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Edited Transcript of POLA.OQ earnings conference call or presentation 15-May-19 2:00pm GMT

Q1 2019 Polar Power Inc Earnings Call

GARDENA May 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Polar Power Inc earnings conference call or presentation Wednesday, May 15, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Arthur D. Sams

Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary

* Luis Zavala

Polar Power, Inc. - CFO

* Rajesh Masina

Polar Power, Inc. - COO

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Conference Call Participants

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* Eric Grossman

* Jeffrey Kobylarz

Diamond Bridge Capital, L.P - Analyst

* Robert Marcin

* Timothy D. Chatard

Quantum Capital Management, Inc. - Director of Research & Portfolio Manager

* Shawn Severson

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Presentation

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Operator [1]

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Good day, everyone and welcome to the Polar Power First Quarter 2019 Financial Results Conference Call. Today's call is being recorded. And at this time, I'd like to turn the conference over to Shawn Severson. Please go ahead, sir.

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Shawn Severson, [2]

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Thank you, and good morning, everyone. I'd like to thank you all for taking the time to join us today for Polar Power's first quarter 2019 conference call. Your host 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 then be followed by Raj, who'll provide an operational update as well as updates on key strategic objectives, after which, Luis will discuss the financial results.

A press release detailing the quarter's results has crossed the wire today at 9 a.m. Eastern time and is available on the company's website at www.polarpower.com. Following management's prepared comments, we will open the call to questions.

Before I begin, I'd like to remind everyone that statements made on the call and webcast today, including those regarding future financial results and industry projections 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 will 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 CEO.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [3]

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Thank you, Sean, and welcome, everyone, to Polar Power's first quarter 2019 earnings conference call. During today's call, I will briefly discuss our key highlights for the quarter, first quarter 2019, but before I'll provide you with an update for each of our core markets. First, I'd like to give a brief summary of financial results, and then Luis will provide greater financial detail later during this call.

Revenues for Q1 2019 were $7.75 million, which is a 59% increase compared to $4.87 million last year with a majority of the growth driven by sales of our DC power systems to Tier-1 telecommunications customers in the U.S. Our backlog at the end of the quarter stood at $14.16 million compared to $2.56 million last year and $16 million backlog at the end of Q4 2018. The increase over last year was again driven by increasing sales to our Tier 1 telecommunications customers in the U.S., which we believe will remain steady for the next several quarters. Gross profit for the quarter stood at $2.39 million compared to $1.48 million last year. Gross margin for the quarter was 31%, an increase of last -- over last year's 30%.

During Q1 2019, we posted a profit of $70,703 compared to a loss of 3,000 -- excuse me, $300,018 -- excuse me, $318,802. On a per share basis, we earned $0.01 per basic and diluted share as compared to a net loss of $0.03 per basic and diluted share Q1 of 2018.

Now I'd like to provide a business update and review. I'm happy to say that we are starting out strong in 2019 with higher revenues in backlog. We are clearly still in an investment phase as a company, as we are investing to meet expected higher demand and leverage the numerous growth opportunities we see in front of us. During the first quarter of 2019, we continue to invest heavily in developing our product -- production infrastructure and increase our production labor force by 21%, including key production management positions. And we have implemented new state-of-the-art manufacturing equipment. Raj will provide more color later during this call.

For a big picture perspective, I believe we have to take these steps in order to build a world-class global business. We could invest in our business less, but then we would grow at slower rate. And I believe that with the window of opportunity we have to date, the prudent action is to grow and take advantage of the conversions towards DC power systems in the market for both primary and backup power.

Raj will provide you with a business update on our primary business category. We view our business in 2 general silos: Telecom and emerging growth. As a reminder, one of our key advantages is that our core DC power systems have numerous advantages over incumbent technologies. We are able to expand on our core technology to develop and customize new and innovative solutions for multiple markets and applications. Beginning with telecom, we view this segment as having 3 major categories: domestic Tier 1, domestic last mile and international. The demand for our DC generator systems from domestic Tier-1 markets are being driven by a couple of key factors. First is that Tier-1 carriers are increasingly focused on network hardening and improving the reliability, and they are using our systems to provide backup power.

The second driver, which is more on the horizon, is 5G. This will also be a backup power but with larger sized DC generators in the 15 to 25 kilowatt range. Our momentum in the Tier 1 continued from the fourth quarter as evidenced by our high backlog. I'm optimistic that this segment will see more sustained strength in 2019 based on current forecast. Most last mile providers are small private firms with owner operators managing the telecom infrastructure.

These providers also sublet their infrastructure to various other providers for improving site efficiency. Due to off-grid and bad grid nature of these installations, I believe we bring a higher value proposition to the customer with our DC solar hybrid power system.

What's unique about this market is that it's highly fragmented among what I believe are approximately 500 carriers within the U.S. With the manufacturing capacity additions and the new production management, we are now able to target these customers and will help diversify our telecom business in the up-and-coming year. On the international front, we saw accelerated sales activity in 2018, which led to the sales later half of this year.

We are seeing repeat sales from customers acquired in the previous quarter, and I see no reason for this to slow down. Since 2017, we've invested in sales infrastructure in the international market, which now has led to a number of active programs internationally, and we expect to gain momentum as we move from pilot program to more commercial orders in the second half of this year.

We have 4 key areas of our focus in our emerging growth category: specialty hybrid electric vehicles; propane, natural gas DC generators and solar hybrid renewable energy system; our distributed power for residential and rural needs along with electrical vehicle charging.

Our push into supplying power systems for specialty hybrid vehicles is being driven by the military and airport application. As a reminder, we are currently working on a few key programs for the U.S. Army, and we've been designated and we have designed a lightweight compact DC power system that charges the batteries within these robotic vehicles being used to transport personnel and goods.

In 2018, we delivered our onboard generator to military contractors responsible for delivering integrated vehicles to the military for testing. This program is still in the field trial stage, and there's no new procurement developments since our last update. But we expect more updates as the year progresses. We believe this program will give us an excellent launching point to take our technology to other similar applications, involving robotics and autonomous vehicles.

Propane and natural gas generators will be -- sales, will be driven by the high cost of diesel engines meeting new emissions regulations. In other words, diesel engines have been increasing in cost due to additional equipment to reduce emissions of these engines. The very low maintenance of propane and natural gas fuels; diesel is a high maintenance fuel compared to these LPG, propane and natural gas fuels.

Natural gas and LPG are lower cost per energy source in many regions of the world. Diesel in many regions of the world is much higher in cost than propane or natural gas. And this could mean substantial savings to the operators. Natural gas and LPG have a lower [SAP rate] than diesel. SAP rate at so many sites, telecom sites throughout the world can be as much as 20%. Increased power consumption worldwide as a resulted in the need for power off-grid and bad grid areas. Distributed power is a megatrend in the market today, and we believe that our solar hybrid systems using clean fuels will be the most cost-effective and reliable solution for the microgrid power. These DC solutions have a great potential for applications in residential and commercial markets in both domestic and overseas.

We believe the up-and-coming popularity of electric vehicles will strain the grid. If air conditioners during the summer will strain the grid in California and New York, then adding millions of electric vehicles would certainly exacerbate the problem. The solution is to use natural gas with a DC generator to charge the vehicle and then make use of the waste heat for various applications, including pool and spa heating, laundry, house heating or even air conditioning using absorption technology. Charging electric vehicles could launch the micro CHP, combined heat and power market.

Conclusion. Looking ahead towards the rest of the year, our focus is on continuing to train our new production labor force, improve our labor efficiency and strengthen our business relationships with top tier communication carriers, both domestically and internationally, increase our inventory of subassemblies to reduce the order fulfillment time and have the infrastructure and people we need in place to meet a growing demand.

As a reminder to everybody, our continuing key strategic objectives are: one, to increase our market share with top tier U.S. cell phone providers, target last mile carriers and expand our presence in international markets; two, to diversify our customer and product base by providing more comprehensive services to our telecom customers and increasing our exposure to other markets, including military, commercial, residential and electric car charger; three, to increase the production capacity and efficiency by opening up our second manufacturing plant and facilitate revenue growth; and four, to provide industry-leading technology and power solutions through our R&D and technology roadmap.

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

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Rajesh Masina, Polar Power, Inc. - COO [4]

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Thank you, Arthur. Let me expand on those four strategic objectives that Arthur mentioned. The first one, to increase our market share with top-tier U.S. telecom providers, target the last mile carriers and expand our presence in international markets.

So the first one is the top-tier U.S. telecom providers. Our traction with our Tier-1 U.S. carriers continued in the quarter as evidenced by our high backlog. This momentum has continued in the first quarter and we are seeing some positive forecast for the remainder of the year. Also AT&T and FirstNet jointly launched their program, which was geared towards America's first responders is expected to start soon. Authorized by Congress in 2012, its mission is to develop, build and operate the nationwide broadband network that equips first responders to save lives and protect U.S. communities. The number of programs that these Tier-1s are launching this year, are very encouraging for us. We view the last mile carriers as a great opportunity like Arthur mentioned. We will be pursuing these customers more actively from the second half of 2019.

This sector also has attractive margins. We expect international sales will become a larger portion of our business through the end, which will diversify us further from the Tier-1 carriers. Since the past quarter, we've been actively engaged in submitting several proposals to key Tier-1 clients in select countries around the world. It's a little too early to disclose the details, but we'll update our shareholders as some of these materialize over time.

Second objective is diversifying our customer and product base by providing more comprehensive services to our telecom customers and increasing our exposure to other markets and applications. Sales in international markets are giving us the opportunity to capture more revenue per site than the average revenue we generate from the U.S. Tier-1s. As mentioned last quarter, we now have the infrastructure and the ability to provide ancillary services in select countries. These services include installation of radios, construction of cell sites and maintaining all the equipment within the site.

As part of this initiative, we have continued providing such services in the Namibia partnering with Huawei for the past three months. We believe this strategy will uniquely position us as a comprehensive solutions provider for telecom carriers internationally.

We think that developing these capabilities and relationships will enable us to pursue additional markets and applications, which are interrelated. The third one is expanding capacity. I want to spend a bit more time on this as we have made significant investments in the business during the past few quarters, which has created a modest headwind on our contribution margins in the short term.

We are a growth company with numerous opportunities as Arthur highlighted in his section. Historically, we have been limited by production, engineering and sales in terms of pursuing business outside of the top-tier telecom. This bottleneck was likely to be exacerbated even further by the fact that we're seeing strong demand from those same customers. In order to grow and diversify, we needed to take several steps. As a reminder, in November of 2018, we opened our second manufacturing plant which is approximately 29,000 square feet, and it's located just minutes away from our corporate office in Gardena. This expansion is expected to nearly double the production capacity that it is operating at full efficiency. However, the steps we've taken are way deeper than just adding a facility. In April, we completed a 6-month project to restructure our operations management. Our goal was to reduce the number of responsibilities that key management had and increase the overall production management experience and resource. So we're talking about the mid-level bench-depth that we're adding to.

Now we brought in the following specialists. First, we increased the high-level production managers from 1 to 2, then we added a material management department with its own staff, then we created a separate production plan department with junior planners along with production control clerks, then we increased the technical services team that direct us from 1 to 2. We created a metrology department with calibration, tool crib and tool training. We also added staff to our quality control, including inspectors, quality auditors, test operators. This would also lead into our goal of being an ISO 2009 (sic)[9000] certified company. We're also presenting -- we also presently restructuring material and labor flow on the shop floor to increase production efficiencies and improve production lead times. With experienced staff we have now in place, we are becoming more proactive in solving late vendor shipments and related bottlenecks.

In summary, we're investing in our business, which we believe is a prudent step and we expect they'll pay dividends throughout 2019 and beyond as we drive more revenue through our investments. The last objective, the fourth one, is to provide industry-leading technology and power solutions through our R&D and technology roadmap. We continue to make progress on the 2 key platforms mentioned last quarter. I won't spend too much time on this, as we provided an update only a few weeks ago. As a reminder the 2 key platforms in development are: one is integrating solar and lithium battery storage solutions with our DC generators; and the second one is the new LPG product that we're about to launch in the second half of the year.

The first one, regarding the renewables, with our integrated systems, we are currently upgrading our battery management systems, and in the process of developing new remote monitoring solution that not only monitors, but also controls our systems remotely in the field. We believe this is a key differentiator in the international market and improves our competitiveness. And the second one is LPG product. As we explained last quarter, the LPG product is focused on the next generation of LPG and natural gas power systems and we will have application across a wide variety of markets, including the telecom on grid, bad grid and off-grid sites. But also it opens avenues in distributed power for commercial and residential, electric vehicle charging and solar hybrid systems for rural electrification and peak power shaving, et cetera.

Again, we expect to be able to use this platform in multiple markets. We're still planning to launch this product in the second half of 2019. We've initiated some key discussions with a few large LPG suppliers, domestically and overseas. Overall, we had a good start in 2019 and we believe we are on the right track. It is a critical year for us to leverage the investments we've made over the past year or 2 -- we've made and we expect operating improvements as the year progresses.

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

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Luis Zavala, Polar Power, Inc. - CFO [5]

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Thank you, Raj. Net sales for the 3 months ended March 31, 2019, totaled $7.75 million, which is an increase of 59% as compared to $4.87 million for the three months ended March 31, 2018.

The increase is primarily a result of an increase in sales of our DC power systems to Tier-1 wireless telecom customers in the U.S. Our backlog totaled $14.16 million at March 31, 2019, as compared to $15.92 million at December 31, 2018 and as compared to $2.55 million at March 31, 2018. 98% of our March 31, 2019 backlog are purchase orders received from Tier-1 telecom customers in the U.S. Gross profit during the three months ended March 31, 2019, increased 61% to $2.39 million as compared to $1.48 million during the same period in 2018.

Gross profit, as a percentage of net sales, was 31% for the quarter ended March 31, 2019, as compared to 30% in the same period in 2018. The increase in gross profit margin was attributable to production efficiencies gains that are the use of new manufacturing equipment added in the previous quarter, coupled with slight increases in labor efficiencies.

For our operating expenses during the 3 months ended March 31, 2019, increased 28% to $2.31 million as compared to $1.81 million in Q1 2018. The increase in operating expenses was primarily due to a 52% increase in G&A, which included increases in salaries, addition of key management staff, increase in stock compensation expense and office rents.

Sales and marketing expenses increased by 3% as we continue to promote our product at international levels and R&D expense increased by 21%, as we continue to customize our DC power systems for our clientele.

Net income in Q1 2019, totaled $70,703 or $0.01 per basic and diluted share compared to net loss of $318,802 or negative $0.03 per basic and diluted share in Q1 2018. Cash at March -- Cash as of March 31, 2019, totaled $3.53 million as compared to $5.64 million at December 31, 2018.

Working capital as of March 31, 2019, totaled $20.63 million as compared to $21.09 million as of December 31, 2018. This was the result -- the decrease in cash was a result of increased inventories of $1.6 million, a $1.5 million increase in accounts receivable associated with increased shipments to Tier-1 carriers with net 90 payment terms.

Now I would like to turn the call back to Arthur. Arthur?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [6]

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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 each one of you in the first quarter and year-end financial results conference call.

Now we would like to open up this call for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we will take our first question today from [Davin Stanton] with Pacific Financial Corporation.

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Unidentified Analyst, [2]

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Congratulations guys on a profitable quarter. It's exciting to hear all the potential markets that are opening up, but I have to admit it's a bit frustrating that your revenue wasn't moving up quicker. In the last conference call, Raj talked about how Q1 started off weak in January and got better in February, better in March. Can you kind of give a better breakdown of that in terms of revenue and then the trend you see going into Q2, please?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [3]

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Raj or Luis, do you want to handle that?

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Rajesh Masina, Polar Power, Inc. - COO [4]

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Luis, do you want to handle that?

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Luis Zavala, Polar Power, Inc. - CFO [5]

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That's regarding our revenue. In terms of how fast -- I believe we have a steady forecast on DC power systems from our domestic Tier-1 carriers. We believe that revenue will remain constant from the domestic markets. Where we're betting on gaining is on the international and military and then also...

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Rajesh Masina, Polar Power, Inc. - COO [6]

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Luis, the question was the breakdown of January to March, and how that is kind of looking in Q2. So let me take that. So yes, I mean as we indicated last quarter, revenue started small in January and then increased in February and then increased in March, because mainly supply chain constraints, and we're in the process of ramping the production. So those are the problems that we had. So it was less than $2 million, I can't give the exact number because we don't divulge the monthly numbers. It was basically -- it was -- yes, it was less than -- it was between $1.5 million and $2 million in the month of January. So that's the main culprit. And then February and March we definitely improved.

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Unidentified Analyst, [7]

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Okay, that's the trend that I wanted to see is how -- Because right now your biggest restraint seems to be, not demand or even potential market, it's getting the product out there. On terms of your new facilities that are opening up, you talk about doubling your production capacity when it's operating at full efficiency. What is the estimated debt capacity when it is finished?

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Rajesh Masina, Polar Power, Inc. - COO [8]

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We believe that we have the capabilities with both factories running at full efficiencies to do up to $5 million a month in revenue.

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Unidentified Analyst, [9]

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Okay, excellent, excellent. And one last question is, how is your cash position? I mean, your inventory is going up, your accounts receivable go up. In the last conference call, you talked about might needing to get a line of credit against your Tier-1 receivables. Is this going to be needed? Or is the cash position good enough to keep the things flowing smoothly?

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Luis Zavala, Polar Power, Inc. - CFO [10]

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I'll take that, Raj. Yes, we will be moving forward with one of the options that we have on the table, which -- our best deal right now is to -- is the one that you just mentioned. So we're looking at executing that agreement within the next week or so. And we believe that will sustain us for the next year or 2.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [11]

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Let me add one thing to that question is that as we increase our production efficiencies we'd be able to turn our inventories faster, which would also diminish our need for capital for our inventory part.

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Operator [12]

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We'll go to the next question, and that comes from Timothy Chatard with Quantum Capital.

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Timothy D. Chatard, Quantum Capital Management, Inc. - Director of Research & Portfolio Manager [13]

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Thanks for the rundown on all the operation things that you've been talking about. Raj, talked about a number of different things there, production manager, quality control. How many people did you add as a part of that effort?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [14]

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We'd have to count them on her fingers as opposed to knowing them off the top of her head. But Raj have you counted them on your fingers?

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Rajesh Masina, Polar Power, Inc. - COO [15]

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No. As a percentage, we said 21%. We've added 21%. So yes, as a percentage, we've added -- we increased it by 21 -- we increased our staff by 21%.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [16]

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That's the overall workforce.

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Rajesh Masina, Polar Power, Inc. - COO [17]

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Overall workforce. But in terms of the operations team, the mid-level management team, it's close to like 12, 14 people looks like, on average.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [18]

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Yes. I haven't counted.

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Rajesh Masina, Polar Power, Inc. - COO [19]

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Yes. We haven't counted up.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [20]

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But what would you say, we can probably spend by $0.5 million on the new team in terms of dollar rate?

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Rajesh Masina, Polar Power, Inc. - COO [21]

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Easily, sir. So on that point of spending, obviously, we can spend less like Arthur mentioned in one of his commentary. We could spend $1 million less in sales, we can spend $0.5 million dollars less in service, definitely spend $0.5 million to $1 million less in R&D. But we believe that growing the top line is extremely important for us, so that we can leverage these investments into more EBITDA for our investors.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [22]

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Let me shine a different light on that. Old management that's been managing production, let's say, for the past 10 years couldn't break the 7,000 -- $7 million a quarter mark. So what we did is we brought in new management who come from production lines significantly larger than ours, dwarfing ours from larger companies, and we put them in charge. So we expect them to greatly break our bottleneck of $7 million to $8 million a quarter.

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Timothy D. Chatard, Quantum Capital Management, Inc. - Director of Research & Portfolio Manager [23]

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So a couple of related questions there. The expense run rate that you showed in this quarter about $2.3 million across G&A, R&D and sales, do you expect to maintain that level over the course of this year? Or should it grow further from there?

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Rajesh Masina, Polar Power, Inc. - COO [24]

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It's relatively flat. So we can model it to remain flat for the rest of the year.

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Timothy D. Chatard, Quantum Capital Management, Inc. - Director of Research & Portfolio Manager [25]

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And the progress on getting towards full production at the new facility, how far along are you in that process? Percentage-wise or utilization anything along those lines if you could just comment on qualitatively.

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Rajesh Masina, Polar Power, Inc. - COO [26]

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We would say between 60% to 70%.

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Timothy D. Chatard, Quantum Capital Management, Inc. - Director of Research & Portfolio Manager [27]

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In the last quarter end, I think you talk about a couple of supplies...

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Rajesh Masina, Polar Power, Inc. - COO [28]

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Currently. Let's just say in the month of April, March-April time frame, we're about there.

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Timothy D. Chatard, Quantum Capital Management, Inc. - Director of Research & Portfolio Manager [29]

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You expect to hit the full utilization or something near that by the end of 2019? Or do you think that takes until 2020?

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Rajesh Masina, Polar Power, Inc. - COO [30]

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Yes, we believe we'll get there in 2019.

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Operator [31]

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And we'll now go to Eric Grossman with Aquilian Financial.

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Eric Grossman, [32]

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My questions have been answered by the previous callers.

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Operator [33]

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(Operator Instructions) And will now go to Jeff Kobylarz with Diamond Bridge Capital.

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Jeffrey Kobylarz, Diamond Bridge Capital, L.P - Analyst [34]

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Wondering if you could talk about the LPG generator. Any developments where that stands as far as getting that out to the market?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [35]

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Okay, right now, we are caught up with, how can I say -- we are getting ready to submit the engines to EPA for certification. And we are still doing testing of the integration of the Robert Bosch equipment onto the Toyota engine.

We're pushing that along as quickly as we can as we have approximately 400 engines purchased from Toyota. We want to turn that inventory. So I would say that we could be anywhere between 4 to 9 weeks out in terms of getting the EPA certification for those engines. As soon as we do, then we open up the U.S. market. But in the meantime, if we get overseas markets buying it, we probably will be able to market them first overseas. So we're not sure on that. We're still working with the integration of the controls with the engine.

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Jeffrey Kobylarz, Diamond Bridge Capital, L.P - Analyst [36]

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How difficult is that? Is that -- how new is the science for doing that, integrating with (inaudible)...

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [37]

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We've got the resources in place, certainly, between Toyota and Robert Bosch, it's just coordinating activities that take time between these two large companies. It just simply takes some of their own time to move forward on that. But it is pretty close, it is very close.

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Jeffrey Kobylarz, Diamond Bridge Capital, L.P - Analyst [38]

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Okay, all right. And did you said what's the average price would be relative to the price of your typical generators that you sell? Roughly what is that?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [39]

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It will be in the same price range. It will not increase the price. As a matter of fact, the way things are going now, this new engine will lower our price over the older Kubota engines that we're using.

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Jeffrey Kobylarz, Diamond Bridge Capital, L.P - Analyst [40]

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Okay. All right. Any comment about tariffs and the impact on your raw materials or any materials you buy?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [41]

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Well the tariffs are still affecting the prices of steel and aluminum, that as far as we know they haven't fallen down yet. We purchased significant inventories because there's two things, price was going up and materials were becoming scarce, so we purchased a very large inventory of aluminum and steel for our applications.

The price of electronics will continue to rise. How much? We really don't know. For the past 15 years we've tried to avoid purchasing electronic components out of China because of quality issues that always are concerned with that. Magnets that we purchased for our alternators are originating out of China, and we understand that the tariffs are not touching those, even the new tariffs.

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Jeffrey Kobylarz, Diamond Bridge Capital, L.P - Analyst [42]

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Okay, all right. And then I saw in the earnings release, you said that you brought in -- you hired consultants to restructure the manufacturing over the last six months. So I think you and Raj said that you increased your staff...

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [43]

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No. We did not bring in consultants. We brought in full-time employees.

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Jeffrey Kobylarz, Diamond Bridge Capital, L.P - Analyst [44]

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I see. Okay. And I'm just curious about all these -- this dozen or so additional managers. Is there -- are they starting right can kind of with a clean sheet in trying to restructure operations...?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [45]

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Yes. Definitely. Definitely, we're giving them a clean sheet.

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Jeffrey Kobylarz, Diamond Bridge Capital, L.P - Analyst [46]

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Got it. And where is that -- when did that clean sheet kind of start? Are they still debating -- deciding like how to optimize the flow of the product -- the work in process? Or where does that stand? How far along are they with this optimization effort?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [47]

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Okay, first of all, we're talking about clean sheet in terms of implementing SAP with the ERP with the Enterprise Resource Planning and Material Resource Planning. So each department in terms of planning, in terms of quality control, in terms of production scheduling, which is (inaudible) they've been planning, all of them are starting off with clean sheets of paper. They started implementing these. There is a review process ongoing. So this process of material and labor enhancements is going on now and will go on throughout the next 6 months to 9 months or so. It's not an overnight switch that turns the light on. It will take time. And we do see some results. Our results are barely measurable, but we do see results now.

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Jeffrey Kobylarz, Diamond Bridge Capital, L.P - Analyst [48]

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Okay, and can you say what the biggest bottlenecks are for you right now?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [49]

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The biggest bottlenecks for us is still material planning. It's making sure that we have the right amount of subassemblies in place ready to go into final assembly and still management of the supply chain and getting materials in for our vendors at the right time at the right place.

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Operator [50]

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Next is Robert Marcin with Penn Capital.

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Robert Marcin, [51]

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Congratulations on teeing this up. Apparently, we're -- we've learned how to crawl and we're ready to walk. International sales, when are we going to see real volumes there? You just mentioned that 98% of your backlog was domestic Tier-1. At one point, 2 years ago, it was supposed to be at bigger part of the U.S. business in 3-ish years, perhaps, as we speculated then. When do you expect to see the production orders really make a difference on the income statement from the international business? Shareholders are getting impatient. We are starting to get impatient, gentlemen.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [52]

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We understand that. So are we. We'd like to see our stock values increased too and we'd like to, let's just say, be comfortable that the investments that we've made in international markets over the past 2 years payoff. Now of course because we have the confidence that they will or else we would've shut down operations a while ago. But our biggest problem is too -- sometimes overconfidence in our sales directors overseas and then two, the natural delays of customers actually signing the contracts that they promised to us. So these contracts without exaggeration can start appearing next week or maybe get delayed as much as 2 months from now. We're going day-to-day on looking at trying to close certain key contracts in the Southeast Asia and Africa. So, go ahead.

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Robert Marcin, [53]

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Let me phrase it in a different way. At what point in the calendar on a quarterly basis might you expect international become a quarter of the revenue? Is this 2 quarters out or 12 quarters out? I know that's a challenging question.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [54]

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Okay, at what point is the international sales will be 25% of our sales, was that the question?

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Unidentified Analyst, [55]

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Yes.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [56]

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Okay. I'd have to do some math on that, but Raj is going to throughout a reasonable guess. It might be towards the end of this year.

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Robert Marcin, [57]

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Towards the end of this year. Okay. That's encouraging, all right, but definitely in 4 to 6 quarters you would hope.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [58]

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Yes.

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Robert Marcin, [59]

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Okay, great. Margins, gross -- I'm going to go away from there. Gross margins, we started out in the '40s, very proud, that it was much higher than conventional generator manufacturers with the one customer. I don't think we appreciate how much cost of investment we needed to layer into -- in order to grow the business the way we want to grow, and that's all occurring and you guys are doing a great job there. I think shareholders should be delighted with how you're positioning the company to hit the $65 million, and then $100 million revenue levels over the next few years.

What would be intermediate and longer-term gross margin targets as you get to $5 million a month at full production and even grow for another year or two from there. Are we thinking now that it's still a mid-30, high-30? We know it's not a four-handle anymore, but we would sincerely hope we're not stuck in the low 30s at peak efficiency production levels. Can you give us an idea on where you see the gross margins at various revenue levels, say $50 million, $100 million over the next few years, if everything is working right?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [60]

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Okay. Let me answer that question in 2 parts. The first part is, what are we doing to increase the margins. First part is, is that we went after these Tier-1s and with their volumes and stuff like that, we got squeezed. We have too much customer concentration with these Tier-1s. With many companies, manufacturing companies, generator companies, they have a more diverse customer base. So the big guys who are ordering large quantities get the best deal. But the overall margins at the end of the day are offset by the smaller guys who buy an equal quantity but pay a higher price.

In other words, looking after the last mile carriers they may buy instead of 1000 generators a year, they may buy 20 generators or 15 generators a year. But because of the lower volume they'll pay a higher price. But here's the trick, the trick is that there's more of these small guys than the big guy. And I'm estimating that we should be able to get 1 to 200 smaller guys buying our generators that higher-margin than the 2 or 3 large guys we have, and their overall volume should be equal or greater to the big guy. That's one area.

Second area is that we have to improve our production efficiencies, our labor efficiency, and we've got a long ways to go on that. I consider that as good news because it gives us...

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Robert Marcin, [61]

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It's all upside.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [62]

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Exactly, exactly. So with that, let me have Raj answer the second part of the question.

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Rajesh Masina, Polar Power, Inc. - COO [63]

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Yes, yes. Robert, we would like our investors to also look at contribution margins, operating contribution margins along with the gross margins. Because you look at the first quarter results, we are slightly [positive] but call it a breakeven point. So $7.75 million, if we are breakeven with all the expenses that we're incurring to hire the additional production per structure and production management and the second factory and all the development we're doing there. So every $1 million that we're adding to it, to the top line, would add whatever gross margin that we've reported. Let's just say, even on the low 30s, even if you take 30%. Even if we thought we want to go super aggressive on pricing for some of these international customers, because the revenue per site is so high with these Tier-1 carriers around the world, even though they're price-sensitive. There we're building cell sites from the ground up. There we are providing hybrid systems, complete solar hybrid systems, as opposed to just selling a generator. So you're talking about revenues which are 4x to 8x the size of what we're getting here from Verizon or an AT&T.

So a percentage of that -- of gross margin -- a significant percentage of that gross margin is directly going as EBITDA. So that is what we'd like our investors to look at is that the why it is critical for us to grow the top line to leverage up the fixed and semi-fixed overhead and G&A costs that we are incurring. Ultimately that increases the earnings for the company and our shareholders.

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Robert Marcin, [64]

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All right. We hope so. We don't want a $100 million breakeven company, because there's a lot of costs associated with it that we didn't anticipate, right?

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Rajesh Masina, Polar Power, Inc. - COO [65]

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No. I understand. I understand. We obviously don't want to grow the company that way. But this was a conscious decision taken in terms of the investments we want to make, is investments which are manageable, investments that doesn't need to break the bank.

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Robert Marcin, [66]

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And back to the original question, there was a number required in that answer. What kind of gross margins would you expect to do?

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Rajesh Masina, Polar Power, Inc. - COO [67]

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It would be lumpy quarter-to-quarter. It will still be in the 30% to 35% range. The products have been priced to get to 35%, but we're not there yet because we haven't gained those efficiencies yet. So if all things being equal, if you're not pursuing so many other international opportunities, that there was strictly the U.S. business, yes, you could say 35% is probably good to model it. But there's too many balls juggling in the air right now in terms of international.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [68]

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Okay, now. It's my turn to ask you a question. Okay. We've got a significant window of opportunity to generate much higher revenue, should we take that? Or should we -- there's two ways we can do, we can go for higher profit margin and reduce our revenue growth or we can lower our margins for now and take the high revenue growth direction, which would you take?

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Robert Marcin, [69]

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I think balance is important. You kind of need to -- balance is important. So let's say you get an opportunity to price a massive contract at a 25% gross margin. We don't care about that, okay? And here's why, you don't get service, you don't get spares, you don't get a material amount of revenue, recurring revenue out of this business for quite a long time.

So this is a capital investment that an entity makes once every X amount of years for that one generator and it's a capital good with a long lifetime without a considerable amount of service revenue too. So we're not like Boeing, which is selling planes and then just minting money on the spares and service, right?

So considering the nature of the sale, for us to be able to grow and fund our growth with profitability and cash flow, we have to have legitimate profits all along the process, okay? So I would say you take the revenue growth up to a level of profitability that is acceptable to the shareholders and the management team and the cash flow requirements of the business, all right?

But we don't want profit with prosperity. We don't want $40 million of sales, then $80 million in sales and $100 million in sales breakeven along the way. Now that's -- I don't think that -- because what is $100 million in revenue get you? Unless you have an exit strategy to sell the business for 2x or 3x revenues at some point, what does that get the shareholders? Then there's an economic downturn and then suddenly we're doing $50 million or $60 million or $80 million again. So because we're not compensated with tremendous amount of free cash flow per dollar revenue generated at 30% or lower gross margins, I would strongly encourage the Corporation to avoid that type of business.

The stock market is not paying us either for that type of revenue, right guys? Isn't it fair with where the valuation is? You have an exceptional revenue growth now and there's a very low valuation on the business. Why would the evaluation improve if we take even higher levels of revenue without profitability?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [70]

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Now one thing is that if you noticed the way I run the business for the past 35 years, and you've seen how much capital I consume, I think we are kind of frugal. I think we are kind of agreeing with you in the way we've actually run the business. I mean, how many other companies you know have been able to get to $20 million in revenue sales with an investment of $1.2 million?

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Robert Marcin, [71]

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I thought the equity capital raise was far better when you went public.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [72]

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No. We're talking about before going public. We went public at about $20 million to $24 million in sales. That's the point we went public. But to get to that sales, we spent $1.2 million. Now of the $17 million that we netted out on the IPO, we spent very little of that in terms of lost capital.

Most of that money is back into machines on the shop floor and to inventory in the warehouses and into accounts receivables and work in progress. So we're kind of frugal there. Now I agree with you. I've studied other clean-tech, high-tech renewable companies over the past 40 years, and one of the biggest problems that these companies do is they create a situation where they instead of selling product, they're just focused on selling stock. All their resources are put into the next capital raise or in the next loan or whatever. Because instead of creating a company that gets revenues from products, they create a company that gets revenues from investors. And that's an awfully stable situation to be in. So we -- our plans are to grow the revenues. Our plans are not to get deep into the red ink, to stay in the black and our security is by making money.

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Robert Marcin, [73]

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Okay. Just keep in mind the need to generate -- valuations are composed of two things in my opinion. The growth rate for -- the organic revenue growth rate opportunities and the profitability and free cash flow characteristics of that growth rate. And if you sacrifice one at the expense of the other, you're not going to get paid in the stock market. You won't be able to sell equity to grow ever again. If you want to sell stock at $4, I would be very disappointed. And if you want the stock market to value the stock considerably higher, you have to grow revenues a lot and show profitability. Not breakeven.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [74]

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And that's what we aim to do. And in our presentation, we had given you areas of improving our profitability by increasing our labor production efficiencies and by having a greater diversification in our customer base.

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Robert Marcin, [75]

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I hope I answered your question, Arthur. My final question is this, what happened to the data center business?

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [76]

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What happened to the data center business, our engineers got overloaded with production. The data center plans have not gone away. But what we have to do is we had -- the engineering had to shift its focus over to customizing some of the products for our Tier-1 customers and focus on engineering with the new production equipment rollout and stuff like that. So we got waylaid and distracted by some of the other [projects].

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Robert Marcin, [77]

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I understand that, but your top tier customers are only letting you make 30% gross margins again. And from what I can tell as an investor in many companies that sell products into the data center, they really pay for performance, they pay for quality, they pay -- they don't mind their suppliers making decent gross margins. They're not as price sensitive as the traditional Tier-1 carriers. So as soon as we can get that product into the field, I think that would be an excellent diversification and profit center for the company.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [78]

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Well, here's the motivation for that. One is military; two is the solar hybrid system, getting to larger solar hybrid systems; and three is the data center. Now not in any particular order, but those are the tremendous incentives for us to do that. But if we go after too many developmental projects at the same time, then we get deeper into the red ink.

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Robert Marcin, [79]

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I understand that. At one point a year ago, I just thought the way we position it that was our priority developmental product, so it seems those shifted down on the priority.

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Arthur D. Sams, Polar Power, Inc. - Chairman of the Board, President, CEO & Secretary [80]

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It has shifted, but it will shift back.

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Operator [81]

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(Operator Instructions)

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Shawn Severson, [82]

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Actually, there are no further questions?

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Operator [83]

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That's correct. There are no further questions, sir.

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Shawn Severson, [84]

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All right. Thank you. We can, I think, wrap up the call.

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Operator [85]

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Okay. Thank you very much. That does conclude our conference for today. I'd like to thank everyone for your participation. And you may now disconnect.