Capstone Green Energy Corp (CGRN) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Capstone Turbine Corporation earnings conference call for the fourth quarter and FY15 financial results ended on March 31, 2015. During today's call, Capstone Management will be referencing slides that can be located at www.CapstoneTurbine.com, under the Investor Relations section.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Clarice Hovsepian, Vice President Human Resources and Corporate Counsel. Ma'am, you may begin.

Thank you. Good afternoon, and welcome to the Capstone Turbine Corporation's conference call for the fourth quarter and FY15 ended March 31, 2015. Capstone filed its Annual Report on Form 10-K with the Securities and Exchange Commission today, June 15, 2015. If you do not have access to this document and would like one, please contact us by e-mail at IR@CapstoneTurbine.com, or you can view all of our public filings on the SEC website at www.SEC.gov, or on our website at www.CapstoneTurbine.com.

During the course of this conference call, management may make projections or other forward-looking statements regarding future events or financial performance of the Company within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements relate to, among other things, growth and diversification of our end markets, strengthened distribution channels, ongoing new order flow, reduced cash usage, growth in revenue, gross margin and backlog, attaining profitability, achievement of our EBITDA and cash goals, adequacy of liquidity and capital resources, improved operating leverage, new product development, shifts to larger markets for our products, benefits from our cost reduction initiatives, improving conditions with respect to foreign currencies, continued NASDAQ listing, implementation of new Capstone Finance business, collection of reserved accounts receivable, continued opportunities in Russia, growth of key markets, advantages of recent policy developments, and compliance with government regulations.

Forward-looking statements may be identified by words such as expects, objectives, intends, targeted, plans, 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 revisions to any forward-looking statements to reflect events or circumstances after the date of this conference call or to reflect occurrence of unanticipated events. I will now turn the call over to Capstone President and Chief Executive Officer, Darren Jamison.

Thank you, Clarice. Good afternoon, and welcome everyone, to Capstone's fourth quarter and FY15 earnings call. Joining me today is Jayme Brooks, our Chief Financial Officer and Chief Accounting Officer.

I'd like to take a moment to welcome Jayme in her newly expanded role that includes the responsibilities of the CFO position. Jayme has taken this in addition to her existing role of Chief Accounting Officer, which she has held since 2008. I've had the pleasure to work with Jayme for over eight years, and look forward to her ongoing contributions to the Company and leadership team, as we execute against our future growth strategy.

Today I will start with a review of our business in FY15, and then Jayme will review the specific detailed financial results for the fourth quarter and full year. I will then go back to discuss our global pipeline, our sales activity, give you an update on policy developments, talk about our FY16 strategy, our FY16 goals, and Management's expectations for the upcoming year. As the operator said during our remarks, we will be referring to presentation slides that can be found on Capstone's website under Investor Relations.

Let's turn to slide 2. Slide 2 shows our FY15 business in review. It's a very simple slide. FY15 was a challenging year for Capstone, but we've adapted to the global and economic market dynamics in ways that I believe we've built a stronger, more resilient Capstone today and for the future.

Unfortunately, the operating progress we made during FY15 was eclipsed by the three very challenging macroeconomic headwinds that we faced during the year, and continue into this year. First came the US and European sanctions in Russia, in response to the invasion of Ukraine, which devalued the ruble and severely damaged the Russian economy. The steep decline in the ruble had a substantial impact on one of our biggest and most important partners, BPC Engineering.

Second, the strengthening US economy versus sluggish economies around the rest of the world created a substantially stronger US dollar making our products that much more expensive overseas. This had a major impact, considering that we ship nearly half our product internationally. And last but not least, was the fall in crude oil prices, as global production outstripped worldwide demand, resulting in the US rig count and drilling activity being reduced substantially. As of the start of FY15, Capstone was generating about 60% of its revenue from the oil and gas markets worldwide.

In light of each of these macroeconomic headwinds, we experienced delayed orders, delayed shipments, obviously it impacted the timing of our revenue, which led to a decline in annual product revenue for the first time since I joined the Company back in 2007; however, service revenue grew 7% year-over-year as FPP contracts increased and product quality drove contribution margin expansion. That being said, our growing aftermarket service business was not enough to offset the 18% decline in product revenue. Unfortunately, this pushed out our anticipated achievement of EBITDA breakeven in Q4.

On a more positive note, the operational improvements to our cost structure we've implemented over the past several years resulted in flat gross margin of 16% of revenue for FY15, even with a 13% overall decrease in top line revenue. Additionally, we continued to make significant progress in strengthening our Company by further diversifying our business, growing and maturing our distribution network, and improving our product reliability, all while expanding into promising new geographies.

Let's go ahead and turn to slide 3. Slide 3 shows our worldwide shipments by megawatts for FY15. The main drivers of these results are shown above and below the map.

Above the map are the ongoing macro drivers that are helping to accelerate the overall market acceptance to our products, and fueling new business opportunities. These favorable trends include heightened corporate focus on reducing energy costs through energy efficiency, and substantially low cost sustained environment for natural gas. Widespread issues such as grid reliability, new gas flaring regulations, and more stringent emission requirements and fuel standards also helped drive the business. The bottom of the slide you can see are the key factors that made FY15 particularly challenging for our business, which I previously discussed.

Essentially, FY15 was a very challenging year, with a perfect storm of macroeconomic environment events, but Capstone pushed through in many areas to still drive relatively good results, considering the headwinds that we had. With that, I'll pause and turn the floor over to Jayme for the specific financial results.

Thanks, Darren. Good afternoon, everyone. Let's begin on slide 4, with the review of the fourth quarter. Revenue for the fourth quarter of FY15 was $29.9 million compared to $30.1 million for the third quarter, and $36.4 million for the same period last year. Product revenue was $22.5 million for both the fourth and third quarters of FY15, and $30 million for the fourth quarter of FY14.

For the fourth quarter of FY15, revenues from accessories, parts and service was $7.3 million as compared to $7.6 million for the prior quarter, and $6.4 million for the fourth quarter of last year. Gross margin for the fourth quarter was $3.5 million or 12% of revenue, compared to $6.1 million or 20% of revenue for the third quarter, and $6.1 million or 17% of revenue for the same period last year.

It is normal to see a sequential margin dip from the third quarter to the fourth quarter because of year adjustments, however this year we had a couple of significant one-time items that impacted our fourth-quarter margins. First, we recorded a $1.2 million non-cash charge for slow moving inventory related to our waste heat recovery generator product. Additionally, gross margin was negatively impacted by $0.7 million of products shipped, where we did not recognize the associated revenue as of March 31. Without these two items, gross margin for the fourth quarter of FY15 would have been $5.4 million or 18% of revenue, which is approximately 100 basis point increase over the fourth quarter of 2014, despite the 18% year-over-year drop in quarterly revenue. These adjustments are detailed in slide 5 of the presentation.

Fourth quarter R&D expenses were $2.9 million, compared to $2.4 million for the third quarter and $2.5 million for the fourth quarter of last year. SG&A expenses were $14.7 million for the fourth quarter of FY15 compared to $7.5 million for the third quarter and $6.8 million for the fourth quarter of last year. The large year-over-year increase in SG&A expenses was primarily because of bad debt reserve of approximately $7.1 million that was recorded during the fourth quarter of FY15 against receivables owed to us by our Russian distributor BPC Engineering, which has been impacted by the steep decline of the Russian ruble.

In comparison, the Company had no such expenses of this magnitude during the third quarter of FY15 or the fourth quarter of 2014. Since the close of the fiscal year, the ruble has stabilized, and we are continuing to do business with BPC, but now on a cash on delivery basis. In addition, BPC has indicated it will repay the $7.1 million of reserve accounts receivables that they owe us over time. In the future as we collect money from BPC, we will treat those payments as a reduction to our SG&A during the quarter in which they are received.

The loss from operations for the fourth quarter of FY15 was $14.1 million compared to $3.8 million for the third quarter and $3.1 million for the fourth quarter of last year. After removing the impact of the $7.1 million increase in bad debt reserves, the $1.2 million in inventory reserves, and the $0.7 million of products shipped to BPC that was recorded in the fourth quarter of FY15, our adjusted loss from operations is $5.1 million.

Net loss was $14.3 million or $0.05 loss per share for the fourth quarter of FY15. [Prior to a] net loss was $3.9 million or $0.01 loss per share for last quarter, and a net loss of $3.4 million or $0.01 loss per share for the fourth quarter of last year. After removing the impact of adjustments as mentioned earlier, the adjusted net loss for the fourth quarter of FY15 is $5.3 million or a $0.02 loss per share.

Please turn to slide 6 and I will now discuss our performance for FY15. Revenue for FY15 was $115.5 million, compared to $133.1 million for FY14, and consisted of $89.4 million of product revenue, down 18% year-over-year, and $26.1 million of aftermarket service revenue, up 7% year-over-year.

As Darren mentioned, the decline in product revenue was primarily due to three major headwinds we faced during the year: the Russian economy, the strong US dollar, and lower oil prices, which impacted revenue across most of our geographical regions. However we did experience increases in Australia and South American markets by $3.6 million and $0.8 million, respectively, as a result of our continued efforts to improve our distribution channels in these developing regions.

A couple of other key revenue-related metrics that I would like to point out are that we ended the year with product backlog of $165.7 million, down 3% year-over-year, and FPP service contract backlog of $61.2 million, up 30% year-over-year. The record service backlog reflects our growing install base of micro turbines, as well as the ongoing efforts of more mature distributors in selling our FPP service contracts as a way of further enabling our end customer to achieve a lower total cost of ownership versus traditional alternatives.

FY15 gross margin was $18.3 million or 16% of revenue, compared to FY14 gross margin of $21.7 million or 16% of revenue. As Darren pointed out, even though annual revenue decreased 13%, gross margin percentage was flat compared to FY14, which is the result of our focus on cost savings over the last few years. The change in gross margin dollars is driven by multiple factors, including lower royalty expense of $1.2 million, lower production and service labor, and overhead expense of $1 million, and lower warranty expense of $0.4 million.

The positive impact of these factors was offset by the adverse impacts of lower volume, lower average selling prices, a change in product mix of $5 million, and higher inventory charges of $1 million. R&D expenses were $9.7 million for FY15, compared to $9 million for FY14. Benefits from cost sharing programs decreased by approximately $0.9 million to $0.5 million for FY15 and from $1.4 million in FY14. In addition, professional services expense decreased $0.2 million in FY15 as compared to the previous year.

SG&A expenses were $39.5 million for FY15 compared to $28 million for FY14. The net increase in SG&A expenses was comprised of $9.9 million increase in bad debt reserves, of which $7.1 million was recorded in the fourth quarter of FY15 as I mentioned earlier, along with increases in salaries, professional services, marketing and business travel expense, partially offset by a decrease in facilities and supply expense.

Our loss from operations was $30.9 million for FY15, compared to a loss from operations of $15.3 million for FY14. After removing the impact of the $9.9 million increase in bad debt reserves, the $1.2 million in inventory reserves, and the $0.7 million of products shipped to BPC that was recorded in FY15, our adjusted loss from operations is $19.1 million. Net loss was $31.5 million, or a $0.10 loss per share for FY15, compared to a net loss of $16.3 million or $0.05 loss per share for FY14. After removing the impact of the adjustments as mentioned earlier, the adjusted net loss for FY15 is $19.7 million, or a $0.06 loss per share.

Now, I'll provide some comment on our cash flow and balance sheet. Our cash used in operating activities for FY15 was $23 million, as compared to $14.5 million in FY15. We spent $1.6 million in capital expenditures in 2015, and $1.2 million in 2014.

At March 31, 2015, we had cash and cash equivalents of $32.2 million, compared to $27.9 million as of March 31, 2014. Between our cash on hand and our Wells Fargo credit facility we believe that we have sufficient liquidity to fund our growth plans and to meet our working capital requirements. We continue to focus on reducing our fixed operating expenses, manage our inventory, and minimize our cash usage.

Additionally, the initiatives that we announced in April regarding flattening our organizational structure are expected to result in $2 million of annual savings, net of the associated severance cost. Receivables were $13.1 million at March 31, compared to $28 million a year ago. DSO was 40 days at March 31 after adjusting for the amount owed by BPC, which has fully been reserved. This compares to DSO of 70 days at March 31, 2014. Inventories were $25.4 million at March 31, up $21 million a year ago. We turned inventory 4 times in the fourth quarter of 2015, compared to 5.3 times in the fourth quarter of 2014.

Turning to our control environment, I'm happy to report that we have remediated the material weakness from FY14 and we do not have a material weakness this year. And then lastly, we have submitted our application to NASDAQ for an additional 180 day period, and it will be reviewed after the expiration of the initial 180 day period, which is on June 17. That concludes my comments, now I'll return the call back to Darren.

Thanks, Jayme. Now I'll talk about our strengthening aftermarket, our maturing market channels, potential market opportunities, provide some regional commentary and give you our strategy and expectations for FY16, so let's start with slide 7.

As Jayme mentioned, our FPP backlog grew approximately to $61.2 million as of March 31, 2015, a new record level, and a direct result of our strengthening aftermarket service business. Our market leading FPP closely aligns our service offering with our customer requirements, and we believe it's virtually unmatched in the industry. Our over 8,500 units shipped to date provide a large install base which affords us scalability in our aftermarket service business. We're also seeing improved product reliability, which decreases both our warranty costs as well as our maintenance costs associated with these fixed price five and nine year factory protection plans.

Today we have three Capstone service centers globally, supporting a large fleet of operating units. Approximately 20% of our units in the field are currently under FPP, leaving plenty of head room or opportunity to both expand and further scale our aftermarket service business, which as you all know, carries higher contribution margins than our product margins. We expect the portion of aftermarket services to increase as a percentage of our total revenue, as our global fleet continues to grow everywhere each year, and we signed more long term factory protection plan contracts.

Let's turn our focus to slide 8. Our growing channel to market, throughout FY15, we continue to grow and mature our distribution network, and as a result, our distributors are becoming more productive and more efficient. We consider our worldwide distribution network, which we have developed grassroots from the ground up over the last eight years, to be our most valuable and tangible asset. Our 88 distributors and nine OEM partners give us the manpower and global presence of approximately 740 employees, collectively spreading out among 152 locations around the world. Each one of our distributors is an strategically placed independent partner that is out on the front lines marketing, applying, selling, and servicing the Capstone product, and the FPP service contracts.

Please turn to slide 9. Slide 9 shows Capstone's $1.5 billion pending project opportunity pipeline. Based on opportunities that have been identified by our global distributors, as you can see, a significant portion of this pipeline is in markets in which we are only starting to scratch the surface and make inroads like Latin America, Africa, and the Middle East.

Essentially this pie chart shows where we can expand the business to overcome some of the temporary macroeconomic headwinds we faced in FY15, and in the beginning of 2016. Capstone's ability to execute on this pipeline with our distributors over time is a major factor of market acceptance for our solutions, and the maturation of our distributors, and it's our responsibility to continue to develop, cultivate, coach, and help our distributors through education, training, and factory support to achieve as much of this pipeline as fast as we can.

Obviously it is a key area of focus for us strategically, because as I mentioned earlier, our distribution channel is extremely valuable and extremely critical to our future growth of our business. We think that our own flexibility in working with and supporting our distributors in this most challenging environment last year has further strengthened our relationships and fostered a mutual bond of loyalty, and is building a long lasting trust. With finely tuned sales and distributor training programs, we can work to accelerate our close rates and shorten our cycle times and drive top line revenue growth from these new markets.

Let's turn to slide 10. We have kind of a global update here. I won't read each slide, but I'll go over a brief recap of our achievements with our distributors and what we're seeing in the field.

First in the US and Canada. In the US, Hawaii has been a very promising market for Capstone for several years, with the highest cost of electricity of any state and the smallest electrical grid. Hawaii is prime for distributed generation and needs our product. At the beginning of April, we received a 3 megawatt order from our new Hawaiian distributor for upgrading several high-profile luxury resorts on the island of Maui.

Our new distributor in the Midwest recently received an order -- a groundbreaking order for a mission critical data center in Minnesota. The prevailing theory for many years has been that the Midwest is not a good market for CHP or CCHP projects, and poor project economics, in combination with the conservative nature of the customers in the market, it's just not a good opportunity. But lower natural gas prices coupled with rising Electric rates created an opening for best-in-class CHP, CCHP systems like Capstone's, and the OATI South Campus, with the Capstone micro turbine and other generation and other NG storage technologies will play an important role in proving how micro grids can bring significant benefit for building owners everywhere.

We can also share good news from our distributors in the shale regions. Despite the precipitous drop in oil prices, shale gas production continues to expand, just at a slower more deliberate rate than the past couple of years. On June 3, we announced an order for 25 C65s to expand existing oil and gas customer fleets in key shale plays in the western United States. This was shortly after a 1.4-megawatt order out of the Marcellus and Utica shale plays, to support two new shale compressor stations. I think these orders should be considered as good market indicator that despite the low energy prices, shale gas producers are continuing to focus on increasing efficiency, while lowering their operational costs.

Turning to Europe, although Europe remains economically constrained, we are also encouraged by the strengthening demand for CHP and CCHP applications in a number of countries. Most importantly, Germany and Italy, but also Austria, Switzerland, Finland, Poland and the United Kingdom. We're continuing to diversify our channel in Europe. For example, Turner in the United Kingdom has added several new salespeople, and we have a new distributor in Hungary working on a strong product pipeline. In addition, despite the tough Russian market, BPC Engineering is diversifying its business by selling CHP and CCHP plants within Russia's manufacturing sector, but also in neighboring Kazakhstan and Belarus.

The Mexican energy forum has established reduced electrical costs and natural gas prices, and this is creating an opportunity for Capstone. Our distributor, Industrias Energeticas, secured two of the largest orders in Capstone history recently, and the participation of the Los Ramones pipeline project in Eastern Mexico. With the freer market energy policy in place, natural gas development in Mexico is poised for substantial growth, and with these types of wins, Mexico is certainly poised to be one of our top markets throughout FY16 and beyond.

Elsewhere in Latin America, we shipped our first CCHP C1000 to Colombia for an application in a large urban complex of government buildings. In El Salvador, we received an order for an upgrade of a plastics manufacturing plant, and this also marks our first project in El Salvador, which hopes to plant a seed for future developments and future projects there.

The Caribbean is also a very attractive market for Capstone. The high and volatile price of electricity is the most important issue in the Caribbean energy sector, where electricity prices are among the highest in the world. This makes CHP and CCHP as a very attractive alternative for power generation. Incremental growth in markets like Central and South America and the Caribbean is critical to Capstone's future revenue growth, and further diversifies and strengthens our global distribution channel.

Let's turn our focus to slide 11 and talk about Asia and Australia. In Indonesia we've expanded our footprint with the 1.6-megawatt order, and we are well positioned there as the new Indonesian government has committed to providing power to every island, village, and town in the country.

We're seeing an increasing number of businesses in Australia adopt CHP or CCHP, and as Jayme said, our Australian business was up year-over-year. These technologies are part of the push toward environmental best practices and green building initiatives. We secured a 3.2-megawatt order for office buildings in Australia, and recently delivered a 1.4-megawatt order for a high profile project for the Sydney central business district, which has potential for several follow-on orders.

New territory for us is Africa and the Middle East. We have seen a strong demand for flare gas reduction. We have been very attractive and very active in sales training and marketing initiatives, B2B events, as well as adding new distributors in these areas. We see positive growth going forward as our distribution network matures in this region, and we look at all of the different opportunities to apply the product.

In turning to slide 12, let's take a minute to look at policy. As you can see, Capstone in partnership with our distributors is working diligently to drive changes in policy, as it relates to increased development and funding of key energy efficiency, CHP and CCHP programs on both a state, national and obviously global basis. In addition, we'll continue to push for lower emission standards around the world, as the innovative Capstone product offers substantial environmental benefits over traditional reciprocating power generation solutions.

Turning to slide 13, this covers product development R&D for the year. Our engineering and program teams continued their work in developing highest quality products in the energy industry worldwide, and this slide lists our key achievements in FY15 and some of our R&D goals as we go forward.

We have made significant product developments in our flagship C200 and C1000 Series product line. A liquid fuel version of the C1000 series was produced and shipped, with the use of Capstone's lean pre-mixed combustion technology, based on the development of work done previously with the C200 liquid fuel system.

Additionally, a dual mode grid connected standalone, digester gas C1000 was produced to run off the palm oil milling effluent biogas produced as a by-product of the palm oil extraction process. The advancements realized in both of these products open up new markets for Capstone, and also allow for further development possibilities in the areas of liquid fuel and palm oil worldwide.

We also continued our work with the US Department of Energy on the development of the C370 dual spool high efficiency micro turbine, and have extended the design contract to support a second attempt at successful operation of the bi-metal turbine wheel. Capstone was selected by the US DOE Advanced Manufacturing Office to present our C370 program at a peer review of key DOE projects on a national scale. In addition, we've successfully completed the first of two long term endurance tests for the AFA stainless steel, and the next milestone will be to finish life testing and start field trials in this important low-cost alloy.

Let's go ahead and go to slide 14. Slide 14 shows our business strategy and management's expectation for 2016. This past year, we have focused on adapting quickly, executing better under very challenging macroeconomic headwinds.

To accomplish this, we have closely evaluated all areas within our business that we can control, and took decisive actions that ultimately have made Capstone stronger, leaner, more flexible, and better positioned for future growth and profitability. As I mentioned earlier in April, we implemented a flattening of the organizational structure to streamline internal operations, as well as a faster improved innovation and creativity process.

In addition, we merged the Chief Financial Officer and Chief Accounting Officer roles by promoting Jayme. We have eliminated the SVP of Engineering and Product Development position, and the SVP of Customer Service position, which thereby strengthens the linkage between sales, service and our applications teams. In addition, we promoted several lower level managers and employees within the organization to better motivate, enhance accountability, and promote flexibility from the top down.

Obviously these are very tough decisions, but Capstone is now set up for more informational transparency, better communication, improved collaboration, the lower operating costs result an estimated $2 million in annual savings, after severance costs. Along with diversifying our global geographies we'll focus on speeding up product adoption for data centers, truck and marine markets, to further diversify for new oil and gas vertical markets. Management will focus on training and the maturation of our global distribution channel, and we'll continue to drive growth in our aftermarket FPP service business.

We'll continue to closely manage our cash through disciplined expense control and inventory management. Based on all of the above actions management's planning for increased annual revenues in FY16, led by a rebound in oil and gas and the stabilization of Russia, and moving to these other markets we've been discussing. This revenue growth should expand our gross margin by at least 200 basis points and should bring us to EBITDA breakeven milestone late in the fiscal year.

Let's turn to slide 15. This slide really discusses the market assumptions that are our basis for the comments that I've just made, discussed on the previous slide. We are already seeing what appears to be a stabilization of the ruble, and improving conditions generally with respect to foreign currency. Our recent orders can point to an uptick in shale activity in the US and we anticipate our business to grow as we see gradual recovery in oil prices.

Additionally, our robust $1.5 billion project pipeline shows continued momentum in CHP and CCHP in the US and in new markets that are developing globally that we hope to tap. To offset the strong US dollar we did not follow our typical pattern of an annual April 1 price increase this year, so the traditional pull forward of orders from June quarter did not happen in March.

The Mexican energy reform will be key driver for FY16 revenue growth, and our significant untapped market opportunity in Central and South America, Africa, and Middle East should more than offset the downturn in Russia. Finally, new Tier 4 emissions standards and new gas flaring regulations worldwide will continue to drive opportunities for our unique Capstone product.

Finally slide 16 highlights our long term goals. This slide has been part of our standard investor presentation for some time now, and highlights our outlook for the future growth and development of the Company. Up until the challenges of FY15, we have demonstrated over and over the significant operating leverage of our business. Operating expenses have shown a remarkable stability, and extremely flat over time, despite significant revenue growth. As a reminder, you can see this relationship and business leverage on slide 20 of our appendix.

But back to slide 16, if you look at the middle of slide 16, you can see the growth rates for two of our key markets, critical power and mobile power. These are based on our distributor pipeline and recent economic forecasts. We've expanded our product capabilities of our flagship C200 and C1000 Series, which have already built substantial traction worldwide, and our new product development will continue in the future with the C250 and C370 as we execute against our future R&D product development road map.

If you look out into one to three year outlook, you can see Capstone Finance joint venture. This is a new opportunity for us to drive additional top line revenue growth. We have spent the last 18 months meeting with dozens of potential financial partners, and are presently in discussions with one potential partner to develop a new Company that would be a joint venture to provide the necessary initial capital to develop several projects. The new JV will own the assets and sell the power and thermal energy under long term FPP or power purchase agreements. Capstone would be a minority owner of this new entity, and its sole purpose would be to provide customers with an alternative to spending their own capital dollars, and drive additional top line revenue growth for Capstone's business.

A fully owned Capstone finance business is still in the cards, but it may be over three years away. We are still very excited about this new JV as we are starting to put together a pipeline of good potential customers and solid projects in anticipation of closing this round of financing and funding. With that, I would like to open up the call to questions from our analysts.

(Operator Instructions)

Our first question comes from Eric Stine with Craig-Hallum.

Maybe you can just start with backlog, just wondering some comments on the health of backlog, I'm sure you scrubbed it, but is this something where going forward, given your headwinds, are you thinking about cancellations potentially, or is this still more about timing push outs?

Great question. We have scrubbed it very hard. We've seen very little cancellations in last two quarters, especially in Q4. We do believe that there will continue to see some push-outs but I think we're encouraged with the stabilization of crude oil prices and in the ruble, that we're going to see some acceleration of that backlog going forward. So I think as we look at it, we kind of believe that we are through the worst of it, and that we'll come out the other side of the trough, especially in Q1 and Q2, and look for a strong second half of the year. So we don't see any reason to modify the backlog and again have not seen any recent cancellations.

And is BPC, can you speak to, and it's probably in the Q, but can you speak to what percentage they are of the backlog, or how much they are?

We don't break them out but let's talk about BPC in general. We took a very large AR hit this quarter, and that is a reserve, not a write-off, which is obviously a very big difference. We thought it was the prudent thing to do in working with our auditors, and the way to properly reflect the risk in the business and the lack of visibility that we have.

That being said, they've made some payments already in the first quarter. We expect more payments by the end of June. We expect to reverse some of the product that we shipped and take revenue on from last quarter, as well as probably get some recovery on the bad debt reserve.

That should happen each quarter going forward. They are on cash up front, but again, this is a fairly large distributor. We've got a ten-year relationship with them. They are not going out of business. It's not a green environment situation.

We just believed it was a prudent thing to do with the lack of visibility that we had, but we met with their key ownership last week in Amsterdam, still very confident about the business, we will be shipping them product on a cash up front basis, and as Jayme said in her remarks, letting them make payments on the balance owed, so we do not see them going away. They've got over 1,400 micro turbines running in Russia. A lot of good customers and projects, so definitely, we've seen a slowdown and gone from our biggest customer to still in the Top 10, but definitely on the lower end of that Top 10. But we do think, especially in the second half of the year, they will regain their footing a little bit and move forward.

And you mentioned that they've made some payments. Do you expect more? Is there any way you can quantify maybe what cash collections have been to this point in the first quarter, or perhaps what your expectations are for the balance of the year? I know it's tough to sometimes look at working capital, but thoughts here would be helpful.

Yes, I think we are very focused on working capital. Obviously, with the drop in top line, we took a little bit of a hit from a inventory turn standpoint, and went from 5 to 4. Obviously with growing revenue, we would be closer to 6 or 7, our goal is to get the turns to 6 or 7 by the end of the year. We are managing the product and the parts flow very tightly.

Obviously we're also managing our payables and our expenses. We expect that the cash we have on the balance sheet is more than enough to get us through this year and beyond. Our auditors agree with us. That's why there's no, if you read the K, there's no issue as far as our going concern opinion, which is positive, so I think our auditors get it. Our Board gets it. Doesn't mean we don't have to manage our cash, but we do have enough cash and we think that if properly managed, we're in good shape going forward.

Okay, got it. And then CHP, you've mentioned, well you didn't necessarily talk about it, but it was in the slide presentation. Just the pipeline there and it looks like you're targeting June and July some strong bookings. Just maybe what's going on in the market that gives you the confidence that those are on the horizon?

Yes if you look at our top five distributors in Q4, Optimal was number one, and that was all CHP. Number three was Critchfield Pacific, which is our Hawaiian distributor, that's all CHP. Regatta was next which was all CHP, and E-Finity was mostly CHP, so the only non-CHP customer in our top five in Q4 was Industrias Energeticas, which was the next phase of the pipeline in Mexico.

If you look back to Q3, very similar. DTC in Mexico was CHP, Optimal, E-Finity, Horizon was really the only non-CHP customer. So the last two quarters we've seen a mix of CHP increase as oil and gas have slowed down, but I'd say the recent order in both Marcellus and Utica shale, as well as the Horizon order do bode well.

Oil and gas is, despite the precipitous drop, is not dead. It's just slowing down. But really I think we're going to come out the other side of this a better business. We're going to be more geographically diversified and more market vertical diversified, which will make us a much stronger business going forward. So as difficult as this year has been, I think we're going to come out in 2016 with a nice revenue growth and more diversified and more robust business.

Got it. Okay, last one for me. Just I know you've talked in past about large orders in the pipeline. Just given some of the challenges, maybe your outlook there, has that changed since your last few calls and do you expect any of those closing in FY16?

Yes, most of our large scale projects are oil and gas based. A lot of them are either shale gas or flare gas, so I would say the outlook has gotten a little bit worse in that area. We still have a few large projects we're chasing, I'll be in Ecuador again shortly as we have a 30-megawatt order there we're chasing. So I would say not as bullish I was just because of the oil and gas space has slowed down in general. But that being said, there's still opportunities out there, and I still think we're going to get more than our fair share of some of these projects, especially as the oil starts to recover a little bit in the second half of the year.

Okay, thanks a lot.

Our next question comes from Jeff Osborne with Cowen and Company.

Good afternoon. Most of the questions were asked by Eric, but a couple on my end. I was wondering, Darren, if you could just touch on the gross margin levers for next year. You mentioned up 200 basis points. What would need to play out to exceed that, or with the dollar where it is, is there some pricing pressure that maybe is a headwind as we look out into 2016?

Yes, again I think that it's really disappointing that we had the accounting adjustments we had, and the headwinds we had for the year, because the reality is even on the surface, revenue is down 13%, and margins are flat. The reality is, you dig underneath that, we have discounted more this year, more than any other year with a strong dollar, almost every order we've received customers are looking for additional discount because our product went up 30% to 40% overnight in some cases, because of the change in the dollar and strengthening dollar.

So despite these additional discounts we've given, despite the revenue being down, and despite the accounting adjustments, even though they're non-cash, we were still flat. So you start backing out some of those things and the numbers look very good very quickly, so I'm very proud of the margins we've been able to generate. I think even if you just take out the accounting adjustments alone, we're up 100 basis points, but any kind of revenue growth as we continue to flatten out the organization, lean out the organization, we have several Six Sigma events going on this year, we're going to get leaner, faster, better, and when you start adding revenue growth on top of that as well as the FPP growth the margin expansion of 200 basis points is actually fairly conservative.

Got it, thank you. A question for Jayme for the R&D. It was a little higher than we were expecting this quarter, certainly than prior quarters. What should be the run rate on R&D going forward with the initiatives you have?

R&D should run pretty much the same it has historically. This year compared to prior years, we had less cost offset from DOE programs.

So really what you're seeing is the number of R&D folks has not changed. The only reason a number looks like it's getting larger is the DOE contribution is getting smaller every year, and at this point we're down to a fairly low number with the DOE, and that's really by choice.

When I came to Capstone, we had a lot of DOE programs, most of them were not going to deliver any kind of product in the near ten-year time frame, and as we move the Company from being an R&D company to being a product company, it's harder and harder to find alignment with the DOE to find projects that make sense for both of us. So unlike some other people in our space who are out there actively seeking a lot of DOE programs, they take revenue on those programs, we don't. We see it as an offset and we will not take US taxpayer dollar unless it's going to create a product that create a US job.

Understand, and I just had two questions about the financing, Jayme, that you're contemplating, or moving forward on with the partner that you mentioned. One is, has the Board indicated what the maximum dollar commitment that you would make as an upfront capital commitment to that financing arm? That would be helpful to understand just given the situation that's transpired over the past 12 months. So that's question one, and then question two around it is what's the accounting treatment of both from a cost of goods as well as a revenue perspective for units that are sold to the JV?

Yes, so I think if you look at it, we're working on, and I probably should put this in prepared remarks, the partner we're looking for is to have them bring the equity. We'll be using zero Capstone dollars in this JV. We're going to be supporting it with selling the product at a discount into the JV, which would be similar to what we sell to our distributors.

We'll be giving engineering expertise, legal, accounting support, so we're going to be giving services and not dollars, and that was really the key for this Capstone JV, was to find a way to solve customer problems without using our own dollars, because our balance sheet we don't want to be tying up capital at this point. When we get to Capstone Finance as a wholly owned subsidiary, after we're profitable, then we look to use our own equity once we're generating profit. But from an accounting standpoint, it will really look like a sale to a distributor, and look no different than anything else today.

Right a certain percentage of profit would not be recognized, it will be inter-company but it will be an equity investment basically, so that would just be equity accounting. There won't be a consolidation.

So the real goal here is, if you look at it, the goal is we've got a lot of -- especially in oil and gas where a lot of customers still have good projects but their capital budget has been severely limited because of the precipitous drop in oil. So if we can have this be an operating type expense where they just sign a long-term power purchase agreement, we put the equipment in place, the JV does, and we sell power to that entity, that's the right answer. And then as we make more profit, we'll reinvest that into the entity and continue to go.

I know a lot of people are talking about yield cos. This is not a yield co. This is going to be a Capstone financing joint venture that's going to drive good projects, and then we'll go lever that equity up with some debt, and then hopefully do more projects. Eventually we could sell these to a yield co, but I don't see us -- we aren't going to be large enough to be our own yield co any time soon. But the real reality is we're trying to solve customer problems, get around their equity constraints, and get good projects running as fast as possible.

Got you and last one for me is just, what's the philosophy over the next three to six months as it relates to communication around the issue with BPC? As you receive those checks, if they're meaningful, is it something you think you would be press releasing to highlight that, or what's just the overall strategy there given the magnitude of the charges?

Yes, we've had other charges like this. We had another one with another distributor. I don't know if we'll press release that or not, we'll have to talk to our lawyers about it. This is really continuing course of business.

I guess if BPC were to file Chapter 11 or have some major business change, we would obviously press release that, but I think as long as they're continuing to buy parts and buy units and make payments, we'll consider that the kind of new course of business. The only real difference is we've put a reserve in place and we're making them be cash up front instead of allowing them to have their credit line. So I think it's a business decision that allows the Street to see the magnitude of the potential, but really I look at it and say this is a one-time pain in Q4 that we're going to benefit over the next four to six quarters as we pay down that credit line.

It will also allow us to reset the relationship a little bit. I think we all love our Russian business, and I think if it was a smaller part of our overall portfolio, and we had a little lower exposure to Russia, that would be probably a good thing at the end of the day. That being said, they bought over $150 million of equipment over the years, so it's still an important part of our business.

Okay, thank you. Appreciate it.

Thank you. Our next question comes from Matt Koranda with ROTH Capital.

A lot have been answered already, but maybe we can cover some market stuff here. So you had mentioned some positive indicators from key shale plays. Was just wondering if could you dig down a little deeper and talk about where you're seeing strength, in what particular shale plays and then maybe if you could also just get a little more granular in terms of the oil and gas market. How does it look on the compression front, production, exploration? If you could just kind of splice it out for us that would be great.

Yes, if you saw the one announcement we made was Utica and Marcellus. Eagle Ford has been by far our most successful shale play. We tend to be more midstream, though we are having some conversations at looking at different applications to solve some of the drilling challenges. We mentioned that I think in some of our prepared slides, but it's really more of the same, Anadarko is up to several hundred units. They're primarily a C65 customer, so I'm guessing a lot of the recent C65 we sold to Horizon will go to Anadarko.

I think the reality is that the pace at which things are happening has slowed down, but it's still happening. And I think as we figure out some of the cyclical load issues by a different battery solution, where we can get into more of the drilling and pump jack applications which have eluded us so far. So I think if you look at it we're continuing to move in the US market. I think we need to expand in the oil field into different applications, as we make modifications to the product.

Obviously, South America there's a local of oil and gas applications we've yet to tap. Middle East is a huge untapped market for us, and I think you'll see a lot of opportunity there from an oil and gas standpoint. So I think we can diversify geography wise in oil and gas, and I think we can get higher penetrations in more areas in oil and gas but all of us can take some hard work this year.

Okay, great. And if you could just also discuss competitive landscape for us. I mean I think you've alluded to it a bit with the financing option here, but it looks like maybe some competitors being more aggressive on pricing or around financing terms. Maybe if you could talk about the general environment you're seeing there?

Sure, being Caterpillar, their balance sheet and their products with Cat Finance they can easily go in and take a project off the table. That's always been challenging for us, and so I think with our load of balance sheet to have a financial instrument that we can use is going to be a huge opportunity for us. So my guess is that entity will start with probably $10 million in capital, and we'll get some leverage behind that, and they might turn that into $40 million or $50 million but we'll probably eventually with not too long, need to go find additional money.

Once we get the JV up and going, we show good products or projects with good returns. Most of these projects are 16% to 18% IRR. The reliability of the product is phenomenal so I think once we can prove that, that attracting more money is not going to be a challenge. It'll be just finding enough projects and getting them built.

Okay great, that's helpful. Last one for me, in terms of the revenue outlook. You've alluded to double digit revenue growth for the year. Maybe if you could just break that out for us, in terms of what's the contribution from FPP versus product this year?

Yes I think you're going to see aftermarket services, as we bundle it together, FPP and parts and training is going to probably be at least 20% of revenue. Its historically been around that number. I think we'll see both a product revenue growth and FPP will grow together, which will keep that number in the maybe 20% to 22% range, but I really think product growth is key. Because again, FPP is great but to really move the top line number, we've got to get the product engine running again.

I think we are going to see that again through strong US, strong Mexico, strong Canada, we'll be building in South America, Africa, Middle East, very happy what's going on in Australia, and we changed distributors a couple years ago, and they're putting up very good numbers. The real weakness we'll have will be Russia. Russia will be down year-over-year, and in parts of Europe will be down, but I think we can see especially the second half of the year, we'll see Germany pick up, Italy pick up, and we're getting a lot of revenue out of new places, Finland, Hungary, Slovakia, very small parts of Europe that have opportunities. The UK has always underperformed for us, as has Alaska, Hawaii, Caribbean. So there's good markets where we have new distribution that can also pick up.

But for us, that $1.5 billion is more than enough opportunity. It's really how fast can we get orders closed, and how is our rate going to be. Today we're call it 11% close rate and 182 day average cycle. We need to get that close rate up to 15% or 20%, and drive that cycle down.

Got it. Very helpful. Let me just sneak one more in here if I could. In terms of speeding adoption rates for the non oil and gas markets you referenced in your slides, just talk about the levers you have there. Obviously pricing is one, but if you have other levers, maybe you could highlight those as well for us?

Yes, I would say pricing is probably the least effective, and the reality is we're 30% higher first cost, with a strong dollar that's made it worse in some areas. People aren't buying us because we're the low cost solution, frankly, and you can buy from Caterpillar or GE. Nobody has ever been fired for buying from those guys.

If we got into a pricing war with GE or Caterpillar we wouldn't win, so people are buying our product because of the reliability, they're buying it because of the low emissions, they're buying it because it's a better product, so we're not going to play a price war with folks. The reality is they need to be thrilled with the product. They need to see the features and benefits, and we need to continue to make the product that much more robust.

And as I've mentioned, we've done a lot of work this year and we'll do it again in 2016 on improving the reliability, improving the applications, making different minor changes to the architecture to make it even better for our customers, and I think that's really what's key is, we are meeting customer satisfaction today but we need to blow them away, and exceed them even more. And I think that's going to drive it.

And we talked about double digit revenue growth. One of these years, we're going to wake up and see much higher revenue growth rates, and people are going to think we did it overnight. And the reality is we're continuing to do all the right things with improving the product, coming up with unique features and benefits, building out a distribution channel. There's nobody in our space with a distribution channel close to us and obviously Caterpillar has got 100 year old channel that's amazing but we've come a long way in eight years. So if we have a product that's better than Caterpillar and a distribution channel close to Caterpillar, we'll be formidable in the future.

Okay, great thanks Darren, I'll jump back in queue.

Thank you. Our next question comes from JinMing Liu with Ardour Capital.

First regarding the pricing. Did I hear it correctly that the lower ASPs were a reason for lower revenue here? Did you lower your price over the course of last year, or just simply due to a product mix issue?

Yes, you've got a product mix issue, and then we have done more discounting as I mentioned before, since the strong dollar, more distributors are asking for discounts. But for us again we don't get into a price battle. We may give a 5% discount, but nothing significant. It's really more mix than anything else. But as I also said we did not do our April 1 price increase, just because with the strong dollar, we don't think that would be beneficial.

Okay, all right and the situation with BPC. Why do you ship the $7 million products to BPC in the first quarter?

Yes, so we shipped a C1000 to BPC during the quarter. We planned on taking revenue on it during the quarter and after quarter ended, talked it through with our auditors, we decided to reserve the AR of the $7 million. And therefore we can't take revenue and reserve, they are in the same quarter from an accounting perspective. So when we ship the product, we'll have revenue but as we close the books we did not take revenue. So payments in Q1 is supposed to allow us to take revenue upon that product that we shipped, and then the100% margin in Q1 when we take the revenue for that.

Okay, got that and regarding the joint venture you potentially will set up, will you need to put in the equity investment into that joint venture?

No, we're going to put sweat equity but not dollars.

Good for you. Lastly regarding your cash position. It looks like you have to keep a good cash reserve due to the credit facility arrangement. Your potential cash burn and the cash reserve required for the credit facility, it looks like you'll have to do some financing this year, is that right way to think?

Yes, we don't think our cash burn for the year will be more than probably $10 million from operations. The revenue comes back and the margins continue to improve, we've got a lot of inventory we can turn around, so I think that we don't think that we'll have to do an equity raise this year. I think if you look at the $32 million that we have based on our operating income. We also have a piece of that Wells Fargo line that we have not exercised, with the overall size of that line, but have not done it yet.

Okay, got that. Thank you.

Thank you. I'm showing no further questions. I would like to turn the call back to Darren Jamison for closing remarks.

Thank you. Great questions everybody. I know this is a difficult quarter and a challenging year. We've put a lot out there for you to look at in the K in a very short period of time.

I think the reality is if you look at any business that had three major macroeconomic headwinds impact their biggest portions of their business, to only be down 13% revenue is actually somewhat remarkable. But all that being said, we did not get to EBITDA breakeven in Q4 like we had planned on, and we talked about, and we own that. I own that. And that's why we made the changes we made during the quarter to flatten the organization, and to show that we are that dedicated, that we will even go to the leadership team level to get this Company to profitability.

If you look at it from a reserve standpoint, it's challenging to put reserves in place. Again, these are not write-offs. These are reserves, these are non-cash. I am dedicated to collecting every dollar that is owed us to by our distributors.

If you look at the total year, we have about $10 million reserve from an AR standpoint. We plan on getting all $10 million back hopefully as fast as possible. It may take more than FY16. My guess is we're looking at probably six to seven quarters, but we'll have good traction hopefully every quarter to get that done.

From an inventory standpoint, we didn't talk about it, the major inventory hit that we took or reserve that we took was for the ORCs. The organic rank and cycle heat recovery modules. If you'll remember correctly, we had a deal with General Electric, we bought 15 of them originally, in exchange for some exclusivity in the micro turbine space.

We sold five over the years, we have a PO for nine, but we still have ten that are on the books. And unfortunately moving one a year is not exactly fast moving inventory, and the PO we have for nine is with a customer that had some financing challenges right now, so we took the reserve, again. But we still plan on selling that inventory, and when we do sell it will be 100% profit to the Company, we'll reverse the reserve obviously, so we're working diligently to get that done also.

So I think all the reserves that we've taken for the year adequately reflect the challenges we've had in the business, and the risk in the business, but that doesn't mean we're going to capitulate and write them off. We're going to put the reserve in place and work very hard reverse those reserves as fast as we can.

Obviously the share price has taken the big hit in the last year. Again, I think for a 13% reduction in revenue, we've gotten more than a 13% haircut in share price. Hopefully that will turn back the other way as we grow revenue double digit we'll get more than double digit increase in our share price. But at the end of the day, all we can do is the best thing for the business and work hard every day with our distributors and our vendors and our customers to improve the business.

I would say from a Company standpoint, my morale is probably as high as its ever been. I think morale in turn in the Company is as high as its ever been. Everybody is very excited about the upcoming year, and we feel like we've weathered the perfect storm of bad events, and the sun is coming up and things will be very good going forward. Not going to be easy, but I think each quarter hopefully better.

From a Q1 standpoint if you look at the last two years, we had very challenging first quarters, I think $23 million, $24 million in revenue. I believe we'll do much better than that in this first quarter, which would be great to not start the year on a down quarter. We feel very confident going into the New Year. I think lost in all this was our warranty expense was down for the year, our FPP margins are improving, they've tripled in the last 11 quarters, all says the product is more reliable. More reliable product lowers our cost but also improves customer satisfaction. Satisfied customers are our best salespeople, and that gets us to grow going forward.

Again from a reliability and R & D perspective, we're still working on the 250, the 370 and AFA materials, but we're still making product improvements in the 200, 1000, and we'll continue to do that until we get the product perfect, and make sure it's the best it can be. I think we're excited about the 250 and the 370 turbine wheel, the first bonding attempt was good. It did not work in the full speed operation, but we're going to go back and do it again with help from our partners. We're very excited about where that program can go. If not the AFA from a cost of materials standpoint and our recuperator is a very important program to us, we'll continue to look at.

Our distribution channel again I think it's the most underrated part of our story. There's nobody else that's in our clean tech space that's building anything close to what we have in our distribution channel. We have 220 Capstone employees and 740 Capstone folks working on our behalf in the channel. It's amazing when you think about the leverage that we have, and how flat our operating expenses are. So that's an investment that takes a lot of time and effort, but like anything, you take the high road, the long road, the dividends we'll get for years to come will be impressive.

I think if you look at the -- getting back to growth and profitability, it's going to come from a diversified portfolio, both verticals end markets by tapping new markets, marine, truck, data centers, but also new geographies. We have to be geographically diversified, just like everybody's stock portfolio is.

So I think for us, this is a marathon not a sprint. We had a difficult lap this year but I think these macroeconomic headwinds are easing. Oil prices have come back up off lows. The ruble is stabilized and come back a little bit, and again we're still here, and I think our customers are very confident we're going to a very good year going forward.

So with that we'll leave it until the next earnings call, and look forward to talking about Q1 and showing the progress we've made since the Q4 report. Also, we have the annual shareholder meeting coming up, and I look forward to seeing the folks that come out for that. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day.