Maxwell Technologies Inc. Q1 2009 Earnings Call Transcript

| About: Maxwell Technologies, (MXWL)

Maxwell Technologies Inc. (NASDAQ:MXWL)

Q1 2009 Earnings Call

May 5, 2009 5:00 pm ET

Executives

Mike Sund - VP of Communications and IR

David Schramm - President and CEO

Kevin Royal - CFO

Analysts

Steve Sanders - Stephens Incorporated

Ted Kundtz - Needham & Company

Mark Tobin - Roth Capital

Dilip Warrier - Thomas Wiesel

Elaine Kwei - Piper Jaffray

Craig Irwin - Merriman Curhan Ford

Bryce Dillie - JMP Securities

Jim Brilliant - Century Management

Operator

Good day everyone and welcome to today’s program, the Maxwell Technologies financial results conference call. At this time, all participants are in a listen-only mode and later you will have the opportunity to ask questions during the question-and-answer session. (Operator Instructions)

It is now my pleasure to turn your conference over to Mr. Mike Sund. Please go ahead, sir.

Mike Sund

Good afternoon. In a moment you will hear from David Schramm, Maxwell’s President and CEO, and Kevin Royal, our Chief Financial Officer.

Before we begin, I need to advise you that the following discussion will include forward-looking statements, that are based on our current expectations and assumptions, which are subject to numerous risks and uncertainties.

Actual results may differ materially because of factors such as our history of losses and uncertainty about our ability to achieve profitability or to obtain sufficient capital to operate successfully, disruption of financial markets and reduced credit availability, development and acceptance of products based on new technologies, demand for original equipment manufacturers’ products reaching anticipated levels, general economic conditions in the markets served by our products, cost effective manufacturing of new products and the success of outsourced manufacturing, the impact of competitive products and pricing, risks and uncertainties involved in foreign operations, including the impact of currency fluctuations, and product liability or warranty claims in excess of our reserves.

For further information regarding risks and uncertainties associated with Maxwell’s business, please refer to the management’s discussion and analysis of financial condition and results of operations and risk factor sections of our SEC filings, including our most recent Form 10-Q and our Annual Report on Form 10-K.

Electronic copies of these filings maybe accessed by visiting the investors section of our website at maxwell.com and hard copies maybe obtained by contacting the company by mail, e-mail or telephone. Some of you are listening to this call via the internet and an archived replay of the call will be available at our website. All information in today’s call is as of May 5, 2009. The company undertakes no duty to update our forward-looking statements to conform the statements to actual results or changes in the company’s expectations.

It is now my pleasure to introduce David Schramm, Maxwell’s President and CEO.

David Schramm

Thank you, Mike, and good afternoon, everybody. We are pleased to report that Maxwell’s total revenue of $22.5 million for the first quarter ended March 31st was 31% higher than the $17.1 million reported in the same period a year ago.

As stated in our press release, this growth continue to come from all three of Maxwell’s product lines, each of which posted double-digit sales growth over Q1 ‘08. So, even as global economic conditions and tight credit impacted most other industries, key markets for our products including electric utility infrastructure, wind energy, public transportation and space programs, have been relatively stable and they are among the likely beneficiaries of US and Foreign Government stimulus programs. So, we expect them to remain in reasonably good shape.

Q1 BOOSTCAP ultracapacitor revenue came in at $7.7 million, 43% higher than the $5.4 million recorded in last year’s first quarter. Ultracapacitor growth continues to be driven mainly by new orders for energy storage solutions for wind turbine blade pitch systems and breaking energy recuperation systems for hybrid and electric transit buses and electric rail vehicles, plus miscellaneous backup power, wireless communications and other industrial applications.

Even though tight credit availability is delaying some wind energy projects, we have added several new customers over the past year. So, we are gaining market share and are generating year-over-year growth in wind related revenue. As discussed earlier, we have been able to broaden our wind customer base, as a result of a license we obtained to a patent covering the use of ultracapacitors in wind turbines, which is held by our original wind customer Enercon in Germany.

Ultracapacitors help to increase the consistency and efficiency of wind turbine output and ensure orderly shutdown in the event of high winds that could damage these large expensive systems. Ultracapacitors have demonstrated higher reliability and a superior value proposition versus batteries. So, we are aggressively pursuing additional wind business.

Another well established ultracapacitor application that promises to generate even faster sales growth for us this year, is breaking energy recuperation and torque assist systems for hybrid and electric public transit vehicles and more energy efficient electric rail systems.

A couple of weeks ago, we announced that we have received purchase orders with a total value of $13.5 million from three of China’s leading bus producers for ultracapacitor based energy storage and power delivery systems for hybrid buses. We have already begun deliveries and are ramping up production to fill the balance of those orders by the end of this year.

According to industry estimates, there are more than 0.5 million transit buses currently in service in China, so the opportunity there is truly staggering. Last year, the Chinese government announced its 13 by 1000 program, through which 13 of the country’s largest cities, each will receive 1,000 new hybrid buses to address severe urban air quality problems. So, the orders we received appeared to be the first wave of could prove to be a tsunami.

We’re also working with both existing and new customers on additional programs in North America and Europe that we expect to move into production in coming quarters. As discussed in last quarter’s call, the European Union has taken the lead in legislating carbon dioxide emission reduction targets and levying penalties for vehicles whose emission exceed mandated thresholds.

The Obama Administration also has begun signaling his intension to use regulatory pressure to reduce CO2 emissions and increase federal investments in greener transportation technologies.

Ultracapacitors efficiency in absorbing breaking energy, their ability to operate reliably and safely in extreme temperatures, and their million cycle durability are enabling our BOOSTCAP products to serve as a stand-alone energy storage solution in many heavy vehicle drive systems or to complement batteries in others.

Similar opportunities are developing in lifting applications, such as with cargo cranes in core facilities. As with heavy vehicles, ultracapacitor-assisted cranes capture and store energy from breaking that otherwise would be dissipated as friction and heat, and that stored energy is reused to reduce the amount of diesel fuel required for lifting, thereby reducing emissions.

The EU carbon dioxide emission reduction legislation we discussed in our February conference call mandates that 65% of new cars produced in Europe must emit no more than 130 grams of carbon dioxide per kilometer by 2012, and that threshold is set to ratchet down to 95 grams per kilometer by 2020.

Many current models emit as much as 200 grams per kilometer. So virtually all European automakers are preparing to produce and launch low emission micro and mild hybrid vehicles. The key features of these new cars will be a start/stop function, which turns off the internal combustion engine as the car slows and doesn’t restart the engine until the driver touches the accelerator.

Experience with early start/stop systems has shown that this repetitive cycling causes early battery failure, so several automakers and the Tier 1 suppliers who develop those systems for them are designing ultracapacitors into next generation models, scheduled to move into production in the next couple of years.

Even with today’s reduced global auto production, automotive applications such as stop/start, electrical system stabilization, and cold starting represent extremely high volume opportunities for ultracapacitors.

We know that some of you have grown weary of waiting for these applications to show up in production models and we share your impatience. Some of our automotive customers told us last year that we needed to be ready to begin delivering initial production volumes by later this year.

So, we have made significant investments in staffing and capital equipment to ensure that we could meet that schedule. While it is now clear that initial production volumes may not materialize until early next year, the program still exists. So, we now anticipate that we will just have to run faster when the orders arrive.

We also expect to have news on some new industrial applications before long so stay tuned.

In a few moments I will touch briefly on our other two product lines and comment on Maxwell’s prospects for the balance of the year. But, first, I’d like to introduce our new Chief Financial Office, Kevin Royal.

Kevin officially came abroad April 20. So, he and the finance team have been very busy closing the quarter. He brings deep financial and operational experience to his new role here, including 10 years of public accounting with Ernst & Young and since as CFO Novellus Systems and more recently Blue Coat Systems in Silicon Valley.

So, with the caveat that he has been only on the job a couple of weeks I am going to ask him to go in some additional detail underlined the Q1 financial results. Kevin, and welcome.

Kevin Royal

Thank you, David. First of all, it’s very good to be at Maxwell. I am going to spend a few minutes this afternoon discussing certain areas of our Q1 2009 financial results in comparison to Q4 2008, to provide further color on the financial operations of the company.

Related to gross profit, it’s important to understand that changes in foreign currency exchange rates can positively or negatively impact our gross profit as a percent of sales. Our reported gross profit as a percentage of revenue for the first quarter of 2009 was 31% compared to 39% in Q4 2008.

In the current quarter, without the negative impact of foreign currency exchange rates, gross profit would have been 37%. In comparison, gross profit was favorably impacted in the fourth quarter of 2008.

Without the positive impact of the change in exchange rates, our gross profit would have been 36% for the fourth quarter of 2008. The unfavorable foreign currency loss included in gross profit was $1.2 million in the first quarter 2009 and a favorable foreign currency gain in gross profit was $800,000 in the fourth quarter of 2008.

On an operational basis, our cost structure for ultracapacitors continues to decline the improvements in design, material cost, productivity and lower labor cost due to outsourcing cell and module assembly.

I am going to discuss our net loss and the impact to certain non-cash and non-operating items on our reported loss. Most of these items are non-cash. We reported a net loss of $3 million for the first quarter of 2009. There are four items included in our net loss that I would like to highlight.

Included in our Q1 loss is total foreign currency related losses of $711,000, stock-based compensation of $738,000, amortization of debt discount of $379,000 and a loss on embedded derivatives of $607,000. Excluding these items, yield a net loss of approximately $530,000 for the first quarter of 2009, which is much closer to our EBITDA for the quarter.

Net income for Q4 2008 included foreign currency gains of $808,000. Stock-based compensation is $661,000, Amortization of debt discount of $466,000 and a gain on embedded derivatives of $3.2 million. Adjusting for these items, yield a net loss of $738,000 for the fourth quarter ended December 31, 2008.

Now, I would like to turn to the balance sheet. We ended the quarter with cash and restricted cash of $15.4 million, which represents decline of $5.2 million from Q4 2008. The most significant cash usage during the first quarter relates to an increase in account receivable of $3.7 million and capital spending of $1.5 million. While we did experience a decline in cash, it’s important to note that the majority of the cash usage relates to an increase in accounts receivable, which we expect will be collected during the second quarter.

Given the cash usage during the quarter, I wanted to comment on potential avenues for Maxwell to raise capital. First, the company is operating near breakeven on an EBITDA basis. In addition, the company has an effective shelf registration statement with more than $80 million available. We sold more than $8 million in common stock to our Equity Distribution Program over the last three quarters and we continue to balance cash needs versus dilution.

In addition, we have engaged in numerous discussions with potential business partners, regarding the possibility of obtaining strategic funding on more favorable terms in a possible with financial investors. In addition, we do have the option of using our common stock to make quarterly convertible debt payments.

Before I turn it back over to David, I would like to comment on recent developments related to our business in China. As noted in our earnings announcement and our form 10-Q, we have changed the financial statement classification for commission payments to our outside sales rep in China. These payments have historically been characterized as sales commissions.

We recently informed the significant portion of these commissions were essentially customer rebates and should therefore be classified as a reduction of revenue. We are reviewing this matter further to ensure that we understand the management actions that are required under US law if any.

Now, I will turn it back over to David, to discuss other areas of the business.

David Schramm

Great, thanks Kevin. Obviously, we are very encouraged by the year-over-year top line growth recorded in Q1, particularly in view of what’s happening in the global economy. However, considering the economic environment, we are going to continue to guide one quarter at a time.

As noted in our release today, second quarter revenue is on pace to come in well above Q2 ‘08. So, sales should be significantly higher at mid-year and operating results should show additional improvement compared with the first half of 2008.

We have talked mainly about ultracapacitors, so lets spend a couple of minutes on Maxwell’s other products. Our high tension products consist mainly of grading and coupling capacitors and capacity of voltage dividers. These large high-voltage capacitors are used in the electric utility grid and other applications involving the transport distribution and measurement of high-voltage electrical energy.

Although the name suggests some relationship to ultracapacitors, the high tension technology and materials, the know-how involved in making them and the applications in which they are used are quite different. We sell high-voltage capacitors to the large prime contractors, who build power plants and electric utility infrastructure around the world.

Our products enjoy a dominant position in a well-defined niche. So, sales track with global spending on utility infrastructure. China and other developing countries that are increasing electrical energy generation capacity to support rapidly growing industrial and residential demand, our major drivers for high tension product sales, which continue to roll along at last year’s record rate.

The Obama Administration has indicated that modernizing the US Grid will be a major focus of its stimulus package and Federal Energy Policy going forward, so we are closely monitoring developments in Washington.

Sales of our microelectronic products are running well ahead of last year, and we are up to about for some large single board computer orders that could accelerate growth over the next couple of years. Our customers are the large satellite and spacecraft OEMs in the US and Europe.

So, micro sales track with the number of satellite and spacecraft launches each year. Because micro electronics revenue was program driven, it can vary quite a bit quarter-to-quarter. So, our goal is to increase the value of Maxwell products for satellite or spacecraft launch and the high value single board computer product is an industry leading product that is helping us to do that.

High profile win such as with Northrop Grumman for the next generation US weather satellite program and with Astrium in Europe for the European Space Agency’s Giotto science mission have raised Maxwell’s profile and positioned us to compete for even larger single board computer opportunities.

Moving to the big picture; with sales continuing to grow steadily, it’s fair to ask about Maxwell’s path to profitability. As Kevin told you, Q1 demonstrated further progress in that direction. Increasing volumes, improving the efficiency, and cost reduction initiatives, including moving assembly of our largest selling, D Cell ultracapacitor product to China, will drive continuing operating performance improvement.

Although no one can predict with certainty as how the worldwide economic problems may affect our customers and their plans for the balance of the year, my personal goal is for Maxwell is to exit this year at a profitable run rate.

One of the first things I did when I joined the company nearly two years was to put an end to the company’s past practice of offering strategic, meaning below cost pricing to customers that management believe would become market leaders.

During that early market creation phase, those supply agreements were seen as investments to create demands. Now, we need to invest in capacity expansion, product development and qualifying as an automotive supplier.

Our sales organization is also now understanding that we need to focus on markets and applications where we can generate appropriate margins. Operationally, we continue to focus on product design improvements that reduce costs and improve manufacturing ability and quality.

By the end of this year, we will have completed moving material sourcing and ultracapacitor cell and module assembly to low cost countries; however, to protect our proprietary technology, fabrication of electrode material will remain under lock and key inside Maxwell.

With volumes increasing, we have improved logistics and planning, allowing us to take advantage of low cost ocean freight to get our products from where they’re assembled in Asia to our customers around the world. As a result of these actions, we expect significant year-over-year gross margin improvement a critical step on that path to profitability.

As noted earlier, global economic conditions have had some impact on sales, but some other macro factors are working in our favor. While some investors worry that oil prices might work against us, demand for greener, more efficient and reliable energy storage solution is still driving many new opportunities for ultracapacitors.

In Europe, where fuel prices have been high for many years, it is carbon dioxide emission reduction, not oil prices that is driving innovation and resulting opportunities for ultracaps.

There has also been concern that the United States auto industry’s problems might start Maxwell’s growth. The fact is, all of the automotive programs we have discussed, are with European automakers and Tier 1 suppliers, so anything good that happens in the US is upside for us.

On the stimulus front, the Obama Administration has highlighted renewable energy generation, as in wind energy and energy storage technologies to power low emission, energy efficient hybrid and electric automobiles and transit vehicles as funding priorities.

We have had face-to-face contact with identified funding sources at the Department of Energy and elsewhere in Washington, and are involved with approximately 20 technology and product development funding proposals.

With all those lines in the water, some on our own and some with battery and auto industry collaborators, we have good reason to believe Maxwell will receive some R&D funding and that we are likely to benefit indirectly from funding that flows through our customers and development partners.

One area of particular interest is establishing a domestic lithium-ion battery industry, so that the conversion to new hybrid and electric vehicles doesn’t simply swap our US dependence on foreign oil for US dependence on foreign batteries. Funding for this initiative is creating opportunities for us to demonstrate the advantages of our proprietary dry electrode fabrication process and battery manufacturing.

It is a green, solvent free process that has demonstrated potential to reduce costs, improve battery performance, and extend the operating lifetime. These new activities are in addition to our announced relationships with Johnson Controls-Saft in the US and the Lishen Battery Company in China.

Also continuing our development and testing programs with Argon and other national laboratories that are generating data that validates the synergy between batteries and ultracapacitors in the integrated energy storage solutions. These solutions take advantage of BOOSTCAP’s ability to perform over a wide temperature range for millions of charge/discharge cycles, extending battery life and allowing batteries to become smaller and lighter.

So, in conclusion, we are pressing forward with multiple initiatives to advance our core technologies and create new opportunities, while delivering on our business plan.

Thanks again for your interest and your support. I would now like to entertain your questions.

Question-and-Answer Session

Operator

(Operator Instructions).

We will take the first question from Steve Sanders from Stephens Incorporated.

Steve Sanders - Stephens Incorporated

Just a couple of follow-on, on the China side; on the contract manufacturers, how are they doing in their ramp and in the quality control and just trying to get a sense of how well positioned they are to meet significant potential incremental orders on the bus side?

David Schramm

Yes, that’s a good question. Building industries in Shenzhen, China has for the last 20 years they making part for Seagate and also for Western Digital. So, they got a quality acumen, as to what you do with hard disk drive business, which was one of the reasons we chose them. They’ve got a completely trained workforce. They are ISO certified. Their quality system is equivalent to ours based on the audit, we’ve had from various customers. We are a small portion of their business. They have space to improve the utilization. They have extra space to add capacity and I’ll be going over there in about another month to discuss with them how we end up putting a second plan deal?

Steve Sanders - Stephens Incorporated

Okay, so bottom line, you’re very comfortable with how they’re doing?

David Schramm

Very comfortable with how they’re doing, the quality, the yield has been there. We’ve moved the module assembly that was in Santiago and again it’s very important to understand all the technology that goes into the ultracap is in how we make the electrode and how we put that package together, the interfaces if you will. So, what we have, our partners in China doing from a contract manufacturing standpoint, is nothing more than putting these together. So, we have outsourced the hands part, not the head part.

Steve Sanders - Stephens Incorporated

Okay and then do the China bus orders meets your margin expectation, your current margin expectations for the ultracapacitor business or was there an element of discounting to get the volumes in there?

David Schramm

There was no strategic pricing involved in this, Steve. These were done at a profit.

Steve Sanders - Stephens Incorporated

All right, great to hear and then more broadly, as I think about scaling up volumes in the ultracap business and I think about the electrode manufacturing, the cells, the module assembly. What are the challenges for you in terms of striking the balance between margin improvement and being positioned to serve, what could be a lot of different opportunities popping up over the next year or two?

David Schramm

The strategy hasn’t changed. What we want to do is standardize ourselves and then customize our solutions. We have eliminated a lot of SKUs in the last year and a half and we’ve also done is standardize on the modules. The whole strategy again is to have good application engineering designed into their system and apply our standard product in different formations that look customized for the customer, but as I go through our manufacturing process are standard.

Steve Sanders - Stephens Incorporated

Okay and I think you made some comments about adding some additional wind customers. I’m not sure I heard that correctly. Can you just expand on that a bit?

David Schramm

Yes, if you remember correctly, it was last year that we purchased a right to the application patent that Enercon has. Enercon owns a patent for applying ultracapacitors for blade pitch control. What that did, that stopped anybody else in the wind industry from using ultracapacitors to use pitch.

We bought a license and the license we bought was a one time fee license. It’s not a royalty, which then allows us to call on other customers. So, as there has been a slowdown if you will, in the wind market, we’ve increased our breadth. So, our overall wind presence has gone up and we’re still knocking on doors.

This morning there was a pretty good article in the Wall Street Journal about wind and what the growth is for United States. The Wall Street article said that the writer called, the middle of the United States to Saudi Arabia wind. So, hopefully he is correct.

Operator

Our next question will come from the site of Ted Kundtz from Needham & Company.

Ted Kundtz - Needham & Company

Couple of questions for you, one could you comment a bit more maybe Kevin, this is for you, on the SG&A line, big drop from last year’s even fourth quarter, even all the quarters, as a matter of fact and I’m just wondering if any of that was affected by the Fx impact as well and what do you expect the SG&A levels to look like going forward.

Kevin Royal

Yes, Ted, the SG&A line was in fact impacted by actually [payroll] transaction gains of about $450,000 in the quarter. So, previously the accounting that we used for foreign currency transaction gains was to put that down in other income and expense and more recently, we believe that it’s more appropriate since those transactions are more operationally focused to get that up in the operating expense. So, that is the significant different that you see between historical numbers that we reported in the past and the SG&A line that you see in our current quarter reported results for the first quarter.

Ted Kundtz - Needham & Company

Okay, but you’d then say more normal run rate except would be $5.5 million range that’s still a pretty nice cut from prior quarter levels? Is that where you are? Is that fair to say?

Kevin Royal

Let me just take a look at something here Steve.

Ted Kundtz - Needham & Company

If I just add that back and just…

Kevin Royal

Yes, I think if you get a more normalized run rate for where we are, that’s what you would do.

Ted Kundtz - Needham & Company

Okay, that’s about the right number?

Kevin Royal

Yes.

Ted Kundtz - Needham & Company

Okay. That’s still a nice impressive trend there. You’ve got going which is great. David, could you talk a little bit more about, I don’t know if you would be willing to do this or not, but you’re looking at your BOOSTCAP revenue line. Would you be willing to break that down into buckets for us or not, like how much is it going into vehicles, how much into wind, how much into kind of all other buckets there?

David Schramm

No. We don’t break it down into those buckets for a lot of good reasons. We report as one company. So what I’m looking at is the high tension in the micro and the BOOSTCAP is all one company for me with three product groups.

Ted Kundtz - Needham & Company

Right. Okay. I was just trying to get a sense, or maybe you could put just a little more color than around the BOOSTCAP trends you’re seeing in the wind markets? And then the vehicle markets, what kind of momentum you have, what kind of order trend you’re seeing?

David Schramm

And that I can do, I think the bus market in China is obviously, we’ve had a very, very good few months here with what’s going on in China. And again just the sheer number of buses they have. And again it’s the typical approach that we’ve seen in China that when they decide to go hybrid, they can do 13,000 buses.

Well, that’s more buses than we built in the US and Europe together in a year and they’re going to make them just the hybrid ones. And as I said earlier, we see in the literature, there is about 0.5 million buses. So, if they have a 10-year life, that’s 50,000 a year and how many of those become hybrid. So, that we see as uptick that is really now.

The orders we announced that 13.5 million, a huge majority that is deliverable in 2009 and more to follow. When I look at the wind, the wind is being impacted by financing.

In the journal this morning, the article talked about T. Boone Pickens slowed down his $1 billion investment waiting for things to get a little bit better.

But he goes on to say that the demand is still there through 2011. So, we believe with this license we have that the uptick in the wind market is still going to be there for us.

Automotive, we read the legislation. We know we’re designed in. We are just waiting for the orders to come through, and that’s where we’re at and we’re hoping that that’s going to happen sooner not later, because based on the timelines they’ve shown us, we need to get product to them late this year, early next year in volumes.

Ted Kundtz - Needham & Company

Okay. And then, there is kind of an all other bucker there too, where you would have meters and you would have forklifts and you’d have other things in there as well. Is that also you’re seeing more opportunities in other sectors as well, other areas?

David Schramm

We’re seeing a lot of interest in industrial. The cranes at the dock level, there is a great application there it cuts noise, it cuts diesel fuel. So, it does all the right things that we see. We’re also seeing some different applications, one that we announced a while back is cold starting for school buses in Chicago, and we think that application has got a lot of room to grow.

Ted Kundtz - Needham & Company

Okay. Did you ship anything yet on the order from China that you just mentioned and you’ve announced earlier?

David Schramm

Yes. We did.

Ted Kundtz - Needham & Company

You have shipped some already?

David Schramm

Those were standard modules and again the logic is, they had a customized solution and we provided standard modules to put in series and we meet that demand.

Ted Kundtz - Needham & Company

Okay. Can you say how much is remaining to ship in that order?

David Schramm

More is remaining than we shipped, because, like I said, we just announced this in the last couple of weeks.

Ted Kundtz - Needham & Company

All right. But, you said you already shipped against it?

David Schramm

We have shipped against it.

Ted Kundtz - Needham & Company

Yes. Somewhat, okay, but you’re just starting.

David Schramm

Just started.

Ted Kundtz - Needham & Company

Got it. Okay.

David Schramm

Yes. Not much of that hit Q1 and we’ll see how much we hit in Q2 and Q3.

Ted Kundtz - Needham & Company

Got it. Okay. So the bulk of it’s going to be booked going forward. Okay, terrific. Thank you.

Operator

Our next question will come from the site of Mark Tobin from Roth Capital. You’re line is open. Please go ahead.

Mark Tobin - Roth Capital

Looking at ultracapacitor gross margins, can you comment on what you have seen just trend-wise? Then specifically, as far as the transition of your C and D Cell production to be shunned, is that complete? I know you were targeting late first quarter, early second quarter timeframe.

David Schramm

Yes. Again the trend is, we are going from underwater to above and it is lot nicer to be on top of the water. We have been tracking listing of where do we have customers that we were underwater and that list is getting significantly smaller. And we have got a couple left that we are working on, and as those purchase orders come up for renewal, we are going to renegotiate.

Relative to the D Cell that is currently the electrode’s meet in Santiago and it’s assembled in the middle of Switzerland that is being move to Lishen Battery Company for assembling. We are building qualification samples as we speak and are completely on track to have that move from Switzerland into Lishen Battery Company.

Mark Tobin - Roth Capital

Can you give us an indication of the time frame for that transition or is that something that ramps through the balance of the year?

David Schramm

It’s going to ramp up but will be in production before the end of this quarter, before the end of Q2. And that was the original plan.

Mark Tobin - Roth Capital

And then, can you provide any additional color on unfavorable contracts, when do you expecting them to start?

David Schramm

The one we have commented on, the one that was designated in pieces and that one we believe based on their order will come to be completely fulfilled later this year and then we are going to fill that up with new and improved product that we have already started negotiations and that will not be underwater.

We have taken a strategy that we are not going to offer strategic pricing, because frankly my experience is once you do it, once you have to do it twice and then you are underwater for the life of a program. So, there is no value in doing that. The value is providing for what we do offer as value and then drive the cost out of it to make sure that you got an acceptable margin for the stakeholders. Well, we’re not going to start underwater and try to work our way out.

Mark Tobin - Roth Capital

I understood. Thank you.

Operator

Your next question will come from the site of Dilip Warrier with Thomas Wiesel.

Dilip Warrier - Thomas Wiesel

So, just going back to the Chinese hybrid bus opportunity, clearly its opening up really quickly and like you said, they’re pretty aggressive. I was just wondering, if you could talk about the sales effort that you made there that culminated in these orders and then we already talked about 13, one positive opportunity, but what are in your conversations with these top three bus makers and potentially some of the others? What are you hearing in terms of production plans and then just finally, what made those bus manufacturers choose you versus say, a local auto car producer, who perhaps uses electrode material from W.L. Gore or something?

David Schramm

Yes, it’s good questions. The sales, I’ll start with that. We do have an office in Shanghai and I do have a Director of Asian Sales, that he has been located here in San Diego and they just been very, very successful in contacting the people and with the engineers, with our application engineers, really selling the engineered solution, as to what we can do, how we can perform.

The good news is, that we’ve made million of ultracaps. So, we’ve got some production data there. We can backup, as to what the performance levels are, and what the customer can get. So, our sales force in China obviously is a good inroad because they are local and they give good customer support. That effort we will be growing, as we get more and more business in China.

We have to add more quality people under the Chinese market, more customer service into the Chinese market and again I think you’d find, we got good team effort here with the engineers, not afraid to fly and fly coach I might add, help that SG&A, to go over there and support our Chinese partners.

Dilip Warrier - Thomas Wiesel

Right and then when these guys play the stack you up versus a local competitor, how does that really work?

David Schramm

Well, frankly we haven’t seen a lot of local competitors out of the Chinese market. This business is roughly 10 years old and we see competition out of Korea and out of Japan and out of France, but we haven’t seen a lot of homegrown ultracap manufacturers out of China. That being said they probably will be there.

Dilip Warrier - Thomas Wiesel

Okay and then just sticking within sort of the heavy duty transportation, are you seeing, outside of transit busses are you seeing any other opportunities open up. I really haven’t seen too much in the form of hybrid trucks and tractors and stuff like that?

David Schramm

The technology that we’ve developed for the busses is applicable to a lot of heavy duty vehicles. Anything that does lifting like a heavy duty crane, the Cold Start System that we announced that we put in, with one of our distributors in the Chicago bus fleet. One of that technologies applicable to heavy trucks and we just got to find the right entry point to showcase it and then land that sale.

Dilip Warrier - Thomas Wiesel

Okay and then just housekeeping question. I see that license fees revenues went down to zero this quarter and that kind of a trend to be expected or is that going to go back up to historical levels?

Kevin Royal

Yes, I think the reason for that, we had some license arrangements that concluded. I think the company still works on developing that area and I think we’d expect that in the future, but we don’t forecast at the granular level.

Operator

Your next question will come from the site of Elaine Kwei from Piper Jaffray.

Elaine Kwei - Piper Jaffray

Could you give us a general idea of the time line for getting design into wind turbine applications and how far long it might be with from the potential customers’ in that area?

David Schramm

The good news is, that the windmills are big enough the packaging does become a significant issue for us and frankly today, if they’re using an electric system they got batteries. So, the spaces there and typically the architecture is there.

Now about a third of the windmills in the world today use a hydraulic system. So, they don’t have an electrical system and we are calling on them basically to convince them, that they should consider the electric system because of the tolerance requirement that you can get and try to sell them the ultracapacitors, but designing at end is rather quick. Because again packaging tends to be the biggest issue, you have on an application, that’s really not an issue with windmills.

Elaine Kwei - Piper Jaffray

Okay. So, if there is already an electric system in place switching over to ultracapacitors is fairly easy?

David Schramm

It is in fact, when we started with Enercon, Enercon was using batteries and one of the drivers just to why you go to an ultracap is, a battery is temperature sensitive and you can only charge a battery so many times and discharge it so many times and you have to change it and we all have that experience.

When you are dealing with the windmill that could be 500 feet in the air, it becomes a little bit of maintenance logistics, so how do you get fresh batteries up 500 feet and change them periodically. So, they switched over to the ultracapacitors because you can charge and discharge the ultracap a million times and it doesn’t wear out. It also works at 40, below zero and it works at 65 above in Celsius and again batteries chemically have an issue with that, when it gets too cold or gets too hot. So, the overall cost effective solution for Enercon was to go to ultracaps.

Elaine Kwei - Piper Jaffray

All right. How significant do you see the Chinese wind opportunity versus Europe or the US and would you expect most of this growth to come from incumbent or new windmill manufacturers?

David Schramm

I’d answer yes to both, 1.3 billion population and the infrastructure is really rather limited and they are building infrastructure rather quickly. So how much of this could be windmill versus coal fire, I think we’re going to see a lot of pressure from the Chinese government to try to clean up what they have and my sense is the windmill is one of the opportunities they see.

Elaine Kwei - Piper Jaffray

And just a real quick on the gross margin, were there any production related issues or anything apart from the foreign exchange and some of those type of things that impacted the margin?

David Schramm

Yes, really the only negative impact to gross profit margin was the foreign currency exchange rate loss that I pointed out. Operationally, we had improvements and I’ll just repeat that overall when you take the impact of the foreign currency movements out of the gross margin and compare it to Q4, we actually improved from 36% to 37% for the quarter.

Elaine Kwei - Piper Jaffray

And do you have any strategies in place for addressing or hedging any of those foreign currency exposures?

Kevin Royal

This is my third week with the company, but as we went through and closed the books and looked at the results, certainly seen the significant foreign currency loss, made me reach out to people I’ve worked with in the past to help me come to the effective hedging strategy to reduce those losses in the future. So, the answer is yes.

Elaine Kwei - Piper Jaffray

Thanks a lot.

David Schramm

I guess to add to the answer of that question. It’s nice to see that our revenue is growing such that SCTA is going to be an issue we’ve got to deal with.

Operator

We’ll take our next question from Craig Irwin from Merriman. Your line is open.

Craig Irwin - Merriman Curhan Ford

Congratulations on the quarter. Quick question and I apologize if this has already been addressed. I got on the call a little bit late, but SG&A was down sequentially. I know you’ve been very careful about managing costs and that I guess the year ago expenses from the litigation with NESCAFE and then some of your qualification expenses maybe could have rolled off. But, can you give us a little color on the sequential progression of SG&A in the quarter and how we should think about this over the next couple of quarters?

David Schramm

Yes. So the way to think about is that, we had actually foreign currency transaction gains in the quarter and historically those transaction gains are included down in other income and expense, net it out. The amount for the quarter was $450,000 positive amount. We reviewed the classification and determined that it was more appropriate to put those up in as an operating expense.

So, we’ve included that $450,000 positive amount in SG&A expense, so to get more of a run rate, you could take the $5 million that we reported and add that $450,000 back and you’d see that we have had a slight increase in SG&A expense year-over-year.

Craig Irwin - Merriman Curhan Ford

Okay, excellent. And then just a follow-up. On LTi, obviously LTi is a very important customer of yours in the wind market. But LTi has a variety of customers on their own. Can you give us an idea of the breadth of their customer base that you might be participating with and whether or not there is potential there for further expansion throughout 2009?

David Schramm

Yes. It’s a good question Craig. Yes, there is a lot of potential there. LTi just makes the pitch control system, and they’re selling their pitch control system to European manufacturers as well as the ones located in Asia. Right outside of where Lishen has their headquarters in Tianjin, there are at least two windmill manufacturers that are both on manufacturing sites. And I believe LTi is knocking on their doors.

Craig Irwin - Merriman Curhan Ford

Okay, excellent. And you mentioned Lishen. Any update on the D Cell manufacturing acquisitions or the timeline when we can expect products off that line?

David Schramm

Yes. The equipment is in place. The floor is painted. We are running qualification samples. We’re going to have those samples out within the next weeks, and we’ll have those to customers that have been qualified. And then, we’re going to crank the line up. So, the next conference call, we’ll be able to tell you how many we’re making.

Craig Irwin - Merriman Curhan Ford

All right, thank you very much. That’s all of my questions.

Operator

Our next question will come from the site of Richard Baxter from Ardour Capital. Your line is open.

Unidentified Analyst

This is (inaudible) for Richard Baxter. Just a quick question about the hybrid bus opportunity. You talked a lot about the opportunities in China. Could you give us just a little bit more detail in terms of what you see as far as the hybrid bus opportunity for China versus US?

David Schramm

Well, it’s a numbers game at this point. We got a relationship with ISE that we’ve had for quite a few years, and they do hybrid buses here in the US. They’ve got more than a hundred of them in service, Long Beach and throughout other parts of the US. We’ve announced relationship with Vossloh Kiepe in Germany who put together trolley buses for the city of Milan. Again, if you just look at the total number of buses, China makes more than the rest of the world, and they’re appetite to hybridize, to clean their air quality in their cities is now.

So, when they announced this program, in fact the program started out, but they’re going to take 10 cities and have a 1000 hybrid buses this year. They then decided to make 13 cities and 1000 hybrid buses. They’re going to hybridize more busses in one year than, if you take a look I think its all of what North America and Europe makes in total. So, that’s why China is such an opportunity and that’s why the timing of it is now.

Unidentified Analyst

I’m wondering if you could just give us just a little more color in terms of how your current outlook in terms of how the recession is sort of impacting the gross margin trend and purchasing and so forth?

David Schramm

Well, the gross margin I think if anything hasn’t been that impacted with what’s going on in the world. The biggest issue that we’ve seen, as we commented on is our final customers getting the financing with their projects in, but we have been fortunate that we have been growing the base of our customers. So, as the customer slow down a bit, we have more customers and when you multiply through we see the growth, which is what we reported today.

31% growth, quarter-over-quarter, it’d be a nice trend to continue and grow from that number if we could, but wind farms are being held back because it can’t get financing, but with our license we’re allowed to go more wind manufacturers. That’s been a plus. The transit busses, we had a relationship with ISC and the net expanded bus will [keeping] then expand it to China.

So, that has broadened us out. With a stimulus package that looks like it’s going to extend to green vehicle structures. I think we’re in the right spot that we’re going to take advantage of that growth. So, I’m really confident that whatever is going to happen in the economy, the green movement is going to be on our side and it’s going to help us grow.

Unidentified Analyst

All right. One final question; just wondered if you guys are able to give us any sense of how long the internal review on the Chinese reseller issue might take?

Kevin Royal

At this point, we’re pretty early on in that process and really don’t have a timeline. The amounts were involved are relatively small. So, we’re hoping that would be concluded rather quickly.

Operator

Our next question will come from the site of Bryce Dillie from JMP Securities.

Bryce Dillie - JMP Securities

My guess my question relates to your comment on production volumes that were expected in the second half ‘09 period that you alluded to shift into 2010 timeframe. Is that imply the continental relationship for the model your 2010? Is that moving out to 2011 now at this point?

David Schramm

No, I don’t want to mislead with you that.

Bryce Dillie - JMP Securities

Okay.

David Schramm

We thought we’d see that production in third or fourth quarter of 2009. So, right now and again the best guess I have based on talking with them in the last two days is that, it’s going to be late fourth quarter ‘09 and then ramp up in 2010, but the CO2 requirement from the EU is not moving. They took that to court once and they got told that okay instead of 100% of the fleet it’s 65% of the fleet, but they’ve got to have something in place by 2012 and you can’t get there if you don’t start that thing within the next 12-month period.

Bryce Dillie - JMP Securities

Okay, and then I guess my other question, which maybe is for Kevin. Congratulations on a new position.

Kevin Royal

Thank you.

Bryce Dillie - JMP Securities

When I look at the Q4 gross margin, exclusive the recurring charges and then the progression that we’ve seen developed in Q1 now. I guess, what could we assume or what we look for as a longer term range, that you guys are looking to achieve?

Kevin Royal

I have been with the company a relatively short period of time. I think the main thing at this point in time is to continue the ongoing cost reduction efforts in order to continue to increase the gross profit margin on the ultracapacitors. The other two product lines have solid and very substantial gross profit margin.

So, I don’t have a forecast for you at this point, but we are making substantial progress in turning that gross profit positive and increasing as we move forward.

David Schramm

Let me help Kevin with that, I have been a little longer than three weeks. The goal of course is to become market price which we have to do. The other part of that goal of being market price is to realize that this is a technology that we are selling, it is not a commodity.

So, we want to provide extremely high value, we want the value proposition to be there and we want customers to understand total lifecycle cost as to why the value proposition is there. At the same time, we keep putting a lot of effort into our R&D to make this technology even better to make it run faster, better, to make it lighter smaller, do everything we can and all of that is starting to pay off.

We are making electrodes today on our equipment and we are getting substantially better output than we got a year ago with better quality. So as we go down this road, I think you are going to find, that’s going to continue our R&D. There is a couple of things we are working on that as soon as we find the magic answer on those, we will see another cost reduction. So that doesn’t go away.

Bryce Dillie - JMP Securities

Okay, good deal. Thank you, guys.

Operator

Our next question will come from the site of Jim Brilliant from Century Management. Your line is open.

Jim Brilliant - Century Management

Back to the SG&A side, I just wanted to get a little clarification. Last years, I know there is a lot of noise in some of these numbers. So that maybe the answer, but we started out about $5 million a quarter, in the first quarter ended around $7 million. But what I am hearing is kind of an ongoing SG&A numbers of about $5.5 million, is that right? Can we use that kind of as a quarterly number until because you don’t need a whole lot of SG&A given your kind of pretty small customer base?

David Schramm

Yes. I think we certainly don’t provide guidance on revenue and expenses, but based on that run rate, $5.5 million or so would be a good estimate looking forward.

Jim Brilliant - Century Management

Okay. And then in the sequential gross profit improvement, where did that come from, where is the bulk of the benefit coming from?

David Schramm

As I mentioned earlier, a lot of work has gone into improving the cost structure of the ultracap product, and so the majority of the improvement quarter-to-quarter comes from those efforts around ultracap gross profit margins.

Jim Brilliant - Century Management

How much of it is a mix between some of the giveaway gross profit margin sales versus the new sales that have gross profit build into the sale?

David Schramm

You know that some of it, but there is one thing we did that really helped and that is as the volume got up, we switched from basically buying first class tickets to ship our parts to ocean freight and that was significant. So, we’re moving now, the negative to that is, it did increased the inventory, but the analysis we did, so the cost of money for the inventory, we saved that many times over what we saved in the freight reduction.

Jim Brilliant - Century Management

Okay, and then back to the Chinese bus, the 13, was it 13 or $13.5 million revenues? I forgot the number.

David Schramm

15.5

Jim Brilliant - Century Management

Okay. How many buses are there?

David Schramm

850, a rough number. They’re going to have 13,000. So, we still see quite a bit of upside this year and we have Maxwell people on the ground, as we speak over there knocking on doors.

Jim Brilliant - Century Management

Okay and you said that this wasn’t, I forgot your exact term, but basically there is gross profit in it.

David Schramm

Yes

Jim Brilliant - Century Management

Is it at, where is that relative to ultracap gross profits as a whole? In other words not the corporate gross profit, but your gross profit of ultracaps is it above, below, average?

David Schramm

Well, I resolute here is, we don’t segment report and I really don’t know. All I can tell you is, I know its not underwater because the ones I keep track of, is the ones that are underwater, but Kevin has got some of that detail, but really just don’t break that out.

When you’re so far underwater in a new technology like ultracap, getting into a breakeven is almost a place to pause and take a refresh and then start pushing hard again and that’s where we’re at. The goal is to get the company profitable and we’re going to get there, by the end of the year. That’s a personal goal that I have taken on and I don’t plan to miss it.

Jim Brilliant - Century Management

Okay. Can you comment on whether you’ve got the division at a profitable gross profit line?

Kevin Royal

Yes, we don’t report either by product. We don’t report.

Jim Brilliant - Century Management

I now have been long, long enough with the company you know that, but…

David Schramm

Okay.

Jim Brilliant - Century Management

From a directional standpoint, I mean, we bought a lot of business at negative margins, and so I’m trying to get an idea of where we’re at in that.

Kevin Royal

It is definitely improving quarter to quarter, and it’s headed in the right direction. There’s cost reduction efforts I talked about in my prepared remarks, and those are ongoing, and we strongly believe that those will yield results that will continue to improve the gross profit margin not only for capacitor, but for the business in total.

David Schramm

And again if you remember, the Enercon, that purchase order was designated in pieces, and we’re going to have that built out sometime this year. So when that’s done, that’s a loser…

Jim Brilliant - Century Management

Yeah, I know. How much is that [slit] now? At one time I thought it was to be built up by the end of the fourth quarter.

David Schramm

That still looks good. It of course is based on their orders, but their order book, last time I was at Enercon, they were sold out for at least two years on windmills. So, I think they’re going to stay on track and that we will finish that purchase order in 2009.

Operator

We have a follow-up question from Ted Kundtz from Needham & Company. Your line is open.

Ted Kundtz - Needham & Company

Yeah, it’s already been asked and answered. Thanks.

David Schramm

Thanks Ted.

Operator

And we have no further questions in queue.

David Schramm

Very good. Well, thank you very much everybody. Appreciate your time, and we look forward to doing this again in three months, and hopefully we can continue the story. Thank you.

Operator

This concludes today’s teleconference. You may disconnect at any time. Thank you, and have a wonderful day.

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