Capstone Turbine CEO Discusses F2Q11 Results - Earnings Call Transcript

| About: Capstone Turbine (CPST)

Capstone Turbine (NASDAQ:CPST)

F2Q11 Earnings Call

November 9, 2010 4:45 p.m. ET


Clarice Hovsepian - Corporate Counsel

Darren Jamison - President and CEO

Ed Reich - EVP and CFO

Mark Gilbreth - EVP of Operations and CTO


Sanjay Shrestha - Lazard Capital Markets

Eric Stine - Northland Capital Markets

Shawn Severson - ThinkEquity

Walter Nasdeo - Ardour Capital


Good day, ladies and gentlemen, and welcome to Capstone Turbine Corporation earnings conference call for second quarter fiscal year 2011 financial results, which ended September 30, 2010. [Operator Instructions.] During today's call, Capstone management will be referencing slides that can be located at under the Investor Relations section.

I would like to now turn the call over to your host for today, Ms. Clarice Hovsepian, Capstone corporate counsel. Please proceed.

Clarice Hovsepian

Thank you. Good afternoon and welcome to Capstone Turbine Corporation's conference call for the second quarter ended September 30, 2010. I am Clarice Hovsepian, your contact for today's conference call.

Capstone filed its Annual Report on Form 10-Q with the Securities and Exchange Commission today, November 9, 2010. 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 our website at

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 provision of the Private Securities Litigation Reform Act of 1995.

These statements relate to, among other things, future financial performance and attaining profitability; the ability to reduce costs and improve inventory turns and contribution margins; higher average selling prices; continued growth in current market conditions; the availability of a line of credit; the success of the C200 and C1000 products; new products and technologies; compliance with certain government regulations and increased government awareness and funding of our products; growing market share and market adoption of our products; new applications for our products; growth in the oil and gas, office building, biogas, UPS and hybrid electric vehicle markets; the successful integration of Calnetix Power Solutions MicroTurbine business; revenue growth and increased sales volume; our success in key markets; negotiations with strategic partners; our ability to enter into new relationships with channel partners and distributors, and other third parties, and a successful implementation of those relationships; the energy efficiency, reliability, and low cost of ownership of our products; and the expansion of the production capacity and manufacturing efficiency.

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, and may not lead to increased sales. We may not be able to reduce our manufacturing costs. 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 and capital expenditures. The current economy could make it difficult or impossible for us to raise necessary funds or for our customers to buy our products. We may not be able to utilize our line of credit, for example, as a result of a failure 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 on a timely basis or at reasonable prices. Our release of products may be delayed or new products may not perform as we expect. If we continue to fail to meet all applicable NASDAQ global market requirements and NASDAQ determines to delist our common stock, the delisting could adversely affect the market liquidity of our common stock, impair the value of your investment, and adversely affect our ability to raise needed funds. We have substantial accounts receivables and increased bad debt expense or delays in collecting accounts receivables could have a material adverse effect on our cash flows and results of operations. 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, distributor, and other relationships that are expected to result in an 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 will not increase as expected. We may not be able to successfully integrate the acquired Calnetix assets and achieve productive relationships with the distributors. And if we do not effectively implement our sales, marketing, service, and product enhancement plans, 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 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 these 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

Thanks, Clarice. Good afternoon and welcome everyone to Captstone's second quarter of fiscal 2011 earnings call. With me today is 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 general overview of our second quarter results, and then turn the call over to Ed for a review of our specific financial results. Ed will then turn the call back over to me, and I'll discuss what is happening in some of our key markets and update you on our progress toward our strategic objectives and improved gross margins and positive cash flow. As the operator said, we will be using slides in our presentation today that can be found on Capstone's website under the Investor Relations section.

In the second quarter, Capstone achieved one of its near-term strategic objectives when we generated positive gross margin on record quarterly sales. The management team and the board of directors have been extremely focused on lowering overall direct material costs and increasing revenues to achieve this important milestone.

Capstone achieved positive gross margins despite an increased warranty cost, resulting from the shipment of four new C200 engines due to a lack of cores in house to rework and an unfavorable product mix with a heavy concentration of lower margin C30 products being shipped in the quarter.

The gross profit for the second quarter was 1% of revenue, which is a substantial improvement over last year's second quarter gross loss of 19%, or negative $3 million, and a nice improvement over last quarter's gross loss of negative 3%, or negative $500,000.

Obviously, this has been a long time coming, and a very anticipated milestone achievement for Capstone's management team and loyal shareholders. We can see the path forward now to profitability and sustainability for our clean and green microturbine technology company.

As mentioned, revenue for the quarter was a record $18.9 million, up $3.4 million, or 22%, from the second quarter last year, or up $2.8 million, or 17%, over the first quarter of this year. Revenue was up primarily from stronger than anticipated C65 and C30 demand.

The higher revenue and improved gross margins contributed to Capstone's substantially lowering its cash [verge] from $20 million in the first quarter to only $6.5 million in the second quarter. In addition, Capstone shipped its first two 125kW zero-emission waste heat recovery generators to landfills in France during the quarter.

As most of you know, Calnetix's waste heat recovery generator business was recently purchased by General Electric. I see this as a positive event for Capstone as GE was willing to assume Capstone's exclusive OEM agreement as part of the Calnetix purchase.

As part of Capstone's acquisition of the Calnetix T100 microturbine business back in February, Capstone successfully negotiated a worldwide exclusivity on the zero-emission, 125kW waste heat recovery generators for microturbine applications. Access to this thermal technology is a critical part of our current business strategy. Slide 2 illustrates the efficiency improvement of six C65s when combined with the GE waste heat recovery generator.

Overall, I am extremely pleased with the second quarter results for fiscal 2011, as we not only achieved positive gross margin for the first time in the company's 22-year history, but we extended our streak to 14 consecutive quarters of revenue growth over the same period last year, as shown in slide 3.

If you step back and look at it, that is more than three years of revenue growth over the prior year period, in what is said to be the worst economic conditions in 70 years. Just imagine for a moment what Capstone's 95 distribution partners can do when capital budgets are reinstated and project financing becomes plentiful once again.

New bookings for the second quarter were a solid $14.4 million, which gives us over $80 million in new product backlog, not including parts, service, and accessories, over the last four quarters. Slide 4 shows that continued momentum in our product backlog, and the strength of our new C200 and C1000 series products continuing to push that backlog.

Capstone's $83.5 in product backlog sets the stage for continued revenue growth in the remainder of fiscal 2011 and well into fiscal 2012. We expect our growing revenue and large backlog to drive our company beyond our near-term achievement of positive gross margins and propel us to profitability as we continue to execute against our cost reduction programs.

Slide 5 shows this quarter against the backdrop of our profitability model. It should be obvious that the key to our profitability is continued revenue ramp to $25 million per quarter and continued execution of our direct material cost reduction program. As we head into the third quarter, I look for continued positive momentum in revenue, continued improved gross margin improvement, as we continue against our positive strategic plans to improve to positive cash flow.

We continue to see follow-on orders and new orders from some of the largest natural gas producers in the United States for insulation and shale plays. Capstone has sold a C600, multiple 1000s, and two dozen C65s in the last six months alone for these applications. These substantial end users are producing natural gas from six key reserves, or plays, across the United States. They're using electricity produced by Capstone's systems of power compression stations in West Virginia, Pennsylvania, Texas, New Mexico, Colorado, and southern New York.

As air permitting has become a major concern for gas developers and producers, Capstone's clean, green microturbines can serve a key role in ensuring continued development of the natural gas rich shale plays. The six very large shale formations that I mentioned earlier will pave the way for a new century of natural gas abundance and stable natural gas prices that should further drive CHP and CCHP projects around the U.S.

This has turned into a great opportunity for sales for Capstone microturbine technology and new compression stations and along new natural gas pipelines. One of Capstone's key oil and gas distributors Pumps & Service, located in Farmington, New Mexico, has already doubled last year's purchases in the first six months of this fiscal year, as a direct result of the shale opportunity. Year-to-date, Pumps & Service has become our third-largest distributor behind BPC in Russia and Aquatec in Australia.

The oil and gas business continues to be a critical market for Capstone. As I said last quarter, I view the shale play opportunity in the U.S. to be similar to, if not greater than, our current oil and gas opportunities in Russia with Gazprom and in Australia with coal seam gas producer Origin Energy.

Also during the second quarter, Capstone continued its product development and product certification activities as we recently completed and released our California Air Resources Board, or CARB, C200 product for waste gas emissions and digester applications, and we fully expect our C30 CARB certification for natural gas transit bus applications any day now.

This natural gas transit bus certification is key, as it will open up the California market to our transit bus partner DesignLine. As I mentioned last call, DesignLine has hired a new president from the bus industry and is currently closing another round of funding. Our record second quarter revenue of $18.9 million did not have any shipments to DesignLine, but we look forward to DesignLine taking units in the third quarter as they attempt to ramp production to one bus per day by early 2011.

We continue to focus on building our accessories, parts, and service business, and aggressively selling our industry-unmatched five-year and nine-year factory protection plans. For the first two quarters of the fiscal year, our accessories, parts, and service business, which is obviously a higher-margin reoccurring revenue portion of our business, has accounted for approximately 19% of our total revenue.

I'll now turn the call over to Ed to give a more detailed review of our financial results. Ed?

Ed Reich

Thanks Darren. Good afternoon everyone. I'd like to provide you with our financial results for the second quarter of fiscal 2011, which ended September 30, 2010. Let's begin with a recap of the major items on our balance sheet.

The sequential changes in our working capital accounts from the first quarter to the second quarter balance sheet were as follows. Accounts receivable was $24.7 million at the end of the second quarter, which was flat when compared with the first quarter ending balance of $24.5 million on higher revenues. We collected over $17 million in receivables during the second quarter, which was a big improvement from our Q1 collections. However, we continue to experience payment delays and heavy end-of-quarter shipments, both of which are affecting the cash collection cycle.

We made progress on our inventory reductions in the second quarter, decreasing inventory $1.4 million from the first quarter. Our ending inventory was $21.9 million, with inventory turns of approximately 2.8 times. Going forward, we expect to continue to make progress in reducing our inventories to appropriate carrying levels and benefitting from their conversion to cash, with the goal of four turns per year or better.

Accounts payable and accrued expenses were $14.5 million, which is relatively unchanged, decreased slightly, on lower inventory purchases from the first quarter balance of $14.7 million. Cash balances including restricted cash were $25.3 million at the end of the second quarter, compared to $31.8 million at the end of the first quarter. This was a change of $6.5 million and it was much improved over the first quarter cash used of $20 million.

I mentioned on the first quarter call that $5 million was reclassified from cash to restricted cash on our balance sheet, as required by the amendment of the Wells Fargo credit agreement and that we were in discussions with Wells pertaining to the release of all, or a portion of, that restricted cash. Well, on Friday of last week, the bank agreed in principle to release 50% of the cash collateral upon the filing of the Form 10-Q today, with the remaining portions released in equal installments following the release of results for our next two quarters, assuming of course that we remain in compliance with our covenants. We expect to execute that amended document in the next several days.

Our revenue for the second quarter was $18.9 million. It was up 17% from the $16.1 million we reported in Q1. We shipped 174 units during the quarter compared to 98 last quarter. Please refer to slide 6 to see the mix effect on average selling price and direct materials cost. As you can see on the slide, our average selling price per unit in the second quarter was down from the prior quarter as the result of the heavy concentration of C30 shipments that Darren mentioned previously.

The second quarter gross margin was approximately $100,000, or 1% of revenue, compared to a gross loss of $500,000, or 3% of revenue, from the first quarter. The improved gross margin from the first quarter was primarily generated from the sale of 45 more units of our C65 than in the first quarter, and the initial sales of the GE waste heat recovery generator as well as our new C200 [inaudible] upgrade offerings.

Moving on to R&D, R&D expenses were $2 million for the second quarter, an increase of $500,000, or 33%, from the first quarter. R&D expenses were higher in the second quarter on increased labor and non-recurring engineering expenses for development programs that are not offset by DOE funding.

Our selling, general, and administrative costs were $6.6 million for the quarter, up $200,000, or 3%, from the first quarter, as a result of slightly higher professional fees. Our net loss reported was $1.9 million and $0.01 per share for the second quarter of fiscal 2011 compared to net income of $392,000 and $0.0 per share in the first quarter.

The net loss reflects the adoption of accounting standards codification 815, which is derivatives and hedging, and it affects our accounting for warrants with certain antidilution provisions. We recorded non-cash benefit of $6.9 million to warrant liability expense during the second quarter. As a result, the net loss and corresponding loss per share before the effect of the new warrant accounting would have been $8.8 million and $0.04 per share respectively. Please refer to slide 7 for a reconciliation from the GAAP to non-GAAP.

Backlog at the end of the second quarter was $83.5 million, a healthy increase of 41% from the prior year quarter and down only $1.1 million from the first quarter. We received $14.4 million in new orders during the quarter, which was an improvement of $3.3 million from Q1.

Overall, the second quarter's results were encouraging, as we saw an improvement in revenue, margin, new orders, and cash usage. That concludes my comments on our second quarter results, and I'll now turn the call back over to Darren.

Darren Jamison

Thanks Ed. An encouraging sign of economic recovery is we continue to see healthy quotation and order activity in all of our four market segments, which are reflected in slide 8. I continue to be especially enthusiastic, though, with the activity in the oil and gas sector, combined heat and power sector, biogas, and the hybrid electric vehicle markets.

I believe our improved second quarter results are a leading indicator of what's happening as the financial markets slowly recover. Project financing becomes more readily available and companies' capital budgets are reinstated. These record quarterly revenues were achieved without any orders or shipments to four of our most key U.S. partners, UTC Carrier, Office Power, PowerTherm WESCO, and DesignLine.

However, as I mentioned earlier, we expect DesignLine will take product in the third quarter. We also expect UTC Carrier to order units during the quarter, as they are now heavily working sales in the New England area and New York areas, and are starting to see activity in Texas because of recent alternative energy legislation.

We look for better things from Office Power, as they appear to be able to close another round of funding and should have several New York projects under construction by spring. Last, I hope to see results in the coming quarters from PowerTherm and WESCO as they work leads generated from earlier kaizen event and executive joint sales calls and leverage the support they have from the New York Department of Buildings.

The continued success in the shale plays, combined with DesignLine, UTC Carrier, Office Power, and PowerTherm WESCO all coming online, should further boost our U.S. business and positively impact our overall revenues for this year and beyond. However, until then our business continues to be heavily weighted toward the international markets.

Our German distributor recently sold a C800 to a metro group cash and carry store in Germany. The metro group is the leader in the German self-service wholesale market, with 300,000 employees working at over 2,100 outlets in 34 countries in Europe, Africa, and Asia. Their portfolio of strong brands offers a wide range of services for both private and commercial customers.

The natural gas Capstone C800 was installed at a busy 25,000 square meter metro cash and carry wholesale store in Germany. In addition to electricity produced by the ultra-low emission C800, the highly efficient application will feed waste heat energy into two absorption chillers once the system is commissioned. These absorption chillers are using the energy to produce air conditioning and cooling for the building, resulting in lower energy costs since the need for utility power will be greatly reduced.

The metro group has an active sustainability initiative with a goal to reduce carbon dioxide emissions by 15% from 2006 to 2015. It is estimated the Capstone CCHP installation will reduce carbon dioxide emissions by 570 tons each year. The CCHP system's energy efficiencies are expected to be equivalent to removing 700 cars from the road or planting 730 acres of forest. Energy costs are expected to drop more than 15% at this one location.

If we turn our sights to Asia, the Asian market continues to develop nicely for Capstone, and I recently attended POWER-GEN Asia in Singapore. China continues to promote CHP, and the central government has established a four-part policy to encourage the installation of combined heat and power on an energy service, or ESCO model basis.

Capstone currently has three ESCO projects underway in China. One is operated by [Sun Energy], using a CCHP application, and two are C65 ICHP projects operated by Shanghai Aerospace Energy. Shanghai Aerospace is a welcome addition to our top ten distributor list, with revenues over $1.5 million in just the last two quarters. In India, our new distributor, CICB, continues to be very active, and they closed their first order for three C65s for a biogas project during the quarter.

Another area of expected future growth is the electrical vehicle market. As we continue to expand very rapidly, we continue to position Capstone to be a player in the electric vehicle range extender market. However, range extenders are not just limited to cars and trucks, as we recently commissioned our first hybrid electric boat in the Netherlands, which is now operational and providing customer demonstrations.

In related marine news, Reagan Equipment, Capstone's partner in the marine market, recently launched its Kilo-Pak Klean-Pak C30 and C65 water or [inaudible] cooled marine version of our product at the Fort Lauderdale International Boat Show. This ultra-low-emission, compact marine product is specifically designed for the 75-foot and above luxury yacht market, and offers a cleaner and quieter solution over traditional marine reciprocating engines. This new product offers lower emissions over a wider range of powers in today's [gen sets].

Reagan's new marine microturbine Kilo-Pak product eliminates many of the wet stacking, soot, noise, and vibration issues related to conventional marine generation products on the market today. The product was well-received at the boat show, and should quickly make inroads into the marine luxury yacht market that is looking for lower emissions, lower vibration, lower maintenance, and obviously increased reliability.

Last quarter we announced our first electric class A truck microturbine range extender application with US1 Industries and Cal Motors, and I'm proud to report that the product was successfully integrated with an 18-wheeler and was showcased at our annual shareholders meeting and the National Hybrid Truck Users Forum, or HTUF, show in Dearborn, Michigan. The truck will now go into revenue service for US1 and we will hopefully lead to dozens of retrofits after successful demonstration of the electric truck's range and realization of the anticipated economic savings for this significant intermodal freight carrier.

In addition, we announced last quarter that Capstone has initiated a demonstration project with a major U.S. manufacturer of Class 5 to Class 8 heavy duty trucks that will utilize the Capstone 65 kW microturbine as a clean, efficient range extender in a hybrid electric drive system. This truck will be the first to take advantage of the complete Capstone drive solution, which includes the Capstone microturbine along with liquid cool power electronics, permanent magnet traction drive motor, and vehicle control system. You can see these products featured in slide 9.

The Capstone drive solution will make it easier for vehicle manufacturers to integrate microturbines into a series hybrid electric drive train. As part of our recently announced joint development agreement with Cal Motors, the Capstone HUV product offering will now include inverted drives, traction motors, and a vehicle power control module that will seamlessly integrate with both the 30 and the 65 microturbines.

These inverters and traction motors are mobile-hardened versions of the proven Parker Hannifin industrial motor drive products. The microturbines are able to operate on traditional liquid fuels such as diesel or biodiesel, and can also utilize alternative fuels such as natural gas, without sacrificing efficiency or reliability. This makes the Capstone drive solution suitable for a wide range of electric vehicle applications worldwide.

Other hybrid electric demonstrations continued during the quarter, with Grupo Plaza, a bus manufacturer in Argentina, and the LincVolt. As many of you know, the LincVolt is musician Neil Young's converted 1959 Lincoln Continental convertible hybrid vehicle that was recently displayed at the Hard Rock Café in Florida, and will accompany Neil on his current concert tour.

The increased revenue in the second quarter reflects the fruit of our labor as Capstone begins to leverage the success of exciting new products, including the 200, the 1000 series, HUV, UPS, and eventually marine products. During the quarter, Capstone continued its strategic talks with multiple companies to develop electric vehicles with Capstone range extenders for delivery in refuse trucks.

The plug-in electric, or HEV, market continues to be a very small portion of Capstone's revenue, but the revenue should grow with product demonstrations [inaudible] product orders and new low-volume OEM agreements are negotiated and executed.

As we look at the passenger vehicle market, Capstone continued its meetings with two strategic drive train partners as mentioned in previous earnings calls. The pace of the negotiations is increasing, with both of the Fortune 500 automotive drive train component manufacturers [inaudible] the negotiations are to build a high-volume, lower cost, 10,000-hour version of our C30 and C65 product. I am hopeful that one or both of these negotiations will come to successful conclusion in the near future.

During the quarter, Capstone continued to work on our next generation of products, as illustrated on slide 10. The next generation of Capstone products will increase output of our successful C200 product at 250 kW and improve the electrical efficiency 35%. As a result, it will only take four turbines to make a C1000 product that's lowering the size, weight, and more importantly, the cost.

We'll then develop a new 370 product by combining the new 250 with the traditional C65. That product will make Capstone more first cost competitive with the antiquated internal combustion engines of today and provide Capstone with a first cost similar to that of an engine, but with our lower CARB certified emissions, our lower lifecycle cost, our higher reliability, and as good, or better, system efficiency at 42%.

Capstone continues to work hard to be a cutting-edge industrial clean tech company that continues to grow revenues and reduce material costs, while maintaining operating expenses and while increasing market share in all of our markets worldwide with customers and governments looking for more cost-efficient clean tech energy solutions.

I'm proud to be partnered with the U.S. Department of Energy on three of our four key product development efforts, shown in slide 10. With the DOE's support, Capstone will continue to develop world-class energy products that provide lower emissions and higher efficiency solutions worldwide.

During the second quarter we met with several key policymakers and White House energy representatives about the importance of expanding the microturbine investment tax credit from 10% today to 30%. The effect on jobs, emissions, and energy efficiency would be considerable. Capstone estimates the first year of microturbine projects under a 30% investment tax credit would result in a reduction of 170,000 tons of CO2 per year, while creating 2,200 job years. With support from several key policymakers, like Henry Waxman, Congressman Linda Sanchez, and Senator Barbara Boxer, I hope to have a microturbine tax bill authored and presented for debate shortly.

In conclusion, this was an historic quarter in the 22-year history of Capstone, but we're not finished or satisfied with our great achievements. The Capstone management team is more committed than ever to continue improved gross margins, drive top line revenue growth, and further reduce cash burn towards becoming a cash-generator. We are not done improving our operational efficiencies or lowering our direct material costs, and we're still increasing our average selling prices and reaching our short-term goal of more than four inventory terms.

[inaudible] goal for the third quarter is to set a new record for quarterly revenue, further improve positive gross margins, drive inventories even lower, and improve receivables collections to continue to reduce the cash burn from prior quarter levels.

At this point I'd like to open the call to questions from our analysts. Operator?

Question-and-Answer Session


[Operator Instructions.] Your first question comes from the line of Sanjay Shrestha with Lazard Capital Markets. Please proceed.

Sanjay Shrestha - Lazard Capital Markets

A couple of quick questions. How should we think about the sequential improvement here on the top line for the second half of the year as well as the margin trend? You briefly mentioned that you expect cash burn to get even better, so is there a level where we could actually see a cash-neutral kind of a quarter in this fiscal year? Or how should we be thinking about that?

Darren Jamison

Let me start with the first one. From a revenue standpoint, we stand by our hypothesis that our overall revenue for the year will be similar to the backlog we entered the year with, so that would put us in the low- to mid-$80 million range for the year. Based on that you should see continued growth in Q3 and Q4 sequentially over Q1 and Q2. I think that we still feel very good about that as we enter the third quarter.

From a margin standpoint, as I mentioned, we still had some warranty costs during the quarter that we think will come down in Q3. There's some other cost reduction activities that should roll into Q3 and Q4, so the combination of the lower costs, lower warranty, and higher revenue should drive improved gross margins for the next couple quarters.

Cash is a little trickier to forecast, depending on working capital and their collection efforts. As Ed mentioned, we collected about $17 million in receipts this quarter, up from $12 million in Q1. We still have work to do there. Our DSOs are still too long, so we've got very focused on improving that. But we'd like to see collections being north of $20 million this quarter and have our cash burn drop sequentially quarter-over-quarter.

Will we be positive from a cash generation perspective before year end? I'd say probably not, but we should cut the burn down again substantially the next two quarters.

Sanjay Shrestha

Two quick follow ups. When we think about this Fortune 500 strategic drive train partner and two discussions that you guys have going on, and you said that it's progressing. How should we think about that? What is the level of discussion right now, and what's the timeline on it? And what could we expect to hear from that?

And part two question is with the oil and gas industry you sound pretty optimistic about the outlook there, so can you give us a sense of bidding activity there, and what kind of bookings potential could we see over the next few quarters?

Darren Jamison

Let me take the second one first. Oil and gas continues to be one of our strongest markets and is gaining nice momentum with the C200, C1000 products being adopted. We have very good market penetration with the 30 and the 65; we're now getting that kind of penetration with the 200 and the 1000. So we've seen lots of shale gas opportunity in the U.S., which I think will continue to accelerate. We've seen very good results with Gazprom in Russia, which we think will accelerate, and then we've also had very good success down in coal seam gas in Australia with just one coal seam gas manufacturer or producer - there's several down there we're trying to get in with.

So all of our distributors in those areas are adding resources. They're adding more parts and service closer to where the units are, and all very focused on growing that business. So we think the oil and gas, whether it's shale, offshore, onshore, or coal seam, will continue to be robust and drive revenue and growth for the next several years.

When it comes to the two automotive partners, those are future opportunities. What you're going to see is hopefully we'll sign one if not both up for licensing agreements. They will help lower our costs. In fact, we're already being connected with some of their suppliers and getting some cost reduction even as we speak, some opportunities.

But really that's more of a three-year play by the time we get through developing a lower cost high volume product, probably three years to get through the automotive PPAP process. But I think it's important as we look to leverage the business going forward, and we look to really lower the cost of the product going forward.


Your next question comes from the line of Eric Stine, with Northland Capital Markets. Please proceed.

Eric Stine - Northland Capital Markets

I just wondered if we could start with the finished goods. Definitely good to see that come down this quarter. I believe it was $1 million, and on the last few quarters it's been something that's kind of plagued you. Is this something we should think of as kind of the norm, that you've got that under control and that the product sitting on the dock is a thing of the past?

Darren Jamison

I would love to say that, but I think honestly we continue to be a lumpy business. If you remember, last quarter we decided that it was a new norm and we were going to back off our production slots. Of course, the second we backed off from production slots our C30 and our C65 demand increased and we actually struggled to get product out at the end of the quarter. We've got a pretty good pent up demand for Q3, especially on the C65 front. So you saw very little to no C65 and C30 orders sitting on the dock, and I think you're going to see the same for this quarter. C200 and C1000 is a little more hit and miss as these bigger projects based on permitting and construction schedules can bounce around. So hopefully it gets better. I think as the economy gets better it will get better, but we really have to manage our production spots on a quarter to quarter basis to maximize our inventory turns and not end up with too much finished goods.

Eric Stine

And maybe just turning to DesignLine, you mentioned their financing. Can you give us an idea or some color on maybe the size of that? And you mentioned potentially some units that you might ship in this current quarter, what those numbers could look like.

Darren Jamison

It's not public information on the size of that financing, but it is enough to get their production ramped up. They really need to get to that one bus per day to execute on the 500 units they have in backlog, so the goal is to close this financing and immediately ramp bus production. So they've already talked to us about units this month. As soon as they close that financing and bring their account current we'll be shipping them product. So I think it will take them probably three to four months to get to one unit per day, or five units per week, but I think that's a level they should be getting to, probably by the end of Q1 2011.

Eric Stine

And just to clarify, those will be C65s now?

Darren Jamison

It will be more C65s than C30s, but it will be a mix. New York is going to C65s. Baltimore is still C30s. Charlotte is still C30s. The California properties are a mix. Denver I believe is C65s. Montreal I believe is C65s. Hawaii is a mix I believe. So really depends on the application. The larger 40-foot bus typically is a C65 and the smaller 30-foot bus is typically a C30.

Eric Stine

Okay. Maybe I'll turn to Origin Energy. Did you ship the last unit this quarter? And just wondering on the potential timing and size of the next order.

Darren Jamison

Yeah, we did ship the last bit of that purchase order, which was 130+ units in the quarter. That was part of our C30 shipments, so we are waiting for the next order. We've heard everything from 400 to potentially 1000 units. We're also working with several other coal seam producers down there on RFPs and RFQs. So we expect in the next if not Q3 and Q4, to have that order to be [inaudible]. And again, the size is to be negotiated.

Eric Stine

Two last questions. Just bookkeeping on op ex, little higher than the level I think we've talked about in the past. Is this $8.5 million, is that kind of the new level we should think about?

Darren Jamison

I think if you look at it the R&D expense was a little hot for the quarter. Some of that was just the projects that we have. We've got the three DOE programs, which we get cost recovery on. We had some other reliability and cost reduction programs that took a lot of engineering hours this quarter, so I think it's something you should see trail back down closer to $8 million, maybe $8.2 million.

Ed Reich

And we also had a bit of, like I said, professional expenses that were a little above plan. So those should go away, or they won't be recurring anyway, and we should be at $8.5 million or less for the rest of the year.

Darren Jamison

Yeah, I think somewhere between the $8 million and $8.5 million will back and forth. If you look at the actual sales expense and traditional expense it's very flat, and very well controlled.

Ed Reich

And then last one, just any commentary on how orders have been to this point in the quarter?

Darren Jamison

I'd say orders have been fairly normal. I think we've been satisfied with what we've had for the quarter. Last quarter the $14.4 million was great. It was a lot of 30s and 65s and small orders, which is nice. Obviously it's great to have large C1000 orders, but it's also nice to have a lot of singles and have a very diversified portfolio of customers who ship for the quarter. But I think overall we expect this quarter to be in line with Q2, if not better.


Your next question comes from the line of Shawn Severson with ThinkEquity. Please proceed.

Shawn Severson - ThinkEquity

You mentioned in the Q you talked a little bit about part shortages, delayed some shipping at the end of the quarter? Can you tell me what that was?

Darren Jamison

Yeah, as I mentioned earlier we dialed back our production slots because of high finished goods the last two quarters and when we did that we actually had some shortages on the C30 and the C65 production line. So we had to then go back and increase the production slots and try to pull forward parts shipments, specifically recuperators. Recuperators are our single most expensive part, so we tend to try to make those just in time. So obviously changing the production slots mid-quarter left us scrambling at the eleventh hour to get those units out. And we still did not get all the C65s out for the quarter that the customers wanted.

Shawn Severson

Okay, but it wasn't actually a shortage in availability, it was just what you had -

Darren Jamison

Absolutely. Just tried to match our production slots and increase our inventory terms and not have finished goods. If you look at it, when I came to the company three and a half years ago, we had less than one turn. We're just about closing in on three turns today. We really want to get that up to north of four, especially if we start to really ramp revenue from a working capital standpoint we need high inventory turns.

Shawn Severson

And just turning to the gross margin, maybe approaching it from a different way, looking at it from a contribution margin. It came down a bit in the quarter, but what do you think for the second half? Are you going to return to a 25%-plus type contribution margin in the third and fourth quarter?

Darren Jamison

We should drive that north of 25% by the end of the year. If you look at it we had a high amount of C30s and while those C30s were for Origin, which were a lower margin product even among our C30s, so I think as we get more C65s, 200s and 1000s in Q3 and Q4, you're going to see those margins improve. Plus, the cost reduction continues to come down and Mark could maybe speak to that. But basically we're on track with our cost reduction program. Our biggest challenge is shutting out one vendor, starting up a new vendor, without having a quality issue, a part shortage issue, making sure that we don't have any problems going forward.

Shawn Severson

And just a quick update on your credit situation with your distributors and with your customers? I know you've been trying to tighten it up a bit. Could you just give a little bit of an update on that? Would be perfect.

Darren Jamison

We've probably got more deposits during the quarter than any time I've been at the company. We're really trying to push deposits with orders and tightening the credit standards with our customers and lowering their credit lines if appropriate. Also, when we look at evaluating our distributors, the strength in their balance sheet is moving up the list on the critical factors. So I think you've got to combine market improving customers getting financing easier and our distributors getting healthier. But that being said, we still aren't satisfied with where it's at and had we been able to collect everything that was past due we would have been positive cash for the quarter. So a lot of collections to make and get our DSOs down.

Shawn Severson

Do you expect to prune some of these going forward? Do you have it in the plan to try to improve the overall quality of those customers so it isn't as much of an issue? Or do you think for now you kind of see if the economic conditions help bring them up and lift them into a better situation? Or are you going to be proactive on shedding some?

Darren Jamison

We're definitely being proactive on shedding ones that aren't performing or struggling financially. We just put up a new distributor in Canada. Our California distributor one of the keys was their financial stability. As we look around the world, not only are we getting opportunities into higher-caliber better distributors, but where we can trade up we definitely will do that. So I think we don't need more than the 95-100 distributors that we have today, but as we weed and feed we will move toward stronger balance sheets. Most definitely.

Ed Reich

The economy's still definitely playing a part for distributors who are doing that right now.

Darren Jamison

I think the economy is better, but it's still a challenge, and I think everybody pays everybody slower. I'm sure most of our partners would be saying the same thing, that we stretch payments. Everybody stretches payments. So I think as the general economy improves and we tighten up our credit terms and we look for stronger partners, that's going to drive our DSOs down.

Shawn Severson

I don't know if you look at this metric or not, but do you check the average size of your distributors? Not just maybe with your business, but with multiple lines or whatever, but has that been growing in the sense that your distributors are increasing in size and strength over the last couple of quarters? Or is this something more we should expect to see in the next few quarters versus the past?

Darren Jamison

I would say in the last, probably, two to three quarters you've seen us bring on some stronger, bigger distributors. That's probably a trend that we'll increase. But we also look at what markets they're in, their business plan. We definitely have small distributors that frankly are outselling the likes of UTC or WESCO or some of the bigger guys. So I think it's really about level of effort and balance sheet combined, and that's in the business plan, and that's really what we look for.


[Operator Instructions.] Your next question comes from the line of Walter Nasdeo with Ardour Capital. Please proceed.

Walter Nasdeo - Ardour Capital

Most of my questions have already been touched upon and you guys have done a nice job of answering. I would like to kind of chat a little bit about the breakdown in the C250s and 1000s and in the 30s and 65s, and how it seems like a lot of future business is revolving around the development on the 30s and 65s, with the HUVs and some of that stuff, the buses. Given the differential in the margin of those two different lines of products, how is the development on the larger ones going and the rollout of those? Is that meeting your expectation, or is there any issue there with how that's being adopted right now?

Darren Jamison

I would say our goal from a margin perspective is a 50% contribution margin on all of our products, whether it's a C30 or a C1000 or anywhere in between. We're definitely closer to that level on the C65 and the C200. The C1000 because of the overall package is giving us some challenges and the C30 just because of the pricing pressure in that small range is giving us challenges.

But I would very much expect that as we finish our cost reduction strategies over the next three to four quarters, we will be there on all the products with the exception of the C30, which is more dependent on probably this automotive version to really get the cost down to the level where we can sell them like hotcakes.

I think if you look at the opportunities, I think Eric brought up the coal seam opportunity for C30s. There's huge opportunities in coal seam gas for the small product. The hybrid vehicle market, the C30 and the C65, has huge upside. Now that being said we're seeing lots of one to two to three to five [megawatt] opportunities on the large side.

The C1000 because it's a more sophisticated buyer, buyers are more interested in total emissions, reliability, uptime, so we're seeing very nice growth in landfills in France. We're seeing good opportunities in coal seam and shale gas, offshore platforms. We're shipping C1D2 explosion proof C200s now to Petronas, Petrobras, [PEMEX]. So I think really we see a diversified portfolio approach across all of our market segments and market verticals and it's really a cost reduction strategy at this point and increasing inventory turns.

Walter Nasdeo

What's the average you're expecting to get the 30s to once you start squeezing cost out?

Darren Jamison

We haven't really got to that number yet, but again the goal would be 50% DMC. Without increased volume, though, we'd be lucky to get probably three quarters of that.

Walter Nasdeo

So a 50% DMC overall, on everything?

Darren Jamison

I think that's an important point I put in my script, is we continue to get more FPPs. We're up to closing on a million dollars a quarter in FPP business. That's 650 plus units worldwide under factory protection plan. The accessories and parts business is growing. We're very happy with the TA100 sales. We see the GE 125 kW zero-emission product has more upside for us. So I think the parts, service, accessories which is obviously high margin, north of 50% margin business, growing also helps us in the overall strategy.

Walter Nasdeo

I noticed backlog was down just a little bit quarter-over-quarter. Are you expecting to kind of add to that as we finish out the year, or are you going to just be working out of it?

Darren Jamison

I think we'll be working out of it a little bit. If we hit our revenue targets you should see north of $20 million revenue in Q3 and Q4 both, and frankly I wouldn't mind if backlog was two to three quarters worth of revenue. So we've been a little bit heavy on backlog because of the economy. I'd like to see the backlog turn a little quicker and so coming down a little bit's not a major issue for us.


And at this time I'd like to turn the call back over to Darren Jamison for closing remarks.

Darren Jamison

Thank you everybody. As I think about the quarter, as I mentioned we are a lumpy business, and it's always hard to evaluate our business, especially at the early growth stage quarter-over-quarter. But the best way for me to analyze the business is year-over-year. And if I look back at FY10, the second quarter versus the quarter we just closed, with revenue being up 22%, backlog up 41%, margins improving 20% from -19 to +1, R&D expenses down 13%, SG&A down 3%, loss from operations improving by 30%, lower inventories and higher inventory turns. It really shows that our business is improving year-over-year, that the management is focused, that the board's focused on our strategy of building a strong foundation in a strong company to leverage our growth going forward is taking hold and delivering dividends. So we're excited about this quarter. We're happy about this quarter, but as I said we are no way satisfied or stopping or resting on our laurels. We want to drive positive gross margins into high gross margins and positive cash flow into profitability. So we'll continue to work hard and I look forward to talking to everybody after the third quarter. Thank you.

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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.


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