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.
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.
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
|
|
|
|
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
|
|
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.
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
|
|
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.
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.
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.