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Active Power Inc. (NASDAQ:ACPW)

Q3 2009 Earnings Call

October 23, 2009; 11:00 am ET

Executives

John Penver - Chief Financial Officer

Jim Clishem - President & Chief Executive officer

Analysts

Walter Nasdeo - Ardour Capital

Tushar Shah - Unidentified Company

Operator

Welcome to Active Power’s third quarter 2009 earnings conference call with your host John Penver, Chief Financial Officer; and Jim President and CEO. Today’s conference will begin with the presentation followed by a question-and-answer session. Instructions on that feature will follow later in the program.

I would now like to call over to Mr. Penver, please go ahead.

John Penver

Thank you. Good morning and welcome to Active Power’s third quarter 2009 conference call. I’m John Penver, Chief Financial Officer for Active Power. We issued a press release this morning announcing our third quarter 2009 results. If you do not have copy of this release it can be found on our website at www.activepower.com.

Jim Clishem, President and Chief Executive Officer of Active Power will lead today’s call. After Jim’s presentation I will briefly discuss financial details, after which point we will be happy to answer your questions during the question and answer session of the call.

Before we begin, let me remind everybody that any forward looking statements we may make are based on our current views and expectations. Although we believe our expectations and views are based on reasonable assumptions we can give no assurance they will be attained.

Factors and risks that could cause these to differ materially from expectation include but are not limited an inability to accurately predict revenue and budget for expenses for future periods, fluctuations in revenue and operating results, dependence on our relationship with Caterpillar, Hewlett-Packard and other Microsystems, inability to successfully manage and integrate new direct sales efforts or channel partners, competition, overall economic and market performance, and the other risk factors as set forth in our most recent SEC filings.

I will now hand it over to Jim.

Jim Clishem

Thanks John. Good morning everyone. I’ll first detail some of the business highlights from the quarter and then our current outlook for the remainder of 2009. After I conclude, John will detail our financial results. Looking at highlights revenue for the quarter was $8.5 million a 29% increase from the previous quarter, but a decrease of 31% from $12.4 million in the same period last year.

For the nine month period ended September 30, 2009 revenue decreased 2% to $26.3 million from the same period last year. Gross margin this quarter remained unchanged from the previous quarter at 22%. This compares to a gross profit margin of 9% in the third quarter of 2008.

Net loss was reduced to $3 million or $0.04 per share for the quarter compared to the net loss of $3.5 million or $0.06 per share in the previous quarter and a net less of $4.1 million or $0.07 per share in the same period a year ago. Cash and investments totaled $8 million as of September 30 compared to $11.7 million at June 30, 2009.

The decrease of $3.7 million from the prior quarter includes $1.4 million of increased inventory levels to support future customer orders. We shipped 56 flywheels to 21 countries this quarter. This resulted in revenues from the Americas of 40% and international revenues of 60%.

Service and other revenues increased 12% compared to the second quarter of 2009. We are pleased with our revenue improvement this quarter and remain cautiously optimistic. As we conveyed during our earnings call last quarter customers have been slow to commit to capital spending due to a tight credit market and the overall global economic climate.

However we’re now beginning to see customers secure funding and dedicating it to investments in power and infrastructure projects, which is obviously a very positive sign. We do see positive trending for Active Power in the market overall and I’d like to highlight some of these items now and take a look at the business ahead.

Our sales pipeline continues to grow and in fact has grown 32% over recorded levels for the same period in 2008. In addition order of volume has increased we have received more than $15 million in new booking since July of 2009, which includes additional orders from our strategic IT partners from PowerHouse systems. Some of these orders will be shipped this quarter and others will be shipped in early 2010.

Our direct sales initiative also yielded positive results up 87% compared to the prior quarter with a higher mix of European sales. Our direct sales strategy and the solution sales inherent with it have enabled us to build and grow our service business along with it. Our service revenue in the third quarter of 2009 increased by 12% compared to the second quarter of 2009.

With respect to our OEM partner Caterpillar, it is unfortunate but Active Power revenue from cat was down this quarter about 63% from the previous quarter. Caterpillars overall business at the momentum is exhibiting some global challenges, but we remain encouraged for the road ahead for this key Active Power sales channel as the economy continues to improve.

That said and as a result of our multi channel sales strategy we set into motion a few years back to mitigate these types of risks. We continue to focus our efforts on the following. First diversifying our sales channel and geographic markets so, we can ride out markets or channel fluctuations without significant impact to our overall business.

Second, working with Caterpillar to support and enable their sales and marketing efforts globally and third, building upon our momentum with HP and Sun Microsystems to grow the PowerHouse business within the global IT marketplace. Our PowerHouse product designs to support any mission critical power application, integrates our high efficiency UPS, switch gear, generator and are monitoring software, all of that is resonated very well in the marketplace.

This product compliments to continue our datacenters offered by Sun, HP and others. The ability to Power and cool these datacenters is a challenge the operator must address. The Power and Cooling solution has to be just as capable and resilient as the mission critical IT equipment it protects.

PowerHouse delivers just that in a very modular portable package designed to support the datacenter. The interest opportunities and orders we are receiving for PowerHouse validates the performance and economic benefits of container as to approach versus Bricks and Mortar implementation.

We are growing our opportunity funnel via our direct sales efforts and in conjunction with our strategic IT partners HP and Sun. In late August we announced multiple PowerHouse orders totaling more than $500 million being generated through these partnerships. For the quarter our PowerHouse product revenues represented approximately 22% of total revenue.

Here is why PowerHouse has as a product is so significant to the company. For every $1 in UPS sales we can generate $4 to $5 packaging our UPS as a component of a complete PowerHouse solution. Our message to the market continues to highlight our key product differentiators.

Energy savings, space savings, reliability and green, I’m happy to announce our CleanSource UPS product is now listed as the only UPS on the carbon trust energy technology list after having met all energy savings criteria managed by the U.K. Government products listed on the energy technology list allow U.K. based businesses to benefit from a one hundred percent capital allowance against taxable profits for their critical power infrastructure projects that incorporate our high efficiency UPS.

This provides a substantial savings to customers are looking to deploy high efficiency infrastructure thus reducing their carbon footprint. In July we published our 14 whitepaper, high efficiency UPS for our power hungry world. The while paper compares energy efficiency differences among the two most common UPS topologies, double conversion which is used with conventional battery based UPS systems and line interactive which topology reuse in our flywheel UPS systems.

These differences were annualized in a third party lab setting at Lawrence Berkeley National Lab and actual fuel test to be of the Silicon Valley leadership group. The research concluded that flywheel based UPS technology achieve higher efficiencies as compared to double conversion, UPS with batteries across all load factors. This higher efficiency equates to substantial cost savings for the customer over the life of the system.

Because of the significance of this white paper we also teamed up with one of the largest IT media companies on the web to help us syndicate this paper along with our reliability white paper publish last year, to its massive qualified subscriber base. Since beginning the campaign in late July we generated tremendous interest and hundreds of leads to date.

The strong interest regarding with these two papers is a clear signal that energy efficiency and reliability are top of mind for datacenter operators and IT professional, particularly when it comes to Power infrastructure and Power consumption is becoming even more important due to high energy losses. In fact the percentage of IT manager who stated datacenter power consumption is a major concern increased from 48% to 55% in 2009 according to 920 IT managers polled by www.datacenter.com in a recent study.

As I think you are all aware Active Power manufactures the most energy and space efficient backup power solution available in the market today. Put simply, customers can significantly lower their utility bills by reducing energy losses. Our UPS products also protect more power and less space, freeing up revenue generating real estate for customers. None of this comes at the sacrifice of reliability.

Our UPS systems are inherently reliable with more than $68 million hours with run time in the field and have been proven to be seven times less likely to fail according to a study by risk assessment firm and technology inc. at a Boston and the fact that the UPS system is environmentally friendly positions Active Power is a more compelling choice to conventional technologies.

Now looking ahead, we’re beginning to see evidence that the market is slowly improving as an example Fortress International Group a large datacenter construction company just last week announced that the credit markets are opening up in the datacenter sector and it helped them secure a number of new contracts, because of relief in the credit markets and the overall economic improvement, we are excited to see increases in quoting and proposal activity resulting in new orders, not only for our high efficiency UPS before our PowerHouse solution as well.

We believe there will be a steady increase in PowerHouse orders now and throughout 2010, which will bring with it the challenge of needing additional financing to support the growth for our company. To put this in perspective we typically require deposits and interim progress payments from customers to meet this need. We are also now actively working with a number of key vendors and customers to provide trade credit or structured financing to enhance our financial flexibility to deliver PowerHouse orders.

To argument these activities we are also working to improve our existing bank credit arrangements domestically and aboard to provide additional funds and we are evaluating other options that include methane and funding or growth equity lenders to help support the growth of this highly differentiated product. Indication or that we will be able to secure sufficient capital to support the anticipated increase in PowerHouse sales. In addition to these financing options that we are exploring to fuel our growth, managing working capital continues to remain a priority. Our inventory levels increased more than anticipated this quarter as we plan for certain deliveries during the period.

However, with the volume of orders we’ve received to-date, I believe this will allow us to materially reduce these inventory levels by year end. We remain focused on increasing sales and margins to our proven execution strategy of building brands, expanding distribution, creating innovative solutions and reducing our costs. We will continue to improve the fundaments of our business and work diligently towards our next common goal, which is to achieve annual operating profitability.

Finally, as you may have noticed in the press release we issued yesterday, we announced the appointment of Dietmar Papenfort as Vice President of Sales for Europe, Middle East and Africa. This action highlights our intent to continue improving our international sales and marketing; Dietmar as Seasoned Executive with more than 20 years of UPS sales and service experience. We look forward him, hitting the ground running to lead our efforts in these regions to grow and develop our distribution channels, improve our service to our customers and increase our international market share.

I also want to express my sincere appreciation again from the support from our customers, partners, shareholders and employees as we prudently work to move this forward in a methodical and determined fashion. John will now discuss financial details from third quarter and provide a brief overview for our near term outlook. We’ll then move to the Q-and-A portion of our call. John

John Penver

Thank you, Jim. Our revenue for the third quarter was $8.5million, this was a decrease of 31% or $3.9 million compared to the third quarter of 2008, but was actually an increase of 29% or $1.9 million compared to the second quarter of 2009. For the nine months ending September 30, our revenue of $26.3 million was 2% lower than the same period of 2008, where we had $26.8 million in revenue.

The decrease in revenue from the prior year from primarily would be attributed to a decline in revenue from our OEM channel. Our sales at Caterpillar, decreased by $4.2 million or by 82% compared to the third quarter of 2008. This represented only 11% of our total revenue in the third quarter, compared to the second quarter of 2009, Caterpillar decreased by 1.6 million or by 63%. We’ve been able to off set this decline in our OEM business with substantial increase in our level of direct sales, which actually increased by 87% or $3.5 million during the third quarter compared to the second quarter of 2009.

During this quarter, we saw three PowerHouse Systems that generated $1.9 million or 22% of our total revenues. Our flywheel based UPS products represented 51% of revenue and this compares to 60% of revenue in second quarter of 2009 and 59% of our revenues in the third quarter of 2008. This quarter, we also had more ancillary revenue, which is revenue from the sale of third party equipment, such as generators and switch gear that we repackage and sell to our customers along with our UPS product.

We’re seeing a level of ancillary revenue fluctuate quite significantly on a quarterly basis as it’s tied just specific customer orders. However, it is fluctuated from $2 million in the fourth quarter last year to $150,000 in the first quarter of 2009, and now back up to $1.2 million in the third quarter of 2009. Our service revenue was 12% higher in this quarter than the second quarter of 2009, $1.6 million this was down from the third quarter last year due to a lower number of projects underway.

Our service revenues represented approximately 19% of our total revenue this quarter, which compared to 21% of our revenue in the second quarter of 2009. During the quarter, we shipped 56 flywheels at an average selling price of $78,000 per flywheel. This was a decrease of 40% in real volume compared to the third quarter last year and an increase of 2% compared to the second quarter of 2009.

In looking at the geographic mix, in a reversal from the prior quarter, our sales from EMEA, European, Middle East and Asia represented a majority of our revenues reflecting a large number of lot system orders in this during the period. Our international sales, was 60% of our revenues for the third quarter of 2009. This compared to 23% of our revenues in the second quarter this year and 56% in the third quarter of 2008.

The revenues from the Americas were 40% of revenues this quarter down from 77% of revenue from the prior quarter. On a year-to-date basis, which is say in year-over-year growth from 12% in North America, and 9% decline in Asia, and a decline of 22% in our EMEA business, highlighting the difficulties we had in the EMEA market this year. In a future CoolAir from each of the geographic regions will continue to fluctuate depending on the timing and size of orders received and dependent upon our success of winning large projects.

During the third quarter of position of total revenue sold through our direct channels was 88%, this compared to 61% in the second quarter and 57% in the second quarter of 2008. For the nine months ended September 30, revenues from Caterpillar represented 31% of total revenue, compared to 44% for the same period in 2008.

In absolute terms on a year-to-date basis, our revenue from Caterpillar has decreased by $3.6 million and this has been offset by 22% increase in our direct business, of which new PowerHouse revenues have contributed approximately one half of this increase. This high level of direct sales and I will have to maintain a gross margin at 22%, the same levels in the second quarter of 2009.

This compares favorably to the 9% margin we recorded in the third quarter of 2008, which also had included the effect of $1.5million charge for excess CoolAir inventories. We were able to maintain a margin despite lower production levels this quarter and then carrying a high of excess manufacturing costs, due to combination of better pricing and overall cost controls we have put in place.

Our research and development expenses for the quarter were $1.1 million, down 9% for the prior year, mainly due to lower headcount and remain steady for the prior quarter. Our selling and marketing expenses at $2.6million were 8% lower than the third quarter last year and were 3% lower than the second quarter of 2009. This decrease reflects lower compensation cost and low marketing spending as we attempted to control our spending in light of the sales slowdown over the last several quarters.

General and administrative expenses for the quarter at $1.2 million were 9% lower than the expense level in the 2008 and were 2% higher than the second quarter of 2009. This increase reflected higher professional fees, in connection with this stock option exchange program and registration of shares from a private placement of shares we made in the second quarter.

Our reported net loss for the quarter was $3 million or $0.04 a share. This was a 28% improvement from the $4.1 million net loss or $0.07 of share that we recorded in the third quarter of 2008 and was a 15% improvement from the $3.5 million net loss or $0.06 of share we had in the second quarter of 2009.

Our cash and investments in September 30 were $8 million. During the third quarter our cash consumption was higher than anticipated, due in part to further increase in $1.4 million of our inventory level. This was due partially to the falloff in OEM sales and our inability to decrease production quickly enough to compensate to these changes.

We do however, believe that the orders we have already received will allow us to decrease a majority of this additional inventory by the end of the year and convert it to receivables or cash. Absent this inventor, our cash and investments will decrease $2.3 million this quarter, which compares to the $2.4 million decrease in cash investments we had during the third quarter of 2008 and then it was 31% higher. The timing of new orders also impacted the level of customer deposits and interim payments received as reflected in our regulative third revenue. Our deferred revenue balance decreased by $.9 million compared to the second quarter of 2009.

As we increase the amount of sales from our PowerHouse product, this really has the potential to materially change the financial operating model for the company. Let me give you an example to highlight the difference this is cash to cash cycle between the sale of a UPS versus the sale of a PowerHouse system.

By this time, remain the time from when we procure raw materials to the time we actually collect cash from our customers. The cash to cash cycle of UPS sales can be as little as 45 days, but this can be as much as 210 days for a PowerHouse system. We typically try to mitigate the impact of this by requiring deposits and interim payments from our customers. Sometimes this is not commercially possible and this would then require us to invest more in working progress.

Inventory place a greater strain on our balance sheet. As Jim indicated, we’re working with our business partners, both vendors and customers to secure additional sources of credit and structured finance. We are also looking at modifying and improving our existing bank credit facilities and looking at some additional bank facilities as a way to provide greater financial flexibility and allow us to respond to a greater level of PowerHouse businesses.

Also evaluating various structure data arrangements and other alternatives as a possible way to secure the necessary funds to support a growth in this business should that needs material lays. Monitoring and controlling on working capital continues to be a highest priority to help us manage to growth and expansion their operation. We also scaled back our production levels in Q3 and in Q4 to better alignment with our order flow and we do expect to see this result and increase in our inventory level this quarter.

Based on our current plans and experience we have had with managing the balance sheet over the last 12 months we believe we have adequate cash investments on hand to continue funding the business through at least the middle of next year. As long as our current business expectations are realized we have more than enough cash resources and with our existing bank credit facilities and other credit resource to operate the business.

Our capital expenditures were not significant during this last quarter and we do not anticipate any major level of capital expenses in the remainder of 2009. Let me turn to the fourth quarter. Based on orders we already closed or expect to close shortly we do anticipate fourth quarter revenues to be between $12 million and $15 million, it should be an increase of between 41% and 76% from our third quarter level.

We provided this range because our recent history without timing so there is a risk transaction can slip the later quarter. We have seen substantial increase in orders during Q3 compared to Q2 and this pattern has continued since the beginning of Q4. Based on the projected sales mix and expected orders this would result in a gross profit margin between 26% and 33% and that current operating levels remain a net loss between $0.02 and $0.04 a share.

Now, achievement of these results will depend upon the realization of expected orders and the product and channel mix we anticipate. Operating expenses excluding variable selling expenses should be fairly consistent with the results we recorded during the third quarter. Cash requirements will therefore be largely driven by our working capital management.

We will continue to prudently manage the use of our banking facility, customer and vendor and cash flows as we have indicated to mitigate any unnecessary consumption. With regard to the listing of our stock, NASDAQ had announce in July and expiration of the temporary suspension the $1 minimum bid price rule that’s requires to continue listing of the stock on the NASDAQ market to take it that from August 3, 2009.

The impact of that change for Active Power was that this moves to time required for us to regain compliance with the minimum bid rule to December 2, 2009. Stock as recently being trading is up these $1 dollar minimum level it must maintain above $1 for at least 10 consecutive trading days gained compliance. Today we are not got gained compliance with the NASDAQ rule and we will continue to monitor the situation. Again we appreciate your continued support of Active Power. I will now be go to answer any questions that you may have.

Question-and-Answer Session

Operator

Your first question comes from Walter Nasdeo - Ardour Capital.

Walter Nasdeo - Ardour Capital

If you could just kind of walk me through some of the order that gives you such confidence and a pretty FD guidance range for the fourth quarter. You are talking about orders that you’ve taken and expected orders. How do you classify an expected orders and then maybe if you can go into a little on your sales cycle for me, I would appreciate it?

John Penver

We have announced a number of significant customer wins since August and so we do know a number of those that are going to shift this quarter and Jim will probably chip in after I’m done. On the expected orders, we have got indications from a number of companies, very late in the sales cycle of expected delivery times and start up times if they need the systems, that would give us a very high degree of confidence that there is an order within weeks.

We don’t actually announce every order that we win. We tend announce the more significant ones these days, but we’ve had since date of the beginning of this quarter quite a number of orders we’ve received and booked. We’ve managed the sales cycle fairly actively and so each week we have an update of orders that we expect to close over the next week or two and that’s really how we have to have some of that to plan production, so that we don’t get too out of sync we’ve had, but we’ve seen an up tick in the quoting activity, the pipeline and just the actual volume of orders received.

So we can reasonably be comfortable that we provide the bottom end of that range, I probably got secured already and booked and that’s how I can get that degree of comfort, but we provide some range because there’s couple other things that we anticipate that we should be shipping and receiving and shipping by the end of the year. I hope to that answers to your question.

Walter Nasdeo - Ardour Capital

A real briefly, if you could give me a little bit of better understanding of the sales cycle itself from acquiring your customers to the whole process actually book in the sale?

John Penver

I’ll throw it to Jim a little bit, because he little more intimate that than I.

Jim Clishem

Yes, Walter, the sales cycles because as we’ve indicated on previous recent quarter calls, they’ve been strange this past 12 months. Our degree of confidence has increased a great deal at the moment, but a typical sales cycle for a UPS sale could be anywhere from 30 to 60 day timeframe to as much as eight months to a year, that’s for UPS sale.

What we are seeing is that these continue its power solution sales, the PowerHouse sales. As John indicated in his sort of financial description of power changes the business model. The sale on those is really a function of the partners as well that you’re engaging and selling those systems.

So the Sun and HP’s of the world, the IT marketplace. They really do like these package solutions and we are seeing sales cycles again in a very similar fashion that can be turned around extremely quickly to as much as a year. I’d say the average though as you’re looking at is three to six months is a pretty good model to think at.

The PowerHouse sales in particular have another interesting dynamic to the business model. It’s important to sort of talk about that. In a UPS sale, as John indicated, you can convert inventory to cash in about a 45 day cycle. When you’re buying generator switch gear in addition to the UPS that were building there, it does tend to lessen out the delivery cycle and therefore the cash return cycle, but the order cycle is about the same as what we’re seeing on the UPS sales.

John Penver

Walter, this is John. I mean I had one additional comment in that through. Jim talked about some really long sales cycles on some customers. We have seen, I’d say probably in the last four or five months, some projects that we’ve worked on some lengthy time ago, back in 2008 where a lot of customers are now a little more comfortable and willing to reengage.

So we don’t have to go back through the entire sales process. People have evaluated the technology, made decisions to proceed utilizing Active Power products, but then either through lack of credit or general uncertainty about, where the world was going earlier this year. They didn’t make a lot of those decisions and lot things that are coming out of the pipeline. It actually ends up with the much shorter cycle than reengaging to our shipping.

Operator

Your next question comes from Tushar Shah – Unidentified Company

Tushar Shah – Unidentified Company

I’d be curious to get your perspective on kind of how things are going in general for UPS systems or if you look at the battery guys that are out there selling their systems and what you guys are doing? Give me a sense of kind of the growth of their business relative to the growth of your business and competitively to think about the share of UPS flywheel based UPS versus battery based UPS. If you can give a little bit color around that would be helpful?

Jim Clishem

This is Jim. I’m glad to do that. What we’ve seen year-to-date many of our competitors are up 20% or more. I think we announced this morning, that year-to-date we’re only up about 2%. We’re still stealing share as the way to characterize that. Now that we have taken this PowerHouse on top of the UPS sales, moving up the food chain, we’re actually opening in up new IT marketplace as opposed to traditional infrastructure, power infrastructure marketplace.

So we think those two combinations of stealing share and opening new market are really weathering the storm for us pretty well. I think you also heard John mention that, with the Caterpillar revenues being off, we’ve more than replaced that between those two initiatives that I had just mentioned, because of our strategy we put in place several years ago the diversify of those sales channel so far. I think, competitively we have fared extremely well in comparison to these competitive pressures.

Tushar Shah – Unidentified Company

I thought I would ask another one. What’s your sense around sort of the Caterpillar? What is happening with the Caterpillar relationship? Obviously, your direct sales has done fabulously to counteract the decrease in Caterpillar, but have they made a change in how they view this business or any kind of changes in sort of how they’re viewing this opportunity?

Jim Clishem

Their overall global business is down and so 90% of what Caterpillar does is in the dirt moving equipment business and 10% is in the electrical power generation. So a lot of the dealers in our view have sort of pulled into their core, into that mode of right-sizing their own businesses. So I think that’s one dynamic that is in place. The good news is that the groups that we interface with, in fact Caterpillar are very much moving down this power solutions business as well.

We have a great deal of experience in our on direct business doing that so, they’ve engaged us both domestically in abroad in additional training and marketing support and things of this nature to prepare them for selling more than just a UPS if you will. We think their engagement at that levels a very positive sign despite the fact that their distribution channels, which is the dealer are in a midst of right-sizing their own business. So, I’m still very encouraged by the channel. I think it’s a cycle they indeed are going to for other dynamics, besides say our UPS business here, but John may have a perspective as well.

John Penver

I think as Jim said the Caterpillar dealers really have a discriminating products with which to make their revenue. Majority of their revenue hasn’t traditionally come from the UPS products, but I think they’ve still stayed engaged and I offer a pretty compelling solution for a lot of their customers. They can provide engines and UPSs even switch gear and financing. So it’s definitely a great market opportunity for them and even though they have certainly had challenges this year overall, that remained engaged and we’ve been doing a lot more cross training and promotion.

Historically, we’ve also had a lot of revenue from them really from the North American market. So we’ve been working with them in some foreign markets to try to increase debt visibility and their awareness of their products and UPS product to their deal yet working foreign markets to help grow our revenue from that channel. So I think that, it’s pretty good likely that will say that our resurgency in Caterpillar revenues for us next year.

Operator

Gentlemen, it appears we have no other questions in queue.

Jim Clishem

Okay, thank you so much. Thanks to everyone on the call today for joining us and your continued interest in Active Power. Talk to you next quarter.

Operator

That concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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Source: Active Power Inc. Q3 2009 Earnings Call Transcript

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