Capstone Turbine (NASDAQ:CPST) pre-reported some of its Q3 results Monday, and the stock has responded favorably the past few days on above-average volume. (Note: Capstone is on a fiscal year that ends March 31st. Its Q3 ended on December 31st.) From a low of $0.67 last week (barely above the 52-week low of $0.66), the shares moved as high as $0.82 on Monday and followed that up by reaching a high of $0.93 on Tuesday. The closing prices over the past three days were $0.80, $0.84 and $0.86. Are the moves justified?
I confess to being surprised by the reaction. Capstone continued its string of disappointing news, and as it has often done in the past, is trying to put a positive spin on a company that continues to hemorrhage cash. It has regularly forecasted shipments that weren't met, had expenses that were too high, rewarded executives with fat bonuses as the company lost money, regularly diluted shareholders, extended credit too liberally... and the list goes on. Here are some major points made in the press release:
Cash Usage Decreased 56% on a 35% Increase in Revenue from the Prior Quarter - Sounds terrific, doesn't it? Unfortunately, Q2 was one of the worst quarters the company had in years, generating a paltry $15 million in total revenue. And of that Q2 revenue, nearly one-quarter, or $3.5 million, was service revenue.
Total revenue for Q3 was $20 million, and although this is a 35% increase from Q2, it is lower than the $21.6 million for Q3 of fiscal 2016. Even worse, Capstone's fiscal Q3 is typically one of the strongest, and this past quarter received a boost from product that didn't ship at the end of the previous quarter. On that quarter's conference call, CEO Darren Jamison had said:
... we built 6 megawatts, didn't ship last quarter. So, we're anticipating $20 million to $21 million quarter. And three projects moved out on us, so that gives a little bit of surprise. So I guess I would mute our expectations a little bit, things seem to be happening slow.
At least Q3 came in at the $20-21 million that was expected. Of that figure, the company noted that approximately $4 million was service revenue.
Contributing to the reduction in cash usage were the ongoing cuts in personnel and an inventory reduction of $2.5 million.
Total Gross Margin Declined on a One-Time Non-Cash Warranty Reserve - This was one of the more interesting items in the preliminary report. The company will be taking a charge to retrofit some of its...
... select fielded non-Signature Series C200 microturbines in order to improve performance, reliability and customer satisfaction. The proactive retrofit has the potential to decrease future warranty and FPP expense significantly.
Assuming that the potential savings are realized, this should be a good long-term move. For investors in Capstone, this also depends on the company's ability to stop burning through cash and survive for the long term.
Cash Balance - At the end of Q3, the cash balance had increased by $3.3 million to $19.3 million from $16.1 million at the end of Q2. That increase was due to another dilutive equity and warrants offering that raised net proceeds of $6.8 million.
Orders and Backlog - Capstone reported it had net product orders of approximately $11 million in Q3, compared to $8.9 million the previous quarter. Although there was ample discussion about the increase of Factory Protection Plan (or FPP) backlog, the press release did not directly discuss product backlog. Regardless, it's easy enough to calculate an approximate number.
Since service revenue was ~$4 million and total revenue was ~$20 million, we know product revenue was ~16 million. We also know the product backlog as of the end of Q2 was $109.1 million. Since product shipments exceeded orders by ~$5 million, the product backlog at the end of Q3 should have declined to ~$104 million.
The future survival of Capstone will depend on increasing sales. Currently, the gross margin is too low to cover expenses, and it won't be possible to cut expenses enough to reach a cash breakeven point.
Increasing sales all starts with turning the company's pipeline of prospects into orders and its orders into shipments and revenue. On the Q2 conference call, CEO Darren Jamison discussed the geographic diversification of the prospects, calling it a "$923 million rolling 12-month opportunity pipeline." On the topic of orders and backlog, he further noted:
Our total product backlog as of September 30, 2016, was $109.1 million compared to $104.8 million as of September 30, 2015. Backlog as of September 2016 includes the removal of a portion of the TA100 microturbine backlog of approximately $2.4 million for 17 units or 1.7 megawatts. This impairment which occurred during the three months ended March 31, 2016 aligns ourTA100 backlog with management's decision to limit the production of TA100 systems on a case by case basis for key customers.
Our book-to-bill ratio for the quarter improved to 1.1 to 1 compared to 0.7 to 1 in the year ago second quarter. Our FEP service contract backlog as of September 30, 2016 was $72.7 million compared to $66.5 million at March 31, 2016 and $65.3 million at September 30, 2015. This continuing increase reflected growing installed base in microturbines as well as the ongoing efforts of our distributors to sell our FEP service contracts, which enables the end-users to achieve a lower total cost of ownership.
Capstone does not give annual forecasts, but at one time had stated that the product backlog was a reasonable indication of the next 12 months of revenue. As oil and gas prices collapsed and US production and exploration were curtailed, the backlog began to stretch out. It is now believed to be indicative of the next 15-18 months of revenue. If the product backlog of $104 million represents the next 5-6 quarters of revenue, that translates to $17.3-20.8 million of revenue per quarter. Unfortunately, that's well below the $25 million cash breakeven point that Jamison discussed on the Q2 call, and the prospects of reaching that point remain elusive.
In this latest press release, Jamison acknowledges that the breakeven point needs to be lowered:
We continue our focus on decreasing our cash burn by looking at areas where we can reduce expenses, increase inventory turns and improve our cash cycle. We have made tremendous strides in this area as business expenses are down dramatically over last year, but we must continue to lean out our business operations in order to achieve the lowest EBITDA breakeven point possible without compromising customer satisfaction...
As a team, we remain firmly focused on shortening our path to profitability by lowering our expenses, growing our product and service revenue, diversifying our business, launching new products, creating new partnerships and managing our balance sheet.
As a long-time investor in Capstone, I only wish that focus had been put in place several years earlier.
Disclosure: I am/we are long CPST.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: In addition to my long position I will may also trade large blocks of CPST at any time.
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