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RPC Inc. (NYSE:RES)

Q2 2010 Earnings Conference Call

July 28, 2010 05:00 am ET

Executives

Mike Sund - VP, IR

David Schramm - President and CEO

Kevin Royal - SVP, CFO

Analysts

Steve Sanders - Stephens

Brian Kremer - Roth Capital Partners

Michael Horwitz - Baird

Dilip Warrier - Stifel Nicolaus

Jin-Ming - Ardour Capital

Matthew Crews - Noble Financial Group

Operator

Good day, everyone, and welcome to today’s Maxwell Technologies Second Quarter 2010 Financial Results Conference Call. At this time all participants are in a listen only mode. (Operator Instructions). It is now my pleasure to turn the conference over to Mr. Mike Sund, Vice President of Investor Relations. 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 credit availability demand for OEM 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 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 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 July 29, 2010. We undertake no duty to update our forward-looking statements to confirm the statements to actual results or changes in the company’s expectations.

Finally, we will presenting at an Investor Conference in Southern California on August 17. Details on the live and archived webcast 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

Thanks, Mike and good afternoon, everybody. We are pleased to report that Maxwell recorded total revenue of $29.6 million for the second quarter ended June 30, 2010. That’s up 19% from the $24.8 million reported in the same period a year ago. That growth was driven by strong ultracapacitor sales of $15.9 million up 48% from Q2 of ‘09.

Sales of our more mature Microelectronics and high-voltage capacitor products were down about 2% versus last year’s second quarter, but increased by 7% sequentially from Q1 of this year, and both continued to make significant contributions to the bottom line. Gross margins for the quarter came in at 40%.

Along with strong ultracapacitor sales growth came continuing costs in efficiency improvements, and we were able to generate nearly $0.5 million of cash from operations in Q2. That’s the fourth time in the past five quarters, we’ve managed to do that. We believe it’s something our business can sustain going forward.

Perhaps more remarkably if you read our press release, you would have seen that on a non-GAAP basis, excluding an accrual for anticipated SCPA settlement and stock based compensation, Maxwell turned a profit at the operating income line. After more than a decade of operating losses that feels like a giant step in the right direction. Kevin will provide more details on that and other financial items in a few minutes. Also noted in our press release, we are delivering ultracapacitors in production quantities for our first automotive design in with Continental AG.

It’s for a micro hybrid stop start and voltage stabilization system that a major European automaker will have in showrooms in a few months. As we have said in the past, electrification and hybridization of cars, trucks, buses and other heavy vehicles, represents an enormous opportunity for our products. So this start of production is another very significant milestone for Maxwell.

As we all know, consumers and governments around the world are demanding greener, more efficient, personal, commercial and public transit vehicles. Obviously, safe, reliable, cost effective energy storage solutions are an essential enabling technology to support the innovation sweeping across the transportation industry.

Legislative and regulatory initiatives are also driving significant changes in how the world generates and uses energy and ultracapacitors are also gaining broad acceptance as a key enabling technology for renewable energy sources, such as wind and solar.

Sales of Maxwell ultracapacitors to provide efficient, reliable, cost effective energy storage for recuperative breaking systems, with low emission, hybrid electric transit buses and zero emission electric rail vehicles continue to be a major driver of ultracapacitor sales growth.

The three major Chinese bus OEM customers that we announced last year are on pace to meet or exceed last year’s consumption of our 48 volt modules. We learned recently that the Chinese government is now targeting more than 30 major cities, rather than the initial announcement of 10 with subsidies for hybrid and electric public transit vehicles. So demand should increase and continue well into the future.

We are also continuing to deliver ultracapacitor cells and modules to heavy vehicle OEMS and drive train integrators in Europe and North America. And we estimate that nearly 2,000 hybrid and electric transit vehicles using Maxwell products are now in daily operation around the world.

Obviously, there’s no substitute for that kind of experience and performance in very demanding duty cycles and harsh environments to validate our products. Sales of ultracapacitor cells, in a variety of standard multicell modules for wind turbine blade pitch and power quality applications, also are running well ahead of last year’s pace.

We now estimate that more than 12,500 Maxwell ultracapacitor equipped turbine are operating 24 by 7 around the world. A lot of that product is going into China where the appetite for electrical energy and concerns about CO2 emissions from coal fired powered plants are driving rapid expansion of wind generation.

We have spoken often about the European Union’s aggressive carbon dioxide ignition reduction mandate for cars as a key catalyst for automotive applications for ultracapacitors. The EU legislation requires that 65% of new cars produced in Europe in 2012 emit no more than 130 grams of carbon dioxide per kilometer. That standard ranches up to 100% in 2015, and the threshold goes down to 95 grams per kilometer in 2020.

That leaves the European auto makers no choice, but to develop and launch more fuel efficient, low emission micro and mild hybrid vehicles over the next couple of years. All hybrid cars incorporate idles, start stop systems that turn off the internal combustion engine as the car slows and then restart the engine with a burst of energy when the driver touches the clutch or accelerator.

The first stop start cars have used battery shoot out function but auto makers are learning that constant high current cycling in stop and go urban traffic dramatically shortens battery life. So several auto makers and leading Tier 1 parts suppliers are now developing systems that take advantage of ultracapacitors ability to charge and discharge a million times or more and continue performing normally, which is well in excess of a car’s life expectancy.

The new news is that as US auto makers try to regain their footing, the light is dawning that US Path A fuel economy standards in the prospect of far more fuel efficient and cleaner Asian and European competition require them to step up hybrid and electric vehicle development programs.

So we sense a new urgency in Detroit that is finally opening doors that we have been knocking on for years without much response. With some 60 million new cars produced annually around the world, 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 the decade.

Look for announcements regarding more recent designing for a variety of back up power, wireless communication and other industrial applications and our consumer product design in, in the coming months.

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 Q2 financial results and the progress of our settlement negotiations 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 second quarter 2010 financial results.

Our revenues were $29.6 million for the second quarter of 2010 up 11.1% from Q1. The higher revenues in the quarter were driven by continued growth in our ultracapacitor products, and an increase in sales of a micro AC electronics products.

Ultracapacitor sales for Q2, 2010 were 15.9 million representing a 15.2% increase over Q1. Our High Voltage business was essentially flat in comparison to Q1 levels.

Our reported gross profit as a percentage of revenue for the second quarter of 2010 was 40% compared to 38% in Q1. In the current quarter, overall gross profit was positively impacted by continuing improvement in our gross profit margins on our ultracapacitor products.

We continue to make improvements in the cost structure or our ultracapacitor products, which will further increase the profitability of these products in 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 our outsourcing, sale and modular assembly as well as increases in ultracapacitor production volumes.

Total non-GAAP operating expenses for Q2, 2010 were 11.1 million, compared with Q1 non-GAAP operating expenses of 11.3 million. Non-GAAP operating expenses exclude stock based compensation expense, amortization of intangible assets and the accrual for potential settlement with the SEC in DOJ for alleged Foreign Practices Act violations.

In addition, our Q2 operating expenses include foreign currency losses of 1.2 million, compared with foreign currency losses of 330,000 in Q1. We initiated a limited hedging program last year to reduce our exposure to currency fluctuations and we are in the process of expanding that program to further limit our exposure.

We reported non-GAAP net income of $455,000 or $0.02 per diluted share for the second quarter compared with a non-GAAP net loss of 1.2 million or $0.05 per diluted share for the first quarter of 2010.

Non-GAAP net income includes stock based compensation expense, amortization of intangible assets the accrual for potential settlements due to SEC and DOJ and the gain on imbedded derivative and warrants.

Our earnings before interest expense, taxes, depreciation and amortization or EBITDA net of the 3.4 million Foreign Corrupt Practices Act accrual increased from 672,000 in Q1 to 2.5 million in Q2 of 2010.

Now I’d like to provide an update on the company’s ongoing Foreign Corrupt Practices Act inquiry. As we have 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 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 DOJ. We’ve cooperated fully and provided documents and other analysis as requested by both agencies.

During the second quarter, the company negotiated an agreement in principle with the SEC to resolve the ongoing FCPA investigation for a payment of approximately 6.35 million which would be payable in two installments with half being paid upon signing and the remaining half on the one year anniversary of the signing, as well as certain other non financial settlement terms.

The settlement with the SEC remains subject to final approval of the Commission. Settlement discussions with the DOJ are ongoing, and the company is awaiting a response from the DOJ for our offer to settle the ongoing investigation for 6.35 million, the same amount we’ve agreed to pay to the SEC.

Although our discussion with the DOJ are ongoing they have indicated the settlement terms could include a payment plan over a period of up to three years.

Prior discussions with the DOJ have also indicated that they will accept a settlement offer of 8 million but as indicated earlier we’re continuing our discussions with the DOJ and are awaiting a response to our most recent offer.

In Q4, 2009 the company accrued 9.3 million for a potential settlement and we’ve accrued an additional 3.4 million in Q2 of 2010, to reflect the full amount of our pending settlement offers to both the SEC and DOJ. We also anticipate paying interest on deferred amounts due to both the SEC and DOJ settlement agreements. Because these settlement offers are in process, I’d like to remind you that there can be no assurance that the settlement with the SEC will be approved or that the company will be able to settle with the DOJ for 6.35 million.

Now I’d like to turn to the balance sheet. We ended the quarter with cash and restricted cash of 36.2 million which represents a decrease in cash of 1.9 million from the first quarter of 2010. The significant components of our cash activities for the quarter include cash generated from operations of 469,000 capital spending of 2.1 million and net debt repayment in foreign currency loss totaling 215,000.

Given our fairly modest cash consumptions our demonstrated ability to generate cash from operations and our expectations that payments to the SEC and DOJ to settle the FCPA issues will be spread over the next couple of years. We do not anticipate the requirements to raise capital just on these settlement payments.

Depending on whether the convertible debt that matures next year is converted to common stock, but paid in cash and the timing and expense of future capital spending for capacity expansion it is reasonable to expect that we made some more stock in the future but our intention would be to do so opportunistically.

I also wanted to note that our debt declined during the quarter as a result of the accounting for the embedded derivatives in our convertible divestiture. For our balance sheet notes our debt as 14.1 million. The actual underlying cash amount that we owe is approximately 13.4 million.

The difference between the recorded amount of debt and the actual amount owed is an accounting adjustment of nearly 693,000 to value the embedded conversion option. The remaining debt consists of buying at attractive interest rate. Our Swiss entity, which owes local Swiss banks approximately 5.1 million.

Now I’ll turn it back over to David to discuss other areas of our business.

David Schramm

Great. Thanks, Kevin. Purely our focus mainly on ultracapacitor products and markets, so let’s spend a few minutes on the developments with Maxwell’s other products.

For those of you aren’t familiar with the company, Maxwell’s Swiss subsidiary develops in market high voltage capacitor products that are used in the electrical utility grid and other applications involving the transport, distribution and measurement of high voltage electrical energy. While their name suggests that high voltage capacitors might be related to ultracapacitors, the products are quite different and addressed entirely different markets. Our largest high voltage capacitor customers are the large global prime contractors who build power plants and electrical 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 expanding electrical energy generation and distribution to support commercial and industrial activity, and improving standards of living are major consumers of our products. High voltage sales have been a bit soft this year, but these products generate solid margins and contribute to make a meaningful contribution to Maxwell’s bottom line.

A lot of attention and resources are being focused on how the grid can be made smarter to better manage electrical energy generation, distribution and consumption. The federal government is making modernization of the US grid a major focus of federal energy policy in spending, so we are tracking these developments closely and getting a better understanding of how Maxwell can participate.

At the same time we know that from experience that grid programs involve not only funding but extensive engineering and permitting before infrastructure construction starts. So whatever Smart Grid opportunities eventually develop for our high voltage products, likely this is going to take a year or maybe two to materialize. Those of you who are familiar with the story know that Maxwell also develops and markets radiation hardened components and single board computers to major satellite and spacecraft OEMs in the US and Europe. Government and commercial space programs often stretch over several years and deliveries of our products are tied to program schedules and funding schedules, 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. The proprietary, high value, single board space computer product developed by our Microelectronics product development team has enabled us to significantly increase the value of Maxwell content per launch over the past several years. Our computers have been designed into some significant programs, including the high profile Iridium Next Communications (inaudible), which plans to launch 72 satellites over the next several years.

Iridium has selected (inaudible) as its prime contractor, and contracts with subcontractors, including the single board computer supplier, are expected to be awarded soon. If awarded to Maxwell, this would represent a very significant growth opportunity for Maxwell’s Microelectronics group.

Looking ahead, as we stated in our press release, based on the strength of current bookings and order activity with both new and existing applications, we expect ultracapacitor sales to grow 5 to 10% sequentially in the third quarter. However, due in part to the three week summer shutdown of Europe and our Swiss operations, we anticipate that combined revenues from High Voltage and Microelectronics products will down slightly when compared with Q2. Therefore, we anticipate that total third quarter revenue will range from flat up to 5% compared with Q2.

The redesign and transition of our (inaudible) ultracapacitor product to off shore assembly in China was completed this month. That along with completion of a legacy low margin (inaudible) supply agreement sets the stage for further margin improvement during the balance of the year.

Earlier this year our engineering team completed a large cell redesign that we call K2. This better performing, lower cost cell moved into full production in Q1 and is largely responsible for improving margins for hybrid bus and other heavy duty applications. We also continue to refine and improve multicell module design to further reduce costs in improved manufacture ability and quality although material sourcing and virtually all ultracapacitor cell and module assembly are being outsourced to low cost countries. I want to emphasis that we produce our proprietary intellectual property ultracapacitor electrode material behind closed doors in our San Diego facility and electrode fabrication will not go offshore.

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 to be able to release some news of some of these within the next couple of quarters. And as we stated earlier this year, we continue to focus on our goal of translating increasing ultracapacitor volume, important contributions from our Microelectronics and high voltage products and improving profit margins into profitability at the operating income line.

We will now be very happy to entertain your questions.

Question-and-Answer Session

Operator

(Operator Instructions). We’ll go first to the site of Steve Sanders with Stephens. Please go ahead.

Steve Sanders - Stephens

Kevin, maybe first a quick question for you. If the convert gets settled in cash next year, what is that number? I think you gave and I just missed it.

Kevin Royal

Yes. 8.3 million and it would be paid in equal installments in June, September and December of next year.

Steve Sanders - Stephens

And then coming back to the ultracap side and this is kind of a very much a big picture question. I saw a data point from a large auto supplier recently that said they think by 2015, 2016 half of the cars produced in Europe will have stop start. Does that sync with your own research? And can you sort of quantify the opportunity there relative to your comments about multibillion of potential?

David Schramm

It’s the European regulation that by 2012, 65% of the cars can emit no more than 130 grams of CO2 per kilometer. As we sit here today the average cars are about 160. And the way the European Union has set that regulation is they have got a fine per gram of CO2. And it scales. But once you get to the fourth gram the fine is 95 euros per gram. So if you translate that into these exchange rates, if the car’s at 160 and you got to get to 130, you’re looking at about $4,000 worth of a fine that you’d have to put onto the vehicle. One way to help reduce that carbon dioxide is start stop.

And frankly what we see working with Continental it’s a relatively unobtrusive add to the car. It doesn’t require a complete redesign if you will. And Continental, we are shipping parts to Continental and they are assembling assemblies and they are shipping them to the car companies as we speak. And again, these cars should be on dealers’ showrooms within the next few months.

Steve Sanders - Stephens

And as we start to see automotive become a bigger percentage of the mix, and I know it’s hard to tell at this point, you know, what the relative growth of the various pieces of the ultra cap products are. But are we going to notice significant gross margin pressure? Or do you think the initiatives that you’re undertaking to make the product more efficiently and sell into high value markets is going to keep those margins moving up nicely?

David Schramm

Well, I think you just answered the question for me, Steve. Yes, there’s margin pressure. But that continues in all of our businesses as people become more and more acquainted with what an ultra cap can do. And along with that, the more volume we have, and we’ve got some very good history in non-volumes. It is helping us drive our costs down. We are getting smarter on how we build these things. And our throughput is going up. So volume helps us learn. Volume helps us reduce cost. And you know hopefully we can share the margin with our customers and maintain a solid margin for us as a company.

Steve Sanders - Stephens

Can you quantify and/or put a timeline on the Meridian Palace opportunity if it goes your way? Understanding there’s a long way to go between here and there.

David Schramm

My best take right now, and again, they haven’t made all of their final decisions. But we would see revenue I would think in late ‘11/’12 and then ‘13. ‘14 and ‘15. From what I see today, it’ll extend itself over four or five years.

Steve Sanders - Stephens

And ballpark on the revenue potential?

David Schramm

Revenue potential I think we’ve said in the past in just under $40 million for the program.

Operator

Thank you. Next we’ll go to the site of Brian Kremer with Roth Capital Partners. Please go ahead.

Brian Kremer - Roth Capital Partners

On the ultracaps I guess maybe hit two of the other key markets; automotive’s already been discussed. When obviously you’re talked about seeing strong growth this year, most of your sales are probably into China. We’re seeing wind slowing down here in the US; obviously not happening over there. So looking out, how much visibility do you have on the wind side relative to say the bus side, which seems to be pretty limited in terms of when they’re ordering? So when you look at a 2011 and ‘12 can you even look there?

David Schramm

All we can do, Brian, is basically connect the dots from what we had in ‘09 and what we’re seeing this year and what we think next year is. When I have talked to the Chinese bus manufacturers, the government has said you’re going to have transit buses but they get a pretty short schedule also. So it’s been when they get a schedule they send us a schedule. But if I connect the dots, right now we are on track to supply them at least as many capacitors as we did last year and potentially a whole lot more.

The wind, we see the same thing. There’ an awful lot of wind farms going into China. And the two major areas we ship the caps are [stitch] control for Chinese windmills and [stitch] control for European windmills. And again, we still see a robustness in both of those.

Brian Kremer - Roth Capital Partners

Okay. So no anticipated slowdowns on either front. Now on the buses, you mentioned 30 cities. Do you have a sense in talking to your counterparts over there is this a one two three year type effort to hit all those cities and hit the numbers they want to hit?

David Schramm

If I can back up on that, a year ago we announced that we had three companies of the combined order of $13.5 million. And we shipped all of that in 2009. So we did that in less than 12 months. We’re on track to do more than that in 2010. The initial drive of that is the Chinese government says they wanted 10 cities each to have at least 1,000 hybrid buses. That was the press release. That 10 got moved to 13, 13 got moved to 20 and just recently we were told the government now is targeting 30 cities with 1,000 buses each. So that’s 30,000 buses. And as we’ve said in the past, we’ve got between 10,000 and $20,000 of content per bus for the ultracaps depending on the configuration. And we’re working very hard to earn as much of that business as we can.

Brian Kremer - Roth Capital Partners

Let me see if there was another here. Could you comment you talked about other products, consumer and then R&D is there anything more you can say there? Or are you going to leave that teaser out there for us?

David Schramm

Well all I can tell you is we haven’t announced the commercial product. We hope to do that in the next quarter or two. Uninterrupted power supplies are still getting an awful lot of play and attention and frankly, we’re taking a look at how do ultracaps work into the Smart Grid scenario. Could we use ultracaps to store episodes so there’s an awful lot of opportunity and I got to believe that right now, the amount of education effort that Maxwell has put into the market to educate engineers as to what an ultracap is, it’s really starting to pay off for us.

Brian Kremer - Roth Capital Partners

Actually one more. Legal expenses, Kevin maybe, relate it to the FCPA? I’m assuming some of that’s in SG&A. What do we see going forward? Are you still seeing some expenses in Q3, tapering in Q4? Assuming something happens, let’s just say assume something happens this quarter, are there some lingering expenses in the Q4, what does that look like?

Kevin Royal

So my best guess right now and I guess to frame the comment, our legal expenses associated with this matter have been running, I would say, a low of about 125,000 to a high kind of an ongoing basis over the last four quarters of around say 200,000. I would anticipate that as we move into the back and forth on a settlement, that it would be approximately $200,000 say in Q3 and probably a similar amount in Q4 if the settlement discussions do extend that far.

Operator

Thank you. Our next question comes from Michael Horwitz with Baird. Please go ahead.

Michael Horwitz - Baird

Just quickly, regarding your Carbon Electrode manufacturing capacity. I believe you had installed a new machine not too long ago. You have the older machine that I believe was going to get re-tooled but perhaps you’re running flat out that you can’t do that right now and what are your plans for ordering the next machine? And how do I think about capacity per machine given that, that’s your bread and butter and you’re not going to allow that overseas? It’d be helpful to get a little bit more detail along the lines of that capacity and how it plays into some of the demand you’re seeing across applications? Thanks.

David Schramm

One thing that’s happened here is, in the last three years, the engineers have really come to understand how to get the most out of this processing equipment that we’ve got, so we have increased the throughput per machine, and you’re exactly right. We just put a new machine in, and it’s got some good output characteristics also.

The plan is to keep upgrading and add that capacity, and stay ahead of the curve, so we work very closely with our sales and marketing groups on what is the capacity we’ve got to have, because you know, obviously I need to have enough capacity to satisfy customer requirements, but I don’t want to have so much capacity that I drive my cost up, so we’re staying ahead of that curve. We will stay ahead of that curve, and I believe we could add capacity faster than the customers’ requirements are going to be at this point.

Michael Horwitz - Baird

So is it fair to say that you’re already planning on another new machine for 2011?

David Schramm

It’s fair to say that we’re looking at least one, maybe two more, and what we have to do is, you know, one thing we’ve talked about in the past also is, today we currently do all of that in our Balboa Avenue facility in San Diego, and so we may have to look at another facility just to have, you know, a little more flexibility.

Michael Horwitz - Baird

This is a little bit big picture grasp, a bit of a softball. But if I get through this legal expense that you just alluded to, I get through some of this liability, and now understanding that ultracapacitors are outperforming your other two segments combined, at least for now until maybe some new contracts kick in on either of those segments, it appears to me after covering your company now for six years that you finally have enough visibility and scale on the ultracapacitor model, that we can start to see that leverage and really see an ultracapacitor company going forward.

If I back everything out, I can get to a barely robust revenue of profit model on the back of ultracapacitors in the 2012 and beyond, so strategically, when are you going to start to, you know, give us a little bit more clarity how that business really looks? And what the future really looks like? Understanding that we’ve been going quarter to quarter now for about 25 quarters.

David Schramm

And I appreciate the history you’ve got there, Michael. I’ll tell you the one thing I look forward to is, one of these days when Mr. Sund can do his safe harbor, and not talk about the history of losses. We’d like to get forward, and keep on with this, you know, this non-GAAP profit felt really, really good, and again, you’re exactly right. Ultracapacitors drive it. That is the focus of the strategy of the company, but I’ll tell you what.

We have not lost focus on microelectronics or the high tension, and we believe the three of them together offer some significant synergies. You can put ultracapacitors together with the high tension and really make a case for what we can do in the Smart Grid. You know, how you monitor that with satellites that use our microelectronics product, you know, that might be a little bit of a stretch, but we intend to grow all three of our product groups and a major focus is going to be on ultracapacitors, cause frankly that’s got the most legs.

Operator

Thank you. Our next question comes from Dilip Warrier with Stifel Nicolaus. Please go ahead.

Dilip Warrier - Stifel Nicolaus

Just a follow up on the negotiation with the DOJ, are you expecting worst case then too? Perhaps I caught another at most another 1.6, 1.7 million?

David Schramm

Yes. As we disclosed we made an offer 6.35. In previous discussions they had given us essentially an offer of 8 million. We do believe that worst case would be that we will take that accrual for the DOJ portion of the settlement from 6.35 to 8 million. But having said that, we remain very hopeful that we can move forward with the DOJ and settle at the amount that we have accrued for their portion of the settlement, which is the 6.35.

Dilip Warrier - Stifel Nicolaus

Do you expect then, when you said you could pay the fill with two years, would that be kind of two installments and one installment?

David Schramm

So there’s a payment plans that have been discussed, and I’ll just reiterate that nothing has been papered or is final at this point, but in our discussions the SEC has offered that we would pay half of that settlement amount up front and half at the one year anniversary, and what we’ve discussed with the DOJ would be a payment plan that would result in three equal installments at 12 - 24 and 36 months from the date of signing.

Dilip Warrier - Stifel Nicolaus

And I think you were targeting something like 40% gross margins towards the end of the year. It sounds like you’re early on that. I was wondering do you expect for the rough side to the gross margin profile?

David Schramm

So you’re right, Christmas did come a little early this year, but we had an unexpected upside surprise in our Microelectronics business. So we would expect to maintain that 40% as the target exiting the year. So we’re not forecasting any upside to what we had talked about last quarter when we talked about the gross margin targets exiting 2010. So 40% still remains a good number.

Dilip Warrier - Stifel Nicolaus

That makes sense. One last question, recent ripples coming out of China suggest that Stop-Start could very rapidly be introduce across new vehicles there, and I was wondering if you are working with auto makers in China to introduce there.

David Schramm

We buy a lot of plane tickets, Dilip, to go to China, and the answer to your question is yes we’re talking with them. We’re talking with auto makers all over the world because we do believe that with the government pressure on making greener cars and Start-Stop is like I mentioned earlier it’s a relatively easy way to pick up some fuel economy, reduce emissions. So yes the answer to your question is we’re going to talk with every auto maker in the world on how do we get Start-Stop into their cars using ultracapacitors as the power source?

Operator

Our next question comes from Walter Nasdeo with Ardour Capital. Please go ahead.

Jin-Ming - Ardour Capital

This is Jin-Ming in for Walter. David, I have a question regarding your ultracapacitor deals. Can you break out net sales by region and by application?

David Schramm

Region is easier to do and basically it’s a great focus on China and Europe and very little in North America at this time. We’re going to refocus on North America. We think there’s some renewed interest here. But we have really seen the how do you get greener in China has really been a focus of what the government is pushing there in both windmills as well as transit. So again the breakout would be China and then Europe. Wind and buses tend to be the drivers for us.

Jin-Ming - Ardour Capital

Okay. So can I have some like a 40% sales for China and Europe and the rest just in the US?

David Schramm

We don’t really break it out, but again China is number one. Europe’s number two and whatever is left over shows up in the rest of the world.

Jin-Ming - Ardour Capital

Because I know China has it’s going to see a very strong growth in wind installation again this year. Let’s to you in this way, out of the 13.8 gigawatt turbine installed last year how many gigawatts of turbines used your ultracapacitor?

David Schramm

You know that one I can honestly tell you I have no idea. What I can tell you is in the wind market there are two ways to do pitch control. One is hydraulic and one is electrical. Roughly two thirds of the windmills use electric so that is the market segment that we can deal with. We are talking and continue to talk with the windmills that use hydraulic because our stint is at some point they will consider or convert over to electric pitch control, but I really don’t have a sense for that because we tend to go in all sizes and we haven’t tracked it. The only number I’ve got is that we’ve done 12,500 windmills to date, and I’m hoping to have an update on that number by the time we do Q3 results.

Jin-Ming - Ardour Capital

Okay. On average, I just want to get some idea on the unit economics. (inaudible) windmill how much sales you can generate from there.

David Schramm

The windmills we deal with typically are in the two to six block range. They’re large windmills. And again, they use multiple ultracapacitors for the pitch control. I think I’ve mentioned on other calls the ultracapacitor is because you can charge and discharge it and cycle it millions of times, it ends up being a very low maintenance item for the windmill manufacturer. And a rough number that we throw out it’s about $5,000 of caps per windmill. That’s plus or minus depending on the size of the windmill.

David Schramm

Surely. I think we’ve got time for about one more question.

Operator

Certainly. Our final question will come from Matthew Crews with Noble Financial Group. Please go ahead. Mr. Crews, your line is open.

Matthew Crews - Noble Financial Group

I had a question regarding the ultracapacitors going back to the (inaudible) opportunities. I missed some of the prepared remarks, so I apologize if this is redundant. Looking at what you’ve quoted in the past at 50 to $150 per collar and what your opportunities are with Continental, can we translate that into a number of vehicle opportunities? Is this a 10,000 vehicle opportunity this year? A 100,000 vehicle opportunity next year for 2011? Is that a fair way of looking at it?

David Schramm

You know, what we have said in prior calls is this year it’s a start up mode, and we expect about $2 million of revenue this year. That grows significantly in 2011 and it doubles in 2012. I believe that once the market sees cars that are actually on the road utilizing this start stop system that Continental has, I believe they’re going to have more interest. There are 60 million cars in the world, so again, if you just dream a little bit about what percentage of those could have start stop, and we really believe ultracaps are the right answer for that start stop, the market potential for this is quite large.

Matthew Crews - Noble Financial Group

I think that dove tails into a second question. You do have working relationships with a couple of Tier One. What kind of compensation do you see with the other ones, other Tier One manufacturers? And what’s market share? I know it’s a growing opportunity, so I don’t want to walk into it’s great having everybody selling. But just curious on what market share you might be able to obtain. I guess this often goes with China in terms of if you do have a chance to sell into that market, what, what sort of levels of competition in the market share do you think you might hit?

David Schramm

Well right now based on the data that we have, and then keep in mind we are one of the few public companies that reports data from ultracaps. Some of our competitors are either private companies or they’re subsidiaries of a very large company, so it’s really hard to get the data as to what they are doing. Our goal is to continue to earn our customers’ business everyday and to be the number one choice and we work really hard to do that, but as far as what part of that market, we’re going to try to grab as big a share as we can, our focus is win, it’s on buses, uninterrupted power supplies, automotive, and hopefully consumer products here very soon.

David Schramm

Everybody, thank you very much and we look forward to talking with you at the end of Q3.

Operator

Thank you.

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Source: Maxwell Technologies Inc.Q2 2010 Earnings Call Transcript
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