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Active Power, Inc. (NASDAQ:ACPW)

Q3 2010 Earnings Call Transcript

October 26, 2010 11:00 am ET

Executives

Jim Clishem – President and CEO

John Penver – VP, Finance and CFO

Analysts

Michael Legg – Merriman Capital

Dilip Warrier – Stifel Nicolaus

Matthew Crews – Noble Financial

Walter Nasdeo – Ardour Capital

Operator

Good morning, everyone. Thank you for participating in today’s conference call to discuss Active Power’s financial results for the third quarter ended September 30th, 2010. With us today is Mr. Jim Clishem, President and Chief Executive Officer of Active Power; and Mr. John Penver, the company’s Chief Financial Officer. Following their remarks, we will open up 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 fourth quarter and for fiscal 2010, its future operating results, and its customers’ current 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 deferral or cancellation of sales commitments as a result of general economic conditions or uncertainty, risks related to our international operations, and product performance and quality issues.

For more information on the risk factors that could cause actual results to differ from those forward-looking statements, please refer to Active Power filings with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the year ended December 31st, 2009 and its current reports on Form 8-K filed since then.

Active Power assumes no obligation to update any forward-looking statements or information, which are in effect as of their respective dates. I would like to remind everyone that this call will be available for replay online until November 9th, 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. Sir, please go ahead.

Jim Clishem

Thank you and good morning to everyone for joining us here today. Earlier today, we issued a press release announcing our third quarter 2010 results. I’m happy to report we achieved record revenues this quarter of $18.5 million; this was a 15% increase over our previous quarter and a 116% increase over the same quarter a year ago.

For the nine months ending September 30th, 2010, our revenues totaled a record $45.6 million, increasing 73% over the same period the previous year. In fact, in the first nine months of 2010, our revenues are already 13% more than our total sales for all of 2009. We are well on track for a substantial year-over-year revenue increase in 2010. This significant revenue increase drove several improvements in gross, operating, and net margins across the board. As a result, I’m pleased to announce that Active Power was successful in achieving its first ever net profit of $55,000 in its 18-year history.

This major milestone was accomplished through a great deal of hard work and very focused execution strategy to build a profitable business serving mission-critical clients. While the profit was small in the sense of what we look forward to generating in future quarters, this is nonetheless an important first step in our long-term plan.

Along with this significant achievement, it’s important to acknowledge that we also achieved record EBITDA of $826,000 or 4% of revenues. I believe it’s also worth mentioning here a few other highlights from the quarter to provide additional color on our results. We shipped 97 flywheels in UPS systems at an average selling price of $88,000 per unit, a $10,000 increase in our average selling price versus the same quarter a year ago.

We also achieved 7.4 million in revenue from the sale of continuous infrastructure solutions. We recorded 30% gross margins. We generated $31,000 in operating income compared to an operating loss of $3 million in the same quarter of 2009.

We received a large number of orders since the beginning of the third quarter, 77% of which came from existing clients and 23% from new clients, a very nice mix indicating both significant new customer adoption and recurring client satisfaction.

Now, I’d like to turn the call over to our Chief Financial Officer, John Penver, who will take us through the financial details for the quarter. I will then come back to discuss some of the market trends we’re currently seeing, why we continue to win in the marketplace, and to further articulate our strategy to grow revenue and profitability moving ahead. We’ll then open the call to your questions. John?

John Penver

Thank you, Jim. Good morning everyone. Thank you for joining us on the call today. As Jim mentioned, our revenue for the third quarter was a record $18.5 million, increasing sequentially by 15% and by 116% over the same quarter a year ago.

On a year-to-date basis and through the first nine months, our revenues were $45.6 million, which is 73% higher than the 26.3 million we had in the first nine months of 2009. We view this as substantial revenue growth under either measure. Revenue this quarter was favorably impacted by $7.4 million of revenue from containerized data center infrastructure that we manufactured for one of our IT partners. This enabled our partner to sell modularized data centers to their customers.

Now, looking at the breakdown of just our product revenue that was split as follows; UPS systems $8.4 million, continuous power solution $1.2 million, and continuous infrastructure solution $7.1 million.

The split of product revenue between these product families should be expected to fluctuate on a quarterly basis due to the size and the timing of orders. These orders can be infrequent but large and it will cause significant fluctuations in our quarterly revenues. For example, as aforementioned, very large order for continuous infrastructure solutions primarily drive the sequential increase in third quarter revenues. However, this quarter, we expect minimal revenue from this product group before we anticipate it increasing again in early 2011.

Revenue from continuous power solutions, which includes our PowerHouse product family can fluctuate quarterly due to the timing of the orders, and we anticipate this increasing again in the fourth quarter based on orders we have in hand that we will deliver before December. But, in the third quarter, this revenue was down by $3.5 million from the previous quarter.

Our UPS system revenue has been fairly consistent and just short of 100 wheels in each of the last two quarters. We anticipate this revenue to increase in the fourth quarter. We shipped 97 flywheels in UPS systems this quarter at an average selling price of $88,000 per wheel. This compares to 99 wheels sold in the second quarter of 2010 at an average selling price of $79,000 per wheel. And it’s up substantially from the 56 wheels we shipped in the same quarter a year ago at an average selling price of $78,000 per wheel.

The average selling price per wheel fluctuates due to a number of factors, including the mix between our OEM and direct sold units, as our OEM sales obviously come in at lower price per wheel. In addition, we’ve been in the process of fully implementing our CleanSource UPS’ Z Series product, which includes our new touch screen display and retiring our original E-Series product, which came without touch display at slightly lower selling price.

Our total UPS system revenues were up by 110% compared to the same quarter a year ago and were up 52% in terms of the nine-month comparison. Because the continuous infrastructure solutions revenue sold this quarter was for a large North American IT customer, our total revenues from the Americas represented 82% of our revenue during the third quarter. This compared to 69% of total revenue in the previous quarter and 40% of revenues in the third quarter of 2009. In fact, our revenues from the Americas were 335% higher than the same quarter a year ago and are up 92% through the first nine months of this year.

Our revenues from the EMEA market declined by 49% compared to the third quarter of 2009, primarily due to the timing of large PowerHouse orders. However, in the first nine months of 2010, our EMEA revenues are up by 18% as compared to same period of 2009, and this was achieved even while we are in the process of rebuilding our EMEA sales organization.

Revenues from EMEA were 13% of total revenue this quarter, which compared to 29% of revenue in the previous quarter and 60% of revenue in the same quarter a year ago. Our revenues from Asia, although still small and approximately 4% of total revenue this quarter, were up by 121% compared to the third quarter a year ago and up the same percentage in the first nine months of 2010.

Looking at our revenue by sales channel, we’ve seen year-over-year growth across all of our channels. Our IT channel revenues increased by 100% in the third quarter compared to 2009 and was 40% of our total revenue compared to 15% of total revenue in the previous quarter.

Direct sales, which includes sales made by Active Power directly or through its network of manufactures’ representatives represented 50% of our revenue this quarter. This compared to 60% of total revenue in the previous quarter and 88% of revenue in the same quarter one year ago. Through the first nine months of 2010, our direct sales revenue has increased by 44% versus 2009.

Sales from our OEM business, which includes sales to Caterpillar, decreased to 10% of our revenue in the third quarter from 26% of revenue in the second quarter and from 11% of revenue in the same quarter a year ago. This level fluctuates substantially based on the size and timing of orders from this channel, but the smaller OEM percentage is more indicative of the higher growth rate and the larger total sales of our direct and IT channels for the quarter.

Our overall sales from the OEM channel have increased 5% in the first nine months of 2010 compared to 2009. We have recently received a number of orders from our OEM channel that will ship during the fourth quarter. Therefore, we expect the annual increase in OEM revenues to be higher than what we achieved in the first nine months of 2010. We do expect the rate of growth in this business will be less than from our direct and IT channel business.

Our service revenues this quarter were down 35% from the previous quarter due to lower professional services, but were 13% higher than the third quarter of 2009. The level of professional services can fluctuate quarterly based on our sales mix. But, on the first nine-month basis, our service revenues actually grew by $1.8 million or 41% compared to the same nine-month period of 2009.

Our international sales were 18% of revenue in the third quarter compared to 31% of our revenues in the previous quarter and 60% of the third quarter of 2009. On a year-to-date basis, our international sales were 27% of revenues compared to 35% in 2009. Our gross margin this quarter improved to 30%, up from the 22% we recorded in the same quarter a year ago on much lower flywheel volume and the 27% margin we had in the second quarter.

The number of flywheels sold has historically been our primary barometer of our factory efficiency and gross company margin. As we broaden our product line, this metric loses its utility as a full indicator of company gross margin. For now though, the higher wheels compared to the prior year, with a higher proportion of continuous infrastructure solutions revenue, has driven improved margin performance due to better utilization of our personnel.

The margins on our service business declined this quarter due to a combination of the lower project revenues and higher expenses, as we continue to invest in the service organization to better serve our growing customer base. We anticipate service revenue margins to improve in the fourth quarter.

Our research and development expenses for the quarter were approximately $830,000 which was 2% lower than the previous quarter and 24% lower than the third quarter of 2009. This decrease in spending reflects lower product-related development this year. The prior year expenses included higher prototype and development costs paralleling our CleanSource UPS product. We do anticipate an increase in R&D expenses, as we add headcount and increase our product development efforts next year.

Our selling and marketing expenses of $3.5 million were flat with prior quarter and was 38% higher than the third quarter of 2009. This increase from the prior year was primarily due to higher sales headcount, especially in EMEA, higher variable sales compensation due to significant increase in revenues compared to 2009, over 116% increase, and from higher based – performance-based compensation.

General and administrative expenses of 1.1 million decreased by 25% from the previous quarter and were 9% lower than the third quarter of 2009. This primarily reflects lower professional fees and performance-based compensation expenses compared to the previous period.

As Jim mentioned, for the first time in Active Power’s 18-year history, we recorded an operating profit. While essentially breakeven on a per share basis, our operating profit for this quarter is $31,000, which compares to an operating loss of 1.5 million in the previous quarter and an operating loss of $3 million in the same quarter a year ago. We also had a small net income for the first time of $55,000 or $0.00 per share. This compares to a net loss of $1.5 million or $0.02 per share last quarter, and a net loss of $3 million or $0.04 per share in the same quarter a year ago.

On a year-to-date basis, our net loss of 4.1 million or $ 0.05 per share is a 54% reduction from the 8.8 million net loss or $0.14 per share we recorded in the first nine months of 2009. The change in cash and investments in the quarter, $1.3 million, was largely as we had predicted due to fluctuations in our working capital requirement. This was predominantly because of the increase in receivables caused by the continued quarterly revenue increase and from payments of accounts payable that had materially increased at the end of the second quarter for the continuous infrastructure solutions project.

On a nine-month basis, the net cash used in operations decreased by 54% to $2.5 million as compared to the 5.5 million we used in the first nine months of 2009. We successfully completed a new credit facility with our bank in August designed to afford us greater borrowing ability against our receivables, including certain foreign receivables, our inventory and even purchase orders. This credit facility has a much higher credit limit of $12.5 million and will allow us to respond to and finance larger orders without the need to raise additional equity or to dilute our cash reserves. The financial flexibility this gives us should support significantly higher quarterly revenue level of about $25 million per quarter without requiring additional funding.

Based on our current plans for the remainder of this year, the equity funding that we completed in the first quarter of this year, the new credit facility, and our experience with managing cash, we believe we have adequate cash investments on hand and available sources of liquidity to continue funding the growth of the business.

Our capital expenditures were not significant during the quarter. We’ve historically invested substantially in our manufacturing infrastructure and still have a production capacity far in excess of our current revenue level, so we can substantially increase production levels without needing to make any material capital investment. As a result, our capital expenditures will primarily support expansion of our service and our sales capabilities, and our marketing and promotional efforts as required.

During the quarter, we also received notification from NASDAQ that we were back in compliance with their minimum listing standard, following the increase in the trading price of our stock.

I’d like to add that our continued efforts with our IR firm, the Liolios Group, to expand awareness of Active Power in the financial community continues to bear fruit.

We recently received new research coverage from Merriman Capital analyst Michael Legg, issued through Merriman’s infrastructure technologies and efficiency group. Along with research coverage by Stifel Nicolaus and Nobel Financial added this summer and Ardour Capital continuing its long-term coverage, we have generated additional visibility that we believe will help management more effectively communicate information about our results, strategies, and positioning to the financial community.

This now completes the financial portion of the presentation. I will turn the call back to Jim for further comments. Thank you.

Jim Clishem

Okay. Thank you, John. And in taking a look at some of the key macroeconomic trends in the power infrastructure and data center markets, we do continue to see more mission-critical organizations gravitating towards innovatively designed data center and infrastructure solutions that offer less risk, less cost, less complexity, ultra-modularity and more automation. In this very cost-sensitive economic climate, end users are looking to save money on electricity and space requirements.

Additionally, these clients typically want to work with vendors who can broadly solve problems through aggregated solutions rather than having to seek out multiple vendors for various power infrastructure components. It’s all about convenience, value, accountability and lower total cost of ownership.

Just to paraphrase a keynote address at the DatacenterDynamics New York show in March of this year, Microsoft indicated the total cost of ownership within the data center environment is the single most important metric. To achieve the lowest TCO possible, the next generation data center and its associated power and cooling architectures will be built from pre-configured manufactured components that are pre-assembled and pre-tested for rapid delivery anywhere in the world.

According to Microsoft, the goal is to deliver pre-manufactured data centre solutions that can be shipped globally just in time and deployed twice as fast as much as 50% of the cost of a traditional brick-and-mortar approach.

Further, energy efficiency continues to remain top of mind for CIOs and data center operators, as energy costs are anticipated to be the fastest growing cost in data centers according to Gartner. In an article that published in late September in IT PRO, which is a UK-based online news outlet, Gartner believes energy cost will continue to rise as organizations expand infrastructure capacity to meet evolving business and IT demands.

Sustainable technologies for the data center market are also in demand. The green data center market will continue to grow, particularly as organizations and users become more reliant on cloud computing. To put numbers to this growth, Environmental Leader Insights predicts the U.S. green data center market will increase from roughly $3.8 billion at present to nearly 14 billion by 2015.

More to the point, 28% of the total data center market by 2015 will be made up of energy efficient data centers. This incredible growth in the green data center market comes as no surprise, as data centers make up 3% of the total energy used in the United States. If we consider just data center in telecommunication sectors alone, this technology is expected to require 2 billion kilowatt hours of energy by 2020 that will produce more than 250 metric tons of carbon dioxide annually.

Modular data center infrastructure solutions, lower TCO, higher energy and space efficiencies, green technologies, all of these market trends play right into the attributes inherent to the Active Power products and solutions; intelligently efficient, inherently reliable and economically green. These are tangible benefits that continue to resonate with CIOs, facility managers and data center operators as evidenced by the growth in the number of new and repeat orders we continue to receive, particularly from large high profile mission critical operators.

Specifically, we have received more than $18 million in orders since the beginning of third quarter. 73% of these orders were repeat orders from existing customers, with remaining 27% from new customers. These repeat orders validate our technology and its ability to offer customers tangible economic benefits, high energy efficiencies, small footprints, high reliability, low maintenance and a small carbon footprint.

We also believe this speaks volumes to the acceptance of our higher energy efficiency UPS systems and continuous power solutions like PowerHouse for mission critical applications across multiple geographies. Notably, none of our customer benefits come at the sacrifice of reliability, as our UPS systems are inherently reliable with more than 87 million hours of run-time in the field and proven to be seven times less likely to fail, according to a study by risk assessment firm MTechnology Incorporated. The fact that the UPS system is also environmentally friendly positions Active Power as a more compelling choice to conventional technologies.

Now, all of this said, it begs the question, what is our strategy to grow revenue and profit for the business in the years ahead. Well, to help answer that question, it’s important to note that over the last few months in particular, the executive team has been working diligently to develop and finalize a five-year strategic plan for Active Power.

We asked ourselves a lot of pointed questions such as, what does Active Power look like in five years and what new innovations, markets and geographies will the company be focused on, how do we want the market and our customers to perceive us, how do we best serve our clients with differentiation in economic value-add, and what products and solutions will Active Power deliver? More to the point, how are we going to execute this plan to take Active Power to the next level of a sustainable revenue growth and profit?

We presented this vision and comprehensive plan to the company’s Board of Directors in mid-September. I want to take a few minutes to share with you some of those highlights that we shared with our Board. In terms of near-term product innovations, we are now investing in the development of a next generation UPS system improving upon our existing intellectual property in core UPS technology. This system will allow us to compete in a higher percentage of larger power opportunities, particularly larger infrastructure projects that require high power densities. The system will offer the same inherent benefits that set us apart from other UPS and power infrastructure competitors, higher energy and space efficiencies, higher power densities, lower maintenance cost, reduction in our carbon emissions, configurable flexibility and of course lower TCO.

We anticipate introducing this product in the market in late 2011. Consistent with previous messaging, Active Power will market and sell, not just UPS systems, but modular infrastructure solutions uniquely designed for mission-critical customers. The product development team is exploring ways to develop and improve our continuous power and infrastructure products and services for a variety of applications, including facility infrastructure expansion, disaster recovery, business continuity, temporary critical power needs and event support, but also for a wide array of containerized data center deployments.

We are also pursuing the development and/or integration of various software systems and applications to enhance the operating information management environments for our clients. We will begin talking more about this vision in future quarters. From a market perspective, Active Power will key in on specific countries in the Americas, Europe and Asia Pacific regions for global distribution. We will not try to be all things to all people, but rather we will focus on key value-added initiatives in key markets, where we can profitably serve clients.

We will aggressively engage our direct, third-party, OEM and IT partner channels to increase visibility and grow share within these markets. Our strategic focus will be on mission critical IT applications operated by medium and large-sized enterprise service providers and what we like to call extreme scale IT customers. This strategy will enable us to focus on key markets, applications and geographies rather than pursuing opportunities that might not be as lucrative. We are truly at an inflection point as we build upon our core energy storage technology, having transitioned from selling a DC only flywheel system to our patented integrated flywheel-based UPS, to our continuous power systems and now continuous infrastructure solutions.

We intimately understand the UPS and critical infrastructure markets, but also the pain points our customers are facing in deploying mission-critical infrastructure. This strategic plan enables Active Power to leverage our patented technologies and core capabilities to directly address those pain points and customer demands. And this approach will effectively broaden our addressable market share and our addressable market fourfold over the UPS market alone. It will mitigate risk and expand our global revenue potential. Ultimately, this will take Active Power from a niche UPS supplier into a high growth and profitable multi-hundred million dollar a year business, as a leader in the continuous infrastructure solutions market.

Now, looking at the fourth quarter and 2010 expectations. For our guidance, we usually provide a range of revenues, as unforeseen customer events can impact the timing and amounts of revenue recognized for a particular quarter. Based on orders we have on hand and our current forecast, we anticipate sequential quarterly revenue growth this quarter.

That said, we are providing revenue guidance between 16 million and 19 million for the fourth quarter. This would represent an increase between 13% and 36% compared to the revenue level we’ve recorded in the fourth quarter of 2009. This would result in an annual revenue between 62 million and 65 million for 2010, an annual increase between 50% and 60% compared to 2009.

Based on projected sales mix, this would result in a gross profit margin of between 26% and 30%. At current operating expense levels, this would result in net earnings per share between a profit of $0.01 per share and a loss of $0.02 per share. It is likely we will achieve EBITDA profitability again this quarter and potentially continued GAAP net income profitability. The achievement of these results will depend on the realization of expected orders, products and channel mix and average selling price.

Operating expenses, excluding our variable selling expenses, should be fairly consistent with results recorded during the third quarter. Our cash used in operations will therefore be largely driven by our working capital requirement during the quarter and will be affected by the timing and size of orders we fulfill this quarter. We will continue to utilize our banking facility and manage customer and vendor cash flows appropriately to mitigate cash requirements if possible.

Thank you for being on our call this morning, and on behalf of the entire senior management team and our Board, I’d like to express our appreciation for the continued support of our customers, our employees, stockholders as we work to continue the profitable growth of our company.

Now, at this time, John and I would be happy to open the call up for your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Sir, I now have Michael Legg with Merriman Capital. Michael Legg, your line is now open.

Michael Legg – Merriman Capital

Great. Thank you. Congratulations on the great quarter. A couple of questions. When you are out in the market competing against other competitors, what are you hearing as far as the reason you’re winning contracts and the reason that you’re not winning them?

Jim Clishem

Yes. Michael, I’d tell you that we’re really winning on the basis of economic benefits that result from our higher efficiency, both space and power, so saving people money on electricity and space. We also find ourselves winning in areas where our modularity and being able to expand the systems, not only quickly but in chunks of power that is rightsizing for the customer so they don’t have to overbuy, I think is another key component. And I also think that we’re winning because of some brand halo effects that we’re getting, not only with the resurgence again of Caterpillar, but some of our IT partners as well. So it’s opening up some new markets and bringing some, if you will, credibility to the marketplace that is helping us penetrate and win.

Michael Legg – Merriman Capital

Okay. And when you lose, what are you hearing?

Jim Clishem

Yes. When we lose, I would tell you it is probably for the same reasons. In some cases, people may not know Active Power well enough yet. Of course, we’ve made some tremendous inroads, as you know, in that. And I think also for the extreme large power applications, which you probably heard me say earlier in my comments here that our new product line that we’re developing is in fact to address that.

So, when customers want very large buckets of power, Active Power sometimes cannot play or lose those opportunities. So where we’ve got, say, 10, 20, 50 megawatt opportunities that we are now being invited to participate in, it takes more of our systems to equate to that kind of power. So, by increasing power densities and also larger power instances of our products, we think we’ll capture those, which will drive us further up in those new power categories. And why that’s so important is because, again, back to power efficiencies and space efficiencies, the larger the power opportunities, the more absolute dollars we really do create for our customers in savings on electricity and certainly on real estate.

Michael Legg – Merriman Capital

Okay. Couple of questions on the revenue, you mentioned sequential quarterly revenue growth when you gave guidance of 16 million to 19 million. Were you talking year-over-year, or are you talking fourth quarter up from this year’s third quarter?

John Penver

We are talking up from the third quarter, Michael. This is John. We do provide a range, but we always like to add a little caveat, and based on orders we’ve got on hand, we anticipate fourth quarter being sequentially higher than the third. But, there is always a risk of customer-driven events that could influence particular transactions.

Michael Legg – Merriman Capital

Okay. Along those lines, you mentioned since the beginning into the third quarter you’ve had 18 million of bookings, can you – how much of that was captured in the third quarter and how much of that remains?

John Penver

I don’t have the exact number in front of me and we tend not to break that out. But, we’ve got orders that go out into the first quarter. So, a large portion of those orders that we’ve received would be for fourth quarter and first quarter deliveries. I think very little of it would have been included in the third quarter, because we came into that with a very strong order book.

Michael Legg – Merriman Capital

Okay. And just one last question, I’ll get back in the queue. On the G&A front, you obviously had a very good number there, is it – can we expect that to continue or should we get back to more of a historic rate?

John Penver

I think it’s going to be between $1.1 million and $1.3 million is kind of the range. Professional fees fluctuate for a bunch of reasons from recruiting, guidance with strategic planning, financing transitions with a bank or equity, things of that nature. There is not a lot of those activities going on right now, which is why it came down, and I think fourth quarter will be somewhat comparable to the third quarter.

Michael Legg – Merriman Capital

Great. Thank you. Congratulations.

John Penver

Thanks, Michael.

Operator

Our next questioner is David Warrier [ph] with Stifel Nicolaus. David Warrier, your line is now open.

Dilip Warrier – Stifel Nicolaus

Hi, it’s Dilip Warrier.

John Penver

Hi, Dilip.

Jim Clishem

We knew who you were.

Dilip Warrier – Stifel Nicolaus

That was an interesting variation, but – now, congratulations on the quarter. As you look into 2011, is it fair to say that the majority of growth you’re looking at would be more from the PowerHouse and containerized infrastructure solutions business versus sort of your core UPS business? And part two to that question is, do you see the PowerHouse kind of an – the infrastructure business going international in 2011, and what sort of visibility do you get from your IT channel partners here?

Jim Clishem

Yes, great questions, Dilip. So first, we do in fact see a propensity of growth and this is why I think John stated the way he did that traditionally, you look back at our business and the average selling price and the wheel count alone gave you a pretty good indicator of overall company gross margins. But, the rate of growth that we’re seeing in the solutions business where we are taking our products, our intellectual property that is really around the high-efficiency UPS, and now driving this towards PowerHouse solutions and continuous infrastructure solutions, we’re getting a couple of really interesting dynamics out. And one is we’re driving more what probably will be in 2011 pulling more UPS product with that. Because whereas packaging a solution, it has to – in its integral form has to have a UPS with it, so we’ll be driving more and more UPS with that.

Secondly, if you look at this growth of continuous power solutions versus UPS alone, it’s about a four to arguably five times larger market to do that. And so, our revenue opportunity in expandable market is, it really does grow globally four to five times larger than the UPS business alone. UPS business in our addressable share is about $1.7 billion year business. This is easily four to five times that and we’re – and you saw that even in our Q3 results, with 82% of our North American revenues being driven largely by, not only the UPS sale, but the infrastructure solutions sale. So, I think you’re going to see that not only continue, but that will accelerate. We will see dramatic growth I think for us in 2011 resulting in that. John, would you like to add anything to that?

John Penver

I’ll add one another comment. Certainly, in some of the international markets, the customers historically have purchased solutions, so they’re often looking for an integrated solution anyway. And so, I think you’ll see that that product type will go. That said, we still have a substantial number of large technology based customers who just want to buy the UPS systems from us, and so we are still seeing substantial growth in just that core UPS business. So, we anticipate growth from both sectors going forward.

Dilip Warrier – Stifel Nicolaus

Got it. And just in terms of visibility, I think typically you (inaudible) some visibility on the core business perhaps six to nine months. On this newer solutions business, does it add to visibility, does it perhaps add a little bit of uncertainty there that’s because of the lumpiness?

Jim Clishem

Yes, the lumpiness definitely adds to the reason why we do tend to give those ranges on our revenues. That being said, your other question – point of your question was about visibility, and I can tell you that the, both, not just brand halo, but the IT marketplace is very, very interesting to us and I think we’re about – there is not that other UPS companies don’t sell into IT-related distribution. But the selling that they typically do are component level selling.

What we’ve done is we’ve approached this more on the professional solutions side of the IT partners where they are in their selling solutions as part of their offering, which would include data storage arrays, it would include software engagements, professional service engagements. And under those, we have a lot of visibility into some fairly large clients and getting into quite frankly clients that we otherwise wouldn’t get into by ourselves.

So, we have good visibility through their pipeline. We have a – every single, for example, containerized data center infrastructure, in particular for one of our IT partners has with it the opportunity to sell a PowerHouse along with it, because you don’t sell containerized data centers without the infrastructure to go with it, which is of course power and cooling. So that visibility is actually quite good. We currently have about a nine-month window and I think that would be consistent with what we’re seeing through the IT channel partners as well.

Dilip Warrier – Stifel Nicolaus

Got it. One more question, ASPs of – on the UPS side of about 88,000 this quarter, up 10%, I understand it has a lot to do with mix, but kind of based on your outlook of Caterpillar business versus other business, is the 80s kind of number a sustainable number over the foreseeable future?

John Penver

Yes. I think that’s a fairly reasonable assumption, Dilip. That’s really the two key drivers. We’ve made some product changes that affected pricing, the sales mix seems to be the bigger determinant, how much is up the straight UPS is going through the OEM channels.

Jim Clishem

All right. Dilip, I’ll just add to that. I think John does a pretty good job of kind of segmenting out the ASP for the pure play UPS sales. Realize that when we throw a UPS inside one of our solutions sales, the average selling price goes way, way, way up. And so, John is not distorting those numbers. When he gave those numbers to you, it’s the pure UPS sale ASP.

Dilip Warrier – Stifel Nicolaus

I got it. Thank you.

John Penver

Okay. All right. Thanks, Dilip.

Operator

Matthew Crews with Nobel Financials. Matthew Crews, your line is now open.

Matthew Crews – Nobel Financials

Hi. Yes, thank you. Good morning, everyone.

Jim Clishem

Good morning.

Matthew Crews – Nobel Financials

On your – could you just describe a little bit more – any more detail on the next generation, you mentioned the product on your strategy plan, are you increasing the power rating on those flywheels, or are you sort of – what’s the next gen sort of advantage?

Jim Clishem

Yes, a great question. We are in fact increasing the power level. We are increasing power density as a result as well. So, when you take – and we’re leveraging our core intellectual property, our patents that we have on that integration of the energy storage with our power electronics to create larger scale.

So, let me give you an example which ties back to the comment, I think, I gave a moment ago as to where we see an opportunity to win larger power deals that maybe we are not in today. So, when you do a 10 megawatt, for example, installation, that requires 40 of our wheels to accomplish that goal. That means there is also redundancy and cost from inverters and other power electronics and certainly energy storage that has to be repeated. So, when you get – when you know our priority that you’re going to be in much higher power applications, you can then start to consolidate both power electronics, getting cost out and increasing quite frankly reliability as well, because you’re – you have fewer components across and you would increase the energy storage.

And so, we’ve done a great deal of work looking at how far we can take the technology we’ve developed, we think there is some great upside, and it would be in two areas. Again, as you just pointed out, increasing the raw energy storage and therefore the density that you can get and then of course consolidation of power electronics as well at higher power levels will give us a per unit decrease in our per unit of kilowatt or megawatt cost delivered. So, we think it’s going to be a win-win.

Matthew Crews – Nobel Financials

That’s helpful. In terms of the market opportunities, could you describe how much larger market opportunity you had opened yourself up to that you wouldn’t otherwise be as competitive with?

Jim Clishem

Well, I guess, I’ll give it to you sort of this way. Of the addressable share that we know exists today, and which is about 1.7 billion, we are giving an estimate right now of somewhere north of 62 or so, 64, $65 million. So, there is a lot of further opportunity here for Active Power, not only to steal existing business, but to capture that larger share. And that by the way, that $1.7 billion figure I give you is 250 kVA and above, and the market resource that we have analyzed suggests that the higher power applications, let’s say a megawatt and above, are growing at much faster compound annual growth rates – double-digit compound annual growth rates even in today’s economy. So, those are all pointing to what we think are smart decisions to move our technology into bigger power and to really focus on that upper end of that $1.7 billion market.

Matthew Crews – Nobel Financials

Last question, just trying to understand when you’re, from a sales force perspective, selling containerized infrastructure solutions, is this with the direct sales force? Are you kind of taking out the middleman in terms of you have a total sales package and you can go in and sell that all on your own? Is this a better way for you to penetrate new costumers versus relying on the tradition – third engineering firm?

Jim Clishem

Yes and no. Yes, it is for those customers that like pre-engineered packaged solutions and those would be characterized more by the IT client channel that we have. In the traditional facilities channels, we are finding that our contracting and consulting engineering firms across the globe are beginning to look at these containerized power systems that in fact could be in a container or, if you will, could even be in a building, just assembled all as one continuous solution. Either way, they’re looking at that – beginning to look at that more as building blocks, just the way they used to look at a UPS alone being a building block. So, when you do a continuous power system of switch gear, generator, UPS, and we’ve developed some software also that integrates all that, provides some information at a higher level of value-add, that becomes a building block even for the consulting contracting engineer. So, we have seen it work both ways.

Matthew Crews – Nobel Financials

Okay. Thank you very much.

Jim Clishem

Welcome.

John Penver

Thanks, Matthew.

Operator

Walter Nasdeo with Ardour Capital. Walter Nasdeo, your line is now open.

Walter Nasdeo – Ardour Capital

Thank you. Good morning.

Jim Clishem

Hi Walter. How are you?

Walter Nasdeo – Ardour Capital

I’m fantastic. Thanks. This is – a bunch of my questions have already been answered. But, one of the things that I would like to touch on is, you mentioned the EMEA was down quarter this year. And I would like to get a better understanding of what your plan is to build growth over there. And if you could explain a little bit the sales cycle in Europe as opposed to here, what the major differences are and what the challenges may be?

Jim Clishem

Sure. Yes, let me take a try and then we’ll have John chime in too. I think we both have perspectives on that. So, in EMEA, we’re making a very concerted effort in growing, and the two largest markets, let’s take Europe first, are really the UK and Germany. And there is sort of a dark trading area around Germany, which includes of course Switzerland and Austria. We have very proactively begun to insert additional, both sales, service and some support capabilities, in the German and now also adding more into the UK marketplace. So, those investments we’re making now, we believe will continue to produce and that’s all along the direct side, Walter.

On the channel side of things, the IT channel particularly for us has been dominated in the North American market as they have rolled out sort of more domestically to keep things close, to improve the product. And I think you’re going to see next year, both from Active Power and our IT channel partners, a little more push into the European and Asian marketplaces. There is already plans that I’m aware of that’s – so it’s about rolling it out a little bit more which I think will help the EMEA market. We also, as you probably remember Walter, we put a new VP of Sales in place a little over a year ago now. And we are doing some business development activity there, much the same way we did here domestically, that we believe will produce additional channels of distribution in both Europe and in Asia.

John pointed out in his comments I think in the script that we’ve just sort of walked through that the Asia marketplace has percentage wise grown pretty dramatically. However, it is still largely small; we think there is a huge opportunity there. You know from our past release that we put a General Manager in place in China; we’ve been in China for over two years now. We’ve also have now formed relationships both for distribution and also for solutions selling and a little bit of our supply chain also in the Chinese market to facilitate PowerHouse as well as some of our infrastructure products. So, I think you’ll see more of that as they are just – I think they are phase shifting in time a little bit. Maybe on that point, I will stop and let John add anything that he might want to add to that.

John Penver

Yes, Walter, I would comment that in the European market, we certainly don’t have the same level of brand awareness, and I think that’s an inhibitor to performance, and our ability to recruit the talent and skill sets that we want is an operating challenge. And that’s why you see the lumpiness in our results. So, in our third quarter a year ago, EMEA was 60% of revenue. This quarter, it will be up again, but it’s been very lumpy. And so, we’ve got to increase our scale to offset that lumpiness, as Jim put it. And instead of trying to cover 14 countries across the continent, we’ve made a conscious effort to focus in a couple of significant markets. Actually, we’ve got technical support, sales support, service support in those markets and start marketing to build our brand in those markets, and I think that will bear fruit and we’ll continue to increase the team.

And then Jim alluded to doing the same thing in Asia. We’re a little further behind the curve, but we only recently opened up our office in Beijing, are expanding our sales force down there. I think that growth opportunities long term will come from Asia and come from Europe for the company. And I think that, if you look at our long-term picture, you’d expect a more even distribution of revenue from those three territories, but a small American company trying to expand in foreign markets takes time and money, and we’ve had to mitigate that with an eye on profitability at the same time.

Walter Nasdeo – Ardour Capital

Okay. Are you expecting to do much assembly type work in either of those locations?

John Penver

Yes.

Jim Clishem

Okay. Well, we already are. We’ve had several PowerHouse deliveries in China. We have vetted a pretty good supply chain there. Of course, the UPS product is being both designed and built here in the United States, but then it gets integrated either for European distribution in our UK facility or now we’ve got few partners in place in China where we’re doing distribution, but more as you pointed out, integration and assembly there. So, we already are taking that and it helps to mitigate some of the currency risk as well, as you quite well are aware of. John, you were going to add....

John Penver

Yes. That was going to be my comment, Walter, was that we already have capability in Europe, in the UK and Germany to build continuous power and infrastructure solutions, and we’ve added that capability in China as well. So, we probably haven’t emphasized that point in the past, but we’re already there.

Walter Nasdeo – Ardour Capital

Okay, very good. Thank you.

John Penver

Thanks, Walter.

Operator

Matthew Crews of Noble Financial. Matthew Crews, your line is now open.

Matthew Crews – Nobel Financials

Yes, just a follow-up question. Did you – can you give any sales figures, actual employee sales headcount? You usually disclose it on the Ks, but just some trends on that and hiring?

John Penver

Matthew, I don’t have the actually headcount in front of me. I can tell you the trend is that it has gone up. It’s probably a bit of a rebalance, but I believe we kind of include our service folks in the whole sales organization umbrella and that number was running around 48 to 50 people. I will get that and provide it to you though.

Matthew Crews – Nobel Financials

Okay, thank you very much.

John Penver

All right, thank you.

Jim Clishem

You’re welcome.

Operator

I have no other questions in queue.

Jim Clishem

Okay. Well, again, I want to thank you for joining us today and we obliviously appreciate your continued support and look forward to speaking with you again next quarter. Thanks again.

Operator

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

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