- Capstone's pre-announcement of earnings had limited surprises.
- Uneven or "lumpy" year ahead.
- Accounts receivable climbs, forcing equity dilution.
Capstone Turbine (NASDAQ:CPST) reported earnings after the market closed on Thursday and provided few surprises. This was largely due to the company's revelations in the prospectus for a secondary stock offering that took place at the start of June. These revelations drove the share price all the way down to $1.28 and the company eventually issued a press release that discussed the poor fourth quarter performance. That release included annual revenue of $133.1 million, well below the soft guidance of $148.9 million.
FY 2014 Recap
To put things in the proper perspective, Capstone does not issue firm guidance. Instead it instructs analysts to look at the year-end backlog as a good approximation of revenue for the next year. In a press release last August that discussed the first quarter results for the recently completed year, Capstone CEO Darren Jamison was quoted:
While the first quarter was disappointing from a revenue perspective, this was not a result of systemic business issues, but rather a timing issue with regard to collections and shipments. ... The management team remains confident and looks forward to a strong rebound in Q2 and reaching our total year goal of continued revenue growth and EBITDA breakeven for the first time in company history.
On that Q1 conference call, Jamison also discussed backlog and the poor revenue number as follows:
So the backlog that we entered the year with is a good indicator of what we think we'll do for the year. We don't give specific guidance on a quarterly basis just for this very reason. As you know, we can be lumpy quarter-to-quarter. But I think for us, the most important thing is to manage our cash. Obviously, we don't want to do anymore equity raises especially before we're profitable. So we're really going to focus on the cash cycle, receivables, managing our inventory turns back up.
The backlog entering the recently completed 2014 fiscal year was $148.9 million and was the soft guidance referred to by Jamison. The $133.1 million of revenue wasn't the only disappointment. EBITDA breakeven once again remained an elusive goal. And, the company also failed miserably when it came to cash management and preventing equity dilution. One of its warrant holders was permitted to exercise those warrants after expiration of the exercise period, for an unexpected additional cash infusion of $6 million. This was discussed in one of the conference calls and can be found in the second fiscal quarter 10Q under Subsequent Events:
On October 31, 2013, warrants to purchase 4.7 million shares were exercised resulting in proceeds of approximately $6.0 million.
We now know that $6 million also wasn't sufficient and the company was forced to proceed with another equity offering following the close of the fiscal year when it announced:
the closing of its public offering of 18,825,000 shares of its common stock. The closing occurred on May 6, 2014. The stock was priced at $1.70 per share and allocated to a single institutional investor. Net proceeds from the sale of the shares, after underwriting discounts and commissions, were approximately $30.2 million.
So much for "we don't want to do anymore equity raises especially before we're profitable." And the receivables haven't been managed very well either. During the conference call that explained the first quarter miss, Jamison had described it as the company being prudent, unwilling to loosen credit terms, and withholding $8 million of shipments that had been scheduled to go out the door in the last week of the quarter.
I'm not sure what happened to being prudent, but Capstone entered the year with Accounts Receivable, or A/R, of $17.9 million representing 46 days sales outstanding, or DSO, and A/R had climbed to $23.7 million and 89 DSO by the end of Q1, despite quarterly revenue of less than $25 million. Here's what Edward Reich, Capstone EVP and CFO, had to say about the fiscal 2014 year end figures:
Receivables were $28 million at March 31st compared to $22 million at the end of the prior quarter and $18 million a year ago. DSO was 70 days for Q4 compared to 54 days in Q3, 46 days for the same period of last year. The increase in DSO for the fourth quarter of fiscal '14 was primarily due to the timing issues and we expect to return to more typical levels in Q1 of fiscal '15.
Clearly, the company continues to have "timing issues" and with collecting payments from its distributors. This would explain, in part, the need to raise additional capital through the equity dilution as well as an increase and amendment to its borrowing facility with Wells Fargo to $20 million, both of which occurred following the close of the fiscal year, and both of which will be used to fund increasing levels of accounts receivable. The amendment to the Wells agreement also extended the expiration out to 2017.
It wasn't all bad news at Capstone. Despite badly missing the revenue target, gross margin continued to improve. This was attributable to a combination of factors, including
- Price increases,
- Improvements in direct material costs,
- Lower royalty costs, and
- A shift in mix to larger units.
Backlog grew to a record $171.6 million, an increase of $22.7 million, or 15.2%. And revenue also grew to a new record of 133.1 million, $5.5 million or 4% over $127.6 million achieved last year.
Unfortunately, the $5.5 million and the 4% growth were the smallest increases since revenue declined in 2007, and well below the annual double digit growth rates achieved each year since then. And, as I pointed out in a previous article, if fiscal 2014 revenue had come in at the $148.9 million level, Capstone backlog would not have grown 15%.
... if the company had actually shipped product totaling $148.9 million rather than $133 million, there would be $16 million less in backlog. The "$22.7 million, or 15%" backlog growth cited by Jamison would have been under $7 million and closer to 5%.
What Lies Ahead
During the recent conference call, management statements were somewhat less bullish than in prior years when discussing FY 2015 and "guidance." For example, Reich stated:
We are cautiously optimistic that we will return to higher revenue growth rates in fiscal '15 given the positive momentum that we are seeing in Europe and the broad traction we're getting in a number of our other markets.
Let's hope so. Management reflected several times on the compound annual growth rate of 30% since 2007, and another year of low single digit growth won't do much for the share price. In response to a question, Jamison noted:
We closed the year with a highest backlog in company history. I think more importantly backlog is up 15% year-over-year which sets us up nicely for hopefully double-digit growth and strong double-digit growth going into fiscal '15.
In response to another question, Jamison later added:
... [I] hesitate giving short term guidance. We haven't fared it very well doing that. We'd much rather give you annual guidance. But I will say you could look at historical trends, Q1 is normally not our best quarter, Q2 usually build, Q3 is our strongest and Q4 is close to Q3 but margin rates usually slip a little bit. So I wouldn't expect a gain for us for Q1 but I do think our goal is going to be again year-over-year improvement on revenue, year-over-year improvement on margin and hold our expenses flat. For a total year our backlog's up 15%. We'd like to grow much faster than the 4% last year. So our goal to be solidly into double-digit growth for the year and again as I said put 400 to 500 basis points of margin improvement and keep our operating expenses flat.
While Jamison hasn't fared well at giving short-term guidance, he hasn't been very good at giving long-term guidance either. Anyway, in his concluding comments, Jamison added:
If you look at backlog a year ago you could see it was fairly flat over the previous year. We can see -- we saw that come out in revenue this year. Now with backlog being up 15% we hope to see the benefit of that increase.
Yes, investors saw that "come out in revenue this year," but the more important question that Jamison didn't answer is why he didn't know it would come out in 2014 and lower guidance. Or, whether 2015 "guidance" will also turn out to be too high.
The company is looking for continued margin improvement, and on an annual basis that should be relatively easy to achieve as the reduced royalty rate will be in place for the full year. It also expects that the hiring of Richard Lewis as a new VP in charge of operations will help the company reduce direct material costs. Lewis comes with a background in supply chain management.
The dilemma facing investors is the inability of the management team to forecast. During the year end 2013 conference call when discussing breakeven and margin, Jamison said:
We're still thinking high teens. We don't want to give specific guidance. The quarter is still in process. It really depends on if we get all of our slots filled and what the orders look like. But definitely we're talking about an EBITDA breakeven within the next couple of quarters, so that's around 21%, 21.5% at these revenue levels. So we should be somewhere, in the next 2 quarters, breaking the 20% barrier.
During this year's Q3 conference call on February 10th, Jamison said:
Obviously this is the best all around quarter [Q3] in the company history. We're very happy with the results; highest revenue, highest product revenue; gross margin in both dollars and percentage, record backlogs like we discussed, both in FPP and in product; a tremendous book-to-bill ratio of 1.4:1, average selling price is at the highest levels and strong cash, I mean our cash position is becoming more of a strength for us.
...So we still are maintaining our goals for Q4 -- as these are breakeven and a cash balance of $33 million to $36 million. So hopefully we can achieve those goals and have a great Q4 call.
Failure to achieve the expected results in Q4 triggered another equity dilution.
If management could not adequately predict what would happen two quarters out into the future at this time last year - or even seven weeks into the future last February - why should investors expect them to be getting any better at it? It seems reasonable that Capstone will continue to grow revenue, and that the company will eventually get to break-even.
The issue is that if management doesn't know when it will get to breakeven and stop burning cash, how can investors figure it out with much less information? Still, I see this as a long-term buy for the speculative portion of your portfolio if you can put the shares away for a couple of years and forget about them. For those that are more conservative, wait until the company actually turns the corner and stops burning through its cash balance. You may lose out on some of the potential appreciation, but at least you will be spared the disappointments of miss, after miss, after miss...
Additional disclosure: In addition to a long term investment in CPST, I also actively trade the shares.