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CPST > SEC Filings for CPST > Form 10-Q on 9-Feb-2012All Recent SEC Filings

Show all filings for CAPSTONE TURBINE CORP

Form 10-Q for CAPSTONE TURBINE CORP


9-Feb-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes included in this Form 10-Q and in our Annual Report on Form 10-K for the year ended March 31, 2011. When used in this Form 10-Q, and in the following discussion, the words "believes", "anticipates", "intends", "expects" and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from those projected. These risks include those under Risk Factors in our Annual Report on Form 10-K for Fiscal 2011 and in other reports we file with the SEC. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. All dollar amounts are approximate.

Overview

We develop, manufacture, market and service microturbine technology solutions for use in stationary distributed power generation applications, including cogeneration (combined heat and power ("CHP"), integrated combined heat and power ("ICHP"), combined cooling, heat and power ("CCHP")), resource recovery and secure power. In addition, our microturbines can be used as battery charging generators for hybrid electric vehicle applications. Microturbines allow customers to produce power on-site in parallel with the electric grid or stand-alone when no utility grid is available. There are several technologies which are used to provide "on-site power generation" (also called "distributed generation"), such as reciprocating engines, solar power, wind powered systems and fuel cells. For customers who do not have access to the electric utility grid, microturbines can provide clean, on-site power with lower scheduled maintenance intervals and greater fuel flexibility than competing technologies. For customers with access to the electric grid, microturbines can provide an additional source of continuous duty power, thereby providing additional reliability and potential cost savings. With our stand-alone feature, customers can produce their own energy in the event of a power outage and can use the microturbines as their primary source of power for extended periods. Because our microturbines also produce clean, usable heat energy, they provide economic advantages to customers who can benefit from the use of hot water, chilled water, air conditioning and heating. Our microturbines are sold primarily through our distributors. Our distributors install the microturbines. Service is provided directly by us through our Factory Protection Plan ("FPP") or by our distributors. Successful implementation of microturbines relies on the quality of the microturbine, marketability for appropriate applications, and the quality of the installation and support.

We believe we were the first company to offer a commercially available power source using microturbine technology. Capstone offers microturbines designed for commercial, industrial and utility users from 30 kilowatts ("kW") up to one megawatt in electric power output. Our 30 kW ("C30") microturbine can produce enough electricity to power a small convenience store. The 65 kW ("C65") microturbine can produce enough heat to provide hot water to a 100-room hotel while also providing about one-third of its electrical requirements. Our 200 kW ("C200") microturbine is well suited for larger hotels, office buildings, and wastewater treatment plants, among others. By packaging the C200 microturbine power modules into an International Organization for Standardization ("ISO") sized container, Capstone has created a family of microturbine offerings from 600 kW up to one megawatt in a compact footprint. Our 1000 kW ("C1000 Series") microturbines are well suited for utility substations, larger commercial and industrial facilities and remote oil and gas applications. Our microturbines combine patented air-bearing technology, advanced combustion technology and sophisticated power electronics to form efficient and ultra-low emission electricity and cooling and heat production systems. Because of our air-bearing technology, our microturbines do not require liquid lubricants. This means they do not require routine maintenance to change and dispose of oil or other liquid lubricants, as do the most common competing products. Capstone microturbines can be fueled by various sources including natural gas, propane, sour gas, renewable fuels such as landfill or digester gas, kerosene, diesel and biodiesel. The C65 and C200 microturbines are available with integrated heat exchangers, making them easy to engineer and install in applications where hot water is used.

Our products produce exceptionally clean power. The California Air Resources Board ("CARB") has established extremely high industry standards for distributed generation technologies by requiring them to meet emissions levels comparable to the Best Available Control Technology for large state-of-the-art central utility power plants. Capstone's microturbines have become even "greener" with ultra-low emissions by complying with the Environmental Protection Agency and CARB 2007 emissions requirements which reduced previous requirements for mono-nitrogen oxides (NOx) by 86%, carbon monoxide (CO) by 98%, and volatile organic compounds (VOCs) by 98%. Our C65 was certified by CARB to meet its stringent 2007 emissions requirements-the same emissions standard used to certify fuel cells and the same emissions levels as a state-of-the-art central power plant. Our C65 Landfill and Digester Gas systems were certified in January 2008 by CARB to meet 2008 waste gas emissions requirements for landfill and digester gas applications. Our C200 Landfill and Digester Gas systems were certified in November 2010 by CARB as meeting 2008 waste gas emissions requirements for landfill and digester gas applications. In August 2011, we released C30 and C65 natural gas fueled microturbines that meet extremely low global emission standards, including CARB requirements for New On-Road Heavy-Duty Engines for Urban Bus-Hybrid service.


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On February 1, 2010, the Company acquired the 100 kW ("TA100") microturbine product line from Calnetix Power Solutions, Inc. ("CPS") to expand the Company's microturbine product line and to add new relationships with distributors to supply the Company's products. See Note 16-Acquisition, for discussion of the TA100 acquired from CPS. On February 1, 2010, the Company and CPS also entered into an agreement pursuant to which we agreed to purchase 125 kW waste heat recovery generator systems from CPS. In exchange for certain minimum purchase requirements during a three-year period, we have exclusive rights to sell the zero-emission waste heat recovery generator for all microturbine applications and for applications 500 kW or lower where the source of heat is the exhaust of a reciprocating engine used in a landfill application. We must meet specified annual sales targets in order to maintain the exclusive rights to sell the waste heat recovery generators.

On April 28, 2011, we purchased from CPS for $2.3 million the remaining TA100 microturbine inventory that was not consumed as part of the TA100 manufacturing process and acquired the TA100 manufacturing equipment.

In order to increase volume and reduce cost, we focus our efforts in vertical markets that we expect to generate repeat business for the Company. To support our opportunities to grow in these markets, we continue to enhance the reliability and performance of our products by regularly developing new processes and enhancing training to assist those who apply, install and use our products.

An overview of our direction, targets and key initiatives follows:

1) Focus on Vertical Markets- Within the distributed generation markets that we serve, we focus on vertical markets that we identify as having the greatest near-term potential. In our primary products and applications (energy efficiency, renewable energy, natural resources, critical power supply and mobile products), we identify specific targeted vertical market segments. Within each of these segments, we identify what we believe to be the critical factors to success and base our plans on those factors.

Energy Efficiency-CHP/CCHP

Energy efficiency maximizes the use of energy produced by the microturbines, reduces emissions compared with traditional power generation and enhances the economic advantage to customers. Energy efficiency uses both the heat and electric energy produced in the power generation process. Using the heat and electricity created from a single combustion process increases the efficiency of the system from approximately 30% to 75% or more. The increased operating efficiency reduces overall green house gas emissions compared with traditional independent sources such as power generation and local thermal generation and, through displacement of other separate systems, can reduce variable production costs.

Renewable Energy

Our microturbine products can use renewable methane gases from landfills, wastewater treatment facilities and other biogas applications like cow, pig and chicken manure. Capstone's product can burn these renewable waste gases with minimal emissions, thereby, in some cases, avoiding the imposition of penalties incurred for pollution, while simultaneously producing electricity from this "free" renewable fuel for use at the site or in the surrounding community.

Natural Resources-Oil, Natural Gas, Shale Gas & Mining

On a worldwide basis, there are thousands of locations where the drilling, production, compression and transportation of natural resources and other extraction and production processes creates fuel byproducts, which traditionally have been released or burned into the atmosphere. Typically oil and gas or mining operations have no electric utility grid and rely solely on Capstone's microturbine product for reliable low emission power supply.

Critical Power Supply

Because of the potentially catastrophic consequences of even momentary system failure, certain power users such as high technology and information systems companies require particularly high levels of reliability in their power service.

Mobile Products-Hybrid Electric Vehicles

Our technology is also used in hybrid electric vehicle applications. Our customers have applied our products in hybrid electric vehicles such as transit buses, trucks and boats. In these applications the microturbine acts as an onboard battery charger to recharge the electric vehicle battery system as needed. The benefits of this microturbine hybrid include extended range, fuel economy gains, quieter operation, reduced emissions and higher reliability compared with traditional internal combustion engines.


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During the three months ended December 31, 2011, we booked total orders of $23.3 million for 102 units, or 26.5 megawatts, compared to $20.0 million for 73 units, or 21.2 megawatts, during the three months ended December 31, 2010. We shipped 136 units with an aggregate of 23.5 megawatts, generating revenue of $21.9 million compared to 171 units with an aggregate of 20.0 megawatts, generating revenue of $18.8 million during the three months ended December 31, 2010. Total backlog as of December 31, 2011 increased $30.4 million, or 36%, to $115.1 million from $84.7 million as of December 31, 2010. As of December 31, 2011, we had 641 units, or 129.8 megawatts, in total backlog compared to 569 units, or 94.6 megawatts, as of December 31, 2010. As of December 31, 2011 and December 30, 2010, all of the backlog was current and expected to be shipped within the next twelve months. The timing of shipments is subject to change based on several variables (including customer payments and changes in customer delivery schedules), many of which are not in our control and can affect our quarterly revenue and backlog. Our actual product shipments during the three months ended December 31, 2011 were: 23% for use in energy efficiency applications, 11% for use in renewable energy applications, 63% for use in oil, gas & other natural resources applications, 1% for use in critical power supply applications and 2% for use in mobile products applications.

The following table summarizes our backlog:

                                         As of December 31,
                                      2011                2010
                                Megawatts   Units   Megawatts   Units
Current
C30                                   3.8     126         3.7     122
C65                                  21.8     336        20.5     316
TA100                                 2.7      27         3.3      33
C200                                  7.8      39         4.0      20
C600                                 12.6      21         3.6       6
C800                                  8.8      11         8.0      10
C1000                                71.0      71        50.0      50
Waste heat recovery generator         1.3      10         1.5      12
Total Backlog                       129.8     641        94.6     569

2) Sales and Distribution Channels- We seek out distributors and representatives that have business experience and capabilities to support our growth plans in our targeted markets. In North America, we currently have 35 distributors and Original Equipment Manufacturers ("OEMs"). Outside of North America, we currently have 60 distributors and OEMs. We continue to refine the distribution channels to address our specific targeted markets.

3) Service- We serve our customers directly and through qualified distributors, who will perform their service work using technicians specifically trained by Capstone. We offer a comprehensive FPP where Capstone charges a fixed annual fee to perform regularly scheduled maintenance, as well as other maintenance as needed. Capstone then performs the required maintenance directly with its own personnel, or contracts with one of its local distributors to do so. In January 2011, we expanded the FPP to include total microturbine plant operations if required by the end use customer. Capstone provides factory and on-site training to certify all personnel that are allowed to perform service on our microturbines. FPPs are generally paid quarterly in advance. Our FPP backlog as of December 31, 2011 was $31.5 million, which represents the value of the contractual agreements for FPP services that has not been earned and extends through Fiscal 2026.

4) Product Robustness and Life Cycle Maintenance Costs- To provide us with the ability to evaluate microturbine performance in the field, we developed a "real-time" remote monitoring and diagnostic feature. This feature allows us to monitor installed units and rapidly collect operating data on a continual basis. We use this information to anticipate and more quickly respond to field performance issues, evaluate component robustness and identify areas for continuous improvement. This feature is important in allowing us to better serve our customers.

5) New Product Development- Our new product development is targeted specifically to meet the needs of our selected vertical markets. We expect that our existing product platforms, the C30, C65, TA100, C200 and C1000 Series microturbines, will be our foundational product lines for the foreseeable future. Our product development efforts are centered on enhancing the features of these base products. We are currently focusing efforts on developing a more efficient microturbine CHP system. The first phase of the development program is expected to improve our existing C200 engine to increase power output and electrical efficiency, resulting in a system with a targeted power output of


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250 kW and projected electrical efficiency of 35% (compared to 33% for the C200). The second phase of the program is expected to incorporate further engine efficiency improvements, resulting in a product with a projected electrical efficiency of 42% and targeted power output of 370 kW. The DOE awarded us a grant of $5.0 million in support of this development program.

In addition, we are developing and testing a fuel flexible microturbine system capable of operating on synthetic gas fuel mixtures containing varying amounts of hydrogen.

6) Cost and Core Competencies- We are continuing to make progress towards achieving cost improvement goals through design and manufacturability changes, robotics, parts commonality, tier one suppliers and lower cost offshore suppliers. We continue to review avenues for cost reduction by sourcing to the best value supply chain option. We have made progress and plan to continue diversifying our suppliers internationally and within the United States. Management also expects to be able to continue leveraging our costs as product volumes increase.

Management believes that effective execution in each of these key areas will be necessary to leverage Capstone's promising technology and early market leadership into achieving positive cash flow with growing market presence and improving financial performance. Based on our recent progress and assuming achievement of targeted cost reductions, our financial model anticipates that we will achieve positive cash flow when we ship approximately 200 units in a quarter, dependent on an assumed product mix. Management believes our manufacturing facilities located in Chatsworth and Van Nuys, California have a combined production capacity of approximately 2,000 units per year, depending on product mix. Excluding working capital requirements, management believes we can expand our combined production capacity to approximately 4,000 units per year, depending on product mix, with approximately $10.0 to $15.0 million of capital expenditures. We have not committed to this expansion nor identified a source for its funding.

Critical Accounting Policies and Estimates

The preparation of our condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. Management believes the most complex and sensitive judgments, because of their significance to the condensed consolidated financial statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Actual results could differ from management's estimates. Management believes the critical accounting policies listed below affect our more significant accounting judgments and estimates used in the preparation of the condensed consolidated financial statements. These policies (except as noted below) are described in greater detail in our Annual Report on Form 10-K for Fiscal 2011 and continue to include the following areas:

Impairment of long-lived assets, including intangible assets with finite lives;

Inventory write-downs and classification of inventories;

Estimates of warranty obligations;

Allowance for doubtful accounts;

Deferred tax assets and valuation allowance;

Stock-based compensation expense;

Loss contingencies; and

Fair value of financial instruments.

Results of Operations

Three Months Ended December 31, 2011 and 2010

Revenue. Revenue for the three months ended December 31, 2011 increased $3.3 million, or 14%, to $27.5 million from $24.2 million for the three months ended December 31, 2010. The change in revenue for the three months ended December 31, 2011 compared to the three months ended December 31, 2010 included increases in revenue of $2.3 million from the North American market, $1.6 million from the European market, $0.9 million from the African market and $0.2 million from the Australian market, primarily because of our continued efforts to improve distribution channels. This overall increase in revenue was offset by decreases in revenue of $1.2 million from the Asian market and $0.5 million from the South American market because of lower sales volume in these regions. Lower sales volume primarily reflected non-recurring microturbine product sales for specific projects that had occurred in the same period last year.


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For the three months ended December 31, 2011, revenue from microturbine products increased $3.1 million, or 16%, to $21.9 million from $18.8 million for the three months ended December 31, 2010. Overall microturbine product shipments were 35 units lower (3.5 megawatts higher) during the three months ended December 31, 2011 compared to the three months ended December 31, 2010, totaling 136 units (23.5 megawatts) and 171 units (20.0 megawatts), respectively. Average revenue per unit increased for the three months ended December 31, 2011 to approximately $161,000 compared to approximately $110,000 per unit for the three months ended December 31, 2010. Megawatts shipped and revenue during the three months ended December 31, 2011 increased as a result of higher sales volume for our C200 microturbine and further market adoption of our C1000 Series product line.

For the three months ended December 31, 2011, revenue from our accessories, parts and service increased $0.2 million, or 4%, to $5.6 million from $5.4 million for the three months ended December 31, 2010. The increase in revenue resulted from increased FPP contract enrollments offset by lower sales of microturbine parts. The timing of shipments is subject to change based on several variables (including customer payments and customer delivery schedules), some of which are not within our control and can affect our quarterly revenue and backlog. Therefore, we evaluate historical revenue in conjunction with backlog to anticipate the growth trend of our revenue.

The following table summarizes our revenue (revenue amounts in millions):

                                          Three Months Ended December 31,
                                      2011                               2010
                         Revenue    Megawatts    Units      Revenue    Megawatts    Units
C30                     $     1.1         0.8         26   $     0.8         0.6         20
C65                           5.4         5.1         79         7.8         7.9        121
TA100                           -           -          -         2.0         1.6         16
C200                          3.5         3.0         15         0.6         0.6          3
C600                          1.1         1.2          2         0.6         0.6          1
C800                          2.1         2.4          3         1.2         1.6          2
C1000 Series                  8.7        11.0         11         5.6         7.0          7
Waste heat recovery
generator                       -           -          -         0.2         0.1          1
Total from
Microturbine Products   $    21.9        23.5        136   $    18.8        20.0        171
Accessories, Parts
and Service                   5.6           -          -         5.4           -          -
Total                   $    27.5        23.5        136   $    24.2        20.0        171

Sales to Banking Production Centre ("BPC"), one of the Company's Russian distributors, and Pumps and Service Company ("Pumps and Service"), one of the Company's domestic distributors, accounted for 27% and 23%, respectively, of revenue for the three months ended December 31, 2011. Sales to BPC and Pumps and Service accounted for 24% and 16% of revenue for the three months ended December 31, 2010, respectively.

Gross Margin. Cost of goods sold includes direct material costs, production and service center labor and overhead, inventory charges and provision for estimated product warranty expenses. Gross margin was $2.3 million, or 8% of revenue, for the three months ended December 31, 2011 compared to a gross margin of $0.9 million, or 4% of revenue, for the three months ended December 31, 2010. The improvement in gross margin of $1.4 million was the result of a $2.9 million benefit realized from a change in product mix, which reflects the sale of higher priced microturbine products, increased FPP contract enrollments offset by lower sales of microturbine parts during the three months ended December 31, 2011.All microturbine products had better margins than in the same period last year as a result of higher average selling prices and overall lower direct material costs. The $2.9 million benefit related to product mix was offset by increases in production and service center labor and overhead expenses of $0.5 million, royalty expense of $0.4 million, warranty expense of $0.4 million and inventory charges of $0.2 million. Management has implemented certain initiatives to further reduce direct material costs and other manufacturing and warranty costs as we work to achieve profitability.

Production and service center labor and overhead expense increased $0.5 million during the three months ended December 31, 2011 compared to the three months ended December 31, 2010 as the result of increased salaries and supplies expense and further expansion of our service centers to meet obligations under FPP contracts.

Royalty expense increased $0.4 million during the three months ended December 31, 2011 compared to the three months ended December 31, 2010. The increase in our royalty expense is the result of sales growth of our C200 and C1000 Series systems. We pay Carrier Corporation an ongoing royalty of a predetermined fixed rate for each microturbine system covered by the Development and License Agreement.


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Warranty expense is a combination of a standard warranty provision recorded at the time revenue is recognized and changes, if any, in estimates for reliability repair programs. Reliability repair programs are estimates that are recorded in the period that new information becomes available, including design changes, cost of repair and product enhancements, which can include both in-warranty and out-of-warranty systems. The increase in warranty expense of $0.4 million reflects an increase in the standard warranty provision, an increase in warranty claims related primarily to early production C200 and C1000 Series systems and more units under warranty during the three months ended December 31, 2011 compared to the prior year period.

Inventory charges increased $0.2 million during the three months ended December 31, 2011 compared to the three months ended December 31, 2010 primarily as the result of physical inventory adjustments and reserves for excess and obsolete inventory.

Research and Development ("R&D") Expenses. R&D expenses include compensation, engineering department expenses, overhead allocations for administration and facilities and materials costs associated with development. R&D expenses for the three months ended December 31, 2011 increased $0.4 million, or 29%, to $1.8 million from $1.4 million for the three months ended December 31, 2010. R&D expenses are reported net of benefits from cost-sharing programs, such as DOE grants. The overall increase in R&D expenses of $0.4 million resulted from increased salaries of $0.3 million and consulting expense of $0.1 million. There were approximately $0.3 million of cost-sharing benefits during each of the three months ended December 31, 2011 and 2010. Cost-sharing programs vary from period to period depending on the phases of the programs. Management expects R&D expenses in Fiscal 2012 to be slightly higher than in Fiscal 2011.

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