Maxwell Technologies, Inc. Q2 2008 Earnings Call Transcript

Sep.16.08 | About: Maxwell Technologies, (MXWL)

Maxwell Technologies, Inc. (NASDAQ:MXWL)

Q2 2008 Earnings Call

August 6, 2008 5:00 pm ET

Executives

Mike Sund – Vice President of Investor Relations

David Schram – President and Chief Executive Officer

Tim Hart – Vice President, Chief Financial Officer, Treasurer & Secretary

Analysts

Richard Baxter – Ardour Capital Investments LLC

Steve Sanders – Stephens, Inc.

William Gibson – Nollenberger Capital Partners, Inc.

Ted Kundtz – Needham and Company, LLC

Operator

Welcome to Maxwell Technologies second quarter 2008 conference call. (Operator Instructions) I will now turn the program over to your moderator for today, Mike Sund, Vice President of Investor Relations.

Mike Sund

Good afternoon, in a moment you will hear from David Schramm, Maxwell's President and CEO and Tim Hart, 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 management's current expectations and assumptions which are subject to numerous risks and uncertainties. Actual results could differ materially because of factors such as the company's history of losses and uncertainty about our ability to achieve or maintain profitability or to obtain sufficient capital to meet customer demand or other corporate needs.

Also development and acceptance of products based on new technologies, demand for original equipment manufacturers products reaching anticipated levels, general economic conditions in the market 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 those filings may be accessed by visiting the investors section of our website at www.maxwell.com and hard copies may be obtained by contacting the company by 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 August 6th, 2008. 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

As noted in our press release today, Maxwell recorded its highest ever quarterly ultracap sales during the second quarter of 2008. Of particular note, that record revenue includes shipments to two new wind turbine manufacturer customers utilizing the license that was obtained from InterCon. These shipments are the first made by Maxwell to a wind turbine manufacturer other than to InterCon and more shipments will follow. We are actively pursuing all wind turbine manufacturers and we are very encouraged by the present and future growth opportunities that this market affords. Having T. Boone Pickens pushing the wind energy market is very welcomed at Maxwell Technologies. The hybrid bus market also showed good growth for Maxwell on the second quarter, with announcements of sales and more importantly what we expect to be foundational business relationships with major Europe and Chinese bus integrators. We now have a presence in the regenerative brake energy market for buses in North America, Europe and Asia, the three dominant world areas for bus manufacturers. We have also begun receiving orders for ultracapacitors for regenerative braking energy recapture and the resulting fuel economy benefits in cranes in harbor installations. The ultracapacitor technology helps to improve air quality in and around port facilities by reducing diesel fuel emissions as well as significantly improving fuel efficiency. We will have more on this in the coming months.

BMW made a presentation entitled "super Cap Enhanced Power Net For Improved Functionality In Bmw Microhybrid Vehicles" at the recent advanced automotive battery conference in Florida. In it, they specifically note that using ultracapacitors to handle repetitive cycling extends battery life and allows for more effective management of the power requirements of the vehicle's system. A similar report was published by General Motors and Hughes Research Labs at 2008 Advanced Capacitor World Summit. In tandem with any battery type, lithium ion, nickel metal hydride or lead acid, ultracapacitors have shown they can improve the battery life and extend the range for a vehicle's system. Besides simply handling the power while the battery handles the energy, ultracapacitors also perform very well at low and high temperatures where batteries struggle. At minus 20 degrees centigrade, the typical lithium ion battery loses 80% of its power capacity. When it heats above 35 degrees C, power derates very quickly. These characteristics require that the battery be warmed or cooled or oversized. Electric vehicles will have to be able to function in harsher climates than we enjoy here in southern California.

We continue our progress with lithium ion battery electrode development and are working very closely with our announced collaboration partners, Lishen Battery Company in Tianjin, China and Johnson Controls-Saft here in the United States as well as some others as yet unannounced who have expressed a lot of interest in our process. We are also seeing increasing interest from battery producers, tier 1 suppliers and automotive OEMs and the benefits of paring ultracapacitors with batteries to achieve better overall power and energy performance.

This was the subject of a presentation at the recent Society of Automotive Engineers World Congress by Maxwell's Dr. John Miller and a representative of the Argonne National Laboratories, which is conducting extensive testing on the synergy between ultracaps and lithium ion batteries. Also we continue to improve our ultracapacitor electrode and will soon see higher voltage as well as lower resistance, which equate to better performance in smaller, lighter, more cost effective packages. Our investments in research and development will keep us at the leading edge of electrode science.

I would like to break the business update and have Tim Hart, Maxwell's CFO, give some financial details on what all of these developments mean to Maxwell.

Tim Hart

I will discuss some of the significant items from our financials for Q2. Starting with a year-over-year revenue comparison, total revenue for Q2 2008 increased from Q2 2007 about 44%. This is the fifth consecutive quarter that revenue has increased. We expect this trend to continue in Q3 of 2008. The overall gross margin percentage increased year-over-year to 28% in Q2 2008, compared to 20% in Q2 2007. However, the total gross margin decreased from 30% in the first quarter of 2008, primarily due to increased offshore freight costs and the impact of some strategic pricing.

We are taking action to reduce the costs for offshore freight by moving from air to ocean freight but the full benefit of these changes will not occur for a couple quarters. Operating expenses increased by 17% from Q2 2007 to Q2 2008. However, as a percentage of sales, both SG&A and R&D expenses decreased from Q2 2007. Selling, general and administrative expenses decreased from 37% of sales to 30% and R&D decreased from 23% of sales to 18%.

Q2 compensation expense related to stock option and restricted stock grants was approximately $498,000, some of which is in cost of goods sold with the remainder below the gross margin line depending upon the job function of the recipients.

The net loss from operations improved by about $1.5 million in Q2 2008 as compared with Q2 of 2007, with the higher Q2 2008 revenue and gross margin more than offsetting the increased operating expenses. Now moving over to the balance sheet, the inventories increased about $2.1 million from Q1 of 2008 to Q2 2008, primarily from increased customer demand for high tension BOOSTCAP products, as well as increased work-in-process for microelectronic products that will be shipped in the third and fourth quarter of 2008.

Net fixed assets increased about $2 million from Q1 of 2008 to Q2 of 2008, primarily for equipment purchases that we need to make to increase the production capacity for both BOOSTCAP and high tension products. We consumed cash of about $6.4 million during the first six months of 2008. That was about $1.6 million in the first quarter and $4.8 million in the second. Our cash investments and restricted cash totalled $23.8 million at June 30, 2008.

We expect our net cash burn for the next six months of 2008 to be as much or more than the cash consumed during the first six months of 2008. Cash usage will be impacted by our results from operations, the timing of certain capital expenditures and the quarterly $2.8 million principal payment, which the holder of convertible debentures we issued in 2005 has either option to either collect or defer. The balance of that note is about $19.4 million at June 30th.

For those of you that are new to the Maxwell story or who are not really well versed in the accounting treatment of the conversion features of those convert debentures and associated warrants, we are required to mark them to market each and every quarter using a black scholes calculation based on the change in the stock price from the close of the last trading day of the previous quarter compared to the closing price on the final day of the current quarter. In the current Q2, the impact was negligible, a non-cash gain of about $33,000 was recorded.

However, in Q2 of '07, a non-cash charge of $1.4 million was recorded so that affects the net loss comparison for the current and year ago quarters. Earlier today we announced our intention to launch an equity distribution program that will allow Maxwell to use our existing shelf registration to offer and sell shares of our common stock from time to time through UBS at market prices. Although there is no obligation for Maxwell to use this program, the total amount of common stock authorized for sale through this program is $15 million.

We plan to use it opportunistically to raise additional cash based upon the share price, the trading volume and our cash needs as we go forward. This equity distribution program is one of several options Maxwell has to raise cash, which include negotiations to reduce or eliminate current restrictions on $8 million of cash, bridge financing, private placement or a public offering of our common stock, and the sale of certain tangible or intangible assets. The Company believes that we have adequate resources to fund the working capital requirements, capital equipment additions, product development for at least the next 12 months.

Back to you, David.

David Schramm

As Tim just reviewed, our BOOSTCAP revenue continues on a pace consistent with our view of a robust 2008 for these exciting products. So as we stated in our press release, we anticipate additional top line growth in the third quarter. Overall gross margins were negatively impacted in Q2 by significant increases in freight expense that every business is experiencing today. We are attacking the freight issue have developed strategies and plans to control our freight and other costs with a near-term goal of returning gross margins to over 30%.

Our customer support office in Munich that was opened last quarter is being staffed with costs added to our SG&A. This near-term investment will result in solid, long-term returns as our exposure and service to the European automotive customer base is enhanced. We are very mindful of our SG&A expense growth and pay particular attention to every dollar spent. That said, we must put the proper structures in place today to foster customer relationships that will bring revenue growth in near future years. The same goes for R&D, where we will spend the funds required to ensure we maintain our leading edge technologies in both electrode and ultracapacitors.

Our high tension product group continues to show strong revenue growth and has now set new revenue records for the last three quarters. Developing countries where infrastructure is needed to meet the world's increasing appetite for electrical energy are our primary growth targets and our success continues. A similar scenario exists for our microelectronics products group. However, it is program driven rather than a run rate business and, therefore, a little lumpy in the short bursts but overall is showing good growth year-over-year.

Q2 2008 is now the fifth consecutive quarter in which Maxwell has produced sequential top line growth. We are committed to continuing this performance and are more excited than ever about our future and our ability to generate new revenues, improve our cost structure and, of course, to begin generating profits from our combined operations as soon as possible.

I will now entertain your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Richard Baxter - Ardour Capital.

Richard Baxter – Ardour Capital Investments LLC

The question I guess on the wind turbines. You had not mentioned the names of the companies you have been working with there?

David Schramm

That is correct.

Richard Baxter – Ardour Capital Investments LLC

Just curious on that, how long is it when you were working with these guys going through the proving-out process and getting it out into the field and such, how long does that usually take for some of these different companies.

David Schramm

We have already shipped some modules, Richard. We just have not made an announcement on that yet.

Richard Baxter – Ardour Capital Investments LLC

I did not mean that. I meant in general, working with the different wind developers.

David Schramm

Typically, this is in months, not in years. Because we have a track record with InterCon. And again, a little history there, InterCon has a patent, I should say, on the application of ultracapacitors for the blade pitch adjustment. Maxwell has purchased a license that indemnifies our customers from using that. That really stopped us from going outside of InterCon. Having purchased that license, we started working with other windmill manufacturers in late '07 and again we are producing revenue now with new clients.

Operator

Your next question comes from Steve Sanders - Stephens Inc.

Steve Sanders - Stephens, Inc.

Couple of questions, first, congratulations on the Golden Dragon order. I just wanted to see if you can give us additional color there. I think you shipped a product. Where are they in the integration process and how should we think about their testing, evaluation period and potential timing for additional orders?

David Schramm

You are right. We have shipped a product to Golden Dragon and the dates they have given us, they need 4 or 5 months. We will have people there. We do have an office in Shanghai and we do have that staffed at this point. So we are going to stay very, very closely with them to make sure that they are hugely successful, because they are one of the largest bus manufacturers in the world and have some pretty grand plans as to what they are going to do with hybrid buses.

Steve Sanders - Stephens, Inc.

And another attempt on the wind turbine side, would you characterize these new customers as Tier 1 suppliers?

David Schramm

Very much so, they are part of the major players.

Steve Sanders - Stephens, Inc.

And then it sounds like you have got some good sponsorship on the ultracap benefits working with lithium from BMW, GM, etc. What about the lithium guys themselves, and how involved are you in some of that integration work?

David Schramm

As you know, we have got two announced relationships. One is with Lishen in Tianjin, China. Last year Lishen made 200 million lithium ion batteries. And the second relationship is with Johnson Control-Saft in Milwaukee, and they are a major player in the U.S. market and with their Saft connection they are a major player in Europe. And both of those are major producers of lithium ion batteries.

Steve Sanders - Stephens, Inc.

And then the sequential gross margin compression on the higher sales I think you mentioned two things, one, freight, and we certainly understand that that has been a tough thing to deal with. But the strategic pricing was the other one. Can you just expand on that a little bit?

David Schramm

Yes, I would really like to do that. I am not a supporter of strategic pricing if it lasts very long. But what we have is, we had an opportunity to get a new customer, and I had to price it strategically. My costs, I do have a plan to get the cost down to where that will no longer be strategic and it will be profitable business. It is a timing issue at this point based on how quickly I can move to a low-cost source, and that plan is in place.

Steve Sanders - Stephens, Inc.

So in conjunction with your comment about getting back to the 30% kind of level overall, we should think about that as a pretty near-term goal.

David Schramm

Yes, yes, in fact I would like to get significantly above 30, and like I said, the team at Maxwell is committed to doing that.

Steve Sanders - Stephens, Inc.

And then, we have obviously seen some pretty significant increases over the past couple of quarters in the operating expenses and I know you have given us some detail on the investments that you are making there. How close are we getting to little more stability in the OpEx line?

David Schramm

I think, I have been here now a year and two weeks. It seems like it has been a lot longer than that some day and a lot shorter than that others, but I am getting more and more confident that we are getting better exposure at what expenses we have to control and how we can control them, to where we can run a lot more of our businesses as a business. So my confidence is growing that we are going to get better as to how we keep the expenses in line and let the revenue grow faster than the expenses.

Steve Sanders - Stephens, Inc.

I think I understood this, but when you say additional growth in 3Q, you are talking versus 2Q, so sequential not year-over-year. Is that correct?

David Schramm

We are going to do both, but one thing that we did do, Steve, if I can back up to your last question. We did adjust prices, because where we had prices that were way under the cost and I could not get a cost curve with all of the cost savings we could think of to do that, we adjusted prices upward. And, frankly, customers do not like that, but we did not lose very much revenue after we did that.

Operator

Your next question comes from Bill Gibson - Nollenberger Capital.

William Gibson – Nollenberger Capital Partners, Inc.

Yes, I would like to follow along that same line on the margins. I think early in the presentation you talked about a two-quarter lag. I assume that is mainly due to the strategic pricing instead of the change in freight, or am I incorrect in that?

Tim Hart

I had mentioned it with about the freight cost same thing David did. And what I said is moving from air to ocean freight and we will not have realized the full benefit of that for the couple of quarters. I was only referring to the freight benefits that we will be able to bring costs back down a little bit.

William Gibson – Nollenberger Capital Partners, Inc.

Is that to meet delivery schedules? Is not that relatively easy to make that switch?

David Schramm

Bill, it is a matter of getting the inventory. Right now we use an awful lot of Federal Express to move the finished, assembled product from China to our customers. The intellectual property is all maintained within the walls of Maxwell here in San Diego. We then ship that to China for assembly. From China we were airshipping that via FedEx that to the customer. With the price of freight going up so substantially, the decision we have made, is we are going to build a moderate inventory so we can get that on the water. And again, what Tim's alluding to is that when I get it on the water, I have to put about six weeks of inventory into the system, before I can get totally out of the airplane. So that is why there is a lag time.

William Gibson – Nollenberger Capital Partners, Inc.

And can you share with us what industry or broad segment the strategic pricing was for?

David Schramm

Yes, it was buses at this point. But, again, we have got a plan that we have shared that we keep the intellectual property here in San Diego and the people that do best at chasing low-cost labor, we are going to let them do that for the assembly. And again, some of this just has not transitioned. We are in the process, but it is not all there yet. But it will be there very quickly and then we will get them validated and make sure that we can deliver perfect quality and then we will have it moved and then the costs will drop out and then we will be back in the margins we need to be.

William Gibson – Nollenberger Capital Partners, Inc.

And then just one last question, sort of grappling with the same issue of building a model. The microelectronics, you mentioned the build in inventory that ships in the third quarter, will third quarter microelectronics be up from the second quarter?

David Schramm

I got to tell that business, I have been around a lot of businesses and that one is really contingent on space programs and its lumpiness. The politics involved as to where the government is going to spend money on satellites. I would tell you it is anybody's guess. Right now, I feel comfortable that we are going to have those satellite programs. I think our military needs it. So I think it should be there the third quarter.

Operator

Your next question comes from Ted Kundtz - Needham & Company.

Ted Kundtz – Needham and Company, LLC

Could you just give us a sense of some of the vertical maybe the breakdown of the vertical markets in the ultracap business in the quarter, like how much went to automotive and how much the going to the wind side and maybe then the other group would be maybe just the miscellaneous, which I guess includes some forklifts.

David Schramm

Ted, wind is still our biggest customer at this point. And the good news is, like I said, I was more than pleased when I saw T. Boone Pickens take full page ads out in Wall Street saying that is what he wants to do. That creates a lot exposure for us. But the wind market is still are largest. The automotive obviously has got the largest volume potential, but as we know, those programs, as we have already announced, late '09 and early '10, then we get into the modules for the buses and that has the quickest uptick. Because, again, we have got a tried and true system that seems to be working extremely well . And now we are in all three of the major markets. Automatic meter reading comes into play, uninterrupted power supplies are coming back onto the horizon. We see a lot of different markets that at some point I think we will be at an equal with the wind market that we have got.

Ted Kundtz – Needham and Company, LLC

So wind is more than half of the business at the moment?

David Schramm

I do not think we have broken that out yet, other than to tell you wind is the biggest.

Ted Kundtz – Needham and Company, LLC

And then you did mention something with the crane market. Is there any more you can say about that?

David Schramm

There is more to follow on that, but again what we are doing is taking advantage of the energy that a crane uses on the way down that is not captured. And again, in most of the ports there is an awful lot of pressure to get rid of the dirty diesels. One way to do that is put in smaller engines and then use the ultracapacitors along with electric motors to do the heavy lifting.

Ted Kundtz – Needham and Company, LLC

So look for some announcements up and coming?

David Schramm

You will see that, Ted, just as soon as we can. As you know , the one thing we tried to do is try to overexecute our promises and we are very careful not to announce anything that the customer has not agreed to.

Ted Kundtz – Needham and Company, LLC

David, now, just looking at the margins going back to that, again, the gross margins on the ultracap side, looks like they are improving. You did mention the reasons why they were little bit lower this quarter, but if you took those reasons out, the freight issue and the strategic sale, are you satisfied with the, could you talk about the progress on the gross margins on the ultracap side ex those events, if you took those out, where are you.

David Schramm

We have a weekly meeting on potential cost reduction and there is two things we track. One is, as the volume goes up, it affords us the ability to get cost reduction just because of volume. We also get cost reduction because of making the process more robust and our throughput becomes better. And then the third one we have got is we work with a timeline as to where do we need what I call an invention that helps us make a paradigm shift to really drop cost out. And that is the guidance we give to a portion of our R&D. So part of R&D is working on how do you get the next technology that improves electrode and BOOSTCAP overall and part of R&D is also working on how do you find those near-term inventions that help us drop cost out of the current product. We are doing both and both have resulted in us improving margins on BOOSTCAP.

Ted Kundtz – Needham and Company, LLC

So you feel like you are on the right track. You are really got it. You are comfortable with the track you are on?

David Schramm

I am very comfortable with that. It is obviously as CEO I would like it to be faster and my guys are working really hard here and it is a great team effort.

Ted Kundtz – Needham and Company, LLC

How about sales of electrodes to the Chinese?

David Schramm

The sales, we have one order that we announced a long time ago and I just talked with that gentleman here in the laugh two weeks and they are ready to start back up again with some higher volumes. They have been at lower volumes, but they sense the need for growth in the hybrid vehicles in the Chinese market and they are pretty confident.

Ted Kundtz – Needham and Company, LLC

That will be ramping up when?

David Schramm

I would say before the end of this year we ought to see a ramp-up on that.

Operator

There are no further questions.

David Schramm

Very good. I would like to thank you all for your participation today and more announcements to follow and we appreciate your participation. Thank you.

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