Capstone Green Energy Corp (CGRN) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Capstone Turbine Corporation finance results conference call for the third quarter fiscal year 2016, ended on December 31, 2015. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to hand the conference over to Ms. Clarice Hovsepian, Vice President Human Resources and Corporate Counsel. Please go ahead.

Thank you. Good afternoon, and welcome to Capstone Turbine Corporation's conference call for the third quarter of fiscal year 2016 ended December 31, 2015.

Capstone filed its quarterly report on Form 10-Q with the Securities and Exchange Commission today, February 3, 2016. If you do not have access to this document and would like one, please contact us by email at IR@Capstoneturbine.com. Or you can view all of our public filings on the SEC website as 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 the 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, collection of reserved accounts receivables, shipment of finished goods, benefits from our cost-reduction initiatives, improved operating leverage and organizational efficiencies, strengthened distribution channels, new product development, implementation of new Capstone finance business, product reliability, product price increases, growth and diversification of our end markets, performance in light of our macroeconomic headwinds and attaining profitability.

Forward-looking statements may be identified by words such as believes, expects, objected, intends, 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 within the Securities and Exchange Commission that may cause Capstone's actual results to be materially different from any future results expressed or implied with 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 any 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 third quarter earnings call. Joining me today beside Clarice is Jayme Brooks, our Chief Financial Officer and Chief Accounting Officer.

During my remarks, I will again be referring to presentation slides that can be found on Capstone's website under the Investor Relations section.

During last quarter's call, we reported on the strategic measures and initiatives that we had already started to implement into the organization, as well as additional actions that we're planning to put into place to streamline our operations and reinvigorate our revenue growth.

These steps were necessary in order to counteract the headwinds in our business caused by the state of the oil and gas industry, and the macroeconomic and geopolitical issues that have been affecting the energy industry at our Company. Additionally, having taken these steps, we continue to strive toward our goal of being EBITDA breakeven as quickly as possible. During today's call, I will update you on the progress we have made toward our near-term and long-term goals.

To begin, I want to let you know that while it's been a challenging operating environment for Capstone, we are reporting several positive achievements on today's call. We are extremely pleased with the new product launch for our new C1000 signature series, the announcement of our Capstone Energy Finance entity and the successful inroads continuously being made into the energy efficiency combined heat and power markets.

We are also encouraged by the progress we have made reducing our operating expenses to enable us to reach even our breakeven at significantly lower revenue levels.

Some of the highlights I'll be touching on today include the improving financial results and the strengthening of our balance sheet, the overall improving status of our business, the official C1000 Signatures product launch at PowerGen International Show in December, increased diversification in our markets with a greater focus on energy efficiency vertical, and geographically entering into markets such as Latin America, Africa, Australia and the Middle East, and our continued success in Europe and the United States.

We'll touch on the launch of our new Capstone Energy Finance entity, give you an update on the progress that's being made in hiring new sales professionals in our distribution channels, and the future general business outlook.

So let me begin with a very brief overview of the improvements of our financial results and balance sheets, touch upon our sequential quarterly progress, then we'll go back to our other initiatives. After that, I'll hand the call over to Jayme so that she may provide more in-depth year-over-year information about our financial results and take you through the quarterly changes.

So let's start with our improving financial results and strengthening balance sheet. Let's go ahead and turn to slide 2. Slide 2 shows our Q3 financial highlights. We reverse the revenue trend this quarter and sequentially grew our top line revenue by $3.6 million to $21.5 million compared to the second quarter's revenue of $17.9 million. The third quarter revenue is in line with expectations and we continue to make progress toward our stated goal of reducing expenses to achieve EBITDA breakeven at a $30 million quarterly revenue level by April 2016.

More importantly, we plan to follow this up by further reducing our EBITDA breakeven level to $25 million in quarterly revenue by April 2017. If you look at this historically, we've achieved $30 million in quarterly revenue 9 of the last 18 quarters and $25 million in 14 of the last 18 quarters. Revenue in this quarter was driven by the growing demand in the energy efficiency in CHP market in the United States, Europe and Mexico. Our resource recovery, or oil and gas business, was driven by associated gas to energy projects in the US and Canada.

Sequentially our gross margin improved to 19% this quarter compared to 11% in the second quarter. More importantly, our cash and cash equivalents balance, including restricted cash of $5 million, improved to $18.5 million from the $15.6 million in the second quarter after significantly paying down our Wells Fargo credit line.

These tremendous balance sheet improvements were from concentrated collection efforts, reduced raw material purchases and shipment of finished goods inventory.

Now let's turn our focus to slide 3. I'd like to give you an overview of the actins we have taken to improve our financial results and achieve our goals, some of which we mentioned that we'd already implemented or are planning to implement during our last quarterly call.

As you can see, we have decreased our employee base as of the end of the third quarter by approximately 20% through two reductions in force and eliminated almost all contract employees and consultants.

This employee reduction, combined with spending cuts in manufacturing, cuts in service, R&D and SG&A, puts us well on track to achieve our 25% reduction in total operating expenses by our new fiscal year starting this April.

In addition, management voluntarily forfeited any invested stock options and we have suspended executive bonuses, executive equity and executive merit increase programs until we further strengthen the balance sheet and reach our stated goal of EBITDA breakeven.

Unfortunately we also had to suspend all current employee equity grants and employee merit increases. We have also limited CapEx spending for the remainder of the fiscal year and for the majority of fiscal 2017.

We are developing plans to increase our use of tier 1 suppliers, increase our outsourcing and further consolidate our manufacturing operations. Unfortunately, we are forced to suspend the commercialization of the C250 and C370 programs to further reduce our R&D spend and to focus on our core Capstone product, the C30, the C65, the C200 and most importantly, the new C1000 Signature Series product. This will reduce our R&D spend from approximately $10 million a year to just over $6 million.

Combined, these initiatives are expected to lower our EBITDA breakeven by $10 million per quarter to $30 million in quarterly revenue at a 25% gross profit. As I mentioned, in addition we are currently developing plans to further drive efficiencies into the business through the year in order to further reduce the breakeven level even more with a goal of getting to $25 million in quarterly breakeven by the following April or April 2017.

Slide 4 shows our historical revenue with overlapping the new EBITDA breakeven targets in April 2016 and April 2017.

While none of us enjoys making tough decisions when faced with a need to reduce costs across the organization, it has nonetheless been widely understood and widely accepted that this is the process that's vital to the Company's success going forward. The entire Capstone organization from top to bottom remains committed to attaining our financial goals as quickly as possible.

So let's turn our focus to the overall status of the business. While we've seen improvements throughout the quarter, our business showed particular strength late in the quarter as our geographical diversification efforts started to produce solid results with several significant new orders being received, as highlighted in slide 5.

We've had new orders from several distributors in diverse geographical areas, including Horizon, E-Finity, Vergent and Regatta in the US, DTC in Mexico, E-Quad in Germany, Regale Energy in Hungary, and SINO Petroleum in China, just to mention a few.

Orders continue to come in from Optimal in Australia, as we have now generated $10 million in Australia alone over the last four quarters. While CHP continued to strengthen globally, the oil and gas sector started to show signs of slow recovery.

With the price of oil declining to prices we haven't seen in more than a decade, our oil and gas customers are slowly beginning to look at ways in order to become more energy efficient and lower their onsite energy costs. And they are considering our microturbine solutions to meet those objectives.

If you go to slide 6, slide 6 highlights the continued shift in our business from oil and gas to energy efficiency. Energy efficiency, or CHP -- CCHP applications, made up 55% of our product revenue for the first nine months ended December 31 and natural resources or oil and gas applications dropped to 37%. And renewal energy and other applications increased slightly to 8%.

We continued also to diversify our business from a geographical perspective. The US dropped to 54% of product revenue over the last nine months ending December 31. Europe was 16%. Australia alone was 11%. Mexico at 9%, Asia at 6% and South America 3% with Africa getting on the board at 1%.

Mexico in particular has steadily become one of our largest markets outside the United States. With its recent energy reform legislation and greater focus on energy efficiency, Capstone's technology has become an even more attractive option to the region as it allows organizations to reduce their own energy at a lower cost than their local electric utility.

And notably, obviously we achieved all of this without any product shipments to our Russian distributor PBC. But we were still shipping them spare parts on a pre-paid basis to support the large fleet of microturbines within the Russian territory and we do expect to start shipping product to them again soon.

Let's turn our attention to the new Signature C1000 series product. This is an extremely exciting launch for our new product. The microturbine took place at our December PowerGen International Show in Las Vegas. Our C1000 Signature Series microturbine is what I believe the smartest 1 megawatt microturbine energy system on the globally distributed generation market.

As highlighted on slide 7, the new C1000 Signature Series has improved air flow, improved 2-stage filtration, lower ambient noise levels, improved overall enclosure design, higher inlet fuel temperatures, a 12-year marine grade paint and relocated engine exhaust to support the integrated CHP heat recovery module on the roof.

I challenge anyone to find a smarter, smaller, sleeker, lower emission, factory integrated, factory backed, more reliable, 82% total system efficiency 1 megawatt CHP power plant in a box.

We made some 73 discrete design changes to improve the reliability, improve the service intervals and improve the overall customer experience. Based on the overwhelming positive response received at the PowerGen International Show in Las Vegas, it's safe to say our customers agree. In fact, shortly after the launch, we received our first order for multiple C1000 Signature Series microturbine packages totaling 3.2 megawatts for our Mid Atlantic Southeastern United States distributor E-Finity and we are pleased to say that we expect to ship our first Signature Series units to Vergent in the coming weeks.

Let's turn our focus to Capstone Finance. As a highlight this quarter was the launch of the new Capstone Energy Finance joint venture entity, as highlighted in slide 8. We are excited to be able to offer to those customers who could not otherwise purchase our product outright an option to secure their energy through a new financing program. To put it into perspective, our distributors have lost an estimated $22 million in FY'16 year-to-date alone because of a lack of viable financing options. Our customers can now purchase all or a portion of their energy from Capstone Energy Finance, thereby eliminating upfront capital expenditure outlays and exposure to volatile utility rates, which locks in fixed rate for a period of up to 20 years.

Capstone Energy Finance monitors and oversees maintenance of the system during the length of the agreement and the customer pays only for the energy they use. We are confident that this new financing option will ultimately help our customers save costs, particularly those in the oil and gas sector who are most affected by the precipitous drop in crude oil prices.

We spent Q3 busily rolling out the Capstone Energy Finance program to our US based distributor channel with very positive response and we have already submitted three project term sheets to qualified projects, prospective customers for their review and approval. We anticipate executing our first project term sheet very shortly and moving into power purchase agreement negotiations soon after.

And next important topic is the new -- 100 new salespeople initiative. The progress is being made in this area on reaching our committed goal of hiring 100 new sales professionals dedicated to selling Capstone products. Having more sales professionals selling our solutions worldwide is one of the key components to our continued long-term growth.

As you may recall, this past summer at our global distributor meeting, our distributors had committed to hiring 100 new sales professionals by the end of the year. As of today, they've hired approximately 25 selected individuals with dozens more still in the interviewing process.

Slide 9 shows the updated total number of almost 50 more professionals representing Capstone in our global distribution channel. Capstone currently has 196 direct employees of their own and collectively with our distribution channel we total almost 1,000 dedicated people selling, marketing, installing and servicing our innovative clean and green technology.

I believe our distribution channel to be a tremendous competitive advantage and an invaluable asset that will pay ever increasing dividends over the years as it continues to grow and mature worldwide.

I think the outlook for our business is looking up. Our fourth quarter has started with a solid order flow. We continue to diversify our global business and build out our energy efficiency vertical. Our C1000 Signature Series has been met with great reviews, as it's an innovative robust product developed after years of field experience.

The good news is despite the macroeconomic headwinds, the worldwide need for clean technology solutions, distributed energy, smart grids and energy efficiency is not fading away, but in fact continues to grow and prosper. Our business spans growth areas such as a Latin America, Africa, the Middle East and Australia. Our distributors represent Capstone in 72 countries worldwide, and as mentioned before, we are working toward our goal of placing 100 new sales professionals into the distribution channel to help fuel the C1000 Signature Series sales and propel our long-term revenue growth.

And lastly, as shown on slide 10, we are also seeing strength in our aftermarket business with growing factory protection program or FPP contract backlogs, in addition to Signature Series heat recovery module will drive additional accessory sales and we'll be launching a new Signature Series standard warranty extended warranty and in a new and improved factory protection program.

So before I turn the call over to Jayme, let me just say the following. The Capstone Board of Directors and I are very confident in the cost reduction efforts and the growth strategies we are developing and I am very optimistic that we have the right management team in place working hand in hand to achieve our goals to EBITDA breakeven as quickly as possible.

Now we'll turn the call over to Jayme to go through detailed financial results and year-over-year results.

Thanks, Darren. Good afternoon, everyone. As Darren mentioned, we reversed the downward trend in revenue this quarter and produced results that we expect will lead us to our goal of becoming EBITDA breakeven. However despite the quarter-over-quarter improvement, we continue to see the impact of the macroeconomic headwinds in our business results year-over-year, which is why it is necessary to implement the cost reductions and revenue strategies Darren discussed earlier.

Revenue for the third quarter of fiscal 2016 was $21.5 million, a decrease of 29% or $8.6 million from last year's third quarter revenue of $30.1 million. Product revenue was $14.8 million for the third quarter of fiscal 2016, compared to $22.5 million in the third quarter of fiscal 2015.

We shipped 15.6 megawatts during the third quarter of fiscal 2016 compared with 22.6 megawatts in the third quarter of 2015. The decrease in product revenue and megawatt shift in the third quarter of fiscal 2016 over the prior year quarter was the result of macroeconomic headwinds, continue softness of the global oil and gas market, delayed customer shipments and project timelines and the strengthening of the US dollar, which makes our product more expensive overseas.

Further, we had no product shipments to BPC, one of our Russian distributors, in the third quarter of fiscal 2016 compared to $2.3 million for the third quarter of fiscal 2015. Revenue from accessories and parts decreased $0.9 million to $3.5 million for the third quarter of fiscal 2016 compared to $4.4 million for last year's third quarter. This decrease is primarily the result of volume reductions in microturbines shipped. Service revenue was $3.2 million for both the third quarter of fiscal 2016 and 2015.

Gross margins for the third quarter was $4.1 million or 19% of revenue compared to a gross margin of $6.1 million or 20% of revenue for the year ago quarter. This decrease was the result of lower volumes and a shift in product mix. We continue to implement initiatives to improve gross margins by further reducing manufacturing overhead and fixed and direct material costs as we continue to strive to achieve profitability.

R&D expenses for the third quarter increased $0.5 million or 21% to $2.9 million compared to $2.4 million in the third quarter year ago. We expect R&D for the full year to be slightly higher than last fiscal year as a result of the development of the C1000 Signature Series and lower benefits from cost sharing programs such as the DOE grant.

SG&A in the third quarter of fiscal 2016 decreased $0.5 million or 7% to $7 million from $7.5 million in the year ago third quarter. We expect SG&A for the full fiscal year to be slightly lower than 2015 as a result of our initiatives to reduce expenses to offset lower than expected revenue. The operating loss for the third quarter of fiscal 2016 was $5.9 million compared to the operating loss of $3.8 million for the third quarter of fiscal 2015.

Net loss for the quarter was $6 million compared with the net loss of $3.9 million for the third quarter a year ago. Net loss per share, taking into account the 1 for 20 reverse stock split that was affected in November 2015 was $0.34 per share compared with the net loss of $0.24 per share in the prior year.

Now I'll provide some comments on our backlog, accounts receivable and cash flow. Our total backlog as of December 31, 2015 was $102.3 million compared with $175.5 million as of December 31, 2014. The year-over-year decrease was $73.2 million or 42%. The decrease in backlogs includes our decision during the second quarter to voluntarily remove $52.4 million or 200 units totaling 64.5 megawatts in backlog from BPC to align our backlog with management's expectation because of the current macroeconomic climate in Russia and the softness in the oil and gas market.

In terms of units, we had 576 units or 105.4 megawatts in total backlog as of December 31, 2015. Compared with 857 units or 192.1 megawatts as of December 31 in the prior fiscal year.

Our SPP service contract backlog at December 31, 2015 was $64.7 million compared to $61 million at December 31, 2014. This increase reflects our growing and solid base of microturbines, as well as the ongoing efforts of our distributors to sell our SPP service contracts, which enables the end user to achieve a lower total cost of ownership.

Our accounts receivable balance as of December 31, 2015, net of allowances, was $13.9 million compared to $13.1 million at March 31, 2015.

Our days sale outstanding or DSO was 59 days at the end of the third quarter of fiscal 2016 compared to 65 days at the end of our third quarter of fiscal 2015 and 82 days as of the end of our second quarter fiscal 2016.

Inventories were $22.7 million as of December 31, 2015, down from $25.4 million at March 31, 2015. Inventories decreased primarily as the result of shipment of finished goods.

Our cash generated in operating activities for the third quarter of fiscal 2015 was $2.6 million as compared to cash used of $1.8 million in the third quarter of fiscal 2015. At December 31, 2015, we had total cash of $18.5 million, including $5 million of restricted cash related to our Wells Fargo credit facility compared to cash and cash equivalents of $32.2 million as of March 31, 2015.

At this point, I will turn the call back to the operator for questions. Operator?

(Operator Instructions) Craig Irwin, ROTH Capital Partners.

Gross margins this quarter were a nice surprise, a little bit stronger than what we were looking for and a little bit more healthy than the consensus forecast. I noticed in the Q that your accessories and parts revenue was a little bit of an uplift, but can you discuss whether or not there was anything one time in there? Or is this something where we're likely to see the benefits of some of the cost out efforts over the last several quarters?

Craig, that's a great point. The margins were very robust, especially for these revenue levels. As you know, we have very high fixed operating expenses, so we tend to get better margins on higher revenue. This quarter we benefited from lower freight because we brought in a lot less raw materials. We benefited by continuing dropping in our warranty expense as the product matures. Plus year-over-year lower revenue, we have less warranty dollars going into the pool. Then obviously you started to see the beginning of the cost reduction efforts that are in the operational side of the business.

So our first wave of reduction in force was primarily in the manufacturing side of the business as we kind of chased the lower revenue levels. The second reduction in force is more in the service and engineering side of the business and G&A side of the business. So those expenses you'll see more in Q4.

Second question I had was how you're tracking versus your target of $30 million quarterly breakeven April this year and then obviously $25 million April of next year. Have you taken all the necessary actions to achieve your target for April of this year? What do you see as the potential risks for achieving that target? And is there any further update that you can share with us there?

No further reduction in force is necessary to meet that $30 million quarterly breakeven level. A lot of that is spend that we spent this year on the development of the C1000 Signature Series of amount spend next year. We've already begun the budgeting process for next year and the entire leadership team is committed and shown Jayme and I how they can meet those numbers. So I'd say our confidence level of meeting that $30 million 25% reduction level is 99% or higher. Obviously getting to another rung on the ladder, getting to the $25 million breakeven is a little more challenging. We're just putting those plans together now. I think we need to see the impact of the first wave of reduction and efficiency goals to get to that next level and make the right decisions.

Obviously going to more tier 1 suppliers, getting our manufacturing facilities from two facilities to one. There's some other things we plan on doing from an efficiency standpoint. And frankly, we're to the point in our maturation of our distribution channel, they can do more and we can do less on the sales and marketing side, and so there's some other areas that we can, I hate to say transfer costs, but basically take the training wheels off some of our newer distributors and have them carry more of the weight going forward.

And then last question if I may. In your own presentation you make the observation that your stock has been pummeled with the fall in oil prices. I guess you've been a big beneficiary of activity in the oil and gas markets over the last couple of years. But as we look back more to fundamentals, to the spark spread in your addressable market, seems like those are actually widening, becoming more favorable for distributed generation. Can you maybe give us some more color on whether or not that's impacting the level of interest out there and potential customers and how financeable projects are becoming for your customer base?

Definitely the precipitous drop in crude oil from $110 a barrel to $30 impacted a lot of our oil and gas customers as they reduced their capital spend. But probably as big a hit was our Russian distributor having financial difficulties and drop of the ruble and all the geopolitical issues we're having in Russia.

And then the third leg of that stool that really impacted us was the strong dollar. So in a very short period of time we lost our biggest distributor, had heavy pressure on our biggest market vertical and we're heavy exporters and our product got considerably more expensive overnight with the strong dollar.

That being said, you hit the nail on the head. The energy efficiency market is growing globally. Low natural gas prices and higher utility rates are increasing spark spreads and making projects better and more financeable and more economical. We believe our Signature Series with the integrated heat recovery module is targeted right at that CHP space and we think it's going to do very well. We think it's really industry leading, so that's going to help grow that.

Then you see it in the nine months, energy efficiency went from 42% in nine months last year to 55%, but this specific quarter we were up to 71% energy efficiency in our business from a product sales standpoint.

But I don't want to dismiss oil and gas. We have a lot of great oil and gas customers. They're great users of the technology and believers in the technology. I actually see this lull in drilling activity as an opportunity. A lot of oil and gas customers that we couldn't get into because they were too busy are now letting us come in and show them the product, do lunch and learns. So the silver lining to that is there may be a slowdown in the business, but long-term we may be better off because we get an opportunity to talk to these folks.

I do think Capstone Finance, especially in the US, will give some of those oil and gas users an opportunity to buy their product. I think another important point is people see us as an oil and gas driven company, one that's less and less every day. But two, most of our oil and gas activity is around the use of associated gas, or the gas you get from drilling for oil. That lowers the operating expense of the end user customer and actually is more of an energy efficiency play than a pure drilling play.

So I'm very confident that what we're doing with the product and once get past the strong dollar, the challenge of the Russian distributor and oil comes back even just a little bit, we're going to see renewed growth across the board in both oil and gas. And we're already seeing it in the energy efficiency space.

Sameer Joshi, Rodman & Renshaw.

The question relates to the Capstone Energy Finance JV. You mentioned that you are about to sign a one term sheet, or it's imminent. What is the kind of term sheets that you're -- or rather I should say, what are the audits that you are using these for? Is it mostly C1000 (inaudible) or is it the C330s and C365s that are being sold under this?

It's all of the product. We're not picking any one. Obviously we're looking for projects that have the highest IRR, so north of 20% and in some cases north of even 25% IRR. Obviously customers that are the most challenging in getting the product, but have a good balance sheet. We have some oil and gas folks that we've given turbine sheets to, but also some CHP folks. And so I think it'll be across the board.

I think we'll do projects probably north of 500 kilowatts first though. Again, the effort it takes to develop a small project and a medium and large project is the same.

So we're excited. I think I mentioned in the presentation, or at least I know it's in the deck, but we've got about $12.5 million of well qualified opportunities and the three term sheets out to customers right now. So we hope to get the first term sheet signed and get into PPA negotiation here soon.

I'm sure people are thinking why is it taking so long? Obviously we had to get the JV in place, then we had to get our distributors onboard and help them understand how to sell and what the features and benefits and what the appropriate customers were and projects were. And then start seeing the projects, meeting the customers, putting together the economics and the term sheets and then move in to contract negotiations.

So hopefully we'll be announcing some good stuff here shortly, but very excited about what this can do for our top line revenue growth.

And should we be looking at sort of the $50 million number that you quoted that you lost as of (inaudible) and (inaudible)? Going forward, would you expect around $50 million of revenue from this channel?

No, that's how much we've lost because of financing. Some of those customers may not be projects that we're looking for or the balance sheet of those customers may not be to the level we're looking for. I think probably if we could do $20 million a year to start in the first kind of 18 months that would be great.

The real key to this though is we want to show what the Capstone Finance can do. We want to get a portfolio of spinning assets that is showing returns and obviously solid returns. We can show the IRRs that the Company has. We'd need to bring in additional equity and debt into the JV. So the performance of those first five projects is key. So we're going to make sure the first five are as perfect as they can be, because that's the leverage we're going to use and the resume we're going to use to go get additional equity and additional debt.

The second question relates to EBITDA lowering to $25 million levels in 2017 finance year. Can you talk about that? I heard your answer to Craig. Was that related to the 2016 product production or the 2017?

We're talking about getting to the $30 million EBITDA breakeven level, down from $40 million we've run historically this April, so just in a couple of months. So as we finish our year-end and we put together our budget for the new year, that's the way the budget will be set up. So our spend and our staffing levels, our R&D operations, our finance, everything, we set up to those levels and we feel very confident that we can meet those levels going forward.

Then during the year, we're going to work on the next level of cost reduction, so a year from this April, our goal is to go into the following fiscal year at $25 million.

Obviously hope that revenue is much higher than $25 million by then. You can see historically we've been hired in those levels, but the real goal is to work on top line revenue growth while simultaneously making the business leaner, more efficient.

I know a lot of folks and a lot of people may say well why didn't you do this sooner? We really had to finish the Signature Series. We think that the C1000 Signature Series product development was so critical we did not want to stop R&D efforts until that product was launched. As I said in our prepared remarks, 73 discrete changes. It is a world class piece of equipment that was already good and we're making it great.

And so now is the time to maybe step back a little bit on the R&D spend, let the new Signature Series mature. I think we've got efficiencies and improvements in our service organization that we're allowed to lower the costs there. I mentioned the warranty spend continues to come down. You go back two years ago, the warranty spend was -- it was a huge challenge for us as we grew the product out in the field and had reliability issues.

On an operational side, Richard Lewis has come onboard. He's done a great job with his team. He continues to take costs out of our manufacturing operations, our purchasing operations, quality organization. So I think we're at the right time, but we can really sharpen the knife and get extremely lean. And it's the right time with the business being a little soft. So I think as business returns, we'll be in that much better shape.

Just one clarification on the BPC. Did I hear that you expect them to come back on (inaudible) in the next year or so?

Yes, each quarter they've been buying spare parts. They've got over 1,400 units running in Russia, so obviously we do not want to punish those loyal Russian customers that have bought the product because of what Putin's done and the challenges we have between our two countries. So we continue to sell them spare parts on a cash upfront basis with an agreement in place that they will pay 15% over on every dollar that they purchase from us. So a portion of everything they buy goes down to pay down the reserved AR we have with them.

They have asked us to ship them product and we are putting some product into our backlog -- or into our forecast for them coming up here. Obviously when that happens and they pay for it and they pay the 15%, we'll go ahead and do a press release at that time. I think that's a significant development.

They have not taken product in over a year, but they still have a lot of pent-up demand and a lot of backlog that we need to execute with them.

Eric Stine, Craig-Hallum.

It's Aaron Spychalla on for Eric Stine. Maybe first on the finished goods you had coming into the quarter, how much did you ship during the quarter and are there any plans just going forward there?

I'm happy to say you saw that it's a big drop in finished goods quarter-over-quarter. A big drop in our inventory overall. Our raw material also came down for the quarter as we kind of managed our inventory turns and planned production better.

All of our C1000 series shipped that was in finished goods, so that was the majority of the dollars. We still have 30 to 40 C65s in finished goods at the end of the quarter, so we're not completely through all the finished goods from last quarter, but all of the big boxes, all the C1000s that shipped during the quarter. So significant reduction quarter-over-quarter.

And then maybe on the backlog, how much of that is oil and gas?

It's typically been similar to our mix, so I would say it's still more than half oil and gas. But as our business has shifted from oil and gas to CHP or energy efficiency, the backlog is having a similar shift. So I think that a couple more quarters we'll have more energy efficiency backlog than we do oil and gas. But right now it's still to say it's probably more than 50% oil and gas.

What you did with BPC last quarter, I mean is that pretty farewell scrubbed or is there anything more there to do? And maybe as the calendar is turned do we get to see -- and budgets and kind of replenished, do we see that start to move a little bit here (inaudible) year?

I think we just announced a fairly significant oil and gas order in Canada. We had a nice oil and gas order in the Mid Atlantic. We had some additional follow-on orders down in Australia. We had some oil and gas activity in Colombia as well as in Europe.

There's still oil and gas spend going on, there's still activity going on. A lot of repowers, a lot of energy efficiency projects. Oil and gas customers are trying to figure out how to lower their costs of operations wherever they can and then obviously if they're burning that associated gas and a microturbine is one way of doing that.

And we've had some exciting conversations with potential new oil and gas customers. We hired an oil and gas professional named Steve Birdsall who's done a great job for us in Houston opening doors. And so I think we're actually pretty bullish about the oil and gas market as oil does eventually come back then we're going to be even better positioned.

And we're still chasing some of these bigger projects we've talked in the past. They're moving forward, maybe it's glacier speed, but still moving forward, which is encouraging.

Colin Rusch, Oppenheimer.

This is Kristen in for Colin. You called out a couple of the CHP projects that you're seeing in the new product orders. Can you talk about the incremental market segment opportunities and the speed with which they're coming in relative to your expectations? Have they been faster or slower? And maybe some of the driving force behind that.

I think we've been focused on two things. One, growing our combined heat and power energy efficiency business. We've been working extremely hard to grow that globally. We've probably seen the biggest uptick in the US and probably Mexico and I think probably in the two biggest areas.

We've seen -- very happy with that result. I think Latin America, Africa, Middle East have been slower to come around than we had hoped, but they are showing positive signs of coming around.

Europe has been very steady, but not coming back as quickly as we'd like. Our distributor in Germany is still very strong, E-Quad. We're seeing some improvements in Switzerland and Italy and Austria.

The UK has been an underperforming market for us for years. We have a new distributor, Turner, is in place, that's got a very strong resume and industry background. We're excited about them adding resources and getting up to speed and doing more for us.

Asia continues to grow and I think the Asian market is getting more and more interesting as they realize that clean air and energy efficiency and reliability of power is critical. We still have a lot of distributors in Asia trying to find the right ones and the right mix.

I mentioned in my prepared remarks Australia. We've done $10 million in Australia in the last 12 months, which is amazing in a market that isn't as big as some of our other markets. So that's primarily CHP, but a little bit of oil and gas.

So for us again, it's growing that CHP market that we believe had got a lot of legs and a lot of long-term economic benefit. We're still doing what we can in the oil and gas space and the renewable space.

Also from a geography standpoint, we're very excited to see revenue growth outside the US and in new markets like Hungary or Poland or Colombia, Peru, Brazil. I mean anytime we can get more diversification in both verticals and geographies, that makes us that much robust to the business.

And then what are you seeing on the project level returns for those CHP projects?

It really varies market to market, installation to installation. We target kind of a three to four year simple payback, so 20%, 25% IRR. If it's longer than that, unless you're a municipality or a hospital, you're probably not going to do the project. So we try to focus on kind of a three to four year simple payback. We think that makes the best economics.

If customers have some environmental aspirations, if they want to reach LEED certification or some energy efficiency, Energy Star, they may take a little bit longer payback. But as I always say, and it drives people crazy, there's two shades of green and you need both. I mean just being environmentally green is not good enough. You need to be economically green. And if you can do both those things, you've got a great project.

And then just wanted to flip over to the finance piece of it. Outside of Capstone Finance, are you seeing any new important financing resources coming online?

Yes, there's always financing done of our projects, but typically it's financing that an end use customer or host project has. They've got a very good relationship, they've got their own financing either abilities or long-term relationship. It's the customers that are smaller than that, that are more challenged or the privately held companies, or they have financing available to them, but just not in the capacity they need. So those are really the activities that we're looking for. It's not that folks aren't financing our projects, in a lot of cases they either just can't get the right financing or they can't get enough of it.

And in some cases I believe that Capstone Finance will move projects ahead sooner. We still have a very long cycle for closing projects, it's about 14 months from quotation to actually signing contracts.

I think if we can bring a financing leverage to that discussion and we tell a customer here's a project that's got a three and a half year payback, you saved $1 million a year on your energy spend, but if you have other projects you'd rather do, if you're a hospital or a hotel and you want to work on the lobby or some other part of your business, great. We'll do a project for you and instead of you saving $1 million a year you can save $100,000 a year. I think a lot of customers will rethink that and redeploy their assets to our project. So I think it's a great leverage tool for customers that may be on the fence. So for every dollar we do in Capstone Finance, hopefully we'll get another dollar out of another customer who decides to finance themselves or self perform.

And then just sort of a housekeeping item. Going forward with the new EBITDA target levels and seeing what you did in the quarter with your inventory turns, I mean are there any new working capital metrics that we should be thinking about going forward or any changes in payment terms that we need to be thinking about?

No, I'd say changing payment terms, we're obviously with the experience we had in Russia and a couple of other receivables we've had to reserve. We are tightening some of our credit decisions, but payment terms are defined on a distributor by distributor basis based on their performance and their balance sheet. So there's no across the board change with the exception, I'd say, we're probably just being more conservative with our risk portfolio right now.

As far as inventory turns, we're working very hard to kind of crank up our inventory turns. We've had a lot of cash tied up in our balance sheet. And as typical, we've got a lot of long cycle materials, so if you have materials that are six to nine months out, and your revenue drops quickly, you tend to overshoot. So we're kind of back in the reprioritizing, reloading numbers into our SAP system and to get inventory turns back to where they were.

So we went from about five turns to two turns in a fairly short period of time. Richard and his group have got sights on six to eight turns as quickly as possible. So I think as the business kind of rebounds a little bit and normalizes going forward, we're going to drive back to those five turns and beyond.

Thomas Boyd, Cowen and Company.

I just a quick one. I was just wondering how we should think about operating expense trends over the next couple of quarters given the kind of the update expectations on breakevens for 2016 and 2017.

It's hard without given you kind of the under the hood. I gave you some numbers on R&D. You can expect R&D next year to be just over $6 million in total spend, down from $10 million.

The rest of the numbers, I would say, wait till Q4 and Q1 as you kind of see them go into place, exactly where they're going to hit and how they're going to hit. I don't want you guys to guess and guess wrong. I think you're going to see the R&D spend come down very quickly. You've already seen the operational spend come down, but sales, marketing, kind of overall G&A, I would just take that as it comes and adjust your model accordingly.

Just one other thing too. With kind of the next step down for the breakeven for April of 2017, is there any CapEx that we should be thinking about as kind of to push that down to get ramp more manufacturing efficiencies or anything like that?

We are planning on collocating our manufacturing operation, so there'll be some non-recurring movement of machines and resetting them back up. I don't think there'll be any large purchase of new equipment. In fact we're looking to outsource more, go to more tier 1 suppliers and get our manufacturing footprint smaller, leaner and really be more of an assembling large purchase components and testing. And I think that's probably the best way. But also give us more flexibility to ramp up and down quicker within our organization.

Just one last one then. When ideally would that collocating of facilities take place? Do you have a bead on that?

I really don't. We're working on that now. We've moved a lot of the operation here already from our (inaudible) facility over to our Stag facility, but when we do that, it's going to probably be sometime middle next year. I don't think it can happen the first two quarters, maybe Q3, if not Q4. But we'll be doing things along the way. We won't do it all in one step. We'll do it in pieces. And again, we got some tier one suppliers that we're working with now that have to come up to speed and we've got to validate their ability to meet our demands.

Craig Irwin, ROTH Capital Partners.

I'll be frank, right? I was hoping someone else was going to ask this, but it's important to ask. Your cash position, $13.5 million plus $5 million in restricted is good. It gives you a few quarters to execute. But maybe not the size of the cushion that you would like. Can you maybe describe the different options that are available for you as far as access to cash, whether or not you've discussed receivables factoring and some of the other things that are available to companies that are sort of coming out of the trough like Capstone is right now?

We are very happy with the improvement in our balance sheet. As you mentioned, we went from roughly $15.5 million to $18.5 million. If you look a layer deeper though, you'll see that our free cash or the cash that was excess of what we had borrowed jumped substantially. So we were in much better position as far as our ratios with Wells Fargo. Our Wells Fargo line was paid down $5.6 million, so we've got a $20 million line with less than $10 million drawn at the end of December. So there's $10 million of availability in that line.

That is an asset based line, so it's not factoring receivables, but it is using our receivables as the assets backing up that line. So we've got $10 million there. We still have probably at least $5 million of inventory that can come out, some finished goods, as well as raw material. So call that $15 million of available cash.

Remember we've got over $11 million in reserve receivables. And so as those receivables come off the reserve and come back into cash, that's another $11 million on top of that $15 million. So there's $26 million of potential either borrowings, cash out of the balance sheet or receivables that we can bring to the business. So that's our first goal. Obviously you know right now the stock market is not for the faint of heart. Doing IPOs and follow-ons is very challenging and so any additional equity in a traditional sense would be very painful for us and for our shareholders.

So our focus is really right now on getting cash out of the balance sheet, leveraging the Wells Fargo line and obviously getting those receivables collected, because that's the fastest path to getting us healthy.

Can you maybe give us a little bit more detail on the timeline for potential resolution of the receivables? Where you are in the process with the relevant customers and what the gating factors will be for a potential release of that cash that could be coming in?

Yes, let me say that our total past due is about $15 million. If you look at it across the board, we have about $7 million with BPC, our Russian distributor. That is coming down slowly as they buy spare parts and make that kind of extra payment as they go to whittle away at it. As they start taking products, why that's so important is obviously that's revenue for us, but then products are much more expensive than parts and they'll be chipping away at that $7 million faster.

Our next biggest reserved AR item is a company called EMI out of the Middle East. We are working with them to repurpose those machines, so we expect that about $2.6 million to come out in Q4. We were hoping for Q3, but we didn't quite make it, but I think they will get repurposed in Q4. That will probably obviously impact our top line revenue a little bit because those will be units that people would have purchased from Capstone as opposed to EMI. But that'll get us cash on the balance sheet.

So that's just over $10 million of the $15 million. The rest are a smattering of different distributors across the globe. We're working hard to get as many of them caught up as possible, but again I think we're not going to get all $15 million in the next quarter. If we got $4 million to $5 million in Q4 of those receivables paid down, that would be great with the kind of a similar burn in Q1, Q2.

The Russian receivable could take a year. I mean it just really depends on how fast the ruble improves with the dollar, how fast he can get his customers back up online in taking product that they previously ordered and haven't paid him for yet.

That concludes our question and answer session for today. I would like to hand the conference back over to Darren Jamison for any closing comments.

Great. Well thank you, folks. Great round of questions. I think we covered a lot of the things that I wanted to talk to you about in my closing remarks, which is incredible.

I just will say kind of as I look at the quarter, there's lots of highlights, but if I probably had to pick the top ones, obviously number one for me is the balance sheet. And Craig kind of said it at the end, when you got down to $15 million in cash last quarter, a lot of folks were concerned about our overall viability. And if you look at our share price, it was basically priced as we were going away. Well that's not happening. We increased our balance sheet about $3 million in total cash, but much more importantly, more of that cash is our own and not borrowed from Wells Fargo, so we're in a much better place.

I want to thank our -- obviously our vendors who have been patient with us as we've moved through this process and we're very excited about getting our cash balance back to where it belongs and our payment terms back where they belong and being back to kind of status quo.

Obviously AR is very important. We made some progress during the quarter, but Q4 and going into next year, improving those collections and those reserved receivables is going to be key.

Inventory levels, I couldn't be more thrilled about our inventory levels this quarter. Obviously we shipped a vast majority of the finished goods by a dollar perspective. We still have some smaller C65 units in inventory we'll get out this quarter. But our receipts were down, our turns came back up, our overall inventory decreased, which is good, which lowers our future liability going forward.

I think if you look at the Signature Series, we're ecstatic with that product. We're very excited to get the first one out there and show it to the customers. The reaction we had at PowerGen was amazing. The foot traffic, it was one of the biggest piece of machines at PowerGen and probably got the most foot traffic of anything at the show.

And again, I think we've had five years of experience with our current product. We've taken all of the feedback from our distributors and our end use customers and rolled that back into the new product. So very much like the next version of an iPhone or other neat technologies, I think we've hit every area that customers wanted to see improve. So we're very excited about that.

Lowering operating expenses, I've always been a revenue growth guy. Cutting operating expenses is not a pleasant thing to do, especially when it involves people that are human beings with families. But the reality is we need to right-size the business for what the market's going to say that our revenue is. So I think we've done it smartly, we've done it respectfully, we've done it honestly and we're very excited about the new levels we're achieving and where we can go even further beyond that.

I touched on the warranty expense. Again, something that was a big issue and a big conversation two years ago is a non-issue today and that's a testament to our engineers and our service folks who have really improved the product and continues to get more and more robust.

The Signature Series products will be more robust and better meantime between failures than our C65, which is in my mind world leading today. So very excited about continuing down that path.

Improving the business mix, again everybody's very negative on our oil and gas today. They're great customers when market's good and it's a cyclical business and it's challenging when it's down. But we still respect and want our oil and gas customers. We're going to work hard to support them through this difficult time. But it's still good for us and our business to focus on energy efficiency right now where the most growth is. And I think globally the energy efficiency space is much bigger and has much more opportunity than the oil and gas space. But they're both important and we're going to focus on growing them both as fast as we can.

Geographical diversification for me is huge. I think we've seen what happens when you have too much concentration with one customer or one market. We had that. We had our biggest market being Russia and because of events beyond our control, it went to zero almost overnight. So by more diversification, we all know a diversified portfolio is a better approach than a single portfolio and we're very excited to see new orders coming out of Mexico and Australia, South America, different parts of the world.

Gross margins, the first question we got today. Doing a 19% gross margin on a $21 million quarter we've never done before. So that really shows all the improvements we're making internally with our cost structures and our operational spends and our variable expenses.

The new finance entity, we worked for three years trying to find the right financial partner. We've had to kind of home grow our own Capstone Finance JV, but we're very excited about what that's going to do and the ability to future leverage for our business.

So with that, obviously it wasn't our best quarter ever, but I think coming off of Q2 we're very happy with the progress. We've hit all of our internal goals across the board and we're very excited about Q4 and moving into the new year.

So with that, look forward to talking to everybody next quarter. Thank you.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day.