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ACPW > SEC Filings for ACPW > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for ACTIVE POWER INC


3-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with, and is qualified in its entirety by reference to, the financial statements and notes thereto included in Item 1 of this Form 10-Q and the financial statements and notes thereto and our Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2012 included in our 2012 Annual Report on Form 10-K. This report contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, that involve risks and uncertainties. Our expectations with respect to future results of operations that may be embodied in oral and written forward-looking statements, including any forward-looking statements that may be included in this report, are subject to risks and uncertainties that must be considered when evaluating the likelihood of our realization of such expectations. Our actual results could differ materially. The words "believe," "expect," "intend," "plan," "project," "will" and similar phrases as they relate to us are intended to identify such forward-looking statements. In addition, please see the "Risk Factors" in Part 1, Item 1A of our 2012 Annual Report on Form 10-K and in Part II, Item 1A of this Form 10-Q for a discussion of items that may affect our future results.

Overview

Active Power designs and manufactures patented flywheel-based uninterruptible power supply ("UPS") products and Modular Infrastructure Solutions ("MIS"). These solutions are designed to ensure continuity for data centers and other mission critical operations in the event of power disturbances.

Our products and solutions are designed to deliver continuous conditioned ("clean") power during power disturbances and outages, voltage sags and surges, and provide ride-through power in the event of utility failure, supporting operations until utility power is restored or a longer term alternative power source, such as a diesel generator, is engaged. We believe our products offer an advantage over those of our competitors in the areas of power density (less space) and energy efficiency, total cost of ownership, system reliability, modular design, and the economically green benefits of our solutions.

We have sold our patented flywheel-based UPS systems since 1999. Our patented flywheel-based UPS products store kinetic energy by constantly spinning a compact steel wheel ("flywheel") driven from utility power in a low friction environment. When the utility power used to spin the flywheel fluctuates or is interrupted, the flywheel's inertia causes it to continue spinning. The resulting kinetic energy of the spinning flywheel generates electricity known as "bridging power" for short periods, until either utility power is restored or a backup electric generator starts and takes over generating longer-term power in the case of an extended electrical outage. We believe our flywheel products provide many competitive advantages over conventional battery-based UPS products, including substantial space savings, higher power densities, "green" energy storage, and higher power efficiencies up to 98%. This high energy efficiency reduces operating costs and provides customers a lower total cost of ownership. We offer our flywheel products with load capabilities up to 8,400kVA. Our flywheel-based UPS systems are marketed under the brand name CleanSource. UPS product revenue may include ancillary components delivered as part of a total UPS solution. As of March 31, 2013, we have shipped more than 3,700 flywheels in UPS system installations, delivering more than 900 megawatts of power to customers in 57 countries around the world, providing nearly 150 million runtime hours of operation. In late 2012, we introduced our next generation CSHD 625kVA and 750 kVA UPS products, which we plan to start distributing in 2013.

We also sell modular power infrastructure solutions, which incorporate our UPS products with other equipment including switchboards, generators and monitoring and analytics tools to provide complete short- and long-term protection in the event of a power disturbance. Where this integrated solution is sold in a containerized package, it is marketed under the brand name PowerHouse. PowerHouse can be deployed in an ISO or purpose built container depending upon location. These systems are specifically designed to handle the demands of the most technically advanced facilities requiring the highest power integrity available while maximizing up-time, useable floor space and operational efficiency. Designed to offer a highly flexible architecture to respond to a customer's constantly changing environment, our PowerHouse systems are offered in four standard configurations, enabling sizing for infrastructure on demand. These systems are highly differentiated as they offer flexibility in placement, space savings, rapid deployment, high energy efficiency, and just in time use of capital deployment. They also deliver significant value to customers as the entire system is integrated and tested prior to delivery for a repeatable simple solution. We also sell modular power infrastructure solutions to customers in a non-containerized format, typically deploying such solutions inside buildings. We plan to grow revenue in coming years from current and future customers as modular data center infrastructure continues to gain acceptance in the market.

In close cooperation with our strategic partners in the technology industry and leveraging our expertise in containerization and power distribution, in 2010 we began to manufacture modular IT infrastructure solutions, designed to specification for select IT channel business partners. These solutions serve as the infrastructure for modular data center deployment model and are in themselves self-contained fully-functional data centers. Modular data centers may be rapidly deployed with other modular infrastructure such as power and cooling to deliver a cost-effective alternative to traditional raised-floor data centers. Active Power designs and delivers the exterior shell and a fully outfitted interior - including electrical, cooling, monitoring, and other elements - ready for the IT channel partner to add its IT racks and servers. After the IT channel partner adds its IT equipment to our modular IT infrastructure solution, the IT channel partner has a functional data center ready for deployment at its end-user site.


Index

Finally, we offer services in the form of installation, maintenance, project management, and other professional services. Services are often sold in conjunction with the products above, and are increasingly becoming a larger part of our overall revenue.

Our headquarters are in Austin, Texas, with international offices in the United Kingdom, Germany, and China.

We sell our products to a wide array of commercial and industrial customers across a variety of vertical markets, including data centers, manufacturing, technology, broadcast and communications, financial, utilities, healthcare, government and airports. However, our primary focus is on data center applications within these vertical markets. We have expanded our global sales channels and direct sales force, selling in major geographic regions of the world, but particularly in North America, Europe and Asia. We sell our products through the following distribution methods:

? sales made directly by Active Power;

? manufacturer's representatives;

? distributors;

? OEM partners; and

? strategic IT partners.

We believe a number of underlying macroeconomic trends place us in a strong position to be one of the leading providers of critical power protection and infrastructure solutions. These trends include:

the increasing business costs of downtime;

a rapidly expanding need for data center infrastructure;

ever-increasing demands placed on the public utility infrastructure;

an inadequate investment in global utility infrastructure;

rising costs of energy worldwide driven by volume of energy used; and

an increasing demand for economically green solutions.

We have evolved significantly since the company was founded in 1992. Our early focus was on research and development of the core products that continue to enable our business today. Over the past several years, we have focused our efforts on brand, markets, and channels of distribution. The technological foundation of Active Power has yielded more than 100 worldwide patents and a highly differentiated, cost-efficient product platform that we have evolved into an expanding suite of infrastructure solutions. As we go forward, it is critical for us to focus on both developing technology to maintain and grow our leadership position and expand our addressable markets and on building channels of distribution to have more avenues into the market.

We have developed and implemented a go-to-market strategy to set the direction for our sales and marketing initiatives and plans around the following components:

Customer: Data Center Applications Across Vertical Markets

Distribution: Partner Enabled Distribution Strategy Transacted Locally

Geography: Global Markets served from four Centers of Operation

Products: UPS and Modular Infrastructure Systems

Value: Efficient, Reliable, Green Solutions

Service: Installation Maintenance, Project Management and Other Professional Services

As a result of this strategy, we have been successful in improving our operating performance, broadening our global footprint, diversifying our customer base, broadening our sales channels and partners, and moving higher up the customer value chain with innovative developments of our core underlying product technology.


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Results of Operations

                                       Three Months Ended March 31,                        Variance 2013 vs, 2012
                                        % of total                     % of total
($ in thousands)           2013          revenue          2012          revenue              $                    %
Product revenue          $  15,636               84 %   $  16,406               83 %   $         (770 )             -5 %
Service and other
revenue                      2,974               16 %       3,392               17 %             (418 )            -12 %
Total revenue               18,610              100 %      19,798              100 %   $       (1,188 )             -6 %
Cost of product
revenue                     11,004               59 %      11,996               60 %             (992 )             -8 %
Cost of service and
other revenue                2,104               11 %       2,495               13 %             (391 )            -16 %
Total cost of goods
sold                        13,108               70 %      14,491               73 %           (1,383 )            -10 %
Gross profit                 5,502               30 %       5,307               27 %              195                4 %
Operating expenses:
Research and
development                  1,631                9 %       1,288                6 %              343               27 %
Selling and marketing        2,937               16 %       3,547               18 %             (610 )            -17 %
General and
administrative               1,134                6 %       1,544                8 %             (410 )            -27 %
Total operating
expenses                     5,702               31 %       6,379               32 %             (677 )            -11 %
Loss from Operations          (200 )             -1 %      (1,072 )             -5 %              872              -81 %
Interest expense, net          (82 )              0 %        (114 )             -1 %               32              -28 %
Other income, net                9                0 %          39                0 %              (30 )            -77 %
Net Loss                 $    (273 )             -1 %   $  (1,147 )             -6 %   $          874              -76 %

Product revenue. Product revenue primarily consists of sales of our UPS and MIS products. Our CleanSource power quality products are comprised of both UPS and energy storage product lines and our MIS products consist of our modular power infrastructure solutions, including PowerHouse (which are comprised of our UPS systems and some combination of third party ancillary equipment, such as engine generators and switchgear) and our modular IT infrastructure solutions that provide a combination of power distribution, cooling capabilities, security systems, fire suppression and monitoring capabilities for our business partners. Our product revenue was derived from the following sources:

                                           Three Months Ended
      ($ in thousands)                          March 31,                 Variance
                                            2013          2012                    $     %
      Product revenue:
      UPS product revenue                $   11,606     $  4,216     $  7,390       175 %
      Modular Infrastructure Solutions        4,030       12,190       (8,160 )     -67 %
      Total product revenue              $   15,636     $ 16,406     $   (770 )      -5 %

Total product revenue for the three-month period ended March 31, 2013 decreased by $0.8 million, or 5%, compared to the same period in 2012 and increased $4.1 million, or 36%, from $11.5 million in the fourth quarter 2012. The decrease from first quarter 2012 to first quarter 2013 was driven primarily by a change in mix of product sales. The increase from fourth quarter 2012 to first quarter 2013 was primarily the result of a large fourth quarter order that was received and built in the fourth quarter of 2012, but that didn't ship until the first quarter of 2013. UPS revenue was up $7.4 million, or 175%, in the first quarter 2013 from the same period in the prior year which mostly offset the decline in MIS revenues of $8.2 million, or 67%. UPS revenue increased in first quarter 2013 compared to fourth quarter 2012 for the same reason total product revenue increased. We expect product mix to continue to shift as we obtain large customer orders for either UPS or MIS products in any particular quarter.

Product revenue from Active Power branded products through our direct and manufacturer's representative channels was $12.8 million, or 82% of our product revenue, for the three-month period ended March 31, 2013, compared to $6.3 million, or 39% of our product revenue, in the same period of 2012, and $5.5 million, or 48% of our product revenue, for the fourth quarter of 2012.

Product revenue from our OEM channels for the three-month period ended March 31, 2013 was $2.0 million, an increase of approximately $1.0 million, or 100%, compared to revenue of $1.0 million for the first quarter of 2012. This reflected increased OEM activity in the EMEA market. Product revenue from our OEM channels for the three-month period ended March 31, 2013 increased by $0.3 million, or 20%, compared to $1.7 million for the fourth quarter of 2012. The size and volume of orders from our OEM channels can fluctuate significantly on a quarterly basis and in 2013 we continue to see fewer, but larger value transactions from our OEM channel. We have supported our OEM partners' efforts to sell total solutions to their customers that include generators and switchgear that they manufacture along with our UPS products as a total solution. Sales to Caterpillar, our primary OEM channel, represented $2.0 million, or 13% of our product revenue, for the three-month period ended March 31, 2013, compared to $1.0 million, or 9% of our product revenue, in the comparable period of 2012 and $1.7 million, or 14%, in fourth quarter 2012. Caterpillar remains one of our largest UPS customers as well as our largest OEM customer.


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Product revenue from our IT channel for the first quarter of 2013 was $0.9 million, compared to $9.0 million for the first quarter of 2012, which represents an $8.1 million, or 90%, decrease, and also decreased $3.4 million compared to the $4.3 million of IT channel revenue from fourth quarter 2012. These decreases were primarily due to a decrease in demand for infrastructure solutions from HP, our largest IT channel partner. Historically, we have manufactured and sold infrastructure solutions to HP, for them to re-sell to end users in conjunction with sales of their IT and computing products. Thus, the level of orders will fluctuate dependent upon our partner's need for infrastructure solutions. We have historically experienced large quarterly fluctuations in the number and value of such orders. Sales to HP accounted for 2% of our product revenue for the first quarter of 2013 compared to 62% in the same period of 2012.

Our MIS products tend to be larger in value and derive sales from a smaller number of customers compared to sales of our UPS products. This smaller number of customers with greater transaction value can contribute to large quarterly fluctuations in revenue from each product family due to the timing of orders and shipments in any particular accounting period. A small number of transactions can lead to significant revenue, but cause greater volatility in our quarterly results and can increase liquidity risk. To manage this risk we continue to refine and improve the payment terms of these opportunities as part of our working capital management process.

North America sales were $10 million or 64% of our product revenue for the three-month period ended March 31, 2013, compared to $10.6 million, or 65% of our product revenue, for the same period in 2012 and $9.2 million, or 80% of product revenue, in the fourth quarter of 2012. This slight decrease compared to prior year reflects lower MIS revenues which historically have largely originated in the North American market.

We also sell products directly to customers in Asia and EMEA and we have a network of international distributors in these and other territories. In some of these markets, customers are more likely to purchase a total power solution such as PowerHouse from us rather than a stand-alone UPS system. This usually results in a longer selling cycle and makes quarterly results from these regions more inconsistent and dependent upon a smaller number of larger value transactions. Thus, the amount of revenue from our international markets can fluctuate significantly on a quarterly basis. Product sales to customers in Asia were $3.9 million, or 25% of our total product revenue, in the three-month period ended March 31, 2013, compared to $1.5 million, or 9%, for the same period in 2012 and $1.0 million, or 8%, for the fourth quarter of 2012. This was primarily driven by one large distributor order. Product revenue in EMEA was $1.7 million, or 11% of product revenue, in the three-month period ended March 31, 2013, compared to $4.3 million, or 26%, for the same period of 2012 and $1.3 million, or 12%, for the fourth quarter of 2012. These fluctuations are primarily attributable to variations in sales of our MIS products in each region in the relevant periods and illustrate the impact of larger orders from fewer customers on quarterly revenue for each of these regions. Products may sometimes be shipped outside of the region in which the revenues were generated.

Service and other revenue. Service and other revenue primarily relates to revenue generated from both traditional (after-market) service work and from customer-specific system engineering. This includes revenue from design, installation, startup, repairs or reconfigurations of our products and the sale of spare or replacement parts to our OEM and end-user customers. It also includes revenue associated with the costs of travel of our service personnel and revenues or fees received upon contract deferment or cancellation. Revenue from extended maintenance contracts with our customers is also included in this revenue category.

Service and other revenue decreased by approximately $0.4 million, or 12%, for the three-month period ended March 31, 2013, compared to the same period of 2012, and decreased $0.8 million or 21% compared to the fourth quarter of 2012. This decrease reflects lower professional fees associated with decreased MIS sales in the March 2013 quarter compared to the prior year and prior quarter sequentially. For our MIS customers, we provide a full power solution, including design services, site preparation, installation of an entire power solution and provision of all products required to provide a turnkey product to the end user, often including maintenance services. Where we make sales through our OEM channel, it is typical for the OEM to provide these types of services to their end-user customers, so these revenue opportunities do not typically exist for us on our OEM sales. We anticipate that service and other revenue will continue to grow with product revenue, particularly as our PowerHouse system revenue grows and as our installed base of UPS product expands, because as more units are sold to customers, more installation, startup and maintenance services will be required.


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Cost of product revenue. Cost of product revenue includes the cost of component parts of our products, ancillary equipment that is sourced from external suppliers, personnel, equipment and other costs associated with our assembly and test operations, including costs from having underutilized facilities, depreciation of our manufacturing property and equipment, shipping costs, warranty costs, and the costs of manufacturing support functions such as logistics and quality assurance. The cost of product revenue as a percentage of total product revenue was 70% for the three-month period ended March 31, 2013, compared to 73% for the same period in 2012 and 60% for the fourth quarter of 2012. The decrease in costs as a percentage of revenue compared to first quarter 2012 reflected more favorable product mix and improved UPS pricing arrangements, and an overall lower cost structure compared to 2012 from vendor management programs and other cost management initiatives. The increase in cost of product revenue in first quarter 2013 compared to fourth 2012 is related to less favorable pricing arrangements on UPS systems orders in the first quarter of 2013 and the increase in the amount of orders from our distributors in Asia. We continue to operate a manufacturing facility that has a manufacturing and testing capacity that can be significantly greater than our current product revenue levels in any given quarter, dependent upon the product mix. A large portion of the costs involved in operating this manufacturing facility are fixed in nature and we have incurred unabsorbed overhead each quarter depending on the level of UPS system production. We continue to work on reducing our product costs through design enhancements and modifications and increasing our sales volume to absorb these expenses. We also are working to create cross-functional utilization of our personnel between UPS and MIS product manufacturing so as to obtain higher overall labor efficiency.

Cost of service and other revenue. Cost of service and other revenue includes the cost of component parts that we use in service or sell as spare parts, as well as labor and overhead costs of our service organization. This includes travel and related costs incurred in fulfilling service obligations to our customers and the costs of third party contractors used in completion of some of our professional services. The cost of service and other revenue was 71% of service and other revenue in the three-month period ended March 31, 2013, compared to 74% for the same period of 2012 and 62% in the fourth quarter of 2012. The decrease in first quarter 2013 compared to first quarter 2012 reflects a shift in the types of services provided, with professional services being down in first quarter 2013 compared to the same period in 2012. The increase in cost of service and other revenue in first quarter 2013 compared to fourth quarter 2012 is due to an increase in materials costs, which can happen when there is a significant warranty repair. The utilization of our service personnel will also be affected by the number of MIS solution products implemented in a particular period, and in periods where we have a low number of installation projects we would expect our costs as a percentage of revenue to increase due to lower employee utilization. A large portion of the costs involved in operating our service organization are fixed in nature, as we have to maintain a certain level of availability to service our contracted customers rapidly, and depending upon the revenues for the quarter, we may incur unabsorbed overhead in the quarter. We continue to work on reducing our service overhead through better utilization of our service employees and cost control measures. This infrastructure also means that we can leverage this investment and grow our service capabilities substantially by adding direct technical labor only as required.

Gross profit. For the three-month period ended March 31, 2013, our gross profit was 30% of revenue, compared to a 27% gross profit margin for the first quarter of 2012 and a 40% gross profit margin for the fourth quarter of 2012. The improvement from the first quarter of 2012 reflects our product mix, as well as overall cost containment initiatives put in place over the last year, and improved UPS pricing arrangements. The decrease in the margin from the fourth quarter of 2012 is related to lower margin orders in the first quarter of 2013 compared to the fourth quarter 2012, of which a high percentage came from distributor channel orders in Asia. We also had an increase of ancillary revenue, which tends to reflect lower overall margins. Our ability to further improve gross margins will depend, in part, on our ability to further improve our sales channel mix, increase sales of higher margin products such as our UPS products, optimize our product pricing, improve our professional service margins through further pricing and operating efficiency, and increase our total revenues to a level that will allow us to improve the utilization of our manufacturing and service operations.

Research and development. Research and development expense primarily consists of compensation and related costs for employees engaged in research, development and engineering activities, third party consulting and development activities, as well as an allocated portion of our occupancy costs. Overall, our research and development expenses were approximately $0.3 million, or 27%, higher in the first quarter of 2013 compared to the first quarter of 2012 and were $0.2 million, or 17%, higher than the fourth quarter of 2012. The increase is primarily due to our next generation of UPS product, which we feel will offer greater power modularity and space efficiencies compared to our existing UPS products, especially as we target the higher power market groups. As we are in the final phases of testing, as well as optimizing ways to reduce the overall future costs of production, we have had an increase in research and development expenses. It is anticipated that the new UPS product line will allow improved profit margins and provide a larger addressable market for our UPS systems business.

Selling and marketing. Selling and marketing expense primarily consists of compensation, including variable sales compensation and related costs for sales and marketing personnel, related travel, trade shows and promotional expenses, compensation paid to resellers and agents, an allocated portion of our occupancy and other costs, and the cost of our foreign sales operations. Selling and marketing costs were approximately $0.6 million, or 17%, lower in the first quarter of 2013 compared to the first quarter of 2012 and decreased approximately $0.3 million, or 10%, from the fourth quarter of 2012 primarily . . .

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