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. The 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. In September 2013 , we entered into an Agreement and Plan of Merger with Toray Industries, Inc. See Part I . Item 1. "Business - Merger Agreement with Toray ." 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. 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 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. 19 -------------------------------------------------------------------------------- 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, such as Asia , with high growth potential for our existing and emerging commercial applications. ? 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 Flows and Cash Management. Our operations provided $19.6 million of cash during fiscal 2013. Our operations provided $17.4 million of cash during fiscal 2012. Cash used for inventory was $4.0 million and decreased accounts receivable provided cash of $4.2 million during fiscal 2013. We have established collection targets and payment targets for all customers and suppliers to optimize our days' sales outstanding and days' payables outstanding. The Company reported $13.0 million of capital expenditures during fiscal 2013. 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 2013. ? Foreign Currency Volatility. The HUF strengthened against the U.S. dollar by 1.7% and the Mexican Peso strengthened against the U.S. dollar by 4.4% during fiscal 2013 compared to fiscal 2012. This resulted in higher processing cost and revaluation of inventory in the respective countries. The Euro strengthened against the U.S. dollar by 1.1% during fiscal 2013 compared to fiscal 2012, resulting in increased revenue from our sales denominated in Euro. The Company's financial statements will continue to be impacted by foreign currency volatility. MERGER AGREEMENT WITH TORAY INDUSTRIES, INC. Strategic Context and Overview For over 20 years, the mission of Zoltek has been to lead the commercialization of carbon fibers for large-scale applications. As its business has grown, Zoltek's Board of Directors and senior management regularly have reviewed and assessed developments in its business units, as well as strategic options available to further its mission and grow shareholder value in light of industry developments and general economic conditions. Zoltek led the first breakthrough application for commercial carbon fibers-blades for large wind turbines where light weight and stiffness offered unique performance attributes for low-cost carbon fiber composites. Zoltek has identified additional emerging applications for commercial carbon fibers with projected demand that far exceeds that from wind turbine blades, as well as the industry's existing capacity. Those applications include automotive components, oil and gas production and distribution and electric transmission lines. Incorporating carbon fibers into these emerging applications requires users to invest substantial amounts to re-engineer processing and manufacturing technologies and capacity. As Zoltek pursued these transformative applications, it became increasingly aware that its relatively small size was an impediment to convincing large industrial users to make the requisite investments, despite Zoltek's demonstrated ability to deliver large volumes of carbon fibers at reliable prices and the performance of Zoltek's commercial carbon fibers. Consequently, over several years, Zoltek explored various strategies for bringing scale to its business and further driving down carbon fiber production costs to make carbon fibers more economically attractive. Those strategies included Zoltek's announced initiatives to seek to align with large companies in strategic joint ventures. Zoltek held a series of discussions with parties from around the world about possible joint ventures. Ultimately, Zoltek concluded that the joint venture proposals it explored did not ascribe adequate value to Zoltek's unique capabilities to produce low-cost carbon fibers in large volumes and, therefore, would not offer attractive opportunities to enhance shareholder value. Developments in emerging carbon fiber applications have created risks, as well as opportunities, for Zoltek's ability to successfully grow shareholder value to reflect Zoltek's leadership in commercial carbon fibers. As noted above, automotive applications comprise one of the leading opportunities for a new breakthrough application. In the United States , mileage standards for the model year 2015 automotive fleet require significantly improved fuel efficiency. Zoltek believes that currently available engine technology has reached a practical limit in the incremental mileage improvements that can be achieved and that the car industry will have to rely on lighter weight vehicles to attain mandated standards. Accordingly, Zoltek believes that automotive applications are at an inflection point that shortly industry participants will select which producers will emerge as primary suppliers to this application over the long term. Zoltek's Board of Directors and management have determined that Zoltek's current size relative to larger industry participants creates uncertainty as to whether it will maintain its leadership position as demand from automotive applications for carbon fibers increases. 20 -------------------------------------------------------------------------------- In recent years, Zoltek also observed consolidation and alignment of businesses of large industry participants which created risk to Zoltek's leadership position in commercial carbon fibers. These transactions included: the joint venture between SGL Carbon and BMW Group in 2009 to produce ultra light-weight carbon fiber reinforced plastics for use in BMW vehicles; SGL Carbon's joint venture with Mitsubishi Rayon in 2010 for the production of carbon fiber precursor to be used in SGL Carbon's joint venture with BMW; and Dow Chemical's joint venture with Aksa Akrilik Kimya Sanayii in 2011 for manufacture and commercialization of carbon fibers. These and other industry transactions confirmed Zoltek's perception that its relatively small size compared to larger producers and customers could become an increasing impediment to achieving greater scale in its business. In addition, and despite the identified long-term potential underlying Zoltek's vision and strategy, its Board of Directors and management have come to believe that its business continues to face risks associated with the applications it currently serves. Wind turbine demand has proven to be very sensitive to government subsidies for alternative energy projects. Zoltek reported record sales in fiscal 2012 because installation of new wind generation was pulled forward into that fiscal year as manufacturers sought to benefit from production tax credits in the United States that were scheduled to expire at the end of that calendar year. Zoltek's sales for this application decreased significantly in fiscal 2013 compared to the prior year due to the uncertainty as to whether the tax credits would be renewed. While the tax credits ultimately were renewed in early 2013, there is a lag between the time that wind generation projects are initiated and when they result in demand for Zoltek's carbon fibers. Consequently, Zoltek's operating results in fiscal year 2013 suffered primarily due to the slow-down in construction of wind generation capacity. As Zoltek reported the effects of the decline in wind energy business, its stock price suffered as well. Strategic Alternative Evaluation Process The Board of Directors has believed for several years that the market price of Zoltek's common stock did not reflect the intrinsic value of Zoltek's business, especially the potential for growth as emerging applications for commercial carbon fibers materialize and Zoltek's installed capacity to profitably supply those applications at reliable prices. The low share price, in turn, has increased Zoltek's cost of capital and, as a result, limited Zoltek's ability to generate demand for these new applications organically or by acquisition of downstream technologies or businesses. In addition, the Board has been concerned that the relatively low stock price could attract speculators seeking a quick profit, including by undertaking a highly leveraged transaction to exploit Zoltek's stable cash flows and relatively low levels of borrowings compared to the value of its assets and its shareholders' equity. The Company therefore undertook a strategic alternatives evaluation process to determine an appropriate course of action with the help of a financial advisor, J.P. Morgan Securities LLC . Zoltek's Board of Directors diligently considered all alternatives presented as part of this process and concluded a definitive merger agreement between Zoltek and Toray Industries Inc. ("Toray") was the best strategic alternative to maximize shareholder value. As such, on September 25, 2013 , Zoltek's Board of Directors held a special meeting and approved the proposed merger with Toray and related transaction documentation. The Merger Agreement is described in Part I. Item 1. "Business - Merger Agreement with Toray ." RESULTS OF OPERATIONS FISCAL YEAR ENDED SEPTEMBER 30, 2013 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30, 2012 The Company's sales decreased 24.6%, or $45.8 million , to $140.5 million in fiscal 2013 from $186.3 million in fiscal 2012. Sales decline was attributable primarily to a decrease in volume shipped due to reduced customer demand, which accounted for 82.8% of the $45.8 million decrease in sales. The strengthening of the Euro accounted for an increase of revenue of approximately $0.6 million . Carbon fiber sales decreased 29.9%, or $45.3 million , to $106.2 million during fiscal 2013 from $151.5 million during fiscal 2012. Carbon fiber sales decreased primarily due to a decline in sales for wind applications due to the expiration of U.S. tax credits at December 31, 2012 . Technical fiber sales remained flat at $32.5 million during fiscal 2013 compared to $32.4 million during fiscal 2012. The Company's cost of sales decreased by 21.4% or $30.1 million , to $110.6 million during fiscal 2013 from $140.7 million during fiscal 2012. Our cost of sales decreased in response to the decrease in sales volume due to reduced customer demand. Costs of our primary raw material, ACN, decreased by approximately 5.3% during fiscal 2013 as compared to fiscal 2012. Carbon fiber cost of sales decreased by 25.8%, or $30.3 million , to $87.1 million during fiscal 2013 from $117.4 million for fiscal 2012, reflecting decreased sales and in combination with a decrease in ACN costs. Technical fiber cost of sales increased 5.2%, or $1.0 million , to $21.9 million for fiscal 2013 from $20.9 million for fiscal 2012 primarily as a result of decreased production levels. 21 -------------------------------------------------------------------------------- The Company's gross profit margin decreased to 21.2% for fiscal 2013 compared to 24.5% for fiscal 2012. The Company's gross profit decreased $15.8 million , to $29.8 million during fiscal 2013 from $45.6 million in fiscal 2012. During fiscal 2013, gross margins were negatively impacted as available unused capacity costs increased to $10.8 million compared to $2.8 million in fiscal 2012. Carbon fiber gross profit margin decreased to 18.0% for fiscal 2013 compared to 22.5% for fiscal 2012. Carbon fiber gross profit decreased to $19.1 million from $34.1 million in fiscal 2013 compared to fiscal 2012. The decreases in carbon fiber gross profit and gross profit percentage resulted primarily from the decrease in production levels in response to the decrease in demand indicated above. Technical fiber gross profit decreased to $10.6 million , or 32.5% of sales, for fiscal 2013 from $11.6 million , or 35.7% of sales, during fiscal 2012. The decreases in technical fiber gross profit and margin resulted from a decrease in production levels in order to better align inventory levels. Application and development costs were $7.7 million in fiscal 2013 and $7.0 million in fiscal 2012. 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 2012 to fiscal 2013 was primarily due to increased spending associated with our pultrusion development. Selling, general and administrative expenses increased by $1.0 million to $14.0 million in fiscal 2013 from $13.0 million in fiscal 2012. The increase from fiscal 2012 to fiscal 2013 was primarily due to a $0.8 million increase in professional fees primarily relating to legal and audit costs. Operating income was $8.1 million for fiscal 2013 compared to operating income of $25.6 million in fiscal 2012. Carbon fiber operations reported a decrease of $15.4 million in operating income to $12.4 million for fiscal 2013 compared to income of $27.8 million in fiscal 2012. Operating income from technical fibers decreased $0.3 million , to $10.0 million for fiscal 2013 from $10.3 million for fiscal 2013. The decrease in operating income in the carbon fiber and technical fiber operations in fiscal 2013 related to the decreases in sales as discussed above. Interest expense, net was $0.6 million for fiscal 2013, compared to $0.3 million in fiscal 2012. The increase in interest expense, net, resulted from increased borrowings. Gain on foreign currency transactions was $0.1 million for fiscal 2013 compared to a loss of $0.6 million for fiscal 2012. During fiscal 2013, the Euro strengthened and the U.S. dollar weakened in value against the HUF. Most of the Company's accounts receivable are denominated in Euros and U.S dollars. The strengthening value of the Euro over fiscal 2013 resulted in a gain recognized in our Hungarian subsidiary, offset somewhat by losses due to the weakening of the U.S. dollar. 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 $1.0 million in fiscal 2013 compared to $0.9 million for fiscal 2012. Other expense, net consisted primarily of the cost associated with our strategic alternatives evaluation process which constituted $1.1 million recorded during fiscal 2013. Additionally included in other expense is less than $0.1 million of amortization of financing fees, which are non-cash expenses, recorded during both fiscal 2013 and fiscal 2012. Partially offsetting these costs was miscellaneous income associated with our Hungarian and Mexican subsidiaries. Income tax expense was $1.4 million for fiscal 2013 compared to a tax expense of $1.2 million for fiscal 2012. During fiscal 2013, income tax expense of $1.1 million was incurred related to the local Hungarian municipality tax and $0.1 million was incurred related to Hungarian federal taxes. Our utilization of Hungarian tax loss carryforward in Hungary is limited to only 50% of taxable income in fiscal 2013 and beyond. Local and federal alternative minimum taxes in the U.S. and Mexico were $0.2 million . During fiscal 2012, income tax expense of $1.1 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 net income of $5.2 million for fiscal 2013 compared to net income of $22.9 million for fiscal 2012. Similarly, the Company reported net income per share of $0.15 and net income per share of $0.67 on a basic basis for fiscal 2013 and 2012, respectively. The Company reported net income per share of $0.15 and net income per share of $0.66 on a diluted basis for fiscal 2013 and 2012, respectively. The weighted average basic and dilutive common shares outstanding were both 34.4 million for fiscal 2013, respectively, and 34.4 and 34.5 million, respectively, for average basic and dilutive common shares outstanding for fiscal 2012. 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 for wind energy applications, 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. 22 -------------------------------------------------------------------------------- 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, gross margins were negatively impacted by available unused capacity costs of $2.8 million compared to $11.7 million in fiscal 2011. 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 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. 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 are 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 . Additionally included in other expense is less than $0.1 million of amortization of financing fees, which are non-cash expenses, recorded during fiscal 2012 compared to no amortization of financing fees in fiscal 2011 (see "-Liquidity and Capital Resources-Financing Activity"). 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 Accounting Standards Codification ("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. 23 -------------------------------------------------------------------------------- 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 $19.6 million of cash during fiscal 2013. An increase in inventory levels used $4.0 million of cash during fiscal 2013. The Company continues its efforts to increase sales and has over time reduced its production levels to better match sales levels. Cash flows were positively affected by depreciation of $18.1 million in 2013, which was included in the operating income of $8.1 million . Cash flows were positively impacted by a decrease of $4.2 million in accounts receivable as a result of decreased sales levels during fiscal 2013. 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 build-up 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. Cash Used In Investing Activities Net cash used in investing activities for fiscal 2013 was $14.0 million , which consisted of capital expenditures related to our technical fiber production in Mexico 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 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). Cash Used and Provided In Financing Activities Net cash used in financing activities was $3.2 million in fiscal 2013 consisting primarily of repayments under notes payable and lines of credit, net of repayments. Net cash provided in financing activities was $17.4 million in fiscal 2012 consisting primarily of borrowings under notes payable and lines of credit. During the third quarter of fiscal 2012, Zoltek Zrt. entered into a $17.1 million term loan secured by the Company's facilities in Hungary , which is guaranteed by the Company. Zoltek Zrt. increased borrowings to supplement working capital and for other general corporate purposes. The Company also borrowed $10 million under its term loan, the proceeds of which were used to repay its former U.S. bank line 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 Panex® carbon fibers represent the majority of our inventory balance in continuous tow, fabric, prepreg, chopped and milled forms. 24 -------------------------------------------------------------------------------- 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 by reporting segment 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, 2013 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 build-up of manufacturing capacity of carbon fibers. Zoltek's Hungarian subsidiary did not receive any grant funding during fiscal 2013 and 2012 and received approximately HUF 0.1 billion in grant funding during fiscal 2011, respectively. As of September 30, 2013 , 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 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 September 30, 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 lower the required employment levels and separate each year into its own measurement period rather than a single five-year measurement period. Whether or not our petition is approved by the Hungarian government, we expect that Zoltek Zrt. will comply with the requirements of the grant agreement during the measurement period. If Zoltek Zrt. is unable to comply with the grant agreement, it would be required to pay back all or a portion of the grant funds with possible interest which as of September 30, 2013 could total up to $16.6 million . UNITED STATES GRANT On September 30, 2011 , the United States Department of Energy awarded the Company a grant related to its development of a novel low cost carbon fiber using a lignin/PAN hybrid precursor. If successful, combining this precursor with improvements in operating and energy efficiencies for carbon conversion will provide lower cost carbon fiber for automotive and other applications, such as wind turbine blades. Zoltek is collaborating with Weyerhauser on this project and together they are allowed a reimbursement of $3.7 million of costs incurred for the project. These funds are being recorded as a reduction to property, plant, and equipment on the Company's consolidated balance sheet. This contra asset will be 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. 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 ( $18.4 million at the September 30, 2013 exchange rate) (the "Term Facility") and (2) a multicurrency overdraft facility in the amount of up to 1.12 billion HUF ( $5.1 million at the September 30, 2013 exchange rate) (the "Revolving Facility"). The Term Facility is a five-year term loan and bears interest at 4.17%. Principal under the Term Facility is payable semi-annually in equal installments. The Revolving Facility is a revolving credit facility that expires on March 29, 2013 and has a total commitment of 1.120 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 ( $15.7 million at the September 30, 2013 exchange rate) as required by the Hungarian government grant. The obligations of Zoltek Zrt. under this credit facility are guaranteed by the Company. 25 -------------------------------------------------------------------------------- This credit facility contains representations and warranties, and contains a requirement that Zoltek Zrt. maintain a minimum current asset ratio and minimum annual EBITDA, along with other covenants. The Company was in compliance with all covenants as of September 30, 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 September 30, 2013 , the Company had borrowed $14.7 million from this new credit facility. US Financing On March 30, 2012 , the Company 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, secured 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 a one-month LIBOR rate, 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 contains a requirement that the Company, on a consolidated basis, maintain minimum fixed charge coverage and leverage ratios, along with other covenants. The Company was in compliance with all covenants as of September 30, 2013 . As of September 30, 2013 , the principal balance of this term loan was $9.1 million . The Company primarily utilized the proceeds of the Enterprise Loan to repay all outstanding balances under the Company's former U.S. revolving credit facility with its former U.S. Bank; the original borrowings had financed 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 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 September 30, 2013 . As of September 30, 2013 , the Company had no borrowings under this revolving credit agreement. Future Contractual Obligations In the table below, we set forth our enforceable and legally binding obligations as of September 30, 2013 . Some of the amounts included in this table (amounts in thousands) are based on our estimates and assumptions about these obligations, including their durations, anticipated actions by third parties and other factors. The enforceable and legally binding obligations we will actually pay in future periods may vary from those reflected in the table because the estimates and assumptions are subjective. See Note 9 of the Notes to Consolidated Financial Statements for discussion of the Company's debt agreements. Payments Due by Period Total Less than 1-3 Years 3-5 Years Over 5 1 Year Years Operating lease obligations (a) $ 6,958 $ 1,235 $ 1,651 $ 1,626 $ 2,446 Long term debt obligations 23,710 4,330 8,660 4,997 5,723 Total debt and leases 30,668 5,559 10,299 6,617 8,193 Purchase obligations (b) 2,119 2,119 - - - Total contractual obligations $ 32,787 $ 7,678 $ 10,299 $ 6,617 $ 8,193 (a) Includes a one-year and nine-year contract for nitrogen gas facility and equipment of approximately $0.3 million and $0.8 million , respectively, per year. (b) Purchase obligations include agreements to purchase goods or services that are enforceable and binding and that specify all significant terms, including fixed or minimum quantities to be purchased, fixed, minimum or variable price provisions and the approximate timing of the transactions. Purchase obligations exclude agreements that are cancelable at any time without penalty. SUPPLY CONTRACTS We are party to a long-term supply contract with our wind energy customer Vestas Wind Systems. In fiscal year 2013, 2012 and 2011, we reported net sales of $61.8 million , $86.6 million and $42.7 million to Vestas Wind Systems, which represented 44.0%, 46.5% and 28.1%, respectively, of our net sales. This was the only customer with whom we have a long-term supply agreement that represented greater than 10% of consolidated net sales during any of these three years. In fiscal 2011, we reported net sales of $15.8 million , which represented 10.4% of our total consolidated net sales to Saertex GMBH & Company , a manufacturer of fabrics for the composite industry, including materials for production of wind turbine blades. We do not have a long-term supply agreement with this customer. We entered into a supply agreement with Vestas Wind Systems in May 2007 , which subsequently has been replaced with a new agreement. The contract as currently in effect obligates us to supply carbon fibers under a five-year delivery schedule, and a rolling three-year schedule as long as the supply agreement is in place. Under the agreement, Vestas provides us with annual forecasts of its supply requirements, and we receive binding orders for shipments on approximately a monthly basis. We are not guaranteed specific levels of sales under the agreement, and we are subject to liquidated damages if we are unable to perform our obligations under the agreement. In general, the agreement may be terminated by: (1) mutual agreement of the parties, (2) by either party with at least 60 months' written notice, (3) by either party as a result of a material breach of the agreement that is not remedied within 30 days of receipt of notice of such breach, and (4) by either party in the event of the bankruptcy, insolvency, or change of control of the other party. 26 -------------------------------------------------------------------------------- In our supply agreement with Vestas, we do not have post-shipment obligations other than that we warrant that our products are free from defects in design, materials, and workmanship at the time of delivery and that the products are produced in accordance with standard production and sales specifications stated in the agreements. The agreement states that the warranty shall continue for a period of five years from the date of delivery of the products. Legal Contingencies In September and October 2013 , a total of 13 purported class actions arising out of the execution of the Merger Agreement were filed against Zoltek and Zoltek's directors in the Circuit Court of St. Louis County, Missouri by purported shareholders of Zoltek . All but one of the lawsuits also named Toray and/or Merger Sub as defendants. The lawsuits allege, among other things, that (1) each of Zoltek's directors breached his fiduciary duties to Zoltek's shareholders in connection with approval of the transactions contemplated by the Merger Agreement, and (2) that Zoltek , Parent and Merger Sub aided and abetted Zoltek's directors in such breaches of their fiduciary duties. The lawsuits seek, among other things, injunctive relief preventing the parties from completing the merger and directing the Zoltek directors to account to Zoltek 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. Zoltek has filed various motions to dismiss the actions against Zoltek and the individual directors of Zoltek , which motions are pending. The Circuit Court of St. Louis County, Missouri consolidated each of the actions described above under the caption In Re: Zoltek Companies, Inc. Shareholder Litigation on November 26, 2013 . On November 27, 2013 , the Court entered an order denying a motion filed by certain of the plaintiffs for expedited discovery. Cross Motions filed by the plaintiffs to designate lead plaintiffs and lead counsel are pending before the Court. On December 4, 2013 , the Court entered an order appointing co-lead plaintiffs in the action, and in the same order, the Court appointed Goldenberg Heller Antognoli & Rowland, P.C. and Holloran White Schwartz & Gaertner LLP as interim co-lead counsel and appointed Wolf Haldenstein Adler Freeman & Herz LLP and Robbins Geller Rudman & Dowd LLP to the Plaintiffs' Executive Committee. We believe that the lawsuits are without merit and intend 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. We establish 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. As of September 30, 2013 , Zoltek recorded no material legal reserves. Our contingent liabilities contain uncertainties because the eventual outcome will result from future events, and determination of current reserves requires estimates and judgments related to future changes in facts and circumstances, differing interpretations of the law and assessments of the amount of damages, and the effectiveness of strategies or other factors beyond our control. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to gains or losses that could be material. CRITICAL ACCOUNTING ESTIMATES Certain of our accounting policies require our management to make difficult, subjective or complex judgments. All of the Company's accounting policies are in compliance with U.S. generally accepted accounting principles ("GAAP"). The Company considers the following policies to be the most critical in understanding the estimates, assumptions and judgments that are involved in preparing our financial statements, and the uncertainties that could affect our results of operations, financial condition and cash flows. ACCOUNTS RECEIVABLE COLLECTIBILITY The Company evaluates the collectability of our accounts receivable for each of our segments based on a combination of factors. In circumstances where we are aware of a specific customer's inability to meet its financial obligations to us (e.g., bankruptcy filing or substantial downgrading of credit), we record a specific reserve for bad debts against the amounts due reducing the net recognized receivable to the amount we estimate will be collected. For all other customers, we estimate reserves for bad debts based on the length of time receivables have been past due and our experience with collection. Our bad debt expense for accounts receivable was less than $0.1 million for fiscal 2013, $0.2 million for fiscal 2012 and less than $0.1 million for fiscal 2011. 27 -------------------------------------------------------------------------------- STOCK-BASED COMPENSATION We measure compensation cost for all share-based awards at fair value. The fair value of stock options is determined using the Black-Scholes valuation model. The Company uses historical volatility for a period of time that is comparable to the expected life of the option. Fair value is recognized as expense over the service period, net of estimated forfeitures, using the straight-line method. INCOME TAXES The Company accounts for certain income and expense items differently for financial reporting and income tax purposes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities applying enacted statutory tax rates in effect for the year in which the differences are expected to reverse. A valuation allowance is provided against certain deferred tax assets when realization of those assets is not considered to be more likely than not. We are subject to the jurisdiction of numerous tax authorities. Our operations in these different jurisdictions are generally taxed on income before taxes adjusted for various differences between tax law and GAAP accounting. Determination of taxable income in any jurisdiction requires the interpretation of the related tax laws and regulations and the use of estimates and assumptions regarding significant future events such as the amount, timing and character of deductions, permissible revenue recognition methods under the tax law and the sources and character of income and tax credits. Changes in tax laws, regulations, agreements and treaties, foreign currency exchange restrictions or our level of operations or profitability in each taxing jurisdiction could have an impact on the amount of income taxes that we provide during any given year. Our tax filings for various periods are subject to audit by the tax authorities in the jurisdictions in which we conduct business. TANGIBLE PROPERTY REGULATIONS In September 2013 , the U.S. Treasury issued final Tangible Property Regulations ("TPR") addressing the tax consequences associated with the acquisition, production, improvement and disposition of tangible property. The TPR are effective for tax years beginning on or after January 1, 2014 , which for the Company is its fiscal year beginning October 1, 2014 . The Company is evaluating the effects of the regulations, but does not believe that they will have a material impact on its consolidated financial statements. RECENT ACCOUNTING PRONOUNCEMENTS See Note 1 of the Notes to the Company's Consolidated Financial Statements.
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