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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q/A
(Amendment No. 1)
(Mark one)
| þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the three months ended December 31, 2007
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to to
Commission File No.0-20600
ZOLTEK COMPANIES, INC.
(Exact name of registrant as specified in its charter)
| Missouri | 43-1311101 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
| 3101 McKelvey Road, St. Louis, Missouri | 63044 | |
| (Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (314) 291-5110
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ No o
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o | Smaller reporting company o | |||
| (Do not check if a smaller reporting company) | ||||||
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ
Yes o No þ
Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date: As of February 11, 2007, 33,922,267 shares of Common Stock, $.01 par value, were outstanding.
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EXPLANATORY NOTE
This Amendment No. 1 on Form 10-Q/A amends the Registrant’s Quarterly Report on Form 10-Q for the quarter year ended December 31, 2007, as originally filed on February 11, 2008 (the “Original Report”), and is being filed solely for the purpose of amending portions of Part I, Item 1 “Financial Statements” and Part II, Item 6 “Exhibits” to include certain information regarding developments that occurred since the Original Report was filed, as set forth below.
In April 2008, the Registrant’s management indentified two payments by a subsidiary in the amounts of $175,000 and $75,000 in September 2007 and January 2008, respectively, that were not properly authorized or reported in the Registrant’s financial statements. The two payments were made by the Registrant’s Hungarian subsidiary at the direction of Kevin J. Schott, the former Chief Financial Officer of the Registrant. On May 2, 2008, Mr. Schott agreed to resign as Chief Financial Officer of the Registrant and paid the Registrant $250,000. The Audit Committee and management immediately initiated an investigation into the circumstances of the payments and to determine whether there were other transactions that were not properly authorized or recorded. On May 5, 2008, following a review by the Audit Committee, the Registrant filed a Current Report on Form 8-K reporting that it had determined that its previously issued financial statements as of September 30, 2007 and for the fiscal year then ended and as of December 31, 2007 and for the quarter then ended should no longer be relied upon pending completion of the Audit Committee’s investigation.
Zsolt Rumy, Chairman and Chief Executive Officer of the Registrant, is serving as Chief Financial Officer on an interim basis, and the Registrant is conducting a search for a permanent Chief Financial Officer. In connection with Mr. Schott’s resignation, the Registrant and Mr. Schott entered into a separation agreement under which Mr. Schott agreed to resign from the Registrant as of May 2, 2008, Mr. Schott paid the Registrant $250,000, and the Registrant agreed to pay him his salary and routine employee benefits through that date. The Registrant released Mr. Schott from claims arising out of the above-described payments that were not properly authorized or recorded and Mr. Schott released the Registrant from claims arising out of his employment and agreed to cooperate with the Registrant in connection with matters relating to his employment.
The Audit Committee has conducted its accounting investigation, including with respect to the circumstances of the two payments and whether there were additional payments that were not properly authorized or recorded in the Registrant’s financial statements. The Audit Committee’s investigation included specified forensic audit procedures conducted by the Registrant’s internal accounting staff and additional procedures developed and performed by forensic accounting experts of an independent accounting firm. The Audit Committee’s investigation has concluded and, based upon the forensic accounting procedures performed, did not detect the existence of other transactions that were not properly authorized or recorded.
The Audit Committee has discussed the results of its accounting investigation, including the report of the independent forensic accountants, with the Registrant’s independent registered public accounting firms. The Registrant has concluded that the Registrant’s previously issued financial statements as of September 30, 2007 and for the fiscal year then ended and as of December 31, 2007 and for the quarter then ended can be relied upon, and that no restatement of these financial statements is required. Management and the Audit Committee assessed the aggregate $250,000 amount under Staff Accounting Bulletin 99 and Staff Accounting Bulletin 108 and determined that the misstatement was not material to the results reflected in the consolidated financial statements. The $250,000 aggregate amount of the two unauthorized payments has been recorded below operating income as other expense in the Registrant’s consolidated statements of operations for the three and six months ended March 31, 2008. To reflect the receipt of the payment from Mr. Schott, the Registrant will record $250,000 below operating income as other income in the Registrant’s consolidated statements of operations for the three and nine months ended June 30, 2008. The Registrant is concurrently filing this amendment to its previously filed Quarterly Report on Form 10-Q for the quarter ended December 31, 2007 and an amendment to its Annual Report on Form 10-K for the fiscal year ended September 30, 2007 to reflect the above-described developments.
On May 13, 2008, the Registrant received a letter from the enforcement staff of the Securities and Exchange Commission indicating that the staff was conducting a non-public, fact finding investigation and requested that the Registrant retain certain records and produce information and documents related to matters disclosed in the Registrant’s Current Report on Form 8-K filed May 5, 2008. The Registrant has advised the staff that it will cooperate fully with its investigation.
This Form 10-Q/A does not reflect all events occurring after the original filing of the Original Report or modify or update all the disclosures affected by subsequent events. Information not modified or updated herein reflects the disclosures made at the time of the filing of the Original Report on February 11, 2008. Accordingly, this Form 10-Q/A should be read in conjunction with all of the Registrant’s periodic filings, including any Current Reports on Form 8-K, the Registrant’s Form 10-K/A for the fiscal year ended September 30, 2007 and Form 10-Q for the quarter ended March 31, 2008, filed with the SEC subsequent to the filing date of the Original Report.
ZOLTEK COMPANIES, INC.
INDEX
INDEX
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| 6 | ||||||||
| 7 | ||||||||
| 18 | ||||||||
| 18 | ||||||||
| 19 | ||||||||
| 20 | ||||||||
| Section 302 Certification of CEO and CFO | ||||||||
| Section 906 Certification of CEO and CFO | ||||||||
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ZOLTEK COMPANIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(Unaudited)
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(Unaudited)
| December 31, | September 30, | |||||||
| 2007 | 2007 | |||||||
Assets | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 63,649 | $ | 121,761 | ||||
| Restricted cash | 23,500 | 13,815 | ||||||
| Accounts receivable, less allowance for doubtful accounts of $971 and $1,150, respectively | 31,997 | 37,495 | ||||||
| Inventories | 35,168 | 27,941 | ||||||
| Other current assets | 16,425 | 10,858 | ||||||
| Total current assets | 170,739 | 211,870 | ||||||
| Property and equipment, net | 235,566 | 188,801 | ||||||
| Other assets | 2,488 | 2,928 | ||||||
| Total assets | $ | 408,793 | $ | 403,599 | ||||
Liabilities and Shareholders’ Equity | ||||||||
| Current liabilities: | ||||||||
| Current maturities of long-term debt | $ | 12,982 | $ | 13,813 | ||||
| Trade accounts payable | 15,193 | 17,253 | ||||||
| Legal liabilities | 24,384 | 24,543 | ||||||
| Accrued expenses and other liabilities | 7,793 | 8,305 | ||||||
| Total current liabilities | 60,352 | 63,914 | ||||||
| Long-term debt, less current maturities | 5,939 | 6,851 | ||||||
| Hungarian grant, long-term | 8,828 | 7,969 | ||||||
| Deferred tax liabilities | 4,120 | 4,046 | ||||||
| Other long-term liabilities | 53 | 52 | ||||||
| Total liabilities | 79,292 | 82,832 | ||||||
| Commitments and contingencies (see Note 8) | ||||||||
| Shareholders’ equity: | ||||||||
| Preferred stock, $.01 par value, 1,000,000 shares authorized, no shares issued or outstanding | — | — | ||||||
| Common stock, $.01 par value, 50,000,000 shares authorized, 33,854,890 and 33,653,735 shares issued and outstanding at December 31, 2007 and September 30, 2007, respectively | 339 | 337 | ||||||
| Additional paid-in capital | 480,260 | 476,205 | ||||||
| Accumulated deficit | (161,420 | ) | (164,024 | ) | ||||
| Accumulated other comprehensive income | 10,322 | 8,249 | ||||||
| Total shareholders’ equity | 329,501 | 320,767 | ||||||
| Total liabilities and shareholders’ equity | $ | 408,793 | $ | 403,599 | ||||
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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ZOLTEK COMPANIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
(Unaudited)
(Amounts in thousands, except per share data)
(Unaudited)
| Three months ended December 31, | ||||||||
| 2007 | 2006 | |||||||
| Net sales | $ | 40,072 | $ | 30,285 | ||||
| Cost of sales | 29,313 | 22,434 | ||||||
| Gross profit | 10,759 | 7,851 | ||||||
| Application and development costs | 1,896 | 1,592 | ||||||
| Selling, general and administrative expenses | 4,072 | 3,242 | ||||||
| Operating income from continuing operations | 4,791 | 3,017 | ||||||
| Other income (expense): | ||||||||
| Interest expense, excluding amortization of financing fees and debt discount | (678 | ) | (1,060 | ) | ||||
| Amortization of financing fees and debt discount | (1,554 | ) | (1,303 | ) | ||||
| Warrant issuance expense | — | (6,362 | ) | |||||
| Gain on value of warrants and conversion feature | — | 204 | ||||||
| Interest income | 1,192 | 386 | ||||||
| Other, net | (142 | ) | (274 | ) | ||||
| Income (loss) from continuing operations before income taxes | 3,609 | (5,392 | ) | |||||
| Income tax expense | 1,005 | 203 | ||||||
| Net income (loss) from continuing operations | 2,604 | (5,595 | ) | |||||
| Discontinued operations: | ||||||||
| Net loss on discontinued operations, net of taxes | — | (68 | ) | |||||
| Net income (loss) | $ | 2,604 | $ | (5,663 | ) | |||
| Net income (loss) per share: | ||||||||
| Basic income (loss) per share: | ||||||||
| Continuing operations | $ | 0.08 | $ | (0.22 | ) | |||
| Discontinued operations | 0.00 | 0.00 | ||||||
| Total | $ | 0.08 | $ | (0.22 | ) | |||
| Diluted income (loss) per share: | ||||||||
| Continuing operations | $ | 0.08 | $ | (0.23 | ) | |||
| Discontinued operations | 0.00 | 0.00 | ||||||
| Total | $ | 0.08 | $ | (0.23 | ) | |||
| Weighted average common shares outstanding — basic | 33,756,205 | 25,944,705 | ||||||
| Weighted average common shares outstanding — diluted | 33,956,205 | 25,960,705 | ||||||
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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ZOLTEK COMPANIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
(Amounts in thousands)
(Unaudited)
(Amounts in thousands)
(Unaudited)
| Add’l | Accumulated Other | |||||||||||||||||||||||
| Common | Paid-In | Accumulated | Comprehensive | Total Shareholders’ | ||||||||||||||||||||
| Stock | Capital | Deficit | Income | Equity | ||||||||||||||||||||
| Balance, September 30, 2007 | $ | 337 | $ | 476,205 | $ | (164,024 | ) | $ | 8,249 | $ | 320,767 | |||||||||||||
| Convertible debt converted | 2 | 2,851 | — | — | 2,853 | |||||||||||||||||||
| Stock option compensation expense | — | 484 | — | — | 484 | |||||||||||||||||||
| Warrants exercised | — | 25 | — | — | 25 | |||||||||||||||||||
| Exercise of stock options | — | 695 | — | — | 695 | |||||||||||||||||||
| Net income | — | — | 2,604 | — | 2,604 | |||||||||||||||||||
| Foreign currency translation adjustment | — | — | — | 2,073 | 2,073 | |||||||||||||||||||
| Balance, December 31, 2007 | $ | 339 | $ | 480,260 | $ | (161,420 | ) | $ | 10,322 | $ | 329,501 | |||||||||||||
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
(Unaudited)
(Amounts in thousands)
(Unaudited)
| Three months ended December 31, | ||||||||
| 2007 | 2006 | |||||||
| Net income (loss) | $ | 2,604 | $ | (5,663 | ) | |||
| Foreign currency translation adjustments | 2,073 | 11,486 | ||||||
| Comprehensive income | $ | 4,677 | $ | 5,823 | ||||
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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ZOLTEK COMPANIES, INC.
CONSDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
(Amounts in thousands)
(Unaudited)
| Three months ended | ||||||||
| December 31, | ||||||||
| 2007 | 2006 | |||||||
| Cash flows from operating activities: | ||||||||
| Net income (loss) | $ | 2,604 | $ | (5,663 | ) | |||
| Net loss from discontinued operations | — | 68 | ||||||
| Net income (loss) from continuing operations | 2,604 | (5,595 | ) | |||||
| Adjustments to reconcile net income (loss) to net cash from operating activities: | ||||||||
| Depreciation and amortization | 3,360 | 2,010 | ||||||
| Amortization of financing fees and debt discount | 1,554 | 1,303 | ||||||
| Warrant issue expense | — | 6,362 | ||||||
| Gain on value of warrants and conversion feature | — | (204 | ) | |||||
| Foreign currency transaction losses | 226 | 274 | ||||||
| Deferred taxes | 64 | — | ||||||
| Stock option compensation expense | 484 | 117 | ||||||
| Changes in assets and liabilities: | ||||||||
| Decrease in accounts receivable | 5,667 | 844 | ||||||
| Increase in inventories | (7,007 | ) | (5,824 | ) | ||||
| Increase in other current assets and other assets | (6,146 | ) | (923 | ) | ||||
| (Decrease) increase in trade accounts payable | (2,351 | ) | 4,853 | |||||
| (Decrease) increase in accrued expenses and other liabilities | 856 | (413 | ) | |||||
| Decrease in legal liabilities | (159 | ) | (75 | ) | ||||
| Decrease in other long-term liabilities | — | 119 | ||||||
| Net cash (used in) provided by continuing operations | (848 | ) | 2,848 | |||||
| Net cash provided by discontinued operations | — | 880 | ||||||
| Net cash (used in) provided by operating activities | (848 | ) | 3,728 | |||||
| Cash flows from investing activities: | ||||||||
| Purchases of property and equipment | (12,480 | ) | (12,338 | ) | ||||
| Proceeds from Hungarian government grant | 779 | — | ||||||
| Purchase of the Mexico facility | (35,000 | ) | — | |||||
| Change in cash restricted for letters of credit | (9,685 | ) | 6,634 | |||||
| Net cash used in investing activities | (56,386 | ) | (5,704 | ) | ||||
| Cash flows from financing activities: | ||||||||
| Proceeds from exercise of stock options and warrants | 720 | 12,659 | ||||||
| Proceeds from issuance of convertible debt | — | 7,495 | ||||||
| Proceeds from issuance of note payable to related party | — | 10,000 | ||||||
| Payment of financing fees | — | (641 | ) | |||||
| (Repayment) borrowings under notes payable and long-term debt | (1,550 | ) | 243 | |||||
| Net cash (used in) provided by financing activities | (830 | ) | 29,756 | |||||
| Effect of exchange rate changes on cash and cash equivalents | (48 | ) | 293 | |||||
| Net (decrease) increase in cash and cash equivalents | (58,112 | ) | 28,073 | |||||
| Cash and cash equivalents at beginning of period | 121,761 | 10,803 | ||||||
| Cash and cash equivalents at end of period | $ | 63,649 | $ | 38,876 | ||||
| Non-cash conversion of convertible debentures | $ | 2,853 | $ | 1,200 | ||||
| Net cash paid during the period for income taxes | $ | 316 | $ | — | ||||
| Net cash paid during the period for interest | $ | 446 | $ | 2,746 | ||||
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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ZOLTEK COMPANIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. ORGANIZATION AND BASIS OF PRESENTATION
Zoltek Companies, Inc. (the “Company”) is a holding company, which operates through wholly-owned subsidiaries, Zoltek Corporation, Zoltek Properties, Inc., Zoltek Zrt., and Engineering Technology Corporation (“Entec”). Zoltek Corporation (“Zoltek”) develops, manufactures and markets carbon fibers 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. Zoltek Zrt. is a Hungarian subsidiary that manufactures and markets carbon fibers and technical fibers and manufactures precursor raw material used in production of carbon fibers. Entec manufactures and sells 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’s sales to Asian markets are increasing.
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 regulation of the Securities and Exchange Commission. 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, 2007, which includes consolidated financial statements and notes thereto. In the opinion of management, all normal recurring adjustments and estimates considered necessary 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 translation of financial statements of the Company’s foreign subsidiaries are reflected as other comprehensive income within shareholders’ equity. Gains and losses from foreign currency transactions are included in the condensed consolidated statement of operations as “Other, net.” All significant inter-company transactions and balances have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the current year presentation.
Adoption of New Accounting Standards
Effective October 1, 2007, we adopted the Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes — and Interpretation of FASB No. 09 (“FIN 48”). FIN 48 addresses the diversity in practice and clarifies the accounting for uncertain tax positions. FIN 48 prescribes a comprehensive model as to how a company should recognize, present, and disclose in its financial statements uncertain tax positions. FIN 48 prescribes a comprehensive model as to how a company should recognize, present, and disclose in its financial statements uncertain tax positions that a company has taken or expects to take on its tax return. FIN 48 specifically requires companies to presume that the taxing authorities have full knowledge of the positions and all relevant facts. Furthermore, based on this presumption, FIN 48 requires that the financial statements reflect expected future consequences of such positions.
2. INVENTORIES
Inventories consist of the following (amounts in thousands):
| December 31, | September 30, | |||||||
| 2007 | 2007 | |||||||
| Raw materials | $ | 13,412 | $ | 7,941 | ||||
| Work-in-process | 9,601 | 11,832 | ||||||
| Finished goods | 11,551 | 7,632 | ||||||
| Supplies and other | 604 | 536 | ||||||
| $ | 35,168 | $ | 27,941 | |||||
Inventories are valued at the lower of cost, determined on the first-in, first-out method, or market. Cost includes material, labor and overhead. The Company recorded an inventory valuation reserve of $0.6 million as of December 31, 2007 and September 2007 to reduce the carrying value of inventories to net realizable value. The reserves were established primarily due to industry overcapacity for certain carbon fiber products in prior years.
3. SEGMENT INFORMATION
The Company’s strategic business units are based on product lines and have been grouped into three reportable segments: Carbon Fibers, Technical Fibers and Corporate/Other Products. The Carbon Fibers segment manufactures low-cost carbon fibers used as reinforcement material in composites, carbon fiber composite products and filament winding equipment used in the composite industry. The Technical Fibers segment manufactures oxidized acrylic 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 and seek to aggressively market carbon fibers and technical fibers. The Carbon Fibers and Technical Fibers segments are located geographically in North America and Hungary.
During the fourth quarter of fiscal 2006, the Company formally adopted a plan to sell certain of the assets of its continuously extruded netting division and to discontinue and exit another division that manufactured thermoplastic components. These operations
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have since been reported as discontinued operations. As of the end of fiscal 2007, the remaining operations related to exiting the thermoplastic division are immaterial to the Company’s overall operations and will, therefore, no longer be segregated from continuing operations. The remaining business represented in the Corporate/Other Products segment relate to water treatment and electrical services provided by the Hungarian operations.
Management evaluates the performance of its operating segments on the basis of operating income (loss) contribution to the Company. The following table presents financial information on the Company’s operating segments as of and for the three months ended December 31, 2007 and 2006 (amounts in thousands):
| Three months ended December 31, 2007 | ||||||||||||||||
| Carbon | Technical | Corporate/ | ||||||||||||||
| Fibers | Fibers | Other | Total | |||||||||||||
| Net sales | $ | 34,120 | $ | 5,033 | $ | 919 | $ | 40,072 | ||||||||
| Cost of sales | 24,958 | 3,713 | 642 | 29,312 | ||||||||||||
| Gross profit | 9,162 | 1,320 | 277 | 10,760 | ||||||||||||
| Operating income (loss) | 7,816 | 83 | (3,107 | ) | 4,792 | |||||||||||
| Depreciation and amortization expense | 2,593 | 542 | 225 | 3,360 | ||||||||||||
| Capital expenditures | 12,062 | 316 | 102 | 12,480 | ||||||||||||
| Three months ended December 31, 2006 | ||||||||||||||||
| Carbon | Technical | Corporate/ | ||||||||||||||
| Fibers | Fibers | Other | Total | |||||||||||||
| Net sales | $ | 21,121 | $ | 8,519 | $ | 645 | $ | 30,285 | ||||||||
| Cost of sales | 16,476 | 5,671 | 287 | 22,434 | ||||||||||||
| Gross profit | 4,645 | 2,848 | 358 | 7,851 | ||||||||||||
| Operating income (loss) | 2,655 | 2,510 | (2,148 | ) | 3,017 | |||||||||||
| Depreciation and amortization expense | 1,347 | 550 | 113 | 2,010 | ||||||||||||
| Capital Expenditures | 9,260 | 1,761 | 1,317 | 12,338 | ||||||||||||
| Total Assets | ||||||||||||||||||||
| Carbon | Technical | Corporate/ | ||||||||||||||||||
| Fibers | Fibers | Other | Total | |||||||||||||||||
| December 31, 2007 | $ | 276,569 | $ | 34,566 | $ | 97,658 | $ | 408,793 | ||||||||||||
| September 30, 2007 | 217,662 | 36,833 | 149,104 | 403,599 | ||||||||||||||||
4. FINANCING
Fiscal 2008 Financing Activity
During the first quarter of fiscal 2008, certain investors converted an aggregate of $2.9 million aggregate principal and interest on convertible debt privately placed in the May, July and October 2006 issuances into 111,739 shares of common stock at conversion prices of $25.51, which was recorded into shareholders’ equity as of December 31, 2007. The Company recorded a non-cash charge of $1.4 million to amortization of financing fees and debt discount representing the remaining unamortized debt discount and deferred financing fees associated with the converted debt.
The terms of repayment for each convertible debt issuance in May, July and October 2006 stipulate that the Company shall pay the principal balance in ten equal quarterly installments commencing on the date 15 months following the closing date and continues for each of the nine quarters thereafter. As of December 31, 2007, the stock price was above the conversion price for all issuances. Therefore, the Company does not anticipate that any of its lenders will demand cash repayment in the near future. Additionally, the May, July and October 2006 issuances allow the Company to require conversion if the price of the Company’s stock stays above $42.50 per share for a period of 20 consecutive days beginning six months after the date of registration of the resale of the underlying shares.
Fiscal 2007 Financing Activity
During the third quarter of fiscal 2007, the Company filed a shelf registration statement with the SEC for a periodic offering of securities with an aggregate public offering price of up to $350.0 million, of which up to $30.0 million may be offered by selling shareholders, in debt securities, common and preferred stock, warrants and/or units. The registration statement provides that the Company may sell securities in one or more separate offerings with the size, price and terms to be determined at the time of sale. On August 14, 2007, the Company completed a public offering of 3,615,000 shares of common stock, par value $0.01 per share, at $38.76 per share, less underwriting discounts. The Company recorded the proceeds of $131.5 million, net of $0.8 million financing costs, as an increase to shareholders’ equity.
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Bond Related to SP Systems Case
In December 2006, the Company obtained the financing to post a bond of up to $40.0 million, which represented the potential bond necessary in connection with the continuing defense of the SP Systems case. The Company raised the financing with a $10.0 million loan commitment from its U.S. bank collateralized by certain real estate of the Company at an interest rate of 7.5%, a $10.0 million loan commitment from the Company’s Chief Executive Officer at 8% interest , the proceeds from the exercise of 827,789 warrants for $11.9 million by existing institutional shareholders and the remainder with the Company’s cash on hand.
In April 2007, the Company reported the results of various post-trial motions in ongoing litigation against its Zoltek Corporation subsidiary brought by SP Systems (see Note 4). The Company posted a supersedeas bond in April 2007, collateralized by a $23.5 million letter of credit issued by the Company’s U.S. bank. As of December 31, 2007, the letter of credit is collateralized by $23.5 million of restricted cash. The Company repaid the loan from to the Chief Executive Officer during the fourth quarter of fiscal 2007.
Hungarian Government Grant
The Hungarian government has pledged a grant of 2.9 billion HUF (approximately $16.8million) to Zoltek’s Hungarian subsidiary that will partially provide the capital resources to modernize its facility, establish a research and development center, and support buildup of manufacturing capacity of carbon fibers. Through December 31, 2007, Zoltek’s Hungarian subsidiary received approximately $10.4 million in grant funding. These funds have been recorded as a liability on the Company’s balance sheet. The liability will be amortized over the life of the assets procured by the grant funds, offsetting the assets’ depreciation expense.
The Company intends to present bank guarantees amounting to 120% of the amount of the grant as received. The Hungarian subsidiary may be required to pay back all or a portion of the grant if, among other things, the Hungarian subsidiary fails to achieve excess export revenues amounting to an average annual sum of 21.7 billion HUF (approximately $125.4 million); fails to employ an average annual staff of 1,200 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. Currently, management anticipates the Company will comply with the requirements of the grant agreement.
Convertible Debt
During fiscal 2007, certain investors converted an aggregate of $6.5 million aggregate principal and interest on convertible debt privately placed in the May 2006 and February 2003 issuances into 920,391 shares of common stock at conversion prices of $25.51 and $3.50 per share, respectively, which was recorded into shareholders’ equity as of September 30, 2007. The Company recorded a non-cash charge of $2.8 million to amortization of financing fees and debt discount representing the remaining unamortized debt discount and deferred financing fees associated with the converted debt. Investors also converted during fiscal 2007an aggregate of $28.3 million principal and interest on convertible debt privately placed in the September 2005, December 2005 and February 2006 issuances into 2.2 million shares of common stock at conversion prices of $12.50, $12.50 and $13.07 per share, respectively, which was recorded into shareholders’ equity. The Company recorded a non-cash charge of $3.3 million to amortization of financing fees and debt discount representing the remaining unamortized debt discount and deferred financing fees associated with the converted debt.
In October 2006, the Company issued convertible debentures in the aggregate principal amount of $7.5 million to institutional private equity investors. The convertible debentures have a stated maturity of 42 months and bear interest at a fixed rate of 7.5% per annum. The convertible debentures are convertible into 293,767 shares of common stock at a conversion price of $25.51 per share. The Company also issued to the investors five-year warrants that give holders the right to purchase up to 102,835 shares of Zoltek common stock at an exercise price of $28.06 per share. The fair value of the debt discount associated with the warrants and conversion features at the time of issuance was $2.8 million and will be accreted to the debt’s face value over the life of the convertible debentures.
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Each outstanding issuance of convertible debt is summarized in the table below which sets forth the significant term of the debt, warrants and assumptions associated with valuing the conversion feature and warrants:
OUTSTANDING CONVERTIBLE DEBT ISSUANCES
| MAY | JULY | OCTOBER | ||||||||||
| 2006(1) | 2006(1) | 2006(1) | ||||||||||
| Amount of debenture (millions) | $ | 20.0 | $ | 2.5 | $ | 7.5 | ||||||
| Per share conversion price on debenture | $ | 25.51 | $ | 25.51 | $ | 25.51 | ||||||
| Interest rate | 7.5 | % | 7.5 | % | 7.5 | % | ||||||
| Term of debenture | 42 months | 42 months | 42 months | |||||||||
| Warrants issued | 274,406 | 34,370 | 102,835 | |||||||||
| Term of warrants | 60 months | 60 months | 60 months | |||||||||
| Per share exercise price of warrants | $ | 28.06 | $ | 28.06 | $ | 28.06 | ||||||
| Fair value per warrant at issuance | $ | 26.03 | $ | 23.89 | $ | 22.13 | ||||||
| Value per share conversion feature at issuance | $ | 18.80 | $ | 19.21 | $ | 19.57 | ||||||
| Stock price on date of agreement | $ | 32.25 | $ | 29.28 | $ | 26.81 | ||||||
| Stock volatility at issuance | 106 | % | 111 | % | 117 | % | ||||||
| Dividend yield | 0.0 | % | 0.0 | % | 0.0 | % | ||||||
| Risk-free interest rate at issuance | 4.88 | % | 4.88 | % | 4.65 | % | ||||||
| Converted | Partial | Partial | Partial | |||||||||
| Warrants exercised | No | No | Partial | |||||||||
| (1) | The May 2006, July 2006 and October 2006 issuances have a beneficial conversion feature. |
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Warrant and Conversion Features
In January, March and October 2004 and February 2005, the Company issued convertible notes and warrants that required the Company to register the resale of the shares of common stock issuable upon conversion or exercise of these securities. The Company accounts for the fair value of these outstanding warrants to purchase common stock and conversion feature of its convertible notes in accordance with Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting For Derivative Instruments And Hedging Activities,” and Emerging Issues Task Force (EITF) Issue No. 00-19, “Accounting For Derivative Financial Instruments Indexed To And Potentially Settled In A Company’s Own Stock,” which require the Company to separately account for the conversion feature and warrants as embedded derivatives contained in the Company’s convertible notes. The Company recorded the fair value of the conversion feature and warrants as long-term liabilities. The Company was required to carry these embedded derivatives on its balance sheet at fair value and unrealized changes in the values of these embedded derivatives are reflected in the consolidated statement of operations as “Loss on value of warrants and conversion feature.”
As of September 30, 2007, all such convertible notes and warrants had been exercised. See table below for impact on the results for three months ended December 31, 2006 (amounts in thousands).
| Three months ended December 31, 2006 | ||||||||||||
| Conversion | ||||||||||||
| Warrants | Features | Total | ||||||||||
| January 2004 issuance — mark to market | $ | 204 | $ | — | $ | 204 | ||||||
| Gain on value of warrants and conversion feature | $ | 204 | $ | — | $ | 204 | ||||||
Amortization of Financing Fees and Debt Discount
At the time of issuance of convertible debt securities with warrants, the Company recorded the fair value associated with the warrants using the Black-Scholes option-pricing model. This fair value discount was recorded as a reduction in the carrying value of the convertible debt security that is accreted to its face value over the life of the convertible security and expensed into the Company’s income statement. If the convertible security is converted prior to the redemption date, the unamortized debt discount associated with the valuation of the warrants is recorded as a reduction to additional paid-in capital at the time of conversion.
The February 2005, February 2006, May 2006, July 2006 and October 2006 issuances were considered to have a beneficial conversion feature because the adjusted conversion price after allocating a portion of the proceeds to the warrants, as discussed above, was less than the Company’s market price of common stock at date of issue. The beneficial conversion is recorded as a reduction in the carrying value of the convertible debt security and is accreted to its face value over the life of the convertible security and expensed into the Company’s income statement. If the convertible security is converted prior to the redemption date, the unamortized balance is recorded in expense at the time of conversion. During the third quarter of fiscal 2006, the February 2005 issuance, which had a beneficial conversion feature, was converted and the Company recorded an expense $5.0 million for the unamortized portion on the beneficial conversion feature which is included in amortization of financing fees and debt discount in the statement of operations.
See the table below for impact of amortization of financing fees and debt discount on the financial results for the three months ended December 31, 2007 and 2006 (amounts in thousands).
| Three months ended December 31, 2007 | ||||||||||||
| Conversion | ||||||||||||
| Warrants | Features | Total | ||||||||||
| May 2006 issuance | $ | 416 | $ | 614 | $ | 1,030 | ||||||
| July 2006 2005 issuance | 73 | 90 | 163 | |||||||||
| October 2006 issuance | 117 | 133 | 250 | |||||||||
| $ | 606 | $ | 837 | $ | 1,443 | |||||||
| Deferred financing costs | 111 | |||||||||||
| Total | $ | 1,554 | ||||||||||
| Three months ended December 31, 2006 | ||||||||||||
| Conversion | ||||||||||||
| Warrants | Features | Total | ||||||||||
| September 2005 issuance | $ | 61 | $ | — | $ | 61 | ||||||
| December 2005 issuance | 109 | — | 109 | |||||||||
| February 2006 issuance | 77 | 172 | 249 | |||||||||
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| May 2006 issuance | 233 | 343 | 576 | |||||||||
| May 2006 issuance | 22 | 27 | 49 | |||||||||
| July 2006 issuance | 35 | 41 | 76 | |||||||||
| $ | 537 | $ | 583 | $ | 1,120 | |||||||
| Deferred financing costs | 183 | |||||||||||
| Total | $ | 1,303 | ||||||||||
The carrying values of unamortized debt discount and financing fees are as follows (amounts in thousands):
| December 31, 2007 | ||||||||||||
| Conversion | ||||||||||||
| Warrants | Feature | Total | ||||||||||
| May 2006 issuance | $ | 3,994 | $ | 5,897 | $ | 9,891 | ||||||
| July 2006 issuance | 527 | 634 | 1,161 | |||||||||
| October 2006 issuance | 779 | 896 | 1,675 | |||||||||
| $ | 5,300 | $ | 7,427 | $ | 12,727 | |||||||
| Debt acquisition cost and financing fees | 796 | |||||||||||
| Total | $ | 13,523 | ||||||||||
| September 30, 2007 | ||||||||||||
| Conversion | ||||||||||||
| Warrants | Feature | Total | ||||||||||
| May 2006 issuance | $ | 4,728 | $ | 6,981 | $ | 11,709 | ||||||
| July 2006 issuance | 403 | 485 | 888 | |||||||||
| October 2006 issuance | 1,236 | 1,422 | 2,658 | |||||||||
| $ | 6,367 | $ | 8,888 | $ | 15,255 | |||||||
| Debt acquisition cost and financing fees | 985 | |||||||||||
| Total | $ | 16,240 | ||||||||||
Earnings Per Share
In accordance with SFAS No. 128, “Earnings per Share,” the Company has evaluated its diluted income per share calculation. The Company does have outstanding warrants and convertible debt at December 31, 2007 and 2006 which are not included in the determination of diluted loss per share for the three months ended December 31, 2007 and 2006 because the shares are anti-dilutive. Had these securities been dilutive, an additional 1.4 million and 4.3 million shares would have been included in the Company’s diluted loss per share calculation.
The following is the diluted impact of the convertible debt and warrants on loss per share for the three months ended December 31, 2007 and 2006, respectively:
| Three months ended | ||||||||
| December 31, | ||||||||
| 2007 | 2006 | |||||||
| Numerators: | ||||||||
| Income (loss) from continuing operations | $ | 2,604 | (5,595 | ) | ||||
| Impact of convertible debt and warrants: | ||||||||
| Less: gain on value of beneficial conversion feature and warrants | — | (204 | ) | |||||
| Income (loss) from continuing operations | 2,604 | (5,799 | ) | |||||
| Loss from discontinued operations | — | (68 | ) | |||||
| Net income (loss) | $ | 2,604 | (5,867 | ) | ||||
| Denominators: | ||||||||
| Average shares outstanding — basic | 33,756 | 25,945 | ||||||
| Impact of convertible debt, warrants and stock options | 200 | 16 | ||||||
| Average shares outstanding — diluted | 33,956 | 25,961 | ||||||
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| Three months ended | ||||||||
| December 31, | ||||||||
| 2007 | 2006 | |||||||
| Income (loss) per share — basic: | ||||||||
| Continuing operations | $ | 0.08 | $ | (0.22 | ) | |||
| Discontinued operations | 0.00 | 0.00 | ||||||
| Basic income (loss) per share | $ | 0.08 | $ | (0.22 | ) | |||
| Income (loss) per share — diluted: | ||||||||
| Continuing operations | $ | 0.08 | $ | (0.23 | ) | |||
| Discontinued operations | 0.00 | 0.00 | ||||||
| Diluted income (loss) per share | $ | 0.08 | $ | 0.23 | ||||
5. DEBT
Credit Facilities
US Operations — In December 2007, the Company extended its existing line of credit until January 1, 2009. The revolving credit facility has a total commitment of the lesser of (1) $6.7 million or (2) an amount equal to a percentage of eligible accounts receivable plus a percentage of eligible inventories, which as of December 31, 2007 totaled $6.3 million. As of December 31, 2007, there is no available borrowing base under the revolving credit facility. No financial covenants currently apply to the credit facility from the U.S. bank.
Hungarian Operations — The Company’s Hungarian subsidiary has a credit facility with a Hungarian bank. Total borrowings under this credit facility were $5.0 million at December 31, 2007. The credit facility is a term loan with quarterly interest payments and repayment of principal at the maturity date on December 31, 2008.
Long-term debt consists of the following (amounts in thousands):
| December 31, | September 30, | |||||||
| 2007 | 2007 | |||||||
| Note payable with interest at 9%, payable in eleven monthly installments of principal and interest of $15 to maturity in January 2009 | $ | 1,261 | $ | 1,272 | ||||
| Non-interest bearing note payable (discounted at 8%) to the City of Abilene, Texas to be repaid from real estate and personal property tax abatements | 2,065 | 2,030 | ||||||
| Facilities with Hungarian banks (interest rate of 5.5% to 10.6%) | 4,974 | 6,417 | ||||||
| Convertible debentures final payment due November 2009 bearing interest at 8.8% | 14,600 | 16,200 | ||||||
| Convertible debentures final payment due January 2010 bearing interest at 7.5% | 2,255 | 2,505 | ||||||
| Convertible debentures final payment due January 2010 bearing interest at 7.5% | 6,494 | 7,495 | ||||||
| Total long-term debt including current maturities | 31,649 | 35,919 | ||||||
| Less: Debt discount associated with conversion feature and warrants | (12,728 | ) | (15,255 | ) | ||||
| Less: Amounts payable within one year, net of discount of $5,867 and $7,006 | (12,982 | ) | (13,813 | ) | ||||
| Total long-term debt, less current maturities | $ | 5,939 | $ | 6,851 | ||||
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6. DISCONTINUED OPERATIONS
During the fourth quarter of fiscal 2006, the Company formally adopted a plan to discontinue and exit certain of the assets of its continuously extruded netting division and to discontinue and exit another division that manufactured thermoplastic components. The discontinuation of the thermoplastic division was completed in October 2006. As of the end of fiscal 2007, the remaining operations related to exiting the thermoplastic division are immaterial to the Company’s overall operations and will, therefore, no longer be segregated from continuing operations. The Company incurred no significant exit costs for the selling or discontinuation of these businesses. These divisions were not part of the long-term strategy of the Company and were not expected to be profitable in the foreseeable future due to the continued pricing pressure from competitive manufacturers. The results from operations of these two divisions have been reclassified to discontinued operations for fiscal 2006 and 2007. Previous to the Company’s fiscal 2006 Form 10-K filing, these businesses collectively comprised the Specialty Products segment and were disclosed as such. Certain information with respect to the discontinued operations for the three months ended December 31, 2006 is summarized as follows (amounts in thousands):
| Three months ended | ||||
| December 31, 2006 | ||||
| Net sales | $ | 1,293 | ||
| Cost of sales | 1,252 | |||
| Gross profit | 41 | |||
| Selling, general and administrative expenses | 87 | |||
| Income (loss) from operations | (46 | ) | ||
| Other (loss) income | (22 | ) | ||
| Income (loss) on discontinued operations | $ | (68 | ) | |
7. STOCK OPTION COMPENSATION EXPENSE
The Company maintains a Long-term Incentive Plan that authorizes the Board of Directors or its Compensation Committee (the “Committee”) to grant key employees, officers and non-employee 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. Outstanding stock options expire 10 years from the date of grant or upon termination of employment. Options granted to employees in 2007 vest 17% in the first year, 33% in the second year and 50% in the third year from date of grant. Options granted to employees in 2005 and 2006 vest two years from the date of grant. The fair value of all options are amortized on a straight-line basis over the vesting period. Annually options to purchase 7,500 shares of common stock are issued to each director, other than the CEO. In addition, newly elected non-employee directors receive options to purchase 7,500 shares of common stock. All options granted to non-employee directors vest immediately at time at grant. All options are issued at a price equal to the market price on the date the Board of Directors approves the grant. These options expire from 2008 through 2017.
Presented1 below is a summary of stock options activity for the first quarter of fiscal 2008:
| Wtd. Avg. | Wtd. Avg. | Wtd. Avg. | ||||||||||||||
| Options | Exercise Price | Exercisable | Exercise Price | |||||||||||||
| Balance, September 30, 2007 | 369,810 | $ | 16.02 | 264,800 | $ | 17.23 | ||||||||||
| Granted | 150,000 | 29.70 | ||||||||||||||
| Exercised | (85,213 | ) | 8.16 | |||||||||||||
| Balance, December 31, 2007 | 434,597 | 22.28 | 272,097 | 16.80 | ||||||||||||
The following table summarizes information for options currently outstanding and exercisable at December 31, 2007:
| Options Outstanding | Options Exercisable | |||||||||||||||||||
| Range of | Wtd. Avg. | Wtd. Avg. | Wtd. Avg. | |||||||||||||||||
| Exercise Prices | Number | Remaining Life | Exercise Price | Number | Exercise Price | |||||||||||||||
| $ | 1.33-2.80 | 17,000 | 5 years | $ | 2.44 | 17,000 | $ | 2.44 | ||||||||||||
| 3.25-5.67 | 15,000 | 4 years | 5.25 | 15,000 | 5.25 | |||||||||||||||
| 6.25-9.25 | 62,587 | 7 years | 8.17 | 62,587 | 8.17 | |||||||||||||||
| 9.60-15.99 | 82,510 | 7 years | 13.80 | 82,510 | 14.07 | |||||||||||||||
| 26.22-39.00 | 257,500 | 8 years | 30.72 | 95,000 | 29.49 | |||||||||||||||
| 1.33-39.00 | 434,597 | 8 years | 22.28 | 272,097 | 16.80 | |||||||||||||||
The Company has historically accounted for stock-based compensation in accordance with that prescribed by Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees” and its related interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation”. APB 25 required the use of the intrinsic value method, which measures compensation cost as the excess, if any, of the quoted market price of the stock over the amount the employee must pay for the stock. Compensation expense for substantially all of the Company’s equity based awards was measured under APB 25 on the date the shares were granted. Under APB 25, no compensation expense was recognized for stock options. The total intrinsic value of options outstanding at December 31, 2007 and 2006 was approximately $6,616,230 and $4,071,000, respectively.
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For the three months ended December 31, 2007 and 2006, the Company recorded into selling and general administrative expense and into its corporate/other segment $0.5 million and $0.1 million, respectively, for 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 SFAS No. 123-(R).
The fair value of each option grant during the first quarter of fiscal 2008 and twelve months of fiscal 2007 is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
| Assumptions | Fiscal 2008 | Fiscal 2007 | ||||||
| Expected life of option | 4 years | 3 & 7.5 years | ||||||
| Risk-free interest rate | 4.9 | % | 4.9 | % | ||||
| Volatility of stock | 66 | % | 66 | % | ||||
| Forfeiture experience | 44 | % | 30 | % | ||||
The Company uses historical volatility for a period of time that is comparable to the expected life of the option. However, the Company only calculates the volatility of the Company’s stock back to November 2003, the date the Company received its first large order for carbon fibers, as that is when the Company considers its business to have changed from a research and development company to an operational company. Management believes this is a better measurement of the Company’s stock volatility.
The fair value of the options granted during the first quarter of fiscal 2008 and the twelve months ended of fiscal 2007 was $2,361,132 and $1,377,648, respectively. As of December 31, 2007, the Company had $2.5 million of total unrecognized compensation expense related to stock option plans that will be recognized over the fiscal years 2008, 2009 and 2010. Cash proceeds received from the exercise of stock options were $0.7 million and $0.4 million for the first quarter of fiscal 2007 and 2006, respectively.
8. COMMITMENTS AND CONTINGENCIES
Legal
Legal contingencies have a high degree of uncertainty. When losses from contingencies become estimatable and probable, reserves are established. The reserves 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 December 31, 2007, the Company had recorded a reserve for legal liabilities of $24.4 million.
In February 2005, SP Systems and its subsidiary Structural Polymer Systems, Limited filed an action against our Zoltek Corporation subsidiary in the U.S. District Court for the Eastern District of Missouri, Eastern Division alleging that we breached a Supply Agreement relating to our carbon fiber product known as Panex 33. The case was tried in November 2006 and on November 29, 2006, the jury in the case rendered verdicts against our Zoltek Corporation subsidiary in the amounts of $21.1 million and $14.9 million, respectively, which verdicts were subsequently entered as judgments against our Zoltek Corporation subsidiary. On April 12, 2007, the Court ruled on various post-trial motions, granting one of our motions to reduce the judgment from $36.0 million to $21.1 million, concluding that the jury’s award of damages on the two separate counts brought by the plaintiffs was duplicative. The Court issued an Order setting the amount of a supersedeas bond at $23.5 million in order to stay the execution of the amended judgment pending our appeal and denied our post-trial motions for a new trial and for a judgment in our favor as a matter of law. The bond was posted in April 2007. We accrued $21.8 million during the fourth quarter of fiscal 2006 in respect of the potential liability and related legal fees in this matter. We have filed an appeal and the plaintiffs have filed a cross appeal. The appeal was argued in January 2008 and a ruling from the appeals court is pending. On the basis of the plaintiffs’ settlement proposals and the reduction of the judgment in April 2007, the Company reduced the accrual to $18.9 million, which decreased litigation charges by $2.1 million for the quarter ended June 30, 2007. As of December 31, 2007, the Company’s accrual with respect to this matter has been reduced to $18.5 million due to litigation cost incurred during the first quarter. The ultimate resolution of this litigation may have a material adverse impact on our results of operations, financial condition or cash flow.
In September 2004, the Company was named a defendant in a civil action filed by an investment banker that was retained to obtain equity investors, alleging breach by the Company of the Company’s obligations under the agreement signed by the parties. A decision granting summary judgment against Zoltek was entered in April 2005. A trial on damages took place in December 2005, after which a judgment was filed in May 2006 against the Company in the amount of $4.1 million in cash and the Court ordered us to issue warrants to purchase 122,888 shares of Zoltek’s common stock at various prices. In October 2007, the United States Court of Appeals for the Second Circuit upheld the liability against Zoltek affirming $2.5 million in cash and approximately 92,000 warrants. The Court reversed the district court’s award of attorney’s fees stemming from indemnification of the plaintiff by Zoltek and remanded the determination of damages in respect to placements of securities not closed within the 18-month tail period back to the district court for reconsideration. The appeal process continues and attempts to settle this case have been made. To date, the Company has not made payments of any portion of this obligation or issued the warrants, although Zoltek posted an appeal bond in the amount of $6.6 million. On the basis of the appeals court ruling and the ongoing settlement discussions the Company charged $5.4 million to litigation charges during the fourth quarter of fiscal 2007 to increase the accrual as of December 31, 2007 to $5.9 million. This accrual is based on management’s best estimate of exposure for this matter, including a likely cash settlement of $2.5 million and a potential issuance of 92,000 warrants valued using the stock price on the date of the appeals court ruling net of the warrants’ exercise price. The Company expects to adjust the recorded liability for this potential warrant issuance as the Company’s stock price materially increases or decreases. These charges or income could be material. If negotiations for settlement of this case are unsuccessful, this matter could have a material adverse effect on our results of operations, financial condition or cash flow.
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The Company is a party to various other 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 these other claims and lawsuits should not have a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity.
Concentration of Credit Risk
Zoltek’s carbon fiber products are primarily sold to customers in the composite industry and its technical fibers are primarily sold to customers in the aerospace industries. Entec ‘s 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, 2007 and 2006, we reported sales of $21.8 million and $8.5 million, respectively, and a related open account receivable balance of $12.6 million and $2.6 million as of December 31, 2007 and 2006, respectively, to a wind turbine manufacturer. In the three months ended December 31, 2007 and 2006, the Company reported sales of $3.7 million to a European manufacturer of prepreg material. These were the only customers that represented greater than 10% of consolidated net sales.
Environmental
The Company’s operations generate various hazardous wastes, including gaseous, liquid and solid materials. Zoltek believes that all of its facilities are in substantial compliance with applicable environmental and safety regulations applicable to their respective operations. Zoltek expects that compliance with current environmental regulations will not have a material adverse effect on the business, results of operations or financial condition of the Company. There can be no assurance, that compliance with future national or local environmental laws, regulations and enforcement policies will not have a material adverse effect on the business, results of operations or financial condition of the Company.
Sources of Supply
As part of its growth strategy, the Company has developed 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. The major materials used by the Specialty Products segment include basic commodity products, which are widely available from a variety of sources.
9. INCOME TAXES
In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes — and interpretation of FASB Statement No. 109, Accounting for Income Taxes. The Interpretation addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, companies may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. The Company adopted the provisions of FIN 48 on October 1, 2007. The Company recognized no increase or decrease in the liability for unrecognized benefits for the first quarter of fiscal 2008.
Zoltek and our U.S. subsidiaries join in the filing of a U.S. federal consolidated income tax return. The Internal Revenue Service “IRS” concluded its examination of our consolidated federal income tax returns for the fiscal year ended September 30, 2003. The U.S. federal statute of limitations remains open for the year 2003 and onward. Foreign and U.S. state jurisdictions have statutes of limitations generally ranging from 3 to 5 years. Years still open to examination by foreign tax authorities include Hungary (2005 onward).
As of December 31, 2007, we had uncertain tax positions for which it is reasonably possible that amounts of unrecognized tax benefits could significantly change over the next year. We expect that amount of unrecognized tax benefits will continue to change in the next twelve months as a result of ongoing tax deductions, the outcomes of audits and the passing of the statute of limitations.
10. SUBSEQUENT EVENTS
In April 2008, the Company’s management identified two payments by a subsidiary in the amounts of $175,000 and $75,000 in September 2007 and January 2008, respectively, that were not properly authorized or recorded in the Company’s financial statements. The two payments were made by the Company’s Hungarian subsidiary at the direction of Kevin J. Schott, the former Chief Financial Officer of the Company. On May 2, 2008, Mr. Schott agreed to resign as Chief Financial Officer of the Company and paid the Company $250,000. Management promptly advised the Audit Committee of its Board of Directors and its independent registered public accounting firm of the two payments that were not properly authorized or recorded. The Audit Committee and management immediately initiated an investigation into the circumstances of the payments and to determine whether there were other transactions that were not properly authorized or recorded. On May 5, 2008, following a review by the Audit Committee, the Company filed a Current Report on Form 8-K reporting that it had determined that its previously issued financial statements as of September 30, 2007 and for the fiscal year then ended and as of December 31, 2007 and for the quarter then ended should no longer be relied upon pending completion of the Audit Committee’s investigation.
In connection with Mr. Schott’s resignation, the Company and Mr. Schott entered into a separation agreement under which Mr. Schott agreed to resign from the Company as of May 2, 2008, Mr. Schott paid the Company $250,000, and the Company agreed to pay him his salary and routine employee benefits through that date. The Company released Mr. Schott from claims arising out of the above-described payments that were not properly authorized or recorded and Mr. Schott released the Company from claims arising out of his employment and agreed to cooperate with the Company in connection with matters relating to his employment.
The Audit Committee has conducted its accounting investigation, including with respect to the circumstances of the two payments and whether there were additional payments that were not properly authorized or recorded in the Company’s financial statements. The Audit Committee’s investigation included specified forensic audit procedures conducted by the Company’s internal accounting staff and additional procedures developed and performed by forensic accounting experts of an independent accounting firm. The Audit Committee’s investigation has concluded and, based upon the forensic accounting procedures performed, did not detect the existence of other transactions that were not properly authorized or recorded.
The Company has concluded that the Company’s previously issued financial statements as of September 30, 2007 and for the fiscal year then ended and as of December 31, 2007 and for the quarter then ended can be relied upon, and that no restatement of these financial statements is required.
Management and the Audit Committee assessed the aggregate $250,000 amount under Staff Accounting Bulletin 99 and Staff Accounting Bulletin 108 and determined that the misstatement was not material to the results reflected in the consolidated financial statements. The $250,000 aggregate amount of the two unauthorized payments has been recorded below operating income as other expense in the Company’s consolidated statements of operations for the three and six months ended March 31, 2008. To reflect the receipt of the payment from Mr. Schott, the Company will record $250,000 below operating income as other income in the Company’s consolidated statements of operations for the three and nine months ending June 30, 2008. The Company is concurrently filing amendments to its previously filed Annual Report on Form 10-K for the fiscal year ended September 30, 2007 and Quarterly Report on Form 10-Q for the quarter ended December 31, 2007 to reflect the above-described developments.
On May 13, 2008, the Company received a letter from the enforcement staff of the Securities and Exchange Commission indicating that the staff was conducting a non-public, fact finding investigation and requested that the Company retain certain records and produce information and documents related to matters disclosed in the Company’s Current Report on Form 8-K filed May 5, 2008. The Company has advised the staff that it will cooperate fully with its investigation.
11. NEW ACCOUNTING PRONOUNCEMENTS
Effective October 1, 2007, we adopted the Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes — and Interpretation of FASB No. 09 (“FIN 48). FIN 48 addresses the diversity in practice and clarifies the accounting for uncertain tax positions. FIN 48 prescribes a comprehensive model as to how a company should recognize, present, and disclose in its financial statements uncertain tax positions that a company has taken or expects to take on its tax return. FIN 48 specifically requires companies to presume that the taxing authorities have full knowledge of the positions and all relevant facts. Furthermore, based on this presumption, FIN 48 requires that the financial statements reflect expected future consequences of such positions.
Under FIN 48 an uncertain tax position needs to be sustainable at a more likely than not level based upon its technical merits before any benefit can be recognized. The tax benefit is measured as the largest amount that has a cumulative probability of greater than 50% of being the final outcome. FIN 48 substantially changes the applicable accounting model (as the prior model followed the criteria of FAS 5, Accounting for contingencies, recording a liability against an uncertain tax benefit when it was probable and estimable) and is likely to cause greater volatility in income statements as more items are recognized within income tax expense. FIN 48 also revises disclosure requirements and introduces a prescriptive, annual, tabular roll-forward of the unrecognized tax benefits.
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FASB statement No. 141 (R) “Business Combinations” was issued in December of 2007. This Statement establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The Statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The guidance will become effective as of the beginning of a company’s fiscal year beginning after December 15, 2008. The Company believes that this new pronouncement will have an immaterial impact on the Company’s financial statements in future periods.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| Zoltek Companies, Inc. | ||||
| (Registrant) | ||||
| Date: June 26, 2008 | By: | /s/ ZSOLT RUMY | ||
| Zsolt Rumy | ||||
| Chief Executive Officer and Chief Financial Officer | ||||
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EXHIBIT INDEX
| Exhibit Number | Description of Document | |
| 10.1 | Third Amendment to Credit Agreement, dated as of January 13, 2003, by and among Zoltek Companies, Inc., Zoltek Corporation, Cape Composites, Inc., Engineering Technology Corporation, Zoltek Properties, Inc. and Southwest Bank of St. Louis filed as Exhibit 10.14 to Registrant’s Annual Report on Form 10-K for the fiscal year ended September 30, 2003, is filed herewith* | |
| 31.1 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as amended. | |
| 32.1 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* Previously filed on February 11, 2008 with original filing of Form 10-Q for three months ended December 31, 2007.
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