| ZOLTEK COMPANIES INC Item 1A Risk Factors - -------- ------------ The following are certain risk factors that could affect Zoltekapstas business, financial results and results of operations |
| These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report on Form 10-K because these factors could cause the actual results and conditions to differ materially from those projected in forward-looking statements |
| Before you buy the Companyapstas common stock, you should know that making such an investment involves some risks, including the risks described below |
| The risks that the Company has highlighted here are not the only ones that the Company faces |
| If any of the risks actually occur, the Companyapstas business, financial condition or results of operations could be negatively affected |
| In that case, the trading price of its stock could decline, and you may lose all or part of your investment |
| ZOLTEK HAS REPORTED NET LOSSES AND NEGATIVE CASH FLOWS FROM OPERATIONS FOR EACH OF THE PAST FIVE FISCAL YEARS Zoltek has reported net losses and negative cash flows from continuing operations for each of the past five fiscal years in the period ended September 30, 2005 |
| The Company reported net losses of dlra31dtta6 million, dlra7dtta8 million, dlra15dtta6 million, dlra22dtta8 million and dlra40dtta4 million in the fiscal years ended September 30, 2001, 2002, 2003, 2004 and 2005, respectively |
| The Company reported negative cash flows from continuing operations of dlra6dtta2 million, dlra2dtta0 million, dlra2dtta2 million, dlra7dtta7 million and dlra7dtta4 million in the fiscal years ended September 30, 2001, 2002, 2003, 2004 and 2005, respectively |
| These net losses and negative cash flows from operations were attributable to, among other things, the adverse market conditions discussed above, combined with excess capacities and inventories it has maintained in anticipation of greater sales volumes and in 2004 and 2005 the non-cash loss related to the mark to market of derivatives of dlra4dtta9 million and dlra16dtta6 million, respectively |
| The Company cannot assure you when, if at all, it will return to profitable operations or generate cash flows from operations |
| The Company has relied on equity financing and borrowings to finance its business over the past five fiscal years |
| The Company intends to fund its near-term continuing operations from cost-containment, aggressive management of its working capital and additional bank borrowings, private equity and debt financing |
| Such additional funding may not be available on favorable terms or at all |
| If adequate funds are not otherwise available, the Company may be forced to curtail operations and/or development activities significantly, or seek other sources of capital, including asset sales |
| ZOLTEK &apos S OPERATING RESULTS HAVE BEEN ADVERSELY AFFECTED BY PREVIOUSLY ADVERSE CONDITIONS IN THE MARKETS FOR CARBON FIBER AND ACRYLIC FIBER Until fiscal 2004, Zoltekapstas carbon fiber operations were adversely affected during the preceding five years by oversupply conditions in the marketplace, coupled with an overall lack of development for large volume applications for carbon fiber composites |
| Accordingly, during such period the Company had excess carbon fiber manufacturing capacity which resulted in substantial depreciation and other charges and constrained the operating results of its carbon fiber manufacturing activities |
| Since the beginning of fiscal 2004, the market has strengthened for current and emerging applications for carbon fiber products, and it has generated meaningful orders and experienced significant sales increases in carbon fiber products |
| However, the Company may not be able to attain anticipated sales increases unless the market and demand for current and emerging applications for carbon fiber products continues to strengthen |
| Since fiscal 1998, the Companyapstas results have been negatively impacted by depressed market conditions in the acrylic fibers sector, which was a principal line of business for its Zoltek Rt |
| In the fourth quarter of fiscal 2004, the Company discontinued and exited two divisions of its Zoltek Rt |
| operations which manufacture acrylic and nylon fibers and yarns |
| In the fourth quarter of fiscal 2004, the Company recorded an impairment loss on discontinued operations of dlra0dtta2 million related to severance obligations due to discontinuance of these businesses |
| In the fourth quarter of fiscal 2005, the Company formally adopted a plan to discontinue the CMC division of its Zoltek Rt |
| operations and does not expect any impairment loss related to discontinuing of this operation |
| ZOLTEK &apos S OPERATING RESULTS HAVE BEEN ADVERSELY AFFECTED BY DIFFICULTIES IN OPERATING THE COMPANY &apos S EXPANDED CARBON FIBERS CAPACITY AT ITS ABILENE, TEXAS FACILITY Demand for Zoltekapstas carbon fibers from existing and potential new customers exceeds its current capacity, and the Company has restarted carbon fiber production at its major carbon fiber manufacturing facility in Abilene, Texas which had been temporarily idled |
| However, the Company presently cannot produce carbon fibers at levels adequate to supply current demand |
| The Company has experienced difficulties in achieving targeted production levels at its Abilene facility, which has resulted in operating losses despite strong demand for its products |
| The difficulties were due in large part the inability to recruit and train qualified workers and managers at the plant that had been dormant for several years |
| The Company may not be able to supply anticipated demand unless it is able to achieve targeted production levels at its Abilene facility |
| 11 ZOLTEK &apos S ABILITY TO MANAGE ITS ANTICIPATED GROWTH WILL AFFECT ITS OPERATING RESULTS The growth in the Companyapstas business has placed, and is expected to continue to place, a significant strain on its management and operations |
| In order to effectively manage potential long-term growth, the Company must add to its carbon fiber manufacturing capacity, have access to adequate financial resources to fund significant capital expenditures and maintain gross profit margins while pursuing a growth strategy, continuing to strengthen its operations, financial and management information systems, and expanding, training and managing its employee workforce |
| There can be no assurance that the Company will be able to do so effectively or on a timely basis |
| ZOLTEK &apos S OPERATIONS AND SALES IN FOREIGN COUNTRIES ARE SUBJECT TO RISKS Zoltekapstas international operations and sales are subject to risks associated with foreign operations and markets generally, including foreign currency fluctuations, unexpected changes in regulatory, economic or political conditions, tariffs and other trade barriers, longer accounts receivable payment cycles, potentially adverse tax consequences, restrictions on repatriation of earnings and the burdens of complying with a wide variety of foreign laws |
| These factors could have a material adverse effect upon the Companyapstas future revenues and business, results of operations and financial condition |
| ZOLTEK &apos S OPERATIONS ARE DEPENDENT UPON ITS SENIOR MANAGEMENT AND TECHNICAL PERSONNEL Zoltekapstas future operating results depend upon the continued service of its senior management, including Zsolt Rumy, the Companyapstas Chief Executive Officer, President and Chairman of the Board, and its technical personnel, none of whom are bound by an employment agreement |
| The Companyapstas future success will depend upon its continuing ability to attract and retain highly qualified managerial and technical personnel |
| Competition for such personnel is intense, and there can be no assurance that the Company will retain its key managerial and technical employees or that it will be successful in attracting, assimilating or retaining other highly qualified personnel in the future |
| ZOLTEK &apos S STOCK PRICE MAY FLUCTUATE Future announcements concerning Zoltek or its competitors or customers, quarterly variations in operating results, announcements of technological innovations, the introduction of new products or changes in product pricing policies by the Company or its competitors, developments regarding proprietary rights, changes in earnings estimates by analysts or reports regarding the Company or its industry in the financial press or investment advisory publications, among other factors, could cause the market price of the common stock to fluctuate substantially |
| In addition, stock prices for many technology companies fluctuate widely for reasons often unrelated to operating results |
| These fluctuations, as well as general economic, political and market conditions, such as recessions, world events, military conflicts or market or market-sector declines, may materially and adversely affect the market price of the common stock |
| In addition, the Company believes that electronic bulletin board postings regarding us could in the future contribute to volatility in the market price of the common stock |
| Any information concerning the Company, including projections of future operating results, appearing in investment advisory publications or on-line bulletin boards, or otherwise emanating from a source other than the Company, should not be relied upon as having been supplied or endorsed by Zoltek |
| 12 ZOLTEK &apos S OPERATING RESULTS MAY FLUCTUATE Zoltekapstas quarterly results of operations may fluctuate as a result of a number of factors, including the timing of purchase orders for and shipments of the Companyapstas products |
| Therefore, quarter-to-quarter comparisons of results of operations have been and will be impacted by the timing of such orders and shipments |
| In addition, its operating results could be adversely affected by these factors, among others, such as variations in the mix of product sales, price changes in response to competitive factors, increases in raw material costs and interruptions in plant operations |
| DEVELOPMENTS BY COMPETITORS MAY IMPACT ZOLTEK &apos S PRODUCTS AND TECHNOLOGIES Zoltek competes with various other participants in the advanced materials and textile fibers markets |
| Many of these entities have substantially greater research and development, manufacturing, marketing, financial and managerial resources than the Company |
| In addition, existing carbon fibers producers may refocus their activities to compete more directly with the Company |
| Developments by existing or future competitors may render the Companyapstas products or technologies noncompetitive |
| In addition, the Company may not be able to keep pace with new technological developments |
| The Companyapstas customers could decide to vertically integrate their operations and perform some or all of the functions currently performed by Zoltek |
| FAILURE TO KEEP PACE WITH TECHNOLOGICAL DEVELOPMENTS MAY ADVERSELY AFFECT ZOLTEK OPERATIONS Zoltek is engaged in an industry which will be affected by future technological developments |
| The introduction of products or processes utilizing new technologies could render existing products or processes obsolete or unmarketable |
| The Companyapstas success will depend upon its ability to develop and introduce on a timely and cost-effective basis new products, processes and applications that keep pace with technological developments and address increasingly sophisticated customer requirements |
| The Company may not be successful in identifying, developing and marketing new products, applications and processes and product or process enhancements |
| The Company may experience difficulties that could delay or prevent the successful development, introduction and marketing of product or process enhancements or new products, applications or processes |
| The Companyapstas products, applications or processes may not adequately meet the requirements of the marketplace and achieve market acceptance |
| Its business, operating results and financial condition could be materially and adversely affected if it were to incur delays in developing new products, applications or processes or product or process enhancements or if it were to not gain market acceptance |
| ZOLTEK &apos S BUSINESS DEPENDS UPON THE MAINTENANCE OF ITS PROPRIETARY TECHNOLOGY Zoltek depends upon its proprietary technology |
| The Company relies principally upon trade secret and copyright law to protect its proprietary technology |
| The Company regularly enters into confidentiality agreements with its key employees, customers and potential customers and limit access to and distribution of its trade secrets and other proprietary information |
| These measures may not be adequate to prevent misappropriation of the Companyapstas technology or that its competitors will not independently develop technologies that are substantially equivalent or superior to its technology |
| In addition, the laws of some foreign countries do not protect its proprietary rights to the same extent as the laws of the United States |
| The Company is also subject to the risk of adverse claims and litigation alleging infringement of intellectual property rights |
| ZOLTEK WILL INCUR INCREASED COSTS AND DEMANDS UPON MANAGEMENT AS A RESULT OF COMPLYING WITH THE LAWS AND REGULATIONS AFFECTING PUBLIC COMPANIES, WHICH COULD AFFECT ITS OPERATING RESULTS As a public company, Zoltek has incurred and will continue to incur significant legal, accounting and other expenses that it would not incur as a private company, including costs associated with public company reporting requirements |
| The Company also has incurred and will incur costs associated with recently adopted corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002, as well as new rules implemented by the SEC and the Nasdaq Stock Market |
| The expenses incurred by public companies generally for reporting and corporate governance purposes have increased |
| These rules and regulations have increased the Companyapstas legal and financial compliance costs and have made some activities more time-consuming and costly, although it is unable to currently estimate these costs with any degree of certainty |
| The 13 Company does believe, however, that it will be able to fund these costs out of its available working capital |
| It is possible that these new rules and regulations may make it more difficult and more expensive for the Company to obtain director and officer liability insurance, and it may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage than used to be available |
| As a result, it may be more difficult for the Company to attract and retain qualified individuals to serve on its board of directors or as its executive officers |
| ZOLTEK MANAGEMENT AND ITS INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM HAVE IDENTIFIED MATERIAL WEAKNESSES IN THE DESIGN AND OPERATION OF ITS INTERNAL CONTROLS, WHICH, IF NOT PROPERLY REMEDIATED COULD RESULT IN MATERIAL MISSTATEMENTS IN ITS FINANCIAL STATEMENTS IN FUTURE PERIODS Zoltek management and its independent registered public accounting firm have identified certain matters that they consider to constitute material weaknesses in the design and operation of its internal controls as of September 30, 2005 |
| See "e Item 9A Controls and Procedures "e |
| A material weakness is defined by the Public Company Accounting Oversight Board (United States) as a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected |
| A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis |
| As set forth in Item 9A Controls and Procedures, as of September 30, 2005, the Company identified material weaknesses in its general control environment and its controls over period-end financial reporting process, journal entries and account reconciliations, determination of allowance for doubtful accounts, accounting for inventory, valuation of property plant and equipment, accounting for derivatives associated with convertible debt and related amortization of financing fees and debt discount and gain (loss) on value of warrants and conversion feature, earnings per share disclosures, segregation of duties and restricted access |
| These control deficiencies resulted in accounting errors which required the restatement of its previously issued financial statements contained in its Annual Report on Form 10-K for the year ended September 30, 2004, and its Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004, June 30, 2004, December 31, 2004 and March 31, 2005 |
| The Company is currently evaluating steps that can be taken to remediate these weaknesses in its internal controls, including steps that can be taken in the process of documenting and evaluating the applicable treatment for non-routine or complex transactions as they may arise |
| Zoltek expects to incur significant expenses associated with these corrective actions to remedy the identified material weaknesses |
| If the remedial policies and procedures the Company implements are insufficient to address the material weaknesses that exist as of September 30, 2005, or if additional material weaknesses in its internal controls are discovered in the future, the Company may fail to meet its future reporting obligations, its financial statements may contain material misstatements and its operating results may be harmed |
| Any such failure could also adversely affect the results of the periodic management evaluations and annual auditor attestation reports regarding the effectiveness of the Companyapstas "e internal control over financial reporting "e that are required by the SECapstas rules under Section 404 of the Sarbanes-Oxley Act of 2002 |
| The existence of a material weakness could result in errors in the Companyapstas financial statements that could result in a restatement of financial statements, cause it to fail to meet its reporting obligations and in turn cause investors to lose confidence in its reported financial information, leading to a decline in the Companyapstas stock price |
| Although the Company believes it can address its material weaknesses in internal controls with remedial measures, it cannot assure you that the measures it will take will remediate the material weaknesses identified or that any additional material weaknesses will not arise in the future due to a failure to implement and maintain adequate internal controls over financial reporting |
| DEVELOPMENT OF NEW MARKETS FOR ZOLTEK CARBON FIBER PRODUCTS IS UNCERTAIN Zoltekapstas future profitability and growth will depend in part upon the development of new markets for a broad range of large-scale applications which incorporate the Companyapstas carbon fiber products |
| Development of new markets for its carbon fiber products will require substantial technical, marketing and sales efforts and the expenditure of significant funds |
| Development of new markets for carbon fibers may not occur and, if such development does occur, its products may not achieve significant market acceptance |
| The Companyapstas business, operating results and financial condition could be materially and adversely affected if new markets for its carbon fiber products do not develop or if its products do not gain market acceptance |
| 14 THERE ARE OPERATIONAL RISKS ASSOCIATED WITH ZOLTEK &apos S BUSINESS Zoltekapstas carbon fiber operations utilize high temperature processes, substantial electrical current and industrial gases which potentially can be subject to volatile chemical reactions |
| The Company believes that its current plant design and operating procedures minimize operational risks associated with these factors |
| However, as a result of mechanical or human failure or unforeseen conditions or events related to its manufacturing and engineering processes or otherwise, its manufacturing capacity could be materially limited or temporarily interrupted |
| ONGOING LITIGATION IN WHICH ZOLTEK IS INVOLVED COULD RESULT IN ITS HAVING TO PAY SUBSTANTIAL DAMAGES Zoltek is party to various legal actions as either plaintiff or defendant |
| As previously disclosed, the Company is party to an action filed in the Court of Common Pleas of Cuyahoga County, Ohio, by the former owners of Hardcore Composites Operations LLC against each of Hardcore and the Company alleging breach by Hardcore and the Company of its respective obligations under a sublease, guaranty and settlement agreement entered into in connection with the former ownerapstas sale of Hardcore |
| In October 2004, the Court ruled in favor of the former owner of Hardcore Composites in the amount of dlra1dtta1 million |
| The Company has recorded an accrual of dlra1dtta1 million in respect of the possible liability in this matter |
| The Company is vigorously defending this motion and it has filed counterclaims and an appeal |
| Additionally, as previously disclosed in September 2004 the Company was named a defendant in a civil action filed by a former investment banker that was retained by it to obtain equity investors, alleging that it breached its obligations under the agreement signed by the parties |
| The investment banker alleges that it is owed commission from equity investment the Company obtained from a different source |
| The ultimate outcome of these actions and other pending litigation and the estimates of the potential future impact on its financial position, cash flows or results of operations for these proceedings could have a material adverse effect on its business |
| In addition, the Company may incur additional legal costs in connection with pursuing and defending such actions |
| ZOLTEK &apos S PRINCIPAL SHAREHOLDER HAS VOTING CONTROL OVER THE COMPANY Zsolt Rumy, Zoltekapstas founder and principal shareholder, owns approximately 30prca of the Companyapstas outstanding shares of common stock |
| As a result, he has effective voting control over the Company, including the election of directors, and is able to effectively prevent an affirmative vote which would be necessary for a merger, sale of assets or similar transaction, irrespective of whether other shareholders believe such a transaction to be in their best interests |
| The Companyapstas Articles of Incorporation and By-laws do not provide for cumulative voting in the election of directors |
| ZOLTEK &apos S BOARD OF DIRECTORS HAS THE AUTHORITY TO ISSUE PREFERRED STOCK WHICH COULD AFFECT THE RIGHTS OF HOLDERS OF COMMON STOCK Zoltekapstas Articles of Incorporation authorize the issuance of "e blank check "e preferred stock with such designations, rights and preferences as may be determined from time to time by the Board of Directors |
| Accordingly, the Board of Directors is empowered, without shareholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights which could adversely affect the voting power or other rights of the holders of common stock |
| Holders of common stock will have no preemptive rights to subscribe for a pro rata portion of any preferred stock which may be issued |
| In the event of issuance, the preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control |
| The possible impact on takeover could adversely affect the price of the common stock |
| Although the Company has no present intention to issue any shares of preferred stock, it may do so in the future |
| ZOLTEK &apos S CLASSIFIED BOARD OF DIRECTORS COULD DISCOURAGE A CHANGE IN CONTROL Zoltekapstas Articles of Incorporation divide the Board of Directors into three classes, with three-year staggered terms |
| The classified board provision could increase the likelihood that, in the event an outside party acquired a controlling block of the Companyapstas stock, incumbent directors nevertheless would retain their positions for a substantial period, which may have the effect of discouraging, delaying or preventing a change in control |
| The possible impact on takeover attempts could adversely affect the price of the common stock |
| 15 FUTURE SALES OF COMMON STOCK COULD AFFECT THE PRICE OF COMMON STOCK No prediction can be made as to the effect, if any, that future sales of shares or the availability of shares for sale will have on the market price of the common stock prevailing from time to time |
| Sales of substantial amounts of common stock, or the perception that such sales might occur, could adversely affect prevailing market prices of the common stock |