Capstone Turbine Corporation (NASDAQ:CPST) Q2 2019 Earnings Conference Call November 6, 2018 4:45 PM ET
Darren Jamison - President and CEO
Jayme Brooks - CFO and Chief Accounting Officer
Colin Rusch - Oppenheimer
Craig Irwin - ROTH Capital Partners
Robert Brown - Lake Street Capital
James Jang - Maxim Group
Sameer Joshi - H.C. Wainwright
Aaron Spychalla - Craig-Hallum
Good day, ladies and gentlemen, and welcome to the Capstone Turbine Corp. Earnings Call for the First Quarter [ph] Fiscal Year 2019 Financial Results ended September 30, 2018. 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. [Operator Instructions] As a reminder, today's conference is being recorded.
I would now like to turn the call over to Ms. Jayme Brooks, Chief Financial Officer and Chief Accounting Officer. Ma'am, you may begin.
Thank you. Good afternoon everyone and thank you for joining today's fiscal 2019 second quarter conference call. On the call with me today is our President and Chief Executive Officer, Darren Jamison. Today, Capstone issued its earnings release for the second quarter of fiscal 2019 and filed its Quarterly Report on Form 10-Q for the second quarter of fiscal 2019 with the Securities and Exchange Commission.
During the call, we will be referring to slides that can be found on our website under the Investor Relations section. I would like to remind everyone that this conference call contains estimates and forward-looking statements that represent the company's views as of today, November 6, 2018. Capstone disclaims any obligation to update or revise these statements to reflect future events or circumstances.
You should not place undue reliance on these forward-looking statements because they involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. Please refer to the Safe Harbor provision set forth on slide two in today's earnings release and Capstone's filings with the Securities and Exchange Commission for information concerning factors that could cause actual results to differ materially from those expressed or implied by such statements.
Please note, that as Darren and I go through the discussion today, keep in mind when we mention EBITDA, we are referring to adjusted EBITDA and the reconciliation can be located in the appendix of our presentation.
I would now like to turn the call over to Darren Jamison, President and Chief Executive Officer.
Thank you, Jayme. Good afternoon everyone and thank you for joining today's fiscal 2019 second quarter conference call. Before we start today, I want to remind investors to focus on what's really happening in the overall energy markets and more specifically the rise of distributed generation technologies behind the meter.
So the slide three in our presentation today it has a quote from JFK that simply states, the change is the law of life. And those who look only at the past or the present are certain to miss the future. If you look closely what we're doing here at Capstone you'll see we're building a global multi-product, multi-market comprehensive energy business to meet the changing behind the meter distributed energy market.
Also important to note on slide four, that we're seeing nearly a dozen positive tailwinds or growth catalysts, wherein the recent years we had a mixture of headwind and tailwinds. This is an extremely positive change and should lead to the continued further growth for the business. As you all know we reported preliminary results on October 3rd, but before I discuss our final Q3 results, I'd like to highlight a few key business developments since our early October press release.
Let's turn to slide five. Since October 3rd, we unveiled an updated product development roadmap including a new C65 Signature Series product similar to the highly successful C200 and C1000 family of Signature Series product line to better serve the fast growing microgrid market. The technology roadmap is shown on slide 17 of the appendix.
We've also continued to expand into the Permian Shale Basin with a 2 megawatt rental for one of the world's largest oil and gas producers. Approximately one week later after the initial rental order Capstone received an additional order for two more C800s or 1.6 megawatts of microturbine rentals. I'm proud to say today that all 3.6 megawatts have been built and shipped to Texas and we'll start receiving rental income during the current quarter.
Both orders were secured by Lonestar Power Solutions, the new Capstone distribution partner who has added to the South region to focus aggressively on addressing the opportunities in this market, which we believe will drive market awareness and rapid growth for our company. This is a very significant development for several reasons; first, it's an opportunity to place some of our highly reliable products with one of our largest oil and gas companies in the world who've previously been reluctant to adopt our technology.
Second, this oil company is extremely active in not only in the United States shale basins, but also internationally where we'd like to continue to expand our Capstone business into regions such as Asia, Oceana and Africa.
Third, reason is significant it's an opportunity to place more turbines in the Permian, which is widely considered one of the most abundant oil and natural gas regions in the United States and reportedly holds a number of the largest crude oil fields including more than 20 of the nation's top 100 fields.
Fourth, we've made a decision strategically to capitalize these units directly in our balance sheet and non-facilities units to a financial rental company. By doing this we're benefitting for the reoccurring high margin revenue stream that will contribute to our path to 100% absorption.
I'd like to remind everyone that once we achieve 100% absorption on a quarterly basis we'll be covering all of our quarterly operating expenses by our reoccurring aftermarket parts, aftermarket service, air bearing and new rental program margins. Capstone is focused on security additional rentals with the same customer in the Permian and the overall regional awareness will help support our Capstone brand, we believe this will lead the more product sales in the Permian and support the company's overall goal of sustained double-digit revenue growth.
Also since the preannouncement we've received multiple orders for projects in Russia and the Commonwealth of the Independent States. The orders include Capstone microturbines for both oil and gas and CHP applications, one of the new orders is a follow on order secured by our Russian partner Turbine International.
Turbine International is working to expand into the oil and gas markets and multiple pipeline projects in the region, and we're very excited to see the results of our reorganization efforts in the Russia and the CIS market. In addition I'm pleased to say that Turbine International have made their schedule bad debt recovery payment during the quarter.
Also for that region our new partner TOO Synergy Astana secured a microturbine order for Kazakhstan, another pipeline project and we expect to see several more follow on orders of the same pipeline in 2019. Additionally, Capstone secured new orders from multiple 665s they will be used by a major oil and gas producer offshore for platforms located off the coast of Malaysia and Brunei. We expect more follow on orders as well here as the oil and gas market continues to recover in the region and globally.
As a reminder to investors, in 2014 oil price collapse triggered away the cost cutting across the global oil and gas industry expenditures were slashed by more than 40% between 2014 and 2016 with more than 400,000 workers left without work and major oil and gas projects cancelled or deferred. During this time oil prices dramatically dropped as we all know.
Today after four difficult year's optimism has started to return to the oil and gas industry. Investment in upstream has reached over $400 billion a year and Capstone is seeing the positive impact of these recoveries, and an increase in spending evidenced by these recent products and rental orders. As a result we expect to see an acceleration of oil and gas business in the back half of the fiscal year.
We're also very excited about the funding we recently received from Theo's Argonne National Laboratory for the DOE Technology Commercialization Fund. The funding was received during the quarter to refine Argonne's high-efficiency fast-charging, fast-discharging thermal energy storage system or TESS, for use for the Capstone C200 CHP system.
Now I'd like to briefly talk about our Equity Analyst and Investor Open House that we hosted on October 3rd at our Van Nuys, California facility as part of our efforts to enhance transparency with our shareholders and the investment community. The day consisted of a presentation by Capstone senior management, followed by Q&A session and then a tour of our newly consolidated manufacturing facility.
The Investor Day was a success and the whole Capstone team is thankful for all the shareholders continued interest and support. I'd like to remind everyone that the webcast presentation from the investor open house day is still available to view under Investor Relations section of our website at www.capstoneturbine.com
Let's go and turn to slide six. I'd like to mention some of the business highlights for the second quarter. First, we recorded our second consecutive quarter of revenue growth and our product shipments with a posted increase of 22% to $14.9 million compared to $12.2 million in the same period last year. This is the highest products revenue in the last five quarters.
I'm sure I don't have to remind our investors that higher product shipments will lead to future growth in our aftermarket parts and FPP service business. We saw a strong C1000 Series product shipments during the second quarter of fiscal 2019, with an increase 31% year-over-year. In addition, we're very excited that we shipped our first two remanufactured C1000 products in the quarter. As you'll see our price per megawatt is lower year-over-year, but the number of megawatts shipped is higher. This is driven by the remanufactured units being sold at a lower selling price. We also shipped our third remanufactured unit last week that the [indiscernible] Frankenstein as was a mess when it came in, but was beautiful and loved.
Product remanufacturing is an exciting new opportunity to take decommissioned, idle or excess Capstone products from the secondary market or the field and remanufacture them to like new status complete with some of the benefits to today's Signature Series products. From a strategic perspective, we believe this will afford us a new lower cost competitive offering, from which we can continue to challenge the lower cost internal combustion engine competition.
Another milestone for the first six months was our continued improvement in the total year-over-year revenue that increased approximate 11% to $43.4 million from $39 million in the same period last year and year-over-year product revenues up for the first six months to 15%.
Our return to double-digit revenue growth is a key goal for us and we successfully achieved it for the first and second quarter year-to-date, despite the lower service revenue, Our FPP revenue was negatively impacted primarily because the reassignment of certain contracts from our - for our legacy California distributor to Cal Microturbine, which unfortunately resulted in not being able to recognize revenue on numerous FPP contracts. As a result it's important to note that total revenue growth for the first six months of fiscal 2019 would have been approximately 13%, if you add back the lost FPP revenue during the period.
We do however expect service revenue to see a rebound in the third quarter and accelerate in the fourth quarter of fiscal 2019, as our service business normalizes from the California distributor change out and returns to more normal growth mode. While these distributor transactions and transitions maybe sometimes result in short-term fluctuations or impacts on revenue, we firmly believe they're beneficial to the long-term business, as we continue to place the right partners in underperforming market to bring growth to our business. We will continue to evaluate our distributors against KPIs and work to get the right partners in place to fuel long-term high margin profitable growth.
Another key milestones achieved during the quarter is that Capstone paid in full the previously negotiated perpetual royalty settlement agreement with Carrier. The payment of $3 million during the quarter is the last payment obligation under the settlement agreement under our no longer any future royalty moneys owe to Carrier. This settlement to this perpetual royalty will avoid tens of millions dollars of expected future royalty obligations, but more importantly frees up toward strategically with other chiller manufacturers beyond Carrier.
I can't overemphasize how significant this is and we look to improve our competitive position in the CHP and CCHP markets. Additionally, we believe our bundling of microturbines as a result from chillers will provide economies of scale and new top-line revenue growth opportunity. Lastly we're proud of the $4.3 million lower cash usage during the quarter, which represents 78% reduction compared to the prior year's second quarter, when excluding the net proceeds from equity transactions and the carrier royalty settlements.
In summary, the return to double-digit revenue growth remains a key objective for us following our successful roll on cost. Our roll on cost initiative where we cut our OpEx essentially 40%. Our goal is to drive double-digit revenue growth, while maintaining very tight control on our cost and leverage our overhead. However that being said, there are places where we are making investments like marketing and customer acquisition, but overall I'm confident we can drive double-digit revenue growth, while maintaining our lean operating cost structure and achieve our gross margin targets.
Let's go ahead and turn to slide seven. I'd like to remind everyone that we began the new fiscal in April with four key strategic objectives as shown on the slide. Objective number one, improved quarterly working capital, quarterly cash flow and strengthen our balance sheet; objective number two, achieve double-digit revenue growth through the acceleration of global product sales; objective number three, diversify the company into new markets, new verticals and new geographies; and lastly, objective number four, to increase our service OpEx absorption percentage, while driving toward 100% absorption or covering all of our operating expenses with our reoccurring revenue.
I'd like to now provide you with an update on the four strategic objectives. Let's go ahead and move to slide eight. Let's start with our goal to improve our quarterly working capital cash flow to strengthen our balance sheet. Cash and cash equivalents decreased slightly to $1.3 million to $18.3 million for the second quarter of fiscal 2019 over the prior quarter, product bookings moderated a little for the second quarter following the normal summer seasonal patterns, but we are glad to share that we are still up considerably compared to the second quarter of fiscal 2018 and the last six months are up considerably over the prior six months.
We continue to expand to see solid bookings and double-digit product revenue growth during the second half of 2019. When you add back the units used for the new rental program, the rental units impacted during third quarter will see lower products revenues since we turned 4 megawatts of production slots for product revenue and a 3.6 megawatts of rentals. If these units would have been sold, they would have added approximately $3.6 million in products revenue in the current third quarter.
However, we expect our service business will start to rebound in the current quarter as our new high margin rental revenue kicks in, together with the significantly lower impact from the California distributor change. In addition, we should see a significant contribution from our new Distributor Support System, fees through our service revenue line. To-date the new Distributor Support System has provided approximately $1.1 million in cash against billings of approximately $1.3 million, with planned with reflect remaining $200,000.
Additionally, during the second quarter, we raised $3.1 million through the aftermarket ATM equity program, which we essentially used to cover the Carrier settlement of this perpetual royalty. And as I previously mentioned will avoid tens of millions of dollars of expected future royalty obligations, but more importantly also frees us up to work strategically with other chiller manufacturers beyond Carrier.
All right, let's move on to slide nine. Our second strategic goal and objective is to achieve double-digit revenue growth through the acceleration of global product sales. As I mentioned earlier, we are glad to achieve that goal during the second quarter and for the first half of fiscal 2019. As previously discussed, we recorded a strong 22% revenue growth in our product shipments, with C1000 Series product shipments that increased 31% year-over-year.
Let's move on to slide 10. Our third business goal to diversify the company into new markets, verticals and new geographies. We had yet another outstanding quarter with growing global interest as we receive new product orders from 23 different distributors and partners, representing 18 countries. Those countries include the U.S., Canada, Mexico, Brazil, Scotland, Germany, Italy, Austria, Spain, Australia, China, South Korea, Japan, Russia, Kazakhstan, Malaysia, Brunei, and Iraq.
As highlighted on this slide, I believe this really sets us apart from most other companies that are in clean tech space, most of which are very heavy customer concentrations or heavy geographic concentrations, as Capstone was back three or four years ago.
As we continue to work on our growth initiatives and expand globally, our diversification strategy is gaining ground. As a principle we believe a strong long-term business model should include a well-diversified revenue base that reduces customer or geographic concentrations and lowers overall risk profile of our business and our shareholders.
Let's move on to slide 11. Capstone's fourth strategic objective is to continue to focus on achieving the previously stated service OpEx absorption target percentage of 100%. This will be achieved by increasing accessories and parts revenue and the service FPP revenue, while maintaining operating expense discipline at the current levels.
Accessories and parts revenue improved slightly in the second quarter versus the first quarter of fiscal 2019. But as previously mentioned, our service revenue in the quarter was down sequentially year-over-year again because of the previously mentioned California distributed change order - change over. This negatively skewed our performance in the quarter, as I mentioned earlier, we expect to see a rebound in the third quarter and acceleration in the fourth quarter of fiscal 2019 as the service business once again normalizes and returns to growth mode.
As a reminder, revenue growth in our aftermarket service business is key to reaching our profitability goals. Just to provide a little more perspective on this, last year the aftermarket business accounted for 39% of our revenue, but 81% of our margins. I've added a slide on this slide 12 just graphically shows how significant our service business is. Not so much driving top line, but really delivering bottom line.
At the end of the second quarter, we had approximately $74 million in long term FPP service contracts. But we have another $25 million in pending FPP service contracts that we expect to close in the back half of this fiscal year.
Therefore, we expect to see significant FPP service growth in the back half of fiscal 2019, both in revenue and bookings and continue into next fiscal year as we execute against our aftermarket service growth strategy at the stated goal of $10 million in quarterly revenue, with a 50% margin rate. And that's a lot to cover.
With that, I'll turn it over Jayme and let her go over some specific financial results for the quarter. Jayme?
Thanks, Darren. I will now review in more detail our financial results for the second quarter of fiscal 2019. The highlights can be found on slide 13. Product revenues for the second quarter of fiscal 2019 was $14.9 million, compared to $12.2 million in the second quarter of fiscal 2018, an increase of $2.7 million or 22%. Our accessories, parts and service revenue decrease $0.3 million or 4% for the second quarter of fiscal 2019 to $7.3 million compared to $7.6 million in the second quarter of fiscal 2018.
As a reminder, we reassigned certain long-term FPP contracts from our legacy California distributor to Cal Microturbine, our new exclusive distributor partner in California. This transition negatively impacted our year-over-year service revenue growth, as Darren mentioned earlier.
Total revenue for the second quarter of fiscal 2019 increased $2.4 million or 12% to $22.2 million, compared with $19.8 million in the year ago second quarter. Gross margin for the second quarter of fiscal 2019 was $2 million or 9% of revenue, compared to $3 million or 15% of revenue for last year second quarter. The decrease in gross margin of $1 million during the second quarter compared to last year was primarily because of an increase in warranty expense related to a supplier defect identified during the first quarter of fiscal 2019 and a decrease in our direct material costs margins.
R&D expenses for the second quarter of fiscal 2019 decrease $0.2 million or 18% to $0.9 million from $1.1 million in the year ago second quarter. G&A expense in the second quarter of fiscal 2019 increased $0.5 million to $5.3 million from $4.8 million in the year ago second quarter. Total operating expenses for the second quarter of fiscal 2019 increased 5% to $6.2 million from $5.9 million in the year ago second quarter.
Net loss for the second quarter of fiscal 2019 increased to $4.4 million compared with the net loss of $3.7 million for the prior year second quarter. Net loss per share was $0.07 for the second quarter of fiscal 2019 compared with the net loss of $0.09 per share in the same period last year. Weighted average shares outstanding at the end of the second quarter of fiscal 2019 was $65.1 million compared with $42.9 million in the year ago second quarter.
The adjusted EBITDA for the second quarter of fiscal 2019 was negative $3.3 million or a loss of $0.05 per share compared to adjusted EBITDA of negative $2.3 million or a loss of $0.05 per share for the second quarter of fiscal 2018. As a reminder, EBITDA and adjusted EBITDA are non-GAAP financial metrics. Please refer to slide 19 in the appendix titled reconciliation of non-GAAP financial measures for more information regarding these non-GAAP financial metrics.
Now please turn to slide 14, as I will provide some comments on our balance sheet and cash flow. At September 30, 2018, we had cash, cash equivalents and restricted cash of $18.3 million compared to cash, cash equivalents and restricted cash of $19.6 million of June 30, 2018. Cash used by operating activities for the second quarter of fiscal 2019 was $6.6 million as compared to cash use of $6 million for the first quarter of 2019. However, $3 million of the cash used in the second quarter was related to the royalty settlement payment to Carrier, which Darren discussed earlier.
Our accounts receivable balance as of September 30, 2018, net of allowances was $16.5 million compared to $15.9 million as of June 30, 2018. Inventories as of September 30, 2018 were $16.6 million or a 3% decrease from $17.2 million as of June 30, 2018. Our accounts payable and accrued expenses were $14.1 million as of September 30, 2018, a 4% increase compared to $13.6 million as of June 30, 2018.
Now at this point, I will turn the call back to Darren.
Thank you, Jayme. In conclusion, this was a quarter that had several significant achievements, which we strongly believe will positively affect the long-term success of the business.
Just to quick give you a summary, here is the list of the kind of top 10 subsequent achievements in no particular order. Number one, obviously was a product revenue, we want to see double-digit revenue growth and product revenue really fuels that growth, 22% growth year-over-year is great. 12% growth for the business, which should be higher, we add the service revenue year-over-year is also good, we can do better. I'd like to see a double-digit revenue be closer to 20% than 10%.
Continued geographic diversification, again many folks in our space have over half of their revenue from one market or one geography. For us to have 23 distributors giving us orders from 18 different countries I think is excellent and we'll continue to make that a key focus. Obviously cash is king, $4.3 million lower cash usage during the quarter as compared to a year ago moving in the right direction. But we need to get positive cash flow as quickly as possible so we can stop burning cash and start becoming a cash generator.
The new high margin long-term rental program, delivering those 3.6 megawatts to one of the world's largest oil and gas customers with more to come, that's very exciting for us. That's going to give us reoccurring high margin revenue to go along with our accessories, parts and long-term service contracts and really move us faster along that curve to get to the 100% absorption of our quarterly expenses.
Elimination of the Carrier royalties is something I've been working on for since probably last five years. This is going to save us millions over the next 15 years, but more importantly it allows us to work strategically with other chiller manufacturers. So, this is a tremendous event for us and a great accomplishment during the quarter.
New product roadmap, again that's in the appendix of the presentation. I think we've got a good line of sight of where we want to take the company from product development standpoint. We want to continue to be a leader in our industry. We're definitely seeing more and more technologies come up for behind-the-meter distributed generation and we want to make sure that we are a leading factor or leading technology and really improve our focus on micro-grids, I think that's a market that's continuing to expand and grow. We want to improve our ability to penetrate those markets as they expand.
The successful Equity Analyst and Investor Open House events that's something we promised shareholders that we do we did do it. Those who did come really saw the tremendous job that Kirk Petty and his team did in getting his two manufacturing facilities together not many folks can put two manufacturing facilities together and actually lower expense, but increase our ability to manufacture product.
The remanufacturing and sale of our first C1000 R system, an opportunity to take product back in the field that maybe out of service or idle or we can just get for the right price and recommission it and sell it against some new products. And so obviously higher first cost [ph], one of our challenges, this gives us another tool in the tool box to sell against the cheaper incumbent kind of engine technologies. Even though they are inferior technologies everybody likes to buy on price. And so we can put our FPP around that remanufactured product and more importantly get more megawatts out in the field to drive our aftermarket service business.
Last but not least DOE's funding of Capstone and Argonne's high-efficiency, fast-charging, fast-discharging thermal energy storage system for use with the Capstone CHP system anything we can do to improve our CHP effectiveness and competitiveness, whether it's storing thermal energy, creating thermal energy, creating chilled water or air conditioning, the absorption chiller manufacturer all that's going to go to driving top line revenue and help us continue our penetration in that market.
I didn't put the slide in here this time, but if you look back in our investor presentation you'll see that our U.S. CHP business has grown from 17% market share to about 25% in the last three years, we can do more as we continue to add more features and benefits and bolt-on opportunities with our product.
So with that, let me go ahead open up to analysts and let's start the Q&A process.
[Operator Instructions] Our first question comes from the line of Colin Rusch from Oppenheimer. You may begin.
Thanks so much guys. Can you just talk a little bit about the efficiencies that you still feel like you can get from the factory as we go forward, it seems like you've got a much better set up in this new facility? And there's going to be an awful lot of level leverage as we walk through the next three to four quarters?
Yes, absolutely it's a great point and I know you recently visit the factory and saw firsthand and again I think tremendous job by our ops group and Kirk Petty. We really took an opportunity to take two factories and put them into one and actually increase our ability to manufacture product. I think sometimes necessity creates creative solutions and I think we really found out that putting two factories together we had to relay out the entire floor including the parts warehouse and came up with the most lean and efficient kind of six sigma approach to get as much product out of here.
So today we're running single shift five days a week. We've got capacity to go to obviously two and half shifts or even close to three and we're still to probably build the entire quarter in a month at this point. And so, I would say conservatively we're running at 20% plant capacity, as this business grows we're not going to add a lot of people. So I think the nice news is we can go from $100 million to $500 million and add a handful of people.
If you look at other folks in our space as they add product they're adding manufacturing overhead, they're adding sales overheads is selling direct. I think from a scale standpoint we're much different than other folks and kind of the things that we bring up.
Okay. And then just on pricing, can you give us a sense of where prices are trending and what your just kind of mechanisms are looking like as we go into the back of - or the end of the calendar year and into the first part of 2019?
Yes, if you're look in our Q, you'll see the exact numbers we're roughly $1,000 kilowatts and that's our price through our distributors, obviously we're selling through a distribution channel it's adding another 25% margin on there. But typically our megawatt solution is going to be about $1,000 into the channel or $1 million into the channel about $1.25 million to a customer. And again that's compared to fuel sales at about $6,000 or $6 million a megawatt.
And so, I think we're seeing some competitive pressures our remanufacturing products will help us if you look at the first two units we sold remanufactured units went into the Middle East. That was part of a 4 megawatt project where we use the two lower cost remanufacturing units to be price competitive with receptor getting engine solution.
So the customer was willing to take a remanufactured microturbine over a new engine because of the inherent liability in our product. And so I think that can open up some more markets for us and give us some more sales flexibility. We don't like to discount the product, we will discount the bundle. And so we're trying to bundle our service agreements with our accessories and our products together to really give customers any kind of discount.
Okay, thank you so much.
Thank you, Colin.
And our next question comes from the line of Craig Irwin from ROTH Capital Partners. You may begin.
Good evening and thanks for taking my questions. Can you maybe share with us where we stand on the aftermarket parts and services offsetting the frictional costs for the company. Can you maybe give us a percentage of approximately what was offset or an approximate margin for aftermarket parts and services?
Yes, our aftermarket business this quarter was unfortunately impacted by the transition of our California distributor. And so, if you look at the numbers for the quarter it was substantially lower than what we want to see. I think if you look back at Q3 last year the high watermark for that group was about 42%, we're significant below that because of the transitions of those service contracts this quarter.
But that is a near-term one time sort of issue that will be better in Q3 and beyond by Q4 until we should see margins in the high mid-30s to closer to 40 by the end of the fiscal year. We've got a stated target of 50%. I think we're probably six quarters away from getting to 50%, but we'll build through the back half of this year and then hopefully keep that momentum going next year.
We're doing more remanufacturing than we've ever done before, we remanufacturing not only the turbine machinery equipment, we're also remanufacturing their coup rotors [ph], the injectors and some of the power electronics and controls. We've come up with a new injector design we think it's going to give us longer life cycles in our maintenance, we continue to Prado every failure because so many of our units are under long-term service contract, we want to continue to lower that cost.
So I'm very bullish, I'm very confident in our aftermarket business and that it's going to grow both in top-line revenue and margins. As I mentioned in my prepared remarks we've got about $25 million of large pending contracts that we've got visibility on that should close in the next couple quarters. So we're watching for those press releases just to give you an idea we've got about $74 million in total backlog and we are chasing $25 million in just near-term large contracts. And so that'll really help boost our aftermarket service business. And as we see products start to ship and product grow obviously that'll drive more aftermarket as well.
Great. Thank you for that. So then I noticed in the quarter you took what $100,000 payment from TI, they continue to chip down the old BPC bad receivables. Can you maybe share with us a schedule of payments over the next couple of quarters. I mean, should we be looking for something similar?
No, it should be larger next quarter. I think there's an 8-K out there that details what we can in that agreement, I am not sure how much it's public. So I won't to make the statement, but it'll be more than $100,000 is our anticipate in the next quarter. And they've paid close to $1 million I think so far just a little over $1 million. So they're making progress.
Again getting one Russian distributor pay another Russian distributor's bad debt is not an easy thing to do. But we're getting it done and that we're kind of working together through this process, as well as collecting over $1.1 million from our general distributors to support our marketing efforts and customer acquisition. So we're finding creative ways to bring cash in, obviously again as I said in my prepared remarks we need to get the cash flow positive though as quickly as possible.
Great. And then last question if I may. Oil and gas, there has some pretty positive dynamics for the underlying commodities. I know globally the CapEx cycle is actually looking pretty interesting. What are you guys seeing from your customers? I mean are you starting to get more people coming back to the table considering putting on Capstone microturbines on their sites and is this something where we can see increasing traction on the shipment side over the next number of quarters?
Yes, absolutely. I think if you look at the energy efficient or the natural resources or oil and gas numbers for us for this last quarter ended it was about 44% of our revenue, a year ago that was 15%. So if you look at the six months it's about 51% and a year ago that was 27%. So if you look at the recent earnings or order announcements probably more than half of them have been oil and gas.
And so we've got this rental opportunity with a new large customer in the Permian. We're seeing repeat orders from EQT, Anadarko, Pioneer, Chesapeake, I mean all the major players here in the U.S. we're getting some offshore orders as well, as I mentioned in my prepared remarks. So definitely the oil and gas market is picking up. We want to be able to do rentals as well as sales and so we're starting down that path. So I think that's exciting for us.
But that being said, we'd really like to keep the CHP business growing and kind of a perfect mix for us would be 40% oil and gas, 40% CHP and 20% kind of renewables and microgrids at least for near-term. And so we don't want to get too heavily weighted any one market as those markets obviously can be cyclical in making change.
Great, thank you for that. Congratulations on the revenue traction even despite the headwinds out there and keep up the strong progress. Thank you.
Thank you. And our next question comes from the line of Rob Brown from Lake Street Capital. You may begin.
On the oil and gas business. Maybe just dive into how much of a rental market is that? Is it weighted to rentals and do you need to do rentals to get into that market or is it really customer specific?
Yes, it's really customer specific. We've shied away from that market, because we haven't frankly had the balance sheet for it. Now that we've got the EBITDA breakeven a couple of times in the last few quarters. We can see kind of a clear path to profitability we're willing to start to kind of waiting into that market even with our limited balance sheet. But it is definitely one that the very high margin. Our simple payback on those rentals will be less than two years and those are 20 years assets. And so the margins on those rentals will be good.
And I think that the at least a year rental if not longer and I am guessing most of them will be several year rentals. Because in most cases the utilities can take a long time to ever show up. And if it is, it's going to expensive in probably several years ago. And so really the best thing about rentals is a way to penetrate customers quickly. They I kind have said in opening remarks that we got the PO in one week once we agreed to do the rental and got another PO a week later for almost another 1.6 megawatts.
And so it's easy for an oil and gas company to rent products it's much more of a longer term process and a lot more hooks and procedures to rent to byproduct. So the best way to penetrating new customer and to get the products kind of get the Trojan Horse into the fort is to rent them the product in a long-term rental.
So very excited about that and obviously as we get profitability as we build our balance sheet that will be something we can do more of. And if they come off rent, the good news is we've now got this capability to remanufacture the product. So we could pull the unit out of the rental fleet three or four years from now, bring it back to like new condition and sell it into the marketplace in oil and gas or in CHP.
So I think in general it's a very positive step for us. And again another quarter from a revenue and margin standpoint probably in the most exciting quarter we've ever hard. But if you look at kind of the underlying as I mentioned 10 things we achieved from the UTC royalty to the DOE funding to the rental to the remanufactured products, there is a lot of exciting things that we accomplish this quarter.
Okay, great. And then the - kind of switching to the kind of the order rate, you had a good acceleration in orders in the quarter. How does the order kind of book or order pictures looks for the back half of the year?
Yes, I mean, it's always hard to tell, but obviously oil and gas should be good. I mean. oil prices still remain strong. We're seeing a lot of activity. Our distributors are reporting a lot of quotations and opportunities. We tend to have a good Q3 especially in the oil and gas space as people look to spend capital dollars for the end of the year or at least try to allocate them, so that's positive.
We've got several distributor changes. We think they're going to yield additional orders. CHP market is a little harder to judge, but in general the market seems to be good. If you look at kind of the regions for us almost every region is up year-over-year with the exception of Asia, Australia. And we've got a lot of pending opportunities in Australia. So that hopefully will pick back up in the second half.
So hard to call the ball, but I'd definitely say we're looking forward increased bookings and increased product shipments. We do have to deal with a little bit of the impact of the rentals that does impact our product shipments, because it switches from a product order to a long-term service and rental order. But in general we see very strong back half of the year.
Okay, great. Thanks for the overview and congratulations on the traction.
And our next question comes from line of James Jang from Maxim Group. You may begin.
Hi. Good afternoon, guys.
How are you doing?
So it seems you guys are kind of going back to the well for the E&P sector. It seems that back half of the year truly should slow down. How is that going to affect your projections for the next two quarters if drilling does slowdown as people are expecting?
Yes, I mean, a lot of our projects are not drilling specific; there are other parts of the oilfield. And again, it's really how much can we get from customers. I think on the rental side with the one customer talking about, they've already shown us 20 more sites, which obviously one site was 2 megawatts and the other two were 800 kilowatts each. So, they've got near-term requirements for another 20 megawatts for 20 sites on average. That's interesting.
We've got another large oil and gas customer that's obviously here, they were doing rentals and is showing some interest. Rumor on the street is Caterpillar is eight months out for 35 series products that definitely will help us. So, I think there is opportunities in the oil and gas space.
I wouldn't say it's not really back to the future, it's just we want to be diversified and oil market is up, we want to take advantage of it. When the oil market is down, we want to make sure we're diversified in CHP and in other markets. I know many people still got scar tissue over the last time oil collapsed. And it's really why giving that 100% absorption is still key.
Once we get to 100% absorption with our reoccurring revenue, frankly oil can collapse and bust and boom and it really doesn't impact our business from a profitability standpoint. Obviously we'll be more profitable in a boom, but we will limit our downside in the bust. But more importantly, we need to be able to be strategic with our pricing.
We're getting looks from larger customers today whether it's Corning, Pepsi, Mohawk Carpets, MAG International and these larger Fortune 100, 500 companies, they want to potentially buy direct or have national account status and have strategic pricing. And so, that gets a lot easier once we're covering our operating expenses with our reoccurring revenues.
So, excited for that. I think again, when we got to EBITDA breakeven in Q3 and Q4 of last year, two of our better aftermarket service performances and that will really drive the business. As I'd like to say, the product revenue drives top-line and service revenue drives bottom-line. And so, we think that Q3 is typically our best quarter of the year and Q4 is typically our second best. So, we're excited to go into those quarters and see if we can post another couple of really strong showing and then keep the momentum going into next year.
Okay. And let me just follow up with that. So, what's different this time around with the Russian market? Is it just a better distributor?
Yes, we got six distributors instead of one. We had one distributor that was basically head all of Russia and all vertical and all geographies. And so, that's always challenging when things go bad, you've only got one person. Obviously they were large enough and had credit terms and some other pricing and other terms that they had prior to me getting to Capstone. It's always hard to put that genie back in the bottle.
With the new distributors we have today, they're all cash up front. We don't even take LCs from Russia, it's all got to via a transfer before we ship. So, we've eliminated our risk there. And then just by diversifying through six distributors that really helps us to limit our market risk with one player.
Again I see other folks in our space where 60%, 70% of their business is in Korea or California one market or one customer. And I just don't want to go see that movie again, we've seen it before. And I think being diversified is really, really important both from verticals and geographies.
Okay. And can you elaborate a little bit more on the new partnership with Synergy Astana? So, is this like - I mean, how do you see that playing out? Is there opportunities there to expand greatly because I know there is a lot of associated gas that comes out in Kazakhstan?
Yes. There is lots of opportunities in Kazakhstan for associated gas. I'm heading over to Dubai in a couple of hours; there is lots of opportunities over there. We've done first associated gas projects in the Middle East. We just did our first associated gas project in India. We're doing projects in Africa. So, I think associated gas is a huge market globally.
We do obviously a lot of work here in the U.S., but expanding that into Kazakhstan, into India and into the Middle East is all great opportunities for us. And the product works very well on casing gas or associated gas. So it's definitely an area we want to continue to exploit. And I think oil and gas companies get it.
I think there a lot of you are aware of the regulation for governments to force them to do something like gas. I think a lot of them are waking up to the fact that burning a natural resource and creating global warming is about a stupid a thing you can do from an environmental standpoint, but also economically. And so, as they kind of wake up to that fact, I think it's positive for us and for our business.
So, like on the revenue impact on the associated gas side, is that part of the global expansion, the diversification or do you see that's something incrementally positive moving, I guess, into next fiscal year?
I think it's something that's incrementally positive during the next fiscal year. I think we're going to see revenue growth because of associated gas. I think we're going to see continued attachment rates in CHP. We've got a lot of high profile buildings that are being built right now that are going to be great showcases for our CHP projects. If you look at the cover of our presentation today that's a CHP project for Kings County Hospital in New York.
And so I think we're getting bigger projects, with bigger customers and higher profile. So I think associated gas is going our direction I think green building is going our direction, getting bigger customers there can be repeat orders is great, but low cost natural gas is a positive, microgrid adoptions is a positive. You've got Volkswagen cheating on emissions and other global raising their hand where we might have done that too.
You're going to see more and more engine companies come out, say yes, we cheated on emissions because internal combustion engine is a very old technology and a difficult architecture to get emissions down on. Severe weather, we're seeing a lot of money go into Texas and to Florida. We're working with architects and engineers in how to harden universities and put CHP and to make those places where people can go during the next flood or natural disaster.
Again, oil prices are still solid. So I think, in general, if you look at kind of the growth catalysts we had in the presentation, virtually all of them are pointed in the right direction or green forest, which is good.
And then again, the fleets aging where over 9,000 unit shipped, $125 million operating hours, that's going to drive more parts revenue. I think Jeff and his team are doing a better job of convincing customers that the FTP is the right way to go. We will continue to raise parts pricing every year. We've done it for the last 10 we'll do it for 10 more and we won't raise the cost of the FPP. So eventually people will realize that not buying the FPP is not a very good idea. And that we really have been in line with our customers.
And then one final one on. Have you seen an uptick of orders following the hurricane?
Not yet. I'd say we've seen an uptick of inquiries. And so, our average sale cycle is 13 months, we're not a portable power or temporary power solution where capital expenditure and something installed permanently. But definitely, I expect to see increased orders from the Caribbean, from Florida, from Texas and I think that more and more people are realizing that power resiliency is important.
I was just at a hospital B2B events in Denver. One of the hospital administrators was from a hospital that was impacted from the hurricane. And his first question was, I had a Capstone would I have power right now. I said, well, do you have natural gas? He says, yes. I said is the hospital above sea levels, is it dry? Yes. I said, then you have got power.
And so I think there's people waking up to the fact that putting fragile utilities on poles of wires and hanging inventories is a bad way to go and having on-site power generations is robust is very important. And it's not the only reason to buy the product, but it's definitely a compelling secondary reason.
Okay, great. That's all I had. Thank you.
Great question. Thank you.
And our next question comes from the line of Sameer Joshi from H.C. Wainwright. You may begin.
Hey. Thanks for taking my questions. Most of my questions have been answered. But just in terms of gross margins, what are your targeted gross margins, say 12 to 24 months from now? And do you see - or how much of contribution do you see from the rental program and from the remanufacturing program?
Yeah, that's great questions. And sorry to get - we will move you up next time. So you can get your questions earlier. I think we put out there publicly, we want to get to about 36% gross margin is kind of our next target. Obviously we were down a little bit this quarter, because of some of those things we've spoken to. But definitely as we continue to grow that service business and the rental business and the product margins get back up there again, that's a reasonable expectation with the kind of margin if we hold our cost structure we will be thrown off, pretty robust 19% operating profits.
The real key is we need to get the service margins up our parts margins are already good. We need to continue to grow our product revenue. So all those things will happen and we maintain our discipline on the cost side and stay around the $6 million OpEx, which is half to a third or less than most of our folks that are in our space. I think we've done a great job of leaning out the business that we can get to those kind of margin rates.
On the rental side, those will be very high margin just to begin with, because we will be depreciating that equipment over probably 8 to 10 years and obviously that will be one cost and the rental field becoming on top of that. So that will be a very robust margin, which is one of the reasons we wanted to put it on the balance sheet and not sell it to a third party. Because I think adding the reoccurring revenue that's predictable and high margin helps us get to that absorption target they're trying to get to, which again is a key for us for kind of protecting our downside and leasing our upside.
And so I think not the most exciting strategy in the world, but I think it really changes things and again it allows us to really build a foundation, from which to grow the business.
Great, thanks. The next question is about the Carrier settlement, over the last two, three years how much royalty payments were been done to them on average? And part two that on the same subject are you already engaged with other chiller manufacturers for potential sales or partnerships?
Yes, so on the Carrier - back three or four years ago that was probably $0.5 million a quarter I'd say the last couple of years it was closer to $250,000 a quarter obviously it depends on product shipments. And not to say too much out of school, but obviously we're start to seeing our products revenues ramp up again timing was good to settle out Carrier royalty when we're coming out three years of declining revenue before we get into three years of accelerated growth.
And so definitely whether it's reach $10 million, $15 million, $20 million we've offset in the next 15 years will depend on what kind of growth we can get. But again it helps our margins, it helps our cash flow and it doesn't hurt us as we grow the business now. And so we can grow the business without growing our royalty exposure, which is very positive. And then more importantly, we really think there's an opportunity to partner with some other chiller manufacturers to have an integrated product potentially a pre-packaged product.
The DOEs is launching a new website of pre-packaged CHP solutions, which we will be a part of, and New York had a similar program that we've been involved with for years. And so the industry wants to see more pre-packaged solutions on the CHP side kind of pre-engineered that you can plug and play and I love that statement, but basically the plug and play as you can get the lower cost. And so very excited about that opportunity and again it's something we've been trying to do for last five years and we got the right opportunity to get it done.
Okay. So you mentioned the DOE and you also mentioned in your prepared remarks about the Argonne National laboratories…
Yes, we've been working with multiple national labs and DOE for years. they helped us with the C200 and the original C65 and 230 products. We have had multiple different opportunities to work with them, whether it's booking for new [indiscernible] fuels that are lower cost, longer life we're looking at combustion technologies.
We currently have a program we're working on hydrogen with one of the national labs. This opportunity was working with Argonne. They've got this thermal energy storage device that we think we can couple up with our microturbine and again it gives us another CHP solutions to improve economics for customers. And so they wouldn't have to use all of thermal energy at one time that's created by the microturbine it allow them to store it similar to battery storage on electricity side as the thermal storage.
So again it's another tool in our tool box, another creative technology to improve economics for customers. And on the CHP side it's all about economics right. I think the number one thing folks want to do is save money, obviously producing CO2 and saving the environment is also nice, but at the end of the day saving money is job one.
Great, thanks a lot for that color, Darren. I'll step back in queue.
And our next question comes from the line of Eric Stine from Craig-Hallum. You may begin.
Yes, hi, it's Aaron Spychalla on for Eric. Thanks for taking the questions.
Yeah, no problem.
Maybe first on gross margins, I think you called out the supplier defect still being an issue in 2Q I just wanted to confirm that? And just get your thoughts on the impact to that in the second half and just you're thinking about product gross margins given that and some of the supply chain stuff over the last couple of quarters?
Yes, no definitely the product defect is something we should talk about it, that's an issue we've had with a supplier we have had the supplier for 21 years. They've been a very good supplier, they're a U.S. based and so they were key in developing this part for us as far as in a signature series. They manufactured this very well in the U.S. and then they moved it offshore at a lower cost to subsidiary. We qualified the part there as they performed very well and at some point after that they made some changes to the manufacturing process without approval of us.
And so that impacted us so we've had to go back and pull those parts out of the field and replace them with correctly manufactured parts. We are meeting with the highest levels of management, just talked to their CEO. We just had a team that was just visiting them as well. So you're seeing the negative side of that on the margin side, there is potential recovery there as we work through getting those parts returned for credit. And obviously we're going have a commercial conversation when this is all done about the impacts to our business and frankly our brand and our customers.
And similar on the California distributor change you're seeing the impact of this not taking revenue on several contracts. We believe we potentially have a path to get that revenue back. And so again we're not taking it today, but there is an opportunity in the future to get some that revenue back. But regardless even if we don't have recoveries on either one of those issues they will both be behind us here in one to two quarters. And so as we put that behind us we will naturally get to better margins, if we get recoveries than those margins will be even better.
So working both of those issues. But again we want to get back to the margins you saw in kind of Q3, Q4 last year and the December and the March quarter and beyond. So we need to get back to the 20%, 25% margins and then push toward that kind of ultimate goal of 36%.
Got you, okay. And then maybe last for me, just on the offshore, haven't heard about it a lot in the last couple of years given everything in the market. But it sounds like you're pretty excited there. Can you just kind of talk about the pipeline there and then are those kind of better margin given kind of the corrosive nature there?
Yes, offshore business has always been good margins for us. They tend to be high humidity or high salt environments. And so we've developed special packaging for that that helps us. Those markets are smaller I'd say there is definitely more opportunities onshore than offshore for us. I would say the U.S. shale gas markets are probably our biggest opportunities in the next 12 months. But definitely we love seeing offshore opportunities any kind of oil and gas customer. Frankly we want to be their partner across the board whether it's a 30 kilowatt, cathodic protection along the pipeline or 2 megawatts offshore on a platform where everything in between.
And so I think that that's our goal to really be their solution provider from an energy standpoint and frankly their long-term partner. And that means if we selling the product or now if we rent them the product, we still shouldn't doing PPAs with gas energy finance or potentially directly at some point. But again we want to be the sole solution provider for customers.
Thanks for the color.
Thank you. And I am showing no further questions at this time, I'd like to turn it back to our CEO Darren Jamison for closing remarks.
Thank you. I understand that we've had some technical difficulty. So hopefully if you missed the beginning of the call you can call back in and listen to replay. I believe all of our analysts heard the call that were dialed in or folks were dialed in directly. But if you were on a webcast apparently I'm getting word that we did miss the beginning of the call. So please dial back in and listen to the whole webcast. I apologize that our service provider had some sort of issues.
Again I think the closing comments, this quarter was very good from a revenue standpoint, I'm very happy with the bookings and the product revenue, disappointed with some of the aftermarket revenue numbers. But again that's from a kind of one-time event and frankly something that we have to do. We really are pushing our distributors to do more. We've got KPIs in place and I think we're getting better at managing the distributor network and frankly pushing them to grow their business faster.
We run a model distributor program and any distributor that's not meeting that model will need to vigorously deal with. But in general most distributors are coming up into turf [ph] faster, very excited about the distributor support payment program it allow us to increase our marketing. If you saw that recent press release, if you didn't take a look at it, we did more marketing in October than we did in probably most of last year.
So the Distributor Support Program that $1.3 million essentially doubled our marketing and customer acquisition budget for the year. And obviously as the business grows we'll continue to grow that fund and do more and more. And so very exciting to be marketing the product more. As I mentioned I'm heading over to ADIPEC in Dubai here in a few hours that's a huge show for us. We'll continue to do all the major oil and gas and CHP shows, but more importantly regional shows and B2B events are very, very critical for us.
Very excited about the new rental opportunity. We've did some 3.6 megawatts, but there's easily another 20 megawatt opportunity in the next call four quarters as we expand into that business. The service businesses got $25 million of pending projects and contracts. You should see some nice awards and press releases over the next several quarters as we execute on those projects. Again those are customers that already have the capital technology we're just trying to get them into their FPP where the warranty period is expiring or trying to get into the FPP.
So in general I think things look good going forward. I mentioned the growth catalysts we've got about a dozen growth catalysts that are all green and going the right direction. And the other issue make sure we continue are our diligence on our cost side. And so the OpEx for the quarter I know we don't have a question on it, but it was pretty good. We want to stay as closer to kind of $6 million a quarter as we can and then continue to obviously give raises and better benefits for our employees and all the things we can do as a company.
So with that, I'll wrap up the call and look forward to talking to everybody after the third quarter. Thank you.
Ladies and gentlemen thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.