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| CPST > SEC Filings for CPST > Form 10-K on 14-Jun-2012 | All Recent SEC Filings |
14-Jun-2012
Annual Report
The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause a difference include, but are not limited to, those discussed under Item 1A (Risk Factors) in this Annual Report. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appears elsewhere in this Annual Report.
Overview
Capstone is, and has been, the market leader in microturbines based on the number of microturbines sold. We were able to significantly increase revenues again this year despite the challenging economic conditions worldwide. Management believes that our efforts on the continued growth and broadening of our distribution network and the stronger than anticipated market acceptance of our new C1000 Series products were the primary reasons for our revenue growth.
Capstone continues to gain market share in all five of its major vertical markets (energy efficiency, renewable energy, natural resources, critical power supply and mobile products). In the energy efficiency market we continue to expand our market share in hotels, office buildings, hospitals, retail and industrial applications globally. The renewable energy market continues to be a significant portion of our business as we shipped products around the globe for applications fueled by landfill gas, biodiesel, biogas such as food processing and agricultural waste, referred to as green waste, and cow, pig and chicken manure. Our C1000 Series microturbine continues to drive our near term business success in the oil and gas and other natural resource markets as we gain product acceptance in U.S. shale plays and Russian oil fields. Our critical power supply data center product is performing well, and we continue to focus efforts on gaining market share with this new product. Capstone's mobile products market utilizing microturbines for electric vehicles is gaining interest for use of our products as range extenders in electric buses, trucks, and the marine industry.
We continue to focus on improving our products based on customer input, building brand awareness and new channels to market by developing a diversified network of strategic distribution partners. Our focus is on products and solutions that provide near-term opportunities to drive repeatable business rather than discrete projects for niche markets. In addition, management closely manages operating expenses and strives to improve manufacturing efficiencies while simultaneously lowering direct material costs and increasing average selling prices. The key drivers to Capstone's success are continuing to increase C200 microturbine engine production rates, higher average selling prices, lower direct material costs, positive new order flow and reduced cash usage.
On February 1, 2010, we entered into an asset purchase agreement with CPS ("APA"). The Company acquired, subject to an existing license retained by CPS, all of the rights and assets related to the manufacture and sale of the TA100 microturbine generator, including intellectual property, design, tooling, drawings, patents, know-how, distribution agreements and supply agreements. Pursuant to the APA, the Company issued to CPS 1,550,387 shares of common stock at the closing date on February 1, 2010 and agreed to pay additional consideration of $3.1 million on July 30, 2010 (the "Second Funding Date"). The additional consideration was to be paid, at the Company's discretion, in shares of the Company's common stock or cash. The Company elected to satisfy the amount due on the Second Funding Date with common stock and issued 3,131,313 shares to CPS.
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. 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 through December 2015, 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. As of March 31, 2012, we were in compliance with the minimum purchase requirements in the agreement.
To support our opportunities to grow in our targeted 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:
º 1)
º 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.
During Fiscal 2012, we booked orders for 136.3 megawatts and shipped 96.1 megawatts of products, which combined with our backlog at March 31, 2011, resulted in 158.8 megawatts in backlog at the end of the fiscal year. Our product shipments in Fiscal 2012 were: 58% for use in natural resources applications, 25% for use in energy efficiency applications, 16% for use in renewable energy applications and 1% for use in other applications (including critical power supply and mobile products).
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 greenhouse 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.
Our microturbines can use renewable methane gases from landfills, wastewater treatment facilities and other biogas applications such as food processing and agricultural waste (green waste) and 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 area.
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 create fuel byproducts, which traditionally have been released or burned into the atmosphere. Typically oil and gas or mining operations are in remote locations where the electric utility grid is not available. Therefore, these operations rely on the microturbines' ability to provide reliable low emission 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.
Our technology is also used in hybrid electric vehicle applications. Our customers have applied our products in hybrid electric mobile applications, such as transit buses, trucks and boats. In these applications the microturbine acts as an onboard battery charger to recharge the battery system as needed. The benefits of microturbine hybrids include extended range, fuel economy gains, quieter operation, reduced emissions and higher reliability compared with traditional internal combustion engines.
º 2)
º Sales and Distribution Channel We seek out distributors that have
business experience and capabilities to support our growth plans in
our targeted markets. In North America, we currently have 35
distributors and OEMs, which include six distributors added as a
result of the CPS transaction. Internationally, outside of North
America, we currently have 58 distributors and OEMs, which include 11
distributors added as a result of the CPS transaction. We continue to
refine the distribution channels to address our specific targeted
markets.
º 3)
º 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. In January 2011, we
expanded the FPP to include total microturbine plant operations if
required by the end use customer. Capstone provides factory and onsite
training to certify all personnel that are allowed to perform service
on our microturbines. FPPs are generally paid quarterly in advance.
Our FPP backlog at the end of Fiscal 2012 was $33.7 million which
represents the value of the contractual agreement for FPP services
that has not been earned and extends through Fiscal 2027. Service
revenue in Fiscal 2012 was approximately 8% of total revenue.
º 4)
º Product Robustness and Life Cycle Maintenance Costs To provide us
with the ability to evaluate microturbine performance in the field we
are developing an updated "real-time" Internet based remote monitoring
and diagnostic feature, to replace our previous CSN system and take
advantage of newer generation technology. This feature will allow us
to monitor installed units and rapidly collect operating data on a
continual basis, even in areas with limited or no landline internet
connection. We will use this information to anticipate and more
quickly respond to field performance issues, evaluate component
robustness and identify areas for continuous improvement.
º 5)
º 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
Combined Heat and Power ("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 250 kW and projected electrical
efficiency of 35%. 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. The DOE awarded us a grant of $2.5 million in support of this development program.
º 6)
º 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 indicates that we will achieve positive cash flow when we ship approximately 200 units in a quarter, depending 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 to $15 million of capital expenditures. We have not committed to this expansion nor identified a source for its funding.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosures of contingent liabilities. On an on-going basis, we evaluate our estimates, including but not limited to those related to long-lived assets, including finite-lived intangible assets and fixed assets, bad debts, inventories, warranty obligations, stock-based compensation, warrant liabilities, income taxes and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Management believes that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
º •
º We evaluate the carrying value of long-lived assets, including
intangible assets with finite lives, for impairment whenever events or
changes in circumstances indicate that the carrying value of such
assets may not be recoverable. Factors that are considered important
that could trigger an impairment review include a current-period
operating or cash flow loss combined with a history of operating or
cash flow losses and a projection or forecast that demonstrates
continuing losses or insufficient income associated with the use of a
long-lived asset or asset group. Other factors include a significant
change in the manner of the use of the asset or a significant negative
industry or economic trend. This evaluation is performed based on
undiscounted estimated future cash flows compared with the carrying
value of the related assets. If the undiscounted estimated future cash
flows are less than the carrying value, an impairment loss is
recognized and the loss is measured by the difference between the
carrying value and the estimated fair value of the assets. The
estimated fair value of the assets are determined using the best
information available, which generally is an estimate of the future
discounted cash flow associated with the assets using a discount rate
that approximates the weighted-average cost of capital for the
Company. On a quarterly basis, we assess whether events or changes in
circumstances have occurred that potentially indicate the carrying
value of long-lived assets may not be recoverable. Intangible assets
include a manufacturing license, technology, backlog and customer
relationships. We reevaluate the useful life determinations for these
intangible assets each reporting period to determine whether events
and circumstances warrant a revision in their remaining useful lives.
The estimation of future cash flows requires significant estimates of factors that include future sales growth and gross margin performance. If our sales growth, gross margin performance or other estimated operating results are not achieved at or above our forecasted level, or inflation exceeds our forecast, the carrying value of our asset groups may prove to be unrecoverable and we may incur impairment charges in the future. A significant assumption in our forecasts is our ability to reduce our direct material costs. Based on our current forecasts, if we were not able to achieve additional significant cost reductions, our estimated undiscounted cash flows may not exceed the carrying value of our long-lived assets, which could result in a future impairment of our long-lived assets. The Company performed an analysis as of March 31, 2012 and determined that the estimated undiscounted cash flows of the long-lived assets exceeded the carrying value of the assets and no write-down was necessary. See Note 5-Intangible Assets in the "Notes to Consolidated Financial Statements."
º •
º Our inventories are valued on a first in first out ("FIFO") basis and
at the lower of cost or market. We routinely evaluate the composition
of our inventories and identify slow-moving, excess, obsolete or
otherwise impaired inventories. Inventories identified as impaired are
evaluated to determine if write-downs are required. Included in this
assessment is a review for obsolescence as a result of engineering
changes in our product. Future product enhancement and development may
render certain inventories obsolete, resulting in additional
write-downs of inventories. In addition, inventories are classified as
current or long-term based on our sales forecast and also, in part,
based on our projected usage for warranty claims and service. A change
in forecast could impact the classification of inventories.
º •
º We provide for the estimated cost of warranties at the time revenue
from sales is recognized. We also accrue the estimated costs to
address reliability repairs on products no longer under warranty when,
in our judgment, and in accordance with a specific plan developed by
us, it is prudent to provide such repairs. We estimate warranty
expenses based upon historical and projected product failure rates,
estimated costs of parts, labor and shipping to repair or replace a
unit and the number of units covered under the warranty period. While
we engage in extensive
quality programs and processes, our warranty obligation is affected by failure rates and service costs in correcting failures. As we have more units commissioned and longer periods of actual performance, additional data becomes available to assess future warranty costs. When we have sufficient evidence that product changes are altering the historical failure occurrence rates, the impact of such changes is then taken into account in estimating future warranty liabilities. Changes in estimates are recorded in the period that new information, such as design changes, cost of repair and product enhancements, becomes available. Should actual failure rates or service costs differ from our estimates, revisions to the warranty liability would be required and could be material to our financial condition, results of operations and cash flow.
º •
º Our revenue consists of sales of products, parts, accessories and
service, which includes FPPs, net of discounts. Our distributors
purchase products, parts and FPPs for sale to end users and are also
required to provide a variety of additional services, including
application engineering, installation, commissioning and
post-commissioning service. Our standard terms of sales to
distributors and direct end users include transfer of title, care,
custody and control at the point of shipment, payment terms ranging
from full payment in advance of shipment to payment in 90 days, no
right of return or exchange, and no post-shipment performance
obligations by us except for warranties provided on the products and
parts sold. We recognize revenue when all of the following criteria
are met: persuasive evidence of an arrangement exists, delivery has
occurred or service has been rendered, selling price is fixed or
determinable and collectability is reasonably assured. Service revenue
derived from time and materials contracts is recognized as the service
is performed. FPP contracts are agreements to perform certain
agreed-upon service to maintain a product for a specified period of
time. Service revenue derived from FPP contracts is recognized on a
straight-line basis over the contract period. We occasionally enter
into agreements that contain multiple elements, such as equipment,
installation, engineering and/or service. For multiple element
arrangements, we recognize revenue for delivered elements when the
delivered item has stand-alone value to the customer, the Company's
estimated selling price of each element is known and customer
acceptance, if required, has occurred. We allocate the total contract
value among each element based on its relative selling price.
º •
º We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required
payments. We evaluate all accounts aged over 60 days or past payment
terms. If the financial condition of our customers deteriorates or if
other conditions arise that result in an impairment of their ability
or intention to make payments, additional allowances may be required.
º •
º We have a history of unprofitable operations. These losses generated
significant federal and state net operating loss ("NOL")
carryforwards. We record a valuation allowance against the net
deferred income tax assets associated with these NOLs if it is "more
likely than not" that we will not be able to utilize them to offset
future income taxes. Because of the uncertainty surrounding the timing
of realizing the benefits of our favorable tax attributes in future
income tax returns, a valuation allowance has been provided against
all of our net deferred income tax assets. We currently provide for
income taxes only to the extent that we expect to pay cash taxes,
primarily state taxes. It is possible, however, that we could be
profitable in the future at levels which could cause management to
determine that it is more likely than not that we will realize all or
a portion of the NOL carryforwards. Upon reaching such a conclusion,
we would record the estimated net realizable value of the deferred
income tax asset at that time. Such adjustment would increase income
in the period that the determination was made.
º •
º We record an estimated loss from a loss contingency when information
available prior to issuance of our financial statements indicates that
it is probable that an asset has been impaired or a liability has been
incurred at the date of the financial statements and the amount of the
loss can be reasonably estimated. Accounting for contingencies, such
as legal matters, requires us to
use our judgment. Any unfavorable outcome of litigation or other contingencies could have an adverse impact on our financial condition, results of operations and cash flow.
º •
º We recognize stock-based compensation expense associated with stock
options in the statement of operations. Determining the amount of
stock-based compensation to be recorded requires us to develop
estimates to be used in calculating the grant-date fair value of stock
options. We calculate the grant-date fair values using the
Black-Scholes valuation model.
The use of Black-Scholes model requires us to make estimates of the following assumptions:
º •
º Expected volatility-The estimated stock price volatility was
derived based upon the Company's actual historic stock prices
over the expected option life, which represents the Company's
best estimate of expected volatility.
º •
º Expected option life-The expected life, or term, of options
granted was derived from historical exercise behavior and
represents the period of time that stock option awards are
expected to be outstanding.
º •
º Risk-free interest rate-We used the yield on zero-coupon U.S.
Treasury securities for a period that is commensurate with the
expected life assumption as the risk-free interest rate.
The amount of stock-based compensation recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest. We estimate forfeitures at the time of grant and revise, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The term "forfeitures" is distinct from "cancellations" or "expirations" and represents only the unvested portion of the surrendered option. We review historical forfeiture data and determine the appropriate forfeiture rate based on that data. We re-evaluate this analysis periodically and adjust the forfeiture rate as necessary. Ultimately, we recognize the actual expense over the vesting period only for the shares that vest.
º •
º As discussed in Note 9-Fair Value Measurements in the "Notes to
Consolidated Financial Statements", ASC 815 requires that our warrants
be accounted for as derivative instruments and that we mark the value
of our warrant liability to market and recognize the change in
valuation in our statement of operations each reporting period.
Determining the warrant liability to be recorded requires us to
develop estimates to be used in calculating the fair value of the
warrants. We calculate the fair values using the Monte Carlo
simulation model.
The use of the Monte Carlo simulation model requires us to make estimates of the following assumptions:
º •
º Expected volatility-The estimated stock price volatility was
derived based upon the Company's actual historic stock prices
over the contractual life of the warrants, which represents the
Company's best estimate of expected volatility.
º •
º Risk-free interest rate-We used the yield on zero-coupon U.S.
Treasury securities for a period that is commensurate with the
warrant contractual life assumption as the risk-free interest
rate.
Results of Operations
Year Ended March 31, 2012 Compared to Year Ended March 31, 2011
Revenue Revenue for Fiscal 2012 increased $27.5 million, or 34%, to $109.4 million from $81.9 million for Fiscal 2011. The change in revenue for . . .
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