P10 Industries, Inc. - FORM 10-Q - October 31, 2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2012
 
Or
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______ to ______
 
Commission file number: 000-30939

ACTIVE POWER, INC.
(Exact name of registrant as specified in its charter)
 
 
Delaware
 
74-2961657
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
2128 W. Braker Lane, BK12, Austin, Texas
 
78758
(Address of principal executive offices)
 
(Zip Code)
 
(512) 836-6464
(Registrant’s telephone number, including area code)
 
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   x  Yes  ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).    x  Yes  o  No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
 
Large Accelerated Filer     ¨
 
Accelerated Filer   x
 
 
 
Non-Accelerated Filer       o
(Do not check if a smaller reporting company)
Smaller Reporting Company   ¨
 

Indicate by check mark whether the registrant is a Shell Company (as defined in Rule 12b-2 of the Exchange Act).    ¨ Yes   x No
 
APPLICABLE ONLY TO CORPORATE ISSUERS:
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
The number of shares of common stock, par value of $0.001 per share, outstanding at October 29, 2012 was 95,457,376.
 
 
 
 
 
ACTIVE POWER, INC.
FORM 10-Q
 

 
2


Active Power, Inc.
Condensed Consolidated Balance Sheets
(in thousands)
 
 
 
September
30,
2012
 
 
December
31,
2011
 
 
 
(unaudited)
 
 
 
 
ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 
$
14,079
 
 
$
10,357
 
Restricted cash
 
 
386
 
 
 
389
 
Accounts receivable, net of allowance for doubtful accounts of $662 and $337 at September 30, 2012 and December 31, 2011, respectively
 
 
17,666
 
 
 
11,163
 
Inventories
 
 
9,362
 
 
 
9,439
 
Prepaid expenses and other
 
 
1,457
 
 
 
414
 
Total current assets
 
 
42,950
 
 
 
31,762
 
Property and equipment, net
 
 
2,896
 
 
 
2,861
 
Deposits and other
 
 
307
 
 
 
404
 
Total assets
 
$
46,153
 
 
$
35,027
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
Accounts payable
 
$
4,653
 
 
$
4,757
 
Accrued expenses
 
 
3,849
 
 
 
5,351
 
Deferred revenue
 
 
5,464
 
 
 
2,366
 
Revolving line of credit
 
 
5,535
 
 
 
5,535
 
Total current liabilities
 
 
19,501
 
 
 
18,009
 
Long-term liabilities
 
 
798
 
 
 
726
 
Stockholders’ equity:
 
 
 
 
 
 
 
 
Common stock
 
 
95
 
 
 
80
 
Treasury stock
 
 
(135
)
 
 
         (115
)
Additional paid-in capital
 
 
288,193
 
 
 
277,023
 
Accumulated deficit
 
 
(262,399
)
 
 
    (260,895
)
Other accumulated comprehensive income
 
 
100
 
 
 
          199
 
Total stockholders’ equity
 
 
25,854
 
 
 
16,292
 
Total liabilities and stockholders’ equity
 
$
46,153
 
 
$
35,027
 

See accompanying notes.
 
 
3
 
Active Power, Inc.
Condensed Consolidated Statements of Operations and Comprehensive Loss
(in thousands, except per share amounts)
(Unaudited)
 
 
 
Three Months Ended
September 30,
 
 
Nine Months Ended
September 30,
 
 
 
2012
 
 
2011
 
 
2012
 
 
2011
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
Product revenue
 
$
16,647
 
 
$
16,996
 
 
$
50,534
 
 
$
47,890
 
Service and other revenue
 
 
2,964
 
 
 
3,612
 
 
 
10,534
 
 
 
9,262
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total revenue
 
 
19,611
 
 
 
20,608
 
 
 
61,068
 
 
 
57,152
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of goods sold:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of product revenue
 
 
12,254
 
 
 
13,112
 
 
 
35,608
 
 
 
35,625
 
Cost of service and other revenue
 
 
1,742
 
 
 
2,649
 
 
 
6,766
 
 
 
7,337
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total cost of goods sold
 
 
13,996
 
 
 
15,761
 
 
 
42,374
 
 
 
42,962
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
 
5,615
 
 
 
4,847
 
 
 
18,694
 
 
 
14,190
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
 
 
1,325
 
 
 
1,272
 
 
 
4,045
 
 
 
3,279
 
Selling and marketing
 
 
3,447
 
 
 
3,527
 
 
 
10,891
 
 
 
10,397
 
General and administrative
 
 
1,691
 
 
 
1,280
 
 
 
5,175
 
 
 
4,083
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total operating expenses
 
 
6,463
 
    
6,079
 
    
20,111
 
    
17,759
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating loss
 
 
(848)
 
 
 
(1,232
)
 
 
(1,417
)
 
 
(3,569
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense, net
 
 
(80
)
 
 
(68
)
 
 
(246
)
 
 
(149
)
Other income (expense), net
 
 
81
 
 
 
8
  
 
 
159
 
 
 
(34
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
$
(847)
 
 
$
(1,292
)
 
$
(1,504
)
 
$
(3,752
)
Net loss per share, basic and diluted
 
$
(0.01)
 
 
$
(0.02
)
 
$
(0.02
)
 
$
(0.05
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares used in computing net loss per share, basic and diluted
 
 
95,575
 
 
 
80,119
 
 
 
91,998
 
 
 
79,990
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
$
(847)
 
 
$
(1,292
)
 
$
(1,504
)
 
$
(3,752
)
Translation gain (loss) on subsidiaries denominated in foreign currencies
 
 
211
  
 
 
(193)
 
 
 
(99
)
 
 
416
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Comprehensive loss
 
$
(636)
 
 
$
(1,485
)
 
$
(1,603
)
 
$
(3,336
)
 
 
4
 
Active Power, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
 
 
 
Nine Months Ended
September 30,
 
 
 
2012
 
 
2011
 
Operating activities
 
 
 
 
 
 
Net loss
 
$
(1,504
)
 
$
(3,752
)
Adjustments to reconcile net loss to cash used in operating activities:
 
 
 
 
 
 
 
 
Depreciation expense
 
 
955
 
 
 
1,093
 
Change to allowance for doubtful accounts
 
 
325
 
 
 
16
  
(Gain) Loss on disposal of fixed assets
 
 
31
 
 
 
130
  
Stock-based compensation
 
 
1,131
 
 
 
1,149
 
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
 
Restricted cash
 
 
3
  
 
 
(403)
 
Accounts receivable
 
 
(6,828
)
 
 
    (2,033
)
Inventories
 
 
77
 
 
 
(4,301
)
Prepaid expenses and other assets
 
 
(946
)
 
 
(80)
 
Accounts payable
 
 
(104)
 
 
 
13
 
Accrued expenses
 
 
(1,502
)
 
 
    (1,689
)
Deferred revenue
 
 
3,098
 
 
 
2,074
 
Long-term liabilities
 
 
72
 
 
 
232
 
Net cash used in operating activities
 
 
(5,192
)
 
 
(7,551
)
 
 
 
 
 
 
 
 
 
Investing activities
 
 
 
 
 
 
 
 
Sales/maturities of marketable securities
    
        —
      
         134
  
Purchases of property and equipment
 
 
(1,021
)
 
 
(2,225
)
Net cash used in investing activities
 
 
(1,021
)
 
 
(2,091
)
 
 
 
 
 
 
 
 
 
Financing activities
 
 
 
 
 
 
 
 
Proceeds from private placement of common stock
 
 
9,750
 
 
 
—
 
Issuance costs of private placement
 
 
(187
)
 
 
—
 
Proceeds from draw on revolving line of credit
 
 
2,017
 
 
 
3,000
 
Payments on revolving line of credit
 
 
(2,017
)
 
 
—
 
Proceeds from employee stock purchases
 
 
491
 
 
 
277
 
Purchases of treasury stock
 
 
(20)
 
 
 
(12
)
Net cash provided by financing activities
 
 
10,034
 
 
 
3,265
 
 
 
 
 
 
 
 
 
 
Translation gain (loss) on subsidiaries in foreign currencies
 
 
(99)
 
 
 
416
 
 
 
 
 
 
 
 
 
 
Change in cash and cash equivalents
 
 
3,722
 
 
 
(5,961
)
Cash and cash equivalents, beginning of period
 
 
10,357
 
 
 
15,416
 
Cash and cash equivalents, end of period
 
$
14,079
 
 
$
9,455
 

See accompanying notes.
 
 
5
 
Active Power, Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2012
(unaudited)

1.
Significant Accounting Policies

Organization and Basis of presentation

Active Power, Inc. and its subsidiaries (hereinafter referred to as “we”, “us”, “Active Power” or the “Company”) manufacture and provide critical power quality and infrastructure solutions that provide business continuity and protect customers in the event of an electrical power disturbance. Our products and solutions are designed to deliver continuous clean power, protecting customers from voltage fluctuations, such as surges and sags, and frequency fluctuations, and also to provide ride-through, or temporary, power to bridge the gap between a power outage and the restoration of utility power. Our target customers are those global enterprises requiring “power insurance” because they have zero tolerance for downtime in their mission critical operations. The Uninterruptible Power Supply (“UPS”) products we manufacture use kinetic energy to provide short-term power as a cleaner alternative to electro-chemical battery-based energy. We sell stand-alone UPS products as well as complete continuous power and infrastructure solutions, including containerized continuous power systems that we brand as PowerHouse. We sell our products globally through direct, manufacturer’s representatives, Original Equipment Manufacturer (“OEM”) channels and IT partners. Our current principal markets are Europe, Middle East and Africa (“EMEA”), Asia and North America.

The accompanying condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles and include the accounts of the Company and its consolidated subsidiaries. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring items) necessary to present fairly the consolidated financial position of the Company and its consolidated results of operations and cash flows. These interim financial statements should be read in conjunction with the financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

2.
Supplemental Balance Sheet Information

Restricted Cash

Restricted cash balance of $386,000 as of September 30, 2012 consists of secured performance and deposit guarantees given to customers. Upon satisfaction of these guarantees, the restriction on these funds will be released.

Receivables

Accounts receivable consist of the following (in thousands):

 
 
September
30,
2012
 
 
December
31,
2011
 
Trade receivables
 
$
18,328
 
 
$
11,500
 
Allowance for doubtful accounts
 
 
(662
)
 
 
(337
)
 
 
$
17,666
 
 
$
11,163
 

 
6

Inventory

We state inventories at the lower of cost or market, using the first-in-first-out-method (in thousands):

 
 
September
30,
2012
 
 
December
31,
2011
 
Raw materials
 
$
6,897
 
 
$
6,493
 
Work in process
 
 
2,769
 
 
 
3,085
 
Finished goods
 
 
942
 
 
 
1,680
 
Allowances for obsolescence
 
 
(1,246
)
 
 
(1,819
)
 
 
$
9,362
 
 
$
9,439
 

Property and Equipment

Property and equipment consist of the following (in thousands):

 
 
September
30,
2012
 
 
December
31,
2011
 
Equipment
 
$
10,060
 
 
$
9,980
 
Demonstration units
 
 
2,149
 
 
 
1,345
 
Computers and purchased software
 
 
4,177
 
 
 
4,029
 
Furniture and fixtures
 
 
375
 
 
 
369
 
Leasehold improvements
 
 
7,647
 
 
 
7,425
 
Construction in progress
 
 
653
 
 
 
1,107
 
 
 
 
25,061
 
 
 
24,255
 
Accumulated depreciation
 
 
(22,165
)
 
 
(21,394
)
 
 
$
2,896
 
 
$
2,861
 

Accrued Expenses

Accrued expenses consist of the following (in thousands):

 
 
September
30,
2012
 
 
December
31,
2011
 
Compensation and benefits
 
$
1,844
 
 
$
3,037
 
Warranty liability
 
 
614
 
 
 
583
 
Property, income, state, sales and franchise tax
 
 
336
 
 
 
529
 
Professional fees
 
 
466
 
 
 
463
 
Other
 
 
589
 
 
 
739
 
 
 
$
3,849
 
 
$
5,351
 

Warranty Liability

Generally, the warranty period for our power quality products is 12 months from the date of commissioning or 18 months from the date of shipment from Active Power, whichever period is shorter. Occasionally we offer longer warranty periods to certain customers. The warranty period for products sold to our primary OEM customer, Caterpillar, is 12 months from the date of shipment to the end-user, or up to 36 months from shipment to Caterpillar. This is dependent upon Caterpillar complying with our storage requirements for our products in order to preserve this warranty period beyond the standard 18-month limit. We provide for the estimated cost of product warranties at the time revenue is recognized and this accrual is included in accrued expenses and long-term liabilities on the accompanying consolidated balance sheet.
 
 
7
 
Changes in our warranty liability are presented in the following table (in thousands):
 
 
 
 
 
Balance at December 31, 2011
 
$
613
 
Warranty expense
 
 
1,060
 
Warranty charges incurred
 
 
(1,009
)
Balance at September 30, 2012
 
$
664
 
Warranty liability included in accrued expenses
 
$
614
 
Long-term warranty liability
 
 
50
 
Balance at September 30, 2012
 
$
664
 
 
Revenue Recognition

In general, we recognize revenue when four criteria are met: (i) persuasive evidence that an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the sales price is fixed or determinable; and (iv) collectability is reasonably assured. Revenue-generating transactions generally fall into one of the following categories of revenue recognition:

 
●
We recognize product revenue at the time of shipment for substantially all products sold directly to customers and through distributors because title and risk of loss pass on delivery to the common carrier. Our customers and distributors do not have the right to return products. If title and risk of loss pass at some other point in time, we recognize such revenue for our customers when the product is delivered to the customer and title and risk of loss have passed.

 
●
We recognize installation and service and maintenance revenue at the time the service is performed.

 
●
We recognize revenue associated with extended maintenance agreements (“EMAs”) over the life of the contracts using the straight-line method, which approximates the expected timing in which applicable services are performed. Amounts collected in advance of revenue recognition are recorded as a current or long-term liability based on the time from the balance sheet date to the future date of revenue recognition.

 
●
We recognize revenue on certain rental programs over the life of the rental agreement using the straight-line method. Amounts collected in advance of revenue recognition are recorded as a current or long-term liability based on the time from the balance sheet date to the future date of revenue recognition.

 
●
Shipping costs reimbursed by the customer are included in revenue.

Multiple element arrangements (“MEAs”). Arrangements to sell products to customers frequently include multiple deliverables. Our most significant MEAs include the sale of one or more of our CleanSource UPS or PowerHouse products, combined with one or more of the following products: design services, project management, commissioning and installation services, spare parts or consumables, and EMAs. Delivery of the various products or performance of services within the arrangement may or may not coincide. Certain services related to design and consulting may occur prior to delivery of product and commissioning and installation typically takes place within six months of product delivery, depending upon customer requirements. EMAs, consumables, and repair, maintenance or consulting services generally are delivered over a period of one to five years. In certain arrangements revenue recognized is limited to the amount invoiced or received that is not contingent on the delivery of future products and services.

When arrangements include multiple elements, we allocate revenue to each element based on the relative selling price and recognize revenue when the elements have stand-alone value and the four criteria for revenue recognition have been met for each element. We establish the selling price of each element based on Vendor Specific Objective Evidence (“VSOE”) if available, Third Party Evidence (“TPE”) if VSOE is not available, or best estimate of selling price (“BESP”) if neither VSOE nor TPE is available. We generally determine selling price based on amounts charged separately for the delivered and undelivered elements to similar customers in stand-alone sales of the specific elements. When arrangements include an EMA, we recognize revenue related to the EMA at the stated contractual price on a straight-line basis over the life of the agreement.

Any taxes imposed by governmental authorities on our revenue-producing transactions with customers are shown in our consolidated statements of operations on a net-basis; that is, excluded from our reported revenues.
 
 
8
 
 
3.
Net Loss Per Share

The following table sets forth the computation of basic and diluted net loss per share (in thousands, except per share data):
 
 
 
Three Months Ended
September 30,
 
 
Nine Months Ended
September 30,
 
 
 
2012
 
 
2011
 
 
2012
 
 
2011
 
Numerator:
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
$
(847)
 
 
$
(1,292)
 
 
$
(1,504
)
 
$
(3,752
)
Denominator:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted-average shares of common stock outstanding used in computing basic and diluted net loss per share
 
 
95,575
 
 
 
80,119
 
 
 
91,998
 
 
 
79,990
 
 
 
 
                          
 
Basic and diluted net loss per share
 
$
(0.01)
 
 
$
(0.02)
 
 
$
(0.02
)
 
$
(0.05
)
Common stock equivalents that were not included in the calculation because the option or restricted stock unit price was greater than the average market price of the common shares or the net loss would cause the effect of the options to be anti-dilutive:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Employee stock options
 
 
9,641
 
 
 
10,260
 
 
 
9,641
 
 
 
10,260
 
Performance-based options
    
-
      
1,440
      
-
      
1,440
  
Restricted stock units
 
 
997
 
 
 
-
 
 
 
997
 
 
 
-
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
10,638
 
 
 
11,700
 
 
 
10,638
 
 
 
11,700
 

There were no restricted stock unit awards outstanding at September 30, 2011. As of September 30, 2012 and 2011, respectively, there was no common stock subject to repurchase.

4.
Fair Value of Financial Instruments
 
Investments in marketable securities consist of money-market funds, commercial paper and debt securities with readily determinable fair values. Active Power accounts for investments that are reasonably expected to be realized in cash, sold or consumed during the year as short-term investments. We classify investments in marketable securities as available-for-sale and all reclassifications made from unrealized gains/losses to realized gains/losses are determined based on the specific identification method.

In accordance with our investment policy and guidelines, our short-term investments are diversified among and limited to high quality securities with a minimum of investment grade ratings. We actively monitor our investment portfolio to ensure compliance with our investment objective to preserve capital, meet liquidity requirements and maximize return on our investments. We do not require collateral or enter into master netting arrangements to mitigate our credit risk.
 
 
9
 
Effective October 1, 2008, we adopted an accounting standard that defines fair value, establishes a framework for measuring fair value as well as expands on required disclosures regarding fair value measurements. This standard applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.

Level 1—uses quoted prices in active markets for identical assets or liabilities we have the ability to access.

Level 2—uses observable inputs other than quoted prices in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3—uses one or more significant inputs that are unobservable and supported by little or no market activity, and that reflect the use of significant management judgment.

Inputs are referred to as assumptions that market participants would use in pricing the asset or liability. The uses of inputs in the valuation process are categorized into a three-level fair value hierarchy.

Our Level 1 assets and liabilities consist of cash equivalents and short-term investments, which are primarily invested in money-market funds. These assets are classified as Level 1 because they are valued using quoted prices in active markets and other relevant information generated by market transactions involving identical assets and liabilities.

The fair value of our cash equivalents, which are primarily invested in money-market funds, was determined using the following inputs as of September 30, 2012 and December 31, 2011 (in thousands):

September 30, 2012
 
 
 
Fair Value Measurements at Reporting Date Using
 
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
Total
 
Money-market funds
 
$
3,092
 
 
$
—
 
 
$
—
 
 
$
3,092
 
Total
 
$
3,092
 
 
$
—
 
 
$
—
 
 
$
3,092
 
Amounts included in:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
3,092
 
 
$
—
 
 
$
—
 
 
$
3,092
 
Short-term investments
 
 
—
 
 
 
—
 
 
 
—
 
 
 
—
 
Total
 
$
3,092
 
 
$
—
 
 
$
—
 
 
$
3,092
 

December 31, 2011
 
 
 
Fair Value Measurements at Reporting Date Using
 
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
Total
 
Money-market funds
 
$
3,093
 
 
$
—
 
 
$
—
 
 
$
3,093
 
Total
 
$
3,093
 
 
$
—
 
 
$
—
 
 
$
3,093
 
Amounts included in:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
3,093
 
 
$
—
 
 
$
—
 
 
$
3,093
 
Short-term investments
 
 
—
 
 
 
—
 
 
 
—
 
 
 
—
 
Total
 
$
3,093
 
 
$
—
 
 
$
—
 
 
$
3,093
 

For cash and cash equivalents, marketable securities, accounts receivable, and accounts payable, the carrying amount approximates fair value because of the relative short maturity of those instruments.

5.
Guarantees
 
In certain geographical regions, particularly Europe and Africa, we are sometimes required to issue performance guarantees to our customers as a condition of sale. These guarantees usually provide financial protection to our customers in the event that we fail to fulfill our delivery or product warranty obligations. We secure these guarantees with standby letters of credit through our bank. At September 30, 2012 and December 31, 2011, we had $433,000and $446,000 respectively, of performance guarantees outstanding to customers that were secured with letters of credit.
 
 
10
 

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, 2011 included in our 2011 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 2011 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 continuous power and infrastructure solutions. These solutions 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 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 uninterruptible power supply (“UPS”) systems since 1999. As of September 30, 2012, we have shipped more than 3,500 flywheels in UPS system installations, delivering more than 875 megawatts of power to customers in 43 countries around the world with more than 131 million runtime hours of operation.

In addition to selling stand-alone UPS systems, we also manufacture and sell modular infrastructure solutions (“MIS”) that provide critical power and infrastructure solutions in a pre-packaged format and that offer the same customer benefits with regard to operating efficiency, reliability and cost as our UPS systems. These MIS solutions may include our UPS systems as a component. For example we manufacture and sell continuous power systems (“CPS”) that integrate our UPS products with other related equipment such as switchgear and backup diesel generators that are sold as a complete power solution for customers. We also manufacture and sell other containerized power and infrastructure solutions. These solutions serve as the infrastructure for modular data center products which are self-contained fully functioning data centers. We design and build enclosures that have a fully built out interior – including electrical, cooling, monitoring and other elements – ready for the customer to add its IT racks and servers. We also integrate and build modular power and infrastructure solutions to specification, based on our customers and other third party designs. Once the customer adds its IT equipment to our infrastructure solution, it has a functional modular data center. These industry emerging products can be deployed rapidly and at a lower cost than traditional brick-and-mortar solutions and are optimally suited for hyper-scale IT and cloud applications.

We are headquartered in Austin, Texas, with international offices in the United Kingdom, Germany, and China.

We continue to develop client relationships by selling directly and through our network partners. Specifically, we bring products to market through the following distribution methods:

 
 ●
sales made directly by us;
 
 ●
manufacturer’s representatives;
 
 ●
distributors;
 
 ●
OEM partners; and
 
 ●
strategic IT partners.

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

 
 ●
increasing business costs of downtime;
 
 ●
a rapidly expanding need for data center infrastructure
 
 ●
ever-increasing demands placed on the public utility infrastructure;

 
11
 
 
 ●
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 building channels of distribution to have more avenues into the market.

Active Power has 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:  9 Global Markets around 4 Centers of Operation
 
 ●
Products:  Continuous Power and Infrastructure Solutions
 
 ●
Value:  Efficient, Reliable, Green Solutions

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.

In line with our ongoing efforts to improve margins and operational efficiency and to achieve consistent and growing levels of profitability, we have been evaluating our fixed cost position. During the third quarter of 2012, we executed cost savings measures that we expect to yield annualized savings of about $1.6 million, and recorded a one-time restructuring charge of approximately $200,000. We believe these measures will help ensure we are making appropriate investments for the future while also aligning our overhead to support consistent and profitable growth.
 
 
12

Results of Operations
 
 
 
Three Months Ended September 30,
 
 
Variance 2012 vs. 2011
 
($ in thousands)
 
2012
 
 
% of
 total
revenue
 
 
2011
 
 
% of
total
 revenue
 
 
$
 
 
%
 
Product revenue
 
$
16,647
 
 
 
85
%
 
$
16,996
 
 
 
82
%
 
$
(349)
 
 
 
(2)
%
Service and other revenue
 
 
2,964
 
 
 
15
%
 
 
3,612
 
 
 
18
%
 
 
(648)
 
 
 
(18)
%
Total revenue
 
 
19,611
 
 
 
100
%
 
 
20,608
 
 
 
100
%
 
 
(997)
 
 
 
(5)
%
Cost of product revenue
 
 
12,254
 
 
 
62
%
 
 
13,112
 
 
 
64
%
 
 
(858)
 
 
 
(7)
%
Cost of service and other revenue
 
 
1,742
 
 
 
9
%
 
 
2,649
 
 
 
13
%
 
 
(907)
 
 
 
(34)
%
Total cost of goods sold
 
 
13,996
 
 
 
71
%
 
 
15,761
 
 
 
76
%
 
 
(1,765)
 
 
 
(11)
%
Gross profit
 
 
5,615
 
 
 
29
%
 
 
4,847
 
 
 
24
%
 
 
768
 
 
 
16
%
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
 
 
1,325
 
 
 
7
%
 
 
1,272
 
 
 
6
%
 
 
53
 
 
 
4
%
Selling and marketing
 
 
3,447
 
 
 
18
%
 
 
3,527
 
 
 
17
%
 
 
(80)
 
 
 
(2)
%
General and administrative
 
 
1,691
 
 
 
9
%
 
 
1,280
 
 
 
6
%
 
 
411
 
 
 
32
%
Total operating expenses
 
 
6,463
 
 
 
33
%
 
 
6,079
 
 
 
29
%
 
 
384
 
 
 
6
%
Operating profit (loss)
 
 
(848)
 
 
 
(4)
%
 
 
(1,232)
  
 
 
(6
)%
 
 
384
 
 
 
(31)
%
Interest expense, net
 
 
(80
)
 
 
—
 
 
 
(68
)
 
 
—
 
 
 
(12)
 
 
 
18
%
Other income (expense), net
 
 
81
 
 
 
—
 
 
 
  8
 
 
 
—
 
 
 
        73
 
 
 
913
%
Net income (loss)
 
$
(847)
 
 
 
(4)
%
 
$
(1,292
)
 
 
(6
)%
 
$
445
 
 
 
(34)
%
 
($ in thousands)
 
Nine Months Ended September 30,
 
 
Variance
2012 vs. 2011
 
 
 
2012
 
 
% of
total
revenue
 
 
2011
 
 
% of
total
revenue
 
 
$
 
 
%
 
Product revenue
 
$
50,534
 
 
 
83
%
 
$
47,890
 
 
 
84
%
 
$
2,644
 
 
 
6
%
Service and other revenue
 
 
10,534
 
 
 
17
%
 
 
9,262
 
 
 
16
%
 
 
1,272
 
 
 
14
%
Total revenue
 
 
61,068
 
 
 
100
%
 
 
57,152
 
 
 
100
%
 
 
3,916
 
 
 
7
%
Cost of product revenue
 
 
35,608
 
 
 
58
%
 
 
35,625
 
 
 
62
%
 
 
(17)
 
 
 
—
  
Cost of service and other revenue
 
 
6,766
 
 
 
11
%
 
 
7,337
 
 
 
13
%
 
 
(571)
 
 
 
(8)
%
Total cost of revenue
 
 
42,374
 
 
 
69
%
 
 
42,962
 
 
 
75
%
 
 
(588)
 
 
 
(1)
%
Gross profit
 
 
18,694
 
 
 
31
%
 
 
14,190
 
 
 
25
%
 
 
4,504
 
 
 
32
%
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
 
 
4,045
 
 
 
7
%
 
 
3,279
 
 
 
6
%
 
 
766
 
 
 
23
%
Selling and marketing
 
 
10,891
 
 
 
18
%
 
 
10,397
 
 
 
18
%
 
 
494
 
 
 
5
%
General and administrative
 
 
5,175
 
 
 
8
%
 
 
4,083
 
 
 
7
%
 
 
1,092
 
 
 
27
%
Total operating expenses
 
 
20,111
 
 
 
33
%
 
 
17,759
 
 
 
31
%
 
 
2,352
 
 
 
13
%
Operating loss
 
 
(1,417
)
 
 
(2
)%
 
 
(3,569
)
 
 
(6)
%
 
 
2,152
 
 
 
(60)
%
Interest expense, net
 
 
(246
)
 
 
—
 
 
 
(149
)
 
 
—
 
 
 
(97)
 
 
 
65
%
Other income (expense), net
 
 
159
 
 
 
—
 
 
 
(34
)
 
 
—
 
 
 
193
 
 
 
(568)
%
Net loss
 
$
(1,504
)
 
 
(2
)%
 
$
(3,752
)
 
 
(6)
%
 
$
2,248
 
 
 
(60)
%
 
 
13
 
Product revenue. Product revenue primarily consists of sales of our CleanSource power quality products and our MIS solutions. Our CleanSource power quality products are comprised of both UPS and DC product lines and our MIS solutions consist of our CPS solutions (which are comprised of our UPS systems and some combination of third party ancillary equipment, such as engine generators and switchgear) and our other 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:
 
($ in thousands)
 
Three Months Ended
September 30,
 
 
Variance
 
 
 
2012
 
 
2011
 
 
$
 
 
%
 
Product revenue:
 
 
 
 
 
 
 
 
 
 
 
 
UPS systems
 
$
14,785
 
 
$
5,991
 
 
$
8,794
 
 
 
147
%
MIS solutions
    
1,862
 
 
 
11,005
 
 
 
(9,143)
 
 
 
(83)
%
                                 
                                 
Total product revenue
 
$
16,647
 
 
$
16,996
 
 
$
(349)
 
 
 
(2)
%
 
($ in thousands)
 
Nine Months Ended
September 30,
 
 
Variance
 
 
 
2012
 
 
2011
 
 
$
 
 
%
 
Product revenue:
 
 
 
 
 
 
 
 
 
 
 
 
UPS systems
 
$
28,554
 
 
$
20,764
 
 
$
7,790
  
 
 
38
%
MIS solutions
    
21,980
 
 
 
27,126
 
 
 
(5,146)
 
 
 
(19)
%
                                 
                                 
Total product revenue
 
$
50,534
 
 
$
47,890
 
 
$
2,644
 
 
 
6
%
 
Total product revenue for the three-month period ended September 30, 2012 did not vary significantly from the same period of 2011.  Product mix did change significantly, however, we saw a 147% increase in sales of our UPS products and an 83% decrease in our MIS solutions revenue compared to the prior year. The increase in UPS product revenue was primarily due to large UPS installations in the third quarter of 2012 in Europe, the Middle East and Africa (“EMEA”) and Asia and a broader increase in the number of UPS customers as we re-focused our sales activities on growing UPS product sales. Included in UPS systems revenue this quarter was approximately $5.6 million of ancillary equipment related to completion of a large integrated UPS system deployment in Europe. Excluding ancillary equipment, UPS system revenue was approximately flat with the previous quarter’s revenue levels and up by 51% compared to the third quarter of 2011. There was also a 114% increase in OEM sales of UPS products compared to the previous year. UPS product sales comprised 89% of our product revenue for the third quarter of 2012, as compared to 35% for the third quarter of 2011. The decrease in MIS solutions revenue reflects the small number of customers and large order values inherent in this business that can result in large short-term fluctuations in MIS solution revenues. Due to timing of customer projects, there was $499,000 or 3% of product revenue in sales of CPS products in the third quarter of 2012,  compared to CPS product sales of $7.0 million, or 41% of our product revenue, in the third quarter of 2011.  Sales of infrastructure solutions decreased by $2.6 million, or 66%, compared to the third quarter of 2011 due to lower customer orders.

Total product revenue for the nine-month period ended September 30, 2012 increased by $2.6 million, or 6%, compared to the same period in 2011. This increase was driven primarily by an increase of $7.8 million, or 38%, in sales of UPS products compared to the prior year, reflecting the higher level of ancillary equipment sales and also improved UPS sales performance and strong growth internationally for our UPS solutions. In the aggregate, MIS revenues declined by $5.1 million, or 19%, compared to the first three quarters of 2011. Sales of our CPS solutions declined by $14.7 million, or 73%, compared to 2011 due to the absence of large customer projects in the U.S. market compared to 2011, and less complementary sales of CPS solutions with infrastructure products compared to 2011. Sales of our infrastructure solutions for the first three quarters of 2012 increased by $9.5 million compared to 2011, which offset this decline in CPS product revenues.

Product revenue from Active Power branded products through our direct and manufacturer’s representative channels was $10.2 million, or 61% of our product revenue, for the three-month period ended September 30, 2012, compared to $5.1 million, or 30% of our product revenue, in the same period of 2011, and $7.9 million, or 45% of our product revenue, for the second quarter of 2012. For the nine-month period ended September 30, 2012, product sales of Active Power branded products through our direct and manufacturer’s representative channels were $24.5 million, or 48% of our product revenue, compared to $22.4 million, or 47% of our product revenue, for the same period of 2011.

Product revenue from our OEM channels for the three-month period ended September 30, 2012 was $5.0 million, an increase of approximately $3.0 million, or 149%, compared to $2.0 million for the third quarter of 2011. This reflected several large multi-megawatt UPS systems sales in Asia in the current quarter and increased OEM activity in the EMEA market. For the nine-month period ended September 30, 2012, product revenue from our OEM channel was $7.8 million, a decrease of $1.4 million, or 15%, compared to $9.2 million for the same period in 2011, reflecting lower OEM activity in the US market compared to 2011. Product revenue from our OEM channels for the three-month period ended September 30, 2012 increased by $3.4 million, or 205%, compared to $1.7 million for the second quarter of 2012. The size and volume of orders from our OEM channels can fluctuate significantly on a quarterly basis and in 2012 we have seen 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 systems as a total solution. Sales to Caterpillar, our primary OEM channel, represented $5.0 million and $7.8 million, or 30% and 15% of our product revenue, for the three-month and nine-month periods ended September 30, 2012, respectively, compared to $2.0 million and $9.1 million, or 12% and 19% of our product revenue, in the comparable periods of 2011. Caterpillar remains one of our largest UPS customers as well as our largest OEM customer.
 
 
14
 
Product revenue from our IT channel for the third quarter of 2012 was $1.4 million, compared to $9.9 million for the third quarter of 2011, which represents a $8.5 million, or 86%, decrease. This decrease was 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 success and need for infrastructure solutions. We have historically experienced large quarterly fluctuations in the number and value of such orders. Sales to HP accounted for 8% of our product revenue for the third quarter of 2012 compared to 58% in the same period of 2011.

Our MIS solutions transactions tend to be larger in value and 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 or shipments in any particular accounting period and as evidenced by low MIS sales in the third quarter of 2012. Generally, the size of these transactions has been increasing and individual CPS and infrastructure transactions have been as high as $6 million in 2011. A small number of transactions can therefore lead to significant revenue, but cause greater volatility in our quarterly results and increase liquidity risk for us as these orders require much larger amounts of working capital to fulfill, which we attempt to manage through customer and vendor payment terms as part of our working capital management.

North America product revenue was $5.9 million or 35% of our product revenue for the three-month period ended September 30, 2012, compared to $14.5 million, or 85% of our product revenue, for the same period in 2011 and $12.1 million, or 69% of product revenue, in the second quarter of 2012. This decrease reflects lower MIS revenues which historically have largely originated in the North American market. For the nine-month period ended September 30, 2012, our North America product revenue was $28.6 million, or 57% of our total product revenue, compared to $30.8 million, or 64%, for the same period in 2011. The decrease in North American sales has been driven by the decrease in sales of MIS solutions.

We also sell products directly to customers in Asia and Western Europe and we have a network of international distributors in other territories that sell products for us. In these markets, customers are more likely to purchase a total power solution 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 volatile. Thus the amount of revenue from our international markets can fluctuate significantly on a quarterly basis. Product sales to customers in Asia were $2.0 million, or 12% of our total product revenue, in the three-month period ended September 30, 2012, compared to $842,000, or 5%, for the same period in 2011 and $1.0 million, or 6%, for the second quarter of 2012. Product revenue in EMEA was $8.8 million, or 53% of product revenue, in the three-month period ended September 30, 2012, compared to $1.6 million, or 10%, for the same period of 2011 and $4.4 million, or 25%, for the second 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.

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 $648,000, or18%, for the three-month period ended September 30, 2012, compared to the same period of 2011. This decrease reflects lower professional fees associated with decreased MIS sales in the quarter compared to the prior period. For the nine-month period ended September 30, 2012, service and other revenue increased by approximately $1.3 million, or 14%, compared to the same period in 2011. The increase for the nine-month period reflects higher levels of service and contract work from direct product sales and from higher professional fees associated with increased infrastructure sales. 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.  We had increased service revenues from maintenance contracts and repair-related activities as our increasing installed base of UPS customers provides greater opportunities to generate such revenues. 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.
 
 
15
 
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, 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 74% for the three-month period ended September 30, 2012, compared to 77% for the same period in 2011, and was 70% in the nine-month period ended September 30, 2012 compared to 74% in the same period of 2011. These decreases in costs as a percentage of revenue reflect more favorable UPS pricing compared to 2011 and higher levels of absorbed overhead costs attributable to a higher level of UPS system production. We continue to operate a manufacturing facility that has a manufacturing and testing capacity significantly greater than our current product revenue levels. 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, vendor management programs and increasing our sales volume to absorb these expenses. We have also improved our capabilities and efficiency in manufacturing and managing our infrastructure solutions which have reduced our total cost of production for these products and further contributed to the decrease in cost of product revenue as a percentage of revenue.

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, including travel and related costs incurred in fulfilling our service obligations to our customers. Costs paid to third parties in fulfillment of service and design or installation services are also included in costs of service and other revenue. The cost of service and other revenue decreased to 59% of service and other revenue in the three-month period ended September 30, 2012, compared to 73% for the same period of 2011, and decreased to 64% in the nine-month period ended September 30, 2012 compared to 79% in the same period of 2011.  These percentage decreases reflect higher utilization of our service personnel and improved revenues on the professional service work we perform for MIS systems installation. We have had higher costs relative to the increase in service and other revenues as we have continued to expand our service team and broaden the geographic regions where we have service capability as our total business grows. 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 and depending upon the revenues for the quarter, we may incur unabsorbed overhead each 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 September 30, 2012, our gross profit was 29% of revenue, compared to a 24% gross profit margin for the third quarter of 2011 and a 36% gross profit margin for the second quarter of 2012. The improvement from the third quarter of 2011 reflects improved margins on our UPS business as a result of more favorable pricing and from higher manufacturing efficiency. The decrease in the margin from the second quarter of 2012 reflects the change in product mix from the prior quarter in which we had a significant increase of $5.3 million in revenue from third party ancillary equipment revenue in the third quarter. We experience lower margins from the sale of third-party equipment compared to the margins on our manufactured UPS and MIS products. Historically, MIS sales of our CPS and infrastructure products have generated lower margins for us than sales of our UPS products because they include a higher proportion of third party ancillary equipment. Our ability to improve our gross profit from these product lines has come from our ability to continue to reduce material costs and our efforts to improve our service margins through pricing and operational efficiency. 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, increase product prices, 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 product development activities, as well as an allocated portion of our occupancy costs. Overall, our research and development expenses were approximately $53,000, or 4%, higher in the third quarter of 2012 compared to the third quarter of 2011 and were $107,000, or 7%, lower than the second quarter of 2012. We are currently developing a new generation of UPS product that we believe will offer greater power modularity and space efficiencies especially as we target the larger power market segments, which we expect to introduce later this year.   We have increased headcount and prototyping expenses to support this new product development and meet our delivery deadline and to support new infrastructure and UPS products that we believe will contribute to future revenue growth.

Selling and marketing. Selling and marketing expense primarily consists of compensation, including variable sales compensation, and related costs for sales and marketing personnel, and related travel, selling and marketing expenses, as well as an allocated portion of our occupancy costs and the cost of our foreign sales operations. Selling and marketing costs were approximately $80,000, or 2%, lower in the third quarter of 2012 compared to the third quarter of 2011 and decreased approximately $450,000, or 12%, from the second quarter of 2012 primarily from lower headcount and lower commissions for third party manufacturers’ representatives as well as lower employee sales compensation.
 
 
16
 
General and administrative. General and administrative expense is primarily comprised of compensation and related costs for executive and administrative personnel, professional fees, and taxes, including sales, property and franchise taxes. General and administrative expenses for the third quarter of 2012 increased approximately $411,000, or 32%, compared to the same period in 2011 due to higher recruiting and other professional services fees, as well as an increase in our provision for doubtful accounts, and decreased by approximately $249,000, or 13%, compared to the second quarter of 2012 due to lower compensation costs and professional fees.

Interest expense, net. Net interest expense for the third quarter of 2012 increased by approximately $12,000, or 18%, compared to the third quarter of 2011. We incurred higher interest expense in 2012 as we had a larger average outstanding balance on our revolving credit facility. Our average cash and investments balance over the three-month period ending September 30, 2012 increased by $4.8 million, or 45%, compared to the average balance over the same period ending September 30, 2011. This higher average cash balance resulted in higher interest income, which offset a portion of the higher interest expense.

Other income (expense), net. Other income (expense) in the third quarter of 2012 and 2011 primarily reflects foreign exchange gains (losses) on a bank account and sales contracts held in foreign currencies.

Liquidity and Capital Resources

Our primary sources of liquidity at September 30, 2012 are our cash and investments on hand, our bank credit facilities and projected cash flows from operating activities. If we meet our cash flow projections in our current business plan, we expect that we will have adequate capital resources in order to continue operating our business for at least the next 12 months. Our business plan and our assumptions around the adequacy of our liquidity are based on estimates regarding expected revenues and future costs. However, there are potential risks, including that our revenues may not meet our projections, our costs may exceed our estimates or our working capital needs may be greater than anticipated. Further, our estimates may change and future events or developments may also affect our estimates. Any of these factors may change our expectation of cash usage in the remainder of 2012 and beyond or significantly affect our level of liquidity, which may limit our opportunity to pursue certain opportunities to grow our business.

A substantial increase in sales of our MIS solutions, including our PowerHouse or our infrastructure solutions products, or a substantial increase in the volume of UPS sales may materially impact the amount of liquidity required to fund our operations. The amount of time between our expenditures for raw materials, manufacturing and shipment of products and our receipt of payments from our customers (the cash cycle) for sales of our CleanSource UPS product can be as short as 45 days, and is typically 60 days. However, the cash cycle on a PowerHouse product sale can be as much as 210 days, depending upon customer payment terms. We intend to mitigate the financial impact of this longer cash cycle by requiring customer deposits and periodic payments where possible from our customers. This is not always commercially feasible, and in order to increase our MIS revenues, we may be required to make larger investments in inventory and receivables. These larger investments may require us to obtain additional sources of working capital, debt or equity financing in order to fund this business.

Should additional funding be required, we would expect to raise the required funds through borrowings or public or private sales of debt or equity securities. If we raise additional funds through the issuance of debt or equity securities, the ownership of our stockholders could be significantly diluted. If we obtain additional debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, and the terms of the debt securities issued could impose significant restrictions on our operations. We do not know whether we will be able to secure additional funding, or funding on terms acceptable to us, to continue our operations as planned. If financing is not available, we may be required to reduce, delay or eliminate certain activities or to license or sell to others some of our proprietary technology.
 
 
17
 
The following table summarizes the quarterly changes in cash used in operating activities:

($ in thousands)
 
Nine Months Ended
September 30,
 
 
Variance
2012 vs. 2011
 
 
 
2012
 
 
2011
 
 
$
 
 
%
 
Cash used in operating activities
 
$
(5,192
)
 
$
(7,551
)
 
$
2,359
 
 
 
31
%

Cash used in operating activities decreased by $2.4 million in the nine-month period ended September 30, 2012 compared to the same period of 2011. This was primarily due to a $2.2 million decrease in our level of operating losses and from changes in our working capital requirements caused by the timing of product shipments to our customers. This timing of large orders can cause large fluctuations in the amount of cash required for operations on a quarterly basis.

The fluctuations in working capital are impacted by the timing of product orders and shipments. In the nine-month period ended September 30, 2012, we saw a decrease of approximately $77,000 in inventory as inventory levels declined primarily due to  timing of product delivery on MIS projects. Our receivables increased by $6.5 million since December 31, 2011, reflecting the higher revenue levels and a higher proportion of revenues that were recognized toward the end of the reporting period. Our prepaid expenses and other assets increased by $1.0 million since December 31, 2011, due to prepayments required on supplier purchase orders for inventory required to fulfill infrastructure solutions sales orders. These uses of funds were offset by an increase in deferred revenue of $3.1 million since December 31, 2011. These increases reflect timing of customer deposits and advance payments related to the timing of our large CPS and infrastructure projects. We anticipate that cash provided by (used in) operations will fluctuate significantly based upon the volume and size of our CPS and infrastructure solutions sold and by the timing of product delivery relative to our reporting periods, and that such volatility in sources and uses of funds will continue based upon growth of our CPS and infrastructure solutions businesses.

The following table summarizes the quarterly changes in cash used in investing activities:

($ in thousands)
 
Nine Months Ended
September 30,
 
 
Variance
2012 vs. 2011
 
 
 
2012
 
 
2011
 
 
$
 
 
%
 
Cash used in investing activities
 
$
(1,021
)
 
$
(2,091
)
 
$
1,070
  
 
 
51
%

Investing activities primarily consist of purchases of property and equipment. Capital expenditures were $1.2 million, or 54% lower in the nine-month period ending September 30, 2012, compared to the same period of 2011, which is attributable to the fact that in the 2011 period that we invested in multiple demonstration CPS systems in Asia and Europe. This year’s expenditure is related to the commencement tooling for our next generation UPS product.
 
The following table summarizes the quarterly changes in cash provided by financing activities:

($ in thousands)
 
Nine Months Ended
September 30,
 
 
Variance
2012 vs. 2011
 
 
 
2012
 
 
2011
 
 
$
 
 
%
 
Cash provided by financing activities
 
$
10,034
 
 
$
3,265
 
 
 
6,769
 
 
 
207
%

Funds provided by financing activities during the nine-months ended September 30, 2012 primarily reflect the sale of common stock in the first quarter of 2012 pursuant to which we sold approximately 14.3 million shares of common stock at a purchase price of $0.68 per share, for proceeds, net of fees and expenses, of approximately $9.6 million, and also reflects proceeds from the exercise of employee stock options.

The shares that were sold in the first quarter of 2012 were sold pursuant to a prospectus included in our shelf registration statement on Form S-3 dated November 24, 2009, as amended on December 17, 2009 (Registration No. 333-163301), which was declared effective by the Securities and Exchange Commission (the “SEC”) on December 21, 2009, as supplemented by a prospectus supplement dated March 7, 2012 filed with the SEC pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the “Offering”).  No discounts or placement agent fees were payable in connection with the Offering.
 
 
18
 
In connection with the Offering, we also entered into a Side Letter Agreement with Kinderhook, LP (formerly known as Kinderhook Partners, LP) (“Kinderhook”) pursuant to which Kinderhook was granted the right to designate one member of our board of directors. Pursuant to this Side Letter Agreement, in June 2012 Kinderhook appointed a designee, Mr. Stephen Clearman, to the Company’s board of directors.
 
We also entered into a Resale Registration Rights Agreement (the “Rights Agreement”) pursuant to which we were obligated to prepare promptly and file with the SEC a Registration Statement on Form S-3 covering the resale of shares of Common Stock held by Kinderhook. The registration statement covering such shares was declared effective on July 18, 2012 in accordance with the terms of the Rights Agreement. All expenses incurred by us in connection with registrations, filings or qualifications pursuant to the Rights Agreement have been borne by us.
 
We renegotiated the term of our $12.5 million revolving line of credit facility with Silicon Valley Bank during the third quarter of 2012. The new facility is on substantially the same terms and conditions as our previous facility and extends the expiration date of this facility until August 2014. We believe the renegotiated credit facility will enable us to extend and better utilize this credit facility and provide us greater flexibility in our working capital management.

We believe that our cash and investments and our sources of available liquidity, including our bank credit facility, will be sufficient to fund our operations for at least the next 12 months. However, a sudden change in business volume or product mix, positive or negative, from any of our business or channel partners or in our direct business could significantly impact our expected revenues. The global economic downturn has reduced our confidence at predicting future revenues, and even with improving economic conditions, there is still uncertainty and risk in our forecasting. However, we feel we have sufficient demand visibility to provide us with some opportunity to adjust expenditures or take other measures to reduce our cash consumption if we can see and anticipate a shortfall in revenue or give us time to identify additional sources of funding if we anticipate an increase in our working capital requirements due to increased revenues or changes in our revenue mix. A significant increase in sales, especially in our PowerHouse or our infrastructure solutions business, would likely increase our working capital requirements, due to the longer production time and cash cycle of sales of these products.
 
 
19
 

We invest our cash in a variety of financial instruments, including bank time deposits, and taxable variable rate and fixed rate obligations of corporations, municipalities, and local, state and national government entities and agencies. These investments are denominated in U.S. dollars.

Our interest income is sensitive to changes in the general level of U.S. interest rates. The majority of our investments are in short-term instruments. We believe that our investment policy is conservative, both in terms of the average maturity of investments that we allow and in terms of the credit quality of the investments we hold. Because of the nature of the majority of our investments, we do not believe a 1% decline in interest rates would have a material effect on interest income or their fair value.

Our international sales were historically made in U.S. dollars. As we have increased sales in foreign markets and opened operations in multiple foreign countries, we have executed more transactions that are denominated in other currencies, primarily Euro, British pounds and Chinese Renminbi. Those sales and expenses in currencies other than U.S. dollars can result in translation gains and losses which have not been significant to date. Currently, we do not engage in hedging activities for our international operations other than increasing the amount of sales and support expenses being incurred in foreign currencies as a natural hedge. However, recent volatility in currencies, particularly with the pound and Euro, is increasing the amount of potential translation gains and losses and we may engage in hedging activities in the future to mitigate the risks caused by such currency volatility.


Evaluation of disclosure controls and procedures.

Our Chief Executive Officer and our Chief Financial Officer, based on the evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that, as of September 30, 2012, our disclosure controls and procedures were effective to ensure that the information we are required to disclose in reports that we file or submit under the Exchange Act, (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in internal control over financial reporting.

During the three months ended September 30, 2012, there were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and Rule 15d-15(d) under the Exchange Act that have materially affected, or that we believe are reasonably likely to materially affect, our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.


Item  1.

We are, from time to time, subject to various legal proceedings, claims and litigation arising in the ordinary course of business. We do not believe we are party to any currently pending legal proceedings the outcome of which may have a material effect on our operations or consolidated financial position. There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse affect on our financial position, results of operations or cash flows.

Item  1A.

You should carefully consider the risks described below and in Item 1A of our 2011 Annual Report on Form 10-K before making a decision to invest in our common stock or in evaluating Active Power and our business. The risks and uncertainties described below and in our 2011 Annual Report on Form 10-K are not the only ones we face. Additional risks and uncertainties that we do not presently know, or that we currently view as immaterial, may also impair our business operations. This report is qualified in its entirety by these risk factors.

 
20
 
The actual occurrence of any of the risks described below and in our 2011 Annual Report on Form 10-K could materially harm our business, financial condition and results of operations. In that case, the trading price of our common stock could decline.

Our increased emphasis on larger and more complex system solutions and customer concentration may affect our ability to accurately predict the timing of revenues and to meet short-term expectations of operating results and may adversely impact our liquidity.

Our increased emphasis on larger and more complex system solutions has increased the effort and time required by us to complete sales to customers. Further, a larger portion of our quarterly revenue is derived from relatively few large transactions with relatively few customers. For example, during the three months ended September 30, 2012, our three largest customers contributed an aggregate of 65% of our revenue. Any delay in completing these large sales transactions or reduction in business volume from these large customers, may result in significant fluctuations in our quarterly revenue. In addition, we use anticipated revenues to establish our operating budgets and a large portion of our expenses, particularly rent and salaries are fixed in the short term. As a result, any shortfall or delay in revenue could result in increased losses and would likely cause our operating results to be below public expectations.  Further, we may purchase inventory and enter into commitments with our suppliers based on purchase orders we receive from our customers, which orders subsequently may be cancelled or deferred.  While our customers are typically legally obligated to take delivery against a purchase order, any such cancellation or deferral may extend the amount of time between our expenditures for inventory and supplier commitments and our receipt of payment from our customers. The occurrence of any of these events would likely materially adversely affect our results of operations, and could adversely impact our liquidity, which would likely cause the market price of our common stock to decline.
 
We are significantly dependent on our relationships with Hewlett Packard and Caterpillar. If these relationships are unsuccessful, for whatever reason, our business and financial prospects would likely suffer.

Caterpillar (including its dealer network) is our primary OEM customer and our largest single customer for our UPS products. Caterpillar and its dealer network accounted for 19%, 16%, and 15% of our revenue in 2010, 2011 and the nine months ended September 30, 2012, respectively. HP is our largest IT channel partner and accounted for 25%, 36%, and 36% of our revenue in 2010, 2011 and the nine months ended September 30, 2012, respectively. A number of factors could cause these customers to cancel or defer orders, including interruptions to their operations due to a downturn in their industries, delays or changes in their product offerings or securing other sources for the products that we manufacture, cancellations or deferrals by their customers, or developing such products internally.  If our relationships with HP or with Caterpillar are not successful or suffer a material adverse change, such as a material reduction in the level of orders or their failure to timely pay us, our business and operating results would likely suffer.

The transition to a new Chief Executive Officer and new Chief Financial Officer may limit our ability to effectively execute on our business plan.
 
Effective March 1, 2012, Douglas Milner became our President and Chief Executive Officer.  Because he is relatively new to Active Power, his experience with our management team and knowledge of our operations is limited.  While Jan Lindelow, who had been serving as our Interim Chief Executive Officer, is assisting Mr. Milner as he transitions into the position, this leadership change may result in disruptions to our business or operations or otherwise limit the ability of our management team to effectively execute on our business plan, which could have an adverse effect on our results of operations and financial condition.

In addition, on June 13, 2012, John Penver delivered his resignation as our Vice President of Finance, Chief Financial Officer and Secretary, to be effective as of October 31, 2012.  We have hired a new Chief Financial Officer, Steven Fife, who will assume responsibility on November 1, 2012.  The transition to a new Chief Financial Officer will require time and expense, may cause disruptions in our finance and accounting function and may limit the ability of our management team to effectively execute on our business plan. If we are unable to manage this transition efficiently and effectively, our business and operating results may be adversely affected.

Our common stock could be delisted from The Nasdaq Capital Market if our stock price continues to trade below $1.00 per share.
 
Prior to June 21, 2012, our common stock was listed on The Nasdaq Global Market. In June 2012, we applied to transfer the listing of our common stock from The Nasdaq Global Market to The Nasdaq Capital Market.  Upon transfer to The Nasdaq Capital Market, we are required under Rule 5550(a)(2) to maintain a minimum bid price of $1.00 for our common stock.  On June 19, 2012, we received approval from Nasdaq of our application for the transfer of the listing of our common stock from The Nasdaq Global Market to The Nasdaq Capital Market, effective at the market open on June 21, 2012, and granting us an additional 180 days pursuant to Marketplace Rule 5810(c)(3)(A)(ii) to regain compliance with the minimum $1.00 per share bid price requirement for continued listing on The Nasdaq Capital Market.  If at any time before December 17, 2012, the bid price of our common stock closes at or above $1.00 per share for a minimum of 10 consecutive business days, Nasdaq will provide written confirmation that we have achieved compliance. If compliance with Marketplace Rule 5550(a)(2) cannot be demonstrated by December 17, 2012, our common stock will be subject to delisting from The Nasdaq Capital Market.
 
 
21
 
In the event that we receive notice that our common stock is being delisted from The Nasdaq Capital Market, Nasdaq rules permit us to appeal any delisting determination by the Nasdaq staff to a Nasdaq Hearings Panel.

We will continue to monitor the bid price for our common stock and consider various options available to us (including a possible reverse stock split) if our common stock does not trade at a level that is likely to regain compliance.

Delisting from The Nasdaq Capital Market could have an adverse effect on our business and on the trading of our common stock.  If a delisting of our common stock from The Nasdaq Stock Market were to occur, our common stock would trade on the OTC Bulletin Board or on the “pink sheets” maintained by the National Quotation Bureau, Inc. Such alternatives are generally considered to be less efficient markets, and our stock price, as well as the liquidity of our common stock, may be adversely impacted as a result.


None.


None.


None.


None.
 
 
22
 
Item  6.

  The following documents are filed as exhibits to this report:
 
3.1*
Restated Certificate of Incorporation, dated June 7, 2006 (filed as Exhibit 3.1 to Active Power’s Quarterly Report on Form 10-Q filed on April 30, 2012)
 
 
3.2*
Second Amended and Restated Bylaws as adopted February 1, 2007 (filed as Exhibit 3.2 to Active Power’s Quarterly Report on Form 10-Q filed on April 30, 2012)
 
 
3.3*
Amendment to Second Amended and Restated Bylaws as adopted December 6, 2007 (filed as Exhibit 3.3 to Active Power’s Quarterly Report on Form 10-Q filed on April 30, 2012)
 
 
4.1*
Specimen certificate for shares of Common Stock (filed as Exhibit 4.1 to Active Power’s IPO Registration Statement on Form S-l (SEC File No. 333-36946))
 
 
4.2*
See Exhibits 3.1, 3.2 and 3.3 for provisions of the Certificate of Incorporation and Bylaws of the registrant defining the rights of holders of common stock
 
  
10.1*
 Second Amendment to Second Amended and Restated Loan and Security Agreement with Silicon Valley Bank, dated August 15, 2012 (filed as Exhibit 10.1 to Active Power’s Current Report on Form 8-K filed on August 20, 2012)
   
Offer Letter, dated October 1, 2012, between Active Power, Inc. and Steven R. Fife
   
Severance Benefits Agreement, dated October 8, 2012, between Active Power, Inc. and Steven R. Fife
   
Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2003
   
Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2003
 
 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003
 
 
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003
 
  
101
The following financial statements from the Active Power’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, formatted in XBRL: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations and Comprehensive Loss, (iii) Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements.
 
*
Incorporated by reference to the indicated filing.
 
 
23
 
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
ACTIVE POWER, INC.
 
(Registrant)
 
 
October 31, 2012
/s/    J. Douglas Milner
(Date)
J. Douglas Milner
 
President and Chief Executive Officer
 
(Principal Executive Officer)
 
 
October 31, 2012
/s/ John K. Penver
(Date)
John K. Penver
 
Chief Financial Officer and Secretary
 
(Principal Financial and Accounting Officer)
 
24
 

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