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Active Power, Inc. (NASDAQ:ACPW)

Q2 2013 Earnings Call

July 30, 2013 4:30 PM ET

Executives

Ake Almgren – Chairman

Steve Fife – CFO and VP, Finance

Analysts

Carter Driscoll – Ascendiant Capital Markets

JinMing Liu – Ardour Capital Investments

Jeff Osborne – Stifel, Nicolaus & Co

Jim McIlree – Dominick & Dominick

James McIlree – Dominick & Dominick

Operator

Good afternoon, everyone. Thank you for participating in today’s conference call to discuss Active Power’s Financial Results for the Second Quarter ended June 30, 2013. With us today is Dr. Ake Almgren, Chairman of Active Power and Steve Fife, Chief Financial Officer 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 like to remind everyone 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 company’s Chairman Dr. Ake Almgren. Please go ahead.

Ake Almgren

Good afternoon everyone, and thank you for joining us today. We issued a press release earlier today announcing our results for the second quarter of 2013.

In the second quarter sales of MIS compromised the majority of our revenue topping $12 million or 62% of total revenue due to strong demand for both our modular IT and modular power solutions. Driven in part by increased MIS revenue, our service revenue was also up substantially increasing from $1.8 million to $4.8 million from the first quarter of 2013. This is an important metric since our global professional services group is a critical element of our growth strategy and service will continue to play a key role in helping drive our top-line growth and improve our gross margin.

I like our CFO Steve Fife to take a few more of the financial details about the quarter but first I like to talk about our recent announced transition to a new President and CEO. As we previously announced our President and CEO Doug Milner tendered his resignation to our Board of Directors to pursue a new opportunities. As Active Power’s Chairman I will succeed Doug on an interim basis until we identify an appointment of new President and CEO. Well we are disappointed to see Doug go, he has left the business in a much healthier position and one which believe will attract the strong successive to take us to a next level of growth. I can say as a member of Active Power’s Board for more than nine years and its Chairman since December of last year, I believe Active Power has never been on a more solid footing operationally and in a better position to compete in the marketplace.

Over the last 15 months we have reduced our fixed cost structure and repositioned our operating expense investments to fund the discrete product and service development activities. This combined with our focus on variable cost productivity on gross margins has improved the breakeven point for the company positioning us for improved profitability as we grow the business. We are pleased that our operating activities have generated positive net income adjusted EBITDA and cash flow through the first half of the year. As we exit the first half, we believe we have established our product development pipelines at they’re start coming to creation in the second half of the year.

Now I’d like to turn the call over to Steve to give us financial details about the quarter. I’ll come back to provide an update on our new CSHD UPS product progress in our growth strategy and some perspective on the market. Steve?

Steve Fife

Thank you Ake and good afternoon everyone. Thanks for joining us today. Our revenue totaled $21.2 million in the second quarter of 2013 which was an increase of 9% sequentially and a decrease of 7% from the prior year quarter. The sequential increase came primarily from our MIS revenue which grew $5.8 million due to strong demand in both modular IT and modular power infrastructure solutions. UPS revenue declined sequentially to $2.8 million dollars due in part to the inherent variability in our business. As we’ve discussed this variability continues to – contributes to quarterly fluctuations in revenue mix and is caused by a number of factors including changes to customer deployment schedules which impact the timing and shipment of our orders.

For the third quarter of 2013 we expect UPS to be a stronger portion of our overall revenue mix. Service revenue increased $1.8 million sequentially in part due to services related to the MIS revenue in the second quarter. As compared to the year ago quarter UPS revenue decreased $6.7 million well MIS revenue increased $4.6 million and service revenue increased by $632,000. It’s worth noting UPS revenue in the second quarter of 2012 was impacted by a large single UPS shipment to Europe. Now continuing down the income statement. Gross margin this quarter was 34.3% compared to 35.9% in the second quarter of last year. We experienced higher gross margins across both products and services but the shift in the revenue mix out of higher margin UPS sales to lower margin MIS sales drove the decrease in margin at a total level year-over-year.

We saw a substantial improvement in margin sequentially as higher margins in both products and services offset the impact of the shift in revenue mix. The sequential improvement in margins in UPS was due to lower sales in the second quarter through multi-tier distribution compared to the first quarter of 2013. Total operating expenses were $6.4 million for the quarter up $710,000 sequentially but down $857,000 versus the same quarter last year. The increase from the first quarter of 2013 was due to investments in R&D sovereign expenses and relocation costs. First quarter 2013 expenses also decreased due to the cancellation of stock options granted to former employees.

Second quarter 2013 expenses included benefits resulting from restructuring initiatives taken at the beginning of the third quarter of 2012 partially offset by investments in R&D related to our next generation UPS product line. Additionally, last year second quarter G&A expenses were impacted by CEO transition cost and higher bonus expenses. Net income for the second quarter of 2013 was $332,000 or $0.02 per share. This compares to a net loss of $273,000 or $0.01 per share in the prior quarter and net income of $490,000 or $0.03 per share in the second quarter of 2012.

Adjusted EBITDA was $1.1 million in the second quarter of 2013 compared to a $191,000 in the first quarter of 2013 and $1.4 million in the second quarter of 2012. The sequential quarterly increase was primarily due to increase in earnings that was also due to higher depreciation and stock-based compensation. The decrease in adjusted EBITDA from the year ago quarter was due to lower net income and lower depreciation expense from the second quarter of 2013. We continue to be pleased with our ability to deliver positive adjusted EBITDA which is reflective of the operating improvements we are making across the business. Our press release contains details of how we calculate adjusted EBITDA.

Now turning to the balance sheet. Operating cash flow was negative $197,000 compared to positive $1.7 million in the first quarter of 2013. This change was driven primarily by a $1.7 million increase in receivables as well as the $2.9 million increase in inventory related to our new product and the timing of orders of existing products. These increases were partially offset by a $2.7 million increase in payables. Year-over-year second quarter operating cash flow improved by $2.5 million from last year’s second quarter results of negative $2.7 million. For the first six months operating cash flow was positive $1.5 million compared to negative $4.6 million in the first six months of 2012. Capital expenditures were $508,000 in the quarter compared to $231,000 in the first quarter.

This completes the financial portion of our presentation. I’d now like to turn the call back over to Ake.

Ake Almgren

Thank you Steve. As we begin the second half of the year we remain focused on the key elements of our growth strategy, the strategy which we have shared with you since the beginning of the year. This strategy is one the Board and the executive team are permitted to and I would provide leadership to the executive team to further develop and execute this plan. The four key element of this strategy include, expanding our pipeline of new products supported by increasing research and development investments by at least 10% compared to 2012. Growing our global services organization with the goal of making service revenue at least 25% of total sales for 2015. Targeting our investment in geographies with the best growth prospect and finally driving efficiency of productivity through our lean and continuous improvements through programs.

In the second quarter we hired a General Manager for Asia Pacific region who is based in our Beijing office. This seem to be we have extensive experience in growing new sales and manages towards businesses of sales organizations in China and other countries in the region. We also expect to begin shipping our CSHD 625 and 750 kVA products later this quarter as we complete final system testing and secure them regulatory certifications. Shipments are expected to first begin to Asia and Europe follow soon after by shipments to North America. We continue to believe the level of interest we have gone today for CSHD worldwide is an indication of just how relevant and timely this UPS product is for today’s data centers. As an engineer by trade and having served in leadership roles for number of electrical equipment in new and latest technology companies I am familiar with what it takes to develop these type of products from concept to commercial introduction.

I have met with engineering team on a number of occasions recently to better understand the progress we’re making on this front and I am confident on where we stand here. After the introduction of the fourth versions of the CSHD we will continue to expand the CSHD platform and further we will develop an additional product platforms which we believe will uniquely meet our customers’ needs and augment our competitive advantage based upon the combination of our power reliability and total cost of ownership.

And now a few comments about the market. A recent survey conducted by UBM Tech and InformationWeek Marketing Services, there is some interesting attitudes among IT professionals involved in data center management and in our decision making of North American company. In this survey more than 100 such professionals were asked about their more significant technical challenges in their facilities. Half have responded as they indicated they struggle with reducing complexity and improving operational efficiencies. And now the 45% of those surveys that their biggest challenge was awarding costly power interruptions while others commonly sighted attaining energy efficiency goals.

These sort of challenges are common among data center owners and operators and mainly what we heard for example from two of our customers Datum and COMLINK two forward thinking data center providers as we begin to listen and began to – listen and better understand their design goals. The UK-based Datum was keen on deploying electrical infrastructure that was both resilient and energy efficient which combines COMLINK aim for achieving high operating efficiencies and system reliability while eliminating battery replacements and reducing associated maintenance cost. These two customers choose Active Power because of the inherent benefits of our products and solutions our density, reliability and total cost of ownership. We believe these are the reasons why customer selects our products. Active Power operates highly differentiated product and deliver tangible financial operating benefits and ultimately may provide customers competitive advantage.

So, now turning to third quarter expectation. Based on our current view of customer’s demands of schedules we are providing a revenue guidance of $15 million to $18 million for the third quarter of 2013. Third quarter earnings per share expected to be a loss between $0.04 and $0.09 per share. Changes in cash on investments in the third quarter expected to be minimum and driven by changes in working capital requirements. Based on our outlook for the remainder of the year we’re targeting sequential year-over-year revenue growth with positive adjusted EBITDA and breakeven to positive net income.

This outlook for the third quarter and full year is subject to a number of factors including those outside the company’s control such as customer changes to their deployment schedules which may cause actual revenues and earnings to differ from these expectations.

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

Question-and-Answer Session

Operator

(Operator Instructions). And our first question is going to be Carter Driscoll [Ascendiant Capital Markets]. Mr. Driscoll your line is live.

Carter Driscoll – Ascendiant Capital Markets

Thank you. Good afternoon. Yeah I was hoping we could drill little deeper into the guidance you just provided and kind of par some of the factors and it’s been outside of the push out in the fourth quarter last year this is one of the weakest quarters you guys given the revenue lines for couple of years now. And trying to figure out how much of this is potentially customers waiting on that next generation platform whether its specific customer deployments that maybe you could shed a little color on for those weakness in an particular region maybe this is relatively weak number as I said the last couple of years, any guidance or color if you can provide would be helpful.

Steve Fife

Yeah Carter this is Steve. So, I think the first thing is to know that we had a, we’re really pleased with the second quarter MIS revenue numbers and that came in very strong because of demand both for our IT product and for our PowerHouse product. And as you know and as we’ve stated both our business is lumpy and where we get and are subject to some relatively big orders that can cause this kind of fluctuation on a quarter-to-quarter basis. We’re – we fully expect our UPS revenue to come back in Q3 we’re not seeing right now, we don’t have visibility to, and really strengthen our service business as well in Q3. But right now we don’t have the visibility on the MIS segment of our business in the quarter.

I’d say geographically we continue to see a lot of strong interest in from all of the regions if anything – I think our China business is maybe a little bit slower than we anticipated it at this point in time but we still remain very optimistic about the market size and the opportunities throughout in that market. And we expect that the 750 we will be shipping that during the quarter, it’s going to come out a little bit later than we had anticipated and so that’s also having a little bit of an impact in the quarter from what we had previously anticipated. But are encouraged by all indications of where we’ll end up by for the year in total.

Carter Driscoll – Ascendiant Capital Markets

Okay. Can you speak all to the changes in some of the customer deployment challenge you mentioned any of this would have typically been your top OEM partners and IT partners or is that something throughout the customer base that you’re seeing?

Steve Fife

There is no one major delay in Q3 that we can point to right now for this there is a number of opportunities though that we’re in the process of, we have clear line up site too we’re looking to book here in the very short term that we fully anticipate being able to ship during Q4.

Carter Driscoll – Ascendiant Capital Markets

Is it fair to say that Q3 would be a near reversal of the product mix you experienced this quarter?

Steve Fife

I think that’s fair to say.

Carter Driscoll – Ascendiant Capital Markets

Okay. And what factors could potentially I mean you tend to have I guess a little bit shorter turnaround to deploy some of the modular solutions, is it possible that you could see a better quarter than you might be anticipating at the beginning of this quarter or is to the point we’re at now by the end of the next quarter or is it really, but it takes several weeks to get an indication of interest and then to actually deploy the order?

Steve Fife

Well, either I, again, I think it’s safe to say that our pipeline of opportunities when we and I know that we don’t disclose numbers externally but the pipeline of opportunities is our sale organization is actively working right now is frankly it’s greater than it’s ever been. And so we have a number of these things opportunities keyed up and it’s a matter of that we’re one piece in a big cargo of logistic implementations when it comes to the build-out of these large data center sites. And so our timing and our customer’s timing aren’t always aligned exactly but we remain encouraged with the opportunities that we’re looking at and again to some degree don’t have as much control over when that product get shipped is as we’d like to.

Carter Driscoll – Ascendiant Capital Markets

Okay. May be just shifting gears a little bit and direct this to your new interim CEO, Doug had a very specific plan about turning around organizationally and focused on driving EPS sales and streamline the organization with business cost structure and obviously you guys I think done a good job on two of the three, maybe you could just lay out his top priorities that we already seen his job at short time but what do you see next – this quarter, next quarter may be next year strategically what you like to accomplish before you hand the rings off to successor?

Ake Almgren

I mean I’m – I’d set them three priorities I mean the one priority is this year with succession I mean it’s definitely is our high priority, we want to make this interim period as short as possible. I mean the second is that the shape as the 750 I mean it’s been a huge product it’s taken little bit longer than we anticipated but we come to a point now where we are confident that we can start shipping and that’s the start because that’s a whole new platform so there are more products and the first products so that’s the main priority. And then the third priority as happiest our goal strategy and fine tune the strategy for the 2014 to 2016 timeframe including the product developments.

Carter Driscoll – Ascendiant Capital Markets

Appreciate it. I’ll step back in the queue. Thanks, gentlemen.

Operator

And our next question comes from JinMing Liu [Ardour Capital Investments]. Mr. Liu your line is live.

JinMing Liu – Ardour Capital Investments

Thank you for taking my question. First question just go back to your full year guidance, based on that it looks like you are expecting a very strong fourth quarter. How much visibility do you have into the sales into the second half, I mean especially the fourth quarter this year?

Steve Fife

Yes. As I said previously our pipeline and visibility of opportunities that our sales force is working on right now is frankly greater than it’s ever been. And so – and we are focusing on converting those opportunities to formal bookings. Right now we have visibility that would support where we think we’re going to end the quarter and so we’re confident about the numbers or the guidance that we’ve provided for the year.

JinMing Liu – Ardour Capital Investments

Okay, okay. For the second quarter numbers can you give us a breakout of sales by region?

Steve Fife

Yes, that’s actually included in the back of the press release.

JinMing Liu – Ardour Capital Investments

Okay.

Steve Fife

And so on the last page the Americas dominated this quarter it’s about 92%, 91% of our overall revenue came from the Americas. And then followed by, Asia was 3% and then Europe and the rest of the world was about 6%.

JinMing Liu – Ardour Capital Investments

Okay. Thanks a lot.

Operator

Our next question comes from Mr. Jeff Osborne (Stifel Nicolaus & Co). Mr. Osborne your line is live.

Jeff Osborne – Stifel, Nicolaus & Co

Everything has been pretty much as I just had a question for Ake in terms of the budgeting process for 2014. Is that something that you’re going to be doing towards year end or would you be delaying that until and you see those – assuming it takes a couple of months?

Ake Almgren

No, I think it’s part of the strategic planning, I mean they have say if we look for 2014, 2015, 2016 so at least at the high level then you could say part of the budgeting is down as part of the strategic process.

Jeff Osborne – Stifel, Nicolaus & Co

Got you. And then in terms of for Steve the OpEx run rate for the rest of the year should it be similar, did you hear Ake right that R&D will be up 10% for the year or was it 20, I had a hard time understanding it.

Steve Fife

It’s up over 20% for the year but we remain I think our original comments at the beginning of the year was that OpEx would be flat to down even though we’re increasing our R&D spend and we still expect that that’s going to be the case.

Jeff Osborne – Stifel, Nicolaus & Co

Okay. And then with the uptake in UPS next quarter, would that be with third party distributors or is that more direct, I’m just trying to think about directionally for pretty wide range in terms of EPS of what the gross margin impact is?

Steve Fife

Yes, it’s fairly balanced it’s I won’t say that our distribution is going to be dominated by any one of our channels.

Jeff Osborne – Stifel, Nicolaus & Co

Okay. And then last question, any comments with the new China partner and how the training there and synergies are ramping in terms of joint sales pitches and what that?

Steve Fife

Yes. Well, I guess first of all as Ake said we hired a new General Manager for our Asia business and he’s been in place for a few weeks now and I think it’s going to add tremendously to our over side and frankly closing opportunities that we’ve identified in China in particular but he’s met with a number of our key customers end customers as well as with our distributor partner that we entered into an – Digital China as we entered into an agreement with back in the end of Q1 and he’s working through those details but yet we do have Digital China has dedicated peoples we’re starting to set up formal trainings with them and with our team and there are joint calls that are taking place right now.

Jeff Osborne – Stifel, Nicolaus & Co

Great to hear. And the $2.5 million increase in inventory is it fair to say that, that was largely associated with the 750 in the delay there, are you just pre-making things and then as they get qualified or certified you’ll then start shipping those out to Asia and Europe later in the quarter?

Steve Fife

That’s right, I mean that’s a portion of that we also had we also built some 300 inventory as well just in part because of the demand that we see in Q3 for it.

Jeff Osborne – Stifel, Nicolaus & Co

Okay. I’m just trying to think would that the reconcile the revenue being down, cash being kind of flattish but then pretty sizeable at the midpoint of your range for 3Q if you hit this up for the year you would be doing kind of low 20s for the fourth quarter. At what point do you have to start building inventory for that kind of low 20s number assuming that’s the case for the fourth quarter.

Steve Fife

Well, hit during Q3 as well.

Jeff Osborne – Stifel, Nicolaus & Co

Okay. So your receivables will start coming in then to offset the inventory build or you’re going to that’s on a payables?

Steve Fife

No, that’s absolutely right we don’t – we don’t anticipate a big change in our working capital during the quarter.

Jeff Osborne – Stifel, Nicolaus & Co

Got you. Okay. Thank you.

Operator

And your next question comes from Jim McIlree [Dominick & Dominick]. Mr. McIlree your line is live.

Jim McIlree – Dominick & Dominick

Yes, thanks. Good afternoon. I think you mentioned in the prepared remarks an increase in R&D spending for the year is that offset by declines in other operating expense items?

Steve Fife

It is Jim, that’s – that was our stated objective at the beginning of the year we still expect that R&D is going to grow by over 20% and yet OpEx we anticipate is going to be still under our last year spend in total.

Jim McIlree – Dominick & Dominick

Okay. And as far as the guidance for Q3 goes are you looking for service revenue to come down quarter to quarter?

Steve Fife

No, I think the service revenue will be roughly in line with where it was in Q2 that was that the increase in Q2 was driven by a lot of our MIS sales we provide a lot of quarter (inaudible) professional services associated with the installation of those units and we expect that, that’s going to continue into Q3 as some of those units were shipped late in the quarter.

Jim McIlree – Dominick & Dominick

And so, the sequential decline in revenues is associated with sequential decline in MIS, is that one customer fill this order in Q2 and is just not coming back in Q3 or is there a multiple customers or something else going on?

Steve Fife

No, that the Q2 numbers are it really consisted of two primary customers and again that was it was very high for us recently in terms of our overall MIS revenue and we just don’t see them or other customers ordering at the same level in Q3.

James McIlree – Dominick & Dominick

Thanks. And then lastly I know you continue to express confidence in the 750 it seems you’ve gotten pushed again at least from the last time you had a conference call. Is there something on the engineering side is it on the marketing side is it the market side what’s and I know it’s common for these things get pushed a little bit I’m just trying to understand again why the push is there.

Ake Almgren

Well, I think it’s fair to say to take a big picture it’s been very extensive development and then as it goes I mean there have been challenges but they have been done we’ve now gone to the final details about the final test and then and also without documentation these kind of things but on the technical side and then I’m very, very confident in the products and I think it’s also (inaudible) I point out I think it’s been it’s more test and developed than we ever were with seen so you end up when that came out so it’s a major change. I don’t think it’s just been a major undertaking and so then we reasonably for now to be able to stop sweeping the first units.

James McIlree – Dominick & Dominick

Okay. Fair enough. It seems like it would be reasonable to say that it has a modest contribution for 2013 results and then real impact that it will have it would be in 2014.

Ake Almgren

Yes, that’s correct I mean it’s an as we said the impact in 2013 financially would be in small in terms of the revenue but this is a platform which will grow and I think it would be a significant impact in the 2014.

James McIlree – Dominick & Dominick

Very good, thanks a lot. Good luck.

Steve Fife

All right. Thanks Jim.

Operator

This concludes our question and answer session. I will now like to turn the call back over to Dr. Almgren.

Ake Almgren

Yeah, 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 continuous support and look forward to speaking with you again in 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 company’s management made forward-looking statements that involve risks and uncertainties including statements relating to our product release and development plans, our strategy our market position our revenue and earnings per share guidance for the third quarter of 02013. Our expected changes in cash and investments in the third quarter and our expected revenue adjusted EBITDA and net income for the full year.

Any forward-looking statements and all other statements 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, Caterpillar, other original equipment manufacturers, OEM, other strategic IT partners, and on our distributors including Digital China Information Service Company. Our increased emphasis on larger and more complex system solutions the success of our product deployment 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 the deferral or cancellation of sales commitments as a result of general economic conditions or uncertainty risks related to our international 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 its annual report on Form 10-K for the year ended December 31, 2012, its quarterly reports on Form 10-Q, and its Current Reports on the 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.

This now conclude today’s call. Thank you for joining us. You may now disconnect.

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