Capstone Green Energy Corp (CGRN) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Capstone Turbine Corporation Earnings Conference Call for Fourth Quarter and Fiscal Year-End 2017 Financial Results ended on March 31, 2017. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to turn the call over to Ms. Jayme Brooks, Chief Financial Officer and Chief Accounting Officer. Ma'am, you may begin.

Thank you. Good afternoon, and thank you for joining today's Fiscal 2017 Fourth Quarter and Year-End Conference Call. Today, Capstone filed its annual report on Form 10-K to the Securities and Exchange Commission.

During the call, we will be referring to slides that can be found on our website under the Investor Relations tab. I would like to remind everyone that this conference call contains estimates and forward-looking statements that represent the company's views as of today, June 13, 2017. Capstone disclaims any obligation to update or revise these statements to reflect future events and circumstances. You should not place undue reliance on these forward-looking statements because they involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond our control. Please refer to the safe harbor provisions set forth in the slides and in today's earnings release and in Capstone's filings with the Securities and Exchange Commission for information concerning factors that could cause actual results to differ materially from those expressed or implied by such statements.

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

Thank you, Jayme. I'll be starting off the call today by talking about our positive fourth quarter results and then go into more detail on what we have accomplished this fiscal year to substantially improve the business. I'll then turn the call back over to Jayme, who'll review the specific financial results for the full fiscal year. I will then close the call by discussing our goals for fiscal 2018, and the overall future vision of the company.

Let's go ahead and turn to Slide 3. Slide 3 lists some of the fourth quarter financial highlights. Overall, I'm extremely pleased with the results of the fourth quarter as revenue increased 13% to $22.9 million from the third quarter, which was the highest revenue in 7 quarters. However, more importantly, cash increased $335,000 in the quarter as a result of improved revenue, positive changes in working capital, additional borrowings on the line of credit and continued tight expense controls. Overall, cash used in operations decreased 47% over the prior quarter, which in turn, was down from the second quarter. In our current business environment, I have to say that cash is king but cash flow is queen.

Another key highlight is our accessories, parts and service revenue which reached $7.7 million for the quarter against our medium-term profitability goal of $10 million per quarter. Also very exciting was that our book-to-bill ratio was 1.3:1 for the fourth quarter of fiscal 2017, and net product orders were the strongest in 9 quarters at over $20 million. However, for me, the most important development is that -- was the lowest loss from operations in the last 14 quarters. The last time our loss from operations was this low, we had $37 million in quarterly revenue which coincidentally was the highest in the company's history.

I think this really highlights the tectonic shift of our business that we're experiencing as we diversify our business into the energy efficiency market and lower our dependence on revenue from oil and gas market. The shift is driving our aftermarket long-term service contracts, or FPP business, as CHP customers are signing FPP agreements at much higher rates than the oil and gas customers that already have trained on-site personnel to maintain sophisticated equipment such as microturbines. This is what we refer to as our FPP attachment rate. This shift to higher-margin aftermarket service business, which includes accessories, parts and long-term FPP service revenue when combined with our lower operating expenses, has changed our business substantially and makes us much, much more stable and viable and we believe, leads to a more robust long-term profitability model.

Let's go ahead and turn to Slide 4. Slide 4 shows our past oil and gas-centric business model, today's current more balanced business model and our future projections. The future projects the acceleration of revenue growth as a result of reaching adjusted EBITDA breakeven and getting larger customers to become more comfortable with our overall viability. As you see, our breakeven has dropped from $40 million in the quarter to $25 million in the quarter, and we are much less reliant on unpredictable quarterly product revenue. A couple of solid quarters are nice but let's look back at the entire fiscal 2017 and see what we've accomplished. Fiscal 2017 proved to be a pivotal year for Capstone, as the company continued to make clear and distinct progress towards short-term sustainability and medium-term profitability.

Let's go ahead and turn our attention to Slide 5. Slide 5 looks at the three-pronged plan we've had for the last year. The first goal management set was the goal of reducing quarterly operating expenses by 35%, and I'm proud to report that in Q3 fiscal 2017, we exceeded this goal and operating expenses were down 42% versus the first quarter of fiscal 2016 when we started this critical initiative. Operating expenses went from $10.5 million in Q1 of fiscal 2016 to $6.1 million in Q3 of fiscal 2017, and we continue these same reduced levels in the fiscal fourth quarter. Again, just to stress, this is the lowest level of operating expenses since 2003 or approximately 14 years. To achieve this goal during fiscal 2017, Capstone managed a wage war on operating exposes, from the boardroom to the shop floor, from high temp steels to alloys, to coffee. Nothing was off limits. As a result to these actions, total operating expenses for Capstone during the year dropped from $37.3 million annually to $26 million, which is a net reduction of $11.3 million annually. As impressive as these cost reductions are in 2017, management is not finished and the war on cost rages on. We're in the process of consolidating our 2 manufacturing operations into one single location and we'll continue to look at creative new ways to reduce operating costs and eliminate waste from our business.

If you look at Slide 6, slide 6 highlights some of the Q4 onetime charges or onetime adjustments and, more importantly, the continued cost reductions not yet realized in our future operating expenses. I'm proud to say the new goal for fiscal 2018 is to drive operating expenses further down to $5.7 million per quarter or $22.8 million annually, and then further down to $5.5 million or $22 million annually in fiscal 2019 after we achieve our facility consolidation. These new lower operating expenses and our lean business operations have lowered our breakeven levels, reduced our cash usage, increased our sustainability and viability.

In fact, looking at our operating expenses compared to other clean tech companies, let's take a look at Slide 7. If you look at Slide 7, we are currently 52% lower than the average of 4 other similar small-cap distributed generation clean tech companies in our space. If you look at the most recent quarterly numbers, Capstone beats the average in quarterly revenue, beats the average in gross margin and beats the average in EBITDA. And quarterly cash rate is lower than the average as well. If you force rank the group, Capstone has the second-highest quarterly revenue, the lowest operating expenses by far and is the closest reach in EBITDA breakeven of anyone in this group. The only areas Capstone is not significantly above the group average or leading is in the cash balance and market cap. Our market cap, we trade at significant discounts compared to the other companies, I believe, because we are perceived heavy reliance on the oil and gas market.

So let's go back to Slide 5. The next goal we have for fiscal 2017 was to develop a new CHP product and to grow and diversify our markets into the energy efficiency space and minimize our exposure to the volatile oil and gas market. During the year, Capstone unveiled several innovative and new products, including additions to our Signature Series product line that were specifically designed for CHP and CCHP. All of Capstone's new Signature Series include the over 70 system design and performance improvements that the original Signature Series product has. Some of the improvements include improved noise reduction, 12-year Marine-grade paint, relocation of the engine exhaust deck, redesigned discharge for enclosure cooling air, integrated heat recovery module for CHP and CCHP applications, 2-stage air filtration, and the list goes on. In addition to the launch of these 3 new products, Capstone fine-tuned both systems to fit into smaller, sturdier enclosures to further reduce insulation footprint, insulation costs and shipping costs. I'm proud to say our new Signature Series products are performing very well in the field, and the FPP contract backlog has grown 16% over the last 12 months to an impressive $77.1 million.

Let's go ahead and turn our focus to Slide 8. Slide 8 highlights this improvement in our market vertical diversification with a near-term management goal of 50% energy efficiency or CHP, 30% oil and gas, and 20% renewables and other. As part of this goal was to increase sales in new geographic markets as well as diversifying our market verticals within those new geographies. Capstone partnered during the year with 9 new distributors to improve our geographic diversification.

Slide 9 highlights our much improved market diversification and growth within Asia and Australia, Latin America, Africa and the Middle East. Our growing sales pipeline jumped $453 million recently to a record $1.5 billion. This pipeline reflects all the identified sales opportunities that our distributors have entered into our customer relationship system, which better equips us in monitoring our overall sales cycle process.

During fiscal 2017, in order to improve geographic diversification, as I said, Capstone added the following new distribution partners to our global distribution family: BMTec and DV Energy in Russia to expand our Russian marketing presence; Cal MicroTurbine in the critical California market; EED International in Singapore; Inmo Tech in Saudi Arabia; Optimal South Pacific in Australia; OSEG LTD in Israel; Synergy Astana in Kazakhstan; and Viridis Consult in Malaysia. Capstone also secured critical projects in high-growth geographies such as Africa, Latin America, the Middle East and Southeast Asia. Today, I'm proud to say we are much more diversified and not as susceptible to macroeconomic events in any single market, as we did in the past with our previous heavy exposure to oil and gas and the Russian market.

Now if you go back to Slide 5 one more time, the third goal for management was the development of Capstone Financing Solution and to create a power purchase agreement or PPA business. Capstone formed the joint venture's subsidiary, Capstone Energy Finance, or CEF, at the end of fiscal 2016. But Capstone partnered with global independent power producer Sky Solar in fiscal 2017 to provide up to $150 million in potential future funding for CEF.

Now let's go and turn our attention to Slide 10. Slide 10, you can see that we have several projects in contract negotiation and several term sheets in legal review. CEF recently added equipment leasing, and our near-term goal is to add limited short-term rentals as well. Although I'd say we have yet to fully accomplish this goal, which is nonetheless disappointing to me, the CEF's project pipeline has grown and includes $55 million of microturbine product, which is very encouraging, as I would be satisfied that CEF added just 10% to our top line revenue in fiscal 2018.

But that wasn't all. In other financing activity during the year in order to better support our key distribution partners, Capstone tapped full service advisory firm, Acresis, to help build $1 million product financing program for our key distribution partners that will provide better payment terms and better cash flow for Capstone. As I said earlier, cash is king, but cash flow is queen.

Last but not least, we just announced a new banking relationship with Bridge Bank last week. Not only will this new $12 million revolving credit facility provide us with an increase in borrowing availability compared to our old facility, but the overall total cost of capital of the facility will also be reduced.

All right. Let's go ahead and turn to Slide 11. Obviously, this is a very important slide. Slide 11 highlights our aftermarket service business growth. The growth of our aftermarket service business is key to our short-term viability and medium-term profitability. The fiscal 2017 combined accessories, parts and service revenue increased 8% despite lower product shipments to a record high of $28.9 million or 37% of total revenue compared to $26.8 million or 31% of total revenue in fiscal 2016. Because our aftermarket service business is reoccurring higher-margin revenue, it is a critical element to our short-term sustainability and medium-term profitability plan. The aftermarket service business continues to expand with an average gross margin of 30% for fiscal year -- for the fiscal year compared to our planned margins and target margins of 50%.

Capstone's revolutionary factory protection plan or FPP contract backlog increased 16%, again despite lower product revenue to $77.1 million compared to last year's $66.5 million and should accelerate even further, as product revenue is now rebounding and we supply a greater number of microturbines into the CHP and CCHP energy efficiency markets, which I said earlier, have much higher attachment rates than our traditional oil and gas markets.

With that, I'll now turn the call over to Jayme to go over the specific financial results.

Thanks, Darren.

Please turn to Slide 12 for fiscal 2017 P&L financial results. Revenues for fiscal year 2017 was $77.2 million, a decrease of 9% or $8 million from fiscal year 2016 revenue of $85.2 million. Product revenue for fiscal 2017 was $48.3 million compared to $58.4 million in fiscal 2016, a decrease of $10.1 million or 17%. We shipped 49.3 megawatts during fiscal 2017 compared to 60 megawatts in fiscal 2016, a decrease of 10.7 megawatts or 18%, and the average revenue per megawatt shipped was approximately $1 million for both fiscal 2017 and 2016. The decrease in product revenue and megawatts shipped in 2017 over the prior fiscal year was primarily the result of delays of certain oil and gas projects globally, resulting from the continued volatility in the oil and gas market.

Revenue from accessories and parts increased $0.3 million or 2% to $15 million for fiscal 2017 compared to $14.7 million for fiscal 2016. The increase in revenue from accessories and parts was primarily because of an increase in sales of heat recovery modules.

During the 3 months ended March 31, 2017, we shipped 10 of our new roof-mounted integrated CHP heat recovery modules designed for our new C1000 Signature Series system.

Service revenue increased $1.8 million or 15% for fiscal 2017 to $13.9 million compared to $12.1 million in fiscal 2016. As a percentage of revenue, service revenue was 18% in fiscal 2017 compared with 14% in fiscal 2016. The increase in service revenue was primarily the result of our growing installed base and the higher attachment rates of our FPP offerings in the CHP and CCHP markets, as Darren mentioned earlier.

Gross margin for fiscal 2017 was $1.8 million or 2% of revenue compared to gross margin of $12.8 million or 15% of revenue for fiscal 2016. The decrease in gross margin was primarily because of lower volume and a shift in product mix in fiscal 2017 and a onetime warranty provision in Q3 of fiscal 2017, to retrofit proactively selected non-Signature Series C200 microturbines with a more robust new Signature Series generator component to improve product performance, reliability and customer satisfaction. These decreases were offset by reductions in production labor and overhead expense, inventory charges and royalty expense. Management continues to implement initiatives to improve gross margin by reducing manufacturing overheads, by consolidating manufacturing into one facility, and further reducing fixed indirect material costs and improving product performance.

R&D expenses for fiscal 2017 decreased $4.8 million or 47% to $5.4 million from $10.2 million for fiscal 2016. The overall decrease in R&D expenses of approximately $4.8 million primarily resulted from decreases in salaries, supplies, consulting and business travel expenses. These overall decreases were part of our initiatives to reduce operating expenses. Management expects R&D expenses in fiscal 2018 to be lower than the fiscal 2017, as we continue our cost-reduction initiatives.

SG&A expenses in fiscal 2017 decreased $6.4 million or 24% to $20.7 million from $27.1 million in fiscal 2016. SG&A for fiscal 2017 was lower than fiscal 2016 as a result of decreases in salaries, marketing, professional services, business travels, facilities and consulting expenses. These decreases were primarily the result of our cost reduction program to lower our operating expenses throughout the organization. Management is continuing the war on costs, as Darren explained earlier, and we are planning to bring down SG&A expenses in fiscal 2018 compared to fiscal 2017, as we demonstrated in Slide 6.

The operating loss for fiscal 2017 improved to $24.3 million compared to an operating loss of $24.5 million for fiscal 2016. The net loss for fiscal 2017 improved to $23.9 million compared with a net loss of $25.2 million for fiscal 2016. Net loss per share was $0.75 per share for fiscal 2017 compared with a net loss of $1.39 per share in fiscal 2016.

The adjusted EBITDA for the year ended March 31, 2017 was negative $22.3 million or a loss of $0.70 per share compared to adjusted EBITDA of $20.2 million or a loss of $1.11 per share for the year ending March 31, 2016. The adjusted EBITDA is a non-GAAP financial metric that is defined as net income before interest, provision for income taxes, depreciation and amortization expense, stock-based compensation expense and the change in the fair value of warrant liability. Please refer to Slide 23 in the appendix titled Reconciliation of Non-GAAP Financial Measure for more information regarding this non-GAAP financial metric.

Please now turn to Slide 13, and I'll provide some comments on our balance sheet and cash flows. At March 31, 2017, we had cash, cash equivalents and restricted cash totaling $19.7 million compared to cash, cash equivalents and restricted cash of $16.7 million as of March 31, 2016. Cash used in operating activities for fiscal 2017 was $18.5 million as compared to cash used of $22.5 million in fiscal 2016. Our accounts receivable balance as of March 31, 2017, net of allowances, was $17 million compared to $13.6 million at March 31, 2016. Our days sales outstanding, or DSOs, were 60 days at the end of fiscal 2017 compared with 66 days at the end of fiscal 2016. Inventories decreased $2.8 million or 15% to $15.5 million as of March 31, 2017 from $18.3 million at March 31, 2016. Inventories decreased primarily as a result of the reduction in raw materials. Our accounts payable and accrued expenses increased $1.5 million or 11% to $14.7 million as of March 31, 2017 and $13.2 million at March 31, 2016.

At this point, I will turn the call back to Darren.

Thank you, Jayme.

During fiscal 2017, Capstone achieved many milestones that included the launch of the new CHP, CCHP-focused industry's product lines, the acceleration of our key aftermarket service business and dramatic decrease in our operating expenses. These activities collectively combine to lower Capstone's estimated breakeven from a previous $160 million annual revenue to today's $100 million at a 25% gross margin. The early success of Capstone distinguishes each product in the field, recovering crude oil prices, our growing aftermarket service business, our geographic expansion, our 9 new distributors, all these will be drivers for the business going forward into fiscal 2018. In order to ensure our success this year, we are driving several key initiatives in fiscal 2018 and beyond.

Let's turn to Slide 14. Slide 14 outlines the 9 critical initiatives that management is focused on executing in fiscal 2018, while closely managing the balance sheet and minimizing cash burn. As we strive for continuous improvement, these initiatives are capitalizing on our Capstone finance program I discussed earlier, continuing our war on costs, increasing our CHP product sales, growing FPP service business, growing our spare parts business, the closing out of our C200 Reliability Program, all while we continue down our product development road map and lastly, but never least, ultimately pushing forward our goal of achieving adjusted EBITDA breakeven levels in fiscal 2018. I think it's important to note on this slide that our leadership team is extremely dedicated and has gone through the last difficult 2 years without any turnover and without any equity, without any merit increases or additional equity in the company. The leadership team will get a bonus on 2 consecutive adjusted EBITDA positive quarters, so the team is extremely focused on getting to EBITDA positive as quickly as possible.

New CHP product sales will continue to be a major area of focus and as part of this initiative, we recently launched the global Sell-to-Win contest to all authorized distributors globally. The program is for the new C200S ICHP bundle so that's the new C200S microturbine with the roof-mounted integrated heat recovery module, and more importantly, a prepaid factory protection contract. This Sell-to-Win program also includes the C65 ICHP bundle, which is the C65 microturbine roof-mounted heat recovery module, and again, a prepaid FPP contract. That is all highlighted on Slide 15. This program is key because it empowers marginal projects with the best additional discounts to help move forward and drive additional CHP product accessory and FPP service revenue for Capstone, which is so critical to our profitability. In addition, the prepayment of the FPP contract will improve our overall cash flow. And as I said before, remember, cash flow is queen. This slide further highlights our fiscal 2018 Factory Protection Plan, or FPP, growth initiatives.

Besides the Sell-to-Win contest, we launched a special discount program for fiscal 2018 for all future 5-year or 9-year FPPs that are also 100% prepaid upfront but not part of the bundle to positively impact working capital again and improve our cash flow.

We continue to explore new and creative methods in order to increase the FPP attachment rate, thereby driving recurring cash flow on older systems in the field that are not currently under FPP service contract. We have already launched the program to sell Signature Series upgrade kits to older field that call them R series product. And in May, we launched a new spare parts price lift increase which was 5% domestically, 3% internationally that is already effective today. We'll also continue to look at other spare parts special programs in the future to drive future spare parts growth.

Let's turn to Slide 16. Slide 16 highlights some of the key design improvements made over the last 4 years of the C200 development program. To name a few of the key initiatives: We have improved the combustion liner. We have improved the air bearing coating. We've improved the air bearing housing. We added a new high flow in color. We improved the manufacturing and robustness of the recuperator. We've come out with a new stator and magnet combination and an ongoing continuous product development qualification and certification program. We will be aggressively rolling out the final field upgrades over the first half of fiscal 2018 to maximize customer satisfaction.

During fiscal 2017, Capstone made significant progress in its product development road map, as shown on Slide 17. And in fiscal 2018, we'll continue these product development efforts and releases, including new fuel capabilities, new fuel -- new universal control boards, an upgraded state-of-the-art control system for all current systems. Capstone will also continue to innovate and develop new products despite lowering its R&D spend approximately 50%, 5-0, from the previous years.

In addition, we look to develop and leverage opportunities at the U.S. Department of Energy and the Argonne National Laboratory, test our microturbines with hydrogen and other synthetic fuels, as outlined on Slide 18.

We're also very excited to explore transient plasma technology with the U.S. Department of Energy and the Argonne National Laboratory using Capstone C65 product initially, as shown on Slide 19, to see if we can take our already world-class ultralow emissions down to nondetectable levels.

I think the ultrareliable microturbine combustion-based technology, with a total system efficiency of 60% to maybe 95% and emissions that are nondetectable, could be a very interesting product offering compared to today's fuel cells and traditional engine-based technologies that continue to get caught cheating trying to meet the strict emission regulations.

I now want to take a second and address a couple of slides that are in the appendix. So if you go to the first slide in the appendix, it's a distributed generation megatrend slide. I use this when I do my investor presentation, so I wanted to speak to it briefly here on today's call. This is really just highlighting the major shift we're seeing in the utility industry and the way people buy energy. And again, I think megatrend is not a term that I love. It makes me think of Megatron or the Transformers. But the reality is, the way people are buying energy is changing. The utility model is broken and folks want to be more smart and more proactive on how they buy their energy, especially millennials and the younger generation are much more sensitive to green energy and the clean energy. And they don't want to buy power -- have to buy power the way their father and their grandfathers did.

And so if you look at this slide, it just talks about some of the annual distributed generation, power additions you're going to see by 2020, global electricity consumption. You've probably heard a lot about microgrids recently. Capstone is on several microgrids and continues to look at how to modify our product to be even more effective in microgrids. That's an area that I think we see a lot of growth going forward, combining our technology with other technologies like wind and solar, using battery storage that the microturbine can be base loaded and use other renewable energies that are intermittent. That's a great opportunity and great technical solution.

As mentioned here, there's going to be $205 billion will be invested in global distributed power by 2020. More importantly, I think you're going to see a lot of electrification in emerging markets: Asia, Africa, the Middle East. As you notice in our prepared remarks and recent press releases, we're putting product into North Africa, South Africa, West Africa. We've also got product going into the several parts of Middle East, Saudi Arabia, Qatar. Lots of different areas that our product is up and running, so we've got new distributors in that area as well as penetrating those markets as well.

The other slide I put in there is a little bit tongue in cheek what do these companies have in common, and really, there's a lot of things these companies have in common. But if you look at the list, Amazon founder left Wall Street, came back to my hometown of Seattle, started selling books out of his garage. Why? Because he wanted to compete with Barnes & Nobles and some of the biggest book manufacturers and resellers in the world. Obviously, that didn't seem like a very logical thing to do, but he changed the way that people buy products online and the way they compete and the way retailing is done today. So very much a small business going in the face of a very mature, large competitor and changing the way things are done over the previous. So again, like the same thing we're trying to do in the energy space.

Turner, I selected Turner because of Cable News Network or CNN. Obviously, continuous news network and getting news 24 hours a day is something that's very different.

Apple, we all know, is a very unique company and changed the way personal computing was done, and then obviously, cellphones. We all remember the picture of Steve Jobs flipping off the IBM logo. Well, that could be a Capstone executive with Caterpillar or GE or any utility in the world. And these are not easy endeavors. These were not linear growth. These were very challenging.

I think FedEx is a great example. If you look at the CEO of FedEx, they actually got down to his last $5,000 and did what any good CEO would do faced with bankruptcy. He took his last $5,000 and he went to Vegas. He played blackjack and made $30,000, kept the trucks running long enough to get his next infusion of cash and keep the trucks running. But deciding to sell -- to ship packages against the U.S. Post Office is a pretty challenging thing to do, and he did an amazing job.

I threw in Tesla in here because I find Tesla very interesting. Obviously, they're trying to change the car industry today. They have -- Tesla have a larger market cap than Ford when they do 26,000 vehicles a year and Ford does 600,000 vehicles a year. And Ford is profitable and Tesla is not, I think, says volumes. It's says that people believe that Tesla is going to change the way people buy cars, the way cars operate and the entire car industry. Otherwise, it makes absolutely no sense why Tesla's market cap could be where it is.

So all of these companies have tried to change industries. They've all gone against big brands, big companies that are very entrenched and have lots of money and lots of history, and they've had to change the way people think. I look at the utility business and buying power from a nameless, faceless utility who doesn't treat you as a customer, and frankly, you're getting nothing for it. If you buy a microturbine within 5-year payback, you bought the microturbine. You own a 20-year asset that can save you money and lower your operating expenses. Buying money from the utility is not a good investment long-term. There is no payback. It's just how much you just spend.

I've been to probably close to 72 countries around the world. I always ask customers no matter what vertical they're in, what is key vendor, what's key to their business, who is good partners. And not once, knock on wood, have they mentioned their local utility. Yet when I asked them about their utility spend and their energy spend, natural gas for boilers and chillers, plus their electrical consumption, they scratch their head and say, yes, that's probably my second, third or fourth biggest spend. And I said, but yet, you don't manage it. You don't do anything to be proactive. You just write the check every month, and the cost is going up every year, and the service levels in most cases are going down. And so a lot of folks see that as something they can't control, but Capstone and other technologies are out there to change that model.

So I do believe, as much as I don't like the term megatrend, times are changing. And surviving in a new tech environment is all about paddling long enough to catch the wave. And so getting our business to EBITDA, adjusted EBITDA breakeven, minimizing our cash burn, improving our working capital and our cash flow allows us to paddle long enough to ride that wave when it finally comes in. Because I do believe it will come in, and people will see Capstone at some point as an overnight success, and that can't be farther from truth. It's a lot of hard work by our leadership team, our employees and our vendors.

So with that, I'd like to open the call up to our analysts for questions.

(Operator Instructions) And our first question comes from the line of Jeff Osborne with Cowen & Company.

A couple of questions from my point. One on the prepayment. That certainly is intriguing. Can you just put it in rough numbers, if you did 1 million of megawatt, if somebody were to prepay the service on that, what kind of cash flow that would mean upfront for you?

Yes. I don't know if we want to give out specific competitive information. But obviously, a 9-year FPP more than doubles the sales price of the product. So getting that paid upfront would be -- if it's a full-service FPP, it would be very significant. One of the reasons we haven't brought this program out before is getting somebody to prepay for an insurance policy from an insurance company that's not profitable is a challenge. But as we generate cash this quarter and look to get closer to EBITDA breakeven in the next couple of quarters, we think it's the right time to roll this program out. So as customers want better economics on their project and, obviously, better cost, we'll give them that opportunity by prepaying that FPP. So that's going to put cash on our balance sheet and help our cash flow. We will not take revenue, though, until we actually do the service work on a quarterly basis. So you'll see the prepaid on our balance sheet go up, as we roll this program out.

And then with the -- as it flows through with the gross margin, I know the target is to get to 50%, but could you maintain a 30-ish level with the prepayment? Or do you have to discount that, and we would see it in the gross margin line?

No. We can still get to a 50% blended gross margin. If you look at our margins, they've been heavily impacted by the reliability work we've had to do on the C200. Specifically, last quarter, we took a $5 million charge. But even over the last 4 years, we've been making lots of design improvements and rolling them out into the field. And so as we stop the engineering effort on the Signature Series and the product is meeting our internal reliability, very high reliability targets, you're going to see the FPP margins come up. And so as quoted margins that we put in our contracts are 50%, what's dampening them now is premature failures or higher maintenance costs that we anticipated or reengineered. So the spare parts margins are already over 50%. We just raised them a little bit more. And so accessories, typically, are 20% to 25%, but we're working on getting those margins up as well. So I think we can be in the mid-40s by the end of the fiscal year as far as blended margins. And then by '19, we should be at, hopefully, over 50% or at 50%.

Just 2 others. It's probably in the 10-Q, but can you just disclose what the rest of the receivables outstanding are at the moment? And then I wanted to touch on the facility consolidation. How do we think about any potential disruption to workflow? Any working capital issues? Do you need to build the inventory (inaudible)? Any cash charges or CapEx implications with that? A multiple-part question, but those were the...

Yes. Let me make sure I got them all. The first one was the rest of the receivable. That receivable, we fully reserved a couple of years ago. That was over $8 million. When we started, I think it's roughly $6.5 million today, $6.8 million, somewhere in there. It's come down about $1.5 million in the last fiscal year. We're continuing to get orders from our Russian distributor, BPC, and they're paying today 20% over on Signature Series and 15% over on other products. And so that receivable should continue to be collected. That will be lumpy on a quarter-to-quarter basis depending on shipments and payments. All new product obviously, and spare parts, though, were 100% prepaid with the overpayment to pay down that line. As it relates to the consolidation of the manufacturing, we're doing a lot of the work in-house with our own employees. We've got an incredible internal team with the facility folks and other folks on the shop floor that are doing this in their -- during the daytime and their spare time. We have officially moved the C30 and the C65 over the weekend, and we'll be producing product this week. So we'll be down for less than 7 business days and moving that production line. So that has all of the operational folks over in Stagg facility with the exception of our power electronics. That will move over probably in the next quarter, and then we'll have all of our manufacturing folks over there for manufacturing, quality, purchasing. Engineering, we'll go over next. We're going to need to do a little bit of a build-out on that building. We just renegotiated our Stagg lease and got about $160,000 worth of tenant improvements. The landlord helped pay for the renovation. So from a cash standpoint, we'll probably spend a few hundred thousand dollars to do this move but it's not going to be substantial. We've got it built into our cash plan. And more importantly, my favorite kind of money is other people's money, and so we're using the landlord's money and some other opportunities we get cash to help pay for that. So then the real key is subleasing this building. If you look at our numbers there, we've got it going down to $5.5 million. That is really contingent on subleasing this current facility that we're in. We pay about $1.5 million between rent and utilities in this space. So getting out of this space is going to obviously lower our quarterly burn that much more. We're not sure we'll get the entire company into one facility. We may have a small corporate center nearby, but definitely, we're going to get the cost down substantially.

And our next question comes from the line of Eric Stine with Craig-Hallum.

So I wanted to just touch on gross margins. I mean, I know that's the area that's proven most challenging as you work towards your profitability goal. Just in the past, you've been talking about some of the supply chain steps you're taking related to the Signature Series. I mean, any meaningful steps you made in the quarter? And just thoughts on timing when you might start to see some noticeable improvement there back to -- I mean, is 20%-plus a realistic number for gross margin in fiscal '18?

Yes. No, absolutely. First of all, our margins have kind of rebounded back about 9% but our product margins are still lagging from where we want them to be. We do have several Signature Series cost reduction efforts that are underway. We brought Paul Chase on board not that long ago to help us on that effort, as well as our engineering team. We should be wrapping those up this quarter. I'm pretty bullish on getting penciled down on engineering groups, so you should see some cost reductions flow through on the Signature Series product, as well as we're putting long-term purchase agreements in place. I think of our top 21 vendors, which make up 80% of our spend, we've got 13 under LTA and we've got another obviously 8 more to go. That is a major task for Paul and I over the next, call it, fiscal year to get that done. So I think those LTAs, in combination with some little bit cheaper designs or less expensive designs, will help move that margin. But more importantly, obviously, the more we can get that service margin from the 30% up to 50%, that 20% additional increase will help the overall gross margins as well.

On that service gross margin, and I might have missed it, that I noticed that this quarter was the lowest in a number of quarters. So can you just break out kind of what the onetime items were in the quarter and give us more of a normalized service gross margin for 4Q?

Yes. I don't know if we have that number.

We have that detail, yes, in the filings.

Yes. But as I said, you should see the blended service numbers exit the year, probably low 40s. And by fiscal '19, we should be into the 50% range. So you should see margins increase, hopefully, sequentially each quarter going forward as cost reductions come down, more FPPs get signed, more units go into operation. So I think it's always hard on a quarter-to-quarter basis because the FPP service contract business depends on how much work we do during the quarter. So if we have an engine failure or an expensive repair, that can impact the quarter. But...

It's depending on the timing of maintenance, scheduled and unscheduled.

Yes. But I think in general if you look at over the year, you should see it growing. If you look at our new cost target, I think it's got it down to about 22%, gets us to breakeven. And so again, with heavy -- $10 million in accessories, parts and service being at that 50% margin, we're not as reliant on product margins as we've been in the past.

Okay. Maybe last one for me just related to the pipeline and the big jump that you saw in the quarter. Give us a little detail there. I mean, is that a number of large projects? Or is it really more broad-based as your distributor base matures?

I think it's both. I mean, we're getting looks at bigger projects. We just announced a 5-megawatt CHP project. That's one of our biggest CHP projects done globally. That's with a Fortune 100 company that's got multiple other locations. We just did some other big customers recently. So I think as we get closer to adjusted EBITDA breakeven, getting Fortune 100 customers to invest in our technology, it's going to get easier. And so I think that's really the key. Some of the bigger Latin America projects, we've struggled with the FCPA and some other things, got to make sure that we don't do anything that isn't appropriate. So I think those are always challenging markets. Brazil comes to mind, Ecuador comes to mind, very challenging places to do business. That being said, I think you're going to see more and multiple megawatt projects, just in general, as our business expands and as we get profitable.

And our next question comes from the line of Craig Irwin with Roth Capital Partners.

Oil and gas, in your prepared remarks, you did reference the slowness last year, the fact that some of the headwinds from commodity prices were significant for the company. But with oil back up, is oil and gas as a customer group making a nice contribution to the rise you're seeing in your pipeline and the nice 1.3x book-to-bill that you had in the quarter? And do you expect it to continue to trickle up as a contribution over the next couple of quarters?

Yes. No. If you look at our pipeline, I don't think I said it in my prepared remarks, but we're up almost last couple of quarters. That is the oil and gas industry coming back online (inaudible) project recently we've got (inaudible) both in California as well as Mid-Atlantic. So we are seeing, especially, U.S. oil and gas start to pick up. We also have some quotes out there for some offshore platform work. So definitely, as oil gets around the $50 a barrel level, activity picks up. As it gets further away from $50, activity slows down. But again, I think we're going to see it be a significant contributor. We want to make sure we can -- we have profit diversification. So oil being 70% of our business is challenging, but oil being 30% of our business and being a nice contributor is a lot better place to be. And as I said, the FPP contract margins and attachment rate are much better in CHP. This looks like oil and gas customers used -- are very used to buying equipment. They're cheaper to get repeat orders out of. So I think the real answer is it's a positive blend. But we are seeing the front end of our pipeline increasing, which is very encouraging.

Great. And then just a quick follow-up there. So with oil staying somewhere close near to $50, how do you feel about conversion of the pipeline? Are there any specific items you need to see that maybe facilitate this? Maybe something on the regulatory front or something on the macroeconomic front? Or are these essentially all discrete projects that move at the beat of their own drum?

Yes. They're really discrete projects. I mean, most of our oil and gas customers are repeat customers so whether it's Anadarko, Chesapeake, Pioneer, WPX. I mean, a lot of these customers are folks that already have, in some cases, over 100 microturbines. So it's just a matter of them doing their next project. As you know, Craig, we actually lower the operating expenses of our oil and gas customers when they use associated gas in our microturbines. So as they deploy equipment, as they build out infrastructure, we hope to see that their business increase.

(Operator Instructions) And our next question comes from the line of Colin Rusch with Oppenheimer.

Can you talk a little bit about the pacing of the sales cycle at this point? Are you seeing any increases in that? Or anything that would basically, that some of the pipeline may start flowing through a little bit faster than we may be anticipating?

I would love to say we lowered our sales cycle from 11 to 13 months to 7 months, but that's just -- that's not the case. I think the challenge, especially in energy efficiency, is that it tends to be a longer sales cycle. That being said, we just -- our sales and marketing group has a lot of work to map the sales cycle, to define it better for our distributors, give them better tools to make sure that they don't miss a step in the sales cycle. So I think our goal is really when you look at that $1.5 billion pipeline, how to increase the close rate. So if we're from 9% to 11% close rate, how do we get that number up? And then where we can improve the sales cycle, we will. But I think a lot of these projects just have a sales cycle that is extremely hard to compress. And in some cases, getting the order is one thing. If you look at the work we're doing in New York, we've had a lot of nice press releases in New York whether it's related properties, new builds or stay fresh, new distribution center or new hospitals in the Bronx. But a lot of these projects are 2-year projects, from a construction cycle standpoint. So just getting the order is one thing but then, delivering the equipment is another challenge. So I think the -- we'll continue to work on it, and I think we've got better tools for our distributors. But it's always going to be something that will be challenging, especially in the energy efficiency space.

Great. And then I know you've gone through some real serious reconfigurations with your distributor channel, particularly overseas. But could you talk a little bit about the evaluation on that project and the results that you're seeing, from all that work that you've done over the last couple of years?

Yes. No. I think we've done a better job developing distributer KPIs, and so key performance indicators. We used to focus more just on revenues, which didn't always give you the true performance of a distributor. They may get one big order that gives them good revenue for the year, but they're not doing all the underlying activities that make them successful. So we've developed a very detailed model distributor program, so we can go to distributors and say, okay, here's all the activities you need to do from marketing, sales, lobbying to working with your local gas company. And here's how you apply the product. Here's how you do -- you look at customers. Here's how you propose the equipment. So we've given a very detailed business plan on how to operate their business. And then we developed key KPIs that we can then monitor them and say, okay, are you adding enough sales leads every week? Are you processing your FPP paperwork correctly? Are you doing all the different things that will make you a world-class distributor? And we've seen the distributors that have adopted it do very well, and the ones that are fighting it are struggling. And if they're fighting it, then they're finding additional distributors in their territory or, in some cases, finding their territory get smaller. And in the most terrible cases, we're actually canceling them. But we're -- that's our last resort. Obviously, we're close to 90 distributors, all of them are partners. We don't want to cancel them. We want to help them be successful and help us be successful.

I'm showing no further questions at this time. I would now like to turn the call back to Darren Jamison for closing remarks.

Great. Thank you, operator.

Definitely great questions, folks. I know we're running a little bit long today but we had a lot to go over. I do want to mention a couple of house cleaning things.

As part of our war on costs, we're not going to be holding a formal annual meeting or a full-blown annual meeting. We're going to do just the minimum at our new SEC Council's office in L.A., so we're not doing management presentations. We're not going to do a tour of the facility. So we're going to lower the cost there but we are going to do a facility tour, open house, after we get everything moved over to Stagg. So it will probably be Q3, Q4. We'll do an Analyst Day and a Shareholder Day after we reconfigured into one plant and have something really impressive to show everyone. So please note the annual meeting will just be a bare bones SEC minimum requirement at our lawyer's office.

Annual report, you'll notice the same thing. No more glossy pictures. We'll just have the cover, very bare bones again. Again, it's just everything we can do to lower cost. And then you'll see either probably tomorrow or the day after, NASDAQ listing change on the 8-K. We did get our 6-month extension to get over $1, so that's also positive news.

So with that, I guess on behalf of Capstone, I would like to thank all of our valued stockholders, employees, distributors and suppliers for your continued support. We look forward to reporting on the progress being made and the milestones we achieve over the course of what looks to be an extremely exciting fiscal 2018.

And with that, we'll sign off. Thank you.

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