CPST (CPST) 2018-08-08 Earnings Call Transcript

Good day, ladies and gentlemen, and welcome to the Q1 2019 Capstone Turbine Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] I would now like to introduce your host for today's conference, Jayme Brooks, Chief Financial Officer and Chief Accounting Officer. You may begin.

Thank you. Good afternoon and thank you for joining today's fiscal 2019 first quarter conference call. On the call with me today is Darren Jamison, our President and Chief Executive Officer. Today, Capstone issued its earnings release for the first quarter of fiscal 2019 and filed its Quarterly Report on Form 10-Q for the first quarter of fiscal 2019 with the Securities and Exchange Commission. During the call, we will be referring to slides that can be found on our website under the Investor Relations section. I would like to remind everyone that this conference call contains estimates and forward-looking statements that represent the Company's views as of today, August 7, 2018. Capstone disclaims any obligation to update or revise these statements to reflect future events or circumstances. You should not place undue reliance on these forward-looking statements because they involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. Please refer to the Safe Harbor provision set forth on Slide 2 in today's earnings release and Capstone's filings with the Securities and Exchange Commission for information concerning factors that could cause actual results to differ materially from those expressed or implied by such statements. Please note, that as Darren and I go through the discussion today, keep in mind when we mention EBITDA, we are referring to adjusted EBITDA and the reconciliation can be located in the appendix of our presentation. I would now like to turn the call over to Darren.

Thank you, Jayme. Good afternoon, everyone and thank you for joining today's fiscal 2019 first quarter conference call. As you know, we reported preliminary results on July 26 and provided a range for revenue pending on the resolution of certain long-term Factory Protection Plan contracts. During the process of being reassigned from the company's legacy California distributor to Cal Microturbine, Capstone's new exclusive distribution partner in California. Since that time, we finalized our accessories, parts and service revenue. And as a result, not only is our revenue from product up 8% compared to same quarter last year, but our accessories, parts and service revenue is also up 15% for total revenue which is up 10% year-over-year Q1 to Q1. This revenue growth is reflected on Slide 3 along with other key highlights for the first quarter. Another key highlight for the quarter is our 1.221 book to bill ratio that represents new product orders from 13 different distributors and eleven countries, including the United States, Mexico, China, Kuwait, Russia, Spain, Austria, Italy, Ireland, The Netherlands, and the UK. In order to return to double-digit revenue growth in this fiscal year, we really need growth in our product revenue which is what we are now beginning to see. Capstone had $32.5 million in gross product orders for the six month period ended June 30, 2018 compared to just $16.4 million in the preceding six month period ended December 31, 2017. The total increase in gross product orders for the last six months represents a 98% period-over-period increase. This 98% increase should translate into higher product revenues in the second half of this fiscal year as those product orders eventually turn into product shipments. Our cash position increased $0.2 million during the first quarter as we effectively leveraged both our expanded asset base credit facility with Bridge Bank and are at-the-market equity offering program to help cover our operations. This included $2.2 million in prepayments to one of our single source suppliers who recently notified us they were at or over their capacity and they require prepayment and a significant price increase for all the multiple components on order from Capstone in order to fulfill Capstone's supply requirements for fiscal year. Additionally, we also paid down our accrued expenses by approximately $1 million with respect to the one-time leadership incentive program compensation. These two items together resulted in $3.2 million in one-time cash usage for the first quarter. During the quarter, we did experienced lower than anticipated gross margin for our accessories, parts and aftermarket service business primarily because of higher than normal scheduled maintenance and unscheduled maintenance activities. The increase in unscheduled maintenance activities was result of a quality defect issue with the supplier that resulted in elevated costs of goods at a lower gross margin that we have seen historically. We did also have lower revenue from our accessories, parts and service aftermarket business in Q1 compared to Q4. However, this was expected as I mentioned many times in the past Q3 and Q4 where our December and March quarters are typically our highest revenue quarters during our fiscal year and this year is no exception. So the expected revenue from accessories, parts and service when combined with the higher than normal scheduled and unscheduled maintenance activities resulted in lower gross margin in Q1 compared to Q4. It's important to understand the key factors that can impact our aftermarket business and the scheduled and unscheduled maintenance activities are not a sign of any material long-term quality issues with our products or the profitability of our long-term FPP contracts. The scheduled maintenance activity was related to normal timing of service intervals within the fleet and the increase in unscheduled maintenance was a result of it as I just mentioned the supplier defect which has now been identified and corrective actions are put in place. And of course these factors do not impact our long-term strategic aftermarket revenue or gross margin goals and we should see performance improvement starting in the current quarter and anticipate we will continue to build the both revenue and margin momentum into the back half of the year like we did last year. This short-term volatility only serves to highlight how critical the aftermarket business is in Capstone's profitability and viability plans and why is such a key strategic focus for management and the overall business as we drive towards our goal of $10 million in quarterly aftermarket accessories, parts and service revenue and a 50% gross margin. In summary, we made excellent progress to the numbers of strategic business areas in this quarter, despite some short-term volatility in the aftermarket business and we remain focus on our efforts to execute on management's probability and strategy and specifically our strategic business goals. Let's then turn to Slide 4. Slide 4 outlines our chief strategic goals and objectives for the first quarter of fiscal 2019. Before we start, I would like to remind everyone that we began the new fiscal year in April with four key strategic objectives. Objective number one, improve quarterly working capital, quarterly cash flow, and our balance sheet. Objective number two, achieve double-digit revenue growth through the acceleration of global product sales. Goal number three, diversify the company into new markets, verticals and new geographies and lastly goal number four increase service OpEx absorption percentage while driving toward 100% absorption. I would now like to provide you the update on our core progress report on our objectives for quarter. Moving the Slide 5, we will start with our first goal to continue to improve our quarterly working capital cash flow and balance sheet. Cash on balance sheet as net report increase $0.2 million to $19.6 million for the first quarter of fiscal 2019 over the prior quarter as we effectively leverage or recently renewed an expanded Bridge Bank asset based credit facility. In addition our at-the-market or ATM, equity program helped us cover our operating expenses as well as the cash payments of approximate $3.2 million for the unexpected one time supplier prepayment and the obligation of the leadership team incentive program. Let's go ahead and move on to Slide 6. Our second strategic goal objective for Capstone is to achieve year-over-year double-digit revenue growth. During our last year of fiscal 2018 we successfully return to single digit revenue growth, but that was only the first step. And now we continue to work hard on accelerating growth in FY2019 and beyond. Revenue in the first quarter of fiscal 2019 was $21.2 million or up $2 million, which equals 10% compared to the same quarter last year. This is despite having almost four megawatts in finished goods left on our docks. We expect our accessories parts and service sales to rebound during the second quarter and the remainder of fiscal 2019. This rebound in our aftermarket accessories parts and service business, combined with the growth in our new product orders should provide the necessary catalyst to achieve double digit growth this year. Now let's going to turn to Slide 7, the third business goal for the fiscal year of 2019 is to continue to diversify Capstone into developing market verticals and geographies, new gross product bookings were strong for the second quarter with another $16.3 million in gross new product orders and as I mentioned before the 1.2 to 1 book-to-bill ratio. During the first quarter, we did receive orders for new products from 13 different distributors, representing 11 countries. As I said before, this is the U.S., Mexico, China, Kuwait, Russia, Spain, Austria, Italy, Ireland, the Netherlands, and U.K. and we are very excited about the growing global interest and the increased amount of orders we have receiving from all over the globe. As not to mention recent press release that we talked about with other parts of the Middle East. Moving on to Slide 8, our four strategic objectives to continue to increase the accessories part the service gross margin, operating expense, absorption percentage with a focus on achieving the previously stated target of 100% absorption. As I mentioned earlier during the first quarter, we had lower accessories parts and service revenue in our aftermarket businesses armored by increased cost of goods. The difference really highlights our aftermarket our business results determine the quarterly EBITDA and profitability levels. We want to address this head on as we expect to see some volatility in this business quarter-to-quarter. However, we want to stress the long-term impact on our fundamentals and we expect the business to normalize over the reminder of fiscal 2019. During the first quarter, we continue to focus on increasing our remanufacturing in spare parts in the U.K. in the U.S. and trying to increase our FPP attachment rates, specifically targeting in the oil and gas market. The reason now is that we made in January 2018 were 6.9 megawatts of new oil and gas FPP customer orders and the more recent announcements in April and July, we have made for follow on oil and gas FPP contracts shows the progress we are making against the strategic goal and the growing interest in our at FPP contracts in the oil and gas market. We also continue to evaluate other opportunities still [indiscernible] there bring kids into adjacent products and other technologies as we originally announced our first ever in customer Praxair. At this point, I'll let Jayme discuss the detailed financial results for the fourth quarter. Jayme?

Thanks, Darren. I will now review and more detail, our financial results for the first quarter fiscal 2019. The highlights can be found on Slide 9. As Darren mentioned earlier total revenue for the first quarter of fiscal 2019 increased $2 million or 10% to $21.2 million compared with $19.2 million in the year-ago first quarter. Product revenue for the first quarter of fiscal 2019 was $13.6 million compared to $12.6 million in the first quarter of fiscal 2018, an increase of $1 million or 8%. Accessories, parts revenue increased $0.6 million or 21% to $3.5 million for the first quarter of fiscal 2019, compared to $2.9 million for last year's first quarter. Our service revenue increased $0.4 million or 11% for the first quarter of fiscal 2019 to $4.1 million compared to $3.7 million in the first quarter of fiscal 2018. Gross margin for the first quarter of fiscal 2019 was $1.8 million or 9% of revenue, compared to $2.2 million or 11% of revenue for last year's first quarter. R&D expense for the first quarter of fiscal 2019 decreased $0.2 million or 18% to $0.9 million from $1.1 million in the year-ago first quarter. SG&A expenses in the first quarter of fiscal 2019 increased $0.7 million or 14% to $5.7 million from $5 million in the year-ago first quarter. Total operating expenses for the first quarter of fiscal 2019 increased $0.6 million or 8% to $6.6 million from $6.1 million in the year-ago quarter. Net loss for the first quarter of fiscal 2019 increased to $4.9 million compared with a net loss of $4.1 million for last year's first quarter and increase of 20% year-over-year. Net loss per share was $0.09 for the first quarter of fiscal 2019 compared with a net loss of $0.10 per share in the same period last year. Weighted average shares outstanding at the end of the fourth quarter of fiscal 2019 were $61.8 million compared with $41.1 million for the year-ago quarter. The adjusted EBITDA for the first quarter of fiscal 2019 was positive $3.9 million or a loss of $0.06 per share compared to an adjusted EBITDA of negative $3.4 million or a loss of $0.08 per share for the first quarter of fiscal 2018. As a reminder, EBITDA and adjusted EBITDA are non-GAAP financial metrics. Please refer to Slide 14 in the appendix, titled Reconciliation of Non-GAAP Financial Measure for more information regarding these non-GAAP financial metrics. Now please turn to Slide 10, as I will provide some comments on our balance sheet and cash flow. At June 30, 2018, we had cash, cash equivalents and restricted cash of $19.6 million compared to $19.4 as of March 31, 2018. Cash used in operating activities for the first quarter of fiscal 2019 was $6 million as compared to cash provided by operating activities $0.5 million for the fourth quarter of fiscal 2018. As Darren discussed $3.2 million of the cash used in operating activities with the result of an unexpected supplier pre-payment obligation and the one-time leadership incentive program compensation. Our accounts receivable balance as of June 30, 2018, net of allowances was $16.9 million compared to $16 million as of March 31, 2019. Inventories increased to $0.5 million or 3% as of June 30, 2018 from $15.7 million as of March 31, 2018. Our accounts payable and accrued expenses were $13.6 million as of June 30 2018, a 1 increase compared to $13.5 million as of March 31, 2017. At this point, I will turn the call back to Darren.

Thank you, Jayme. As mentioned on July 26 pre-release we announce that we've successfully negotiated with carrier a one-time lump sum royalty settlement payment for $3 million and remove the knock and be provisions from the development agreement. As I mentioned at the end of our last earnings call during Q&A I believe it was the right time to sunset the carrier C200 perpetual royalty obligation and not to be provisions and this was a significant material event for the quarter. Was now long ago under the similar macroeconomic conditions that we are seeing today that we're paying $4.3 million in annual royalty payments UTC. Our strategically negotiating the settlement we expect to improve our quarterly product margins by approximately 2% at today's revenue levels and improve our future cash flows and shorten our path to sustainability and profitability. This benefit should become even more material in the back half of our fiscal year as we expect to see higher product shipment as mentioned earlier. Also by removing the non-convenient restriction, Jim and team are now free to enter strategic discussions and strategic relationships with other global chiller manufacturers to improve future competitiveness in our largest markets which are the CH. and CCHP markets. Make no mistake, this is a tremendous achievement and was a significant material event for the quarter that we believe will give us strategic flexibility in our largest market vertical and save us millions of dollars in future royalty payments as we execute against our goal of double-digit revenue growth and accelerated product orders as illustrated by our 98% improvement in book-to-bill over the last six months. With that, operator let me open up for call. We've got a couple new analysts covering the company, so I want to have a little extra time today for Q&A. So let's go ahead and open it up to our analysts.

Thank you.

And our next question comes from the line of lot of James Jang with Maxim Group. Your line is now open.

Now that's helpful color. We'll take the rest offline. Thank you so much.

Thank you.

Great. Thank you.

Thank you. Great questions.

All right. Thanks for taking the questions.

Thanks Aaron.

Thank you. And at this time, I am showing no further questions. I'd like to turn the call back to Darren Jamison for any closing remarks.

Okay. Normally I have a fairly lengthy summary but I think the analyst we have really done a great job of vetting through the quarter and go into the numbers. Welcome the folk from Lake Street, Maxima Board is new analysts covering the Company to exciting to get to new folks that are inching the story. Definitely that the biggest two takeaways for the quarter for me really are the 10% year-over-year revenue growth as I think getting back to 20% revenue growth is key we need it for our business, we need to get our volumes up competing with Caterpillar and GE and utilities as a low volume manufactured very challenging so the more we get the revenue up. The more importantly the fact that we're doing it in so many different countries and regions and verticals [indiscernible] companies you know they're selling in two or three markets or two or three countries in one quarter we sold in more countries than they've done in the last you know 20, 30 years. And so I think diversifying by region, diversifying by market vertical is very, very key to avoid the lumpiness very excited to deliver a strengthening Q2 over Q1. More importantly I hope the second quarter is also better than the second quarter last year and we'll keep putting up the year-over-year, quarterly improvements and push to that back to EBITDA breakeven beyond. I do think our service business again we had a challenging quarter, but I'm very confident Jeff and his team the next quarterly better than to the last quarter and obviously on the purchasing side, strategic source we had a couple curve balls. But the sight of a good team is we've said to that curve ball we bounced back and we're managing the problem and move forward. And so with the topline revenue growth very solid book-to-bill the last two quarters, we need to do a little better job on the cost side we got a little over just for see this quarter nobody asked about it but also it will unhappy with the OpEx we should $0.5 million more. So work on timing that back up for the second quarter. But overall we're executing against our four strategic goals and our service business will recover our product business is going to continue to grow we'll do an improving job on the operations and on the strategic sourcing side and expect the back half of the year to be excellent going forward assuming nothing changes on the - in the markets that we're serving. So with that I'll go in the call, I will say I promise investors that we would have an Investor Day and open house for retail investors we're looking at October 3, this year to do that and so we'll have some more information out there coming up. But it's going to circle your calendar we're looking at any Investor open house and a retail shareholder tour of our new facility and what we've done to not only aggregate by the faculties for Kirk and his team to really bring the cost out of the organization approved the efficiency. So look forward to formalizing that date and getting an answer out there. Thank you.

Ladies and gentlemen, thank you for your participation today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.

[Operator Instructions] And our first question comes from the line of Rob Brown from Lake Street Capital. Your line is now open.

Good afternoon. Thanks for taking the question.

Hi Rob.

On the Carrier agreement change, give some color there. But in terms of strategic activity, what sort of the actions there in terms of improving CHP market. Is that open up? And how much more of the market that might open up to you in the past? Thank you.

Yes. That's a great question. I mean if you look at the CHP and CCHP market, it was our biggest market last year as far as overall product shipments and revenue. We really focused on growing that market to kind of offset the cyclical nature of our oil and gas market. If you look at it from a strategic perspective, it's much larger than oil and gas on a global basis. We've done a good job of getting into new REITs and new customers in that area. But really big keys is the total install cost and so we target five-year simple payback, but a big portion of that payback is not just the microturbine it's the absorption chiller or the recovery equipment. And so we launched our own heat recovery for hot water last year as part of the Signature Series and now we're looking for a strategic partner for the absorption chillers to really help us lower that installed cost to be more competitive and get the total cost of ownership down. More importantly, we want to size chillers for our product that was part of the UTC relationship as they were going to develop a specific chiller tailored for the C200 and C1000. That never happened in our relationship, in our product development efforts. So we really want to find a partner that will specifically tailor their product to maximize both the efficiency, the size, the weight and the cost one paired up with our C200 and C1000 Signature Series. So very, very excited about it. And as I said in my prepared remarks, really excited to be out of that UTC royalty that's going to save us millions of dollars a year that will improve our product margins about 2%. If you look last year, our total product margins were I think only 6%, so a 2% increase. We are only making 6% on our product, is significant. Obviously our service margins are the ones that are really carried the business, but it's a major focus for us and I think a major achievement.

Good. Thank you. And the service margins and costs in the quarter, could you look on and kind of what happened there and maybe a sense of how that changes going forward? Is it recovers or is it stayed at a lower level or how the service markets go? Thank you.

It's a great question. As I said, publicly our goal is to get to $10 million quarterly revenue and 50% service margins. We were at $9.6 million in accessories, parts and service in our fourth quarter or March quarter at about 45% margin, so we got close. We did fall back this quarter on a couple factors. One, we had higher than anticipated unscheduled maintenance as well as scheduled maintenance. Scheduled maintenance is simply a lot of units that are under contract, all hitting a maintenance cycle at the same time. Those are somewhat unavoidable and just part of the business. The unscheduled maintenance is around a supplier quality issue. We had some bad parts coming from supplier that we didn't catch on our quality organization to get into the field, so we had to go out and make those repairs as those parts failed prematurely. So we have identified the parts. We've identified the issue with the supplier. We've got root cause corrective action in place. So it's an unfortunate event, but it's one of those things just happened. So definitely it's a period short-term issue, Q2 will be better, where there are build in Q3 and Q4. I would hope that by Q4, we are back to some of levels we were last year is not higher and so the faster we can grow at service business. That being said, the service business will grow faster as we sell more products. So they really are tied to the hit. So accelerated product shipments will lead to future growth in our aftermarket service business. But definitely Q2 will look better than Q1 and Q3 should look better than Q2.

Okay, thanks. Thank you.

All right, good afternoon guys. So just a couple follow-up question, so on the C200, the Carrier of royalty that's gone now and I know you mentioned a margin improvement of 2% in terms of actual sales, is it going to be a bigger push to sell this product and what can we look for in terms of revenue impact for this year and next year?

Yes, definitely we're going to continue to push the Signature Series products, which is focused on the CHP and CCHP market will quickly will defined a strategic partner on the chiller side to help the competitiveness there and so a lot of the efforts will have from a marketing standpoint and with our distributors will be to continue to push in that area. And that's the area we've had a good success in recent years. We've gone from - a measure for one REIT to four REIT. We've got the one Vanderbilt in New York, which is right next to Grand Central Station that is a state-of-the-art building, the one of the tallest building in New York and that's very exciting for us you that product up the ground that is a Tishman Speyer property and so we've got into Tishman. We've got into Brandywine. We've got into Capreit as well as related properties. So we're seeing a lot of new development. But again I think the more we can partner with other chiller manufacturers and optimize our product for the benefit of our customers that definitely going to be good. The 98% improvement of book-to-bill is very, very important. We had eight years of double-digit revenue growth, three years declining revenue, happy back to revenue growth mode and especially with our lower cost structure. If we can get 20% annual revenue growth on top of our very low operating costs and are improving service business that's going to put us in any great shape of probability and growth.

Okay. And going back to I guess - you had during the quarter, so can you give us a breakdown on how much, like what percentage was planned maintenance versus the defective products?

I don't think we break that out, but they were both fairly equal in their impact. If you look at the revenue for - or the average of the last four quarters or about 38% in our accessories parts and service business that dropped from 38% to 23% for the quarter. So it was a very significant drop, but we'll get back up to the mid to high 30s here in the next couple quarters. Again it's always going to be a little lumpy. I know shareholder like to turn lumpy, but the reality is we can't control maintenance of engines and cycles as well as when things on schedule basis. But very confident in the product, very confident in our ability to continue to service our customers and improve those margins.

Okay, and I know you mentioned that you guys identify which supplier and which products or which parts were affected do if there will be any more out in the field for the second quarter or third quarter or do you believe all those points have been taken care off?

Now there's still a little bit left as that population dwindles than the margins will go up. So we'll have a little bit in Q2, and that's why I'm very confident, the Q2 would better than Q1 and Q3 would better than Q2. So as that the population of parts in needed replacement dwindles will get those margin rates back up again.

Okay, so the margin, which you seem like staggered uptick throughout the rest of the year?

That is correct.

Gotcha.

They were stated goal to get 50%, so obviously will get there, some point we got a - we had a stay there on average. So again last year high watermark was 45% and our average for the year was 38%.

Okay. And you guys mentioned that you're switching away from you're topline distributor and can you give us a sis a reason why?

Yes, we were actually as we mature the business to mature our distributors, we put together with - to all the model distributor program and so we're asking them to do more across the board whether it's spare parts stocking levels, whether it's marketing expenses. How they service the product? How they sell the product? How they apply product? Their dedication to the product line and we found the some distributors either get to a point where they're very comfortable it's a simple lifestyle business and so we're having some hard conversation with the voters that are making a very nice living and supporting their family and making their kids soccer games, but they're not growing the business to the pace we want and so that's not acceptable. So all either remedy that situation or make their actual territory smaller that supported their lifestyle businesses or in some cases change them altogether. California was a little different it was really more of a dedication issue. We allow distributors to have multiple product lines we can't be competitive and we require a certain level of focus and so in this case California is one of our top five markets in the world and we were getting the revenue we wanted to add California so we switched to a 100% Capstone dedicated distributor just to make sure we maximized our benefit is key market.

Okay. Do you see any lumpiness in terms of that switch next quarter or the rest of the year?

I mean it's always I mean it's - whenever I talk to shareholders or our Board of Directors are always very quick throughout the service not performing just change them out well it's a little bit like going through a worse when you've got dozens of kids. And so it's very, very challenging we've got a service contracts and customer relationships making change is always a big distraction the business it takes a you know Jeff's time, Jim's time my time you know obviously there's a lot of legal ramifications that Cobalt and his team get involved with so not something we like to do but we will do it is a gamble last resort was right for the business. They'll be a little bit of a ripple effect into Q2 but it should be completely known by Q3. And again if you look back to the last several years Q1 is traditionally our weakest quarter than Q2 to Q3 is your best quarter fall by Q4. So it's kind of the natural order of things for me I'm excited to see revenue up you know over last year's Q1 and the great book-to-bill last two quarter should really put us in good shape for going to expand it revenues next year. And we're seeing some good deal flow this quarter as well and I think we seem some press releases and there's more to come.

Okay. All right. One final one, so what do you view - how do you view the impact from the Chinese terrace right now.

Yes. We don't source a lot from China today about 70% of our product to source in the U.S. we do get enclosures from China we get some print circuit boards from China we have seen some increase in number theory because of the Chinese tariffs we also gets a product from Mexico and see a little bit of pressure there. So those are things are managing with their vendors I don't see the terrorists not to political but I think there are a long term solution and I don't think they'll be seen as a long term solution but if they are then will look to t manage it accordingly. But really at the end of the today we look for the lowest price vendor with the shortest delivery cycle and quality. As you can see this quarter of a vendor falls down on a quality perspective that's very challenging for a business. So first cost is important but we also you know we maintain high level quality for our products.

Okay. Great. All right. That's all I have. Thank you guys.

I guess I will say really quickly to Cobalt has something we talked about in the past as being a bit challenging force was from our batteries in our magnets. We have seen Cobalt price is drop. So there is some good news on the on the materials standpoint the Cobalt prices have come back down as much as I will completely the outset of the steel prices we're seeing but it is a positive development.

Okay. Great thanks.

And our next question comes from the line of Colin Rusch from Oppenheimer. Your line is now open.

Good afternoon. This is Kristen on Colin. Thank you for taking our questions.

No problem. Kristen.

Hi, Kristen

So I wanted to talk about the book-to-bill really solid and reading their 1.2. Can you talk about the book-to-bill really solid, reading their 1.2? Can you talk about sort of the cadence of conversion on those orders and maybe more broadly are you seeing to support a shortening sales cycle?

Great questions. That's one of the things we're working on very hard and we talked about changing distributors or pushing them to do more faster getting that sales cycle down his keys so we still salesforce.com is is kind of our operating platform for distributors. All of our distributors have portal and seeds and we can see what's going on. We are closing today at about 11-month to 13month sale cycle what's going on we're closing today at about eleven to thirteen month sales cycle depending on the distributor we need to get that down to you know 7 months to 9 months and so the more we can short in that sales cycle by your pre-engineered solutions obviously a Capstone specific chiller would help out as well with more you can do the shorten sales cycle the better we are seeing improvements in our distributors, close rates of across the board which is always to be evident in our or better book-to-bill. So really we have about 1.3 billion of pending orders. It's really how fast we can get those orders close and what close rates. So that's definitely a major focus for Jim and his team to really manage those distributors and training them to make sure that we are shorting that sales cycle and improving that gross rates.

And then I guess on the other side of that, if you could talk about as you get to this 100% service OpEx absorption level, or look to achieve that. Can you provide some additional color on the attach rates for the FPP?

Yes. I think we're always seeing very high attachment rates in our CHP business. In some markets, we're north of 80% if not higher, especially with the RFP Systems and Infinity. Cal Microturbine does a good job as well. So I think our CHP centric distributors have done a really good job in that area. The oil and gas side has always been more challenging. They have indigenous personnel. They're very capable of working on sophisticated equipment like microturbines and frankly in a lot of cases they want to do their own work. And so we've taken a strategy really cared and the stick, the cared is we have not raised our FPP service contract prices, in the 10 years you've offered them that's at least five or six years for sure since we've raised prices. More importantly, we're increasing the flexibility of those contracts. We're offering in parts only, parts and labor, different durations in some levels some additional personalization. So trying to make it more flexible for the customer. So that's really kind of the cared side. On the stick side, we're offering spare parts that our prices are going up every year. So we've raised our spare parts pricing virtually almost every year for the last 10 years. And so we're making it more expensive for you to kind of self-insure and give you more and more reasons to go in and build the Capstone FPP. And really for us that FPP is the key corner stone of our value proposition. We want to win with customers when the product runs well and performs well, as opposed to the engine guys who's really model is sell you a mediocre product to the one-year warranty and then make all their money when the product fails. And so that's not the path we want to take with our customers who we see as our partners. So as we get more and more oil and gas customers to come across the table and sign the FPPs, hopefully we'll gain some more momentum there. We're also bundling our solutions and we're starting to see some increase in that area for offering specific discounts if you buy the product, the accessories, and the FPP, and prepay the whole thing. And so you'll see a line on your balance sheet to start carving out those FPP prepayments that will be on our balance sheet until we achieve that revenue.

That's helpful. That actually answered my next question on pricing. So then the last one from us is just on the underlying manufacturing costs ex some of these one-time items. Can you speak to how those are trending?

Yes. I mean I think if you look at it, we did a great job, but reducing our labor and going from two facilities to one, I think Kirk and his team have done an amazing job, and increasing our productivity and our output with a smaller workforce so that's excellent. We are seeing - obviously the Cobalt prices were hurting us for a while, that died down a little bit as I said. Now we've got tariffs and metal prices that are poking their heads up. We did have a vendor who got a large aerospace contract and unfortunately made the decision to really leverage all their smaller clients by hitting them with 20% to 30% price increases and 100% prepayment for your orders for the year. So that was a big shock to us and it's something I haven't seen in 11years I've been here at Capstone. Fortunately, we were able to manage through that and mitigate as much of the price increases we could, but more importantly we survived to having to write a $2.3 million check during the quarter and still kept our balance sheet intact. And so that was a big win for us. Obviously, we will deal with that vendor as far as long-term relationship and what we do with them, but that's something that's very challenging for us. We had three years of declining revenues. That's very hard on our strategic sourcing folks. We brought in a new strategic source professional, but declining revenues really hand-cuffs your strategic sourcing group to cut new deals. Now that we have single-digit revenue growth last year, this quarter up 10% quarter-over-quarter, as we continue to accelerate that's going to arm our strategic sourcing folks with the levers they need to go get better deals and better pricing. So a lot easier to leverage a vendor partner when you're seeing increase in your business. So I think we're going to see a mix. We'll see prices going up in some areas, but I think we'll start to see opportunity to lower prices in other areas. We will look to go offshore where we can, but only if we're very comfortable with the vendor and IP issues and things like that, we're not going to do it just to save a couple nickels. It's not worth from a quality standpoint.

And our next question comes from line of Sameer Joshi from H.C. Wainwright. Your line is now open.

Hi. Thanks for taking my questions. Many of the questions I had have already been answered. But just going back to that $2.2 million pre-payment, can you elaborate a little bit what part or what equipment it was? And do you have alternate sources lined up for this?

Yes, it's a great question. The challenge we have in our manufacturing volumes as much I'd love to have dual source for everything we do, we just don't have the volumes to justify it. And so we are source with many of our key vendors and it's unfortunately was one of them. They were a casting house and in California. I don't want to give their name. But they definitely did castings across the Board for all of our products. So it is crusty to C65 and C200 and so we had to basically solidify our POS for the year, prepay all of our POS and take kind of gun to a head handier till price increase. So that's a short-term solution on their part will work to get leverage back our direction. We've already identified other potential suppliers. But it's always better to stay with the same supplier. We're hopeful that they'll come up with a better business strategy to what they've done. But we'll see and then again that's up to our strategic sourcing team to figure out the best path. But any time in a single source suppliers that does have added risk as we grow the business will look at putting second suppliers of place, but today is manufacturing volume just very challenging. But as we grow the business that definitely good practice that we will put in place going forward.

Okay, understood. On the cost side, are you seeing any impact because of any electronic component shortage that you're seeing in the industry or is they're entering up to supply for the short-term?

No, I think we've been in pretty good shape there, not kind of word, but again we're always on our feet. Capstone is never do moment. So anytime you have a less mature or thin supply base you can see, issues come up. Right now we're not seeing anything and again I think we've gotten through these issues and I'm hopeful that the back half of the year things will streamline a little bit and again as we see increase in product shipments and strength in the service business all that helps the supply chain as well.

Okay, well this one - last one for me, on the air bearing technology, will you be able to collaborate the customers that you're talking to what is in the potential from the more the next - 12 to 18 months?

That's a challenging one and this is a new market for us. Obviously, I know we surprise you guys a little bit because we work on this for years and didn't mention it on any earnings calls or any of their publications. It's something we want to do to diversify our business and really goes back to this whole absorption strategy and I'm sure I answer the question fully before getting to 100% absorption is extremely quick critical for our business. If you look back in fiscal 2016, we're about 25% absorption, meaning we had to sell product to cover the other 75% of our operating expenses. So that was a tall order for the sales organization our distribution channel. If you look at fiscal 2018, we finished at about a 77% absorption that's really what led us to our two quarters of adjusted EBITDA breakeven. Our goal is to get 100% absorption over the next couple of years. And what that does for us is that means that our quarterly OpEx is fully funded by our recurring aftermarket business and so that not only covers us for the down side if we have geographic issues going on whether it's a macroeconomic event in Russia or the dollar, weakens or strengthens or issues in the oil and gas space or whatever it may be that's impacting our business that really puts the floor in and covers us on the downside. But more importantly on the positive side, it gives - Jim and his team to ability to have market based pricing, cut special national account deals with large Fortune 100 companies. It gives us tremendous pricing flexibility and pricing power that we just don't have today. And so covering our downside, but more importantly turbocharging or upside with pricing flexibility on those new products is really, really key so I can't say enough about getting to the 100% absorption as in my mind that really what marks our business and really puts us beyond everybody else. So air bearing business is part of that. Our margins in that business are similar to other product margins or parts margins, and that's north of 50%. So any time I can add 50% plus margin business on a recurring level with a large scale producer of another product with ancillary is very, very important. And we've looked at the motor companies. We've looked at APUs and airline. We talk to fuel cell manufactures, air compressors, obviously to Praxair is a turban expanded that we're doing [indiscernible] food processing blowers down oil pumps. So we'll keep talking to other adjacent product manufacturers pressures are great first win and a great company we are happy to have them on Board. They took three years in their evaluation process, so obviously didn't move to technology very quickly. So it's not going to complete the carrier business is going to accident our business that improve that recurring revenue stream that we're really trying to underpin our business with.

Understood. Thanks for that color Darren. I'll taking to the questions offline.

And our next question comes from the line of Craig Irwin from ROTH Capital. Your line is now open.

Good evening and thanks for taking my questions. So if we can I want to try and maybe pick through the results from this quarter and understand margins from a normalized basis. So your service margins in the quarter clearly there was a lot going on in there - your quality issue in the field with the bad parts from a supplier you know is obviously going to be big issue free to deal with but something that will move behind you relatively quickly. And then they really reallocation of the FPP contracts over to Cal Microturbine and the destruction of there installed basis some of the California accounts are now moved over to your exclusive distributor? Can you maybe talk a little bit about that $1.5 million give or take delta on costs of service that we saw in the quarter? How do you break this down and how quickly would you expect some of these discrete issues to fade away?

Yes. I know Craig good question. Definitely we think the bulk of it is behind us in Q1, I think we will see a little ripple factors - ripple effect in Q2. We have got ongoing conversations with obviously regard Cal Microturbine and customers not all the contracts have been assigned over there issues we've got to work out for a contractual basis. So that will be some heavy lifting here for the next probably four to six weeks and hope we get that behind us that it impacts us on the revenue side as well as the margin side we do have some contracts that we were doing service work on even know the contract had been assigned or we're not getting revenue. So there's an issue there of not getting revenue and also doing work on a contractor and I can paid for. So there's definitely a bridge we got across it's the right thing to do long-term but it is bit of short-term impact. And then obviously the unscheduled maintenance were fairly comfortable we got most of that book at that away this quarter or we'll see some more in Q2 and then wind down the Q3. So if you look at it we lost about 15% in our the average run rate on our service business and that should come back over the next couple quarters and I'd expect this to be back into the you know high-30's if not low-40 's here in the next couple of quarters on the service side. Also we were light on part sales for the quarter as well the accessories and again some of that is just you know timing in general lumpiness. We do have several C200 recovery module schedule for this quarter and I think we've already had five and ship and get a couple more about ship. So that really helps drive our accessory business and as well as you know gas tax and other accessories. And spare parts should ramp back up this quarter. So I think to your point it won't be 100% recovery in Q2 we should take a substantial step changes that say of the you're talking about it's probably two-thirds of that should come back in Q2 and the rest in Q3. And definitely will start to see the impact of UTC royalty here in the next couple of quarters that will adore our product margins. The other important thing is our product margins are very dependent on volume and so because we have such high fixed costs with our manufacturing plants and overhead and people the more products we start to ship out the door especially the back half of the year we're going to see higher product margins. So again if you look at fiscal 2017 our product margins were negative 14% in 2018 there are positive six we should pick up 2% from UTC and it will pick up more on the volume increase in the back half of the year. So product margins should be going up nicely for the year as well as our service margins getting back to where they were just a couple quarters ago as well as a growing beyond there. So I'm really excited about the revenue growth about the bookings, some of the service issues and quality issues to me are short-term I don't want to be little them but they're short-term issue is a lot different than the long term strength of our business.

Okay. Maybe a slightly different way to ask this question is? Would you expect your service margins for 2019 to be similar or better to what you actually achieved in 2018, I mean are we looking at some think you know potentially in the low-40s for the full-year basis. And does that include the price increase that you put through every year would you expect maybe some incremental improvement from that price increase?

Yes. We definitely put a price increase on spare parts for the year and so will do that again probably in the March or April next year. But definitely I think the 38% we saw - aggregate for the year, we did 45% in Q4. I would expect this to get back to the high-30s and mid-40s here fairly quickly. So to specifically answer your question, we don't give specific guidance, but I would be disappointed if our service margins aggregate for next year did not start with the four which you back into the 40% range and if not low-to-mid 40%. And I think the product margin should be approaching 10% if not higher depending on revenue growth.

Okay. So the product margin is the next thing I want to peak through a little bit. So congratulations on the Carrier, UTC exit. I know that's been a headache for you for a number of years. You said very clearly a million dollars annualized this year more or less I guess the disclosed number for last year was 0.9. So the growth - it's very transparent that benefit to margins there. Can you talk maybe a little bit about the Praxair order? If you were to get an order for let's just say 50 or 100 air bearings. Now that would be supplemental to your internal demand of give or take 300 for the turbines you produce. That would be material. Would you expect that to potentially contribute 50 or 100 basis points to margins giving the purchasing leverage? And then the bigger question is utilization, so you've worked really hard over the last several years to bring down excess capacity at Capstone backing your peak in 2014 turbine margins were 15%, which is I would consider actually pretty healthy versus where we've been in the last couple quarters given that you've taken out about half of your capacity would you expect to have similar margins on a normalized basis with around half of the revenue from where you were back at your peak?

Great homework Craig. You're really looking at the numbers. We have the cost in our manufacturing operations, but not the capacity. We were at about 30% of our production capacity where we had two plants, we're still in the same place today. And so we managed to keep our capacity the same and cut our OpEx in half which is I think an admiral thing to do. So on similar volumes we had three years ago, I would expect more than 15% product margin because our costs are going to be lower. I also think we'll do a better job on the sourcing side. We've got of a more sophisticated sourcing organization that we had three years ago. So I think getting to 10%, 12% product margins this year is a very achievable number, but as we really start getting that growth ramp rate, get back to the revenue levels we were three years ago, we should be north of 15% of the product side. So that's - and as this business gets exciting for putting up 18%, 20% on the product side and 50% margins on the service side and we can maintain our discipline on the cost side this business gets real fun, real fast from an operating standpoint.

Great. That's good to hear. Thanks again for taking my questions.

And our next question comes from the line of Eric Stine from Craig-Hallum. Your line is now open.

Hi, it's Aaron Spychalla on for Eric. Thanks for taking the questions.

Hey Aaron.

Hey Aaron.

First for me on the large order front. Good to see some traction with the Kuwait order, can you just provide an update on the large order pipeline and when we can maybe see some more traction there? And then maybe just on that Gulf region, can you just maybe seize the opportunity or the pipeline today there?

Yes. Definitely that's an area that was little or no revenue for us last year. In fact, I think the Middle East, we did back in 2017 $2 million, we did $4.4 million at all of last year. So that is our smallest region of the regions as we break them down. And so growing the Middle East and Africa is key for our success. We've got product running in multiple markets. We just announced as you mentioned another order in Kuwait. We only have 2 megawatts running in Kuwait and so that's another four units going in there that's huge. We just announced our first C1000 going into Iraq. We've got product in multiple parts of the region as well as North Africa. So I think we're very focused on it. We've got new distributors in place. We're hopefully knocking on wood looking for another order. Our first order out of Pakistan. There's lots of great things going on. Oman, we are seeing huge amount of play reduction opportunities. We're looking at 60 plus location RFP that just came out. So I think as they realize that flaring associated gas is bad economically and bad for the environment. We're going to see more and more opportunities. I think Jim and his team have put together a good group of distributors that obviously take some time to get them up to speed, but I'm very excited about seeing more orders of that market. And so that is currently our smallest vertical I think that could be bigger than Latin America here very shortly and maybe even bigger than some you know Asian and Australia at some point. So definitely it's got a potential to probably grow $5 million this year and I mean it could be fairly significant outside from the previous year. And if you look at our there other regions everything grew last year except for Europe and Russia and we saw a nice uptick in our Europe and Russian business for the quarter if you look at the Q1 for the quarter we did $4.9 million in Europe and Russia versus last year about $2.6. So we are seeing a rebound of that market as well both Russia and Europe going back online.

Good things for the color. And then maybe on Puerto Rico you talked about that as an opportunity can you just kind of maybe share your current thoughts and if you start to see some traction there and what the pipeline looks like there?

Yes, definitely we had a nice pipeline, we've had an order that's been you know fish next to the boat that we've been trying to gap and pull over the side here for a couple quarters now I do think we'll get that in that's a major pharmaceutical that will be doing several projects with us. So hopefully we get that done. Well since more time in Puerto Rico we're looking at potentially making some distribution changes there spending more time the focus the Caribbean in general is a big area of focus. We've got a new distributor in Jamaica is doing a great job like probably down there the week after next spending a week with them. So definitely I think there's big opportunities there as well, I mean Puerto Rico the challenge is really which you read on the news that it's an issue of corruption, it's an issue of a lot of red tape and bureaucracy and getting things done just seem to take you know a longer than one with logically think. But I'm very confident we'll get orders this year and it will become a significant market for us well of the Caribbean.