Capstone Green Energy Corp (CGRN) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Capstone Turbine Corporation earnings conference call for third quarter fiscal year 2011 financial results ended December 31, 2010. My name is Stacy, and I'll be your conference moderator for today.

(Operator Instructions).

As a reminder, this conference call is being recorded for replay purposes. During today's call, Capstone management will be referencing slides that can be located at www.capstoneturbine.com under the Investor Relations section. At this time, I would like to turn the presentation over to your host for today, to Miss Jayme Brooks, Vice President Finance and Chief Accounting Officer. Please proceed.

Thank you. Good afternoon, and welcome to Capstone Turbine Corporation's conference call for the third quarter ended December 31, 2010. I am Jayme Brooks, your contact for today's conference call. Capstone filed it's quarterly report on Form 10Q with the Securities and Exchange Commission today, February 7, 2011. If you don't have access to this document and would like one, please contact Investor Relations via telephone at 818.407.3628, or e-mail IR@capstoneturbine.comOr you may view all public filings on the SEC website at www.SEC.gov or on our website at www.capstoneturbine.com. During the course of this conference call, management may make projections or other forward-looking statements regarding future events or financial performance of the Company within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.

These statements relate, to among other things, future financial performance in attaining profitability, the ability to reduce costs and improve inventory turns and contribution margins, higher average selling prices, continued growth in current market conditions, the availability of a line of credit, the success of the C200 and C1000 products, new products and technologies, compliance with certain government regulations and increased government awareness in funding of our products, growing market share and market adoption of our products, new applications for our products, growth in the oil and gas, office building, biogas, EPS, and hybrid electric vehicle markets, increased sales to certain key customers, the successful integration of the Calnetix Power Solutions microturbine business, revenue growth and increased sales volume, our success in key markets, negotiations with strategic partners, our ability to enter into new relationships with channel partners and distributors and other third-parties and the successful implementation of those relationships, the energy efficiency reliability and low cost ownership of our products, and the expansion of production capacity and manufacturing efficiency.

These forward-looking statements are subject to numerous assumptions, risks and uncertainties including the following; our expectations about expansion into key markets may not be realized, certain strategic business initiatives and relationships may not be sustained and may not lead to increased sales, we may not be able to reduce our costs -- manufacturing costs. The growth our backlog has significantly exceeded our internal forecast. In order to meet this increased demand, we may need to raise additional funds to meet our anticipated cash needs for working capital and capital expenditures. The current economy can make it difficult or impossible for us to raise necessary funds, and for our customers to buy our products. We may not be able to utilize our line of credit, for example, as a result of a failure to meet a financial covenant, we may not be able to expand production capacity to meet demand for our products. We may not be able to obtain sufficient materials on a timely basis or at reasonable prices. Our release of our products may be delayed, or new products may not perform as we expect. If we fail to meet all applicable NASDEQ global market requirements and NASDEQ determines to delist our common stock, the delisting could adversely affect the market liquidity of our common stock, impair the value of our investment, and adversely affect our ability to raise needed funds.

We have substantial accounts receivables, and increased bad debt expense or delays in collecting accounts receivable could have a material adverse effect on our cash flows and results of operations. We may be unable to increase our sales, and sustain or increase our profitability in the future.

We may not be able to obtain or maintain customer, distributor and other relationships that are expected to result in an increase in volume and revenue. We may not be able to comply with all applicable government regulations. We may not be able to retain or develop distributors in our targeted markets, in which case our sales would not increase as expected.

We may not be able to successfully integrate the required Calnetix assets, and achieve productive relationships with the distributors. And if we do not effectively implement our sales and marketing service and product enhancement plans, our sales will not grow, and therefore we may not generate the net revenue we anticipate.

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

Because of the risks and uncertainties, Capstone cautions you not to place undue reliance on these statements which speak only as of today. We undertake no obligation, and specifically disclaim any obligation to release any revision to any forward-looking statements to reflect events or circumstances after the date of this conference call, or to reflect the occurrence of unanticipated events. I will now turn over the call to Darren Jaimson, our President and Chief Executive Officer.

Thank you, Jamie. Good afternoon, and welcome, everyone, to Capstone's third quarter fiscal 2011 earnings call. With me today, is Ed Reich, our Executive Vice President and Chief Financial Officer, Mark Gilbreth, our Executive Vice President of Operations and Chief Technology Officer, and Jim Crouse, our EVP of Sales and Marketing.

Today I will start the call with a general overview of our third quarter results, and then turn the call over to Ed who will review our financial results. Ed will then turn the call back to me, and I will discuss what is happening in our key markets, and update you on our progress and our strategic objectives. We will be referring to slides today in our presentation, and they can found on our Capstone website under Investor Relations.

The third quarter was an important inflection point for our Company, our employees, and our stockholders. Capstone achieved the following milestones and strategic objectives during the quarter. We set a new high for quarterly revenue with over $24 million shipped to customers worldwide. To put this in perspective, this is more revenue in one quarter than Capstone's annual revenue for all of fiscal 2007. Or you can look at it, as 50% higher than the same quarter last year. We had positive gross margins for the second consecutive quarter, for the three point improvement from last quarter. We continue to manage operating expenses and working capital while growing our revenue, and the leadership team held operating expenses at a level $1 million lower than the prior quarter. The increased margin and lower operating expenses combined, to reduce the overall operating loss $2 million, from Q2 or last quarter levels.

We further reduced our inventory another 16% or $3.5 million from the second quarter, as we continue to leverage our just-in-time and Kanban manufacturing programs. We continue to improve inventory turns at 3.8 times or turns, against Mandarin's goal of 4 turns. As some of you may remember, inventory was turning less than 1 turn when I came to the Company four years ago.

However, by far the most important milestone for the quarter was that Capstone generated over $4 million in positive cash flow from operations during the third quarter. And in addition to that, Wells Fargo released $2.5 million restricted cash on the good results, and continued our compliance with our bank covenants. This marks the first time in Capstone's 20 plus year history, the Company generated positive cash flow from business without a secondary stock offering or some other form of outside investment. Our cash balance has increased $7.2 million for the quarter, from $20.2 million in the second quarter, to $27.5 million at the end of the third quarter. I think these facts bear repeating, and I have summarized them on slide two.

Capstone not only achieved record revenues, but record positive gross margins, with lower operating expenses, and the Company generated positive cash from operations for the first time in it's 20 plus year history. Therefore, if you add back the remaining Wells Fargo $2.5 million restricted cash, Capstone had approximately $30 million in total cash on December 31st. Obviously, generating positive cash is a significant milestone for our Company, and is a direct result of Mandarin's ongoing strategic plan to lower material costs, increase average selling prices, increase revenue, build a high margin customer service business, lower inventory levels, and speed up receivable collections. This has been a long anticipated milestone achievement for Capstone's management team and loyal shareholders. More than ever before, we can all clearly see the path forward from here to profitability and sustainability for our clean and green microturbine technology Company. However, as estatic as I am, and encouraged I am, with the third quarter results I am by no means satisfied, nor will this management team rest on it's laurels, and stop working 24/7 on behalf of our employees and shareholders to continue to strengthen and grow this great Company .

Now let's talk about new business that will drive our revenue for future quarters. We shipped a record revenue out of our backlog. The backlog actually increased in the quarter from $84 million to $85 million, as bookings were very strong in both the US and abroad. Let me take a minute, and dig a little deeper into the numbers and the positive trend lines we are demonstrating in our business. The gross profit of third quarter was over $900,000 or 4% of revenue, which is solid improvement over last year's third quarter gross loss of negative 3%, and a nice follow-up to last quarter's first-ever positive gross margin of $100,000. However, most encouraging is now we have positive gross margins on a year-to-date basis through the first three quarters, and are on track to eclipse last fiscal year's $8.4 million gross loss and negative 14% gross loss.

Revenue for the quarter was an outstanding $24.2 million, as production continued through both the Thanksgiving and Christmas holidays, to meet increasing customer demand. This new record revenue was up $5.3 million from last quarter's record of $18.9 million, which was up from $2.8 million from the prior quarter. Obviously, this indicates an excellent growth trend, and extended our winning streak to 15 consecutive quarters of revenue growth over the same period last year, as shown in slide three. As I say every quarter, I don't know how many company's have a similar 15 quarter-over-quarter winning streak, but we have to be keeping very elite company in today's difficult economic times.

I cannot say enough about what this management team did to generate positive cash flow for the first time in Company history. The team has battled hard to grow the business in a difficult market, worked hard to lower inventory levels, working hard to improve our reliability, all while cutting in new vendors with lower price parts, and tightening our credit and collection cycles.

Our net bookings for the quarter were strong, in fact, approximately 40% higher than last quarter at $20 million, increasing our total backlog approximately $1 million, despite the record shipments. If you look at our order trends starting Q1 of this year, orders have gone from $11 million, to over $14 million, to now $20 million in just the last three quarters.

Slide four demonstrates that continued strength in our product backlog, and the strength of our new C200, C1000 series products. Capstone's $85 million product backlog sets the stage for continued revenue growth into the coming quarters. And at the end of the third quarter, our FPP service backlog was at $26 million, and our FPP service revenue should surpass the million dollars per quarter mark in the fourth quarter. As I've outlined on previous calls, we expect our growing revenue and our large product and service backlog to drive our Company beyond our near term achievement of positive gross margins, and propel us to profitability, as we continue to focus on cost reduction programs, and increasing our average selling prices.

Slide five shows this quarter against the backdrop of our profitability model. It should be very obvious that the key to our profitability is continued execution against our 30% direct material cost reduction program, and flowing the 21% product price increases through the backlog, to increase our average selling prices.

If I have any disappointments about the quarter, it would be that we did not cut in as many lower price parts as we planned, and as a result gross margin was not as high as it could have been in the quarter. However, it's important to know these material cost reductions are not lost, but the timing of the realization has slipped to the right, because of various delays including first article testing, [available] material upgrades or third-party, like UL certifications.

As a measure against continued slippage of these critical cost reduction programs, I have created a new position of Vice President of Program Management reporting directly to me. This new leadership position will be responsible for executing on-time and on-budget against our cost reduction programs, reliability improvement programs, and our new Department of Energy product development programs. I am actively interviewing several top level candidates today, and I expect to announce this important new member of our Capstone leadership team very shortly.

I'll now turn the call over to Ed to review the specific financial results.

Thanks, Darren. Good afternoon, everyone. I'd like to provide you with our financial results for the third quarter of fiscal 2011 which ended December 31, 2010. Let's begin with a recap of the major items on our balance sheet, and their changes from the second quarter. Accounts receivable was $22.6 million at the end of the third quarter, which was down $2.1 million from the second quarter, all while revenue was improved by $5.2 million. We collected over $26 million in receivables during the third quarter, which was the second quarter in a row of significant collections of outstanding receivables.

I noted in last quarter's earning call, that we were continuing to experience payment delays and heavy end of quarter shipments, both of which were affecting the cash collection cycle. While we experienced heavy end of quarter shipments again this quarter, they were improved from Q2, and our payment issues are improving as well. As a result, I expect that DSO will reflect our efforts over the coming quarters.

We made excellent progress in managing and reducing inventory during the third quarter, decreasing inventory $3.5 million from the end of the second quarter, with a total reduction of $4.9 million over the last two quarters. Our ending inventory was $18.4 million with inventory turns of approximately 3.8 times, which was a 1X improvement from the end of Q2. We were very close to our goal of four turns per year, and I would like to congratulate the team for their efforts in getting us to this point, from less than one turn per year the Company was operating at not that long ago.

Accounts payable and accrued expenses were $17.3 million, increased from the second quarter balance of $14.5 million, primarily on higher inventory purchases to meet higher sales demand. Cash balances, including restricted cash, were $30 million at the end of the third quarter, compared to $25.3 million at the end of the second quarter. This is the first time the Company has ever generated positive cash flow from operations. It was accomplished through discipline management of working capital accounts, improving margins, and controlling operating expenses.

During our first and second quarter calls, I outlined the restriction of $5 million in it's reclassification from cash to restricted cash on our balance sheet, as required by the amendment of the Wells Fargo credit agreement, and that we were in discussions with Wells Fargo pertaining to the release of all, or a portion of the restricted cash. During the third quarter, the bank released $2.5 million of the cash collateral. The bank has agreed in principal to release another $1.25 million upon the filing of the Form 10-Q today, with the remaining $1.25 million to be released following the filing of results for our fiscal year-end 2011 10-K, assuming that we remain in compliance with our covenants.

Revenue for the third quarter was $24.2 million, up 28% from the $18.9 million in Q2. We shipped 171 units during the quarter, compared to 174 units last quarter. Please refer to slide 6 to see the effective of the mix on the average selling price and direct material cost. Gross margins were positive for the second consecutive quarter, coming in at $900,000 or 4% of revenue, compared to $100,000 or 1% of revenue in the second quarter. The improved gross margin was the result of increased average selling prices and higher overall revenue.

Now let's move to operating expenses. R&D expenses were $1.4 million for the third quarter, an improvement of $600,000 or 30% better than the second quarter. R&D expenses were lower, as a result of decreased labor, non-recurring engineering expenses that were lower, and higher cost sharing benefits. Our selling, general administrative costs were $6 million for the quarter, down $600,000 or 9% from the second quarter, as a result of recruiting fees that we incurred during the second quarter, as well as lower administrative and travel expenses in the current quarter. Our net loss was $8.1 million and $0.03 per share for the third quarter of fiscal 2011, compared to a net loss of $1.9 million and $0.01 per share for the second quarter.

You have to remember though, that the net loss reflects the adoption of Accounting Standards Codification 815, Derivatives and Hedging, which affects our accounting for warrants, with certain anti-dilution provisions. We recorded a non-cash expense of $1.2 million to warrant liability during the third quarter. The net loss in the corresponding loss per share, before the effect of the new warrant accounting was $6.9 million and $0.02 per share respectively. Please refer to slide 7 for reconciliation.

Backlog at the end of the quarter was $84.7 million, increased $1.2 million from the second quarter, with strong order flow during the quarter, booking $20 million, which was an improvement of $5.6 million from the second quarter. This year's results continue to be encouraging, as this quarter we saw another significant improvement in revenue, margin, new orders, and cash. We need to continue in the positive direction we have established, and continue to focus on completing our cost reduction program to attain profitability. T

hat concludes my comments on the third quarter results. And I will now turn the call back over to Darren.

Thanks, Ed. An encouraging sign of the economic recovery is that we continue to see healthy quotation and order activity in all four of our market segments, which are reflected in slide 8. I specifically continue to be enthusiastic with the increased activity in the oil and gas, shale gas, biogas, traditional CHP, and hybrid electric vehicle markets. As you can see from slide 9, we have a $14.6 billion addressable market with our innovative clean and green microturbine products. Management believes if we can continue to execute against our business plan and market strategy, the Company can some day potentially capture $1.5 billion of that $14.6 billion market, as also illustrated in slide 9.

Our recent success in the US shale market is evidence of how we can quickly capture market share, after customers start adopting our new products. We went from little to no revenue in the US shale plays to selling $10 million in less than 6 months. We have now [seated] product today in great companies like El Paso Gas, Pioneer Natural Resources and Anadarko Petroleum, Chesapeake Energy, Consol Energy, in both the Marcellus and Eagle Ford shale plays. These marquee customers and these key victories will help us break into other shale plays, and competing shale gas companies like Conoco-Phillips, Cabot Oil, Forest Oil, Goodrich Petroleum, Murphy Oil and EOP Resources just to name a few.

In addition, we also received over $6 million in US orders from our two new distributors in California, and from E-Finity in the Mid-Atlantic region. One of our goals is to lower the imbalance between the international shipments and domestic shipments, which has historically been 70% international and only 30% domestic. This imbalance will continue to improve, when we have shipments to several of our historically key partners like UTC Carrier, Office Power, PowerTherm WESCO and DesignLine. Both DesignLine and PowerTherm WESCO are scheduled to take product this quarter, and we recently received a 5 unit order from UTC Carrier, who we expect will ship in the first quarter of next year. This is the first order from UTC Carrier in more than a year.

I continue to be encouraged by UTC Carrier, as they are actively working sales opportunities, and appear to have a growing project pipeline. Office Power is close to another round of funding, and indicates they have several New York projects that should be underway this summer. The continued success in the shale plays, combined with DesignLine, UTC Carrier, Office Power, PowerTherm WESCO, and our new California distributors should help boost our US business, and positively impact our overall shipment imbalance going forward.

Now let's talk about what you should expect to see from Capstone in the fourth quarter, and into the year. Capstone will hopefully finalize negotiations with one of our 2 potential automotive partners, on developing an automotive version of our C30 product. Capstone will begin the Class seven electric truck performance demonstration program, we have ongoing with a major US heavy duty truck manufacturer, who is evaluating whether or not to add electric vehicles with microturbine range extenders to it's product lines. Slide 10 shows how the microturbine and new Capstone Parker Hannifin drive system solution are being integrated into truck.

Capstone will continue to work on the marketing launch and new product acceptance of the exciting new marine microturbine program, and the UPS data center product launched in last year, with help from two of our strategic partners. Capstone will continue to focus on the US shale plays, and leverage our overall oil and gas experience, both on shore and offshore worldwide. Capstone will continue to focus heavily on material cost reductions, and improving our average selling price, as we continue to build margins as we look to become profitable over the next several quarters. Capstone will continue to tightly manage inventory levels, using just in time and Kanban in an effort to push our turns from the 3.8 that we are today, to Mandarin's target of 4 and beyond.

We will continue to work our receivable collection efforts, and enforce customer deposits to generate the most favorable working capital possible, to limit the cash burn as we grow revenue, and drive towards profitability. Capstone will continue to apply for new certifications and develop new applications to better leverage our product architecture into as many opportunities and market verticals as possible, to drive top line growth and leverage our fixed cost structure. Capstone will continue the flexible fuel development program, the C250 and C370 programs, and externally-fired microturbine program that's highlighted on slide 11, to take advantage of our several DOE grants, and get these exciting new products into the market. Capstone will continue the process of what I call the weeding and feeding of our 96 distribution partners, to help each Capstone franchise generate our targeted $3 million in annual revenue.

Management's goal in the fourth quarter is simple, continue to drive quarterly revenue growth, further improve gross margins, increase inventory turns to Mandarin's goal of 4, improve our receivable collections to keep the cash burn at targeted levels until we reach our short-term goal of profitability and sustainability.

At this point, I would like to open the call up to questions from our analysts. Operator?

Thank you. (Operator instructions). Your first question comes from the line of Sanjay Shrestha from Lazard Capital. Please proceed.

Hi, thank you. Good afternoon, guys. Good quarter. A couple of questions. Right so in the slide you guys talk about sort of $25 million revenue run rate, and the target margin, three, four quarters out. So -- and rightfully you pointed out that direct material cost hasn't fallen as much as you would have liked to, but how should we then think about the inherent profitability in your existing backlog right now? How should we think about that?

Well obviously, Sanjay, the backlog, we have had three price increases over the last two years. So the backlog is made up of both old, and backlog that's got one to two to potentially even brand-new price increases in it. So as that backlog rolls through in the next two to three quarters, that backlog will freshen up, and become obviously more profitable from an average selling price. On the material cost reduction slot side. You're right, we didn't get as much cost cut-in during the quarter, but we still made significant progress. Our enclosure manufacturers shipped new lower price enclosures. They will be cut in this quarter. We signed a new agreement for our C200 recuperator that will cut-in in March. Those are two of our biggest cost reduction activities that will happen this quarter.

Got it.

In Q4 and Q1, you should start to see more benefit. Also mix makes a difference. We didn't have a lot of oil and gas units in the quarter, so that hurt us a little bit from the margin side. Also working both Thanksgiving and Christmas holidays hurt us some from an overtime double time perspective.

Got it. So, but it is fair to say that the days of negative gross margin is completely behind the Company, right? That directionally the rate of margin expansion is a function of all things hitting the right way, but we are probably not going to go back to the negative gross margins anymore, given where the backlog is?

Correct.

Great. Few more follow-ups if you may. So now with the faster burn, a lot of the end markets picking back up, how should we be thinking about your backlog going forward, from a revenue coverage standpoint? And sort of help us understand what are some of the big prospects -- great to hear UTC Carrier comment here -- and would love to actually get some more granularity on this automotive partners that you guys talked about as well? So if you can sort of tie that new bookings opportunity, with how should we thinking about your backlog, especially in light of all these markets picking up.

Sure. If you look at the backlog the last two years during the recession, we really took about a year to turn the backlog each fiscal year. So with the backlog we started the year with, is about what we finished for revenue for the year.

Got it.

As things improved, we are expecting the backlog turn to be three quarters, and eventually two quarters. So our goal is to turn the backlog every two quarters. And I think you'll see the backlog turn, speed up, or increase in the next couple quarters. I think the other point you said as far as big orders, we have lots of quotation activity out there, a lot of large customers looking at the product.

I think the shale gas market is a great example of how a market we had no penetration in, we very quickly get penetration, as people understand the features and benefits of our product. But we still look for great things out of Australia, once they get out from under water, South America, Colombia especially looks very good, Mexico is picking up, Europe is coming back nicely. Our Russian distributor continues to just knock the cover off the ball, and do very well. So it's overall the markets, in general look very good. Very happy with our California distributor, both of them are doing well. We are continuing to make some changes and tweak the distribution around the world, but for the most part we are in a weed and feed stage. I think the last part of your question was the automotive, licensing agreement.

Yes.

They actually -- one of the two companies will be in our offices tomorrow. We continue to negotiate very hard, and push very hard to get at least one of the two across the finish line. I'd be disappointed, if we did not get that done -- at least one of them this quarter. So I think we are very close, we are working very hard. Obviously the more we talk about it, the worse it helps our bargaining position, though so --

So let's not talk about it.

You got it.

So one last question for me, guys. How should we think about the ramp-up with UTC now that they are back again after a year, and starting in pretty nice positives? How should we think about that?

I still think it's going to be slow. I know Jim is hopeful, we are seeing them do the right things, but my guess is we are probably still a quarter or two away before they start adding significant volume to our business. I think same thing DesignLine has -- didn't build a bus for almost a year. They are struggling with some of their contracts that they are potentially delinquent on, but I think both of them and some of our other partners will ramp up over the next couple of quarters. So I'd look more for shale gas opportunities in some of our European and South American distributors to carry the weight, at least for another quarter or two.

Okay. That's great. And congratulations, guys.

Thanks, Sanjay.

Thank you.

Your next question comes from the line of Sean Severson with ThinkEquity.

Thanks. Good afternoon, gentlemen.

Hi, Sean.

I was wondering if you could talk a little more about the shale plays, specifically in the US. I mean it just seems to me like, certainly it's been great; you've been getting volumes there into the marketplace, but would you characterize most of these sales to date, as kind of pilot programs or test programs? Because obviously if you look at the number of wells and the opportunity out there, it's huge. And I'm just trying to understand; are these guys going through a process of trials with you, where they will put a few in the field, they will see if it works. And they can come back and order 100 times what they have done in a trial? And I'm just trying to understand where this process is.

Yes, Sean. Let me hand it over to Jim who is in the room with us today, and let him answer that.

Hi, Sean. How are you doing?

Good. How are you?

Good. I think what we are starting to see is -- a couple reasons for it. First one is truly environmental. A lot of our customers in the shale play are seeing increased pressure on the environmental side, not just emissions, but water regulation, and everything associated with the drilling and capture of the shale oil and shale gas. And they are going out of their way in some cases, to be as environmentally friendly as possible. The orders that we have to date are not pilot projects. We have a couple of customers that have jumped in with both feet, and are deploying the technology for the reliability. Most of them are stand-alone, so there is no utility power either readily available or quickly available, so they are choosing to deploy our technology for both the emissions, environmental friendliness, and the reliability.

And these are -- and this is -- isn't any really --

Sean, the other important point, we are seeing is -- we did a couple early -- call them pilot projects a year ago. Now that these customers can go visit a site that's got a year of operations, that's really helping us get more penetration in the market. Oil and gas companies don't move quickly to new technologies, but if they can visit a site that's got some good maintenance records and good history, then that helps them make that kind of decision.

Yes, because that's the way I was kind of thinking of it. It's a huge market opportunity, but they are not going to -- I mean I guess it sounds like some may have jumped in with both feet, but I would think most would have wanted at least a year operating history on this stuff in the field before you -- they would make any larger scale decisions about how they are going to move forward on new wells.

Correct. Yes, and I think it just depends on customer size and activity. I think we mentioned before, the Origin Energy, their kind of first bite at the apple was 130 units. I mean that's pretty big for us, but for a large company that's fairly still fairly small compared to the opportunity. But we are excited about it, and we are making sure these sites get started up and perform very well and make sure they have very good customer satisfaction, so hopefully we will get a lot of repeat orders out of it.

Sure. And have you guys scaled that market? I mean have you looked to see what the market opportunity is there? Do you have an idea of what -- if you got 5%, 10%, 15% penetration in some of the shale markets, what that would mean in terms of units or kilowatts, however you wanted to look at it?

We've done a little bit of work on it. I think if you go to our pie charts in the presentation, you can see the oil and gas market is one of our bigger slices, and we believe our penetration as a percentage can be higher in those markets. The reality is we are getting everything from single C30s and 65s, up to multiple megawatts per site. So it could be in the coming years beyond dozens into maybe 100 megawatts in annual opportunity. So it's definitely big. We are taking market share away from traditional customers, like Caterpillar and GE Jenbacher and Waukesha, so I think the ability to leverage that with successful installations is really going to be key.

Okay. And then, talking with a range of companies from an SPX to an Emerson over the last couple weeks. The raw material issue is definitely at the forefront of everybody's mind, and really what's going to happen there. And I know it's not a huge part, but could you address some of the issues with steel and aluminum, and some of the other things that are out there, because it's certainly a factor for a lot of companies becoming more so.

Yes, I think the good news there is our power to weight ratio is superior to our competition's. So they are much bigger and heavier than we are so as raw material prices go up there, the impact on them is much greater than it is on us. Mark is sitting here, and we are not seeing little, if any impact. In fact, our increasing volumes are overshadowing any kind of material price increases we are getting. So not that we are not watching it, but it's not a concern for us today. It could be a competitive advantage for us.

Yes, it sounds like it would be an advantage actually, but and just in the quarter -- I'm sorry if you already mentioned it but what was the warranty and service contribution for the quarter?

Yes, accessories parts and service was about 22% for the quarter of total revenue.

22% of total revenue. Okay. And now -- and that's going to -- is that a steady state for you? I mean or are you sell your attach -- I mean -- I guess I'll ask another way. So you're attaching service contracts, to what percentage of the new units you're selling now? And then where would you expect that to get over time? Because obviously it's a big margin contributor, so is it going to stay at about a quarter of the revenue, or is it going to move up or down relative to that?

Yes, this is Darren, Sean. Historically, we've seen overall about 15% capture rate. We expect that to be as high as maybe 40%. We'd like to get it up to those levels. I think the good news is almost all of our key distributors worldwide have some level of factory protection plans. And even if we don't get the business from an FPP standpoint, we are still getting it from a parts standpoint. So if you look at the FPP revenue I mentioned in the script, we are up to $26 million in backlog. And we should see for the first time a $1 million in quarterly FPP revenue this quarter, so to give you an idea of kind of way we are pulling it out of backlog, on an FPP side.

We are looking to aggressively grow that part of our business. We've got a new service organization opening up in Singapore. Our UK service office is open, and we've got an eastern New Jersey office as well. So the service group is growing very quickly. We expect that capture rate to improve, but our parts and regular service and FPP contract service were very good for the quarter overall.

And how does that interact to the distributor? I mean the distributor highly incentivized to sign you guys up for service contract? Or are they doing that themselves? Is that your competition, in some of this, is the distributor, and they are just buying parts from you?

It's really just a customer education, convincing the customer not to do the service work themselves, or not to buy on an ad hoc basis. We show folks that not only does it kind of lock in their long-term service cost, but it helps them plan and manage their business better. And the customers that we have under FPP, see probably a 3% to 4% better uptime than if they don't. So I think that we also show them that they make more money by having us do that FPP work.

Great. Thank you.

Thanks, Sean.

Thanks, Sean.

(Operator Instructions).

Your next question comes from the line of Eric Stine with Northland Capital Markets. Please proceed.

Hi, guys. Congrats on the on the progress on the quarter, especially the cash generation.

Thank you, Eric.

I was wondering if we could stay with the shale opportunity. And that was helpful that you talked about kind of the potential size, but I'm wondering what we should expect as far as follow-on? Is this something that we should think about as being potentially 10 megawatts plus and be very lumpy? Or is this something that is becoming more just part of regular purchasing patterns, in three to six megawatt chunks.

I think if you look at our -- it should be similar to our oil and gas business. If you look at our oil and gas, both offshore and onshore, the biggest customer users today, concentration, we have today is Pemex, Petrobras, Petronas. And I think the largest we have today is Gazprom. And then Origin Energy, the coal and gas producers, is in there on the top five or six as well. Those folks have multiple projects in the pipeline. They are long-term projects that they work on. They buy power generation equipment every day. So I think it will be maybe lumpy just because of some of the sizes of the orders, but we should expect to see orders every quarter, and have shipments every quarter.

Also, we've seen on some of these recent orders, they wanted the product fairly quickly. And so we have worked to add production slots, or move slots around to make them happy and give them the dates they want. But we've seen, I think at least three of the names I mentioned in the call have ordered a second time. And I think one of them even a third time. So we would expect multiple follow-on orders, and if not an order every quarter from each one, I would think something pretty close. I think Gazprom, the same thing, they are taking product every quarter, Pemex, Petronas, Petrobras, same thing.

That helps. Thank you for that. I asked this every quarter, so I guess I'll do it this one as well. But can you just handicap, on the price increases, and also the cost reduction, what inning you would say you're in right now.

I was joking with Ed, that I had to have my inning for Eric. So I thought --

There you go.

Thought you would give you the seventh inning stretch, is where we are at. So, no, in all seriousness, we made progress during the quarter. I know it doesn't look like it is clearly to the street, as it is clear to us, but we've got a lot of stuff moving through the process, and a lot is going to come in the next two quarters. And we got to be very careful, that we don't impact our reliability and hurt our momentum here. We actually had an incident two quarters ago, that fortunately we caught very quickly, but we had a heat shield vendor use the wrong material, and we almost had material get out here that would have been detrimental to our reputation. So we have very tight manufacturing tolerances. We have very specific material requirements. And so when we go to new vendors, we have to be very careful that we make sure that we go through the quality inspection process.

I think the other piece that's been a little bit disappointing to us has been certification. In most of those cases, we had hoped to do UL certification through analysis. And more often than not we have to actually go through and do the testing for UL, which is obviously on their schedule, and can be a little more time consuming than just doing it by analysis. But all part of the process, and we are not making excuses, we are dedicated to getting it done, getting it done as fast as possible without impacting our reliability and our reputation.

Right. So just to clarify, you're not saying seventh inning. It sounds like, from your prepared comments, you're early on in the process, maybe middle innings, or earlier on the cost reduction side?

I think we are -- we should -- most of all the POs are in place. We have parts coming in. We are down to certification, and timing of cut-ins. I mean we are done to last couple of innings.

Okay. And we should start seeing it here, going forward or speed up going forward?

The next two quarters, you should see it. We should be done within three quarters, and we are very close.

Okay. All right. That's great. Maybe just switching gears to the waste heat recovery generator. Just curious, now that's a GE branded product, just curious how that's changed -- the conversations with customers. Does it help to have that, as opposed to Calnetix?

Let me toss that ball over to Jim as well.

Certainly, having GE buy Calnetix from a brand standpoint is helpful, although with any acquisition and transition, there's a period of time where the players are reshuffled. And I think we've lost -- they have lost a little momentum, and a little structure on their end, that we are now getting back to. I think you probably saw the press release where we had a C800 and ORC go to a customer in Mexico. We have a got a couple of units being installed in France in landfills, and we are starting to see good and consistent opportunities in that part of the business.

Okay. And then I guess just last thing, and then I'll jump back into line. Just SG&A, very good quarter there. It sounds like though, cost sharing programs, is that something we should see tick up a little bit? Is that the way to read through the comments a little bit?

We are right now, Eric, we are focusing on reliability and cost reduction programs, and with a lesser focus on the DOE programs, but yes, we are still planning on getting them done. We are just pushing them a little bit. So we expect to get more cost reduction in some of the near term quarters.

Yes, the way we look at our internal programs is reliability is first, cost reduction is second, and then our new product development is third, from a staffing and resource perspective. The new position I'm hiring, to bring in -- to manage our programs, hopefully will get us more efficient internally, and we can move through some of these programs quicker. But I would say I agree with Ed, and maybe some work in Q4, but really as we wind down the cost reduction activity, those resources will be moved on to the DOE programs, and those will accelerate middle of next year.

Okay. So SG&A, that maybe should tick up here?

It was a good quarter. It could run a little higher, but like we said, our plans are to keep our total OpEx down below 8 3%.

Okay. All right. So, no change there?

Not significant.

Okay.

No. I think we had a very good collection quarter. We still have about $4 million of slow movers out there that we need to bring in, but we -- there's still some work we can do on the inventory side to bring inventory down, and there's still older receivables that we can get pulled in. So we are working hard to make sure that we continue to have positive working capital swing as we can.

Okay. Thank you very much.

Thank you.

Thank you, Eric.

Your next question comes from the line of Walter Nasdeo with Ardour Capital. Please proceed.

Thank you. Good afternoon, guys.

Hi, Walter.

Hi, Walter

I'd like to go back over to the distributors again, and get a little bit of clarification if it's possible. You said you had 96 distribution partners. Is that a correct number?

That is correct. When I joined Capstone, I think we had 24, 12 of which had bought in the last year. We are up to 96 now. We got a little over 20 in the Calnetix acquisition, but yes, we are sitting at about 96 partners, about 40% US, 60% outside the US.

Okay. How do you break down revenue generated by -- I mean, I got to imagine that you've got a really skewed bell curve here, where you've got a handful that are really high producers, and then just a bunch of guys in the middle. Is that correct or --

Yes, I think you've got probably three buckets. You've got one bucket that are the more mature distributors that were either here when we got here, or Jim signed up in first year he came on board. Those folks are hitting the ground and getting orders every quarter, doing well, growing their business, reinvesting into their business. You've got a second group, that probably is either came over on the Calnetix acquisition, or we've set up in the last year that are just kind of getting up and going and running. And then there's the third group that maybe has been around for a while and then aren't performing the way we want them, and those are the ones we are focusing on, on kind of the weed and feed stage.

So I think our goal is to obviously keep every distributor we can. But a lot of their contracts are three-year contracts, they are coming up now, and if they aren't performing to a level of their business plan, then we are working to either rectify that situation, or move to another distributor. So I mean our goal, as I said in the prepared comments, for their franchise to make sense and to do all the marketing and lunch and learns, trade shows, and hire the personnel they need, and to have it be a lucrative business for them, they should be doing $3 million annually in our product. So if they are not doing that, it's not beneficial for us, or them. So that's a lot of what we are doing right now. We have a few gaps in distribution in Africa and a few parts of the world, but for the most part it's really just managing the current channel, the current partners.

I see. How much effort or time, are you willing to put in on that third bucket? I mean, when does it come to the point of just saying hey, we need to move on?

Yes, no, we replaced a California distributor. We made some tweaks on the East Coast. We replaced our Canadian distributor. So if we believe the market is there, and they are not investing the time, effort or money, then we move on. And our contracts are fairly clean cut, and keep us out of litigation. But we have no problem cutting off a bad partner, or making them a sub dealer of a new partner, if they have a limited niche market, that they have done well in, but the overall market has not done well, then we put them as a sub dealer to the new distributor. So I think for the most part, you got to realize these contracts or these projects are six months, even a year gestation period. So a lot of these distributors that are new, are just now getting into their second round of projects and opportunities. We are also pushing harder for down payments, and trying to move to better capitalize businesses or distributors wherever we can.

So you mentioned East Coast. How are things distributor-wise over here now? I mean what's going on with your New York distributor, or anything else here on the East Coast?

Our Mid-Atlantic distributor is probably our best distributor today out of Philadelphia. Our New York distributor we are in process of moving to a dealer and then putting a new distributor in place. So New York is, I would say, performing the best it has since I've been here in the four years, but still not up to expectations. California has -- is -- starting to hit on all cylinders and doing well. Mid-Atlantic as I mentioned is doing well. The kind of New England area is okay, but could be better. So I think we are -- the US is performing better, but we are still not completely happy.

And Jim has put together a very detailed kind of model distributor or model franchise program. So we very easily sit down with these distributor principles, and say, here's all the things you should be doing, what are you doing? And if you're not doing all these activities, then you're probably not going to be successful as you need to be, and neither one of us are going to make the money we want to make.

Got you. Okay, good. Can I just jump over to -- as things are growing, you're going into these different markets, and it really looks like there's a maturation process going on within the Company. Are you going to be bumping up against any capacity challenges here in the foreseeable future?

No, not at all, just the opposite. If you remember, Walter, we went public and had a lot of cash at one time, and have two manufacturing plants, with a whole bunch of capacity. Our biggest issues, growing pain-wise, has just been getting vendors to match the pace of our growth. I mean, it was a couple quarters ago, we were doing $15 million of revenue, and now we are bumping up on $25 million in six months. So a lot of distributors didn't ramp as fast as we'd like them to ramp. And that's probably our biggest issue from a capacity, it's just vendors keeping up with us.

Got you. Okay, and then just one quick housekeeping. What were the day sales outstanding?

What was that?

DSOs?

92.

92. Great. All right, guys. Thank you very much. I appreciate it.

Thanks, Walter.

And at this time I would like to turn the call back over to Mr. Darren Jamison for closing remarks.

Thank you. I guess in conclusion, I'd like to say thanks to all the Capstone employees that worked hard over the third quarter. I know it's hard to be away from your families during the holidays, but I really appreciate them taking the time and effort to work the hours needed to meet the growing demand for our product. The entire management team and Board of Directors are extremely focused. I think the good news is, everything that we need to do to improve and mature this business is within our control. The revenues are growing at a rate to sustain our business. It's really about cost reduction and moving the ASP through. So we are very focused on it. We will continue to work hard, but we are very excited about the fourth quarter, and the coming new fiscal year continuing to show the progress, and the positive direction of this business. So with that, I want to thank everybody, and we will talk to you after the fourth quarter.

We thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect, and have a great day.