U.S. Markets close in 6 mins

Edited Transcript of CPST earnings conference call or presentation 7-Feb-19 9:45pm GMT

Q3 2019 Capstone Turbine Corp Earnings Call

CHATSWORTH Feb 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Capstone Turbine Corp earnings conference call or presentation Thursday, February 7, 2019 at 9:45:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Darren R. Jamison

Capstone Turbine Corporation - President, CEO & Director

* James D. Crouse

Capstone Turbine Corporation - EVP of Sales & Marketing

* Jayme L. Brooks

Capstone Turbine Corporation - CFO, CAO & Secretary

* Jeff Foster

Capstone Turbine Corporation - SVP of Customer Service

* Kirk Petty

Capstone Turbine Corporation - VP of Manufacturing

================================================================================

Conference Call Participants

================================================================================

* Amit Dayal

H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst

* Colin William Rusch

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Eric Andrew Stine

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Han Jang

Maxim Group LLC, Research Division - VP & Senior Equity Analyst

* Robert Duncan Brown

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen, and welcome to the Capstone Turbine Corporation Earnings Conference Call for the Third Quarter Fiscal Year 2019 Financial Results ended on December 31, 2018. (Operator Instructions) As a reminder, today's program may be recorded.

And now I'd like to introduce your host for today's program, Jayme Brooks, Chief Financial Officer and Chief Accounting Officer. Please go ahead.

--------------------------------------------------------------------------------

Jayme L. Brooks, Capstone Turbine Corporation - CFO, CAO & Secretary [2]

--------------------------------------------------------------------------------

Thank you. Good afternoon, and thank you for joining today's fiscal 2019 third quarter conference call. On the call with me today is Darren Jamison, President and Chief Executive Officer.

Today, Capstone issued its earnings release for the third quarter fiscal 2019 and filed its quarterly 10-Q report with the Securities and Exchange Commission.

During the call today, we will be referring to slides that can be found on our website under the Investor Relations section. I would like to remind everyone that this conference call contains estimates and forward-looking statements that represent the company's views as of today, February 7, 2019. Capstone disclaims any obligation to update or revise these statements to reflect future events or circumstances. You should not place undue reliance on these forward-looking statements because they involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond our control.

Please refer to the safe harbor provisions set forth on Slide 2 and in today's earnings release and Capstone's filings with the Securities and Exchange Commission for information concerning factors that could cause actual results to differ materially from those expressed or implied by such statements.

Please note that as Darren and I go through the discussion today, keep in mind, when we mention EBITDA, we are referring to adjusted EBITDA, and a reconciliation can be located in the appendix of our presentation.

I would now like to turn the call over to Darren Jamison, President and Chief Executive Officer.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [3]

--------------------------------------------------------------------------------

Thank you, Jayme. Good afternoon, everyone, and thank you for joining today's fiscal 2019 third quarter conference call.

Before we discuss our financial results, I'd like to provide you with an overview of the financial highlights for the third quarter as well as a substantial subsequent event. I'll then go into our broader business conditions, followed by an update on our 4 key strategic initiatives.

In the third quarter of fiscal 2019, Capstone experienced positive trends from increased revenue diversity, expanded revenue from its new Distributor Support System program and launched a newly expanded factory rental program. Capstone ships 10.3 megawatts across a diverse set of market verticals and geographies. In addition, as highlighted on Slide 5, we shipped 3.6 megawatts to the Permian Basin in Texas as part of our newly expanded Capstone factory's long-term rental program. On the units we picture there on Slide 5, as I've mentioned.

Therefore, the grand total of deployed microturbines in the quarter was 13.9 megawatts. In addition, we finished the quarter with a solid book-to-bill ratio of 1.3:1 compared to 0.7:1 in the year ago third quarter, which we believe is a good indication of future product revenue growth.

Capstone received $1.4 million or 99.5% of the expected funds from its new DSS program. And today we announced the potential for approximately $2.4 million in new funding from the second year of this innovative program.

However, most importantly, subsequent to the end of the quarter, Capstone entered into a $30 million 3-year term note with Goldman Sachs to replace the company's existing $15 million asset-based revolving credit facility to provide further funding necessary for our multiple ongoing growth initiatives.

I would now like to provide you with some color on the broader market conditions that Capstone is currently operating in. During the quarter, I had the chance to meet with large number of our customers in the U.S., Canada, Europe, Mexico, South America and the Middle East. In my view, despite macroeconomic and geopolitical issues, our distribution partners and end-use customers are all in agreement that they are bullish on the future of Capstone's opportunities, they're bullish on clean energy adoption, the continued rise of microgrids and the continued rise of behind-the-meter distributed generation assets.

Brent crude oil prices decreased from over $70 a barrel to below $50 a barrel during the quarter but had minimal impact on our business and the natural resource oil and gas market.

Turning to Slide 6. Slide 6 shows our multiple market verticals and some sample Capstone customers. The oil and gas market vertical accounted for 44% of our product shipments in the quarter compared to just 15% in the same period last year. And 9 months to date, the oil and gas business makes up 51% of our product shipments compared to just 27% last year.

I believe, as long as oil and gas stays above $50 a barrel, we'll continue to see strong results from this key vertical.

Overall, in oil and gas, we're somewhat insulated against the full impact of oil price volatility as our clean and green energy systems provide a clear long-term return on investment or ROI to our customers as they burn associated or flare gas, which is a waste fuel that enables oil and gas customers to be compliant with tightening emission standards, while simultaneously lowering their energy costs.

Nonetheless, overall sentiments and conditions can impact how aggressively our customers spend capital dollars and definitely the timing of new equipment purchases.

Despite the continued oil price volatility, we still delivered good results from this sector during the quarter and year-to-date. Specific wins during the quarter, we received a repeat order from a customer in the Utica Shale region. We shipped a 3.6 megawatts of rental units to the new customer in the Permian basin in Texas that I've mentioned, and received orders from customers in Southern California, the Mid-Atlantic region, as well as some nice wins offshore in both Malaysia and Brunei.

A continued bright spot for the company in our energy efficiency vertical applications spanning across numerous industries and applications, from the new Hudson Yards Manhattan West installation in New York City, which is pictured on the front of our presentation today, to multiple low-cost industrial manufacturing plants in Mexico. The energy efficiency vertical accounted for 53% of our product shipped in the quarter, compared to 66% in the same quarter last year.

As a reminder, this application is driven by solid ROIs for our customers as well as the ability to reduce their carbon footprint and provide energy resiliency or backup power in case of a severe weather event.

Let's turn our focus to Slide 7. As you see from Slide 7, the focus on this vertical with our Signature Series products is paying off, as we have increased our U.S. combined heat and power CHP market share in the 100 kilowatt to 5-megawatt range from 17% to 25%, and we continue to receive high-profile wins in key U.S. markets like New York, Philadelphia, San Francisco, Los Angeles, among many others.

In addition, our CHP growth in key international markets, such as Australia, Germany, Italy, the United Kingdom, Mexico, Colombia and the Caribbean, are all very exciting. This continued strength is evidenced during the quarter as we receive CHP orders from our global pharmaceutical company in California, an order from an optical polymer manufacturer in Florida, a new order from a luxury resort in Jamaica, and also our distribution partner in Mexico shows strong signs of regaining momentum after the country's recent presidential election, as we received orders for a global leader in contract manufacturing, orders for a pet food manufacturer and a plastic glove manufacturer.

On the renewable energy vertical side, it's a little light for the quarter, it's only 3% of shipments, as the only shipment was a microturbine to power a landfill in Northern France.

Although we did not have any microgrid shipments during the quarter, we did receive several new orders for microgrid applications, including 9 integrated microturbines for China, utilizing combined heat and power systems with onboard gas compression, also during the quarter.

Let's turn our focus to business highlights for the quarter. Let's go to Slide 8 and 9. You can see from Slide 8 and 9 the improvements in our operating margins and the continued growth of our aftermarket service business. We closed 3 new large Factory Protection Plan contracts, totaling 3.1 megawatts with our key distributor, E-Finity, during the quarter, and our total FPP long-term service contract backlog now stands at $72.8 million at the end of the quarter. We offset several large FPP contracts pending that we anticipate closing in the fourth quarter, the current quarter we're in, which could add an additional estimated 14 megawatts to our growing FPP long-term contract backlog. The upcoming fourth quarter very well could be the first time in the company's 30-plus-year history that our service backlog eclipses our product backlog, which illustrates the direction of our business, and the aftermarket business continues to grow, to improve both our viability and our profitability.

In addition, as I mentioned, our new DSS program, which was launched in early 2018, generated $1.4 million of revenue during the 2018 calendar year. And this new reoccurring source of revenue could generate an estimated $2.4 million in the upcoming calendar year.

However, the biggest takeaway shareholders should get from this 3 -- Q3 earnings call is the fact the company's management team has been extremely focused on improving the business in areas that we have full direct control, areas that are not subject to or impacted by outside market forces or macroeconomic conditions.

As highlighted in Slide 10, management has been focused on reducing direct material costs, increasing aftermarket spare parts margins, expanding long-term FPP contract attachment rates and developing new, creative sources of reoccurring revenue streams like the DSS program and newly expanded factory rental program. These beneficial changes are on top of recent improvements in our operating expenses, consolidation of our 2 manufacturing facilities, extreme improvements at our lean manufacturing, both Capstone and our supply chain, successful negotiation and elimination of the perpetual Carrier royalty, remanufacturing capability additions in our U.K. hub and the ongoing collection of the fully reserved Russian BPC receivable, which was $400,000 in the third quarter. All these internal improvements, when added together, should drive millions of dollars of improved performance in our business and improve our overall viability despite the ongoing outside macroeconomic factors and geopolitical events.

Because the management's focus on what we can control, the business should see improved margins, lower operating expenses, stronger operating leverage and improved cash flows and liquidity in future quarters.

Now I'd like to discuss the quarterly progress on our previously outlined key strategic objectives. Let's go and turn to Slide 11. If you look at our 4 key strategic objectives, number one is to improve our quarterly working capital, quarterly cash flow and strengthen our balance sheet. The second objective, it's a double-digit revenue growth through acceleration of our global product sales. The third objective is to diversify the company into new markets, new verticals and new geographies. And lastly, number four, is increase our service/OpEx absorption percentage while driving toward 100% absorption, recovering all our operating expenses with our reoccurring aftermarket revenue.

Specifically, let's turn to Slide 12, which highlights that during this quarter, we continued to improve our quarterly working capital, quarterly cash flow and strengthen our balance sheet. We are proud to report we generated cash of approximately $2.2 million from working capital, and net cash used in operating activities was only $2,000. This is the lowest cash used in operating activities in the last 3 quarters. This included approximately $675,000 of revenue recognized in the quarter from our new DSS program. As I mentioned, collecting the scheduled payment of $400,000 from Turbine International as part of the BPC bad debt recovery.

Turning to Slide 13. Slide 13 highlights our second strategic objective to achieve double-digit revenue growth. And as previously announced, product revenue for the quarter did not meet our long-term goal as it fell short primarily as a result of our rental units. If you recall, we build a fixed number of production slots for our microturbines each quarter. And early in the third quarter, we made the decision to allocate 4 C1000 Signature Series system production slots to our expanding new factory rental program. The rental units accounted for 3.6 megawatts valued at approximately $4 million in revenue.

Additionally, as noted earlier, overall market conditions were challenged by a number of macro issues and created headwinds during the quarter. However, we believe that the conditions improved towards the end of the quarter as demonstrated by our solid book-to-bill ratio. Despite not reaching our long-term revenue growth target in this quarter, management expects to see both product and aftermarket service revenue grow and expand in the coming quarters.

Let's turn to Slide 14. Slide 14 highlights our third objective: To further diversify Capstone into new markets, new verticals and new geographies, and I believe we did a great job in the quarter on this front.

During this quarter, we secured orders from 20 distributors, representing 14 countries. Over the last 2 quarters, I spent time working with our new distribution partners in Peru, in Chile, in Jamaica, Oman and the UAE. As a direct result of these hands-on initiatives, we have already generated positive results with new product orders received from Chile and Jamaica, and some large pending flare gas opportunities in the Middle East.

Lastly, let's turn to Slide 15. Slide 15 highlights the improvement in our gross margins for aftermarket service business, the sequential improvement is a direct result of the FPP long-term service contracts, the new expanded DSS program and a newly expanded factory rental program. Example of this is 3 separate long-term FPP multiyear service contracts I mentioned earlier, representing 3.1 megawatts. These new contracts are up to 15 years of scheduled and unscheduled maintenance coverage and will generate predictable long-term reoccurring revenue with good margins.

The high margin reoccurring revenue with Capstone in our aftermarket business is key to reaching the company's long-term profitability goals. Growth in these areas are the underlying drivers to Capstone's path to achieving 100% absorption, which means the gross margin for the service business covers the operating expenses of the entire organization.

For the third quarter, the combined gross margin for aftermarket service business, which includes accessories, parts and service, was 36% versus our future target goal of 50%.

As highlighted on Slide 16, Capstone is a service driven business with 39% of last year's revenue coming from our aftermarket service business, which turned in 81% of our gross margins.

Today, I'm proud to announce that we are expanding our industry-leading FPP service offering from the current 5- and 9-year agreements. This new significant expansion of coverage will truly be industry-leading, and help Capstone become very long-term energy partners with our end-use customers as we guarantee life cycle cost to levels other than before. So look for a press release on that shortly.

Additionally, the recent $30 million Goldman Sachs funding will allow us to continue to execute our growth initiatives and deliver on the factors that we can control to significantly improve our near-term performance of the business, and we look forward to improved results in the quarter ahead as we again push to reach EBITDA breakeven and beyond.

In summary, we experienced a number of pushes and pulls in the quarter, which we believe we managed quite well, and we're looking forward to the fourth quarter.

Jayme, want to go through the specific financials of the quarter?

--------------------------------------------------------------------------------

Jayme L. Brooks, Capstone Turbine Corporation - CFO, CAO & Secretary [4]

--------------------------------------------------------------------------------

Thanks, Darren.

I will now review in detail our financial results for the third quarter of fiscal '19. The highlights can be found on Slide 17.

Product revenue for the third quarter of fiscal 2019 was $10.1 million compared to $14.6 million in the third quarter of fiscal 2018, a decrease of $4.5 million or 31%. Our accessory parts and service revenue decreased $0.3 million or 4% through the third quarter of fiscal 2019 to $7.9 million compared to $8.2 million in the third quarter of fiscal 2018.

Total revenue for the third quarter of fiscal 2019 was $18 million compared to $22.8 million in the year ago third quarter. Gross margin for the third quarter of fiscal 2019 was $2.2 million or 12% of revenue compared to $5 million or 22% of revenue in the year ago third quarter. The decrease in gross margin of $2.8 million during the third quarter compared to last year was primarily because of lower product revenue and higher unscheduled maintenance activities for FPP contracts and warranty expense.

R&D expenses for the third quarter of fiscal 2019 decreased $0.1 million or 10% to $0.9 million from $1 million in the year ago third quarter. SG&A expense in the third quarter of fiscal 2019 increased $0.5 million to $4.6 million from $4 million in the year ago third quarter.

Total operating expenses for the third quarter of fiscal 2019 were $5.5 million compared to $5 million in the year ago third quarter. Net loss for the third quarter of fiscal 2019 was $3.5 million compared with the net loss of $0.3 million in last year's third quarter. Net loss per share was $0.05 compared to last year's third quarter loss per share of $0.01.

Weighted average shares outstanding at the end of the third quarter of fiscal 2019 were 69.5 million compared with 46.8 million in the year ago quarter.

Adjusted EBITDA loss was $2.3 million compared to adjusted EBITDA of $0.4 million in the year ago third quarter. Adjusted EBITDA loss per share was $0.03 compared to last year's third quarter adjusted EBITDA per share of $0.01.

As a reminder, EBITDA and adjusted EBITDA are non-GAAP financial metrics.

Please refer to Slide 25 in the appendix titled Reconciliation of Non-GAAP Financial Measures for more information regarding the non-GAAP financial metrics.

Now please turn to Slide 18 as I provide some comments on our balance sheet and cash flow. Cash, cash equivalents and restricted cash were $16.7 million as of December 31, 2018. Compared to Cash, cash equivalents and restricted cash of $19.4 million as of March 31, 2018, and $18.3 million as of September 30, 2018. Cash used by operating activities for the third quarter of fiscal 2019 was only $2,000 as compared to cash used of $6.6 million for the second quarter of 2019.

Our accounts receivable balance as of December 31, 2018, net of allowances was $13.2 million compared to $15.9 million as of March 31, 2018, and $16.5 million as of September 30, 2018.

Inventories as of December 31, 2018, were $19.5 million compared to $16.7 million as of March 31, 2018, and $16.6 million as of September 30, 2018. Inventories increased primarily as a result of forecast missed on configurations, vendor transitions as a result of the safety stock.

Accounts payable and accrued expenses were $15.7 million as of December 31, 2018, compared to $13.5 million as of March 31, 2018, and $14.1 million as of September 30, 2018.

At this point, I'll turn the call back to Darren.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [5]

--------------------------------------------------------------------------------

Thank you, Jayme.

Before I opened up to questions from our analysts, I guess let me go ahead and answer a question that I think is probably on everybody's mind. And that's why did Capstone select Goldman Sachs in the new 30-year -- $30 million, 3-year debt facility. I'll say that's something we've never done in the 12 years I've been at Capstone, and we spent a lot of time looking at all different options and selected Goldman for a multitude of reasons.

But the reason we wanted to put some debt on the balance sheet beyond what we have already, as Capstone need additional capital to support our growing initiatives, including expanding our new higher-margin reoccurring revenue rental fleet, putting 3.6 megawatts on the books for rental fleet was obviously challenging for our balance sheet where we were, paying off the UTC royalty was challenging, facility consolidation, we've had a lot of uses of capital that had been good uses of capital and good investments, but have been challenging with our small balance sheet, as we definitely want to do something to increase the size of the balance sheet and give us additional liquidity.

We evaluated multiple options, everything from traditional equity transaction actions to traditional debt and convertible debt. We looked at the aftermarket that we've done in the past, the ATM. We found that the Goldman note was the better way to go, with the lower dilution solution. And at the end of the day, we think it's a lower cost of capital for the company.

After talking to multiple investors, analysts, bankers and our Board of Directors, the company really believe that Goldman note was not only the lowest dilution solution, but at the end of the day, lowest cost of capital and gives the cash now that we need to grow the business and avoids any future issues from macroeconomic conditions or what's going on in the market or the politics of geopolitical events. So I think getting the cash now to fund our business and push it through to profitability made all the sense in the world.

Also, the $30 million on our balance sheet will help us with larger customers as they look to achieve our goal of double-digit revenue growth. Fortune 100 customers have been challenging for Capstone. With our limited balance sheet, a lot of them can't get comfortable doing business with us. Also, new vendors, as Kirk and his team look to achieve significant direct material cost reductions, having a balance sheet helps us most conversations to lower the DMC with our vendors.

Obviously, the current ATM that we had has been valuable to Capstone. But at this time, we felt it was best to go with the Goldman transaction, and frankly, put the ATM tool back in the toolbox. So

I think debt is always challenging for a nonprofitable company. Putting debt on our balance sheet says that we feel very good about the future profitability. Otherwise, we wouldn't have done it. So we're very confident that all these changes we've made and are going to make to the company are going to get us back to cash flow positive very, very quickly.

So with that, let me open it up to questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from the line of Colin Rusch from Oppenheimer & Co.

--------------------------------------------------------------------------------

Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [2]

--------------------------------------------------------------------------------

Can you talk a little bit about pricing dynamics as you've moved into these new distributors and what's going on with select discounts that you're making with folks and just in terms of general trajectory on the overall portfolio?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [3]

--------------------------------------------------------------------------------

Yes, I think pricing is always challenging. Pricing elasticity in the market is interesting. Obviously, as we move into Asia, that's a very cost-sensitive market. I've been a little surprised, and Jim can jump in here, that the Middle East is as cost-sensitive as they are. And obviously, they've got a lot of cash and a lot of resources, but they are very cost sensitive. I think the U.S., we have more ability to leverage our pricing, to hold our pricing, more than probably any other market. Europe is okay, but we still discount a little bit. And Latin America also pushes for discounts. That's an area, though, that we're going to look to work on in the future. I think as our product matures, as our service business shows that it's that much more valuable and beyond anything else in the market, we can demand higher rates. I think you look at fuel cells and other technologies, they're getting a lot higher prices for their technologies. We want to make sure that we try to hold pricing as much as possible.

--------------------------------------------------------------------------------

Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [4]

--------------------------------------------------------------------------------

Okay. And then in terms of some of the growth initiatives, obviously, you've got the rental and some of the financing aspects. Are there other areas where you're investing in terms of CapEx, OpEx, any additional sales resources, that we might think about as you look to deploy some capital to enable growth here?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [5]

--------------------------------------------------------------------------------

Yes, definitely, we're looking to add some more sales resources. We're looking to spend more money in marketing, more B2B events. But our biggest cash outlay will be growing that rental business. We're at about 3.6 megawatts today. We'd like to expand that to closer to 10. That's going to give us several million dollars a year of high-margin reoccurring revenue. I think the other thing we're doing is obviously distributor support fees are very important to us for cash flow purposes. We're going to do the largest spare parts price increase in company history, which will help in 2 ways, frankly. It'll help improve our parts margins, but more importantly, it'll make the FPP, which we have not raised the price on for years, look that much more viable for customers. And so we really want to influence the behavior of our customers and sign long-term FPP agreements. And like I said, we'll be announcing shortly a new FPP program that we're very proud of.

--------------------------------------------------------------------------------

Operator [6]

--------------------------------------------------------------------------------

Our next question comes from the line of Rob Brown from Lake Street Capital.

--------------------------------------------------------------------------------

Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [7]

--------------------------------------------------------------------------------

On your FPP contract pipeline that you were sort of alluding to, what's -- is it multiple customers? Is it larger terms or time terms? Put some color on the FPP pipeline.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [8]

--------------------------------------------------------------------------------

Yes. No, obviously, we sign FPPs from a single C65 up to multiple megawatts. I highlight the bigger ones because I think we have 3 large pending projects or contracts that are about almost 14 megawatts, so that will obviously drive north of $15 million in future revenue. But no, it's all sizes. And I think what you're seeing is we're seeing the business has shifted over the years from oil and gas-centric to CHP. As those CHP units come off of warranty, they're higher attachment rates than our oil and gas customers. And so the shift the last couple of years in CHP is now delivering itself or manifesting itself in higher attachment rates and faster growth in FPP, which is all very positive. That being said, we're also getting more traction in the oil and gas markets as we continue to raise spare parts pricing. I had some oil and gas customers already unhappy with me with our spare parts pricing. This newest price increase will make me more unhappy. And obviously, they don't think it's fair, but fair is a weather condition, not a business condition. So we really want to push as many of our customers as possible to join the FPP and really become our partners.

--------------------------------------------------------------------------------

Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [9]

--------------------------------------------------------------------------------

Okay. And then in the rental market, is that -- how is that developing? Is it primarily a -- you talked about the Permian -- is it primarily in energy in the Permian market? Or do you see kind of other opportunities out there? And what sort of drives that growth?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [10]

--------------------------------------------------------------------------------

Yes, I think definitely, we're seeing the oil and gas market as being the primary market for the -- I have Jim here, let me -- let him jump in here.

--------------------------------------------------------------------------------

James D. Crouse, Capstone Turbine Corporation - EVP of Sales & Marketing [11]

--------------------------------------------------------------------------------

Yes, Rob, I agree. Oil and gas, Permian, Bakken, Marcellus, those are 3 areas where we get a lot of requests and/or interest from rental. Also, areas where we have good distributors that can help deploy and support the product once it's there.

--------------------------------------------------------------------------------

Operator [12]

--------------------------------------------------------------------------------

Our next question comes from the line of Amit Dayal from H.C. Wainwright.

--------------------------------------------------------------------------------

Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [13]

--------------------------------------------------------------------------------

This FPP contract that we're expecting, this 14 megawatts, is this a shift out from the prior quarter? I think there were expectations of around $25 million being added in the previous quarter. I just wanted to make sure we are talking about the same thing over here or if things have changed on this front?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [14]

--------------------------------------------------------------------------------

Yes, let me let Jeff Foster answer that one so that I can put him on the spot.

--------------------------------------------------------------------------------

Jeff Foster, Capstone Turbine Corporation - SVP of Customer Service [15]

--------------------------------------------------------------------------------

Yes, sure, to answer the question directly, a number of these FPP opportunities are opportunities we've been working for the last 3 to 4 months. Some of them we expected earlier. They've been delayed for a number of reasons. I think there's been a bit of a slowdown in the oil and gas market that's caused people to delay these awards, but they're now starting to come in. So these are the ones that we referred to previously.

--------------------------------------------------------------------------------

Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [16]

--------------------------------------------------------------------------------

Understood. And then in relation to the new Goldman note, et cetera, primarily potentially being used to support the rental business. If this accelerates for you in terms of how you are thinking it will, will you need to go back to the capital markets in some fashion to support this growth? Like, how do you -- how does it grow from here? I just wanted to see if it's going to be organic or you're going to have to rely on outside funding.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [17]

--------------------------------------------------------------------------------

No, it's a great question. I think if you look at the things we've done recently, the new increase in the distributor support payment, the new spare parts price increase, we've got some recoveries and turnaround in the California market from our distributor change out we did recently. We'll see margin improvements in our FPP business, plus expansion of that business. The [Mura] facility rolls off, I believe Jayme, in September, so we'll get that relief. Obviously, the new rental units that we have in place are generating several hundred thousand dollars per quarter, and then we have the relief from the UTC royalty. So if you take kind of all that basket of opportunity together, that's going to take a huge cut out of our negative operating losses, and so that's going to get us very close to breakeven. And so as we add additional rental assets, as we lower our direct material costs, that's going to push us over into profitability, and that will help us to organically fund some of this growth. And so long answer to a short question, but I do believe that if we kind of wade into the water and not go too quickly, we can cash flow using the Goldman Sachs money, plus our own organic cash, I think we can grow the business at a reasonable pace without too much additional equity.

--------------------------------------------------------------------------------

Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [18]

--------------------------------------------------------------------------------

Just one final one from me. You commented you worked towards like sort of a fixed number of production slots. So the sequential drop in revenue, was it because of this? How do you plan to sort of work around this, and potentially overcome this issue going forward?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [19]

--------------------------------------------------------------------------------

Yes, no, I mean, we definitely have a fixed number of production slots. So when I take 4 C1000 slots and turn those into 4 rental slots, that goes from being cash upfront to cash over the next year in monthly rental payments, so there's definitely a timing difference and a revenue difference. But for the business, it's the right thing to do, because it's giving us higher returns, better revenue. In this case, the 3.6 megawatts went into a new customer. It was a very large oil and gas customer globally we haven't penetrated it before, so getting a new customer into our technology is worth it. And so short term, it's challenging because it impacts our product revenue for the quarter. Frankly, it pretty much cost the leadership team their bonus for the year, because we have a bonus tied to the revenue, but it's the right thing for the business. And so we made the right choice. And going forward, that's what we're going to do. So there may be quarters if we do a large amount of new rental equipment, that will impact our product revenue. But again overall, from a profitability standpoint, it's absolutely the right decision.

--------------------------------------------------------------------------------

Jayme L. Brooks, Capstone Turbine Corporation - CFO, CAO & Secretary [20]

--------------------------------------------------------------------------------

So we're looking to deploy those not as fast as we did this last quarter. In a sense, that it won't be as large of an impact in any one particular quarter, that we'll try to spread that out.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [21]

--------------------------------------------------------------------------------

Yes, absolutely. This was an opportunity that we had for 4 units in 1 quarter. As Jayme said, that's not normal. We'd like to do 1 a quarter would be a much more sustainable pace. But again, telling customers no, especially of that size, is not always easy to do.

--------------------------------------------------------------------------------

Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [22]

--------------------------------------------------------------------------------

And I guess this is sort of a new development in the story, where we just might have to drag the rental production capacity versus sales production capacity and then utilization levels, I guess, for each of the units.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [23]

--------------------------------------------------------------------------------

Yes, at the end of the day, though, you don't take revenue to the bank. You take cash and earnings, and so we're really focused on generating cash and earnings. And so as much as revenue from product sales are sexy, I think at the end of the day, we want to be profitable. Not to get too crass, but our vendors are making money, making our parts for us. Our distributors are making money installing our world-class products. And our customers are saving money operating them. And the only person in this chain that's not making money is Capstone, and so that day needs to end and we need to make money. So that's our primary focus.

--------------------------------------------------------------------------------

Operator [24]

--------------------------------------------------------------------------------

Our next question comes from the line of James Jang from Maxim.

--------------------------------------------------------------------------------

Han Jang, Maxim Group LLC, Research Division - VP & Senior Equity Analyst [25]

--------------------------------------------------------------------------------

So just going back to the, I guess, the oil and gas sector, oil prices are coming down. What's plan B? Or what's the pivot if the oil and gas sector doesn't -- the ordering doesn't pick up as you guys expected?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [26]

--------------------------------------------------------------------------------

Yes, and I'll let Jim jump in here as well. But I think, first of all, I'd say our products, as I said in our prepared remarks, we really lower the operating expenses of oil and gas customers. So logically, intuitively, you would think that they'd still buy our products in a low oil price market. I think flare gas is a big key. There's more pressure to take that flare gas and to burn it in the microturbine, not add to global warming. I think we've all been watching the news lately. I think the fourth year in a row that we've seen temperatures in the planet go up. Flare gas is a big piece of that. And so as oil and gas customers are pushing for new ways to lower their emission standards, we hope they keep buying our microturbines, even in lower oil and gas markets. That being said, though, diversification is key, and we've learned our lesson a few years ago when we were very heavy in oil and gas. So today, it's one of our bigger segments, but we're very big in CHP. We're expanding in renewables. We're expanding in our microgrid space and in other areas. And so we've looked to diversify the business, both by geographies and verticals. I look at some of our brothers in the fuel cell industry, and most of them have 3 or 4 markets, one vertical and I think that's very dangerous. So if you lose one market, you lose 25% of your business. So I think -- I'm very proud of what we've done to diversify. Obviously, though, oil and gas is something we'll continue to watch. But I think we're in pretty good shape there. I don't know, Jim, if you want to say a couple of comments about flare gas?

--------------------------------------------------------------------------------

James D. Crouse, Capstone Turbine Corporation - EVP of Sales & Marketing [27]

--------------------------------------------------------------------------------

Yes, no, I think a lot of our oil and gas business is non-drilling. It's more production, gas transmission. And in flare gas, as Darren mentioned, is a growing segment and one that we're seeing interest globally, not just in the Permian or the Bakken, but Middle East, Africa, and we're starting to see some additional life in our markets in Russia. Even as unpopular as they may be, there's new activity around the business there.

--------------------------------------------------------------------------------

Han Jang, Maxim Group LLC, Research Division - VP & Senior Equity Analyst [28]

--------------------------------------------------------------------------------

So -- but like is there a plan B, though? Like, I know you guys are expanding into CHP, but is there another sector or segment we should be keying on if, let's say, oil prices do collapse further and, let's say, additional pipelines that transport the associated gases come through, what is like plan B that you guys have?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [29]

--------------------------------------------------------------------------------

No. I think, again, CHP, microgrids, renewables, are plan B, C and D. And I think that, that's part of it. I think that the rental market also helps. I think a lot of customers in lower oil times, when they're less sure they'll rent product instead of buying products. So I think to be able to play in that market, that also helps inflate us a little bit as well. So I think it's -- there's no simple answer. It's really a shotgun approach of a diversified portfolio.

--------------------------------------------------------------------------------

Han Jang, Maxim Group LLC, Research Division - VP & Senior Equity Analyst [30]

--------------------------------------------------------------------------------

Okay. And final thing is just to go back to the note. So it seems also fiscal Q1 of '22, you have a $30 million payment due, right? So then you think you'll be able to cash flow that out instead of going to the markets?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [31]

--------------------------------------------------------------------------------

No, so I think what -- we started working with Goldman back in June, I believe, Jayme? So we talked to probably 15 other banks that are interested in Capstone and our business. Most of them were not comfortable with where we were as a business and -- or we liked the Goldman terms better. And so I think as we move forward, we'll continue conversations with those other 15 banks that either we couldn't qualify or we didn't select. And as we get cash flow positive, the real goal would be to kind of refinance Goldman out with some of the lower cost of capital, more traditional lender. That being said, Goldman has told us they are interested in continuing relationship as our business grows, and they like our business. And so I think that's -- obviously, there'd be opportunity there as well.

--------------------------------------------------------------------------------

Jayme L. Brooks, Capstone Turbine Corporation - CFO, CAO & Secretary [32]

--------------------------------------------------------------------------------

And we can do that within -- in 24 months as well.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [33]

--------------------------------------------------------------------------------

Yes, correct. So we -- I guess maybe Jayme, can you talk a little bit about this specific note itself.

--------------------------------------------------------------------------------

Jayme L. Brooks, Capstone Turbine Corporation - CFO, CAO & Secretary [34]

--------------------------------------------------------------------------------

Yes, I mean, as we had in the press release, we have -- it's a 13% interest note, firm note, that's due on -- in 3 years. So with that, we have -- we can pay early up to 24 months.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [35]

--------------------------------------------------------------------------------

And then the -- as far as the covenants kick in, in 18 months.

--------------------------------------------------------------------------------

Jayme L. Brooks, Capstone Turbine Corporation - CFO, CAO & Secretary [36]

--------------------------------------------------------------------------------

Yes, covenants kick in 18 months, and we have a certain minimum cash balance now that will drop a year.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [37]

--------------------------------------------------------------------------------

So it's really designed to help us get through what we need to do right now from a capital standpoint to grow our business.

--------------------------------------------------------------------------------

Han Jang, Maxim Group LLC, Research Division - VP & Senior Equity Analyst [38]

--------------------------------------------------------------------------------

Okay. And the $6 million restricted cash, that gets released, right?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [39]

--------------------------------------------------------------------------------

Say again?

--------------------------------------------------------------------------------

Han Jang, Maxim Group LLC, Research Division - VP & Senior Equity Analyst [40]

--------------------------------------------------------------------------------

The restricted cash, that's released now?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [41]

--------------------------------------------------------------------------------

Absolutely, yes.

--------------------------------------------------------------------------------

Jayme L. Brooks, Capstone Turbine Corporation - CFO, CAO & Secretary [42]

--------------------------------------------------------------------------------

Yes, yes.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [43]

--------------------------------------------------------------------------------

Yes, we paid off that facility.

--------------------------------------------------------------------------------

Operator [44]

--------------------------------------------------------------------------------

(Operator Instructions) Our next question comes from the line of Eric Stine from Craig-Hallum.

--------------------------------------------------------------------------------

Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [45]

--------------------------------------------------------------------------------

Just a few for me. Just on the supply chain, I know you've had some things underway here for some time, trying to get suppliers under long-term agreements. And I also know over the last couple of quarters, you've had some disruption there, trying to find second sources for key parts. So maybe just an update on all of that and how we should think about some of this going forward?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [46]

--------------------------------------------------------------------------------

Yes, no, absolutely. That's been a major area of focus, and Kirk has done a great job at lean manufacturing, consolidating our facilities and doing all the wonderful things he's done in the last 18 months, but his #1 goal going forward is DMC reduction and improving our supply chain. So I'll throw him the ball and let him talk about it a little bit.

--------------------------------------------------------------------------------

Kirk Petty, Capstone Turbine Corporation - VP of Manufacturing [47]

--------------------------------------------------------------------------------

Yes, Darren alluded to it a little bit earlier in the call, but the Goldman Sachs situation definitely helps with that, with supplier negotiations, being able to consolidate and integrate a lot of the value stream into a few select suppliers that want to be partners with us and do away with some of the suppliers that necessarily haven't been the best partners with us. But it's mainly focusing on the big cost items, the parts that are going to get us margins in aftermarket that we're really focused on right now.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [48]

--------------------------------------------------------------------------------

I think if you look at it, we've got a couple troubled suppliers, we've got some suppliers with quality issues, we have suppliers that have leveraged us as the aerospace industry has heated up and hit us with big price increases. I think we have an opportunity this year to exit all those suppliers that have been bad actors, as well as attract some new suppliers that we're currently qualifying. And so I think there's a lot of good work we're going to do there. Kirk's being shy on how much he can generate in DMC reduction, but I think it will be very significant this year.

--------------------------------------------------------------------------------

Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [49]

--------------------------------------------------------------------------------

Okay, got it. And maybe just one last one for me, just more big picture. I mean, you've had a fair amount of distributor turnover in the last couple of years, but the diversification that you're seeing right now, I mean, it's greater than I can remember over many years. Just wondering what you attribute that to? I mean, do you think that this is a case of those distributors really maturing? Is it product capability that maybe you didn't have in the past? I mean, just some thoughts there, because it is notable.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [50]

--------------------------------------------------------------------------------

Actually, keep going. You sound great. I think it's all those things. It's -- Jim has a model distributor program, trying to work 70 distributors worldwide and getting all of them to do -- sell all of your products in all of the verticals and all the applications is very challenging. We continue to improve our processes. I mean, part of our Distributor Support System program is to make training free, and so kind of like the all-you-can-eat bar, now distributors, instead of skimping on training, are overeating on training, which is what we want. We want to get them up the curve as fast as possible. And so it's really been a focus. I mean, again, you've been around us a long time, it's been a lot of effort. But as you said, it's the most diversified it's ever been. I mean, Caterpillar, GE, Cummins, their distributor network is a third generation and 100 years old, and it just takes time to develop them. But I think we are seeing an acceleration in the maturation of our distributors, and getting distributors to pay us money to help them, shows that the distribution network is maturing, and frankly, that they value our business. And I said it in our prepared remarks, we've got 99.5% of what we billed, collected on the DSS program. What does that tell you? That tell you distributors value the business, and they're willing to pay us to stay in the business. So I think that's all very -- bodes very well for the future.

--------------------------------------------------------------------------------

Operator [51]

--------------------------------------------------------------------------------

And our next question is a follow-up from the line of James Jang from Maxim.

--------------------------------------------------------------------------------

Han Jang, Maxim Group LLC, Research Division - VP & Senior Equity Analyst [52]

--------------------------------------------------------------------------------

One last one, guys. So the -- can you give us any insight into the book-to-bill ratio as of today?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [53]

--------------------------------------------------------------------------------

For the quarter?

--------------------------------------------------------------------------------

Han Jang, Maxim Group LLC, Research Division - VP & Senior Equity Analyst [54]

--------------------------------------------------------------------------------

Yes, so far. Is this still trending above 1?

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [55]

--------------------------------------------------------------------------------

Yes, we don't look at it here on the interim quarter. I don't know, Jim, if you have anything, you want to say anything about the fourth quarter. But I think, yes, we typically don't run those kind of numbers. So it'd be really hard for us to give you any kind of meaningful answer.

--------------------------------------------------------------------------------

Operator [56]

--------------------------------------------------------------------------------

Thank you. And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Darren Jamison for any further remarks.

--------------------------------------------------------------------------------

Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [57]

--------------------------------------------------------------------------------

Well, thank you. No, hopefully, it was a good session today. I think we had a lot of good questions, very excited about the business and where we're going. I know the quarter from a top line perspective looks a little disappointing because of the product revenue that got shifted to rentals, but it's actually an extremely important and valuable development. Very excited about where we are with the business and getting back to EBITDA breakeven as quickly as possible. But beyond that, generating cash to further fund our growth initiatives, continue our operating expense coverage heading toward 100% and all the different things we talked about on the call today.

So very excited about talking to folks again in the fourth quarter. Thank you.

--------------------------------------------------------------------------------

Operator [58]

--------------------------------------------------------------------------------

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.