Capstone Turbine's (CPST) CEO Darren Jamison on Q4 2016 Results - Earnings Call Transcript

| About: Capstone Turbine (CPST)

Capstone Turbine Corp (NASDAQ:CPST)

Q4 2016 Earnings Conference Call

June 09, 2016, 16:45 PM ET


Clarice Hovsepian - VP Human Resources, Corporate Counsel

Darren Jamison - President & CEO

Jayme Brooks - CFO & CAO


Craig Irwin - ROTH Capital Partners

Eric Stine - Craig-Hallum

Amit Dayal - Rodman and Renshaw

Jeff Osborne - Cowen and Company


Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Capstone Turbine Corporation Earnings Call for the Fourth Quarter and Fiscal Year 2016 Financial Results ended on March 31, 2016. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded.

I would now like to hand the meeting over to Clarice Hovsepian, Vice President, Human Resources and Corporate Counsel. Please go ahead.

Clarice Hovsepian

Thank you. Good afternoon and welcome to Capstone Turbine Corporation's conference call for the fourth quarter and full year of fiscal year 2016 ended March 31, 2016. Capstone filed its annual report on form 10-K with the Securities and Exchange Commission today, June 9, 2016.

If you do not have access to this document and would like one, please contact us by email at Or you can view all of our public filings on the SEC website at or on our website at

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

These statements relate to, among other things, collection of reserved accounts receivables, shipment of finished goods, benefits from our cost reduction initiative, improved operating leverage and organizational efficiencies, strengthened distribution channels and new distributor employee, new product development and success of new products, implementation of the new Capstone Energy Finance business, product reliability, product price increases, growth and diversification of our end markets, performance in light of macroeconomic headwinds and attaining profitability.

Forward-looking statements may be identified by words such as believes, expects, objected, intends, targeted, planned and similar phrases. These forward-looking statements are subject to new risk assumptions, risks and uncertainties described in Capstone's form 10-K, form 10-Q and other recent filings within the Securities and Exchange Commission that may cause Capstone's actual results to be materially different from any future results expressed or implied in such statements.

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 to specifically disclaim any obligation to release any revision to any forward-looking statements to reflect events or circumstances after the date of this conference call or to reflect the occurrence of unanticipated events.

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

Darren Jamison

Thank you, Clarice. Good afternoon and welcome, everyone, to Capstone's fourth quarter earnings call. Joining me today besides Clarice is Jayme Brooks, our Chief Financial Officer and Chief Accounting Officer. During my remarks, I will be referring to presentation slides that can be found on the Capstone website under Investor Relations.

Looking back at fiscal 2016, it was certainly a very challenging year for the company. Without going into extensive detail, we, like many other companies, faced macroeconomic challenges that resulted from strong US dollar, fall in crude oil prices, and numerous geopolitical issues.

Faced with both internal and external challenges, our management team took several strategic countermeasures to reposition our company for future growth and near term profitability.

Unfortunately, along the way, we have to make several very difficult employee, operational, product and commercial business decisions. As difficult as these decisions have been, we believe we've made the right decisions and we've now significantly shortened the path to profitability.

As highlighted on slide 3, we've implemented a three-pronged business plan that includes the following: First, reducing our target breakeven revenue levels from approximately $160 million annually or 25 - with a 25% gross margin to approximately $100 million annually with a 25% gross margin. We did this by reducing our business expenses by approximately 35% overall.

We're developing new sources of product and service revenue to help drive top-line future revenue growth. And the third prong is launching our new Capstone Energy Finance business to capture orders that would otherwise be lost due to capital constraints of our customers.

In addition, throughout the year, we also made many strides in diversifying our business by vertical market and by geography. We successfully launched our new signature series C1000 microturbine that has more than 70 discrete products reliability improvements over our current C1000 product.

Including improved airflow, two-stage filtration, lower noise levels, dramatically improved enclosure design, higher inlet fuel temperatures, 12 year marine grade paint, and most importantly, a relocated engine exhaust to support an integrated CHB heat recovery module on the roof. We believe it's the perfect product for the growing worldwide CHB energy efficiency market.

Go ahead and take a minute and turn to slide 4. Slide 4 illustrate some of the Q4 financial highlights that include growing accessories, parts and service revenue, increasing sales in Asia and Australia, and the strengthening markets in Europe and Russia.

Inventories, both raw material and finished goods, accounts payable and bad debt reserves all dropped as we continued to focus on improving and strengthening our balance sheet.

Turning to slide 5, this is the annual results for the full year and they also highlight an improved business expenses, which drive a reduced net loss despite lower revenue year-over-year. In addition, you'll see several balance sheet improvements, as this was the major focus for Jayme and I in fiscal 2016.

Our cash and cash equivalents position, including $5 million in restricted cash at the end of March, was $16.7 million. However, the $16.7 million does not include the gross proceeds of $14.3 million we recently raised in April. This public offering, we believe, gives us the cash necessary to support our business plan heading into the new fiscal year.

I also think it's important to note that the reduction in operating expense flattened the organization and better streamlines our business. Fortunately, we were able to be in a very unique position where our distribution channel has matured to the point that we've been able to handle certain sales and marketing activities to many of our key distributors.

As many of you know, for the most part, our distribution partners are sales, marketing and application arms, and many of them have the ability to step up and fully take on these sales and marketing activities.

As an example, our distributors will now be solely responsible for nearly 100 trade shows and B2B events that we participate together in each year. Capstone in the past would have shared in the costs or paid entirely for many of these marketing activities.

In the new fiscal year, Capstone will be responsible for only 6 of the approximately 100 marketing events. So while we've decreased our operating expenses substantially, we have not discontinued or decreased these important sales and marketing activities.

Looking at slide 6. Slide 6 highlights some of the other key areas and actions we have taken as part of our cost reduction initiatives to dramatically lower our breakeven levels. The sales and marketing spending cuts and activities I just mentioned will save the Company approximately $4.5 million on an annual basis.

Management voluntarily forfeited all un-vested stock options, forfeited and suspended the executive bonus program, and delayed the executive equity and the executive merit increase programs until we strengthen the balance sheet and once and for all, reach our goal of profitability. These actions will save the company approximately $1.3 million annually.

We consolidated and flattened the executive team, saving approximately $2.2 million annually. We suspended all current employee equity grants and employee merit increases, saving approximately $600,000 annually.

R&D expense cuts and the delayed commercial launch of the C250, C370 program will save approximately $5.5 million annually. Our newer lean manufacturing, key component outsourcing and shops floor consolidation will reduce our manufacturing expenses and save us another $3.4 million annually.

In these difficult times and headwinds, lowering the cost structure of our business is certainly important and leads to lower breakeven levels and improved viability and a much more sustainable business. However, growing revenue is the key to any successful business.

Slide 7 highlights some of the key actions we're taking to increase our top-line revenue going forward. As you can see, we've successfully launched the C1000 signature series product and the associated improved factory protection program and launched a new extended warranty program.

Our goal is to substantially increase the long-term after-market service program attachment rates in CHP by using the new FPP program and in oil gas by using our new extended warranty program.

We should also increase accessory sales with our new heat recovery module for the new signature series products and from sales of signature series upgrade kits for original C1000 series products already in the field.

We are also working hard to improve our vertical markets and customer concentration diversification. The trend throughout the past year or so has been a shift in our verticals, which we believe is pretty telling about how we have changed our focus and adapted to market opportunities.

Slide 8 shows this shift in the energy efficiency market, which in fiscal 2014, energy efficiency was only 25% of our product revenue. In 2015, it grew to 44%. And this last fiscal year, it stands and 53% of our product revenue.

Our newly launched C1000 signature series, with its many improvements, is designed to target this growing CHP energy efficiency market.

In contrast, oil and gas and other natural resources revenue over the past three years has declined as a percentage of our product revenues. In fiscal 2014, 2014 it was 60% of our product revenue, in '15 was 49%, and this last year, it dropped to 37%.

Orders during the fourth quarter also represented our new geographical diversification. We had orders from several distributors in diverse geographies, including Colombia, China, Australia, Mexico and the Netherlands. More importantly, we also saw a slow return of our product shipments to BPC in Russia for projects in Russia and Kazakhstan.

Slide 9 shows the Q4 order momentum has continued into the first quarter of fiscal 2017, with recent orders coming in from around the globe, including Italy, the Caribbean, China, Indonesia, Malaysia, our first product in Oman, and entering Libya.

Another cornerstone of our business plan is the new Capstone Energy Finance joint venture which we launched back in December as part of the third quarter highlights.

If you look at slide 10, I am proud to say we are currently in contract negotiations with two potential PPA customers and we are in negotiations with term sheet basis with three other customers. And overall, we have about a dozen well qualified leads as our total pipeline of potential Capstone Energy Finance projects has quickly swelled to $25 million.

As we mentioned last quarter, we are very excited to be able to offer a microturbine solution to this potential customers who could not otherwise purchase our products outright, an option to secure their energy through our new power purchase agreement program and open our business to new customers.

We hope to capture a good portion of the estimated $42 million in lost business in fiscal 2016, due to the fact that customers did not have viable financing or FPP options.

As we discussed last quarter, Capstone Energy Finance eliminates the upfront capital expenditure outlays and exposure to volatile utility rates. It locks in a fixed rate for a period of 10 to 20 years. Capstone Energy Finance monitors and will oversee the maintenance of the system during the length of the PPA agreement.

We are very confident this new financing option will ultimately help our customers save costs, particularly those hardest hit in the oil and gas sector, who are affected by the precipitous drop in crude oil prices.

And turning to slide 11. Slide 11 you can see the total distributor potential pipeline by region looking forward for fiscal 2017. Our total pipeline of identified project in totals approximately $1 billion in potential opportunities, but more importantly, has the diversification of opportunities which has shifted and improved over the last 18 months with more projects outside of our traditional geographic markets.

We continue to benefit from a growing and maturing distribution channel that is unmatched for clean tech energy companies our size and our space. As you can see from slide 12, today we have 95 distributors and 9 OEMs for a total of 103 partners, representing almost 800 employees, who everyday market, sell, do application engineering services and after-market service of our products.

Last summer, our distribution body committed to Capstone to add 100 new sales professionals dedicated to the selling of Capstone's products, and more specifically, the new signature series.

Having more sales professionals selling our solutions worldwide is an important component of our continued long-term revenue growth. As of today, they've hired approximately 35 select individuals with dozens more still in the interview process.

The ability to hire top quality sales professionals admittedly is taking longer than we anticipated, but we strongly believe our distribution channel to be a tremendous competitive advantage and an invaluable asset that will pay ever-increasing dividends over the years to come as it only grows and matures more overtime.

As many of you have seen from our recent press releases, the first quarter of fiscal 2017 has had good order flow, with continued diversification in markets and increasing strength in the CHP vertical.

We have also seeing growth and strength in our after-market business, with our growing factory protection plan program, or FPP, contract backlog growing to a record $66 million as illustrated in slide 13.

In addition, our new signature series product highlighted in slide 14 with its integrated heat recovery modules will only add to our accessory sales as we sell integrated heat recovery modules and signature series parts upgrade kits again to existing units in the field. All of this will continue to drive our after-market service business.

So before I turn the call over to Jayme to go through the detailed financials, let me just say the following: Although it's been an extremely challenging year on many levels, our board of directors and our management team remain highly confident and highly optimistic that we have the right plan, the right products, the right people, and the right services in place today to drive growth and achieve our goal of profitability as quickly as possible.

With that, I'll turn the call over to Jayme to go through our specific financial performance.

Jayme Brooks

Thanks, Darren. Good afternoon, everyone. I will provide a brief overview of the fourth quarter results and then provide you with more details on the full year results. Revenue was $18.9 million for the fiscal fourth quarter 2016, compared to $29.9 million in the year ago fourth quarter.

Gross margin for the quarter was 11% compared to 12% in the year-ago fiscal fourth quarter despite 37% lower revenue levels, a one-time reserve of $0.7 million for the TA-100 inventory, a one-time write of the TA-100 backlog intangible asset of $0.1 million and a one-time period expense of $0.2 million related to the accelerated stock compensation associated with the forfeiture of management stock options.

Operating expenses in the quarter were reduced by $10.3 million or 59%, to $7.3 million from $17.6 million in the year-ago fourth quarter. This reflects a one-time period recovery of bad debt expense of $1.4 million from EMI in the fourth quarter of fiscal 2016.

Offset by a one-time expense of $0.5 million related to the accelerated stock compensation associated with forfeiture of management stock options compared to bad debt reserve of $7.1 million in the fourth quarter of fiscal 2015 for BPC.

Slide 15 provides a summary of these fourth quarter one-time period adjustments. Net loss for the quarter improved $9 million or 63%, to $5.3 million, or $0.25 per share for the quarter from a net loss of $14.3 million or $0.87 per share in the year ago fourth quarter.

Inventories decreased $4.4 million from the third quarter on lower finished goods in raw materials. Bookings for the fourth quarter were $18.3 million compared to $13.7 million in the year ago fourth quarter.

The book to bill ratio for the quarter improved 1.6 from 0.6 in the year ago fourth quarter. We previously reported our fourth-quarter book to bill ratio as 1.8, but that this was adjusted to 1.6 for a subsequent reduction in backlog for TA-100 systems.

The full year fiscal 2016 financial results were as follows: Revenue for the full fiscal year 2016 was $85.2 million, a decrease of 26%, or $30.3 million from fiscal year 2015 revenue of $115.5 million. Product revenue for fiscal year 2016 was $58.4 million compared to $89.4 million in fiscal year 2015, a decrease of $31 million or 35%.

Service revenue increased $1.3 million or 12% for fiscal year 2016 to $12.1 million compared to $10.8 million in fiscal year 2015. As a percentage of revenue, service revenue was 14% in fiscal 2016 compared with 9% in fiscal 2015. We shipped 60 megawatts during the fiscal year 2016 compared with 91.4 megawatts in fiscal 2015, a decrease of 31.4 megawatts or 34%.

The decrease in product revenue and megawatt shift in fiscal 2016 over the prior fiscal year was the result of continued softness of global oil and gas markets, delayed customer shipments and project timelines, and the strengthening of the US dollar which makes our products more expensive overseas.

Revenue from accessories and parts decreased $0.6 million or 4%, to $14.7 million for fiscal 2016 compared to $15.3 million for fiscal year 2015. This decrease is primarily the result of lower accessories revenue because of volume reductions and microturbine shift.

Gross margin for the fiscal year 2016 was $12.8 million or 15% of revenue, compared to gross margin of $18.3 million or 16% of revenue for fiscal year 2015. Despite 26% lower revenue levels and the fourth quarter adjustments related to the TA-100 and accelerated stock compensation associated with the forfeiture of management stock options.

As mentioned, this decrease was primarily the result of lower volumes of microturbine shift and a shift in product mix. Additionally, the reduction in gross margin was partially offset by decreases in warranty expense, production and service manufacturing expenses, inventory charges and royalty expense.

We continued to implement initiatives to improve margin by further reducing manufacturing overhead and fixed indirect material costs as we continued to strive to achieve profitability.

R&D expenses for fiscal year 2016 increased $0.5 million or 5% to $10.2 million compared to $9.7 million in fiscal year 2015. R&D for the full year was slightly higher than last fiscal year as a result of the development of the C1000 signature series and lower benefits from cost sharing programs such as DOE grants.

SG&A expense in fiscal year 2016 decreased $12.4 million, or 31%, to $27.1 million from $39.5 million in fiscal year 15. SG&A for the full fiscal year was lower than 2015 as a result of the bad debt reserve of $9.7 million in fiscal 2015 or two customers, the recovery of $1.4 million of bad debt expense from EMI in fiscal 2016, offset by the fiscal 2016 fourth-quarter expense related to accelerated stock compensation associated with the forfeiture of management stock options.

Management expects SG&A expenses is fiscal 2017 to be lower than in fiscal 2016, primarily as a result of our initiatives to reduce operating expenses and achieve profitability.

The operating loss for the fiscal year 2016 improved to $24.5 million compared to an operating loss of $30.9 million from fiscal 2015. Net loss for fiscal year 2016 improved to $25.2 million compared with a net loss of $31.5 million for fiscal year 2015.

Net loss per share, taking into account the 1 for 20 reverse stock split that was affected in November 2015 with a net loss of $1.39 per share for fiscal year 2016 compared with a net loss of $1.92 per share in fiscal 2015.

Now I will provide some comments on our cash flow, balance sheet and backlog. Cash used in operating activities for the fiscal year 2016 was $22.5 million as compared to cash used of $23 million in fiscal 2015.

At March 31, 2016, we had cash and cash equivalents of $16.7 million, including $5 million of restricted cash related to our Wells Fargo credit facility, compared to cash and cash equivalents of $32.2 million as of March 31, 2015.

In April 2016, we raised gross proceeds of $14.3 million from a public offering, which is not included in the March 31, 2016 cash and cash equivalents balance. Our accounts receivable balance as of March 31, 2016 net of allowances was $13.6 million compared to $13.1 million at March 31, 2015.

Our day sales outstanding or DSO was 66 days at the end of fiscal 2016 compared with 40 days at the end of fiscal 2015.

Inventories decreased $7.1 million, or 28%, to $18.3 million as of March 31, 2016 from $25.4 million at March 31, 2015. Inventories decreased primarily as a result of the shipment of finished goods and raw materials.

Our accounts payable and accrued expenses decreased $9.1 million or 41%, to $13.2 million as of March 31, 2016 from $22.3 million at March 31, 2015, as a result of the decrease in inventory purchases and an increase in payments to suppliers for past due balances.

Our total backlog, as of March 31, 2016, was $109.6 million compared with $165.7 million as of March 31, 2015. The year-over-year decrease was $56.2 million or 34%.

Ending backlog as of March 31, 2016 includes the removal of approximately $51.6 million for 186 units totaling 63.8 megawatts from PPC Engineering, one of our Russian distributors.

This removal, which occurred doing second quarter of fiscal 2016, was a proactive measure taking to align our backlog to management's expectations because of the unsteady global macroeconomic environment.

Such as the softness of the global oil and gas market, a substantially stronger US dollar, making our products more expensive overseas and ongoing geopolitical tensions with Russia.

In terms of units, we had 593 units or 113.7 megawatts in total backlog as of March 31, 2016 compared with 787 units or 182.8 megawatts as of March 31, 2015. Our FPP service contract backlog at March 31, 2016 was $66.5 million compared to $61.2 million at March 31, 2015.

This increase reflects our growing base of microturbines, as well as the ongoing efforts of distributors to sell our FPP service contracts, which enables the end customer to achieve a total cost of ownership.

At this point, I will turn the call back to the operator for questions from our analyst. Operator?

Question-and-Answer Session


Thank you. [Operator Instructions] Our first question comes from the line of Craig Irwin from ROTH Capital Partners.

Craig Irwin

Good evening and thank you for taking my question. So Darren, first question is really just a big picture question. We've got oil about $50 a barrel now. The stress test that everybody went through was painful. But I think it's pretty clearly behind us right now.

Do you expect that your oil and gas customers could maybe see a little bit of a rebound over the next couple of quarters? What are you seeing when you talk to your distributors?

Darren Jamison

Craig, great question. I think we've definitely seen that the days of $25 oil are behind us now. We're seeing the rebound to the marketplace. Rig count has come down and inventory levels are coming down. So I think that the market is correcting, like most of our other oil downturns, that eventually it does correct and come back.

We're seeing not a huge change from our oil and gas customers, but I think they see the same thing we see. They see the mark improving. We're having a lot of good conversations with some new oil and gas customers, which frankly, when oil was $110 a barrel, they didn't have time to talk to us.

So we're looking at the rental market in the oil and gas space with some couple key customers. We're also looking at getting into some new applications around the globe both in traditional oil and gas as well as associated gas.

So I think the mood is improving. I don't think it's going to be a next quarter event, but I didn't by the back half of this fiscal year, we'll start to see our oil and gas business pick up and I think as it does pick back up again, you're going to see new orders for some new customers that this lull in oil prices and activity has kind of allowed us to broaden our market share a little bit.

Craig Irwin

Great. Thank you for that. My second question is on Capstone Finance. So you had talked publicly about maybe missing something in the range of $30 million, $40 million in revenue a year from not having a finance solution in the past.

Can you update us on where you stand, are we likely to see a potential benefit from availability of financing for customers directly in 2016? In the back half of the year?

Darren Jamison

Yes, definitely, I think you're going to see. We've got two contracts, two customers in contract negotiations, so we're literally going back and forth with language. We've already come to agreement on term sheet. I expect to get both of those projects closed again maybe not in Q1, but definitely in Q2.

I think we've also got three other term sheets that are out in front of customers for their comments and review. The total backlog or potential opportunity has ballooned about $25 million. Again, as I mentioned, historically, we've lost between $40 million and $50 million, at least as far as what our distributors tell us are our orders lost because of lack of financing.

So I definitely think this is an opportunity to add, conservatively, 20% to our revenue growth if we could, on an annual basis. So as we grow this business, I think it could be an important piece.

It's also great from the sales perspective. It's a great way to move a customer off top dead center. If you are working on a project and it's got a nice payback, but the customer is unsure on how he wants to allocate this capital dollars, it's great to be able to say well, if you don't want to do this great project, we will.

And it really forces the customer to action, and I think in a lot of cases, for every Capstone Finance PPA we sign, there's probably two more customers that went ahead and purchased the equipment outright because the economics of purchasing it were more beneficial than Capstone Finance.

So, definitely see it as an important tool. We spent several years trying to get the right tool in our toolbox and I'm excited that it's going to be a big impact in '16 and even more so in more so in '17.

Craig Irwin

Great. And then last question, if I may. Today is June 9. There is only a couple weeks left in the quarter really, maybe one, one and a half for you to ship and have it recognized as revenue. Can you update us whether or not you are seeing continuation of the pretty strong rebound in bookings that you saw in the March quarter?

And I know you probably don't want to give the direct guidance, but can you give us some qualitative commentary on where you think revenue is likely to be comparable to the March quarter?

Darren Jamison

Yes, I think it's always difficult because we are shipping, in a lot of cases, $1 million boxes and so whether they make the quarter or don't make the quarter, and everybody hates it when I say lumpy or having stuff on the dock.

But the reality is if it ships before the end of the month or it doesn't, if it misses by a couple days, that impacts our revenue. That being said, I think the bookings for the quarter should be good. I think we're happy with the book to bill last quarter and expecting to see decent book to billing this quarter.

Revenue for the Q1 will probably be fairly similar to Q4, but I think we're going to build, especially in the second half of the year. So I expect Q1 and Q2 to be fairly flat compared to Q4, but I expect Q3 and Q4 to really pick up as we get Capstone Finance coming online.

We've got some orders that we got recently that are booked but not shipping until the back half of the year. We have several new distributors that are starting to contribute now, whether it's in the UK or Eastern Europe.

Obviously, we're getting orders out of the Middle East and Africa. We've got a new Russian distributor and a new China distributor that are both coming online.

So I think that there's lots of good stuff, especially in the back half of the year. But we will continue to focus on our cost reduction efforts, continue to focus on our balance sheet.

But I'm very confident that even though if revenue is $19 million, $20 million, $21 million for the first couple of quarters, we can finish the year closer to that $25 million rate, which is our new breakeven. So definitely look to exit the year very close to breakeven levels, if not profitability.

Craig Irwin

Great. Thanks again for taking my questions.

Darren Jamison

Thank you, Craig.


Thank you. And our next question comes from the line of Eric Stine from Craig-Hallum.

Eric Stine

Hello. So my first question is just sticking with Russia, and you just touched on it a little bit. I wanted to get some detail as you talked about other distributors in Russia. It sounds like you have one, wondering if there are others in the works there and also just an update on BPC. Were there any shipments in the quarter, and any work-down of that $7.1 million in bad debt?

Darren Jamison

Yes, we had a small amount of shipments in Q4. We are anticipating about $2 million in Q1. And then Q2, he is forecasting around 5 megawatts or $5 million. So we are seeing a kind of coming up the backside of that curve and then we're definitely excited about getting him back online.

We've hired a new Russian speaking sales person who is in the region and so we've added one new distributor. There will probably be another three or four on here in the first half of the year between Russia and the CIS states.

So I think we're working with BPC, we are working to convert as many of the orders they have already in backlog to revenue. But as you said, for each megawatt shipped or every spare parts shipped, he's got to pay cash upfront and an overage of 15% to go up against the credit line.

And we still have some revenues that we didn't take on BPC that's still coming down. So we should see a pickup in a little bit of revenue and in bad debt recovery for most of this year going forward. So as they come online, it's good for the business, it's good for revenue, but it's also good to clean up that reserve that we have on the books.

Eric Stine

Yes, but I mean, are those shipments that you are expecting in the first half, are those predominantly oil and gas or is that some CHP and other applications?

Darren Jamison

I would say it's predominantly CHP. Because the oil and gas business is still fairly slow, but yes, he has diversified his business as well and is doing more in CHP. He is also developed a gas compression line and some other product lines to help kind of offset the headwinds he's seeing in the Russian oil and gas market.

Eric Stine

Okay. Maybe just sticking with the distributors. You had an announcement in early April which I thought was pretty interesting. Serba Dinamik, if I'm saying that, distributor in Asia, and that they are owning and operating the microturbines and then offering PPAs.

Wondering, I know a lot of your distributors are often smaller and maybe more nimble, but, and maybe that limits it, but do you see this as something that you can replicate with other distributors?

Darren Jamison

Yes, definitely if we have distributors that have the balance sheet that is a good business model just like Capstone Energy Finance is a good business model for us, so I think we have seen a lot of distributors do a lot of this, but more frequently, they partner with the bigger ESCO.

I think internationally, we're not ready to take Capstone Energy Finance outside the US yet. So any of our distributors outside the US that could provide customers that type of a solution would be very exciting for us. I think our new distributor in China, JTL, probably has the wherewithal to do that as well as some other folks.

But yes, Serba Dinamik is focused on Indonesia, Malaysia where there's huge opportunities there for their style of business.

Eric Stine

Okay. Maybe last one for me just a update on some of the large order opportunities that you've talked about in the past?

Darren Jamison

I think, great question. We're still, if you look at the potential orders for the year, in the Salesforce, you are seeing Latin America has got a huge potential that's being driven by the project in Ecuador.

That project continues to move ahead at maybe somewhat glacier speed, but is definitely still moving ahead and so we are very confident that there could potentially be a positive outcome for this in the first half of the year for us. That's 29 megawatts with potential follow-on orders.

We've got a couple other, call it, 10 megawatt opportunities in the US and also down in Australia and so those are also moving forward. So I think that we don't have in our business plan any big home runs.

We think we can get to the $25 million revenue level with singles and doubles, but it would definitely be a boost in our business to land one of these larger projects and be able to ramp revenue faster. If we can ramp revenue faster with some of these big orders on top of what we've already done from a cost reduction standpoint, that's going to put us in a good place very quickly.

And I think more importantly, that the cost reduction you are starting to see come through the P&L, obviously, you will see more of that in Q1 and Q2. A lot of the cost reduction actions have taken place, but we may have severance expense or costs that are winding down and some further work to do. But I think each quarter, you should see a more clear picture of what our cost structure looks like going forward.

Eric Stine

Okay, great. Thanks.

Darren Jamison

Thanks, Eric.


Thank you. And our next question comes from the line of Amit Dayal from Rodman and Renshaw.

Amit Dayal

Thank you. Most of my questions have been asked. But I'm just, in terms of the $85 million we did in FY16, should we look at that as sort of the low revenue point for the Company going forward I guess?

Can we anticipate more year-over-year growth? It looks like you have put in place the necessary diversification, et cetera, to kind of propel or bring back growth in the story. Just any color on how we should be looking at revenue growth over the next 12 to 24 months?

Darren Jamison

Definitely, Amit, I believe this is the low watermark for us. I think we will return to revenue growth this fiscal year, especially back in the second half. I guess I would probably conservatively say 4% to 5% revenue growth.

I think we have an opportunity to do more than that, but I think we look at it, we'll probably just want to air on the side of conservatism and say that we'll put up a 4% of 5% year-over-year revenue growth.

I do think, especially, again, the second half of the year, we have lots of opportunity with Capstone Finance. As customers actually see the strength and the benefit and the improvements to our signature series product, which will happen here in the next couple of months, I think that may also accelerate growth for us.

If oil continues to rebound the way it has, especially in the back half of the year, that could give us a more growth. So sitting here today, I would conservatively say 4% to 5%, but I think in the next couple quarters, we may adjust that up as some of these opportunities present themselves and the rebounds continue.

Amit Dayal

Understood. Thank you. And your comments on the financing side, who are these partners or is it a single partner that you are working with at this point? Could you give us any color on that?

Darren Jamison

Yes, currently, it's a single high net worth individual that we've got familiarity with. We are looking to add to that pool of money and investors as we grow. We are conversations with some larger financial institutions.

But frankly, our strategy is to prove the model, prove the IRRs, prove that the reliability of the product and that the payments of the customer are all there and then I think we can easily leverage this into larger financial institutions.

We also want to open it up to our distributor body if they want to be part owners to some of these projects, we could team up as well, and they could actually own a portion. Or even a customer, we could go 50-50.

I think the Capstone Energy Finance we have built in a lot of flexibility and it's really at our discretion and on how we want to structure some of these projects. But the key is, we want to get customers deploying the product, have them start saving money today and get these projects that are north of 20% IRR off the shelf and shovel ready and get them rolling.

Amit Dayal

That's great. And just a final question, it looks like your previous comments, you alluded there might be more room for cost-cutting, et cetera. Could you give us a sense of how much more room there is potentially?

Darren Jamison

I don't think there's more room for cost-cutting as much of the fact that you have not seen all the benefits of the cost-cutting. So there is a lot of things that we've employed or put in place or plans that we have that you've not seen flow through the P&L.

So if you look at it, our operating expenses should be down by the end of year by just under $6.5 million I think on a quarterly basis. So I think that with 25% gross margin and $25 million of revenue will get us to slight profit or breakeven and so that's down substantially from where we were.

Our R&D expense will be half of what it was the year before. Our sales expense will be 40% less. These are fairly significant cuts. We will end up going from, call it, 240 employees to about 175. I think we're sitting at 181 today. We do have a few employees that know that their position is ending in a future month and we just have not finished up their work yet.

So most of the reduction is in force, most of the hard decisions have been made, but there's still kind of a lag between making those decisions and seeing it flow through the P&L.

Amit Dayal

Understood. Thank you for that clarification. I think that's all I have. I will get back in queue. Thank you.

Darren Jamison

Great. Thanks, Amit.


Thank you. And our next question comes from the line of Colin Rusch from Oppenheimer.

Unidentified Analyst

Good afternoon this is Kristen in for Colin. I wanted to go back to the discussion on the distributors. Can you talk a little bit about what your highest priorities are for optimizing that sales channel as you go through the next year?

Darren Jamison

Yes. The number one priority is adding additional salespeople. So I think maturing the channel overall is important, but we need more feet on the street. In several of our key markets, we believe that our distributors could do more revenue if they had more people out there developing the projects.

We also think sales training for our distributors so they could be more effective in the sales process. So we're doing a lot of third-party training in the field, in their native tongue.

We've helped developed workman companies like Alkves [ph] or other folks that do third-party training to do that sales training. These are long sales cycle projects. Typically we're seeing about a 14 month from initial contact to closing the order.

We're closing to date at about 11% close rate and so obviously if we could shorten that sales cycle with a more matured sales channel and if we can improve that close rate from the 11% up to something a more world-class like 20%, based on our $1 million of identified opportunities those are all nice numbers and will drive some nice growth. So the channel has matured.

As I said in my prepared remarks, I don't think there's anybody in the clean energy space, especially in our size range that has a distribution channel of almost 100 distributors and almost 800 people out there in the market working on their behalf. So I think it's expensive to build a channel and it's time consuming to build a channel.

But I would say in the next 4 to 5 years, as that channel matures and we are driving top-line revenue growth quarter after quarter, and we are not adding any more salespeople or selling expense, it's going to be an envy of a lot of people that are in our space.

Unidentified Analyst

Great. Thank you. And then, you mentioned some of the diversification in your verticals, but can you maybe talk about any meaningful changes you may be seeing in the product mix?

Darren Jamison

Definitely, you've seen as oil and gas dropped off, our C30 and our C65 sales have dropped off substantially year-over-year. A big piece of our smaller product sales were going into oil and gas, whether it was shale gas or pipelines or cathodic protection, metering and val stations. So our C30 and our C65 business dropped off quite a bit.

Our C1000 business did not drop off nearly as much and that's really because of the growth in CHP and combined heat and power. So we are doing hospitals, we are doing breweries, we are doing hotels, we're opening up new markets, new opportunities, a lot of industrial applications. So the C1000 series, especially the new signature series with the integrated heat recovery module and all the other benefits really plays well in that energy efficiency space.

So as oil comes back in the back half of the year, I think you'll see an up-tick in our C30 and our C65 business, but in the interim, our revenue is really going to be driven by our service organization and our larger product.

Unidentified Analyst

Great. Thank you for that color and I believe all of my other questions have been answered.

Darren Jamison

Great, thank you.


Thank you. [Operator Instructions] Our next question comes from the line of Jeff Osborne, Cowen and Company.

Jeff Osborne

Hi. Good afternoon, guys. Most of them have been answered, but, Darren, can you touch on the signature series and any sense of either of the pipeline, the $1 billion that you talked about, or what it is book to bill? I'm just trying to get a sense of the up-tick of that product, which looks pretty exciting.

Darren Jamison

If you look at our book to bill ratio, or even just our raw bookings, it was the best in I think over a year. Most of those bookings were the new signature series. We will ship our last, we call it the R series, but the older series C1000 this quarter.

The majority of Q1 will all be signature series products, so we have successively cut over from the old R series to the new signature series. And so that, again, hats off to our operations folks. It always sounds easy to talk about changing models and not missing a heartbeat, but it's definitely a lot harder than people think it is.

So there's a lot of detail and planning and working with vendors and working with our MEs and our engineering team and our procurement folks to make that happen.

So this quarter has been challenging from that perspective, but going forward, we'll be 100% signature series on the larger boxes. And we'll be looking at bringing out signature versions of our other models in future dates.

So I think definitely we are excited about making a product more energy efficiency CHP friendly, improve the application, the installation cost, making the footprint smaller, make it more robust. But more importantly, wrapping the whole thing with a long term factory protection plan and a new extended warranty program that we have.

Jeff Osborne

Got it. And that kind of gets into the follow-up I had about that question. It's just maybe either for yourself or Jayme. How do we think about the gross margins on the new product that, in particular, would warranty reserves be higher for the first 6 to 12 months or any type of commissioning charges or whatnot?

That kind of offsetting versus the factory protection plan and some of the benefits that you have on the services side. I guess I'm just trying to get a sense of, you've given a lot of detail about the revenue trajectory, your expectations through the year and on the OpEx side, but in particular, with the pretty pronounced mix shift in product, how do we think about gross margins?

Darren Jamison

I think you're going to see margins are going to be a little lower than historic in the beginning. A lot of the 70 design improvements we made, some of those are higher cost. So obviously, after we get it cut into production, the next goal for Richard and his team is now to get the cost back out again.

So as we ramp volume on the new parts from vendors, we will seek to get that up, so to see a little bit of lag in margin improvement or even have margins slip a little bit in the first half of the year would not be a surprise. Obviously, we want to mitigate that as much as possible.

But I think in the back half of the year, we will get that accomplished and you'll see margins get back up closer to probably 20%. So I guess if I would, to kind of give you a book end, I would say margins will be kind of 15% into the year and probably low-20%s to end the year.

So again, I think if we can drive our cost reduction efforts to conclusion, if we can drive revenue back to that $25 million a quarter, exiting the year, we might be $1 million, $1.5 million away from EBITDA breakeven just because our margins are quite to 25% yet. But I think that gives you a feel for where we are at.

And frankly from a viability, sustainability standpoint, if we are $1 million away from breakeven, that really changes the conversation we have with vendors and customers. They obviously can see the trajectory and will give us a lot of credit for getting that close. So I think I don't see us at this point getting profitable during this year, where I sit today, but I think we will get very, very close.

Jayme Brooks

And then on the warranty side, Jeff, the warranty you're not really going to see much of a jump up because it is just improvements to an existing platform already. So in the past, you saw that bell curve on when we actually launched the new product. But you won't see that same spike like you did back then when the C200 was launched.

Jeff Osborne

Got it.

Darren Jamison

A lot of those improvements were actually helping the reliability of the product and making the warranty lower or FPP margins better in the future, so our margins in our service business are okay, but they can be good or even great as the product continues to mature.

Jeff Osborne

Got it. All right, that's helpful. And then just two other quick questions here. Do you anticipate with the product transition, any kind of increased working capital intensity on inventory management or whatnot with width and raw materials or, given it's only an improvement, everything is pretty similar to the status quo?

Darren Jamison

The short answer is we certainly are trying to minimize that as much as possible. I call it the Tarzan theory, though. You never want to let go of one vine until you have a firm grip on the next one.

So there are vendors where we're going to have old part and new part coming in simultaneously. So inventory reductions may not be as good as they will be going forward.

But we've done a great job in the last couple quarters at getting our inventory down, both raw materials and width, as well as bringing our payables down a huge amount. So our vendors our payables are very low.

The bank line has come down. I think from a working capital balance sheet standpoint, where we sit today from where we were three or four quarters ago is dramatically different.

Jeff Osborne

You certainly can see that. Now the last question I had just on the 2017 pipeline that you talked about the $9 million, $9.7 million. Can you give us a sense, you did a nice job regionally, but more importantly, with the end markets do you have a pulse on how much of that is oil and gas versus renewable and other applications?

Darren Jamison

I think we will be north of 50% energy efficiency this year. I think, again, oil will pick up in the back half of the year, but I think will be more bookings than shipments. I think renewables, especially in breweries and areas where we can take organic material and put them in a digester are growing.

Waste water treatment plants have done okay. Landfills have been fairly slow for us, but I think the renewable business will continue to grow. So I expect a pretty similar forecast going forward to what it looks like this year. I think the following year, you will see oil pick up and start contributing more.

Now that could change if we get the Ecuador project or one of these larger oil and gas projects, obviously, that would change. But that would be a one-time big project event.

Jeff Osborne

Perfect. I appreciate it. Thanks so much, guys.

Darren Jamison

Thanks, Jeff.


That concludes our question-and-answer session for today. I would like to turn the conference back over to Darren Jamison for any closing comments.

Darren Jamison

Well, thank you, guys. Hopefully, that was a great list of questions and you covered a lot of the things that I was going to say in my closing remarks. But I guess just to summarize, definitely a challenging year, challenge year for leadership team, for employees, both that are here and no longer here. Our vendors have had to be patient with us as we've moved through this challenging time.

All that being said, I think you can hear the confidence in our voice that our Board of Directors, our leadership team, our employees feel very confident about where the business is and our ability to execute going forward.

I think we are a stronger, more resilient company today. We've got a more diversified customer base, both by geographies and verticals. And I think our ability to quickly reach profitability is more clear than it ever has been, despite the headwinds.

Capstone Finance, I couldn't be more excited about the benefits that's going to bring to us. And I'm looking very forward to announcing our first couple contracts and to really have people see what that product can do for us and help drive more top-line sales.

I am frankly tired of discussing our balance sheet with vendors and customers. So as fast as we can get profitability in our balance sheet strong, that's going to enable more business, and frankly, allow myself and Jayme to focus on the more important parts of the business than trying to get people comfortable with our balance sheet.

So I'm very ready to move this thing forward with a stronger balance sheet and get this Company profitable once and for all. I think the less customer concentration in places like Russia, obviously, is good.

But I am encouraged that our Russian distributor is coming back. But if they stay 5% or 10% of our business, that's probably a lot better than where they had been historically, 25%, 30% of our business.

Really excited about Mexico. They're doing a great job. Latin America, South America is growing as well. We are just starting to scratch the surface in Africa and the Middle East. Nice projects coming out of Eastern Europe as well as traditional Europe. You've seen recent orders from Italy, Germany has done well. We're seeing Great Britain, or the UK, come on. But you're going to see more orders out of Slovenia, Poland, Netherlands, areas where we traditionally have not put a lot of product.

The signature series, I know we keep talking about it, but the employees here at Capstone know how great it is. They know how many improvements there are. It was an 18-month secret effort to develop the signature series product. And we think once customers actually see how great it is, it's going to drive more orders and create excited customers.

We don't talk a lot about our after-market business, but our factory protection plan business continues to grow. Our accessory sales are going to grow with the new signature series.

Our new long-term warranty, we think will actually help penetration in the oil and gas space where they tend not to buy service agreements but they will buy long-term warranties. And our ability to offer this warranties and guarantees has never been better since we feel so good about the product.

But more importantly, unlike other people in our space, our service business is profitable today and only getting more profitable. So as that grows and becomes a bigger part of our business, we're really excited about it.

If you look at Caterpillar or larger industrial customers, half their revenue and, in some cases, on a quarterly basis, comes from their after-market. That's a very high margin recurring revenue business so we're really focused on continuing to grow this business and getting it as big as possible as fast as possible.

And more importantly, it really aligns us with our customers. If the customer does not have a long-term service agreement, and the product fails, our distributors and us profit and they don't. But if we have a long-term service agreement, if the product fails or has an outage, then we have the pain of having to fix it and they have the pain of having the unit down.

So I think our long-term service agreements that are unmatched in the industry really aligns us with our customers when they realize what a great product we have plus how well we back it up, I think that's win-win for everybody.

So look forward to quickly announcing Q1 results and giving even more color of what the year looks like next quarter. Thank you.


Thank you. Ladies and gentlemen, this does conclude our presentation for today. We thank you for your participation and you may now disconnect.

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