Capstone Green Energy Corp (CGRN) 2012 Q2 法說會逐字稿

Good day ladies and gentlemen, welcome to the Capstone Turbine Corporation earnings conference call for second quarter fiscal year 2012 financial results ended September 30th, 2011. 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 all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions).

I would now like to turn the conference over to your host for today, Ms. Jayme Brooks, Vice President, Finance, and Chief Accounting Officer, please proceed, ma'am.

Thank you, welcome to Capstone Turbines conference call for the second quarter ended September 30th, 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, November 9th 2011. If you do not have access to this document and would like one, please contact via telephone at 818-407-3628, or e-mail IR@CapstoneTurbine.com. You can view all public filings on the SEC website 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 Provisions 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 continue to reduce costs and improve inventory turns and contribution margins, the ability to reduce cash usage, higher average selling prices, continued growth in current markets, the continued availability of a line of credit,our ability to raise funds toward exercises, The success of the C200 and C1000 products, new products and technologies, compliance with certain government regulations, and increased government awareness and spending of our products. Growing market share and market adoption of our products. New applications for our products, growth in the energy efficiency renewable energy, oil and gas, critical power supply, and mobile product markets, increased opportunities in Japan, revenue growth and increased sales volume, our success in key market segments, our ability to enter into new relationships with channel partners 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 relationships 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 be able to continue to reduce our manufacturing costs. The growth in our backlog has significantly exceeded our internal forecasts, in order to meet this increased demand we may need to raise 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 customer 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 reasonable prices. If we fail to meet all of the applicable NASDAQ global market requirements and NASDAQ determines to delist is 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 collecting Accounts Receivable, could have a material adverse affect on our cash flows and results of operations. Our release of new products may be delayed, or our 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 customers, 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 distributors, and if we do not effectively implement our sales, marketing service and product enhancement plans our sales will not grow and we may not generate the net revenue we anticipate.

These are among many factors which may cause Capstone's results to be different from future results, predicted or implied is such statements, we refer you to the Company's Form 10-K, Form 10-Q and other recent filings with the Securities and Exchange Commission, for a description of these and other risk factors. Because of these 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 the call over to Darren Jamison, our President and Chief Executive Officer.

Thanks, Jayme. Welcome everyone to Capstone's fiscal 2012 earnings call. With me today is Ed Reich, our Executive Vice President and Chief Financial Officer, Mark Gilbreth, our Executive Vice President and Chief Technology Officer, and Jim Crouse, our Executive Vice President of Sales and Marketing.

Today as most calls I will start with a general overview of the second quarter and then turn the call over to Ed, who will review our detailed financial results, Ed will then turn the call back over to me, and I will go over and discuss what is happening in some of our key markets, and update you on the progress towards our strategic objectives of improving positive gross margins and generating positive cash flow. We again will be using slides in our presentation today that can be found on our Capstone website under Investor Relations.

During the second quarter Capstone again built and shipped a record amount of product, and had another solid bookings quarter. In the second quarter we shipped a record $22.4 million in new product, up 7% from last quarter's then record of $20.8 million. In addition Capstone built 76 C200 engines that shipped in our C200 and C1000 series products during the second quarter. This makes a 117% increase from the 35 engines built in the second quarter last year, as we continue to ramp our C200 manufacturing output, without adding any additional or significant touch labor or operating expenses. Product shipments could have been marginally higher in the quarter, if not for some lingering build constraints on the new TA100 acquired product line.

The TA100 manufacturing line was relocated as previously planned from Calnetix in Florida to Capstone in California during both the first and second quarters. The approximately $21 million in new product orders during the quarter were a result of the continued strength of the developing US shale gas market, but did not include any significant new orders from BPC in Russia, the Company's largest distribution partner. Therefore as you can see from slide two, our total product backlog is flat coming in at $114 million from the $115 million from the quarter before. This is a very robust backlog, and puts Capstone in a strong position to again deliver year-over-year revenue growth in fiscal 2012.

Based on the second quarter year-over-year results and the continued improvement in our key performance indicators, I am very encouraged with Capstone's progress. Slide three highlights results of our KPI's, or Key Performance Indicators. The Key Performance Indicators are the best measure of the underlying foundation of our business, and are critical to reaching our goal of improved positive gross margins and cash flow. The key metrics to Capstone's success are production rates, average selling prices, direct material costs, new orders, and of course cash. These metrics continue to show improvement in the second quarter, with the exception of new orders which dropped only slightly from the robust Q1 levels.

Cash used for the quarter improved significantly from Q1 and our current internal projections indicate that we should use less than $3 million during the third quarter. Revenue for the second quarter for fiscal 2012 increased 46% year-over-year to $27.5 million, versus just $18.9 million 12 months ago. Slide four illustrates how Capstone's year-over-year quarterly revenue has now increased an amazing 18 straight quarters, an achievement unmatched by the vast majority of public or even private companies.

More importantly as you can see from slide 5, Capstone has achieved the top line revenue growth without substantially increasing its production labor and overhead over the past five years. This is a tribute to our team of Lean manufacturing engineers, that continues to make progress in improving our production efficiencies, which allows us to build more products without adding significant cost or additional direct labor. During the second quarter of fiscal 2012 Capstone achieved the highest positive gross margin in Company history of 6% on a GAAP basis, and 8.5% on a non-GAAP or cash basis, as shown on slide 6.

Capstone has now posted positive gross margins four of the last five quarters. During the quarter we continued our strategic program to upgrade approximately 180 early vintage C200s to today's more robust design. Because we are selling a premium product, and because every C200 and C1000 seat is in the market, as a potential customer testimonial it is imperative that all of our product meet or exceed our customer expectations. Management has taken remedial steps to more cost effectively upgrade these older units, and lower the warranty rates to targeted levels. The result of these efficiency actions are reflected in the quarter-over-quarter improvement in warranty expense.

As you can see from slide 7, the path to continued improvement in our gross margin from today's 6% to our targeted 35% is higher average selling prices, while lowering our direct material costs and reducing the C200 warranty expenses. Continued margin growth has been and will be the key area of focus for our Board, our management team and myself, as we look for approximately 15% out of direct material costs and manufacturing costs, improve our average selling prices approximately another 7%, and reduce warranty expenses at approximately 4%.

When we accomplish these strategic objectives we will see overall gross margins of 35% of our top line revenue, and generate approximately $9.6 million in margin at today's revenue levels, which would obviously provide positive earnings. At this point, I would like to turn the call over to Ed to review the financial results. Ed?

Thanks, Darren. Good afternoon everyone. I would like to provide you with our financial results for the second quarter of fiscal 2012, which ended September 30th 2011. Let's begin with the recap of the major items on our balance sheet. The significant sequential changes from the Q1 fiscal 2012 to Q2 fiscal 2012 balance sheet were as follows, the inventory increased $800,000 in Q2 to $24.7 million, from $23.9 million in Q1, with inventory turns at approximately 3.8 times. The primary reasons for the increase were the timing of in-transit inventory required for Q3 production, and purchases of GE Clean Cycle ORC units.

The Accounts Receivable balance was $23.2 million at the end of the second quarter compared to $19.9 million in Q1. Our Days Sales Outstanding increased slightly due to higher end of quarter shipments compared to the prior quarter. Cash collected during the quarter was approximately $24 million. Accounts Payable and accrued expenses were $21.3 million at the end of Q2, compared to $18.9 million at the end of first quarter. The increase was primarily due to higher inventory levels.

Our cash balance was $20.3 million at the end of the second quarter. We consumed $1.8 million in cash in the second quarter using $7.4 million in operating activities, of which $4.5 million was used in operations, and $2.9 million was related to changes in working capital accounts. Our goal for the second quarter was to offset the working capital of $6.8 million used in the first quarter. However, we had slower than anticipated payments from customers on their Receivables balances. The affect of this was approximately $3 million, which would have offset the working capital usage.

We successfully amended our line of credit with Wells Fargo during the quarter, increasing the line to $15 million with a new three-year term. I am pleased that the bank has expressed confidence in our business as reflected in this amended agreement. Sequential changes from the Q1 fiscal 2012 to Q2 fiscal 2012 income statement are as follows, total revenue increased 13% sequentially to $27.5 million. Product revenue grew 7% to $22.4 million in Q2. Units shipped during the second quarter were comparable to the first. We shipped 170 units in the first quarter compared to 172 in the second. Average selling price per unit increased 7% to $130,000 per unit, from $122,000 per unit last quarter. Accessories parts and service revenue increased 47% to $5.1 million from $3.5 million in the prior quarter. Gross margins were positive again for the second quarter, coming in at $1.7 million or 6% revenue, compared to $500,000 or 2% of revenue in the first quarter. This improvement in gross margin from the first quarter was the result of increased average selling prices and higher volume.

Note that product margins have improved over the last two quarters. We continue to make progress against our 30% materials cost reduction target, and we are targeting to complete the remaining approximate 15% of reduction over the next three quarters. Margins were again affected by incremental warranty costs during the quarter, primarily related to field upgrades on C200 and C1000 series products, in an effort to bring certain fielded units up to current factory specs. We spent $2.2 million during the second quarter on Research & Development, which was flat when compared to the prior quarter. In Selling, General & Administrative costs we spent $6.6 million in the second quarter, which was basically the same compared to the first quarter.

We had a net income of $1.3 million, or $0.00 per share for the second quarter, compared to a $2.9 million loss, or $0.01 per share for the first quarter. The net income and net loss for both the second and first quarters of fiscal 2012 were affected by the adoption of accounting standards Codification 815, Derivatives and Hedging, which affects our accounting for warrants with an anti-dilution provision. We recorded a noncash benefit of $8.6 million to warrant liability in the second quarter, compared to a noncash benefit of $5.6 million during the first quarter. For the second quarter of fiscal 2012, the net loss and corresponding loss per share before the affect of the warrant accounting was $7.3 million and $0.03 per share respectively. Please refer to slide eight for a reconciliation.

Backlog at the end of the second quarter was $113.7 million, down $1.6 million from the first quarter. This quarter results continues to be encouraging as we experienced another significant increase in revenue and margin. We need to continue in the positive direction that we have established, and remain focused on continuing our cost reduction program to obtain profitability. That concludes my comments on the second quarter results. Now back to Darren.

Thank you, Ed. Accounts have continued to gain market share at all five major of its markets as shown in slide nine. 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 in our business, as we further penetrate the US shale gas markets and Russian oil fields. During the quarter Capstone announced that the Tatarstan President declared Tatarstan's oil companies and specifically Tatneft will be deploying Capstone's microturbines and Capstone's Clean Cycle 125-kilowatt waste heat recovery generators, from mostly associated gas to energy projects.

Tatarstan is one of the most economically developed regions of Russia. The republic is highly industrialized and ranks second only to Samara Oblast in terms of industrial production per square kilometer. The region's main source of wealth is oil and gas and Tatarstan produces 32 million tons of crude per year, and has an estimated oil reserve of more than 1 billion tons. Industrial production constitutes 45% of the republic's gross regional domestic product. The US shale gas market continues to represent an excellent opportunity for Capstone's highly reliable low emission products, as energy producers like Anadarko, Tiner Natural Resources, and Chesapeake are utilizing Capstone's products as better ways to supply clean and reliable electricity to the remote drilling operations in the US shale plays.

The critical power supply data center product is performing extremely well, and data center installations ranging from Syracuse University data center, to United Technologies corporate data center, to Homeland Security locations. Also during the second quarter we shipped several C65 hybrid UPS systems to a university in Ohio for another new data center application. As a result of these successful first installations, we are seeing increased interest from larger data centers and have begun to market a C1000 hybrid UPS solution. Management believes that our data center solution has the potential to drive significant revenue growth as product gains market acceptance. Renewable energy continues to be a significant portion of our business, as we ship products for applications in landfill gas, digester gas, cow or pig manure, and biodiesel applications around the globe. Specifically we are seeing increased businesses from key distributors like Green Environment, or DCS and Cogenco in Europe, and Aquatec-Maxcon in Australia.

In Japan Capstone is continuing its discussions with potential distributors, and hopes to have one or more online during this third quarter, to address the potential increased market demand. In addition we received two follow-on orders from telecom leader entity DoCoMo, as our units performed exceptionally well after the earthquake and subsequent tsunami. We are also looking to increase our focus and effort in Germany and Italy, as they look to move away from dependence on nuclear power, and use more renewable power or distributed generation combined heat and power solutions. Capstone's mobile products market utilizing turbines as electric vehicles is gaining increasing interest for our use of products as range extenders in electric buses, electric trucks, and the marine industry. We recently announced that we are working with domestic heavy duty truck manufacturers Kenworth and Peterbilt to demonstrate Class 7 and Class 8 microturbine range extended series hybrid trucks, using Capstone's carb certified C65 microturbines. Both of these vehicles are series hybrid concept trucks intended to quantify the performance, efficiency and economic benefits of a microturbine based series hybrid solution.

As I stated in the last call, the Class 7 refrigerated Kenworth truck is operating, and is currently running on the test track in Washington state, while the Peterbilt truck is still being assembled. The Kenworth truck program is chartered to validate the Capstone Parker Hannifin drive system with Costco being the first demonstration partner, using real drive cycles and operating conditions. The goal of the Costco demonstration is to collect performance and component data for Kenworth to make product engineering improvements to support a production intent design. The project team also will evaluate utilizing or upsizing or downsizing the system for Class 8 and Class 6 applications. Obviously Capstone is very excited about partnering with two premiere US-based heavy-duty truck companies, on exploring ways to integrate fuel efficient microturbine technology into medium and heavy duty trucks.

As a Company we are committed to provide cost effective business solutions for operators in the trucking industry, while also helping to reduce vehicle emissions. These two programs are an important first of many steps to potentially develop a commercially available microturbine, based on hybrid heavy duty truck in the next several years. On the transit front, the Mobile products business, we continue to look forward for design line to ramp production rates after the recent equity infusion. Our Russian bus manufacturer [Tralzebus] has recently secured new orders in the Black Sea region, and anticipates building at least 50 C65 CNG buses over the next six to nine months.

On the policy front Capstone continues to work diligently to increase the federal tax credit for microturbines from 10% to 30%. The Bill first introduces as HR-6515 in the 2010 session, would raise the microturbine tax credit from 10% to 30%, and remove the $200 per kilowatt cap. Recently Congresswoman Sanchez again introduced the Bill pedaled the American Microturbine Manufacturing and Clean Energy Act. This new Bill is HR-3394 and she introduced the Bill last week, and yesterday visited Capstone's headquarters here in Chatsworth, California. I would like to thank Congresswoman Sanchez for being a consistent and steadfast supporter of clean energy.

Her Bill if passed would stimulate the domestic market for clean power systems that are manufactured nearly exclusively in America. She is an excellent supporter of a California business, and I was honored to have her visit yesterday. I would also like thank the Bill's seven co-sponsors, Representatives Rangel, Baca, Kaptur, Moran, Tonko, Honda and Hirono. Back here on the home state, we have been working on the California self-generation incentive program, which is also very encouraging and should be a beneficial state program. Remember Capstone lobbied heavily to restore the CHP 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 a new program and provide incentives for CHP projects in California. I was very proud to announce during the quarter that microturbines are now eligible for the California self-generation incentive program. Under the new SGIP program microturbines used in renewable projects are eligible for up to $3,000 per kilowatt. Natural gas fired microturbines used in combined heat and power, CHP, are eligible for up to $600 per kilowatt. Incentives we paid 50% initially with the balance of the incentive being paid over a five-year period. Capstone products are eligible for an additional premium of 20% of a California manufactured product. Natural gas powered systems will need to demonstrate greenhouse gas reductions over a 10-year period, the PUC requires a strict and ongoing monitoring measuring and verification process in order to prove emission performance.

Not all gas or natural gas CHP systems will be able to qualify for the program, but we will work closely with our two California distributors to maximize this great potential new opportunity. Additionally waste heat recovery generators are also available for incentives under the SGIP, qualifying for up to $1,250 per kilowatt. Capstone is the exclusive OEM manufacturing partner with General Electric to sell zero emission clean cycle waste heat recovery generators for all microturbine applications, and for landfill applications below 500 kilowatts. In an effort to further strengthen the Capstone GE partnership with the clean cycle waste heat recovery OEM relationship, we recently reached an agreement to lengthen the term of our OEM agreement to January 2016.

The SGIP will require projects to have a 10-year factory warranty in place in order to be eligible for incentives. Capstone's factory protection plan allows customers to fix their maintenance costs over a customized timeframe, and provide optimal performance over the life of the system. Under the SGIP program Capstone will increase its 9-year factory protection plan to a 10-year factory protection plan on both the microturbine and clean cycle waste heat recovery generator.

In conclusion during the second quarter of fiscal 2012, Capstone again set record for top line revenue with revenues soaring 46% year-over-year. In the second quarter on a year-over-year basis Capstone improved gross margins from a small positive $119,000, to a positive $1.7 million on a GAAP basis, and $2.3 million on a non-GAAP or cash basis, again as shown on slide six. This is far and away the best revenue and margin in the Company's 20-plus year history, and we now have had positive margins four of the last five quarters.

The Company continues to closely manage operational expenses, improve manufacturing efficiencies, all while simultaneously working to lower direct material costs and increasing average selling prices. New orders for the quarter were solid, leaving the Company with $114 million in backlog, to execute against over the next 12 months. Cash used for the quarter dropped to $1.8 million, and the Company still has over $20 million on its balance sheet. Still has use of the new $15 million Wells Fargo credit facility, and hopes to receive approximately $9 million additional cash with the $1.17 warrants set to mature in January of 2012. Under management's current operating plan, we currently see no need to raise additional capital, assuming the January $1.17 warrants are exercised or induced prior to reaching EBITDA breakeven.

With two quarters in the books, fiscal 2012 was off to a tremendous start, and it looks like another record breaking year for Capstone, its employees, directors, and shareholders. I look forward to continuing to execute against our strategic business plan and again deliver top line growth and ever-improving gross margins, and overall strengthening and improving financial results.

At this point, Operator I would like to open the call for questions.

(Operator Instructions). Our first question comes from Sanjay Shrestha with Lazard Capital Markets. Please proceed.

Thank you. Good afternoon, guys. First on the new bookings in the quarter Darren, you touched on it a little bit, but can you go through the mix of which end market, how much of that was from the shale gas opportunity, and if I heard you correctly I don't think there was any opportunity that materialized from your Russian distributor. How should we think about that bookings number for the remainder of the fiscal year?

I think let's take the bookings for the quarter. About $20 million was a little lighter than we had seen in the first quarter. When you take out or account for the fact that we had virtually no new orders from our Russian distributor, that is a healthy a pretty healthy number, they tend to be our biggest customer on a quarter-to-quarter basis. Nothing to worry about there, just a typical lumpiness, we expect several large orders from them this quarter, and they are continuing to take a lot of product out of backlog from this quarter and the previous quarter. Just a little bit of a lumpiness in the quarters there. Overall we feel very good about bookings. This quarter seems to be on track with similar to Q2 levels. I think the shale gas, the oil and gas in Russia, Australia is picking up. We really feel like most of our markets, short of Greece or something like that, are extremely strong and will continue to improve results. We just finished our global, about every 18 month distributor meeting, and virtually all 95 distributors are showing increased numbers for next year, very strong business environments, and feel very good about the product. Again I look to see one to one book to bill. We are pretty close to that this quarter, and I feel very good about where we are going forward.

So a few quick follow-ups. In terms of the gross margin target you guys talk about, and one of the issues in the past has been that sort of the limitation from the supply chain standpoint, and product mix, and things like that. One of the biggest buckets here that talked about tremendous improvement in the gross margin is really cost reduction. Can you guys talk about that a bit more? As to this 35% target, how do we get to that, and what is the embedded margin in your current backlog right now?

Yes, so the margin in the backlog depends on how old the backlog is.

Exactly.

A newer backlog has better pricing, the older backlog obviously has older pricing. If you look at when we embarked from going from negative gross margins to positive gross margins, it was a 30% cost reduction program, and a 21% price increase program. You can see pricing of the 21% we have realized all but 7%. And on the cost reduction program we have realized about half of that, about 15% of the 30%. That is how we have gone from negative gross margins to positive gross margins. We expect both the pricing and the cost reductions to be complete within the next three to four quarters. And so you should see it will continue to be lumpy, but quarter-over-quarter improvement as we go forward.

That is very helpful. One final question then for me, guys. What is the life half of the existing backlog right now, and since you don't include the service component in the backlog, would that number be including that? How do I think about the revenue run rate in the second half of the year, and is there anything you need to still do to retweak and adjust the supply chain for us to get the incremental benefit of rolling the backlog much faster, so it turns into more of a six month backlog and lot more for turns business?

Two issues on the backlog. Number one we try to go just in time with our customers. We make sure that we ship the product directly to their end use customer to the job site. Air bearings are a fantastic invention, but they are not wine, and they don't sit very well over time, so we don't want the product to sit in the field, or sit in somebody's shop. We are trying to match our product manufacturing to the requirements of the customer, which makes us a little susceptible to construction schedules and construction delays. But the issue we had a couple of quarters ago, as we were ramping faster than our supply chain could handle. We brought our key suppliers in I think two quarters ago in Q4, and got them on board. I think they are matching our heartbeat pretty well right now. I think they are able to keep up with us, and have good visibility on where we are going. So that is always something we are going to watch when we do 30% to 40% growth in new product. We have to make sure they can keep up with us. Because that is an area, we have got a lot of focus on that and I don't see, knock on wood, any vendors slowing us down in the next year. So the backlog, as you mentioned is product only, you can see each quarter we have $4 million to $5 million in other revenue. Our FBP backlog is up to 780 units, and $30 million, so you should see 15% to 18% of other revenue every quarter besides the product shipments.

Okay, and how do we think of the revenue for the second half of the year?

It is hard to look at exactly quarter to quarter. We would anticipate Q3 to be up slightly from Q2. Obviously Q4 we would like to do the same thing. But again it can move around bit based on shipments. Most analysts have us at $106 million to $110 million in revenue. We have done $51 million in two quarter, if we continue to grow the back half of the year those numbers feel reasonable.

Thank you so much, guys.

Our next question comes from Eric Stine with Northland Capital Markets. Please proceed.

Thanks for taking the questions. Just wonder if we can touch on the cash balance? First question, is an idea of where the cash balance stands today, or how collections have been at this point in the quarter?

We really can't give you details on the collections. Nothing abnormal either positively or negatively. But overall our DSOs slipped two days last quarter, which was disappointing. We hope to get that back this quarter, and pick up three or four days to the positive. Nothing real earth shaking, but several payments came in right after the end of the quarter. Again of our 95 distributors, I think 93 are not public companies, so for them paying three days later doesn't mean a whole bunch. For us obviously, when you take four snapshots a year it is a big deal. We continue to manage collections very closely, we are trying to manage everybody's credit terms, and support the distributor's growth, but on the other side not to open us up to too much risk, which is always a challenging thing to pull off. In general we expect the DSOs to come back in Q3, and working capital to swing back our way in Q3.

Eric, it is Ed. I can also add that we said we collected $24 million in the second quarter. We expect to do better than that in the third quarter, and that we are looking for a similar cash burn in the third quarter of somewhere between $0 and $3 million.

Yes, I said in my prepared remarks $3 million. We hope to do better than that obviously, but I think using a range is the best way to look at it, $0 to $3 million again.

Okay. I mean, just looking at this another way in the cash burn from operations greater than anticipated, and another draw on the line, is this heavy shipments at the end of the quarter? Is it slow pairs? Is it a combination of both? Just wondering what can be done, or what you are doing to smooth out business throughout the quarter, so that heavy shipments doesn't have such an impact?

We are holding to construction schedules. 70% of our projects go overseas. We are trying to meet ship salings. Our biggest distributor BPC has 90-day payment terms, so obviously it is great to see their business grow, but then it impacts us from a DSO standpoint. So I would say we are building on a day-to-day weekly basis, but we are still somewhat back loaded for shipments. We are working hard to improve that. On a cash collection cycle, this quarter was a little weaker than we thought, but I think maybe by about $3 million I think we will get that back and then some this quarter. We will keep watching and keep monitoring it. Obviously we are concerned about it, but not overly concerned.

Okay. Last one from me, just wanted to clarify one of the last questions to orders. This quarter I believe you said at this point you think similar to the second quarter, did you mean, so you do think that orders this quarter are in the low 20s, or are you saying the second calendar quarter?

At this point it is too early to tell. But north of $20 million and south of probably $28 million, somewhere in that range it is hard because the new C1000 series gets us into a lot of 3 and 4-megawatt projects, where one of those goes it obviously moves the needle. Origin Energy is still talking about a hundred of units order. We have got several 3 megawatt to 10 megawatt orders pending. It is always difficult. None of those could happen or two of them could happen and it would move the numbers. In general as I said, all of our distributors are putting up positive growth numbers for next year. Several new distributors are coming online, whether it is in India, in China, South America, even Mexico, some folks getting their first and second orders in. Again I look for at least one to one book to bill, and if we can be a little better than that, then we will be happy.

That's it for me. Thanks.

Thanks, Eric.

Our next question comes from Shawn Severson with JMP Securities.

Good afternoon, thank you, gentlemen.

Hi, Shawn.

In the quarter can you just break out how much the services revenue contributed to the gross margin?

Accessories, parts and service was $5.1 million which is 19%.

And just have another question on your longer term technology road map, how it might impact the profitability. So when you look at the 250 which is coming up here I believe very soon, and then further out to the 370, how is that going to impact the gross margin for you guys, and the mix, and then secondly competitiveness, particularly within 370 of a microturbine versus other alternative technologies.

Yes, I will talk about the cost piece and the margin piece and will throw it over with the competitiveness over to Jim, and let him say a couple of words. Obviously this goal that we have shown in the profitability model slide, has us going from 6% to 35%, that is not including the C250. The C250 would be margin improvement above and beyond what we are looking at right here. We really see our current pricing exercises, our current cost reduction measures, and the warranty settling down and getting us to cash flow breakeven or even slightly positive, and then the C250 obviously would lower our C1000 20% from a DMC perspective. That is really going to take us to the next level of profitability. The product itself had some features and benefits and higher efficiencies, and some other things that will help the market. I will flip it over to Jim to let him talk about that.

Just a quick question first if I could, when you go to manufacture the 250 and even the 370, are you basically looking at the exact same cost structure that you have in place today, right? There isn't a whole lot of incremental costs that we should think of as those two products roll out maybe other than maybe warranty?

Correct. From a manufacturing cost standpoint you can see the slide in the deck. Our manufacturing costs hasn't changed even when we started build the 200 and the 1000s. The 250 and the 370 will be the same. Our bricks and sticks, the machine will not change. Obviously the direct material costs on the bill of material will be slightly higher, just because it is on the components change, but very nominal. So yes, from an overall profitability of the Company, those two products will have a tremendous leveraging factor on our business that is already improving. So definitely you are spot on, Shawn, that these are going to be additional game changers to the business.

Thanks. And from a competitive standpoint, the 250 puts us in a position of not just having a more efficient product as Darren mentioned, but we can do with four engines, where it took five engines to do, so our footprint our weight is down. The product becomes an overall more competitive against the engine guys that we are competing with every day. We are working to design new features into it from an installation flexibility, to allow our customers to ship it more cost effectively, to use it in a wider range of applications. I think there are a lot of different areas as the product comes together, and goes through its validation testing, that will identify its competitive advantages.

Shawn, I think you mentioned warranty, and again, something we probably should spend more time talking about, but typically a new product will have kind of a bell-shaped warranty curve. If you get the product in the market you start building up some hours of operation, you start finding out where you have weaknesses or improvements required for the product. Then you go out and fix the product. You kind of peak at a certain point, and then you start coming down to the side of the curve. We believe we are on the backside of that bell curve with the C200 product. We have increased our field expertise, so we can actually do more warranty work out in the field, in our UK office or our Singapore office, which is cutting down dramatically on our freight costs. Almost half of the warranty expense that we see every quarter is actually shipping costs of moving units around and parts around. As we can truck stuff as opposed to air freighting or shipping stuff overseas, that is reducing our warranty expenses. Both improving the product, getting rid of the fixed population that needs to be fixed, and lowering the freight expense. Obviously when we launch the 250 and the 350 we will see some similar elevated warranty rates for periods of time, and again that is just part of the new product development process.

I know the 370 is a little ways out there in terms of commercialization, but I believe electrical efficiency on that is up to 40% or 42% or something like that, according to the road map, and that's a real game changer, isn't it, for the competitiveness of the turbine versus traditional technologies?

Yes, this is Mark Gilbreth here. The 370 definitely is a building block from the 250 as a low pressure spool, and then we combine a high pressure spool to get higher pressure ratios. That not only helps us on the efficiency side, it helps us to be much more competitive with the larger resips that are out there on the market place. But it also improves the power density which helps drive additional margin for our business as well. So a very exciting opportunity.

And the timing for commercial availability on the 250?

We haven't come out and officially told our distributor base that. We want to make sure they are selling the current product, but I think it is definitely something less than two years away. Obviously we will release it as fast as we can, being comfortable with the robustness of the product.

Great, thank you, guys.

Thank you, Shawn.

Our next question comes from Ajay Kejriwal with FBR Capital Markets. Please proceed.

Thank you, Good afternoon.

Hi, Ajay.

Nice to see the gross margin improvement and wanted to follow-up on that pricing discussion. The 7% improvement in selling prices, is that all pricing, or there is a mix affect in there?

No that is all pricing. If you took our backlog and repriced it at today's price book, That is how much our backlog would increase. So we have gone through, if you remember we used a different slide for the last several quarters trying to explain how we get home from a margin standpoint, and this may be a little simpler for folks. If you look at the current pricing, the last price increase we did as the backlog completely turns over, then we will see our ASPs increase completely 7%. On the cost reduction side, all of the cost reductions we are going after have been identified, in some cases we have parts that are in first article testing. In some cases we still have some design work for cost reduction. We are comfortable. We know where it is coming from, which vendors we are working from, and it is really just how quickly we can get the cost reductions in place. We are seeing some pricing pressure from HR120 from some of the materials we use, and so this is net of the pressure, I think we are fairly comfortable with the price increases. The limited ones we have seen from commodity prices going up over the last year.

Got it. When I think about pricing, the 7% you have in your model when you look at the orders that you booked last quarter, are you there in terms of pricing that gets you to that model, or do you need to put in more pricing increases?

The only way we wouldn't be there with an order we booked would be if you discounted it for some reason. In some cases from a competitive standpoint we will offer discounts. Occasionally we offer a bit of a discount for a cash payment, or better payments from the distributor. For the most part if it is a straight no discount out of the price book, then yes, it has the 7% built into it.

Got it. On the cost reduction comment, what are the milestones between now and the next three and four quarters that you are monitoring? That would be key for you to get to that 15%. Is it any one or two suppliers, or any one or two key products? There is some wood that needs to be chopped, or is it a lot of different things that need to happen?

It is about 12 different parts numbers specifically, maybe 15. So it is a matter of rotating equipment parts, some printed circuit boards and even our display panel. We have that cost so the C200 product is at our target. The C1000 we are going through another revision on the C1000 enclosure. But for the most part it is hard parts, rotating machinery, the C1000 enclosure, some printed circuit boards and the like. As I have mentioned in previous calls, it is more complicated than just you buy a part from a new vendor at a lower price. These are obviously in a lot of cases custom parts, heavily machined parts, very tight tolerances, and the last thing we can afford to do is to accept a vendor or part that is not per spec. We have had some vendors come in on the first or second try, and not be able to manufacture our part within the tolerances we require, so don't want to say it is overly complicated, but it is also not a real short putt. It takes some work it takes some effort. We have a program management group, Rob's group helping that effort to make sure that we cut the product in, and as I say the Tarzan affect, we don't let go of one vine until we grab the next vine. Because the last thing we want to do is cut off an old vendor, and then have a problem with a new vendor, so working out all of the issues, and again I think each quarter should have improvement, and in three to four quarters we should be done.

That is helpful. And then maybe one question on the shale opportunity. Any color on some of the bigger opportunities that you have been pursuing? What is the progress any update there? And then any color on how much is in the backlog from shale that you are carrying today?

We have mentioned the last, I think Q4 we had a really big bump and that was significantly impacted by shale gas. This quarter I think we will probably ship four C1000s to Pioneer, and maybe another couple units here and there to Anadarko and Chesapeake, but for the most part it is a 4 to 5 megawatt a quarter impact on our business. Obviously there is lots of room to grow there. Both our distributors pumps and service and E-Finity are adding more personnel and more aggressively chasing that market as they are two of the distributors have most of the shale gas in the area. We announced obviously an associated gas order of 3 megawatts during the quarter in Canada, and there is lots of associated gas that we are expecting new orders out of Tatarstan and Russia. That could be Tatneft alone it could do 30 to 40 megawatts next year. So a big opportunity. The other thing that maybe Jim can jump in here, the clean cycle waste heat recovery generators, we have not seen a lot of early adoption in that product. We have some in the field, but I think the pipeline of orders and opportunity for that product is growing, and I would not be surprised to see it sell 40 to 60 next year, and see a very nice increase on the waste heat recovery generator side.

I would just add to Darren's comments, one of the exciting things is as we deploy to our existing shale customers, it gives us excellent opportunities, and we have had a lot visited from other oil and gas customers, both domestically and internationally that go to Pioneer, that go to El Paso, that go to Chesapeake. Our goal is to keep all of our existing customers, see repeat orders. But as the awareness in the market place grows, we are anxious to see new customers come on board, and start taking their 3 to 4 megawatts a quarter from us.

Thanks for the color. And Tatneft sounds like a very interesting opportunity. Maybe any update on what the expectation is, in terms of the orders playing out? You said 30 to 40 megawatts, any sense of the timeline there?

Yes, really it is hard to tell with oil and gas prices. They tend to talk a good game about how quick they move, and then move slower. But they gave us some color over the next two years what they want to do. We are pretty comfortable, we have already seen a few orders from them. Our distributor is setting up a regional office closer to their headquarters, and I think we will see a nice deal flow. Gazprom I know is picking up speed and doing a lot of new activities, and there are several other oil companies, Luke Oil and other folks in Russia that we are very happy about. We are doing a very large project in Sochi in Russia, it is part of the Olympics, powering of a shopping mall there. So I think again the Russian market continues to be one of our strongest, I mentioned in the call Aquatec-Maxcon, they have got several deals flowing today. They are still working with Origin Energy. That deal is still alive. We see Australia being a key market. South America and Mexico continues to grow, and the US market, we have seen nice rebound in that business, the California self generation incentive program should help, obviously have got a lot of work to do to try to get the American Microturbine Act passed, but I think having seven co-sponsors to the Bill, and have a Bill that in theory both Republicans and Democrats should be able to support, is something that we at least are going to a good shot at and work heavily on the Hill.

Very nice, thank you very much.

At this time, there are no questions, I would like to turn it back to Mr. Darren Jamison.

Great. So my closing remarks, December 17th will be my five-year anniversary at Capstone. In today's world of daily headlines and quarterly earnings calls, and what have you done for me latelys, sometimes it is nice to kind of step back and have a unique opportunity to reflect over the last five years. When I joined Capstone five years ago, the industry told me the Company was dead and forgot to lie down. A lot of folks were saying that I was crazy, the Company would be bankrupt within a year. The product was too small and too expensive to compete with the likes of GE and Caterpillar. The morale at the Company was terrible, and distribution channel was in shambles, and people would say that the Company has never had a positive gross margin and never will. Some folks in the industry went so far as to even call the Company Crapstone. When I reflect back on the last five years, it has definitely not been the easiest road I have gone down, not achieved every goal that we have set, or kept every promise this team has made, but the global economy has been brutal and financial markets have been unkind.

If you think about it, the hard work and the combination of solid planning and dogged determination is starting to payoff. Five years ago they said you couldn't sell Capstone against Caterpillar and GE. Our revenues had fallen to $21 million from $24 million in the prior year. Fast-forward five years, and today we are announcing quarterly revenue of $27.5 million, more than what we did on an annual basis back then, and the trailing 12-months if you add it up it is $99 million to $100 million in revenue. So incredible growth in the last five years with a product people said would struggle to compete. If you look at, they said morale was terrible, the distribution channel was in shambles. Today we posted our 18th consecutive quarter of year-over-year revenue on a quarterly basis. Great employee turnovers down to 4%. I mentioned our distributor meeting with have 95 distributors today, we had 20 distributors five years ago. Virtually all of them are seeing their business grow. They are reinvesting into Capstone. We probably had 100 folks representing the product worldwide outside of Capstone five years ago. That number is probably closer to 900 today. If you look at our pipeline that we see in the market continues to grow every quarter, and we have got a lot of very talented and entrepreneurial folks that are representing the product.

Five years ago they said the products were too small to compete in the megawatt world, and yet today 75% of our $114 million backlog is our 200 kilowatt based product. I think we have done a great job in marketing it as the C1000, putting it into a single box, having it act like a single machine. We are definitely playing in the megawatt space, and as Shawn had said, your 250 is only going to make you more competitive in that space, and the 370 even further. Five years ago they said we would be unable to build a product with a positive gross margin. Today we posted our fourth positive gross margin in the last five quarters. It wasn't that long ago we were on these calls we said can we even get a positive gross margin, now we are talking about how do we get to 35% positive gross margin. What a difference five years makes. Five years ago they said you couldn't survive another year, yet today Capstone not only survived the last five years, but I would argue we are thriving in a world where more mature companies and established companies are struggling.

We are growing while other companies are shrinking. We are increasing prices while others are slashing prices. We are hiring while others are laying off. We are developing new products whether it is the 250, the 370, or the C1000 hybrid UPS, while other folks are slashing their R&D budgets, and stopping producing new products. We are working with the DoE. We are embracing political leaders, whether from the House or the Senate, or here locally in California, and we are pushing for new policies while others are turning away from government, and are frustrated with government. Simply put, Capstone is thriving while other customers are just trying to survive. And I am very proud of the progress of the Company, I am proud of the progress of our leadership team, I am proud of our Board and all of our Capstone employees that have made this incredible turnaround for the last five years, but I am more proud of the future of our Company, and what the next several years is going to bring, as we hit our next set of goals which include positive cash flow, profitability.

I am excited for the launch of our next round of new products, new innovative technologies, new markets, new distributors and new partners. People talk about during the quarter we went from a Wells Fargo $10 million bank line to $15 million bank line. Well Wells Fargo obviously believes in our product, in our Company, our people, our leadership team, to increase the size of that line. GE agreeing to an extension of our relationship on the ORC product for another three years. Obviously GE agrees and understands that our technology and thinks it is very valuable, and is happy with what we are doing with it. Overall I look forward to the next several years, getting even more traction in this market. If you look at the overall market drivers, whether it is reduced emission levels, higher energy efficiency, more total efficiency of products, distributed generation, smart grids. For the most part everything is going our way. I know the overall market conditions on a day-to-day are lumpy and can be a little bit frightening.

In general we see all of our markets, all of our efforts improving. The automotive market with our truck suppliers both Peterbilt and Kenworth is very exciting. We also look a lot from the transit side to see more out of the design line, more out of Tralzebus and some other bus manufacturers we have around the world. So I think all five of our market areas are growing. All 95 of our distributors are growing, and we will just keep working our plan to reduce the costs, and improve our warranty expenses, and improve our average selling prices, and get the Company stronger and more profitable for the next several years. With that, thanks to everybody for listening, and taking the time today, and look forward to talking to everybody at the next earnings call. Thank you.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.