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

Show all filings for CAPSTONE TURBINE CORP

Form 10-Q for CAPSTONE TURBINE CORP


9-Aug-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, 2012. 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 2012 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

Capstone is, and has been, the market leader in microturbines based on the number of microturbines sold. We were able to increase revenues during the first quarter of Fiscal 2013 compared to the first quarter of Fiscal 2012 despite the challenging economic conditions worldwide. Management believes that our efforts on the continued growth and broadening of our distribution network, along with continued market acceptance of our 200 kW ("C200") microturbine and 1000 kW ("C1000 Series") microturbines products were the primary reasons for our revenue growth during the quarter compared to the first quarter of Fiscal 2012.

Capstone continues to gain market interest in all five of its major vertical markets (energy efficiency, renewable energy, natural resources, critical power supply and transportation 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 transportation 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 continued increase in 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 June 30, 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.


Table of Contents

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 transportation 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 applications use 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.

Renewable Energy

Our microturbines can use renewable methane gases from landfills, wastewater treatment facilities and other biogas applications such as food processing and agricultural waste, referred to as green waste, and cow, pig and chicken manure. Capstone's products 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. The microturbines have demonstrated effectiveness in these applications and outperform conventional combustion engines in a number of situations, including when the gas contains a high amount of sulfur.

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 create fuel byproducts, which traditionally have been released or burned into the atmosphere. Our microturbines are installed in the natural resource market to be used in oil and gas exploration, production, compression and transmission sites both onshore and offshore as a highly reliable critical source of power generation. In addition, our microturbines can use flare gas as a fuel to provide prime power. Typically these oil and gas or mining operations have no access to an electric utility grid and rely solely on Capstone's microturbines for a 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. Management believes that Capstone's critical power supply offerings are the world's only microturbine powered Uninterruptible Power Source solutions that can offer clean, IT-grade power produced from microturbines, the utility or a combination of both.

Transportation Products-Hybrid Electric Vehicles

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.

Backlog

During the first quarter of Fiscal 2013, we booked total orders of $24.1 million for 87 units, or 25.7 megawatts, compared to $29.7 million for 196 units, or 33.2 megawatts, during the first quarter of Fiscal 2012. We shipped 134 units with an aggregate of 25.1 megawatts, generating revenue of $23.6 million compared to 170 units with an aggregate of 21.9 megawatts, generating revenue of $20.8 million during the first quarter of Fiscal 2012. Total backlog as of June 30, 2012 increased $24.2 million, or 21%, to $139.5 million from $115.3 million as of June 30, 2011. As of June 30, 2012, we had 632 units, or 159.4 megawatts, in total backlog compared to 695 units, or 129.9 megawatts, as of June 30, 2011. As of June 30, 2012 and June 30, 2011, 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 first quarter of Fiscal 2013 were: 24% for use in energy efficiency applications, 6% for use in renewable energy applications, 70% for use in oil, gas & other natural resources applications and less than 1% for use in transportation products applications.


Table of Contents

The following table summarizes our backlog:

                                           As of June 30,
                                      2012                2011
                                Megawatts   Units   Megawatts   Units
Current
C30                                   3.1     102         4.5     149
C65                                  20.2     312        24.8     382
TA100                                 3.0      30         2.3      23
C200                                  8.6      43         5.2      26
C600                                 13.8      23        12.0      20
C800                                  7.2       9        13.6      17
C1000                               102.0     102        66.0      66
Waste heat recovery generator         1.3      10         1.5      12
Unit upgrades                         0.2       1           -       -
Total Backlog                       159.4     632       129.9     695

2. Sales and Distribution Channels 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 Original Equipment Manufacturers ("OEMs"). Internationally, 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 Factory Protection Plan ("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 the first quarter of Fiscal 2013 was $36.8 million which represents the value of the contractual agreement for FPP services that has not been earned and extends through Fiscal 2027.

4. 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 Capstone Service Network 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.

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 Combined Heat and Power 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.

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.


Table of Contents

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 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 2012 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 June 30, 2012 and 2011

Revenue Revenue for the first quarter of Fiscal 2013 increased $4.5 million, or 19%, to $28.8 million from $24.3 million for the first quarter of Fiscal 2012. The change in revenue for the first quarter of Fiscal 2013 compared to the first quarter of Fiscal 2012 included increases in revenue of $6.7 million from the North American market and $1.1 million from the Asian market. The increase in the North American market was primarily related to increased sales into the U.S. shale plays market. The increase in the Asian market was primarily because of our continued efforts to improve distribution channels. This overall increase in revenue was offset by decreases in revenue of $2.5 million from the European market and $0.8 million from the South American market. We expect revenues from the European market will continue to be soft as a result of the economic conditions there. The decrease in the South American market was primarily the result of non-recurring microturbine product sales for specific projects that had occurred in the same period last year.

For the first quarter of Fiscal 2013, revenue from microturbine products increased $2.8 million, or 13%, to $23.6 million from $20.8 million for the first quarter of Fiscal 2012. Microturbine megawatts shipped during the first quarter of Fiscal 2013 increased 3.2 megawatts to 25.1 megawatts from 21.9 megawatts for the first quarter of Fiscal 2012. Microturbine units shipped during the first quarter of Fiscal 2013 decreased 36 units to 134 units from 170 units for the first quarter of Fiscal 2012. Average revenue per unit increased for the first quarter of Fiscal 2013 to approximately $176,000 compared to approximately $122,000 per unit for the first quarter of Fiscal 2012. Megawatts shipped and revenue per unit during the first quarter of Fiscal 2013 increased as a result of higher sales volume for our C200 and C1000 Series microturbines, offset by lower sales volume for our C30 and C65 microturbines.


Table of Contents

For the first quarter of Fiscal 2013, revenue from our accessories, parts and service increased $1.7 million, or 49%, to $5.2 million from $3.5 million for the first quarter of Fiscal 2012. The increase in revenue resulted from higher sales of microturbine parts, microturbine service work and FPP contract enrollments.

The timing of shipments is subject to change based on several variables (including customer deposits, payments, availability of credit and delivery schedule changes), most of which are not in our control and can affect the timing of our revenue and shipment of our products from 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 June 30,
                                      2012                               2011
                         Revenue    Megawatts    Units      Revenue    Megawatts    Units
C30                     $     1.0         0.7         24   $     1.3         1.0         33
C65                           5.7         5.3         81         8.1         7.7        119
TA100                         0.1         0.1          1         0.5         0.2          2
C200                          2.3         2.0         10         0.2         0.2          1
C600                          1.2         1.2          2         2.1         2.4          4
C800                          0.7         0.8          1         2.0         2.4          3
C1000 Series                 12.6        15.0         15         6.6         8.0          8
Unit upgrades                   -           -          -           -           -          -
Total from
Microturbine Products   $    23.6        25.1        134   $    20.8        21.9        170
Accessories, Parts
and Service                   5.2           -          -         3.5           -          -
Total                   $    28.8        25.1        134   $    24.3        21.9        170

Sales to Pumps and Service Company ("Pumps and Service"), one of the Company's domestic distributors, Banking Production Centre ("BPC"), one of the Company's Russian distributors, and Regatta Solutions, Inc., also one of the Company's domestic distributors, accounted for 33%, 19% and 10%, respectively, of revenue for the first quarter of Fiscal 2013. Sales to BPC and E-Finity Distributed Generation, LLC, one of the Company's domestic distributors, accounted for 22% and 11%, respectively, of revenue for the first quarter of Fiscal 2012.

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. The gross margin was $2.2 million, or 8% of revenue, for the first quarter of Fiscal 2013 compared to a gross margin of $0.5 million, or 2% of revenue, for the first quarter of Fiscal 2012. The increase in gross margin of $1.7 million was the result of a $1.6 million improvement realized from higher C200 and C1000 Series systems sales volume, increased average selling prices and lower direct material cost during the first quarter of Fiscal 2013. The $1.6 million improvement and lower production and service center labor and overhead expenses of $0.8 million were offset by an increase in royalty expense of $0.4 million, warranty expense of $0.2 million and inventory charges of $0.1 million. Management has initiatives in place to address the increase in warranty expense and continues to further reduce direct material costs as we work to achieve profitability.

Production and service center labor and overhead expense decreased $0.8 million during the first quarter of Fiscal 2013 compared to the first quarter of Fiscal 2012 as the result of timing of overhead allocated to finished goods inventory and decreases in salaries, freight and facility expense.

Royalty expense increased $0.4 million during the first quarter of Fiscal 2013 compared to the first quarter of Fiscal 2012 as a result of higher sales of our C200 and C1000 Series systems. We pay a royalty of a predetermined fixed rate for each microturbine system covered by our Development and License Agreement with Carrier which will be reduced by 50% once the aggregate of Carrier's cash and in-kind services investment have been recovered. Management expects to reach this milestone and the predetermined fixed rate royalty to be reduced during the first quarter of Fiscal 2014.

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 $0.2 million reflects an increase in the standard warranty provision as a result of an increase in warranty claims related primarily to C200 and C1000 Series systems, an increase in reliability repair programs and higher volume of units under warranty during the first quarter of Fiscal 2013 compared to the prior year.


Table of Contents

Inventory charges increased $0.1 million during the first quarter of Fiscal 2013 compared to the first quarter of Fiscal 2012 primarily as a result of reserve 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. We had R&D expenses of approximately $2.2 million for the first quarter of each of Fiscal 2013 and Fiscal 2012. R&D expenses are reported net of benefits from cost-sharing programs, such as DOE grants. During the first quarter of Fiscal 2013 cost-sharing benefits decreased $0.1 million, while salaries increased $0.1 million. There were approximately $0.3 million of cost-sharing benefits for the first quarter of Fiscal 2013 and $0.2 million of such benefits for the first quarter of Fiscal 2012. Cost-sharing programs vary from period to period depending on the phases of the programs. Management expects R&D expenses in Fiscal 2013 to be higher than in Fiscal 2012 as we continue our efforts on new product development and direct material cost reduction.

Selling, General, and Administrative ("SG&A") Expenses SG&A expenses for the first quarter of Fiscal 2013 increased $0.8 million, or 12%, to $7.4 million from $6.6 million for the first quarter of Fiscal 2012. The net increase in SG&A expenses was comprised of an increase of $0.6 million in bad debt expense, $0.4 million in marketing expense and $0.2 million in salary expense, offset by a decrease of $0.4 million in professional services expense, which includes insurance, accounting and legal expenses. Management expects SG&A expenses in Fiscal 2013 to be higher than in Fiscal 2012 as we continue to develop our distribution channels and expand our market presence.

Other Income Other income increased $18,000, or 450%, to $22,000 for the first quarter of Fiscal 2013 from $4,000 for the first quarter of Fiscal 2012. Other income during the first quarter of Fiscal 2013 was primarily the result of a net . . .

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