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Capstone Turbine Corporation (NASDAQ:CPST)

Q2 2009 Earnings Call

November 10, 2008 4:45 PM ET

Executives

Darren Jamison – President, Chief Executive Officer

Edward Reich – Executive Vice-President, Chief Financial Officer, Secretary

Mark Gilbreth – Executive Vice President, Chief Technology Officer

Jayme Brooks – Vice President, Financial Planning and Analysis

Analysts

Sanjay Shrestha – Lazard Capital Markets

Eric Stine – Northland Securities

Ron Oster – Broadpoint.AmTech

Operator

Good day, ladies and gentlemen and welcome to the Second Quarter 2009 Capstone Turbine Earnings Conference Call. (Operator Instructions) I would now like to turn the call over to your host for today’s call, Ms. Jayme Brooks, Vice President, Financial Planning and Analysis. Please proceed, ma'am.

Jayme Brooks

Thank you. Good afternoon and welcome to Capstone Turbine Corporation’s Conference Call for the Second Quarter of Fiscal 2009 ended September 30, 2008. I am Jayme Brooks, your contact for today’s conference call.

Today, we will be using a short PowerPoint presentation that we will reference during the call. The presentation is posted on our website at www.microturbine.com and can be found under investor relations in the presentation section.

Capstone filed its quarterly report on form 10Q with the Securities and Exchange Commission today, November 10, 2008. If you do not have access to this document and would like one, please contact Alice Barsoomian at (818) 407-3628 or you can view all of our public filings on the SEC website at www.sec.gov or our website at www.microturbine.com.

During the course of this conference call management may make projections or other forward-looking statements regarding future events or financial performance of the company within the meaning of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

These statements relate to, among other things, future financial performance and obtaining profitability, the ability to reduce cost and improve inventory turns and contribution margins, continued growth in current market conditions, the ability to obtain a line of credit, the launch of the C200 and C1000 products, compliance with certain government regulations and increased government awareness of our products, increased opportunity for our product in the Obama administration, opening new markets for our products and attracting large customers to our products, increased product parts commonality between the C30 and C65 products, new applications for our products including the hybrid bus, coal steam gas, and oil and gas markets, revenue growth and increased sales volume, our success in key markets, our ability to enter into new relationships with channel partners and distributors and other third parties, energy efficiency, reliability and low cost of ownership of our products, and expansion of production capacity.

These forward-looking statements are subject to numerous assumptions, risks and uncertainties including the following: our expectations about expansion into key markets may not be realized, certain strategic business initiatives and relationships may not be sustained or may not lead to increased sales, we may not be able to reduce cost or improve customer satisfaction. The growth in our backlog has significantly exceeded our internal forecast. In order to meet this increased demand, we may need to raise additional funds to meet our anticipated cash needs for working capital or capital expenditures during the next 12 months.

The current financial crisis and possible future recession could make it difficult or impossible for us to raise necessary funds and for our customers to buy our products, we may not be able to secure a line of credit, we may not be able to expand production capacity to meet demand for our products, we may not be able to obtain sufficient materials at reasonable prices, our release of our new products may be delayed or new products may not perform as we expect, we may be unable to increase our sales and sustain or increase our profitability in the future, we may not be able to obtain or maintain customer and distributor and other relationships that results in increase in volume and revenue, we may not be able to comply with all applicable government regulations, we may not be able to retain or develop distributors in our targeted markets in which case our sales would not increase as expected and if we do not effectively implement our sales, marketing, service and product enhancement plans, our sales will not grow and therefore may not generate the net revenue we anticipate.

These are among many factors which may cause Capstone’s actual results to be materially different from future results predicted or implied in such statements. We refer you to the company’s Form 10-K, Form 10-Q and other recent filings with the Securities and Exchange Commission for a description of these and other risk factors.

Because of the risks and uncertainties, Capstone cautions you not to place undue reliance on these statements which speak only as of today. We undertake no obligation and specifically disclaim any obligation to release any revision to any forward-looking statements to reflect events or circumstances after the date of this conference call or to reflect the occurrence of unanticipated events.

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

Darren Jamison

Thank you, Jayme. Good afternoon and welcome everyone to Capstone’s second quarter earnings call. With me today are Ed Reich, our Executive Vice President and Chief Financial Officer and Mark Gilbreth, our Executive Vice President and Chief Technology Officer.

Today I’ll start the call with a review of the significant events of second quarter and then Ed will walk us through the financial results. Ed will then turn the call back over to me and I will discuss our progress towards our strategic objectives and review developments in some of our key market segments and finally talk about what we hope to achieve in the coming quarters before I open the call up to your questions.

During the second quarter of fiscal 2009, we continued to see the impact of our marketing and branding strategies and the success of our new products. We continue to strengthen our relationships with our business partners and we've been focusing on our key suppliers as we significantly increased our C30 and C65 production rates in the second quarter while simultaneously launching the new C200 product line.

Second quarter revenue increased 74% from the first quarter to $13.1 million and new orders again outpaced shipments as we received $17.6 million in new orders and shipped 9.9 million in new products, resulting in product backlog increasing to a company record $50.4 million. As you can see from the first slide, our backlog has increased from $13.1 million at the end of Q3 to $27.9 million in Q4 to over $42 million in Q1, again to today's record of $50.4 million at the end of Q2. This backlog is highlighted by $27.6 million of our new C200 and C1000 products in that backlog.

As discussed in our last earnings call, the metric we use to measure the development in the health of the business is the sum of the quarterly revenue and backlog as seen on Slide 1. Because Capstone is developing business, our revenues can and will be lumpy. If you measure the business on quarterly revenue backlog combined, you will see a much clearer picture of where the business is headed.

This metric for the last five quarters has grown from $11 million in the first quarter of fiscal 2008 to over $63 million today. I believe that this continued growth with combined revenue and backlog illustrates Capstone has finally reached the critical inflection point with our disruptive, ultra low emission technology and we are making significant inroads in multiple markets and multiple applications around the world.

Management continues to be impressed with the early market acceptance of the C200 and C1000 family of products. As we now have 49 C200s and 29 C1000 family units in backlog totaling 187 equivalent C200 engines.

Capstone has achieved this growth despite a challenging world economy. However I believe that Capstone is less susceptible to market conditions than some of our competition for four important reasons. First as illustrated on Slide Number 2, Capstone sales in the diversified portfolio of end markets from oil and gas, telecom, transit bus, land fills, hotels, hospitals and municipalities just to name a few. Also our markets are global, so we are somewhat insulated from our specific country's economic issues. Today our largest markets are Europe, Russia, followed by the North America or the United States. However, Asia, South America and Australia are starting to pick up positive momentum. The third reason is because our average selling price is about $1,000 per kilowatt and our projects tend to be smaller in nature and less dependent on outside or third party financing. Therefore, if our project has an attractive economic benefit, most companies can afford to fund our products with their working capitals without relying on outside funding. Lastly because we have less than 1% of the annual $4 billion distributed generation market. Therefore, it's reasonable to assume that we can continue to increase our market share even in declining markets.

We continue to seek out and have moved from demonstration projects or test projects into full product implementation and product adoption. Recently, I've been very encouraged by the recent roll-out of a major European grocery store chain that quickly moved from a single unit trial to a 36-unit order in the second quarter and is currently evaluating several stores that would benefit from our unique high efficiency product.

We continue to see interest from transit customers around the globe who are watching what marquee transit properties like New York City are doing with our products and they are requesting their own demo bus for their own fleet evaluations.

I am pleased to see significant international oil and gas customers move from testing single C30 on coal steam gas in Australia earlier this year to ordering over 100 units for insulation in a single gas field in the first quarter. In the second quarter, they ordered 3 C1000s, all this in one single customer in Australia. Energy companies in Australia are looking to drill tens of thousands of coal steam gas wells in the coming years and Capstone is aggressively targeting this market.

However, by far the highlight of the second quarter for me was the shipment of the first commercial C200 unit back on August 28 to our Italian distributor, IVT. This was a tremendous achievement by the Capstone C200 team as well as United Technology's team that provided both financial assistance as well as insightful engineering support.

In September, we initiated the September production line at a rate of 1 unit per week. During the second quarter, Capstone increased manufacturing production rates for both the C30 and the C65 and the plants delivered over 13 million in total revenue as well as simultaneously launching the C200 product line.

In short, the second quarter I believe Capstone took another important step toward achieving our strategic goal of near-term profitability and building long-term shareholder value.

At this point, I'd like to turn the call over to Ed to review our specific second quarter result, Ed?

Edward Reich

Thanks, Darren. Good afternoon everyone. I’d like to provide you with our results for the second quarter ended September 30, 2008.

As Darren mentioned, backlog at the end of the quarter was $50.4 million, an increase of approximately 18% from the prior quarter and over 385% from the prior year comparable quarter. Revenue for the quarter ended September 30, 2008 was $13.1 million; an increase of 82% from the $7.2 million reported from the same period last year and increased 74% from last quarter's revenue of $7.5 million. We shipped 172 units in the second quarter compared to 96 for the same period last year and 89 last quarter.

Our gross loss for the quarter was $300,000 or 2% of revenue compared to $800,000 or 10% of revenue from the same period last year and $1.1 million or 15% of revenue last quarter. The decrease in gross loss and the improvement of 8 points in the gross loss percentage over the past year reflects increased sales of C30, C60 series and C200 series units along with higher absorption of overhead costs in the ending inventory offset by increased manufacturing and warranty expense.

Research and development costs were $2 million for the second quarter, a decrease of $400,000 or approximately 17% from the same period last year and flat when compared to last quarter. R&D expenses decreased as a result of additional funding from UTC Power Corporation from the cost-sharing program that was offset by increased spending for supplies, consulting, shared cost and labor expenses. We expect R&D to be lower in fiscal 2009 than it was in fiscal 2008. This decrease is expected to occur as a result of lower overall spending due to outside funding from UTC Power Corporation for the C200 commercialization.

SG&A expenses were $7.7 million for the quarter, an increase of $800,000 or 11% from the prior quarter and an increase of $1.8 million or 31% from the same period last year. The net increase in SG&A expenses year-over-year is comprised of an increase in non-cash stock compensation as well as labor, travel, consulting and professional expenses. The increase in labor and travel costs reflected the continued effort in developing worldwide distribution and launching the C200 and C1000 products.

Our second quarter net loss was $9.9 million or $0.06 per share an increase of $1.4 million from the $8.5 million loss or $0.06 per share reported for the same period last year.

Cash balances increased by $13.3 million during the second quarter due to our registered direct offering of common stock that closed on September 23, 2008 resulting in net proceeds of $29.5 million. As of September 30, 2008, cash and cash equivalents were $46 million. We are currently in negotiation with a potential lender to obtain a line of credit during the third quarter of fiscal 2009. We currently anticipate the borrowings under the line of credit would be approximately $10 million and will be very beneficial in managing our working capital going forward.

Now, let me turn the call back over to Darren.

Darren Jamison

Thank you, Ed. Capstone has moved from a period of product acceptance to a focus on increasing production rates and manufacturing yields. As shown on Slide Number 3, management's focus for the coming quarters is to continue to increase manufacturing rates of the 30, the 65, C200 and then launch the new C1000 in January. This means we will continue to add to our second shift, work to reduce manufacturing cost per unit and diversify and strengthen our supplier base. I am very confident our manufacturing capabilities and that of our production team as they work their plan to meet these challenges in the coming quarters.

In addition, we've been working to improve our inventory turns to lower our working capital requirements. Another key initiative to increase our contribution margin on all of our products as we begin production of the new C200 today, the initial units are not meeting our target contribution margin rates. However, we have a detailed cost reduction plan to meet our target contribution margins of the C200 and C1000 product and we have begun implementing and expect to see improved margins over the coming quarters.

Today the C65 is our most profitable product from a contribution margin perspective. However, we can and are going to enhance that profitability of this product. Mark and his team has done a tremendous job in developing a strategy to increase the product parts commonality between the C30 and the C65 products. We have designs for a new common package that will house either the 30 or the 65 and greatly simplify the design and reduce the packaging costs of both units as shown on slide number four. We have also identified a design to use one recuperator for both the C30 and C65 products, thus allowing us to lower our cost of the recuperator and drive toward higher inventory turns. In addition, we have identified a path to move to a common C30 and C65’s architecture electronics package. This will again lower our per unit costs by better leveraging our supply chain and increased inventory turns.

As our engineering group rolls off the C200 and C1000 development program, they will roll directly into these key cost reduction programs. I look forward to seeing the success of these cost reduction programs leading to improved contribution margin rates per unit over the next several quarters. Management has implemented a detailed plan and associated organizational changes in support of these key business initiatives.

Now I would like to take a minute to update you on the progress in some of our key markets and discuss what you should expect to see from Capstone in the coming quarters.

The European and Russian markets continue to show growth from last year and have been enthusiastic early adopters of the new C200 and C1000 products. In addition, incentives in markets like Germany, France, Spain, and Italy continue to drive Capstone products into biogas, landfill gas, wastewater treatment plants, and the like. Therefore you should expect to see the European and Russian markets continue to grow as the year goes on.

The market in New York continues to be a prime opportunity for Capstone’s products because of its need for clean and reliable power solutions and the fact that buildings make up 79% of the city’s greenhouse gas emissions. New York is a model city for Capstone as we have 30s going into MTA buses, 65s deployed in commercial buildings and hotels, and the C200 and C1000 going into multi-tenant high-rise office buildings – such marquee buildings like the MetLife Building, Helmsley, and Daily News.

California remains a good market opportunity which was limited, if you remember, absent CARB 2007 certified product. I am proud to say today our California distributor, Collicutt Energy, is gaining strong momentum and was one of our top three customers in the second quarter. I expect to see continued steady growth in both the East and West coast markets as our key partners increase marketing efforts to achieve improved results.

In addition, with last week’s election of Barack Obama, the opportunity for Capstone’s unique ultra-clean and high-efficiency products should only increase in the U.S. and be similar to what we enjoy in Europe, which today is our largest single market. The Obama platform outlines the following plan, which should be beneficial to the Capstone product: His plan would reduce emissions 80% from 1990 levels by 2050; spend $15 billion a year toward clean energy; increase the renewable energy portfolio standards by 10% by 2012, and 25% by 2025. And again, increase overall energy efficiency standards in buildings. I applaud President-elect Obama for his vision on clean energy and dedication to energy efficiency, which is truly the lowest-cost solution in solving this country’s energy independence issues.

That being said, we are still decades away from freeing our nation from dependence on foreign oil and traditional fossil fuels. Therefore, Capstone will continue to focus on the oil and gas markets as we continue to gain market penetration as petroleum exploration, production, and transportation companies are more focused on reliability, maintainability, and total cost of ownership than they are on product first costs.

We continue to work hard in Asia, with the focus on the markets in China, Korea, Japan, and India. We continue to see slow but deliberate growth in these markets as Capstone brings on additional distributors like we recently announced in Vietnam. In the second quarter we received several large orders from Samsung in South Korea as they continue to make good inroads into the high-rise condominium market.

In addition we continue to work with UTC Power as they expand their PureComfort reach into the markets in China and India. We have seen a substantial increase in quotation activity in China since the recent Olympic games.

I believe this quarter was significant as Capstone managed to increase its manufacturing capability and successfully launch the new C200 product. In the coming quarters we will continue to focus on proving our manufacturing ramps, improving our production yields, so we can start to close the gap between product bookings and product shipments.

We will then turn our engineering focus toward improving our contribution margin rates with a development program that will better integrate our C30 and C65 product and provide greater parts commonality and system architecture between the two proven products. The outcome of this development effort will be a lower-cost design for both the C30 and C65 that will further leverage our purchasing power and lower our stocking levels and improve inventory terms.

I am proud of my management team and the entire Capstone organization, including our valued employees, valued vendors, key distributors, all of which are continuing to deliver positive momentum with increased revenues, record backlog, a narrowing growth loss, and the successful launch of the new C200 product. I continue to believe that despite the global economic conditions today Capstone will deliver the best year in the company’s 20-year history.

At this point, I would like to open the calls to your questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Sanjay Shrestha from Lazard. Please proceed.

Sanjay Shrestha -- Lazard Capital Markets

Thank you. Congratulations on a good quarter, guys. A couple of quick questions. First off, you know, in this backlog number, again a point of clarification that does not include that service contract, right?

Edward Reich

That is correct.

Sanjay Shrestha -- Lazard Capital Markets

Okay –

Darren Jamison

Accessories, parts or service or training revenue, that is correct.

Sanjay Shrestha -- Lazard Capital Markets

Okay, and that is usually about 30% of the backlog.

Darren Jamison

25% to 30%, correct.

Edward Reich

As the revenue is going up we are starting to see it become closer to 25% of the total.

Sanjay Shrestha -- Lazard Capital Markets

Okay, great. And in terms of this backlog number, right, how much of that is going to get recognized over the next 12 months?

Edward Reich

The current portion of the backlog, which is the majority of it, we expect to turn into revenue over the next 12 months.

Sanjay Shrestha -- Lazard Capital Markets

Perfect. Now have you guys gone and looked at this existing backlog and sort of evaluated the mix of customer, and do you really think that given what is going on in the credit market or the macroeconomic environment, it could actually have a potentially negative impact or any cancellation or anything like that? Or in other words, do you guys see any potential slowdown to this fantastic momentum from a business growth standpoint that you are seeing given the current environment?

Darren Jamison

Sanjay, that has obviously been of our bigger concerns. First of all, let me clarify, we have not seen a project cancellation or slowdown yet. We have reached out to our largest customers and distributor partners, asking what they are seeing in the marketplace, and again they are not seeing any major slowdowns or issues, especially on landfills and digesters, a lot of the municipal projects been funded quite a while ago that are moving forward. But as I said in the call, because our average selling price is low enough, a lot of customers are paying for this product out of their own internal working capital. And if the payback periods are short enough, they are better off moving forward.

So again, also because we are very small in our market share, we have got a great opportunity to continue to grow the markets in these multiple markets we serve and gain market share even in a declining market. Se we have not seen in yet, knock on wood we won’t, but we are still very aggressive moving forward, going to trade shows, marketing the product, and full steam ahead.

Sanjay Shrestha -- Lazard Capital Markets

Great, one last question then, guys. So, taking into consideration your focus on increasing the contribution margin of C200 and C1000 and focus on inventory management, what was your cash burn in the quarter, and two, what level of revenue do we need to get to see the sort of operating break-even and a cash flow break-even, given some of the recent initiatives that you are undertaking?

Edward Reich

Sure. It is Ed, Sanjay. We burned a little over $17 million in cash during the quarter, and that was to ramp up the inventories to get them to where we need to be. We do not expect the inventories to go any higher than they are now. We should just barely improve the turns at the same level that they are at, which is about $24-25 million.

With respect to cash flow break-even, again because of what we have seen in DMCs and other costs, we feel that we are still pretty close. We have revised our estimate for cash flow break-even from a 250 unit quarter to a 280 unit quarter. Again, based on mixed and net margins.

Darren Jamison

The good news, Sanjay, is with this kind of backlog it really allows us to stage our inventory. We have not been able to do just-in-time and con bonding and some of the things we would like to do in a more mature manufacturing business. With $50 million in backlog we are able to do that. We are moving toward more manufacturing slots, increasing the efficiency of the plant, and moving to higher inventory turns. The difference between where we are today just under two turns versus, four to six turns from a working capital perspective is tremendous. So, margins and working capital inventory turns are the major focus of our organization right now.

So, as I mentioned, we have made a couple of organizational changes internally to better focus the organization, take down some mini barriers that we had and extremely focused on that and delivering higher margin rates going forward.

Sanjay Shrestha -- Lazard Capital Markets

Okay, that is great. Thanks a lot, guys.

Darren Jamison

Thanks, Sanjay.

Operator

And your next question comes from the line of Eric Stine of Northland Securities. Please proceed.

Eric Stine – Northland Securities

Hey guys, nice quarter.

Darren Jamison

Hey, Eric, how are you doing?

Eric Stine – Northland Securities

Not too bad. First thing, I just wanted to talk about the C200. You guys still feel that 48 in the calendar year is still your plan?

Darren Jamison

48 is definitely the plan. I would say we are still at a one per week rate so we need to see what we can do between now and the end of the year to get that rate up. If we do miss the 48 then I think we will catch that up in the first part of next year.

So, we have got the material in, you can see the increase in inventory quarter over quarter. We are driving the production line as fast as we can. Our operating expenses are up again this quarter as we brought in a bunch of new people, those people are being trained, and again, we are in process of increasing that rate from one a week to hopefully three or four a week or even, you know, five a week is where we need to get to in the short term. So, I do not want to comment specifically on the 48 but that is still our goal and we are working hard to meet it.

Eric Stine – Northland Securities

Okay, fair enough. I guess this is more focused on UTC last quarter. You guys said that six of the C200s

in backlog were UTC. Can you comment on that, I guess especially in light of the fact that they have been actively advertising their PureComfort product with the C200.

Darren Jamison

They have been doing a tremendous job advertising the C200. They have got a great data center demo advertisement they are doing right now that is very compelling. During the quarter we did not get anymore C200 orders. They did quite a bit of C65 during the quarter, and the major grocery store chain in Europe I referenced is a UTC customer and they are doing a great job with that client in getting past the initial test of the C65 on biodiesel to 36 biodiesel and natural gas units and then working on multi-store rollout plans. So very excited, the relationship with them is very good. They are running the unit we shipped them as part of their demo program and we expect to see more good things out of UTC going forward.

Eric Stine – Northland Securities

Okay. And this is more on the cost side. Can you just remind me about your hedging policy? I believe you do not hedge, and so a question on that, but also when should we start thinking about you guys benefiting from that? I know you have some long lead times, but when should we think that you will benefit from that?

Edward Reich

Yeah, Eric, you are right, we do not hedge. We do all of our transactions in U.S. dollars.

Darren Jamison

I think one of the big issues we have had is some material costs have gone up in the world market; those are not coming back down again, so I think as we are seeing some of those metals and other things come down so we can leverage that pretty quickly, another way to get some of our costs down. But again, with the designs Mark and his team have come up with, a common enclosure, which obviously helps from planning perspective, helps from a cost perspective, helps from an inventory turns perspective, going to common recuperator is huge. The recuperator is our single biggest cost item in the package, whether it is a 30, a 60, or a 200, as well as what he is doing on the architecture side.

So, the common architecture he is talking about from the power electronics side will take us from three controllers to one, three boards to one. I mean, it is a very significant cost savings for us. So, again, now that we have the backlog, we have really got to get the momentum going, we want to keep that going but really turn our internal focus on cost reduction, manufacturability of the product, manufacturing yields and output, as well as just total inventory turns.

Eric Stine – Northland Securities

Okay, and then just one last question, just on the hybrid bus segment, then I will jump back into line. Can you give an update at all on DesignLine and maybe where they are in ramping their manufacturing? I saw that they did put in an order for battery systems for the ECOSaver IV. Any idea where they are at?

Darren Jamison

Yeah, the word we got is they have opened their plant. They have some initial shipments going out right now. We expect them to pretty heavily increase those rates and start burning down the backlogs that we have with them. And like you said, you are seeing them order other components from other manufacturers. I know they want to get to a 700-units a year production rate in that plant in North Carolina. How long it takes them to go from zero to 700 is really the question. My guess is obviously probably three or four quarters before they get there. We are expecting to see some nice run rates.

We talked to their sales folks and continue to hear good things. Lots of folks requesting demos. Obviously you know New York, Chicago, New Jersey. We are also seeing Syracuse, several people in Florida, Antelope Valley, LAX Airport. So, the amount of people interested in the product continues to grow. I think the more product they can get out in the field the more momentum they are going to get. And our bus OEM over in Europe is also doing very well and continues to make inroads. So, we are very excited about that product line obviously, and where it could go.

Eric Stine – Northland Securities

Okay, thanks a lot, guys. I will jump back into line.

Darren Jamison

Thanks, Eric.

Operator

And your next question comes from the line of Ron Oster with Broadpoint.AmTech. Please proceed.

Ron Oster – Broadpoint.AmTech

Hey, good afternoon, guys.

Darren Jamison

Hi, Ron, how are you doing?

Ron Oster – Broadpoint.AmTech

Good. I just wanted to get a quick question. Common question I get is your exposure to natural gas prices. Those have obviously come down. I was just wondering if you could provide some color with regards to; first, how much of your business is exposed to natural gas prices and how the payback period might have changed, if it has changed, as gas prices have come down from $10 levels to $6-7 range.

Darren Jamison

Ron, great question. I think a lot of people tend to peg our stock to either natural gas prices or oil prices, which is not 100% the best or most accurate rate of forecast for our business. Less than half of our product today is run on natural gas. It is probably closer to 40%. About 60% of our product is other types of gaseous fuels, so landfill gas, digester gas, coaltine gas which I have mentioned, gas from drilling operations, obviously any kind of methane from cow manure, pig manure, agricultural waste. So, those types of projects are, we call it resource recovery, about 60% of our projects today and obviously those are not driven by natural gas or oil process. If you look at liquid fuels, we are doing a lot with diesel and biodeisel, especially in telecom. And as I mentioned, that grocery store chain over in Europe is using biodiesel as well as natural gas.

The real key for us is the difference between the price of natural gas and the price of the local utility. So, if the local utility is tied to natural gas prices, that can impact us. But it is really that spark spread between what we can buy the gas for and what we can make electricity for. So, gas prices going down are great short-term because that helps the economics. If they go up, as long as utilities can adjust to those higher prices, then we are okay. Really what drives us crazy is when gas prices fluctuate and are unstable because that makes it very difficult for our customers to look at the economics and figure out what the paybacks are.

Ron Oster – Broadpoint.AmTech

Okay, and then last quarter I think you said an order from a customer slipped at the very last second because of some credit issues. Can you give an update on the status of that order and just any other – have there been any other delays with potential orders because of similar type issues?

Darren Jamison

No other delays or similar issues. That customer was out of Africa. Because he could not get the LT in place we moved him to the back of the line. We actually took that out of backlog for the quarter until he has the LT opened up, but he is still actively working to get that done. So, unfortunately we were loyal to him last quarter and hung on till the 11th hour; this quarter with the kind of backlog we have today, if you do not have your LT in place by the 15th of the month, we are going to give your slot to somebody else. So, we want to be loyal to our partners but we do not want to have product sitting on the back dock when we have so many people wanting it. So, again, that is the only issue we have and we do not see that really being related to the issues going on today.

Ron Oster – Broadpoint.AmTech

Okay. And Ed, you mentioned a change from 280 from 250 to get the cash flow break-even. What drove that change? What was the big change that resulted in that?

Edward Reich

The direct materials cost that we are experiencing right now. Higher than anticipated costs on the early C200 and C1000 production. That again, is a range that lands on 280 so it could vary to either side of it, again, depending on product mix. But you know we do expect that number to come down as we work to decrease materials costs and other labor and overhead costs.

Ron Oster – Broadpoint.AmTech

And any update on the timing of when you might reach that cash flow break-even level?

Edward Reich

We have not talked about timing on it, so I think what we do is, we will just watch the progression rate. We did 172 units this quarter and there was only four C200s in there, so I would watch it to track it from there. Track our progress, you should see us working to increase revenues over the next two periods as we get the backlog flow through.

Darren Jamison

Yeah, intuitively as we increase our revenue rates, our cost per unit goes down. As our engineers roll off the C200 programs as we finalize that program and onto the cost side, you will see our gross margins get better, our contribution margins get better. So, it is really a combination of contribution margins getting better and revenue rates getting higher, and I think you can plot both those curves and kind of get a feeling for where it is.

Ron Oster – Broadpoint.AmTech

Great, thank you and Ed, I missed what you said about SG&A rates, if you could just comment on that and I’ll hang up. Thanks.

Edward Reich

Okay SG&A was increased quarter over quarter. A couple of one -time items in there that we don’t count in our going-forward rate. You should still expect to see SG&A and R&D combined running at about $9 million to $9.5 million per quarter. Ron?

Darren Jamison

I think he dropped off.

Edward Reich

Alright, went back, okay.

Operator

At this time, there are no questions in queue. I will now turn the call over to Mr. Darren Jamison, President and CEO for closing remarks.

Darren Jamison

Well, great, I want to thank everyone for attending the call today and continuing to follow our story. I think it’s just been a tremendous quarter for us. Obviously, we have a lot of work to do still, but as somebody once said, you can’t make policy if you don’t get elected, so having $50 million in back log or almost 60 megawatts in back log gives us an opportunity to focus internally on our production rates, on our margins, on our efficiencies and really increase our margins to get profitable.

So, we’re happy with the sales of the C-200 and C-1000 product. Again, it gives us an opportunity to put production spots in place and to go in an orderly fashion of increasing our manufacturing rates, so we’ll continue to add to the second shift, continue to focus on costs, continue to work down our working capital requirements and manage our inventory levels.

Ed mentioned the bank line. I think it’s very important that we do get a bank facility in plac. Obviously in this challenging market, it’s taken us longer than we anticipated to get that in place, but we’re very hopeful by the end of this quarter we’ll get that done.

That bank line will tied to our inventory levels and our receivables, so as the business grows, that bank line should grow with us. And hopefully, we’ve got enough cash now on the balance with that bank line combination as some belts and suspenders to get us profitable and have a balance sheet left to look for strategic opportunities thereafter.

So, again, thanks everybody for listening to the call and we’ll look forward to talking to you next quarter.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a wonderful day.

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Source: Capstone Turbine Corporation Q2 2009 Earnings Call Transcript
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