Capstone Turbine Corporation Q3 2009 Earnings Call Transcript

| About: Capstone Turbine (CPST)

Capstone Turbine Corporation (NASDAQ:CPST)

Q3 2009 Earnings Call

February 9, 2009 4:45 pm ET


Jayme L. Brooks - Vice President, Finance & Chief Accounting Officer

Darren R. Jamison - President, Chief Executive Officer & Director

Edward I. Reich - Chief Financial Officer & Executive Vice President

Mark G. Gilbreth - Executive Vice President, Operations & Chief Technology Officer


Sanjay Shrestha – Lazard Capital Markets

Eric Stine – Northland Securities

Samuel Brothwell – Wachovia Capital Markets, LLC


Welcome to the Capstone Turbine Corporation third quarter fiscal year 2009 conference call. My name is Lemanuel and I’ll be your coordinator for today. At this time all participants are in a listen only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions) Now I’d like to turn the call over to Mrs. Jayme Brooks, Vice President of Finance and Chief Accounting Officer.

Jayme L. Brooks

Welcome to Capstone Turbine Corporation’s conference call for the third quarter of fiscal 2009 ended December 31st, 2008. I am Jayme Brooks, your contact for today’s conference call. Today, we will be using a short PowerPoint presentation that we will reference during the call. The presentation is posted on our website at and can be found under presentations in the Investor Relations section.

Capstone filed its quarterly report on Form 10-Q with the Securities and Exchange Commission today, February 9th, 2009. If you do not have access to this document and would like one please contact Investor Relations via telephone at 818-407-3628 or email or you can view all of our public filings on the SEC website at or our website at

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

These statements relate to among other things future financial performance and attaining profitability, the ability to reduce cost and improve the inventory turns and contribution margins, continued growth in current market conditions, the availability of a line of credit, the launch of the C200 and C1000 products, compliance with certain government regulations and increased government awareness of our products, increased opportunity for our product in the Obama Administration, the success of our new long term rental program, opening new markets for our products and attracting large customers to our products, increased product parts commonality between C30 and C65 products, new applications for our products, revenue growth and increased sales volume, our success in key markets, 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.

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 or may not lead to increased sales, we may not be able to reduce costs or improve customer satisfaction, 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 or capital expenditures during the next 12 months. The current recession could make it difficult or impossible for us to raise necessary funds and for our customers to buy our products, we may not be able to utilize our line of credit, 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, our release of new products may be delayed or our 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 and revenue, we may not be able to comply with all applicable government regulations, we may not be able to retain or develop distributors in our targeted markets in which case our sales would not increase as expected and if we do not effectively implement our sales, marketing, service and product enhancement plans, our sales will not grow and therefore we may not generate the net revenue we anticipate.

These are among many factors which may cause Capstone’s actual results to be materially different from future results predicted or implied in such statements. We refer you to the company’s Form 10-K, Form 10-Q and other recent filings with the Securities and Exchange Commission for a description of these and other risk factors.

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

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

Darren R. Jamison

Welcome everyone to Capstone’s third quarter earnings call. Today’s call we’ll be referring to slides that are available on our website under the Investor Relations section. With me today is Ed Reich, our Executive Vice President and Chief Financial Officer and Mark Gilbreth, our Executive Vice President, Operations and Chief Technology Officer.

Today I’ll start the call with a review of our significant events of the third quarter and then Ed will review the specific financial results. Ed will then turn the call back over to me and I will discuss our progress towards our strategic objectives and review developments in some of our key market segments and finally talk about what we hope to achieve in the coming quarters before I open the call up to questions.

During the third quarter of fiscal 2009 we continued to see impact of our marketing and branding strategies and the success of our new C200 and C1000 product launches. It was another quarter of significant progress for the company as we shipped our first C1000 to Spain in conjunction with our overall development program schedule.

This C1000 product represents almost half or approximately $25 million of our current record $57 million in backlog. It is the catalyst that propelled Capstone into the $ billion worldwide megawatt scale distributor generation marketplace as illustrated on our first slide. This exciting new product is compact in size, offers tremendous efficiency and reliability, life cycle costs and world class emissions.

I fully anticipate seeing an acceleration of our customer orders and increased adoption rates after we cede the market with several of these units and customers fully appreciate the superior value proposition offered by the first megawatt scale microturbine solution. The $14.2 million in product bookings for the third quarter again outpaced product shipments of $8 million for the period.

Total revenue for the quarter was $11.5 million which puts us at $32 million year-to-date which is $1 million ahead of last year’s total year results through just the first three quarters of this fiscal year. Therefore Capstone will again deliver exceptional growth for the second consecutive year in the world’s worst economy in the last 75 years.

Revenue for the quarter was lower than anticipated as we experienced several shipments being rescheduled as customers worked to better manage product shipments to project schedules and better manage cash flow in today’s difficult financial environment. Accordingly Capstone ended the quarter with approximately $3 million in C30, C65 and C200s in finished goods inventory at the end of the quarter.

However those rescheduled orders subsequently shipped in January or are scheduled for shipment later this month in February. That being said it’s important to note we are still not experiencing order cancellations or a significant drop in quotation activity. I attribute the quotation success to our new C200 and C1000 products continuing to gain market share as we continue our marketing efforts with these innovative new products.

During the quarter we reorganized the operations group to better align and coordinate engineering and operations to expedite our product cost reduction initiative. We have made significant progress to enable the reduction of our direct material cost of our products and plan to phase in these reductions and expect to progress to a 30% cost improvement over the next four quarters on our new C200 and C1000 products.

One of the first steps towards this cost reduction is converting many of the C200 turbine components from machine parts to cast parts. This is a huge benefit from both a cost and a lead time perspective. We are implementing the necessary design changes outlined during our last earnings call to improve the parts commonality on the C30 and C65 and are moving certain parts offshore to further reduce their cost.

Our cost reduction program is leveraged by today’s dramatically lower worldwide commodity prices allowing us to use this leverage to better negotiate with our key vendors. We will begin to see the positive impact of these cost reduction activities over the coming fiscal year as we consume our current inventories.

Another tremendous achievement for the third quarter was being awarded the Gold Supplier status by ATC Power. This is the highest level of supplier achievement and is awarded for excellence in lean manufacturing, on time deliveries, service responsiveness and overall engineering support. Capstone is proud to be the first CTC supplier to achieve this Gold Supplier status and one of less than 50 in all of United Technologies Corporation.

This is truly a tremendous achievement when you think about only two short years ago when I arrived at Capstone the relationship had broken down to the point that both companies were threatening litigation. We recently announced the initial orders of our new long term rental program.

This long term rental program is designed to specifically target oil and gas sector and telecom companies that frequently deploy cleaner reliable energy solutions where they build out permanent infrastructure. This program was extremely well received at our global sales meeting as it affords our distributors another sales tool to continue to grow our market adoption of our products.

This long term factory rental program fits our strategic objectives by ceding 20 of our proven C65 units into oil and gas customers who previously had no experience with our innovative green product. Finally a Capstone installation at Masonic Village in Elizabethtown, Pennsylvania was recently recognized in the January issue of Diesel and Gas Turbine Worldwide as one of the worlds’ best power plants.

I want to congratulate our distributor E-Finity for this tremendous installation of our proven C65 product. At this point I’d like to turn the call over to Ed to review the specific third quarter results.

Edward I. Reich

I will now provide you with our results for the third quarter ended December 31st, 2008. As Darren mentioned backlog at the end of the quarter was $57 million or 567 units an increase of approximately 13% from the prior quarter and 335% from the prior year comparable quarter. Revenue for the quarter ended December 31st, 2008 was $11.5 million an increase of $2.3 million or 25% from the $9.2 million reported for the same period last year and decreased 12% from last quarter’s revenue of $13.1 million.

We shipped 116 units in the third quarter compared to 121 units for the same period last year and 172 in the second quarter. Our gross loss for the quarter was $600,000 or 5.2% of revenue compared to $40,000 or less than 1% of revenue from the same period last year and $300,000 or 2.5% of revenue in the second quarter.

The increase in the gross loss and the gross loss percentage from the same period last year reflects the lower margin product mix primarily due to the introduction of our C200 and C1000 systems along with increased manufacturing costs offset by lower warranty and increased absorption of overhead into inventory.

Research and development costs were $2.1 million for the third quarter an increase of $300,000 or approximately 17% from the same period last year and increased $31,000 or approximately 1.5% when compared to the prior quarter. R&D expenses increased as a result of labor, consulting and facility costs partially offset by increased recognition of funding from United Technologies Corporation’s power division for the cost sharing program.

We expect R&D expense in fiscal 2009 to be lower than in fiscal 2008. This decrease is expected to occur as a result of lower overall spending due to outside funding from UTC Power Corporation for our C200 commercialization. SG&A expenses were $7.4 million for the quarter an increase of $1 million or 16% from the same period last year and a decrease of $300,000 or 4% from last quarter.

The net increase in SG&A expenses year-over-year was comprised of an increase in labor, travel, marketing and professional services offset by lower supplies and lower shared cost expense. The increase in labor and travel costs reflected the continued effort in developing worldwide distribution and launching the C200 and C1000 series products. We expect SG&A expenses for fiscal 2009 to be higher than the prior year because of these efforts.

Our third quarter net loss was $10 million or $0.06 per share an increase of $2.3 million from the $7.7 million loss or $0.05 per share reported for the same period last year. Cash balances decreased by $21.6 million during the third quarter of fiscal 2009 based on a net loss of $10 million, $2.3 million in addition accounts receivable and $7 million in additional inventories.

We also invested $2.2 million in capital expenditures primarily related to our C200 and C1000 production lines. As of December 31st, 2008 cash and cash equivalents were $24.4 million. Now let me turn the call back over to Darren.

Darren R. Jamison

I’d now like to take a minute to update you on the progress in some of our key markets and discuss what you should expect to see from Capstone in the coming quarters. The European and Russian markets continue to show growth from last year and have been enthusiastic early adopters of the new C200 and C1000 products.

During the quarter we received several large orders totaling several million dollars related the iMAL project the largest energy project in the contemporary history of Russia. This project us unparalleled in terms of size, sophistication and equal only to the development of Western Siberia’s fields in the 1970s.

In addition incentive to the markets like Germany, France, Spain and Italy continue to drive Capstone’s products into biogas, landfill, wastewater and treatment plants. We are pleased to have commissioned several of the first C200s this quarter into these critical markets and will be commissioning the first C1000 in Spain later this year.

We expect to see the European and Russian markets continue to grow as we get positive results from our new C200 and C1000 products and continue to leverage our existing C30 and C65 installations. The market in New York and the entire Eastern Seaboard continues to be a prime market opportunity for Capstone’s products because there’s a need for clean and reliable energy solutions.

Our bus OEM Design Line is now delivering the first hybrid buses for Walt Disney World in Florida and New York’s MTA. Design Line’s new factory in North Carolina is now operational and they look to build over 200 buses in that factory alone in 2009 for the US market. California remains a good market opportunity which was limited last year absent the Carb2000 certified product.

Our California distributor Collicutt Energy continues to gain momentum and we look forward to continued growth in this market close to home. Capstone continues to focus on the oil and gas markets and has received recent orders from Pemex, Petrobras, Petronas, Gazprom as mentioned earlier and Dominion Transmission Company.

We expect to continue to gain market penetration as petroleum exploration, production and transportation companies are more focused on reliability, maintainability and total cost of ownership than they are on product first costs. We continue to work hard in Asia with a focus on the markets in China, Korea and Japan. We continue to see growth in these markets as Capstone brings on additional distributors and leverages our current relationships.

We are extremely pleased with the success of our Korean distributor Samsung and we are currently in discussions about expanding their territory to other parts of Eastern Asia and even Africa. In addition we continue to work with UTC and its carrier division as they expand their Pure Comfort chiller business into the markets in China and India.

During the quarter we built one C200 per week in the third quarter and will increase manufacturing rates to two per week in the fourth quarter. In the first quarter of the fiscal 2010 we plan to take manufacturing up to three units per week and beyond depending on the ongoing order flow and backlog levels.

As a public company the performance is measured on a quarterly basis. However as a management team we must operate the business on a year to year or more long term basis. Viewing this quarter in context of revenue and backlog our growth has combined over the last seven quarters as shown in Slide 2. You will see the business whose products are gaining market adoption and that the new C200 and C1000 are truly the game changers that we said they would be.

As you can see from Slide number 3 the additional orders generated from our new C200 and C1000 products is driving our backlog and positioning the business for higher year-over-year growth in fiscal 2009 as well as fiscal 2010. In fiscal 2008 we experienced 50% revenue growth after being down 15% in fiscal 2007.

This year we anticipate finishing 2009 strong as we increase our C200 build rates in Q4 and again look to post our second consecutive 50% year-over-year growth in revenue. We continue to enjoy a strong order book that should ensure that we are well positioned to continue that momentum into our next fiscal year.

We are making progress improving gross margins but still need to stay focused and finish our current cost reduction programs and work through the inventory on hand to approach our target margin of 40% hopefully by the end of this fiscal year. Another area of critical focus at this time is our operating expense control.

Over the last two years we’ve been extremely focused on rebuilding our distribution networks, repairing customer, vendor, employee relationships, developing and launching the liquid 65 and new 200 and C1000 products. Having successfully achieved those initiatives it is time to turn our full attention to lowering our operating costs.

We have made strides in improving our operating expenses as a percentage of revenue however we must, we can and we will do better. In support of this effort we eliminated 16% of the company’s white collar workforce last Monday. These are always difficult decisions to make as a CEO especially in light of today’s difficult job market but it’s an action that had to be taken as part of our cost reduction plan and in interest of our shareholders.

This is the first of many critical actions to be taken by management to lean out our operations and accelerate our path to profitability. This reduction did not include any manufacturing personnel as they will be needed to continue increase production rates to deliver our record $57 million backlog. Instead this was a 16% reduction in our engineering, quality, procurement, planning, investor relations and other departments.

The average salary of the positions eliminated was $82,000 per year before benefits and represents approximately $3 million in operational savings. Unlike most companies this reduction in force is not the result of disappearing sales or massive order cancellations but a strategic plan to lean out the organization, reduce operating expenses as a percentage of revenue as this business matures toward profitability.

The next step in the process is moving many of our key vendors to tier one suppliers to lower our inventory levels and supply new just in time manufacturing processes. Fortunately for Capstone our $57 million backlog gives us the ability to move from custom or batch building manufacturing to planned production slot manufacturing which will dramatically lower our inventory levels over the next year and free up additional cash to support the working capital needs.

As a shareholder of Capstone stock I too am extremely frustrated by the recent performance of the company’s stock price. However we must keep in mind the challenging economic conditions we are experiencing and keep recent market developments in perspective. As you can see on our Fourth slide Capstone has outperformed distributive generation companies, alternative energy companies and actually the over NASDAQ Index in both good times this year and bad times.

I believe everyone on the call today will join with me in agreeing we’re all looking forward to the end of this financial crisis, a turnaround of the global economy and the return to more prosperous economic times. One of the keys to our nation’s economic recovery is the newly elected President Obama and his upcoming stimulus energy and environmental programs.

Capstone is extremely encouraged by the new President’s vision and looking forward to playing a part in recovery initiatives relating to green building and energy efficiency. We look forward to the new environmental plan as it surely will focus on reducing the carbon footprint of our country and enable a carbon tax or carbon trade program.

Capstone’s ultra low emissions, high electrical efficiency compared to the grid and ability to operate on renewable fuels should position us well under the nation’s new energy bill. To respond to the election Capstone has doubled our lobbying efforts on the Hill in Washington, D.C. We will continue to make sure microturbine based solutions are given full consideration.

As they like to say in Washington if you don’t have a seat at the table, you’re likely to end up on the menu. Our political advisers believe Capstone is well positioned to make microturbine solutions a critical part of the Administration’s new programs. Another major area of focus is the working capital requirements of the company.

As we grow this business 50% year-over-year, launch new products with significantly higher average selling prices we are experiencing an ever increasing demand in our working capital and have become more susceptible to large swings in cash requirements like we experienced this quarter. In the third quarter as Ed said our change in cash in was $21 million despite the fact our operating loss was only $10 million.

Therefore approximately $12 million in cash was invested in our balance sheet in the form of additional inventory, higher receivables and new capital equipment purchased for the C200 and C1000 product line. It is important to understand that most of this cash was not burned but invested in our balance sheet and not lost as a result of operations.

However we cannot continue to support such high working capital requirements and are extremely focused on reducing inventory levels from the third quarter’s high of $33 million to a targeted $16 million over the next year. We expect this improved management of inventory will reduce our working capital requirements over the next year and allow us to free up cash from our inventory.

This positive change in working capital will allow us time to phase in our product cost reductions, time to lower our operating expenses and will significantly lower the number of units required to be sold quarterly to reach break even levels. In support of our working capital strategy today we announced a $10 million asset based line of credit with Wells Fargo Bank.

It is our intent to utilize this line of credit to further mitigate our working capital swings and is a great start for building a long term relationship with Wells Fargo as we grow the business going forward. We believe that as a business practice it’s always good to have an option to have access to capital quickly should it be required. To this end our $150 million shelf registration statement identical to the one that the company filed three years ago became effective last week.

This new shelf will allow ready access to the capital markets over the coming years to ensure Capstone has adequate liquidity at all times. I believe this is testament to our company, our business plan, our market strategy and our clean and green product that Capstone has been able to raise additional capital last September in the middle of the unprecedented collapse of the worldwide financial markets and again today we’ve gained access to cash through a bank credit facility and in what is undeniably one of the most difficult credit market of any of our times.

Another key focus in the coming quarters is continued increase in the manufacturing rate of the C30, 65, 200 and most importantly the new C1000 product I am confident in our reorganized manufacturing team, I’m confident in their capabilities, I’m confident the new just in time production plan that we have will meet the challenges with less touch labor, better inventory turns, lower costs without compromising our outstanding product quality.

I encourage shareholders to take a step back and look at our progress over the last year and assess what Capstone can do to achieve in the quarters to come. Personally as I look at the third quarter I am pleased with the continued progress and tangible success that Capstone has demonstrated against out strategic business objectives.

Those objectives are rebuilding the distribution network, launching game changing products, penetrating critical new markets, rebuilding vendor relationships, lowering employee turnover, growing our service business and of course building a record backlog.

I’m very confident that we will deliver the same success on our new objectives as we focus the team on increased parts commonality, improved gross margins, reduced operating expenses, lower R&D and most important improved inventory turns. When I look at other companies in our industry and beyond it’s hard not to be encouraged by Capstone’s tremendous revenue growth year-over-year in this challenging worldwide economic downturn.

It’s hard not to be proud of the new C200 and C1000 product development efforts. Their launches were on schedule with a remarkable marketing effort that has led to unprecedented early customer adoption. It’s hard not to be impressed with our ability to raise working capital. During a crisis in world financial markets in September and again today as we announce a traditional and most importantly non-dilutive bank credit facility.

I’m excited when I look at Capstone’s products, how they’re positioned to play in the new America, an America that looks for higher energy efficiency, lower emissions, lower dependence on foreign oil and builds an electrical grid powered by a multitude of renewable distributed energy sources.

I am determined to deliver the best year in Capstone’s 20 year history despite the overwhelmingly poor global economic conditions. I’m committed to move Capstone from what has too long been a concept company and deliver to our loyal shareholders a profitable company that’s concept has finally been realized.

I’m incredibly focused on making Capstone profitable in the upcoming fiscal 2010 and start delivering real earnings from a stable growing company in today’s new America. At this point I’ll open the call up to questions.

Question-And-Answer Session


(Operator Instructions) Our first question will come from Sanjay Shrestha – Lazard Capital Markets.

Sanjay Shrestha – Lazard Capital Markets

Couple of quick questions, talking about that bond rate number looking at it from the inventory and the receivables standpoint, am I reading you guys right that you guys should be cash flow positive in the next quarter?

Edward I. Reich

Not necessarily in the next quarter but in the coming quarters and definitely in fiscal 2010 we plan to be cash flow positive.

Sanjay Shrestha – Lazard Capital Markets

But the burn will go down pretty dramatically quarter-over-quarter from Q3 to Q4?

Edward I. Reich

Yes, you should see inventories coming down. You should see better collection times on receivables helping that out as well.

Sanjay Shrestha – Lazard Capital Markets

So when you guys talk about the working capital management and you have a bit of a difficult task at hand, you’ve got to build a working capital to support the long term growth and you can’t build it too much because you’ve got to manage your cash and the balance sheet items.

What exactly, I know Darren you talked on it a little bit, but can you go into some more detail as to exactly what you’re doing so that you can have a better working capital balance while making sure that you’re not sacrificing the growth on a long term basis?

Darren R. Jamison

A couple key issues here, we’re moving from what was more of an aerospace build to the customer demand, manufacturing process or batch building I like to call it. But because of our backlog today we can now lay in production slots and build to those production slots. So we get much more level, sustainable, efficient manufacturing process.

Second we’ve got a lot of suppliers who are now moving to tier one so instead of us buying materials a year ahead of time moving it through three or four vendors we’re now having the vendor buy the material a year ahead of time and move it through their process. That means less inventory on our balance sheet, better use of our cash.

Obviously with the lower commodities cost today and the fact that our business is growing while many other businesses are not growing we’re in a great position to leverage our vendors and to take get more favorable terms as well as pricing. The real key for us is getting the ERP system we run full blown enterprise ASAP with all the inputs correct, to get the turns up. We’d like to see those turns at four or higher here very quickly.

As we bring the C200 production levels up, the C1000 production levels up you’ll see those turns also go up and the inventory levels go down.

Sanjay Shrestha – Lazard Capital Markets

Then that $2.8 million in the finished good inventory that you guys talked about in your release is reflective of what you talked about in terms of the customer being sensitive as to the timing of when they take the delivery of product and I take it that that’s going to get recognized into revenue in Q4?

Darren R. Jamison

Absolutely. A couple things, we had customers reschedule, we also had one customer that had bumped up against his credit limit, had another LC that was a little bit late. The customer that had the credit limit issue has since paid and the product is shipping and the LC is also in place in January and that product has already shipped. The other reschedules were based on customers trying to better match their deliveries to their project schedule.

We’re not seeing order cancellations, we’re not seeing a reduction in quotations. We are seeing customers be a little more sensitive to actually when they take the product and how fast they have to pay for it, better diligence on their part to make sure they maximize their cash. LCs are probably taking two to three weeks longer than they used to in the past and banks just seem to be even more deliberately these days more cautious.

Sanjay Shrestha – Lazard Capital Markets

One last question, you talked about how you want to improve the margin on C200 and C1000 and I was wondering if you can talk a little bit about as to what exactly you’re doing and second just a point of clarification, want to make sure that there’s not going to be any C1000 would be shipping in Q4. Would there be significant revenue contribution from C1000 in Q4 for you guys?

Darren R. Jamison

There’ll be C1000 shipping in Q4 as well as C200s. As you know we shipped the first C1000 recently. We’ve got another one shipping actually this week so we talked C200, C1000s both productions are up and running, that is correct.

Mark G. Gilbreth

Sanjay to your point as we discussed earlier the costs are still higher than we’d like them to be on the C1000 and C200 and Darren can explain more in detail but over the next year we plan to reduce the materials cost by 30%.

Darren R. Jamison

I think the important things here is most new products don’t hit their cost targets in a program on serial number one. Obviously we want it to. I’m kind of put instant coffee in the microwave kind of guy but obviously we’re working very hard to make that happen. The important point is we’re not hoping to take costs out, we’ve identified the costs, we’re negotiating the purchase orders with vendors and it is truly a matter of phasing that lower cost product down into the assembly line.

We’ve got to burn through the initial inventory that was at higher costs. In some cases we’re going from machining parts to cast parts. In come cases we’re going from domestic vendors to international vendors. Whatever it is we’re working through that process very diligently and Mark and his whole team is extremely focused on that.

Obviously it’s such a big part of our backlog, it’s another reason we haven’t ramped the assembly line as fast as some folks wanted us to. If we’re not hitting our margin targets there’s no sense to get the product out that fast. We need to meet customer expectations but maximize our profit as much as possible.


Our next question will come from Eric Stine – Northland Securities.

Eric Stine – Northland Securities

Just a few questions, first to touch on the inventory again, could you talk about how the finished goods is broken out between the 30, 65 and 200?

Mark G. Gilbreth

We don’t break that out into details. I guess it’s fair to say that if our backlog is more than half C200s, are you talking about finished goods or raw material?

Eric Stine – Northland Securities

Finished goods.

Mark G. Gilbreth

We really don’t break that out, Eric. Obviously C200s and C1000s there’s no 1000 in finished goods. There’s very little C200s, it’s mostly 30s and 65s.

Eric Stine – Northland Securities

Going on to the production lines, you talked about in the fourth quarter that we should think about two C200s per week. When you’re referring to that do you include the C1000 as part of that two per week, part of the C200 family or should we think about the C1000 as a separate line?

Darren R. Jamison

You think about the C1000 being five C200s, so you’re looking at the same kind of per week basis. Obviously it would take a couple weeks to build a C1000.

Eric Stine – Northland Securities

You talked about that given your costs engineering those out and taking a number of the steps that you’ve detailed, I haven’t had a chance to read the release, is there a new microturbine break even number or something you can talk about going forward?

Darren R. Jamison

No, we haven’t lowered the number until we actually see those cost improvements come through the P&L. I guess I would say that as we move forward with those cost improvements the next couple quarters you should look to see that number come down.

Edward I. Reich

Eric, I can say too as the next change is right like Darren said the number’ll come down. If you look at this quarter the shipments were 116 units and a year ago on lower revenue they were actually 121. So you’re starting to see the shift downward in the number of units it takes to get to our revenue numbers. We’ll revise that estimate when we have everything in place to announce it.

Darren R. Jamison

Also as we focus on the operating expenses we mentioned the headcount reduction we did. As we continue to bring down the spend on the C200, C1000 program that’s going to lower R&D expenses. The marketing side of the business we’re not launching major new products in the next fiscal year so you’ll see some of the sales and marketing spends trail down. Overall the operating expenses will be lower and the product margin should get better.

That’s going to lead to a lower number of turbines to be sold per quarter to reach profitability.

Eric Stine – Northland Securities

One last question, I’ll jump back in the line. UTC Power, can you give us an update where you stand in the completion of qualification milestone and then just talk about what that would mean as far as selling into the US?

Darren R. Jamison

We’ve got about $500,000 left on that funding program. The final milestone to be achieved is the UL listing. We are in UL testing right now. There’s multiple tests, everything from rain tests to noise tests, both noise emissions as well as electrical noise and performance of the product. As we go through that test which should be done roughly at the end of this quarter we expect to receive the last $500,000 payment and close that out.

Obviously all the 200s and C1000s you’re seeing sold today are CE listed and are going outside the US. Once we have the UL listing we can start shipping to customers inside the US.

Eric Stine – Northland Securities

One last question on pricing, can you talk about how that’s held up here and I know you put through a price increase in the fall and if there’s been any push back?

Darren R. Jamison

We’ve had two price increases in the last 12 months. We’ve not had significant push back. Obviously the change in the dollar compared to other currencies has put a little more pressure on it but overall again our quotation activity is up, we had a very good bookings quarter especially when you consider the holidays that were in there.

So, I think unlike most businesses today we’re very happy with the booking rate, with the backlog. Really our focus now goes internally and things we can control. It’s inventory turns, it’s costs, it’s our operating expenses so I hate to say we’re fortunate in today’s market but I’d say we’re more fortunate than other folks. Our key challenges are internal challenges not external factors at the moment.


Your next question comes from Samuel Brothwell – Wachovia Capital Markets, LLC.

Samuel Brothwell – Wachovia Capital Markets, LLC

A lot of my questions have been touched on but to go back to the UTC agreement, is there any chance especially in light of their elevating you to gold status, that they might reup that or otherwise in a nutshell, it sounds like you guys are hunkering down here but I guess what I’m driving at is there any way that they might be able to step in and help you through this?

Darren R. Jamison

I think we’re pretty comfortable with our cash position today. I mean obviously if that was something we needed to talk to them about we could, the relationship is very good. We expect after we finish the development program to just go back to a more traditional OEM relationship with them. The group we’re working with at UTC is actually switched to the carrier group, we see that as a positive. The carrier division has got more [reaps] then the UTC power division. We’re also not in the same division as the fuel cell group.

Recently changes at UTC are playing we think to our strength and we’re looking to get more product through UTC going forward. If you look at our balance sheet we’ve gone from almost $14 million in inventory a year ago to $33 million to $34 million today, we don’t need to be that high. If you look at even four turns a year which are not herculean especially with the kind of enterprise SAP program we’re running, we should really be down in the $15 million to $16 million range. So, we’ve got almost $20 million that can come out of our balance sheet as well as this bank line obviously tracks with our revenue so we would like to really borrow from the Bank of [inaudible] first and Wells Fargo before we look to do anyone else.

Samuel Brothwell – Wachovia Capital Markets, LLC

In terms of the rental program and the inventory build, how much of a dent do you think that can make in what kind of a timeframe?

Darren R. Jamison

The rental program definitely obviously helps but I think we’re looking at taking pretty big chunks, $4 million or $5 million a quarter out of our inventory as we grow the C200 C1000. A lot of that additional inventory, new inventory that has come in is for the C200 C1000. So, as that ramps up you’re going to see the inventories ramp down. Again, as I mentioned in the call we’re going to just in time, we’ve got [inaudible] systems set up out here. We’re really having vendors deliver on a weekly basis and in some cases every other day.

Again, the good news is that it’s a great time to renegotiate your vendor contracts, they’re very hungry and it’s very fertile ground to get them to not only lower their prices but go tier-1 with you and then deliver to the production line.


At this time I show nor more questions in queue.

Darren R. Jamison

Thank you very much and I appreciate everybody’s time and look forward to talking to you next quarter.


Thank you for your participation in today’s conference. You may now all disconnect. Have a good day.

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