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Edited Transcript of CPST.OQ earnings conference call or presentation 10-Nov-20 9:45pm GMT

·41 min read

Q2 2021 Capstone Turbine Corp Earnings Call CHATSWORTH Nov 11, 2020 (Thomson StreetEvents) -- Edited Transcript of Capstone Turbine Corp earnings conference call or presentation Tuesday, November 10, 2020 at 9:45:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Colby Petersen Capstone Turbine Corporation - Secretary & Corporate Counsel * Darren R. Jamison Capstone Turbine Corporation - President, CEO & Director * Frederick S. Hencken Capstone Turbine Corporation - CFO ================================================================================ Conference Call Participants ================================================================================ * 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 * Robert Duncan Brown Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst * Sameer S. Joshi H.C. Wainwright & Co, LLC, Research Division - Associate * Shawn Severson ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good day, ladies and gentlemen, and welcome to your Capstone Turbine Corporation earnings conference call and webcast for the financial results for the second quarter fiscal year 2021 ended on September 30, 2020. (Operator Instructions) As a reminder, today's program will be recorded. At this time, it is my pleasure to turn the floor over to Mr. Colby Petersen, Corporate Counsel. Sir, the floor is yours. -------------------------------------------------------------------------------- Colby Petersen, Capstone Turbine Corporation - Secretary & Corporate Counsel [2] -------------------------------------------------------------------------------- Thank you very much. Good afternoon, and thank you for joining today's fiscal 2021 second quarter conference call. As a reminder, the company issued preliminary selected second quarter results on October 2, 2020. On the call with me today is Darren Jamison, Capstone's President and Chief Executive Officer; and Eric Hencken, Capstone's Chief Financial Officer. Today, Capstone issued its earnings release for the second quarter of fiscal 2021 and filed its quarterly 10-Q report with the Securities and Exchange Commission. We will be referring to slides that can be found on our website under the Investor Relations section during the call today. I want to remind everyone that this conference call contains estimates and forward-looking statements representing the company's views as of today, November 10, 2020. Capstone disclaims any obligations 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 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 Eric go through the discussion today, when they mention EBITDA, they are referring to adjusted EBITDA and the reconciliations in our presentation's appendix. 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, Colby. Good afternoon, everyone. Thank you for joining us today to review our second quarter fiscal 2021 results ending September 30, 2020. Before getting into specific financial highlights, I'd like to review recent business highlights and provide an update on our adjusted EBITDA initiative. Let's go and turn the presentation to Slide 4. On Slide 4, we have outlined some of the key events from the last couple of months. And I'm glad to say this is a very long list, which is a significant improvement over the first quarter as we started to see our business rebound. I will not run through each item, obviously, but I would like to draw your attention to a couple of the more critical events that demonstrate the inflection point that I believe we have reached at the company. On August 24, we announced a significant progress on our microturbine hydrogen testing as fuel flexibility is a key part of our energy solutions backbone, and hydrogen is clearly emerging as a viable low carbon source of energy over the next couple of years. I'll be spending a little bit more time later in the presentation discussing our more specific hydrogen strategy. On September 10, we secured a new 5-year long-term FPP contract as part of our growing Energy as a Service business in the Asia Pacific region, which I believe indicates that, that region is beginning to also recover and could return to a significant growth opportunity for the company. I'd also say that the market in Europe rebounded nicely during the quarter, but we're actively monitoring the current situation with some countries shutting down for the month of November as COVID-19 continues to create business challenges in various parts of the globe. However, the second quarter's most significant achievement was that Capstone posted positive cash from operations as total cash on hand increased to $16.8 million in the second quarter from $16.2 million in the first quarter, which Eric will be covering in greater detail in the financial results section. However, just to put this accomplishment into some perspective, this is the first positive cash from operations quarter in 11 quarters, and we accomplished this at significantly lower COVID-impacted revenue levels. Lastly, the other critical milestone for the quarter technically came just after the quarter ended, when we successfully upsized our original Goldman Sachs $30 million term note to $50 million and did so 5 months ahead of our stated goal of February 2021. We did this at a significantly reduced interest rate and for a new 3-year term. Make no mistake, this is a huge achievement as it provides additional financial flexibility to aggressively pursue our Energy as a Service strategy and to do so at a substantially lower cost of capital. Also, this gives our new direct sales team the balance sheet it needs to support direct sales efforts with larger Fortune 1000 companies. Also, I believe that Goldman Sachs lending a total of $50 million to Capstone, with its history of losses in the middle of a global pandemic, speaks volumes as to the future of Capstone and its growing Energy as a Service business model. One final comment on this. I believe that the upsized Goldman credit facility is not only significantly lower interest rate and new 3-year term, but the fact that the date we executed the note, our market cap was less than the total loan amount. Let's go and turn to Slide 5. Slide 5 highlights our adjusted EBITDA goal through the second quarter versus our year-over-year goal of $10 million EBITDA improvement despite the ongoing impact of COVID-19 on our business. To date, we have posted an impressive $4.2 million improvement for the 6 months ended September 30, 2020 compared to the same period in 2019, excluding a noncash provision for a potential payout under the annual Executive Bonus program. The numbers really speak for themselves here. And at this point, we are tracking in the range we expected in order to achieve our $10 million adjusted EBITDA improvement goal year-over-year. With that, I will now turn the call over to Eric Hencken to provide more specific details on our excellent second quarter financial results. Eric? -------------------------------------------------------------------------------- Frederick S. Hencken, Capstone Turbine Corporation - CFO [4] -------------------------------------------------------------------------------- Thanks, Darren. I will now review in detail our financial highlights for the second quarter of fiscal 2021, which can be found on Slides 6 through 10. I want to begin by highlighting our total cash and cash equivalents as of September 30, 2020 were $16.8 million, an increase of $0.6 million compared to $16.2 million as of June 30, 2020, which was the result of strong working capital management despite a challenging COVID operating environment. During the quarter, we generated $1.9 million positive cash from operating activities, representing a $3.7 million improvement quarter-over-quarter and an $8.2 million improvement year-over-year as the company benefited from its Energy as a Service, or EaaS, business model. For Capstone, EaaS consists of spare parts, factory protection service contracts, rentals, distributor support subscription fee and other service revenue. Cash flow improvement is a critical milestone, and this quarter showed strong positive momentum. I want to stress that this was accomplished without any financing activities as the company generated positive cash from operations for the first time in 11 quarters. We accomplished this through a combination of tight cost controls, the growing success of our EaaS business and working capital management. Specifically, total inventory decreased by $3.7 million or 19% to $15.5 million in the quarter compared to $19.2 million as of June 30, 2020. And if you refer to our 10-Q filed today, you will see we decreased inventory by $7.2 million or 32% compared to $22.7 million as of March 31, 2020. This decrease supported improved liquidity and positive working capital during the second quarter. New gross product orders were $9.8 million in the second quarter, which compared to $5.5 million in the first quarter, representing a positive book-to-bill ratio of 1.4:1 as the business continues to rebound from the impacts of the COVID-19 pandemic. As Darren mentioned, the company continued to execute against its $10 million fiscal year-over-year adjusted EBITDA improvement goal, posting a $4.2 million improvement for the 6 months ended September 30, 2020 compared to the 6 months ended September 30, 2019, excluding a noncash provision for the Executive Bonus plan. Total revenue for the quarter increased $0.7 million sequentially from $14.2 million in the first quarter to $14.9 million in the second quarter, primarily due to improving product revenue as the impact of COVID-19 continues to subside, but decreased $5.8 million compared to total revenue of $20.7 million in the year ago second quarter. The year-over-year decrease in revenue was primarily the result of lower product parts and accessories volume as project schedules were adversely impacted by the global COVID-19 pandemic. Gross margin as a percentage of revenue was 17%, an increase of 2 percentage points compared to the prior year second quarter, despite a 28% drop in total revenues, primarily due to improving service margins and lower warranty expense. Gross margin as a percentage of revenue decreased 7 percentage points compared to the first quarter due to revenue mix as well as the decline in service margins impacted by the COVID-19 pandemic. Operating expenses in the second quarter were $5.5 million. On a sequential basis, operating expenses increased $1.6 million from $3.9 million in the first quarter which was primarily due to costs associated with our IndyCar racing sponsorship as well as an accrual for executive bonuses. The majority of the IndyCar racing sponsorship cost was recognized in the second quarter as this season was condensed due to COVID-19. Operating expenses decreased $0.9 million compared to $6.4 million in the second quarter of last year, primarily due to lower costs from our COVID-19 Business Continuity Plan. Net loss was $4.2 million for the second quarter of fiscal 2021 compared to a net loss of $4.4 million in the year ago quarter. Adjusted EBITDA, excluding Executive Bonus, was negative $1.9 million for the second quarter of fiscal 2021 compared to an adjusted EBITDA, excluding Executive Bonus, of negative $2.2 million for the year ago quarter. Now I'd like to talk in more detail about our Energy as a Service business, and we have a new slide I would like to share with shareholders to help frame this critical part of our business. Let's go ahead and focus on Slide 12, where we set out our historical Energy as a Service, or EaaS, revenue and gross margin as well as pro forma through fiscal 2023. For the full year of fiscal 2021, we assume Q2 fiscal 2021 year-to-date annualized numbers for both revenue and margin. Fiscal 2022 and '23 are also Q2 fiscal '21 year-to-date annualized for revenue and margin, but we also assume that Capstone builds its current 8.6 megawatt rental fleet by approximately 2 megawatts per quarter until it reaches 21.1 megawatts as required under the new Goldman Sachs note, and we modeled an 85% rental utilization rate. Our model assumes that the average rental contract revenue per megawatt is $90,000 per quarter and a 70% gross margin. This is not meant to be a forecast, and there is no assumed growth in revenue or margin in spare parts, FPP or DSS in this model for fiscal '22 or '23 when compared to year-to-date fiscal '21, only growth in rentals to try and illustrate the importance of our rental business and improve service margins compared to prior years. The one key thing to take away from this new EaaS slide is that there is a tremendous positive margin impact with each incremental dollar of EaaS revenue. Also, it's important to note that we assume in fiscal '23 our EaaS margins will be close to our current annual OpEx rates, which means our EaaS business could cover a significant portion of our OpEx, while margin contribution from product sales would drop to the bottom line. Said another way, we believe the continued growth and profitability of our Energy as a Service business would ensure our future viability, profitability and positive cash flows from operations. I will now hand it back over to Darren to give additional color on our fiscal '21 goals and objectives as well as our strategic initiatives in hydrogen. Darren? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [5] -------------------------------------------------------------------------------- Excellent. Thank you, Eric. Let's go ahead and turn to Slide 14. Slide 14 highlights our 2021 objectives, and those remain unchanged from what you saw in our last quarter and are centered around our goal to see $10 million in year-over-year adjusted EBITDA improvements, excluding any executive bonus. The key components in achieving that goal include a 22% gross margin target compared to the 17% posted this quarter, driving 15% of revenue from our new direct sales channels, reaching the 10 megawatts of rentals that Eric talked about, which is currently at 8.6 megawatts, and improving our working capital to approach 6 inventory turns compared to 3.3 in the second quarter. Speaking of inventory, Kirk Petty and his team have reduced it from 22.7 million to today's 15.5 million in just 2 short quarters, which is simply amazing. We expect that inventory turn should start to accelerate in the back half of this year as product shipments strengthen and start approaching historical pre-COVID product shipment levels. The key takeaway in all of this is the second quarter results show we are on track to reach these key business goals and objectives despite the ongoing global pandemic. However, I do expect volatility and continued difficulties given the world economic uncertainty. But the results this quarter show we are fighting through the challenges, and we are on track to meet our stated goals and commitments to all Capstone stakeholders. I would now like to turn our attention to our hydrogen business strategy, starting on Slide 16. The starting point stems from the fact that hydrogen economy is real and gaining significant momentum. This means that Capstone as a clean energy company must have an answer and expand our fuel flexibility to include the zero carbon fuels of the future. Capstone has demonstrated that it can run on 20% hydrogen mix and recently announced a new research and development partnership with the U.S. Department of Energy and Argonne National Laboratory. And our combined engineering teams are currently running a C65 in the labs at 7% hydrogen, 30% natural gas blend. This is an extremely promising milestone toward our goal of reaching a fully 100% hydrogen fuel microturbine commercial product at a fraction of the cost of the current fuel cell products. Our objective with our technology road map is to carefully manage our R&D spend while staying in front of the technology curve and providing timely, cost-effective solutions to our global customers. I'm proud to say that after years of development efforts, hydrogen is now officially part of our commercial product portfolio and we have shipped our first commercial product at a 20% hydrogen mix to our Australian distributor, Optimal. Let's go ahead and move to Slide 17. On Slide 17, I want to show the importance of green hydrogen with the energy industry. One of the key concepts behind this is the stranded electron from renewable energy assets. What this means is there's a large quantities of stranded renewable electricity that cannot be used at the conventional electrical grid as we show in this diagram. Using the surplus electricity for electrolysis and thereby producing hydrogen is seen as a valuable solution functioning as energy storage and transport medium with the energy burden to create the hydrogen coming from renewable assets. Hence, the term green hydrogen. This renewable hydrogen is blended with natural gas or eventually could be used in its pure form as fuel for our Capstone CHP systems, thereby creating a very ultra low-carbon energy source for our global customers. Slide 18 highlights some of the key topics around the Capstone product when operating at hydrogen. It is also important to note that Capstone's products are typically located behind the utility meter inside the fence at the host site. This means that Capstone is not necessarily held back waiting for the regional natural gas infrastructure to be upgraded to accept the natural gas hydrogen blend, but we could see significant growth from on-site distributed hydrogen generation at a more competitive price to current fuel cell technology. Slide 19 shows our recent patent towards 100% hydrogen fuel for microturbines. As I mentioned earlier, Capstone now offers renewable power with the use of up to 20% hydrogen of our commercial microturbine, and we have successfully operated on a blend of natural gas and hydrogen using the current fuel system architecture. And we'll use this newly patented injector to increase our current blend up to 100% pure green hydrogen in a commercially released system. On Slide 20, I wanted to share with you that this is not just a concept or an idea at this point, but rather, we are moving ahead toward a commercial product launch using blended natural gas and hydrogen fuel. In closing, I'd like to say I am proud of the entire Capstone team and the fact that we are managing to successfully navigate through these key inflection points in our operations and strategic strategies despite less than optimal external business conditions. I'm excited to think of what we can do when we actually have significant tailwinds around the globe and our customers regain stable economic footing. Despite the micro challenges and macro challenges, I will reiterate that there are favorable trends focused on broader corporate and government initiatives, specifically around energy efficiency and global carbon reduction. The green global recovery is real in our view, and we sit right in the middle of it. I entered fiscal 2021 optimistic but cautious given the global pandemic, but have an ever-growing confidence we will be successful navigating our way through this and achieve our short-term business goals and long-term profitability objectives. Operator, I would like to now open the call up from our analyst community. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Our first question comes from Eric Stine with Craig-Hallum Capital Group. -------------------------------------------------------------------------------- Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [2] -------------------------------------------------------------------------------- So I just wanted to start on the rental business with the upsized loan. I know you had the Energy as a Service slide, which was not necessarily a projection. And you do have some requirements as part of the loan. But what do you think this can become? I mean, do you have some internal targets you can share, whether it's 1 year out, 3 years out? How should we think about that? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [3] -------------------------------------------------------------------------------- Yes. Definitely, we want to get to -- from the 8.6 megawatts to the 21 megawatts that's required under the agreement as quickly as possible. We've got about 18-month period to achieve that according to the terms of the loan. We were at 8.6 before the pandemic hit. And obviously, we stumbled backwards a little bit with a couple of our oil and gas customers. We're hopeful to get those units back on rent here shortly and then start building that up. As I said in our prepared remarks, we want to be at 10 megawatts by the end of the fiscal year. But I think Eric is modeling about 2 megawatts growth a quarter. I believe that's very doable. We've got about 62 megawatts of identified pipeline and active quotes out there. We've just gone through a rebranding strategy. We'll be updating our website. We've hired a couple of rental salespeople as well. So we're just really getting spun up from a very small rental fleet into a medium-sized rental fleet, and it's probably still being in kind. Obviously, the rental market is a multibillion-dollar market. So we've got a lot of room to expand. The importance is, as Eric said in his remarks, the margins on this product is approaching 70%. The IRR is about 30%. So the more of these rentals we can get out there, it has a pretty profound impact on our profitability. And having the note from Goldman to give us that ability to build that rental fleet is really key to our success. -------------------------------------------------------------------------------- Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [4] -------------------------------------------------------------------------------- Got it. Okay. That is helpful. And then maybe on hydrogen. Just curious, I know there's a lot of activity or at least a lot of public discussion about it. I mean, when do you realistically think that this is a meaningful contributor to your business? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [5] -------------------------------------------------------------------------------- That's a really good question and a really hard one to answer. I've got a Board meeting next week, I need to try to answer that for our Board. I think our answer is we've seen much more inquiries around hydrogen in the last 6 months than we have the last 6 years. There's definitely a lot of interest. The recent order that we just got in Las Vegas for 4 megawatts, the customer said, "What's your hydrogen path?", even though that's a natural gas CHP-driven site. So I think we're seeing customers talk about hydrogen at levels we've never seen before. We're seeing more and more utilities and energy providers talking about hydrogen. So I would say, I looked through the original hydrogen highway with Schwarzenegger back too many years ago. This feels different. This feels like there's really a lot of momentum behind hydrogen. We sold our first C65 on hydrogen. We've got multiple quotes out there. At today's business levels, I don't know what you consider significant, but it could be 5% to 10% of our business in the next couple of years very easily and maybe more of it grows faster. Our challenge is really to modulate our R&D spend and product development efforts on how fast the market develops. There's no sense being early in hydrogen development and spending a lot of dollars to do that, but I don't want to be late either. So I think managing our R&D spend and product development efforts in a way to match the market development and the opportunities really are key. -------------------------------------------------------------------------------- Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [6] -------------------------------------------------------------------------------- Got it. And maybe last one for me. Just on the FPP backlog over the last couple of quarters. It's been plus or minus $80 million. Just curious any thoughts on why that's kind of stagnated a little bit. And what do you think is needed to kind of break that out of that range? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [7] -------------------------------------------------------------------------------- Yes. A couple of things. Definitely, the pandemic had a big hit on that. I mean we had folks that either idled their facilities or paused their FPPs. We had a couple of cancellations, but I would say nothing overly significant. We didn't see a lot of sites commissioned because of construction halts and people not actually being able to go out there and commission units. So I think the combination of some units not commissioned or put on hold because of the pandemic impacted us. We've had a couple of good recent FPP signings, and there should be some more coming here in the next 30 to 60 days. So we expect that to continue to grow. The challenge is, obviously, we bill every quarter. So if we're not adding new sites or if we have any cancellations, that impacts the growth of that backlog. But nothing we're concerned of long-term once we get past the pandemic. -------------------------------------------------------------------------------- Operator [8] -------------------------------------------------------------------------------- Next on the line we have Colin Rusch. Colin from Oppenheimer. -------------------------------------------------------------------------------- Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [9] -------------------------------------------------------------------------------- Guys, could you talk a little bit about the supply chain and where you're at with that in terms of having drawn down some inventories? Are folks able to keep up with the move towards a little bit leaner turn time? And is that impacting any of your component costs at all? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [10] -------------------------------------------------------------------------------- Great question. As I said on the prepared remarks, Kirk and his team have done a great job on reducing our incoming materials and improving our inventory turns with a target to get 5 or 6 turns by the end of the fiscal year. And I think if we see product revenue growth in Q3 and Q4 based on Q2 bookings, that's something we can think we can achieve. But definitely, the leaner you run, the lower the water level, the rocks pop up in the river. We have seen some challenges in some of our suppliers, and so we're actively working that. We're bringing in on a couple of new resources in the purchasing department that are a little more skilled. Because we've got to get our suppliers to be doing more smaller, more frequent shipments and be a little more nimble with us because we don't want to lose orders, but we don't want to increase our inventory levels. And so it's definitely not the sexiest business in the world, but it's really impactful. Going from 2 inventory turns to 6 turns is $10 million of cash freed up on our balance sheet. You can see what cash from ops this quarter was and what we've done for the first 6 months. So really important for us. I mean we're old fashioned. We think you take cash to the bank, not revenue. And so I think managing our supply chain and making it world-class is really key for the next couple of years for us. -------------------------------------------------------------------------------- Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [11] -------------------------------------------------------------------------------- Okay. And then you'd taken some measures around salary and staffing around COVID. Could you tell us where you're at in terms of bringing people back up to regular salary levels? How should we think about OpEx on an [employee] basis as... -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [12] -------------------------------------------------------------------------------- Yes. No, it's a great question, Colin. We had 6 months of salary cuts. The -- myself and the leadership team and most of the senior folks in the organization took a 25% pay cut for 6 months. The kind of mid- level management folks took a 15% pay cut. And those have all been put back in place at the end of September. And so that's going to impact our OpEx a little bit. The furloughs, we took people back in waves. And so a portion of those folks came back in a month, some in 2 months and some in 3 months. And we really just try to modulate that based on business recovery and to make sure we get people safe. So I think we're in good shape there. All folks that are going to come back have now come back. We did have some people that, based on current business levels, we didn't bring back. And so I think our low point during the furloughs is about 109 -- or about 90 people, or about 120 today. So I think we brought back about 30 of the 50 people, some number like that. But I think, in general, I think we've really had a good business continuity plan. We've had only 2 people get sick. And we've managed the facility, basically the same kind of performance levels before COVID, after COVID and really done a good job. So I think that for us, going forward, it's going to be just a matter of building back. And we've hired salespeople. We're hiring some supply chain people. We'll continue to add people as the business grows back. But I think Q3 and Q4, we expect higher revenues in Q1 and Q2 so that will be positive, much more fun hiring folks than it is furloughing people. -------------------------------------------------------------------------------- Operator [13] -------------------------------------------------------------------------------- Next on the line, we have Rob Brown with Lake Street Capital. -------------------------------------------------------------------------------- Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [14] -------------------------------------------------------------------------------- Just wanted to kind of get a little more clarity on some of the orders. You've had a nice run of orders over the last couple of months. How is the order pipeline at this point and the visibility there? And what sort of areas are you seeing strength in? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [15] -------------------------------------------------------------------------------- Yes, that's a great question. We've seen -- we saw Europe kind of come back first, I think, from COVID and then maybe paying for it a little bit right now. But we saw a really nice order flow in the quarter from Germany. We had a nice order out of the U.K. We saw orders from Slovenia, Poland, Romania, Italy. And so that was great. At the end of the quarter, we started seeing Australia wake up. We started to seeing Mexico coming back online. The U.S. is poised to have a very nice quarter this quarter. So I think the U.S. will be the biggest portion of our bookings for this current quarter. You mentioned that 4-megawatt project we had in Las Vegas. That is a resort development on the strip. That is our first major resort development in Las Vegas. So that's a nice marquee order for us that we'll be building from, that's an annual report cover type of project with our HRMs and 4 megawatts of CHP system. And so I think we're really excited about the opportunity to build on the momentum that we've already had going before COVID. The direct sales force, we started in January. And unfortunately, they get their wings clipped pretty quickly. But they've got a lot of national account momentum going with folks that have 1 or 2 projects and have 100 different installations around the world. So we're really interested about and excited about expanding those relationships with the balance sheet that we have now to be refinanced at Goldman. And the product's running really well. We're getting the parts issue that we have with the vendor behind us, at least in the field. And so we're excited about the back half of this year and then getting into the next fiscal year, hopefully, post COVID. -------------------------------------------------------------------------------- Robert Duncan Brown, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [16] -------------------------------------------------------------------------------- In the rental market, are you -- I think you had a couple of units come back on the oil and gas side. Are you seeing rental strength outside of oil and gas? Or where are you really seeing the rental activity happening at this point? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [17] -------------------------------------------------------------------------------- Yes. We started with oil and gas. That was kind of our launch customer with Shell in the Permian. We've gone out to other oil and gas customers now. And then in the last few months, we've done some renewable projects, some grow house projects. We've really kind of expanded into more CHP. And so we're pretty flexible. We've got some interesting projects going right now that are non-oil and gas. I'd say probably 65% of our pipeline of pending rentals is oil and gas, 35% is renewable in CHP. But I think that's going to be closer to 50-50 over time. I guess one thing I'd add, Rob, is oil prices are below $50 a barrel. We see more rental opportunity in oil and gas above $50. We see more purchase opportunity or capital spend pick up. So I do think that having a rental business in the oil and gas market kind of gives us a natural hedge against a slowdown in product shipments in oil and gas. And so oil and gas customers still have to get product out of the ground. If they can't spend capital dollars, then they'll rent using operational dollars. And so having a rental fleet gives us kind of both sides of that hedge, which I think is important for us going forward. -------------------------------------------------------------------------------- Operator [18] -------------------------------------------------------------------------------- Our next question comes from Sameer Joshi with H.C. Wainwright. -------------------------------------------------------------------------------- Sameer S. Joshi, H.C. Wainwright & Co, LLC, Research Division - Associate [19] -------------------------------------------------------------------------------- Just to follow up on Colin's question about the SG&A and how it plays into your adjusted EBITDA target. You also said that you will be increasing -- you have increased the head count. So OpEx is expected to go up over the next couple of quarters. The adjusted EBITDA has been at the $4.2 million catch-up level. So how do you see the [bid] from here to the $10 million given that your OpEx is going to be higher? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [20] -------------------------------------------------------------------------------- Yes, I'll let Eric take that. -------------------------------------------------------------------------------- Frederick S. Hencken, Capstone Turbine Corporation - CFO [21] -------------------------------------------------------------------------------- Yes. I think we previously guided on the operating expenses that was pre-COVID to a range of $5.2 million to $5.7 million. And given all the actions we've taken as a result of the business continuity plan, a lot of those furloughs did turn into permanent reductions. We should be at the low end of that OpEx range and potentially being even lower than that. And then if you look at -- yes. And if you look at the slide in the deck on our goals, we're guiding towards that 22% margin goal. So I think that gets you to your $10 million improvement year-over-year. -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [22] -------------------------------------------------------------------------------- Yes. And also, I think as Eric said in his prepared remarks, Q2 had some kind of onetime items. We had almost the entire IndyCar season hit 1 quarter just because of the way they compress the schedule. And so that's not going to return in Q3 and Q4. We also had a noncash charge for the Executive Bonus program. Part of our bonus program was tied around refinancing Goldman. So obviously, that hit in 1 quarter. And so I think we've got some legal expense going on with the bad vendor part that we got. And so we think Q3 and Q4 are going to be pretty good, OpEx-wise. Not as good as Q1, but should be at the low end of our range. As margins strengthen and product revenue returns, we're going to see higher revenue rates and higher gross margins. And so I think if you think about Q1 and Q2, it's more focused on -- Q1 was very big on cost reduction and OpEx and our business continuity plan. Q2 was a little bit more of a blend. Q3 should see higher revenue growth and better margins. And Q4 should be a continuation of that. Also, if you look at the $10 million year-over-year improvement, I think Q4 alone was about a $5 million negative EBITDA. So we've got a big opportunity to really hit it out of the park in Q4. If we could be close to EBITDA positive in Q4, we could pick up $5 million of year-over-year improvement in 1 quarter. -------------------------------------------------------------------------------- Sameer S. Joshi, H.C. Wainwright & Co, LLC, Research Division - Associate [23] -------------------------------------------------------------------------------- Understood. Yes, so mainly, it was onetime charges in Q2 that have made this look higher? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [24] -------------------------------------------------------------------------------- Correct. -------------------------------------------------------------------------------- Sameer S. Joshi, H.C. Wainwright & Co, LLC, Research Division - Associate [25] -------------------------------------------------------------------------------- So moving on to the Energy as a Service, and specifically, the rental. Just broadly speaking, if instead of $50 million, if you had, say, $200 million, would you have been able to address, like, secure enough customers? The question is, is there enough pull for the rental business? And then remind me the only thing that is stopping you? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [26] -------------------------------------------------------------------------------- I think that's a great question. I mean we started the rental business at 0. And so obviously, keeping momentum going in the rental business took us some time. As I said, we're just now getting our website landing pages updated, literature done. We just started branding the rental units, and we're making some changes to our standard product to make them more rental ready. And so getting into a new business always takes a little bit of ramp rate. When we started, we had 0 in pending opportunities. Now we're over $60 million. The word's getting out there that we have it. We've hired some direct salespeople that have rental experience and ongoing customer lists and contacts. So we're pretty confident that we can get growing and grow it fairly substantially. There are some rental opportunities that are north of 5 megawatts that could really move the needle quickly. We've already had conversations with Goldman about if we outstrip the 21-megawatt fleet and things continue to go well, can we continue to upsize the line and hopefully continue to reduce that rate. And so I think as we grow and as we build this, I'm confident we'll hit our targets. And I think it will be easier to get capital. Obviously, the more profitable we become and the more cash we generate, the cheaper the capital will become, the easier will be to get. -------------------------------------------------------------------------------- Sameer S. Joshi, H.C. Wainwright & Co, LLC, Research Division - Associate [27] -------------------------------------------------------------------------------- Understood. One last one. The 15% direct sales target, is that something that is for the entire year? Or is it something you expect to achieve on a run rate basis when you exit the quarter 4Q? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [28] -------------------------------------------------------------------------------- No. Those are all annual. So that's what we expect to do for the year. So we expect 15% of our total revenue to come from that direct sales organization. We've already had a couple of wins that have contributed very nicely. One of those wins is a customer who's got multiple sites, and we're looking at doing the second site, which is much larger site than the first site. And so I think that's kind of the business model we're looking for. Our distributors are involved in the direct sales, even though we're kind of taking the lead. They're helping us do job walks and figure out how to install the equipment. And obviously, they do the service component. So it's not meant to take business away from our distributors. It's meant to take our distributors' business which is at a regional level and turn it into a global business or a global relationship at a much larger scale. And so we're excited about it. Obviously, the pandemic impacted the ability for this whole new sales organization together and they couldn't get on a plane. And so that's -- looking forward to that changing. But I think there's lots of opportunities. And really, it's about timing of the product being in the right place, the market being in the right place, our balance sheet being in the right place and then having our distribution channel be mature enough to where we can spend more of our focus on leveraging the single wins and turning them into home runs. -------------------------------------------------------------------------------- Operator [29] -------------------------------------------------------------------------------- Our next question comes from Shawn Severson with Water Tower Research. -------------------------------------------------------------------------------- Shawn Severson, [30] -------------------------------------------------------------------------------- Darren, you're talking about 5-megawatt deployments in the Energy as a Service business. You just had a larger win in Vegas too. If I recall correctly, I think the microturbine in your systems were very competitive at 1 to 2 megawatts. And it just seems like you're getting some bigger orders and targeting bigger orders. So I'm just kind of wondering if that's changed or whether you run into the industrial turbine or other solutions as you get up into these larger megawatts because it seems like you're more competitive at those levels these days. Just trying to understand if something changed or what happened. -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [31] -------------------------------------------------------------------------------- Yes. I think it's a combination of just the more we do with larger projects, we've got more reference sites. And so obviously, Mohawk Carpet was a great one. We've done some sites in Canada and Australia. So when we start pointing to 5-, 6-, 7-, 8-megawatt sites, that helps us get other big customers to make that decision. I think we're competitive up to roughly 10 megawatts. You start getting over 10 megawatts, and we'll probably look at bringing in a different partner. And so we've got some conversations going in that area that where we would partner with another turbine supplier over 10 megawatts. And so I think there's opportunities for us to still play in those spaces. And again, when we get to more national accounts, we may have to meet loads from 30 kilowatts to 30 megawatts and have kind of one face to the customer to do that. And so that's also part of our strategic plan. But definitely, you're right, we are seeing more opportunities at bigger scale projects. And I would say, up to 10 megawatts, we're fairly competitive, especially if there's any variability in the customers' load, either thermally or electrically, or if they want to dispatch the units. Bigger machines don't like to cycle on and off. And if we've got multiple units, we can quickly turn on and off to match load, time of day use, demand, thermal demand, whatever it may be. -------------------------------------------------------------------------------- Shawn Severson, [32] -------------------------------------------------------------------------------- And what about feeding into your technology map? I mean, is there anything there that's looking at bigger loads, bigger machines, something that would -- [you're getting a lot of] units to fill up a 10-megawatt order. So just what's on the technology road map? -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [33] -------------------------------------------------------------------------------- Yes. We still have the 250 out there, and we've obviously got that in the lab operation. The reality is that doesn't really change. [The M4] in the box for megawatt versus 5 doesn't help us address 10-megawatt loads any different. And so I think we've kind of made the strategic decision to really work on the cost and the performance and the reliability of the current C200 and C1000 Signature Series product today. We still haven't seen the reliability catch up to the C65 with that product line, and that's really been my goal; that we're not going to head off on a new architecture until we get the latest architecture up to the same kind of high standard we set with the C65 product line. With that being said, again, I think we've got some strategic relationships we can do above 10 megawatts. And obviously, we wouldn't have to do very many of those projects to move the needle for us on the revenue side. But I think for us, Energy as a Service is really our biggest focus. Whether that's our FPP contracts, our new rental fleet, our distributor subscription model, we want that reoccurring, high-margin revenue and make sure we can cover our OpEx every day. And so I look at other people in our space and they're sexier from a revenue standpoint, but their OpEx is 3 or 4x what ours is. They've got huge cash burns, and I just don't know if those models are sustainable long term. And I think to build a business with a strong foundation that generates cash and grow it in a profitable, responsible way seems like the best thing to do for our shareholders. -------------------------------------------------------------------------------- Operator [34] -------------------------------------------------------------------------------- Okay. There appears to be no further questions at this time. -------------------------------------------------------------------------------- Darren R. Jamison, Capstone Turbine Corporation - President, CEO & Director [35] -------------------------------------------------------------------------------- Excellent. Well, thank you. I'll just say in closing, I'd like to remind investors that we have a very well-defined business plan. We have very clear goals and objectives that you can see in our presentation today. I believe that the unfortunate global pandemic has served to highlight the true value of our Energy as a Service business model as not many companies have reported the 2 strongest quarters in their history during the pandemic, which is something that we've done. And so I think it really highlights the value of that reoccurring high-margin revenue business that we're building. Lastly, I can't wait to get on the other side of the pandemic as generally, we believe that it's going to be a green economic recovery. Obviously, the recent U.S. election is going to lead to the U.S. rejoining the Paris climate accord and money being spent on green energy and a green economic recovery. We think our new hydrogen blend product is going to better position us than we've ever been in the history to capitalize on kind of the changing energy landscape. As I said before, 30% of the global population today has grown up with climate change. And so there's a reason why we're talking about hydrogen and green energy and decarbonizing the oil patch and ESG. That's not an accident. It's not a marketing ploy. It's the fact that 30% of the population has grown up with climate change and global warming, and they want to see some different direction and some different activities happen. And so as those folks that have grown up with climate change become higher ranking in their companies, bigger consumers, more active voters, you're going to see more and more move in this direction. And as I said before, we're starting to see customers, even though they're putting in natural gas-fired CHP, they're asking us about our hydrogen future and how we're going to be able to change with the changing energy landscape. So very excited about where the product is, very excited about where the company is, very excited about where the energy market is going, as I think, as I said, we're well positioned to capitalize on this changing energy landscape. So look forward to seeing everybody in Q3 and hopefully talking about even better results in the upcoming quarter. Thank you. -------------------------------------------------------------------------------- Operator [36] -------------------------------------------------------------------------------- Ladies and gentlemen, this does conclude today's teleconference. You may now disconnect your lines, and enjoy the rest of your day.