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Maxwell Technologies, Inc. (NASDAQ:MXWL)

Q1 2010 Earnings Call Transcript

April 29, 2010 5:00 pm ET

Executives

Mike Sund – VP, Corporate Communications and IR

David Schramm – President & CEO

Kevin Royal – SVP, CFO, Treasurer & Secretary

Analysts

Michael Horwitz – R.W. Baird

Dilip Warrier – Thomas Weisel

Craig Irwin – Wedbush Securities

Shawn Lockman – Ardour Capital

Matthew Crews – Noble Financial

Brian Kremer – ROTH Capital

Ted Kundtz – Needham & Company

Operator

Good day, everyone and welcome to the Maxwell Technologies first quarter 2010 financial results conference call. All this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. (Operator Instructions)

And it is now my pleasure to hand over to Mr. Mike Sund. Please go ahead, sir.

Mike Sund

Good afternoon. In a few moments, you'll hear from David Schramm, Maxwell’s President and CEO; and Kevin Royal, our Chief Financial Officer.

First, 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 could differ materially because of factors such as Maxwell's history of losses, reduced availability of credit, demand for OEMs' products reaching anticipated levels, general economic conditions in the markets we serve, cost-effective manufacturing and the success of outsourced assembly, the impact of competitive products and pricing, risks and uncertainties involved in foreign operations, including 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 MD&A and Risk Factors 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 may be accessed by visiting the Investors section of our website www.maxwell.com and hard copies may be obtained by contacting the company. 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 April 29, 2010. We undertake no duty to update our forward-looking statements to conform the statements to actual results or changes in the company’s expectations.

A couple of additional notes. Our Annual Meeting will be here in San Diego on May 6. You are all invited. And we will be presenting at investor conferences in San Francisco on May 11th and in New York on May 20th. Details can be found in the Investors section of our website.

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

David Schramm

Thank you, Mike. Good afternoon, everybody. We are pleased to report that Maxwell recorded total revenue of $26.6 million for the first quarter ending March 31st, 2010. That's up 19% from the $22.5 million reported in the same period a year ago. That growth was driven by strong ultracapacitor sales of $13.8 million, up 79% from Q1 '09. Sales of our more mature microelectronics and high-voltage capacitor products were down about 13% versus last year's first quarter, but both continue to make significant contributions to the bottom line.

Along with strong ultracapacitor sales growth came from continuing cost and efficiency improvements and we were able to generate more than $2 million of cash from operations. That's the third time in the past four quarters we managed to do that and we intend to make it a habit going forward.

As noted in our press release, governments around the world are demanding greener, more efficient, and cost-effective energy storage solutions. Legislative and regulatory initiatives are encouraging and in some cases are requiring significant changes in how we generate and use energy and ultracapacitors are gaining broad acceptance as a key enabling technology for renewable energy sources such as wind turbines and more efficient, greener public transit, commercial, and passenger vehicles.

Sales of Maxwell ultracapacitors to support efficient, cost-effective energy storage for recuperative braking systems in low-emission, hybrid electric transit buses and zero-emission electric rail vehicles were major driver of Maxwell's top line growth last year and that momentum is continuing and accelerating. We received and delivered follow-on orders from the Chinese hybrid bus OEMs in Q1 and their forecast indicate there is much more to come.

In March, we announced a strategic supply agreement with Voith Turbo, a leading European heavy vehicle drive trains integrator that has won some hybrid transit business here in the U.S. Public transit system operators receive significant federal, state, and local subsidies for vehicle purchases and that funding often comes with requirements for U.S. content, which we are very capable of providing.

Although last year's difficult financing environment put some planned windmill farm projects on hold, we were able to generate enough orders from existing and new wind turbine pitch system customers to grow our wind-related sales year-over-year and 2010 is off to a very promising start. According to our sources in Europe and Asia, wind energy's attractive return on investment versus solar and other renewable sources will enable wind to maintain a strong growth profile for years to come.

As discussed in our February call, audits of our ultracapacitor production facilities in the U.S. and Switzerland and our contract assembly operations in China by Tier 1 auto parts supplier Continental AG brought Maxwell its first "A" supplier rating, the industry's gold standard. Shipments to Continental for our first automotive launch later this year already have begun.

As with global public policy initiatives promoting greener public transit and renewable energy, macro factors are accelerating the timetable for hybridization and electrification of automobiles. Of particular note are the European Union's aggressive carbon dioxide emission reduction mandate for cars and the Obama administration's directive, pulling the 2020 CAFE fuel economy standards for the U.S. automakers forward to 2016.

By a way of review, European Union's CO2 emission reduction legislation requires that 65% of new cars produced in Europe emit no more than 130 grams of carbon dioxide per kilometer by 2012. That standard ratchets up to 100% of the cars in 2015 and the threshold goes down to 95 kilograms per kilometer in 2020. Many cars currently emit from 160 to 200 grams per kilometer.

So every European automaker is developing and launching more fuel-efficient, low-emission micro and mild-hybrid vehicles. All of these hybrids incorporate idle-start-stop systems that turn off the internal combustion engine as the car slows and then restarts the engine with a burst of energy when the driver touches the clutch or accelerator. Early stop-start cars have been using the batteries for that function. But automakers are concerned with constant high current cycling in stop-and-go urban traffic will prove to be a battery killer. That is an application made order for ultracapacitors which can charge and discharge a million times or more and continue performing normally.

With some 60 million new cars produced annually around the world in a normal year, even relatively modest ultracapacitor content per car multiplied by any reasonable fraction of the vehicles produced adds up to an energy storage market opportunity that could be measured in the billions of dollars by the end of this decade. As we announced last year, our ultracapacitor products also have been designed into a variety of back-up power, wireless communication, and other industrial applications.

We are delivering in increasing quantities of our redesigned postage stamp size PC10 ultracapacitor for board-mounted backup power modules to provide power loss protection for solid-state drives that are used in enterprise storage applications such as credit card transaction processing. The PC10's compact, prismatic form factor allows it to be integrated into the drive itself so that if grid power is interrupted, the ultracaps provide enough standby power to store work in process to memory, avoiding any data loss.

In a few minutes, I will discuss recent developments with our other two product lines and comment on future prospects. But first, our Chief Financial Officer, Kevin Royal will provide some additional detail on Q1 financial results and the status of our ongoing discussions with the SEC and the Justice Department. Kevin?

Kevin Royal

Thank you, David. I'm going to spend a few minutes providing some additional information on certain areas of our first quarter 2010 financial results. Our revenues were $26.6 million for the first quarter of 2010, down 4.9% from Q4 2009. Lower revenues were driven by seasonality, which results in our Q1 revenues typically being less than Q4 revenues.

Ultracapacitor sales were $13.8 million, representing a 7% decline from Q4 2009. Our high-voltage business was down in Q1 of 2010 by approximately 8% in comparison to the Q4 2009 levels. While we expect our overall business to grow in 2010, we expect our high-voltage business to lower than 2009 levels by approximately 5% to 10% as a result of the timing of various projects. We expect our microelectronics business to be flat with 2009 levels.

Our reported gross profit, as a percentage of revenue, for the first quarter of 2010 was 38% compared to 34% in Q4 2009. In the current quarter, overall gross profit was positively impacted by a higher mix of microelectronics products and continuing improvement in our gross profit margins on ultracapacitor products. We continue to make improvements in the cost structure of our ultracapacitor products, which will further increase the profitability of these products in the future and improve our overall gross profit as a percentage of revenues.

These ongoing cost reductions include improvements in design, reduced material costs, increased productivity, and lower labor costs due to outsourcing cell and module assembly, as well as increases in ultracapacitor production volumes. We expect gross profit margins to continue to improve throughout 2010 and we are targeting 40% or higher overall gross profit as we exit the year.

Total operating expenses for Q1 2010 were $11.8 million compared to Q4 2009 operating expenses of $9.8 million, which are net of the $9.3 million Foreign Corrupt Practices Act accruals. The increases are related to higher levels of stock compensation, a nonrecurring reversal of an accrual in Q4 for about a similar amount in Q1, foreign currency losses greater in Q1 2010 compared with Q4 2009, and higher labor costs to support 2010 revenue growth. Our quarterly expense run rate for the remainder of the year should be within 5% plus or minus the Q1 2010 amount.

Now, I'm going to discuss our net income and the impact of certain noncash, non-operating items on our reported income. We reported net income of $1.2 million or 40.05 per share for the first quarter of 2010. There were two significant noncash items included in our Q1 2010 statement of operations. The first is the $3.2 million noncash gain on embedded derivatives associated with our convertible debt and the second is the $623,000 noncash stock-based compensation expense. In addition, the company incurred $167,000 of expense in Q1 2010 associated with our ongoing review of commissions paid to an outside Chinese sales representative.

Excluding the gain on embedded derivatives and the stock-based compensation expense, the net loss would have been approximately $1.4 million or a $0.05 loss per share for Q1 2010. On a comparable basis, excluding the $9.3 million Foreign Corrupt Practices Act accrual, stock-based compensation expenses and the gain on embedded derivatives, the Q4 2009 net loss would have been approximately $2.4 million or $0.09 loss per share.

Our earnings before interest expenses, taxes, depreciation and amortization or EBITDA, net of the $9.3 million Foreign Corrupt Practices Act accrual, increased from $1.4 million in Q4 to $500,000 in Q1 2010.

Now, I would like to provide a brief update related to the company's ongoing Foreign Corrupt Practices Act inquiry. As we stated in previous earnings conference calls and disclosed in quarterly press releases and SEC filings, we have been conducting an internal review of commissions paid by our high-voltage business from our Swiss subsidiary to an outside Chinese sales representative. We have been engaged in ongoing discussions related to this matter with both the SEC and the Department of Justice. We have cooperated fully and provided documents and other analyses as requested by both agencies.

During the fourth quarter, we recorded an accrual for the potential settlement of the Foreign Corrupt Practices Act inquiry. The amount we recorded was based on our estimation of loss as required under U.S. Generally Accepted Accounting Principles and discussions with both government agencies. These discussions have resulted in the company's estimate of a potential settlement range of $9.3 million to $20 million. The top end of the range, $20 million, represents the combined first offer of settlement put forth by the governmental agencies.

In our judgment, based on the ongoing discussions with the governmental agencies and current facts and circumstances, we believe the amount that we recorded in Q4 represents a reasonable estimate of the settlement amount for U.S. GAAP financial reporting purposes. As I stated earlier, these discussions are ongoing and a settlement agreement has not yet been reached and there can be no assurance that a settlement will be reached at all or that any final settlement amount will not be more or less than our accrual.

Now, I'd like to turn to the balance sheet. We ended the quarter with cash and restricted cash of $38.1 million. This represents an increase in cash of $484,000 from Q4 2009. The significant components of our cash activity for the quarter include cash generated from operations of $2.4 million, capital spending of $1.2 million, and proceeds from our stock plans of $352,000.

I also wanted to note that our debt declined during the quarter as a result of the accounting for embedded derivatives in our convertible debenture. While our balance sheet lists our debt as $15.2 million, the actual underlying amount that we owe is approximately $13.6 million. The difference between the recorded amount of debt and the actual amount owed is an accounting adjustment of nearly $1.7 million to the value of the embedded conversion options. The remaining debt relates to our Swiss entity, which owes local Swiss banks approximately $5.3 million.

Now, I'll turn it back to David to discuss other areas of the business.

David Schramm

Great. Thank you, Kevin. Earlier, I spent most of my time talking about ultracapacitors. So I'm going to shift my focus now to Maxwell's other products.

As those of you who are familiar with the story know, our high-voltage capacitor products are used in the electric utility grid and other applications involving the transport, distribution, and measurement of high-voltage electrical energy.

While the name suggests that high-voltage capacitors could be close relatives to ultracapacitors, the products are quite different and address entirely different markets. Our largest high-voltage capacitor customers are the prime contractors who build power plants and electric utility infrastructure around the world. We are the world's leading supplier of such products and our sales track closely with global spending on electric utility infrastructure.

Developing countries such as China that are increasing electrical energy generation and distribution to support industrialization and improving standards of living are major consumers of our products. As discussed in our February call, outdoor construction activity slows down in the winter months, so we saw a modest dip in high-voltage sales in Q1. This is a mature product line. So our growth expectations are modest, but high-voltage sales do generate solid margins and make a meaningful contribution to Maxwell's bottom line.

A lot of attention has been focused on something called the Smart Grid to better manage electrical energy generation, distribution, and consumption. The federal government has indicated that they will make modernization of the U.S. grid, a major focus of federal energy policy and spending. So we are tracking these developments closely.

At the same time, we know from experience that grid programs involve not only funding, but extensive engineering and permitting before infrastructure construction begins. So whatever Smart Grid opportunities eventually develop for our products, likely will at least a year or two to materialize.

Moving on to microelectronics, those of you who are familiar with Maxwell know that we sell radiation-hardened components and single board computers to major satellite and spacecraft OEMs in the U.S. and Europe. Government and commercial space programs often stretch over several years and deliveries of our products are tied to program schedules and funding cycles. So volumes tend to fluctuate quarter-to-quarter.

In the end, sales are driven mainly by the number of satellite and spacecraft launches in a given year and the amount of Maxwell content per launch. Our high-value single board space computer products are helping us to increase the value of Maxwell content per launch. Our boards are designed into some significant program proposals. So if one or more of those go our way, growth could accelerate over the next several years.

Now, in case you haven't visited my blog on Maxwell's website, I'd like to direct you there to a video clip of Energy Secretary Steven Chu's remarks at the Washington D.C. Auto Show in January of this year. He devoted more than a minute of his 15-minute speech to discussing the synergies between ultracapacitors and batteries in vehicle electrification. Dr. Chu, who won a Nobel Prize for Physics, pointed out that even the best lithium ion batteries can't accept a charge at the rate that electrical energy is generated by regenerative braking systems.

He proposed development of hybrid energy storage systems that use ultracapacitors to efficiently capture virtually all of the energy generated by brief braking events and then feed that free energy into the batteries at a rate that avoids damage and promotes a longer battery life. He said that such hybrid battery ultracapacitor systems and I quote, "could improve the gas mileage of all vehicles."

An article published last month in the Argonne National Laboratory's newsletter corroborated Secretary Chu's statement. The article noted that conventional lithium batteries absorb braking slowly and inefficiently while ultracapacitors with their immense surface area soak up reclaimed energy like a sponge. By integrating the entire system, the article went on to say, the cost of the energy storage system could be cut in half. Now, I don't want to wear this analogy out, but the – for those of you who aren’t clear on distinction between batteries and ultracapacitors, it bears repeating.

In the energy storage world, ultracapacitors are like sprinters, they're capable of fully charging or discharging in seconds. Batteries are like marathon runners, with 10 to 20 times ultracapacitor's energy storage capacity, but far slower charge/discharge rates. Thus, ultracapacitors are ideal for capturing regenerative braking energy during the few seconds that it takes to stop a vehicle. In addition, ultracapacitor's turnaround efficiency, that is how much stored energy comes back out, is above 95%, whereas many batteries are around 80% or lower.

Ultracapacitors also operate reliably and efficiently in extreme temperatures. Battery's ability to charge and discharge drops off severely in freezing temperatures while high temperatures shorten the operational life. And in normal use, ultracapacitors keep working for a million or more charge/discharge cycles, whereas battery lifetime is measured in hundreds to thousands of cycles. Bottom line, ultracapacitors can provide standalone energy storage solution in partially electric, micro, and mild-hybrid systems and can complement batteries and full hybrids and electric or plug-in hybrid vehicles.

Looking ahead, as we stated in our press release, based on strong current bookings and order activity, we expect sequential ultracapacitor sales and total top line growth in the second quarter. And as we said in February, we believe we are on track to reach our goal of translating, increasing ultracapacitor volume and improving profit margin into an operating profit later this year.

The redesign in transition of our high-volume D Cell ultracapacitor product to offshore assembly in China is nearing completion. Our engineering team also has completed a large cell redesign that we call K2. This better-performing, lower-cost cell moved into full production during Q1 and is now helping us to improve margins for hybrid buses and other heavy-duty applications. We also continue to refine and improve multi-cell module designs to further reduce cost and improve manufacturability and quality.

Although material sourcing and virtually all ultracapacitor cell and module assembly are being outsourced to low-cost countries, I want to emphasize that we produce our proprietary ultracapacitor electrode material behind closed doors in our San Diego facility and electrode fabrication will not go outside at direct Maxwell's control.

We also continue to pursue non-product revenue sources. We have submitted proposals or applications for funding several technology and product development programs and we expect news on some of those within the next couple of quarters.

In conclusion, we are off to a good start, but we expect to a watershed year for Maxwell. As we said in February, we believe that the double-digit growth rate we established last year will be sustained in 2010 and with our first automotive application moving into production, accelerating growth is on the horizon.

It'd be a good time now to entertain your questions.

Question-and-Answer Session

Operator

(Operator Instructions) It looks like our first question will come from the site of Michael Horwitz from R.W. Baird. Your line is now open.

Michael Horwitz – R.W. Baird

Great, thanks. Nice quarter. So it seems now we've had a couple of quarters where we are posting really significant numbers within the ultracapacitor segment, almost like a stair-step change in the run rate. So I know we have multiple end markets that you are selling into, but has something changed significantly that we can count on these kinds of numbers going forward?

David Schramm

Mike, I'd tell you, probably the biggest change is that I really appreciate the fact that Dr. Chu is exposing the benefits of ultracapacitors, because as I stated I think probably about two years ago, one of the major issues we have is educating the marketplace on what an ultracapacitor is. And I think we have really gained some traction specifically in the wind market and in the transit bus market. And there is just an awful lot of pressure right now on specifically the Chinese and the European governments to go forward with this.

So I think it's market acceptance that's helping us drive this and the market education, I think, is paying off for us. So to answer your questions, yes, I think it's going to continue.

Michael Horwitz – R.W. Baird

And then one other question. Regarding the settlement or the issues you have with the Department of Justice, is this impeding you from doing anything strategically that you may want to be working on?

David Schramm

At this time, I'd say it's not. We are still going ahead; we've got a business to run. I'll tell you, Kevin has been the point man on working with the SEC and the DoJ and it's still continuing. And I'll let Kevin give you a few more comments on that.

Kevin Royal

Yes, I think we are making good progress. We are continuing to work with both the SEC and the DoJ. We've got ongoing dialog. No new developments this quarter to report, but on your question of whether it's harming us from a strategic standpoint, I would say that's (inaudible).

Michael Horwitz – R.W. Baird

Great. Thank you.

Operator

And we'll take our next question from site of Dilip Warrier with Thomas Weisel. Your line is open.

Dilip Warrier – Thomas Weisel

Good evening. I was wondering if you could provide some more color on the reason for A3 – for the A3 business to be down this year versus last year.

David Schramm

Meaning the high-tension business?

Dilip Warrier – Thomas Weisel

Yes.

David Schramm

Yes. I think that is really just a function of what's going on in the power generation field. The major players that we deal with that build these power plants, it just slows down on the winter time, but we are seeing a slowing of major infrastructure. We had a good ramp-up a couple of years ago where we had a significant growth. So we've got to that plateau and now this year, I think as Kevin pointed out, we don't look for a lot of growth in the high-tension this year, but my expectation is that sometime in the next two or three, once we better understand what a Smart Grid is, that could change.

Dilip Warrier – Thomas Weisel

Okay. And if you could provide any commentary on your progress in China on the hybrid bus opportunity, have you been able to sign up any new OEMs? And then if you could kind of describe what the shipments look like this quarter perhaps versus the second half of last year?

David Schramm

Yes, that's a real good question. I tell you, we have just had some of the Chinese bus manufacturers in the office and frankly, the way this works is as explained to me, they get an order and they have 90 days to deliver buses and then they call us and give us 60 days to deliver ultracaps. With everything I see, if I just connect the dots, their activity in 2010 is going to be significantly more than it was in 2009. 2009, we did about 850 buses worth of ultracaps and I think we are on pace to beat that by a lot this year.

Dilip Warrier – Thomas Weisel

That's great to hear. And one last question for Kevin. Have you hit a new run rate for R&D expenses? It seemed to have creeped up a bit this quarter.

Kevin Royal

I would say that the R&D expenses are probably impacted a little bit more this quarter from stock option expense; it was higher than in Q4. And then the run rate going forward should be fairly consistent, a little bit above or a little below the Q1 amount.

Dilip Warrier – Thomas Weisel

Thank you very much.

Operator

And we'll move next to the site of Craig Irwin with Wedbush Securities. Your line is now open.

Craig Irwin – Wedbush Securities

Thank you. I was very impressed with the gross margins in the quarter. Dave, maybe can you give us a little bit more color on how you achieved this improvement and what really carries you to 40%, how much of that really has to come from the improvements around the ultracapacitor side and how much of that is general business mix?

David Schramm

Yes. That's a good question, Craig. If you just take a look at the increase in revenue that came off of ultracapacitors and we've said in the past that the other two, the high-tension and the micro have always been good contributors. So if you just take a look at the fact that the ultracapacitors is growing revenue significantly faster than the other two and yet gross margins increased, you hit it on the head, we have been significantly reducing cost out of the ultracapacitor to make that a real viable product for us. And we are continuing to do that. The more we grow that revenue, the more we dilute the overheads, the smarter we get on how to make it, the lower the cost gets.

And I guess I'd ask Kevin to add anything else he might have on that.

Kevin Royal

Sure. I think David mentioned in his prepared remarks that we are transitioning to what we refer to as the K2 cell. That had an impact during the quarter and will have a more significant impact on ultracapacitor gross profit margins as we move forward that through the year.

Craig Irwin – Wedbush Securities

Great. And then if I could just follow up on a similar point, I understand one of the things that's benefitting you is your move from manufacturing D cells in Switzerland to your manufacturing partner in China. Can you maybe give us a little bit of color on whether or not your wind customers have started taking their full volumes from – from your Chinese partner or are these cells still sourced out of Switzerland?

David Schramm

They are both at this point, correct. The D cell line, we are – quality and delivery are just paramount is what we got to do maintain the reputation we have in the market. So we are still in transition, we are operating both at this point, we are building axial cells in the Swiss operation and radio cells out of our Chinese contract manufacturer. They both use the Maxwell proprietary electrode. But we are ramping China up and somewhere in Q2, Q3 that balance shifts to where it will be mostly Chinese assembly and then we will be transitioning out of the Swiss operation with that product.

Craig Irwin – Wedbush Securities

Great. And then just a new subject. Kevin, one of the things that, I guess, you didn’t break out in your discussion was the expenses on your move to a new headquarters facility. I was hoping you might add a little bit of color whether or not that contributed to the SG&A in the quarter.

Kevin Royal

No, it really didn’t. The office we moved into are relatively small, just for the – I would say, to the office staff and we are talking about 12,000 square feet at a buck-and-a-half per square foot – we are not talking about significant costs there.

Craig Irwin – Wedbush Securities

Okay, excellent.

David Schramm

Let me follow on that, Craig. Not everybody knows we have moved the headquarters, but we've added a third facility here in San Diego and they are all within a mile of each other. But we needed to expand the manufacturing space for electrode and that is we have put in a new calendar that gives us some better performance than we've had in the last few years, we've installed a new slitter last year that gave us even better quality levels.

What we needed to do is lay out that in a proper fashion so we get the right material flow and make it more presentable to the employees, as well as the visitors that we do have. So it's – so the easiest way to free that manufacturing space up was to move all of my staff, sales, and finance to a new location. And again, we are within a mile of the old building.

Craig Irwin – Wedbush Securities

Great. And then last question, if I may, you mentioned in your prepared remarks that the shipments to Conti have started for their start-stop program. I was wondering if you might be able to share a little color with us how the volumes could potentially ramp over the course of the year and obviously, if you are expecting gross margins to continue to improve throughout this year, this looks like it will be a profitable line of business for you to be in. I was hoping you might be able to shed a little color there as well.

David Schramm

Sure. As we've said before, in 2010, it's $1 million to $2 million worth of revenue and that goes up substantially in '11 and then if you look at their forecast, it should double again in '12. So we are just getting into start of the start-stop. I see an awful lot more new programs on the horizon that I believe are going to use ultracapacitors for the start-stop.

Again, it's the cyclability that we offer, millions of times you can charge and discharge, it's the low temperature at minus 40C; it’s the plus 65C, which is a 150 degrees Fahrenheit. So there is some significant advantages for start-stop using ultracaps. And again, I think the automakers are looking that as one way they can comply with the regulations.

Craig Irwin – Wedbush Securities

Great. Congratulations on a solid quarter.

David Schramm

Thanks – thanks, Craig.

Craig Irwin – Wedbush Securities

Thank you.

Operator

And we'll move next to the site of Walter Nasdeo of Ardour Capital. Your line is now open.

Shawn Lockman – Ardour Capital

Hi, gentlemen. This is Shawn Lockman for Walter. I wanted to just kind of check back with, I believe, Kevin on – I wanted to make sure that I understood how the SG&A will move through the year. It looks like it's going to be fairly similar to the kind of rate that we saw in 1Q. Is that – did I understand that correctly?

Kevin Royal

That's right. What I said in my prepared remarks is that we would expect our operating expense to be about the same level, plus or minus 5% on a quarterly run rate basis throughout the remainder of the year.

Shawn Lockman – Ardour Capital

Great, thanks. And I was wondering if you could give us an update on how much of your ultracapacitor business this quarter was wind and how much was bus and so forth.

David Schramm

Shawn, we don't break that out. All we can tell you is both of them are growing.

Shawn Lockman – Ardour Capital

Okay, great. Well, that's great. And one last question. Could you give us just an update on the level of sales that you are getting from Europe and talk a little bit about your exposure to the euro with the euro sort of pulling back a bit and how that might impact the business?

David Schramm

Well, it's interesting. The growth that we see – I’ll tell you, most of our growth is coming out of China and frankly, that's driven by the fact that when you look at the number of buses that the Chinese produce in a year versus the rest of the world. So that has really been our growth engine. The wind activity, it – again, China is a big grower of wind and Europe is coming right behind them. So China is growing the most, Europe is second, and the rest of the world comes in third and I include the U.S. and the rest of the world.

So the exposure we have in Europe, Kevin has done a good job of managing that for us and we are watching that on a daily basis, obviously.

Shawn Lockman – Ardour Capital

Okay. And are you able to give us sort of percentage of sales that are coming from Europe or no?

Kevin Royal

Let's see. Probably overall when you look at the business, about 40% of the revenues come from Europe. Some of the sales are denominated in U.S. dollars and a portion is denominated in euros. And so you have a couple of things that we have to watch out for from a financial standpoint.

For those sales that are denominated in euros, we have to make sure we've got provisions in the contracts so that we can adjust the exchange rate that's baked into the pricing on a regular basis and review most of those. And then for the U.S. dollar, for those countries that do business in euros that can weaken our purchasing power when we get into a situation by (inaudible). I have not seen any business or any customers pull back because of the weakening euro at this point.

Shawn Lockman – Ardour Capital

Okay, great. That's it for me, gentlemen. Thank you.

David Schramm

Thank you.

Operator

And our next question will come from the site of Matthew Crews with Noble Financial. Your line is now open.

Matthew Crews – Noble Financial

Yes, thank you. Good afternoon, thanks for taking my call. Just a question regarding on the wind turbines. I know that there was an announcement that LS Mtron had also signed an agreement to be able to sell the ultracapacitors. Is there – have you seen any effect on that or has been able to characterize potential competition there?

David Schramm

Yes, we haven't been able to quantify that. I mean, I – let's face it, that market is lucrative enough that it would be naïve to I think that we are going to keep 100% of that share. So the good news I guess I see with Mtron coming into that market is now I've got some help to educate the market as to why this is the right way to do. So I'm looking for the positive side of having good, strong, healthy competition.

And again, they are a good company and we welcome the competition in the marketplace. So the – with the growth I see in the wind market, I would daresay that we'll be in there with them.

Matthew Crews – Noble Financial

That sounds good. Another question, I know giving a breakout on mix on the ultracapacitors is difficult, but just given the volumes that you've mentioned on the automotive side with Continental and possibly other Tier 1s, do you think next year breakout mix will be – would you be approaching 20%? I'm just trying to look in terms of the ramp on the automotive relative to wind, as well as the heavy-duty transit.

David Schramm

Yes, I think right now the way I look at it is the largest growth we are going to see in 2010 is probably in wind, transit bus is coming in second, and then the automotive is going to ramp up. When I get into 2011, the ramp-up factor for automotive grows significantly faster than the other two, but it will still be the smallest of the three. And then in 2012, it's a question of what volumes really manifest. And if I look at that today, automotive from 2012 on could be our largest penetration.

Matthew Crews – Noble Financial

Okay. And just lastly, just – you just mentioned in your prepared remarks regarding good work in ultracapacitors, positive move to 40% gross margins. Is there a rough revenue number that you have targeted that the ultracapacitor sales would generate positive EBIT?

David Schramm

We don't do segment reporting and I don't know if Kevin can help – answer – I don't think we break that out by product group.

Matthew Crews – Noble Financial

Sure.

Kevin Royal

I haven't done that analysis. So – yes, I'm sorry, but unable to answer that question.

Matthew Crews – Noble Financial

That's fine. Thank you very much.

Operator

And our next question will come from the site of Brian Kremer with ROTH Capital. Your line is now open.

Brian Kremer – ROTH Capital

Hi, guys.

David Schramm

Hi, Brian.

Brian Kremer – ROTH Capital

Going back to SG&A, I just want to – my line of – first my line was breaking up, Kevin, as you went through kind of some of the additions there. Just to understand a little better the change quarter-over-quarter and then going forward.

Kevin Royal

Yes. I mentioned stock compensation was higher by about $0.5 million. We had foreign currency impact of about $400,000 in Q1 as compared to Q4. We had labor cost probably account for another $300,000 there. We had an accrual that we reversed in Q4 that is no longer needed. And so that would have a favorable impact in Q4, but on a comparison basis, it makes it look like our expenses went up in Q1 and that was about another $400,000.

Bottom line, our SG&A for the quarter was about $11.8 million and we would expect that to be the run rate moving forward throughout the year as we add headcount growth and depreciation for some capital, we would expect $11.5 million to $11.8 million be in the range for operating expenses.

Brian Kremer – ROTH Capital

Okay. And then gross margin, also I think you said 40%. I'm assuming that's by the fourth quarter, you are exiting the fourth quarter at 40%, that's not a –

Kevin Royal

That's correct.

Brian Kremer – ROTH Capital

Okay. So you are growing it through – into the fourth quarter?

Kevin Royal

That's right. That's correct.

Brian Kremer – ROTH Capital

And then on the – I think it was the high-voltage, I was also wasn't quite certain. I thought in the prepared remarks, the statement related to the high voltage down 8% versus Q4. I think that statement ended with down 5% to 10% from '09, is that correct?

Kevin Royal

That's – that's correct.

Brian Kremer – ROTH Capital

Year-over-year basis?

Kevin Royal

That's right.

Brian Kremer – ROTH Capital

Okay. And then PC10, I know you guys have said that's a $5 million to $10 million type contribution in 2010. Is that still what you are shooting for?

David Schramm

Yes, that's still – in fact, we still see some growth coming out of that product. It's got an interesting package though because it's like a Chiclet gum, it's nice and flat, and we are finding a lot of acceptance in the board market.

Brian Kremer – ROTH Capital

Okay. And I think that was it.

David Schramm

Great. I think we've got time for one more question.

Operator

Okay, great. It looks like our last question will come from the site of Ted Kundtz with Needham & Company. Your line is now open.

Ted Kundtz – Needham & Company

Yes, hello, everyone. Just a quick question. What's the ongoing cost with the lawyers for this SEC investigation? Is that a – you mentioned – I think you mentioned $150,000 or $160,000 in the quarter.

David Schramm

Yes. In the quarter before, it was around $180,000. So I think now that we are through the heavy lifting associated with document collection, until we wrap this up, it's probably going to run at $100,000 to $200,000 per quarter.

Ted Kundtz – Needham & Company

Okay, great. That's not too bad. Okay. And David, just one quick question. Maybe you could just – maybe it's not so quick, but it – maybe a little more color on the automotive folks that you are working with? Are you picking up any new OEM interest and just try to give us a little bit more sense of besides the start-stop stuff? I assume that's going to be main application for ultracaps near term, but are you working – I just want to get a sense of how many additional OEMs you guys might be working on or that you know of who are looking at ultracap solutions as part of their overall systems.

David Schramm

Ted, it's something I think I've said at conferences in the last couple of years and that is it takes less time to get the purchase order than it does to get the press release. And the only one that we've been given authority to release is our relationships we've got with Continental, Velayo [ph], and Alcoa. And I'm afraid I just can't go any further than that without jeopardizing what I promise my customer.

But I'll tell you, there is – we are working it hard, a year or so ago, we opened an office in Munich, we've got people stationed there and that office is focused on the European automobile market. We've added engineers to that office, because application engineering is the key.

But when we say start-stop, we really need to broaden that out, because not only do you get the starting capability, but you can get boardnet stabilization and you get some power management out of those same ultracapacitors, because if you think about it, the starting application is measured in a second or two. So the ultracaps are there full time, so they can manage other functions in the power. So there is the ability for an automaker or a Tier 1 to really do a system optimization on the power requirement.

So I think we are going to see a lot further penetration with a lot of different automobile customers and all I could tell you is our activities aren’t limited to Europe that – we've got people all over the world. We have an office in Shanghai and of course we've salespeople stationed on the East Coast and in the South West. So we are knocking on doors.

Ted Kundtz – Needham & Company

Can you give us any sense of how many more customers or potential OEMs are looking at these solutions? Just give us a sense of the magnitude of the development effort.

David Schramm

Yes, all I'll tell you, Ted, is again, Dr. Chu was speaking at the Washington Auto Show, I believe it was January 28, 2010 and it's on our website. If you go to the –

Ted Kundtz – Needham & Company

Yes, I heard that.

David Schramm

If you listen to him, it's the way to go. So again, he was spreading the news at the Washington Auto Show and we are following up with all the automakers that we can and we have talked to quite a few. So there is a lot of interest in it, but again, without jeopardizing what the customers ask me not to say, all I can tell you is there is a lot of activity and Mr. Sund will be more than happy to put a press release out just as – because we are capable.

Ted Kundtz – Needham & Company

Terrific. Okay, thanks a lot.

David Schramm

Thanks, Ted. Well, thank you, everybody, appreciate it. And we'll talk to you next quarter.

Operator

And this does conclude today's teleconference. Thank you for your participation, you may disconnect at anytime. And have a wonderful evening.

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