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Energy tech companies have a business model that's closer to Apple Inc. than Apache Corp. In other words, it's all about the new product. The products Dominick & Dominick Analyst James McIlree is excited about offer major benefits like improved geological mapping for oil and gas explorers, or electric grid safety for energy utilities. In an interview with The Energy Report, McIlree talks about his favorite companies in the energy tech space and how understanding product cycles can help investors time their buys.

The Energy Report: Your investment firm, Dominick & Dominick, keeps a sharp eye out for companies that back up electrical grid operations. Are the ongoing battles over President Obama's proposed budget likely to impact small companies in this space?

James McIlree: We focus on companies with new products that have the ability to grow even in a sluggish economic environment. Companies that are looking for federal subsidies, or that rely upon the U.S. government as a customer, should re-think those business plans. Although the overall shape of economy is important, the product cycles of the companies we invest in are much more important to determining their success than the macro-economic scene.

TER: What are product cycles and why do you focus on them?

JM: In the technology markets, product cycles are the most important determinant of success. Companies with strong, new product cycles are successful; those without it are not. Look at a company like Apple Inc. (AAPL). When Apple introduced the iPhone, then the iPad, then the iPad Mini and then the next version of the iPhone, those product cycles drove extremely rapid revenue and earnings growth. Without a new product, Apple's stock falls.

Here are concrete examples of product cycles with energy technology companies that I follow:

Active Power (ACPW) has just introduced a new flywheel that is used for backing up power, primarily in data centers. It is bigger than the firm's previous flywheel, and it's cheaper on a per-unit of power backed up than the previous device. Because of its greater size, it can target a bigger market with a new product cycle.

Hydrogenics Corp. (HYGS) makes utility-scale electrolysers that convert excess electricity into hydrogen. The gas can be stored and used to recreate electricity in place, or transported as a gas to a different part of the grid and re-electrified.

In each case, the new products address an existing need, have a clear return on investment for customers and can have a significant impact on the company's revenue, earnings and cash flow growth.

TER: How does Active Power's product work?

JM: If, for some reason, there is a power outage, Active Power's interruptible power system kicks on and provides electricity until either power returns, or a diesel generator plugs the energy hole. Active Power's UPS [uninterruptible power system] is based on flywheel technology. The UPS is green because it stores energy snatched from the grid itself. And when the grid goes down, it does not fire up a gas or oil-powered generator. Instead, it delivers previously stored energy to the data center until, again, a more permanent fix appears. It's a short-term solution, but it's not a fossil fuel-based solution. This is important, because a smart phone stores applications that seek data in the internet cloud. The telecom companies want the data centers to be physically close to where you are, because that reduces the amount of time it takes to transmit data to your phone. The data centers are very valuable assets that must be powered 24 hours a day.

TER: How does the flywheel work?

JM: Electricity generated by the grid spins the flywheel. When the electricity stops, the flywheel keeps spinning. The spinning motion creates electricity. It will stay on for nine to 10 seconds, which is generally the amount of time needed to fire up a backup generator. Most of grid outages are of very short duration. The flywheel itself is actually relatively small, but it is housed in a cabinet that is 6 feet tall, 3 feet wide and 3 feet deep.

TER: And this is deployed at the site of a factory that is connected to the grid? It is not designed to be inserted into a major node of the grid?

JM: Correct, it would be on an end-user's site, rather than at the electric utility's site.

TER: Let's take a deeper look at Hydrogenics, which is based in Toronto. What makes it attractive?

JM: It sells a device that makes hydrogen gas from water using electricity. Hydrogen is used in a variety of industrial applications. In North America, it's usually provided by Air Products and Chemicals Inc., or Linde Industrial Gases, or Air Liquide. In international markets where there is not a robust distribution network for industrial gases, Hydrogenics markets a fuel cell that produces hydrogen onsite for use in industrial processes. Simply put: the device splits a water molecule [H2O] into its component atoms: hydrogen and oxygen.

TER: By heating?

JM: No, it's an electrolysis-based solution. The electricity separates the hydrogen and the oxygen molecules. This is not about boiling the water, because all that does is create steam, where the H2O is still combined, but in a different form. In the electrolysis process, the oxygen and the hydrogen atoms are split apart from each other. It's very old technology. It's been around for 100 years. Hydrogenics has worked very hard to commercialize it. In large-scale applications, the hydrogen gas can be inserted into a natural gas pipeline and transformed back into electricity many miles away.

This utility-scale electrolyser for the "power-to-gas" application is the real key for the company's success. A utility that generates a lot of electricity from wind, solar or hydro-electricity often has a timing problem. What happens when the wind is blowing, the sun is shining, and the hydro is going, but there is not enough consumer demand to use the electricity at the time of generation? This is a problem in many countries that have mandated renewable sources of energy, such as Germany. It's a problem in Canada. It's a problem in California. It's going to be a problem in a lot of states across the U.S. where renewable fuel standards have mandated that between 20-30% of electricity be generated from wind, solar or hydro. What do you do with the excess electricity? Hydrogenics has a solution.

TER: That's quite interesting. Thanks.

JM: Thank you.

This interview was conducted by Peter Byrne of The Energy Report.

James McIlree has 25 years of experience in the investment business as a sell-side research analyst and buy-side analyst and portfolio manager. He focuses on emerging growth companies in the technology, telecom, energy and defense electronics markets. Prior to joining Dominick & Dominick in October of 2011, Mr. McIlree was a Managing Director and research analyst at Merriman Capital covering firms at the intersection of satellite communications and defense electronics. Prior to Merriman Capital, McIlree was with Collins Stewart and its predecessor firm, C. E. Unterberg, Towbin, where he covered the defense electronics/communications sector and was Director of Research. McIlree holds a Bachelor of Arts in economics from the University of Chicago and a Master of Business Administration from the University of Colorado. He is a CFA charterholder.

DISCLOSURE:

1) Peter Byrne conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.

2) The following companies mentioned in the interview are sponsors of The Energy Report: None. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.

3) James McIlree: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Dominick & Dominick LLC expects to receive or intends to seek compensation for investment banking activities from Active Power Inc., Hydrogenics Corp. and ORBCOMM Inc. in the next three months. Dominick & Dominick LLC has received compensation for investment banking services from Hydrogenics Corp. in the last 12 months. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.

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I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Source: James McIlree: These Companies Could Transform Power Production