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Executives

Doug Milner - President & CEO

John Penver - CFO

Analysts

Carter Dunlap - Dunlap Equity Management

Active Power, Inc. (ACPW) Q3 2012 Earnings Call October 30, 2012 4:30 PM ET

Operator

Good afternoon, everyone. Thank you for participating in today’s conference call to discuss Active Power’s financial results for the third quarter and nine months ended September 30, 2012.

With us today is Mr. Doug Milner, President and Chief Executive Officer of Active Power; Mr. John Penver, Chief Financial Officer and Mr. Steven Fife, Vice President of Finance. Following their remarks we will open up the call for questions. Then, before the conclusion of today’s call, I’ll provide the necessary cautions regarding forward-looking statements made by management during this call. I would like to remind everyone that this call will be available for replay via Active Power’s website at www.activepower.com.

I would now like to turn the call over to President and Chief Executive Officer of Active Power, Mr. Doug Milner. Sir, please go ahead.

Doug Milner

Thank you, operator. Good afternoon, everyone, and thank you for joining us today and for those gratefully could join us today after the storm that just hit the East Coast. Steve Fife, Vice President of Finance is sitting in with us today; who as we announced earlier this month will step in as CFO for John Penver on November 1st. Steve adds tremendous value to Active Power given his background and numerous accomplishments in building effective finance and accounting functions from small to multi-billion organizations across a number of industries. We are excited to welcome Steve to the team.

I would also like you to recognize John Penver in his role as CFO. John has been a tremendous help in making this a smooth and seamless transition. We are very grateful to John for his nearly eight years of service and valuable contributions to the company. He has helped set the stage for the strong future growth of Active Power.

And now some comments on the quarter. We issued a press release earlier today announcing our results for the third quarter and nine months ended September 30, 2012. Overall, we continue to make solid progress on the key priorities we have talked about over the last few quarters which in sum represent a return to the fundamentals and core of our business.

We executed well against our go-to-market strategy and strengthened our UPS business. In fact, we have seen consistent productivity improvement within our sales organization. This was demonstrated by a nearly 10% increase in UPS sales on a year-to-date basis versus the (inaudible) increase versus the third quarter of last year. This in combination with lower operating cost enabled us to achieve the top-end of our guidance.

Before we go further, I would like to turn the call over to John to give us the financial details about the quarter. I’ll then come back to talk about our path forward as a business and provide a high level view of our strategic plan and outlook and also share some of the details around our upcoming new product offering.

Now over to the numbers; John?

John Penver

Thank you, Doug. Good afternoon everyone and thank you for joining us today. Revenue totaled $19.6 million for the quarter. This was a decrease of 9% sequentially and a decrease of 5% from a year ago quarter. However, it was very close to the top-end of our guidance for the quarter which we said at $17 million to $20 million.

Revenue in the third quarter included $17.1 million of UPS related solutions and services, representing 87% of that total revenue in the quarter. Looking at the first nine months of 2012, our revenue increased by 7% to $61.1 million versus the same period in 2011. This indicates that we're well on-track to achieving another year of record revenue.

Beginning this quarter, we've changed how we present the split of our product revenue. This is because over the last year, we've been seeing products and solutions evolving within the Modular Infrastructure Solutions Business, the inter-change of items like our infrastructure solutions sold with or without power quality and protection equipment continues to vary by customer.

So we have begun to look at the total modular data center market as a single opportunity for Active Power. This has led to a change in how we present our sources of product revenue and reducing it into two basic categories; UPS systems and Modular Infrastructure Solutions or what I’ll refer to as MIS. MIS combines what we previously reported separately as Continuous Power Solutions and Infrastructure Solutions.

So looking at our total product revenue of $16.6 million, $14.8 million was from our UPS systems business and $1.8 million was from our MIS solutions. This $14.8 million includes an unusually high proportion of ancillary equipment related to the completion of a large integrated system deployment in the third quarter. Excluding this ancillary equipment, UPS product revenue was roughly flat to second quarter levels and as Doug mentioned, our UPS systems revenue was up by 51% or $2.9 million from the third quarter of 2011, driven by large UPS sales in Europe and Asia and strong growth from our OEM partner compared to the prior year.

However, our MIS solution revenue was down by 83% or $9.1 million from a year ago, largely to the absence of large continuous power system sales this year from our IT partners. This reflects the inherent variability in our modular data center business lines where large value and low volumes of transactions can quickly cause large fluctuations in quarterly revenue.

Looking at our revenue by geography; our revenue from Asia this quarter was $2.2 million, up by $1 million or 90% from the previous quarter, up by $1 million or 85% from the third quarter of 2011. Revenues from Asia comprised 11% of our total revenue for the quarter compared to 6% of revenue in the third quarter of 2011.

For the first nine months 2012, our revenue from Asia was 8% of our total revenue compared to 10% in 2011. And in absolute dollar terms, our business in Asia was $4.9 million in the first nine months 2012 compared to $5.6 million in the same period of 2011.

Now revenue from Europe was $9.5 million, up by $4.1 million or 77% from the previous quarter, an increase by $7.1 million or 295% compared to the third quarter of 2011. Revenue from Europe was 48% of total revenue in the third quarter compared to 25% in the previous quarter and 12% of revenue in the third quarter of 2011.

For the first nine months 2012, our revenue from Europe was 32% of total revenue as compared to 26% in 2011. And in dollar terms, our revenue from Europe was $19.6 million in the first nine months of 2012 compared to $14.9 million in 2011.

Revenues from the Americas of $8 million decreased by $7.2 million or 47% from the previous quarter, was $9.1 million or 53% lower than the third quarter of 2011. This is primarily attributable to lower continuous power solution and infrastructure solution sales through our IT channel. So revenue from the Americas was 41% of our revenue this quarter compared to 70% in the previous quarter and 83% a year ago.

And for the first nine months 2012, revenue from the Americas was 60% of our total revenue compared to 64% in 2011. And in dollar terms, our business in the Americas for the first nine months of 2012 was $36.6 million, which was flat compared to $36.7 million for the same period of 2011.

In total, international sales was 66% of revenue in the third quarter, compared to 35% in the previous quarter and 20% in the third quarter of 2011. In terms of service revenue it’s important to note that this revenue will fluctuate with our product revenue as well as the amount of installation and now that potential services performed on larger projects. In total service revenue was 15% of our revenue in the third quarter, compared to 19% of revenue in the previous quarter and 18% of revenue a year ago and due to lower MIS solutions business activity. In absolute dollar terms, our service revenue of $3 million increased by $0.7 million or 18% from the third quarter of 2011.

Now continuing down to income statement, our gross margin this quarter was 29%. This is an increase from 24% in the third quarter of 2011 and a decline as anticipated from 36% in the previous quarter. These variances in gross margin are typical and driven by the mix and timing of our revenue. So for the third quarter of 2012, we had a large decrease in infrastructure revenue that was offset by the sale of third party UPS ancillary equipment during the quarter. And this resulted in a sequentially quarter decrease in margin.

Research and development expenses for the quarter were approximately $1.3 million, which declined by $107,000 or 7% from the previous quarter and was up by 53,000 or 4% versus the third quarter of 2011. These expenses were driven by investment and next generation UPS products that will be introduced to market later this year. Sales and marketing expenses at $3.4 million were 12% lower than the previous quarter and were 2% lower compared to the third quarter of 2011. This was primarily attributable to reduced headcount and lower variable compensation expenses.

Our general and administrative expenses of $1.7 million were approximately $250,000 or 13% lower than the prior quarter or approximately $410,000 or 32% higher than a year ago. In total, our operating expenses of $6.5 million for the quarter decreased by approximately $800,000 or 11% from the prior quarter. This included approximately $200,000 of expenses associated with the restructuring initiatives we announced on our last call, and we anticipate future annualized savings of $1.8 million from these initiatives. Our net loss for the third quarter of 2012 was $847,000 or minus $0.01 per share. This compares to a net income of $490,000 or $0.01 per share in the prior quarter and a net loss of $1.3 million or minus $0.02 per share in the third quarter of 2011.

For the first nine months of 2012, the net loss was $1.5 million or minus $0.02 per share, which is a 60% improvement from the net loss of $3.8 million or $0.05 per share in the same period of 2011. The changes in our balance sheet since the prior quarter were heavily influenced by the timing, shipment and value of our customer orders and the associated supply chain cash flows. This is typical for our business.

Our receivables increased by $0.6 million or 3% from the prior quarter, our inventory increased by $437,000 or 5% due to higher infrastructure product inventory that we anticipate shipping in the fourth quarter. The deferred revenue balances increased due to the timing of customer payments relative to shipments and our payables decreased by $2.5 million due to inventory received from the end of prior quarter that did not recur in this period. These changes were offset by a decrease of $1 million in vendor prepayments in connection with MIS Solutions orders.

During the quarter, we extended our revolving credit facility for a further two years, and we did believe we currently have adequate liquidity to continue supporting the growth of the business.

So this completes financial portion of the presentation and I will turn the call back over to Doug.

Doug Milner

Thank you, John. The third quarter was a critical quarter for us, as we work to deliver more balance results among our different product lines with an emphasis on Active Power’s core UPS and PowerHouse products. The strong growth in our UPS business during the quarter helped to offset a period of lower demand for our infrastructure products and PowerHouse in particular. We also saw continued strengthening in our service margins during the quarter, a key contributor to improving our profitability.

I would now like to provide some insights in to our overall vision for the business moving forward. Our vision centers on the fact that Active Power will be the solution of choice for global innovators, who operate the world’s largest and most mission critical data centers. To accomplish this vision, the business required a new strategy, which myself and the management team have worked to develop over the last two quarters. This plan is squarely focused on building a foundation to achieve consistent profitability. Our strategic plan supports this vision and is made up of three core elements.

Number one, product innovation that capitalizes on the unique strength of our base of intellectual property and enhances our value proposition of delivering solutions that are efficient, reliable and green. Number two, implement lean operations and optimize our supply chain to drive value for both the business and for our customers. And number three; create partnerships that help broaden our market opportunity, but also solve our customers toughest problems.

First, we have already begun laying groundwork for future generations of UPS platforms that uniquely suit the needs of today’s and tomorrow’s data center. We want to ensure their operating needs will be fully supported in innovative, efficient and cost effective ways. In addition to announcing the launch of our newest generation UPS product later this quarter, we will also introduce the first models in a line of newly redesigned PowerHouse Solutions. Our PowerHouse line will offer low acquisition costs, faster deployment and best-in-class controls and monitoring software.

Secondly, the introduction of lean continuous improvement tools into the company’s operations has commenced. The senior management team has completed its first round of lean training, and we have initiated the first of a series of planned Kaizen programs in the factory and earlier today met with our top 20 suppliers to ensure that they are fully aligned with our strategic plan going forward.

Also in terms of improving operations and based on increased demand, we are adding resources to support the growth of our field service organization. We are also expanding our service capabilities to help customers get the most value from deployment of our products. The success of our service business is a key element to improving profitability. We continue to focus on aligning resources with our most promising opportunities. This includes making investments in key geographies and in critical skill sets, particularly in our technical and market organizations.

Lastly, partnerships with leading companies in the data center space will play a vital role in expanding our market opportunities. We are developing partnerships now that not only provide new business opportunities, but new technical and product capabilities that will help further differentiate our products in the market. We anticipate beginning to announce these new partnerships in the fourth quarter. With this important phase of our strategic planning process behind us; Active Power has now focused on putting the key foundation elements in place, so we can successfully execute on our go-forward plan.

Our market opportunity is large and we continue to gain traction with the most forward thinking customers in the data center market. For example, we announced in early August Stanford University selection of our CleanSource UPS for its new Stanford Research Computing Facility. This facility supports both the university’s computing infrastructure and the SLAC National Accelerator Laboratory. This facility is designed focused on high efficiency and environmental sustainability, and we were able to meet the universities needs on both accounts with no sacrifice to reliability.

One of the more significant deployments in the quarter was a 1000kVA CleanSource system at one of the largest co-location data center facilities in China. This installation is one of a number of high profile UPS projects for Active Power at some of the largest data center facilities in China.

In March, for example, Active Power installed a similar system in a large cloud based data center in a province in West China. We believe we are well positioned to leverage this increasing trend toward large scale data centers in China with the product set that delivers industry leading energy and space efficiencies with high reliability.

To put numbers to this opportunity, the cloud competing market in China is anticipated to reach nearly $19 billion in 2013, compared to 2010 levels at nearly $3 billion, with a compound annual growth rate of 92%. This according to cloud competing strategy research report released by CCID Consulting, a China based research consulting in IT outsourcing services firm in the second quarter.

Lastly, as I mentioned earlier, we will introduce to market our newest GPS product at the 7X24 Exchange Fall Conference in Phoenix on November 12 at DatacenterDynamics London on November 14th and after that the product will be introduced in China at the DatacenterDynamics Beijing meeting on December 11th.

These three industry events are well respected and attended by key decision makers and influencers in the data center space making them ideal product launch venues. Following market introduction and customer testing, our newest GPS products will be available for field deployment in the second quarter of 2013.

Now turning to our fourth quarter expectations and full year performance, for our guidance we usually provide a range of expected revenue as many of our customer projects are large in dollar value and as such changes in customer needs and unforeseen customer events can impact the timing and amount of revenue recognized for a particular quarter.

Based on the orders we have on hand and our current view of customer demand, we are providing revenue guidance of $17 million to $21 million for the fourth quarter of 2012. This would result in full year 2012 revenue of $78 million to $82 million and as John indicated would represent another record year for Active Power.

Fourth quarter earnings per share is expected to range between breakeven to $0.02 per share. This would put us at breakeven to $0.01 per share for the year resulting in a substantial improvement over 2011.

With that we would be happy to open up the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We have a question from [Bill Dawkins].

Unidentified Analyst

I have actually been following your company for some time. I was introduced to this by actually [Leo’s Group] and actually have not made any money with it so far but you do seem to have a grip on what's going on going forward. My question really is very simple, with the current facilities that you fellows have what can your revenue ramp to?

Doug Milner

I mean, first of all, we have capacity to do far above the revenue that we are producing today and that we highlight that feature in our quarterly earnings results and in our annual report and so we feel that this business in the current configuration can support upwards of $200 million in revenue with the footprint that we have, not necessarily with the capital investment that we have within the building but with the footprint we have here today, we can support a substantial upside in revenue.

Unidentified Analyst

Without too much more investment?

Doug Milner

Yeah, the CapEx would be minimal.

Unidentified Analyst

And then just a question coming out of the blue, of course the devastation of the storm in the northeast opens up that same question, I live in the south and so we deal with hurricanes and tornados and everything but does Active Power just out of curiosity, can you all build units that would move more downstream towards the consumer level?

Doug Milner

Well, the opportunity for us is in the large datacenter market. We are, built our strategy around really going after the datacenter market globally and probably if you get down into the individual consumer level, we probably don’t offer the best efficiencies using a flywheel energy storage device. It's also a totally different distribution plan, different distribution system, different cost point and different manufacturing strategy. So, we can scale down somewhat but our target remains large datacenter opportunities.

Unidentified Analyst

Just out of curiosity, didn’t come on this group, but even my main question was what you could ramp to without too much investment. That’s very much interesting. Thank you very much.

Operator

Thank you. Our next question comes from Carter Dunlap [Dunlap Equity Management]. Your line is open.

Carter Dunlap - Dunlap Equity Management

Can you spend just a minute on trying to help me understand how you get the big datacenter decision maker sort of over the hump from your approach versus all the traditional two vendors or three vendors that they go to and all the service that goes out the door for those folks?

Doug Milner

I mean, specifically related to flywheel versus battery?

Carter Dunlap - Dunlap Equity Management

Yeah, I mean as I understand, you have a footprint advantage but I mean it seems like on the face of it, you have a huge inherent advantage and yet you know, I mean as much you are making headway, the market isn’t exactly falling over adopted. So I mean, what's the proof of concept or what is it, when you get to like a Stanford, what is it that they got that you sell?

Doug Milner

They got very high operating efficiency with superior protection. They got the reduced requirement for batteries, much smaller and batteries bring with them by the way not just the space that they use and the issues of reliability, but they also bring cooling and maintenance and other expense that goes along with it. And so they were able to, they selected us on the basis of footprint, total cost of ownership overtime which is a direct result of the combination of lower operating expense and lower maintenance requirements. And we fit nicely into their architecture of the flywheel taking care of 98%, 99% of the everyday power problems with generators being used to provide ongoing power to the facility if they were continued or in extended utility outage which is rare.

Carter Dunlap - Dunlap Equity Management

So, is it just, would you called it inertia, market inertia and what has been in place?

Doug Milner

In terms of limiting our growth?

Carter Dunlap - Dunlap Equity Management

Yeah, I am just trying to understand at a sales and marketing to whoever the high level decision maker is, what on a piece of paper as you guys have presented it in meetings with me, it seems like a slammed dunk.

Doug Milner

Right.

Carter Dunlap - Dunlap Equity Management

And yet people are still buying big large battery forms that have to be replaced and maintained and cooled and other things you said, so I am just trying to figure out what do you think needs to be explained they are just accelerate?

Doug Milner

Well number one, I think the changes in datacenter architectures is what is driving a more appropriate fit or a more beneficial fit for the Active Power product. The UPS specification of 15 minutes of battery ride through can be tied back to I believe sometime in the early 80s in IBM mainframe specification and it has become the de facto specification for a UPS design. And datacenter operators now are looking for solutions that give them enough time to switch operations, if you consider cloud architecture for example, there you just need enough time to move your critical IT support to another facility or to another part of the same facility that year end. And so, the value proposition of providing really a 100% protection for up to 15 seconds and indefinite protection for 98% or 99% of the power problem that they see is becoming more relevant.

And the other thing that works in our favor is the scales of IT deployments are going up in these large datacenters. And so the efficiency gains and the impact of total cost of ownership becomes much more profound as datacenters get larger. So the value of our product is more readily seen. So yeah, I think its market inertia, I think it’s the change in going to the move towards more of a cloud type architecture and the scale of datacenter, the scale of IT deployment that is occurring in the new datacenters designs.

Carter Dunlap - Dunlap Equity Management

That's very helpful. It is a quick follow on. So if you cover sort to say from half a cycle [misses] up to 15 seconds. Can you be brought in as add-on to a traditional 1980s UPS criteria or is that an entire rebuild, can you flipped in there as my question or is it a whole reconfiguration and a rebuild for the datacenter floor?

Doug Milner

Well, in many cases we represented cost reduction to move to a design that was more based around on Active Power flywheel based design. But I think one of the things that we have been hinting at as we have talked about the new product that we are going to bring out is that a solution to, as new battery technologies become available, let's say as new energy storage technologies become available and become commercially viable. We are going to provide a UPS system that allows you to use those in conjunction with the flywheel. So, simultaneously solving both problems. And that's what exciting about the new product that we are going to introduce to the market here in just a couple of weeks.

Operator

(Operator Instructions) Mr. [Chris Manhard].

Unidentified Analyst

A quick question for you guys. I know the stocks been underneath the dollar for a while, has there been any talk for reverse stock split or I know that we've got some regulatory stuff by the end of the year that we have to get to stock up, what's your point of view on that?

Doug Milner

We are completely committed and not being delisted. So that concern shouldn't be on the table. We obviously have a number of options available to us to make sure that doesn't happen. We are in contact with NASDAQ. We have considered a list of options and we will pick the one that most effectively solves that problem.

Unidentified Analyst

Can we talk, what are those options?

Doug Milner

Well, I mean the most obvious one would be a reverse split and that's probably at the, that's one of the options that we've been giving the most consideration to although we really have to really understand what NASDAQ’s position is going to be with regard to timing before we do anything definitive there.

Unidentified Analyst

When would that decision have to be made by?

Doug Milner

December 17. We get, our next notice date or deficiency date from NASDAQ would be the 17 December and then there would be the NASDAQ has a procedure to extend the time beyond that. And so we just need to fully understand what the landscape looks like for us around the 17 December, but we want to assure everybody that we have no intention of being delisted.

Unidentified Analyst

I'm sure there's a lot of individual and institutional investors are quite interested in that.

Operator

Thank you. And we have no further questions in queue at this time.

Doug Milner

Thank you everyone for being on the call this afternoon. On behalf of the entire senior management team, our employees and our Board, I would like to express our appreciation for your interest in Active Power. I would like to again offer my gratitude to John for his contributions to Active Power and wish him all the best in his new endeavor. Thanks for your continued support and we look forward to speaking with you next quarter.

Operator

Before we end today's call, I would like to take a moment to read the company's Safe Harbor statement. The company's management on this call has made forward-looking statements that involve risks and uncertainties including statements relating to Active Power’s current expectations of operating results for the fourth quarter of 2012 and full year 2012, its future operating results and its customers intention. Any forward-looking statements and all other statements that may have been made during this call that were not historical facts are subject to a number of risks and uncertainties and actual results may differ materially.

Factors that could cause the actual results to differ materially from the results predicted include among others our dependence on our relationships with Hewlett-Packard and Caterpillar; our increased emphasis on larger and more complex systems solutions; the deferral or cancellation of sales commitments as a result of general economic conditions or uncertainty; risks related to Active Power’s international operations and product performance; and quality issues.

For more information on the risk factors that could cause actual results to differ from these forward-looking statements, please refer to Active Power’s filings with the Securities and Exchange Commission, including its annual report on Form 10-K for the year ended December 31, 2011, and its current report 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. This now concludes today’s call. Thank you for joining us. You may now disconnect.

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