Capstone Green Energy Corp (CGRN) 2012 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the Capstone Turbine Corporation earnings conference call for first-quarter fiscal year 2012 financial results ended June 30, 2011. My name is Stacy, I'll be your conference moderator for today. At this time all participants are in a listen only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this conference 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. I would now like to turn the presentation over to your host for today, Ms. 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 first quarter ended June 30, 2011. I am Jayme Brooks your contact for today's conference call. Capstone filed its quarterly report on form 10-Q with the Securities and Exchange Commission today, August 9, 2011. If you do not have access to this document and would like one, please contact investor relations via telephone at 818-407-3628 or e-mail IR@CapstoneTurbine.com Or you can view all of our 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 and attaining profitability; the ability to continue to reduce cost and improve inventory terms and contribution margins; the ability to reduce cash usage; 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 and funding of our products; growing market share and market adoption of our products; new applications for our products; growth in the oil and gas in hybrid electrical vehicle markets; increased opportunities in Japan; revenue growth in increased sales volumes; our success in key market segments; our ability to enter into new relationships with channel partner and distributors and other third-parties; the energy efficiency reliability and low cost of ownership of our products; and the expansion of production capacity, manufacturing efficiency and improved relationship with suppliers.

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 able to continue to reduce our manufacturing costs; the growth in our backlog has significantly exceeded our internal forecast, in order to meet this increased demand we may need to raise additional funds to meet our anticipated cash needs for working capital and capital expenditures; the current economy could make it difficult or impossible for us to raise the 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 at regional prices; if we fail to meet all applicable asset global market requirements and NASDAQ determines to delist our common stock, the delisting could adversely affect the market liquidity of our common stock, impair the value of your investment and adversely affect our ability to raise needed funds; we have substantial accounts receivable and increased bad debt expense or delays in collection accounts receivable could have a material adverse effect on our cash flows and results of operations; our release of new products may be delayed or new products may not perform as we expect; we may be unable to increase our sales and sustain or increase our profitability in the future; we may not be able to obtain or maintain customer, distributor and other relationships that are expected to result in an increase in volume and revenue; we may not be able to comply with all applicable government regulations; we may not able to retain or develop the distributors in our targeted market, in which case our sales would not increase as expected; we may not be able to successfully integrate the required Calnetics assets and achieve productive relationships with distributors, and if we do not effectively implement our sales and marketing service 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 10-Q and other recent filings with the Securities and Exchange Commission for a description of these and other risk factors. Because of the risk and uncertainties, Capstone cautions you not to place undo reliance on these statements. We speak only as of today. We undertake no obligation and specifically disclaim any obligation to release any revisions to any forward-looking statements to reflect events or circumstances after the date of this conference call or to reflect the occurrence of unanticipated events. I will now turn over the call to Darren Jamison, our President and Chief Executive Officer.

Thank you Jamie. Good afternoon and welcome, everyone, to Capstone's first-quarter fiscal year 2012 earnings call. With me today are Ed Reich, our Executive President and Chief Financial Officer and Mark Gilbreth, our Executive Vice President and Chief Technology Officer.

Today, we'll start the call with a general overview of the first quarter and then turn over the call to Ed, who will review the financial results. Ed will then turn the call back over to me and I will discuss what is happening to some of our key markets and update you on our progress toward our strategic objectives of improving gross margins and generating positive cash flow. As the operator mentioned, we will be using slides in our presentation today that can be found on our Capstone website under the investor relations section.

During the first quarter, Capstone built and shipped a record amount of product and had another outstanding bookings quarter. In the first quarter, we built and shipped $20.8 million in new product, which was up 8% from last quarter's previous record of $19.2 million. In addition, Capstone built 65 C200 engines that shipped in our C200 and C1000 series products during the first quarter. This represents a 55% increase compared to 42% in the first quarter last year, as we continue to ramp up our manufacturing output without adding additional significant touch labor or operating expenses.

We had another great booking quarter with approximately $28 million in new product orders, which are the result of the continued strength from the developing US shale gas market and strong order flow from the Russian market for both oil and gas and THP combined heat and power applications. As you can see from slide 2, this pushed our total product backlog up from last quarter by 8%, to approximately $115 million or 130 megawatts at the end of the first quarter. This puts Capstone in a very strong position to again deliver tremendous year-over-year revenue -- tremendous growth for fiscal 2012.

Product shipments could have been slightly higher in the quarter, if not for some lingering supply chain constraints and some vendor part shortages still impacted first quarter deliveries. In addition, we did not build any TA 100 product during the quarter, as the TA 100 manufacturing line was relocated as previously planned from Calnetics in Florida to Capstone in California during the quarter. However, the fourth-quarter part shortages improved significantly during the first quarter and I expect there to be little or no impact on production or manufacturing cost in the current or future quarters.

Based on the first-quarter year-over-year results and the continued improvement in our performance indicators, I am very encouraged with Capstone's progress. Slide 3 highlights the results of our key performance indicators or KPIs. These key performance indicators are the best measures of the underlying foundation of our business and what are critical to reaching our goal of improved gross margins and positive cash flow.

The key metrics to Capstone's future success are product production rates, average selling prices, direct material costs, new orders, and cash. These metrics continue to show improvement in the first quarter, with the exception of cash which was up on higher working capital requirements. However, Ed and I both believe our current internal projections indicate that working capital should improve and will reduce the cash usage in the second quarter. As mentioned, revenue for the first quarter of fiscal 2012, it increased an incredible 51% year-over-year to a record $24.3 million versus $16.1 million just 12 short months ago.

Slide 4 illustrates how Capstone's year-over-year quarterly revenue has now increased for 17 straight quarters, an achievement unmatched by the vast majority of today's public companies. More importantly, as you can see from slide 5, Capstone has achieved this tremendous top line revenue growth without substantially increasing its production labor and overhead over the past 5 years, which continued into Q1. Our team of lean manufacturing engineers continue to make progress in improving our production efficiencies, which allows us to build more products without significantly adding additional labor.

During the first quarter of fiscal 2012, Capstone achieved the second highest positive gross margin in Company history on a GAAP basis, but the highest positive gross margin in Company history on a non-GAAP or cash basis, with over 11% positive gross margin for the quarter as outlined on slide 6. The significant difference in our GAAP and cash based gross margin centers are around a $1.4 million non-cash warranty accrual. Capstone's warranty expense continues to run higher than anticipated on the new C200 and C1000 series product lines. In certain instances, we've elected to take strategic reasons in play and upgrade even early vintage C200s to today's more robust design. Because we are selling a premium product and because every C200 and every C1000 seated in the market is a potential customer testimonial, it is imperative that all of our products meet or exceed customer's expectations.

That being said, management has taken several steps to more cost effectively and efficiently upgrade these older units and lower the warranty rates to targeted levels as quickly as possible. Part shortages and higher new product warranty provisions are important but they are short-term issues, if managed correctly. The foundation of our future of long-term profitability and long-term success of the Company is in our product gross margins. As you see from slide 7, the key to improving our product gross margin is improving the average selling prices and lowering direct material costs. As you can see from the chart, margins improved substantially during the quarter, which is very encouraging and critical to our long-term success.

Continued margin growth has been and will be the key area of focus for our board of directors and management team in fiscal 2012. And we look to take approximately another 13% out of direct material costs and improve our average selling prices another 6%. When we accomplish these 2 objectives, we will see overall direct material costs at approximately 50% of revenue and generate approximately $12 million in contribution margin in today's revenue levels. When we get to the normalized warranty costs and $12 million contribution margin, Capstone would be essentially EBITDA breakeven. At this point I turn the call back over to Ed to go to the financials. Ed?

Thanks Darren. Good afternoon everyone. I'd like to provide you with our financial results for the first quarter of fiscal 2012 which ended on June 30, 2011. Let's begin with a recap of the major items on our balance sheet.

The significant sequential changes from the Q4 fiscal 2011 to Q1 fiscal 2012 balance sheet were as follows. Inventory increased in Q1 to $23.9 million from $20.7 million in Q4 with inventory turns at approximately 3.6 times. The primary reason for the increase was in connection with our acquisition of the CA100 microturbine product line from Calnetics, where we purchased the remaining TA100 microturbine inventory for $2.3 million, after Calnetic's contractual commitment to manufacture the TA100 ended. The accounts receivable balance was $19.9 million at the end of the first quarter, compared to $19.3 in Q4. We continue to drive our day sales outstanding down with another successful quarter in cash collections of approximately $24 million.

Accounts Payable and accrued expenses were $18.9 million in Q1 compared to $21.8 million at the end of the prior quarter. The reduction was primarily due to the payment for the Calnetics inventory purchase. Our cash balance was $22.1 million at the end of the first quarter, decreased $11.4 million from the fourth. We used $12.3 million in cash in operating activities during the quarter, of which, $5.5 million was used in operations. And the other $6.8 million was related to changes in working capital accounts, which we expect to be able to offset in the second quarter as that is our goal.

Sequential changes from the Q4 fiscal 2011 to the Q1 fiscal 2012 income statement were as follows. Total revenue increased 7% sequentially to $24.3 million. Product revenue grew 8% to $20.8 million in Q1. Units shipped were comparable to the fourth quarter, where we shipped 168 units compared to shipping 170 units in Q1. Average selling price per unit increased 7% to $122,000 from $114,000 in the fourth quarter.

Accessories parts and service revenue was comparable to the prior quarter at $3.5 million. We continue to make progress in improving material margins during the quarter, as seen on slide 7. Note that product margins have improved significantly over the last 2 quarters, we continue to make progress against our 30% materials cost reduction target and we're targeting to complete the remaining approximately 13% of reduction over the next 9 months.

Margins were again affected by incremental warranty costs during the quarter, that were primarily related to field upgrades on C200 and C1000 series products in our effort to bring certain fielded units up to the current factory specs. We spent $2.2 million in the first quarter on research and development, which was $200,000 higher than the prior quarter. The increase was a result of additional labor costs and we elected to increase our engineering staff during the quarter to amplify our product development efforts.

Selling, general and administrative costs were $6.6 million for the first quarter, decreased $600,000 from the prior quarter on lower selling expenses, offset by year end legal and accounting fees. Our net loss was $2.9 million or $0.01 per share for the first quarter, compared to the $28.8 million loss or $0.12 per share for the fourth quarter of last year. The net loss for both the first quarter of fiscal 2012 and the fourth quarter of fiscal 2011, was affected by the adoption of the accounting standards codification 815, which is derivatives and hedging. It affects our accounting for warrants with anti-dilution provisions.

We reported non-cash benefit of $5.6 million to warrant liability expense in the first quarter, compared to a charge of $18.7 million in the fourth quarter of fiscal 2011. For the first quarter of fiscal 2012, the net loss and corresponding loss per share, before the effect of the new warrant accounting, was $8.5 million and $0.03 per share, respectively. Please refer to slide 8 for reconciliation of those amounts. Backlog at the end of the first quarter was $115.3 million and that was up $8.9 million from the quarter before. That concludes my comments on the first quarter results. Now back to Darren.

Thanks Ed. Capstone continues to gain market share in all 5 of its major markets, as shown in slide 9. In energy efficiency, we continue to penetrate hotels, office buildings, retail and industrial applications around the world. Oil, gas and other natural resources continues to have a major impact on our business, as we penetrate the US shale gas market and Russian oil-fields. The shale gas market represents an excellent opportunity for Capstone's highly reliable and low emission products as energy producers are looking for better ways to supply clean and reliable electricity to the remote drilling operations.

The critical power data center market is performing well and our units installed in data centers ranging from Syracuse University to United Technologies Corporate data center to 2 homeland security sites are all performing up to expectations. I'm pleased to report that during the quarter we received another new order for a university data center located in Ohio to add to our growing list of marquee installations.

Renewable energy continues to be the backbone of our business, as we shipped products for applications on landfill gas, digester gas, cow and pig manure and bio diesel applications around the globe. This is evident by the continuing orders we are getting from Greenvironment, Verdesis and other key partners in Europe.

As outlined in our last call, Capstone's mobile products market, utilizing turbines for electric vehicles is gaining increasing interest as range extenders, electric busses, trucks, cars and the marine industry. During the quarter we had several note worthy events, like our first C1000 packages sold into Eastern Europe and our first C1000 sold into a hospital industry. Despite the many C200 and C1000 sold in recent quarters, we are still penetrating and seeding new markets, new industries and new countries on a quarterly basis.

On the after market side of our business, we recently received another comprehensive, fleet-wide service blanket order with Petroleos Mexicanos, or PEMEX, the fourth larges crude oil producer in the world. This new $8.6 million multi million dollar blanket order will cover PEMEX's entire microturbine fleet. In addition, during the quarter, the city of Sheboygan, Wisconsin received a prestigious award from the Great Lakes and St. Lawrence cities initiative for nearing self-sufficiency as its wastewater treatment plant using Capstone microturbines.

However as I said before, I am most pleased with our recent order flow. It's remarkable to me that think that we have booked $71 million in new orders over the last 2 quarters, and that is essentially equal to all the product shipments in fiscal 2011.

As we look to Japan, Capstone continued its discussions with several potential distributors and hopes to have one or more online soon to address this potential new market demand. In addition we received another follow-on order from telecom leader NTT DoCoMo, as our Capstone units performed exceptionally well after the earthquake and subsequent tsunami. We are also looking to increase our focus and effort in Germany. As they look to move away from dependence on nuclear power and use more renewable power and distributed generation solutions.

Capstone's record $71 million in new orders in the last 2 quarters and new Company high, $115 million in product backlog, proves we are getting increasing traction and penetration in this multi billion dollar market. As you can see from slide 10, Capstone's addressable markets are estimated to be in excess of $14.6 billion annually. With the potential targeted capture of $1.5 billion over the next 7 to 10 years.

Every quarter Capstone is continuing to take customers away from such greats like General Electric and Caterpillar, who together, dominate the space with an older and somewhat antiquated reciprocating engine technology. It is important that all of our markets and all of our geographies are growing year-over-year. But I continue to be the most encouraged and excited about the activity in the oil gas and natural resource space.

Within the oil and gas space we continue to see increasing order flow from BPC engineering, a Russian partner and pumps and services and E-Finity here in the US for the shale gas fields. BPC is selling engineering and is selling C1000 series units to operate on associated gas and Russian oil-fields. The objective of this project is to increase the level of associated gas utilization at the field level in compliance with the Russian government's 2009 declaration to decrease atmospheric pollution from gas flaring. Associated gas utilization for power will allow Russian oil and gas customers to avoid emission penalties and significantly reduce power costs at the oil-field level.

Electricity generated by the C1000 microturbines usually covers all the energy needs at the oil-field and allows the site to use the electric grid, if available, as a backup power source or for peak loads. The Capstone product not only increases the reliability but also decreases the cost of electricity substantially, where compared with the local utility rates.

Back in the US, Capstone distributors Pumps and Service and E-Finity continue to receive the bulk of these orders from oil and gas companies. Exploring the large shale reserves or plays in the US, as shown on slide 11. The shale gas market is expanding rapidly as is the market share for Capstone in these plays. The market is expected to grow substantially, especially since the US EPA Clean Air Act has strict requirements for emission levels on natural gas sites.

Most microturbines delivered are providing prime power to central processing facilities and metering stations at remote well sites in the Eagle Ford shale play in south Texas. The Eagle Ford play is expected to emerge as the major oil and gas play in the United States over the next decade. Experts estimate it will rank 6 in the size among all-time giant oil-fields in the US. Both of these sites are extremely remote and unmanned, which means 24/7 distributed power is paramount.

Even more important, producers must meet the tough EPA air requirement emissions on a day to day and year to year basis. Which makes Capstone's low emission microturbines very attractive. The reliability of Capstone's turbines, along with the low emissions, low cost of ownership, and our key distributor partner's ability to deliver a total solution are all contributing to our shale play success.

In response to the continued growth rate and maturation of our Company, I have recently made several organizational changes to better optimize the performance of the Capstone management team. As announced during the Company's February earnings call, I created a new position, VP level, to ensure the timely execution of the Company's critical cost-reduction programs, reliability improvement initiatives and the department of energy product development programs.

As shown in slide 12, the Company currently has 3 major product development efforts underway -- one for the flexible fuel microturbine to run on agricultural syngas; the second one for an alternative, solar fired powered microturbine; and another to increase the output of our C200 microturbine to 250 kilowatts and utilize that C250 as part of the new multistage, high-efficiency C370.

I am very pleased to announce that Rob Gleason has been a great addition to the Capstone team and brings a wealth of experience and solid accomplishments in leading high-tech program management organizations. Rob has been able to immediately contribute to the organization by prioritizing and driving all of our critical programs to help ensure the success and completion of future on time and budget performance. Prior to joining Capstone, Rob spent more than 17 years in program management, project engineering and business development in other high-tech companies. Most recently he worked at Parker Hannifin in Irvine, California and Kalamazoo Michigan, where he held management positions at several divisions and introduced the first PMO or program management office within Parker Aerospace.

As you can see from slide 13, I've further streamlined the organization, by promoting Mike Eggers to the position of Director of Operations, reporting directly to me. Mike joined Capstone approximately 2 years go from Ingersoll Rand and has steadily taken on more and more responsibility and now oversees Capstone's manufacturing and operations. Mikes primary focus today is further leaning out our manufacturing processes, increasing our C200 and C1000 build rates, and most importantly, eliminating any future parts shortages.

All these organizational changes afford us more leverage with Mark Gilbreth in his role and Capstone's Chief Technology Officer as he continues to lead Capstone forward in new product development, product reliability and executing our current and future material cost reduction programs. These recent changes, I'm even more confident than ever, that Capstone has the right leadership team in place to deliver against our short term goals of improving gross margins and reaching EBITDA breakeven.

Capstone continues to work diligently on the policy front to increase federal tax credit for microturbines from 10% to 30%. The bill introduces HR 6515 in the 2010 session, raises the microturbine tax credit from 10% to 30% and removes a 200 per kilowatt cap. Capstone is in the process of reaching out to targeted lists of politicians and other stakeholders whose district encompasses regions within the US shale plays, in order to assist Congresswoman Sanchez with obtaining cosponsors and support for the bill. If you look at policy at a state level, the California self generation incentive program is one of the most encouraging and potentially beneficial state programs supporting microturbines. Capstone lobbied heavily to restore the CHP, combined heat and power program, for several years and was finally successful with the passage of SB 412 back in 2009.

Since then Capstone and other CHP stakeholders have been engaged with the California Public Utilities Commission to form the new program and provide incentives for CHP projects in California. In July, the commission released a proposed decision to provide $500 per kilowatt incentive for natural gas CHP projects and $2.500 per kilowatt incentive for bio-gas CHP projects in California. The commission will vote on the final decision this month and the investor owned utilities will have 30 days to revise the program as the program administrators. I fully expect to have incentives paid for upcoming California projects in late 2011, early 2012 and to further leverage our domestic microturbine business.

In conclusion, in first quarter fiscal 2012, Capstone again set a record for top line revenue, with revenue jumping 51% year-over-year. In the quarter, Capstone improved gross margins over million dollars, year-over-year on a GAAP basis and $2.2 million year-over-year on a non-GAAP cash basis. This was the second-best margin in the Company's history on a GAAP basis and the best margin in the Company's history on a cash basis.

The Company continues to closely manage operating expenses, improve manufacturing efficiencies, while simultaneously lowering direct material costs and increasing average selling prices. New orders for the quarter, as mentioned, were very, very strong and we have book a record $71 million in product the last 2 quarter, leaving the Company with $115 million in backlog to execute against over just the next 12 months.

In general, despite some short term growing pains, fiscal 2012 is off to a great start and should be another exciting year for Capstone. And I look forward to continuing to execute against our strategic business plan and again deliver steady growth and ever improving gross margins and improving overall financial results.

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

Thank you. (Operator Instructions) Your first question comes on the line of Sanjay Shrestha with Lazard Capital Markets. Please proceed.

Thank you, it's good to hear from Lazard Capital Markets. 2 questions please. First, could you give us little bit more color on the ordering flow for the quarter? And an update on what you are seeing from the US shale market?

Yes, absolutely. As I mentioned during the year end conference call, orders for the first quarter were very strong. We had a phenomenal Q4 with about $43 million in new product orders and then we filled that up with $28 million this quarter. A lot of that is coming, as I mentioned, both the shale gas market in the US, as well as the Russian market.

But, overall we're seeing our US business is up substantially. We recently had an order for a US Hospital. We're seeing lots of applications around the US, as well as Europe is beginning to pick back up again with both bio gas, landfill gas, South America, Mexico.

So, I think in general, we are seeing a nice rebound in the US market driven shale gas, continued strength in the European market driven by both bio gas and oil and gas in Russia. And then Mexico, South America, Australia starting to pick up the pace. Some nice recent orders out of both Columbia and Brazil. Very encouraging

My second question is on the hybrid truck and bus market. Given the new CAFE standards now in the country for the first time for hybrid, essentially for trucks and buses. What kind of impact do you expect that to have on your discussions with your partners? And maybe you could give us an update on the progress you're making with talking to partners in this sector?

Yes, lets start with the bus side We continue to work with several bus OEMs and the US DesignLine is still our key partner, our bus -- we have 13 busses in Baltimore that are performing very well. We have buses in Charlotte performing very well. New buses going to Arlington and Denver shortly.

They're in process of recapitulating their company which has been an ongoing challenge for them. But, we believe they will be successful and they will ramp up their production rates. They have a very good product from an emission standpoint and a fuel economy standpoint that performs are well. Were also seeing nice orders from a Russian bus OEMs and a few other small OEMs around the globe.

On the trucks that, as I mentioned before, we're working with 2 class 4 through 8 US truck manufacturers. Those programs are ongoing. I think that the president's new CAP-A standards are only going to drive more focus on our technology and our ability to meet those emission levels.

Anything that lowers emission standards globally, increases energy efficiency requirements or fuel economy is all good for Capstone. In most cases we have a product that far exceeds our competition, we don't have a level playing field. We're performing much better than our competition from an energy efficiency and reliability and emissions stand point.

So, I think all those things are positive moves. The automobile market, still fairly far off for us. We've had conversations with 2 tier 1 suppliers. Those conversations continue to move forward very slowly. But, I do think multiple factors could move those ahead again fairly quickly.

Great thank you.

Thank you

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

Hi everyone, thanks for taking the questions.

Hello Eric.

Maybe just touch on orders again. Clearly some positive trends. Any way to quantify maybe what you've seen to this point? How it stacks up versus this first quarter. And maybe, internally, the kind of order levels that you feel are sustainable going forward?

Yes, Eric, we're much earlier in the quarter this quarter, so it's harder to comment on it. But I would anticipate Q2 to look similar to Q1. Q4 obviously was a bit of an anomaly. We had several large orders hit in the same quarter. But, I would definitely like to see our backlog remained flat or slightly upcoming after second quarter.

Still feel very good about the health and growth of the distribution channel. Several distributors that had economic problems or difficult times are coming out of the green environment, is getting healthy again and coming up with some nice orders. [Verdeces] continues to put in landfill units. BPC and Pumps and Service are ordering at a tremendous clip and will double the revenue they did last.

So, I think in general, we feel very good about the distribution network. Were still weeding and feeding in a few areas. But I think the economy improves, and we get more and more microturbines in the marketplace, more testimonials, more hours on the machines, it's getting easier and easier to sell our product.

We are seeing in some of our shale gas applications where Pioneer Natural Resources running a site, the shale play next to it, that user who's a different company comes over, sees the technology, stars asking questions and calls us up. Which is usually how you feed a market and start getting additional orders from new customers. So hopefully we get past the Pioneers and the Anadarkos and the other folks that we've actually got penetration with and broaden into a larger base in the shale gas market.

Okay. Thanks for that. Maybe just turning to gross margins. Just wondering, how far do you think you are through the C200 upgrade process that you are undertaking? Just trying to get a sense of when that warranty expense provision might normalize?

Yes, no and hopefully we've given some more transparency on that this quarter. We feel very good about our cost reduction efforts. And the gross margins we have on a product level. If you look at but which is a non-cash charge this quarter for warranty, that based on the last 2 quarters being fairly hot.

We are, in opening up the UK location and the Singapore location, will be able to do repairs and upgrades in the field without bringing them back to Capstone. The biggest cost we have from a warranty expense standpoint right now is shipping costs, trying to bring units back to Capstone for a repair or upgrade. As we start moving that work the field and as the older population gets upgraded we should see that settle them.

So, I would say this quarter we could run hot again to but I expect that the bi Q3 and Q4 do see that trailing down. If you look at new product warranty, it's very much a bell curve. It's low in the beginning, you get product out in the field and as it starts to age and you see different environments from extreme operating parameters, hot cold altitude, different scenarios, you then see the warranty cost come up and then as you upgrade the product, you see it come down.

So, obviously disappointing, but it's definitely not surprising based on how quickly we got the product to market. We have engineering fixes that are already in place for today's products that's been shipping, in fact the product has been shipping for the last 3 or 4 quarters. So, short answer to you question is probably 2 quarters left to get through it and it should be get stabilized.

But, the DMC is much, much improved over last 2 quarters. We expect the next 3 quarters to finish up our cost reduction efforts. So, again we are about 30% product margins today, as you saw on the slides. We need to drive that closer to 50%. But, we are getting there.

Okay. Last thing from me and I'll jump back in the line. Just on the working capital, you're clearly confident that is something that reverses. Just any thoughts on how things have gone, to this point in the quarter? I realize it's still early. That would be helpful. Thanks a lot.

No problem Eric. Working capital again, don't want to make light of it, but we have the Calnetix parts we brought on board. Revenue jumped up a little bit, collections were good but not great. We didn't maximize our bank line. At the end of the quarter, so several things working against us a little bit from a working capital perspective.

We do expect those reverse in the second quarter. If you look at the last three quarters, we generated $5 million in cash and had $5 million operating loss, or cash burn and $11 million this quarter. So, for the last 3 quarters we burned $11 million, we expect that to be less than $3 million. Somewhere between negative or 0 to $3 million in this current quarter. So, we're very comfortable still with our cash balance. We'd like to burn less for the quarter, but the working capital should trail down.

I think the other thing that is important is our bank line with Wells Fargo is up in March. That's a 3-year line, a $10 million line based on a much smaller company at the time. Ed is already in negotiations with Wells Fargo and a couple other banks. We fully anticipate to have a new line in place much before the February/March deadline. In fact, I'd like to get that done in the next 60 days. And that will probably be about a $15 million bank line.

So, we still have the ability to have a larger borrowing on a bank line. We've got some, as you know, we have some warrants out there in January, so not only should the working capital improve this quarter, but we have some other ways to get the cash in the next 2 to 3 quarters.

Your next question comes from the line of Shawn Severson with ThinkEquity. Please proceed.

Thank you, good afternoon.

Hello Sean.

Could you guys give a little color on the backlog in terms of the timing? I mean, should we think of it as a linear over the next 4 quarters? Or is there some type of waiting to that we should take into consideration? If we assume all that is delivered over the next 12 months.

It's probably -- it's definitely not linear, but that's probably the easiest way to model it. The reality is our C30s and our C65s tend to flow through quicker. Our C1000 series tend to take longer to flow through. We've got a lot of Pioneer Natural Resources units that will start delivering in the third and fourth quarter, but some of the other stuff we have is hitting sooner. So, I guess, for modeling purposes, I would assume a fairly linear build out for shipment.

And in that backlog, about how much of that is for oil and gas?

We don't break that out. But, it's probably close to 40%. It's definitely our biggest single market. If you include oil and gas as being onshore or offshore, shale gas, coal [sene] methane, coalmine methane, all the different gases, probably 40% to 45%.

Okay. And what are you thinking about this year in terms of turns business? So, orders shipped same quarter, that kind of thing?

It's for the most part our average shipments today, because of our backlog, we've got a little bit amount of production slots. So, most cases we're probably 12 to 16 weeks on C30, C65 and then 4 months to 5 months on C1000. The C1000s are really more driven by customer demands and when they need the product then when we can deliver them.

Okay, so you are in a pretty small percentage of turns business then? Kind of the revenue over the next 12 months?

Correct.

Okay. And going back to some of the cost initiatives and the getting margins where they need to be, I know you've talked about it already ready. But can you just give a good idea of what some of the very short term, hate to call it low-hanging fruit, but, what are you focused on over the very short term where there are opportunities there? Other than just volume?

Well, it's several things. 1 it's volume, 2, it's outsourcing overseas. We continue to do more and more in Asia. All of our enclosures are made in either Asia or Mexico. But, in some cases it's bringing on new manufactures that are more automotive centric manufactures.

So, as our volume increases, we're getting doors opened up to us we that we didn't have in the past. Also bringing Rob Gleason on board, he's got some contacts and as we look around the industry, we're finding more and folks that are interested in our technology, our company and our growth curve, and it's attracting us.

So, in some cases we are changing some of the product specifications and tolerances. The vast majority of the opportunities is more of a purchasing exercise. And either grouping more parts with 1 supplier or off shoring with suppliers.

So, it isn't going to be any type of stair step event? It's really going to be -- something like that I would assume takes at least a couple quarters to implement? Is that fair to say? To start to have an impact as you resource, or look for new sources in certain products?

Yes, if you look at the chart that we have in the deck, we made some really good progress for the first year against a 30% cost reduction. We saw that for a couple quarters as we didn't have a lot of new cost rolling in. And then in Q4, at the very end, we had recuperate cost reduction, C200 enclosure cost reduction, some printed circuit board and some other components that came in, so it gave us a nice lift in Q1. We've got a lot of cost reductions cutting in in Q1 and Q2, which should give us some additional cost relief in the next couple quarters.

The average selling price has continued to go up every quarter, we should get another 6%, maybe 7% out of ASP's in the next 3 to 4 quarters. So, it's not linear. It'd be nice to see with the 20% we're short, to get 5% a quarter for the next 4 quarters.

But it will be a little lumpier than that. But I think the last 2 quarters have been a nice improvement from DMC perspective. And we're seeing it, as we see orders come in today, we're starting to see orders at 40% margin, 45% margin and that's great see as we add on the new business.

Okay and then just lastly, just so I understand the ASPs. You look at 6% to 7% that would be referring to what you would be booking in your backlog, say in the fiscal third and fiscal fourth quarter? Is that a way to think of it?

Everything we booked in this quarter is all fresh pricing, most everything in Q4 was fresh pricing. So, the $71 million in new orders is all at the fresh pricing. So, as that rolls though the backlog, that going to generate about a 6% higher ASP than what we shipped in the last couple quarters.

Okay, so year-over-year your up 6% to7% in equivalent terms of the backlog book?

No, a year ago, 4 quarters ago, we were -- the backlog ASP was $125,000 and this latest quarter was $166,000. We're up significantly year-over-year.

Okay. All right. Thank you.

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

Thank you. Good afternoon guys.

Hey Walter.

Hi. If I could, just for a second, visit on your development of your supplier network and how that's going as far as having second and third level suppliers to make sure that there's no blips on any large orders and things like we've seen in the past? How's that coming along?

It's much improved from where we were. As I said in the quarter, Q4 we had some probably 4 or 5 supplies that really caused us pain and some other ones that gave us near death experiences. Q1 was much better. Q2, we had a few in the beginning of the quarter, by the end of this quarter we should be completely behind us.

We did the supplier symposium that we talked about last quarter. We've done onsite visits. We've improved our documentation and communication, forecasting with the suppliers. In many cases we are managing down to their supply chain making sure that they got the raw materials coming in. And frankly, we're just working much closer in a partnership basis with our suppliers.

And to your point, on the key vendors, we've got back up to the suppliers in place. Now, some cases we don't want to go that second supplier, because it would be a higher cost. Probably local supplier, but as an emergency basis we can do that.

Right okay.

We've got a new supplier scorecard we're putting together. There's a lot of things we're doing to make our whole supply chain more sophisticated and more robust. You should not see, knock on wood, any additional supplier challenges going forward.

Okay, that's good. That's something that just comes out of left fields and bites you.

Absolutely. And again, I don't want to call them growing pains and shrug them off, but definitely as we take this business from $16 million to $18 million to $25 million a quarter and beyond, you're going to find out where your stress cracks are.

How's the distributor network refinement coming now? What's your number standing at and how's the feeding and seeding, as you say, going?

Were still about 95 or 96 for the most part, most of our distributors are responding very well. We've got another distributor conference, global conference coming up in October. I think our biggest challenge is just helping them manage the growth they're seeing and manage the order flow and make sure they can still execute. One of my bigger concerns is some of the distributors, as fast as we're growing, they're growing even faster and can they manage their business and execute and not die from indigestion by trying to do too much.

But overall we are very happy with them, the communication is good. They're using salesforce.com, they're working well with our service organization, we've adding a second trainer and all of our training classes are full. So, I think the whole distributor network is performing extremely well.

Well thank you. That's what I have.

Thanks Walter, good questions.

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

Great, thank you. Obviously we've all been watching the stock market this week and we've seen the whole debt ceiling crisis and severe correction. Management team at Capstone and our board of directors wants to thank all of our loyal shareholders that continue to stick with us through these difficult times.

Despite the global crisis, we continue to set company records. 17 quarters in a row of improved revenue, we fill very good about continuing that record for the next several quarters. This definitely is a great start to what should be the best year in Company history.

I'm thrilled to have record revenue, record product shipments, to see the C200 build rate come up, it doesn't seem like it was that long ago we we're talking about whether we're going to build 1 a week or 2 a week or to bring it up to 3 C200s a week. So, we've come a long ways with our C200 and C1000 manufacturing line. The product backlog is fabulous.

The gross margins, though, are really the key for us. And hopefully folks wont get lost with the short-term warranty issues and see the real DMC and average selling price improvement that we're making. The core business is strengthening every quarter. The $71 million in new orders at new ASPs that we've closed over the last 6 month will be great to see that flow through in Q3 and Q4. And despite the global weakness, we continue to build a very strong company.

I don't want to ignore the recent part shortages as Walter brought up. Or the warranty [cods] that Eric brought up, or the working capital swings. Just the opposite. As CEO, I want to own those issues. Were not making light of them. But they are, in my mind short-term issues that a good management team can conquer these challenges and continue to move forward.

So, call them growing pains, they are manageable events, we're owning them and we've got the right team to fix them. And our goal is to build the strongest company with the highest revenues, the best gross margins and to dominate our clean tech space as quickly as possible. So, thanks everybody for listening. I look forward to talking to you next 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.