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ZBB Energy Corporation (NYSEMKT:ZBB)

F1Q 2014 Earnings Conference Call

November 14, 2013 16:30 ET

Executives

Eric Apfelbach - President and Chief Executive Officer

Will Hogoboom - Chief Financial Officer

Chuck Stankiewicz - Chief Operating Officer

Analysts

Jim Collins - Van Clemens

Stefan Moroney - Private Investor

Operator

Good afternoon, ladies and gentlemen and welcome to the ZBB Energy Corporation Quarterly Earnings Conference Call. After prepared remarks, we will be opening the call to a question-and-answer period. (Operator Instructions) As a reminder, this call is being recorded.

It is now my pleasure to turn the call over to Mr. Eric Apfelbach. Please go ahead, sir.

Eric Apfelbach - President and Chief Executive Officer

Thank you, operator. Good afternoon and welcome to our quarterly conference call. This is Eric Apfelbach. I am the President and CEO of ZBB Energy Corporation and I am joined today by Will Hogoboom, our CFO and Chuck Stankiewicz, our COO.

First, Will will review the financials and then I will comment on the status of our global strategy and close with an overview of all of our business development activities. Will?

Will Hogoboom - Chief Financial Officer

Thank you, Eric and good afternoon everyone. Thank you for joining us today for ZBB’s conference call for our first quarter of fiscal year 2014. ZBB Energy’s press release containing first quarter results was sent out earlier this afternoon. The press release may also be found on our website at zbbenergy.com.

Before we get underway, I’d like to ask everyone to take note of the Safe Harbor paragraph that appears at the end of the press release issued this afternoon covering the company’s financial results. The paragraph states that any forward-looking statements that we make: 1) speak only as of the date made; 2) are subject to inherent risks and uncertainties, including those described in our most recently filed annual report on Form 10-K and our subsequently filed quarterly reports on Form 10-Q; and 3) should be unduly relied upon except as otherwise required by the federal securities laws we disclaim any obligation or undertaking to publicly release any updates or revisions to any forward-looking statements.

Now, I will walk through the details of our financial results for the first quarter of fiscal 2014 as compared to the first quarter of fiscal 2013. Total revenue for the first quarter was $1,070,000 versus $1.82 million in the same period a year ago. This year’s revenue was comprised entirely from product sales. In the prior year quarter, product sales were $1.6 million. We did not report any engineering and development contract revenue in the first quarter versus $218,000 in the first quarter of last year. While we have performed work under our engineering contracts, the work did not progress to milestone completion before September 30, 2013. We have $200,000 of engineering services revenue to recognize in future periods when additional milestones are achieved on our engineering contract with a major U.S. technology company.

Total costs and expenses for the first quarter decreased approximately $1.1 million compared to last year. This was due to approximately $900,000 decrease in cost of products sold and a $200,000 reduction in general and administrative expense. Cost of products sold during the first quarter of fiscal 2014 was 56.2% of sales versus 92.1% in the first quarter of fiscal 2013 and 81% in the fourth quarter of fiscal 2013. This quarter’s gross margin of 43.8% exceeds our targeted gross margin of 35%, a key metric towards our goals of cash flow breakeven and profitability. The higher than targeted gross margin can be attributed to exceeding our typical pricing levels on a number of our sales this quarter.

In addition, the first quarter sales mix of standard products and components are entirely affected are directly affected by our previously stated material cost reductions of our intersection products, the refinement of our product design that reduced parts count and allowed our supply chain procurement activities to take advantage of standard, commercial, off-the-shelf cards all played a role in realizing higher gross margins although we do not expect to realize the conversions of higher than expected prices and ideal sales mix to occur every quarter. This quarter’s results do validate that our cost reduction efforts are contributing to our bottom line improvement.

For the first quarter of fiscal 2014 our net loss was $0.15 per share versus $0.19 per share in the prior year’s first quarter. The decrease in net loss per share was due to an improvement on gross margin and the decrease in operating expenses. The loss per share figures reflect the one for five reverse stock split that was effective October 31, 2013. The company’s cash balance as of September 30 was $3.1 million and accounts receivable were approximately $500,000 and our current backlog is $3.7 million. We anticipate collecting approximately $1 million in the second quarter from our current backlog and accounts receivable. The current rate of cash consumed by operating expenses continues at approximately $800,000 per month. Please also review our earnings release and our 10-Q for further financial information.

Now I will turn the call back over to Eric. Thank you.

Eric Apfelbach - President and Chief Executive Officer

Thank you, Will. Since our last call was only six weeks ago, our update in this call will be fairly brief. I will cover the progress on our strategic partnerships, our sales pipeline and a summary of the ruling by the California PUC and the impact and potential benefits to our company. During the first quarter of fiscal ’14 the company’s major accomplishments included. Number one, we did payout the compliance validation for our EnerStore Battery is meeting the requirements as the standard GBZ2 2007 for the National Institute of Occupational Safety and Health for the PRC through its joint venture – through our joint venture partner meaning energy.

We completed a private placement of 600 shares of Series B preferred stock resulting in growth proceeds of $3 million to the company. We shipped EnerSystems and system components to both China and South Korea in support of our JV in China in Lotte Petrochemical respectively. Also ZBB shipped our first EnerSystem to Australia that will utilize two EnerStore batteries in combination with a fuel cell, a rankine cycle turbine, PV solar panels and a wind turbine. We completed customer on-site testing in Southern California of 1 megawatt hour EnerStore that is currently our largest operating energy storage system.

And our partner Crosspoint Kinetics announced the introduction of their second generation hybrid system for bus and mid-sized trucks. This is the most cost effective retrofit of a hybrid system in the Class 3 to Class 6 truck markets. According to Frost & Sullivan there are more than 260,000 Class 3 to Class 6 trucks on the road today. They expect an annual run rate of over 68,000 to be produced by 2016. So this represents a sizable opportunity for ZBB. ZBB developed and now manufactures the electronic controller for the S3000 hybrid system. Subsequent to the end of the first quarter, the company completed the installation of the 300 kilowatt hours ZBB EnerStore advanced flow battery at our location in Southern California to demonstrate the combined value of the solar power and energy storage.

Let me touch a little bit on a new angle we are taking on our sales and marketing strategy. Our sales approach in the past has been aimed at providing equipment and our systems for government and commercial projects defined by third party contractors or developers. The product engineer or project engineering typically requires an AC microgrid approach which may or may not take advantage of the ZBB’s core intersection DC integration technology. Also project economics engineering and funding have typically been out of ZBB’s control and has placed ZBB in a position of being dependent on a number of players in a specific project. In some cases this is what the delays in project engineering, delays in finalizing budgets, delays due to subcontractor coordination and has resulted in unacceptable delays in order closures.

We have also found that subsequent to orders shipment, project coordination by various contractors has led to onsite commissioning delays, cost over runs, poor communications and slower revenue recognition and slow cash generation. Obviously this is non-acceptable to achieving ZBB’s growth potential. As a result our management team led by our sales and marketing group is shifting our focus to direct project development with end-use commercial customers rather than relying on intermediate contractors. This allows ZBB to sell our lower cost and better performing intersection microgrid technology directly to end-use customers, cutting out the intermediate contractors and by and large eliminating the coordination difficulties of multiple subcontractors and vendors on a specific project.

We are now in the process of instituting a shift at ZBB. The process involves in demo system installed in our facility that can be configured to provide the least cost and best reliability in meeting a customer’s load requirements. This may involve an optimal mix of distributed generation and storage. The distributed generation may include solar, wind, diesel or natural gas generation or micro turbines. This shift also requires the development of a detailed understanding of how the customers’ energy costs will change with the addition of ZBB’s system.

Market opportunities where we believe this least cost end-use approach will be most applicable includes the recent California Public Utilities Commission order mandate of investor on utilities to install 1.3 – 1.25 gigawatts of energy storage by 2024. ZBB’s new leads costs end-use process gives us the ability to participate in this new California market potential. Other market segments include behind the meter opportunities in high priced electric utility service areas. For example we will be able to demonstrate a least cost configuration to commercial customers in Hawaii, the Caribbean, Alaska or other high cost utility or remote areas.

We expect to have this process ready for execution in the first half of 2014. The market demand for energy storage is accelerating and our sales and marketing efforts are being positioned to take full advantage of the new market dynamics. We expect that this will result in a significant increase in both the size of our sales funnel and the predictability as when these projects will close. In the mean time we will continue to pursue bidding into projects as we have been, continue to work with our China and Korean partners for additional orders, continue to increase our order uptick for hybrid controllers for Cummins Crosspoint and finally pursuing new electronics markets that have substantial market opportunity.

In South Korea the Minister of Trade, Industry and Energy recently announced plans to consider energy storage, energy management and a revision of it’s electricity rate structure. The current plan would mandate energy storage systems and provide financial support up to 50% of the system costs for small and medium sized firms affected by the ruling. The proposed electricity rate structure would increase a spread between peak and off-peak electricity prices further incentivizing load shifting and energy arbitrage for energy storage developers,

A revision of the plan is expected to be weighed this month obviously with our Lotte partnership we are in a very good position to take advantage of this market as it develops. We continue to move the ball forward in our strategic partnership negotiations with several large multinational organizations. These deals have taken longer to close than we anticipate, but we are no les confidence they will close. Without getting into specifics these deals would provide multiple benefits to our company including licensing manufacturing channel support and working capital to fund our future projects.

In regards to our sales pipeline we continue to experience weak near-term sales in our domestic storage business due to the end of the stimulus funding combined with the sequestration. We continue to focus on international markets where the application of energy storage systems is greater. By the end of this year, we anticipate our storage system in Sydney will be installed with commissioning likely coming in early 2014. We continue to work with our joint venture partners in China and obtain state grid approval.

Let me go a bit deeper into the landmark decision by the California PUC and how ZBB can capitalize on this long-term opportunity. As previously announced, the CPUC mandated the investor-owned utilities, including Southern California Edison, Pacific Gas and Electric and San Diego Gas and Electric acquire a total of 1.325 gigawatts of energy storage by 2020 with full installation by 2024. Your decision was based on optimizing the existing grid and deferring investment upgrades, the integration of renewable energy and reducing greenhouse gas emissions to 80% below 1990s level by the year 2050. There is a very good visual representation of the grid balance issues called the duck chart and you can find this on the internet. This was created by California Independent System Operator to show that increasing solar generation paired with the conventional base load resources that can’t be turned off, for instance, nuclear and less flexible natural gas turbines can cause over-generation in the afternoons during the certain months beginning in 2018. March and April are even more extreme cases, because solar intensity is relatively high, but the summer air-conditioning needs haven’t kicked in yet.

We believe this decision validates the distributed storage concept for energy storage and we continue to design – that we continue to design and manufacture. Recently, we completed the installation of a 300 kilowatt hour ZBB EnerStore advanced flow battery at a Southern Californian location to demonstrate the combined value of solar power and energy storage. This installation will help both utilities and end users be able to quantify the real-time benefits associated with this type of system. We are seeing indications with the EnerStore optimum operating characteristics match up perfectly with the needs for California. Storage is intended to bridge the generation gap between the daily ramping down of solar generated power and the peak power demand last through the early evening.

California has identified the duration of this bridge to be four hours. The best discharge regime for the EnerStore zinc bromide battery is four hours exactly matching our identified needs for both the 1.325 gigawatt CPUC order and for the Southern California Edison solicitation of an additional 50 megawatts of storage that will be awarded in 2014 for installation later this decade. Even though we believe our systems offer a viable solution, the results of the first auction are a year away. The potential delivery of product is 18 to 24 months away. We do believe that these early mandates driven by the current accelerated penetration of renewables are the tip of the iceberg of the market opportunity in front of us.

Thank you for calling in today. We would be happy to take questions now. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question will come from Jim Collins with Van Clemens.

Jim Collins - Van Clemens

Yes, Eric. My question would be that you mentioned the S3000, you are producing that product or component of that, what kind of revenue on an annual basis is that expected to produce approximately?

Eric Apfelbach

Yes. Jim, we haven’t given a forecast of the revenue of that. It’s just ramping now actually.

Jim Collins - Van Clemens

Okay.

Eric Apfelbach

It’s been in small scale testing and they commenced just green-lighted the release of that product and so it’s actually ramping up shipments here. We produced the controller for that system, which is maybe a third of the total sales price of the system.

Jim Collins - Van Clemens

Okay.

Eric Apfelbach

And it does have pretty good gross margin. So as we get a little bit more detail from them on how their ramp is going in the following quarters we will be able to give you more kind of visibility on that.

Jim Collins - Van Clemens

And with your new marketing strategy, will you require more employees which seem you would to do what you are – when you were just working with lot of other people, third-party people?

Eric Apfelbach

Yes, there is a different mix. There are some different skill sets that we didn’t necessarily have and also some different product capabilities that were really all on our – already on your roadmap, but we are just stepping up on those. The skill sets that we really need to add whether it’s a full-time employee or a contracted type skill set is that we need to become experts at analyzing rate structures and customer-sighted economics. We have the benefit of being behind the meter or in front of the meter which is good, but we really need to go in and be able to do our return on investment of all these different aspects that connect into our system. You heard that the system we have in Sydney is a good example. We have wind, solar, fuel cells. In the U.S. we have got people talking about doing CHP with turbines all off our system. So it’s an exciting ability go in and be able to be the person who has this virtual power plant that connects anything, but we wanted to seamlessly be able to demonstrate it. Thus the demo system that we have announced today here in our facility, that we are planning on doing, but also being able to model it and then capture that money once the system is installed. The additional capability that we are going to build in over time is adding layers to our software capability on the system so that the customer can have a seamless interface to all of these different assets and be able to maximize capturing peak rates or frequency regulation or any of the other value streams that they are prioritizing at that site.

Jim Collins - Van Clemens

Okay. And then I guess my final question is that the last funding as I recall was called bridge financing and I guess I though that meant that we would be looking at the cash flow positive or something with the money that was obtained, because we are seeking some large company partnerships?

Eric Apfelbach

Correct. We are currently working on some strategic partnerships that we expect to be cash positive to the company in various ways. In terms of operating cash flow breakeven from shipping products alone, we really haven’t given any guidance on that on its own. We have kind of just given mile markers along the way kind of our business model is that number one, we have to have good gross margins, which is one thing that will hit on today both our cost reductions and our pricing power give us the ability to have gross margins. The other component obviously is we have to ramp revenue. So most of what we are working on now at ZBB is how can we ramp the company’s revenue faster? We do have the operations here. They can do a pretty substantial amount of revenue. We have got partners that are positioned appropriately. We have got supply chain that’s positioned. So a lot of this is right now, we are trying to really turn up the burners on booking business in a market that’s kind of developing and fits and starts right now is what we are seeing.

Jim Collins - Van Clemens

And our cash flow lasts until how long?

Eric Apfelbach

We are right now always said in our Q is that the bridge will last through the end of this quarter, current quarter, but obviously we call it a bridge as I said in my last call, we call it a bridge versus a peer, because we think it will get us to the other side.

Jim Collins - Van Clemens

Okay.

Eric Apfelbach

Yes.

Jim Collins - Van Clemens

Very good. Thank you.

Eric Apfelbach

Yes.

Operator

(Operator Instructions) The next question comes from Stefan Moroney, a Private Investor.

Stefan Moroney - Private Investor

Hey, Eric. How are you doing today?

Eric Apfelbach

Very good.

Stefan Moroney - Private Investor

It looks like on your release here, I am going back to the controller question that the last gentleman asked and it looks like in 2016 there is a forecast of maybe 60,000 to 70,000 controllers or vehicles that will be on the road, do you have any kind of range of and that looks to be like a pretty solid program going forward any kind of range of revenue that would be worth towards ZBB assuming that we can get there?

Eric Apfelbach

We have not given any forecast on that. We have kind of talked about the fact that that system, our sale price is in the $8000-ish range so you can kind of get an ASP number on that. The unit volume – the penetration rate it is retrofitable which is good. I think the 68,000 number if I recall was new vehicle shipments in that class range for that year. What’s nice about this system is actually retrofitable to the installed base. We are pretty excited about it though because it is showing kind of that three year payback depending on fuel prices. And it is something that can easily be extended into other countries as well and into other technologies, so that – those efforts are all on our radar screen. It can increase the served available market. But it’s just so hard to tell right now what Cummins’ penetration rate will be. We do talk to them a lot of bit their marketing plans and where they are headed and it looks like a very aggressive program for them to get this product out there.

Stefan Moroney - Private Investor

Yes, okay and I was – sorry I was little bit late on the call. Over the two or three years, there has been a sales funnel that’s been I guess referred to in a lot of the promotional material for ZBB, what if – anyhow you guys are what your conversion rate with that. And maybe that you went into that a little bit before I got on the call with respect the new marketing strategy, but it seems like that not that much you guys haven’t been able to really convert better or is it actually in the pipeline and it is converted, but not being able to be installed or can you give a little bit more color on that and where – what that funnel means now as of today given the new change of strategy?

Eric Apfelbach

Well, yes, our hit rate. We are not happy with that I think that’s why you are seeing us adjust our approach to the market a little bit here too our equipment and product has gives us the ability to go up to a higher level of sales with the customer. So we are trying to do that increase our control over the speed and what comes out of that funnel. Most of the things in our funnel there has been a little bit of churn within the funnel. Things – projects have just gone away. It’s probably the number one thing when we don’t get something it’s usually because it never happened. And that’s one of the frustrating things for us when we see lot of efforts get spend a lot of time. And then there is a lot of ways for things that die in the funnel which we hate to see. We – but we would expect that things are long-term looking better for what I call the real business of grid storage is starting to shape up. These things we are seeing in South Korea, California and Lipa. These are really utilities, real people saying we have to have storage. So that’s what’s going to convert what was a DOD, DOE kind of 1G, 2G business and that’s something that’s more sustainable from our served available market perspective. There are some other sub-segments that we have seen a – we may not compete that really aren’t in our served available market. There is people selling little lithium ion batteries in residential in California for instance. We don’t really have – we have targeted the bigger industrial commercial and industrial buildings and larger grid batteries. So they are selling some things and those primarily accelerated by the specific credit schemes in California. But we are – some of these things have fallen out of our served available market as well.

Stefan Moroney - Private Investor

Okay. And what’s your current employee headcount approximately?

Eric Apfelbach

At around 60, the actual…

Will Hogoboom

There are 60 people.

Eric Apfelbach

60 people.

Stefan Moroney - Private Investor

Okay. That’s all I got for today guys. Thanks.

Eric Apfelbach

Thank you.

Operator

And that does conclude question-and-answer session and it does conclude today’s conference. We do thank you for your participation today.

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