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Executives

Zsolt Rumy - Founder, Chairman, Chief Executive Officer and President

Andrew W. Whipple - Chief Financial Officer, Chief Accounting Officer and Vice President

Analysts

Avinash Kant - D.A. Davidson & Co., Research Division

Joseph A. Maxa - Dougherty & Company LLC, Research Division

Michael Lew - Needham & Company, LLC, Research Division

Zoltek Companies (ZOLT) Q3 2012 Earnings Call August 3, 2012 11:00 AM ET

Operator

Good day, and welcome to the Zoltek Third Quarter 2012 Earnings Conference Call. 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 from Zoltek. Please go ahead, sir.

Zsolt Rumy

Thank you, Jay. Welcome, everybody, for our third quarter call. I think we had a pretty good quarter, so we're getting kind of excited about it. Later on I'll have Andy Whipple, our CFO, talk about some more flavor and more information on the numbers after he goes through the forward-looking statement disclaimer, and then I'll come back and have some, a short review of our situation and our activities. And then, we'll follow it up with questions and answers. Hopefully, there'll be plenty of time for that. Okay. Andy, go ahead.

Andrew W. Whipple

Great, thank you, Zsolt. Again, in the next few minutes, I'll cover some highlights of our third quarter operating results. However, I first need to provide a comment regarding forward-looking statements and certain financial measures.

During today's call, we'll refer to certain financial measures and details to explain or add to the information provided in our earnings release. 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.

So with regard to the third quarter here, sales on a year-over-year basis grew from $38.6 million to $48.1 million or 24.6%. From the prior quarter, we increased from $47 million to $48.1 million, or $1.1 million. I might note that the euro weakened against the U.S. dollar by approximately 5.2% from the prior year, which resulted in a reduction in our revenue by $3.4 million. Zsolt will comment further on revenue in his section of the call.

On the cost of goods sold side. The year-over-year cost of goods sold increased from $34.1 million to $36.7 million or $2.7 million, reflecting the increase in the sales noted previously. Our gross profit margin increased from 11.5% to 23.5% during the same prior year quarter.

We had improvements in the efficiency of our operations, which have decreased our production costs, as well as an increase in our production levels in Hungary and Mexico. We did have Mexico fully operating at this time. We've also had a unit [ph] cost decrease by approximately 18% versus the prior year's quarter.

Zsolt will comment further about drivers in our cost of goods sold in his segment of the call.

On the application and development costs. We've seen these stay relatively constant at $1.7 million this quarter versus $1.9 million in the prior quarter, but we continue to invest in prepreg, wind and auto, and we're continuing to develop on the lignin product, with the support of the Department of Energy at Weyerhaeuser.

On the SG&A side. That again has remained flat at approximately $3.1 [ph] million this quarter and $3.3 million in the prior quarter.

When we go below the line, we can see that there was not much effect in the way of currencies in this quarter. The HUF did strengthen against the euro and then weakened against the U.S. dollar during in the quarter. There was a little bit effect, but not much. We also see that the warrants continued to decrease. There was a little bit of a charge on the warrants. We have 882,000 warrants still outstanding, which will expire by December of 2012. That'll expire if we don't hit $28.06, which is their exercise price.

On the tax line, we had $300,000-ish worth of expense. And that really is driven by the revenue tax in Hungary, the 2% local tax there. On the tax side going forward, the Hungarian tax laws will affect us going forward at a 10% flat rate for the first $2.1 million, and then it's a 19% tax rate beyond that. We can offset that with our NOLs -- with 50% of our NOLs, so we do get some protection there. Of course, we do carry 100% valuation allowance against all our deferred tax assets in the U.S., Mexico and Hungary.

Capital spending for the quarter was $5.8 million. This primarily represents purchases and refurbishments of our prepreg building in St. Peter's that was newly acquired back in October, as well as continued enhancements to our Hungarian carbon fiber lines.

Looking up at the balance sheet. We see that the receivables increased to $37.8 million in Q3. This, again, reflects the continued increase in sales. We obviously continue to monitor our sales and our turns are around 31 days. That's in line with our expectations and customer mix. We'll obviously continue to monitor this closely, so we stay on top of any slow pays. The bad debt expense in the last 12 months has been relatively immaterial.

On the inventory side. We have seen an increase in inventories, up to $62.4 million from $60.4 million in the prior quarter. We continue to push our finished goods inventory, which you see continuing to build. And we have also continued to stay long in the ACN market. So our main raw material is ACN, and we continue to make sure as the prices decrease in that market that we stay long with ACN.

On the liquidity side. We see the cash increase to $29 million from $17 million at the end of fiscal 2011. We entered into a credit agreement with Raiffeisen on June 15, which included a $17.1 million term loan and a $4.8 million overdraft facility. So our cash on hand and cash flow from operations is anticipated to meet all of our cash needs over the next 12 months.

On the EBITDA side, we continue to be -- have a very strong EBITDA at $10.9 million, compared to $10.2 million in the prior quarter. Obviously, we'll continue to drive positive EBITDA through increasing sales and maintaining good production levels.

Zsolt, no further comments on my side.

Zsolt Rumy

Okay. Thanks, Andy. Just reviewing our sales. I think, in general, we have -- our sales increase as we get new major contracts or accounts by steps, and what we're seeing is, just generally increasing our sales results. But we're looking for some new contracts and new customers for the coming year and coming quarters.

The gross margin improvements are fairly stable for the moment. And I think they will -- they reflect the significant improvement in our operations, and we continue to make efforts to reduce our costs. And again, a significant improvement will come as we improve our capacity utilization in the future.

Sales activities continue to be concentrating on the wind turbine business since that's our biggest market for the moment, and also the biggest short-term potential. And this is the -- we're very confident about the future market, although I know there's some negative comments in the U.S. about the investment tax credit. But in reality, it's a global market, and that issue doesn't seem to -- doesn't really apply in the rest of the world. And so we're seeing lots of activities in the larger turbines. And while there were some European wind turbine manufacturers that held back from the offshore development for the moment, the offshore development -- wind farm development is still strong in Asia, particularly in [indiscernible].

The application development, we're concentrating a lot on the automotive applications, which we consider to be the largest -- ultimate largest use for carbon fibers for lightweight materials. And we concentrate on 3 areas. One is the Tier 1 supplier, because they're here and now producing parts and systems for new cars. And the other areas of the process development is a critical issue for automotive applications because that is where most of the cost is. And as I normally tell auto customers when they complain about the carbon fiber prices and we give [ph] carbon fibers then for free, it still wouldn't be economical the way they're using it. So that part of the process development is very critical in the ultimate commercialization of the carbon fibers in cars.

And then the other thing is resin chemistry [ph], which is also somewhat related to the process. The automotive guys are looking for quick reaction, chemical reaction and very quick assembly process. So this is -- resin chemistry is very important. So we're working with several companies that manufacturer resin, and we're targeting some fairly aggressive process conditions.

In our R&D, Andy has alluded to our lignin project, which is a very big deal in the industry because it does represent a couple of things. It represents a lower cost of raw material and readily available raw material at the same time. It's -- there's a lot of pressure in the auto guys, particularly the European auto guys for green cars. And this of course would be a natural material, actually, with the improved pollution issues with the paper makers. So this is a big to-do, and we're leading this process way ahead of anybody else. And hopefully, I think, in the next 2 weeks, we'll have a initial commercial run of this product.

We're also working on some other technologies around the improvement of our precursor, which ultimately improves either the cost or performance of our carbon fibers.

And that pretty well covers most of my comments. And so, Jay, why don't we open it up for questions?

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Avinash Kant with D.A. Davidson & Company.

Avinash Kant - D.A. Davidson & Co., Research Division

So quick question. Zsolt, actually, in the past, you have talked a little bit about -- given us some breakdown in terms of wind being what percentage of total revenues. And also Vestas was what percentage of your total revenues?

Zsolt Rumy

Andy, you got those, Andy?

Andrew W. Whipple

Yes. Please continue. I'll pull those numbers together.

Zsolt Rumy

Okay. There's not much change from previous percentages or numbers.

Avinash Kant - D.A. Davidson & Co., Research Division

Right. And also, I was looking for what percentage of revenues came from U.S., maybe in the current quarter or in the first 3 quarters of the fiscal year, whichever way you can give it to us.

Zsolt Rumy

U.S. what? U.S. wind or U.S....

Avinash Kant - D.A. Davidson & Co., Research Division

Wind. Off the [ph] wind...

Zsolt Rumy

Again, I don't think we can give you that answer because where we sell the carbon fibers and where the wind turbines go are not the same. So I don't think it's reflective of anything.

Andrew W. Whipple

All right. Vestas was 50% of the revenues for the quarter.

Avinash Kant - D.A. Davidson & Co., Research Division

50% in the quarter, right?

Andrew W. Whipple

Right.

Avinash Kant - D.A. Davidson & Co., Research Division

And overall, wind was what percentage of your revenues?

Andrew W. Whipple

Approximately -- let me -- I'll work up a number for you on that.

Zsolt Rumy

Probably close to 60%.

Avinash Kant - D.A. Davidson & Co., Research Division

Okay. Wind. Okay. And the other thing I was talking about was if -- the automotive applications, have you -- you've been working with some of the -- for the partners in there. What kind of traction have you seen thus far in the automotive side?

Zsolt Rumy

Well, again, there's a lot of traction and a lot of answers [ph] and lots of work going on, and lots of estimating of costs and incorporation of carbon fiber components into cars. So -- but again, I remind you that any big change will come when significant carbon content automobiles will be introduced in large volume [ph] models, and that's still probably a couple or 3 years away. But there's a tremendous amount of activity and lots of traction from the level of interest and level of activity from our customers as well as our own.

Avinash Kant - D.A. Davidson & Co., Research Division

Okay. Final question, Zsolt. In terms of competition in the wind side, do you see much coming from Asia at this point?

Zsolt Rumy

Competition for carbon or competition for wind turbines?

Avinash Kant - D.A. Davidson & Co., Research Division

For carbon.

Zsolt Rumy

Well, other than the Japanese, established Japanese carbon fiber manufacturers, there's nothing, nobody really new. And China, they've been working on it, on trying to make carbon fibers for many years, unsuccessfully. And the ones that are working the hardest, they're still pursuing the aerospace rather than commercial concepts. So, no one that -- we're not looking for any significant issues.

Andrew W. Whipple

And, Avinash, just to confirm, the wind revenues for the quarter were, as Zsolt said, around 60%.

Operator

And we'll go next to Joe Maxa with Dougherty & Company.

Joseph A. Maxa - Dougherty & Company LLC, Research Division

The carbon fiber, excluding the wind, so if that's about 40% of your business right now, what are you seeing in that area, given the macro events or macro economy currently, and that are your expectations?

Zsolt Rumy

Well, I think if the wind turbine business grows like that,believe me, we'll grow and we can maintain 40% and on [ph] wind until the automotive really kicks in. I think that will represent pretty good growth. So I -- again, while we're talking about number of applications, not only auto but deep-sea drilling and aircraft interiors and a number of others, infrastructure, among other things, nothing in the next year or so is going to have as big growth as the wind turbine business, which is why we're concentrating on it. And the other good news is, we're pretty well established, generally in the -- in most of the world as being the carbon fiber supplier for the wind turbine business, and we want to maintain that position. So anyway, I'm looking for significant growth from wind, and if we can maintain this percentage until another major application kicks in, I think we'll be doing fine.

Joseph A. Maxa - Dougherty & Company LLC, Research Division

So if we look at, a little more color on the wind side, outside of Vestas, I mean, obviously very big customer, how do you see that growing? Or maybe you can put it on a percentage of sales. If it was 10% of your business roughly, where do you think that'll go in the next year?

Zsolt Rumy

Well, we don't do any predictions and any...

Joseph A. Maxa - Dougherty & Company LLC, Research Division

Ballpark?

Zsolt Rumy

But -- well, we have been working with just about every wind turbine manufacturer, and many of them are starting to adapt carbon fibers. It takes a certain amount of time to get through qualifications and the insurance tests [ph] and all that kind of stuff, so it's not an instantaneous new business. But based on our customer base, I think we're looking for significant improvements [indiscernible]...

Joseph A. Maxa - Dougherty & Company LLC, Research Division

So do you anticipate growth in revenue and earnings in the September quarter?

Zsolt Rumy

Again, I don't give you any anticipation on what to think. It was a good [ph] question before that, and maybe you're hoping that one day I'm going to stumble, but...

Joseph A. Maxa - Dougherty & Company LLC, Research Division

Well, I was hoping for directional. I'm assuming you have pretty good near-term visibility, and it sounds pretty positive based on your press release, so I was just hoping you'd maybe verify that.

Zsolt Rumy

Yes.

Operator

We'll go next to Michael Lew with Needham.

Michael Lew - Needham & Company, LLC, Research Division

With regard to the lignin project you'd mentioned, how much could it drop cost by?

Zsolt Rumy

Well, again, it does -- that's a kind of question that doesn't have a quick answer. It depends on what the ACN cost is. We're looking at replacing 35% to 45% of ACN with lignin, and that's going to be the major part. There's some other operational cost reductions that we have not -- how should I say it, calculated what it should be, but have not done a commercial run yet. But we'll do that in the next couple of weeks. And we'll have a better sense for what other savings there are.

Michael Lew - Needham & Company, LLC, Research Division

No, you mentioned the run -- initial run in the next couple of weeks. Let's say if you're successful, like what kind of time frame are you looking at before you could potentially start to commercialize this material? Is this like 2 years down the road, do you think?

Zsolt Rumy

Well, hopefully not, a lot shorter than -- but probably the biggest time for full commercialization will be required for the lignin purification process that Weyerhaeuser has to install. So we're looking at some way of introducing in steps rather than wait for a major client installation by Weyerhaeuser. So we'll be -- simultaneously we'll be doing our commercial run, we'll be discussing the business issues to sort out what kind of timing we need. But there is a processing step from lignin that just comes out of the paper process, and it has to be purified and reacted and -- so there's a step there that needs to get done. And obviously, we're working with pilot plant operations. And then there's an intermediate-size plant that is being planned. So I can't give you a straight answer, but we're going to be -- once we know that -- what it can do, we're going to be starting -- looking at it, start marketing it. And I think there's a huge interest, so I think we'll try to speed up that process.

Michael Lew - Needham & Company, LLC, Research Division

Yes, I know. There should definitely be huge interest in that, of course. But still, I was going to say, on the Magna relationship, have you started to derive some commercial sales from that? Or is it still in the very early stages?

Zsolt Rumy

Well, we're doing the final plans, the design and installation of equipment, final production runs, and they're already doing a significant amount of quotes for various parts, various programs.

Michael Lew - Needham & Company, LLC, Research Division

And is that just for passenger? Or is it also going to -- are you looking at like truck -- the truck markets, the fleet applications?

Zsolt Rumy

It could be anything. Any large composites, components.

Michael Lew - Needham & Company, LLC, Research Division

Anything that would absorb -- okay. And last question, with the relationship with Vestas, is this an exclusive arrangement that you have as a supplier? Or is it more of a preferred supplier relationship?

Zsolt Rumy

It's a lot more than a preferred supplier. Leave it at that.

Operator

[Operator Instructions] We'll go next to investor Art Frinful [ph].

Unknown Attendee

Zsolt, I'm an investor, and read an article in the St. Louis Business Journal that you reached a supply agreement with Fiberblade S.A., a Spanish company that proposes to offer $65 million to $75 million in sales over 3 years. And I just would like to know if this is an increase in market share, or if this -- or has this been an existing customer in the past?

Zsolt Rumy

I'm not sure what article you're referring to. I don't really follow anything in the St. Louis paper.

Unknown Attendee

Yes, St. Louis Business Journal. It was just within the...

Zsolt Rumy

Oh, in 2005, I think. Fiberblade is the name of the Gamesa Blade manufacturing arm. And so this announcement was back 7 years ago.

Unknown Attendee

Oh, it was? Okay, well [indiscernible]...

Zsolt Rumy

And so -- and we're doing business with them.

Unknown Attendee

You are doing business with them?

Zsolt Rumy

Yes.

Andrew W. Whipple

Yes.

Unknown Attendee

Okay. Also, just one kind of a scientific question, is Zoltek, any of the materials that you're making in carbon fiber, are they adaptable to 3D printing prototype development?

Zsolt Rumy

3D printing?

Unknown Attendee

3D printing, yes, it's a new manufacturing...

Zsolt Rumy

Well, the only thing I know in carbon fiber is used in printing area is only rollers and things like that for all paper manufacturer, including printing. They use carbon fiber rollers, because they're much lower weight and the speed of these rollers, the RPM very high, so it's a huge savings in equipment design and building as well as much safer. And those are the only areas that I know of printing, and there are some anti-static applications and things like that. But I don't know specifically anything about 3D printing.

Unknown Attendee

Yes. Well, there's been $500 million in 3D printers sold within -- in 2011, and they're using it a lot in prototype development now. So I just wanted to raise that question. I know it's probably...

Zsolt Rumy

Well, we'll take a look at it. I...

Unknown Attendee

With your existing customers, that's probably not on the radar screen, but I was mainly wanting to know if the material would -- can be adapted to that process. So...

Zsolt Rumy

Well, I'm sure that it can. Well, like I said, you seem to know a lot more about 3D printing than I know. When I was a teenager, 3D was only the porno movies with.

Unknown Attendee

Yes, exactly. I can agree with you on that. So okay, I do appreciate your answers.

Operator

[Operator Instructions] And Mr. Rumy, there appears to be no further questions at this time.

Zsolt Rumy

It looks like we run out of steam. Thank you very much for participating, and we'll see you next quarter.

Operator

That does conclude today's conference. Thank you for your participation.

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