Capstone Green Energy Corp (CGRN) 2023 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Capstone Green Energy earnings conference call and webcast for the financial results for the second quarter fiscal year 2022 ended on September 30, 2022.

(Operator Instructions) As a reminder, today's program will be recorded. At this time, it's my pleasure to turn the floor over to Mr. Don Ayers, Vice President of Technology. Sir, the floor is yours.

Thank you very much. Good afternoon, and thank you for joining today's fiscal 2023 2nd quarter conference call. On the call with me today are Darren Jamison, Capstone Green Energy's President and Chief Executive Officer; and Scott Robinson, Interim Chief Financial Officer.

Today, Capstone Green Energy issued its earnings release and filed its quarterly 10-Q report with the Securities and Exchange Commission for its fiscal 2023 2nd quarter ended September 30, 2022. We will be referring to slides that can be found on our website under the Investor Relations section during the call today.

This conference call contains estimates and forward-looking statements representing the company's views as of today, November 14, 2022. 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 on Slide 2 in today's earnings release and in Capstone's filings with the Securities and Exchange Commission for information concerning factors that could cause actual results to differ materially from those expressed or implied by such statements.

Please note that as Darren and Scott go through the discussion today, when they mention EBITDA, they are referring to adjusted EBITDA and the reconciliations in the earnings release and the appendix to the presentation slides. I would now like to turn the call over to Darren Jamison, President and Chief Executive Officer.

Thank you, Don. Good afternoon, everyone. Thank you for joining today for a review of our second quarter fiscal 2023 results ending September 30, 2022. If you turn to Slide 3, I'd like to run through today's agenda.

We'll start with the quarter's financial highlights and then review our positive EBITDA plan, followed by an overview of our Energy-as-a-Service or EaaS business. I would like to then provide a brief overview of our financial results and then a review of the company and then the recent U.S. policy changes, including the Inflation Reduction Act or IRA Act, and then conclude with the business summary. We will then be open to take questions from our analysts. Let's go ahead and jump to Slide 5.

Slide 5 shows revenues of $20.8 million for the quarter, an increase of 11% sequentially from $18.7 million in the first quarter and up 21% from the second quarter in the year ago quarter. I remain extremely encouraged by our team's ability to grow revenue in a tough macro and supply chain backdrop. Revenues for the first half of fiscal 2023 totaled $39.4 million, up 18% from $33.3 million for the first half of fiscal 2022. This revenue growth is being led by our Energy-as-a-Service growth strategy.

However, gross margins for the quarter fell to 11% compared to 25% in the first quarter due to increased supply chain costs, specifically related to the C1000 enclosures and the need to source alternative recuperator materials to meet customer delivery requirements during the quarter. Our net loss was $4.9 million, an 18% improvement from a net loss of $6 million last year. Sequentially, the net loss increased from $2.1 million in the first quarter, which was impacted by approximately $1.6 million of additional supply chain expenses quarter-to-quarter.

Adjusted EBITDA improved 19% to negative $2.2 million from negative $2.7 million versus last year, but sequentially, again, was down from a positive $400,000 in the first quarter. Again, this is due to the approximately $1.6 million of additional supply chain expenses, freight and expediting charges.

On a first half basis, though, EBITDA improved 66% to negative $1.7 million for the first half of fiscal '23 compared to negative $5 million last year. The improvement was driven by growth in the high-margin Energy-as-a-Service or EaaS business, offset by increased supply chain costs, freight and expediting charges as discussed.

Lastly and perhaps most importantly, the total energy to service long-term rental fleet under contract on September 30, 2022, was approximately 34 megawatts versus 12.7 megawatts on September 30, 2021. This represents 168% growth year-over-year. Today, the EaaS long-term rental fleet under contract is approximately 39 megawatts and as a reminder, we've been saying for several quarters, our goal is to get to 50 megawatts under contract by March 31, 2023.

Let's continue over to Slide 6. You can see the EaaS rental revenue was $1.8 million for the second quarter, up $1.2 million or 200% from $0.6 million or $600,000 a year ago. Also importantly, the EaaS rental gross margin was extremely strong during the quarter at 72%. Gross new product bookings for the second quarter were solid at $15.4 million, up from $12.4 million sequentially, and product book-to-bill ratio improved to 1.6:1.

Ending product backlog at September 30, 2022, was $28.9 million, up $4.1 million or 16.5% from $24.8 million in the June quarter. Also extremely important is cash. Total cash as of September 30, 2022, was $23.8 million, up from $16.9 million as of June 30, due primarily to net proceeds of $7.3 million from the Lake Street public offering on August 23, 2022. This was offset by working capital needs to manufacture new rental assets for the quarter.

As a result, net cash provided by operating activities was positive $900,000 compared to a loss of $3.4 million in the June quarter. As I mentioned earlier, the supply chain has presented some challenging headwinds this quarter. To mitigate this, we are implementing a new price increase for all of our products, spare parts and Factory Protection Plan or FPP service contracts. That price increase will go into effect January 30, 2023.

Let's go ahead and move to Slide 8. I will review our fiscal year 2023 positive adjusted EBITDA plan. We have outlined 4 key pillars in this strategy and have fully executed on 3 of them with significant progress in the fourth.

The first pillar was to reduce operating expenses by $4.3 million for the full fiscal year, led by restructuring the business around our Energy-as-a-Service model. This was a spread across the board from reductions to executive personnel, Board of Directors, moving assets to our distribution partners and active labor force management.

The second pillar was a price increase as we need to keep pace with inflation. Effective May 1, we did a price increase in the range of 7% to 10%. We also increased existing FPP contracts by 5% for CPI increase and the pricing on new FPP contracts has also increased by 5% as well as spare parts to offset the inflation factors and to focus on the supply chain integrity. Also noted earlier, we are implementing a second round of price increases in January '23.

Third pillar was the increase of the DSS fee from 3% to 5%, which is an annual fee we charge our global distributors for training, marketing, branding, customer acquisition and trade shows.

And the fourth and last pillar is the more significant strategy change to include additional Energy-as-a-Service business in our business mix. The numbers show progress from 7 megawatts under contract to 39 megawatts under contract today, well on the way to our target of 50 megawatts by March.

We turn to Slide 9. Slide 9 shows the details of our adjusted EBITDA first half through the second quarter of fiscal '23 versus the first half of fiscal '22, showing our improvements in negative $5 million last year to negative $1.7 million this year in adjusted EBITDA. And it shows the components which we expect will lead us to successfully achieving our 2023 goal of positive adjusted EBITDA for the full year.

Next, I'll provide you with an EaaS update. I'm sure you have seen Slide 11 before in previous presentations, but it's worth reviewing again as it is the cornerstone to our positive EBITDA strategy. The fact is the economics heavily favor the EaaS business versus traditional product sales for our type of technology.

In case 1 on the left of the graph is the traditional product sales model, which had been the existing way of doing things for many years. The middle bars show what that model looks like with our Capstone long-term service offering or FPP, which was our first strong move to drive long-term predictable income and cash flow. And the last, third set of bars to the far right of the slide illustrates what the EaaS model can do and how powerful it is and can be for us.

For the same C1000 unit, we can generate $1.8 million in revenues at a 60% gross margin over 5 years, and this compares to a product sale with spare parts for 5 years at $1 million or 20%.

Let's go and move to Slide 12. Slide 12 sets out the growth picture for us. On March 2021, we had 7 megawatts under contract in our rental fleet and as of October 31, 2022, we had 39 megawatts under contract in our rental fleet. We believe we are well on our way on track to reach our 50-megawatt goal by the end of March 2023. It is important to note that supply chain constraints and working capital limitations required that 15 megawatts of the rentals to date have been re-rented equipment, which does negatively impact our margins, but we had to do this to meet customer demand.

To the extent we can achieve some more working capital improvements and some supply chain relief, our goal is to return to shipping primarily new units for rentals and even higher margin rates. I'll now turn the call over to Scott, our CFO, to go through some of the specific financial results. Scott?

Thank you, Darren, and good afternoon, everyone. I will now review in more detail our financial results for the second quarter of fiscal 2023.

Moving to Slide 14. You can see our Q2 '23 results compared to Q1 '23. Financial results for the second quarter of fiscal '23 had revenue of $20.8 million compared to $18.7 million in the first quarter of fiscal '23. Product and accessory revenues were $10.6 million, up from $9.2 million in the first quarter of fiscal '23. Parts, Service and Rental revenue, which includes rentals, FPP long-term service contracts and distributor support subscription fees were $10.2 million, up from $9.5 million in the first quarter of fiscal '23. This is primarily due to an increase in our rental revenue. Gross margin as a percentage of revenue was 11% in Q2 '23, down from 25% in Q1 '23, primarily due to the aforementioned supply chain challenges.

Total operating expenses increased slightly to $5.7 million from $5.4 million in the previous quarter. Net loss was $4.9 million for the quarter compared to a net loss of $2.1 million in the first quarter of fiscal '23. Adjusted EBITDA was a negative $2.2 million compared to adjusted EBITDA of a positive $400,000 in the first quarter of fiscal '23.

Turning to Slide 15, you will see the financial results for the second quarter of the fiscal year '23 compared to the prior year period, which had revenue at $20.8 million compared to $17.2 million in the second quarter of fiscal '22. This is driven by higher product sales activity across all product lines. Product and accessory revenue was $10.6 million, up from $8.5 million last year, while Parts, Service and Rental revenue was $10.2 million, up from $8.7 million in the same period last year.

Gross margin as a percentage of revenue was 11%, down from 16% in the year ago period, primarily due to the previously cited supply chain issues, which were partially offset by selling price increases from earlier in the year. Total operating expenses decreased to $5.7 million from $7.4 million in the year ago period, benefiting from cost reduction activities. Net loss was $4.9 million for the 3 months ended September 30, compared to a net loss of $6 million in the prior year period. Adjusted EBITDA was a loss of $2.2 million compared to adjusted EBITDA of a negative $2.7 million in the prior year period.

Slide 16 shows year-to-date fiscal year '23 versus year-to-date fiscal year '22 financial results. Top line revenue has increased from $33.3 million to $39.4 million due to growth in all product lines and selling price increases. Gross margin has increased from 16% to 17% due to contributions from the Energy-as-a-Service product line, offset by the direct material price increases previously mentioned.

Operating expenses reduced from $13.6 million to $11.1 million due to cost reduction activities, and adjusted EBITDA improved from a $5 million loss to a $1.7 million loss.

Turning to Slide 17. You will see select balance sheet and cash flow items. Cash increased significantly to $23.8 million from $16.9 million at June 30, 2022, driven primarily by the recent capital raise. Cash provided in operating activities in the September quarter was approximately $900,000 compared to a negative $3.4 million in the June quarter. The variation was largely due to improved accounts receivable collections. Accounts receivable declined nearly $6 million to $16.3 million as our DSO dropped from 123 days to 85 days during the quarter.

Total inventory levels increased by $3.5 million due to the previously mentioned price increases from vendors and due to the necessity to purchase inventory in advance of forecasted demand due to continued shortages and other supply chain challenges. Despite the increase in inventory values, inventory turns improved from 2.9x to 3.4x.

In addition, we do need more inventory as we ramp production of both new products and focus on growing the rental fleet to 50 megawatts by March 31, 2023. I will turn it back over to you, Darren.

Thank you, Scott. As part of our quarterly update, I'd like to take a few minutes to remind investors of our overall strategy and how we are working to achieve our profitability goals. Let's go to Slide 19 to set out those goals.

First is the direct sales force. We continue to adjust our direct sales force to maximize our EaaS rental growth and the sale of our new network partner products. As the direct sales force continues to grow and mature, I anticipate a couple more quarters until we reach our desired efficiency and output with this team.

Next is our distributor partner network. Now that the worldwide impact of COVID-19 are beginning to subside and relax, we are pushing hard our global distributors to add additional sales resources, drive EaaS rental growth and continue to increase the attachment rate of our industry-leading FPP service contract business.

Next is to grow the mix of our EaaS in our business. We have been focused on this transformation for quite a while. We'll continue to do so. It is key to our profitability. It's key to our growth, and it will drive higher valuation of our business. The near-term goal for the rental fleet is 50 megawatts, but we are only limited by our balance sheet and the ability to get capital regarding how fast we can grow this business.

Next, we need to be flexible and diversify our energy products and service offerings to provide custom solutions to our customers. We operate in a dynamic market and with a wide range of solutions, and we are expanding our business to ensure that we can be flexible and be a problem solver for our customers. This means helping customers with energy efficiency, resiliency, carbon reduction and integrating multiple clean energy products into smart microgrids.

We also need to increase the aftermarket margins and escalate parts availability to drive customer satisfaction and repeat orders. We need to continue the growth of our parts remanufacturing program in the U.S. and our recently upgraded facility in the U.K. Remanufactured parts are not only good for the environment, but they are also typically 40% less expensive than a new part.

We continue looking for additional ways to remanufacture parts to drive margins and make more parts available to our customers in the somewhat challenging supply chain environment.

Next, we are focusing on managing working capital and inventory turns. As Scott mentioned, our DSO dropped in the quarter to 85 days, which is excellent, but we still have several million dollars of past due receivables we need to collect.

Our target is to reduce DSO back to approximately 65 days, which is where it was pre-COVID. Reducing our DSO and tight inventory management would free up additional cash from our balance sheet to build more high-margin rental units.

Lastly is the growth of the Distributor Support System or DSS program. This subscription program is to drive marketing and customer acquisition efforts. We have increased the Distributor Support System annual fee from 3% to 5% this year, which affords us more dollars for marketing, dollars for branding, customer acquisition efforts, as we look to grow both the EaaS business as well as our traditional product business.

Now let's turn to Slide 20. Slide 20 shows the markets we operate in. I put this slide in as I want to remind our investors of how our solutions are being used across several industries and several applications. I will go through each detail, but I do want to highlight renewable energy, smart microgrids, EV charging as our next potential growth markets on top of our traditional energy efficiency in oil and gas markets. As the push toward electrification and the move to lower carbon world, these new markets should continue to grow for Capstone.

Moving on to Slide 21. Slide 21, I set an example of the smart microgrid. Microgrids are seeing unprecedented growth as the broader trend towards distributed energy resources, or DERs, takes hold and are beginning to become a critical part of the global energy infrastructure going forward. As you can see, we can provide a complete microgrid energy system to a customer through Capstone and our network partners. This is important as we want to make customers our partners, and we want to help develop their short-term and long-term energy needs. We can do this by adding a new dimension to how we can sell and engage with our end-use customers.

A cornerstone of the proliferation of DERs will be the electricity demand created by the EV industry. If you move on to Slide 22. Slide 22 shows the forecast for the global EV infrastructure revenues. This will create substantial demand for DERs and smart microgrids, and we will be there to leverage this demand. In fact, we are seeing demand today both in the U.S. and Europe for EV charging solutions, and we are currently working on a portable EV charging solution for the largest industrial real estate company in the world.

Slide 24 summarizes key elements of the Infrastructure Investment and Jobs Act, which touches on several of our applications as we tie them together from the previous slides. Microgrids, EV charging, renewables and critical power supply should all be bolstered by this bill, providing tailwinds for our solutions and our business.

Moving on to Slide 25. Slide 25 is the Inflation Reduction Act. This should be a significant tailwind for us as it's expected to raise $739 billion, of which $369 billion would be dedicated to climate and energy programs. The most significant impact for us is related to tax credits, Section 45, production tax credit; and Section 48, investment tax credit. You can see the details on this slide in the most simplest form.

In conclusion, I'd like to spend a couple of minutes reviewing our business and what I believe are the key factors to focus on as an investor. Let's turn to Slide 27.

Slide 27 shows what we believe are the key catalysts impacting our business today. First are the new U.S. policies I just reviewed with you. These are significant and can be meaningful to enhance our economics of our products and can be truly transformational, especially for our U.S. customers.

The second is to create a larger total addressable market. This is done by adding technologies to our platform, including storage to our microgrid solutions for customers. This would increase our revenue per project and allow us to be true partners with our end-use customers.

Third is our growing EaaS strategy. This is important on many levels as it's critical to reaching profitability and consistent profitable cash flow.

Fourth, as part of our EaaS strategy is our rental business which is growing and has become the cornerstone with the cash flow and margins as they're extremely accretive and attractive for us.

Fifth is the development of our direct sales team. This is strategic as it enables us to target larger customers and, more importantly, larger customer rollouts.

Sixth is the recent $7.3 million net equity offering with Lake Street that strengthens the balance sheet and reduces customers' perception of risk of doing business with Capstone and buying and renting our products.

Lastly is leveraging our network partners. And by leveraging our partners, I mean working with them to jointly develop projects and coordinating our various business development efforts for maximum success in the marketplace. Now with that, I'd like to open the call up for questions from our analysts. Operator?

(Operator Instructions) First question is coming from Sameer Joshi with HC Wainwright.

The price increases, 5% to 7%, that were implemented in May, can you remind us how customers receive that? Ad in that context, what is the expected percentage or range of price increases in the January revision and how do you expect customers to react to that?

Yes. Great quick question, Sameer. I think the first price increase we did back in May was actually very well received. I think everybody is reading the newspapers and online and seeing the 8% inflation. They're feeling it at the grocery store or the gas pump. And so I don't think it was a big surprise to folks. We've seen about a 4% increase from March to now across the board just in all of our commodities that we purchased from 130 vendors worldwide. So definitely, inflation is real. I think people were anticipating something like that, the price increase we put in place.

Last week, we just announced the new price increase. I think distributors are being understanding. Obviously, doing 2 price increases in less than 12 months is not optimal. But the new IRA Act will substantially improve the economics of our projects here in the U.S. And so we did our price increase in 2 phases. We did an international version and the U.S. version. And so the U.S. version was as high as 10% and the international version was a little more subdued in the 4% to 5% range. And so I think we tried to make the price increase targeted to the customers where the economics would still support the price, but we do need to offset the higher costs of our materials.

The 2 major components, the C1000 enclosures and the recuperator materials we had to buy, those were kind of onetime anomalies. We've already got the enclosure price back down to more reasonable levels. We still have some work to do, but that was really a result of changing vendors midstream and to the new vendor at higher cost as they came online to manufacture the product. So we're already going to see, in Q3, lower enclosure prices, and hopefully, Q4, we'll see another drop. The recuperator material we had to buy was really an issue of customer demand versus ability to get material.

As you can see, our book-to-bill is 1.6:1. Our revenue is up year-over-year, quarter-over-quarter. And so we're seeing higher demands for our products, plus we're trying to build the rental fleet simultaneously. So we're pulling on the supply chain harder than we have in years, and the supply chain has global challenges. And so we had to buy some more expensive material than our traditional HR-120 material we buy from Haynes. So that was a onetime purchase to fill the gap and make sure we still met customers' demands for the quarter. As challenging as the supply chain is, we still haven't missed a customer delivery yet, and that's our goal, to keep that trend going and keep growing the business despite the global supply chain issues.

Yes. No, it certainly seems and comes across from the commentary that there is interest from customers and continued interest from customers. That's good to see. Just a question on the re-rental model. Of this 39 megawatts, I think, around 15 megawatts is re-rents. What percent of the more recent 5 megawatts is included in this re-rent jump from 34 megawatts to 39 megawatts?

Yes. So it's fairly dynamic that as we -- we have over 100 megawatts quoted, I think we've close about 130 megawatts right now pending. And so I'm trying to close another 11 megawatts by March out of a 130-megawatt pipeline. So it shouldn't be that challenging. It's just a matter of figuring out which 11 megawatts are going to close and which customers, configurations, models and timing. And so based on parts availability and re-rent ability, we decide how much is going to be new versus re-rent. We're also looking at buying used units, older, we call them our packages, which is the old version before our current version, and then upgrading those packages to our more current signature series. And so it's definitely a mix, and I'd say it's definitely fluid. But our goal is to build as many new units as we possibly can, but still manage our cash.

As you saw, we had a really good receivables quarter. We dropped our DSO from 123 days to 85 days, that's still elevated from where we want to be. So how much we can build new will depend on how much cash we get out of our balance sheet. I was very happy with the $900,000 positive cash from operations for the quarter. That was well timed. As we continue to build the energy service rental fleet, generating cash from operations is very helpful. And if you look at our cash balance for the quarter, essentially, we kept all the money that we raised during the quarter through the equity raise. So that was also beneficial.

Yes, yes. Last one from me. Can you give a little bit more insight or details on the portable EV charging solution that you are working on? How large -- what is the scale of that? Will it support multiple charges at the location? Or just any kind of color would be helpful.

Yes. No, it's a great question, Sameer. So it is a 200-kilowatt portable EV fast charging station. And so it's trailer-mounted and so it has ability to move from place to place to do vehicle charging with supercharger. I think we've seen other stationary opportunities for EV charging, both in the U.S. and in Europe. And so I think that's a market we see as definitely a growth area for us. And as I mentioned in my prepared remarks, it's one of the largest companies in the sector that's doing this. So therefore, we're playing with the right kind of folks. But we've got a huge opportunity. And I think if you look at electrification of both vehicles and buildings, the amount of energy that's going to need to be produced is going to far outstrip what the grid can do.

In fact, as you all know, here in California, about a month ago, we announced that it will be illegal to sell internal combustion engine vehicles in 2035. The next day, we had Flex Alerts being texted to everybody in Southern California saying don't charge your car. So I think that just graphically highlights the challenge you're going to have from the infrastructure and the grids. As more and more vehicles, more and more buildings get electrified, you're going to need more power generation and charging solutions.

So fortunately, there's abundance of natural gas in the U.S. and other fuels like renewable fuels and biogas or even hydrogen, where Capstone machines can be put in place to support that infrastructure and quickly scale both vehicle charging and building electrification.

That looks like -- and you did point out to the 3 new sectors that will be a future growth opportunity, this being one of them. Good luck on that.

Up next we have Rob Brown with Lake Street Capital.

Nice progress in getting the rental fleet built out. I guess, at the 50-megawatt level, what's sort of the revenue level that you can generate there? And how is the margins looking at that point in time?

Yes. The kind of target margins, I'll take that first, is 60%. You saw for the quarter, we announced we're at 72%, and that's obviously got re-rents in the mix. We think as we add more re-rents and as the fleet ages, 60% is a reasonable number, but we have been running above that since inception of the rental fleet. But again, as the mix changes between re-rents or re-manufactured product versus 100% new and as the fleet ages a little bit, we should see 60% is a reasonable expectation.

But still much better than anything else we have in our business. I'd say on the expectations on revenue growth, I would expect $0.5 million kind of growth per quarter, each quarter as we kind of move up toward that 50 megawatts. That's what it looks like internally for us right now. And so we'll continue to report those numbers. The most important thing is that 50 megawatts, we should be throwing off positive EBITDA every quarter, quarter in, quarter out, and positive cash flow from ops. And so that's really kind of the golden ticket for us is to be EBITDA positive, cash flow positive quarter in, quarter out. And the only question is how much product we can sell on top of that.

So as I look at the quarter, lots of highlights, but I think to your point, growing that rental fleet is the most strategic important part of our business, and everything else is a little bit secondary right now for us.

Okay. Great. And then the margins, I think you said much of the margin hit in the quarter was one time. How do you see the margins recovering throughout the year? And I guess do those issues take a little time to play through? Or does that snap back pretty quickly?

Yes. It should snap back fairly quickly. I don't see it's a 25% margin again in this current quarter we're in. I think it will probably be Q4 before we get back to the Q1 levels. So I think you're going to see some bleed into Q3. The good news is the vast majority of that supply chain hit and an increase was in 2 parts. So it's very easy for the team and myself to jump on it and remediate it. As I said, being enclosure manufacturer, the new enclosure manufacturers already lowered their price substantially, and we got some more work to do there, but we will be much better. And then the additional material we had to buy because of lead times and growth in the business was a onetime purchase. And so we'll see some more costs for that material this quarter, but then by Q4 to be gone.

So I think Q3 will be better than Q2, but probably not as good as Q1, and Q4 should be back to kind of Q1 levels, and obviously, the more rental units we can build and the more rental units that are 100% new, those margins will even go beyond the 25% we saw in Q1 as we continue to grow that business.

Okay. Great. And then on the demand environment, it's quite strong right now, and I presume we have not seen much from the IRA yet, but how do you think about the IRA impact helping demand and the timing. When you should start to see that?

Yes. No, that's a really good question. The IRA bill should improve our paybacks close to 2 years in the U.S. for CHP projects. And so if you had a 6-year payback project, it should be closer to a 4-year payback or 5 or between. We see that as a dramatic shift and transformational for the economics of our machines, and it's the biggest incentive we've ever had in the history of the company. So for U.S. CHP projects, we should see substantial growth. We've analyzed it, and it looks like if truly, it's a 2-year improvement. We should see close rates go from roughly 13% in the U.S. to about 20% in the U.S. And so that would be $40 million to $50 million of improved business results on an annual basis. So it's significant. Now it is U.S. only, it is CHP, it's not oil and gas, but we are seeing an uptick in the oil and gas business in the U.S. as well. So we're very bullish on what next year would look like from a product revenue U.S. standpoint.

From a timing perspective, typically, our projects can be anywhere from 6 months to 14, 15 months from quote to close. So this definitely will be a next year phenomenon. But again, book-to-bill was 1.6:1 this quarter. Our product backlog is already up quarter-over-quarter, year-over-year. So I think that's just going to give us more tailwinds for next year. I think as I look at demand environment, the U.S. should still be very strong next year across the board, both rentals and products. Europe is struggling. Obviously, the ground war in Ukraine has kind of royaled the energy markets and we've seen renewable projects continuing, but a lot of CHP projects have been hampered because of the spark spread issues and natural gas issues over there. Asia is doing good. Australia is doing good. Latin America is starting to pick up. Mexico is pretty sound. So the biggest issues we have right now is definitely Europe, and the strong dollar doesn't help either. But in general, I'd say in most of our markets, we're seeing strong demand, and we're looking for continued growth year-over-year.

Next we have Shawn Severson with Water Tower Research.

Darren, I'm curious how a higher rate environment affects the EaaS business, because obviously, it's a rate of return business, right? So as we get into this environment and nobody wants to predict how long interest rates are going to stay high, but just curious, how does this impact? And how do you manage through the economics of that business as rates change like this?

Yes. Definitely, I think as the Energy-as-a-Service business grows, our biggest factor is going to be cost of capital. And so if we can generate our own capital, that's great. If we have to go out for capital and capital is more expensive because of the interest rate environment, that's going to be more impactful. But I think the good news is when you're looking at a business with over 30% IRR and over 60% margins, you can withstand a little bit of rate increase, but that being said, I think a lot of folks know we've got a $50 million note with Goldman Sachs that expires a year from October, so next October. We've hired Greenhill & Company to go out and refinance that note for us. That note is at LIBOR plus 8.75, which seemed expensive a year ago. Now it doesn't seem quite so expensive.

So I think that will be very important in the next quarter or 2 as we refinance that note what that cost of capital is going to look like and then the ability to get additional debt on top of that. So that's something we are keenly focused on and not just refinancing Goldman, but what that cost of capital is going to be as we kind of grow that relationship.

My next question is on the direct sales effort. And when you approach these larger customers, obviously, the goal is to get a big international rollouts, national rollouts, large customers. Are you approaching them with the EaaS strategy with Energy-as-a-Service product? I assume everything, but I'm trying to understand where is their appetite do you think coming in on what we should expect? So you make a big announcement with a hotel chain, for example, would we expect to see that as product and equipment rollouts? Or would we expect to see that in the EaaS wrap?

Yes. That's a great question, Shawn. So obviously, we offer the full suite of products and services and solutions to the customers. And our goal is to custom tailor a solution that meets their needs. Most of our bigger customers obviously have access to capital and so the Energy-as-a-Service business may not make as much sense for them from a cost standpoint.

That being said, we're working with the hotel chain in the Caribbean, which we've done our first megawatt energy service agreement with, and we're working on several more. So it just depends, I think, for a very large customer like a Marriott, that may be one answer. If it's a smaller regional hotel with 30 properties throughout the Caribbean in Mexico, that may be more of an Energy-as-a-Service play. So it really depends on what the customer is looking for. But our goal is to really go in and say, look, we can be your one-stop shop solution provider. If we sell you the product, we'll wrap it in a 20-year factory protection plan, we'll guarantee life cycle cost, we'll be your partner and be really married to you for 20 years in the performance of your fleet. Or if you want to do Energy-as-a-Service solution, we can do that as well.

So I think flexibility is key. And I think markets change. Obviously, the hospitality industry was really damaged during COVID, and so they're very limited with capital spend. Some other industrial customers are the same. Hospitals, obviously, had a lot on their plate during COVID. But other customers did better during COVID and have plenty of capital dollars to spend. So we want to be flexible. And more importantly, we just want to make sure that we tailor a solution that meets their needs and makes them realize this is the only business we're in. We don't make D9 earth moving equipment. We're not in other products. We are in Energy-as-a-Service and distributed generation microgrids and we're here to give you a great product and stand behind it.

My last question is the plan to get from 39% to 50%. What do you need? Was there going to be a mix in there of re-rents, again, in order to fulfill the demand? And then lastly, as part of that, how much cash can you get out of those targeted receivables that you still have?

Yes. No. You heard Scott's numbers on how we brought down the AR for the quarter and generated cash from operations. So that was great. We still have probably another $4 million or $5 million we can get out of the receivables to get down to 65 days, which would build almost half of what we need to build for the growth to 50 megawatts. Inventories are up, as Scott mentioned. Some of that is just the price increase we got from those 2 vendors. Some of it is obviously anticipatory purchasing to keep growing product and rental at the same time. But inventory turns are over 3, which is good, but we've been over 5 before. So I think if we can really focus on inventory turns going into next year, that will free up another $3 million or $4 million of cash. So I think all of that is helpful.

I think the number of re-rents we do will probably really be driven more by availability. As we're trying to grow both the product side and the rental side, it's pulling out supply chain harder than we have in the past. And so the availability of components may drive more re-rents. But I think it's important to say that each re-rent we do, with the exception, I think, of one, we've got a purchase option out to 3 years. And so even if we re-rent the product for 3 years, we can then buy it at the end, put it on our balance sheet and see those kind of margins we get from the new equipment.

Also, as we bring back re-rent equipments or used equipments, we're refurbishing it, putting it to like new type conditions. So if the customer sees virtually a new machine, whether it's a re-rent or a used piece of equipment that we've purchased and refurbished or built it new. So from a customer perspective, they're getting a great result regardless of what the product is. The re-rent strategy is one I know that confuses people a little bit. But the reality is, as we grow this rental business, we don't know how many contracts we're going to get when, so when you've got parts that are a year lead time and you're trying to grow both the product business and the rental business, you've got to build in some flexibility and the re-rents have allowed us to do that.

And in some cases, these are projects where the project was canceled because of COVID, or equipment maybe was older and the business changed for the customer, they don't have a need for it anymore. So there's actually kind of a silver lining to getting some of these products out of the market and put back into revenue generation and creating value for us and our customers.

Okay. We have no further questions in queue. I'd like to turn the floor back to Darren Jamison for any closing remarks.

Well, I have some really great closing remarks, but the questions were really excellent and really touched on most of them. I guess, what I'll say is, as I look at the quarter, I'm obviously very critical of our performance. I have very high standards for myself and the team. Disappointed with the gross margins for the quarter, down from 25% in Q1, which has been our target. But really, it was 2 vendors and 2 issues that we see as short term and can be mitigated. Global supply chain challenges are real and we're facing those. But I think our team is doing a good job to work through those. So I'm highly confident we'll see margin improvement back in Q3 and hopefully get back to our target levels in Q4 and beyond.

Inventory is up a little bit, but I think that's also understandable with some of the price increases we saw, as well as needing to build both rental units and product. But if I look at the rest of the quarter, revenues up quarter-over-quarter and year-over-year. OpEx is down quarter-over-quarter, year-over-year. We're seeing adjusted EBITDA improved year-over-year. We're seeing growth in the EaaS business as well as the rental business hitting that 50 megawatts. I think we're very well positioned at 39 megawatts today and a lot of pending orders. Very happy with the gross product bookings at 1.6:1 book-to-bill on top of a growth quarter. Product backlog being at $4.1 million is great.

Cash. Cash is important, especially when we're trying to grow this Energy-as-a-Service business, which is a capital-intensive business. So keeping all the money that we did for the quarter that we had during the equity raise, $900,000 from operations is positive. It was a big improvement quarter-over-quarter. We're seeing the DSO come down from 123 days to 85. If you go back in the quarter, it was 150 days. And so we've gone from 150 days to 123 days to 85 days. And if we can get back to 65 days, that will free up more cash to get more rental units and that's where we want to be. I can't overstate how transformational the new U.S. government incentives are going to be. The tax incentives, especially the IRA bill, should be a very big improvement to our business next year. We're very excited about that and what that does for our customers and the viability of our product and profitability it will drive for our customers.

I think DSS, increasing that fee from 3% to 5% is not always thrilled by our distributors. But it really allows us to get back to doing trade shows, B2B events, really getting aggressive to get customer acquisition. We just finished ADIPEC in Abu Dhabi, had a great booth there and really great show traffic. We've got MJBizCon, which is a cannabis show in Vegas this week as well. So we're back to doing heavy marketing, heavy branding, trade shows and media events. And so that's obviously good timing as we come out of COVID and start continuing to grow the business.

Couldn't be happier with the job Greenhill & Co. is doing for us. We looked at 12 different investment banks, Scott and I did the interview to see who can refinance Goldman for us, and they definitely came out on top and have not disappointed. And so look forward to them launching shortly and seeing what kind of pricing we can get for some additional debt and refinance that Goldman note that's up in a little under a year.

Continue to work, Don and his team, on hydrogen development. We're 30% commercial hydrogen today, heading to 100%. There's going to be a lot of money that's going to come through the Department of Energy and other government resources for hydrogen development and hydrogen hubs and we want to make sure we're part of that as well. So that's also very exciting.

I'll be heading over to our U.K. facility here with Tracy and Jen and team here shortly and see the great work they've done in the last year at the U.K. hub. Building re-manufacturing capacity doesn't sound very exciting, but 40% cheaper components is exciting and more of them is exciting. And so as we bring that hub online, I think it's more ability to be more of a full-service organization and those folks have done an amazing job and look forward to seeing them again.

And then really, this next couple of quarters, we'll be focusing on strengthening our supply chain, supply chain integrity, mitigating cost increases, and more importantly, make sure we can get the parts we need to keep our customers happy and not miss any deliveries. And so we want to keep growing the business, keep growing the rental fleet despite the global supply chain challenges that every manufacturer in the world is facing.

And so overall balance, a very good quarter, especially coming off Q1, which was an excellent quarter. We want to keep that momentum going in the back half of the year, and I look forward to talking to everybody after the third quarter. Thank you.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.