Capstone Green Energy Corp (CGRN) 2018 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Capstone Turbine Corporation Earnings Conference Call for Second Quarter Fiscal 2018 Financial Results ended on September 30, 2017. (Operator Instructions)

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 2018 Second Quarter Conference Call. Today, Capstone issued its earnings release for the second quarter of fiscal 2018 and filed its quarterly report on the Form 10-Q with 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, November 2, 2017. Capstone disclaims any obligation to update or revise these statements to reflect future events or 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 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. Good afternoon, everyone, and thank you for joining today's Fiscal 2018 Second Quarter Conference Call. Today I'll be starting the call by commenting on quarterly business highlights, and then I'll turn the call over the Jayme who will review the specific financial results. Jayme will then turn the call back to me, and I will talk about multi-faceted profitability plan and what we are doing to accelerate our plans to reach adjusted EBITDA breakeven in the upcoming December and March quarters, which would mark a significant milestone for the company, its employees and stakeholders.

Please note that as Jayme and I go through the discussion today, keep in mind when we mention EBITDA, we are referring to the adjusted EBITDA calculation, and that reconciliation is located in the appendix of today's presentation.

The second quarter and 6-month year-to-date financial results for fiscal 2018 were essentially in line with our internal expectations, and represents a significant improvement over last year. In fact, our second quarter operating expenses were the lowest in 18 years, and we are now getting close to the 50% overall reduction since we started our war on cost initiative. I'm not sure how many other public companies have lowered their operating expenses by over 50% without comprising customer satisfaction, eliminating major product lines or entire business units. Regardless, I am very excited about this remarkable accomplishment, and I am very proud of our Capstone employees who have executed this dramatic cost reduction plan, and frankly, exceeded all of our internal goals.

During the second quarter, we continued to make significant progress on our multipoint strategic profitability plan. We recently announced that we were expecting to see an expansion of our accessories, parts and service business over the next 2 quarters with increases in revenue and improved margins from today's approximately 30% gross margin to a record 40% gross margin by the end of the fiscal year. And we are well on our way to our final accessories, parts and service target margin of 50, that is 5-0, percent.

In addition, we recently announced that we are further lowering our operating expense target to $5 million a quarter. Once our Chatsworth facility, which will be empty in the next couple days, is subleased, as well as our recently announced agreement with our new Russian partner, that we'll generate $2.5 million in bad debt recovery in the next 2 quarters.

Lastly, we recently confirmed shipment of a very large 5.2 megawatts for a big pipeline project. We believe this shipment gives us a great opportunity to accelerate our goal of reaching EBITDA breakeven in the upcoming December and/or March quarters.

Now let's go ahead and turn to Slide 3. Slide 3 highlights some of our many business accomplishments in the second quarter, and I'm proud to say one of the biggest ones is we recently received a letter from NASDAQ saying that the company had regained compliance with the NASDAQ Stock Market's minimum bid price listing requirements, thus avoiding the need for us to enact reverse split approved at our recent stockholder meeting.

We recently signed a 2-megawatt factory protection plan multiyear contract with our Hawaiian distributor, Critchfield Pacific, for a global resort hotel chain on the island of Maui. Total FPP long-term contract coverage for Capstone units operating in Hawaii now stands at 74% as a result of this multi-megawatt contract.

AIDC secured the first C1000 Signature Series order for a biogas project in Taiwan. The biogas-fueled microturbine will be installed at a large piggery, and was selected for the project due to its high reliability, low maintenance requirements, very low emissions, and successful use in other biogas applications around the world.

As I mentioned earlier, we've executed a new agreement appointing a new oil and gas distributor in Russia. This agreement grants Turbine International and its affiliate, MTE Service, the sole distribution rights for our products and services in the Russian oil and gas sector in exchange for $6.3 million in cash, which includes $2.5 million in bad debt recovery over the next 2 quarters.

We developed a new partnership with Energy Innovation Center, or EIC, in Pittsburgh to retrofit its building with clean and green Capstone microturbines. EIC worked with E-Finity, our local distributor, to install the 2 natural gas-fueled microturbines to provide integrated cooling, heat and power, or ICHP, Capstone's integrated heat recovery module, or HRMs, on top.

We successfully wound down our $5.2 million field retrofit program to upgrade non-Signature Series C1000 and C200 microturbines. This retrofit program was completed on schedule and within budget. This critical program provides a significant improvement in demonstrated performance and demonstrated reliability of all non-Signature Series C1000 and C200 microturbines.

Also as mentioned earlier, we announced a new plan to further lower our total operating expenses by an additional $500,000 per quarter, or $2 million a year. As a result of the new management, quarterly total operating expense target has been set for $5 million. This includes the successful completion of its consolidation plan for the 2 manufacturing facilities into a single manufacturing facility, allowing for immediate increase in operational efficiency, reduced facility expense when the exited facility is subleased.

And lastly but not least, Capstone Energy Finance executed a 5-year agreement with a large greenhouse operation in Colorado. Multiple propane-fired C65 microturbines will be installed in standalone mode at a remote location to provide electricity for the Colorado greenhouse.

I'll now turn the call over to Jayme to discuss the specific financial results for our fiscal second quarter 2018. Jayme?

Thanks, Darren. I will now review in more detail our financial results for the second quarter of fiscal 2018. The highlights can be found on Slide 4.

Overall, we booked another strong quarter. Revenue for the second quarter of fiscal 2018 increased $4.8 million, or 32%, to $19.8 million, compared with $15.0 million in the year-ago second quarter. Product revenue for the second quarter of fiscal 2018 was $12.2 million compared to $8.2 million in the second quarter of fiscal 2017, an increase of $4 million or 49%.

We shipped 11.3 megawatts during the second quarter of fiscal 2018 compared with 8.2 megawatts in last year's second quarter, an increase of 3.1 megawatts or 38%. The increase in revenue in megawatts shipped was because of the shift in product mix as we sold higher number of our C65, C200 and C1000 series systems during the second quarter of fiscal 2018 compared to the same period last year.

Accessories and parts revenue increased $0.5 million, or 15%, to $3.8 million for the second quarter of fiscal 2018 compared to $3.3 million for last year's second quarter. This increase in revenue was primarily because of higher accessory shipments.

Our service revenue increased $0.3 million or 9% for the second quarter of fiscal 2018 to $3.8 million compared to $3.5 million in the second quarter of fiscal 2017. This increase in revenue was primarily the result of our growing installed base, and as a result of an increase in our energy efficiency customers purchasing our FPP service agreements.

Gross margin for the second quarter of fiscal 2018 was $3.0 million or 15% of revenue, compared to gross margin of $0.7 million or 5% of revenue for last year's second quarter. The improvement in gross margin was primarily the result of a shift in product mix and lower warranty costs, offset by an increase in our production service and our overhead expense, higher royalty expense, and an increase in inventory charges.

R&D expense for the second quarter of fiscal 2018 decreased $0.3 million, or 21%, to $1.1 million from $1.4 million in the year-ago second quarter. Reduction in R&D expense resulted primarily from lower supplies and salaries expense, net of severance cost, related to cost reduction activities.

SG&A expense in the second quarter of fiscal 2018 decreased $0.2 million, or 4%, to $4.8 million from $5.0 million in the year-ago second quarter. The SG&A decrease consisted primarily of decreases in salaries, facilities, and professional service expense. These reductions in expenses were the result of our ongoing war against cost throughout our organization. These decreases were offset by lower bad debt recovery in the second quarter of fiscal 2018 compared to the same period last year.

Total operating expenses for the second quarter of fiscal 2018 decreased 8% to $5.9 million from $6.4 million in the year-ago quarter. Operating expenses, excluding bad debt recovery, decreased 14% for the second quarter of fiscal 2018 to $5.9 million from $6.9 million for the second quarter of fiscal 2017. Bad debt recovery for the second quarter of fiscal 2017 was $0.5 million compared to $9,000 for the second quarter of fiscal 2018.

The loss from operations for the second quarter of fiscal 2018 improved to $2.9 million from $5.7 million in the year-ago second quarter.

Net loss for the second quarter of fiscal 2018 improved to $3.7 million compared with a net loss of $5.9 million from last year's second quarter. The improvement in the net loss during the second quarter of fiscal 2018 was primarily because of an increase in revenue of 32% and a reduction of operating expenses of approximately 8% compared to the same period last year.

Net loss per share was $0.09 for second quarter of fiscal 2018 compared with a net loss of $0.19 per share in the same period last year.

Weighted average shares outstanding at the end of the second quarter of fiscal 2018 were 42.9 million compared with 30.5 million in the year-ago quarter.

The adjusted EBITDA for the second quarter of fiscal 2018 was negative $2.3 million, or a loss of $0.05 per share, compared to an adjusted EBITDA of negative $5.1 million, or a loss of $0.17 per share, for the second quarter of fiscal 2017.

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, change in warrant valuation, and restructuring charges. Restructuring charges include onetime costs related to our cost reduction initiatives. Please refer to Slide 15 in the appendix titled Reconciliation of Non-GAAP Financial Measure for more information regarding this non-GAAP financial metric.

Now turn to Slide 5 as I will provide some comments on our balance sheet and cash flows. Cash used in operating activities for the second quarter of fiscal 2018 decreased 35% to $5.1 million as compared to cash used of $7.8 million in the second quarter of fiscal 2017.

Working capital change for the second quarter of fiscal 2018 was negative $3.2 million as compared to a negative $3 million during the same quarter last year. Cash usage, excluding net proceeds from equity transactions, during the first 6 months of fiscal 2018 was $5.2 million lower, representing a 38% reduction compared to the same period last year.

At September 30, 2017, we had cash, cash equivalents and restricted cash of $15.2 million compared to cash, cash equivalents and restricted cash of $19.7 million as of March 31, 2017, and $16.1 million as of September 30, 2016. However, last week we entered into a warrant exercise agreement, and received net proceeds of approximately $1.7 million from the exercise of existing warrants, which was not dilutive to existing stockholders calculated on a fully diluted basis. This not only contributed to our objective at maintaining a strong balance sheet, but also contributed to our objective of working to clean up our cap table.

Our accounts receivable balance as of September 30, 2017, net of allowances, was $13.2 million compared to $17 million at March 31, 2017, a decrease of $3.8 million or 22%. And our accounts receivable balance as of September 30, 2016, net of allowances, was $12.8 million.

Our days sales outstanding, or DSO, improved to 61 days compared with 68 days as of March 31, 2017 and 78 days as of September 30, 2016.

Inventories increased to $17.3 million as of September 30, 2017 from $15.5 million as of March 31, 2017 as a result of an increase in finished goods. And inventories were $19.2 million as of September 30, 2016.

Our accounts payable and accrued expenses were $14.1 million as of September 30, 2017, compared to $14.7 million as of March 31, 2017. And accounts payable and accrued expenses were $12.1 million as of September 30, 2016.

We booked product net orders of approximately $5.8 million during the second quarter for a 0.5:1 book-to-bill ratio, compared with $16.9 million of product net orders booked during the prior quarter, which was a 1.3:1 book-to-bill ratio. And we booked $8.9 million of product net orders during the year-ago second quarter, which was a 1.1:1 book-to-bill ratio.

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

Thanks, Jayme. In my opinion, the single most important slide in today's investor presentation is Slide 6. So let's go ahead and turn to Slide 6. Slide 6 shows where the business is today and where the business needs to improve in order to close the gap on reaching EBITDA breakeven as quickly as possible. This slide not only highlights the areas of necessary improvement, but also has corresponding notes and comments on what strategic initiatives management has put in place or undertaken in order to improve the business results and achieve this goal as quickly as possible.

Let's go ahead and start at the top of the slide with revenue. As Jayme just said, total revenue for the second quarter increased 32% to $19.8 million over the prior-year second quarter. Product revenue increased 49% to $12.2 million. And accessories, parts, and FPP long-term service revenue increased 12% to $7.6 million, all over last year's second quarter. However, if you look at it from a year-to-date or 6-month perspective, we were up approximately 14% over last year's same time period. Obviously this is great, considering some of the lingering market headwinds we're facing, but we need to get to $25 million per quarter as quickly as possible to reach our EBITDA breakeven goal.

Slide 7 highlights what we were doing to increase future revenue from today's approximately $20 million quarterly run rate to tomorrow's $25 million target run rate. In order to grow revenue $25 million a quarter, we have launched several new strategic initiatives, all centered around our world-class products and services.

These include the following: new Signature Series microturbine product focused on the CHP markets, or CCHP market; the launching of a new sell-to-win ICHP bundled solutions program; launching a special platform for FY '15 (sic) [’18] for all future 5 and 9-year factory protection plan service contracts that are 100% prepaid. So that's prepaid 5-year and 9-year service agreements. We launched a program to sell Signature Series upgrade kits for older model non-Signature Series systems to give them some of the benefits of the current Signature Series product.

A new spare parts price increase, which is 5% domestic and 3% international because of the difference in the strength of the dollar. A new creative plan to increase FPP service contract attachment rate targeted for the second half of fiscal year. New spare parts programs planned also for the second half for the fiscal year as well. And last, we have a focus on distributor recommended spare parts stocking levels to help increase quarterly spare parts revenue.

Although, as Jayme mentioned, our book-to-bill ratio temporarily slowed compared to the previous 2 quarters as our product mix shifted to smaller 65-kilowatt units during the quarter, these bookings should rebound in the third quarter as that traditionally is our strongest quarter of the fiscal year as December is yearend for many companies.

Also, the second quarter book-to-bill results do not take into account the recent hurricane activity, which is driving additional near-term opportunities in Texas, Florida, and Puerto Rico. We had previously quoted projects in these regions, however, as a result of the recent hurricanes, the project operators are looking to potentially accelerate their project timelines.

If you turn to Slide 8, on Slide 8 you can see the impact of the recent hurricanes and the past results from Hurricane Sandy back in October 2012. The positive news is the overwhelming majority of our products, our microturbine installations in Texas, Florida, Puerto Rico, Dominican Republic, and U.S. Virgin Islands not only survived the storms, but were fully operational, providing critical power, and in some cases power needed to pump water for our customers.

You can see one of our sites pictured in the slide. You see 2 fully operational Capstone C1000 microturbines at the Margaritaville Hotel in St. Thomas, surrounded by debris from Hurricane Irma. This was the only hotel that we know of that had electricity and water in the area after the storm. Capstone had similar results in late October 2012 when Hurricane Sandy devastated the states of New York and New Jersey. An estimated 93 of our 95 microturbines in the affected area remained fully operational during the storm.

Looking at the bar chart in the lower left hand corner of this slide, it highlights how 5 years removed from Hurricane Sandy, RSP Systems, Capstone's distributor for the Greater New York area, is now a top 3 Capstone revenue producer worldwide, and truly illustrates how a dramatic loss of energy during a hurricane can influence customers to find a new and better way to get their energy.

Another key part of our strategic profitability plan is improving our gross margins. As Jayme outlined in her comments, our quarterly gross margins increased from $3 million -- or $3.0 million for the quarter, or 15% of revenue, from $700,000, or 5% of revenue, in the year-ago second quarter. In addition, we are working to sell higher margin accessories, and we have a direct material cost reduction program well underway for new Signature Series product to lower the direct material cost for this key new product line. We also have a program to get 80% of our annual material spend under long-term purchase agreements. We expect to accomplish this by March 31, and this will additionally lower our parts acquisition cost.

These strategic initiatives, when combined with our new revenue growth, are expected to move our margins from today's 15% and approach 20% over the next 2 quarters. It should also be noted that these initiatives are specifically designed to both improve margins and also generate positive working capital, as working capital management is still critical to our business at this state.

Besides growing revenue and improving margins, the third item of our multipronged profitability plan is continuing to dramatically reduce operating expenses. As Jayme highlighted, our operating expenses for the quarter decreased 8% to $5.9 million from $6.4 million a year ago. Operating expenses are the lowest reported since fourth quarter of fiscal 1999 where revenues were a fraction of where they are today. That's 18 years.

Slide 9 outlines the clear path from our second quarter $5.9 million in operating expenses to management's new goal of $5 million. As you can see that the recent cost reduction activities related to the engineering reorganization and the subleasing of the Chatsworth facility are the last 2 major items left to be realized in order to achieve this goal.

Capstone's current $5.9 million quarterly operating expense compares extremely favorably with other public companies that are in the clean tech space, whether they are fuel cell companies, ultra caps or any other clean tech technology. All of these companies' quarterly operating expenses are about $10 million to $15 million a quarter. Capstone is hands down the industry leader on operating expenses within our space, even before we finish consolidating our 2 facilities and hitting our new $5 million target.

I encourage everyone to now look at Slide 10. Slide 10 shows how favorable Capstone compares to other public clean tech companies in our space that also report quarterly. You will notice very quickly that Capstone beats the collective peer average in at almost every aspect with one exception, and that's market cap. But I firmly believe that that will change also when investors realize we no longer have heavy exposure to Russia, and that we have no longer heavy exposure to the volatility of crude oil prices that we were seeing in the past, back in the past when Capstone had a $300 million to $400 million market cap.

As you've seen earlier in the call, the recent improvements in revenue, recent improvements in margins, recent improvements in operating expenses have produced the lowest EBITDA loss in 16 quarters. However, as excited as the management team is about these second quarter results, we are much more excited that we finally have a very clear line of site to near-term EBITDA breakeven for really the first time in company history.

We can all agree that that will be a tremendous accomplishment, but it's more important to remember that this is a milestone; not a destination. Management's goal, make no mistake, is to create a worldclass, highly profitable, distributed energy solutions company that sets the gold standard for clean and green onsite energy generation.

With that, operator, I'd like to open the call up to the analysts' questions.

(Operator Instructions) Our first question will come from the line of Craig Irwin from Roth Capital.

Darren, I wanted to ask a little bit about the impact of this hurricane activity. Can you maybe give us color on the installed base in Texas, Florida, and Puerto Rico? And the approximate breadth of the pipeline in those 3 geographies maybe combined, prior to the hurricane? And I know it's very early days as far as the recovery in all 3 since, but your partners down there must be very active in working with customers on recovery. Structure hardening effort likely to take shape over the next couple years. Any color you could share there, please.

Absolutely, Craig. It's an important point. As I kind of pointed out in the presentation, when these kind of events happen, it really has a strong impact on customers. Because when you lose power for a couple hours, you don't think very much about it. But when you lose it for weeks at a time, or in the case of Puerto Rico, could be months or even a portion of the year, that has a dramatic impact on what peoples do and how they look at their energy going forward. And frankly, highlights how fragile the electric utility grid really is in most areas. Plus the fact these storms are getting more frequent and more dangerous and stronger with more damage. So I think if you look at it, I'll take the last place you said first. I'll take Puerto Rico. I was there a little over a year ago. We have pending projects right now with the local brewery. We have a couple megawatts at the airport pending. We have about 7 or 8 pharmaceuticals that I visited that has anywhere from 1 to 2 megawatts in pending projects. These projects are really spurred by the fact that the local government could no longer continue to subsidize the utility, and the utility rates were projected to go up as much as 50% over the next year, and so they were starting to look at what they were going to do to offset those energy costs. I think the dramatic impact that this hurricane had is going to improve those project economics, as well as drive more demand. We have a Popeye's Chicken that's running very well right now in Puerto Rico, as well as some other smaller hotel operations. But any of these customers that have microturbines that survived the storm are a great sales tool for our distributors. We've seen a huge inbound rush of calls, everything from a single C30 or 65, up to multiple megawatts. We're handling those as quickly as we can. Expect the important point is we're not really a temporary power solution. We are a prime power solution. So we're not looking for opportunities to provide power for a few weeks. We're looking for opportunities to harden infrastructure, help customers save money, and avoid the next hurricane and the next outage going forward. And so we'll look for the customers that are industrial or commercial customers that are looking to put in multiple megawatts and really want to do an energy efficiency CHP/CCHP application. Texas and Florida, a little harder to get a handle around. We have a lot of product in Texas already. A lot of oil and gas opportunities, as well as CHP. We were seeing an increase in that market anyway with the work our distributor was doing. So I expect to see additional increase there, similar to what we saw in New York. I think as the New York slide shows, we went from less than $0.5 million a year in microturbine sales for probably 5 years running, and then we jumped to $3 million for 3 years and then 4 and then 5 and we should be about 7 this year. So very, very strong. And the biggest change with Sandy that people woke up and realized onsite generation that saves money, but also hardens my infrastructure, is a win-win. And so I think we'll see similar results in both Florida and in Texas. Never want to capitalize on bad things that happen to people, but I think the reality, the infrastructure that we have in the U.S. in many of these areas is not that robust, and it's getting older every year. So I think more and more of these outages are going to happen, and more and more folks are going to look at putting onsite generation behind the meter at the source. If you look at that picture on Slide 8, a lot of people wonder about natural gas. These are actually propane-fueled machines at 2 megawatts. You see there in the right hand corner, you see an aboveground LNG or propane tank. So they have their own onsite fuel. I believe those units will run for up to about 3 months on that propane tank. Whether it's propane, LNG, CNG, diesel, biodiesel, kerosene, we don't care; whatever fuel you can get in abundance and make sure that you can harden your infrastructure.

Second thing I wanted to ask about is the factory protection plan. I know you guys were looking at a couple million dollars in uplift to gross margins a quarter as you mature the business model towards this. But maybe can you scope out where we stand today as far as attach rates? What do you see as important things that'll drive up attach rates, and how does this impact attach flows over the course of the next year?

So let me say, our attachment rates today are on average about 30%, but if you look at them by market, they vary quite a bit. And the shift that we've seen over the last 2 years or even 18 months is really driving those attachment rates. So when we were heavy oil and gas, oil and gas users have onsite indigenous personnel that are highly trained and they want to do that service work themselves. And they're very concerned about having people on their site because of security issues and health and safety issues, so they weren't buying our factory protection plan at a very high rate. As we shift over to CHP and CCHP, those folks are buying those factory protection plans at a much higher rate. So if you look at our factory protection plan revenue, our accessories, parts and service revenue over the last 3 years, even though we had market headwinds and product was declining, our service business has been growing and building. And so those attachment rates will continue to go up. In New York, we're probably close to 80%. I think it just depends on which market. I mentioned 74% attachment rate in Hawaii. So markets that are very heavy CHP, you see very high attachment rates. Areas that are very heavy oil and gas, you see lower attachment rates. But make no mistake; the shift to energy efficiency is driving more service revenue, more accessory revenue, because we have the onboard heat recovery modules that you don't have for oil and gas, and we're seeing better pricing in a lot of cases. So it's very, very important as we continue to move into the energy efficiency space from a margin standpoint, revenue per sale, and growth of our service business. So I think that's very important. The other key that people are missing is that $5 million field retrofit program that we did took the Signature Series, high reliable new parts that we put into the machine and put them back into existing product was already in the field at higher failure rates. And so part of the way you're going to see in our margin improvement over the next couple quarters is the older product not failing. And so our cost to goods sold on the FPP going forward is lower on the new Signature Series, but will also be lower on the older series units now that they've been retrofitted. Finishing that retrofit program not only was that $5 million of cash that was very hard for us to come by and to spend, but we're probably avoiding $30 million of future cost of goods sold in our factory protection plan. So that is a huge shift. Going from -- again, people don't quite understand the math here. If you're doing $7.5 million a quarter at 30% margin, you're throwing out one level of contribution margin. You go to $8.5 million or $9 million of revenue at a 40% margin, that's a significant bulk of the revenue growth at a margin improvement. You take that to $10 million at 50%, which is our ultimate goal, you're now covering your entire operating expense with your aftermarket [reaferring] service business, meaning any product revenue for the quarter goes to the bottom line. That is a dramatically different business than where we were 3 years ago.

And my last question is about RSP Systems. Looking at the chart you gave us on Slide 8, looks like they had about $17 million in total revenue over the next 5 years after Sandy, after being a sub-million dollar distributor. That's actually quite a lot better traction than what I remember. Maybe 70% more. Would this kind of an uptick be directly translatable to Florida, Texas and obviously Puerto Rico, or do you expect more variance in the different markets?

No. I think obviously every market is a little different, but I would say RSP Systems was a distributor that had been on onboard about 5 years at that point. And so they've been seeding the market, working very hard doing sales and marketing, lunch and learns with architects and engineers. So they had plowed the ground and did a lot of work prior to Sandy, so they benefited. I would say that if you look at Texas, that's got one of our better distributors, Horizon Power, who's another long-term distributor that's also been plowing the ground. And Florida is E-Finity, who is also one of our best distributors who's done a lot of great work. I think because those markets have very strong distributors who have been out there doing the marketing efforts, doing the missionary work, they're going to reap the benefits. As I mentioned, in Puerto Rico, we have a less experienced distributor, but the factory, myself, Jim Crouse, we spent time in the region and have been out there working with these customers, and we'll soon be going back there again helping them close these orders. And so I think every market's a little different, but these aren't unusual results. I think the reality is -- again, the hardest part with energy efficiency space is getting people's call to action to move forward on a project. Oil and gas customers have to buy a product, they have to buy somebody's generator, and so the only issue is getting to buy ours. And there's the efficiency. You kind of lack that burning platform a little bit because they can keep buying power from the utility like they've always done. This provides a burning platform which will help drive those markets.

Great. Thanks again, and congratulations on the strong cost out progress. You always continue to impress.

I know it's not the sexiest thing in the world, but it really helps change our business. I have a son that likes to run marathons that I joke that I can now run a marathon in 11 miles. So maybe I got a chance to beat him now.

And our next question comes from the line of Colin Rusch from Oppenheimer.

Can you talk a little bit about the cadence of the conversion of these orders into actual sales? I'm assuming that there may be some movement as you adjust some of the distribution channels, as well as some of the urgency on some of these things.

I think the cadence with every distributor is a little bit different. Our goal is to improve the close cycle. If you look at our, call it $1.4 billion, $1.5 billion in pending orders, most distributors on average are in kind of 11 to 14-month range. We need to speed that up. I think the biggest thing you're going to see is the Signature Series is going to have a higher repeat order rate than the old series, they're called the R Series. Because we're seeing customers that are extremely excited with the product because it's more powerful, it's more efficient, it's more reliable. It's got better packaging, better controls. And so we're seeing companies, whether they're Corning or Mohawk Carpets or Pepsi or other big companies that are now trying the technology and are very, very pleased with it. And so the best way to drive a repeat order is to exceed customers' expectations. The new Signature Series is doing that, exceeding expectations. So I expect shorter sales cycle with that product as it continues to penetrate the market.

And then just thinking about gross margins on a go-forward basis. I know you're not guiding, but where's your confidence level on seeing incrementally better gross margins as we go into the back half of the fiscal year?

I think several things will drive better gross margins. Our operating expenses, even though they're low and getting lower, they're still relatively flat. And so whether Mr. Petty here builds $20 million of product or $10 million in product, our operating expense is about the same. As we crank up our production slots and put more product through the plant, we see higher margins in our product revenue. And I think you can see that quarter over quarter, our product margins improved fairly substantially over the last quarter, and that will continue as we put more product out the door. On the service side, like I said, the factory upgrade program, now that that's complete, the new Signature Series and just the growth of the service business is going to drive our factory protection plan margins. And so if our service margins are increasing, our product margins are increasing, our warranty rates are dropping because the new Signature Series is much more reliable than the older products, so those costs are going down. Then obviously we've done a lot to streamline our operations. And having everybody in one facility is going to have a big improvement that's hard to quantify, but it's definitely going to be there. I think with everything I've said, in my prepared remarks, we talked about margins going from the current 15% to 20%, which is kind of our near-term target really over the next couple quarters, so we should be very close. I think confidence level today, we've never been more confident about reaching near-term EBITDA breakeven than we are right now. I think you layer in the fact that we've got that Russian receivable collection now coming through, that even helps us more with that EBITDA breakeven effort with approximately $700,000 coming in Q3 and about $1.8 million coming in Q4.

And our next question comes from the line of Sameer Joshi from H.C. Wainwright.

Just a clarification on the book-to-bill. Have you in the last month seen a recovery in that and have had more bookings?

I think it's a great question. I think that what we saw in the quarter was much heavier on C65s. In fact, we had zero finished goods, or I think maybe one unit left on the dock at the end of the quarter, and we had booked almost 70% of this current quarter, last quarter. So very, very strong C65 activity last -- in the second quarter. The C1000 activity slowed down for the quarter. We are expecting that to pick up. We just announced an order in Taiwan, but we've got more that are very, very close we should be announcing soon. But it's too early to say what book-to-bill will be for the quarter. But I think the fact that we're rolling into the quarter pretty much with full production slots on the C65 line, we have that large pipeline project for the U.S. shale gas order that's confirmed to ship at the end of November. That allows us to add a couple more production slots this quarter for the C1000 production line. The C30 line we're only running about 10 a quarter, so it's not a big mover either way, but we hope to fill those production slots as well. I think from a revenue standpoint, we feel very good about Q3. We would like to see increased book-to-bill. I think the hurricanes will help that, plus some of the orders that were very close to closing last quarter will roll into this quarter.

And then just to follow up on that. Have you disclosed your backlog or pipeline? I may have missed it.

Yes, the backlog is $110 million at the end of the quarter.

Product backlog.

Product backlog, yes.

Correct.

Only the product backlog, okay. The second question relates to are you seeing any traction on the sell-to-win initiative? And when do you expect to see substantial revenues ahead of that initiative?

I think we've closed a couple of them. I would say -- I don't have the exact number in front of me, but it's probably 2. Again, with our sales cycle being kind of 12 to 14 months, it'll take a little while for some of those to come through. I think the other issue is EBITDA breakeven will make that a lot more attractive. And so we've launched the sell-to-win program now, which allows folks to get a discount on the microturbine, the heat recovery module, and the long-term service agreement if all of it's paid upfront. But customers are going to be reluctant to pay that long-term service agreement upfront until we're at least EBITDA breakeven or profitable. So we launched it a little ahead of that because of our sales cycle, but as we break through in EBITDA breakeven in Q3 and Q4, that's going to help customers feel a lot more comfortable about prepaying. Because frankly, our factory protection plan is a long-term insurance agreement, and nobody wants to prepay a long-term insurance agreement with a company that's not profitable. Make no mistake; EBITDA breakeven, as I mentioned, is a milestone, not a destination. But it's a very important milestone because it's very important to our vendors, it's very important to our employees, and most importantly, it's really important to our customers. And so these bigger kind of Fortune 100 customers are hesitant to buy from us until we're profitable. So that's going to be a great sales tool and a great lever to pull for our distributors going forward.

And my last question relates to there's a slide, Slide 12, about the Kenworth Class 7 testing. Would you comment on that and give us some more insight into it?

That's the Class 7 truck. That is a Kenworth vehicle. As you know, we have the Walmart Class 8 truck, which is a Peterbilt vehicle. You may not know, both Peterbilt and Kenworth are owned by Paccar up in Washington, from my neck of the woods. So we really look at the Peterbilt truck with Walmart as being a future move the market, take to shows kind of vehicle. We look at this Class 7 Kenworth truck as an actual truck that will go to a customer and actually do useful work. The picture you see here is up in Washington. This is on the performance track at Paccar. We did all sorts of different testing from gradients to speed to really work the performance out and the kinks out of the product. That is a refrigerated trailer that you see on that truck. You can see the refrigeration unit up top. That's an electric refrigeration unit. So the microturbine is both charging batteries and operating that refrigerated box trailer. As we get the kinks out of this product, it will go to Costco either late this winter or early in the spring for probably 6 months and maybe longer. After Costco, we've got a florist lined up that is very interested to try the technology as well. We list both automotive and marine as future markets or markets we're penetrating, but I think the seeds we're planting are very important, and they can lead to long-term applications of our product. And so whether it's a marine application or a truck application, we need to put successful installations out there, show customers what they can do. And really, we need to both push and pull. We need to get Costco and Walmart to pull, and we need Peterbilt and Kenworth to push. Again, not big revenue. The next couple quarters, we'll get to EBITDA breakeven and profitability without penetrating these markets, but when you look at where we're going to be in 2, 3, 5 years from now, these are very important installations and demonstrations that we're doing.

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

It's Aaron Spychalla on for Eric Stine. Maybe first on the gross margin side. Darren, you touched on it a little bit, but on the cost reduction program for the Signature Series, can you just talk about where we are in getting the 21 suppliers into long-term supply agreements, and just your confidence in the getting to that early 2018 goal?

I'd say it's really, it's two-pronged approach. We have specific vendors that are critical to the new Signature Series, and we're negotiating cost reductions, as well as engineering efforts to reduce some of those costs. We're focused on parts that are non-rotating for the most part. It's the fuel header, it's the enclosure, it's items that are low risk to take cost out of. So those are well underway, and we should have those done in the next couple months. I would say we're probably about 14 to 15 out of 21 vendors as far as long-term LTAs or purchase agreements. Unfortunately, the 4 or 5 we have left are some of our bigger hitters and are tougher negotiations, but those are in the process. And we've brought in a new purchasing professional recently that's going to help lead that effort, as well Kirk Petty and the rest of the team. But it's definitely a team effort. I feel very good about getting that done by the end of March, though. I think we're well underway. And again, I think the improvements in the business help us leverage some of those bigger vendors. Obviously when you're trying to get a long-term purchase agreement done and you're asking for cost reductions, the better our balance sheet looks and our profitability picture looks and the higher our revenue starts to grow, that gives us leverage in our side of the negotiation.

Maybe second on Capstone Finance. Can you just give us an update on the pipeline there and characterize maybe the size of the projects that are in that pipeline? And then with the first one done, just maybe talk about does it get easier from here after navigating the process with some, or is it going to be oneoff going forward?

It's a great question, but a little harder one. Every state has different rules. Every utility has different rules. So from a power purchase agreement contract standpoint, each one's a little bit different. Each customer has some different ideas on what they want the purchase agreement to look like, whether it's terms or length, so each one is somewhat custom. However, getting the first couple done on anything, just from a muscle memory standpoint, is helpful, so we're very excited to get that first one done. We've got about $60 million of identified projects, and those are moving through the pipeline. Obviously with the hurricanes, we had a lot of inbound balls and people looking to get product quickly, and so Capstone Energy Finance will be involved in some of those conversations. I would say, and I think I said this in the last call, a year from now we'll put some numbers up, and my guess is 3 out of 4 customers that look to Capstone Energy Finance will end up buying the equipment themselves. And so when they look at the benefit of not owning it and having zero risk versus the benefit of owning it, we will assure that some of that risk with our factory protection plan, it's a big drop in payback, and frankly a big drop in profit for them. So I think either way we win. I don't care whether it's Capstone Energy Finance or whether we sell it direct. Our goal is to sell microturbines and to penetrate the market and to get more and more customers to stop buying power the way their father and their grandfather did.

Then maybe last, just saw that in the tax bill today, there's tax credits in there for microturbines. Just curious your thoughts on that.

Obviously, we want to do everything we can to get our fair treatment by the government. I'm not big on government handouts. We've had bills in the past that either increased the microturbine tax credit to that of fuel cells and wind and solar, or removed all of them. So I'm a big believer that the government shouldn't pick winners and losers, and they shouldn't favor technologies. But if they're going to have tax credits for other technologies, we want to get our fair share as well. Again, we're fairly neutral. Either tax credits for all new clean tech technologies that are relatively equal, or no tax credits; we're okay either way. I think our goal, if you look at other folks in our space who lost the ITC, some of the fuel cell companies are doing creative things like giving away warrants to have customers buy their product. That's not a path we're going to go down. We're not going to give pieces of the company away to convince somebody to take our technology. Again, we may be a little more steak than sizzle sometimes, but we're about doing the right thing for our customers and the right thing for our shareholders and our employees.

And our next question comes from Jeff Osborne from Cowen and Company.

Most of them have been answered, Darren and Jayme, but just a couple quick ones on my end. I guess what are the swing factors of reaching EBITDA breakeven in December or March? Is it something on the production side, given the order trends that you expect to pick up here late in the quarter? I'm just trying to get a sense of what you control versus what you don't control to hit that target.

That's a great question. We've put the production slots in place. So the 5.2 megawatts for the large oil and gas customer has allowed us to safely add some more production slots and not risk negative working capital for the quarter. So we will build enough C1000 slots, 65 slots, and C200 slots to get us there. The real issue is did the customers pay their deposits, and are they credit cleared, and do we ship the units. And so that's always a challenge. I know folks hate hearing units sitting on the dock at the end of the quarter, but that will really be the issue. I think from the service standpoint, we have very good visibility on the growth of the service business, as well as the growth of the margin improvements. On the cost side, we're very comfortable with where the costs are unless, knock on wood, some weird cost item comes across the bow. We should see operating expenses drop from the $5.9 million levels to somewhere in the mid-5s. And so if you look at the $2.3 million of negative EBITDA for the quarter, you've got $0.5 million of cost improvement before we sublet the building from the recent cost out that we've done. You've got several hundred million dollars, if not close to -- or $700,000, if not close to $1 million, coming from the improvement in the service organization. And if the product revenue goes up $2 million or $3 million, that's additional contribution margin there. You add the $700,000 from the Russian receivable, you start doing that simple math on a back of a napkin and it looks pretty good. Again, we typically don't call near-term -- in fact, I don't remember us ever calling EBITDA breakeven in the next coming quarter or the quarter that we're currently in. That is a unique opportunity for us. And so we're excited about it. The team's very focused on it. As you've probably seen or you know, our management team, as well as myself, have forfeited any executive bonus program or additional equity until we got to 2 quarters or EBITDA breakeven. So that's something that we're all looking forward to getting that back up and going again. And so very, very focused team who's not had an executive bonus for several years until we got this thing to EBITDA breakeven. Getting there the next 2 quarters is job one.

Got it. Makes sense. I appreciate the detail there. Then in terms of the subleasing itself, where does that stand? You're fully out of the facility, it sounds like, but is that still being marketed or you feel you're closer?

Those things are tricky because we talked to the folks that are the professionals. They said it could take on average 6 months, but it could be as quickly as 3 and as long as 12. And so we couldn't market it too quickly because we're in process of getting out, and if we had a tenant that wanted it quickly, we couldn't be ready. And so we put it on the market about 2 months ago. We've had several folks look at it and view it like you would when you sell your house. We've got all of manufacturing into the new Van Nuys, or we call stag location, and that's all up and running. We just started moving employees last week, this week. My office is half packed. I'll be moving tomorrow. Jayme and the finance team will finish the quarter and they go the following week. And our goal is we've got a mid-November board meeting and to have all the employees under one roof. At that point then, we'll work on really turning the heat up on trying to get this facility sublet, because once we're out of it, there's no sense continuing to pay the rent. But then there's facility expense, insurance expense, lots of other costs that go with that facility.

That was my follow up is what is that roughly on a quarterly basis that would go away?

It's well over $100,000 a month just for the rent by itself, plus other insurance and everything else. So it's -- I think we've got some numbers in the deck, but those numbers are fairly conservative. It's a big cost reduction. Plus, this is the first time in I think 20 years the Company's been under one roof, and so since the very early days. The opportunity to leverage those efficiencies, I think it's going to be huge benefit to the business. And so having two plants that are a half an hour apart is very, very challenging. It's helped us lean our personnel. It helps us lean our processes. Communication lines are shorter. There'll just be a lot of good things that happen, being in the one facility.

I just had two other quick ones. One just a nitpick accounting question for Jayme. But as you receive prepayments for future service agreements, would that cash need to be restricted in any fashion, or would it just hit the bank and be easily accessible?

No. That wouldn't be restricted, and it'd just be sitting in deferred revenue.

And then how do we think about, Darren, it's been a couple quarters since I've asked you this, but just some of the larger multi-megawatt type contracts that are out there in the 10-plus megawatt range that have been lurking for several years now. Is there any movement on those?

It's a great question. We continue to see a shift towards larger opportunities. I would say our biggest installation to date is 8 megawatts up in Canada. It's an oil and gas installation. We just are commissioning 5 megawatts in Tennessee for Mohawk Carpets. That's a CHP installation, one of our biggest. We've got another big, I think 4-megawatt greenhouse down in Australia. So we're seeing kind of mid-tier, 4, 5, 8-megawatt opportunities that we're landing. We have not landed a 10-megawatt or above opportunity yet. They're still out there. We had the big opportunity down in Ecuador. Unfortunately, the government had some grafts and corruption issues and that sidelined that project for indefinitely. Hopefully the new government will come in and we'll get that revived. But I do think as we continue to strive to get profitable and the Signature Series gets out there, we're going to see more and more customers moving up the megawatt scale. And so I think that, combined with the higher rate of repeat orders, is going to help drive the business. Plus, if you look at the last 3 years, we've been impacted by the issues in Russia and the class of the ruble and the sanctions. We've completely restructured and reorganized our Russian business. You should see increased order rates and order flow from Russia going forward now. Obviously that $6.4 million is great to get that kind of -- cover that receivable that we've had fully reserved for several years. So we're getting cash that's been tied up on the balance sheet. We're going to get additional revenue from our 5 new distributors that are there. Plus we're more diversified and we have lower country risk, which is obviously a very positive thing. So that helps. I think you look at oil and gas or crude oil prices today are $55 a barrel. That's the best they've been for quite a while. We're seeing increased activity in the oil and gas space. As I just mentioned, that big oil and gas opportunity that we're shipping this quarter is one that firmed up nicely, and I think the higher crude oil prices helped that. And then the dollar started to weaken. And so if you look at all the headwinds that we've had, we've been suffering through the last 3 years, not only have we diversified the business, pivoted the business, made new products and services, but we're also seeing those headwinds start to subside. And so I think the combination of all the great things we've done to the business to get through those headwinds, and have those headwinds actually turn into tailwinds, that really makes me bullish on where we're going to be 2 or 3 years from now.

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

Great. No, I don't have a lot of closing remarks. I think the story is pretty clear. Our path to EBITDA breakeven is very clear. I think the questions we've had from the analysts have really hit all the areas I was going to hit in my closing remarks. Again, I know reducing your operating expense isn't the sexiest thing in the world, but getting down to $5 million operating expense is head and shoulders above anybody else in our industry. That makes any kind of revenue growth and improvements in our service business that much more leverageable and drives that much more improvement in our business. We're very excited about continuing to drop that EBITDA breakeven from the current levels all the way down to zero and then start generating cash. We know cash is very critical. We're managing our balance sheet as tight as we can. Working capital always happens. We had a great working capital quarter last quarter. Burned less than $1 million. We got hit a little harder with working capital this quarter as it just swings back and forth. But the reality is, we need to get profitable, blow through that EBITDA breakeven, and never look back. And that's really the goal from here. And we've got the right products to do it, we've got the right service organization to do it, and we've got the right customer base that's starting to come to us now. Whether it's from the hurricanes or from the new Signature Series or the changes we've made in the Russian market or the weakening dollar, all these things are going to help our business. And once we get profitable, I think the impact that's going to have on our distributors and their ability to get new customers and larger customers, we'll just never look back. I think we'll break through that and have some very nice growth from there. So, very exciting times. Very excited to finish packing my office and get over to the new facility, and really look at leaning out our operations and doing as much as we can to be as lean, mean, and cost effective as we can. So with that, I'll leave it up to close out the call and we look forward to talking to everybody at the end of our third quarter.

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