Capstone Turbine Corporation F2Q10 (Qtr End 09/30/09) Earnings Call Transcript

| About: Capstone Turbine (CPST)

Capstone Turbine Corporation (NASDAQ:CPST)

F2Q10 (Qtr End 09/30/09) Earnings Call

November 9, 2009 4:45 pm ET


Jayme Brooks - VP of Finance and CAO

Darren Jamison - President and CEO

Ed Reich - EVP and CFO

Mark Gilbreth - EVP of Operations and CTO


Eric Stine - Northland Securities

Sanjay Shrestha - Lazard Capital

Michael Lew - ThinkEquity

Megan Moreland - Ardour Capital


Good day, ladies and gentlemen and welcome to the second quarter 2010 Capstone Turbine Corporation earnings conference call. My name is Stacey and I'll be your moderator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today, Ms. Jayme Brooks, Vice President of Finance and Chief Accounting Officer.

Jayme Brooks

Thank you. Good afternoon and welcome to Capstone Turbine Corporation conference call for the second quarter ended September 30, 2009. I am Jayme Brooks, your contact for today's conference call.

Capstone filed its Quarterly Report on Form 10-Q with the Securities and Exchange Commission today, November 9, 2009. If you do not have access to this document and would like one, please contact Investor Relations via telephone at 818-407-3628 or email or you can view all of our public filings on the SEC website at or on our website at

During the course of this conference call, management may make projections or other forward-looking statements regarding the future events or financial performance of the company within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements relate to, among other things, future financial performance in obtaining profitability, the ability to reduce costs and improve inventory turns and contribution margins.

Reduce working capital requirements, continued growth in current market conditions, the availability of a line of credit, the success of the C200 and C1000 products, compliance with certain government regulations and increased government awareness of our products, growing market share and market adoption of our products, new applications for our products, growth in the automotive, marine, solar and power rental markets, the success of our new manufacturing leadership team, revenue growth and increased sales volume, our success in key markets, our ability to enter into new relationships with channel partners and distributors in other third parties, the energy-efficiency, reliability, and low cost of ownership of our products, and the expansion of production capacity and manufacturing efficiencies.

These forward-looking statements are subject to numerous assumptions, risks and uncertainties, included the following. Our expectations about expansion into key markets may not be realized. Certain strategic business initiatives and relationship may not be sustained and may not lead to increased sales. We may not be able to reduce our manufacturing cost. The growth of 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 and capital expenditures during the next 12 months. The current recession can 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 utilize our line of credit, for example as a result affiliate to meet a financial covenant. 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 new products maybe delayed or new products may not perform as we expect.

We may be unable to increase our sales and sustain our increase or profitability in the future. We may not be able to obtain or maintain customer distributor and other relationships that are expected to result in an increase in volume in revenue. We may not be able to comply with all applicable government relations. We may not be able to retain or develop distributors in our targeted markets in which case our sales will not increase as expected.

If we do not effectively implement our sales, marketing service and product enhancement plan, our sales will not grow and therefore, we may not generate the net revenue we anticipate. These are among many factors, which may cause Capstone's actual results to material differ from the future results predicted or implied in such statement. We'll refer you to the company's Form 10-K, Form 10-Q and other recent filings with the Securities and Exchange Commission for description of these and other risk factors.

Because of the risks and uncertainties, Capstone cautioned you not to place undue reliance on these statements, which speak only as of today. We undertake no obligation and significantly disclaim any obligations to release 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 the call over to Darren Jamison, our President and CEO.

Darren Jamison

Excellent. Thank you, Jayme. Good afternoon, and welcome everyone to Capstone's second quarter fiscal 2010. With me today is are Ed Reich, our Executive Vice President and Chief Financial Officer; and Mark Gilbreth, our Executive Vice President of Operations and Chief Technology Officer.

Today I'll start the call with a review of our second quarter fiscal 2010 significant events, provide an update on some of our key markets and then turn over the call to Ed to review the specific financial results. Ed will then turn the call back over to me and I will discuss our progress toward our strategic objectives of positive gross margin and positive cash flow.

As I look at the results for Q2, I am very pleased with our ability to ramp production to never before achieved levels. The revenue in the second quarter of $15.5 million is the largest in the company's 21-year history.

In addition, the $15.5 million in revenue indicates continued significant growth while compared to Q2 revenue of $13.7 million and Q2 2008 revenue of $7.5 million.

As shown on slide number one, Capstone continued to demonstrate strong revenue growth over the prior year period for the last six consecutive quarters. I believe this is proof of our growing market share and market adoption of our new ultra-clean and energy-efficient products. These revenue results were impressive against the backlog of a continuing global recession and very tight credit markets.

Also, impressive is slide number two, which shows that despite the poor economic climate, Capstone's new order bookings were strong and total product backlog remained essentially flat from June to September despite the record $15.5 million in revenue.

Capstone product backlog equates to essentially year's worth of product shipments and does not include FPP or service billing or service contract backlog which extends out over the next 11 years. That backlog amounts to another $15 million in additional backlog to the product backlog being in the second quarter.

This large product backlog is critical as we continue to ramp our C200 production as shown in slide three from approximately three per week in Q2 to over four per week in Q3. The C200 turbine build may appear flat in Q2, but it's a little deceiving because of the timing of a specific 1.6 megawatt order which slipped out at the end of the quarter in to the beginning of next quarter as well as the five C200 turbines that were needed for Capstone's R&D group for the C1000 UL 2200 and UL 1741 certification testing. But despite only shipping 38 C200s in the quarter, Capstone still increased revenue this quarter over last quarter with increased shipment of C30 and C65 product.

During the quarter, Capstone achieved several key milestones that I believe are critical to the continued success and continued growth of our company. First, we concluded testing and successfully received certifications for UL 2200, UL 1741 which enables Capstone to begin selling and shipping our C200 product in North America.

Second, California Senate Bill, SB 412, was passed into law allowing Capstone products to be eligible for a substantial cash rebate of an estimated 36% under the California Self-Generation Incentive Program or SGIP program starting early next year.

Next I'm pleased to announce that Capstone shipped unit number 5,000 during the quarter. This unit was fittingly one of our new C65 Hybrid UPS units. That was one of 12 units shipped to Syracuse University new Green Data Center as part of IBM's new Smarter Planet Initiative.

As shown in slide four, the new [2.4 million], 6,000 square-foot state-of-the-art data center incorporates both advanced infrastructure and smarter computing technologies. A critical factor driving energy savings is the onside electrical combined heat and power system using Capstone's 12 C65 Hybrid UPS microturbines that allows Syracuse University freedom from utility power.

As I said, the project is part of IBM's Smarter Planet Initiative as energy consumption is critical issue for today's data centers. Energy use is the largest single cost in operating a data center with an estimated two billion per year wasted due to inefficiencies.

Another critical milestone achieved during the second quarter was a successful third-party demonstration testing of Capstone's C30 liquid fuel or diesel turbine. The turbine was tested for compliance for the pending Environmental Protection Agency 2010 and California Air Resources Board emission standard.

Capstone has invested significant research and development dollars to dramatically improve the emission profile and overall reliability and performance of the C30 liquid fuel product. Tests conducted at the third-party lab demonstrated that the C30 diesel fuel turbine emissions were significantly below the EPA 2010 and CARB 2010 requirements for heavy-duty diesel engine and Urban bus application.

These tests were conducted over a power range of eight kilowatts or 30 kilowatts. Demonstrated range were emission compliance. No exhaust after treatment was required which obviously minimizes the increased product cost and maintenance costs while maintaining high overall system reliability that Capstone enjoyed today.

Slide five shows the third-party measured emission results for the C30 microturbine as compared to the pending CARB, EPA and European emission standards. These results are impressive and confirmed that Capstone is the world leader in low emission combustion technology not only stationary power, but also the vehicular market.

Today, I am proud to announce that we are submitting our formal application to CARB for their official review and approval and issuance of the required executive order.

Finally, Capstone added a new distribution partners during the quarter not only in Chicago, but United Arab Emirates, Colombia, Mexico and Costa Rica. This continued expansion of our worldwide distribution network enables us to build the larger base of distributors with which we can continue to expand and grow our business.

We continue to see activity in all of our vertical markets as shown in slide six during the quarter, but I was most impressed with our activity in the oil and gas, office building, biogas and hybrid vehicle markets.

Take the oil and gas market, where we had our first repeat customer for the C1000 Series product with one oil and gas company purchasing to date three C600s and one C1000 for two onshore natural gas drilling projects.

We also received orders for additional C30s from our Australian coal seem gas producer that now has on ordered 154 C30s for insulation of remote coal seem gas fuels. This one customer is looking to drill thousands of wells over the next several years and we look forward to continuing to supply them products throughout that period.

In addition, we took orders for nine C30 and C65 Class 1 Division 2 explosion proof offshore oil and gas platform units during the quarter. These units sell at an average price of over $3,000 per kilowatt.

The C200 version of the Class 1 Division 2 is scheduled for release and presales early next year. Also during the quarter, Capstone received an order for two C800 microturbine systems for a new 10-storey building in Bogota, Colombia. The total of order value was approximately $1.5 million and was the first sale of Capstone C800 microturbine in Columbia.

The project was originally slated for fuel sell, but Capstone's new distributor Supernova convinced the property owner to switch to ultra low emission microturbines as the building was already under construction. Also during the quarter, Capstone received an order for three C800 microturbines for a wastewater treatment plants in Brazil. The total order value of this project was in excess of $2 million. Fluxo, Capstone distributor in Brazil sold three C800s to one of the largest wastewater treatment plants in Brazil that serves two cities and millions of residents.

While we're still in a most exciting developments during the quarter, we're in the hybrid vehicle market. Capstone's U.S. hybrid transit bus customer DesignLine recently completed a reverse merger with a the public shell in order to take the company public and raise funds to increase manufacturing capacity of its hybrid electric vehicles.

As outlined in my next slide, slide seven, DesignLine's backlog as of September 30th was 533 buses were very impressive $260 million in backlog. This consists of approximately 458 hybrid and alternative fuel buses in the United States.

DesignLine is currently building today buses for New York, Baltimore, Charlotte and Los Angeles and is looking to dramatically increase manufacturing capacity over the next 12 months.

If you look in transit markets for the United States as of 2006, the transit bus fleet was approximately 83,000 vehicles in the U.S. alone. According, to the American Public Transportation Authority or APTA, the industry has averaged approximately 5,000 new vehicles purchases per year during the period of 1992 to 2006. In 2007, APTA also projected to more than 60% of new transit bus purchases by 2010 would be hybrid or electric vehicles.

Turn our focus to the hybrid automotive market, where Capstone continues to hold discussions with two automotive component supply companies about licensing and royalty agreements for the C30 and an automotive range extender application. These applications are shown on slide number eight and slide number nine.

Today, we are working with two high-volume automotive companies to analyze how to reduce the cost of our C30 dramatically. Our C30 is designed to run for 40,000 hours or more with the rebuild of 20,000 hours and thus requires more expensive longer life materials.

However, the automotive version of C30 only needs to realize about 3,000 hours. Therefore in addition to the opportunity for potential long-term licensing and royalty agreement, Capstone will be able to leverage the new high volume lower cost automotive C30 products in our traditional stationery power businesses and markets.

In addition to the licensing discussions, Capstone is also working with Factory Five Racing as seen on slide nine so offer a hybrid electric performance, kit car, that will be available for sale and showcase at the upcoming LA Auto Show in December.

At this point, I'd like to turn the call over to Ed to review the specific financial 2010 second quarter results. Ed?

Ed Reich

Thanks, Darren. Good afternoon, everyone. I would like to provide you with our financial results for the second quarter fiscal 2010 ended September 30, 2009.

Revenue for the second quarter ended September 30, 2009 was $15.5 million or just 18% from $13.1 million reported in same period last year. We shipped a 138 units during the second quarter compared to a 172 a year ago. The lower unit shipments are a result of the introduction of the C200 and C1000 Series units, and as a result average revenue per units during this second quarter increased to $91,000 compared to $58,000 on the 172 units in the second quarter of last year. We expect our average revenue per unit to increase since we book at higher prices and continue to increase manufacturing rates on the C200 and C1000 Series products.

Gross loss for the second quarter was approximately $3 million or 19% of revenue compared to $300,000 or 2% of revenue from the same period last year. The increased gross loss reflects lower sales of C60 Series systems, resulting in a lower margin from the change in the product mix, increased manufacturing costs because of the recent introduction of the C200 and C1000 Series system for which the cost isn't at our target yet, as well as higher standard warranty per unit for the C200 and C1000 Series systems.

To show the impact of our material cost reduction plan on the quarter, if we remove the warranty charges from the gross loss for the last two quarters, the gross loss improved quarter-over-quarter by approximately 9% as a result. You can see this reconciliation on slide number 10.

R&D expenses were $2.3 million for the second quarter, an increase of $300,000 or 15% from the same period last year. R&D expenses were higher in the second quarter because there were no cost-sharing benefits from the UTC Power Corporation funding as that program was concluded in the first quarter. This increase was offset by lower spending for consulting fees, supply, salary and facilities expense.

SG&A expenses were $6.8 million, a decrease of $900,000 or 12% through the same period last year and that decrease in SG&A expenses was comprised of a decrease in salaries, consulting and travel, and offset by increased professional services fees when compared to the same period last year.

Our net loss was $31.9 million for the second quarter of fiscal 2010 after the adjustment for warranty liability which was $90 million non-cash. This was increased $22 million from the $9.9 million for the same period last year. Primary reason as I said for the increase in net loss was the result of the adoption of Accounting Standards Codification 815, "Derivatives and Hedging" which affects our accounting for warrants with certain anti-dilution provisions.

We recorded a non-cash charge, as I said, of $19.6 million to warrant liability expense which was below the operations line during the second quarter of fiscal 2010. Net loss and corresponding loss per share before the effect of the newer warrant accounting was $12.3 million and $0.07 per share, respectively.

Please refer to slide number 11 for reconciliation from GAAP. As our stock prices increased as it did from $0.83 at the end of Q1 to $1.32 at the end of Q2, it causes our loss to increase. Inversely, if our stock prices decreased from the first quarter, we would have recorded a gain.

Our loss from operations for the second quarter of fiscal 2010 was $12.1 million or 20% higher than the prior year comparable quarter. Loss per share for the second quarter of fiscal 2010 was $0.17. Loss per share for the same period last year was $0.06. The loss per share before the non-cash charges related to the warrants was $0.07 per share.

Please again refer to slide number 11. As of September 30, 2009, cash and cash equivalents were $24 million. Cash balances decreased to $1.4 million during the second quarter. The company entered into warrant exercise agreements with certain warrant holders during the second quarter resulting in gross proceeds of approximately $6.5 million. Backlog at the end of the second quarter was $59.3 million, increased 18% from the prior year comparable quarter and decreased only $200,000 from the first quarter of this fiscal year.

Now, turning the call back over to Darren.

Darren Jamison

Thank you, Ed. Despite the $1.6 million reschedule I mentioned, earlier Capstone entered the second quarter with $15.5 million in revenue which is 18% growth over the same quarter last year and 115% growth over Q2 a year ago.

It is important to know that we are not experiencing significant order cancellations and we are still seeing quarter-over-quarter growth in new quotation activity and total project pipeline.

I attribute the quotation success for our new C200 and C1000 products gaining market share as we continue our marketing efforts to those products along with strong customer support from our early C200 and C1000 installations.

The largest area of quotation activity is now the Americas which has had significant growth in activities over the last two quarters. I continue to believe that the fiscal 2010 will best be described as Capstone year of growth continued significant revenue growth, but also year of cost reduction, working capital improvement and progression to positive gross margins and eventually cash flow positive.

Although, our operating expenses were higher in the second quarter than they were in the first quarter, we continue to track to our own operating budget for the first six months of our fiscal year. You should still expect to see our third and fourth quarter at $8.5 million or less in operating expense.

Results of our operating expense efforts is very much evident in our year-to-date results over the prior periods as illustrated in slide 12. This slide shows Capstone's operating expenses are coming down while revenue is trending up directive levels year-over-year.

Another critical initiative for Capstone's success is decreasing inventory and improved inventory turns. Capstone has taken several steps to increase its churns as discussed in our last earnings call.

Mark and his team have implemented fixed production slots, just in-time deliveries and the processes establishing more tier-one suppliers and the vendor taking a con-bon production strategy.

As you can see in the next slide, slide 13. The inventory turns are showing strong improvement as a result of these new efforts. Capstone's inventory turns which had historically ranged from 1 to 1.5, now 2.2 last quarter and 2.6 turns in the second quarter.

Mark's planned to continue to reduce overall inventory and achieve approximate turns or four turns by the end of this fiscal year. This plan will drive lower working capital requirements and more importantly turn inventory into cash.

In order to ensure the success of these manufacturing initiatives, we have also taken steps to improve our human capital at Capstone on the operations team. Capstone has recently hired a new Director of Production Planning and Logistics and a new manager of the manufacturing at the Chatsworth plant. Both of these new hires have tremendous experience and have substantially improved our manufacturing leadership expertise.

So, as I sit here today, the four operations managers reporting directly to Mark have overall combined experience of 80 years of manufacturing, productivity improvements, quality assurance, material control, scheduling, purchasing, process engineering, manufacturing engineering and compliance of con-bon, MRP, SPC and ISO standards.

I very much look forward to reporting the results of this new and improved manufacturing leadership team in the quarters to come.

However, our most critical initiative is still the C200, C1000 cost reduction initiative. This program is well under way as Ed educated, we have seen approximately 9% improvement in gross loss in the second quarter from the first quarter. When you net out warranty charges, we expect to see continuing improvement as majority of our cost savings are estimated to fall to the P&L by the end of the fiscal year.

As you can see in the next slide, slide 14. We have achieved some of the savings to-date, but the majority of the savings are scheduled to occur in third and fourth quarters. The C200/C1000 cost reduction initiative is well under way today and it's very similar to launch of the many other new products with the other companies and it's a process of maturation of the bill of material and the design.

When C200 products initially entered the low volume production phase, components were produced in initial manufacturing techniques. That are capable of meeting rapid design change requirements but obviously were more costly.

Alternate manufacturing techniques such as excursions, forgings, castings along with a supporting longer lead time tooling are now being put in place to provide these parts at significantly lower cost. As these processes are implemented and C200/C1000 volumes increased, we are more and more moving to offshore suppliers to provide parts at even lower costs.

This strategic has enabled to C200/C1000 product to meet critical time to market requirements be it still flush out early field issues, manage production tooling investments and ultimately drive cost towards our business objectives and achieve our target product margins modeled to achieve positive cash flow.

As I state in our first quarter call, I am confident in our ability to have margin targets as Capstone has purchased orders or firm quotes from qualified vendors in place for the vast majority of the parts identified for reduction. In addition, we have implemented two C200 and C1000 price increase over the last sixteen months. These two price increases totaled 6% on the C200 product and 14% on the C1000 product.

Many of the 201,000 units shipped in the first quarter and again in the second quarter or orders received before one, if not both of the price increases. As these early quarters clear backlog, we will continued and begin to ship products with the benefit of both the lower material costs and the higher average selling price which should enable positive gross margin followed by positive cash flow.

In addition, we recently just announced a third price increase of approximately 6% across all of Capstone's product line to be effective January 1st, 2010.

We move on to slide 15, it graphically shows that management believes is Capstone's clear path to profitability and meeting our short-term goal of gross margin positive before the end of this fiscal year or March 31st. As we look at that goal, the most critical drivers continue to be revenue growth, manufacturing expense reduction, margin improvement and achieving our fourth inventory turns.

I believe the Q1 and Q2 has proven that Capstone is well on its way to increased revenue levels, lower operating expenses and is improving their inventory turns each quarter. I also believe in Q3 and Q4, we will demonstrate our ability to lower material cost and show the market our improved gross margins.

So in conclusion, when I reflect back on the quarter, I see the following significant events. It's hard to get past the record $15.5 million in revenue, that is 18% year-over-year growth from Q1, our best quarter last year and 115% revenue growth over Q2, two years ago.

Very excited about the successful testing and certification of the C200, UL 2200 and UL 1741 that finally opens up that portion of the US market to our C200 product. I am excited to see the continued strength of our products backlog, that is still at 67 megawatts after a record $15.5 million revenue quarter and despite two product price increases.

I am very pleased to see the early impact of our operating cost reduction plan that does deliver decreased expenses year-over-year while achieving record levels of shipments revenue. It's great to see the $2 million reduction in inventory and improving inventory turns from one to 1.5 to 2.2 and now 2.6.

Very impressed with the successful third-party testing of the liquid fuel C30 product to meet CARB, EPA and future European emission standards making Capstone one of the only products today to achieve these ultra low emission levels without expenses, heavy, reliability, exhaust after treatment.

It was nice to meet the milestone of 5,000 units shipped as we continue to provide highly reliable low emission products in a multitude of applications and environments worldwide. The key to have the shipment of our first 12 hybrid UPS systems for installation at the Syracuse University's new 6,000 square foot data center as part of IBM's Smarter Planet initiatives.

We worked hard over the last year in California and we are very pleased with the California Senate Bill SB412 that was passed into law allowing Capstone's products to be eligible for substantial cash rebates of an estimated 36% under the California Self-Generation Senate program and frankly putting it on a level playing field with fuel cell and other technologies.

Also important is the human capital. Capstone's operations team with the new Director of Production, Planning and Logistics and new manager of manufacturing in Chatsworth.

As I said on slide 16, I firmly believe that Capstone has reached the inflection point and is positioned for success because we continue to have strong international market drivers and strong international worldwide market penetration. Capstone is better positioned today for success in the US because of the new and the pending US policy focused on energy efficiency and renewable power and portfolio standards that will certainly drive the US market towards Capstone products.

Capstone's is positioned as the industry leading green ultra-low emission and high efficiency technology as recently demonstrated graphically by the C30 third-party testing. Capstone has a new C200/C1000 product that enables megawatts scale solutions in a $4 billion market.

If all that wasn't enough, to give Capstone a great chance for success. Capstone is developing future markets in the high-volume automotive business, and the very interesting high-margin marine business, in the expanding solar markets and the very mature power rental space.

As CEO of Capstone, I firmly believe that we are in the right markets, with the right drivers, with the right products, with the right team with the right incentives, and we are 100% laser focused on all the right things. At this point, operator I would like to open to questions?

Question-and-Answer Session


(Operator Instructions). Your first question from the line of Eric Stine with Northland Securities. Please proceed.

Eric Stine - Northland Securities

First I was wondering could you just talk about the warranty expense in the quarter maybe how that compares quarter-over-quarter and how long you anticipate that will persist?

Ed Reich

All of our product carries a per unit warranty expense which we calculate using a viable statistical analysis. So with the early introduction of the C2100 and 1000 there weren't enough units in the field to have a valid statistical population to make a forward-looking forecast on. So what we did is we started with the forecast for our C65, which was a reasonable place to start, we thought given we had a lot of experience with it in the field and it's similar to C200 and C200 is just a larger unit.

So given that, now at the end of the second quarter, we had enough units in the population to begin using the LIBOR and have it get back reasonably [after]. So the per unit warranty increased and we took that adjustment in this quarter.

Darren Jamison

Eric, it's Darren. I think what you are going to see here, I mean it's hard to give a quarterly guidance on this, but typically with the new product you will see somewhat of a bell-shaped curve. You'll have very little warranty exposure when the units are just originally being shipped and commissioned, as you get more units in the field like we have today, you will start to see some level of warranty issues which obviously we quickly get on and fix and then as the population grows, you will have units start to roll off the warranty backlog or the warranty books and suppose the product matures, you will see, you come back down the backside of that Bell curve.

So not surprising to see the warranty ticker spike with the new products. We'd like to see it though level out and come down over the next couple of quarter as the product matures and eventually we'll start to get unit's rolling off the warranty backlog.

Eric Stine - Northland Securities

I might have missed it in the prepared statements but did you indicate kind of what percentage of the gross loss that was?

Ed Reich

Yes, it was 800,000 of the gross loss.

Eric Stine - Northland Securities


Ed Reich

In the quarter, the change from last year was 600,000.

Eric Stine - Northland Securities


Ed Reich

Yes. So when we broke that out, because obviously the warranty with the new product is different in prior years and prior quarters, plus it kind of math the improvements we're making on the comps side and the improving gross loss.

Eric Stine - Northland Securities

That kind of gets me to my next question and maybe this is for Mark. Just, from a price standpoint and also the input cost, could you kind of give an idea of where you think we are or what inning we're in?

Darren Jamison

I think, if you look at the slide we have and if you look at slide 14, if you got the deck in front of us, but it basically shows, and this is Darren by the way, Mark had a coughing attack so he had to leave the room. We had about 4% reduction in DMC on the C200 product in Q1. We had about another 4% in Q2. Q3 is our largest as we get more products in through quality testing and first article testing, we should see about 14% in Q3 and then Q4 is another 8%.

So, if you look at the 30%, 22% to 24% of it's in the next upcoming two quarters plus the Q3 and Q4, you're going to have the benefit of higher price or average selling price of units coming in. Though, again, not giving guidance, but based on this chart and the pricing that we have out there and the price increases you should see a pretty substantial improvement in our gross margins in the next two quarters.

Eric Stine - Northland Securities

You've mentioned an order that slipped, has that order shipped and could you just give a few more details around that?

Darren Jamison

Yes. It was an order that the customer requested witness testing at the 11th hour and we couldn't get that accomplished before the quarter end. So that witness testing did take place in October and those units have shipped. So, like anything, living quarter-to-quarter, especially with the larger products it makes it more difficult to match timings, specifically week-to-week at the end of the quarter. Had that gone out on time, obviously there have been another $1 million to $1.2 million in revenue for the quarter. So we would have been pushing $70 million in revenue.

So, very happy with the C200 production ramp, obviously we also built some units for UL testing because as you know very happy to have C200 UL testing behind us. We still have C1000 UL testing to do, so we have got a product that's on the path right now getting scheduled to do that testing.

Eric Stine - Northland Securities

What kind of luck have you had as far as talking to UL and just getting them to accept some of the test you did for the C200?

Mark Gilbreth

This is Mark Gilbreth here. We've actually had quite a ways through with UL, we submitted a preliminary test plan to them. I think there were probably about five is the test the we were in discussions. Of which about four of them we've come to an agreement on and we have one left that we're in the final stages of coming to agreement on. So, that will allow us to proceed on schedule with what we had predicted for UL.

Ed Reich

Yeah, obviously, we've got four C1000, Eric, that were sold at Office Power for delivery and installation at the Helmsley building, the MetLife and the Daily News building in New York. We, obviously, want to get those installations in place. New York is one of our best markets and best potential markets. So, getting those C1000s in-place as you kind of showcase to leverage more customers, something we're very focused on.


Your next question comes from the line of Sanjay Shrestha with Lazard Capital Markets. Please proceed.

Sanjay Shrestha - Lazard Capital

A couple of quick questions guys, so with your continued focus on better inventory turn and the cash flow management, how should we be thinking about your sort of the backlog going forward?

Ed Reich

As we I said in the call, still $60 million plus of backlog...

Sanjay Shrestha - Lazard Capital

That's right.

Ed Reich

Most of that is all short-term. They're considered less than one year. A lot of our backlog depends on partners. We still got over a 100 units in backlogs from DesignLine yet to deliver. As I mentioned in the call, DesignLine has over 500 bucks sold, so how fast we delivered that backlog and get new orders from them, obviously depends on their ability to ramp production.

They've hired a new manufacturing team out of the General Motors hummer plant to set up that hummer line. Very confident that they're going to get their act together and increase manufacturing rates to make sure they keep their customers happy and continue their growth, because, frankly, as they grow, we grow.

Also, the oil and gas customer in Australia, I mentioned has got a 154 units on order and most of those have not been delivered. I think less than 50 had been delivered so how quickly they drill wells and need products will also drive that. The rest of it is just timing with customers on project's lead times. We've seen project's schedules get a little tighter these days and move up a little bit which is good, but we'd like to see majority of that backlog delivered really in the next three quarters.

Sanjay Shrestha - Lazard Capital

That kind of leads me to my follow-up question, I had for you guys. Sort of talking about DesignLine, how should we be really thinking about sort of like I mean the opportunity associated with these guys and I know you just pointed out that it's really, how quickly they can ramp up but over the next two to three years, how big of an opportunity can that turn out to be for you guys?

Ed Reich

I mean if you look at them alone, they are building one bus a week today. They are trying to quickly going to bus a day, so obviously that's great. New York is switching from C30 to C65 as are several other transit properties. So, not only could they dramatically increase production, but the introduction of more C65 in their products will be very good for us both revenue and margin standpoint.

But I think more importantly, it's the awareness. New York being the kind of the bellwether of the transit industry, they have openly called this the bus of the future and they are very impressed with the results they've put it on a shaker table, out of Canada and simulated 12 years of going over Manhattan potholes' fully loaded, could not break the turbine, could not break the bus. So, they are great cheerleader and a great kind of key customer for us as New York goes, I think you are also going to see Philadelphia, Chicago, Boston a lot of the other large metropolitan transits will follow suite.

We do not have an exclusivity with them today, that's something that obviously we have had discussions about and will continue to, but my hopes as we get other transit properties looking at this and other transit OEMs, or BUS OEMs also look at our products and move forward.

So simple answer is, this could be 200 plus severance for us next year and growing, but then it could also be exponential into other markets. They have got a lot of ties into Saudi Arabia and looking at the European markets as well as China. So their growth could be explosive as well as other people adopting our technology.

Sanjay Shrestha - Lazard Capital

But another question then, sort of kind of related to that but not directly I guess, is, so you guys have your sort of the C200, even though that's not DesignLine related, production cost reduction roadmap or I see how 4%, 4% and then 14% jumps in Q3 '10 fiscal year. The reason why it jumps up significantly in Q3 is because as, I take it you guys have a very good visibility on that and is that enough for us to see a positive gross margin quarter, excluding the warranty related cost on C200 side?

Ed Reich

It's going to be very close, it will depend on how much of it cuts in at what point in the quarter. My guess would be you'll see a dramatic improvement in gross loss but not positive gross margin. We're very confident though that if you don't see it in Q3, you're going to see positive gross margins in Q4. I know that's what many shareholders are looking for.

We are obviously looking forward as well. I know there's a lot of people that still believe, the more we build the more we lose. We are laser focused on getting this cost reduction, getting it out as well as the price increases. We've passed along, as I said the two price increases have a third one coming in January. We are beyond the introductory pricing phase. The product is performing very well in the field. We are getting repeat orders as I mentioned. Also the European market was soft a little bit last quarter, you see our bookings are up this quarter as Europe comes back online.

UTC is still trying to get back online. So, if you look at the fact that Europe has been soft. We have been ramping the US market and our largest customer historically has gone through some growing pains of their own, UTC, we are actually doing very well and look for the next quarters to continue to improve.

Sanjay Shrestha - Lazard Capital

Two last questions, before leaving guys. So the kind of first one is when we then think about sort of like year-on-year growth you guys, obviously DesignLine is a big contributor to that, sounds like oil and gas would contribution and sort of talk to us as to some of the near-term visibility that you guys have with sort of flattening backlog here. How do we think about sort of the revenue growth materializing year-over-year over next few years?

Then second part is have you guys sort of after all this cost out initiatives, at what sort of a quarterly revenue run rate are we talking about and I recognize there is going to be some mix issue, but in sort of a normal world I guess, what type of a revenue run rate are we talking about to get to that cash flow breakeven?

Ed Reich

Yes. Cash flow breakeven we have always said is about 200 units, obviously units is a little bit hard to nail down, but it's approximately a third, a third, a third, so as we sell more 200s, and 1000s and that becomes a bigger part of our mix and we achieve our margin targets that 200 units will equate to about 25 million of revenue plus or minus two million so in that general range. So I think if you notice this quarter, our unit sales dropped or shipment dropped, but our cost per unit went up. So you're going to continue to see the cost per unit on average grow from $80,000, $90,000 per unit on average to $100,000 to $125,000 per unit on average. So if you think about 25 million per quarter, 200 units gives you a pretty close unit costs where it would come out.


Your next question comes line of Michael Lew with ThinkEquity. Please go ahead. Proceed.

Michael Lew - ThinkEquity

Could you also spend some time addressing the potential market segment such as the solar concentrator and marine markets like what is the addressable market opportunity each? Now are you currently bidding on any projects there?

Ed Reich

Let's start with the marine market. Reagan Equipment is one of our 65 partners that have been in the marine business since the late 40's. Definitely very talented in that space, they make not only marine switch gear but also internal combustion or recip marines power plants. They are in the process of marinizing our products, like they already have a wet exhaust manifold done for our products and now we're going to all the marine certifications. So we're looking to put the first C200 or C65 installation in a workboat probably first quarter next year or fourth quarter fiscal quarter. So I don't think we are actually bidding projects until we get that demonstration (inaudible) out there, so we're probably three quarters away from actually bidding projects.

The solar cluster side, we are working with a company called HelioFocus on a dish that's concentrating, it's all about solar energy into a single receptacle. Mark can probably give a better update there but I know, we've completed the production of our units and is in process marketing shipped over to Israel.

Mark Gilbreth

That's right. We've completed the initial design, the ATP or acceptance test to the product here. That product is now shipping over to Israel where there is a solar collector dish to marry up with the unit. That should occur later this quarter. Testing probably go through next quarter and then HelioFocus beyond that would then begin to look at the sales launch of that product.

Ed Reich

I think as far as market size, both the solar market is obviously a huge and growing market space. Probably you're very familiar with it. Many of our shareholders are owners of solar stock and technology. The marine market is very mature market. But both pleasure boat and work boat operators are under pressure to reduce their emissions, plus their reliability inherent in our project is suited well to marine environments where if you are away from land for days at a time having products that's 99.6% available and reliable is a great place to be.

Michael Lew - ThinkEquity

Another opportunity which I think is potentially huge one for you is in building energy efficiency. Can you like give us an idea of how large that market is and then maybe adjustable market is for you?

Ed Reich

Yes, that's another multibillion-dollar market. We're doing a lot of energy efficiency, Green Building, Gold Star are LEED certified depending on where you are in the world what you call it. It's a lot of our European business today. It's a lot of our Australian business today. The U.S. market is picking up and we're doing a lot almost on a daily basis.

The launch and learns for engineering firms, architect firms, introducing the technology, most of those projects, today we're doing a retrofit existing buildings. So once a boiler gets outdated, it needs to be updated or a HVAC system is upgraded, we have a chance to get in there.

But the real home run is getting into the original new building specs. So we're very focused on architects and engineers that as new building, new construction happens, we become a part of that package.

To get to the highest level of LEED certified platinum, you need to have onsite generation and obviously, our technology especially when used in absorption chiller, we can get 85% or higher over all system efficiency.

So our real challenge, I mentioned the bus market 5,000 units a year, the only gas industry is a huge multi-billion dollar market, wastewater treatment plant, farm digesters, hotels, schools, TESCO, it's really getting more market share, more penetration and getting our product which is really a revolutionary product out there in the mainstream and getting more and more testimonials and customers to use it.

Michael Lew - ThinkEquity

Given that the ARRA, the stimulus money is yet to be awarded yet. The expected timeframe is I guess in mid-2010. Have you seen an increase in bid activity or are you more…

Ed Reich

Yeah, I mentioned the Europe has always been our best market the last two quarters. The Americas and also the U.S. driving the Americas has suppressed Europe. So, hopefully I didn't gloss over that too quickly. But no, we are definitely seeing a huge increase in our U.S. bidding and quotation activity and a lot of that is obviously stimulus related.

So I think between the stimulus and green building, we're going to see great opportunities in the U.S. as well as [AB] 412 have really opened the California market back up to us with great incentives.


Your next question comes from the line of Megan Moreland with Ardour Capital. Please proceed.

Megan Moreland - Ardour Capital

What was your operating cash consumption and CapEx for the quarter?

Ed Reich

Operating cash was $6.9 million in Ops is what we used. CapEx for the quarter was fairly low [like a] million dollars. Fall in the queue.

Darren Jamison

Yes, for CapEx, we have got very little CapEx going forward in the next, wait until you get over a couple thousand units a year. So we have really got to break some sticks and all the equipment in place so until we get to 2000 units, there will be very little capital expenditure, mostly replacement of components. The cash burn, 68 was a little higher than we wanted to see for the quarter. We're still seeing our days outstanding and our receivable higher than we had seen them a year ago. Obviously, we attribute that to the recession. People are hanging on with their money as long as possible these days. But as the DSO comes down and our revenues continue to go up and margins improve, we expect to see that cash used from operation to drop below five very quickly.

Megan Moreland - Ardour Capital

How should we think about future warrant liability charges or gains. I know, it depends on where the share price goes, but is there something we're going to have to recalibrate our forecast forever at the end of or approaching the end of every quarter?

Darren Jamison

I think there is two choices, you either ignore it because it's non-cash and its hard to be a liability when the effect is it either expires or somebody gives us cash, but I think unless you want to try to guess what our stock price is going to be every quarter. There is only really two things you can do, guess our stock price, or which you think you can do that and you probably know our business right. So I think its probably just estimating our EPS without it the best way.

Obviously, many companies are faced with this situation. We are in talks with our bankers on what we can do to get rid of this warrant liability, not that it has a material impact on the company but I think it's very confusing especially for some of our retail investors who may be don't do the deals and some of the institutional folks do it and see these big numbers as disconcerning. So we don't like it. We hope to see if we can do something about it but its not a huge focus for us right now.


At this time I'd like to turn the presentation back over to Mr. Jamison for closing remarks.

Darren Jamison

All right. I want to thank everybody, great questions on the call. I know this quarter is a little bit confusing with the warrant liability charge and the warranty charge that hopefully we've made that a little more clear on what's going on in our business. The reality is that we had a very good bookings quarter as far as new orders. We had a very good revenue quarter, but we're seeing our cost of the product come down and are improving our gross loss, which will only get better in the next two quarters if we continue to work our plan.

Very exciting markets in oil and gas, very exciting markets in the hybrid vehicles. We look to see hopefully DesignLine quickly ramp their manufacturing abilities since the oil and gas business continue to grow and we'll keep an eye on the automotive market. As I said, that's another big potential market for us.

We are in talks with two very large automotive companies that could really revolutionize our product from a cost and volume perspective and to have that royalty and licensing agreement would be wonderful because it is 100% margin, but really what I would like to have is to make microturbine a household name like the Cummins diesel and the ramp pickup truck, the ingredient branding ability of that would be huge but more importantly the access to lower-cost high-volume products for our stationary power business would be tremendous.

So not only could we get a great royalty stream, we've learned from our engineers going to school on the high-volume manufacturing capabilities of our partner but then taking that product back and that ingredient branding and using it in on the other side of our business, so very exciting stuff. I think people are very interested in our product today, the inquirers were getting worldwide are up tremendously from when I joined the company almost three years ago.

So, the markets are [ripe], like I said. Our product is right. I believe we have the right management team that we're always looking to upgrade at any positions we can as we have the best athletes on the field everywhere. But, really the right product, the right direction, the right focus and we're going to keep moving forward and look forward to giving everybody another update next quarter. Thank you.


We thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!