Shawn Severson - Integra IR Arthur Sams - President, CEO, and Chairman Rajesh Masina - COO Luis Zavala - VP and CFO.

Craig Irwin - Roth Capital Partners Ashok Kumar - ThinkEquity.

Good day ladies and gentlemen and welcome to the Polar Power's Third Quarter 2018 Financial Results Call. As a reminder, today's conference is being recorded. At this time, I'd like to turn the floor over to Shawn Severson. Please go ahead..

Thank you and good afternoon everyone. I'd like to thank you all for taking the time to join us today for Polar Power's third quarter 2018 conference call. Your hosts today are Arthur Sams, Polar Power's Chief Executive Officer; Raj Masina, Chief Operations Officer; and Luis Zavala, Chief Financial Officer.

Arthur will begin by providing an overview of the key events in the quarter. This will be followed by Raj, who will provide an operations update as well as updates on the key strategic objectives. After which, Luis will discover -- discuss the financial results.

A press release detailing this quarter's results crossed the wires this afternoon at 4:15 Eastern Time and is available on the company's website, www.polarpower.com. Following management's prepared comments, we will open the call for questions.

Before we begin, I'd like to remind everyone that statements made on the call and webcast today, including those regarding future financial results and industry prospects, are forward-looking and may be subject to a number of risks and uncertainties that could cause actual results to differ materially from those described in the call.

Please refer to the company's SEC filings for a list of associated risks and we also would refer you to the company's website for more supporting industry information. At this time, I'd like to turn the call over to Arthur Sams, Polar Power's CEO..

Thank you, Shawn and welcome everyone to Polar Power's third quarter 2018 earnings conference call. During today's call, I will briefly discuss our key highlights for the third quarter 2018 before I provide you with an update for each of our core markets.

First, I would like to give a brief summary of financial results and then address key issues regarding revenue, gross margin and backlog. Luis will provide a greater financial detail later during this call. Backlog at the end of Q3 2018 was $11.5 million compared to $5.8 million at the end of Q2 2018.

As of November 9th, our backlog has increased to $15.2 million. A significant portion of the growth is a result of production orders from two of our Tier 1 telecom customers and this validates the strong product demand trend, mainly from our U.S.-based telecom customers.

Net sales increased 67% to $5.1 million in Q3 2018 as compared to $3 million during -- in sales during the same three-month period last year. Increased production and lower material cost resulted in a gross margin increase from 27% in Q3 2017 to 30% during Q3 2018.

However, due to a change in product mix towards new production models, gross margin dropped from 36% in the previous quarter to 30% during Q3 2018 -- third quarter 2018. Net loss was $0.7 million in Q3 2018 or $0.07 per basic and diluted share as compared to a net loss of $0.4 million or $0.04 per basic and diluted share in Q3 2017.

Now, I'd like to address some of the key issues we are experiencing during the quarter that affected mainly revenue gross margin and our backlog.

I'd like to start by stating that the sequential slide in revenue was a result of supply disruptions and not related to a negative shift in demand, which was a strong -- which was in fact, strong in the quarter as indicated by our record backlog.

Our ability to manufacture and ship products during this quarter was negatively impacted by the tariffs put in place and the possible trade wars, which created an international and domestic short-term surge in demand for engines, electronic parts, aluminum, and steel.

This resulted in longer lead-times than expected in some of the key parts of our supply chain, including engines, and was the culprit behind the revenue shortfall. We believe this issue has been resolved by our suppliers, and indications are that we are back on track with our original suppliers.

Gross margin, next, I would like to address the gross margins slide from Q2 2018. The decline was primarily driven by three key factors; first and foremost, was lower fixed cost absorption related to the lower revenue levels.

We have made material investments in staffing, manufacturing, equipment, and in a new manufacturing facility in anticipation of growing demand, which I have discussed with you in previous calls, and has begun to materialize as you can see per our backlog.

The second factor is also tied to the supply chain disruption and resulting in increased -- and resulting from increased component costs.

Most notable were extended lead-times for engines from key supplier that forced us to turn to higher-cost supply for our short-term needs, which we had to absorb and subsequently, negatively impacted our gross margin. We believe this issue has been resolved and now receiving engines from our original suppliers on a timely basis.

The third issue is related to a new product launch with a top-tier customer that began in Q3 2018. It's not normal to experience higher-cost with new product launches as there's the manufacturing learning curve we have to navigate. Now, I'd like to briefly discuss our $15.2 million record-breaking backlog as of November 9th.

As I have stated in private -- prior calls, I believe we are entering a period of investment by global telecommunications providers. In our view, this quarter's backlog is evidence that we are beginning to see this happening in the market.

I also believe we are succeeding in our strategic goal of gaining market share that is also driving our growing backlog.

Luis will cover the financial results in more detail later during this call and I would now like to discuss the business highlights for the quarter and provide you with a progress reports on our key strategic objectives as outlined earlier this year.

As a reminder for everyone, our continuing key strategic objectives are; one, to increase our market share with top-tier U.S.

telecom providers and expand our presence in international markets; two, diversify our customer and product base by providing more comprehensive services to our telecom customers and increasing our exposure in other key markets including military, commercial, residential operate markets and electric car charging.

Increase our production capacity and efficiency by opening up our second manufacturing plant and facilitate revenue growth. To provide -- four is to provide industry-leading technology and power solutions through our R&D and technology road map.

Now, I'd like to hand it over to Raj so that he can provide an operational update on our strategic objectives..

Thank you, Arthur. Let me expand on those four strategic objectives Arthur mentioned. The first one, in regarding to -- regards to our first objective of market share gains and international expansion, our traction with our Tier 1 U.S. carriers continued in the quarter as evidenced by our record backlog.

We had also increased by the initial forecast for 2019 from our top Tier 1 telecom customers. On the international front, during the quarter, we had a key strategic win with Huawei in Namibia, which issued purchase orders to our Polar Power in Namibia office for radio and microwave installations across previous Namibian networks.

This is a positive first step, though it's not material in nature, but it's a good positive first step and we look forward to collaborating with Huawei's African operations.

Other key developments in the quarter and in the international markets include the installation and commissioning of five off-grid and bad-grid sites in Sri Lanka and we expect additional purchase order activity as soon as early 2019. We have also received approval for initial orders for Thailand.

We are working on a new product that we believe will help drive our market share with the U.S. top-tier carriers and grow international emerging markets sales. Specifically, we have been working on a new power system that runs off of LPG and natural gas.

This is important for our international markets, where the LPG and natural gas infrastructure is well developed and power grids are not available or unreliable. We believe this product will help drive incremental sales as we can provide a solution using a lower-cost and widely available fuel source and reduce dependency on diesel.

Domestically, it will enable U.S. top tier telecom customers to better comply with emission standards and permitting titles as it pertains to their backup power systems.

The second strategic objective is to diversify our customer and product base by providing more comprehensive services to our telecom customers and thereby, increasing our exposure in other key markets.

In regard to our customer diversification across Tier 1 telecom customers, we started receiving significant DC power system orders for T-Mobile during this quarter. We believe that the combined sales to AT&T, T-Mobile, and Verizon shows that we have successfully diversified across the domestic Tier 1 telecom customers.

We're also continuing to gain momentum in military applications.

With regards to the new programs we mentioned in the previous calls, in the third quarter of 2018, we delivered a significant percentage of the order that they we have received from these different contractors, which were related to the Army Robotic and Autonomous Systems, which is called the RAS program.

To develop autonomous vehicles that provide logistics, reconnaissance, and surveillance functions. We believe during the fourth quarter of 2018, our program partners will begin demonstration of these autonomous vehicles to the Army and other commercial customers worldwide.

We believe our on-time delivery on this program has benefited us in the seat of additional orders from other military programs requiring lightweight, compact DC generators. We have successfully completed Phase 2 of the program and Phase 3 is expected to begin sometime in 2019. Also, during this quarter, we have successfully closed a U.S.

Air Force contract for our power system. This is a great opportunity for us to provide our DC power systems for mobile and fixed trailers for disaster relief, surveillance, and command, U.S. borders communication, military, mining, and oil field operations.

Also, the previously mentioned next-generation LPG and natural gas power system will be a key platform to help drive additional sales outside of telecom. Our third key strategic objective is to expand our capacity to meet what we believe is a solid demand profile in the coming years.

In November -- in early November 2018, we opened our second manufacturing facility, which has approximately 29,000 square feet and is located just minutes away from our corporate office and our main manufacturing facility. We believe this new facility will allow us to significantly increase our manufacturing capacity and labor efficiencies.

This expansion is expected to nearly double the capacity than it is operating at full efficiency. Despite a short delay in securing the facility, we're making solid progress in getting the facility fully operational. We're also in the process of ramping up our supply chain to meet the expected demand.

This will require us to begin to secure the long lead-time components and also fulfill the staffing requirements adequately. Our fourth key strategic initiative is to provide industry-leading technology and power solutions through our R&D and technology road map.

Our present focus is integrating the solar and lithium ion storage technologies with our DC generators, which are designed for use in bad-grid and off-grid applications, which is the case in most emerging markets. One key project is our next generation of LPG and natural gas-fueled power system.

As a goal of this program is to improve fuel efficiency by about 12%, increase the engine life to 40,000 hours and reduce the overall engine cost, thereby reducing the overall generator cost. We hope to have launched -- we hope to have a launch in the second quarter of 2019.

The application for this would be bad and off-grid towers, but this might be our first launch into other markets -- other platforms like commercial and retail as well. We have initiated discussions with a few key large LPG suppliers domestically and overseas.

We believe our technology and power solutions demand a high-level of innovation for seamless integration into our customer systems. We believe this is a key differentiator and also a key success factor and it gives us as the competitive advantage in the market compared to generic power solutions.

I'll now turn the call over to our CFO, Luis, for his financial summary.

Luis?.

92% in purchases of DC power systems by telecom customers, 6% in purchases by military contractors, and 2% from other markets. We believe that the majority of our backlog will be shipped within the next six months. Gross profit increased to 85% to $1.5 million in Q3 2018 as compared to $0.8 million in Q3 2017.

Gross profit as a percentage of net sales was 30.2% in Q3 2018 as compared to 27.4% in the same period in 2017. The increase in gross profit margin over the last year was attributable to improved labor efficiencies and improved manufacturing overhead absorption.

On a quarterly basis, gross profit decreased $0.5 million compared to $2.0 million in Q2 2018. As Arthur mentioned previously during this call, our gross margins were negatively impacted by engineering issues related to our T-Mobile units and increased R&D spending, and increased overtime to meet last-minute customer demands.

We expect gross margins to improve in the upcoming quarters. Operating expenses increased to $2.3 million in Q3 2018 from $1.5 million in Q3 2017.

The increase in operating expenses was primarily due to investments in our sales infrastructure and support teams and establishing operations in Namibia and significant investments in marketing of our DC power systems to key Tier 1 telecom customers globally.

Net loss in Q3 2018 totaled $0.7 million or negative $0.07 per basic and diluted share compared to net loss of $0.4 million or negative $0.04 per basic and diluted share in Q3 2017. Cash as of September 30, 2018 totaled $10.6 million as compared to $14.2 million at December 31, 2017, with $0.6 million in long-term debt outstanding.

The decrease in cash as of the comparative period end of September 30, 2018 and December 31, 2017 was the result of increased inventories and manufacturing equipment acquisitions and preparation of increased demand of our DC power systems. Now, I would like to turn the call back to Arthur.

Arthur?.

Yes. Thank you, Luis. I'd like to thank everyone for their time today and all of our shareholders for their continued support as we continue to work on executing our growth strategy. We look forward to speaking with you on our fourth quarter and year-end financial results conference call. Now, I would like to open up the call for questions.

Operator?.

Thank you, sir. [Operator Instructions] And first we have Craig Irwin with Roth Capital Partners..

Good evening and thanks for taking my questions. So, the $15.2 million in backlog is a big number. You did see customers placing those orders. Luis, you mentioned that the majority of this will ship over the next six months.

Do you have visibility you can share with us on what portion is likely to ship before December 31st?.

I said six months?.

Six months from September 30th..

Craig thanks for the question. We are not providing guidance and I believe that answering your question would be basically guidance. But a significant amount of that backlog will be shipped in Q3 -- I mean, Q4..

So, a significant portion will be shipped..

Yes..

So, Craig, let me add -- this is Raj, let me add to Luis' point there. One of the main reasons that we saw a big spike in that backlog member also is because of these telecom companies have budgets that expire on December 31st so they have to receive the product before the 31st. So, we're doing the best we can to ship as much product as we can.

Obviously, the supply chain and the new factory and everything has to cooperate, so it's been production hell for now..

Okay, excellent. Second question is a point of clarification. So, in the press release and at multiple points in the script you referenced shortages in engines and components. It's something that's been out there in the press, so I'm not surprised if you guys were impacted by the same thing that everybody else in the industry was.

In the script comments Luis made, he referenced engineering issues with T-Mobile.

Can you may be comment whether or not this is a component availability issue or is this something more to the engineering issues?.

You kind of hit the nail on the head is when you are missing parts from vendors, then engineering has to get involved and try to find substitutes or a way of engineering around it by possibly redesigning the part as subsection.

The other factor to it is that you place a new product with a customer and the customer frequently has last-minute changes, say he wants two of the product, so then that brings an engineering again to make these last-minute changes..

Okay, understood. Thank you for that. The next question I have is about inventory. So, in the quarter, you used about $2.7 million in cash for inventory. It was a significant build so that makes sense with the supply chain issues you had in the quarter, sort of backing up deliveries from where we all hope they would have been.

Can you comment about whether or not you expect inventory to normalize via source of cash in the fourth quarter?.

We believe it will normalize because we've also gained in terms of accounts receivables. So I think, right now, we have purchased enough engines that will carry us and before we have to do another large purchase of engines..

Okay. And then last question I have [Indiscernible].

[Indiscernible] One more thing, Craig. I'm looking at the balance sheet. Our prepayments have also increased and there's long lead-items that we also had to release substantial amounts of cash, so we believe that cash would eventually -- will normalize by the end of the year..

Okay, that's fine. And then last question, if I may. The topline is a little bit light, we understand that.

With a couple million dollar builds in inventories, is it fair to say that you probably could have had revenue, $2.5 million to $3 million higher, if there were no supply chain issues in the quarter?.

To say the least..

That's--.

Yes, I mean, Craig, yes, we were in line with what The Street is expecting us to do until the point where we had to slip back, mainly because of the new plant and coming in late than what we expected and also the supplies and disruptions..

The engine manufacturers was between 60 -- around 60 days late on the delivery of engines, for example..

We had to leave out those engines..

Thanks again for taking my questions. Congratulations on getting that second sign up and those chunky orders..

Thank you..

Next question today is from Ashok Kumar with ThinkEquity. .

Great. Thank you, Arthur, Raj, and Luis. The first question is on the topline, given that the target level was in the mid-20 for the year and the top line and the demand was ahead of supply in the September quarter. How realistic would it be for you to double your run rate in the December quarter to meet those goals? So that is part one.

And two is related to various, where do you stand in terms of qualified your second facility? It seems you're running a second shift on your first facility.

When do you think you'll have your second facility qualified and conditioned?.

You answer the second one; I'll answer the first one..

So, I'll answer the first question regarding, I guess, you saw us once again, guidance for the year.

So, we don't want to answer that question directly but our aim -- our goal is to meet what the industry is expecting quarter-to-quarter, it's a little lumpy, we agree, because some of the sales from Q3 fell over to Q4, but the overall goal remains to come as close as we can to that street estimate. That's all I can say for now on the revenue goal.

As far as the factory -- when is the second factory up and running, phases? Talk about the phases..

Okay. Well, we're bringing up the -- the factory is running now. And what we're moving is department by department over to the new factory to minimize disruption.

The second shifts are always hard to maintain, given the issue of people don't want to work the second shift and either they want to migrate to the first shift or they'll go ahead and leave Polar and join another company. So, the labor management is very difficult and requires a lot of overhead.

So, the second factory allows us to accommodate more workers during the daytime, which means that we have less pressures on employment, recruiting, and onboarding new employees and then off-boarding them because they don't want to work on an evening shift..

Right. Now just to get some color on the supply chain. You have -- I mean you're sourcing engines from Japan, you have three suppliers, of which -- and that includes Isuzu and Kubota and--.

[Indiscernible] more than just Japan..

Okay..

We source from Volvo Penta, Sweden. We support -- we purchased Perkins, which is U.S.-owned U.K. company. And we also do a little bit work with Doosan, South Korea. So, we have multiple sources for engines. We have to..

Okay.

And so I was wondering, the 60-day rerouting delay, or the district delay was it related to -- I've seen they are related to a supplier, right? And did it impact just Polar or did it impact your competitors as well?.

It's kind of hard to judge our competitors because we don't know what the company -- what the engine company is shipping. And recently, I haven't really studied our competitors' shortage of engine products.

But it's generally known that engine supply disruptions have been problematic for the past couple of years, which is also impacted by changing emissions requirements, too..

Okay.

And Arthur, can you also talk about the negative variance on the gross margins, right? Was any of this pricing related? In other words, I think you had earlier talked about pricing feed started about $20,000 or thereabouts, I was wondering is there any possibility that you underestimated the manufacturing cost for the new 15-kilowatt unit thereby where -- thereby the gross margin pressure would not be a one-off issue?.

No, I wouldn't call it gross margin pressure, but basically, we've seen this trend repeat itself when we started new product or new customized product for a new client.

Normally the first quarter or two which -- it's a slow progress in terms of the learning curve for our production facility here and also because you don't have the completion of doing ready for the product. So, gross margins will take a hit immediately but they would kind of normalize over the next few months.

So, we believe it's the same trend that is continuing with this product as well. I don't -- we don't see that it was priced wrong. We're just priced in line with our gross margin profile. It's just that it would take a little bit of time to get there..

Right. So, just a color on the T-Mobile, Raj, the 105 units that you had announced back in June, right, that originally had indicated would be deliverable in the subsequent three months, I assume. Are you still on track to deliver the original auto by year-end? And the add-on order of--.

Those have been delivered..

They all have been delivered. Okay..

Those have been delivered and received subsequent orders..

Got it.

So, if you look at the current backlog, Raj, or at least, the incremental buildup, how do you assign this spread across your legacy Tier 1 carriers? The military customers and the new Tier 1 customer?.

Luis, you said that all right. Yes, Luis did mention that out of the backlog, a significant portion of that -- about 92% of that came from telecom customers. And most of them is from the Tier 1 customers from the U.S. and 6% is from military and 2% is from other markets..

Got it. Then refocusing on international markets, given that your 2018 performance is going to be primarily domestic and, Raj, you've had firsthand experience in what's happening in Sri Lanka there, some recent political turmoil there.

How does that impact your contribution from that region in 2019? And Namibia, the new order win, was this given that Huawei and their relationship with Delta, I mean, is Delta potential supplier to Huawei given that they are also of PRC domicile in Namibia?.

Well, as far as Sri Lanka is concerned, we don't believe that it would affect us directly because we're dealing with multinational companies, which they do business in several Asian countries. So, Sri Lanka is one of the territory for them. So, we didn't believe that there is a material event for anything like that..

One thing nice is both sides will use cell phones. Either side is going to give up their cell phone..

Right, right. And Namibia, Arthur, you can probably comment you've been there recently..

Okay, well, the relationship with Delta and Huawei, I don't have too much insight into the relationship, but what we do in Namibia is Delta is not there as far as we know..

Thank you very much..

Did that answer your question?.

Yes, Arthur. Thank you very much..

[Operator Instructions] We'll move on to Greg [Indiscernible]..

Yes, hi gentlemen. I was wondering if you could talk about the non-military, non-telco market that you're addressing.

Did you have any products that you've designed just for those markets? And how long will it take to develop those markets? And are you being -- spreading the company too thin to expand resources for those ancillary markets?.

Let's just say, over the past -- this is Arthur Sams, let's just say over the past 35 years, I have a true understanding of spreading yourself too thin, but we try not to do that and that's why we focused a lot about -- on to telecom. That's where all our sales and production is focused on.

But at the same time, way have to expand to other markets to fuel our growth and we do have some products. And the type of market they would sell into would be the early adopters. The people are willing to pay a more expensive price for our product, people who realized that they can't go to Home Depot and get the same quality.

We intend to do a little bit more commercial, possible residential work next year. And one of the products that we have will help launch that is this new LPG and natural gas engine that we're working with and our suppliers in Germany and in Japan.

This newer engine is -- would be aimed at applications such as electrifying the home and heating it at the same time, so that would be micro CHP. And there's numerous applications including charging electric cars off of the natural gas supply line as opposed to the utility energy supply line. So, go ahead..

And how are you going to go to market? Do your distributors -- do you have a marketing strategy for these ancillary markets? Or they can be -- are you going to hire a salesman? Or are you just going to -- I take it you're going to go with distributors or people that will help you in your marketing cost..

Okay. We would go with some type of a channel partner or partner relationship whereas there is minimum quantities of product to buy in warehouse and there's minimum amounts of tooling to be expected. When I say that tooling, special insulation tools or spare parts and training to happen.

But before we get there, we'd have to also stabilize our production. When you're selling retail, the expectation is for shorter deliveries than industrial customers. So, there's more of like -- I paid for I want to get it next week.

We may have to plan another plant -- another factory dedicated to that market, especially since we don't want to impact our core markets, military, telecommunications, and such..

Okay.

And the timeframe for this ancillary markets become material to the company, so it probably won't be material for like another two years? Do you think that's a true statement?.

I would say somewhere between one to two years, being an optimist, I would say one and being a pessimist, I would say two..

Okay. And if the size of these markets -- I take it the size of these ancillary markets is fairly large, it is in hundreds of millions of dollars..

Yes, exactly..

Okay. Thanks for your comments Arthur..

Thank you..

And we'll move back to Ashok Kumar for a follow-up..

Great. A question on the international market you bought in Malaysia in specific, I think earlier on, I think you had indicated you received an RFQ in Malaysia.

And while the overall contract is or was big, you were waiting on more information on how much you're involved with the project and this was supposed to be a two-year program with revenues in 2018 and 2019. I was wondering where does that stand at this point..

It's still in the works, Ashok. We don't have any confirmed information on that one that we can disclose at this point of time. Malaysia is one of them, obviously, Thailand is another one and we spoke about Sri Lanka, so other territories as well but yes, we haven't solidified any contract or meaningful purchase order from Malaysia yet..

All right, got it, okay.

So, back on the margins and I was wondering, I think, given your target level -- your revenue of 25% or mid-20%, you can hit sustained gross margins in the high 30s, I mean, qualitatively would that be the length to continue to look at with one operational efficiencies resume in 2019, your business model can support gross margins in the high 30s?.

Yes, so our gross margin will increase as our sales volumes increases. If you look at Q3 gross margin and as a percentage of net sales and look at our Q1 of this year, we had similar net sales and our gross margin was about the same, 30%.

We start experiencing some better gross margins once we get to the $6 million of net sales, but the backlog at the dollar amount that it's had right now is increasing our capacity by adding the second production facility, our gross margin is expected to go back to 30% to 40%..

All right. Okay. And I think those were the primary questions I had. Again, thank you once again. Really appreciate it..

And looks like--.

And one last question was the military, I think, you were working with a new contractor, you are in Phase 2, are there any progressions to the next phase? Or are you still in the -- given the three stages tend to be long, nine to 12 months long, are you still in Phase 2 for that contract at this point?.

Yes, we are in the tail end of Phase 2 -- the program itself, I mean, we have done our part already, we're done with Phase 2.

So the Army is supposed to validate these and test these and Phase 3 will begin in 2019, they said they did not give a particular month in 2019 and then the real production contract would be Phase 4, which is in 2020 -- 2020 to 2024. It's a five-year contract..

Once again Arthur, Raj, and Luis, thank you very much and all the best..

Thank you..

All right. It appears we don't have any further questions from the audience; I'd like to turn the floor back to the management for additional or closing remarks..

Thank you everybody for joining today and please follow-up with any questions that you have, we'll get back to you as soon as we can. Thank you..

Or maybe one last question or a statement. If you're in the neighborhood, set up an appointment and drop on by..

Thank you..

Once again, ladies and gentlemen, that concludes our call for today. Thank you for joining us. You may now disconnect..