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EX-32 - EXHIBIT 32.2 - ZOLTEK COMPANIES INCex32-2.htm
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EX-31 - EXHIBIT 31.2 - ZOLTEK COMPANIES INCex31-2.htm
EX-31 - EXHIBIT 31.1 - ZOLTEK COMPANIES INCex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

Washington, DC 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 three months ended December 31, 2013

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 No. 0-20600

 

 

 

ZOLTEK COMPANIES, INC.

(Exact name of registrant as specified in its charter)

 

Missouri 

 

 43-1311101

 (State or other jurisdiction of   

  incorporation or organization)

 

 (I.R.S. Employer

 Identification No.)

 

 

 

 3101 McKelvey Road, St. Louis, Missouri

 

 63044

 (Address of principal executive offices)

 

 (Zip Code)

 

Registrant's telephone number, including area code: (314) 291-5110

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x   No __ 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x   No __ 

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one).

Large Accelerated Filer ____ Accelerated Filer X      Non-accelerated Filer ____ Smaller Reporting Company ____

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes __ No x     

 

Indicate the number of shares outstanding of each of the registrant's classes of common stock as of the latest practicable date: As of February 7, 2014, 34,396,422 shares of Common Stock, $.01 par value, were outstanding.

 

 
1

 

  

ZOLTEK COMPANIES, INC.

INDEX 

 

PART I.       FINANCIAL INFORMATION

Item 1. 

Financial Statements (Unaudited)

 

Condensed Consolidated Balance Sheets – December 31, 2013 and September 30, 2013

 

Condensed Consolidated Statements of Operations – Three Months Ended December 31, 2013 and 2012

 

Condensed Consolidated Statements of Comprehensive Income – Three Months Ended December 31, 2013 and 2012

 

Condensed Consolidated Statement of Changes in Shareholders’ Equity – Three Months Ended December 31, 2013

 

Condensed Consolidated Statements of Cash Flows –Three Months Ended December 31, 2013 and 2012

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 Item 2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

 Item 4.   

Controls and Procedures

 PART II.      OTHER INFORMATION 

 Item 1.

Legal Proceedings

 Item 6.

Exhibits

SIGNATURES  

EXHIBIT INDEX

 

 
2

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

ZOLTEK COMPANIES, INC.

CONSOLIDATED BALANCE SHEET

(Amounts in thousands, except share data)

 

   

(Unaudited)

December 31,

2013

   

September 30,

2013

 

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 42,401     $ 32,291  

Accounts receivable, less allowance for doubtful accounts of $182 and $177

    26,164       31,722  

Inventories, net

    71,005       71,945  

VAT receivable

    4,075       3,527  

Other current assets

    3,284       3,336  

Total current assets

    146,929       142,821  

Property and equipment, gross

    378,588       371,988  

Less: accumulated depreciation

    (169,861 )     (162,367 )

Property and equipment, net

    208,727       209,621  

Other assets

    395       423  

Total assets

  $ 356,051     $ 352,865  
                 

Liabilities and shareholders' equity

               

Current liabilities:

               

Current maturities of long-term debt

  $ 4,416     $ 4,330  

Trade accounts payable

    9,054       6,270  

Accrued expenses and other liabilities

    8,057       8,133  

Construction payables

    847       850  

Total current liabilities

    22,374       19,583  

Long-term debt

    17,597       19,380  

Hungarian grant liability

    6,071       6,083  

Other long-term liabilities

    -       481  

Liabilities carried at fair value

    62       122  

Total liabilities

    46,104       45,649  

Commitments and contingencies (See Note 7)

               

Shareholders' equity:

               

Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued and outstanding

    -       -  

Common stock, $.01 par value, 50,000,000 shares authorized, 34,396,422 and 34,390,922 shares issued and outstanding at December 31, 2013 and September 30, 2013

    344       344  

Additional paid-in capital

    482,476       482,425  

Accumulated other comprehensive loss

    (40,556 )     (45,500 )

Accumulated deficit

    (132,317 )     (130,053 )

Total shareholders' equity

    309,947       307,216  

Total liabilities and shareholders' equity

  $ 356,051     $ 352,865  

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 
3

 

 

ZOLTEK COMPANIES, INC.

CONSOLIDATED STATEMENT OF OPERATIONS

(Amounts in thousands, except share and per share data)

(Unaudited)

 

   

Three months ended December 31,

 
   

2013

   

2012

 
                 

Net sales

  $ 35,123     $ 35,877  

Cost of sales

    29,842       26,800  

Gross profit

    5,281       9,077  

Application and development costs

    2,203       2,067  

Selling, general and administrative expenses

    3,483       3,361  

Operating (loss) income

    (405 )     3,649  

Other (expense) income:

               

Interest expense, net

    (191 )     (117 )

Loss on foreign currency transactions

    (1,331 )     (50 )

Other (expense) income, net

    (486 )     80  

(Loss) income from operations before income taxes

    (2,413 )     3,562  

Income tax (benefit) expense

    (149 )     585  
                 

Net (loss) income

  $ (2,264 )   $ 2,977  
                 

Basic (loss) income per share

  $ (0.07 )   $ 0.09  

Diluted (loss) income per share

  $ (0.07 )   $ 0.09  
                 

Weighted average common shares outstanding – basic

    34,393,971       34,355,152  

Weighted average common shares outstanding – diluted

    34,393,971       34,412,453  

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 
4

 

 

ZOLTEK COMPANIES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Amounts in thousands)

(Unaudited)

 

   

Three months ended December 31,

 
   

2013

   

2012

 

Net (loss) income

  $ (2,264 )   $ 2,977  

Foreign currency translation adjustment

    4,884       1,012  

Change in unrealized fair value of cash flow hedge, net of tax of $0

    60       26  
                 

Comprehensive income

  $ 2,680     $ 4,015  

  

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 
5

 

 

ZOLTEK COMPANIES, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Amounts in thousands)

(Unaudited)

 

   

Total

Shareholders’ Equity

   

Common

Stock

   

Additional

Paid-In

Capital

   

Accumulated

Other Comprehensive

Loss

   

Accumulated

Deficit

 

Balance, September 30, 2013

  $ 307,216     $ 344     $ 482,425     $ (45,500 )   $ (130,053 )
                                         

Comprehensive income (loss)

    2,680                       4,944       (2,264 )

Stock option expense

    19               19                  

Exercise of stock options

    32               32                  
                                         

Balance, December 31, 2013

  $ 309,947     $ 344     $ 482,476     $ (40,556 )   $ (132,317 )

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 
6

 

 

ZOLTEK COMPANIES, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

 

   

Three months ended December 31,

 
   

2013

   

2012

 

Cash flows from operating activities:

               

Net (loss) income

  $ (2,264 )   $ 2,977  

Adjustments to reconcile net (loss) income to net cash from operating activities:

               

Depreciation

    5,025       4,658  

Amortization of financing fees and debt discount

    24       15  

Reversal of uncertain tax positions

    (481 )     -  

Foreign currency transaction loss

    827       88  

Stock compensation expense

    19       240  

Changes in assets and liabilities:

               

Decrease in accounts receivable

    6,047       6,611  

Decrease (increase) in inventories

    2,064       (11,777 )

Increase in other current assets and other assets

    (381 )     (4,660 )

Increase (decrease) in trade accounts payable

    2,604       (1,318 )

Decrease in accrued expenses and other liabilities

    (262 )     (1,072 )

Net cash provided (used) by operations

    13,222       (4,238 )
                 

Cash flows from investing activities:

               

Purchases of property and equipment

    (1,960 )     (2,907 )

Decrease in construction payables

    (3 )     (756 )

Net cash used in investing activities

    (1,963 )     (3,663 )
                 

Cash flows from financing activities:

               

Payment of financing fees

    -       (65 )

Proceeds from exercise of stock options

    32       -  

Repayment of notes payable

    (2,082 )     (1,498 )

Net cash used in financing activities

    (2,050 )     (1,563 )
                 

Effect of exchange rate changes on cash and cash equivalents

    901       10  

Net increase (decrease) in cash and cash equivalents

    10,110       (9,454 )

Cash and cash equivalents at beginning of period

    32,291       29,935  

Cash and cash equivalents at end of period

  $ 42,401     $ 20,481  

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 
7

 

 

ZOLTEK COMPANIES, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1. GENERAL

 

MERGER AGREEMENT WITH TORAY INDUSTRIES, INC.

 

Merger Agreement and Plan

 

On September 27, 2013, Zoltek entered into an Agreement and Plan of Merger (the “merger agreement”), by and among Zoltek, Toray Industries, Inc. (“Toray”) and TZ Acquisition Corp. (“Merger Sub”). Under the terms and subject to the conditions in the merger agreement, Merger Sub, a wholly-owned subsidiary of Toray, will merge with and into Zoltek (the “merger”), with Zoltek continuing as the surviving corporation in the merger as a wholly-owned subsidiary of Toray. Following completion of the merger, Zoltek will be delisted from The Nasdaq Stock Global Select Market (with there no longer being a public market for Zoltek’s common stock), and Zoltek’s common stock will be deregistered under the Securities Exchange Act of 1934, as amended. 

  

At the effective time of the merger (the “effective time”), pursuant to the merger agreement, each issued and outstanding share of Zoltek’s common stock (other than any shares (1) owned by Toray, Merger Sub, Zoltek or any of their subsidiaries, and (2) owned by shareholders who are entitled to, and who have properly exercised, appraisal rights in accordance with applicable Missouri law) will be converted automatically into the right to receive $16.75 per share in cash, without interest (the “merger consideration”). At the effective time, each stock option outstanding under the Company’s equity plans, whether vested or unvested, will also be converted into the right to receive the merger consideration with respect to each share subject to the award, less the applicable exercise price per share. No shareholders have exercised appraisal rights in connection with the merger.

 

The merger agreement includes customary representations, warranties and covenants of the parties. Each party’s obligation to consummate the merger is subject to customary conditions, including, but not limited to: (1) approval of the merger agreement by the holders of at least two-thirds of the outstanding shares of Zoltek’s common stock entitled to vote thereon , (2) the expiration or early termination of the waiting period applicable to the Merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”), (3) written confirmation from the Committee on Foreign Investment in the United States (“CFIUS”) that review of the Merger under the Foreign Investment and National Security Act of 2007 has been completed and that there are no unresolved national security concerns with respect to the merger, and (4) the absence of any order enjoining or prohibiting the merger. Additionally, each party’s obligation to consummate the merger is subject to certain other conditions, including, but not limited to: (a) the accuracy of the other party’s representations and warranties contained in the merger agreement (subject to certain materiality qualifiers), and (b) the other party’s compliance with its obligations under the merger agreement in all material respects. The waiting period under the HSR Act was terminated effective November 8, 2013. As previously disclosed, Zoltek has received a notice from CFIUS that it would undertake an investigation of the Merger. CFIUS has advised the parties that its investigation is to be completed no later than March 3, 2014. Zoltek anticipates that the merger will close as soon after completion of the CFIUS review as possible. The merger agreement does not contain a financing contingency.

 

On January 23, 2014, at a special meeting of the shareholders of the Company, the Company’s shareholders approved the merger agreement and the transactions contemplated thereby. The Company’s shareholders also voted to approve (1) any proposal to adjourn the special meeting to a later date or dates if necessary to solicit additional proxies if there were insufficient votes to approve and adopt the merger agreement and (2) by non-binding, advisory vote, certain compensation arrangements for the Company’s named executive officers in connection with the merger. The proposals are described in detail in the Definitive Proxy Statement on Schedule 14A filed with the Securities and Exchange Commission by the Company on December 11, 2013.

 

ORGANIZATION AND BASIS OF PRESENTATION

 

Zoltek Companies, Inc. is a holding company, which operates through wholly-owned subsidiaries Zoltek Corporation, Zoltek Zrt., Zoltek de Mexico SA de CV, Zoltek de Occidente SA de CV, Engineering Technology Corporation (“Entec Composite Machines”), Zoltek Properties, Inc., and Zoltek Automotive, LLC. Zoltek Corporation develops, manufactures and markets carbon fibers and related products, including carbon fibers preimpregnated with resin known as “prepreg,” and technical fibers in the United States. Carbon fibers are a low-cost but high performance reinforcement for composites used as the primary building material in everyday commercial products. Technical fibers are an intermediate product used in heat-resistant applications such as aircraft brakes. Zoltek Zrt. is a Hungarian subsidiary that manufactures and markets carbon fibers and technical fibers and manufactures acrylic fiber precursor raw material used in production of carbon fibers and technical fibers. Zoltek de Mexico SA de CV and Zoltek de Occidente SA de CV are Mexican subsidiaries that manufacture carbon fibers and precursor raw material. Entec Composite Machines manufactures and markets filament winding and pultrusion equipment used in the production of large volume composite parts. The Company’s primary sales markets are in Europe and the United States; however, the Company has an increasing presence in Asia. Unless the context otherwise indicates, references to the “Company” or “Zoltek” are to Zoltek Companies, Inc. and its subsidiaries.

 

Certain amounts have been reclassified to conform to the current year or quarter presentation.

 

 
8

 

 

Basis of Presentation

 

The accompanying condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and the rules and regulations of the SEC. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2013, which includes consolidated financial statements and notes thereto. In the opinion of management, all normal recurring adjustments and estimates considered necessary for a fair presentation have been included. The results of operations of any interim period are not necessarily indicative of the results that may be expected for a full fiscal year.

 

The unaudited interim condensed consolidated financial statements include the accounts and transactions of the Company and its wholly-owned subsidiaries. Adjustments resulting from the currency translation of financial statements of the Company’s foreign subsidiaries are reflected as “Accumulated other comprehensive loss” within shareholders’ equity. Gains and losses from foreign currency transactions are included in the condensed consolidated statements of operations as “Other income (expense).” All significant inter-company transactions and balances have been eliminated in consolidation.

 

Adoption of New Accounting Standards

 

In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. Under this standard, entities are required to disclose additional information with respect to changes in accumulated other comprehensive income (“AOCI”) balances by component and significant items reclassified out of AOCI. Expanded disclosures for presentation of changes in AOCI involve disaggregating the total change of each component of other comprehensive income (loss) as well as presenting separately for each such component the portion of change in AOCI related to (1) amounts reclassified into income and (2) current-period other comprehensive income. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012 (the Company’s fiscal year ended September 30, 2013), with early adoption permitted. We did not include the required expanded disclosures for presentation of changes in AOCI as there were no material amounts classified out of other comprehensive income into income for the periods shown.

 

In July 2013, the FASB issued ASU No. 2013-10, Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes. The amendments in this update permit the Fed Funds Effective Swap Rate (OIS) to be used as a U.S. benchmark interest rate for hedge accounting purposes in addition to U.S. Treasury (“UST”) and London Interbank Offered Rate (“LIBOR”). The amendments also remove the restriction on using different benchmark rates for similar hedges. The amendments are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The Company has not entered into any new hedging relationships since July 17, 2013.

 

In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This new standard requires the netting of unrecognized tax benefits against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. Under the new standard, unrecognized tax benefits will be netted against all available same-jurisdiction loss or other tax carryforwards that would be utilized, rather than only against carryforwards that are created by the unrecognized tax benefits. The Company does not expect that the new standard will have a material impact on the Company’s consolidated financial statements.

 

 
9

 

 

2.      INVENTORIES


Inventories, net of reserves, consist of the following (in thousands):     

 

   

December 31,

2013

   

September 30,

2013

 

Raw materials

  $ 8,400     $ 5,414  

Work-in-process

    12,685       13,135  

Finished goods

    45,983       49,430  

Consigned inventory

    3,649       3,227  

Supplies and other

    288       739  
    $ 71,005     $ 71,945  

 

Inventories are valued at the lower of cost or market and are removed from inventory under the first-in-first-out method (“FIFO”). Cost of inventory includes material, labor and overhead. The Company recorded inventory valuation reserves of $0.8 million as of both December 31, 2013 and September 30, 2013 to reduce the carrying value of inventories to net realizable value.

 

Consigned inventory represents contractually required finished goods inventory levels for certain key customers physically located at customer sites. If future demand or market conditions are less favorable than the Company’s projections, additional inventory write-downs may be required and would be reflected in cost of sales on the Company’s statement of operations in the period in which the determination is made.

 

3.      SEGMENT INFORMATION     


The Company’s strategic business units are based on product lines and compromise three reportable segments: carbon fibers, technical fibers and corporate/other products. The carbon fibers segment manufactures commercial carbon fibers used as reinforcement material in composites and related products, including prepregs and equipment used to manufacture composite products. The technical fibers segment manufactures oxidized acrylic fibers and specialty carbon fibers used to manufacture aircraft brake pads and for heat/fire barrier applications. These two segments also facilitate development of product and process applications to increase the demand for carbon fibers and technical fibers. The carbon fibers and technical fibers segments’ production facilities are located geographically in the United States, Hungary and Mexico. The remaining business represented in the corporate/other products segment relates to water treatment and electrical services provided by the Hungarian operations and costs associated with the corporate headquarters. Management evaluates the performance of its segments on the basis of operating income (loss) contribution. The following tables present financial information on the Company’s segments as of December 31, 2013 and September 30, 2013, and for the three months ended December 31, 2013 and 2012 (in thousands):

 

   

Three months ended December 31, 2013

 
   

Carbon

Fibers

   

Technical

Fibers

   

Corporate/

Other

   

Total

 

Net sales

  $ 26,763     $ 7,995     $ 365     $ 35,123  

Cost of sales

    23,555       5,949       338       29,842  

Gross profit

    3,208       2,046       27       5,281  

Operating income (loss)

    1,600       1,955       (3,960 )     (405 )

Depreciation

    4,162       502       361       5,025  

Capital expenditures

    914       125       921       1,960  

 

 
10

 

 

   

Three months ended December 31, 2012

 
   

Carbon

Fibers

   

Technical

Fibers

   

Corporate/

Other

   

Total

 

Net sales

  $ 28,715     $ 6,590     $ 572     $ 35,877  

Cost of sales

    22,178       4,139       483       26,800  

Gross profit

    6,537       2,451       89       9,077  

Operating income (loss)

    4,571       2,346       (3,268 )     3,649  

Depreciation

    4,167       370       121       4,658  

Capital expenditures

    851       1,769       287       2,907  

 

   

Total Assets

 
   

Carbon

Fibers

   

Technical

Fibers

   

Corporate/

Other

   

Total

 

December 31, 2013

  $ 252,579     $ 45,597     $ 57,875     $ 356,051  

September 30, 2013

  $ 288,544     $ 44,946     $ 19,375     $ 352,865  

 

4. EARNINGS PER SHARE


In accordance with Accounting Standards Codification (“ASC”) 260, the Company has evaluated its diluted income per share calculation. The Company had outstanding stock compensation at December 31, 2013 and outstanding warrants and stock compensation at December 31, 2012 which were not included in the determination of diluted income per share because these shares were anti-dilutive.

 

The following is the diluted impact of the stock options on net income (loss) per share for the three months ended December 31, 2013 and 2012, respectively, (in thousands, except per share amounts):

 

   

Three months ended December 31,

 
   

2013

   

2012

 

Numerators:

               

Net (loss) income

  $ (2,264 )   $ 2,977  
                 

Denominators:

               

Average shares outstanding – basic

    34,394       34,355  

Impact of stock options

    -       57  

Average shares outstanding – diluted

    34,394       34,412  
                 

Basic (loss) income per share

  $ (0.07 )   $ 0.09  

Diluted (loss) income per share

  $ (0.07 )   $ 0.09  

 

 
11

 

 

5.     FINANCING TRANSACTIONS


Hungarian Grant

 

The Hungarian government has pledged a grant of 2.9 billion HUF to Zoltek’s Hungarian subsidiary, which translated at the December 31, 2013 exchange rate, is approximately $13.5 million. The grant is intended to provide a portion of the capital resources to modernize the subsidiary’s facility, establish a research and development center, and support buildup of manufacturing capacity of carbon fibers. As of December 31, 2013, Zoltek’s Hungarian subsidiary has received approximately 2.6 billion HUF ($12.1 million) in grant funding. These funds have been recorded as a liability on the Company’s consolidated balance sheet. The liability is being amortized over the life of the assets procured by the grant funds, offsetting the depreciation expense from the assets into which the proceeds of the grant are invested. The Company has presented bank guarantees amounting to 120% of the amount of the grant as received.

 

The Hungarian subsidiary may be required to repay all or a portion of the grant if, among other things, the Hungarian subsidiary:  fails to obtain revenue targets; fails to employ an average annual staff of at least 1,200 employees (as of December 31, 2013 Zoltek Zrt. has fewer than 800 employees); fails to utilize regional suppliers for at least 45% of its purchases; fails to obtain consent from the Hungarian government prior to selling assets created with grant funds; fails to use grant funds in accordance with the grant agreement; fails to provide appropriate security for the grant; makes or made an untrue statement or supplies or supplied false data in the grant agreement, grant application or during the time of the grant; defaults on its obligations by more than 30 days; withdraws any consents it gave in the grant agreement; or causes a partial or complete failure or hindrance of the project that is the subject of the grant. These targets must be achieved during a five-year measurement period from October 2013 to October 2018. In November 2013, we petitioned the Hungarian government to amend the current grant requirements, specifically to lower the required employment levels and separate each year into its own measurement period rather than a single five-year measurement period. The Hungarian government has verbally advised us that it agrees in principle with the amendment to the terms proposed in our petition. Accordingly and subject to receipt of negotiation and execution of appropriate documentation, we expect that Zoltek Zrt. will comply with the requirements of the grant agreement, as amended, during the measurement period. If Zoltek Zrt. is unable to comply with the grant agreement or if the amendment is not finalized, it would be required to pay back all or a portion of the grant funds, possibly with interest, which as of December 31, 2013 could total up to $17.1 million.

 

Financing Activity

 

Hungarian Financing

 

On June 15, 2012, Zoltek Zrt. completed an amended credit facility with Raiffeisen Bank Zrt. (the “Lender”) pursuant to which Zoltek Zrt. and the Lender entered into a Credit Facility Agreement, dated as of June 1, 2012, and a Restated and Amended Uncommitted Credit Line Agreement, dated as of June 1, 2012. Under the credit facility, the Lender agreed to provide Zoltek Zrt.: (1) a term facility in the maximum amount of 13.6 million EUR ($18.7 million at the December 31, 2013 exchange rate) (the “Term Facility”); and (2) a multicurrency revolving credit facility in the amount of up to 1.12 billion HUF ($5.2 million at the December 31, 2013 exchange rate) (the “Revolving Facility”).

 

The Term Facility is a five-year term loan and bears interest at 4.17% per annum. Principal under the Term Facility is payable semi-annually in equal installments. The Revolving Facility is a revolving credit facility that expires on May 30, 2014 and has a total commitment of 1.12 billion HUF subject to a borrowing base. In addition to the Term Facility and the Revolving Facility, Zoltek Zrt. has obtained from the Lender a bank guaranty in the amount of HUF 3.48 billion ($16.2 million at the December 31, 2013 exchange rate) as required by the Hungarian government grant. The obligations of Zoltek Zrt. under this credit facility are guaranteed by the Company.

 

This credit facility contains representations and warranties, and a requirement that Zoltek Zrt. maintain a minimum current asset ratio and minimum annual EBITDA, in addition to other covenants. Zoltek Zrt. was in compliance with all covenants as of December 31, 2013. Zoltek Zrt. had previously maintained a credit facility with the Lender, which expired May 30, 2012 and the facility was replaced with the new facility. As of December 31, 2013, the Company had borrowed $13.1 million under this new credit facility.

 

U.S. Financing

 

On March 30, 2012, Zoltek Companies, Inc. entered into a $10 million term loan with Enterprise Bank & Trust (the “Enterprise Loan”) secured by the real property associated with its facilities in the St. Louis, Missouri area. The Enterprise Loan is a seven-year term loan maturing March 30, 2019. Principal of the Enterprise Loan is payable monthly with a balloon payment due at maturity. The Enterprise Loan bears interest at an annual rate equal to one-month LIBOR plus 3%. The Company contemporaneously entered into a swap agreement that fixes the interest rate on the Enterprise Loan at 4.75% per annum. The loan agreement contains representations and warranties, and a requirement that the Company, on a consolidated basis, maintain minimum fixed charge coverage and leverage ratios, in addition to other covenants. The Company was in compliance with all covenants as of December 31, 2013. As of December 31, 2013, the principal balance of this term loan was $8.9 million.

 

The Company primarily utilized the proceeds of the Enterprise Loan to repay all outstanding balances under the Company's former revolving credit facility with its former U.S. bank; the refinanced borrowings had been incurred in connection with the purchase of our St. Peters, Missouri plant.

 

On April 27, 2012, the Company entered into a $15 million revolving credit agreement with JPMorgan Chase, N.A., with annual interest based on LIBOR plus 2.5%, adjusted monthly. The revolving credit facility is subject to a borrowing base and financial covenants and expires on April 27, 2015. The Company was in compliance with all covenants as of December 31, 2013. As of December 31, 2013, the Company had no borrowings under this revolving credit agreement.

 

 
12

 

 

The Company had no borrowings under credit lines as of both December 31, 2013 and September 30, 2013. The Company’s long-term debt consists of the following (amounts in thousands):

 

   

December 31,

2013

   

September 30,

2013

 
                 

US term loan

  $ 8,889     $ 9,055  

Hungarian term facility

    13,124       14,655  

Total long-term debt including current maturities

  $ 22,013     $ 23,710  

Less: amounts payable within one year

    (4,416 )     (4,330 )

Total long-term debt, less current maturities

  $ 17,597     $ 19,380  

 

6. STOCK COMPENSATION EXPENSE


The Company maintains long-term incentive plans that authorize the Board of Directors or its Compensation Committee (the “Committee”) to grant key employees, officers and directors of the Company incentive or nonqualified stock options, stock appreciation rights, performance shares, restricted shares and performance units. The Committee determines the prices and terms at which awards may be granted along with the duration of the restriction periods and performance targets. All issuances are granted out of shares authorized, as the Company has no treasury stock.

 

Stock option awards

 

During fiscal 2012 the Company awarded performance-based stock options with separate performance conditions in fiscal year 2012, 2013 and 2014, to named executive officers and other key employees. The Company recognizes compensation expense related to each separate service period during the respective period. As of December 31, 2013 the maximum number of performance-based options available to vest subject to certain operating performance targets is 340,000. During fiscal 2013, the Company granted stock options to purchase a total of 30,000 shares of common stock with a vesting period of one to two years to certain key employees. Additionally during fiscal 2013, the Company granted stock options to purchase a total of 37,500 shares of common stock to our directors which vested immediately at time of grant. During fiscal 2014, the Company has not yet granted any stock options to purchase shares of common stock.

 

The following table summarizes information for options currently outstanding and exercisable at December 31, 2013:

 

           

Options Outstanding

 
 

Range of

Exercise Prices

   

Number

 

Wtd. Avg.

Remaining

Life (years)

 

Wtd. Avg.

Exercise

Price

   

Aggregate

Intrinsic

Value

 
  $5.47 - 5.72       525,203  

6

  $ 5.71     $ 5,800,489  
   7.09 - 8.60       141,338  

4

    7.92       1,248,156  
   11.94 - 15.99       90,000  

2

    13.55       288,225  
    31.07         45,000  

3

    31.07       -  
  $5.47 - 31.07       801,541               $ 7,336,870  

 

           

Options Exercisable

 
 

Range of

Exercise Prices

   

Number

 

Wtd. Avg.

Remaining

Life (years)

 

Wtd. Avg.

Exercise

Price

   

Aggregate

Intrinsic

Value

 
  $5.47 - 5.72       200,203  

5

  $ 5.68     $ 2,174,377  
   7.09 - 8.60       110,088  

3

    7.92       904,468  
   11.94 - 15.99       90,000  

2

    13.55       288,225  
    31.07         45,000  

3

    31.07       -  
  $5.47 - 31.07       445,291               $ 3,367,070  

 

 
13

 

 

The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

Assumptions

 

Fiscal 2013

   

Fiscal 2012

 

Expected life of option (years)

   3 - 5      3 - 5  

Risk-free interest rate

   0.4% - 0.9%      0.4% - 0.8%  

Volatility of stock

   59% - 75%      72% - 79%  

Forfeiture rate

   0% - 16%      0% - 16%  

 

Volatility, expected term and dividend yield assumptions were based on the Company’s historical experience. The risk-free rate was based on a U.S. treasury note with a maturity similar to the option grant’s expected term.

 

The Company recorded into selling and general administrative expense for its corporate/other products segment the cost of employee services received in exchange for equity instruments based on the grant-date fair value of those instruments in accordance with the provisions of ASC 718, which was less than $0.1 million for the three months ended December 31, 2013, and $0.2 million for the three months ended December 31, 2012. There were no recognized tax benefits during the three months ended December 31, 2013 or 2012, as any benefit is offset by the Company's full valuation allowance on its net deferred tax asset. The number of options included in the calculation of expense associated with performance-based shares is based on the Company’s assessment of the probability of achieving expected targets.

 

7. COMMITMENTS AND CONTINGENCIES


LEGAL

  

In September and October 2013, a total of 13 purported class actions arising out of the execution of the merger agreement were filed in the Circuit Court of St. Louis County, Missouri against Zoltek and Zoltek’s directors by purported shareholders of Zoltek. All but one of the lawsuits also named Toray and/or Merger Sub as defendants. The Circuit Court of St. Louis County, Missouri consolidated the actions under the caption In Re: Zoltek Companies, Inc. Shareholder Litigation, Cause No. 13-SL-CC-3419, on November 26, 2013 (the “Consolidated Action”). The Consolidated Action alleges, among other things, that (1) each of the Company’s directors breached his fiduciary duties to the Company’s shareholders in connection with approval of the transactions contemplated by the merger agreement, (2) the Company, Toray and Merger Sub aided and abetted the Company’s directors in such breaches of their fiduciary duties, and (3) the Company failed to disclose certain material information in the Definitive Proxy Statement. The Consolidated Action seeks, among other things, injunctive relief preventing the parties from completing the merger and directing the Company directors to account to the Company and the purported class for all damages suffered as a result of the breaches of fiduciary duties and awards of attorneys’ fees and expenses for the plaintiffs.

  

On January 15, 2014: (1) the parties agreed to withdraw certain pending discovery motions; (2) the lead plaintiffs agreed not to pursue injunctive or other relief to delay the Company’s Special Meeting of Shareholders or the consummation of the merger; (3) the Company agreed not to oppose a motion to be filed by the plaintiffs after the Special Meeting and consummation of the merger for leave to further amend the amended petition in the Consolidated Action; and (4) the Company agreed to furnish the lead plaintiffs copies of certain minutes of meetings of the Board of Directors, presentations made by Company management and the Company’s financial advisor, and confidentiality agreements executed by parties participating in the Company’s strategic alternatives evaluation process. These agreements were memorialized in a stipulated Order and Judgment entered by the Court on January 17, 2014.

 

The Company believes that the lawsuits are without merit and intends to defend against them vigorously. There can be no assurance, however, with regard to the outcome of this litigation.

 

Legal contingencies have a high degree of uncertainty. The Company records reserves when losses from contingencies can be reasonably estimated and become probable. The reserves would reflect management’s estimate of the probable cost of ultimate resolution of the matters and are revised accordingly as facts and circumstances change and, ultimately, when matters are brought to closure. If any litigation matter is resolved unfavorably, the Company could incur obligations in excess of management’s estimate of the outcome, and such resolution could have a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity. In addition, the Company may incur additional legal costs in connection with pursuing and defending such actions.

The Company is exposed to various claims and legal proceedings arising out of the normal course of its business. Although there can be no assurance, in the opinion of management, the ultimate outcome of such claims and lawsuits when and if they arise should not have a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity. As of December 31, 2013, Zoltek has no recorded material legal reserves.

 

 
14

 

 

CONCENTRATION OF CREDIT RISK

 

Zoltek's carbon fiber products are primarily sold to customers in the wind energy and composite industries and its technical fibers are primarily sold to customers in the aerospace industry. Entec Composite Machines’ products are primarily sold in the composite industry. The Company performs ongoing credit evaluations and generally requires collateral for significant export sales to new customers. The Company maintains reserves for potential credit losses and such losses have been within management's expectations.

 

In the three months ended December 31, 2013 and 2012, the Company reported aggregate sales of $17.2 million and $17.6 million, respectively, to Vestas Wind Systems, a leading wind turbine manufacturer.

 

ENVIRONMENTAL

 

The Company's operations generate various hazardous wastes, including gaseous, liquid and solid materials. The operations of the Company's carbon fibers and technical fibers business segments utilize thermal oxidation of various by-product streams designed to comply with applicable laws and regulations. The plants produce air emissions that are regulated and permitted by various environmental authorities. The plants are required to verify by performance tests that certain emission rates are not exceeded. The Company does not believe that compliance by its carbon fibers and technical fibers operations with applicable environmental regulations will have a material adverse effect upon the Company's future capital expenditure requirements, results of operations or competitive position. There can be no assurance, however, as to the effect of interpretation of current laws or future changes in federal, state or international environmental laws or regulations on the business segment's results of operations or financial condition.

 

SOURCES OF SUPPLY

 

As part of its growth strategy, the Company has developed and manufactures its own precursor acrylic fibers and all of its carbon fibers and technical fibers. The primary source of raw material for the precursor is ACN (acrylonitrile), which is a commodity product with multiple sources.

 

8. INCOME TAXES


The Company currently has net operating loss carryforwards available to offset future tax liabilities. The Company has recorded a full valuation allowance against its deferred tax assets in Hungary, the United States and Mexico. The valuation allowance will be retained until there is sufficient positive evidence to conclude that it is more likely than not that the tax benefits associated with the deferred tax asset, or some portion of them, will be realized. In the consolidated balance sheet, the Company classifies its deferred tax assets and liabilities as either current or non-current, according to the expected reversal date of the temporary differences as of the reporting date.

 

As of December 31, 2013, we have released uncertain tax positions due to the expiration of the statute of limitations, which recorded a tax benefit of $0.5 million. The Company tracks uncertain tax positions under the guidance of ASC 740-10. Income tax benefit was $0.1 million for the three months ended December 31, 2013, compared to an expense of $0.6 million for the three months ended December 31, 2012. During the first three months of fiscal 2014, the Company recognized expense of $0.3 million related to the local Hungarian municipality tax, and $0.1 million was recorded related to U.S. and Mexico minimum tax payments.  Our utilization of tax loss carryforwards for federal tax in Hungary is limited to only 50% of taxable income in fiscal 2014 and beyond. During the first three months of fiscal 2013, an expense of $0.2 million was incurred related to the local Hungarian municipality tax and less than $0.1 million was recorded related to U.S. and Mexico minimum tax payments.

 

9. FAIR VALUE MEASUREMENT OF INSTRUMENTS


The Company adopted ASC 820 on October 1, 2008. ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The fair value hierarchy for disclosure of fair vale measurements under ASC 820 is as follows:

 

Level 1 – Valuations based on quoted prices for identical assets or liabilities in active markets that the Company has the ability to access.

 

Level 2 – Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

 

Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

 

 
15

 

 

Interest Rate Swap

 

On March 30, 2012, the Company entered into an interest rate swap agreement that fixes the interest rate on its term loan in order to manage the risk associated with changes in interest rates. This interest rate derivative instrument has been designated as a cash flow hedge of our expected interest payments under the FASB’s ASC Topic 815, “Derivatives and Hedging.” This instrument effectively converts variable interest payments on the term loan into fixed payments. In a cash flow hedge, the effective portion of the change in fair value of the hedging derivative is recorded in accumulated other comprehensive income (loss) and is subsequently reclassified into earnings during the same period in which the hedged item affects earnings. The change in fair value of any ineffective portion of the hedging derivative is recognized immediately in earnings. The fair value of the interest rate swap is determined using an internal valuation model which relies on the expected LIBOR yield curve as the most significant input. Additionally included in the model are estimates of counterparty and the Company’s non-performance risk as the most significant inputs. Because each of these inputs are directly observable or can be corroborated by observable market data, we have categorized the interest rate swap as Level 2 within the fair value hierarchy.   

 

The fair value of the swap as of December 31, 2013 and September 30, 2013, was as follows (amounts in thousands):

 

Description

 

Total

   

Level 1

   

Level 2

   

Level 3

 
                                 

Interest Rate Swap

                               

As of December 31, 2013

  $ 62       -     $ 62       -  

As of September 30, 2013

    122       -       122       -  

 

Derivatives designated as hedging instruments

 

Change in Unrealized Gain

 
         

Interest Rate Swap

       
         

Three months ended December 31, 2013

  $ 60  

Three months ended December 31, 2012

    26  

 

We did not record any ineffectiveness in earnings related to the interest rate swap for the three months ended December 31, 2013 and 2012. As of December 31, 2013, no deferred gains or losses are expected to be reclassified into earnings as interest expense related to the interest rate swap over the next twelve months as we expect the hedging relationship will remain unchanged.

 

10. FOREIGN CURRENCY TRANSLATION


The Company’s Hungarian subsidiary, Zoltek Zrt. has a functional currency of the HUF. As a result, the Company is exposed to foreign currency risks related to this investment. The consolidated balance sheet of Zoltek Zrt. was translated from Hungarian Forints to U.S. dollars, at the exchange rate in effect at the applicable balance sheet date, while its consolidated statement of operations was translated using the average exchange rates in effect for the periods presented. The related translation adjustments are reported as other comprehensive income (loss) within shareholders’ equity. Gains and losses from foreign currency transactions of Zoltek Zrt. are included in the results of operations as other income (expense). The HUF strengthened by 2.8% against the U.S. dollar during the first three months of fiscal 2014. This currency fluctuation caused a decrease of $4.9 million in our accumulated other comprehensive loss for the three months ended December 31, 2013.

 

The functional currency of Zoltek de Mexico is the U.S. dollar.

 

 
16

 

 

Item 2.     Management's Discussion and Analysis of Financial Condition and Results of Operations

 

General

 

Zoltek Companies, Inc. is an applied technology and advanced materials company. Our mission is to lead the commercialization of carbon fiber through our development of a price-competitive, high-performance reinforcement for composites used in a broad range of commercial products which we sell under the Panex® trade name. In addition to manufacturing carbon fiber, we produce an intermediate product, a stabilized and oxidized acrylic fiber used in flame- and heat-resistant applications which we sell under the Pyron® trade name. Unless the context otherwise indicates, references to the “Company” or “Zoltek” are to Zoltek Companies, Inc. and its subsidiaries.

 

We led the development of the carbon fiber commercialization concept and we believe we are the largest manufacturer primarily focused on producing low-cost carbon fibers for commercial applications. We have spent over 15 years developing and refining our proprietary technology and manufacturing processes and building capacity.

 

During 2006, we began our transformation from primarily a development business to an operational phase and continued our expansion plans that were first announced in 2005. Also during 2006, the demand from commercial carbon fibers continued to increase substantially and the aerospace and commercial applications diverged. We believe this divergence will persist over a long period and validates our commercialization strategy.

 

Zoltek’s mission to commercialize carbon fibers has proven successful over the past several years, but the development of large volume applications has been constrained because converting commercial carbon fibers to a finished product depends heavily on a fragmented and inefficient supply chain. Consequently, we are taking steps to accelerate the commercialization process. We design new equipment and develop new processing methods to support the commercialization strategy. The goal is to develop higher-throughput, lower-cost conversion methods designed to consolidate the supply chain and open new applications. These value-added, or “composite intermediate” products and processes, are being coordinated by Zoltek’s research and development (R&D) group.

 

On September 27, 2013, Zoltek entered into the merger agreement by and among Zoltek, Toray and Merger Sub. Under the terms and subject to the conditions in the merger agreement, Merger Sub, a wholly-owned subsidiary of Toray, will merge with and into Zoltek, with Zoltek continuing as the surviving corporation in the merger as a wholly-owned subsidiary of Toray. See Note 1 to the Condensed Consolidated Financial Statements included in Part I. of this Quarterly Report on Form 10-Q.

 

Key Performance Indicators

 

Our management monitors and analyzes several key performance indicators within each of these segments to manage our business and evaluate our financial and operating performance, including:

 

Revenue. In the short-term, management closely reviews the volume of product shipments and indicated customer requirements in order to forecast revenue and cash receipts. In the longer term, management believes that revenue growth through new product applications is the best indicator of whether we are achieving our objective of commercializing carbon fiber. We expect that new applications, including those we are attempting to facilitate, will positively affect demand for our products.

 

Gross profit. Management focuses on improving the gross profit over the long term while leading the commercialization of carbon fiber and controlling associated costs. The Company’s strategy is to maintain available unused capacity that positions the Company to capture opportunities in emerging applications.

 

Operating expenses. Our operating expenses are driven by headcount and related administrative costs, marketing costs and research and development costs. We monitor headcount levels in specific geographic and operational areas. We believe that research and development expenditures will be the primary means by which we can facilitate new product applications.

 

Cash flow from operating activities. Management believes that operating cash flow is meaningful to investors because it provides a view of Zoltek with respect to sustainability of our ongoing operations and the extent to which we may or may not require external capital. Operating cash flow also provides meaningful insight into the management of our working capital.

 

Liquidity and cash flows. Due to the variability in revenue, our cash position fluctuates. We closely monitor our expected cash levels, particularly as they relate to operating cash flow, days’ sales outstanding, days’ payables outstanding and inventory turnover. Management aggressively pursues any past due receivables and seeks to actively manage inventory levels in order to effectively balance working capital with the Company’s strategy of assuring customers availability of supply. Management also monitors debt levels and the financing costs associated with debt.

 

 
17

 

 

BUSINESS TRENDS

 

Zoltek management has focused its efforts on building on the long-term vision of Zoltek as the leader in commercialization of carbon fibers as a low-cost but high performance reinforcement for composites. Management primarily emphasizes the following areas:

 

 

Increased Sales Efforts in Selected International Markets. We have identified international markets with high growth potential for our existing and emerging commercial applications. Accordingly, we have added sales personnel and increased our marketing efforts in Asia.

 

 

Business Development in Emerging Applications.  We have identified emerging applications for our products with high growth potential across a variety of industries and regions. In November 2011, we took a major step toward growing our carbon fiber prepreg capabilities by opening a new 135,000 square foot facility outside of St. Louis, Missouri. One of our goals is to leverage our leadership in commercial carbon fibers to become the leading provider of commercial carbon fiber prepreg in the global marketplace.  Our research and development center, to support our targeted applications with high volume manufacturing and processing technologies, is located at this new facility. We have also recently added pultrusion capacity and are now selling a line of pultrusion products.

 

 

Operating Cash Flow and Cash Management. Our operations provided $13.2 million of cash during the first quarter of fiscal 2014. We reported negative operating cash flow of $4.2 million during the first quarter of fiscal 2013. Cash provided by reduction in inventory was $2.1 million and decreased accounts receivable provided cash of $6.0 million during fiscal 2014. We have established collection targets and payment targets for all customers and suppliers to improve control over our days’ sales outstanding and days’ payables outstanding. The Company reported $2.0 million of capital expenditures during the first three months of fiscal 2014. The Company intends to utilize operating cash flow and existing credit lines in order to accommodate working capital and capital expenditure requirements for the remainder of fiscal 2014.

 

 

Foreign Currency Volatility. During the first quarter of fiscal 2014, the HUF strengthened against the U.S. dollar by 2.8% from the fourth quarter of fiscal 2013 and the Mexican Peso weakened against the U.S. dollar by 0.9% from the fourth quarter of fiscal 2013. This resulted in offsetting changes to processing costs in the respective countries. During the first quarter of fiscal 2014, the Euro strengthened against the U.S. dollar by 2.7% from the fourth quarter of fiscal 2013 resulting in increased revenue and some increased costs. The Company’s financial statements will continue to be impacted by foreign currency volatility.

 

RESULTS OF OPERATIONS

 

THREE MONTHS ENDED DECEMBER 31, 2013 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2012

 

The Company's sales decreased 2.1%, or $0.8 million, to $35.1 million in the first quarter of fiscal 2014 from $35.9 million in the first quarter of fiscal 2013. During the first quarter of fiscal 2014, volume of product shipments remained similar as compared to the first quarter of 2013. The strengthening of the Euro accounted for an increase of revenue of approximately $0.7 million. Carbon fiber sales decreased 6.8%, or $1.9 million, to $26.8 million in the first quarter of fiscal 2014 from $28.7 million in the first quarter of fiscal 2013 due to decreased shipments to wind customers. Technical fiber sales increased 21.3%, or $1.4 million, to $8.0 million in the first quarter of fiscal 2014 from $6.6 million in the first quarter of fiscal 2013 due to increased shipments to aircraft brake customers.

 

The Company's cost of sales increased by 11.4%, or $3.0 million, to $29.8 million in the first quarter of fiscal 2014 from $26.8 million in the first quarter of fiscal 2013. The increase in cost of sales reflected increased inventory costs through reduced production levels. Costs of our primary raw material, acrylonitrile (ACN), increased by approximately 4.0% from the first quarter of fiscal 2013. Carbon fiber cost of sales increased by 6.2%, or $1.4 million, to $23.6 million for the first quarter of fiscal 2014 from $22.2 million for the first quarter of fiscal 2013. The increase in carbon fiber cost of sales reflected increased inventory costs due to reduced production levels. Technical fiber cost of sales increased by 43.7% or $1.8 million, to $5.9 million for the first quarter of fiscal 2014 from $4.1 million for the first quarter of fiscal 2013 as a result of increased sales of 21.3% as discussed above and increased inventory costs due to reduced production levels.

 

The Company's gross profit decreased by $3.8 million, to $5.3 million, or 15.0% of sales in the first quarter of fiscal 2014 from $9.1 million, or 25.3% of sales in the first quarter of fiscal 2013. During the first quarter of fiscal 2014, available unused capacity costs increased to $3.8 million compared to the first quarter of fiscal 2013 when gross margin was negatively impacted by $1.9 million of available unused capacity costs. Carbon fiber gross profit percentage decreased to 12.0% for the first quarter of fiscal 2014 compared to 22.8% for the first quarter of fiscal 2013. Carbon fiber gross profit decreased to $3.2 million from $6.5 million during these respective periods. The decreases in carbon fiber gross profit and margin resulted primarily from increased inventory costs due to decreased production levels. Technical fiber gross profit decreased to $2.0 million, or 25.6% of sales, in the first quarter of fiscal 2014 from $2.5 million, or 37.2% of sales, in the first quarter of fiscal 2013. The decreases in technical fiber gross profit and margin resulted from increased inventory costs due to reduced production levels.

 

Application and market development costs increased to $2.2 million in the first quarter of fiscal 2014 compared to $2.1 million for the first quarter fiscal 2013. These costs included product development efforts, product trials and sales and product development personnel and related travel. Targeted emerging applications include automobile components, offshore oil and gas drilling, fire/heat barrier, compressed natural gas (CNG), electrical transmission, consumer electronics and alternate energy technologies.

 

Selling, general and administrative expenses increased to $3.5 million in the first quarter of fiscal 2014 compared to $3.4 million in the first quarter of fiscal 2013. The Company recorded less than $0.1 million for the cost of employee and director services received in exchange for equity instruments under ASC 718 during the first quarter of fiscal 2014 and fiscal 2013.

 

 
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Operating loss from the first quarter of fiscal 2014 was $0.4 million, a decline from operating income of $3.6 million reported during the first quarter of fiscal 2013. Carbon fiber operating income decreased to $1.6 million in the first quarter of fiscal 2014 from income of $4.6 million in the first quarter of fiscal 2013. Operating income from technical fibers decreased to $2.0 million in the first quarter of fiscal 2014 from $2.3 million in the first quarter of fiscal 2013. The decrease in operating income resulted primarily from the decrease in gross profit described above.

 

Loss on foreign currency translations was $1.3 million for the first quarter of fiscal 2014, compared to a loss of $0.1 million for the first quarter of fiscal 2013. During the three months ended December 31, 2013, the Euro and the U.S. dollar weakened in value against the HUF as compared to the three months ended December 31, 2012 when the Euro and U.S. dollar also weakened in value against the HUF. As most of the Company’s Hungarian accounts receivables are denominated in Euros and U.S. dollars, the weakening in value of the Euro and U.S. dollar resulted in a loss recognized in our Hungarian subsidiary. The translation of the Hungarian subsidiary’s financial statements from its functional currency (HUF) to U.S. dollars is not included in determining net income for the period but is recorded in accumulated other comprehensive loss in equity.

 

Other expense, net, was $0.5 million in the first quarter of fiscal 2014 compared to an income of $0.1 million in the first quarter of fiscal 2013. Other expense, net consists primarily of costs associated with our strategic alternative process and merger agreement with Toray which amounted to $0.3 million for the first quarter of 2014.

 

As of December 31, 2013, we have released uncertain tax positions due to the expiration of the statute of limitations, which recorded a tax benefit of $0.5 million. The Company tracks uncertain tax positions under the guidance of ASC 740-10. Income tax benefit was $0.1 million for the three months ended December 31, 2013, compared to an expense of $0.6 million for the three months ended December 31, 2012. During the first three months of fiscal 2014, the Company recognized expense of $0.3 million related to the local Hungarian municipality tax, and $0.1 million was recorded related to U.S. and Mexico minimum tax payments.  Our utilization of tax loss carryforwards for federal tax in Hungary is limited to only 50% of taxable income in fiscal 2014 and beyond. During the first three months of fiscal 2013, an expense of $0.2 million was incurred related to the local Hungarian municipality tax and less than $0.1 million was recorded related to U.S. and Mexico minimum tax payments.

 

The foregoing resulted in a net loss of $2.3 million for the first quarter of fiscal 2014 compared to net income of $3.0 million for the first quarter of fiscal 2013. Similarly, the Company reported losses of $0.07 per share on a basic and diluted basis for the first quarter of fiscal 2014 and income of $0.09 per share on a basic and diluted basis for the first quarter of fiscal 2013. The weighted average basic common shares outstanding were 34.4 million for the first quarters of both fiscal 2014 and 2013. The weighted average diluted common shares outstanding were 34.4 million for the first quarters of both fiscal 2014 and 2013.

 

Liquidity and Capital Resources

 

The Company believes its cash currently on hand, cash flow from operations, and cash available from unused credit facilities should be sufficient to fund its identified liquidity needs during fiscal 2014.

 

     Cash Provided By (Used In) Operating Activities

 

Operating activities provided $13.2 million of cash for the first quarter of fiscal 2014. The change in inventory levels provided $2.1 million of cash during the first quarter of fiscal 2014. The Company continues its efforts to increase sales. We expect to continue to reduce our inventory quantities as we align our production and sales levels. Cash flows were positively affected by depreciation of $5.0 million for the first quarter of fiscal 2014, which was included in the operating loss of $0.4 million. Accounts receivables decreased by $6.0 million during the first quarter of fiscal 2014 reflecting decreased sales. Payables and accrued expenses increased by $2.3 million.

 

Operating activities used $4.2 million of cash for the first quarter of fiscal 2013. Inventory levels used $11.8 million during the first quarter of fiscal 2013 in anticipation of increased sales levels, including increases in consigned inventory, which represented contractually required finished goods inventory levels for certain key customers. Cash flows were positively affected by depreciation of $4.7 million for the first quarter of fiscal 2013, which was included in the operating income of $3.6 million. Decreased sales decreased accounts receivables by $6.6 million during the first quarter of fiscal 2013.

 

Cash Used In Investing Activities

 

Net cash used in investing activities for the first quarter of fiscal 2014 was $2.0 million, which primarily consisted of capital expenditures for existing production lines and new equipment. The change in property and equipment, net was primarily impacted by $2.0 million of capital expenditures and depreciation expense of $5.0 million.

 

Net cash used in investing activities for the first quarter of fiscal 2013 was $3.7 million, which primarily consisted of capital expenditures for existing production lines and new equipment. The change in property and equipment, net was also impacted by $2.9 million of capital expenditures and depreciation expense of $4.7 million.

 

 
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     Cash Used In Financing Activities

 

Net cash used by financing activities was $2.1 million for the first quarter of fiscal 2014 resulting primarily from repayment of our notes payable.

 

Net cash used by financing activities was $1.6 million for the first quarter of fiscal 2013 resulting primarily from repayment of our notes payable.

 

 
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Item 3.      Quantitative and Qualitative Disclosures About Market Risk

 

Foreign Currency Risk

 

The consolidated balance sheets of the Company's international subsidiaries, Zoltek Zrt. and Zoltek de Mexico, were translated from Hungarian Forints (HUF) and Mexican Pesos to U.S. dollars, respectively, at the exchange rates in effect at the applicable balance sheet date, while its consolidated statements of operations were translated using the average exchange rates in effect for the periods presented. The related translation adjustments are reported as other comprehensive income (loss) within shareholders' equity. Gains and losses from foreign currency transactions of Zoltek Zrt. are included in the results of operations in other expenses (income). The Company views as long-term its investments in Zoltek Zrt. and Zoltek de Mexico. Zoltek Zrt. has a functional currency of the HUF. As a result, the Company is exposed to foreign currency risks related to this investment. The HUF strengthened by 2.8% against the U.S. dollar during the first quarter of fiscal 2014. This currency fluctuation caused a decrease of $4.9 million in our accumulated other comprehensive loss for the three months ended December 31, 2013.

 

As of December 31, 2013, the Company had a long-term loan of $108.0 million to its Zoltek Zrt. subsidiary denominated in U.S. dollars. The potential loss in value of the Company's net foreign currency investment in Zoltek Zrt. resulting from a hypothetical 10% adverse change in quoted foreign currency exchange rate of the HUF against the U.S. dollar at December 31, 2013 and 2012 amounted to $10.8 million and $10.8 million, respectively. The Company does not expect repayment of the loan in the foreseeable future. As such, the Company considers this loan as a permanent investment. In addition, Zoltek Zrt. routinely sells its products to customers located primarily throughout Europe in sales transactions that are denominated in foreign currencies other than the HUF. Also, Zoltek Zrt. has debt that is denominated in foreign currencies other than the HUF.

 

As of December 31, 2013, the Company had a long-term loan to its Zoltek de Mexico subsidiary. There is no potential loss in value of the Company's net foreign currency investment in Zoltek de Mexico resulting from an adverse change in quoted foreign currency exchange rate of the Mexican Peso against the U.S. dollar at December 31, 2013 because Zoltek de Mexico’s functional currency is the U.S. dollar. The Company does not expect repayment of the loan in the foreseeable future. As such, the Company considers this loan as a permanent investment.

 

Commodity Price Risk

 

We are exposed to commodity price risk arising from changes in the market price of certain raw materials and other production inputs, such as ACN and utilities. Due to competition and market conditions, volatile price increases cannot always be passed on to our customers. Management assesses commodity price trends on a regular basis and seeks to adjust purchasing accordingly. The Company does not currently utilize derivative instruments to hedge purchases of commodities.

 

Interest Rate Risk 

 

We are exposed to various market risks, including fluctuations in interest rates. We use interest rate swap agreements to manage our interest costs and reduce our exposure to increases in floating interest rates. Using interest rate swap agreements, we agree to exchange, at specified intervals through 2017, the difference between fixed and variable interest amounts calculated by reference to agreed-upon notional principal amounts.

 

We do not hold or issue derivative instruments for speculative trading purposes. We have interest rate derivative instruments that have been designated as cash flow hedging instruments. Such instruments effectively convert variable interest payments on certain debt instruments into fixed payments. For qualifying hedges, realized derivative gains and losses offset related results on hedged items in the consolidated statements of operations. We formally document, designate and assess the effectiveness of transactions that receive hedge accounting. As of December 31, 2013, there was no cash flow hedge ineffectiveness on interest rate swap agreements.

 

* * *

Special Note Regarding Forward-Looking Statements

 

This quarterly report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, you should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur and actual results could differ materially from those projected in the forward-looking statements.

 

 
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The forward-looking statements contained in this report are inherently subject to risks and uncertainties. The Company’s actual results could differ materially from those in the forward-looking statements. The factors that might cause such differences include, among others, our ability to: (1) successfully adapt to recessionary conditions in the global economy and substantial volatility in order rates from our wind energy customers, including our principal customer Vestas Wind Systems; (2) penetrate existing, identified and emerging markets, including entering into new supply agreements with large volume customers; (3) continue to improve efficiency at our manufacturing facilities on a timely and cost-effective basis; (4) successfully add new planned capacity for the production of carbon fiber, prepregs and precursor raw materials and meet our obligations under long-term supply agreements; (5) operate profitably; (6) increase or maintain our borrowing at acceptable costs; (7) manage changes in customers’ forecasted requirements for our products; (8) continue investing in application and market development for a range of applications; (9) manufacture low-cost carbon fibers and profitably market them despite fluctuations in raw material and energy costs; (10) successfully operate our Mexican facility to produce acrylic fiber precursor and carbon fibers; (11) successfully continue operations at our Hungarian facility if natural gas supply disruptions occur; (12) successfully prosecute patent litigation; (13) successfully facilitate adoption of our carbon fibers by the auto industry for use in high-volume applications; (14) establish and grow prepreg capacity; (15) speed development of low-cost carbon fiber sheet molding compounds for the automotive industry pursuant to our global collaborative partnership with Magna Exteriors and Interiors; (16) resolve possible disputes with a group of shareholders that filed a Schedule 13D, including the group’s request for a special shareholders meeting to remove the current Board of Directors and elect new directors; (17) manage and respond to matters relating to our proposed merger with Toray, including without limitation (a) the occurrence of any event, change or other circumstances that could give rise to termination of the merger agreement before the merger is completed; (b) the outcome of any legal proceedings instituted against Zoltek and others following announcement of the merger agreement; (c) our ability to complete the proposed merger due to the failure of Zoltek, Toray or Merger Sub to satisfy the conditions to the merger; (d) potential employee retention difficulties as a result of the proposed merger; (e) disruption of our operations as a result of the merger; and (f) our ability to realize the benefits of the merger; and (18) manage the risks identified under "Risk Factors" in our filings with the SEC.

 

* * *

 

 
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Item 4.      Controls and Procedures

 

Evaluation of Controls and Procedures

 

As of the end of the period covered by this report, an evaluation was carried out by management, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended. The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed in reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

 

Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures as of December 31, 2013, were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission’s rules and forms.

 

There has been no change in our internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

 
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ZOLTEK COMPANIES, INC.

 

PART II.     OTHER INFORMATION

 

Item 1.      Legal Proceedings.

 

In September and October 2013, a total of 13 purported class actions arising out of the execution of the merger agreement were filed in the Circuit Court of St. Louis County, Missouri against Zoltek and Zoltek’s directors by purported shareholders of Zoltek. All but one of the lawsuits also named Toray and/or Merger Sub as defendants. The Circuit Court of St. Louis County, Missouri consolidated the actions under the caption In Re: Zoltek Companies, Inc. Shareholder Litigation, Cause No. 13-SL-CC-3419, on November 26, 2013 (the “Consolidated Action”). The Consolidated Action alleges, among other things, that (1) each of the Company’s directors breached his fiduciary duties to the Company’s shareholders in connection with approval of the transactions contemplated by the merger agreement, (2) the Company, Toray and Merger Sub aided and abetted the Company’s directors in such breaches of their fiduciary duties, and (3) the Company failed to disclose certain material information in the Definitive Proxy Statement. The Consolidated Action seeks, among other things, injunctive relief preventing the parties from completing the merger and directing the Company directors to account to the Company and the purported class for all damages suffered as a result of the breaches of fiduciary duties and awards of attorneys’ fees and expenses for the plaintiffs.

  

On January 15, 2014: (1) the parties agreed to withdraw certain pending discovery motions; (2) the lead plaintiffs agreed not to pursue injunctive or other relief to delay the Company’s Special Meeting of Shareholders or the consummation of the merger; (3) the Company agreed not to oppose a motion to be filed by the plaintiffs after the Special Meeting and consummation of the merger for leave to further amend the amended petition in the Consolidated Action; and (4) the Company agreed to furnish the lead plaintiffs copies of certain minutes of meetings of the Board of Directors, presentations made by Company management and the Company’s financial advisor, and confidentiality agreements executed by parties participating in the Company’s strategic alternatives evaluation process. These agreements were memorialized in a stipulated Order and Judgment entered by the Court on January 17, 2014.

 

The Company believes that the lawsuits are without merit and intends to defend against them vigorously. There can be no assurance, however, with regard to the outcome of this litigation.

 

Except as disclosed above, neither we nor any of our properties are currently subject to any material legal proceedings or other regulatory proceedings.

 

Item 6.      Exhibits.

 

See Exhibit Index

 

 
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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

Zoltek Companies, Inc.

 

 

(Registrant)

 

 

 

 

 

Date: February 10, 2014

By: 

/s/ ZSOLT RUMY

 

 

 

Zsolt Rumy

 

 

 

Chief Executive Officer

 

 

 

(Principal Executive Officer)

 

 

 

 

 

Date: February 10, 2014

By:

/s/ ANDREW W. WHIPPLE

 

 

 

Andrew W. Whipple

 

 

 

Chief Financial Officer

 

 

 

(Principal Financial Officer)

 

       

 
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EXHIBIT INDEX

 

Exhibit Number

Description of Document

   

2.1

Agreement and Plan of Merger dated as of September 27, 2013, by and among Zoltek Companies, Inc., Toray Industries, Inc. and TZ Acquisition Corp., filed as Exhibit 2.1 to Registrant’s Current Report on Form 8-K dated September 27, 2013 and incorporated herein by reference.

   
31.1

Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.

   
31.2

Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended.

   
32.1  

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

   
32.2

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

   

 

101.INS**

XBRL Instance

 

101.SCH**

XBRL Taxonomy Extension Schema

 

101.CAL**

XBRL Taxonomy Extension Calculation

 

101.DEF**

XBRL Taxonomy Extension Definition

 

101.LAB**

XBRL Taxonomy Extension Labels

 

101.PRE**

XBRL Taxonomy Extension Presentation

 

** XBRL

information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

 

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