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Zoltek Companies, Inc. (NASDAQ:ZOLT)

F1Q09 (Qtr End 12/31/08) Earnings Call

February 10, 11:00 am ET

Executives

Zsolt Rumy - President, CEO

Andy Whipple - VP, CAO

Analysts

Michael Lew - ThinkPanmure LLC

Joe Maxa - Dougherty & Company LLC

Michael Carboy - Signal Hill Capital LLC

Operator

Good day and welcome to Zoltek's first quarter 2009 earnings results conference call. Just a reminder, today's call is being recorded. And now, for introductions and opening remarks, I would like to turn the call over to Mr. Zsolt Rumy, President and Chief Executive Officer for Zoltek. Please go ahead, Sir.

Zsolt Rumy

Good morning. Welcome to our first-quarter conference call. As usual, I have a group of our management team here, including Andy Whipple, who is our Chief Accounting Officer. I'll get him to the floor to tell you about our forward-looking statement weasel words. After that, he has some information on the financial report that is not part of the press release, but that we considered might be interesting to you. Andy?

Andy Whipple

Thanks, Zsolt. I'll just take the next few minutes. I'll cover some highlights of our first quarter operating results versus the prior year, and I will also provide some comments regarding forward-looking statements and certain non-GAAP financial measures.

During today's call, we'll refer to certain non-GAAP financial measures. We've reconciled these measures to GAAP figures in our earnings release, which is available on our website at zoltek.com.

We will also be making certain forward-looking statements today. Please review our Safe Harbor language found in our press release and our SEC filings, which describe factors that could cause our actual results to differ materially from those projected by us in our forward-looking statements.

With regard to our year-over-year results, as we noted in the earnings release, our first-quarter 2009 net sales decreased 3.6% to $38.6 million, and this compared to the prior year's amount of $40.1 million. Our cost of sales aligned with this; we saw a decrease of 3.2%, from $29.3 million to $28.4 million. I know that Zsolt will be covering sales and cost of sales in his part of the conversation, so I won't spend time addressing those particular areas.

With regard to SG&A expense, for the first quarter they were $4.8 million. This compared to the prior year, where we had approximately $4.1 million. The increase year-over-year primarily had to do with the underwater stock options out there. This non-cash cost to us was approximately $950,000 for the quarter.

We also had to include approximately $350,000, which was a catch-up entry associated with adjusting our forfeiture rate per FAS 123R.

Unfortunately, pursuant to the FAS, we have to continue to monitor our forfeiture rate and adjust it throughout the life of the options. As I said, the charge for the quarter was $350,000 just for that specific (inaudible).

With regard to income tax expense, of course, our income taxes are derived primarily from our Hungarian operations. We saw a decrease from a $1 million in the prior year to $600,000 in the current quarter. We had two basic components to the decrease; one was a change -- a decrease in the value of the HUF year-over-year.

The change in the functional currency for Hungary causes the loan that's due to the parent company, which is a US dollar-denominated loan, to have experienced an unrealized loss. For Hungary and their taxes, they have what I would refer to as an AMT tax, alternative minimum tax, that factors in that unrealized loss and, as a result, that actually brings down our tax expense in Hungary.

But we also had a FIN 48 reserve, which is another accounting reserve required in the prior year, associated with our intercompany transactions. That was about a $300,000 reserve that was taken last year that wasn't repeated in the current quarter.

With regard to capital spending, for the quarter it was $8.3 million, versus the prior year's quarter, which was $12.5 million. As we have completed our construction in Hungary and have got to the end of our construction in Mexico, of course, our capital spending is declining.

In the prior year's quarter, we had capitalized interest of almost $1.6 million. In the current quarter, we had no capitalized interest. Again, the Hungarian construction has wound down and that's where our capitalized interest had been associated.

In our foreign currency translation adjustment for the quarter, we had a $27.5 million charge. This was primarily due to a devaluation of the HUF against the US dollar of approximately 12%, and a devaluation of the Mexican peso of approximately 19%. The charge associated with the devaluation of the HUF was approximately 19 million of that charge, with the peso approximately 8.5 million.

As a part of our expansion into Mexico, we had initially set up the functional currency in Mexico as the Mexican peso. As a result of finishing construction and starting sales, and our sales being denominated in US dollars, effective November 1st, we changed our functional currency to the US dollar. As a result of that change in our functional currency, we will certainly limit our exposure to the Mexican peso in the financial income statement.

And then a final point, with regards to liquidity, as of December 31, 2008, we had unrestricted cash of $17.5 million. We continue to generate positive EBITDA; our current ratio is over 2.0, and our long-term debt is only 2.2 million. So we feel very comfortable with our financial position; we feel that we are in a solid financial spot at this point in time.

Now that concludes my remarks, Zsolt, and I hand the microphone back to you.

Zsolt Rumy

Thanks, Andy. I want to start off with some administrative issues. First of all, lawsuits. I can report that we are free of lawsuits at this point. We have settled all of our legal issues relating to the business. I did want to mention that we had an announcement during the quarter about our long-term lawsuit of patent infringement against the US government. I think I was on vacation at the time, and somehow the wrong version of the press release went out. So it was a little confusing, more confusing than it should have been.

But basically, we have a lawsuit going for 13 years against the government on the Stealth Bomber, and that continues at the Court of Claims. On the other hand, we were not allowed to continue that lawsuit for the F-22 stealth technology, and that is what the District Court -- (inaudible) was remanded to the District Court of Atlanta. And someone else made the announcement about that, and we felt that we needed to put something out to clear up the issue.

So again, the two lawsuits are going forward, one with the Federal Court of Claims for the B-2, and other one is for the F-22, suing Northrop in the District Court of Atlanta.

So all lawsuits are now behind us. It has been painful, needless to say, but had virtually no effect on this past quarter, and I can say that we are done with them. It's costly and also a distraction, but it's good to be over with them.

There's another misconception that came up through the last quarter. It is not in my train of thought; that would be included if I make a special note of it. Somehow, Bloomberg reported that we were shut down because the Russians cut our gas off. The gas pressure went down and we had some contaminant for about a 12-hour period. I don't think this has any current or forward issues, so I just wanted to make sure that that was a misstatement from our Hungarian manager and overreaction by the Hungarian press. We are hoping that that kind of publicity is not going to happen again.

Let me move on to the general conditions, the global economic conditions that offer us some challenges. We will try to give you some flavor as to what's happening to us when certain things happen in the economy. There are really two significant things: the costs of our material and energy, and currency fluctuations. Andy covered some of the currency fluctuations. I think what he said was kind of confusing. The twenty some million dollar effect of currency devaluation did not go through, obviously the income statement, that is an adjustment in the balance sheet.

It's an ongoing thing, I think, since the beginning of acquiring Hungary. Our total net for all 12 years was something in the neighborhood of $12 million, a negative effect. We are trying every way possible to eliminate that kind of confusing adjustment on our balance sheet.

But on the other hand, we have on a currency fluctuation. 70% of our sales is euro based. In the last quarter, the euro went down 15% against the dollar. Obviously, that affected our gross sales. Costs in Hungary and Mexico are affected only for the local purchases, and that's to the positive in our cost and, of course, that is a valuation we talked about.

Now, the big effect this past quarter, and going forward this year, is the cost of energy and our cost of ACN. Energy is an interesting thing, because each country has its different nuances. In Hungary, we signed a six-month contract; it's a 12-month contract on electricity, which is slightly higher than our previous year. We're starting to negotiate for the second half of this year, and it looks like it's going to be a positive change, meaning we will probably get some benefits in cost. On gas prices, again, that negotiation will start also for the second half of the year.

So in Mexico, it's relatively high energy cost. Abilene continues to be probably the best-controlled energy costs, because a long time ago we had tied in our electricity costs with the cost of natural gas, and it certainly has gone in our favor most of the time.

The ACN is another situation. It affected us last quarter, because last quarter we paid the highest amount for ACN ever. During the quarter, it started to decline; for this quarter, it has actually declined by about 50% from the highest that we paid for ACN. Needless to say, that is a huge impact on our cost. But given that everybody knows, it is public information, it's a commodity product, we also maintain some sort of a pressure on our pricing. So we've got to go through these challenges and try to maintain our pricing as well as we can and not give away all of the benefits of lower cost.

On the sales and marketing side, we can certainly see the positive effect of our contracts. 70% of our revenue last year was under contract, and this continues into this year, although we mentioned a little blip, a little postponement on one of our contracts. I think it's no reflection on our customers' overall business and/or our relationship with them. It just happened to be a relatively normal thing.

So much of our business comes from Europe, and the Christmas holidays in Europe are fairly expensive. Some people didn't work for most of December. Consequently, there has always been an inventory adjustment at the end of the calendar year, which affects our first quarter. So, some of the decline in our orders was not unusual.

The other 30% of our business is a mixture of all kinds of other end-use products, and there we had some reaction to the turmoil. Some people, particularly in the computer and automotive business, reacted very quickly, and that affected our business, where again, I think there are some advantages. In one particular case, our customer decided to down-select a number of suppliers in order to cover what they anticipate to be a 30% decline in their business, and we ended up being selected as one of the two suppliers. In fact, while in the first quarter we postponed some orders with them, for the year we are looking at more than doubling our sales with the customer.

So, there are some benefits to some of the changes. To make a long story short, fundamentally, there was really nothing different, nothing that we can see that has any long-term effect either on our continued demand or projects or our sales. Now, needless to say, the currency fluctuations may have some effect of our gross revenue as we go forward, and we will just have to see.

The other thing is pricing, particularly in our major contracts. Yes, there is some movement and reduction in price. As I said earlier, we are looking to maintain pricing in such a way that we can look for higher margins going forward. I see that potentially happening maybe late part of the current quarter, and for the rest of the year, although our negotiations have been for six months, again considering the uncertainties of costs and currency movement. So we will be renegotiating some of the prices in June. When I talk about six months for the contracts, it is our calendar year and not fiscal year.

We mentioned Gamesa, which is against our normal policy. We don't like to talk about specific customers and their activities, but in their case, they made an announcement of plant shutdowns, and we have had several questions. Again, there's nothing to be concerned about with Gamesa. They had just made some adjustments at the end of the year, and they made some announcements of their shutdowns. That's why we referred to them. Otherwise, our relationship is fine, and their anticipated volume for this year is not diminished at all.

I wanted to cover all the key areas of markets, the wind. Again, there is a tremendous amount of activity in the wind area, and what we had hoped to see happening last year, that people are going to reconsider using carbon. It's happening this year; as several people are anxiously looking at the benefits of carbon and incorporating it into some of their bigger wind blades, which, again, the market would (inaudible) towards larger blades for higher production wind turbines.

Interesting thing in Asia; compressed natural gas is coming into the market, and that requires compressed natural gas tanks. We are discussing a number of potential customers for that market.

Deep sea drilling: we have seen some significant increases in current activities and we continue to work on the major applications going forward. I don't know if some of the development area, I don't know if the enthusiasm has slackened at all. I think the idea to export deep-sea sources of oil continues. It was going on when oil was $30 a barrel, same thing, the wind turbine business was growing significantly when oil was $30 a barrel. So I don't think the two tie together very closely.

In the automobile area, we certainly have a number of active projects. We are still confident and optimistic that by 2012 or 2013, there will be a major auto project of an assembly line type model that will come out that will have a huge impact on our future.

The aerospace area: there are two comments I want to make about this. First of all, there is constant rhetoric about the crossover from aerospace into our market. Any of you who are interested in more detail, I just participated in an aerospace and defense investment conference in New York, and my presentation is on the website and you can refer to it. And, basically, the likelihood of our fiber migrating into the commercial airplane manufacturing has a significantly higher probability than aerospace fibers migrating into our market. I think those of you who are concerned about this issue ought to look at the presentation and give Casey or myself a call and we can explain some of the issues.

The brake business looks fine. There's no major movement one way or another. As you may remember, most of the older Boeing planes are steel brakes. So any stoppage of airplanes may or may not affect our brake business. From 757 onward, 757 has a choice of carbon or steel. After that, essentially all the Boeing brakes are carbon/carbon, and all of the Airbus planes are carbon/carbon. We continue to get the repair portion of the business and all the new builds, so we don't see a major movement in this market. Whatever we may lose in one, we will gain in the other. And certainly 787 is starting to look like it's about to start flying and it will take a lot of pressure off of some of this rumor.

I want to get back to talking about the contracts. Someone has the misconception . . . I have explained at least half a dozen times in this conference call that our contracts are nothing like a take-or-pay contract; there is no such thing as take-or-pay. I don't even know that that terminology is used anymore. We have contracts where we generally get indications a quarter in advance of what the requirements will be, and then we gear up to produce for that requirement, then we have monthly releases. So there's a certain possibility for fluctuations, but most of our major customers are living up to their contracts and, in some cases, actually better than what we expected.

Back to the list, the last on my list is the operations. Not much to say. We have 29 million pound installed capacity, which is 13,000 metric tonnes. This is more than our current demand and, frankly, we could probably do $300 million revenues with the capacity that we have without any real capital investment requirements.

We try to utilize all the plants in the most efficient way, and that's a challenge that our COO, Karen, is working on every day.

I want to reiterate that the Mexico plants have started up extremely successfully. Precursor quality has actually shown some improvements over Hungarian, and we're incorporating some of the improvements in Hungary. We are going through some customary review on qualification of the Mexican product, and we are already shipping some of the products to customers.

Hungary is running smoothly. Again, this Russian gas interruption was actually more of a humorous thing than anything else. If you are familiar with Russian and West European politics and the Ukraine and all that, it actually has some real humor in it. It could turn less than humorous in the future, but for now, it is kind of funny.

The Abilene operations continue to be improved. We have better staff, improved management, and the plant is running smoother, and it is also very effectively producing some of the value-added products.

This concludes what I have to say about the last quarter. I do want to reiterate, if some of you have seen our annual report, we've called everybody's attention to four misconceptions that we feel have been in the investment community, that I wanted to make some comments on. We talked about, certainly, the crossover from aerospace to commercial fibers. That really is not a reality, because I wanted to explain that this whole idea goes back to ten years ago and earlier, when our concept of commercial carbon fiber was brand new. The industry was in its infancy and was dependent almost entirely on government contracts for military projects.

When the military projects weren't involved and they eventually developed the golf shaft business and some other commercial businesses around some of their excess capacity. But as the requirements and the business have grown, the whole concept is no longer valid. Nobody is dumb enough or aggressive enough to invest deliberately in new capital, and our competition requires a lot more capital than we do in order to try to obtain a business that they would lose money on.

So the whole idea is dumb. I'm sorry to continue to talk about it, but I guess we have to, as some people believe that this is reality.

The other thing that we talked about is wind energy. I mentioned again that wind energy was going long before oil hit $150, and that it really has very little impact on the growth. The adaptation of carbon fibers into long blades is really what controls our business in that market and as I said before, and certainly this year, that activity has increased significantly.

The other thing that we've seen is panic about supply and demand fluctuations. I want to call your attention to the fact that the entire carbon fiber business is only 100 million pound, approximately, give or take 10% or 15% and this is virtually nothing in the marketplace. So in a situation like this, any new line or any new customer can have a significant impact on supply and demand, and it takes a little time to adjust to those changes. In my opinion, it will take four or five times the volume that we have today before that fluctuation will change. In the meantime, there really is no impact on our long-term outlook and potential for our carbon fiber business.

I think the other thing is that we have not given guidance for a good reason, and the good reason is that there is a fluctuation in our customers' requirements in both the positive and, this past quarter, a little bit to the negative. So we are not in the mode yet of clearly predictable quarters. I would like to have our shareholders concentrate on long-term viability and long-term results, meaning two, three years out, and how we are proceeding and meeting those long-term objectives versus trying to pin down what exactly will be our next quarter's results. I know I'm not successful at achieving that, but I keep trying to tell our investors that.

That concludes my comments. I went on too long, as I noticed. But anyway, for those of you who still haven't fallen asleep, maybe I am trying to imitate Obama from last night. In any event, if people are still there, please ask any questions that you would like.

Question-and-Answer Session

Operator

Thank you, Sir. (Operator Instructions) And we will take our first question from Michael Carboy. Go ahead please, your line is open.

Michael Carboy - Signal Hill Capital LLC

Good morning, ladies and gentlemen.

Zsolt Rumy

Hi, Michael.

Michael Carboy - Signal Hill Capital LLC

Good morning, Zsolt. I'd like to explore operating leverage here, in the context of manufacturing under capacities. Could you give us a sense, Zsolt, of the split in terms of your cost of goods sold for energy costs versus other ACN costs? What I'm trying to get at is, how much margin lift there might be as plants come back up to capacity over time?

Zsolt Rumy

Generally, we have used this 1/3, 1/3, 1/3, meaning 1/3 energy, 1/3 ACN cost and 1/3 labor, not labor, but labor packaging and all the other depreciation and everything else. Obviously, when ACN is $2400 versus $1200, it's a bigger percent than when it's lower cost. So there are some fluctuations in that percentage. But in general terms, that's kind of a rule of thumb.

Michael Carboy - Signal Hill Capital LLC

Because fully loaded, you ought to be about $0.50 per pound in depreciation, right?

Zsolt Rumy

Yes, approximately.

Michael Carboy - Signal Hill Capital LLC

Okay, and do you have any plans at this point to expand beyond four lines in Mexico? And if so, when do you need to start planning and ordering for that?

Zsolt Rumy

Well, two things. As I mentioned earlier, that we really have significant opportunity for growth. And as I mentioned in previous conference calls and in our annual report, too, we are looking at this joint venture concept. We have a couple of interested parties that we may end up joint venturing some, at least part of our future expansions and that would eliminate any capital requirements from our side. Nevertheless, unless we get a very significant contract, there are really no plans for any expansion. And I want to reiterate that we can, in fact, expand in six-month increments. And in Mexico, we have a plant or a building that can take another 5 million pounds without constructing a new building. So that is a stopgap, immediate response to any new contracts that we may have.

Michael Carboy - Signal Hill Capital LLC

Okay, and then on the aerospace side of things; could you share with us your views on the timetable which you see existing steel brake fleet being retrofitted?

Zsolt Rumy

The airplanes rarely get retrofitted, other than just recently the 737 was retrofitted, and that doesn't mean that every airplane immediately changes to carbon. It's an optional thing with each airline. But our fiber is the primary source of supply for that brake, and that could be very significant going forward. Obviously, that may have been affected somewhat with the oil price. The incentive may be a little less on the cost side, but on an operations side, I think it's very significant. So we expect some reasonable implementation of the retrofit.

Michael Carboy - Signal Hill Capital LLC

Do you have an idea of what proportion of steel brakes have been retrofitted already, and what proportion remains to be retrofitted?

Zsolt Rumy

On the 737?

Michael Carboy - Signal Hill Capital LLC

Yes.

Zsolt Rumy

That whole process is just starting.

Michael Carboy - Signal Hill Capital LLC

Okay, just starting, all right. And then, you talked about the finished goods inventory buildup in the 10-Q; could you give us a split on carbon fiber versus tech fiber in the finished goods?

Zsolt Rumy

I think it is all carbon fiber.

Michael Carboy - Signal Hill Capital LLC

All carbon fiber, all right, thanks. I will hop back in the queue.

Zsolt Rumy

Thanks, Mike.

Operator

Thank you. Our next question comes from the side of [Tom Bishop]. Go ahead, please, your line is open.

Tom Bishop

Thank you. Good morning.

Zsolt Rumy

Good morning.

Tom Bishop

You mentioned that you believe that Zoltek's long-term growth objectives are still attainable. I assume you're talking about that $500 million...

Zsolt Rumy

That's correct.

Tom Bishop

…target out there? I am assuming you are saying it's still attainable, but not necessarily in the original time frame, or not necessarily…

Zsolt Rumy

No; in my current opinion, unless this recession or whatever we want to call it right now is prolonged, we don't really see a significant decline in people's future anticipated projects. And if we see that, then I would have to back off the timetable. But for right now, I think some projects are going about as fast as we had hoped. There's this one huge project out there that certainly, automotive is now somewhat delayed, although even there, there are some projects going on that are very significant and important. So I don't see anything that would tell me that we are going to really miss it. Obviously, it's not a hard and fast goal, but I don't see any adjustment in my plans.

Tom Bishop

What was that time frame, again?

Zsolt Rumy

This is a 2012 time frame, when we are looking at reaching that goal.

Tom Bishop

Okay. What is your understanding of how the economic stimulus package could help your industry or how much might be -- how it will function? I mean, tax credits, I assume -- I've heard there's trouble getting those tax credits turned into the funds used to build these wind-farms.

Zsolt Rumy

Well, I'm trying to figure out how to become a bank holding company. As soon as I can figure that out, then it may be a little more clear. But on a serious note, personally, in my opinion, all governments are bad and some are worse than others. So, I don't really like to line up at the public trough. But having said that, price lowered, if some of our industry people will get some support, I think we have got the staff and people that try to go for maybe some research money or something like that.

Our (inaudible) the last couple of years has gotten $250 million for development from the government, so they obviously get help. And as a matter of fact, a lot of that money went for testing carbon fibers for blades. So, anyway, I don't have a real answer until we can see what's going to happen. On the other hand, if financing for wind farms are going to improve, that could have an impact on some of our customers.

Tom Bishop

What is going on with the T. Boone Pickens wind farm? Anything?

Zsolt Rumy

Well, we're trying to separate opinion from facts. My understanding and my opinion of what happened, first of all, he's right on as far as the technology is going and the economics and all that, I don't think anything has changed in what he was preaching. So he's right on, so there is nothing wrong with what he is doing. But I think his plan for wind turbines was to buy GE turbines and have GE finance them. Again, this part is definitely purely opinion. Of course, that got derailed with GE falling into kind of hard times. So, that's what I think is happening.

But he will be back. The concept hasn't changed. Financing has changed, and when that changes I think Boone Pickens will be right back at it.

Tom Bishop

You're still working with GE to get the supply carbon fiber for their blades?

Zsolt Rumy

Yes.

Tom Bishop

Good luck with that, all right, thank you.

Zsolt Rumy

Thanks.

Operator

Thank you. We will now move on to the side of Joe Maxa.

Joe Maxa - Dougherty & Company LLC

Thank you. Zsolt, you mentioned the pricing of carbon fiber. Can you give us an idea on a percentage, what level it is versus a year ago?

Zsolt Rumy

I really don't, because it's variable and it's a moving target. One of our primary management tasks is to maintain some control over it, and our long-term contracts are reasonable and certainly have declined along with ACN. And so I don't think our margin should be as good or better, and our pricing decline, which may have some impact on our revenue if our volume doesn't come up, but the profitability should maintain.

Joe Maxa - Dougherty & Company LLC

I know you don't want to give guidance, but just a give us a little bit of color. You mentioned some expected growth in the wind vertical and, given that you have a pricing that has come down a little bit and you have some foreign currency headwinds, are you still looking at '09 being an up year overall versus '08?

Zsolt Rumy

I expressed optimism that it will be and we see a number of things that could make it that way. As I mentioned, some volumes are going up and some of our customers, even though first quarter didn't look like that. And we're also making headway in China, both in the wind turbine area, as well as in other applications. We are just starting operations in Korea, and we have a salesperson in India.

So we are looking at new markets, and we will see some successes coming forward. There are some difficulties in those markets, with export licensing and those kind of things, but they are just the procedural delays. But things are happening. So they are really as much or more positive outlook than negative.

Joe Maxa - Dougherty & Company LLC

Okay. It does appear that, at least for the Q1, everything outside of wind, if you lump it together, was down pretty significantly sequentially. Are you seeing any change quarter to date where we may suggest that those revenues pick back up?

Zsolt Rumy

Yes, I think this quarter looks more positive. Actually, the decline in the last quarter really took place in December, and I think we have generally, like everybody else, there's big pressure to ship at the end of the quarter. And I think that effort fizzled out last quarter.

Joe Maxa - Dougherty & Company LLC

Okay, and I just wanted to touch on the inventory levels being up around $53 million. If we were to continue to have quarters, if they don't progress and have $40 million, $50 million a quarter, will you continue to increase that inventory level, meaning continue production, even if…

Zsolt Rumy

No, the answer to your question is, we will not increase inventory. As a matter of fact, we are caught a little off guard with the inventory value increase as a result of some of the sales discipline and so to speak in December.

Joe Maxa - Dougherty & Company LLC

Where do you see appropriate inventory level?

Zsolt Rumy

I think, given our business, I think certainly a five times turn would be a reasonable number which I think would result in somewhere in the region of $40 million inventory.

Joe Maxa - Dougherty & Company LLC

Okay. Thanks, Zsolt. That is it.

Operator

Thank you. Your next question comes from [Shawn Brackman].

Zsolt Rumy

Hi.

Shawn Brackman

Hey, Zsolt, filling in for Steve Dyer. You mentioned that the lawsuits were settled, and I still noticed that there are litigation reserves still on the books as of December 31st. Is that restricted cash going to be paid out in settlement, or are we going to see some of that go back into cash?

Zsolt Rumy

No, it's -- I think we exhausted our appeals, and it will disappear by next quarter.

Shawn Brackman

Okay. And then, regarding the currency, when was that change effective to make USD as the functional currency, and how much did that affect the numbers in Q4?

Zsolt Rumy

No effect, even in Q1, no effect in Q1. It's typically just…

Andy Whipple

November 1 was the date that we made the change.

Shawn Brackman

November 1 was the date, okay. That is it. Thanks.

Operator

Thank you. We now go to Robert Silver. Go ahead please.

Zsolt Rumy

Hi, Robert.

Robert Silver

Hi, Zsolt. Did I understand correctly, all litigation now is done with appeals in all areas, or is it just…

Zsolt Rumy

Yes.

Robert Silver

…in the patent litigation?

Zsolt Rumy

Well, the patent litigation has been going on for 13 years, was almost a part of our business, it seems. And that is done, by the way, on contingency basis. So we accumulate some relatively small amount of expenses, but it's no legal fees. We have been cheated on this SP lawsuit fraudulently, and we do pursue that and we have a cross-suit against them. I have no idea how successful we will be, but it's a significant lawsuit to recover our losses. But those are the only legal actions that…

Robert Silver

That are left?

Zsolt Rumy

Yes.

Robert Silver

In your annual report, you spoke of an opportunity, an automotive opportunity; I believe it was; that was 150 pounds per unit with an estimated 250,000 build-out. Is that the one you have been referring to during this call, and is it realized in 2012?

Zsolt Rumy

Yes. We have been talking about that being an objective and a possibility, and I think there are some interests and some movement in that area. So I don't know what's going to happen in the auto industry or whether this particular project has any validity or anything. But we are getting closer and closer, like we talked about the ZR1, which is a Corvette. That's more or less an assembly size model, a very small assembly size model. But there are some movements, and we are hoping for and talking about a major project that may come along in the 2012 time frame, three to four years from now.

Robert Silver

Okay, is that domestic or foreign?

Zsolt Rumy

I can't really say any more.

Robert Silver

Okay. Do you see any automotive within the 2010 time frame that's significant?

Zsolt Rumy

Well, I think it depends on what you call significant. In total, our sales into the auto industry are becoming significant, but no single project that will be a multi-million dollar, or multi-million pound carbon fiber that I…

Robert Silver

How much is already going, in pounds, into the auto industry, one way or another?

Zsolt Rumy

I'm not quite sure, but maybe 200,000 to 400,000 pounds, maybe.

Robert Silver

So there's a lot of room to grow?

Zsolt Rumy

Oh, yes.

Robert Silver

How are we doing in the offshore drilling industry?

Zsolt Rumy

We have several development projects that are ongoing.

Robert Silver

What do you think the timeframe is there?

Zsolt Rumy

…and some increase in some of our existing business.

Robert Silver

Are there any experimental installations that are on trial?

Zsolt Rumy

Yes. We just finished one at Petrobras, and that is going on, finished the carbon fibers rods. I'm not exactly sure at the moment where the installation of that demonstration project is, actually.

Robert Silver

So, we don't know if it was successful or not yet?

Zsolt Rumy

Oh, I'm sure it was successful. They wouldn't put it in the ocean floor if it wasn't.

Robert Silver

So it is an installed trial?

Zsolt Rumy

Right.

Robert Silver

Okay. What would that industry promise to us?

Zsolt Rumy

I think we talked about that. It's a huge implementation time with these stages on various products, but it's at least as much as the wind turbine business we are enjoying now.

Robert Silver

Okay, it is as much as the wind turbine business? Okay. That's about all. Good job, Zsolt, keep it up.

Zsolt Rumy

Thanks.

Operator

Our next question comes from Michael Lew. Go ahead please.

Zsolt Rumy

Michael, are you the Law or Lew?

Michael Lew - ThinkPanmure LLC

I believe it is Michael Lew. Hi, Zsolt.

Zsolt Rumy

Hi, Michael, how are you doing?

Michael Lew - ThinkPanmure LLC

Good. Yourself?

Zsolt Rumy

Just fine.

Michael Lew - ThinkPanmure LLC

Hey, Zsolt, I had a couple of questions. You delivered some gross margin improvement this quarter. Was it all energy-related?

Zsolt Rumy

Well, really, it's nice but it's not that's significant. Actually, energy was not much different. I think our actual ACN cost was up. It probably is a product mix, but nothing that I could put my finger on that is significant.

Michael Lew - ThinkPanmure LLC

Could you elaborate? I guess, can we expect incremental improvement throughout the year? And can you talk about some of the actions that are taking place that you're undertaking right now to drive this improvement?

Zsolt Rumy

Well, obviously, cost improvements of all kinds. Some of them are internal efficiency improvements and some of them are because of ACN is huge. But we cautioned that it can turn around, and that's why we are doing six-month pricing rather than annual pricing. And so, definitely prices for ACN have come down since December, and last quarter I think we paid the highest price for ACN. So we are, again, trying to maintain a pricing level that gives us reasonable margins. And that's really from a sales side, from a manufacturing side, operations side, we constantly look at improving efficiency. I think the precursor of quality has been helpful. So we are doing a lot of things that drive our cost down.

Michael Lew - ThinkPanmure LLC

Okay, and I just want to switch gears. Now that there seems to be some visibility with regard to Boeing delivering planes this year, can you update us on the commercial aerospace opportunity with regard to the secondary structure opportunity?

Zsolt Rumy

Well, there are two things. I tried to cover this before, that there are…

Michael Lew - ThinkPanmure LLC

You talked about Boeing last time.

Zsolt Rumy

…some retrofit projects going on that we are trying to participate and/or some of our customers are participating in; some customers, meaning some people that we sell carbon fibers to and don't know exactly where it ends up. So there's a lot of that activity. Ultimately, we need to be qualified at the OEM level. And as shipments are taking off, I think the Boeing and the Airbus people will have more time to deal with product approvals and reviews and all that, and we plan to get some approvals. I think the way they go is they take certain carbon fibers specs and approve a certain number of carbon fibers into those specs. So, we are looking to participate in those approvals which basically doesn't guarantee any business, but it makes the ultimate manufacturer of seats or floors or other things much more easy to qualify our fibers into their products. And so that's the way we are looking to do it.

As I mentioned in my aerospace defense presentation, you need to understand that this kind of usage of carbon fibers, although the aerospace guys have been using carbon fibers for decades, but this quantity and this size of fabrication with carbon fibers is new. And, as they get more confident seeing our fibers and they get higher and higher pressure to reduce costs of their own and we have more confidence in large-structure fabrication and testing and so on, I see the probability of our concept, our carbon fibers, migrating into that application as much more likely than the other way around.

And as I showed in the presentation, the properties of our carbon fiber are actually as good or better than the predominant products going into Toray and Hexcel. So we have no reason to be skittish about pursuing that market, except we are not going to do it in the old-fashioned way, where you go through millions and millions of dollars worth of qualification over a long period of time. I think the whole industry is going to change in the next 5 - 10 years, and that will open up opportunities for our products.

Michael Lew - ThinkPanmure LLC

Okay, great. Also, last quarter, you had mentioned you had begun to talk to Airbus, because obviously they have a significant backlog. Can you provide an update on that? Also, have you talked to any of the regional or business jets?

Zsolt Rumy

The answer to, again, Airbus, same as Boeing. They've got their hands full for the moment. I think we made contact with both places; regionals, we have not.

Michael Lew - ThinkPanmure LLC

Okay. All right, thank you.

Operator

(Operator instructions)

Zsolt Rumy

Let's take one more question, if there is one. We have taken up our time already.

Operator

Very well sir. Our last question comes from the side of Anthony Dawson.

Anthony Dawson

Hi, Zsolt. I have a quick question, if you could update everybody about the situation with Kevin Schott. I haven't heard from him in a long time, and I was wondering if there's any kind of proceedings going on, any charges being pressed, the lack of charges or just what the situation with that was.

Zsolt Rumy

Well, if you have to ruin my day and bring his name up. But really, there is -- what we did is we basically let him off the hook on that one single event of trying to embezzle $250,000. We have paid back on it, and although obviously our investigation, so to speak, that we had to go through was a little more than, a lot more than what the embezzlement was more or what he took from us. But to make a long story short, we have not found anything else, and the SEC is going through their investigation, and we really are not privy to what they do.

Anthony Dawson

All right. And I feel sorry for ending on a sour note. But have a good one.

Zsolt Rumy

Thank you very much, and thanks, everybody, for staying with us.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect at this time.

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Source: Zoltek Companies, Inc. F1Q09 (Qtr End 12/31/08) Earnings Call Transcript
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