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Executives

Doug Milner - President & CEO

Steve Fife - CFO & VP, Finance

Analysts

Jeff Osborne - Stifel Nicolaus

Carter Driscoll - Capstone Investments

Active Power, Inc. (ACPW) Q4 2012 Earnings Call February 19, 2013 4:30 PM ET

Operator

Good afternoon, everyone. Thank you for participating in today’s conference call to discuss Active Power’s financial results for the fourth quarter and full-year ended December 31, 2012.

With us today is Mr. Doug Milner, President and Chief Executive Officer of Active Power and Steve Fife, CFO and Vice President of Finance. Following their remarks, we will open up the call for questions. Then before the conclusion of today’s call, I’ll provide the necessary cautions regarding forward-looking statements made by management during this call.

I would now like to remind everyone that this call will be available for replay via Active Power’s website at www.activepower.com.

I would now like to turn the call over to the President and Chief Executive Officer of Active Power, Mr. Doug Milner. Please go ahead.

Doug Milner

Thank you. Good afternoon everyone, and thank you for joining us today. We issued a press release earlier today announcing our results for the fourth quarter and full-year 2012.

Our annual sales were up incrementally to $76.3 million, however, we were pleased with the progress we made throughout the year both strategically and operationally. This included a 34% increase in UPS product sales driven in large part by the improving productivity of our sales organization. We also achieved solid double digit growth in our service business. Our initiatives to drive operating productivity internally and favorable product mix externally resulted in a record gross margin year with gross profits growing nearly 38%.

As we mentioned throughout the year, our focus on these key fundamentals has been a consistent theme in our strategy to reposition the business for sustainable and profitable growth. We completed the global market introduction of our next-generation CleanSource High Density UPS product platform and received our first order for four 625kVA units for deployment at one of the largest auto manufacturers in China. We expanded our base of partners in the IT space including an exciting new partnership with IO a leading player in the modular datacenter market.

We redesigned and cost reduced our PowerHouse modular continuous power infrastructure platform which we plan to introduce to the market in the first quarter. We also announced a number of significant wins including ARM’s high performance computing facility in the UK and Stanford University’s Research Computing Facility in California.

Before we go further, I would like to turn the call over to Steve to give us financial details about the quarter and the full-year. I'll then come back to discuss how we view our market opportunity and our priorities for 2013. So now for the numbers. Steve?

Steve Fife

Thank you Doug and good afternoon everyone and thanks for joining us today. Before we get into the discussion of our financial results, there are a couple of items I would like to discuss. First, last Monday we pre-announced our revenue and earnings per share for the fourth quarter and 2012. Our results were adversely affected by a multi-million dollar order that shifted from the fourth quarter of 2012 for which we anticipate revenue recognition in the first quarter of 2013. Although, we are disappointed in this, the nature of some of our revenue and shipments of products may result in timing issues like this.

Secondly, you will notice in today's press release we provided supplemental information breaking out revenue by geography and by product line as well as providing our adjusted EBITDA calculation. We believe this supplemental information is helpful in understanding some of the dynamics of our business.

Also as a reminder, during the third quarter we started reporting our sources of product revenue under two categories. UPS Systems; MIS combines what we previously reported separately as power solutions and infrastructure solution. We will continue doing this going forward as we believe it better reflects the nature of our business.

Now onto our results. Revenue totaled $15.2 million for the quarter. This was a decrease of 22% sequentially and a decrease of 17% from the prior year quarter. This sequential decrease came entirely from our UPS revenue. In the third quarter of 2012, our UPS revenue included an unusually high proportion of ancillary equipment related to completion of a large integrated system deployment in that quarter, which we did not expect to repeat in the fourth quarter.

Additionally, results were affected by the shift in timing of the revenue recognition through a single multi-million dollar order from the fourth quarter for which we anticipate revenue recognition in the first quarter of 2013. The decrease in year-over-year quarterly revenue came entirely from lower sales of MIS products.

As we've discussed previously, MIS revenue reflects the inherent variability in our modular datacenter business lines, where large value and low volume of transactions can cause large quarterly fluctuations in revenue. We continue to seek long-term partnership for standardized product offer in the MIS product segment and continue to emphasize our growth strategies on UPS and Service revenue in 2013. We are pleased with our year-over-year growth in these two categories.

For the full year 2012, our revenue increased by 1% to $76.3 million versus the same period in 2011. This growth was driven by a 34% increase in UPS sales and 11% increase in the Service business offset by a decrease in our MIS revenue. Please refer to the supplemental information and our press release for more details on our revenue split by product and geography.

Now continuing down the income statement, gross margin this quarter was 39.5% compared to 20.2% in the fourth quarter of last year driven by improved margins in both products and services. We also saw improvements in margins sequentially as the third quarter margins of 28.6% was negatively affected by the sale of third party UPS ancillary equipment during the quarter.

For the full, year margins improved to 32.4% from 23.7%. This margin improvement reflects our improved product mix and our focus on lean and continuous improvements in the manufacturing service organizations. Although, we continue to focus on these productivity improvements, we do not anticipate gross margins will continue to improve at the same rate as they did in 2012 due to anticipated geographic and product mix components of our 2013 growth plan.

Total operating expenses were $6.3 million for the quarter, down $100,000 sequentially and $700,000 versus the prior year quarter. This year-over-year decrease was primarily due to lower payroll and benefits resulting from the restructuring initiative taken at the beginning of the third quarter of 2012.

For the full year, operating expenses increased to $26.4 million from $24.8 million in 2011. This increase was driven by higher research and development expenses from investments in our next-generation UPS products line introduced in the fourth quarter and higher G&A due to higher legal and professional services fees, bad debt expense and a fourth quarter impairment charge associated with R&D and demo equipment that is no longer in service.

Adjusted EBITDA was positive $487,000, for the fourth quarter of 2012 compared to negative $101,000 in the third quarter of 2012 and negative $2.4 million in the fourth quarter of 2011. For the year, adjusted EBITDA was positive $1.3 million compared to negative $3.8 million last year. We are very pleased with our growth in adjusted EBITDA which is reflective of the operating improvements we are making across the business. The press release contains details on how we calculate adjusted EBITDA.

Net loss for the fourth quarter of 2012 was $418,000 or $0.02 per share. This compares to a net loss of $847,000 or $0.04 per share in the prior quarter and a net loss of $3.3 million or $0.21 per share in the fourth quarter of 2011. For the full year 2012, net loss of $1.9 million or $0.10 per share which is a $5.2 million improvement from the net loss of $7.1 million or $0.44 per share in 2011. Our prior earnings per share results have been restated to reflect the five-for-one reverse split that we successfully completed in 2012 or in December. The company is now fully compliant with all NASDAQ trading requirements.

Now turning to the balance sheet, changes since the prior quarter were heavily influenced by the timing, shipment and value of our customer orders and the associated supply chain cash flow. This is typical for our business. Looking at the fourth quarter of 2012 compared to the third quarter of 2012, free cash flow was negative $1.6 million compared to negative $700,000 in the third quarter. This change was driven primarily by a $1.7 million increase in inventory due to the timing of the previously discussed revenue item that shifted from the fourth quarter of 2012 for which we anticipate revenue recognition in the first quarter of 2013.

The change was also due to $900,000 decrease in the deferred revenue balance from lower milestone payments related to the MIS business. These were partially offset by an accrued expense increase of $1.1 million due to payroll inventory and higher amounts of items paid out annually and a $900,000 decrease in prepaid expenses.

For the year, free cash flow was negative $7.8 million, a $1.3 million improvement over 2011 due primarily to lower capital expenditures. This completes the financial portion of our presentation. I would like to now turn the call back over to Doug.

Doug Milner

Thanks Steve. Active Power serves one of the largest and fastest growing markets in the world in part driven by the creation, storage and movement of data across the internet. The base of internet users is climbing and is estimated at 2.4 billion in 2012 and expected to grow nearly 50% to 3.6 billion by 2017 according to internetworldstats.com. Moreover, global datacenter IP traffic is forecasted to increase a 154% from 2012 to 2016 according to our recent report from Cisco Systems.

The engine behind all of this is the datacenter which is constantly evolving to support the growth in data management communication. This growth directly affects power and space requirements. Power requirements increased 63% from 2011 to 2012 and are expected to increase again in 2013.

Demand for datacenter floor space also grew more than 8% in 2012 and shows a sharper rise of more than 19% in 2013 according to datacenter dynamics 2012 global census. Based on feedback from our customers, a common theme is the need for sustainable critical power infrastructure equipment that can support their datacenter not only for today but also for future growth. This includes UPS and modular integrated solutions designed for rapid deployment, optimized costs and that supports the intelligent use of capital.

Customers want these solutions wrapped in powerful monitoring and analytics tools that enable them to make smart informed decisions in support of their availability, efficiency and sustainability goals. To fully capitalize on these trends and customer needs, our priorities for 2013 are aimed at three key areas of the business. Product line expansion, service growth and geographic focus.

First, we will accelerate growth in our core EPS and PowerHouse product lines as we begin shipping our CleanSource, high density, 625 and 750kVA UPS products and introduce our more cost and space efficient PowerHouse solutions. Shipments of our CSHD UPS systems to Europe and Asia are anticipated to begin in the second quarter with shipments to North America following in the third quarter. Our CSHD platform has already generated a tremendous amount of interest globally, a clear signal that the inherent benefits of the product resonate with our customers.

Secondly, we will grow our global services organization with a long-term goal of making this business at least 25% of our total sales. As I mentioned on our last call, service is a critical element to the future success of the business. This is true not only from a profitability perspective but service also creates closer client relationships and enables us to be an integral part of our clients’ successful deployments.

Third, we plan to expand our presence in geographies where there are prospects for rapid growth and demand for our products. For example, we deployed our UPS systems at some of the largest and most forward thinking datacenters in China, including one of the largest co-locations facilities which we announced in 2012.

And as I mentioned earlier, we received the first purchase order for our new UPS platform in China. We view China as a strategic part of our growth going forward and we will continue to invest in our on the ground personnel and key distribution partnerships in that region.

In support of these initiatives, we continue to refocus the mix of our operating expense to drive higher top line growth enabled by expansion in our product engineering efforts. To put numbers to this, we anticipate growing our R&D and product engineering investments more than 20% this year versus 2012. We anticipate our expanded pipeline of new product developments will uniquely address our customer’s needs and further expand our competitive advantage based upon the combination of power density, reliability and total cost of ownership that is unmatched in the industry.

Now, turning to first quarter expectations. For our guidance and to reiterate Steve’s earlier comment, we provide a range of expected revenue as many of our customer projects are large in dollar value and as such, changes in customer needs and unforeseen customer events can affect the timing and amount of revenue recognized for a particular quarter.

Based on this and coupled with a seasonally lower first quarter due to the basic seasonality in our business, we are providing revenue guidance of $18 million to $21 million for the first quarter of 2013. First quarter earnings per share is expected to range between breakeven and $0.03 per share.

Now with that, we would be happy to open up the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jeff Osborne [Stifel Nicolaus]. Your line is now live.

Jeff Osborne - Stifel Nicolaus

I just had a question on the delay in revenue recognition I noticed the inventory was up about $1.7 million that you called out, is that the entire scope of the project delay or is there portions that have been deployed that are hidden somewhere else on the balance sheet?

Steve Fife

That Jeff, this is Steve, that’s the bulk of it.

Jeff Osborne - Stifel Nicolaus

Got you. And just a couple other questions here on the gross margin trajectory I got the message there about the improvement in ‘13, now that it is pronounced as 2012, which is understandable but how do we think about kind of the cadence of gross margins through the year, truly you got some products ramping up, is there any kind of tiding issues and tiding paying on the manufacturing side that we should about with a down tick there potentially higher warranty reserves on new products that your auditors are making you incurred?

Doug Milner

No, this is Doug. I think the best way to think about that is, we are introducing that product. We are beginning shipments of that product shortly and yes, there are some tiding pains. I think overall our expectations are that our gross margins will be impacted by expanding our sales in China, and also to some extend by the fact that we are introducing a new product and we have got some cost optimization to do on that product and those efforts are all under, we know well under way right now.

We also gain ground on our goal to improve gross margins pretty quickly and so our focus this year is to really consolidate those gains, make improvements where we can and manage our mix of geographic expansion, new product introduction, and also the change in mix in our MIS line to make sure that we protect the gains, that we have made in gross margins.

And then I think you also see as I have said this quarter and last quarter, services are critical element and that will contribute to productivity improvements as well at the gross margin level. And so there's a lot of balls in the air when it comes to managing mix and margin. You touched on some valid ones, but overall we expect to hold the line or drive some modest improvements.

Jeff Osborne - Stifel Nicolaus

And on the OpEx I heard the 20% increase in R&D which is completely understandable. Given the restructuring that you folks had in the third quarter, should we assume something less than revenue growth for sales and marketing expenditure increases or do you have any type of new initiatives in that area for 2013 in terms of growing that type of line.

Doug Milner

I think generally speaking our expectations are that overall OpEx are going to be flat to slightly up over 2012, which would then say that we are making investments in R&D and we are offsetting those for changes elsewhere. Our focus in sales and marketing is recall that we've made over the past 18 months a significant investment in sales and marketing and our efforts have been to improve the productivity of the people in the field rather than just add more.

So I think we went through the period of time where we turned over the sales organization, we made a significant investment, we are signing up distribution partners, internationally and domestically, and its really just the work and the time to make that investment more productive and specifically those people more productive and so that's how I'd set your expectations for OpEx.

Jeff Osborne - Stifel Nicolaus

Just a couple of other quick ones here for Steve on the CapEx, what was that for the quarter and what are your anticipations for 2013?

Steve Fife

CapEx for the quarter was actually fairly low, it was less than $100,000. For ’13 and that brings us to about $1 million in total for the year. For the ’13 we expect that will increase largely around the continued investment in new products.

Jeff Osborne - Stifel Nicolaus

Two to three sound reasonable or just trying to get a sense of cash usage.

Steve Fife

Pardon me.

Jeff Osborne - Stifel Nicolaus

$2 million to $3 million sound reasonable for the year or what…

Steve Fife

It will be less than $2 million.

Jeff Osborne - Stifel Nicolaus

I know you folks don't break out backlog and book-to-bill and useful measures like that. But just as we think about the seasonal weakness in Q1 and then you have a plethora of new products coming out, and I'm assuming that you’ll kind of be as you look at your plan backend loaded, but do we think about order starting to build in kind of 2Q for delivery in the third quarter with these new products or do we think about Q1 even though budgets are being set and it’s a seasonally weak quarter from a revenue perspective would you expect book-to-bill hypothetically to be above one in that quarter. I'm just trying to get a sense of your direct and indirect sales partners and how quickly they can push these new products into the channel.

Doug Milner

We expect backlog to begin building in Q1. In fact we've seen backlog begin building in Q1 for delivery in Q2 and beyond. It includes our new products, but it’s also our new UPS platform but also for our powerhouse products which we have as you recall the MIS segment a year ago was very heavily tilted towards the IT rack space that we were building for others and we've been working very hard over the course of 2012 and as we go in to 2013, to really migrate that to products that contain much more of Active Power’s technology and products and so we've seen backlog begin building on both the UPS side and on the PowerHouse side and expect to build through Q1 and Q2.

Jeff Osborne - Stifel Nicolaus

And just two real quick ones here on the PowerHouse redesign, can you quantify the reduction in selling price that you expect to hit the market with that later this year?

Doug Milner

Yes. We anticipate that will be right around 15% lower average selling price than what we have configured in the past.

Jeff Osborne - Stifel Nicolaus

Great and if I heard you right, on the ancillary product revenue, there was no ancillary revenue at all in the fourth quarter, and given your backlog you don’t expect that to continue at least in the first half of the year, is that fair?

Doug Milner

I don't know that I can really predict that into that level of detail in the first half, but we certainly did not have it to the extent we did in Q3 and in Q4.

Steve Fife

It was pretty nominal.

Doug Milner

Yeah, it was pretty nominal. We’ll always have some, but Q3 was different from other quarters.

Operator

Our next question comes from Carter Driscoll [Capstone Investments]. Mr. Driscoll, your line is now live.

Carter Driscoll - Capstone Investments

Doug, maybe talk to the go-to market strategy. Obviously, moving beyond, US and traditional Europe and particularly China, are going to be selling and using a direct presence or using a channel partners. Can you talk about that and maybe some other non-traditional geographies that you are targeting beyond China?

Doug Milner

Sure our intent and we have been working for some time now really setting up an intelligent distribution system in China. We will use a distribution partner, we intend to use a distribution partner that will be our primary fulfillment channel for not just China but I would say Asia generally. And then that partner will work with our direct technical sales support people to develop opportunities and close them and they have been doing that for the past several months that in part is one of the reasons we have been successful finding or landing our first order for our new CSHD system in China. So it will be a distribution of fulfillment partner in China that we are having a network of resellers as resellers will be supported by our technical people on the ground. And I believe it’s going to prove out to be a very efficient system.

Carter Driscoll - Capstone Investments

Thank you. Traditionally you have talked about 10% customers can you just give us what may be Caterpillar and or HP were in the quarter, I am assuming that HP was minimal?

Doug Milner

I don’t know what they were in the quarter actually (inaudible) Steve?

Steve Fife

Yeah I can’t seem to put my hand on it right now.

Doug Milner

While he is searching.

Carter Driscoll - Capstone Investments

My next question really just if you could take a step back and look at with the introduction of the new UPS platform maybe where you stand vis-à-vis a competitors and how much more differentiation this delivers to your organization. It’s such a obviously a key new product for you, as you start to build other products, rebuild the PowerHouse line, but just kind of frame out where you see you closer competitors and people you should be keeping an eye on?

Doug Milner

Well, I mean for the first time, we will be selling our solution at what we anticipate to be price priority in the market and that has not been the case in the past. Our flywheel-based systems have been sold significant initial purchase price premium and then justified based on their efficiency and reliability and cost of ownership overtime.

With this product we anticipate being initial purchase price parity, but still delivering all those benefits and reliability, efficiency and cost of ownership which we think will make a very attractive in the market. And as I mentioned in the remarks, we have got significant interest in this platform and globally based on that. And then the added feature that if the customer decide to some point in the future or even at the time that they installed the product, they can use batteries for extended runtime.

We expect that take rate on that feature to be reasonably low, but I think we have a whole new competitor position here. We have price parity; we’ve have got incredible power density; low cost of ownership over the long haul based on the economics that have always driven flywheel-based decisions and superior reliability. So our competitive position I think is greatly enhanced with the introduction of this product.

Carter Driscoll - Capstone Investments

And maybe just a couple of quick questions maybe a little off the beaten path. Was there any effect from Hurricane Sandy in terms of new sales leads or interest in your products based on what the Hurricane did to northeastern in particular.

Doug Milner

I'll tell you what we did get was some pretty high profile accolades for how well the product performed during Sandy. I can't point to the fact that we had a big surge in demand right afterwards, but I think what happened was we certainly did get some enhanced visibility and probably some sales leads in the field based on how our products performed.

Operator

This concludes our question-and-answer session. I would now like to turn the call over back to Mr. Milner.

Doug Milner

Well, thank you for being on our call this afternoon. On behalf of the entire senior management team, our employees and our Board, I would like to express our appreciation for your interest in Active Power. Thanks for your continued support and look forward to speaking with you again next quarter.

Operator

Before we end today's call, I would like to take a moment to read the company's Safe Harbor statement. On this call the companies management will make forward-looking statements that involve risks and uncertainties including statements relating to Active Power’s current expectations of operating results for the first quarter of 2013, its future operating results and its customers intention, our focus in 2013 that are part of benefits and operating platform will significantly improve our competitive position in 2013, our revenue and earnings per share guidance of or the first quarter of 2013 and our expected changes in cash and investment.

Any forward-looking statements and all other statements that are made on this call that are not historical facts are subject to a number of risks and uncertainties and actual results may differ materially.

Factors that could cause the actual results to differ materially from the results predicted include among others our dependence on our relationships with Hewlett-Packard and Caterpillar and our distributors, our increased emphasis on larger and more complex systems solutions, the success of our product development, efforts and our ability to manufacture and deliver products in a timely manner, the level of acceptance of our current and future products in the market that [defer] our cancellation of those commitments as a result of general economic conditions or uncertainties. Risks related to our internal operations and product performance and quality issues.

For more information on the risk factors that could cause actual results to differ from these forward-looking statements, please refer to Active Power’s filings with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2011, its quarterly report on Form 10-Q and its current reports on Form 8-K filed since then.

Active Power assumes no obligation to update any forward-looking statements or information, which are in effect as of their respective dates. That concludes today’s conference. Thank you for your participation. You may now disconnect.

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