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ZOLT > SEC Filings for ZOLT > Form 10-K on 27-Nov-2012All Recent SEC Filings

Show all filings for ZOLTEK COMPANIES INC

Form 10-K for ZOLTEK COMPANIES INC


27-Nov-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand Zoltek, our operations and our business environment. MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes. This overview summarizes the MD&A, which includes the following sections:

Our Business -- a general description of the key drivers that affect our business, the industry in which we operate and the strategic initiatives on which we focus.

Results of Operations -- an analysis of our overall results of operations and segment results for the three fiscal years presented in our consolidated financial statements appears elsewhere in this report. We operate in two principal segments: carbon fiber and technical fiber. Other miscellaneous and corporate are combined into a third business segment called headquarters/other.

Liquidity and Capital Resources -- an analysis of cash flows, sources and uses of cash, contractual obligations, the impact of currency fluctuations and an overview of our financial condition.

Critical Accounting Estimates -- a description of accounting estimates that require critical judgments and estimates.

OUR BUSINESS

EXECUTIVE OVERVIEW

We are an applied technology and advanced materials company. Our mission is to lead in 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 that we refer to as technical fiber, a stabilized and oxidized acrylic fiber used in flame- and heat-resistant applications which we sell under the Pyron® trade name. We have spent over 15 years developing our proprietary technology and manufacturing processes. We believe that we have the largest capacity primarily focused on producing low-cost carbon fiber for commercial applications.

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 sales to new customers in existing applications and new product applications are 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 continue to 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. Gross margin was positively impacted during fiscal 2012 by several factors. Production levels increased with improved sales as we brought our Mexican capacity online and increased output in Hungary. We also improved the efficiency of our operations which decreased production costs.

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 are an important 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 varies. 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 late receivables and seeks to actively manage inventory levels in order to effectively use working capital. Management also monitors debt levels and the financing costs associated with debt.


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:

· 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. We have taken a major step toward growing our carbon fiber prepreg and pultrusion capabilities by opening a 135,000 square foot facility outside of St. Louis, Missouri in November 2011. Our intent is to leverage our leadership in commercial carbon fibers to become the leading provider of carbon fiber prepreg and pultrusion 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 facility. We also expanded our plant in Hungary to allow for greater fabric manufacturing capability.

· Operating Cash Flows and Cash Management. The cash generated by our net income was offset by the buildup of inventory in anticipation of sales growth and contractual requirements and increased receivables. We had operating cash inflows of $17.2 million in fiscal 2012 compared to a cash outflow of $3.2 million in fiscal 2011.

· Foreign Currency Volatility. The HUF weakened against the U.S. dollar by 15.9% and the Mexican Peso weakened against the U.S. dollar by 10.0% during fiscal 2012 compared fiscal 2011. This resulted in lower processing cost and devaluation of inventory in the respective countries. The Euro weakened against the U.S. dollar by 7.2% during fiscal 2012 compared to fiscal 2011, resulting in decreased revenue from our sales denominated in Euro. The Company's financial statements will continue to be impacted by foreign currency volatility.

RESULTS OF OPERATIONS

FISCAL YEAR ENDED SEPTEMBER 30, 2012 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30,
2011

The Company's sales increased 22.8%, or $34.6 million, to $186.3 million in fiscal 2012 from $151.7 million in fiscal 2011. Sales growth was attributable primarily to an increase in volume shipped, which accounted for 80.1% of the $34.6 million increase in sales. The weakening of the Euro accounted for a decrease of revenue of approximately $5.9 million. Carbon fiber sales increased 27.3%, or $32.5 million, to $151.5 million during fiscal 2012 from $119.0 million during fiscal 2011. Technical fiber sales increased 6.4%, or $1.9 million, to $32.4 million during fiscal 2012 from $30.5 million during fiscal 2011. Technical fiber sales increased in fiscal 2012 primarily due to increased shipments to aircraft brake customers.

The Company's cost of sales increased by 5.0% or $6.7 million, to $140.7 million during fiscal 2012 from $134.0 million during fiscal 2011. Our cost of sales increased in response to the increase in production volume to meet the customer demand. Carbon fiber cost of sales increased by 9.9%, or $10.6 million, to $117.4 million during fiscal 2012 from $106.8 million for fiscal 2011, reflecting increased sales and increased production efficiency in combination with a decrease in ACN costs. Technical fiber cost of sales decreased 18.2%, or $4.6 million, to $20.9 million for fiscal 2012 from $25.5 million for fiscal 2011 primarily as a result of the increased production efficiency and a decrease in ACN costs.

The Company's gross profit margin increased to 24.5% for fiscal 2012 compared to 11.7% for fiscal 2011. The Company's gross profit increased $27.9 million, to $45.6 million during fiscal 2012 from $17.7 million in fiscal 2011. During fiscal 2012, available unused capacity costs decreased to $2.8 million compared to fiscal 2011 when gross margin was negatively impacted by $11.7 million of available unused capacity cost. Carbon fiber gross profit margin increased to 22.5% for fiscal 2012 compared to 10.2% for fiscal 2011. Carbon fiber gross profit increased to $34.1 million from $12.1 million in fiscal 2012 compared to fiscal 2011. The increases in carbon fiber gross profit and gross profit percentage resulted primarily from the increase in the production levels to satisfy the increase in demand indicated above. Technical fiber gross profit increased to $11.6 million, or 35.7% of sales, for fiscal 2012 from $5.0 million, or 16.3% of sales, during fiscal 2011. The increases in technical fiber gross profit and margin resulted from increased production efficiency improving capacity utilization and a decrease in ACN costs.

Application and market development costs were $7.0 million in fiscal 2012 and $8.6 million in fiscal 2011. These costs included product and market development efforts, product trials and product development personnel costs. Targeted emerging applications include automobile components, offshore oil and gas drilling, fire/heat barrier and alternate energy technologies. The decrease from fiscal 2011 to fiscal 2012 was primarily due to decreased spending associated with our prepreg development.

Selling, general and administrative expenses decreased by $0.9 million to $13.0 million in fiscal 2012 from $13.9 million in fiscal 2011. The decrease from fiscal 2011 to fiscal 2012 was primarily due to a $0.5 million decrease in consulting costs and a strengthening of the U.S. dollar against the HUF which resulted in a $0.6 million decrease in our HUF denominated costs.


Operating income was $25.6 million for fiscal 2012 compared to operating loss of $4.7 million in fiscal 2011. Carbon fiber operations reported an increase of $24.9 million in operating income to $27.8 million for fiscal 2012 compared to income of $2.9 million in fiscal 2011. Operating income from technical fibers increased $6.6 million, to $10.3 million for fiscal 2012 from $3.7 million for fiscal 2011. The increase in operating income in the carbon fiber and technical fiber operations in fiscal 2012 related to the increase in sales and production.

Interest expense, net was $0.3 million for fiscal 2012, compared to $0.1 million in fiscal 2011. The increase in interest expense, net, resulted from new credit facilities entered into during fiscal 2012.

Less than $0.1 million of amortization of financing fees, which are non-cash expenses, was recognized during fiscal 2012 compared to no amortization of financing fees in fiscal 2011 (see "Liquidity and Capital Resources-Financing Activity").

Loss on foreign currency transactions was $0.6 million for fiscal 2012 compared to a gain of $1.5 million for fiscal 2011. During fiscal 2012, the Euro weakened and the U.S. dollar strengthened in value against the HUF. Most of the Company's accounts receivable is denominated in Euros and U.S dollars. The weakening value of the Euro over fiscal 2012 resulted in a loss recognized in our Hungarian subsidiary, offset somewhat by gains due to the strengthening of the U.S. dollar. During fiscal 2011, the Euro and the U.S. dollar gained in value against the HUF. The translation of the Hungarian subsidiary's financial statements from its functional currency (HUF) to US 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 $0.9 million in fiscal 2012 compared to $0.6 million for fiscal 2011. Other expense, net consists primarily of loss from the sale of miscellaneous equipment and from miscellaneous fees in Hungary.

Gain on liabilities carried at fair value was $0.1 million at the end of fiscal 2012 compared to a gain of $1.2 million for fiscal 2011 due to the adoption of ASC 815, "Derivatives and Hedging." (See "- Liquidity and Capital Resources - Derivative Instruments and Fair Value Measurements.")

Income tax expense was $1.2 million for fiscal 2012 compared to a tax expense of $0.9 million for fiscal 2011. During fiscal 2012, income tax expense of $1.1 million was incurred related to the local Hungarian municipality tax. Local and federal alternative minimum taxes in the U.S. and Mexico were $0.1 million. During fiscal 2011, income tax expense of $0.6 million was incurred related to the local Hungarian municipality tax. An additional income tax expense of $0.1 million was recorded during fiscal 2011 related to increasing the valuation allowance against the deferred tax asset for the Hungarian subsidiary. Local and federal alternative minimum taxes in the U.S. and Mexico were $0.2 million.

The foregoing resulted in a net income of $22.9 million for fiscal 2012 compared to a net loss of $3.6 million for fiscal 2011. Similarly, the Company reported net income per share of $0.67 and net loss per share of $0.10 on a basic basis for fiscal 2012 and 2011, respectively. The Company reported net income per share of $0.66 and net loss per share of $.10 on a diluted basis for fiscal 2012 and 2011, respectively. The weighted average basic and dilutive common shares outstanding were 34.4 and 34.5 million for fiscal 2012, respectively and 34.4 million for both average basic and dilutive common shares outstanding for fiscal 2011.

FISCAL YEAR ENDED SEPTEMBER 30, 2011 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30,
2010

The Company's sales increased 18.1%, or $23.2 million, to $151.7 million in fiscal 2011 from $128.5 million in fiscal 2010. Sales growth was attributable primarily to an increase in volume shipped, which accounted for 73% of the $23.2 million increase in sales. Price increases to customers and the strengthening of the Euro accounted for approximately $1.9 million and $2.9 million of the increase in revenue. Carbon fiber sales increased 15.1%, or $15.6 million, to $119.0 million during fiscal 2011 from $103.4 million during fiscal 2010. Technical fiber sales increased 30.8%, or $7.2 million, to $30.5 million during fiscal 2011 from $23.3 million during fiscal 2010. Technical fiber sales increased in fiscal 2011 primarily due to increased shipments to aircraft brake customers.

The Company's cost of sales increased by 16.3% or $18.8 million, to $134.0 million during fiscal 2011 from $115.2 million during fiscal 2010. Our cost of sales increased in response to the increase in production volume to meet the customer demand. Carbon fiber cost of sales increased by 12.6%, or $11.9 million, to $106.8 million during fiscal 2011 from $94.9 million for fiscal 2010, reflecting high ACN costs. Technical fiber cost of sales increased 33.8%, or $6.4 million, to $25.5 million for fiscal 2011 from $19.1 million for fiscal 2010 primarily as a result of the increased sales and ACN costs.

Included in the Company's cost of sales in fiscal 2011 were available unused capacity costs of $11.7 million. These costs were comprised of fixed production costs allocated to manufacturing lines which were primarily related to our Mexico plant producing below normal levels and amounted to $10.1 million for the carbon fiber segment and $1.4 million for the technical fiber segment during fiscal 2011. The Company believes maintaining this available unused capacity was necessary to encourage development of significant large-scale applications and maintain a level of readiness as we anticipated a return to more robust market conditions.


The Company's gross profit increased by 33.2%, or $4.4 million, to $17.7 million during fiscal 2011 from $13.3 million in fiscal 2010. Carbon fiber gross profit margin increased to 10.2% for fiscal 2011 compared to 8.2% for fiscal 2010. Carbon fiber gross profit increased to $12.1 million from $8.5 million in fiscal 2011 compared to fiscal 2010. The increases in carbon fiber gross profit and gross profit percentage resulted primarily from the increase in the production levels to satisfy the increase in demand noted above. Technical fiber gross profit increased to $5.0 million, or 16.3% of sales, for fiscal 2011 from $4.2 million, or 18.2% of sales, during fiscal 2010. The increases in technical fiber gross profit and margin resulted from increased production efficiency from improved capacity utilization.

Application and market development costs were $8.6 million in fiscal 2011 and $8.2 million in fiscal 2010. These costs included product and market development efforts, product trials and product development personnel costs. Targeted emerging applications include automobile components, offshore oil and gas drilling, fire/heat barrier and alternate energy technologies. The increase from fiscal 2010 to fiscal 2011 was primarily due to increased focus on developing new production methods that will enable potential automotive customers to fabricate cost-effective carbon fiber intermediate products.

Selling, general and administrative expenses decreased by $1.7 million to $13.9 million in fiscal 2011 from $15.6 million in fiscal 2010. The Company recorded $0.8 million for the cost of employee and director services received in exchange for equity instruments during fiscal 2011, a decrease of $1.2 million from $2.0 million in fiscal 2010. Additionally, the decrease was due to a $0.5 million decrease in bad debt expense, $0.7 million decrease in professional fees, $0.2 million decrease in depreciation expense and a $0.1 million decrease in insurance costs. The Company increased employee costs by $1.0 million, primarily related to corporate sales activities.

Operating loss was $4.7 million for fiscal 2011 compared to operating loss of $10.6 million in fiscal 2010. Carbon fiber operations reported an increase of $2.6 million in operating income to $2.9 million for fiscal 2011 compared to income of $0.3 million in fiscal 2010. The increase in operating income in the carbon fiber operation in fiscal 2011 related to the increase in production and sales. Operating income from technical fibers increased $0.3 million, to $3.7 million for fiscal 2011 from $3.4 million for fiscal 2010.

Interest expense, net was $0.1 million for fiscal 2011, compared to $0.3 million in fiscal 2010. The decrease in interest expense, net, resulted from the repayment of debt during fiscal 2010.

No amortization of financing fees, which are non-cash expenses, was recognized during fiscal 2011 compared to $0.3 million during fiscal 2010. (See "Liquidity and Capital Resources - Financing Activity.")

Gain on foreign currency transactions was $1.5 million for fiscal 2011 compared to $1.9 million for fiscal 2010. During fiscal 2011, the Euro and the U.S. dollar gained in value against the HUF. As most of the Company's accounts receivable is denominated in Euros, the strengthening value over fiscal 2011 resulted in a gain recognized in our Hungarian subsidiary. This gain during fiscal 2011 was offset by currency gains incurred related to US dollar-denominated intercompany receivables; however, an overall gain was recognized. The translation of the Hungarian subsidiary's financial statements from its functional currency (HUF) to US 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 $0.6 million in fiscal 2011 compared to $0.7 million for fiscal 2010. Other expense, net consists primarily of loss from the sale of miscellaneous equipment and from miscellaneous fees in Hungary.

Gain on liabilities carried at fair value was $1.2 million at the end of fiscal 2011 compared to a gain of $1.8 million for fiscal 2010 due to the adoption of ASC 815, "Derivatives and Hedging." (See "Liquidity and Capital Resources - Derivative Instruments and Fair Value Measurements.")

Income tax expense was $0.9 million for fiscal 2011 compared to a tax benefit of $1.8 million for fiscal 2011. During fiscal 2011, income tax expense of $0.6 million was incurred related to the local Hungarian municipality tax. An additional income tax expense of $0.1 million was recorded during fiscal 2011 related to increasing the valuation allowance against the net operating loss for the Hungarian subsidiary. Local and federal alternative minimum taxes in the U.S. and Mexico were $0.2 million. During fiscal 2010, income tax expense of $0.8 million was incurred related to the local Hungarian municipality tax. This expense was offset by the release of the $2.2 million reserve on the Company's uncertain tax positions due to a favorable resolution of a tax position with the Hungarian Tax Authority. An additional income tax benefit of $0.7 million was recorded during fiscal 2010 related to the net operating loss for the Hungarian subsidiary. Local and federal alternative minimum taxes in the U.S. and Mexico were $0.2 million.

The foregoing resulted in a net loss of $3.6 million for fiscal 2011 compared to $6.3 million for fiscal 2010. Similarly, the Company reported net loss per share of $0.10 and $0.18 on a basic and diluted basis for fiscal 2011 and 2010, respectively. The weighted average basic common shares outstanding were 34.4 million for both fiscal 2011 and 2010.


LIQUIDITY AND CAPITAL RESOURCES

The Company believes its cash currently on hand, cash flow from operations and credit facilities should be sufficient to fund its identified liquidity needs over the next twelve months.

CASH FLOWS

Cash Provided By Operating Activities

Operating activities provided $17.4 million of cash during fiscal 2012. An increase in inventory levels used $20.7 million of cash during fiscal 2012 due to a buildup of inventory in anticipation of increased customer demand and contract requirements. Cash flows were positively affected by depreciation of $17.8 million in 2012, which was included in the operating income of $25.6 million. Cash flows were negatively impacted by an increase of $6.0 million in accounts receivable as a result of increased sales levels during fiscal 2012.

Operating activities used $3.2 million of cash during fiscal 2011. An increase in inventory levels used $10.3 million of cash during fiscal 2011 due to a buildup of inventory in anticipation of increased customer demand. Cash flows were positively affected by depreciation of $17.8 million in 2011, which was included in the operating loss of $4.7 million, and $6.4 million due to an increase in trade accounts payable. Cash flows were negatively impacted by an increase of $8.7 million in accounts receivable as a result of increased sales levels, and $3.3 million as other current assets and other assets increased during fiscal 2011.

Cash Used In Investing Activities

Net cash used in investing activities for fiscal 2012 was $21.6 million, which consisted of capital expenditures for energy efficiency gains related to our carbon fiber production in Hungary and expansion of our capacity for our composite intermediates production at our St. Peters, Missouri plant. No funds were received from the Hungarian government as a conditional grant to reimburse capital expenditures and related outlays (see Note 7 of the Notes to Consolidated Financial Statements).

Net cash used in investing activities for fiscal 2011 was $8.0 million, which consisted of capital expenditures on existing production lines and new equipment. This included less than $0.1 million of funds received from the Hungarian government as a conditional grant to reimburse capital expenditures and related outlays.

Cash Used and Provided In Financing Activities

Net cash provided in financing activities was $17.4 million in fiscal 2012 consisting primarily of borrowings under notes payable and lines of credit, net of repayments.

Net cash provided in financing activities was $7.1 million in fiscal 2011 consisting primarily of borrowings under notes payable and lines of credit.

INVENTORIES

The Company evaluates its ending inventories for estimated excess quantities and obsolescence. This evaluation includes analyses of sales levels by product and projections of future demand within specific time horizons. Inventories in excess of future demand, if any, are reserved. Remaining inventory balances are adjusted to approximate the lower of cost on a first-in, first-out basis or market value. Cost includes material, labor and overhead. 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 change in projection is made. Under supply arrangements with certain customers, the Company has agreed to maintain levels of inventory on hand.

The Company historically has not experienced material problems related to the pricing or functionality of carbon fibers inventory. Our PanexÒ carbon fibers represent the majority of our inventory balance in continuous tow, fabric, prepreg, chopped and milled forms.

VALUATION OF LONG-LIVED ASSETS

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Zoltek management is responsible for routinely assessing whether impairment indicators are present. The Company expects that the components of each operating segment will exhibit similar financial performance over the long term and, therefore, groups assets accordingly for analyzing whether impairment exists. It is possible that actual future financial performance related to the Company's long-lived assets may materially differ from the Company's determination of expected future financial performance. Additionally, if the Company's expected future financial performance (undiscounted cash flows) was less than the carrying amount of the asset group being analyzed, it would be necessary for the Company to make significant judgments regarding the fair value of the asset due to the specialized nature of much of the Company's carbon fiber production equipment in order to determine the amount of the impairment charge.


HUNGARIAN GRANT

The Hungarian government has pledged a grant of 2.9 billion Hungarian Forint ("HUF") to Zoltek's Hungarian subsidiary, which translated at the September 30, 2012 exchange rate, is approximately $13.1 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. Zoltek's Hungarian subsidiary did not receive any grant funding during fiscal 2012 and received approximately HUF 0.1 billion and HUF 0.1 billion in grant funding during fiscal 2011 and 2010, respectively. As of September 30, 2012, Zoltek Zrt. had received an aggregate of approximately HUF 2.6 billion ($11.7 million) in funding pursuant to the grant. 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 . . .

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