Active Power Inc. (NASDAQ:ACPW)
Q4 2009 Earnings Call
February 9, 2010 11:00 am ET
John Penver - Chief Financial Officer
Jim Clishem - President & Chief Executive officer
[Dilpit Warrior] – Unidentified Company
Analyst for Walter Nasdeo - Ardour Capital
Eiad Asbahi - Prescience Investment Group
Jim Kennedy – Unidentified Company
Good morning everyone. Thank you for participating in today’s conference call to discuss Active Power’s financial results for the fourth quarter and year ended December 31, 2009. With us today is Mr. Jim Clishem, President and Chief Executive Officer of Active Power and Mr. John Penver, Chief Financial Officer. Following their remarks we will open the call for questions.
Before I continue, I would like to take a moment to read the company’s Safe Harbor statement. The company’s management on this call may make forward-looking statements that involve risks and uncertainties including statements relating to Active Power’s current expectations of operating results for the first quarter of 2010, its future operating results and its customers intentions. Any forward-looking statements and all other statements that may be made during 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; the completion of the audit of the fiscal year 2009 financial results, specific results and uncertainties include the deferral of cancellation of sales as a result of general economic conditions or uncertainty related to our international operations, 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 the annual report on form 10-K for the year ended December 31, 2008 and its quarterly reports on form 10-Q and current reports on form 8-K filed since such year ended.
Active Power assumes no obligation to update any forward-looking statements or information which are in effect as of their respective dates. I would like to remind everyone this call will be available for replay online until February 23, 2010 via Active Power’s website at www.ActivePower.com.
I would now like to turn the call over to the President and Chief Executive Officer of Active Power, Mr. Jim Clishem. Please go ahead, Sir.
Thank you. Good morning everyone and thanks for joining us today. Earlier today we issued a press release announcing our fourth quarter and fiscal year 2009 results. Revenue for the fourth quarter totaled $14 million which was up 64% over our previous quarter. This represented the second highest quarterly revenue in our company history.
These results were largely due to the improved performance of our direct sales channels, the creation of our strategic IT sales channel program and increased acceptance of our Power House solution in the marketplace. We reported revenues for the year of $40.3 million. While this represents a 6% decrease from 2008 we attribute this to a challenging overall marketplace in 2009. In fact, according to the information we have on most of our UPS competitors, they all experienced sales decreases during 2009 of between 18-38%.
Despite the challenges we were still able to narrow our operating loss for the year by 22% versus 2008. This was largely due to an increase of our gross margin of 23% for the full year of 2009 up from 19% in fiscal 2008.
Before we go further I would like to turn the call over to our Chief Financial Officer, John Penver, who will take us through the financial details of the quarter and the year. Then I will come back to discuss some of our operational highlights for the fourth quarter and talk about our outlook for 2010. We will then open the call to your questions. John?
Thank you Jim. Good morning everyone and thank you for joining us today. As Jim mentioned our revenues for the fourth quarter ended December 31, 2009 increased 64% to $14 million from the $8.5 million we reported in the previous quarter. This was a decrease of 14% from the $16.2 million we had in the fourth quarter of 2008.
As Jim indicated, this big improvement in the fourth quarter from our third quarter was attributable to the improved performance of our direct sales channel as well as increased demand for our Power House products in the marketplace. These positive trends helped us mitigate the declining performance of our traditional OEM business. Our direct sales grew by 68% compared to the third quarter. This was predominately in our North American markets where we had multiple Power House sales. In fact, our Power House sales were $4.2 million during the quarter.
On an annual basis we achieved sales growth in North America during 2009 although we did see decreases in Asia and Europe. Europe is our second largest marketplace after the United States. However, we are encouraged that our second half 2009 performance in Europe actually increased by 175% over the first half.
Our fourth quarter service revenues of $2.7 million also increased dramatically from the prior quarter, up 98%. This was also 23% higher than the fourth quarter of 2008 and this was attributable to the higher level of project related services in connection with Power House sales. Looking at our revenue from different channels we saw revenues from our OEM channel were 9% of our revenue in the fourth quarter. OEM sales of $1.2 million were down 76% compared to the fourth quarter of 2008. For the full year our OEM sales were $9.7 million which decreased by 44% or $7.5 million from 2008.
As a percentage of total revenue our OEM business decreased from 40% of sales in 2008 to 24% of sales in 2009. Conversely, our direct sales increased from 60% of sales in 2008 to 76% of sales in 2009. This was driven by the growth in Power House sales and strong performance in North America where we had more success with some of our IT channel partners including Sun and Hewlett Packard.
Our fly wheel based UPS products again contributed to the majority of our revenues and were 51% of our total revenue for the quarter. This compared to 45% of revenue in the third quarter. The Power House sales represented a further 30% of total revenue in the fourth quarter. So between them, clean source and Power House represented the majority of 81% of our revenue in the fourth quarter.
Our Power House contract is potentially larger in value and this may contribute to more volatility on a quarterly basis. They also significantly affect our cash flows as we end up with fewer customers with significantly larger receivables. This concentration does increase liquidity risk for us and we continue to improve and refine the payment terms of these sales opportunities as part of our working capital management.
As our solutions business grows the composition of our sales will likely change and fluctuate on a quarterly basis. We have experienced an increase in third-party systems and components that are being packaged and resold to our clients. This also drives an increase in top line revenues. Even though the pass through margins on third-party equipment are less than we would generate on our own manufactured goods, it does become an important catalyst for professional services and maintenance revenues that do attract higher margins.
The level of third-party revenues will fluctuate quarterly due to the timing of the specific orders we have. This is demonstrated in the fourth quarter of 2009 with such third-party revenues of $1.1 million compared to $1.3 million in the previous quarter. The total number of fly wheels we shipped this quarter was 86. This is up from the 56 wheels we shipped in the third quarter and in fact by 54% and fairly well correlated with the increase in total revenues.
Our average selling price this quarter of $90,000 for fly wheels was much higher than the $78,000 we had in the third quarter. Concerning our ability to generate higher average selling prices on direct business, for the year, we shipped 315 fly wheels at an average selling price of $81,000. This compares to 363 wheels at an average selling price of $78,000 in 2008. The benefit of selling total solutions becomes more apparent here as you can see a 30% reduction in wheels was greater than the overall decline in revenues for Active Power in 2009.
International sales were 22% of total revenues in the fourth quarter which compared to 60% in the third quarter and for the year our international sales were 31% compared to 39% in 2008. This was a combination of lower absolute revenue levels and improved performance from the North American market. Our future quarterly results from international sales will continue to fluctuate depending upon the timing and size of orders received and have been more unpredictable and dependent upon our success in winning larger orders.
Gross margin in the fourth quarter was 19%. This was down from the 32% we recorded in the fourth quarter of 2008 on much higher fly wheel volumes and down from the 22% we had in the third quarter of 2009. We attribute this to a higher proportion of Power House revenues in the fourth quarter which weighed down our total gross margin since we do have lower margins on Power House sales compared to UPS sales. We also have scaled back our production levels in the fourth quarter to deliberately reduce our inventory levels and to help improve our company liquidity.
As a result we experienced higher excess capacity costs which dampened our gross margins since this resulted in a higher unabsorbed overhead in our factories. On an annual basis, however, we were able to improve our gross margin to 23% in 2009 compared to 19% in 2008 even with the lower revenue levels. This reflects the absence of inventory impairment charges this year and lower cost levels at the product level. Longer term, gross margins above 30% are attainable for Active Power.
Our research and development expenses for the quarter were $0.9 million which was 16% lower than the previous quarter and 24% lower than the fourth quarter of 2008. For the year our research and development expenses were $4.2 million or 28% lower than 2008 primarily reflecting lower headcount and credit [type] expenses. Our selling and marketing expenses of $2.9 million were 12% higher in the fourth quarter than third quarter levels mainly due to higher variable sales expenses on a 64% increase in revenue but they were 6% lower than the fourth quarter of 2008 when we had higher revenues.
For the year our selling and marketing expenses of $11.4 million were 3% lower than the $11.8 million we had in 2008 reflecting our spending controls and lower variable selling expenses. In the fourth quarter our general and administrative expenses decreased by 11% and were 25% lower than the fourth quarter of 2008. This reduction is due to lower compensation expenses, the absence of bad debt write offs and were offset by higher professional and legal fees. For the full year 2009 our general and administrative expenses decreased by 10% or $500,000 from 2008 primarily due to lower compensation and bad debt expenses.
Our operating loss for the year of $11 million represented a 22% improvement from the $14.1 million operating loss we incurred in 2008. This was on a 6% decrease in revenue showing the effects of improved pricing and operating expense control during a difficult 2008. Our net loss for the quarter was $2.2 million or $0.03 per share. This compares to a net loss of $3 million or $0.04 per share in the previous quarter and a loss of $0.4 million or $0.01 in the fourth quarter of 2008. For the year, our net loss of $11 million or $0.17 per share represented an 18% improvement from the $13 million loss or $0.22 per share we recorded in 2008.
The decrease in our cash investments during the quarter was $0.5 million. This was a significant improvement from the $3.7 million increase in cash investments we had in the third quarter of 2009 and better than the $0.6 million decrease we had in the fourth quarter of 2008.
Our business continues to grow as evidenced by the 64% increase in quarterly revenue. As a result, we have had to [find] a larger level of receivables and our receivables in fact increased by $4.5 million during the fourth quarter. We were able to decrease our inventory by $1.9 million since September through lower production and lower purchases and accelerated customer payments as indicated by the increase in deferred revenues. This combined with higher trade payables allowed us to finance the increase in our business during the fourth quarter without significant depletion of our available cash and investments.
Our cash and investments on hand at the end of December were $7.5 million. As a small company, we tend to significantly be impacted due to the concentration of receivables amongst a small number of customers. Cash management will remain a focus for us in 2010. Based on our current plans for 2010 and the experience we have had with managing our cash over the last 12 months, we believe we have adequate cash and investments on hand and available sources of liquidity to continue funding the business through 2010.
We would anticipate returning to our historical or recent three-year average growth rates in 2010. As long as our expectations are realized we should have more than enough cash resources along with our bank credit facility to operate the business. However, an expansion of our Power House business could place additional demand on the company for liquidity. The longer sales cycle of Power House lengthens the time between order and receipt of cash. Combined with anticipated higher sales in 2010 it is possible we may need to generate additional source of liquidity for the company to fund this growth.
To that extent in December we completed the registration and [effectiveness] of the shelf registration statement that would allow us to sell additional equity in the future. We are also investigating changes to our existing bank credit facilities to provide the higher amounts of bank credit and variability for the financing of more Power House business. We believe this will give us the necessary financial flexibility to provide the additional working capital for the company during 2010 using either debt or equity to fund this growth if we so desire.
Our capital expenditures were not significant during the quarter. We have historically invested a lot in our manufacturing infrastructure and with the production capacity far in excess of our current revenue levels we can substantially increase production levels without needing to make material capital investment. Our capital expenditures therefore will primarily support expansion of our sales and service capabilities and our marketing efforts as required.
This completes the financial portion of the presentation. I will now turn the call back over to Jim for some further comments about the quarter and the year.
Thank you John. While we experienced a challenging environment as mentioned in 2009 particularly with tight capital markets and reduced capital spending globally we still managed to grow Active Power’s market share in 2009. Our reported revenues could be dissected a bit further to reveal some interesting results.
There were really two different stories evolving in Active Power in 2009. Our OEM channel sales decreased by 44% or $7.5 million whereas our direct and strategic IT partner sales grew by 20% or $5.5 million. Our commercialization strategy to expand our product offerings and broaden our sales and distribution channels over the last three years worked as designed to properly mitigate the business risk associated with any one underperforming channel.
Despite the fact OEM sales were only 9% of our total revenue in the fourth quarter we believe the OEM business will recover and remain strategically important to Active Power in the years ahead. In fact we are starting to see signs of improvement in this channel already in 2010 with an increase in quoting activity and orders.
With regard to our direct sales our efforts to grow this part of our business globally and to add other relevant distribution channels such as our strategic IT partners including Sun Microsystems and Hewlett Packard continue to result in higher levels of sales and brand awareness. We should also emphasize the growing importance of our Power House offering, a complete containerized, turnkey critical power solution. Selling complete, continuous power solutions which integrate generator, UPS, switch gear, monitoring and services opens up a $6 billion market to Active Power instead of the $1.4 billion UPS market alone.
We continue to generate market momentum worldwide with Power House having booked more than $10.5 million in Power House orders during 2009 with about one-half coming from our strategic IT partner relationships. The ability to deliver this complete, integrated, pre-tested solution is very compelling to our customers. Power House is built in a factory environment at factory labor rates with the highest level of quality control instead of the traditional bricks and mortar approach. For the customer, Power House represents a just-in-time capital deployment advantage and allows for the asset to be moved if necessary.
Our Clean Source UPS anchors Power House, an extremely rugged power dense UPS system that doesn’t require condition space as compared to conventional battery based UPS technology. No other UPS manufacturer can deploy as much power into a confined space as Active Power, creating a competitive barrier of entry to the containerized power infrastructure market for conventional systems.
The strong sequential growth in the fourth quarter reflects the general improvement in overall economic conditions. We have witnessed more customers moving ahead with capital projects some of which have been under consideration for a long time with these customers now less fearful of future conditions and with better access to capital particularly for our large customers. However, many small customers are still struggling with a lack of available credit. We do believe this too will likely improve over the course of 2010.
Now looking at leading revenue indicators, orders received during the fourth quarter were more than $17 million higher than a year ago. Although our forward visibility is generally limited to no more than three quarters the outlook is definitely much improved compared to the same time last year as our sales pipeline continued to grow.
With regards to annuity based revenue sources it is also worth reiterating here the importance of our service business which we had quite a bit of success with in 2009. Service revenues also expand and play an important role for us particularly on Power House sales.
A few comments on strategy, in 2005 we set into motion a simple and clear commercialization strategy; a strategy focused on execution and harvesting the intellectual property assets of the business. The pillars of this strategy were first, to build and diversify distribution. Second, to reduce costs. Third, building brand. Fourth, to build innovative solutions. With this strategy we also set into motion the foundation to improve financial performance. As a result we believe it is important to reflect with quantifiable metrics what has been accomplished to date.
For example, comparing 2004 to 2009 revenue grew by 155%. Operating margin improved by 85%. Our gross margins went from negative 14% to a positive 23%, a 264% improvement. Our direct sales revenue grew from $3.5 million to over $30.6 million. That is a 762% increase. Likewise our service business grew from $1.7 million to $7.5 million or a 331% increase or as our average dollar per wheel, in other words our revenue per wheel increased from 2004 to 2009 by 33% going from $61,000 per wheel to $81,000 per wheel.
So in 2009 we began to reap several new benefits of our commercialization strategy particularly in two areas; first, our work with our new sales partners is beginning to bear fruit as we have received significant orders during the second half of 2009. We believe this growth will continue to be realized this year. We have also started to reap the benefit of our direct sales strategy designed to build long-term relationships with clients who will place large and repeat orders for Active Power products and services. Several of our largest orders this past year in fact were repeat orders of which we believe are precursors to more orders yet to come.
Turning to our outlook for 2010 and our plans for the business. Overall, the improvement in the direct and strategic IT partner sales and the performance of our new distribution partners and our efforts to improve and expand our product offerings with products like Power House show positive momentum. Our overall strategy remains intact and relevant even though our industry experienced a difficult year in 2009.
This I do know, our solutions are differentiated and compelling focused on saving customer’s money through exemplary power and space efficiencies and improved reliability delivered through our patented fly wheel UPS technology. All of these benefits are appealing to those receptive of an economically green solution, a message that is valued and remains timely today.
Our focus as a company is to reach the next significant milestone in our maturity and that is to achieve and sustain operating profitability. To achieve this we must build on our momentum to increase our top line while focusing on managing our operating expenses. Thus, you will see many of our initiatives in 2010 geared towards attaining profitable quarterly results. We demonstrated over the last several years the ability to manage product and operating costs and we are a much more efficient and sales focused organization today than ever before.
So what are the important metrics to watch for? As we indicated in the past to our investors fly wheel shipments and service revenues are critical metrics of the business. Fly wheel numbers are a good barometer of the efficiency of our manufacturing facility which is a key to our efforts to achieve operating profitability. In the long-term the service business can be more lucrative then product shipments which is also a key factor in achieving operating profitability. Broadening our service footprint is also critical to supporting our sales efforts.
Another important metric as we move into 2010 will be the number of Power House orders we receive. Power House allows us to magnify the revenue opportunity of an individual sale. As a result, we can get four or even more times the revenue we would otherwise get from simply selling a UPS product to a customer alone. Although the percent gross margins on Power House can be lower than the margins from UPS sales, in absolute dollars we can generate more profit along with significantly more service revenue.
The Power House product is significant from several other perspectives. First, it enables our strategic IT channel partners to more effectively sell their containerized data center products with a more complete offering. To the extent that demand continues to increase for our containerized data center partners I believe we are in a great position to capitalize on this movement. Second, Power House is not just a product to compliment containerized data centers. It has multiple applications including disaster recovery, temporary critical power needs, mobile deployment, event support, clients who are running out of existing facility space and is a direct replacement for the traditional brick and mortar based power infrastructure within a data center.
In 2010 we continue to provide marketing support and assistance to all of our distribution partners who are symbiotically interested in promoting the Power House solution as a means to expand their own product or solution sales within their respective markets. In 2010 we are also in the process of realigning our sales organizations in EMEA under new leadership. In October of last year we announced the appointment of Dietmar Papenfort as our Vice President of sales for Europe, Middle East, Africa and Asia.
Papenfort brings to Active Power more than 20 years of sales service and technical experience with power infrastructure equipment and will oversee all of our customer relationships and sales activities in these regions. We will focus on those markets which we already have a direct presence; primarily in the U.K., Germany and Italy to improve our financial results in each of these markets as they represent the largest UPS opportunities for us in Europe. We continue to review and monitor the performance of our distributor and representative partners and will look to expand these channels where we can support our growth.
We are optimistic as we move into 2010 with greater confidence to build upon our momentum to improve our financial results further. This confidence stems from the better market visibility we have now as compared to this time last year particularly with the Power House business as our solutions are specified often times 6-12 months in advance of deployment. Since September we have experienced a strong increase in demand and an increase in the number of sales opportunities we are working.
We are also seeing a large increase in follow-on orders as mentioned which is exciting and critical to our longer term prospects. We believe that macroeconomic trends currently in play are ones we can leverage not only in 2010 but over the next several years. Gardner recently focused enterprise data center needs will actually increase 650% over the next five years. As a result, enterprise and co-location data centers will have to deploy more servers and more IT equipment to handle this enormous influx of data which requires more space, more power and more cooling.
Space in the data center will continue to come at a premium and energy costs and consumption will continue to increase as will the demand for enterprise wide green initiatives. Active Power is able to address these most common industry pain points with a highly differentiated offering; solutions that reduce energy losses, decrease electricity costs for the customer while improving reliability.
We are also able to protect more power in a smaller space as compared to conventional technologies which means customers are able to dedicate more floor space to revenue generating equipment. Our technology also enables us to operate within a very wide range of environmental conditions without degradation in performance. These include data centers, oil fields, industrial plants, clean rooms and pharmaceutical labs just to name a few.
Having products and solutions with unique advantages supported by an increasingly recognizable brand is helping build and sustain a growing business that is gaining worldwide reputation for protecting mission critical businesses. We believe we are in the right place at the right time with the right distribution channels in place. These channels that we will in fact support and grow in 2010.
Now turning our attention a little bit here to the first quarter of 2010. The first quarter of every calendar year is typically the slowest of the year for the UPS business and revenues are usually down sequentially from fourth quarter levels. This is a trend we expect to continue with the first quarter of 2010. For Active Power having carried a substantial backlog into 2010 and based on orders we have closed or expect to close we anticipate our first quarter revenues to be between $9-12 million.
Based on our projected sales mix, this would result in a gross profit margin between 22-26%. At our current operating expense levels this would mean our net loss would be between $0.02 and $0.04 per share. Achievement of these results, as usual, will depend on 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 recorded during the fourth quarter. Our cash used in operations will therefore be largely driven by our working capital requirement during the quarter.
At this point we anticipate our cash balance will not decrease this quarter from year-end levels and we will continue to utilize our banking facility and manage customer and vendor cash flows appropriately to meet this cash neutral expectation.
Thank you for being on our call this morning and on behalf of the entire senior management team and our board I would like to express our appreciation for the continued support of our customers, employees and shareholders as we work to achieve quarterly profitability in 2010. So now at this time John and I would be happy to open the call up to your questions. Operator, I will leave it to you.
Question and Answer Session
(Operator Instructions) The first question comes from the line of [Dilpit Warrior] – Unidentified Company.
[Dilpit Warrior] – Unidentified Company
[audio break] better than 2009. I was wondering where you see this growth coming from? Are you going to see it in the Active Power branded channel or the OEM channel which obviously has slowed down in 2009? Or perhaps your partnership with HP and Sun Micro?
I think that is a multifaceted answer. We think the growth in 2010 will come from a variety of places. First, the expanded channels we have begun in 2009. We see that growing a great deal especially in the IT channel part of our business. Our direct business continues to gain great momentum in both brand acknowledgements in the marketplace here and abroad. Thirdly, we are seeing a larger revenue opportunity as a result of selling through Power House. As I mentioned today at 100 KDA and above the power market is about a $2.1 billion market. If you look more specifically where the growth area, about 16% constant annual growth rate is at the 250 KDA and above. That is a $1.4 billion business.
If you take that same UPS opportunity and now think about offering the more continuous power solutions which integrate both generator, switch gear, services, monitoring and of course UPS and the like, that market grows to about $6 billion. So we are seeing an amplification of our market potential but in addition I think better throughput and close rates with the multiple channels we have deployed. Hopefully that answers that part of the question on the direct.
As far as the Caterpillar side of the business which is our OEM business we know they have had some challenges in the past year in their overall business. However, we do believe the power quality business as they begin more and more selling this part of their business and as their overall business improves we are going to see them returning to more opportunities and resulting in more orders for Active Power. I think the critical piece of information here is that through our commercialization strategy of diversifying the sales channel, we put ourselves in a position to survive through a pretty tough year in multiple channels and not rely on a single channel, in this case the OEM. I think those are the points I would answer to. John I don’t know if you have anything to add to that?
[Dilpit Warrior] – Unidentified Company
I think as you look at the commentary coming out of Europe can you talk about where you see the business mix shaping up in 2010? North America versus Europe versus Asia?
I think we are going to see again on the order of 40% or so coming from outside of the United States. It could be as much as 50%. We have had some nice orders. We didn’t mention a whole lot of it on the call here today. We have had some nice orders also come from our Asia operations of which we put last year about mid last year we put a country manager in place in Beijing and of course our operations are hosted out of Japan. I think we are going to see something on the order of 40-50% outside of the U.S. with a pretty good growth rate particularly as a percentage out of our Asia Pacific region.
Europe is, as we mentioned in the call today, going to be focused on those three markets; the U.K. which has been traditionally strong for us. We have made some pretty significant investments in the German marketplace by virtue of putting Dietmar Papenfort in place with some other personnel. We think Germany being the second largest UPS market is fertile ground for us. We do have some incumbent competitors there like [Pilar] that we think we are well positioned against. So we think that is where the growth is going to come from specifically in Europe. Primarily in that order, U.K., Germany followed by the southern European, Italian area.
The next question comes from the line of Analyst for Walter Nasdeo - Ardour Capital.
Analyst for Walter Nasdeo - Ardour Capital
Obviously some strong ASPs this quarter and I believe you attributed that to some good Power House sales. How should we look at that going forward? 90 was a pretty nice bump up in the ASP that have traditionally been in the low 80’s or high 70’s. What is a good way of looking at that as we look ahead over the next couple of quarters and maybe throughout 2010?
That is a good question. What I will clarify for you so that it doesn’t sound too sketchy, when we quote the ASP we quote the ASP for fly wheel sales only. We exclude the fly wheels that get sold in the Power House because it would significantly distort that metric. It is higher. If I sell a $1 million Power House that has four wheels in it I would have $250,000 ASP for example. So we try and do a straight UPS sale, this is the average selling price. We actually had some strong sales performance in our direct business aside from the Power House business in the fourth quarter.
Traditionally we have gotten higher ASPs on our direct business than we did through our OEM channel. So a combination of that channel being depressed and the direct performance is really what drove up the ASP. Going forward when we quote the ASP out that metric will only reflect straight UPS sales.
Analyst for Walter Nasdeo - Ardour Capital
As far as obviously as I look at the fly wheel count and the volumes going forward a very good quarter but we know you had some orders at the end of last year you were going to be filling I think in 4Q and 1Q and I am thinking about the 16 megawatt order. How should we think about those volumes going forward as far as fly wheels? Good quarter but looking ahead into the next couple of quarters.
I think we would expect volumes to be similar to what we did in the fourth quarter. Maybe up as much as 20%. It really will depend upon the timing and size of some of the containerized Power House orders so the revenue could be up significantly more than the manufacturing volume. For now we have certainly had some large orders like the ones we announced like last year with some of the technology companies buying 16 megawatts. I think you will see somewhere between 80-110 wheels for the next several quarters.
Analyst for Walter Nasdeo - Ardour Capital
If you could go into a bit more detail about what…you talked a little bit about the shelf and what might actually trigger you going to that. Can you give us a little more color there about what point that becomes an option? Also you talked about some debt financing as well. Just want to get a little more color there.
The whole point of filing the shelf was to give us the flexibility to respond quickly in the event we saw a need for additional working capital. We want to be cognizant of not just using equity as a source of finance. We really wanted to have more than one arrow in the quiver. So we have been working with some outside firms to help us evaluate changes to our bank facility to get more debt as a way to finance working capital as well as working with structuring payment terms. Then we wanted to have that equity available as well so if we did see a significant sudden increase in orders and we needed the ability to raise money quickly that we had the tools to do that.
Whether we use one, the other or both of them I think is still up in the air but having the ability to do that was more important. We really position ourselves, and you might say why would you do that but there are revenue opportunities we are engaged in we have not yet won but that are a significant business opportunity. Individual deals in excess of $10 million and if you get more than one of these or a big inflow of orders at a point in time that massive, sudden increase in demand could really change our working capital requirements and so we have to have the tools available to be ready to respond to that when and if that happens.
Analyst for Walter Nasdeo - Ardour Capital
I wanted to get a general take on how things have progressed with HP and Sun and what kind of opportunities you are seeing there going forward.
I will start and I will see if Jim wants to join in. Certainly both of those companies have been advantageous for us because they are [boosting] the sales opportunities that they have had with their own containerized data center products. It is actually a nice sale for us because in some cases it is customers we have never had access to previously. By the time they involve us in the sales conversation what is nice is that HP or Sun resells our Power House so they go sell their containerized product and tell the customer you now need this infrastructure to go with it. We are not selling them. We are basically providing them technical assistance in closing a sale.
So it is actually a much shorter sales cycle for us and very advantageous. I think it is still a nascent trend in the data center business. I would say HP is probably a leader in deploying containerized solutions there. Very nice coattails to ride along but I think they definitely have introduced us to a significant volume of sales opportunities and we continue to support them and their sales efforts because it helps us. I think what is really exciting for us in 2010 is that it could be a catalyst for a very significant growth in revenue if they are successful in that channel. I do want to point out and I think Jim made the point that Power House is more than just Sun and HP and our IT partners for example. It definitely gets you excited. They could really bring us into a lot of revenue and rapidly grow Active Power going forward. I think that is what gets us excited.
The only thing I would add to John’s point here is internally we made the decision late last year to sort of put some real strong focus on this alternative distribution channel. Martin Olson who has been our VP of Systems Development at Active Power for the last three years is now taking as a responsibility reporting directly to me the management of the entire global channel business which is inclusive of the OEM and the IT channel infrastructure along with some other business development activities that we are doing to fold into that business.
The important thing is we have decided to put some real strong focus and not mix the channel support between direct, OEM and IT. We have a really nice, focused strategy that is in place to really capitalize on the opportunities John just spoke about.
The next question comes from the line of Eiad Asbahi - Prescience Investment Group
Eiad Asbahi - Prescience Investment Group
I think Jim one of the things you had referenced was that Gardner study. I think one of the things you had said was you were expecting to return to historical levels of growth from 2006 and 2008 you were growing the top line at like 35%. What that leads me to ask about is what are you seeing in terms of the capacity situation today in your primary end markets?
When you say capacity do you mean manufacturing capacity? Sales of service capacity? What reference?
Eiad Asbahi - Prescience Investment Group
Capacity utilization in the data center market.
On the demand side of it. We absolutely think we have several vertical markets we are very good at from broadcast to industrial to communications. All sorts of logistical companies. We certainly believe the online community and even cloud computing and all of the things we are seeing that people are quoting are finally actually doing things about building data centers in a very horizontal way across the world. For profit and loss it is the big data centers that do it for a living. The big hosting centers. That business is continuing to grow probably even more so now because a lot of their end users have had capital constraints that are just better sufficient ways to deploy that capital in a monolithic or large, co-location data center.
We are going to see that part of the business I think continue to grow. We have many of those customers across the world. We are also just seeing the online community finally getting in place in real material ways whether it is storing data in healthcare and the proliferation of that data storage and the requirements which is what the Gardner study really referred to or we also know in the next three years almost 60% of our data center customers today are going to be running out of space. The Active Power solution and our capacity to move forward in that market is a really good solution for them because we can allow the customer to reclaim space that was formerly used for infrastructure with a smaller footprint which is the Active Power solution. Whether it is a UPS or Power House for that matter.
We are going to see these micro trends continue which will improve that overall demand capacity you have referred to. If I just net it all out I think data center growth is going to be the lion’s share and it is very horizontal and then we are going to continue to see some of these really strong verticals that we have had in healthcare, logistics and industrial as the economy picks up again we are going to see that continue to grow. I don’t think I can give you a good percentage yet because I think it is a little bit still uncertain but looking at our pipelines and the growth and the areas we are seeing most of our activity I would say horizontally it is the data center marketplace.
The next question comes from the line of Jim Kennedy – Unidentified Company.
Jim Kennedy – Unidentified Company
Could you give us a bit of direction, I won’t even call it guidance, but in terms of gross margins going forward not necessarily for 2010 but in the longer run you are bouncing back and forth between 19, 20, 23, 26, what is a reasonable long-term model look like in this business?
Long-term you should be able to expect margins between 35-40%. We have hit a quarterly high of 32% which was driven by wheel volume in the fourth quarter of 2008. Our current margins are depressed by the fact we have excess manufacturing capacity. In the longer term you would look to have a service business that is approximately 25% of your business. That garners higher margins than you do on the product side. So if you blend all that out and we can improve the margins on our Power House product through efficiency and knowledge then 35-40% margin should be a long-term model.
Jim Kennedy – Unidentified Company
The other question relates to your international versus domestic business. I don’t think I heard earlier necessarily the growth rates internationally. Is there something unique about the footprint versus the domestic that allows one to grow faster than the other or are they comparable markets?
I think there is definitely localized competitive differences. I think the opportunity is there across most of those markets. I think the reason for our varied success has to do with some of the strategy we have evolved which is we have a much stronger brand presence in North America for example than we do in some of the foreign markets. As we improve the brand, improve our reference base and improve our sales in those markets I think the growth opportunities are probably greater in some of those markets. We are just starting from a much smaller point than we did in North America.
I was going to line up with those same comments. We do know some of the Asian markets, for example, are just massive and just being very straight forward we are still a relatively small company in the overall grand scheme of things and building brand in China, for example, is a massive investment one of which we are not prepared to take. We tend to be more rifle shooters in markets like that. I would look for GDP growth especially in both China and India, as an example, of being precursors to wherever we might spend more of our time.
As John said I think there is a spectrum of customers that know who we are, strongest here in the United States. Now quite strong in the U.K. and growing pretty rapidly in Germany, Italy and Southern Europe, least so since we just started the Asia Pacific initiative about almost two years ago. I do think you have to separate out awareness of those customers of Active Power to the overall economic GDP growth areas. You could say for example the GDP is going to grow fairly decently in both China and India yet our presence and awareness of those customers we wouldn’t be able to capitalize as significantly on those but we are gaining pretty good momentum. I just wanted to give you a little perspective on where I thought the growth was going to come from.
As I mentioned earlier on a previous question I do still think we are going to have about 40% or maybe a bit more total revenues in 2010 from international markets.
Jim Kennedy – Unidentified Company
This is my number, not yours, but let’s suppose you do double revenues over the next X years. I know it depends on the mix but what happens to your operating expenses? Is there some sort of ratio there? Again, I realize the service business is a bit different than the OEM business but again is there some sort of ratio there I should look for as your revenues go higher?
Long-term I talk about a 35-40% margin we look to a 10% operating margin. So that would give you some idea of what should happen to the operating expenses. We can significantly expand our top line business and you will see most of the investments we will need to make will predominately be in expanding the sales organization and our service organization to support that growth. So you would look to less increases in research and development and general administration. Those kinds of costs won’t grow proportionately. Hopefully that answers the question for you.
It appears we have no other questions in queue at this time.
Thank you operator. Thank you everyone that attended the call today. Thank you for joining us. We appreciate your continued support and I look forward to speaking with you again next quarter. Thanks so much.
This concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.
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