Capstone Green Energy Corp (CGRN) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Capstone Turbine Corporation Earnings Conference Call for Third Quarter Fiscal 2018 Financial Results Ended on December 31, 2017. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Ms. Jayme Brooks, Chief Financial Officer and Chief Accounting Officer. You may begin.

Thank you. Good afternoon, and thank you for joining today's fiscal 2018 third quarter conference call. Today, Capstone issued its earnings release for the third quarter of fiscal 2018 and filed its quarterly report on 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, February 5, 2018. 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.

Please note that as Darren and I go through the discussion today, keep in mind when we mention EBITDA we are referring to adjusted EBITDA and the reconciliation can be located in the appendix of our presentation.

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

Thank you, Jayme.

Good afternoon, everyone, and thank you for joining today's fiscal 2018 third quarter conference call. If you remember back in October, we publicly confirmed a large product order that afforded Capstone an opportunity to securely expand the production rates during the upcoming third and fourth quarters, thus fueling the opportunity for revenue growth necessary to support our EBITDA breakeven profitability model.

In October, we also announced that we were expecting to see an expansion of our accessories, parts and service business over the next 2 quarters as well as lower operating expenses and increased bad debt recovery, all of which, when added together, should significantly contribute to achieving our EBITDA profitability goals. Well, today, I'm very proud to announce that we, in fact, delivered on all of these elements and that we have achieved our EBITDA-positive goal, and the company is nearly net-loss neutral for the quarter.

This is a major milestone in Capstone's 30-year history and positions the company for its next stage of profitable evolution. As proud and excited as I am about this important achievement, I'm even more excited about the overall trends in our business.

If you look at Slide 3, you'll see that our business is improving not only quarter-over-quarter, year-over-year, but more importantly, 9-months-over-9-months in almost every possible area. We are seeing significant improvements in our revenues, in our gross margins, in our lower operating expenses, in our strengthening balance sheet, and importantly, that's all leading toward improved EBITDA and net income. I'm encouraged about our positive business trends, and I'm very proud of our Capstone employees who have executed this dramatic turnaround and helped us either meet or exceed all of our internal goals.

If you take a minute to turn to Slide 4, it outlines some of the recent business highlights as we continue to make progress in expanding our CHP market, in growing our profitable FPP long-term service contract business and in general, executing our multi-pronged profitability plan.

In the early stages of my career at Stewart & Stevenson, I had a mentor from West Texas that told me as a leader in business, you need to either have great numbers or you need to have a really great story to tell about your future potential. Well, today, I'm proud to say that Capstone story time is officially over as we have great numbers and we are positioned to build on this achievement going forward for years to come.

If you now look at Slide 5, you can see how our Q3 results compare to our EBITDA breakeven model that we've had out for some time. You can see we nearly hit the product revenue goal and posted record accessories, parts and service revenues. Total revenue was slightly below the EBITDA plan, but we made up the difference with higher gross margins for the quarter on lower warranty costs. Gross margins and total operating expense results were virtually identical to our EBITDA model.

At this point, I'll let Jayme discuss the excellent financial results for the quarter and then come back with some comments afterwards. Jayme?

Thanks, Darren.

I will now review in more detail our financial results for the third quarter of fiscal 2018. The highlights can be found on Slide 6.

Overall, we had an exceptional third quarter and we achieved our EBITDA profitability target, which is very encouraging. Product revenue for the third quarter of fiscal 2018 was $14.6 million compared to $12.8 million in the third quarter of fiscal 2017, an increase of $1.8 million or 14%.

Accessories and parts revenue increased $0.6 million or 16% to $4.3 million for the third quarter of fiscal 2018 compared to $3.7 million for last year's third quarter. Our service revenue increased $0.2 million or 5% for the third quarter of fiscal 2018 to $3.9 million compared to $3.7 million in the third quarter of fiscal 2017.

Total revenue for the third quarter of fiscal 2018 increased $2.6 million or 13%, $22.8 million compared with $20.2 million in the year-ago third quarter.

Gross margin for the third quarter of fiscal 2018 was $5 million or a positive 22% of revenue compared to a negative gross margin of $4 million or negative 20% of revenue for last year's third quarter.

R&D expenses for the third quarter of fiscal 2018 decreased $0.3 million or 23% to $1 million from $1.3 million in the year-ago third quarter.

SG&A expenses in the third quarter of fiscal 2018 decreased $0.8 million or 17% to $4 million from $4.8 million in the year-ago third quarter.

During the third quarter of fiscal 2018, we recorded a $700,000 bad debt recovery in SG&A from our new Russian distributor. Under the agreement, our new Russian distributor had a payment of $1.8 million that was due on February 1, 2018. This payment has not yet been received, and we are currently in discussions with them regarding the timing of this payment.

Total operating expenses for the third quarter of fiscal 2018 decreased 18% to $5 million from $6.1 million in the year-ago quarter.

Net loss for the third quarter of fiscal year 2018 improved to $0.3 million compared with a net loss of $10.7 million for last year's third quarter. This is an amazing improvement of 97% year-over-year. Net loss per share was $0.01 for the third quarter of fiscal 2018 compared with a net loss of $0.31 per share in the same period last year.

Weighted average shares outstanding at the end of the third quarter of fiscal 2018 were 46.8 million compared with 34.8 million in the year-ago quarter.

The adjusted EBITDA for the third quarter of fiscal 2018 was positive $0.4 million or a gain of $0.01 per share compared to an adjusted EBITDA of negative $9.6 million or a loss of $0.28 per share for the third quarter of fiscal 2017.

As a reminder, EBITDA and adjusted EBITDA are non-GAAP financial metrics. Please refer to Slide 15 in the appendix titled Reconciliation of Non-GAAP Financial Measure for more information regarding these non-GAAP financial metrics.

Now please turn to Slide 7 as I will provide some comments on our balance sheet and cash flow.

At December 31, 2017, we had cash, cash equivalents and restricted cash of $16.5 million compared to $15.2 million as of September 30, 2017. Cash used in operating activities for the third quarter of fiscal 2018 decreased 35% to $3.3 million as compared to cash use of $5.1 million for the second quarter of fiscal 2018.

Our accounts receivable balance as of December 31, 2017, net of allowances, was $16.1 million compared to $13.2 million as of September 30, 2017. Inventories decreased $15.3 million or 12% as of December 31, 2017, from $17.3 million as of September 30, 2017.

Our accounts payable and accrued expenses were $12.8 million as of December 31, 2017, a 9% decrease compared to $14.1 million as of September 30, 2017.

Now I'd like to turn our attention to our financial year-to-date results for the first 9 months of fiscal 2018 versus the first 9 months of fiscal 2017 as I believe the comparison is very compelling and illustrates the improvements we have made in our business. These impressive results can be found on Slide 8.

Product revenue for the first 9 months of fiscal 2018 was $39.4 million compared to $33.1 million for the first 9 months of fiscal 2017, an increase of $6.3 million or 19%.

Accessories and parts revenue increased $0.3 million or 3% to $11 million for the first 9 months of fiscal 2018 compared to $10.7 million for the first 9 months of fiscal 2017. Service revenue increased $1 million or 10% for the first 9 months of fiscal 2018 to $11.4 million compared to $10.4 million in the first 9 months of fiscal 2017.

Total revenue for the first 9 months of fiscal 2018 increased $7.6 million or 14% to $61.8 million compared with $54.2 million in the first 9 months of fiscal 2017.

Gross margin for the first 9 months of fiscal 2018 was $10.2 million or 17% of revenue compared to gross margin of negative $0.3 million or negative 1% of revenue for the first 9 months of fiscal 2017.

R&D expenses for the first 9 months of fiscal 2018 decreased $1 million or 23% to $3.3 million from $4.3 million for the first 9 months of fiscal 2017. SG&A expenses in the first 9 months of fiscal 2018 decreased $1.8 million or 12% to $13.8 million from $15.6 million for the first 9 months of fiscal 2017.

Total operating expenses for the first 9 months of fiscal 2018 declined 14%, $17.1 million from $19.9 million for the first 9 months of fiscal 2017.

Net loss for the first 9 months of fiscal 2018 improved to $8.1 million compared with a net loss of $21.1 million for the first 9 months of fiscal 2017. This is a remarkable improvement of 62% year-over-year. Net loss per share was $0.18 for the first 9 months of fiscal 2018 compared with a net loss of $0.68 per share in the same period last year.

The adjusted EBITDA for the first 9 months of fiscal 2018 was negative $5.3 million or a loss of $0.12 per share compared to an adjusted EBITDA of negative $18.4 million for a loss of $0.60 per share for the first 9 months of 2017.

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

Thank you, Jayme.

In my opinion, the most -- single most important slide in today's investor presentation is the next slide, Slide 9. Slide 9 shows where the business is today and where the business is going now that we've achieved our EBITDA breakeven milestone. This slide heavily highlights the areas where we will continue to improve the business, but also have the corresponding strategic initiatives management is taking and put in place to achieve this new target model as quickly as possible.

If we continue to improve the business as we have done over the last several years and achieve the necessary revenue growth, we should quickly become a highly profitable business with 34% gross margins and a 19% bottom line, with minimal in tax burden -- income tax burden because of our large federal and state NOLs.

We had previously announced that we were expecting to see an expansion of our accessories, parts and service business over the next 2 quarters, with increased revenue and improved margins from last year's rates. I'm particularly pleased to say that the Q3 service margins were a record 41.6%, and they should remain in this range for Q4 and Q1 of the new fiscal year but then start to build over the next several quarters toward our final target goal of 50%, driven by the continued population growth of our new Signature Series product and the continued development of our spare parts remanufacturing program.

If you now turn to Slide 10, you can see graphically the tremendous benefit of our increased service growth and strengthening margins in combination with our rapidly declining operating expenses as our reoccurring aftermarket service business is now covering more and more of our operating expenses.

As you look to the future, you can see a day when eventually all of our operating expenses are covered with our reoccurring service business over the next couple of years. At that point, Capstone is essentially breakeven on its reoccurring aftermarket spare parts and FPP long-term service contract business, and all the product or variable sales just add to the bottom line profit for the quarter.

This is truly a tectonic shift from where we've been historically over the past 30 years and reflects our focus on operational excellence and is a key part of our operational backbone of a successful energy technology company.

However, as nice it is to be EBITDA breakeven and almost net income neutral, Capstone's goal is much larger. We expect to be a several hundred million-dollar disruptive clean and green power generation business, and for that, we need accelerated revenue growth.

Slide 11 highlights what Capstone's management is doing to increase future revenue from today's approximately $23 million quarterly run-rate to tomorrow's target of $40 million quarterly run-rate. We believe the broader market for Distributed Generation or DG is accelerating as on-site power production and energy as a service is now becoming mainstream. The industrial commercial and utility scale markets are looking for more reliable and clean ways to reduce power, and this is especially true in CHP or combined heat and power. We believe the overall market is now a tailwind for us, and we need to execute on our specific strategy to grow revenue now.

In order to grow to the next level of $40 million a quarter, we launched several new strategic initiatives centered around our world-class products and services. These include many of the following you see on the slide: the new state-of-the-art Signature Series product focused on the CHP and CCHP market; launching of our new sell-to-win ICHP bundled solutions program; launching of a special program for FY '18 and FY '19 for all future 5- and 9-year FPP service contracts that are 100% prepaid at the time of execution; launching of a program to sell Signature Series upgrade kits for older non-Signature Series systems; annual new spare parts price increases; new and creative plans to increase service contract attachment rates in both CHP and in oil and gas; and lastly, a focus on distributor KPIs and more specifically, distributor spare parts stocking levels.

Also, the third quarter new product orders do not take into account the recent hurricane activity, which is driving additional near-term opportunities in Texas, Florida, Puerto Rico and other areas. We have previously quoted projects in these regions; however, as a result of the recent hurricanes, the project operators are looking to potentially accelerate the project time lines.

If you now take a look at Slide 12, you can see the impact of the recent hurricanes, from past results from Hurricane Sandy back in October 2012. As devastating as hurricanes have been to several of the hardest-hit countries, we are pleased to report that the overall majority of our microturbine installations located in Texas, Florida, Puerto Rico, the Dominican Republic and the U.S. Virgin Islands not only survived the storms but thrived. They're fully operational and providing critical power. In some cases, our microturbines are providing the power needed to also pump clean water. You can see pictures on Slide 2, fully operational Capstone C1000 microturbines at 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 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 out of 95 Capstone microturbines remained fully operational at that time. Looking at the bar chart on the lower left-hand part of the corner of the slide, it highlights how 5 years removed from Hurricane Sandy, RSP Energy Systems, Capstone's distributor in the greater New York area, is a top 5 Capstone revenue producer worldwide and truly illustrates how dramatic loss of energy can influence end-use customers to find new and better energy solutions.

Additionally, we're working to sell higher-margin accessories, and we have a direct material cost-reduction program well underway for the new Signature Series product to lower the direct material costs for this new key product.

We also have a program to get 80% of our annual material spend under long-term purchase agreements or LTAs hopefully by March 31 of this year. And obviously, we want to do that at lower acquisition costs wherever possible. These strategic initiatives, when combined with our renewed revenue growth, are expected to move our margins from today's 22% to our new targeted rate of 34% over the next several years. It should also be noted that these initiatives are specifically designed to both improve margins but also generate positive working capital as working capital management is critical to our business.

I encourage everyone to look at Slide 14 in our appendix, which shows how favorably Capstone compares to other public clean tech companies in our space that also report quarterly. You will notice that Capstone beats the collective peer average in almost every aspect, with one notable exception, and that's market cap. However, I firmly believe that will change now that we have achieved EBITDA breakeven, also as investors finally realize we have reduced our heavy exposure in Russia and that we are far less impacted by the volatility of crude oil prices today than we have been in the past. Not to mention the fact that crude oil prices have actually rebounded to the mid-60s per barrel recently, and natural gas prices continue to remain at record lows worldwide.

As we stated earlier in the call, the recent business improvements that have allowed us to achieve EBITDA breakeven goal are amazing, and I'm very proud of this historic accomplishment. However, we're just getting started in getting Capstone rolling. I think we can all agree that it is a tremendous accomplishment, but it's more important to remember that this is a milestone, not a destination for Capstone. So let us not forget the management's goals to create a world-class, highly profitable distributed energy solutions company that sets the gold standard for clean and green on-site energy.

With that operator, I will now open the call up for questions from our analysts.

(Operator Instructions) And our first question is from Craig Irwin from Roth Capital.

42% parts and service margin, that is really strong. You guys are executing really well in this category. And I was intrigued by your slide that laid out how you intend for service and OpEx absorption to basically match over time, in the next couple of years. Can you maybe discuss the growth trajectory you expect to deliver on the parts and service line over the next couple of years?

It's a new chart that we've now put in the deck. I think it really helps illustrate where we've been and where we're going as our accessories, parts and service business grows. I know the top line revenue numbers aren't as exciting as our product revenue numbers, but the margin rates as they move from 20% to 30% and now to 40% and headed to 50% really contribute to the overall health of the business and really help us from a profitability standpoint.

You're seeing increased interest in our Factory Protection Plan as customers are realizing it's more economical and you get better performance if you sign the FPP, that we've never raised our prices on our FPP contracts in 8 years and yet, we continually rise our -- raise our spare parts pricing. So the cost to self-insure is getting higher and higher, and the Capstone insurance policy for your long-term profitability of your project is a great choice. So I think you're seeing that element -- you're seeing distributors execute better on getting customers to sign up. You're going to start to see the bundled solutions, where we're bundling the FFP contract with the product and selling it all upfront. It's going to impact that as well.

We're seeing good attachment rates and reoccurring rates, where people are renewing their contracts. And more importantly, if you look at our business when we grew originally, it was on the back of U.S. oil and gas and shale gas activity. Those units have now been in the field for almost 5 years, and we're starting to see those units head for overhaul. And so as you're starting to see some overhauls in the higher-service business as the fleet matures, you're seeing a rise in that service business.

So you almost have a perfect storm of good events. The new Signature Series product warranty is down to about 1% and dropping. It's performing amazingly well in the field, extremely reliable. And then you're seeing the older product come up for maintenance events and service intervals. All at the same time, we're seeing product revenue return, which should drive additional service contract backlog.

So Stewart & Stevenson would call this 100% absorption. It makes you essentially recession-proof, which was critical for S & S as they were having the oil patch. But for us, it's really about making it a robust profitable company. It also would allow us to be more flexible in our product pricing. If all of our OpEx is covered by a reoccurring revenue, we get a lot more flexibility on how we price our products and how we go after key customers. So it is really a tectonic shift. It's like I said in my prepared remarks, this is a huge achievement for us and we're very excited about continuing to grow the service business.

Great. That's really good to hear.

So one of the things I noticed is I know you have a lot of initiatives beyond what you've actually shared with us. One of them, you press-released over the last couple of months, your severe environment air filtration system. Typical HRSGs on large turbines, the filtration on the front end is kind of like a razor and a blade model too, where you replace the filter cartridges regularly, and the actual system itself is very, very high-margin.

Can you maybe describe for us whether or not you see other factors that can potentially contribute in there, or are you looking at maybe some of these new products that you're introducing in the market as potentially incremental to the trajectory you've described for the next couple of years?

Well, twofold. One, we're seeing more accessory sales for our product, especially the C200, C1000 Series, heat recovery module or HRM. That's a new product for us, so CHP applications are -- or we're recovering heat from a machine that's driving new revenue. So a fully loaded C1000 may be a $1,000,000 box, but you have the heat recovery modules on top, and now it's $1,250,000. So it's a fairly substantial addition to any order that we get. So that's driving revenue for us.

We're also looking, as the volumes come up, how we can increase our margins and improve our cost structure in all the accessories as well. But we're also -- came up with a new line of controls and control systems and have some new capabilities with our controls, which are very exciting for our customers and how we transfer load and how we manage the units.

As you mentioned, high-dust environments, as we move into the Middle East, so we get product in Saudi Arabia, Qatar, Kuwait, we're seeing a need for high-dust environments. That's additional add-on accessories in sales force too. We're also looking at some high salt and moisture environments offshore and ways we can improve the packaging there to improve the service intervals. So to your point, we are trying to grow our other accessories and other initiatives and really, put our product all over the world and have it be as robust and as successful as it is here at home.

Great. And then last question, if I may. This last year, you've put a bunch of C1000s in the field. C800s are also going out there. Can you talk about how this changes the ability to get repeat orders out of customers and the ability of customers to go on and visit a site, where maybe nearby, there's one installed that they can discuss with the facility manager, the pros and cons, how this actually worked out for them and how this is translating into overall momentum on the order flow?

Absolutely. I think the best salesperson we have is a happy customer. So we can take customers to a like-minded similar customer that's applying the product in a similar application. That is our best sales tool. If you look at the markets where we're doing extremely well, in Mid-Atlantic, with E-Finity and RSP Systems and Horizon and Cal Microturbine, Regatta here in California, those folks have a lot of reoccurring customers.

We actually had a customer last quarter who called up and ordered a C1000 because they had some extra budget dollars left in the quarter. So looking for a quick turnaround and delivery of the unit. So when you can get a customer to call up and order a C1000 just because they're a happy repeat customer on a short-cycle project, that's exciting.

But we're seeing lots of opportunities. I think if you look at areas where we've been a little slow, Europe and Russia is down year-over-year, and I think Latin America is down year-over-year. The rest of the world we're up. I think Russia will be coming back online with our 5 new distributors. I think Jim is in Istanbul today meeting with our Russian partners and getting that market reenergized.

The Mexican market should be picking back up. New utility rates have just come out, and end-use customers are getting those builds for the first time right now as we sit here. So they see those new rates and new concepts, it's going to drive more CHP activity. Our distributor in Colombia has got a lot of good things going on. And so I think you're going to see some of the areas that have been lagging a little bit pick back up.

Obviously, the dollar has softened, we've solved our Russian issue, we're seeing oil prices come back up, so many things that were headwinds in the last 3 years are now turning into tailwinds. And so I think we're well positioned with an amazing product, with a great aftermarket service contract option and really well-positioned with our distributors to take advantage of these tailwinds.

And our next question is from Colin Rusch from Oppenheimer.

Just on the gross margin side, given the roughly 260 basis point impact of the warranty reversal, can you talk a little bit about how long you expect these other initiatives to take before you make up that delta on the gross margin line?

I think it really depends quarter-to-quarter. It depends on mix. We've seen our C65s pick up in the last couple of quarters. That's both CHP- and oil and gas-related. That product today is our highest-margin product, the C1000s, and C200s are next. So I think that, that mix will impact us.

Some of the cost reduction activities we're doing from the procurement side should start coming through. If you think about it, we went from almost $140 million of revenue to $70 million of revenue and didn't lose too much ground on our acquisition costs. And so as we get revenue moving again, we'll turn around and try to leverage that. We're looking at offshoring some more parts and some other strategic relationships to lower our costs.

And so I think it's really across the board. Obviously, we're in one facility there, we're more efficient. We haven't sublet the other facility yet, but that's high in our mind. The warranty costs, like I said, have dropped to about 1% because with the new Signature Series, that can go even lower. And so I think it's across the board, but it will probably take a couple of quarters to get back to those couple of basis points but it's not an if, but a when. And obviously, the more product we can push through the plant, the better our product margins get.

All right. Perfect. And then just moving onto the sustainability of the product sales. Obviously, you guys have a pretty good sense of the next couple of quarters. But with the acceleration of some of these product sales, happy customers, things like that, how are you thinking about kind of quarter-to-quarter growth? And should we expect some potential lumpiness as you go along a growth trajectory from here?

Yes. I mean, I hate the term lumpy, and I know our shareholders do too, but unfortunately, we are a project-based business. This quarter, we had almost 0 finished goods, which is a home run for us. So we project each quarter how many units to build based on what we believe customers will pay for and take. So it's always going to be a challenge for us.

Again, I think the stronger that service business comes and the more of those 2 lines intersect with each other, the less important the product sales become every quarter. It's just how much profit do we make, not whether we're profitable.

But yes, absolutely, there is going to be ups and downs. We're working to push out our lead times and to shore up our backlog as much as possible. But it's, I'd say for the next fiscal year, that's probably still going to be a challenge for us. Obviously, if we had 40-week lead times or something like that, that might be different, but that's not where we are today.

Perfect. And then just lastly, on Capstone Finance, can you just talk about how many transactions you've been able to do and how impactful that's been on driving some of these sales?

Yes. I need to put together some slides on that. I think the reality is we've only got one transaction done, but I think it's helped close several projects where customers choose to buy the product, and so we're offering it very, very frequently. And a lot of customers look at it and they say, well, the savings are so much better if I buy it myself, or they look at it and say that the cost of money they can get is lower than ours. And so regardless, we're all about giving customers choices and growing product revenue and total revenue.

So if Capstone Energy Finance never turns into a huge business, that's fine as long as it drives the rest of our business. But I do think there are certain markets and certain customers that will see some growth in that area. Obviously, as we get the profitability, we have more cash than our cost of money will go down if we use our own money as opposed to using other folks' money.

And our next question is from Amit Dayal from H.C. Wainwright.

Good to see you guys set aggressive targets for yourselves already on the heels of achieving initial targets. So congratulations on that. Just one question in regard to that is the time line, if you could provide any granularity on what we should expect for these new targets sort of to start coming through potentially?

Yes. I mean, it's always hard to nail down. I think it longterm depends on how fast we can execute some things. I think getting the -- some larger product orders will be helpful. Obviously, product orders drive service business as well. It will depend on what happens on some of the product that's already in the field that's coming up for overhaul because that will help drive our business. And then the whole bundled solution, how much customers enjoy that.

For us, that's really key. Before we hit EBITDA profitability or breakeven, it was really hard to sell a bundled solution. Getting someone to pay forward 5 years or 9 years on a long-term service agreement when you're not a profitable company, that's a long putt, that's a challenge. And so as we hit profitability and sustainability, getting folks to prepay those FPPs is going to be key. And so that gives us ability to bundle the product and give customers more value, but also give us more cash flow and then working capital, which is key.

So I think we kind of loosely put kind of a 2-year collar out there. We can grow faster than that. It could take longer than that, it just depends on the market and how successful we can be. We're really working to drive our distributors to excellence. If you look at some of our best distributors, like we just had the webinar with E-Finity there, top shelf, gold standard, if all of our distributors were operating at that level, we'd be a several hundred million-dollar company and very profitable. So getting everybody to kind of believe in the model distributor program and do all the right things will be a major focus for us in fiscal '19.

Got it. And from a working capital and available capacity perspective, are we in good shape roughly to sort of achieve these new targets that you're setting for yourselves?

Yes, I mean, if you look at it -- I mean, our receivables are up for the quarter because revenue was up, but that was a fairly honest and normal bump. I think our DSO jumped 3 days, 61 to 64 days, nothing too interesting there. We did obviously collect on some of our Russian receivable, which is very positive for us. Anytime you can get one Russian to pay for another Russian's bill, I think that's a very challenging thing to do, and I'm proud that we got that done. We'll keep looking to do that in the quarters ahead.

But really, I think the key is our -- if you look at our payables, they're down. They're about as low as they've been in 4 or 5 quarters. We're paying all of our vendors pretty much on terms. And so there's not much more payables work to do to get down to terms or to get where we need to be. So as revenue grows, we should have some positive working capital swings.

Inventory, it was -- we're happy where we're at. We're about 4.8 turns. We can do better than that though. I'd like to see us up in the 6 to 7 turns. And so I think that will be another major focus for us in the next year to 18 months.

Got it. And then in regards to opportunities associated with these weather events, et cetera, have you seen any concrete order flow from the recently affected geographies? And then correlated to that question is can your financing arm play a role in supporting any opportunities from that site?

Yes. We've definitely -- Capstone Energy Finance has quoted some opportunities. We've had some small, I'll call them, island orders, C65s. We're chasing some bigger C1000 orders that we actually truthfully hoped to close in the December quarter, so now we're hoping to close them in our March quarter, our fourth quarter. Unfortunately, we tend to have long sales cycles and we are a big capital spend, and so it's not the fastest thing.

I think if you look at New York, it took a couple of years to really see the benefit of Sandy, but I think you're going to see the benefit long term. A lot of the folks we're quoting are U.S. or European companies that are fairly large. A lot of large pharmaceuticals are in Puerto Rico, so it takes them time to do their diligence and pick a solution. But we think we stack up pretty well versus batteries or fuel cells or portable generators that they're dealing with now. So I think we're definitely going to see a spike. Hopefully, we'll announce some larger orders here in the next couple of quarters.

Got it. Just one last question for me. On the tax front, are your customers seeing any positive benefits from those developments? Does that help you overall?

Yes. That's really hard to tell. I mean, logically, the answer is yes, but we haven't seen -- again, because our sales cycles are typically 9 to 13 months, it's hard to see near-term benefit of these kind of activities.

And our next question is from Eric Stine from Craig-Hallum.

I was having some phone issues, so I apologize if these have already been asked. But I'm just curious your thoughts about book-to-bill as you get into fiscal year '19. I know you just mentioned long sales cycles, and you've got a number of initiatives. But the last few quarters, I mean, arguably, you'd likely say you've been disappointed with that number. So with your long-term targets in mind, what are your expectations as you get into fiscal year '19?

Yes -- no, Eric, we always look for book-to-bill at least 1:1. In the last couple of quarters, we haven't achieved that. Bookings were up quarter-over-quarter, so that was a positive sign. The U.S. is very strong. Canada is strong. As I mentioned earlier, I think we really need to see Europe pick up, Russia pick up and then Mexico pick up and Latin America. So I think as those markets kind of come back online, we should see that book-to-bill get healthier and hopefully see more product orders.

Obviously, U.S. oil and gas is also very interesting to us as well as we're seeing a lot more oil and gas opportunities with oil prices where they are. So I would say, I'm not overconfident, but I'm reasonably confident we're going to see better book-to-bills in the next couple of quarters.

Okay. And maybe turning to margins. I know you've talked about the -- your goal by, I think, end of March to get some -- I think it's 21 suppliers under the long-term agreements, and that you'd had -- you were kind of in the 15 to 16 range. If my memory is correct, I think that the last few are some big ones and potentially have maybe an outsized effect on margins. Is that the case? And just any color you can give there would be helpful.

No, you're absolutely correct. We're -- we have about 5 more to do and they're the biggest 5. So they're the hardest ones to get wrestled to the ground. A couple of them are under short-term LTAs. We're looking for longer-term LTAs and some cost reduction. We're also competing with some of these bigger suppliers, so I won't mention the commodities. But obviously, if you go after your largest 4 or 5 spends and if you can get the -- either an LTA done at lower prices or a competing alternative at a lower price, that has the most impact on the business.

So hopefully, in the March quarter, we can kind of give a little more update on where we're at. But we're definitely looking, as the business strengthens, as our balance sheet strengthens, as product revenue grows, we want to see some longer-term LTAs with some built-in price deceleration.

Right. Okay. Last one for me, just on OpEx. Did you mention that -- your expectation of timing on the sublease? And is that something where, I know you had a onetime item in OpEx this quarter, I mean, is that something you think you can be sub-5 million once that sublease is in place per quarter?

No. Our stated target is 5. Actually, if you look at the future model, have it walking up to 6 just because we just gave employees raises for the first time in a couple of years in December. Obviously, as product revenues grow, we'll pay more sales expense. And so I'd like to keep it around 5 for now, but then it's probably going to float up 5.5 to 6 over the next couple of years. But if you still look at it, that's 1/2 to 1/3 of anybody else in our space. And I think our revenue per employee is excellent. I think we do a very good job with what we have.

But the sublease, specifically, we've got a professional firm working on it. They've showed it to multiple folks. We're still cleaning up and getting out of that facility. So hopefully, we'll get that done over the next quarter and make it a little more presentable and showable. But our goal would be to obviously get it leased as quickly as possible because that's an additional cost reduction for us. Plus, the leaseholder of this facility helped pay for some of our tenant improvements that we needed to do. And I think that's kind of lost on people. But to hit EBITDA breakeven or positive EBITDA in the quarter that you actually consolidate your facilities is a pretty amazing feat because that's a -- it was a lot of work and a lot of moving pieces to actually dismantle an entire facility and move another one in and meanwhile keep operating the business.

(Operator Instructions) And our next question is from Jeffrey Osborne from Cowen and Company.

Most of the questions have been asked. Just a few.

How do we think about the hardware so that x -- you certainly did a very nice job on the service and accessories margins, and you talked about the trajectory there, Darren. But when you look at the hardware side, it looks like about starting the year, fiscal year around 1%, and that's now up over 10%. It's nice to see the improvement. But what's the kind of trajectory of the improvement there, especially as the Signature Series becomes a bigger piece and warranty is less of an impact?

Yes. If you look at the kind of our new target of getting to that 34% gross margin that has product margins north of 20% and then service margins are heading to around 50%, so that kind of blended margin gives you that 34%. I do think that we can get margins up to 20%. At some point, though, I want to start being a little more strategic in our pricing because we are more expensive than older technologies. And so if I can be a little more strategic in certain markets with my product pricing that will allow me to grow revenue faster; the faster I grow revenue and get service contracts and get my supply chain a little more leveraged, that would be more beneficial to the business. But I think 20% is very achievable, maybe as high as 25%, but that's probably as high as we can get on the product side.

Got it. And maybe just to that point on pricing. So when you look at your roughly million dollars a megawatt, where do you think that tipping point would be, that 850 that you could go to, and do you think you'd be much more competitive? I guess, in your eyes, where do you need to go to really move the business much faster?

Yes. If you look at Caterpillar and GE and the engine guys, they typically are 700- to 800-kilowatt. And so I think if you could -- if we get our pricing down, closer to that, that would be helpful. Obviously, if we bundle our long-term service agreement, our service contracts are much cheaper than their operating expenses so that helps us level the playing field. But if I can get close in first cost and be better on total cost of ownership and guarantee it, and I'm lower emissions and higher reliability, it's kind of checkmate. And so that's kind of where we're moving toward. I think to be a $300 million or $400 million business, we've got to probably be within 15% to 20% of them on first cost.

Got it. And maybe just speaking of service, can you just -- I'm having a hard time reconciling the attach rates of the multiyear service agreements. You've been talking about that for, give or take, 18 months now. But it looks like the FPP backlog has been kind of hanging out in the 75-ish range. Am I missing something? Is that not a holistic number that would add in the 5- to 9-year deals that people are signing?

Yes -- no, I think there's a lag between product shipments and getting to the warranty period and signing those contracts. The contracts move around a little bit. If somebody doesn't pay their FPP, we suspend the contract, or if the customer cancels, so there can be some ins and outs on any given quarter. Obviously, just like your car insurance, so if you're not paying your insurance, you're not covered, and so we'll pull that contract out of the backlog.

But in general, our attach rates are about 36% kind of blended. We'd like to see that number north of 50%. And so as we continue to market the benefits, we just announced the, I think it's 6-megawatt or 7-megawatt, 6.9 major oil and gas user in the U.S. that had been self-insuring. They've been doing their own maintenance for 5 years, and then our distributor did a good job of coming in and saying, "Well, based on your maintenance costs in the last 5 years doing it yourself, you could actually have signed the FPP and you would have saved money."

And so I think customers are going to realize that our long-term service agreement is actually cheaper and lower risk than pay-as-you-go, if you have -- especially if you have any kind of issues or problems. And so I think it's an area we should see growth and then more importantly, the margin expansion. As the Signature Series gets out there, the failure rates are much lower. We don't talk about it, but we made 86 design improvements around the reliability and performance between the old, called the R Series, and the new Signature Series, the S Series. And so those are huge improvements for our customers and drive value with lower operating expense. And so that's key for us.

And then remanufacturing, I know it's not very sexy, but as we can get parts back and learn how to remanufacture them at little or no cost, that's going to help drive those service margins in the future. So there's lots more upside on the service side, and a healthy reoccurring revenue with very high margins is a great thing for your business.

Makes sense. Last question I had is, you mentioned that the pipeline of activity looks pretty good on the oil and gas side, and that's understandable for what's going on there. But just when you look at the figures in the Q about the end-market exposure you have, it looks like your exposure to energy efficiency was down pretty meaningfully sequentially. Can you just talk about what the pipeline of opportunities are in that piece of the business?

Yes. I mean, we had so many slots in the quarter, we just filled more oil and gas slots than we did energy efficiency slots. So I think the -- both the markets are trending in the right direction. We've got some nice opportunities on both. It was -- so I think that's something we're going to see.

Quarter-to-quarter, it may bounce back and forth, but I think we're going to move more to a kind of a 50-50 blend. We were very heavy oil and gas and then we went very heavy energy efficiency. I think, hopefully, we'll end up somewhere in the middle where it's fairly equal on a quarter-to-quarter basis, year-to-year basis. And so I think growth of both those markets are important. Energy efficiency can be even lumpier than oil and gas. The project time lines can be longer, but we've got a lot of exciting REITs that we're working with, whether it's Related Properties or Brandywine-ers, or the different folks around the globe we're working with as well as industrial customers. I mean, we just got 5 megawatts installed at Mohawk Carpets. And we've got Corning. We've got a lot of really Fortune 100-, 500-type companies that are now turning to our technology.

So as we see those folks become repeat customers, that's going to help us on the CHP and CCHP side. Also, I think we're looking at strategic relationships as far as boilers and chillers, on how to make those installations less expensive and leverage some better partnerships there.

At this time, I'm showing no further questions. I would like to turn the call back over to Darren Jamison, President and Chief Executive Officer, for closing remarks.

Great. Thank you. It was very much an exciting quarter for us, very excited for our Capstone employees and our vendors and our Board of Directors.

It's been a long road, but to get to this milestone is very, very important. As I said in my prepared remarks, though -- this is a milestone to be celebrated, but it's not a destination. We still have a lot of work to do. And if you look at some of our slides of where we want to go, like our new target model on Slide 9, we've got a lot of heavy-lifting to do to get from today's 22% to 34% margins, to get our revenue growth rate back up to $40 million a quarter.

Obviously, we've done a tremendous job on the operating expense side. I'm not sure how many companies can cut their operating expenses in half without getting rid of product lines or taking care of customers and then still continuing to do the business that we did and be public, let alone move their -- half their manufacturing operations and other employees during a quarter that they hit an important milestone like this. I'm very proud.

If you look at Slide 3, on just the growth trends, I mean, everything from revenue quarter-to-quarter, year-to-date, 9 months to-date is up. The margin expansion is very impressive. Accessories, parts and services, I'm very excited about breaking through that kind of 40% threshold.

Expense controls, again, I think we've done an incredible job on both OpEx but also on warranty, our R&D expense and our facility consolidation. Getting to adjusted EBITDA and EBITDA breakeven is a great improvement from where we've been. And we're up 71% improvement year-over-year. Net loss improved 91% quarter-over-quarter, and these are some staggering numbers. Obviously, $0.01 per share, it would be nice to have been completely neutral or flat, but we'll get there.

And then the balance sheet, I think we've added some cash during the quarter. Our cash burn is down 33% year-over-year. If you take out the equity transactions, our accounts payable is down. Our accounts receivable is up, which is good. Our finished goods are down. Our inventory turns are up. Our work-in-process is down. So I think we're focusing on all areas of the business which is important. We're not just focusing on revenue, we're focused on having a strong, profitable, low-cost, very efficient well-run business.

If you look at our 9-month year-over-year numbers, we're up across the board. I mean, product and accessories, parts and service revenue, total revenue, gross margins, R&D expense is down, SG&A is down, total OpEx is down, net loss is down. The EBITDA is better -- I mean, across the board, we're doing a better job.

So again, not a destination but a milestone, but we've got a lot of -- of improvement to do. But I think it gets a lot more fun once you break into profitability. I think that will increase our momentum. I think customers that were worried about doing business with Capstone will be less worried. Our long-term service contracts are a lot more valuable and more profitable. I think that's a huge relief to customers, and we can back up our long-term service commitments that we're making.

So a lot of exciting times ahead, and we're very proud of what we've done and look forward to our next earnings call, which will be our fourth quarter and total year call coming up after the March quarter. So with that, I'll go ahead and close the call, and we'll look forward to talking to everybody next quarter. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.