Capstone Green Energy Corp (CGRN) 2004 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Capstone Turbine corporation fiscal year 2004, conference call. My name is Bill and I will 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. If at any time during the call you require assistance, please press star, followed by zero, and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ms. Alice Barsoomian, your contact for Investor Relations. Please proceed, ma'am.

Good afternoon. And welcome to Capstone Turbine Corporation's call for fiscal year 2004. I am Alice Barsoomian, your contact for Investor Relations. Let me begin by letting you know that over the course of the next several weeks, I will be transitioning from my role in Investor Relations to a position in marketing. During this transition time, I will introduce you to your new contact person, Cindy Martinez. I have sincerely enjoyed working with you, but I am very excited about returning to a role in marketing. This afternoon, Capstone issued a press release which contains the financial results for the period. If you do not have a copy of the press release and would like one, please call Cindy at 818-407-3643 and she will get a copy to you.

During the course of the conference call, management may make projections or other forward-looking statements regarding future events or financial performance of the company within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which may cause Capstone's actual results to be materially different from future results, expressed or implied in such statements. We refer you to the company's annual report and other periodic filings with the Securities and Exchange Commission for a description of these 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. On the call today are members of Capstone's leadership team. John Tucker, Chief Executive Officer; Karen Clark, Chief Financial Officer; John Fink, Senior Vice President of Sales and Service; Mike Redmond, Senior Vice President for Operations; and Marty Sigoury (ph), Vice President of Quality. I will now turn the call over to Karen.

Thank you, Alice. We are delighted to have all of you on the call today. This is the conference call I have been looking forward to for quite some time, where we get an opportunity to talk with you about our strategic plans. Before John goes over that with you, I will do a brief review of our results for 2004 and provide some highlights on the fourth quarter. For the discussion of 2004 results, I will be comparing the annual results of the fiscal period April 1, 2003, through March 31, 2004, our fiscal 2004 year, to the calendar year 2002. The summary results for our transition period, the three months of January through March, 2003, can be found in our press release.

Sales for fiscal 2004 were $12.6 million, down significantly from the $19.5 million reported in calendar year 2002. These sales included $2.9 million or 2.6 megawatts for the first -- fourth quarter of fiscal year 2004. The lower full-year sales resulted in part from the new disciplines at Capstone where we're more focused on quality sales than chasing sales volume. This change is reflected in the gross margins as well. For 2004, our margins were a loss of $16.8 million. In 2002, the reported loss was $22 million. However, that included a $5 million impairment loss. So before consideration of the impairment loss, the gross loss was about the same each year despite 35% lower sales in the current year.

In the fourth quarter this year, our margins were adversely impacted by a $6 million charge we took as a result of the decision we've made to step beyond our warranty obligations, and address issues with products in the field. As a result of our reliability tiger team work we have identified items that we will replace on impacted units to improve the overall fleet performance. Looking again at the full fiscal year, operating expenses in 2004 were $32.1 million, about 40% lower than last year's $54.8 million. However, last year's number included a $16 million impairment loss. So excluding that item, last year's operating expenses would have been $38.8 million, and this year's expenses would be about 20% lower. This change reflects a $4.3 million increase in engineering costs, more than offset by an $11 million reduction in selling, general, and administrative costs. The R&D spending increase is nearly all attributable to the lower level of reimbursements from development contracts. As you are aware, this funding has decreased as the underlying projects near completion. About $3 million of the SG&A benefit came from lower amortization in 2004. You will recall that in calendar year 2002, we took an impairment charge related to marketing rights. Because of that charge, there is no longer amortization expense related to that item. The remaining roughly $8 million reduction in SG&A spending came from predominantly cost control measures.

For the fourth quarter of 2004, operating expenses were $9.2 million, an increase of $1.5 million versus the average of the prior three quarters this year. About half of this increase came from higher R&D costs. Although contract reimbursement billings to the government resumed with notice that our program was funded, and we billed $1.3 million in the fourth quarter, the spending for R&D was $4.7 million. This was significantly higher than the $2.7 million average for the prior three quarters. The increase reflected two key items. First, increased spending on the C200 as we completed work prior to initiating beta testing, and second, higher spending for product enhancement programs including the reliability tiger team initiative. The remaining portion of the increase in operating expenses versus the prior quarter's average reflected relocation and other employee-related costs that are not expected to recur at this level in the next year.

Moving on, interest income net for the full year was roughly half the amount earned in 2002, reflecting both the lower average cash balances, and lower interest rates. So overall, the financial loss for 2004 was $47.7 million, or 58 cents per share. Whereas in calendar year 2002, the loss was $74.4 million, or 95 cents per share. Let's talk now about how these results impacted our cash performance. The 2002 net loss when adjusted for noncash items used $31.1 million in cash, whereas this year's loss on the same basis used $29.7 million. Which was $1.4 million less than in the prior year. Including benefits from changes in working capital, total cash used for operations, was $29.5 million this year, versus $30.8 million last year. These results reflected a fourth quarter cash usage for operations of $9.6 million. This was higher than prior periods this year, largely due to the higher R&D, and employee-related costs that we just discussed. Cash used for asset acquisitions was $1.3 million for the full-year 2004. About half the $2.5 million used last year. Financing activities provided a source of $2.8 million last year, driven largely by the sale of stock to United Technologies. This year's cash from financing activities was $600,000, and was provided by proceeds from stock option exercises. Overall, cash usage was $30.2 million this year, versus $30.6 million in 2002.

Our balance sheet remains strong. Cash stood at $102.4 million at March 31, 2004. Inventories are getting worked down, and the increase in warranty liability primarily reflects the charge taken in the last quarter of 2004. We entered fiscal year 2005 with 6.5 megawatts of backlog. That completes our review of the financials. Now, John Tucker will provide the much-anticipated review of the strategic plan. John?

Thanks, Karen. Good afternoon, everyone. Thanks for joining us on the call today. As Karen mentioned, fiscal year 2004 marked a year of transition for Capstone. During the last half of the year, we completely overhauled our management team, and strengthened the entire organization. As compared with a year ago, more than 25% of our employees at year-end were in their new positions having either come from outside of Capstone, or from other positions within the company. We heightened our focus on customers, learning from them what we needed to do to improve our delivery of products and services. As a result, we evaluated every aspect of our business, and implemented changes to address short-term needs. Finally, as Karen mentioned, we put in place a new strategic plan, which addresses fiscal years 2005, 2006, and 2007.

We continue to implement the necessary changes to transition Capstone from a research and development-focused business structure and culture to a business focused on customers and operational excellence. As with any R&D focused company, engineering generally dominates the business process. Moving forward, the company will be driven by the market and customer requirements. Engineering projects will be approved based on these requirements, and decisions will be based on those projects that clearly meet our financial goals. We will focus on products and solutions that provide the greatest near-term opportunity to drive repeatable business with positive contribution, rather than one-off projects for niche markets. In order to increase volume and reduce costs, we will focus our efforts in vertical markets with main-stream customers that will generate repeat business. This should allow us to drive the necessary improvements to become cash flow positive by year three of our planning period.

Fiscal year 2005, will be a year of continuing change within the company, as we improve internal processes, rationalize manufacturing and engineering, and restructure sales and service to drive customer satisfaction. While our products have significant market advantages, the rate of adoption of our technology has been slower than anticipated. The economic environment with tight restrictions for capital expenditures certainly has made sales significantly more challenging. In our effort to drive a higher rate of adoption and become cash flow positive, we are working on several key strategic areas. Let me share them with you.

The first being vertical markets. Within the space we serve, we are focusing on vertical markets that are strategic analysis identified to have the greatest near-term potential. In each of those markets we serve, CHP, CCHP, resource recovery, power reliability, and remote power, we have identified specific targeted vertical market segments. Within each of these select markets, we have highlighted the important attributes to penetrate these markets and have built our plans around those actions. Relative to sales and distribution channel activity, I'm sure you all recall that the company's previous sales strategy was based primarily on selling large volumes of product through distribution. Sales volumes did not meet expectations and some distributors refocused their efforts on opportunities other than MicroTurbines. As a result, several customers expressed a strong interest to, and actually began working directly with folks at Capstone.

Going forward, we will rationalize the distribution channel, and we will implement a direct sales channel for select vertical markets to augment our efforts in the Americas. As we transition this sales approach, I would like to emphasize that the distribution channel will continue to provide a majority of our business. We will continue to develop and strengthen key distributors, while moving other distributors into dealer or manufacturers representative type arrangements. Additionally, we will be adding new distribution and representatives which are experienced in our target markets. We believe this combined approach leverages the best of what our distributors and Capstone have to bring to our customers and overall will make us more responsive. At the end of the day, folks, it's all about putting a high number of qualified feet on the street.

Let me turn now to geographies. The Americas has been and will continue to be our largest market. Within the U.S., our focus will be on California, and the northeast. Internationally, Japan is our second largest market based on installed units, but we expect growth in Japan to be moderate. We have several capable distributors in Japan, and we will continue to rely on their ability to develop the market, obtain sales, and service the installed base. During the next three years, we believe Europe will offer significant opportunities for Capstone. In particular, we expect the resource recovery market to expand, particularly based on a number of positive EU directives toward environmental projects. We will be expanding our distribution in Europe to capture those opportunities, and in the process of -- and we are in the process of establishing a direct European sales presence this summer. Africa, the Middle East, and Asia represent opportunities which we will pursue on a project by project basis, where they clearly complement our strategic direction.

Let me turn to service. For us, service in this plan is a new business focus. Our previous service strategy was to serve all customers through our distributors and authorized service providers which we refer to as ASPs. Distributors were expected to sell the product, provide engineering solutions, and perform as ASPs, providing installation, commissioning, and service. Several of our distributors did not provide the level of service required, and a number of customers requested to work directly with us as a result. Going forward, we will implement a strategy to serve customers directly, as well as through qualified distributors, and authorized service companies. All of whom will perform their service work using technicians specifically trained by Capstone. We will expand our direct service presence in California and the northeast and establish a spare parts distribution center to allow easier access to parts on the East Coast. We intend to strengthen our relationship with those distributors who have developed and demonstrated their service capabilities. And for those distributors who have not developed their capabilities to support our products, we expect to terminate our service relationships with them.

Additional priorities for improving our service worldwide include establishing a European parts distribution center, to locate critical spare parts within Europe, to -- in support of our expanded sales presence in the region. Further, we plan to add field service engineers in the U.S., Europe, and Japan, to support the growth opportunities identified in our plan. You've heard me talk a lot in the past about product robustness and maintenance costs. Well, certainly customers expect high performance and competitive total cost of ownership. To address those needs, we must continually ensure a high level of performance. It's important to understand that performance is impacted not only by our MicroTurbine unit, but the proper application, design, and installation. And of course, the quality of ongoing service.

To enhance the robustness of our MicroTurbines, you've heard me talk previously about our reliability tiger team. This team was clearly established to enhance the robustness of both our C30 and C60 products. The objective of this team is to meet and then exceed an average of 8,000 hours mean time between failures, for our MicroTurbine installations. We expect that this robustness improvement effort, and our rationalization of the distribution channel, will have a positive impact on our overall system performance. Additionally, through our new direct sales and service actions, and the installation and service work of the authorized service companies I previously spoke about, we are confident we can improve our end users' experience with our MicroTurbine systems. Combined, these efforts will in turn lower our warranty costs and other support costs for the product.

To further provide us with the ability to evaluate the MicroTurbine's performance in the field, we are developing a realtime remote monitoring and diagnostic feature. This feature will allow us to monitor installed units instantaneously and collect operating data on a continual basis. We intend to use this information to anticipate and quickly respond to field performance issues. Evaluating component robustness and identifying areas for our ongoing continuous improvement process. But more importantly, this improvement will allow us to better serve our customers. Turning to product development, our new product development is targeted to specifically meet the needs of our selected vertical markets. We are prioritizing those efforts, and we are deferring other product development activities which are not directly linked to our three-year strategy. We expect our existing product platforms, the C30 and the C60, will be our foundational product lines throughout the strategic planning period.

During the time that C200 is in beta testing and while we introduce this product to the market, gaining traction, our product development efforts will be centered on enhancing the features of all of our base product offerings. And with regard to the C-200, I really shouldn't miss this opportunity to share with you the results of our beta testing. I'm very delighted to tell you that our first unit at the university of California Irvine is progressing very well. And we've accumulated greater than 600 hours of operations to date, with no incidents. And more importantly, it's performing to all design objectives. I guess I'd truly be remiss if I didn't talk about the important need to improve our overall product costs. I've mentioned on previous conference calls about our efforts to evaluate our core competencies, and to rationalize those activities within the business. This planning process supported those perspectives. These cost improvements will be specifically directed to those activities where outsourcing will enhance our value-added proposition.

Our ongoing focus will be that of a design, assembly, test, and installation support provider which is where the value-added lies within Capstone. In conjunction with these changes, a number of supply chain-driven component cost reduction actions have been identified. Additionally, a number of opportunities in engineering and manufacturing have also been identified which will provide further improvement in our cost structure over the planning period. With those key elements of the plan, I would like to tell you that we at Capstone are extremely excited about this strategic effort. It has been a truly integrated process which has aligned this organization in a way that has never happened before. As you might imagine, personally, I'm very proud of the effort and vision which was established by my team, and all the members at Capstone. To accomplish this incredibly challenging task. So I'm honored to share with you the direction of the new Capstone.

I know I've covered a number of key points, but I would like to go back and cover a few final points with you. First, we have a plan supported by detailed actions which enables our objective of being cash flow positive in fiscal year 2007. Second, as I shared with you, fiscal year '05 is a year of continued investment to achieve the goals of the plan strategy. Therefore, we do expect cash usage in the year to actually increase slightly from 2004 levels. Third, reflecting the fundamental improvements in the business and the direction we are taking, revenues for 2005 will be at least twice that of 2004. Our sales team will be engaged with and drive our distribution channel, and direct sales opportunity in a way not seen before at Capstone. And five, we will take an active role in ensuring customer satisfaction, quality, and growing the service component of our revenue. Again I want to thank you all for joining us today, and now we'll take your questions.

Thank you very much. Ladies and gentlemen, if you wish to ask a question, please key star one on your touch-tone telephone. If your question has been answered or you wish to withdraw your question, please key star two. Questions will be taken in the order they are received. Please key star one to begin. And we will wait one moment to compile a list of questions. And our first question today comes from Tyson Bauer of Wealth Monitors. Please proceed.

Yeah, a couple of quick questions. John and Karen, a couple of bookkeeping ones first. What was the order rate in the previous quarter? And also, the turbine inventory levels in the marketplace, where does that stand currently?

Let me start with the inventory levels in the channel. We have on the order of 500 units still out in inventory at our distributors, again we continue to work with our distributors on refurbishment programs and the like to get those units worked through and get them deployed. The order rate -- just a second. I'm looking at my role of order here. I'll come back and give you that number in just a second.

Okay. In regards to the C200, are we still on the same timetable as far as it being ready for -- commercially available? And also, is UTC running its own test? And how are those results compared with your own?

Tyson, this is John. Yeah, we're on schedule. The first unit that I mentioned about in my discussion materials at UC Irvine was on time and has been performing as I mentioned. UTC will receive the next unit that we're in the process of building, and they will receive a third unit as well, so UTC will receive two units. And then we will continue to get other units to support the beta testing program. But we're quite positive right now. But as I've shared with you in the past, everyone, that our initiation into the marketplace will be driven by ensuring ourselves that we have the right product quality before we commercialize. But right now, everything is moving forward quite well.

Are you excited by the success that Ingersoll Rand's had with their larger turbine, or is it something that is worrisome that they are getting a lead time on you of having it available?

Well, I would never say anything bad about a competitor. But I guess they've had their share of challenges with their unit. Certainly, they've had some applications, but I'm still very confident of our position in the marketplace, and where we're headed with the C200.

Okay. A couple of quick Europe questions. Why is it -- specifically why is Europe expected to have a better adoption of the technology or a quicker rate of adoption than what the U.S. and Japan has illustrated? And when you enter the European market, are you looking to have a partner in this venture?

We -- as I mentioned in the -- in the narrative, we will -- we will continue to build distribution in Europe. We won't have a partner per se. But we will have some distributors that we have -- had begun to line up and will continue to add some distribution in Europe. One of the things that I'm sure you're aware of is that certainly Europe is very green, if I can use that term. Certainly, their ability to embrace efficient sources of generation are very positive. I mentioned in my discussion that there have been a number of EU directives that make the possibility of our product being applied much more advantageous. And we feel very good about that. Particularly in Europe. And when I talk about Europe, I also include in that Russia. So we're -- we're very confident that the applications in which we have, frankly, a very good running product, it will be a -- it will be certainly readily adoptable to the European opportunities.

And the last question, has to do with concerning some more comprehensive benchmarks. Intra-plan, the three-year plan that you talk about, you detailed some of the areas that you want to hit in '05. And kind of the end objective, the end of the three years. In '05, in '06, what -- or I mean really at the end of '04, '05, '06, what are some of the things that we as the investment community should be watching and should be measuring to know if you're on that path, and you are tracking accordingly to meet your goals and objectives?

Tyson, this is Karen. I think some of the key elements that the market can be watching is the sales, as John mentioned, we do expect more than doubling sales in FY '05, and clearly getting that market adoption is one of the indicators that we're on the right path. Another is going to be the contribution margin coming through at the gross margin level. Eventually we will get to gross margin. Today it is a gross loss level. But as we make the right kinds of improvements in our product quality and enhancing the robustness, not just of the product but also the installation, we expect to see improvement in our warranty costs which you can also see directly in our 10-Qs and as we're hitting the right market, we're get the repeatability, we should see benefits coming through in better contribution margins and lower direct -- that come in part from lower direct material costs. So those would be some of the key indicators that we're going the right direction.

Okay. How about such as the, eliminating the inventory levels that are in the channels, such as in the year three, what kind of revenue run rate should you be at to get to that cash flow positive? And you keep talking about these markets, these integrated markets you want to hit. Any type of generic type of examples that may be -- John Fink, I know you're on the call, if you could elaborate where you're attacking, and then I will go back in queue.

Tyson, let me -- let me kind of pick that one up. One of the key things here that you've probably heard us talk about that I think is -- I will share is that the area of the resource recovery, free fuels type of market segment that I believe you and probably others on the phone have heard us talk about in the past, clearly for us, that is the bio gas type applications, which is driven by landfills and waste water treatment plants, but also, the application of approaching our units on offshore oil rigs, as well as oil and gas in general. Clearly, that's a targeted market for us. One of several that we have identified in the strategic planning process. I'm probably going to make folks a little unhappy by not sharing the several other targeted markets, but unfortunately, at Capstone, and I'm sure we have a number of our competitors listening in, I don't want to give them a road map for a competitive basis, but we know exactly where we're going, we've identified the opportunities, clearly the application of our products that you -- you all know, that combine heat and power our cooling combined heat and power applications which are in concert with UTC, our bio-gas products and free fuel products which have application on offshore oil and oil and gas in general, are just some of the very focused approaches that we're taking.

One of the other things that I would point out that I hope came out very clear in the discussion of the first part of the presentation by Karen is that we have dramatically changed our focus to go after opportunities that give us the best margin contribution. And hence, as you saw, the revenue was down this past year, but margins were comparable to the previous year, with about a third less revenue. And that will be our focus. Because it is about quality of earnings that we're focused on, with this plan, that is going to give us the ability for you to see the results in the areas that Karen just touched on. We're very excited about this plan. And I have to tell you, it was -- it was a lot of hard work, but we're excited.

Tyson, going back to your first question, the order rate for fiscal Q4 was 2.9 megawatts.

Thank you .

Thank you very much, sir. Ladies and gentlemen, your next question comes from Maclain Cover of ThinkEquity Partners. Please proceed.

Hi, John and Karen.

Hi, Maclain.

Along with what Tyson was asking, can you give us some quantifiable outlook on what the operating model looks like in 2007, whether it is gross margins, and operating margins, some of the, you know, the cost targets that you've addressed on a summary basis during the comments?

Well, obviously to get to the point of cash flow positive out in that time frame, we've hit margin positive, and bottom line positive and obviously we hit margin positive well before the bottom line positive in the three-year planning horizon. We're not prepared to lay out the quarters that these things happen for, folks. But obviously that end of FY '07 position is hitting on all marks. It is margin, it is bottom line, and cash flow positive.

Just out in 2007, do you have a sense for what the gross and operating margins might look like?

We of course do in our model but at this time, we're not going to be sharing those with folks.

Thank you.

Thank you very much, sir. Ladies and gentlemen, your next question comes from Murray Vanderbilt of UBS. Please proceed.

Good afternoon. I want to pursue this a little bit more in '07. You know, doubling of revenues hopefully in fiscal '05, are you then sort of on a 20%, 25% growth curve in revenues? Can you give us some sense of where the revenues need to get to in '07 for your models to break even?

The revenue growth continues at a fairly aggressive rate throughout the planning horizon. You know, obviously with the cost structure that the business has today, we need to significantly continue to expand our revenues year-over-year in order to reach the contribution margins necessary. So they're very aggressive numbers, you know, similar to the '05 type of aggressive year on year growth.

Okay. Thank you.

You're welcome.

Thank you very much. Again, ladies and gentlemen, to ask a question, it is star one on your touch-tone telephone. Next up we do have a follow-up from Maclain Cover of ThinkEquity Partners. Please proceed.

Karen one follow up question with regard to fiscal 2005 you indicated that the plan is to make incremental investments in the business. Do you have a sense of what that cash burn might look like in 2005?

Maclain, we think the cash burn in FY '05 will be only slightly higher than what we experienced in FY '04. You've seen for our past calendar year 2002 and FY '05 that we spent about $30 million in each of those years. We expect it to be just marginally north of that, in this next period. And that clearly is reflecting benefits of improving margins and the like in the business that we're anticipating. Because we are making investments in our infrastructure, with more folks in sales and service, and a continued emphasis on product development and robustness and quality.

Thank you.

You're welcome.

Thank you very much, sir. And ladies and gentlemen, your next question comes from Eric Prouty of Adams Harkness. Please proceed.

Maybe you can give a little update on the legislative fund both from a federal standpoint, and maybe on an international and then state by state standpoint, what you're seeing out there as far as CHP or MicroTurbine specific incentives and markets you think have more prospects, from an incentive turbine standpoint?

Yeah, maybe before John answers that directly, Eric, I should mention that our plans do not rely on getting new incentives. While there are a number of things that John will discuss here in just a moment that represent opportunities, to us they are opportunities for enhancement, because we haven't baked those kinds of benefits into our expectations. So I think that is kind of important background. John, do you want to talk about the incentives?

Well, Eric, you might be aware of Senate bill 1637 which was passed by the U.S. Senate on May 11. It is a MicroTurbine tax credit. It does contain a 10% tax credit for MicroTurbine properties. And the credit itself is capped at around $200 per kilowatt. That particular legislation was passed by the Senate on like an 85 to 13 vote, so it was pretty warmly received in the Senate, and it has now moved on to the house for their vote. You know, what's really important about that -- that particular description in the bill, that it is a MicroTurbine property it is defined as it must be less than two megawatts, which obviously is positive for Capstone since our product offerings are certainly well below the two megawatt level. And you have to have an electrical efficiency of 26% or better. An ISO requirement. So the key elements of the definition of that particular bill are very supportive to what happens here at Capstone in terms of our products.

Additionally, we have been working the political front in California as well. We've participated in some key meetings with Senator Morrow here, in California, who is supportive of a co generation bill here in California to put in co-gen as supported by state incentives. We're working that very closely and feel very comfortable with the direction that that's going. Additionally, I mentioned in my discussion when we think about the political side of the opportunities, I mentioned the EU activities that would affect us and have us excited about the European market, there are a number of bio gas tariff rates in Europe in countries such as Austria, Italy, Switzerland, the U.K., France, that are very supportive of the adoption of our technology. I think it kind of responds a little bit in part to the question that was asked of me earlier, why will Europe embrace our product. And certainly, we have had product in Europe there that is running and running successfully. So a number of initiatives on the political side in support of the application of our products, we feel very good about.

Great. And just a bit of follow-up, United Technologies, at least looks like they're getting a bit more visible with their product rollouts here, using your MicroTurbines. I guess what are you looking for? What should we be looking for, for the next step out of UTC now that they got some products in the market, they're advertising at least in some trade magazines that I get. What's the next step that we should be looking for out of these guys?

Well, you know, I think that that question would probably be best answered from the UTC folks. But I can share with you that our relationship with UTC has been, and continues to be, really terrific. They are an incredibly competent and capable company. That goes without saying. But I really feel compelled to say that. Terrific working relationship. And as we view their activities, they're really beginning through the process that you mentioned of seeing the kind of advertisements in magazines and journals, they're really starting to gain some traction from what we can see, but I think maybe the best answer to that solution would come out of the UTC folks.

Do you know if they've actually made sales yet?

Oh, yes, of course. Let me -- let me -- and maybe -- let me let John Fink respond here about Ronald Reagan as an example.

Yes, John, we received an order from UTC for the Ronald Reagan library, and we have several others as well. And as John mentioned, they have -- to continue to work on their marketing, and their advertising for their pure comfort system. We're very excited about that. Our MicroTurbines are a key part of their pure comfort system. And we're looking forward to this year, working with UTC to develop that market, which we term as CCHP. And you know, John Tucker already mentioned that that is a key part of our strategic part of our plan.

Eric, one of the things, too, John didn't mention it, but the Ronald Reagan library is for pure comfort systems, and for Capstone, that meant 16 MicroTurbine units. So we're starting to see some real positive things, and we're very confident in the direction forward with UTC.

Fantastic. Thank you.

Thank you very much, sir. Ladies and gentlemen, your next question comes from Peter Patterson of Green Mountain Investments. Please proceed.

Good afternoon, folks.

Good afternoon, Peter.

And congratulations on your new strategic focus. This is a plan long in need, and it looks like it is going to work.

Thank you.

Thank you, Peter.

I wanted to focus just for a moment on the hybrid vehicle area. And as you look out over the next three fiscal years, is this product area something you might consider to be seriously operating in? What are your thoughts here?

Peter, this was a certainly a key focus of our discussions during the strategic planning process. John and his team analyzed the opportunities in the marketplace, based on our experience in a number of the applications that Capstone had made certainly prior to me arriving here. We are going to continue to monitor that segment of the business, and be supportive to the product that we've fielded, in support primarily of a number of key customers. And we'll continue to watch it. But it was not -- is not a big player in this three-year strategy at this point in time. One of the things that I would like to share with you, Peter, since you asked this question, around the hybrid vehicle propulsion product, I would like to share with you, as well as the entire audience, that I didn't go into a lot of detail about our strategic planning process.

I would like to make it clear to everyone that while I talk about this three-year strategic planning process as a three-year look-forward, we will revisit this strategic plan on an annual basis. So we will be sharing with you around this time next year, the same call, regarding a re-look and a refreshment of our strategic plan. As I look at it, strategic plan is not a static device. It will be very dynamic. And we'll make whatever adjustments are necessary as we move forward to make sure we're capturing the most important opportunities to help Capstone achieve success.

Does the Japanese market present some kind of opportunities in the hybrid vehicle area for Capstone?

They do. Most of our applications in the Japanese market have been in buses.

Right.

And so that's why I say we're going to continue to monitor that element of our business segment closely. We do have buses running today in Tokyo. And we're supporting that effort. And along with our partners in Japan, we will continue to watch that very closely.

Thank you very much.

You're welcome.

Thank you, sir. Ladies and gentlemen, your next question comes from Ross Haberman of Haberman Brothers. Please proceed.

How are you?

Hi, Ross.

I just had a couple of quick questions. I know you didn't go into your strategic plan that specifically. Are you at a point yet where you -- where you can enunciate you're looking to sell X amount of units, you know, over the next two or three years? Are you at that point yet?

This is John.

And/or how much do you think you're going to burn basically over the next -- I think you said three years. I guess that brings you out to '07, I think it is, the end of '07. What do you think your -- are you planning, or not planning but how much do you think is going to end up cash will be burned before you hit that break-even point?

I can tell you, Ross, that we know all the answers to your questions.

Care to share any of them?

And I -- and we're just not prepared to share those with you right now. But what I will tell you is, and I did offer up that very measurable metric to tell that you we would be at least twice the revenue in 2005, as compared to last year, to get you started. We've tried to provide you with some measurable benchmarks, and as we gain traction and go in the direction that we are focused and plan to be, we will certainly be sharing more things with you.

I think what -- I think again the -- that's a good start, you know, the revenue, you know, projection, I guess what -- what we would hope to look for, is you know, again, I'm not asking you to go out more than a year or so, but you know, what -- you know, what I would say is, you know, what would say an average margin be looking like, you know, on -- on, you know, either a gross or, you know, operating margin? I guess that would also be important. Can I ask today what kind of gross margins are you getting on new machines being sold?

Ross, we haven't come out with what our margins are on our individual products. And they really do vary quite dramatically depending on the market that we're serving. One of the key elements of our strategic planning process was focusing on those markets where we believe we can extract higher premiums, and higher configured units that allow us to drop more dollars to the bottom line on individual units. I think it's important that we move forward and start delivering on some of these elements before we come out and give you too much more specific on where we see those numbers.

Okay.

Going back to the prior question you asked, though, Ross, you were kind of pinging about the cash flow in the plan and one additional data point I think we can give you is that the cash flow low point in our strategic planning process is still a pretty comfortable number. One of the things obviously that I paid attention to as this process went on is just how low do we go, and what's the bandwidth. And while obviously we do net-net use cash over the three-year period, the low point is still sufficient that we have some elbow room.

Can I ask -- just one final question, in terms of -- in terms of competitive products, has any of that changed over the last 6 to 12 months? Any new products come out which are more competitive or on a quality or price point?

Not that we've seen directly, Ross.

Okay. I will get back in the queue. Thank you.

Thank you.

Thank you very much, sir. Ladies and gentlemen, your next question comes from Sonjay Shrestha from Capstone. Please proceed.

Actually it is Craig Irwin from First Albany. Not from Capstone.

Hi.

Hi, guys. How are you doing?

Hi, Craig.

I just want to talk a little bit about the C200 that you guys are now working with out there and get, you know, sort of getting out to your customers. I want to know a little bit about the efficiency of these units. Are these performing better than the C30s and the C60s. And you know, where do you really see the sweet spot of these units in the market and sort of how the initial units are performing?

This is John. The units, as I mentioned during the -- during the presentation are really -- are really performing extremely well. We do have one unit out at UC Irvine, so it is -- is actually doing quite well. I mentioned we're very excited about it. It's actually producing beyond 200 kilowatts. It is around 207 kilowatts. So that we do have margin in the initial design prototype. In terms of efficiency, the efficiencies are quite a bit better than the C30 and the C60. The efficiencies of the first unit that's out there running is around 33.5%. So we see that this initial beta testing of this particular C200 unit to be very, very encouraging.

Our team has done a really nice job of designing that product, and I will tell you, our engineering team did a great job of getting the first beta units out to test on time. So we're very pleased with where we are today. On the sweet spot for the -- for the product, our real focus there has been on the -- that we see is the CCHP application. If you will, the relationship we have with UTC on the pure comfort type technology, it is a product that we think will bring some real positives forward in our -- in our market opportunities for the 200.

Great. That's fantastic. 33% efficiency is definitely an accomplishment. I was just wondering if you could give us a little more detail on that. That's operating obviously recuperated without any CHP mode?

Right. It is -- you hit the nail on the head. It is. It is recuperated. And it is not running in CHP. It is not -- it is not taking any additional advantage. That's the pure machine.

Fantastic. And do you see much improvement potentially in the efficiencies out of those units, you know, as you get a little more experience with them?

On the 200?

Yes, on the 200.

There may be -- there may be some improvement there, but I think we're -- we've got a performance level that we think is a good fit, and frankly, is a well-designed, efficient unit, so I would say right around that 33.5%. You know, you can squeeze another plus-minus .25 points out of it, but right around 33.5 is about it.

Great. Great. And then just a follow-up on this, I guess on a slightly different line, can you give us a little -- a little detail on the license agreement that you have with Solar for the recuperator cores? Is there a size limit which you guys would bump into where you can no longer use the technology? Like say if you wanted to develop a C500, is that not feasible under the agreement? Or do you guys pretty much have an open field?

The agreement, to the best of my recollection, allows us to deploy the technology in ways that we can make it work. So it really comes down to much more of a technical question, as to whether that particular technology would be our best option if we were to upsize.

Yeah, I think, you know, the -- I think if you look at where we are, it is our ability to deploy it in configurations that would be advantageous for our designs. But from what Mike Redmond and I and Karen can recall of that agreement, there is no size limitation per se.

Okay. Excellent. Thanks very much.

Thank you very much, sir. Your next question comes from Harold Webber of Smith Barney. Please proceed.

Yes, hi. A couple of questions. With regards to the mix, what would you say the mix is currently between the 30s and 60s last quarter? And looking forward, however far you would be willing to be looking, what type of mix do you see us having 30, 60, into the 200s, over the next I guess year or so, two years?

Harold, as John mentioned over the course of the strategic planning horizon, the 30 and 60 are really the work horses of our product line. Because the C200 will be, you know, this year most of the time in beta testing, and then it still takes time for market adoption.

Sure.

Today, we're relatively balanced between the 30s and 60s. But as we move forward, we will switch, we believe, more predominantly to 60s.

Okay. On that basis, are you going to be looking to create more of a CCHP package with the 30s at all or are you just going to be offering that mainly with the 60s as it exists today? Like with the UTC product which I'm familiar with and I've seen some installations.

Yeah. Harold, this is John Fink.

Yes, John.

We see the real opportunity in CCHP with the C60 which is our current product offering with UTC, and going forward, the C200. When you get to the lower kilowatt ranges, it really becomes difficult to justify a CCHP in a 30 kilowatt situation. And as we've mentioned, we will predominantly see movement toward C60s and you know, when you look at installing one C60 versus two C30s you really have some advantages, and that's really where the market is going.

Okay. Will you -- I have not seen a single 60 an a CCHP set-up. Is that going to be something that you are going to try to address more? Like I talked to a number of smaller-type businesses that certainly could and would be interested in that type of a package. It's not that they're showing for example the UTC product as a comfort solution as a four-pack. That is much too big for a lot of small businesses who are very, very warm to the idea of buying a product of this type.

Yes, and we've had a number of distributors that have provided smaller-type CCHP systems. And we're evaluating that. And we've also had discussions with UTC. So they may choose to go smaller or larger. But we will be evaluating that. And you have a very good point.

Well, I personally have been there. And I've seen it and I've been to many customers, potential customers about this, and you know, the small business operator is a decision maker, and they want to buy this stuff, but really, it is not -- it is not available for them to purchase it. UTC is really pushing the four-pack. Which is okay. But for a smaller customer, they don't have the product. So I think it is something that you guys should really focus on because those customers are real decision makers.

We are actually very much looking at that, Harold. In fact, a number of our Japanese partners have mated our product with smaller absorption chillers by a number of the Japanese manufacturers, and the product has performed extremely well.

So I'm told.

I think a way for us to go to market there is in teaming with some of our stronger, as I mentioned in my presentation, stronger, more capable distributors who have the ability to put together a package, and go to market with our product. And certainly, that's an area of interest to us.

That's specifically what I'm trying to get across. Like the UTC people are comfortable looking at them, because they're comfortable with them in their competency level, and the product is a package deal that they bring to them. These other things are sort of retro-fit type of thing. I'm talking about coming across with a product in a similar type of a design and package and, you know, overall profile as the comfort solution package. But on a one or a two unit versus a four-unit deal.

I fully agree with you. I think you're --

I have customers for you now if it would be there.

My number is 818-407-3601. I will take as many calls as you can send my way, Harold. I would appreciate it. I got to help think in any way I can here.

That goes for both of us.

Absolutely.

Okay. Thanks.

Thanks for the input, though. I think it is really much appreciated.

Thank you.

Thank you very much, sir. Ladies and gentlemen, there are no further questions in queue. I would like to turn the call back over to Mr. John Tucker for his closing remarks. Please proceed, sir.

Well, I guess I would like to follow-up and first thanks for all the questions. I think they were really excellent. We are excited here at Capstone about the direction we're taking. Just stay tuned, folks, because we're going to start to really make things happen. Thanks very much. And thank you for calling in.

Thank you, ladies and gentlemen, for your participation in today's conference. That concludes the presentation. You may now disconnect. Have a good day