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Executives

Jayme Brooks - Chief Accounting Officer and Vice President of Finance

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

James Crouse - Executive Vice President of Sales & Marketing

Darren Jamison - Chief Executive Officer, President and Director

Analysts

Eric Stine - Northland Securities Inc.

Sanjay Shrestha - Lazard Capital Markets LLC

Shawn Severson - ThinkEquity LLC

Walter Nasdeo - Ardour Capital Investments, LLC

Capstone Turbine (CPST) Q3 2011 Earnings Call February 7, 2011 4:45 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Capstone Turbine Corp. earnings conference call for the third quarter fiscal year 2011 financial results ended December 31, 2010. My name is Stacy, and I'll be your conference moderator for today. [Operator Instructions]

During today's call, Capstone management will be referencing slides that can be located at www.capstoneturbine.com under the Investor Relations section. At this time, I'd like to turn the presentation over to your host for today to Ms. Jayme Brooks, Vice President, Finance and Chief Accounting Officer. Please proceed.

Jayme Brooks

Thank you. Good afternoon, and welcome to Capstone Turbine Corp. conference call for the third quarter ended December 31, 2010. 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, February 7, 2011. If you do not have access to this document and would like one, please contact Investor Relations via telephone at (818) 407-3628 or e-mail ir@capstoneturbine.com, or you may view all our public filings on the SEC website at www.sec.gov or on our website at www.capstoneturbine.com.

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

These statements relate to, among other things, future financial performance in attaining profitability; the ability to reduce cost 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 in 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, bio-gas, UPS and hybrid electric vehicle markets; increased sales of certain key customers; the successful integration of the 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 the successful implementation of those relationships; the energy efficiency, reliability, and low cost of ownership of our products; and the expansion of 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 and 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 our products may be delayed or new products may not perform as we expect. If we 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 our 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 receivable could have a material adverse effect in 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 would 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 enhancements 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 be materially different from future results predicted or implied in such statements. We refer you to the company's Form 10-K, Form 10-Q and other recent filings with the Securities and Exchange Commission for a description of these and other risk factors.

Because of the risk 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 the events or circumstances after the date of this conference call or to reflect the occurrence of unanticipated events.

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

Darren Jamison

Thank you, Jayme. Good afternoon, and welcome, everyone, to Capstone's Third Quarter Fiscal 2011 Earnings Call. With me today is Ed Reich, our Executive Vice President and Chief Financial Officer; Mark Gilbreth, our Executive Vice President, Operations and Chief Technology Officer; and Jim Crouse, our EVP of Sales and Marketing.

Today, I'll start the call with a general overview of our third quarter results, and then turn the call over to Ed to review our financial results. Ed will then turn the call back to me, and I'll discuss what is happening in our key markets and update you on our progress on strategic objectives. We will be referring to slides today in our presentation, and they can be found on our Capstone website under Investor Rations.

The third quarter was an important inflection point for our company, our employees and our stockholders. Capstone achieved the following milestones and strategic objectives within the quarter. We set a new high for quarterly revenue with over $24 million shipped to customers worldwide. To put this in perspective, this is more revenue in one quarter than Capstone's annual revenue for all of fiscal 2007, or you can look at it as 50% higher than the same quarter last year. We had positive gross margins for the second consecutive quarter with a three-point improvement from last quarter. We continue to manage operating expenses and working capital while growing our revenue, and the leadership team held operating expenses at a level $1 million lower than the prior quarter.

The increased margin and lower operating expenses combined to reduce the overall operating loss of $2 million from Q2 over last quarter levels. We further reduced our inventory another 16% or $3.5 million from the second quarter as we continue to leverage our just-in-time and CONBON manufacturing programs.

We continue to improve inventory turns at 3.8x or turns against management's goal of 4 turns. As some of you may remember, inventory was turning less than 1 turn when I came to the company four years ago. However, by far the most important milestone for the quarter was that Capstone generated over $4 million in positive cash flow from operations during the third quarter.

And in addition to that, Wells Fargo released $2.5 million restricted cash on the good results and continued our compliance with our bank covenants. This marks the first time in Capstone's 20-plus year history the company generated positive cash flow from business without a secondary stock offering or some other form of outside investment. Our cash balances increased $7.2 million for the quarter from $20.2 million in the second quarter to $27.5 million at the end of the third quarter.

I think these facts bear repeating, and I have summarized them on Slide 2. Capstone not only achieved record revenues, record positive gross margins, with lower operating expenses and the company generated positive cash from operations for the first time in its 20-plus year history. Therefore, if you add back the remaining Wells Fargo $2.5 million restricted cash, Capstone had approximately $30 million in total cash on December 31.

Obviously, generating positive cash is a significant milestone for our company had a direct result to management's ongoing strategic plan to lower material costs, increase average selling prices, increase revenue, build a high margin customer service business, lower inventory levels and speed up receivable collections. This has been a long anticipated milestone achievement for Capstone's management team and loyal shareholders.

More than ever before, we can all clearly see the path we're working here for profitability and sustainability for our clean and green microturbine technology company. However, as ecstatic as I am and encouraged as I am with our third quarter results, I am by no means satisfied nor will this management team rest on its laurels and stop working 24/7 on behalf of our employees and our shareholders to continue to strengthen and grow this great company.

Now let's talk about new business that will drive our revenue for future quarters. We shipped a record revenue out of our backlog. The backlog actually increased in the quarter from $84 million to $85 million as bookings were very strong in both the U.S. and abroad.

Let me take a minute and dig a little bit deeper into the numbers and the positive trend lines we are demonstrating in our business. The gross profit for the third quarter was over $900,000 or 4% of revenue, which is a solid improvement over last year's third quarter gross loss of negative 3% and a nice follow-up to last quarter's first-ever positive gross margin of $100,000. However, the most encouraging is now we have positive gross margins on a year-to-date basis through the first three quarters and are on track to eclipse last fiscal year's $8.4 million gross loss and negative 14% gross loss.

Revenue for the quarter was an outstanding $24.2 million as production continued through both the Thanksgiving and Christmas holidays to meet increasing customer demand. This new record revenue is up $5.3 million from last quarter's record of $18.9 million, which was up from $2.8 million from the prior quarter.

Obviously, this indicates an excellent growth trend, and it extended our winning streak to 15 consecutive quarters of revenue growth over the same period last year as shown on Slide 3. As I say every quarter, I don't know how many companies have a similar 15 quarter-over-quarter winning streak, but we have to be keeping very elite company in today's difficult economic times.

I cannot say enough about what this management team did to generate positive cash flow for the first time in company history. The team has battled hard to grow the business in the difficult market, worked hard to lower inventory levels, working hard to improve our reliability, all while cutting in new vendors with lower price parts and tightening our credit and collection cycles.

Our net bookings for the quarter were strong. In fact, approximately 40% higher than last quarter at $20 million, increasing our total backlog approximately $1 million despite the record shipments. If you look at our order trend starting Q1 this year, orders have gone from $11 million to over $14 million to now $20 million in just the last three quarters.

Slide 4 demonstrates the continued strength in our product backlog and the strength of our new C200 and C1000 series products. Capstone's $85 million in product backlog sets the stage for continued revenue growth into the coming quarters. At the end of the third quarter, our FPP service backlog was at $26 million and our FPP service revenue should surpass the $1 million per quarter mark in the fourth quarter. As I've outlined on previous calls, we expect our growing revenue in our large product and service backlog to drive our company beyond our near-term achievement of positive gross margins and propel us to profitability as we continue to focus on cost reduction programs, increasing our average selling prices.

Slide 5 shows this quarter against the backdrop of our profitability model. It should be very obvious that the key to our profitability is continued execution against our 30% direct material cost reduction program and flowing the 21% product price increases through the backlog to increase our average selling prices.

If I have any disappointments about the quarter, it would be that we did not cut in as many lower price parts as we planned and as a result, gross margin was not as high as it could have been in the quarter. However, it's important to note these material cost reductions are not lost for the timing of the realizations slipped to the right because of various delays including first article testing, oil field [ph] upgrades or third-party like UL certifications.

As we measure against continued slippage of these critical cost reduction programs, I've created a new position of Vice President Program Management reporting directly to me. This new leadership position will be responsible for executing on time and on budget against our cost reduction programs, reliability improvement programs and our new Department of Energy product development programs. I am actively interviewing several top level candidates today, and I expect to announce this important new member of our Capstone leadership team very shortly.

I'll now turn the call over to Ed to review the specific financial results. Ed?

Edward Reich

Thanks, Darren. Good afternoon, everyone. I'd like to provide you with our financial results for the third quarter of fiscal 2011, which ended December 31, 2010.

Let's begin with a recap of the major items on our balance sheet and their changes from the second quarter. Accounts receivable was $22.6 million at the end of the third quarter, which was down $2.1 million from the second quarter,all while revenue was improved by $5.2 million. We collected over $26 million in receivables during the third quarter, which was the second quarter in a row of significant collections of outstanding receivables.

I noted in last quarter's earnings call that we are continuing to experience payment delays and heavy end-of-quarter shipments, both of which were affecting the cash collection cycle. While we experienced heavy end-of-quarter shipments again this quarter, they were improved from Q2 and our payment issues are improving as well. As a result, I expect that the DSO will reflect our efforts over the coming quarters.

We made excellent progress in managing and reducing inventory during the third quarter, decreasing inventory $3.5 million from the end of the second quarter, with a total reduction of $4.9 million over the last two quarters. Our ending inventory was $18.4 million, with inventory turns of approximately 3.8x, which was a 1x improvement from the end of Q2. We are very close to our goal of 4 turns per year, and I would like to congratulate the team for their efforts in getting us to this point from less than one turn per year the company was operating at not that long ago.

Accounts payable and accrued expenses were $17.3 million, increased from the second quarter balance of $14.5 million primarily on higher inventory purchases to meet higher sales demand. Cash balances, including restricted cash, were $30 million at the end of the third quarter, compared to $25.3 million at the end of the second quarter. This is the first time the company has ever generated positive cash flow from operations. It was accomplished through disciplined management of working capital accounts, improving margins and controlling operating expenses.

During our first and second quarter calls, I outlined the restriction of $5 million and its reclassification from cash to restricted cash in our balance sheet as required by the amendment of the Wells Fargo credit agreement, and that we were in discussion with Wells Fargo pertaining to the release of all or a portion of the restricted cash. During the third quarter, the bank released $2.5 million of cash collateral. The bank has agreed in principal to release another $1.25 million upon the filing of Form 10-Q today, with the remaining $1.25 million to be released following the filing of results for our fiscal year end 2011 10-K assuming that we remain in compliance with our covenants.

Revenue for the third quarter was $24.2 million, up 28% from the $18.9 million in Q2. We shipped 171 units during the quarter compared to 174 units last quarter. Please refer to Slide 6 to see the effect of the mix on the average selling price and direct material costs. Gross margins were positive for the second consecutive quarter coming in at $900,000 or 4% of revenue, compared to $100,000 or 1% of revenue from the second quarter. The improved gross margin was the result of increased average selling prices and higher overall revenue.

Now let's move to operating expenses. R&D expenses were $1.4 million for the third quarter, an improvement of $600,000 or 30% better than the second quarter. R&D expenses were lower as a result of decreased labor, nonrecurring engineering expenses that were lower and the higher cost sharing benefits. Our selling, general and administrative costs were $6 million for the quarter, down $600,000 or 9% from the second quarter as a result of recruiting fees that we incurred during the second quarter as well as lower administrative and travel expenses in the current quarter.

Our net loss was $8.1 million and $0.03 per share for the third quarter of fiscal 2011, compared to a net loss of $1.9 million and $0.01 per share for the second quarter. You have to remember though that the net loss reflects the adoption of Accounting Standards Codification 815, Derivatives and Hedging, which affects our accounting for warrants with certain anti-dilution provisions. We recorded a noncash expense of $1.2 million to warrant liability during the third quarter. The net loss and the corresponding loss per share before the effect of the new warrant accounting was $6.9 million and $0.02 per share, respectively. Please refer to Slide 7 for reconciliation.

Backlog at the end of the quarter was $84.7 million, increased $1.2 million from the second quarter. With a strong order flow during the quarter, booking $20 million, which was an improvement of $5.6 million from the second quarter. This year's results continue to be encouraging as this quarter we saw another significant improvement in revenue, margin, new orders and cash. We need to continue in the positive direction we've established and continue to focus on completing our cost reduction program to obtain profitability.

That concludes my comments on the third quarter results. I'll now turn the call back over to Darren.

Darren Jamison

Thanks, Ed. The encouraging sign of the economic recovery is we continue to see healthy quotation and order activity in all four of our market segments, which is reflected in Slide 8. I specifically continue to be enthusiastic with the increased activity in oil and gas, shale gas, bio-gas, traditional CHP and hybrid electric vehicles markets.

As you can see from Slide 9, we have a $14.6 billion addressable market with our innovative clean and green microturbine products. Management believes if we can continue to execute against our business plan and market strategy, the company can some day potentially capture $1.5 billion of that $14.6 billion market, as also illustrated in Slide 9.

Our recent success in the U.S. shale market is evident of how we can quickly capture market share after customers start adopting our new products. We went from little or no revenue in the U.S. shale plays to selling $10 million in less than six months. We have now seeded products today in great companies like El Paso Gas, Pioneer Natural Resources, Anadarko Petroleum, Chesapeake Energy, CONSOL Energy and both the Marcellus and Eagle Ford shale plays.

These marquee customers and these key victories will help us break into other shale plays and competing shale gas companies like ConocoPhillips, Capital Oil, Forest Oil, British Petroleum, Murphy Oil and EOG Resources just to name a few. In addition, we also received over $6 million in U.S. orders from our two new distributors in California and from E-Finity in the Mid-Atlantic region.

One of our goals is to lower the imbalance between international shipments and domestic shipments, which has historically has been 70% international and like 30% domestic. This imbalance will continue to improve when we have shipments to several of our historically key partners like UTC Carrier, OfficePower, PowerTherm/WESCO and DesignLine. Both DesignLine and PowerTherm/WESCO are scheduled to take products this quarter, and we recently received a five unit order from UTC Carrier we expect we'll ship in the next quarter next year. This is the first order from UTC Carrier in more than a year.

I continue to be encouraged by UTC Carrier as they are actively working sales opportunities and appear to have a growing project pipeline. OfficePower has close another round of funding and indicates they have several New York projects that should be underway this summer. The continued success in the shale plays, combined with DesignLine, UTC Carrier, OfficePower and PowerTherm/WESCO and our new California distributors should help boost our U.S. business and positively impact our overall shipment imbalance going forward.

Now let's talk about what you should expect to see from Capstone in the fourth quarter and end of year. Capstone will hopefully finalize negotiations with one of our two potential automotive partners on developing an automotive version of our C30 product. Capstone will begin the Class 7 electric truck performance demonstration program that we have ongoing with a major U.S. heavy-duty truck manufacturer, who is evaluating whether or not to add electric vehicles with microturbine range extenders to its product line.

Slide 10 shows how the microturbine and new Capstone Parker Hannifin Drive System Solution are being integrated in the truck. Capstone will continue to work on the marketing launch and new product acceptance of the exciting new marine microturbine program, and the UPS data center product launched in last year will help two of our strategic partners. Capstone continue to focus on the U.S. shale plays and leverage our overall oil and gas experience both onshore and offshore worldwide.

Capstone will continue to focus heavily on material cost reductions and improving our average selling price as we continue to build margins as we look to become profitable over the next several quarters. Capstone will continue to tightly manage inventory levels using just-in-time and CONBON in an effort to push our turns from the 3.8x that we are today to management's target of 4x and beyond. We will continue to work our receivable collection efforts and enforce customer deposits to generate the most favorable working capital possible to limit the cash burn as we grow revenue and drive towards profitability.

Capstone will continue to apply for new certifications and develop new applications to better leverage our product architecture and to as many opportunities in market verticals as possible to drive top line growth and leverage our fixed cost structure. Capstone will continue the flexible fuel development program, the C250 and C370 programs, and externally fired microturbine program as highlighted on Slide 11 to take advantage of our several DOE grants and get these exciting new products into the market. Capstone will continue to process what we call weeding and seeding of our 96 distribution partners to help each Capstone franchise generate our targeted $3 million in annual revenue.

Management's goal in the fourth quarter is simple: continue to drive quarterly revenue growth, further improve gross margins, increase inventory turns of management's goal of 4x, improve receivable collections to keep the cash burn at targeted levels until we reach our short-term goal of profitability and sustainability.

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

Question-and-Answer Session

Operator

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

Sanjay Shrestha - Lazard Capital Markets LLC

So in the slide, you guys talked about sort of $25 million revenue run rate and the target margin of three, four quarters out. And you pointed out that the direct material cost hasn't fallen as much as you would have liked to. So how should we then think about the inherent profitability in your existing backlog right now? How should we think about that?

Darren Jamison

Well, obviously, Sanjay, the backlog, we've had three price increases over the last two years. So the backlog is made up of both old and backlog that's got one to two to potentially even brand-new price increases in it. So as the backlog rolls through the next two to three quarters, that backlog will freshen up and become obviously more profitable from an average selling price. On the material cost reduction side, you're right. We didn't get as much cost cut in during the quarter, but we still made significant progress. Our enclosure manufacturer shipped new lower price enclosures that we cut in this quarter. We signed a new agreement for our C200 recuperator, which will cut in, in March. So those are two of our biggest cost reduction activities that will happen this quarter. For Q4 and Q1, you should start to see more benefit. Also, mix makes a difference. We didn't have a lot of oil and gas units in the quarter, so that hurt us a little bit from the margin side, also, working both Thanksgiving and Christmas holidays hurt us some from an overtime, double time perspective.

Sanjay Shrestha - Lazard Capital Markets LLC

So it's fair to say though that the days of negative gross margin is completely behind the company, right? Directionally, the rate of margin expansion is a function of all things hitting the right way. But we're probably not going to go back to the negative gross margin today given where the backlog is.

Darren Jamison

Correct.

Sanjay Shrestha - Lazard Capital Markets LLC

So with the faster burn, a lot of the end markets picking back up, how should we be thinking about your backlog going forward from a revenue coverage standpoint? And sort of help us understand what are some of the big prospects. Great to hear UTC Carrier comment here, and would love to actually get some more granularity on this automotive partners that you guys talked about as well. So if you can sort of tie that new bookings opportunity with how should we be thinking about your backlog especially in light of all these markets picking up?

Darren Jamison

Sure. if you look at the backlog the last two years during the recession, we really took about a year to turn the backlog each fiscal year. So with the backlog, we started the year with at about what we finished for revenue for the year. As things improve, we're expecting the backlog turn to be three quarters and eventually two quarters. So our goal to turn the backlog every two quarters, and I think you'll see the backlog turn speed up or increase in the next couple quarters. And the other point you said as far as the big orders, we have lots of quotation activity out there, a lot of large customers looking at the product. I think the shale gas market is a great example of how a market we had no penetration and we very quickly get penetration as people understand the features and benefits of our product. We still look for great things out of Australia, once they get out from underwater. South America, Columbia especially looks very good. Mexico is picking up. Europe is coming back nicely. Our Russian distributor continues to just knock the cover off the ball and get very well. So overall, the market in general looks very good. I'm very happy with our California distributor, both of them are doing well. We're continuing to make some changes and tweak the distribution around the world. But for the most part, we are on a weed and seed stage. I think that the last part of your question was the automotive licensing agreement. They actually -- one of the two companies will be in our offices tomorrow. We continue to negotiate very hard and push very hard to get at least one of the two cross the finish line. I'd be disappointed if we did not get that done, at least one of them this quarter. So I think we're very close. We're working very hard. Obviously, the more we talk about it, the worse it helps our bargaining position though.

Sanjay Shrestha - Lazard Capital Markets LLC

How should we think about the ramp up with the UTC now that they are back again after a year and starting in pretty nice positives? How should we think about that?

Darren Jamison

I still think it's going to be slow. I know Jim is very hopeful. We're seeing them do the right things, but my guess is we're probably still a quarter or two away before they start adding significant volume to our business. I think the same thing, DesignLine didn't build a bus for almost a year. They're struggling with some of their contracts that they're potentially delinquent on. But I think both of them and some of other partners will ramp up over the next couple of quarters. So I'd look more for shale gas opportunities and some of our European and South American distributors to carry the weight at least for another quarter or two.

Operator

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

Shawn Severson - ThinkEquity LLC

I was wondering if you could talk a little bit more about the shale plays specifically in the U.S.? I mean, it just seems to me like, I mean, certainly it's been great. You've been getting volumes there in some marketplace. But would you characterize most of these sales to date as kind of pilot programs or test programs? Obviously, if you look at the number of wells and the opportunity out there is huge. And I'm just trying to understand, are these guys going through a process of trials with you where they'll put a few in the field to see it work and come back and order 100x what they've done in the trial. I'm just trying to understand where this process is?

Darren Jamison

Yes, Shawn. Let me hand it over to Jim who is in the room with us today. I'll let him answer that.

James Crouse

Hi, Shawn. I think what we're starting to see is a couple of reasons for it. First one is truly environmental. A lot of our customers in the shale play are seeing increased pressure on the environmental side, not just emissions, but water regulation and everything associated with the drilling and capture of the shale oil and shale gas. And they're going out of their way in some cases to be as environmentally friendly as possible. The orders that we have to date are not pilot projects. We have a couple of customers that have jumped in with both feet and deploying the technology for the reliability. Most of them were stand-alone. So there is no utility power either readily available or quickly available. So they're choosing to deploy our technology for both the emissions, environmental friendliness and their reliability.

Darren Jamison

Another important point we're seeing is that we did a couple early, call them, pilot projects a year ago. Now these customers can go visit a site that's got a year of operations. That's really helping us get more penetration in the market. Oil and gas companies don't move quickly to new technologies. But if they can visit a site that's got some good maintenance records and good history, then that helps them make that kind of decision.

Shawn Severson - ThinkEquity LLC

Yes, so that's the way I was kind of thinking of it is that they're huge market opportunity. But they're going to, I mean, I guess, some have jumped in with both feet. But I would think they most would have wanted at least a year of operating history on this stuff in the field before they would make any larger scale decision with how they're going to move forward on new wells.

Darren Jamison

Correct. Yes, and I think it just depends on customer size and activity. I think we mentioned before at Origin Energy, they're kind of first bite at the apple was 130 units. I mean, that's pretty big for us. But for a large company, that's fairly small compared to the opportunity. But we're very excited about it, and we're making sure these sites get started up and perform very well and make sure they have very good customer satisfaction. So hopefully, we'll get a lot of repeat orders out of it.

Shawn Severson - ThinkEquity LLC

And have you guys scaled that market? I mean, have you looked to see what the market opportunity is there? I mean, do you have an idea if you got 5%, 10%, 15% penetration in some of the shale markets what that would mean in terms of units or kilowatts, however you want to look at it?

Darren Jamison

We've done a little bit of work out. I think if you go to our pie charts in the presentation, you can see that the oil and gas market is one of our bigger slices, and we believe our penetration as a percentage can be higher in those markets. The reality is we're getting everything from single C30s and 65s [C65] up to multiple megawatt per site. So it could be, in the coming years, beyond dozens into maybe 100 megawatts in annual opportunities. So it's definitely big. We're taking market share away from traditional customers like Caterpillar and GE, Vanderweil and Waukesha. So I think the ability to leverage that with successful installation is really going to be key.

Shawn Severson - ThinkEquity LLC

And then in talking with a range of companies from an SPX to an Emerson, whoever, over the last couple of weeks, the raw material issue is definitely at the forefront of everybody's mind and really what's going to happen there. I know it's not a huge part, but could you address some of the issues with steel and aluminum and some of the other things that are out there because certainly a factor for a lot of companies and becoming more so.

Darren Jamison

Yes, I think the good news there is our power-to-weight ratio is superior to our competitions. So they're much bigger and heavier than we are. So as raw material prices go up there, the impact on them is much greater than it is on us. Mark is sitting here, and we're not seeing little of any impact. In fact, our increasing volumes are overshadowing any kind of material price increases we're getting. So not that we're not watching it, but it's not a concern for us today. In fact, it could be a competitive advantage for us.

Shawn Severson - ThinkEquity LLC

Yes, sounded like it could be an advantage actually. But just in the quarter, I'm sorry if you already mentioned it, but what was the kind of the warranty and service contribution for the quarter?

Edward Reich

Yes, accessories, parts and service was about 22% for the quarter of total revenue.

Shawn Severson - ThinkEquity LLC

22% of total revenue. And that's going to -- is that a steady state for you? I mean, you're attaching -- I mean, I guess I would ask another way. So you're attaching service contract to what percentage of the new units you're selling now? And then where would you expect that to get over time? Because obviously it's a big margin contributor. So is it going to stay at about a quarter of the revenue or is it going to move up or down relative to that?

Darren Jamison

This is Darren, Shawn. Historically, we've seen overall about 15% capture rate. We expect that to be as high as in 40%. We'd like to get up to those levels. I think the good news is almost all of our key distributors worldwide have some level of factory protection plan. And even if we don't get the business from an FPP standpoint, we're still getting it from a parts standpoint. So if you look at the FPP revenue, I mentioned in the script we're up to $26 million in backlog. And we should see for the first time $1 million in quarterly FPP revenue this quarter. So to give you an idea kind of the way we're pulling it out of backlog on an FPP side. We're looking to aggressively grow that part of our business. We've got a new service organization opening up in Singapore. Our U.K. service office is open, and we've got a Eastern New Jersey office as well. So the service group is growing very quickly. We expect that capture rate to improve, but our parts and regular service and FPP contract service were very good for the quarter overall.

Shawn Severson - ThinkEquity LLC

And how does that interact to the distributor? I mean, is the distributor highly intensified to sign you guys up for service contracts? Are they doing that themselves? Is that your competition in some of the distributor and they're just buying parts from you?

Darren Jamison

It's really just customer education, convincing the customer not to do the service work themselves or not buy on an ad hoc basis. We show folks that not only does it kind of lock in their long-term service cost, but it helps them plan and manage their business better. And the customers that we have under FPP see probably 3% to 4% better up-time than if they don't. So I think that we also show them that they make more money by having us do that FPP work.

Operator

[Operator Instructions] Your next question comes from the line Eric Stine with Northland Capital Markets.

Eric Stine - Northland Securities Inc.

I'm just wondering if we could stay with the shale opportunity, and that was helpful that you talked about kind of the potential size. But I'm wondering what we should expect as far as follow on? Is this something that we should think about as being potentially 10 megawatts plus and be very lumpy? Or is this something that is becoming more just part of regular purchasing patterns in 3 to 6 megawatt chunks?

Darren Jamison

It should be similar to our oil and gas business. As you look at our oil and gas both offshore and onshore, the biggest customer users today, concentration we have today, is TIMEX, Petrobras, Petronas. I think the largest now is Gazprom and then Origin Energy. The Colson gas producers is in there in the top five or six as well. Those folks have multiple projects in the pipeline, the long-term projects that they work on. They buy power generation equipment everyday. So I think it will be maybe lumpy just because of some of the sizes of the orders, but we should expect to see orders every quarter and shipments every quarter. Also, we've seen some of these recent orders they want the product fairly quickly. And so we work to add production slots or move slots around to make them happy and give them the date they want. But we've seen, I think, at least three of the names I mentioned in the call have ordered the second time, and I think one of them even a third time. So we would expect multiple follow-on orders and fat order every quarter from each one, I would think something pretty close. I think Gazprom, the same thing. They're taking product every quarter. TIMEX, Petronas, Petrobras, same thing.

Eric Stine - Northland Securities Inc.

But can you just handicap on the price increases and also the cost reduction? What inning you'd say you're in right now?

Darren Jamison

I was joking with Ed that we have to have my inning for Eric, so I thought I'd give you the seventh-inning stretch is where we're at. So no, with all seriousness, we made progress during the quarter. I know it doesn't look like it's clearly to the street as it is clear to us. But we've got a lot of stuff moving through the process and a lot is going to come in the next two quarters. And we got to be very careful that we don't impact our reliability and hurt our momentum here. We actually had an incident two quarters ago, but fortunately, we caught very quickly. But we had a heat shield vendor use the wrong material, and we almost had a material get out of here that would have been detrimental to our reputation. So we have very tight manufacturing tolerances and very specific material requirements. And so when we go to new vendors, we have to be very careful that we make sure that we go to the quality inspection process. I think the other piece that's been a little bit disappointing to us has been certification. Most of these cases, we had hope to do UL certification through analysis. And more often than not, we have to actually go through and do the testing for UL, which is outside of our schedule and can be a little more time-consuming than just we're doing it by analysis. But all part of the process, and we're not making excuses. We're dedicated to getting it done, getting it done as fast as possible without impacting our reliability and our reputation.

Eric Stine - Northland Securities Inc.

Right. So just to clarify, you're not saying seventh inning. You're saying -- I mean, it sounds like from your prepared comments, you're early on in the process, maybe middle innings or earlier on the cost reduction side.

Darren Jamison

No, I think we should -- most of all in the fields are in place. We have parts coming in. We're down to certification and timing of cut ins. I mean, we're down to the last couple innings.

Eric Stine - Northland Securities Inc.

And we should start seeing it here going forward?

Darren Jamison

The next two quarters you should see it. We should be done within three quarters, and we're very close.

Eric Stine - Northland Securities Inc.

Maybe just switching gears to the waste heat recovery generator. Just curious now that that's a GE-branded product, just curious how that's changed the conversation with customers? Does it help to have that as opposed to Calnetix?

Darren Jamison

Let me pass that ball over to Jim as well.

James Crouse

Certainly, having GE buy Calnetix from a brand standpoint is helpful. Although, with any acquisition and transition, there's a period of time where the players are reshuffled. And I think they've lost a little momentum and a little structure on their end that we're now getting back to -- I think you'd probably saw the press release where we had a C800 and ORC go to a customer in Mexico. We've got a couple of units being installed in France in landfills. And we're starting to see good and consistent opportunities in that part of the business.

Eric Stine - Northland Securities Inc.

Just SG&A, very good quarter there. It sounds like though cost sharing programs, is that something we should see pick up a little bit? Is that the way to read through the comments a little bit?

Edward Reich

Right now, Eric, we're focusing on reliability and cost reduction programs. And so that's our focus on the DOE program. But yes, we're still planning on getting them done. We're just pushing them a little bit. So we expect to get more cost reduction in some of the near-term quarters.

Darren Jamison

Yes, the way we look at our internal program is reliability is first, cost reduction is second and then our new product development is third from a staffing and resource perspective. The new position I'm hiring to bring in to manage our programs hopefully will get us more efficient internally and we can move through some of these programs quicker. But I would say I agree with Ed and maybe some work in Q4, really as we wind down the cost reduction activity, those resources will be moved on to the DOE programs and those will accelerate middle of next year.

Eric Stine - Northland Securities Inc.

So SG&A, that maybe should pick up here --

Edward Reich

It was a good quarter. It could run a little higher. But like we said, our plans are to keep our total OpEx down below $8.3 million.

Eric Stine - Northland Securities Inc.

So no change there?

Edward Reich

Not significant.

Darren Jamison

We had a very good collection quarter. We still have about $4 million of kind of slow movers out there that we need to bring in. There's still some work we can do on the inventory side to bring inventory down and there's still some older receivables that we can get pulled in. So we're working hard to make sure that we continue to have as positive working capital as much as we can.

Operator

Your next question comes from the line of Walter Nasdeo with Ardour Capital.

Walter Nasdeo - Ardour Capital Investments, LLC

I'd like to go back over to the distributors again and get a little bit of clarification if possible. You said you had 96 distribution partners. Is that a correct number?

Darren Jamison

That is correct. When I joined Capstone, I think we had 24, 12 of which had bottomed last year. We're up to 96 now. We got a little over 20 in the Calnetix acquisition. But yes, we're sitting in about 96 partners. About 40% U.S., 60% outside the U.S.

Walter Nasdeo - Ardour Capital Investments, LLC

How do you break down revenue generated by -- I mean, I got to imagine that you've got a really skewed bell curve here where you've got a handful that are really high producers and then just a bunch of guys in the middle. Is that correct or...

Darren Jamison

Yes, I think you've got probably three buckets. You got one bucket that are the more mature distributors that were either here when I got here. Jim signed up in the first year. He came on board. Those folks are hitting the ground and getting orders every quarter, doing well, growing their business, reinvesting into their business. You've got a second group that probably is either came over on the Calnetix acquisition, or we've set up in the last year that are just kind of getting up and going and running. And then the third group that maybe has been around for a while and that aren't performing the way we wanted them, and those are the ones we're focusing on and kind of the weed and seed stage. So I think our goal is to keep every distributor we can, but a lot of their contracts are three-year contracts. They're coming up now. And if they aren't performing to a level of their business plan, then we're working to either rectify that situation or move to other distributors. So I mean, our goal, as I said in the prepared comments, for their franchise to make sense and to do all the marketing and lunch and learns, trade shows and hire the personnel they need and to be a lucrative business for them they should be doing $3 million annually in our products. So if they're not doing that, it's not beneficial for us or them. So that's a lot of what we're doing right now. We have a few gaps in distribution in Africa and a few parts of the world. But for the most part, it's really just managing the current channel and different partners.

Walter Nasdeo - Ardour Capital Investments, LLC

How much effort or time are you willing to put in on that third bucket? I mean, when does it come to the point of just say, "hey, you know, we need to move on"?

Darren Jamison

No, we replaced a California distributor. We made some tweaks on the East Coast. We replaced our Canadian distributor. So if we believe the market is there and they're not investing the time, effort or money, then we move on. And our contracts are fairly clean cut and keep us out of litigation, but we have no problem cutting off a bad partner or making them a sub dealer of a new partner. If they have a limited niche market that they've done well and that the overall market has not done well, then we put them as a sub dealer to the new distributor. So I think for the most part, you got to realize these contracts or these projects are six months even a year gestation period. So a lot of distributors that are new are just now getting into their second round of projects and opportunities. We're also pushing harder for down payments and trying to move to better capitalize businesses or distributors wherever we can.

Walter Nasdeo - Ardour Capital Investments, LLC

So you mentioned East Coast, how are things distributor wise over here now? I mean, what's going on with your New York distributor or anything else here on the East Coast?

Darren Jamison

Our Mid-Atlantic distributors are probably our best distributor today out of Philadelphia. Our New York distributor we're in process of moving to a dealer and then putting a new distributor in place. So New York is, I would say, performing the best it has since I've been here in the four years but still not up to expectations. California is starting to hit and also doing well. Mid-Atlantic, I mentioned, is also doing well. The kind of New England area is okay, but could be better. So I think the U.S. is performing better, but we're still not completely happy. And Jim's put together a very detailed kind of model distributor or model franchise program. So we very easily sit down with these distributor principles and say, "here is all the things you should be doing, what are you doing. And if you're not doing all these activities, then you're probably not going to be as successful as you need to be and neither one of us are going to make the money we want to make".

Walter Nasdeo - Ardour Capital Investments, LLC

As things are growing, you're going into these different markets and it really looks like there's a maturation process going on within the company. Are you going to be bumping up against any capacity challenges here in the foreseeable future?

Darren Jamison

No, not at all, just the opposite. If you remember, Walter, we went public and had a lot of cash at one time and had two manufacturing plants and a whole bunch of capacity. Our biggest issue is, growing pain wise, is just been getting vendors to match the pace of our growth. I mean, it was a couple quarters ago, we're doing $15 million in revenue and now we're bumping up on $25 million in six months. So a lot of distributors didn't ramp as fast as we'd like them to ramp, and that's probably our biggest issue from a capacity is just vendors keeping up with us.

Walter Nasdeo - Ardour Capital Investments, LLC

And then just one quick housekeeping, what were the days sales outstanding?

Edward Reich

What was that?

Walter Nasdeo - Ardour Capital Investments, LLC

DSOs?

Edward Reich

92 [days].

Operator

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

Darren Jamison

Thank you. I guess, in conclusion, I'd like to say thanks to all the Capstone employees that worked hard over the third quarter. I know it's hard to be away from your families during the holidays, but I really appreciate them taking the time and effort to work the hours needed to meet the growing demand for our product.

The entire management team and Board of Directors are extremely focused. I think the good news is everything that we need to do to improve and mature this business is within our control. The revenues are growing at a rate to sustain our business. It's really about cost reduction and moving the ASP through.

So we're very focused on it. We'll continue to work hard. We're very excited about the fourth quarter and the coming new fiscal year and continuing to show the progress and the positive direction of this business. So with that, I want to thank everybody, and we'll talk to you after the fourth quarter.

Operator

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

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