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Capstone Turbine (NASDAQ:CPST)

Q1 2012 Earnings Call

August 09, 2011 4:45 pm ET

Executives

Jayme Brooks - Chief Accounting Officer and Vice President of Finance

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

Darren Jamison - Chief Executive Officer, President and Director

Analysts

Eric Stine - Northland Securities Inc.

Shawn Severson - ThinkEquity LLC

Unknown Analyst -

Walter Nasdeo - Ardour Capital Investments, LLC

Operator

Good day, ladies and gentlemen, and welcome to the Capstone Turbine Corporation Earnings Conference Call for First Quarter Fiscal Year 2012 Financial Results ended June 30, 2011. My name is Stacey. I'll be your conference operator today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. During today's call, Capstone management will be referencing slides that can be located at www.capstoneturbine.com under the Investor Relations section. I would now like to turn the presentation over to your host for today, Miss Jayme Brooks, Vice President, Finance and Chief Accounting Officer. Please proceed.

Jayme Brooks

Thank you. Good afternoon, and welcome to Capstone Turbine Corporation's Conference Call for the first quarter ended June 30, 2011. I am Jayme Brooks, your contact for conference call. Capstone filed its quarterly report on Form 10-Q with the Securities and Exchange Commission today August 9, 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 can view all of 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 continue to reduce cost and improve inventory turns and contribution margins, the ability to reduce cash usage, higher average selling prices, continued growth in current market condition; 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 spending of our products; growing market share and market adoption of our products; new applications for our products; growth in the oil and gas and hybrid electrical vehicle market; increased opportunities in Japan; revenue growth and increased sales volume; our success in key market segments; our ability to enter into new relationships with channel partners and distributors and other third parties; the energy efficiency reliability and low cost of ownership of our products; and the expansion of production capacity, manufacturing efficiency and improved relationships with suppliers.

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 continue 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 can make it difficult or impossible for us to raise necessary funds and for 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 at reasonable prices; if we fail to meet all applicable NASDAQ global market requirements, and NASDAQ determines to delist our common stock, the delisting could adversely effect 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 receivable and increased bad debt expense or delays in collecting accounts receivable could have a material adverse effect on our cash flows and results of operations; our release of new products may be delayed or new products may not perform as we expect; we may be unable to increase our sales and sustain or increase our profitability in the future; we may not be able to obtain or maintain customer, distributor and other relationships that are expected to result in an increase in volume in revenue; we may not be able to comply with all applicable government 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 these distributors; and if we do not effectively implement our sales and marketing service, product enhancement plans, our sales and 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 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 obligations to release any revision to any forward-looking statements to reflect events or circumstances after the date of this conference call or to reflect the occurrence of unanticipated events. I will now turn over the call to Darren Jamison, our President and Chief Executive Officer.

Darren Jamison

Thank you, Jayme. Good afternoon and welcome, everyone, to Capstone's first quarter fiscal year 2012 earnings call. With me today are Ed Reich, our Executive Vice President and Chief Financial Officer; and Mark Gilbreth, our Executive Vice President and Chief Technology Officer.

Today, we'll start the call with a general overview of the first quarter, and then turn over the call to Ed, who will review the 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 towards our strategic objectives of improving gross margins and generating positive cash flow.

As the operator mentioned, we will be using slides in our presentation today that can be found on our Capstone website under the Investor Relations section. During the first quarter, Capstone built and shipped a record amount of product and had another outstanding bookings quarter. In the first quarter, we built and shipped $20.8 million in new product, which was up 8% from last quarter's previous record of $19.2 million. In addition, Capstone built 65 C200 engines that shipped in our C200 and C1000 Series products during the first quarter. This represents a 55% increase compared to 42 in the first quarter last year, as we continue to ramp-up our manufacturing output without adding additional significant touch labor or operating expenses.

We had another great booking quarter with approximately $28 million in new product orders, which were the result of the continued strength from the developing U.S. shale gas market and strong order flow from the Russian market for both oil and gas and CHP combined heat and power applications.

As you can see from Slide 2, this pushed our total product back up from last quarter by 8% to approximately $115 million or 130 megawatts at the end of the first quarter. This puts Capstone in a very strong position to again deliver tremendous year-over-year revenue, tremendous growth for fiscal 2012.

Power shipments could've been slightly higher in the quarter, if not from the lingering supply chain constraints as some vendor part shortages still impacted first quarter deliveries. In addition, we did not build any TA100 product during the quarter, as the TA100 manufacturing line was relocated as previously planned from Calnetix in Florida to Capstone in California during the quarter. However, the fourth quarter part shortages improved significantly during the first quarter, and I expect there to be little or no impact on production or manufacturing cost in the current or future quarters.

Based on our first quarter year-over-year results and the continued improvement in our performance indicators, I am very encouraged with Capstone's progress. Slide 3 highlights the result of our key performance indicators or KPIs. These key performance indicators are the best measures of the underlying foundation of our business and what are critical to reaching our goal of improved gross margins and positive cash flow. The key metrics to Capstone's future success are product production rates, average selling prices, direct material costs, new orders and cash. These metrics continue to show improvement in the first quarter with the exception of cash, which was up on higher working capital requirements. However, Ed and I both believe our current internal projections indicate that working capital should improve and will reduce the cash usage in the second quarter.

As mentioned, revenue for the first quarter of fiscal 2012, it increased an incredible 51% year-over-year to a record $24.3 million versus $16.1 million just 12 short months ago. Slide 4 illustrates how Capstone's year-over-year quarterly revenue has now increased for 17 straight quarters, an achievement unmatched by the vast majority of today's public companies. More importantly, as you can see from Slide 5, Capstone has achieved this tremendous top line of revenue growth without substantially increasing its production labor and overhead over the past 5 years, which continued into Q1. Our team of LEAN manufacturing engineers continues to make progress in improving our production efficiencies, which allows us to build more products without significantly adding additional labor.

During the first quarter of fiscal 2012, Capstone achieved its second highest positive gross margin in company history on a GAAP basis, but the highest positive gross margin in company history on a non-GAAP or cash basis with over 11% positive gross margin for the quarter as outlined on Slide 6.

The significant difference in our GAAP and cash-based gross margin centers around a $1.4 million non-cash warranty accrual. Capstone's warranty expense continues to run higher than anticipated on the new C200 and C1000 Series product lines. In certain instances, we've elected to take strategic reasons in play and upgrade even early ventured C200s to today's more robust design. Because we are selling a premium product and because every C200 and every C1000 seated in the market is a potential customer testimonial, it's imperative that all of our products meet or exceed customers' expectations. With that being said, management has taken several steps to more cost effectively and efficiently upgrade these older units and lower the warranty rates to targeted levels as quickly as possible.

Parts shortages and higher new product working provisions are important, but they are short-term issues if managed correctly. The foundation of our future long-term profitability and long-term success of the company is on our products' gross margins. As you see from Slide 7, the key to improving our product gross margin is improving the average selling prices and lowering direct material costs. As you can see from the chart, margins improved substantially during the quarter, which is very encouraging and critical to our long-term success.

Continued margin growth has been and will be the key area of focus for our Board of Directors and management team in fiscal 2012, and we look to take approximately another 13% out of direct material cost and improve our average selling prices another 6%. When we accomplish these 2 objectives, we will see overall direct material cost at approximately 50% of revenue and generate approximately $12 million in contribution margin in today's revenue levels. When we get to normalized warranty costs and $12 million contribution margin, Capstone would be essentially EBITDA breakeven. At this point, I'll turn the call back over to Ed to go through the financials. Ed?

Edward Reich

?

Thanks, Darren. Good afternoon, everyone. I'd like to provide you with our financial results for the first quarter of fiscal 2012, which ended on June 30, 2011. Let's begin with a recap of the major items on our balance sheet. The significant sequential changes from the Q4 fiscal 2011 to Q1 fiscal 2012 balance sheet were as follows: inventory increased in Q1 to $23.9 million from $20.7 million in Q4, with inventory turns of approximately 3.6x. The primary reason for the increase was in connection with our acquisition of the TA100 microturbine product line from Calnetix where we purchased the remaining TA100 microturbine inventory for $2.3 million after Calnetix's contractual commitment to manufacture the TA100 ended. The accounts receivable balance was $19.9 million at the end of the first quarter compared to $19.3 million in Q4. We continue to drive our days sales outstanding down with another successful quarter in cash collections of approximately $24 million. Accounts payable and accrued expenses were $18.9 million in Q1 compared to $21.8 million at the end of the prior quarter. The reduction was primarily due to the payment for the Calnetix inventory purchase.

Our cash balance was $22.1 million at the end of the first quarter, decreased $11.4 million dollars from the fourth. We used $12.3 million cash in operating activities during the quarter, of which $5.5 million was used in operations. And the other $6.8 million was related to changes in working capital accounts, which we expect to be able to offset in the second quarter. That is our goal.

Sequential changes from the Q4 fiscal 2011 to the Q1 fiscal 2012 income statement were as follows: Total revenue increased 7% sequentially to $24.3 million. Product revenue grew 8% to $20.8 million in Q1. Units shipped were comparable to the fourth quarter where we shipped 168 units compared to shipping 170 units in Q1. Average selling price per unit increased 7% to 122,000 from 114,000 in the fourth quarter.

Accessories, parts, and service revenue was comparable to the prior quarter at $3.5 million. We continue to make progress in improving material margins during the quarter as seen on Slide 7. Note that product margins have improved significantly over the last 2 quarters. We continue to make progress against our 30% materials cost reduction target, and we're targeting to complete the remaining approximately 13% of reduction over the next 9 months.

Margins were again affected by incremental warranty costs during the quarter that were primarily related to field upgrades on C200 and C1000 Series products in our effort to bring certain fielded units up to the current factory specs. We spent $2.2 million in the first quarter on research and development, which was $200,000 higher than the prior quarter. The increase was a result of additional labor costs. We elected to increase our engineering staff during the quarter to amplify our product development efforts.

Selling, general and administrative costs were $6.6 million for the first quarter, decreased $600,000 from the prior quarter on lower selling expenses, offset by year end legal and accounting fees. Our net loss was $2.9 million or $0.01 per share for the first quarter compared to the $28.8 million loss or $0.12 per share for the fourth quarter of last year. The net loss for both the first quarter of fiscal 2012 and the fourth quarter of fiscal 2011 was affected by the adoption of Accounting Standards Codification 815, which is derivatives and hedging, and it affects our accounting for warrants with anti-dilution provisions. We recorded noncash benefit of $5.6 million to warrant liability expense in the first quarter compared to a charge of $18.7 million in the fourth quarter of fiscal 2011. For the first quarter of fiscal 2012, the net loss and corresponding loss per share before the effect of the new warrant accounting was $8.5 million and $0.03 per share, respectively. Please refer to Slide 8 for a reconciliation of those amounts.

Backlog at the end of the first quarter was $115.3 million, and that was up $8.9 million from the quarter before. That concludes my comments on the first quarter results. And now back to Darren.

Darren Jamison

Thank, Ed. Capstone continued to gain market share in all 5 major of its major markets as shown on Slide 9. In energy efficiency, we continue to penetrate hotels, office buildings, retail and industrial applications around the world. Oil, gas and other natural resources continues to have a major impact in our business as we penetrate the U.S. shale gas market and Russian oilfields. The shale gas market represent an excellent opportunity for Capstone's highly reliable and low-emission products as energy producers are looking for better ways to supply cleaner, reliable electricity to their remote drilling operations.

The critical power data center market is performing well, and our units installed in data centers ranging from Syracuse University to United Technologies Corporate data center to 2 Homeland Security sites are all performing at their expectations. I am pleased to report that during the quarter, we received another new order for a university data center located in Ohio to add to our growing list of marquee installations.

Renewable energy continues to be the backbone of our business as we shipped products for applications on landfill gas, digester gas, cow and pig manure and biodiesel applications around the globe. This is evident by the continuing orders we're getting from green environment producers and other key partners in Europe.

As outlined at our last call, Capstone's mobile products market utilizing turbines for electric vehicles is gaining increasing interest as range extenders in electric buses, trucks, cars and the marine industry.

During the quarter, we had several noteworthy events, like our first C1000 packages sold into Eastern Europe and our first C1000 sold into a hospital industry. Despite the many C200 and C1000 sold in recent quarters, we are still penetrating and seeding new markets, new industries and new countries on a quarterly basis.

On the aftermarket side of our business, we recently received another comprehensive fleet-wide service blanket order with Petroleos Mexicano, also PEMEX, the fourth largest crude oil producer in the world. This new $8.6 million, multimillion dollar blanket order will cover PEMEX's entire microturbine fleet. In addition during the quarter, the city of Sheboygan, Wisconsin received a prestigious award from the Great Lakes and St. Lawrence Cities Initiative for nearing self-sufficiency as its Wastewater Treatment Plant using Capstone's microturbines. However, as I said before I'm most pleased with our most recent order flow. It's remarkable to me to think that we have booked $71 million in new orders over the last 2 quarters, and that is essentially equal to all the product shipments in fiscal 2011.

As we look to Japan, Capstone continued its discussion with several potential distributors and hopes to have 1 or more online soon to direct this potential new market demand. In addition, we received another follow-on order from telecom leader, NTT DoCoMo, as our Capstone units performed exceptionally well after the earthquake and subsequent tsunami. We're also looking to increase our focus and effort in Germany as they look to move away from dependence on nuclear power and use more renewable power and distributed generation solutions.

Capstone's record $71 million new orders in the last 2 quarters and new company high $115 million in product backlog proves we are getting increasing traction and penetration in this multibillion dollar market. As you can see from Slide 10, Capstone's addressable markets are estimated to be in excess of $14.6 billion annually with the potential targeted capture of $1.5 billion over the next 7 to 10 years.

Every quarter, Capstone is continuing to take customers away from such greats like General Electric and Caterpillar, who together, dominate this space with an older and somewhat antiquated reciprocating engine technology. It's important that all of our markets and all of our geographies are growing year-over-year, but I continue to be the most encouraged and excited about the activity in the oil and gas and natural resource space. Within the oil and gas base, we continue to see increasing order flow from BPC Engineering, our Russian partner, and pumps and service in E-Finity here in the U.S. for the shale gas fields. BPC is selling, engineering and installing C1000 Series units to operate on associated gas in Russian oilfields. The objective of these project is to increase the level of associated gas utilization at the field level in compliance with the Russian government's 2009 declaration to decrease atmospheric pollution from glass flaring. Associated gas utilization for power will allow Russian oil and gas customers to avoid emission penalties and significantly reduce power cost at the oilfield level.

The electricity generated by the C1000 microturbines usually covers all of the energy needs at the oilfield allows the site to use electric grid, if available, as a backup power source or for peak loads. The Capstone product not only increases the reliability but also decreases the cost of electricity substantially when compared with the local utility rates.

Back in the U.S., Capstone distributors pumps and services in E-Finity continue to receive bulk of these orders from oil and gas companies exploring the large shale reserves or plays in the U.S. as shown on Slide 11. The shale gas market is expanding rapidly as is the market share for Capstone in these plays. The market is expected to grow substantially, especially since the U.S. EPA Clean Air Act has strict requirements for emission levels on natural gas sites. Most microturbines delivered are providing prime power to central processing facilities and metering stations at remote well sites in the Eagle Ford shale play in South Texas. The Eagle Ford play is expected to emerge as the major oil and gas play in the United States over the next decade. Experts estimate it ranks sixth in the size among all-time giant oilfields in the U.S.

Most of these sites are extremely remote and unmanned, which means 24/7 distributed power is paramount. Even more important, producers must meet the tough EPA air requirement emissions on a day-to-day and year-to-year basis, which makes Capstone's low-emission microturbines very attractive. The reliability of Capstone's turbines along with low emissions and low cost of ownership and our key distributor partners' ability to deliver a total solution are all contributing to our shale play success.

In response to the continued growth rate and maturation of our company, I have recently made several organizational changes to better optimize the performance of the Capstone management team. As announced during the company's February earnings call, I created a new position, VP level, to ensure the timely execution of the company's critical cost reduction programs, reliability improvement initiatives and the Department of Energy product development programs. As shown on Slide 12, the company currently has 3 major product development efforts underway, 1 for the flexible fuel microturbine to run on agricultural syngas, the second one for an alternative solar fire powered microturbine and another to increase the output of C200 microturbine to 250 kilowatts and utilize that C250 as part of the new multistage, high-efficiency C370.

I'm very pleased announce that Rob Gleason has been a great addition to the Capstone team and brings a wealth of experience and solid accomplishments in leading high-tech program management organizations. Rob has been able to immediately contribute to the organization by prioritizing and driving all of our critical programs to help ensure the success and completion, future, on-time and budget performance. Prior to joining Capstone, Rob spent more than 17 years in program management, project engineering and business development in other high-tech companies. Most recently, he worked at Parker Hannifin in Irvine, California and Kalamazoo, Michigan where he held management positions at several divisions and introduced the first PMO, or program management office, within Parker Aerospace.

As you can see from Slide 13, I have further streamlined the organization by promoting Mike Eggers to the position of Director of Operations reporting directly to me. Mike joined Capstone approximately 2 years ago from Ingersoll Rand and has steadily taken on more and more responsibility and now oversees Capstone's manufacturing and operations. Mike's primary focus today is further leaning out our manufacturing processes, increasing our C200 and C1000 build rates and most importantly, eliminating any future parts shortages. All these organizational changes afford us more leverage with Mark Gilbreth in his role as Capstone's Chief Technology Officer, as he continues to lead Capstone forward in new product development, product reliability and executing our current and future material cost reduction programs. With these recent changes, I'm even more confident than ever that Capstone has the right leadership team in place to deliver against our short-term goals of improving gross margins and reaching EBITDA breakeven.

Capstone continues to work diligently on the policy front to increase federal tax credit for microturbines from 10% to 30%. The bill introduces H.R. 6515 in the 2010 session, raises the microturbine tax credit from 10% to 30% and removes the 200 per kilowatt cap. Capstone is in the process of reaching out to targeted list of politicians and other stakeholders whose district encompasses regions within the U.S. shale plays in order to assist Congresswoman Sanchez with obtaining cosponsors and support for the bill.

To look at policy at a state level, the California Self-Generation Incentive Program is one of the most encouraging and potentially beneficial state programs supporting microturbines. Capstone lobbied heavily to restore the CHP combined heat and power program for several years and was finally successful with the passage of SB 412 back in 2009. Since then Capstone and other CHP stakeholders have been engaged with the California Public Utilities Commission to form the new program and provide incentives for CHP projects in California. In July, the commission released a proposed decision to provide $500 per kilowatt incentive for natural gas CHP projects and $2,500 per kilowatt incentive for biogas CHP projects in California. The commission will vote on a final decision this month, and the investor-owned utilities will have 30 days to revise the program as the program administrators. I fully expect to have incentives paid for upcoming California projects in late 2011, early 2012 and to further leverage our domestic microturbine business.

In conclusion, in first quarter of fiscal 2012 Capstone again set a record for top line of revenue, with revenue jumping 51% year-over-year. In the quarter, Capstone improved gross margins over $1 million year-over-year on a GAAP basis and $2.2 million year-over-year on a non-GAAP cash basis. This was the second best margin in the company's history on a GAAP basis and the best margin in the company's history on a cash basis. The company continues to closely manage operating expenses, improve manufacturing efficiencies while simultaneously lowering direct material costs and increasing average selling prices.

New orders for the quarter, as mentioned, were very, very strong, and we have booked a record $71 million in product the last 2 quarters, leaving the company with $115 million in backlog to execute against over just the next 12 months.

In general, despite some short-term growing pains, fiscal 2012 is off to a great start and should be another exciting year for Capstone. I look forward to continuing to execute against our strategic business plan and again deliver steady growth and ever-improving gross margins and improving the overall financial results. 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 of Sanjay Shrestha with Lazard Capital Markets.

Unknown Analyst -

It's [indiscernible] here from Lazard Capital Markets. Two questions please. First is could you give us a little bit more color on the order inflow for the quarter and an update on what you are seeing from the U.S. shale market?

Darren Jamison

Yes, absolutely. As I mentioned during the year-end conference call, orders for the first quarter were very strong. We had a phenomenal Q4 with about $43 million in new product orders, and then we followed that up with $28 million this quarter. So a lot of that is coming from, as I mentioned, both the shale gas market in the U.S., as well as the Russian market. But overall, we're seeing our U.S. business is up substantially. We recently had an order for a U.S. hospital. We're seeing lots of applications around the U.S., as well as Europe is beginning to pick back up again with both biogas, landfill gas, South America, Mexico. So I think, in general, we're seeing a nice rebound in the U.S. market driven by shale gas, continued strength in the European market, driven by both biogas and oil and gas from Russia. And then Mexico, South America, Australia are starting to pick up the pace. Some nice recent orders out of both Colombia and Brazil, very encouraging.

Unknown Analyst -

My second question is on the hybrid truck and bus market. Given the new [indiscernible] now in the country for the first time for hybrid, essentially for trucks and buses, what kind of impact do expect that to have on your discussions with your partners? And maybe you could give us sort of an update on the progress you're making when talking to partners in this sector.

Darren Jamison

Yes, let's start with the bus side. We continue to work with several bus OEMs in the U.S. DesignLine is still our key partner. Our bus -- we have 13 buses in Baltimore that are performing very well. We have are businesses in Charlotte performing very well. New buses going to Arlington and Denver shortly. They're in process of recapitalizing their company, which has been an ongoing challenge for them. But we believe they'll be successful, and they'll ramp their production rates. They've got a very good product that, from an emissions standpoint and a fuel economy standpoint, performs very well. We're also seeing nice orders from a Russian bus OEM and a few other small OEMs around the globe. On the truck side, as I mentioned before, we're working with 2 class, kind of 4 through 8, U.S. truck manufacturers. Those programs are ongoing. I think the President's new CAPA standards are only going to drive more focus on our technology, and our ability to meet those emissions levels. Anything that lowers emissions standards globally, increases energy efficiency requirements or fuel economy is all good for Capstone. In most cases, we have a product that far exceeds our competition, and we don't have a level playing field. We're performing much better than our competition from an energy efficiency and reliability and emissions standpoint. So I think all those things are positive moves. The automobile market, still fairly far off for us. We've had conversations with two Tier 1 suppliers. Those conversations continue to move forward very slowly, but I do think multiple factors can move those ahead again fairly quickly.

Operator

Your next question comes from the line of Eric Stine with Northland Capital Market.

Eric Stine - Northland Securities Inc.

Maybe just touch on orders again, clearly some positive trends. Any way to quantify maybe what you've seen to this point, how it stacks up versus this first quarter and maybe internally the kind of order levels that you feel are sustainable going forward?

Darren Jamison

Yes, Eric, obviously we're much earlier in the quarter this quarter, so it's harder to comment on it. But I would anticipate Q2 to look similar to Q1. Q4 obviously was a bit of an anomaly. We had several large orders hit in the same quarter, but I would definitely like to see our backlog remain flat or slightly up coming out of the second quarter. Still feel very good about the health and growth of the distribution channel. Several distributors that had economic problems or difficult times are coming out of the green environment is getting healthy again and coming up with some nice orders. The DCs continues to put in landfill units. BPC is in, and Thompson Services are ordering at a tremendous clip and will double the revenue they did last year. So I think in general, we feel very good about the distribution network. We're still leading and feeding in a few areas. But I think as the economy improves and we get more and more microturbines in the marketplace, more testimonials, more hours on the machines, it's getting easier and easier to sell our product. We are seeing, in some of our shale gas applications, where like Pioneer Natural Resources is running a site, the shale play next to it, that user is a different company, comes over and sees the technology and starts asking questions and calls us up, which is traditionally how you seed a market and start getting additional orders from new customers. So hopefully, we get past the Pioneers and the Anadarkos and the other folks that we've actually gotten penetration with and broaden into a larger base in the shale gas market.

Eric Stine - Northland Securities Inc.

Maybe just turning to gross margins. Just wondering, how far do you think you are through the C200 upgrade process that you're undertaking? Just trying to get a sense of when that warranty expense provision might normalize?

Darren Jamison

Yes, hopefully, we've given some more transparency on that this quarter. We feel very good about our cost reduction efforts and the gross margins we have from a product level. If you look at what we took as a noncash charge this quarter, for warranty, that's based on last 2 quarters being fairly hot, we are -- in opening up the U.K. location and the Singapore location, we'll be able to do repairs and upgrades in the field without bringing them back to Capstone. The biggest cost we have from a warranty expense standpoint right now is shipping cost trying to bring units back to Capstone for repair or upgrade. So as we start moving that work to the field and as the older population gets upgraded, we should see that settle down. So I would say this quarter, we could run hot again, but I expect definitely by Q3 and Q4 to see that trailing down. If you look at new product warranty, it's very much of a bell curve. It's low in the beginning. You get product out in the field and as it starts to age and you see different environments from an operating -- extreme operating parameters: Hot, cold, altitude, different scenarios. You then see the warranty costs come up, and then as you upgrade the product, you see it come down. So obviously, disappointing, but it's definitely not surprising based on how quickly we got the product to market. We have engineering fixes that are already in place for today's product that we will be shipping. It's the product we're shipping for the last 3 or 4 quarters. So short answer to your question, it's probably too much -- 2 quarters left to get through it and it should get more stabilized. But the DMC is much, much improved over the last 2 quarters. We expect over the next 3 quarters to finish up our cost reduction efforts. So again, we're about 30% product margin today as you saw on the slides, we need to ride that closer to 50%, but we're getting there.

Eric Stine - Northland Securities Inc.

Last thing for me, and then I'll jump back in the line. Just on the working capital, you're clearly confident that, that is something that reverses. Just any thoughts on how things have gone to this point in the quarter? I realize it's still early, but that would be helpful.

Darren Jamison

Working capital, I don't want to make light of it, but we have the Calnetix parts we brought on board. Revenue jumped up little bit. Collections were good, but not great. We didn't maximize our bank line at the end of the quarter. So several things were working against us a little bit from a working capital perspective. We do expect those to reverse in the second quarter. If you look at the last 3 quarters, we generated $5 million in cash, had $5 million operating loss or cash burn, and $11 million this quarter. So for the last 3 quarters, we burned $11 million. We expect that to be less than $3 million, somewhere between negative or 0 to $3 million in this current quarter. So very comfortable still with our cash balance. We'd like to burn less for the quarter, but the working capital should trail down. I think the other thing that's important is that our bank line with Wells Fargo is up in March. That's a 3-year line, a $10 million line based on -- we were a much smaller company at that time. Ed's already in negotiation with Wells Fargo and a couple of other banks. We fully anticipate to have a new line in place much before the February, March deadline, in fact we'd like to get that done in the next 60 days. That will probably be about a $15 million bank line. So we still have the ability to have a larger borrowing on a bank line. We've got some, as you know, we had some warrants out there in January. So not only should the working capital improve this quarter, but we have some other ways to get the cash in the next 2 to 3 quarters.

Operator

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

Shawn Severson - ThinkEquity LLC

Could you guys give a little color on the backlog in terms of the timing? Should we think of it as a linear over the next 4 quarters? Or is there some type of weighting to that, that we should take into consideration if we assume all of it's delivered over the next 12 months?

Darren Jamison

Probably. It's definitely not linear, but that's probably the easiest way to model it. The reality is our C30s and our C65s tend to flow through quicker. Our C1000 Series tend to take longer to flow through. We've got a lot of Pioneer Natural Resource units that will start delivering in the third and fourth quarter. But some of the other stuff we have is hitting sooner. So I guess, for modeling purposes, I would assume a fairly linear build out or shipment.

Shawn Severson - ThinkEquity LLC

And in that backlog, about how much of that is for oil and gas?

Darren Jamison

We don't break that out, but it's probably close to 40%. It's definitely our biggest single market. If you include oil and gas as being onshore, offshore, shale gas, coal sea methane, coal mine methane, all of the different -- the gas is probably 40% to 45%.

Shawn Severson - ThinkEquity LLC

And what are you thinking about this year in terms of the turns business? So order shipped, same quarter, that type of thing?

Darren Jamison

For the most part, I'd say our average shipments today, because of our backlog, we got a little bit of amount of production slots. So most cases, we're probably 12 to 16 weeks on a C30, C65, and then 4 to 5 months on C1000. C1000s are really more driven by customer demands on when they need the product than when we can deliver them.

Shawn Severson - ThinkEquity LLC

So you're at a pretty small percentage of turns business on kind of the revenue over the next 12 months?

Darren Jamison

Correct.

Shawn Severson - ThinkEquity LLC

And going back to some of the cost initiatives and getting margins at where they need to be, I know you talked about it already, but can you just give a good idea of what some of the very short term, I hate to call it low-hanging fruit, but what are you folks done over the very short term where there are opportunities there? Or is it other than just volume?

Darren Jamison

Well, it's several things. One is volume; two, it's outsourcing overseas. We continue to do more and more in Asia. All of our enclosures are made in either Asia or in Mexico. But in some cases, it's bringing on new manufacturers that are more automotive-centric manufacturers. So as our volume increases, we're getting doors opened up to us that we didn't have in the past. Also, bringing Rob Gleason on board. He's got some contacts. And as we look around the industry, we're finding more and more folks that are interested in our technology, our company and our growth curve and it's attracting us. So in some cases, we are changing some of the product specifications and tolerances. The vast majority of the opportunity is more of a purchasing exercise in either grouping, more parts with 1 supplier or offshoring with suppliers.

Shawn Severson - ThinkEquity LLC

So it isn't going to be any type of stair-step event, it's really going to be something like that, I would assume, takes at least a couple of quarters to implement. Is that fair to say? Does it start to have an impact as you resource or look for new sources on certain products?

Darren Jamison

Yes, if you look at the chart that we have in the deck, we made some really good progress for the first year, again, to 30% cost reduction. We saw that for a couple of quarters as we didn't have a lot of new cost rolling in. And then in Q4, at the very end, we had recuperater cost reduction, our C200 and closure cost reduction, some printed circuit board and some other components that came in to give us a nice lift in Q1. We've got a lot of cost reductions cutting in, in Q1 and Q2, which should give us some additional cost relief for the next couple of quarters. The average selling prices continue to go up every quarter. We should get another 6%, maybe 7% out of ASPs in the next 3 to 4 quarters. So it's not linear. It'd be nice to see with the 20% we're short to get 5% a quarter for the next 4 quarters, but it will be a little lumpier than that. But I think the last 2 quarters have been a nice improvement from a DMC perspective. And we're seeing it. As we see orders coming today, we're starting to see orders at 40% margin, 45% margin. And that's great to see as we add on the new business.

Shawn Severson - ThinkEquity LLC

And then lastly, just so I understand the ASPs, when you look at the 6% to 7%, that would be what you would be -- referring to what you would be booking in your backlog, say, in the fiscal, third fiscal, fourth quarter. Is that the way to think of it?

Darren Jamison

Everything we booked in this first quarter is all fresh pricing. Most everything in Q4 was fresh pricing. So the $71 million of new orders is all at the fresh pricing. So as that rolls through the backlog, that's going to generate about a 6% higher ASP than what we shipped in the last couple of quarters.

Shawn Severson - ThinkEquity LLC

So year-over-year, you're up 6% to 7% and equivalent in terms of backlog book?

Edward Reich

A year ago, 4 quarters ago, the backlog ASP was $125,000. And this latest quarter, it was $166,000, dropped significantly year-over-year.

Operator

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

Walter Nasdeo - Ardour Capital Investments, LLC

If I could just for a second visit on the -- your development of your supplier network and how that's going as far as having second and third level suppliers to make sure that there's no blips on any large orders and things like we've seen in the past. How that's coming along?

Edward Reich

It's much improved from where we were. As I said, in the quarter, Q4, we had some probably 4 or 5 suppliers that really caused us pain and some other ones that gave us near death experiences. Q1 was much better. Q2, we had a few of the beginning of the quarter. But by the end of this quarter, it should be completely behind us. We did the supplier symposium that I talked about that last quarter. We've done on-site visits. We've improved our documentation and communication forecasting with the suppliers. In many cases, we are managing down to their supply chain, making sure that they've got the raw materials coming in, and frankly, are just working much closer on a partnership basis with our suppliers. And to your point, on the key vendors, we've got back-up, contingency suppliers in place. In some cases, we don't want to go to that second supplier because it will be higher cost, probably local supplier. But as an emergency basis, we can do that.

Darren Jamison

We've got a new supplier scorecard we're putting together. There's a lot of things we're doing to make our whole supply chain more sophisticated, more robust. But you should not see, knock on wood, any additional supplier challenges going forward.

Walter Nasdeo - Ardour Capital Investments, LLC

That's something that just comes out of the left field and bites you.

Darren Jamison

Absolutely. And again, I don't want to call them growing pain and shrug them off, but definitely as we take this business from $16 million, $18 million a quarter to $25 million a quarter and beyond, you're going to find out where your stress cracks are.

Walter Nasdeo - Ardour Capital Investments, LLC

How's the distributor network refinement coming now? What's your number standing at? And how's the kind of feeding and seeding, as you say, going?

Darren Jamison

We're still about 95, 96. For the most part, most of our distributors are responding very well. We've got another distributor conference, global conference coming up in October. I think our biggest challenge is just helping them manage the growth they're seeing and manage the order flow and make sure they can still execute. One of my bigger concerns is some of the distributors as fast we're growing, they're growing even faster and can they manage their business and execute and not die from indigestion by trying to be too much. But overall, we're very happy with them. The communication is good. They're using salesforce.com. They're working well with our service organization. We've added a second trainer. All of our training classes are full. And so I think the whole distributor network is performing extremely well.

Operator

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

Darren Jamison

Great, thank you. Obviously, we've all been watching the stock market this week, and we've seen the whole debt ceiling crisis and severe correction. The management team at Capstone and our Board of Directors wants to thank our loyal shareholders to continue to stick with us during these difficult times. Despite the global crisis, we continue to set company records, 17 quarters in a row of an improved revenue. We feel very good about continuing that record for the next several quarters. This definitely is a great start to what should be the best year in company history. I'm thrilled to have record revenue, record product shipments to see the C200 build rate come up. It doesn't seem like it was that long ago we were talking about whether we're going to build 1 a week or 2 a week or bring it up to 3 C200s a week. So we've come along ways with our C200, C1000 manufacturing line. The product backlog is fabulous. The gross margins, though, are really the key for us. And hopefully, folks won't get lost with the short-term warranty issues and see the real DMC and average selling price improvement that we're making. The core business is strengthening every quarter. The $71 million in new orders at new ASPs that we've sold through the last 6 months, it will be great to see that flow through in Q3 and Q4. And despite the global weakness, we continue to build a very strong company. I don't want to ignore the recent parts shortages, as Walter brought up or the warranty costs that Eric brought up or the working capital swings, just the opposite. As CEO, I want to own those issues. We're not making light of them. But they are, in my mind, short-term issues that a good management team can conquer these challenges and continue to move forward. So call them growing pains, they're manageable events. We're owning them, and we've got the right team to fix them. And our goal is to build the strongest company with the highest revenues, the best gross margin and to dominate our clean tech space as quickly as possible. So thanks, everybody, for listening. I look forward to talking to you next quarter.

Operator

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

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