Capstone Green Energy Corp (CGRN) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Capstone Turbine Corporation earnings conference call for second quarter fiscal year 2013 financial results, ending September 30th, 2012. During today's call Capstone management will be referencing slides that can be located at www.capstoneturbine.com under their Investor Relations section.

My name is Clinton, and I'll be your operator today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I'd now like to hand the call over to Mrs. Jayme Brooks, Vice President Finance and Chief Accounting Officer. Please go ahead, ma'am.

Thank you. Good afternoon, and welcome to Capstone Turbine Corporation's conference call for the second quarter of fiscal year 2013. I am Jayme Brooks, your contact for today's conference call.

Capstone filed its quarterly report on a form 10-Q with the Securities and Exchange Commission today, November 8th, 2012. 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, 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, market expansion, new product development, distributor network expansion, growth in revenue, gross margin and backlog, attaining profitability, improvement in certain key performance indicators and strategic initiatives, the performance of our products in crisis situations, low cost of ownership, and advantages over competing technologies.

Forward-looking statements may be identified as words such as expects objective, intend, targeted, plan, and similar phrases. These forward-looking statements are subject to numerous assumptions, risks, and uncertainties described in Capstone's form 10-K, form 10-Q, and other recent filings with the Securities and Exchange Commission that may cause Capstone's actual results to be materially different from any future results, expressed or implied, in such statements.

Because of the risks and uncertainties, Capstone cautions you not to place undue reliance on these statements which speak only as of today. We undertake no obligation and specifically disclaim any obligation to release any revision to any forward-looking statements to reflect events or circumstances after the date of this conference call, or to reflect the occurrence of unanticipated events.

I will now turn the call over to Darren Jamison, our President and Chief Executive Officer.

Thank you, Jayme. Good afternoon and welcome, everyone, to Capstone's second quarter fiscal 2013 earnings call. With me today is Ed Reich, our Executive Vice President and Chief Financial Officer.

As the operator said, today I'll start the call with a general overview of our second quarter achievements, and then turn the call over to Ed, who will review our detailed financial results. During our remarks we will be referring to presentation slides that can be found on Capstone's website under Investor Relations.

Starting with our second quarter highlights on slide 2, our results show continued progress overall on our path to profitability. As stated in our press release, revenue and gross margins both peaked at the highest points in company history. We now had over 5 years of consecutive year-over-year quarterly revenue growth and positive gross margin in 8 of the last 9 consecutive quarters.

Our distributor network continues to expand, and overflow was especially strong in North America, South America, and the Asian markets during the quarter. Orders increased 21% year-over-year, generating a book-to-bill of greater than 1-to-1, which is right where we want to be to continue to grow our business.

Shipments were strong at 24 megawatts, and we delivered our third consecutive quarter of record backlog. At September 30th, backlog was $141.1 million, up 24% year-over-year. Our cash cycles were particularly strong with dramatically improved DSOs, inventory turns, as well as reduced cash burn. I'm proud to say cash used in operations dropped 66% year-over-year, and our cash balance stayed level at a healthy $45.2 million at quarter end.

Now let's turn to slide 3. Slide 3 shows some of the significant second-quarter contracts that were received. I'd like to highlight just a few of them. We received large, follow-on orders from a key customer in the US, Australia, and Canada. In the US, these orders included approximately 7 megawatts from a major oil and gas customer operating on shale gas. This producer's fleet now has 38 systems of various sizes totally 8.5 megawatts.

Down in Australia, we received a new follow-on 5-year supply contract from a large Australian coal seam gas company. The initial order from this customer was back in July 2008, and was for a supply of 110 C30 packages, and totaled $4.7 million. The initial order release from the second contract is for 44 C30 microturbines scheduled to be shipped by the end of the fiscal year.

Returning to Canada, we received a follow-on order for 5 C1000 power packages from Genalta Power. These systems will be installed at 2 of Genalta's customers' natural gas processing plants and be fueled by natural gas captured from oil and gas players. This is similar to the approach in Russia, where Canada has enacted strict regulations to reduce gas flaring among various industries.

Capstone's microturbines are playing a key role in helping customers meet these new flare gas regulations around the world, and at the same time provide clean and reliable energy. We received a new order for 39 diesel-fueled microturbines totaling 7.2 megawatts, to provide power for mission critical loads for a Mexican government facility. The order includes 35 C200s and 4 C65 liquid fuel systems, which are expected to be installed in early 2013.

Now let's turn to slide 4. Slide 4 shows that we are experiencing some great momentum in the New York metropolitan area, with a number of high-profile installations under construction. Our distributor reliable secure power systems, or RSP systems, currently have 9 projects under construction, including C800 for DHL and 12 C65s for the New York Palace Hotel in midtown Manhattan.

In the New York Class A office building space, our partner [OP] Energy is currently in the process of installing 9 C65s at a 37-story high-rise office building located at 110 East 59th Street, and 5 C200s at another high-rise 41-story office building, located at 666 Fifth Avenue. Across the eastern region, we're seeing strong demand for our systems for use in energy efficiency applications.

Turning to slide 5, slide 5 shows our shipment mix for the second quarter. The oil and gas market continues to be our fastest growing market worldwide, because producers want high reliability and low emission benefits that our products can provide, and the assurance of around-the-clock. Oil and gas and other natural resource applications represent 52% of shipments for the quarter. Energy efficiency increased to 42%, critical power was 4%, and renewal energy dropped to 2%.

Overall, domestic demand is very healthy. 3 of our 4 top distributors for the second quarter were US-based. We're also seeing particular strength for our products in the energy efficiency market for commercial facilities such as hotels, major retailers, and office buildings. As you saw a couple slides back, we also had good momentum internationally, particularly in South America and the Pacific Rim, which is offsetting some of the ongoing weakness or softness we're experiencing in Europe.

If you turn to slide 6, slide 6 gives you a look at our key performance indicators, all of which continues to trend favorably.

Now let's turn to slide 7. As you can see from slide 7, we continue to make progress in one of our top product development initiatives. I'm proud to say our first C250 unit is now running in the labs and has demonstrated full power and efficiency in Capstone lab testing.

With these positive business indicators and improving financial performance, we continue to feel very confident about the second half of the year and look forward to increasing revenues and ever-improving gross margins.

I'll stop there and turn the call over to Ed, for review of our specific financial results for the second quarter. Ed.

Thanks, Darren. Good afternoon, everyone. Let's begin with slide 8. Revenue for the second quarter of fiscal 2013, was $30.1 million, an increase of 5% from $28.8 million in the first quarter, and a gain of 9% from $27.5 million for the second quarter of fiscal 2012. Product revenue was $23.6 million, flat quarter-over-quarter and up 5% year-over-year. Average revenue per unit for the second quarter was approximately $175,000, compared to $176, 000 in the first quarter and $130,000 for the same period last year. 5% year-over-year increase was due to a higher sales volume of our C200 and C1000 series microturbines, which was offset by lower sales of our C30 and C65 microturbines.

For the second quarter of fiscal 2013, revenue from our accessories, parts, and service increased to $6.5 million, from $5.2 million in the quarter prior and $5.1 million for the second quarter of last year. The increases resulted from higher sales of microturbine parts, microturbine accessories, FPP contract enrollment, and microturbine service work.

Gross margin for the second quarter was $2.6 million or 9% of revenue compared to $2.2 million or 8% of revenue for the last quarter, and $1.7 million or 6% of revenue for the same period last year. The year-over-year increase in gross margin was primarily the result of higher C200 and C1000 series system sales, increased average selling prices, and lower direct material costs. Capstone's now posted positive gross margins for 8 of the last 9 quarters.

R&D expenses were $2.4 million for the second quarter of fiscal 2013, compared to $2.2 million in the first quarter and $2.2 million for the same period a year ago.

SG&A expenses were $6.4 million for the second quarter of fiscal 2013, down 14% from $7.4 million in the first quarter and down from $6.6 million for the same period last year.

Our net loss was $6.2 million, or a $0.02 loss per share for the second quarter of fiscal 2013, compared to a net loss of $7.8 million or a $0.03 loss per share for the first quarter of fiscal 2013, and net income of $1.3 million, or $0.00 per share for the second quarter of last year.

Loss from operations for the second quarter of fiscal 2013, was $6.2 million, an improvement from the $7.5 million loss in the first quarter and the $7.2 million loss for the second quarter of fiscal 2012. Net income for both fiscal years was affected by the adoption of adoption of Accounting Standards Codification 815, derivatives and hedging, which affects our accounting for warrants with anti-dilution provisions.

We recorded a non-cash benefit of $302,000 to the change in fair value of warrant liabilities during the second quarter of fiscal 2013. Our net loss for the second quarter of fiscal 2013, before considering the non-cash benefit to the change in warrant liability, would have been $6.5 million, or a $0.02 loss per share. During the second quarter of fiscal 2012, we recorded a non-cash benefit of $8.6 million to the change in fair value of warrant liability. Our net loss for the second quarter of fiscal 2012, before considering the non-cash benefit to the change in warrant liability would have been $7.3 million, or a $0.03 loss per share. Please refer to the non-cash warrant charges slide in the appendix for a reconciliation.

Now turning to slide 9, here you can see a visual representation of our revenue growth for the first half of 2013, and for the last 5 years.

On slide 10, you can see our gross margin analysis for the quarter. While the reported gross margin is up 300 basis points year-over-year and over 100 points sequentially, we believe that the 9% gross margin percentage for the second quarter still somewhat masks the improvement that we've seen from a more favorable product mix and lower direct material costs.

This slide highlights the improved gross margin as a result of better average selling price and lower direct material costs in the second quarter by isolating changes in various line items and our cost of goods sold is measured against the baseline Q3 '12 margin. Some of these items include higher accruals for estimated future warranty costs, timing of overhead absorption, freight charges, and higher utilities. You can see when stripping these items out, our adjusted gross margins increase from 8.5% in the baseline third quarter of fiscal 2012, to 13.8% this quarter.

Let me now provide some of the balance sheet and cash flow activity for the second quarter. Please turn to slide 11. Cash and cash equivalents totaled $45.2 million at the end of the second quarter as compared to $45.1 million at the end of the prior quarter. Receivables were $15.1 million compared to $18.5 million in the prior quarter.

Our DSO dropped significant to 46 days during the second quarter, compared to 59 days the quarter before and 77 days for the same period a year ago. We experienced strong collections of $34 million in cash during the quarter, and our DSO's not at its lowest point since the height of the recession.

Inventory was $22.8 million at the end of the second quarter, with inventory turns improving to 4.4 times, compared to 4.1 times in the first quarter, and 3.8 times in the same period last year.

Overall, we continue to maintain a strong balance sheet with a healthy cash balance and relatively low debt of approximately $12 million outstanding on our Wells Fargo credit line at quarter end. In terms of cash flows, we used $2.6 million of cash in operating activities compared to $7.4 million in the same period last year. Expenditures were $400,000, and flat year-over-year.

Finally, on slide 12, you can see a visual record of our consistent growth in backlog since the second quarter of fiscal 2009, as it has grown at a 28% compounded annual growth rate since that time.

As Darren mentioned, this was our third consecutive quarter of record backlog, reaching $141 million at the end of the second quarter.

That concludes my comments on our second quarter financial results. Now back to Darren for some closing remarks.

Thank you, Ed. Hurricane Sandy was obviously an unprecedented storm, and our hearts go out to the millions of people impacted by the magnitude of this natural disaster. But it gives us a cautionary lesson. The storm is a great example of why buying energy the way your parents and your grandparents did may not be the best solution from both a cost and a reliability perspective.

Those who have embraced onsite distributed generation technologies like microturbines were much better prepared to weather the storm than those that continue to rely solely on traditional centralized power plants, substations, poles, and overhead wires.

As we reported on slide 13, we've checked in with all of our customers and local distribution partners in the region, and we're pleased to report that the installed Capstone systems continued to operate seamlessly during and after this disastrous storm. Capstone applications that powered through Sandy range from shale gas installations to luxury hotels, office buildings, datacenters, healthcare facilities, industrial customers, customers from Virginia to New Jersey, from New York to Massachusetts.

Capstone has over 100 systems in the region hit by the hurricane, and all but one of them continue to provide mission critical heating or cooling and electric power. Unfortunately, the one that didn't was under several feet of water. Pretty remarkable track record.

Essentially, Capstone systems could have kept the power and lights on for many of those people who suffered for so many days in the cold and dark after the storm. It's unfortunate in many cases that it takes a major event like this to get people to start to think differently about how to reliably secure their energy needs and change traditional utility buying habits. Hurricane Sandy's a tragedy that represents a terrible loss of life and property, and we send our very best to all those that are just now starting the long, difficult process of rebuilding on the east coast.

However, in the coming weeks, we'll be focused working with our distributors, with our partners to further educate potential customers on the role that microturbines can and will play in rebuilding of the affected areas.

If you turn to slide 14, tools like Capstones new iPad app pictured on slide 14, and available at the Apple App Store, will help educate architects and engineers and customers on the benefits of distributed generation and microturbines.

So in conclusion, when I look at the second quarter, I see very strong results in both the P&L and the balance sheet. On the P&L, we see both revenue and gross margins at the highest levels in company history, revenues are again up on a year-over-year basis, as we have now done for over 5 years under terrible economic conditions. Book to bill was positive again, and we set a new record for backlog, as Ed mentioned, $141 million. Backlog is up 24% from the second quarter of last year.

When looking at the balance sheet, cash used in operations was down 66% year-over-year, and our DSO dropped to 46 days. Inventory's gone from less than one turn when I joined the company, to a record 4.4 turns today.

Last, but not least, our cash position remains strong at $45 million, which is extremely important for our shareholders, our vendors, and potential new customers who have to rely on Capstone.

So, Operator, at this point, we're ready to open up the call for analysts' questions.

(Operator Instructions) Please standby for your first question. Eric Stine of Craig-Hallum Capital Group.

Now, Ed, just was hoping we can start on gross margin. Nice to see the improvement there. I know something you have talked about is that you expect here in the next quarter or two that there may be a bit of a step-up. And I'm just wondering what your thinking is on that. So I guess two parts, the increased warranty accruals and any view on how that trend's going forward. And then also just an update on the UL certification process with some of your parts.

Great. Okay. Let's start with the gross margin analysis. I think two things. As we mentioned before, we've got a kind of a multiple-pronged approach for improving gross margins. And that's coming from pricing, cost reduction, warranty reduction, and reduction of the UTC royalty. So we did see a little bit of a pickup in pricing during the quarter, as Ed talked about, as well as some cost reductions during the quarter.

Slide 10 helps you see the improvement in both the cost DMC and the pricing when you strip out some of the other factors that impact gross margin. So I think that allows you to see similar revenue or similar margin in Q2 versus Q3 last year, how much better the actual DMC and ASPs look.

Warranty for the quarter was flat. I will say that was a bit of a disappointment for us. We'd like to see it start to trend down. I do think in Q3 we could be flat again or maybe slightly down. I think it'll be Q4 and Q1 by the time we start really seeing some great improvement on the warranty side.

I am proud to announce during the quarter we hired Paul Campbell, who came to us from Rolls-Royce. I think he's going to do a great job to help us improve, not only the speed in which we're updating these engines, older C200s in the field, and then improving the cost for those reliability upgrades that we're doing.

On the cost reduction front, which is the biggest piece of our margin improvements, as I have mentioned in previous calls, we have about 14 specific part numbers that we are improving the cost on, 3 of which have been cut in in Q2, 4 of which will cut in in Q3, and then 3 in Q4, and then the balance in Q1. Obviously, that's a risk area for us. We're managing that very tightly. We've done a lot to improve our program [office] to make sure we manage these programs effectively.

Also, as mentioned before, Q3 has 2 of the biggest single cost-reduction parts, which are ongoing with the UL, and we're on that process. So, I'd say pretty comfortably we're going to cut those in in Q3. The question is how much benefit we get in Q3 and how quickly we can cut them in. But I think sitting here today, Ed and I are both very confident we will cut those in during the quarter. The question is just how fast we can get them cut in.

Okay. You anticipated my question with those two main parts, and --

I knew you were going to go there, so I thought I'd just beat you to the punch.

Yes. So that's good. I mean, so your view's still intact of how margins trend here towards the end of the year?

Yes. No, I think we're going to see margin improvement in Q3 and Q4. I guess my only disappointment or that my only cautionary tale would be the warranty may not come down as fast as we'd hope. But on the cost reduction side, I feel very good that we're going to get those parts cut in and we're going to see the benefit of that.

Okay. Maybe we can just turn to the order side. I'm just interested in where things stand with Tatneft. So just wondering, have you shipped or are you through the original 16.2 megawatts? And just thoughts on timing of when you might see that additional, I believe it's 20 megawatts that they have an option on for the remainder of the year?

That is correct. Yes, we are mostly through that first 16 megawatts. I don't have the exact number. But I'd say we're more than three-quarters of the way through it. We'll be shipping all that by the end of the calendar year. We've got a planned meeting with them coming up here before the end of the year, which we will discuss exercising that 20 megawatt option. So, obviously, we're optimistic. The product's performing well. But until they exercise that, we can't, obviously, press release it or give any further guidance.

Right. But they have been more vocal in the last few months about their long-term plan. So I mean, it sounds like they're definitely committed to doing this [just] to deal with the associated gas restrictions?

Absolutely correct. They put a lot of stuff out there in the public domain talking about Capstone microturbines and how they're trying to achieve their flaring reduction goals and associated gas reduction goals. And unfortunately, for us to press release some of that stuff is very difficult. But it's good if you go out on the Internet and find some of those stories and them talking about their plans. But it's a great point.

Yes, okay. All right. We'll stay tuned on that. Last one for me. Just expectations for cash usage in 3Q.

Hi, Eric. We're expecting that we should use $4 million or less in the third quarter.

Sanjay Shrestha of Lazard.

Thank you. First question, Darren, when I look at this mix of sort of energy efficiency and oil and gas for you guys, energy efficiency now 42%, and that's a market where some of the other guys serving the energy efficiency market, wouldn't necessarily sort of highlight that as like necessarily a big growth opportunity right now, given the overall environment and everything. But you guys seem to be doing pretty -- sounds like you're doing pretty well in that market. Can you go into some more detail? Are you finally getting that value proposition sold, and so we should start to see that piece of the pie keep on growing? And if you can also tie that with sort of the bidding activity within that particular segment of your business.

Sure, Sanjay. Great point. I mean, 42% is a big step up for us. I think we've never had more than 30%, 33% of our revenue coming from that space. Two really big factors there, I think. One, the California SGIP is finally impacting our California business, so Regatta Energy is doing a great job for us and is bringing in higher order levels than we've seen in the 6 years I've been here at Capstone.

On the east coast, I mentioned both RSP Systems and OP Energy, which are both doing CHP projects. RSP's got over 9 projects under construction, which is, by far, the most we've had going on in New York. And OP's got 2 class A office buildings that they're putting product on as we speak.

So I think we're definitely seeing -- and even mid-Atlantic on the east coast as well with [eFinity]. We're seeing nice order moment on both the east and the west coast and almost all in the CHP, CCHP space.

Okay, that's great. Now, in terms of the bidding activity for you guys right now, right, so when we sort of think about the oil and gas and the shale gas potentially going into the oil opportunities for some of the independents playing that market, how does that really change the overall addressable opportunity for you guys? And sort of what is the discussion that you have with some of the players who are pretty active in those areas? And how do we think about addressable opportunities that would grow trajectory at that [market space]?

Yes. No, we've said before we see that as potentially 100 megawatts a year for us. It's hard to get exact opportunities based on rig counts and how the units are being used, how much electrification they can do in these fields in the shale gas markets. But as I mentioned, during the quarter we've had several repeat orders. We have several shale gas customers that are approaching 10 megawatts of product.

Again, this is a market that approximately 2 years ago, we had zero penetration. And now some of our biggest customers worldwide are shale gas customers. And I think, obviously, shale gas is a great opportunity for our nation from an energy independence standpoint, but it's also driving lower natural gas prices. Which the other piece of kind of the energy efficiency or CHP, CCHP benefit we're seeing is record oil -- or natural gas prices is making the economics on these projects much better.

So even though the US economy's still not as robust as we'd all like, some of these projects are dropping below that kind of magic 3-year payback threshold because of low natural gas prices.

I guess the other thing I'd say about that is Hurricane Sandy obviously devastated the electrical grid. All those grid repairs are going to have to be made. All those costs will have to be put back on the utility base. And so those folks are going to be seeing even higher electric rates. So I think we may see even a bigger spark spread, especially on the east coast, of utility power rates and ultra low natural gas prices, which obviously is very good for our business.

Got is. So another question for you guys. So following up on the, obviously, this situation with Sandy, a very unfortunate event. (Inaudible) feeling it in the east coast as well. So are you guys actually seeing increasing level of inquiry or it is something that you think might change the mindset of big commercial and industrial clients in terms of how they buy energy? Or are you guys seeing some indication from your dealers that there's a very big uptick in the inquiry level and we might actually [see that you guys] are finally realizing that there's something that needs to be done in terms of the overall energy infrastructure and the way it's --?

Yes, I think the -- I mean, I will say probably anybody who is in the power generation business phones were ringing off the hook as people were looking for emergency generator sets and backup power. Obviously, we're not in the backup power business. We're in the prime power business and the energy efficiency business. So we couldn't help on any really short-term disaster relief efforts, because we obviously didn't have ready inventory. We build to customer order slots.

But I think what we are doing is we're talking to architects and engineers who are talking to their customers saying, how do we keep this from happening again, and it's starting some great dialogues.

Now, obviously, I mentioned in my prepared remarks we were already seeing an uptick in the eastern region business. So I think it's only going to further propel or turbo charge our opportunities as people are saying, look, I can save energy costs, natural gas prices are at record lows, and I can avoid the loss of power, the loss of revenues, and all the challenges people are having with the storm.

So it's not something that will give you the immediate boost to your bookings, but directionally it's something that probably even help people realizing pretty strong value proposition of your product. That's probably how we should think about it, right?

Absolutely how you should think about it. Absolutely correct, Sanjay.

Okay. Great. One last question then, guys. So the C250 high-efficiency product certainly pretty big cost reduction for you guys as well. When can we actually start to see this product in the market? Obviously, it's in the lab right now. But when will we see this in the market? And what sort of a timeline on that?

Yes, we're probably still looking 5 to 7 quarters. We have important milestones we have to hit to commercialize the product. We moved the C200 to the market very quickly commercially, and, obviously, we have some of the pain to suffer because of that. So I think we want to make sure that we fully vet this product, we go through all of the [holthaus] testing and do everything we need to do before we release this product.

But I think we're trying to get it to market as quick as possible. As you said, from a competitive standpoint, as well as a cost reduction standpoint, it's a huge game-changer for us. So it's in the lab today, performing well. I would think within 6 months we'll probably have it in some field trials and some beta customers. And as I said, probably somewhere, 18 months, plus or minus, start offering it to commercial customers.

Okay. That's all I had. Thank you so much, guys.

Great questions, Sanjay.

(Operator Instructions) Shawn Severson of JMP Securities.

I apologize if I missed this. I've been jumping in on a couple calls. But I wanted to address the warrant expense issue in the quarter and kind of going forward. What was the -- I know you said you were a little bit disappointed by that. I was just wondering if you could give a little more clarity on what you mean by that and the slope of decline that we should expect in that going forward, along the -- and then not counting what we'd be talking about for the C250.

Yes. So I think there's probably 3 or 4 different reliability issues on the early product that we're dealing with. And we were trying to get them upgraded as quickly as possible and do it at a reasonable price. One of our challenges is, is some of this is very heavy from a freight standpoint, a vat, logistics. That's part of the reason for bringing Paul Campbell onboard is to help us speed up the pace at which we get these older units retrofitted and upgraded, but not increase the cost as we do that and do it smarter. And I think that's [been a big] a challenge for us.

One of the key issues for us was, I think I've mentioned sticky bearings or an area where we put desiccant in the machine to make sure we don't have problems with the air bearing. We've been doing that for, I think 13 months now. We believe all those have flushed through the system that shipped without desiccant and had issues. But we still had some this quarter, which we'd hoped to be through it by now.

But I think the good news is, hopefully it's flat or down in Q3, and then we can start seeing some real nice progress in Q4 and Q1, and get that behind us.

Obviously, getting all of the reliability issues and getting the current C200 up to our high standards when it comes to reliability is key, because the C250 is 80% of the same bill of material. So we want to come right over the top with the 250, and have it hit the market with the highest levels of reliability and robustness instead of a new product, really leverage that C200 architecture.

Is it going to be like a dropping-off-a-cliff-type change, because you're going through and once you've sort of gone through the install base that needs to be upgraded, I mean, does it just stop and we see warranty expense go to some level that's a couple hundred thousand a quarter?

No, you should see warranty expense higher than that. I mean, probably a natural warranty level for us is closer to $0.5 million a quarter.

At today's run rate.

At today's run rates, yes. Anything above that is additional cost for the early product. I think 3 or 4 different issues, as each one finishes up, it'll roll off fairly quickly. Plus, we're trying to put reserves in place to make sure we cover as much of these future costs as we can.

So I think you'll see a little bit, like our cost reduction you'll see come down in chunks, but not overnight.

On our biggest near-term improvement opportunity is what Darren talked about, and that's logistics. That --

Logistics, yes.

Yes, fairly quick [dent] there.

Yes, about 40% of our reliability warranty adjustments during the quarter are related to logistics, freight and vat and stuff like that. So there's a lot we can do there to improve it.

So when you have that number in there, the $900-plus thousand, that should be $0.5 million is what you're saying, right?

No, that $900,000 is over --

Incremental, okay.

-- over Q3 baseline, which was about $780,000. So it's a little higher than that. But essentially you're very close to that number.

Okay. All right. Great. Thank you.

Ajay Kejriwal of FBR Capital.

So just maybe on SG&A sounds like you're doing a good job keeping that under tight control. So what's the outlook? I mean, is this SG&A rate sustainable? Any one-timers that helped in the quarter? Any color there would be helpful.

No, Ajay. Yes, we believe it's sustainable. There weren't any one-timers that helped. The big improvement was, if you recall, in Q1, we had about $630,000 in bad debt reserves that we booked, and so we didn't have that in the second quarter. So the second quarter should be a good run rate going forward.

Okay. Good.

Let me jump in there, Ajay. I'd like to talk real quick. I know a lot of folks saw that one of our partners in Germany, Green Environment, filed for insolvency during the quarter. We had fully reserved all those receivables ahead of time when they started having issues. And so all that expense was already reserved on our balance sheet and our P&L.

The flip side is, we're disappointed with them being a victim of the European kind of economic crisis. But we are working directly with all of their end-use customers to make sure we don't, one, leave a customer behind or lose any orders they had in the pipeline. And then we've seen several new potential distributors step up and be interested in the business.

So definitely a difficult situation, but the silver lining is we may end up with 2 or 3 distributors in the area to give us even more opportunity.

It sounds like you had reserved already in 1Q, and now the 2Q rate that you saw is more a sustainable rate.

Yes, we very much feel we have a handle on the European crisis in which distributors could be impacted, and we're properly reserved. Going forward, you shouldn't see anything. Knock on wood, unless things change.

Good. So could you maybe provide a little bit more color on what you're seeing in Europe? All the headlines [seen], sounds like things are not great, but not deteriorating. What are you seeing with regards to bid activity? You mentioned one of your distributors went bankrupt. But beyond that, any change you're seeing in the bid activity versus last quarter?

Yes. I would say our bid activity or pipeline is flat. It's not going down, but orders aren't closing very quickly. So I would say the impact we're seeing is a slowdown in order development and process and closing. And so our European distributors are struggling to get orders closed. Financing's harder to get. I think everything is just happening at a much slower pace.

So if you see, the renewable part of our business was down quite a bit, and a lot of that was the softness in Europe. Now, the upside is the US market is making up for that. But as I said in our last call, I think our overall revenue for the year, I think I lowered expectations a little bit to around a 20% growth rate in revenue. We still kind of uphold the same kind of trajectory. I think Europe, unfortunately, is going to be flat to down for us for the year.

Okay. And then on direct materials, you provided good color on the 14 parts and the trajectory in terms of when you expect those parts to kick in. So first quarter next fiscal, that's when you expect these cost improvements to kick in. Is that when we expect margins, other costs, to also improve? Or will the ramp up take a little bit more time beyond that?

No. I mean, as we tried to show in slide 10, that if some of the other factors impacting the gross margin were the same as they were in the baseline, which we picked Q3 last year, we'd be approaching 14% margin today. So as warranty settles down and some of these other manufacturing variances settle down, as the cost increases roll in and some of the pricing, ASP pricing benefits happen, we should see high teens by Q1 next year, and maybe even 20%. Obviously, we're looking to get to those levels and quickly as possible, bring down the cash burn. Ed mentioned $4 in Q3. We expect Q4 to be lower than that and Q1 to be lower than that. So we believe we're on the right trajectory. And there's obviously some risk on timing of this stuff. We feel very good that we're going to get it accomplished.

Thank you very much.

Thank you. At this time, we have no questions. (Operator Instructions)

Well, great. I think we had some good questions. I mean, again, overall, I think Ed and I feel very good about the quarter. I think the business is getting easier to manage and understand and more predictable. I think most of our analysts were fairly close with their numbers this quarter, which is good. I think we've seen some nice progress during the quarter, as I mentioned in my closing remarks, on both the P&L and the balance sheet, everything from backlog and inventory turns. And that's all important. I know revenue section gets a lot of the headlines. Margin's obviously very important. But we need to manage the entire business. And operating cash flow, operating efficiencies, getting new products to market, all of that is important to us. We think we made great progress in all those areas this quarter, and look forward to doing the same thing in Q3.

So with that, I want to thank everybody for participating in the all, and we'll talk to you next quarter.

Thank you for joining today's conference. This concludes your presentation. You may now disconnect. Good day.