by us); and 14 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS o each such redemption occurs within 60 days after the date of the related public offering. 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% of the principal amount redeemed, plus accrued and unpaid interest to the redemption date. For this purpose, a change in control occurs on: o the date on which any person beneficially owns more than 35% of the total voting power of GTI; or o the date on which individuals, who on the issuance date of the Senior Notes were directors of GTI (or individuals nominated or elected by a vote of 66 2/3% of such directors or directors previously so elected or nominated), cease to constitute a majority of GTI's Board of Directors then in office; or o the date on which a plan relating to the liquidation or dissolution of GTI is adopted; or o the date on which GTI merges or consolidates with or into another person or another person merges into GTI, or all or substantially all of GTI's assets are sold (determined on a consolidated basis), with certain specified exceptions; or o the date on which GTI ceases to own, directly or indirectly, all of the voting power of GrafTech Global, UCAR Carbon and GrafTech Finance. 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. The Senior Notes have been guaranteed on a senior unsecured basis by GTI, GrafTech Global and UCAR Carbon and other U.S. subsidiaries holding a substantial majority of our U.S. assets, except that the guarantee by UCAR Carbon is secured as described below. Unsecured intercompany term notes in an aggregate principal amount equal to $420 million (based on currency exchange rates in effect at June 30, 2002) 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 15 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 equals $403 million, or about 73% of the principal amount of the outstanding Senior Notes. The remaining unsecured intercompany term notes held by GrafTech Finance in an aggregate principal amount of $17 million (based on currency exchange rates in effect at June 30, 2002), 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 Graftech, 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 Graftech 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. 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 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 of 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. 16 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SENIOR FACILITIES The Senior Facilities consist of: o A Tranche A Facility providing for initial term loans of $137 million and of (euro)161 million (equivalent to $158 million based on currency exchange rates in effect at February 22, 2000) to GrafTech Finance. In October 2000, we converted $78 million of these loans from dollar-denominated to euro-denominated loans. o A Tranche B Facility providing for initial term loans of $350 million to GrafTech Finance. o A Revolving Facility providing for dollar and euro-denominated revolving and swingline loans to, and the issuance of dollar-denominated letters of credit for the account of, GrafTech Finance and certain of our other subsidiaries in an aggregate principal and stated amount at any time not to exceed(euro)200 million ((euro)25 million of which can only be used to pay or secure payment of the fine assessed by the EU Competition Commission). The Revolving Facility terminates on February 22, 2006. As a condition to each borrowing under the Revolving Facility, we are required to represent, among other things, that the aggregate amount of payments made (excluding certain imputed interest) and additional reserves created in connection with antitrust, securities and stockholder derivative investigations, lawsuits and claims do not exceed $340 million by more than $75 million (which $75 million is reduced by the amount of certain debt (excluding the Senior Notes) incurred by us that is not incurred under the Senior Facilities ($23 million of which debt was outstanding at June 30, 2002)). At June 30, 2002, after giving effect to the issuance of the Senior Notes in February and May 2002 and the application of the net proceeds therefrom: o the term loans under the Tranche A Facility have been fully repaid; and o the principal amount of term loans outstanding under the Tranche B Facility is $137 million, all of the scheduled principal payments of which are due in 2007. We are generally required to make mandatory prepayments in the amount of: o Either 75% or 50% (depending on our net debt leverage ratio, which is the ratio of our net debt to our EBITDA) of excess cash flow. The obligation to make these prepayments, if any, arises after the end of each year with respect to adjusted excess cash flow during the prior year; o 100% of the net proceeds of certain asset sales or incurrence of certain indebtedness; and 17 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS o 50% of the net proceeds of the issuance of certain GTI equity securities. 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 which were outstanding at that time, except for intercompany revolving loans to UCAR Carbon and our Swiss subsidiary. GTI unconditionally and irrevocably 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. 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). 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, 2002, the interest rates on outstanding debt under the Senior Facilities were: Tranche B Facility, 5.5%. The weighted average interest rate on the Senior Facilities was 5.5% during the 2002 second quarter and 8.0% during the 2001 second quarter, and 5.6% during the 2002 first half and 8.4% during the 2001 first half. 18 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 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), 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 net debt 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 April 2001, the Senior Facilities were amended to, among other things, exclude certain expenses incurred in connection with the lawsuit initiated by us against our former parents (up to a maximum of $20 million, but not more than $3 million in any quarter) and certain charges and payments in connection with antitrust fines, settlements and expenses from the calculation of financial covenants. After giving effect to subsequent amendments to the Senior Facilities, payments within the $340 million charge recorded in 1997 are excluded from the calculation of financial covenants and charges over and above the $340 million charge are excluded from the calculation of financial covenants (until paid) up to a maximum of $75 million reduced by the amount of certain debt (other than the Senior Notes) incurred by us that is not incurred under the Senior Facilities ($23 million of which debt was outstanding at June 30, 2002). As a result, the fine assessed by the EU Competition Authority, as well as the additional $10 million charge recorded in July 2001 and any payments related to such fine (including payments within the $340 million charge), are excluded from such calculations. In July 2001, in connection with an underwritten public offering of common stock, the Senior Facilities were amended to, among other things, change our financial covenants so that they were less restrictive than would otherwise have been the case. In connection therewith, we 19 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS agreed that our investments in unrestricted subsidiaries after this amendment will be made in the form of secured loans, which will be pledged to secure the Senior Facilities, and the maximum amount of capital expenditures permitted under the Senior Facilities would be reduced in 2001 and 2002. We do not expect that our capital expenditures would exceed such maximums. In connection therewith, we paid an amendment fee of $2 million and the margin which is added to either euro LIBOR or the alternate base rate in order to determine the interest rate payable thereunder increased by 25 basis points. In December 2001, the Senior Facilities were amended to, among other things, permit the corporate realignment of our subsidiaries. In connection therewith, we paid an amendment fee of $1 million. 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 are calculated to exclude any letter of credit issued to secure payment of the antitrust fine assessed against us by the EU Competition Commission. In addition, the amendment expanded our ability to make certain investments, including investments in Graftech, and eliminated provisions relating to a spin-off of Graftech. In connection therewith, we paid an amendment fee of $1 million and the margin which 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 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 (euro)200 million from (euro)250 million ((euro)25 million of which can only be used to pay or secure payment of the fine assessed by the EU Competition Commission) 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 ($23 million of which debt was outstanding at June 30, 2002). In connection with the amendment and the consent, we paid fees and costs of $1 million. The net proceeds from the sale of the Senior Notes in February and May 2002 were applied to repay term loans under the Tranche A and B Facilities and reduce the outstanding balance under the Revolving Facility. INTEREST RATE MANAGEMENT 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 the Senior Facilities. In 2002 first half, we entered into two ten-year interest rate swaps for a total notional amount of $250 million to 20 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS effectively convert that amount of fixed rate debt to variable rate debt. These interest rate swaps are fair value swaps and are accounted for based on the short-cut method. These swaps reduced our interest expense in the 2002 second quarter by $1 million. LEVERAGE We are highly leveraged and, as discussed in Note 7 on page 22, have substantial obligations in connection with antitrust investigations, lawsuits and claims (in respect of which we have an unfunded reserve totaling $101 million). We had total debt of $710 million and a stockholders' deficit of $348 million at June 30, 2002. 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 2002 first half, certain of our subsidiaries sold receivables totaling $94 million. If we had not sold such receivables, our accounts receivable would have been about $47 million higher at June 30, 2002. In addition, if we are required to pay or issue a letter of credit to secure payment of the fine assessed by 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. Our leverage and obligations, as well as changes in conditions affecting our industry, changes in global and regional economic conditions and other factors, have adversely impacted our recent operating results. We use, and are dependent on, funds available under the Revolving Facility, including continued compliance with the financial covenants under the Senior Facilities, as well as monthly or quarterly cash flow from operations as our primary sources of liquidity. 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 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 financial covenants under the Senior Facilities. A failure to so comply, unless waived by the lenders thereunder, would be a default thereunder. This would 21 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS permit the lenders to accelerate the 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. EXTRAORDINARY ITEM In May 2002, we recorded an extraordinary charge $1 million ($1 million after tax) for write-off of capitalized fees associated with the term loans under Tranche A and B Facilities repaid with the net proceeds from the issuance of Senior Notes. In February 2002, we recorded an extraordinary charge of $3 million ($2 million after tax) for write-off of capitalized fees associated with the term loans under Tranche A and B Facilities repaid with the net proceeds from the issuance of Senior Notes. (6) FINANCIAL INSTRUMENTS Certain of our subsidiaries sold receivables totaling $94 million in the 2002 first half and $119 million in the 2001 first half. None of the receivables sold were recorded on the Consolidated Balance Sheets at June 30, 2002 or December 31, 2001, respectively. If we had not sold such receivables, our accounts receivable would have been about $47 million higher at June 30, 2002. (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, payable in six annual installments of $20 million, $15 million, $15 million, $18 million, $21 million and $21 million, commencing July 23, 1998. The plea agreement was approved by the 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 2001, the due date of each of the remaining three payments was deferred by one year and, at our request, in January 2002, the payment schedule for the $60 million unpaid balance outstanding at that time was revised to 22 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 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. In January 2002, the statutory rate of interest was 2.13% per annum. Accrued interest will be payable together with each quarterly payment. The revised payment schedule has been approved by the court. All payments due have been timely made. In March 1999, pursuant to a plea agreement between our Canadian subsidiary and the Canadian Competition Bureau, our Canadian subsidiary pled guilty to a one count charge of violating Canadian antitrust law in connection with the sale of graphite electrodes and was sentenced to pay a fine of Cdn. $11 million. The relevant Canadian court approved the plea agreement and, as a result, under the plea agreement we will not be subject to prosecution by the Canadian Competition Bureau with respect to any other violations of Canadian antitrust law occurring prior to the date of the plea agreement. The fine was 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 it had, after holding a hearing, assessed a fine against us in the amount of 676 million KRW (approximately $560,000, based on currency exchange rates in effect on June 30, 2002). Five other graphite electrode producers were also fined by it in amounts ranging up to 4,396 million KRW (approximately $3.6 million based on currency exchange rates in effect on June 30, 2002). Our fine represented 0.5% of our graphite electrode sales in Korea during the relevant time period. 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, in August 2002. In January 2000, the antitrust enforcement authority of the European Union (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 European antitrust law in connection with the sale of graphite electrodes. In July 2001, the EU Competition Authority issued its decision regarding the allegations. Under the decision, it assessed a fine of (euro)50.4 million (about $50 million, based on currency exchange rates in effect at June 30, 2002) against us. Seven other graphite electrode producers were also fined, with fines ranging up to (euro)80.2 million. From the initiation of its investigation, we have cooperated with the EU Competition Authority. 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 challenging the amount of the fine. Appeals of this type may take two years or longer to be decided and the fine or collateral security therefor would typically be required to be paid or provided at about the time the appeal was filed. We are currently in discussions with the EU Competition Authority regarding the appropriate form of 23 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS collateral security during the pendency of the appeal. If the results of these discussions are not acceptable to us, we may file an interim appeal with 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 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. In May 2002, the antitrust authority of the European Union 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. As a result of our substantial cooperation to date and our intention to continue to cooperate, under the Notice of Non-Imposition or Reduction of Fines in Cartel Cases issued by the antitrust authority of the European Union, we believe that we will benefit from the maximum reduction possible (a 100% reduction) with the result that no fine will be payable. Except as described above, antitrust investigations against us in the U.S., Canada, the European Union, Japan and Korea have been resolved. We are continuing to cooperate with some of these antitrust authorities 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 by antitrust authorities in Brazil or other jurisdictions. The guilty pleas and decisions described above 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, 2002, 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 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. One of the settlements also covers the actual and potential claims against us by certain foreign customers arising out of alleged antitrust violations occurring prior to the date of that settlement in 24 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 settlement payments due have been timely made. In 1999, 2000 and 2002, we and other producers of graphite electrodes were served with four complaints commencing four separate civil antitrust lawsuits (the "FOREIGN CUSTOMER LAWSUITS"). The complaints were filed by an aggregate of 37 steelmakers and related parties, all but one 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 regard to these dismissals. The third complaint was dismissed without prejudice to refile pending the resolution of such appeals. The fourth complaint was filed in March 2002 and also names Mitsubishi Corporation as a defendant. We filed a motion to stay the lawsuit commenced by the fourth complaint pending the resolution of such appeals 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 complaints were filed by an aggregate of three companies and the estate of a bankrupt company. Other producers of carbon electrodes are named as defendants in two of the 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. We filed motions to dismiss the second and third complaints. In May 2001, our motion to dismiss the second complaint was denied. In October 2001, we settled the lawsuit commenced by the third complaint. The guilty pleas and decisions described above do not relate to carbon electrodes. In March 2002, we received notice that a complaint had been filed commencing a civil antitrust lawsuit (the "CARBON CATHODE LAWSUIT"). The complaint was filed by two producers of aluminum. One of our subsidiaries and other producers of carbon cathodes are named as defendants in the complaint. In the complaint, the plaintiffs allege that the defendants violated U.S. federal antitrust law in connection with the sale of carbon cathodes and seek, among other things, an award of treble damages resulting from such alleged violations. We intend to vigorously defend against such lawsuit. The guilty pleas and decisions described above do not relate to carbon cathodes. The foreign customer lawsuits, two of the three carbon electrode lawsuits and the carbon cathode lawsuit 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 25 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. 1997 AND 2001 SECOND QUARTER ANTITRUST EARNINGS CHARGES We recorded a pre-tax charge of $340 million against results of operations for 1997 and, as a result of the assessment of a fine by the EU Competition Authority, we recorded a pre-tax charge of an additional $10 million against results of operations for the 2001 second quarter, as a reserve for potential liabilities and expenses in connection with antitrust investigations and related lawsuits and claims. The aggregate reserve of $350 million is calculated on a basis net of, among other things, imputed interest on installment payments of the fine payable to the DOJ. 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 payment thereof could be sooner than anticipated. In the aggregate (including the assessment of the fine by the EU Competition Authority and the additional $10 million charge), 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, 2002, $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, 2002, we have paid an aggregate of $249 million of fines and net settlement and expense payments and $14 million of imputed interest. At June 30, 2002, $101 million remained in the reserve. The balance of the reserve is available for the fine payable to the DOJ, 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, 2002 was about $6 million. 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, we commenced a lawsuit against our former parents, Mitsubishi Corporation and Union Carbide Corporation. In the lawsuit, we allege, among other things, that certain payments made to our former parents in connection with our leveraged equity recapitalization in January 1995 were unlawful under the General Corporation Law of the State 26 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of Delaware, that our former parents were unjustly enriched by receipts from their investments in us and that our former parents aided and abetted breaches of fiduciary duties owed to us by our former senior management in connection with illegal graphite electrode price fixing activities. The defendants have filed motions to dismiss this lawsuit and a motion to disqualify certain of our counsel from representing us in this lawsuit. We are vigorously opposing those motions. Oral hearings were held on those motions in the 2001 first and second quarters. We expect that a decision on those motions will be rendered by the end of September 2002. Through June 30, 2002, we had incurred about $4 million of legal expenses in connection with this lawsuit. 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) OTHER TRANSACTIONS In January 2002, we announced a new major cost savings plan. The key elements of the 2002 plan include: o the rationalization of graphite electrode manufacturing capacity at our higher cost facilities, including the mothballing of our graphite electrode plant in Caserta, Italy, which was completed in the 2002 first quarter, and the incremental expansion of capacity at our lower cost facilities; o the redesign and implementation of changes in our U.S. benefit plans for active and retired employees; o the implementation of work process changes, including the consolidation and streamlining of order fulfillment, purchasing, finance and accounting, and human resource processes, along with the identification and implementation of outsourcing opportunities; o the implementation of additional plant and corporate overhead cost reductions; and o the corporate realignment of our subsidiaries, consistent with the operational realignment of our divisions, to generate significant tax savings, which was substantially completed in the 2002 first half. We intend to sell real estate, non-strategic businesses and certain other non-strategic assets over the next two years. These non-strategic businesses contributed net sales of about $25 million in 2001. (9) 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 27 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 Graftech, 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. Graftech and our other subsidiaries which are not guarantors are called the "NON-GUARANTORS." The following table sets forth condensed consolidating balance sheets at June 30, 2002 and December 31, 2001 and condensed consolidating statements of operations and cash flows for the six months ended June 30, 2002 and 2001 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, 2002, retained earnings of our subsidiaries subject to such restrictions were approximately $462 million. Investments in subsidiary companies are recorded on the equity basis. 28 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING BALANCE SHEET AT JUNE 30, 2002
JUNE 30, 2002 ------------- U.S. NON- PARENT ISSUER GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED ------ ------ ---------- ---------- ------------ ------------ (DOLLARS IN MILLIONS) ASSETS CURRENT ASSETS: Cash and cash equivalents..................... $ - $ 10 $ 2 $ 39 $ - $ 51 Notes and accounts receivable................. - 731 454 112 (1,180) 117 Inventories: Raw materials and supplies................ - - 3 39 (1) 41 Work in process........................... - - 33 67 2 102 Finished goods............................ - - 8 22 (1) 29 ------ ---------- ---------- --------- --------- ------- - - 44 128 - 172 Prepaid expenses and deferred income taxes.... - - 11 11 (1) 21 ------ ---------- ---------- --------- --------- ------- Total current assets...................... - 741 511 290 (1,181) 361 ------ ---------- ---------- --------- --------- ------- Property, plant and equipment................... - - 308 669 (5) 972 Less: accumulated depreciation................. - - (266) (404) (14) (684) ------ ---------- ---------- --------- --------- ------- Net fixed assets.............................. - - 42 265 (19) 288 ------ ---------- ---------- --------- --------- ------- Deferred income taxes and other assets........... 50 29 (58) 83 116 220 ------ ---------- ---------- --------- --------- ------- Total assets.................................. $ 50 $ 770 $ 495 $ 638 $ (1,084) $ 869 ====== ========== ========== ========= ========= ======= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Accounts payable.............................. $ - $ 28 $ 21 $ 86 $ (29) $ 106 Short-term debt............................... 419 10 200 527 (1,139) 17 Accrued income and other taxes................ (21) 2 34 32 1 48 Other accrued liabilities..................... - - 32 37 (10) 59 ------ ---------- ---------- --------- --------- ------- Total current liabilities................. 398 40 287 682 (1,177) 230 ------ ---------- ---------- --------- --------- ------- Long-term debt................................... - 694 - 6 - 700 Other long-term obligations...................... - - 193 35 1 229 Deferred income taxes............................ - - 1 31 (1) 31 Minority stockholders' equity in consolidated entities....................................... - - - 27 - 27 Stockholders' equity (deficit)................... (348) 36 14 (143) 93 (348) ------ ---------- ---------- --------- --------- ------- Total liabilities and stockholders' equity (deficit)................................... $ 50 $ 770 $ 495 $ 638 $ (1,084) $ 869 ======== ========== ========== ========= ========= =======
29 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING BALANCE SHEET AT DECEMBER 31, 2001
DECEMBER 31, 2001 ----------------- U.S. NON- PARENT ISSUER GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED ------ ------ ---------- ---------- ------------ ------------ (DOLLARS IN MILLIONS) ASSETS CURRENT ASSETS: Cash and cash equivalents..................... $ - $ 16 $ 8 $ 14 $ - $ 38 Notes and accounts receivable................. - 885 442 365 (1,597) 95 Inventories: Raw materials and supplies................ - - 3 32 (2) 33 Work in process........................... - - 45 66 - 111 Finished goods............................ - - 8 26 (1) 33 -------- -------- ------- --------- --------- --------- - - 56 124 (3) 177 Prepaid expenses and deferred income taxes.... - - 7 5 - 12 -------- -------- ------- --------- --------- --------- Total current assets...................... - 901 513 508 (1,600) 322 -------- Property, plant and equipment................... - - 308 627 (4) 931 Less: accumulated depreciation................. - - (256) (394) - (650) -------- -------- ------- --------- --------- --------- Net fixed assets.............................. - - 52 233 (4) 281 -------- -------- ------- --------- --------- --------- Deferred income taxes and other assets........... 58 29 216 74 (183) 194 -------- -------- ------- --------- --------- --------- Total assets.................................. $ 58 $ 930 $ 781 $ 815 $ (1,787) $ 797 ======== ======== ======= ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Accounts payable.............................. $ 8 $ 13 $ 50 $ 92 $ (62) $ 101 Short-term debt............................... 397 274 407 450 (1,521) 7 Accrued income and other taxes................ (15) - 42 18 - 45 Other accrued liabilities..................... - - 39 33 (15) 57 -------- -------- ------- --------- --------- --------- Total current liabilities................. 390 287 538 593 (1,598) 210 -------- -------- ------- --------- --------- --------- Long-term debt................................... - 626 - 21 (16) 631 Other long-term obligations...................... - - 197 34 - 231 Deferred income taxes............................ - - 5 32 (5) 32 Minority stockholders' equity in consolidated entities....................................... - - - 23 2 25 Stockholders' equity (deficit)................... (332) 17 41 112 (170) (332) -------- -------- ------- --------- --------- --------- Total liabilities and stockholders' equity (deficit)................................... $ 58 $ 930 $ 781 $ 815 $ (1,787) $ 797 ======== ======== ======= ========= ========= =========
30 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2001 AND 2002
THREE MONTHS ENDED JUNE 30, 2001 -------------------------------- U.S. NON- PARENT ISSUER GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED ------ ------ ---------- ---------- ------------ ------------ (DOLLARS IN MILLIONS) Net sales........................................... $ - $ - $ 63 $ 133 $ (35) $ 161 Cost of sales....................................... - - 52 103 (30) 125 -------- -------- -------- --------- --------- --------- Gross profit..................................... - - 11 30 (5) 36 R&D, SG&A, global realignment and related expenses, restructuring charge and impairment loss of long-lived and other assets, and other expenses.. 5 (16) (91) 19 113 30 Interest income..................................... - (12) (6) - 18 - Interest expense.................................... 6 16 4 9 (18) 17 -------- -------- -------- --------- --------- --------- Income (loss) before provision for income taxes.. (11) 12 104 2 (118) (11) Provision for (benefit from) income taxes........... (4) 4 (13) 8 - (5) -------- -------- -------- --------- --------- --------- Income (loss) of consolidated entities........... (7) 8 117 (6) (118) (6) Minority stockholders' share of income.............. - - - - - - Equity in earnings of subsidiaries.................. - - 124 - (124) - -------- -------- -------- --------- --------- --------- Income (loss) before extraordinary item.......... (7) 8 (7) (6) (6) (6) Extraordinary item, net of tax...................... - 1 - - - 1 -------- -------- -------- --------- --------- --------- Net income (loss)............................. $ (7) $ 7 $ (7)$ (6) $ (6) $ (7) ======== ======== ======== ========= ========= =========
THREE MONTHS ENDED JUNE 30, 2001 -------------------------------- U.S. NON- PARENT ISSUER GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED ------ ------ ---------- ---------- ------------ ------------ (DOLLARS IN MILLIONS) Net sales........................................... $ - $ - $ 63 $ 139 $ (31) $ 171 Cost of sales....................................... - - 49 97 (26) 120 -------- -------- -------- --------- --------- --------- Gross profit..................................... - - 14 42 (5) 51 R&D, SG&A, global realignment and related expenses, restructuring charge and impairment loss of long-lived and other assets, and other expenses.. - (1) 141 15 (65) 90 Interest income..................................... - (19) - (5) 24 - Interest expense.................................... 9 21 4 6 (24) 16 -------- -------- -------- --------- --------- --------- Income (loss) before provision for income taxes.. (9) (1) (131) 26 60 (55) Provision for (benefit from) income taxes........... (3) - (41) 6 22 (16) -------- -------- -------- --------- --------- --------- Income (loss) of consolidated entities........... (6) (1) (90) 20 38 (39) Minority stockholders' share of income.............. - - - - - - Equity in earnings of subsidiaries.................. 33 - (58) - 25 - -------- -------- -------- --------- --------- --------- Net income (loss)............................. $ (39) $ (1) $ (32)$ 20 $ 13 $ (39) ======== ======== ======== ========= ========= =========
31 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2001 AND 2002
SIX MONTHS ENDED JUNE 30, 2002 ------------------------------ U.S. NON- PARENT ISSUER GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED ------ ------ ---------- ---------- ------------ ------------ (DOLLARS IN MILLIONS) Net sales........................................... $ - $ - $ 116 $ 252 $ (69) $ 299 Cost of sales....................................... - - 97 195 (60) 232 -------- -------- -------- --------- --------- --------- Gross profit..................................... - - 19 57 (9) 67 R&D, SG&A, global realignment and related expenses, restructuring charge and impairment loss of long-lived and other assets, and other expenses.. 5 (19) (102) 39 131 54 Interest income..................................... - (24) (12) (4) 40 - Interest expense.................................... 12 32 9 17 (40) 30 -------- -------- -------- --------- --------- --------- Income (loss) before provision for income taxes.. (17) 11 124 5 (140) (17) Provision for (benefit from) income taxes........... (6) 4 (25) 17 - (10) -------- -------- -------- --------- --------- --------- Income (loss) of consolidated entities........... (11) 7 149 (12) (140) (7) Minority stockholders' share of income.............. - - - 1 - 1 Equity in earnings of subsidiaries.................. - - 153 - (153) - -------- -------- -------- --------- --------- --------- Income (loss) before extraordinary item.......... (11) 7 (4) (13) 13 (8) Extraordinary item, net of tax...................... - 3 - - - 3 -------- -------- -------- --------- --------- --------- Net income (loss)............................. $ (11) $ 4 $ (4)$ (13) $ 13 $ (11) ======== ======== ======== ========= ========= =========
SIX MONTHS ENDED JUNE 30, 2001 ------------------------------ U.S. NON- PARENT ISSUER GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED ------ ------ ---------- ---------- ------------ ------------ (DOLLARS IN MILLIONS) Net sales........................................... $ - $ - $ 131 $ 278 $ (67) $ 342 Cost of sales....................................... - - 104 195 (57) 242 -------- -------- -------- --------- --------- --------- Gross profit..................................... - - 27 83 (10) 100 R&D, SG&A, global realignment and related expenses, restructuring charge and impairment loss of long-lived and other assets, and other expenses.. - (1) 153 27 (65) 114 Interest income..................................... - (40) - (10) 50 - Interest expense.................................... 19 42 11 13 (50) 35 -------- -------- -------- --------- --------- --------- Income (loss) before provision for income taxes.. (19) (1) (137) 53 55 (49) Provision for (benefit from) income taxes........... (7) - (43) 14 22 (14) -------- -------- -------- --------- --------- --------- Income (loss) of consolidated entities........... (12) (1) (94) 39 33 (35) Minority stockholders' share of income.............. - - - 1 - 1 Equity in earnings of subsidiaries.................. 24 - (71) - 47 - -------- -------- -------- --------- --------- --------- Net income (loss)............................. $ (36) $ (1) $ (23)$ 38 $ (14) $ (36) ======== ======== ======== ========= ========= =========
32 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2001 AND 2002
SIX MONTHS ENDED JUNE 30, 2002 ------------------------------ U.S. NON- PARENT ISSUER GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED ------ ------ ---------- ---------- ------------ ------------ (DOLLARS IN MILLIONS) Net cash provided by (used in) operating activities. $ (23) $ 70 $ 109 $ (243) $ 51 $ (36) Net cash provided by (used in) investing activities. - 133 92 255 (500) (20) Net cash provided by (used in) financing activities. 23 (209) (207) 10 449 66 -------- -------- -------- --------- --------- --------- Net increase (decrease) in cash and cash equivalents...................................... - (6) (6) 22 - 10 Effect of exchange rate changes on cash and cash equivalents...................................... - - - 3 - 3 Cash and cash equivalents at beginning of period.... - 16 8 14 - 38 -------- -------- -------- --------- --------- --------- Cash and cash equivalents at end of period.......... $ - $ 10 $ 2 $ 39 $ - $ 51 ======== ======== ======== ========= ========= =========
SIX MONTHS ENDED JUNE 30, 2002 ------------------------------ U.S. NON- PARENT ISSUER GUARANTORS GUARANTORS ELIMINATIONS CONSOLIDATED ------ ------ ---------- ---------- ------------ ------------ (DOLLARS IN MILLIONS) Net cash provided by (used in) operating activities. $ (19) $ (8) $ (68) $ 89 $ 7 $ 1 Net cash provided by (used in) investing activities. - (54) 8 (83) 122 (7) Net cash provided by (used in) financing activities. 19 60 55 (10) (129) (5) -------- -------- -------- --------- --------- --------- Net increase in cash and cash equivalents........... - (2) (5) (4) - (11) Effect of exchange rate changes on cash and cash equivalents...................................... - - - (1) - (1) Cash and cash equivalents at beginning of period.... - 31 7 9 - 47 -------- -------- -------- --------- --------- --------- Cash and cash equivalents at end of period.......... $ - $ 29 $ 2 $ 4 $ - $ 35 ======== ======== ======== ========= ========= =========
33 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Unsecured intercompany term notes in an aggregate principal amount, at June 30, 2002, equal to $403 million (based on currency exchange rates in effect at June 30, 2002), 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 described above, the guarantee of the Senior Notes by UCAR Carbon has been secured by a pledge of all of our shares of Graftech, 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. Rule 3-16 of Regulation S-X adopted by the SEC provides that, for each of the registrant's affiliates whose securities constitute a "substantial" portion of the collateral for registered securities, financial statements (that would be required to be filed if the affiliate were a registrant) must be filed with this Report. Under Rule 3-16(b), securities of a person will be deemed to constitute a "substantial" portion of the collateral if the aggregate principal amount, par value, or book value of securities as carried by the registrant, or the market value of such securities, whichever is the greatest, equals 20% or more of the principal amount of the registered securities. In this case, the pledges of common stock of Graftech and the intercompany notes and related guarantees have been limited such that they will never be more than 19.99% of the principal amount of the outstanding Senior Notes. Therefore, no such financial statements are required to be included in this Report. (10) OTHER (INCOME) EXPENSE, NET The following table presents an analysis of other (income) expense, net: FOR THE SIX MONTHS ENDED JUNE 30, ------- 2001 2002 ---- ---- Interest income.................................. $ (2) $ (2) Currency (gains) losses.......................... (1) (20) Bank fees........................................ 1 1 Loss on sale of accounts receivable.............. 1 1 Amortization of goodwill......................... 1 - (Gain) loss on sale of assets.................... (1) - Legal liability reserve (other than antitrust investigations and related lawsuits and claims)...................................... - 2 Other............................................ 1 2 ----- ----- Total other (income) expense, net............ $ - $ (16) ===== ===== 34 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES We have intercompany loans between GrafTech Finance and some of our subsidiaries. Some of these loans are denominated in currencies other than the dollar and, accordingly, are subject to translation gains and losses due to changes in currency exchange rates. Some of these intercompany loans are deemed to be essentially permanent and, as a result, translation gains and losses on these loans are reflected in accumulated other comprehensive income (loss) on the Consolidated Balance Sheets. The remaining intercompany loans are expected to be repaid in the foreseeable future and, as a result, translation gains and losses on these loans are reflected in other (income) expense, net on the Consolidated Statement of Operations. (11) SUBSEQUENT EVENT On July 1, 2002, we amended our U.S. post-retirement medical coverage. Effective December 31, 2003, we will discontinue the Medicare supplement plan (for retirees 65 years or older or those eligible for Medicare benefits). This change will apply to all employees not covered by a collective bargaining agreement, all current retirees and those employees who retire while their current collective bargaining agreement is in effect. This change will reduce our net post-retirement medical benefit obligation by about $7 million. 35 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES INTRODUCTION TO PART I, ITEM 2, AND PART II, ITEM 1 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 Report. "GTI" refers to GrafTech International Ltd. only. GTI is our public parent company and the issuer of the publicly traded common stock covered by this Report. GTI is a guarantor of the Senior Notes. 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. 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. "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"). Prior to June 7, 2002, GrafTech Finance was named UCAR Finance Inc. "GRAFTECH" refers to Graftech Inc. only. Graftech is our 97.5% owned (wholly owned, prior to June 2001) subsidiary engaged in the development, manufacture and sale of natural graphite-based products. "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 graphite and carbon cathodes. "SUBSIDIARIES" refer to those companies which, 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, 2002, except for: o Carbone Savoie, which has been and is 70% owned; and o Graftech, which was 100%, owned until it became 97.5% owned in June 2001. 36 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 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, MARKET AND LEGAL 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%. We use the equity method to account for 50% or less owned entities (excluding less than 20% owned entities accounted for using the cost method), and we do not restate financial information for periods prior to the acquisition of subsidiaries. This means that the financial information for our consolidated subsidiaries is consolidated on each line of the Consolidated Financial Statements and the equity of the other minority owners is reflected on the lines entitled "minority stockholders' equity in consolidated entities" and "minority stockholders' share of income." Unless otherwise stated, when we refer to "EBITDA" we mean gross profit, less research and development expense, selling, administrative and other expenses, restructuring charges (credits), investigation, class action, lawsuit and claim expenses, global realignment and related expenses and other (income) expense, net, plus depreciation, amortization, inventory write-downs and that portion of restructuring charges (credits) applicable to non-cash asset write-offs. Compensation expense associated with stock grants and impairment losses on long-lived assets and securities held-for-sale are excluded from EBITDA. The amount of restructuring charges (credits) applicable to non-cash asset write-offs was a charge of $3 million in the 2001 first half and nil for the 2002 first half. We believe that EBITDA is generally accepted as providing useful information regarding a company's ability to incur and service debt. EBITDA should not be considered in isolation or as a substitute for net income, cash flows from continuing operations or other consolidated income or cash flow data prepared in accordance with generally accepted accounting principles or as a measure of a company's profitability or liquidity. Our method for calculating EBITDA may not be comparable to methods used by other companies and is not the same as the method for calculating EBITDA under the Senior Facilities or the Senior Notes. The method for calculating EBITDA under the Senior Facilities is not the same as it is under the Senior Notes. References to cost in the context of our low-cost supplier strategy do not include the impact of special or non-recurring charges or credits, such as those related to investigations, lawsuits or claims, restructurings, impairment losses, inventory write-downs or expenses incurred in connection with lawsuits initiated by us, or the impact of accounting changes. 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). All cost savings and reductions relating to our new major cost savings plan announced in January 2002 are estimates or targets based on a comparison to costs in 2001 (and assuming no change in 37 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES currency exchange rates). For these purposes, in 2001, our average graphite electrode production cost per metric ton was $1,691, our annual overhead costs were $78 million and our effective income tax rate was 45% before taking into account the corporate realignment of our subsidiaries. Estimates and targets of savings in interest expense resulting from the 2002 plan do not give effect to the increase in interest expense resulting from the issuance of the Senior Notes. Neither any statement made in this Report nor any charge taken by us relating to any legal proceedings constitutes an admission as to any wrongdoing or liability. Unless otherwise specifically noted, market and market share data in this Report are our own estimates. Market data relating to the steel 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 the International Iron and Steel Institute and other industry sources as well as assumptions made by us, based on such data and our knowledge of the industry, which we believe to be reasonable. 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 Inc. ("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, which we believe to be reasonable. 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, which we believe to be reasonable. Although we are not aware of any misstatements regarding any industry or market share data, our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under "Risk Factors" and "Forward-Looking Statements" in this Report and the Annual Report. We cannot guarantee the accuracy or completeness of this data and have not independently verified it. We have not sought the consent of any of the sources mentioned above to the disclosure or use of data in this Report. Unless otherwise noted, when we refer to dollars, we mean U.S. dollars. Unless otherwise noted, references to "MARKET SHARES" are based on unit volumes in 2001. As used herein, references to "MAJOR PRODUCT LINES" mean graphite and carbon electrodes and cathodes and flexible graphite. The GRAFTECH logo, GRAFCELL(R), eGraf(TM), GRAFOIL(R), GRAFGUARD(R) and GRAFSHIELD(R) are our trademarks and trade names. This Report also contains trademarks and trade names belonging to other parties. 38 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES We maintain a Web site at http://www.graftechinternational.com, our subsidiary Graftech maintains a Web site at http://www.graftech.com and our High Tech High Temp ("HT2") business unit maintains a Web site at http://www.HT2.com. The information contained on these Web sites is not part of this Report. Reference is made to our Annual Report on Form 10-K for the year ended December 31, 2001, filed under GTI's former name, UCAR International Inc. (the "ANNUAL REPORT"), for background information on various risks and contingencies and other matters related to circumstances affecting us and our industry. FORWARD LOOKING STATEMENTS AND RISKS This Report contains 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, fuel cells, electronic devices 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 various businesses; strategic plans; impacts of regional and global economic conditions; restructuring, realignment, strategic alliance, 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 and equity securities of us and our subsidiaries; and future costs, working capital, revenue, business opportunities, values, debt levels, cash flows, cost savings and reductions, margins, earnings and growth. The words "will," "may," "plan," "estimate," "project," "believe," "anticipate," "intend," "expect," "should," "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: o the possibility that global or regional economic conditions affecting our products may not improve or may worsen; o the possibility that anticipated additions to capacity for producing steel in electric arc furnaces, or announced or anticipated reductions in graphite electrode manufacturing capacity, may not occur; o the possibility that increased production of steel in electric arc furnaces or reductions in graphite electrode manufacturing capacity may not result in stable or increased demand for or prices or sales volume of graphite electrodes; 39 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES o the possibility that economic or technological developments may adversely affect growth in the use of graphite cathodes in lieu of carbon cathodes in the aluminum smelting process; o the possibility of delays in or failure to achieve widespread commercialization of proton exchange membrane, or "PEM," fuel cells which use natural graphite materials and components and that manufacturers of PEM fuel cells may obtain those materials or components used in them from other sources; o the possibility of delays in or failure to achieve successful development and commercialization of new or improved electronic thermal management or other products; o the possibility of delays in meeting or failure to meet product development milestones or delays in expanding or failure to expand manufacturing capacity; o the possibility that we may unable to protect our intellectual property or may infringe the intellectual property rights of others; o the possibility that the lawsuit against our former parents initiated by us could be dismissed or settled, our theories of liabilities or damages could be rejected, material counterclaims could be asserted against us, legal expenses and distraction of management could be greater than anticipated, or unanticipated events or circumstances may occur; o the occurrence of unanticipated events or circumstances relating to antitrust investigations or lawsuits or to lawsuits initiated by us against our former parents; o the commencement of new investigations, lawsuits or claims relating to the same subject matter as the pending investigations, lawsuits or claims; o the possibility that expected cost savings from our various cost savings efforts may not be fully realized; o the occurrence of unanticipated events or circumstances relating to health, safety or environmental compliance or remediation obligations or labor relations; o the occurrence of unanticipated events or circumstances relating to strategic plans or relating to restructuring, realignment, strategic alliance, supply chain, technology development and collaboration, investment, acquisition, operating, tax planning, rationalization, financial or capital projects; o changes in interest or currency exchange rates, in competitive conditions or in inflation affecting our raw material, energy or other costs; 40 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES o the possibility of our failure to satisfy conditions or milestones to our strategic alliances with Jilin, Pechiney, Ballard Power Systems, Conoco or others; o the possibility that changes in our financial performance may affect our compliance with financial covenants or the amount of funds available for borrowing under the Senior Facilities; and o other risks and uncertainties, including those described elsewhere or incorporated by reference in this Report. 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. 41 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL We are one of the world's largest manufacturers and providers of high quality natural and synthetic graphite- and carbon-based products and services, offering energy solutions to industry-leading customers worldwide. We manufacture graphite and carbon electrodes and cathodes, used primarily in electric arc furnace steel production and aluminum smelting. We also manufacture other natural and synthetic graphite and carbon products used in, and provide services to, the fuel cell power generation, electronics, semiconductor and transportation markets. We believe that we have the leading market share in all of our major product lines. We have over 100 years of experience in the research and development of graphite and carbon technology, and currently hold numerous patents related to this technology. We are a global business, selling our products and engineering and technical services in more than 70 countries. We have 13 manufacturing facilities strategically located in Brazil, Mexico, South Africa, France, Spain, Russia and the U.S. Our customers include industry leaders such as Nucor Corporation and Arcelor in steel, Alcoa Inc. and Pechiney in aluminum, Ballard Power Systems in fuel cells, Intel Corporation in electronics, MEMC Electronic Materials, Inc. in semiconductors and The Boeing Company in transportation. REALIGNMENT AND NAME CHANGE In early 2001, we launched a strategic initiative to strengthen our competitive position and to change our corporate vision from an industrial products company to an energy solutions company. In connection with this initiative, we have realigned our company and management around two new operating divisions, our Graphite Power Systems Division and our Advanced Energy Technology Division. We believe that this realignment is enabling us to develop and implement strategies uniquely designed to maximize the value of each of our businesses. We may also adopt compensation plans designed to incentivize management of each division on a basis consistent with its particular strategies. In addition, we believe that this transparent, unified divisional focus has and will continue to better enable us to structure and enter into strategic alliances beneficial to each respective division. To reflect our new emphasis on graphite and carbon technology, our new corporate vision, we changed the name of our parent public company to GrafTech International Ltd. in May 2002. Our new trading symbol on the NYSE is "GTI." We have realigned the corporate organizational structure of our foreign subsidiaries. As a result, most of the non-U.S. businesses of each of our two divisions are segregated into separate companies along divisional lines. In addition, because most of the operations, net sales and growth opportunities of our Graphite Power Systems Division are located outside the U.S., most of its operations are held by our Swiss subsidiary or its subsidiaries. Most of our 42 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES technology is held by our U.S. subsidiaries. We may in the future similarly realign the corporate organizational structure of our U.S. subsidiaries. As part of our new major cost savings plan announced in January 2002, we have used and are continuing to use opportunities created by this corporate organizational realignment to change our U.S. benefit plans, improve cash management, intellectual property management and corporate services delivery, reduce associated costs, reduce taxes and reallocate intercompany debt. 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. OUR DIVISIONS Our Graphite Power Systems Division manufactures and delivers high quality graphite and carbon electrodes and cathodes and related services that are key components of the conductive power systems used to produce steel, aluminum and other non-ferrous metals. Graphite electrodes are consumed in the production of steel in electric arc furnaces, the steel making technology used by all "mini-mills." Mini-mills constitute the higher long-term growth sector of the steel industry. Graphite electrodes are also consumed in refining steel in ladle furnaces and in other smelting processes. Our graphite electrodes accounted for about 76% of this division's net sales during the 2002 first half. Carbon electrodes are used in the production of silicon metal, a raw material primarily used in the manufacture of aluminum. Graphite and carbon cathodes are used in aluminum smelting. Because of its strong competitive position, we believe that this division is well positioned to benefit from the expected cyclical recovery in production of steel and other metals. To maintain its strong competitive position, we have instituted a number of strategic initiatives to improve the cost structure, increase the revenues and maximize the cash flow generated by this division. These strategic initiatives include pursuing cost savings, leveraging our global presence with industry leading customers, expanding value-driven enterprise selling, delivering exceptional and consistent quality, and providing superior technical service. Our Advanced Energy Technology Division develops, manufactures and sells high quality, highly engineered natural and synthetic graphite- and carbon-based energy technologies, products and services for both established and high-growth-potential markets. We currently sell these products primarily to the transportation, chemical, petrochemical, fuel cell power generation and electronic thermal management markets. In addition, we provide cost effective technical services to a broad range of markets and license our proprietary technology in markets where we do not anticipate engaging in manufacturing ourselves. We believe that this division will be successful because of our patented and proprietary technologies related to graphite and carbon materials science and our processing and manufacturing technology. Natural graphite-based products, including flexible graphite, are developed and manufactured by our subsidiary, Graftech. We are the world's leading manufacturer of natural graphite-based products, including flexible graphite. Flexible graphite is an excellent gasket and 43 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES sealing material that to date has been used primarily in high temperature and corrosive environments in the automotive, chemical and petrochemical markets. Advanced flexible graphite can be used in the production of materials, components and products for proton exchange membrane fuel cells and fuel cell systems, electronic thermal management applications, industrial thermal management applications, and battery and supercapacitor power storage applications. Our synthetic graphite- and carbon-based products are developed and manufactured by our Advanced Graphite Materials and Advanced Carbon Materials business units, respectively. Their products range from established products, such as graphite and carbon refractories, graphite molds and rocket nozzles and cones, to new carbon composites used in fuel cell power generation and electronic thermal management markets. Our technology licensing and technical services are marketed and sold by our HT2 business unit. We are focused on leveraging our strengths to build the value of this division through the development and commercialization of our technologies into high-growth-potential markets. These strengths include: o developing intellectual property; o developing and commercializing prototype and next generation products and services; and o establishing strategic alliances with leading customers and suppliers as well as key technology focused companies. We seek to identify technologies where this division's products and services offer advantages in performance or cost as compared to competitive technologies, materials, products or services. We filed 18 new patent applications during the 2002 second quarter and 29 during the 2002 first half. We received 6 new patents during the 2002 second quarter and 4 during the 2002 first quarter. The new patent filings primarily relate to fuel cell and electronic thermal management applications. In the 2002 second quarter, total patent application and patent application rights filings increased to more than 280 and total issued patents increased to 168. COST REDUCTION PLANS OVERVIEW. GTI's Board of Directors adopted a global restructuring and rationalization plan in September 1998 and we launched additional initiatives to enhance the plan in October 1999. The 1998 plan is now completed. By the end of 2001, we delivered recurring annualized run rate cost savings of $132 million. In January 2002, we announced a new major cost savings plan. Like the 1998 plan, we believe that the 2002 plan is by far the most aggressive major cost reduction plan being implemented in the graphite and carbon industry. 44 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 2002 PLAN. In January 2002, we announced a new major cost savings plan designed to generate cost savings to strengthen our balance sheet. The key elements of the 2002 plan consist of: o the rationalization of graphite electrode manufacturing capacity at our higher cost facilities and the incremental expansion of capacity at our lower cost facilities; o the redesign and implementation of changes in our U.S. benefit plans for active and retired employees, which was completed in the 2002 first quarter; o the implementation of global work process changes, including the consolidation and streamlining of order fulfillment, purchasing, finance and accounting, and human resource processes, along with the identification and implementation of outsourcing opportunities, targeted for completion by the end of 2003; o the implementation of additional plant and corporate overhead cost reduction projects; and o the corporate realignment of our subsidiaries, consistent with the operational realignment of our businesses into two operating divisions, to generate significant tax savings. As part of the 2002 plan, we mothballed our graphite electrode manufacturing operations in Caserta, Italy during the 2002 first quarter, ahead of schedule. These operations had the capacity to manufacture 26,000 metric tons of graphite electrodes annually. After the shutdown of our graphite electrode manufacturing operations in Clarksville and Columbia, Tennessee in the 2001 third quarter, these operations were our highest cost graphite electrode manufacturing operations. We expect to further incrementally expand graphite electrode manufacturing capacity at our facilities in Mexico, France and Spain over the next nine to twelve months. After the mothballing and incremental expansion, our total annual graphite electrode manufacturing capacity will remain about 210,000 metric tons. During the 2002 second quarter, we launched the expansion at our facility in Monterrey, Mexico, which will increase its capacity from about 40,000 metric tons to about 60,000 metric tons annually. We expect to complete this expansion during the 2003 first quarter. We have identified a number of additional plant and overhead cost reduction projects. One of the major projects is employee benefit plan redesign. We have redesigned and implemented changes in our retiree medical insurance plan and our U.S. retirement and savings plans for active and retired employees. These benefit plan changes resulted in annual cost savings of $2 million in 2001 and are expected to result in annual cost savings of more than $19 million in 2002 and thereafter. We expect that about half of the other plant and overhead cost reduction projects will be completed in 2002. The corporate realignment of our subsidiaries was substantially completed in the 2002 first half and resulted in substantial tax savings. As a result of the corporate realignment of our 45 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES subsidiaries, the effective income tax rate for 2002, excluding non-recurring charges or benefits associated with the corporate realignment of our subsidiaries, is expected to be about 35%. We intend to sell real estate, non-strategic businesses and certain other non-strategic assets over the next two years. We anticipate that the aggregate estimated pre-tax, cash proceeds from these sales will total $75 million by the end of 2003. These non-strategic businesses contributed net sales of about $25 million in 2001. We believe that satisfactory progress is being made on the planned asset sales and that successful completion of those asset sales will strengthen our balance sheet. We are targeting recurring annual cost savings of $80 million by the end of 2004. These savings are additive to those which we achieved by the end of 2001 under the 1998 plan that is now completed. The following table summarizes the targeted savings under the 2002 plan: SUMMARY OF TARGETED ANNUAL COST SAVINGS
YEAR ENDED DECEMBER 31, ---------------------- 2002 2003 2004 CUMULATIVE ---- ---- ---- ---------- (PRE-TAX DOLLARS IN MILLIONS) Cost of sales: Graphite Power Systems Division................... $ 24 $ 43 $ 43 $ 110 Advanced Energy Technology Division............... 4 4 4 12 ---- ---- ---- ------- Total cost of sales............................ 28 47 47 122 Overhead costs........................................ 9 10 11 30 ---- ---- ---- ------- Total cost of sales and overhead costs......... 37 57 58 152 Interest expense savings due to the 2002 plan......... 2 8 12 22 Tax expense........................................... 6 10 10 26 ---- ---- ---- ------- Total savings.................................. $ 45 $ 75 $ 80 $ 200 ==== ==== ==== =======
We achieved cost savings of about $2 million in the 2002 second quarter and about $9 million in the 2002 first half. While we expect increased cost savings during the 2002 second half as our operating levels improve, we also expect that targeted savings for 2002 will be realized over a longer period primarily due to recent changes in currency exchange rates, lower than expected graphite electrode production during the 2002 first half and the reintroduction of our global incentive programs during the 2002 first half. As a result, we expect that cost savings targets for 2002 will not be achieved until mid-2003. We remain confident that we will achieve the $80 million recurring annual cost savings target for 2004. We believe that the 2002 plan will: o further strengthen our position and our competitive advantage as a low cost supplier to the steel and other metals industries; o better enable us to largely maintain our gross profit margin and operating margin during the current global economic downturn; 46 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES o rationalize our capacity to manufacture both higher value added "supersize" ultra-high power graphite electrodes as well as cost competitive high power small diameter graphite electrodes for ladle furnaces; o further improve our position to benefit, in terms of operations, earnings and cash flow from operations, from the expected cyclical recovery in electric arc furnace steel production; and o enable us to further reduce total debt, which should result in savings in interest expense (interest expense savings do not take into account higher interest expense resulting from the sale of the Senior Notes). We completed the mothballing of our Italian graphite electrode operations during the 2002 first quarter. As expected and previously announced, working capital requirements temporarily increased similar to what we experienced with the closure of our U.S. graphite electrode operations, and net debt levels increased during the 2002 first half as a result of these working capital needs and lower net sales of graphite electrodes, due to both seasonal factors and economic conditions. We believe that implementation of the 2002 plan will require about $20 million of cash exit costs, of which about $15 million has been recorded and expensed through June 30, 2002. Approximately $7 million of the $15 million has been paid through June 30, 2002. The 2002 plan resulted in about $29 million of non-cash restructuring charges and impairment losses on long-lived assets, of which about $24 million was recorded in the 2001 fourth quarter. In addition, in the 2002 first quarter, we recorded a $5 million restructuring charge that related primarily to the mothballing of our graphite electrode operations in Italy under the 2002 plan. This charge includes estimated pension, severance and other related employee benefit costs for 102 employees and other costs related to the mothballing. These costs are additive to the $3 million of cash exit costs and $58 million of non-cash restructuring charges and impairment losses on long-lived assets related to the shutdown of our graphite electrode manufacturing operations in Tennessee recorded in 2001. The mothballing of our graphite electrode operations in Italy will enable us to avoid annually an average of $2 million of otherwise necessary capital expenditures. We expect to make the planned incremental expansions of graphite electrode manufacturing capacity for capital expenditures of $15 million and complete such expansion within the next nine to twelve months. 1998 PLAN. The key elements of our global restructuring and rationalization plan announced in September 1998 and enhanced in October 1999 included the shutdown of our graphite electrode manufacturing operations at our facilities in Canada and Germany and the downsizing of our graphite electrode manufacturing operations at our facilities in Russia. 47 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES As a result of the 1998 plan and other cost savings initiatives, we have reduced our average graphite electrode production cost per metric ton by the end of 2001 by 15% since the 1998 fourth quarter. OTHER COST SAVINGS ACTIVITIES. Since 1998, we have initiated other cost savings activities. Some of these activities will continue while the 2002 plan is being implemented. We began to implement in 2000 and are continuing to implement a global business process rationalization and transformation initiative. Through June 30, 2002, our investment in the initiative included about $4 million of consulting fees and $3 million of capital expenditures, primarily for advanced planning and scheduling software and global treasury management systems. We believe that most of the future investment for this initiative will be funded from realized cost savings. We have evaluated every aspect of our supply chain and improved and continue to improve performance through realignment and standardization of supply chain processes and systems and improvement of interfaces with trading partners. We reduced inventory levels from 1998 by about 33%, or to about $180 million, by the end of 2001 and reduced our cash cycle time, as compared to 1998, by about 25% by the end of 2001. Effective April 2001, we entered into a ten year service contract with CGI Group Inc. pursuant to which 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 objectives. 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 target cost savings. In the 2001 second quarter, we recorded a $58 million charge for restructuring and impairment loss on long-lived assets related to the shutdown of our graphite electrode manufacturing operations at our facilities in Clarksville and Columbia, Tennessee. In 2000, these operations were our highest cost graphite electrode manufacturing operations. We expect that the shutdown will result in total annual cost savings of $18 million and will enable us to avoid about $9 million in otherwise necessary capital expenditures. Certain of these cost savings were realized in 2001 and the balance are expected to be realized in 2002. The shutdown was completed on schedule near the end of the 2001 third quarter. We incrementally expanded graphite electrode manufacturing capacity at our facilities in Mexico, Spain and South Africa for a capital investment of about $3 million. In the 2001 third quarter, we recorded a $2 million charge for restructuring and impairment loss on long-lived assets related to the realignment of our businesses into our Advanced Energy Technology Division and Graphite Power Systems Division, the relocation of 48 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES our corporate headquarters and the shutdown of our coal calcining operations located in Niagara Falls, New York. 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 lower net effective cost than we can produce it for ourselves. The shutdown was completed at the end of 2001. As part of the business realignment, we have centralized management functions of our Advanced Energy Technology Division in Cleveland, Ohio, and management functions of our Graphite Power Systems Division in Etoy, Switzerland. On December 21, 2001, we relocated our corporate headquarters, consisting of about 10 employees, from Nashville, Tennessee, to Wilmington, Delaware. The charge relates primarily to a workforce reduction of 24 employees. In the 2001 fourth quarter, we recorded an impairment loss on long-lived and other assets of $27 million, $24 million of which was associated with the mothballing of our Italian graphite electrode operations. We also recorded a $7 million non-cash restructuring charge, $5 million of which was associated with our Italian operations and $2 million of which was associated with the shutdown of our U.S. graphite electrode operations in addition to the charge recorded in the 2001 second quarter. In the 2002 second quarter, we recorded a $13 million ($8 million after tax) non-cash charge primarily related to the impairment of our long-lived carbon electrode assets in Columbia, Tennessee, primarily due to a decline in demand and loss of market share. The primary end market for carbon electrodes is silicon metal, which remains very depressed in the U.S. where our main customer base is located. STRATEGIC ALLIANCES We are pursuing strategic alliances that enhance or complement our existing or related businesses and have the potential to generate strong cash flow. Strategic alliances may be in the form of joint venture, licensing, supply or other arrangements that leverage our strengths to achieve cost savings, improve margins and cash flow, and increase net sales and earnings growth. We have developed a strategic relationship with Conoco. In December 2000, we entered into a license and technical services agreement with Conoco to license our proprietary technology for use at the carbon fiber manufacturing facility that Conoco is building in Ponca City, Oklahoma. We also will continue to provide a wide variety of technical services to Conoco. Under a separate manufacturing tolling agreement entered into February 2001, we are providing manufacturing services to Conoco at our facility in Clarksburg, West Virginia for carbon fibers. Under the three-year manufacturing tolling agreement, we are using raw materials provided by Conoco to manufacture carbon fibers. Conoco's new carbon fiber technology could be used in portable power applications, such as batteries for personal computers and cell phones, as well as a wide range of other electronic devices and automotive applications. We are working with Conoco to expand our strategic relationship in supply chain and other areas. 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 49 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 2001, we contributed our Brazilian cathode manufacturing operations to Carbone Savoie. Pechiney, the 30% minority owner of 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. Under our now broadened alliance, Carbone Savoie holds our entire cathode manufacturing capacity. In April 2001, we entered into a joint venture agreement with Jilin to produce and sell high-quality graphite electrodes in China, which we believe to be the largest market for graphite electrodes in the world. The joint venture is expected to utilize renovated capacity at Jilin's main facility in Jilin City and complete additions at another facility in Changchun that were begun by Jilin. The joint venture facilities are expected to commence operations in 2003. We are required to make capital contributions of $6 million of cash ($2 million of which has been contributed to date) plus technical assistance (a substantial portion of which has already been contributed) for our 25% ownership interest in the joint venture. The completion of the parties' capital contributions to the joint venture is subject to the receipt of required Chinese governmental approvals and satisfaction of other conditions. We have been working with Ballard Power Systems since 1992 on developing natural graphite-based materials for use in Ballard Power Systems fuel cells for power generation. In June 2001, our subsidiary, Graftech, entered into a new exclusive development and collaboration agreement and a new exclusive long-term supply agreement with Ballard Power Systems, which significantly expand the scope and term of the prior agreements. In addition, Ballard Power Systems became a strategic investor in Graftech, 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-based materials and components for proton exchange membrane fuel cells. The scope of the new exclusive development and collaboration agreement includes natural graphite-based materials and components, including flow field plates and gas diffusion layers, for use in proton exchange membrane 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-based materials for Ballard Power Systems fuel cells and fuel cell systems. We will also be the exclusive manufacturer of natural graphite-based components, other than those components that Ballard Power Systems manufactures for itself. The initial term of this agreement, which contains customary terms and conditions, extends through 2016. We have the right to manufacture and sell, after agreed upon release dates, natural graphite-based materials and components for use in proton exchange membrane fuel cells to other parties in the fuel cell industry. GLOBAL ECONOMIC CONDITIONS AND OUTLOOK We are impacted in varying degrees, both positively and negatively, as global, regional or country conditions affecting the markets for our products fluctuate. 50 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES Beginning in mid-2000, economic conditions began to weaken in North America, becoming more severe in the 2000 fourth quarter. Even with this weakening, worldwide electric arc furnace steel production was 285 million metric tons in 2000 (about 34% of total steel production). The 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. More than 29 steel companies in the U.S. filed for protection under the U.S. Bankruptcy Code since January 1, 2000. Electric arc furnace steel production declined in 2001 as compared to 2000 by about 11% in the U.S. The economic weakness in North America adversely impacted Europe, Asia (except for China), Brazil and other regional economies, and this impact became more severe during 2001. Electric arc furnace steel production declined in 2001 as compared to 2000 by about 11% in Asia (excluding China) and 11% in Brazil. The decline of electric arc furnace steel production in Brazil was caused both by shortages of electricity brought on by a drought that reduced hydroelectric power generation (although allocations of electricity in response to the shortages have since been terminated) as well as by the weakening in global economic conditions. Brazil was also impacted by developing currency, debt and related economic crises in Brazil itself as well as in neighboring Argentina. Electric arc furnace steel production in China remained relatively stable. We believe that worldwide electric arc furnace steel production declined by about 2% in 2001 (to a total of about 279 million metric tons, about 33% of total steel production) as compared to 2000. These fluctuations in electric arc furnace steel production resulted in corresponding fluctuations (to a greater or lesser extent, depending on economic conditions affecting, and decisions by, electric arc furnace steel producers) in demand for graphite electrodes. We estimate that worldwide graphite electrode demand declined in 2001 as compared to 2000 by about 10%. 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. We have been experiencing intense competition in the graphite electrode industry. One of our U.S. competitors, The Carbide/Graphite Group, Inc., filed for protection under the U.S. Bankruptcy Code in October 2001. In order to seek to minimize our credit risks, we have 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 unpaid trade receivables from steel companies in the U.S. that have filed for protection under the U.S. Bankruptcy Code since January 1, 2000 have aggregated only 1.4% of net sales of graphite electrodes in the U.S. during the same period. Our volume of graphite electrodes sold declined in 2001 as compared to 2000 by about 20% due primarily to the decline in electric arc furnace steel 51 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES production as well as our efforts to implement and maintain local currency selling price increases and our efforts to seek to minimize credit risks. Demand and prices for most of our other products sold to the metals and transportation industries are affected by the same global and regional economic conditions that affect graphite electrodes. During 2000, demand for most of these products as a group was relatively stable. Overall pricing did not strengthen. The global and regional economic conditions that have impacted demand and prices for graphite electrodes since mid-2000 have also similarly impacted demand and prices for most of these products (other than graphite cathodes). Demand and prices for graphite cathodes has remained relatively strong since 1999 primarily due to construction of new aluminum smelters using graphite cathodes, even as old smelters using carbon cathodes are removed from service. We believe that this global economic weakness bottomed in the 2002 first half and that a modest recovery is occurring. Total global steel production increased in the 2002 first half as compared to the 2001 first half by about 4%. This increase was primarily due to an increase in production of about 24% in China, partially offset by declines in production of about 3% in Western Europe, 5% in the U.S. and 6% in Mexico. If this production level is maintained through the 2002 second half, total global steel production would set a new record. Electric arc furnace steel production increased in the 2002 first half as compared to the 2001 first half by about 1%. This increase was primarily due to an increase in production of about 5% in China, partially offset by a decline in production of about 3% in Europe. Electric arc furnace steel production remains weak in Asia (other than China) but has increased modestly in the U.S. 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. There is a pending review of the tariffs by the World Trade Organization and several additional exemptions being considered by the Bush administration. We believe that the tariffs are having a modest positive impact on electric arc furnace steel production in the U.S. The change in steel shipments by steel service centers in the U.S. has begun to improve relative to the change in their inventories. While steel imported from Mexico is exempt from those tariffs, steel imported from Europe, Asia and Brazil is not exempt. Steel production in those regions has been adversely impacted by the tariffs. In addition, steel production in Brazil continues to be impacted by its own economic crises (although the debt restructuring recently approved by the World Bank may mitigate the impact of those crises). Further, import duties in China on both steel and 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. We believe that worldwide graphite electrode demand in the 2002 first half as compared to the 2001 first half was stable and as compared to the 2001 second half increased by about 3%. We also believe that graphite electrode pricing worldwide in the 2002 first half as compared to the 2001 fourth quarter declined about 7%, but bottomed in the 2002 second quarter. We believe that graphite electrode prices worldwide, in local selling currencies, in the 2002 second quarter 52 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES as compared to the 2002 first quarter increased by about 1% as price weakness in the U.S. and Asia was offset by a strengthening in Europe. We believe that business conditions for most of our products (other than cathodes) will remain challenging through 2002 and that a strong recovery in the steel, metals and transportation industries will not occur until the end of 2002, at the earliest. In particular, demand for carbon electrodes in the U.S. (where our main customer base is located) is still very depressed. Carbon electrodes are used in the production of silicon metal. We believe that the rebound we have experienced in graphite electrode demand from the extraordinarily low level in the beginning of the 2002 first quarter is primarily due to the modest improvement in conditions in the steel industry and an increase in our market share as we continue to implement our enterprise selling and other strategies. Our graphite electrode order book has strengthened significantly since the middle of the 2002 first quarter, and for the remainder of 2002 is now over 90% full. We announced, effective for new orders placed after July 15, 2002, an increase of $200 or (euro)200, as the case may be, in the price for our graphite electrodes sold in Europe, the Commonwealth of Independent States and the Middle East. During the third quarter, typically a lower volume quarter than the second quarter, particularly in Europe, we expect graphite electrode sales volume to be approximately 45,000 metric tons. We plan to continue to operate our plants at capacity to meet demand, which is expected to positively impact average electrode production cost per metric ton as compared to the 2002 first half. Our cathode order book is virtually full for the remainder of 2002 and into the beginning of 2003. In the Advanced Energy Technology Division, we currently have over 20 active component development programs for our electronic thermal management business, offering greater opportunity for the commercialization of our eGraf(TM) products to drive our future growth. We expect our cost savings to mitigate the impact on gross profit of pressure on net sales. We expect to achieve a graphite electrode production cost per metric ton of approximately $1,600 by the end of 2002 and $1,400 by the end of 2004. Although conditions are improving for graphite electrode price increases over the long-term, we do not expect worldwide graphite electrode prices to strengthen significantly in 2002. Under current global and regional economic conditions, we cannot assure you that we will have the same success in minimizing our credit risks in the future that we have had in the U.S. relating to sales of graphite electrodes in the past. We have implemented interest rate management initiatives to minimize our interest expense and optimize our portfolio of fixed and variable interest rate obligations. We entered into two ten-year interest rate swaps for a total notional amount of $250 million that effectively converted that amount of fixed rate debt to variable rate debt. We are targeting interest expense of $60 million for 2002, essentially the same as 2001. 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, the occurrence of further terrorist acts and 53 developments (including increases in security, insurance, data back-up, transportation and other costs, transportation delays and continuing or increased economic uncertainty and weakness) resulting from terrorist acts and the war on terrorism, and changes in global and regional economic conditions. FINANCING TRANSACTIONS We believe that the offerings described below together with the repayment of term loans under the Senior Facilities, the reduction in the outstanding balance under our revolving credit facility and other amendments to the Senior Facilities have strengthened our balance sheet and enhanced our flexibility to implement our business strategies. 2002 PRIVATE SENIOR NOTE OFFERINGS. On February 15, 2002, we completed a private offering of $400 million aggregate principal amount of Senior Notes at a price of 100% of principal amount. On May 6, 2002, we completed a private 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 balance 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. 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%. At June 30, 2002, after giving effect to the offerings, the application of the net proceeds and the corporate realignment of our subsidiaries, the Senior Facilities constituted $137 million of our total debt of $710 million, all of which $137 million was borrowings under term loans and all of the scheduled principal payments of which are term loans due in 2007. 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 the additional Senior Notes issued in May 2002 to make intercompany loans to our foreign subsidiaries and, on April 30, 2002, entered into a Supplemental Indenture to give effect to such amendment. 54 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES We recorded an extraordinary charge of $3 million ($2 million after tax) in the 2002 first quarter and an extraordinary charge of $1 million ($1 million after tax) in the 2002 second quarter for write-off of capitalized fees associated with the term loans under Senior Facilities repaid with the net proceeds from the issuance of the Senior Notes. 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. 60% of the net proceeds were used to repay term loans under the Senior Facilities. The balance of the net proceeds will be used to fund growth and expansion of our Advanced Energy Technology Division, including growth through acquisitions, and, pending such use, has been applied to reduce outstanding balance under our revolving credit facility. 2000 DEBT RECAPITALIZATION. In February 2000, we completed a debt recapitalization and obtained the Senior Facilities. The Senior Facilities consist of a six year term loan facility in the initial amount of $137 million and (euro)161 million, an eight year term loan facility in the initial amount of $350 million and a six year revolving credit facility in the initial maximum amount of (euro)250 million. The debt recapitalization lowered our average annual interest rate, extended the average maturities of our debt and replaced our financial and other covenants. In light of changes in conditions affecting our industry, changes in global and regional economic conditions, our recent financial performance and other factors, we closely monitor our compliance with those covenants. In the 2000 third quarter, pursuant to our debt recapitalization in February 2000, our Italian subsidiary entered into a (euro)17 million (about $15 million, based on currency exchange rates in effect at December 31, 2001) long-term debt arrangement with a third party lender. We also placed on deposit with the third party lender funds in the same amount, which secure the debt. Since we had the legal right to set-off, and the intent to do so, such amounts had been netted and were not reflected separately in the Consolidated Balance Sheets. In February 2002, in connection with the corporate realignment of our subsidiaries, we exercised our right of set-off and retired the debt arrangement. In April 2001, the Senior Facilities were amended to, among other things, exclude certain expenses incurred in connection with the lawsuit initiated by us against our former parents (up to a maximum of $20 million, but not more than $3 million in any quarter) and certain charges and payments in connection with antitrust fines, settlements and expenses from the calculation of financial covenants. After giving effect to subsequent amendments to the Senior Facilities, payments within the $340 million charge recorded in 1997 are excluded from the calculation of financial covenants and charges over and above the $340 million charge are excluded from the calculation of financial covenants (until paid) up to a maximum of $75 million, reduced by the amount of certain debt (other than the Senior Notes) incurred by us that is not incurred under the Senior Facilities ($23 million of which debt was outstanding at June 30, 2002). As a result, the fine assessed by the antitrust authority of the European Union, as well as the additional $10 million charge recorded in July 2001 and any payments related to such fine (including payments within the $340 million charge), are excluded from such calculations. 55 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES In July 2001, in connection with the underwritten public offering of common stock, the Senior Facilities were amended to, among other things, change our financial covenants so that they were less restrictive than would otherwise have been the case. In connection therewith, we agreed that our investments in unrestricted subsidiaries after this amendment will be made in the form of secured loans, which will be pledged to secure the Senior Facilities, and that the maximum amount of capital expenditures permitted under the Senior Facilities would be reduced in 2001 and 2002. We do not expect that our capital expenditures would exceed such maximums. In connection therewith, we paid an amendment fee of $2 million and the margin which is added to either euro LIBOR or the alternate base rate in order to determine the interest rate payable thereunder increased by 25 basis points. In December 2001, the Senior Facilities were amended to, among other things, permit the corporate realignment of our subsidiaries. In connection therewith, we paid an amendment fee of $1 million. 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. In addition, our maximum permitted leverage ratio was substantially increased and our minimum required interest coverage ratio was substantially decreased. The amendment also changed the manner in which net debt and EBITDA are calculated to exclude any letter of credit issued to secure payment of the antitrust fine assessed against us by the antitrust authority of the European Union. In addition, the amendment expanded our ability to make certain investments, including investments in Graftech, and eliminated provisions relating to a spin-off of Graftech. In connection therewith, we paid an amendment fee of $1 million and the margin which 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 additional 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 against new specified amounts. Our interest coverage ratio was also changed. We believe that these changed ratios will provide us with greater flexibility. In addition, the amendment reduced the maximum amount available under our revolving credit facility to (euro)200 million from (euro)250 million ((euro)25 million of which can only be used to pay or secure payment of the fine assessed by the antitrust authority of the European Union) 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 ($23 million of which debt was outstanding at June 30, 2002). In connection therewith, we paid fees and costs of $1 million. The net proceeds from the sale of the Senior Notes in February and May 2002 were applied to repay term loans under the Senior Facilities and to reduce the outstanding balance under our revolving credit facility. 56 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 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. In the lawsuit, we allege, among other things, that certain payments made to our former parents in connection with our leveraged equity recapitalization in January 1995 were unlawful under the General Corporation Law of the State of Delaware, that our former parents were unjustly enriched by receipts from their investments in GTI and that our former parents aided and abetted 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 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. We are vigorously opposing those motions. Oral hearings were held on those motions in the 2001 first and second quarters. We expect that a decision on those motions will be rendered by the end of September 2002. Litigation such as this lawsuit is complex. Complex litigation can be lengthy and expensive. 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, 2002, we had incurred about $4 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. ANTITRUST AND OTHER LITIGATION AGAINST US Since 1997, we 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 threatened against us and other producers and distributors of graphite and carbon products in the U.S., Canada and elsewhere. We recorded a pre-tax charge against results of operations for 1997 in the amount of $340 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 of $20 million, $15 million, $15 million, $18 million, $21 million and $21 million, commencing July 23, 1998. The payments due in 1998, 1999 and 2000 were timely made. In January 2001, at our request, the due date of each of the remaining three payments was deferred by one year and, at our request, in January 2002, the payment schedule for the $60 million unpaid balance outstanding at that time was revised to $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 U.S. Department of Justice 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 unpaid balance, commencing in April 2004, at the statutory rate of interest then in effect. In January 2002, the statutory rate of interest 57 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES was 2.13% per annum. Accrued interest will be payable together with each quarterly payment. Of the $110 million aggregate amount and before giving effect to the restructured payment schedule, $90 million is treated as a fine and $20 million is treated as imputed interest for accounting purposes. In March 1999, our Canadian subsidiary pled guilty to a one count charge of violating Canadian antitrust law in connection with the sale of graphite electrodes and was sentenced to pay a fine of Cdn. $11 million. All payments due have been timely made. 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 it had, after holding a hearing, assessed a fine against us in the amount of 676 million KRW (approximately $560,000, based on currency exchange rates in effect on June 30, 2002). Five other graphite electrode producers were also fined by it in amounts ranging up to 4,396 million KRW (approximately $3.6 million, based on currency exchange rates in effect on June 30, 2002). 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, 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, in August 2002. In January 2000, the antitrust authority of the European Union issued a statement of objections initiating proceedings against us and other producers of graphite electrodes. The statement alleged that we and other producers violated European antitrust laws in connection with the sale of graphite electrodes. In July 2001, that authority issued its decision. Under the decision, it assessed a fine of (euro) 50.4 million ($50 million, based on currency exchange rates in effect at June 30, 2002) against GTI resulting from the role of our former management in a graphite electrode price fixing cartel. Seven other graphite electrode producers were also fined, with fines ranging up to (euro) 80.2 million. As a result of the assessment of the fine against us, we recorded a pre-tax charge of $10 million against results of operations in the 2001 second quarter as an additional reserve for potential liabilities and expenses in connection with antitrust investigations and related lawsuits and claims. This decision has brought to a conclusion our last major antitrust liability. From the initiation of its investigation, we have cooperated with the antitrust authority of the European Union. 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 that 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 challenging the amount of the fine. The fine or collateral security therefor would typically be required to be paid or provided at about the time the appeal was filed. We are currently in discussions with that authority regarding the appropriate form of collateral security during the pendency of the appeal. If the results of these discussions are not acceptable to us, we may file 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 interim appeal. 58 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 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. In May 2002, the antitrust authority of the European Union 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. As a result of our substantial cooperation to date and our intention to continue to cooperate, under the Notice on Non-Imposition or Reduction of Fines in Cartel Cases issued by the antitrust authority of the European Union, we believe that we will benefit from the maximum reduction possible (a 100% reduction) with the result that no fine will be payable. 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 carbon electrodes and carbon cathodes as well as 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, 2002, we have paid an aggregate of $249 million of fines and net settlement and expense payments and $14 million of imputed interest. At June 30, 2002, $101 million remained in the reserve. The balance of the reserve is available for the balance of the fine payable by us to the U.S. Department of Justice (excluding imputed interest thereon), the fine assessed against us by the antitrust authority of the European Union and other matters. The aggregate amount of remaining committed payments payable to the U.S. Department of Justice for imputed interest at June 30, 2002 was about $6 million. 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 (including the assessment of the fine by the antitrust authority of the European Union and the additional $10 million charge), 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 decision by the antitrust 59 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES authority of the European Union 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. CURRENCY MATTERS We incur manufacturing costs and sell our products in multiple currencies. As a result, in general, our results of operations, cash flows and financial condition are affected by changes in currency exchange rates as well as by inflation in countries with highly inflationary economies where we have manufacturing facilities. To manage certain exposures to risks caused by changes in currency exchange rates, we use various off-balance sheet financial instruments. To account for translation of foreign currencies into dollars for consolidation and reporting purposes, we record foreign currency translation adjustments in accumulated other comprehensive income (loss) as part of stockholders' equity in the Consolidated Balance Sheets, except in the case of operations in highly inflationary economies (or which use the dollar as their functional currency) where we record foreign currency translation gains and losses as part of other (income) expense, net in the Consolidated Statement of Operations. We also record foreign currency transaction gains and losses as part of other (income) expense, net. During the 2001 first half, the euro declined about 10%, the Brazilian real declined about 16% and the South African rand declined about 6%. During the 2002 first half, the South African rand and the euro strengthened about 15% and 11%, respectively, while the Brazilian real declined about 19%. RESULTS OF OPERATIONS HIGHLIGHTS OF 2002 SECOND QUARTER AS COMPARED TO 2002 FIRST QUARTER. Net sales of $161 million in the 2002 second quarter represented a $23 million, or 17%, increase from net sales of $138 million in the 2002 first quarter. Gross profit of $36 million in the 2002 second quarter represented a $5 million, or 16%, increase from gross profit of $31 million in the 2002 first quarter. Gross margin was consistent at 22.5% of net sales in 2002 second quarter and 22.3% of net sales in 2002 first quarter. Earnings in the 2002 second quarter, before non-recurring charges and benefits, was net income of $3 million, or $0.05 per diluted share, and, after those charges and benefits, was a net loss of $7 million, or $0.14 per diluted share. Earnings in the 2002 first quarter, before non-recurring charges and benefits, was a net loss of $1 million, or $0.02 per diluted share, and, after those charges and benefits, was a net loss of $4 million, or $0.06 per diluted share. The following table summarizes the impact of those non-recurring charges and benefits. 60
THREE MONTHS ENDED THREE MONTHS ENDED JUNE 30, 2002 MARCH 31, 2002 ------------- -------------- (DOLLARS IN MILLIONS) Net loss............................................. $ (7) $ (4) Non-recurring charges: Restructuring charges (including global realignment and related expenses) and impairment loss on long-lived and other assets, net of tax............................ 9 6 Extraordinary item, net of tax.................. 1 2 Non-recurring tax benefit related to legal and tax restructuring............................... - (5) ----- ------ Net income before non-recurring charges and benefits..................................... $ 3 $ (1) ====== =======
The legal and tax restructuring and global realignment mentioned in the preceding table and elsewhere in this Report are part of the corporate realignment of our subsidiaries. The tax benefits from the corporate realignment (which are referred to as tax benefits from legal and tax restructuring) have been recorded separately from expenses to implement the corporate realignment (which are referred to as global realignment and related expenses). GRAPHITE POWER SYSTEMS DIVISION. Net sales increased to $133 million in the 2002 second quarter from $111 million in the 2002 first quarter, primarily due to higher volume of graphite electrodes and cathodes sold. Volume for graphite electrodes sold increased 27% to 48,800 metric tons in 2002 second quarter from 38,500 metric tons in 2002 first quarter. The higher volume of graphite electrodes sold in 2002 second quarter contributed $21 million to net sales. Average sales revenue per metric ton of graphite electrodes in the 2002 second quarter was $2,095, a slight improvement over the average in the 2002 first quarter of $2,083. Of this increase of $12 per metric ton, changes in currency exchange rates resulted in an increase of $48 per metric ton, partially offset by a decline in average local currency selling prices of $36 per metric ton. Average graphite electrode production cost per metric ton in the 2002 second quarter increased to $1,666, about $28 higher than in the 2002 first quarter. The average was higher than anticipated primarily due to changes in currency exchange rates during the 2002 second quarter, which increased the average by about $32 from the 2002 first quarter and the impact of the sale of higher cost inventories associated with low operating levels in the 2002 first quarter. In the 2002 second half, the average is expected to decline by approximately 3-4% from the 2002 second quarter level. Gross profit in the 2002 second quarter was $30 million (22.5% of net sales), an increase of $5 million from gross profit in the 2002 first quarter of $25 million (22.3% of net sales). ADVANCED ENERGY TECHNOLOGY DIVISION. Net sales increased to $28 million in the 2002 second quarter from $27 million in the 2002 first quarter. Sales of advanced graphite and carbon 61 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES materials strengthened in the 2002 second quarter as compared to the 2002 first quarter. New product development and commercialization efforts continued to progress successfully. During the 2002 second quarter, this division launched the planned commercialization of new, advanced eGraf(TM) HiTherm thermal interface products designed to aid the cooling of chip sets and other heat generating components in computers, telecommunications equipment and other electronic devices. Tests conducted on the new product line and confirmed by customers, including IBM Corporation and Intel Corporation, indicate an approximately 40% improvement in thermal conductivity and 45% reduction in thermal resistance as compared to our first generation product line. Gross profit in the 2002 second quarter was $6 million (22.4% of net sales), virtually the same as in the 2002 first quarter. OTHER ITEMS. Selling, administrative and other expenses were $20 million in the 2002 second quarter as compared to $18 million in 2002 first quarter. The increase was primarily due to the reintroduction of our global incentive programs. In the 2002 second quarter, we also recorded a $5 million non-cash compensation charge associated with the accelerated vesting of a 2002 employee restricted stock grant. We recorded other income of $13 million for the 2002 second quarter, primarily due to a currency exchange gain on euro-denominated intercompany loan receivables that are expected to be repaid in the foreseeable future, partially offset by losses on currency forward and option contracts. Interest expense was $17 million in the 2002 second quarter, an increase of $4 million from the 2002 first quarter, due to an increase in average annual interest rates and average total debt outstanding. Those increases were primarily due to costs associated with the issuance of the Senior Notes and the fact that the Senior Notes bear interest at a higher rate than the term loans under the Senior Facilities that were repaid with the net proceeds therefrom. Our average total debt outstanding was $708 million in 2002 second quarter as compared to $668 million in 2002 first quarter. Our average annual interest rate was 9.1% in 2002 second quarter as compared to 7.6% in 2002 first quarter. NET DEBT AND WORKING CAPITAL. Net debt (total debt less cash, cash equivalents and short-term investments) decreased to $659 million at June 30, 2002 from $663 million at March 31, 2002. Total debt at June 30, 2002 was $710 million. Working capital improved by $20 million in 2002 second quarter primarily because of changes in our interest payment schedule. Interest is payable during the first and third quarters on the Senior Notes while interest was payable quarterly on the term loans under the Senior Facilities that were repaid with the net proceeds from the issuance of the Senior Notes. As a result, working capital benefited during the 2002 second quarter due to the reduction in interest payments. We have an interest payment of approximately $26 million due on the Senior Notes in August 2002. This change in our interest schedule is expected to introduce greater volatility in our working capital as measured on a quarterly basis (but not in total on an annual basis). In addition, in the 2002 second quarter, we incurred $6 million of cash costs associated with the issuance of Senior Notes in May 2002 and the related amendment of the Senior Facilities as compared to $14 million associated with the issuance of Senior Notes in February 2002 and the related amendment of the Senior Facilities. These costs were capitalized and will be amortized over the term of the Senior Notes. 62 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES THREE MONTHS ENDED JUNE 30, 2002 AS COMPARED TO THREE MONTHS ENDED JUNE 30, 2001. Net sales of $161 million in the 2002 second quarter represented a $10 million, or 6%, decrease from net sales of $171 million in the 2001 second quarter, primarily due to the lower average local currency selling prices of graphite electrodes and lower net sales in our Advanced Energy Technology Division, partially offset by increased net sales of cathodes. Cost of sales of $125 million in the 2002 second quarter represented a $5 million, or 4%, increase from cost of sales of $120 million in the 2001 second quarter, primarily due to higher volume of graphite electrodes and cathodes sold. Gross profit of $36 million in the 2002 second quarter represented a $15 million, or 29%, decrease from gross profit of $51 million in the 2001 second quarter. Gross margin declined to 22.5% of net sales in 2002 second quarter from 29.9% in 2001 second quarter. GRAPHITE POWER SYSTEMS DIVISION. Net sales decreased to $133 million in the 2002 second quarter from $137 million in the 2001 second quarter, primarily due to lower average graphite electrode sales revenue per metric ton. Volume of graphite electrodes sold was 48,800 metric tons in the 2002 second quarter as compared to 46,000 metric tons in the 2001 second quarter. The higher volume of graphite electrodes sold represented an increase of $7 million in net sales. The increase was primarily a result of stronger demand for graphite electrodes in North America. Average sales revenue per metric ton of graphite electrodes in the 2002 second quarter was $2,095 as compared to the average in the 2001 second quarter of $2,367. The lower average sales revenue per metric ton represented a decrease of $13 million in net sales. Changes in currency exchange rates represented $2 million of the $13 million decrease in net sales of graphite electrodes. Net sales of cathodes increased in the 2002 second quarter by 32%, or $5 million, from the 2001 second quarter. Cost of sales increased to $103 million in the 2002 second quarter from $96 million in the 2001 second quarter. Average cost of sales per metric ton of graphite electrodes was $1,666 in the 2002 second quarter, virtually unchanged from $1,663 in the 2001 second quarter. Cost savings largely offset an increase of $60 per metric ton due to changes in currency exchange rates. Gross profit in the 2002 second quarter was $30 million (22.5% of net sales), a decrease from gross profit in the 2001 second quarter of $41 million (29.8% of net sales). ADVANCED ENERGY TECHNOLOGY DIVISION. Net sales decreased to $28 million in the 2002 second quarter from $34 million in the 2001 second quarter, primarily due to a decrease in the volume of refractories sold, lower technology sales and lower volume and prices of products sold to customers in the semiconductor and industrial sectors, particularly in Europe. New product development and commercialization efforts continued to progress successfully. Cost of sales was $22 million in the 2002 second quarter as compared to $24 million in the 2001 second quarter. Gross profit in the 2002 first quarter was $6 million (22.4% of net sales) as compared to gross profit in the 2001 second quarter of $10 million (31.2% of net sales). ITEMS AFFECTING US AS A WHOLE. Selling, administrative and other expenses were $20 million in the 2002 second quarter, an increase of $1 million from the 2001 second quarter. The increase was primarily due to the reintroduction of our global incentive programs and additional charges for potential bad debts. In addition, in June 2002, in recognition of, among other things, 63 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES extraordinary efforts by employees during difficult economic and business conditions without significant salary increases or cash bonuses due to the desire to preserve our cash resources, GTI's Board of Directors accelerated the vesting of 412,300 shares of restricted stock granted to employees in March 2002. The shares had been scheduled to vest in 2003 and 2004. The accelerated vesting resulted in a $5 million non-cash charge to compensation expense. In the 2002 second quarter, we recorded a $13 million ($8 million after tax) non-cash charge, primarily related to the impairment of our long-lived carbon electrode assets in Columbia, Tennessee and a charge of $2 million related to the corporate realignment of our subsidiaries. In the 2001 second quarter, we recorded restructuring impairment and antitrust charges totaling $68 million, primarily related to our graphite electrode business. Other (income) expense, net was income of $13 million in the 2002 second quarter as compared to nil in the 2001 second quarter. This change was primarily associated with $16 million of currency exchange gains primarily associated with euro-denominated intercompany loan receivables that are expected to be repaid in the foreseeable future, net of $3 million of losses on currency forward and option contracts. Interest expense was $17 million in the 2002 second quarter as compared to $16 million in the 2001 second quarter. Average total debt outstanding was $708 million in the 2002 second quarter as compared to $703 million in the 2001 second quarter. The average annual interest rate was 9.1% in 2002 second quarter as compared to 8.0% in the 2001 second quarter. These average annual rates excluded inputed interest of the fine payable to the DOJ. The increase in the average annual interest rate was primarily due to the fact that the interest rate on the Senior Notes is higher than the interest rate on the term loans under the Senior Facilities repaid with the net proceeds therefrom. Provision for income taxes was a $5 million benefit in the 2002 second quarter as compared to a $16 million benefit in the 2001 second quarter. The effective income tax rate, before non-recurring charges, was 35% in the 2002 second quarter as compared to 48% in 2001 second quarter. The lower rate reflects the impact of our legal and tax restructuring. In the 2002 second quarter, we recorded an extraordinary item, net of tax, of $1 million in connection with the write-off of capitalized fees associated with term loans under the Senior Facilities repaid with the net proceeds from the issuance of the Senior Notes. As a result of the changes described above, net loss was $7 million in the 2002 second quarter as compared to net loss of $39 million in the 2001 second quarter. Net income per diluted share, before non-recurring charges, was $0.05 in the 2002 second quarter as compared to earnings per diluted share of $0.13 in the 2001 second quarter. Net loss per diluted share, after non-recurring charges, was $0.14 in the 2002 second quarter. SIX MONTHS ENDED JUNE 30, 2002 AS COMPARED TO SIX MONTHS ENDED JUNE 30, 2001. Net sales of $299 million in the 2002 first half represented a $43 million, or 13%, decrease from net sales of $342 million in the 2001 first half. Gross profit of $67 million in the 2002 first half 64 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES represented a $33 million, or 33%, decrease from gross profit of $100 million in the 2001 first half. Gross margin declined to 22.4% of net sales in 2002 first half from 29.2% in 2001 first half. The decrease in net sales, gross profit and gross margin was primarily due to lower net sales of all products with the exception of cathodes, which had a 16% improvement in net sales. GRAPHITE POWER SYSTEMS DIVISION. Net sales decreased to $244 million in the 2002 first half from $273 million in the 2001 first half, primarily due to the lower volume of graphite electrodes sold and lower average graphite electrode sales revenue per metric ton. Volume of graphite electrodes sold was 87,300 metric tons in the 2002 first half as compared to 89,000 metric tons in the 2001 first half. The lower volume of graphite electrodes sold represented a decrease of $4 million in net sales. The decrease was primarily a result of a decline in North American electric arc furnace steel production, weaker demand in Europe and Russia, actions taken by us to manage credit risk and limited availability of finished graphite electrode inventories to meet increased demand in June 2002. Average sales revenue per metric ton of graphite electrodes in the 2002 first half was $2,090 as compared to the average in the 2001 first half of $2,392. The lower average sales revenue per metric ton represented a decrease of $26 million in net sales. Changes in currency exchange rates represented $8 million of the $26 million decrease. Cost of sales decreased to $189 million in the 2002 first half from $194 million in the 2001 first quarter. The decrease was primarily due to lower sales volumes. Average cost of sales per metric ton of graphite electrodes benefited from improved productivity, head-count reductions, plant cost reductions and lower maintenance spending as compared to the 2001 first half, partially offset by higher than anticipated graphite electrode production costs of approximately $2 million resulting from activities associated with the accelerated mothballing of our Italian graphite electrode plant and extensive furnace maintenance, which resulted in extended production down time, at our Brazilian graphite electrode plant in preparation for higher operating levels during the remainder of 2002. Average cost of sales per metric ton of graphite electrodes was $1,653 per metric ton in the 2002 first half, a decline of $63, or about 4%, as compared to the 2001 first half, despite lower operating levels and lower sales volumes. Low operating levels were due to both reductions in production in response to weakness in economic conditions that continued into the middle of the 2002 first quarter as well as reductions in production associated with the mothballing of our Italian graphite electrode plant as part of the 2002 plan and furnace maintenance at our Brazilian graphite electrode plant. Gross profit in the 2002 first half was $55 million (22.5% of net sales), a decrease from gross profit in the 2001 first half of $79 million (28.6% of net sales). ADVANCED ENERGY TECHNOLOGY DIVISION. Net sales decreased to $55 million in the 2002 first half from $69 million in the 2001 first half, primarily due to decreases in volume of refractories sold, in new business sales, in volume of flexible graphite sold for gasket applications due to lower demand from the automotive industry and in products sold to customers in the semiconductor and industrial sectors, particularly in Europe. We believe that the core businesses in this division bottomed during the 2002 first half. New product development and commercialization efforts continued to progress successfully. During the 2002 65 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES first half, IBM Corporation and Intel Corporation approved and purchased eGraf(TM) thermal interface products for computer, consumer electronic and telecommunication applications. Cost of sales was $42 million in the 2002 first half as compared to $48 million in the 2001 first half. The decrease was primarily due to the decreases in volumes sold. Gross profit in the 2002 first half was $12 million (22.3% of net sales) as compared to gross profit in the 2001 first half of $21 million (31.6% of net sales). ITEMS AFFECTING US AS A WHOLE. Selling, administrative and other expenses were $38 million in the 2002 first half, a decline of $2 million, or 5%, from 2001 first half. The decline was primarily due to a reduction in franchise and other non-income taxes and redesign of benefit plans. In the 2002 first half, we recorded a $5 million non-cash charge to compensation expense associated with the accelerated vesting of restricted stock. In the 2002 first half, we recorded a $13 million ($8 million after tax) non-cash charge primarily related to the impairment of our long-lived carbon electrode assets in Columbia, Tennessee, a restructuring charge of $5 million related to the mothballing of our graphite electrode plant in Italy, and a charge of $3 million related to the corporate realignment of our subsidiaries. In the 2001 first half, we recorded restructuring, impairment and antitrust changes of $68 million, primarily related to our graphite electrode business. Other (income) expense, net was income of $16 million in the 2002 first half as compared to nil in the 2001 first half. This change was primarily associated with $20 million of currency exchange gains primarily associated with euro-denominated intercompany loan receivables that are expected to be repaid in the foreseeable future, net of $9 million of losses on currency forward and option contracts. Interest expense was $30 million in the 2002 first half, a decrease of $5 million from the 2001 first half. The decrease resulted from lower average debt outstanding. Average total debt outstanding was $688 million in the 2002 first half as compared to $716 million in the 2001 first half. The average annual interest rate was 8.5% in 2002 first half as compared to 8.4% in the 2001 first half. These average annual rates excluded imputed interest of the fine payable to the DOJ. The increase in the average annual interest rate was primarily due to the fact that the interest rate on the Senior Notes is higher than the interest rate on the term loans under the Senior Facilities repaid with the net proceeds therefrom. Provision for income taxes was a $17 million benefit in the 2002 first half as compared to a $49 million benefit in the 2001 first half. Excluding the benefit of $6 million, which was related to the corporate realignment of our subsidiaries, the provision for income taxes for the 2002 first half would have been $11 million. No tax benefit was provided on the restructuring charge and impairment loss on long-lived and other assets of $6 million related to the mothballing of our graphite electrode plant in Italy. The effective income tax rate, before non-recurring charges, was 35% in the 2002 first half as compared to 45% in 2001 first half. The lower rate reflects the impact of our legal and tax restructuring. 66 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES In the 2002 first half, we recorded an extraordinary item, net of tax, of $3 million in connection with the 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. As a result of the changes described above, net loss was $11 million in the 2002 first half as compared to net loss of $36 million in the 2001 first half. Net loss per diluted share was $0.20 in the 2002 first half as compared net loss per diluted share of $0.80 in the 2001 first half. 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 have substantial obligations in connection with antitrust investigations, lawsuits and claims (in respect of which we have an unfunded reserve totaling $101 million). We had total debt of $710 million and a stockholders' deficit of $348 million at June 30, 2002 as compared to total debt of $638 million and a stockholders' deficit of $332 million at December 31, 2001. 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 2002 first half, certain of our subsidiaries sold receivables totaling $94 million. If we had not sold such receivables, our accounts receivable would have been about $47 million higher at June 30, 2002. In addition, if we are required to pay or issue a letter of credit to secure payment of the fine assessed by the antitrust authority of the European Union pending resolution of our appeal regarding the amount of the 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. Our leverage and obligations, as well as changes in conditions affecting our industry, changes in global and regional economic conditions and other factors, have adversely impacted our recent operating results. The following tables summarize our long-term contractual obligations and other commercial commitments at June 30, 2002. 67 SUMMARY OF LONG-TERM CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
PAYMENTS DUE BY PERIOD ---------------------- LESS THAN 1 1-3 4-5 AFTER 5 TOTAL YEAR YEARS YEARS YEARS ----- ------ ----- ----- ----- (DOLLARS IN MILLIONS) CONTRACTUAL AND OTHER OBLIGATIONS --------------------------------- Long-term debt...................................... $ 693 $ - $ 1 $ 1 $ 691 Operating leases.................................... 11 4 6 1 - Unconditional purchase obligations.................. 62 7 18 20 17 --------- -------- ------ -------- --------- Total contractual obligations.................... 766 11 25 22 708 Liabilities and expenses associated with antitrust investigations and related lawsuits and claims... 99 3 80 16 - Postretirement, pension and related benefits........ 109 11 51 16 31 Other long-term obligations......................... 21 3 5 2 11 --------- -------- ------ -------- --------- Total contractual and other obligations.......... $ 995 $ 28 $ 161 $ 56 $ 750 ========= ======== ====== ======== =========
AMOUNT OF COMMITMENT EXPIRATION BY PERIOD ----------------------------------------- LESS THAN 1 1-3 4-5 AFTER 5 TOTAL YEAR YEARS YEARS YEARS ----- ---- ----- ----- ----- (DOLLARS IN MILLIONS) OTHER COMMERCIAL COMMITMENTS ---------------------------- Lines of credit..................................... $ 11 $ 11 $ - $ - $ - Letters of credit................................... 13 13 - - - Guarantees.......................................... 27 - - - 27 ------ ------ ------ -------- -------- Total other commercial commitments................ $ 52 $ 25 $ - $ - $ 27 ====== ====== ====== ======== ========
The first preceding table includes the fine of (euro)50.4 million (about $50 million based on currency exchange rates in effect at June 30, 2002) assessed against us by the antitrust authority of the European Union under the column captioned "payments due in 1-3 years" on the line entitled "liabilities and expenses associated with antitrust investigations and related lawsuits and claims." It is the policy of that 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 the amount of the fine. Although we cannot predict how or when the court would rule on the appeal, appeals of this type may take two years or longer to be decided. While we cannot assure you that such will be the case, we believe that amount of the fine will be impacted by the appeal and that, after such ruling, we will be permitted to pay the fine over an extended period. The second preceding table includes a line "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. 68 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES Cash and cash equivalents were $51 million at June 30, 2002 as compared to $38 million at December 31, 2001. Net debt (which is total debt, net of cash, cash equivalents and short-term investments) was $659 million at June 30, 2002 as compared to $660 million at June 30, 2001. As a result of our high leverage and substantial obligations in connection with antitrust investigations, lawsuits and claims, changes in conditions affecting our industry, changes in global and regional economic conditions and other factors, we have placed high priority on efforts to manage cash and reduce debt. CASH FLOW AND PLANS TO MANAGE LIQUIDITY. For at least the past five years, we have had positive annual cash flow from operations, excluding cash used for capital expenditures and payments in connection with restructurings and investigations, lawsuits and claims. Typically, the first quarter of each year results in neutral or negative cash flow from operations (before such exclusions) due to various factors. These factors include 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 result in significant positive cash flow from operations (before deducting such exclusions). The third quarter tends to produce relatively less positive cash flow primarily as a result of scheduled plant shutdowns by our customers for vacations. Following a recovery in the steel and other metals and transportation industries, we believe that our cash flow would follow this historical pattern. Prior to 2000, our cash flow from operations (before such exclusions) in the first and third quarters was adversely impacted by the semi-annual interest payments on our previously outstanding senior subordinated notes. The second and fourth quarters correspondingly benefited from the absence of interest payments on such notes. We expect the semi-annual interest payments on the Senior Notes to have a similar impact. We use, and are dependent on, funds available under our revolving credit facility, including continued compliance with the financial covenants under the Senior Facilities, as well as monthly or quarterly cash flow from operations as our primary sources of liquidity. We believe that our cost savings 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. 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 is dependent on our future financial and operating performance. Our ability to maintain compliance with the covenants under the Senior Facilities is also 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 69 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. We cannot assure you that our cash flow from operations and capital resources will be sufficient to enable us to meet our debt service and other obligations when due. Even if we are able to meet our debt service and other obligations when due, we may not be able to comply with the financial covenants under the Senior Facilities. A failure to comply with any of the covenants under 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 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 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. 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 our revolving credit 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 specified minimum interest coverage and maximum net senior secured debt leverage ratios that become more restrictive over time. At June 30, 2002, we were in compliance with the financial covenants under the Senior Facilities. If we were to believe that we would not continue to comply with such covenants, we would seek an appropriate waiver or amendment from the lenders thereunder. There can be no assurance that we would be able to obtain such waiver or amendment on acceptable terms or at all. While our revolving credit facility provides for maximum borrowings of up to (euro)200 million ($198 million, based on currency exchange rates in effect at June 30, 2002), our 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 under the Senior Facilities. In addition, (euro)25 million of the (euro)200 million is reserved exclusively for use to pay or secure payment of the fine assessed by the antitrust authority of the European Union. At June 30, 2002, we had full availability under our revolving credit facility and the outstanding balance thereunder was nil. In addition, payment of the fine or issuance of a letter of credit to 70 secure payment of the fine assessed by the antitrust authority of the European Union would significantly reduce remaining 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 efforts to reduce costs and working capital needs, improve efficiencies and product quality, generate growth and earnings and maximize funds available to meet our debt service and other obligations, we will be able to manage our working capital and cash flow to permit us to service our debt and meet our obligations when due. CASH FLOW FROM OPERATING ACTIVITIES. Cash flow used in operating activities was $36 million in the 2002 first half as compared to cash flow provided by operating activities of $1 million in the 2001 first half. The decreased generation of cash flow of $37 million resulted primarily from a $33 million decline in gross profit. Working capital was a use of cash of $25 million in the 2002 first half as compared to $21 million in the 2001 first half. The benefit from an increase in accounts receivable, a decrease in accounts payable and a reduction in restructuring payments and fines and net settlements and expenses in connection with antitrust investigations and related lawsuits and claims were largely offset by an increase in inventories in anticipation of higher sales volumes in the 2002 second half. Careful management of credit risk allowed us to avoid significant accounts receivable losses in light of the poor financial condition of many of our potential and existing customers. In light of current global and regional economic conditions, we cannot assure that we will not be materially adversely affected by accounts receivable losses in the future. CASH FLOW FROM INVESTING ACTIVITIES. We used $20 million of cash flow for investing activities during the 2002 first half as compared to $7 million during the 2001 first half. This increase of $13 million was primarily due to higher capital expenditures for expansion in the 2002 first half as compared to a reduced level of capital expenditures in the 2001 first half to preserve cash resources. CASH FLOW FROM FINANCING ACTIVITIES. Cash flow provided by financing activities was $66 million in the 2002 first half as compared to cash flow used for financing activities of $5 million in the 2001 first half. The increase was primarily due to additional borrowings in the 2002 first half to fund working capital needs and $20 million in cash costs associated with the issuance of the Senior Notes in February and May 2002. During the 2001 first half, we received $9 million from an additional minority investment in connection with the broadening of our strategic alliance in the cathode business with Pechiney. During the 2002 first half, we completed private offerings of $550 million aggregate principal amount of Senior Notes. Net proceeds (excluding accrued interest paid by the purchasers) were $538 million, all of which were used to repay term loans under the Senior Facilities and reduce the outstanding balance under our revolving credit facility. 71 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES CRITICAL ACCOUNTING POLICIES The SEC recently issued disclosure guidance for critical accounting policies. The SEC defines critical accounting policies as those that require application of management's most difficult, subjective or complex judgments, 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 Consolidated Financial Statements. Not all of these significant accounting policies require management to make difficult, subjective or complex judgments or estimates. However, the following accounting policies could be deemed to be critical by the SEC. USE OF ESTIMATES. In preparing the Consolidated Financial Statements, we use estimates in determining the economic useful lives of our assets, obligations under our employee benefit plans, provisions for doubtful accounts, provisions for restructuring charges, tax valuation allowances 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. 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 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 future net cash flows expected 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 fair value of the asset. Assets to be disposed are reported at the lower of the carrying amount or fair value less costs to sell. If the actual value is significantly less than the estimated value, our assets may be overstated. INVENTORIES. We record the value of inventory 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 72 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 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. RECENT ACCOUNTING PRONOUNCEMENTS In June 2002, FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which is effective for financial statements issued for fiscal years beginning 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)." We are currently evaluating the impact of SFAS No. 146 on our consolidated financial position and results of operations. 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 shall be applied in fiscal years beginning after May 15, 2002. The provisions of SFAS No. 145 related to SFAS No. 13 shall be effective for transactions occurring after May 15, 2002 and all other provisions of SFAS No. 145 shall be 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." SFAS No. 145 also rescinds SFAS 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 are currently evaluating the impact of the provisions of SFAS No. 145 relating to SFAS No. 4 on our consolidated financial position and results of operations. 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 August 2001, FASB issued SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets," which addresses financial accounting and reporting for the impairment or disposal of long-lived assets, excluding goodwill and other intangible assets not being amortized pursuant to SFAS No. 142, and certain other assets. SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001. We adopted SFAS No. 73 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 144 effective January 1, 2002. The adoption of SFAS No. 144 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. SFAS No. 143 will be effective for financial statements issued for fiscal years beginning after June 15, 2002. We anticipate that the adoption of SFAS No. 143 will not have a significant impact on our consolidated financial position or results of operations. In July 2001, FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets," both of which are effective for financial statements issued for fiscal years beginning after December 15, 2001. SFAS No. 141 and SFAS No. 142 establish accounting and reporting standards for business combinations, goodwill and intangible assets. We adopted SFAS No. 141 and SFAS No. 142 effective January 1, 2002. The adoption of SFAS No. 141 and SFAS No. 142 did not have a significant impact on our consolidated financial position or results of operations, except that we no longer amortize goodwill. Goodwill amortization was $1 million in the 2001 first half. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS We are exposed to market risks primarily from changes in interest rates and currency exchange rates. To manage our exposure to these changes, we routinely enter into various transactions that have been authorized according to documented policies and procedures. We do not use derivatives for trading or speculative purposes or to generate income, and we do not use leveraged derivatives. We implement interest rate management initiatives to seek to minimize our interest expense and optimize our portfolio of fixed and variable interest rate obligations. Our exposure to changes in interest rates results primarily from floating rate long-term debt (or derivatives that effectively convert fixed rate debt to variable rate debt) tied to LIBOR or euro LIBOR. We enter into agreements with financial institutions, which are intended to limit, or cap, our exposure to the incurrence of additional interest expense with respect to a portion of such debt (or derivatives) due to increases in variable interest rates. At June 30, 2002, we had entered into two ten-year interest rate swap for a total notional amount of $250 million to effectively convert that amount of fixed rate debt to variable rate debt. These interest rate swaps are fair value swaps and are accounted for based on the short-cut method. Fees related to these agreements or swaps are charged to interest expense over the term of relevant agreement or swap. We have intercompany loans between GrafTech Finance and some of our subsidiaries. Some of these loans are denominated in currencies other than the dollar and, accordingly, are subject to translation gains and losses due to changes in currency exchange rates. Some of these intercompany loans are deemed to be essentially permanent and, as a result, translation gains and losses on these loans are reflected in accumulated other comprehensive income (loss) on the Consolidated Balance Sheets. The remaining intercompany loans are expected to be repaid in 74 PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES the foreseeable future and, as a result, translation gains and losses are reflected in other (income) expense, net on the Consolidated Statement of Operations. In addition to these intercompany loans, our exposure to changes in currency exchange rates results primarily from: o investments in our foreign subsidiaries and in our share of the earnings of those subsidiaries, which are denominated in local currencies; o raw material purchases made by our foreign subsidiaries in a currency other than their local currencies; and o export sales made by our subsidiaries in a currency other than their local currencies. When we deem it appropriate, we may attempt to limit our risks associated with changes in currency exchange rates through both operational and financial market activities. Financial instruments are used to attempt to hedge existing exposures, firm commitments and, potentially, anticipated transactions. We use forward, option and swap contracts to reduce risk by essentially creating offsetting currency exposures. We held contracts for the purpose of hedging against these risks with an aggregate notional amount of about $37 million at December 31, 2001 and $24 million at June 30, 2002. All of our contracts mature within one year. All of our contracts are marked-to-market monthly and, accordingly, transaction gains and losses are reflected in other (income) expenses, net in the Consolidated Statements of Operations. Unrealized gains and losses on our outstanding contracts were nil at December 31, 2001 and a $7 million loss at June 30, 2002. 75 PART II (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES ITEM 1. LEGAL PROCEEDINGS ANTITRUST INVESTIGATIONS In April 1998, pursuant to a plea agreement between the Antitrust Division of 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, payable in six annual installments of $20 million, $15 million, $15 million, $18 million, $21 million and $21 million, commencing July 23, 1998. The payments due in 1998, 1999 and 2000 were timely made. 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. In January 2001, at our request, the due date of each of the remaining three payments was deferred by one year and, 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 (which was paid), 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. In January 2002, the statutory rate of interest was 2.13% 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 March 1999, pursuant to a plea agreement between our Canadian subsidiary and the Canadian Competition Bureau, our Canadian subsidiary pled guilty to a one count charge of violating Canadian antitrust law in connection with the sale of graphite electrodes and was sentenced to pay a fine of Cdn. $11 million. The relevant Canadian court approved the plea agreement and, as a result, under the plea agreement we will not be subject to prosecution by the Canadian Competition Bureau with respect to any other violations of Canadian antitrust law occurring prior to the date of the plea agreement. The fine was 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, after holding a hearing on this matter, assessed a fine against us in the amount of 676 million KRW (approximately $560,000, based on currency exchange rates in effect on June 30, 2002). Five other graphite electrode producers were also fined by the Korean antitrust authority in amounts ranging up to 4,396 million KRW (approximately $3.6 million, based on currency exchange rates in effect on June 30, 2002). 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 76 PART II (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES decision. In July 2002, the Korean antitrust authority affirmed its decision on appeal. We paid the fine, together with accrued interest, in August 2002. In January 2000, the Directorate General-Competition of the Commission of the European Communities, the antitrust enforcement authority of the European Union (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. On July 18, 2001, the EU Competition Authority issued its decision regarding the allegations. Under the decision, the EU Competition Authority assessed a fine of (euro)50.4 million (about $50 million, based on exchange rates in effect at June 30, 2002) against us. Seven other graphite electrode producers were also fined under the decision, with fines ranging up to (euro)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 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 challenging the amount of the fine. Appeals of this type may take two years or longer to be decided and the fine or collateral security therefor would typically be required to be paid or provided at about the time the appeal was filed. We are currently in discussions with the EU Competition Authority regarding the appropriate form of collateral security during the pendency of the appeal. If the results of these discussions are not acceptable to us, we may file 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 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. In May 2002, the antitrust authority of the European Union 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. As a result of our substantial cooperation to date and our intention to continue to cooperate, under the Notice of Non-Imposition or Reduction of Fines in Cartel Cases issued by the antitrust authority of the European Union, we believe that we will benefit from the maximum reduction possible (a 100% reduction) with the result that no fine will be payable. 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 and the Canadian Competition Bureau in their continuing investigations of others. In 77 PART II (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 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. The guilty pleas and decisions described above 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, 2002, 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 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 settlements in connection with the sale of graphite electrodes. One of the settlements 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 settlement payments due thereunder have been timely made. 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 collectively 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 were 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 78 PART II (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES granted with respect to substantially all of the plaintiffs' claims. Appeals have been filed by the plaintiffs and the defendants with the Third Circuit Court of Appeals with regard to these dismissals. The third complaint was dismissed without prejudice to refile pending the resolution of such appeals. We have 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, filed in the U.S. Bankruptcy Court for the Northern District of Ohio, is entitled 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. We filed motions to dismiss the second and third complaints. In May 2001, our motion to dismiss the second complaint was denied. In October 2001, we settled the lawsuit commenced by the third complaint. The guilty pleas and decisions described above do not relate to carbon electrodes. In March 2002, we received notice that a complaint had been filed 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. Our subsidiary, Carbone Savoie, is named as a defendant in the complaint, but has not been served with the complaint. Other producers of carbon cathodes are also named as defendants in the complaint. In the complaint, the plaintiffs allege that the defendants violated U.S. federal antitrust law in connection with the sale of carbon cathodes and seek, among other things, an award of treble damages resulting from such alleged violations. We intend to vigorously defend against such lawsuit. The guilty pleas and decisions described above do not relate to carbon cathodes. The foreign customer lawsuits, two of the three carbon electrode lawsuits and the carbon cathode lawsuit 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. 1997 AND 2001 SECOND QUARTER ANTITRUST EARNINGS CHARGES We recorded a pre-tax charge of $340 million against results of operations for 1997 and, as a result of the assessment of a fine by the EU Competition Authority, we recorded a pre-tax 79 PART II (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES charge of an additional $10 million against results of operations for the 2001 second quarter, as a reserve for potential liabilities and expenses in connection with antitrust investigations and related lawsuits and claims. The aggregate 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 payment thereof could be sooner than anticipated. In the aggregate (including the assessment of the fine by the EU Competition Authority and the additional $10 million charge), 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, 2002, $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, 2002, we have paid an aggregate of $249 million of fines and net settlement and expense payments and $14 million of imputed interest. At June 30, 2002, $101 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, 2002 was about $9 million. 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 and Union Carbide. 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 80 PART II (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 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. 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. We are vigorously opposing those motions. Oral hearings were held on those motions in the 2001 first and second quarters. We expect that a decision on those motions will be rendered by the end of September 2002. 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, 2002, we had incurred about $4 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. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On March 1, 2002, GTI's Board of Directors granted 412,300 shares of restricted stock to more than 175 management employees, including executive officers, pursuant to various employee incentive compensation plans. The issuance of the shares granted was registered pursuant to various registration statements previously filed under the Securities Act of 1933. On June 28, 2002, GTI's Board of Directors accelerated the vesting of all of those shares of restricted stock. Those shares may be freely resold at any time and from time to time by employees. In the case of employees who are deemed to be affiliates of the Company (i.e., executive officers), any such resale may be made pursuant to a registration statement previously filed under the Securities Act of 1933. It is expected that approximately 123,690 of the shares will be resold to cover income and other taxes associated with the restricted stock and required to be withheld from or otherwise paid by the employee. 81 PART II (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 7, 2002, GTI held its annual meeting of stockholders in Wilmington, Delaware. The stockholders elected directors, and the shares present at the meeting were voted for or withheld from each nominee, as follows: NUMBER OF PERCENTAGE NUMBER OF SHARES OF VOTES SHARES NAME OF DIRECTOR CAST FOR CAST FOR WITHHELD ---------------- -------- -------- -------- R. Eugene Cartledge 49,355,602 98.52 739,334 Mary B. Cranston 49,026,132 97.87 1,068,804 John R. Hall 49,351,173 98.52 743,763 Thomas Marshall 48,913,511 97.64 1,181,425 Ferrell P. McClean 49,491,618 98.80 603,318 Michael C. Nahl 48,922,178 97.66 1,172,758 Gilbert E. Playford 49,366,600 98.55 728,336 The stockholders voted on a proposal to change the name of our public parent company from UCAR International Inc. to GrafTech International Ltd. The proposal was approved and the name change became effective May 7, 2002. The shares present at the meeting were voted on the proposal as follows: NUMBER OF PERCENTAGE OF NUMBER OF SHARES NUMBER OF SHARES CAST FOR SHARES CAST FOR CAST AGAINST SHARES ABSTAINING --------------- --------------- ------------ ----------------- 49,965,954 99.74 104,916 24,066 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS The exhibits listed in the following table have been filed as part of this Quarterly Report on Form 10-Q. EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------ ---------------------- 4.5 Amendment No. 2 to Rights Agreement among GrafTech International Ltd. and ComputerShare Investor Services LLC dated as of May 21, 2002. 10.30 Letter amending Employment and Restricted Stock Agreements between GrafTech International Ltd. and Gilbert E. Playford dated as of July 22, 2002. 82 PART II (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES (B) REPORTS ON FORM 8-K The following Reports on Form 8-K were filed during the quarter ended June 30, 2002: (i) Report on Form 8-K dated April 23, 2002 as filed by UCAR International Inc., filing a press release dated April 23, 2002 announcing the launching of a solicitation for consents of holders of its outstanding senior notes to permit the issuance of up to an additional $150 million of senior notes. No financial statements were filed. (ii) Report on Form 8-K dated May 1, 2002 as filed by UCAR International Inc., filing a press release dated May 1, 2002 announcing preliminary 2002 first quarter results. No financial statements were filed. (iii) Report on Form 8-K dated May 1, 2002 as filed by UCAR International Inc., filing a press release dated May 1, 2002 announcing the private offering of additional senior notes of UCAR Finance Inc. No financial statements were filed. (iv) Report on Form 8-K dated May 2, 2002 as filed by UCAR International Inc., filing a press release dated May 1, 2002 announcing the pricing of the private offering of $150 million aggregate principal amount of additional senior notes of UCAR Finance Inc. No financial statements were filed. (v) Report on Form 8-K dated May 7, 2002 as filed by UCAR International Inc., filing a press release dated May 6, 2002 announcing the closing of the private offering of $150 million aggregate principal amount of additional senior notes of UCAR Finance Inc. No financial statements were filed. (vi) Report on Form 8-K dated May 7, 2002 as filed by GrafTech International Ltd., filing a press release dated May 7, 2002 announcing the change of UCAR International Inc.'s corporate name to GrafTech International Ltd. No financial statements were filed. (vii) Report on Form 8-K dated May 9, 2002 as filed by GrafTech International Ltd., filing a press release dated May 8, 2002 announcing 2002 first quarter results. Summary financial information for the quarter ended March 31, 2002 was filed. (viii) Report on Form 8-K dated May 24, 2002 as filed by GrafTech International Ltd., filing a press release dated May 23, 2002 announcing key commercial approvals of its eGraf(TM) thermal interface products. No financial statements were filed. 83 PART II (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. GRAFTECH INTERNATIONAL LTD. Date: August 13, 2002 By: /S/ CORRADO F. DE GASPERIS -------------------------------------------- Corrado F. De Gasperis VICE PRESIDENT, CHIEF FINANCIAL OFFICER AND CHIEF INFORMATION OFFICER (PRINCIPAL ACCOUNTING OFFICER) 84 PART II (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES INDEX TO EXHIBITS EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------ ---------------------- 4.5 Amendment No. 2 to Rights Agreement among GrafTech International Ltd. and ComputerShare Investor Services LLC dated as of May 21, 2002. 10.30 Letter amending Employment and Restricted Stock Agreements between GrafTech International Ltd. and Gilbert E. Playford dated as of July 22, 2002. 85