CPST (CPST) 2019-11-08 Earnings Call Transcript

Good day ladies and gentlemen and welcome to your Capstone Turbine Corporation Earnings Conference Call and Webcast for Second Quarter Fiscal Year 2020 Financial Results ended on September 30, 2019. All lines have been placed in a listen-only mode and there will be a question-and-answer session following the presentation [Operator Instructions].At this time it's my pleasure to turn the floor over to Mr. Colby Petersen, Corporate Counsel. Sir, the floor is yours.

Thank you. Good afternoon and thank you for joining today's fiscal 2020 second quarter conference call. On the call with me today is Darren Jamison, Capstone's President and Chief Executive Officer and Eric Hencken, Capstone's Interim Chief Financial Officer and Chief Accounting Officer.Today, Capstone issued its earnings release for the second quarter of fiscal 2020 and filed its quarterly 10-Q report with the Securities and Exchange Commission. During the call today, 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 8, 2019. Capstone disclaims any obligation to update or revise these statements to reflect future events or circumstances. You should not place undue reliance on these forward-looking statements because they involve known and unknown risks, uncertainties, and other factors that are, in some cases, beyond our control.Please refer to the Safe Harbor provisions set forth on slide number two and 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 Eric go through the discussion today, keep in mind that when they mention EBITDA, they are referring to adjusted EBITDA and the reconciliations that are located in the appendix of our presentation.I would now like to turn the call over to Darren Jamison, President and Chief Executive Officer.

Thank you, Colby. Good afternoon everyone. And thank you for joining today's fiscal 2020 second quarter conference call. You'll probably notice that we are presenting our results in a unique and a little more simplified format today. The reason is that I really want to focus stakeholders on how Capstone is adopting more of an energy as a service business model, and where we are going in regard to reaching our positive adjusted EBITDA plans. As a company, we have accomplished much and several notable successes.First, we have our technology that's extremely solid and performs well at a high level. We have shipped well over 9000 units in our history, with an estimated 717 megawatts installed and running around the world with more being deployed each and every month. Today we have a well proven and extremely reliable technology with approximately 96% global availability. As we have worked through product reliability problems and vendor parts quality issues. Our products may make both economic and environmental sense and our valued assets by our customers.In fact, today we are starting to see more and more reoccurring Capstone customers, as microturbines provide a competitive energy solution for end users that have come to rely on Capstone, clean and simple. There's several favorable tailwinds driving demand, including green building, and distributed energy generation trends, growing demand for reliable behind-the-meter sources of energy, both primary and backup microgrid applications, developing trends toward customers voluntarily limiting the flaring of associated gas in the oil patch and Trance will electrify or decarbon oil production.We made a strategic pivot a couple of years ago to drive hard on our aftermarket Factory Protection Plan service products. This is a very profitable business for the company and we have made significant progress toward reaching our targets. Today we have 250 megawatts under long-term FPP contracts, compared to 265 megawatts still under the traditional time and material service approach. However, very soon, we will have more than half our valuable global fleet excluding Russia under our industry leading Factor Protection Plan service product.And we will be bringing a second parts remanufacturing center online in our UK Hub to further lower our future spare parts costs under these long-term contracts. Lastly, and most importantly, we know what we need to do to achieve our goal of sustainable, positive adjusted EBITDA, and how we're going to do it. This is the absolute focus of our company. And this is what I want to spend the time today really focus on with our multiple Capstone stakeholders on our call.Before Eric discusses our detailed financial results, I'd like to provide you with an overview of the financial highlights for the second quarter ended September 30, 2019. I will then discuss our newly set out positive adjusted EBITDA initiatives announced earlier this quarter.We'll start with financial business highlights of the second quarter fiscal 2020 on Slide 3. During the second quarter, total revenue was 20.7 million representing a 1.5 million or 8% sequential increase up from 19.2 million the previous quarter. The increase in total revenue is primarily due to 19% sequential increase in product revenue, up from 10.1 million in the first quarter to 12 million this quarter.New Product gross book-to-bill ratio was 1.0:1 for the second quarter fiscal 2020, up from 0.7:1 in the year ago quarter and compared to 1.7:1 for the first quarter. As part of our strategic initiatives to drive the rental business, we grew our rental fleet revenue 52% on a sequential basis. We are pleased to say that our high margin long-term rental fleet currently stands 6.2 megawatts, with a near term goal of achieving 10 megawatts deployed.Total gross margin increased 1.1 million to 3.1 million compared to 2 million in the year ago period, despite reported lower revenues on a year-over-year basis, further demonstrating that our margin improvement efforts are working. Gross margin as a percentage of sales expanded to 15% from 9% in the year ago first quarter, but was flat on a sequential basis because of business mix shift change of aftermarket revenue versus product revenues.Adjusted EBITDA loss improved to 2.2 million from 3.3 million in the second quarter last year, and also improved significantly on a sequential basis from 3.4 million in the previous quarter. Net loss improved 1.2 million on a sequential basis and was flat compared to a year ago period despite our new Goldman Sachs debt service expense.Now I'd like to discuss the positive adjusted EBITDA initiative as set out earlier this quarter. Let's move on to Slide 4. This is simply the most important slide we'll be discussing today. As this is where the real opportunity sits for Capstone and our stakeholders on a short-term basis. The first message in this slide is that we have implemented a positive adjusted EBITDA plan and stated goal of achieving positive adjusted EBITDA in the quarter starting in April and ending in June 2020.What is critical is to focus in fact that this initiative is based on 23 million in quarterly revenues compared to just 20.7 million reported quarter which isn't a huge job obviously, and is well below our historical levels. While I’m confident that we can and should have higher revenue in this model, this plan allows us to not simply bet on the future revenue growth, but reflects a plan that we can implement and control internally. Obviously, higher revenues will just add and further enhance the bottom line of the plan.Now, let me run through some of the initiatives and give you a quick progress report. There's still money to be saved in our warranty costs. And our goal is to lower operating expenses from the current 6.4 million in the September ended quarter to somewhere between 5.2 million and 5.7 million on an ongoing quarterly basis. This will be done by reducing headcount by another approximately 10% by greatly reducing travel, eliminating all non-critical spending. We're also planning on our Ops team to deliver an even leaner manufacturing process, which will further reduce waste and overtime and better leverage our manufacturing assets.Our goal is to reduce our annual direct material cost by up to 3 million, which will significantly help our product margins. We plan to accomplish DMC reduction by finding new sources of parts supply while simultaneously improving product forecasting accuracies and operational flexibility. I believe our microturbine technology is in a very strong leadership position. And although we will continue to innovate, we can do it with a reduced budget and better concentrate on our annual spend. Our goal is to lower R&D spend by approximately 15% by pushing out all non-essential product development activities until we are safely cash flow positive on an ongoing basis.We want to get to our 10 megawatt rental fleet target over the next couple of quarters. We are currently at 6.2 megawatt and have had significant success in developing this model with an eye on 10 megawatt field fleet. This is a very good return on investment or ROI business for us with consistent and predictable cash flows. And this business model has proven successful with the 6.2 megawatts we've already deployed. You've heard me talking about how important the aftermarket is to our profitability model in the past, the FPP service contract attachment rate currently sits at 38% with a near term goal of being at 45%. We plan to close the gap over the next couple quarters as we focus on our attachment rates.Our products are already one of the best on the market today based on their inherent air bearing design and only one moving part. However, we can do better in eliminating vendor quality issues and ensuring we're getting parts that are a 100% meet our stringent performance specifications and very tight manufacturing tolerances. As a result, you will see warranty expenses drop from 2.6% in the fiscal year 2019 to 1.25%, which is in line with our most recent quarters. This warranty improvement will drop straight to the bottom line and help margins on a year-over-year basis.We have been working with our distributor network even closer than usual this year. We have been and will continue to place even greater demand and pressure on them to perform and meet mutually agreed upon targets. The inconsistent and unpredictable range of performance by some of our distributors is simply not acceptable, especially as they are the spearhead that drives product revenue growth and FPP backlog. As we drive towards adjusted EBITDA positive, we are seeing more opportunities with large fortune 500 customers.In order to address this developing opportunity we'll be leveraging sales people dedicated 100% for national account development and drive incremental global business expansion across multiple distributor areas of responsibility. To make no mistake, the goal is not to replace our current distributor network, but to work hand in glove with our existing network in accelerating future product revenue growth for both us and our distributors.You will notice that we are transforming Capstone more into an energy as a service business by developing a robust long-term service contract business by developing new long-term rental business, by launching our new distributor support system and by eventually moving toward full own power purchase agreements and power by the hour business. I believe that once Capstone has a strong and stable balance sheet, the energy as a service business model is the greatest approach that will yield more robust gross margins and a superior bottom line performance when compared with more traditional models of selling in energy products and waiting for future product failures to sell customers aftermarket spare parts.I believe customers will learn to truly value and appreciate the mutual win-win benefit of a factory and customer aligned energy as a service business model more than the traditional win-lose relationship of the old razor and razor blade business models that our internal combustion competition have been using for years. Lastly, because of the long 20 plus year life of our product and low lifecycle maintenance costs inherent in our air bearing technology, I believe Capstone is uniquely suited for energy as a service win-win business model.Now let's move on to Slide 5 to discuss our near term adjusted EBITDA positive plan versus where the business is today. As part of a new operating model, we target revenue to grow modestly from today's 20.7 million to 23 million in the quarter ending June 2020. We expect accessories, parts, service, rental and DSS revenue to expand to 9 million from today's 8.7 and product revenue to grow from 14 million from today's 12 million in the quarter just ended. However, we really see the inflection points in the gross margin expansion despite the extremely conservative revenue assumptions.We project product margins to be 1.3 million in the June quarter, up from 400,000 today in the second quarter of fiscal 2020 and 300,000 in the second quarter fiscal 2019. This should be driven by lower warranty costs as I just mentioned, reduced discounting of the product and lower direct material cost as I mentioned. However, the largest impact in profitability should be the margin improvement for accessories, parts, service, the new rental fleet and distributor support system. We are targeting 4.1 million by the upcoming April to June quarter compared to 2.7 million this last quarter.As I reviewed earlier, improvements should come from the lower impact from supplier parts quality issues, increased remanufacturing parts capability with the new UK Hub expansion, the expanded new 10 megawatt long-term rental fleet and improved factory protection or FPP attachment rates. Total gross margin is projected to reach 5.4 million by the first quarter of fiscal 2021, from 3.1 million in most recent quarter. Lastly, we anticipate reducing our operating expense by a minimum of 700,000 to 5.7 million when compared to our most recent quarter and reach a positive adjusted EBITDA by June 2020.Now, I would like to have the call over to Eric Hencken to discuss the detailed second quarter fiscal 2020 financial results on Slide 6 to Slide 8. Eric?

Thanks, Darren. I will now review in detail our financial results for the second quarter of fiscal 2020. As Darren just mentioned, the highlights can be found on Slides 6 through 8. Total revenue for the second quarter of fiscal 2020 increased 1.5 million to 20.7 million, compared with 19.2 million in the first quarter.Total revenue decreased 1.5 million compared with total revenue of 22.2 million in the year ago second quarter. This decrease in revenue was primarily because of a decrease in product revenue, as we deployed two C1000 Signature Series systems to our rental fleet during the second quarter of fiscal 2020.Product revenue for the second quarter increased 1.9 million on a sequential basis to 12 million compared with 10.1 million to the first quarter. Product revenue decreased 2.9 million compared to 14.9 million in the year ago second quarter.Accessories, parts and service revenue decreased 0.4 million to 8.7 million in the second quarter, compared to 9.1 million in the first quarter. On a year-over-year basis accessories, parts and service revenue grew 1.4 million or 19% compared to 7.3 million for the second quarter of fiscal 2019.Gross margin percentage for the second quarter and for the first quarter of fiscal 2020 were both 15%. Gross margin in the second quarter increased to 3.1 million, compared to 2.9 million in the first quarter. However, compared to the same period last year, gross margin increased 1.1 million from 2 million, representing a 55% increase.Operating expenses in the second quarter were 6.4 million. On a sequential basis, operating expenses decreased 0.7 million from 7.1 million in the first quarter and compared to 6.2 million in the second quarter of last year. The decrease compared to the first quarter is primarily due to a decrease in marketing expense and a decrease in professional service costs.Adjusted EBITDA loss was 2.2 million in the second quarter, compared to adjusted EBITDA loss of 3.4 million in the first quarter and adjusted EBITDA loss of 3.3 million and the second quarter of last year.Cash and cash equivalents were 20.9 million as of September 30, 2019 compared to 24.6 million as of June 30, 2019. Accounts receivable net allowances were 18.1 million as of September 30, 2019, compared to 14.8 million as of June 30, 2019. The increase was primarily due to delayed collections from certain customers.During the second quarter, we continue to drive the initiatives that are key to our positive adjusted EBITDA plan, such as the expansion of our rental fleet, and a reduction of our operating expenses.At this point, I'll turn the call back to Darren.

Thank you, Eric. Before we move on to analysts Q&A, I'd like to talk about some more recent kind of current events. October 21, the company affected a one-for-ten reverse stock split in order to regain the compliance for this NASDAQ listing. The board of directors and leadership team did not make this decision lightly, but felt, in the end, that it was the best interest of Capstone stakeholders to make sure the company could most easily and effectively meet its future liquidity requirements and execute against its adjusted EBITDA positive business plan.In addition, we needed to be sensitive to consider the potential negative impact on our customers and vendors, if we were to relinquish our NASDAQ listing. However, it was critical that the management build positive support to offset the negative perception of retail investors on the reverse split, so the team mobilized to maximize investor communications, investor outreach before, after and during the split. Capstone effect of the reverse split at $2.91 and ended the NASDAQ 10th trading day compliance period at $2.71 down 6.8%.If you think about it, this is truly remarkable when you consider the massive trading volume as approximately 6 million of our approximately 8 million shares traded during that 10 day period. On November 5, Capstone received official notification that NASDAQ had determined that the last 10 consecutive business days from October 22 to November 4, 2019, the closing bid price of the company's common stock had been at $1 per share or greater. According to the company has now regained full compliance with its NASDAQ listing rule 5550 and the matter is now officially closed. Another current event, you may have seen the recent news multiple California wildfires, in combination with the California utility companies proactive power outage program and creating a state of crisis for many California residents and businesses with no end in sight.In fact, the entirety of the management team with multiple fires was evacuated at one time or another. The major utility companies in an effort to make up for their ageing infrastructure to avoid additional catastrophic wildfires and potential liability have resorted to affecting planned safety power shut downs or nicely called PSPS where they shut down power at specific times in specific areas, and for several hours if not several days at a time. Thousands of California business owners are now faced with potential for lost production and lots of revenue. The newly initiated PSPS program is now expected to be the new normal for California residents and business owners.As you can see from Slide 9, Capstone and the sales team have been out in force from the beginning of the crisis to educate California business owners on the many benefits of Capstone's microturbine technology and the resiliency they provide as well because environmental benefits. Capstone microturbines provide safe, reliable, clean and low emission power solutions for today's businesses. And we see the wildfires and PSPS program as a seminal event like Super storm Sandy was in the growth of our New York and Mid Atlantic microturbine business.Slide nine highlights just a few examples of Capstone's recent marketing outreach initiatives in light of the reason wildfires and associated PG&E and so cold weathers [ph] and power shut offs. Here I have provided examples of paid advertising for both LinkedIn and Facebook's new seeds that were specifically targeted at industrial and commercial customers by location. I've also included examples of the type of social media advertising that we are doing on Twitter, LinkedIn, Facebook, and Instagram, as well as an example of Capstone corporate Twitter feed, and LinkedIn post in response to the planned safety power shut offs.You will note that as the reader clicks on the Learn More button, they will be directed to a new custom landing page located on our Capstone corporate website. Here on our website, easily able to capture lead qualifiers, and filter the incoming information. The information coming in is contact information from the customer, facility information, monthly electric bills and monthly gas bills. Each and every customer lead is automatically entered and tracked in our salesforce.com customer relationship management system or CRM.In addition, Capstone recently ran a quarter page ad and sorted in the Sunday and mid-week issues in the main section of the Sacramento Bee. Incoming leads and inquiries are tracked with the QR code and our inbound call metrics tracking software. It is evident the utility customers are noted not to please, on the oncoming seemingly forced to accept this new normal of planned, safety power shutdowns, and are interested in learning more about Capstone microturbine product offerings and technology. So you can imagine, we have received dozens of inquiries and released three or four potentially viable new projects already.So before I open the call to questions, I'm going to throw that over to Jim and let him give us a little update on this opportunity. What's happening and changing in an hour-on-hour to day-by-day basis.

Sure. Thanks, Darren. I think to me what we've done our distributor here in California account microturbine, has had their own marketing plan is those social media email campaigns. We're also working with the Governor's Energy Office. So we've provided them data around the technology to both try and help solve the current issue, but also with a forward looking ability to incorporate CHP or CCHP to the solutions after they've been installed to solve the energy problem or the electricity issue with the longer term ability to look at some of the future fuels to decarbonizes the grid with renewable natural gas and hydrogen. So we've had very positive response from the Governor's office and we continue to work opportunities with them.I think the other area that's been quite interesting is we've had several customers who had either delayed and/or chosen not to move forward in the last couple of years with the CHP project, and they've reached back out to our distributor to figure out how they can reengage and reevaluate the project, adding the reliability or the resiliency aspect to it the same way we saw on the East Coast with Super storm Sandy and some of the other areas in the world that projects get redesigned after natural disasters. It's pretty exciting. And then we're filtering and pursuing all the opportunities as quickly as we can.

Excellent. Well, thank you. Good color Jim. So with that, let me open the call up for analysts’ questions. Operator?

Thank you.

Thank you.

And that does conclude our Q&A session for the day. So I'll turn the call back over to Darren Jamison for your closing remarks.

Thank you. No, good call today, great questions. I think most people are seeing what we're doing here. I think as far as the presentation goes, we try to be a little simpler today. Slide 5, though, is the most important slide where it shows our results of September 2018, September 2019, and what we think in the April to June forecast time, I think we've been to EBITDA positive twice in the company's history. We weren't able to stay there. I think what's different this time in the April to June quarter is the underlying factors are stable and should not change and so we should get to EBITDA positive and stay there and then build from there frankly. Obviously, that's not an end goal. That's an interim goal for us. As I said, you know, reducing cash burn is important.We're going to focus on $6 million of capacity receivables to get that down this quarter. So we have a good cash burn quarter. We'll continue to hopefully have positive book-to-bill ratio. We are shifting our sales focus to one of managing the distribution channel, but also developing larger strategic customers and larger national accounts. Whether it's Mohawk or Magna or Pepsi or Marriott, we need to build bigger relationships as we build our balance sheet at the same time, so excited about that, excited over the next couple quarters, excited to getting to EBITDA positive and staying there. With that, we'll go ahead and close off for today and look forward to talking to you next quarter.

And that does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time and have a great day.

Thank you, the floor is open for questions. [Operator Instructions] And we'll take our first question from Colin Rusch with Oppenheimer. Please go ahead.

Hi, good afternoon. This is Luis Emmerdale [ph] for Colin. Can you just talk about different ways where you - in which you could stimulate near term growth without sacrificing your gross margins?

Yeah and I think what Jim was talking about is definitely one way. The California crisis is moving a lot of customers that look differently at their energy needs. We saw a huge uptick in our New York business after Super storm Sandy. If you look at the recent installations in New York, we've got one Vanderbilt next to Grand Central, we've got two buildings down the Hudson Yards location, lots of different major buildings in New York adopting our technology, a lot of that interest came from Super storm Sandy and people are realizing they needed to not only save money on their energy bill, but also have resiliency when the power went out. And we're seeing similar installations in the Mid Atlantic areas to the Philadelphia, FMC tower, new schoolyards and some other big development projects. So I think a lot of its education but a little natural disaster or stimulus never heard to get customers moving up top center on a decision making process.

Okay, that makes sense. And obviously your service business is growing in a meaningful way. Is there a possibility to go out to the installed base and sign additional agreements to drive sales faster to the target model?

Absolutely, it's a great point. We were definitely growing our service business and our rental business and our DSS business and our parts business. But on the FPP service contracts we found getting them initially sign up when the product comes out, the warranty is definitely the highest attachment rate we can have, like if you're if you're buying a product at a store, it's much easier to buy long-term warranty, when you're actually buying the TV or the piece of equipment. But for us, we do target existing customers. We are raising spare parts pricing fairly precipitously. So we're seeing more customers interested in it and a lot of is just customer education, understanding that if you sign a long-term service contract or FPP agreement with Capstone, our motivation as a factory is to support your site, make sure it runs well. And make sure that you get a great customer experience.Our cost of goods on that future service contract depends on how well that site runs. If we sell the product, and we don't have a long-term service agreement then we make money when the product breaks, and so that's what traditional engine companies do. I don't like the concept of I profit from my poor performance of my product. We want to profit on the excellent performance of our product with a win-win relationship with our customers. I've got Jeff and his team, looking at the largest areas in the world where we have fleets of units not under FPP. Most of them are oil and gas centric, and so we will help target those distributors and help them go out and try to sign more contracts. I think you've seen and maybe Jeff can jump in to add a little color, increase in FPP contract signing in since the last spare parts price increase and since we increased the focus.

Sure, thanks Darren.

That's very helpful. And if I can ask one last one. How should we think about the growth in your R&D spend, as you said, you're targeting to reduce that. But are there any areas where it will make sense to increase investment?

Yeah, I think for us, the most important thing right now is we need to stop being serial capital raisers. I think a lot of folks on clean tech space just continue to go back to the well and continue to dilute the company and their shareholders. We want to stop the cash burn; we want to get profitable. And our balance sheet is really our biggest impediment to getting large scale customers and so for us a solid balance sheet and positive cash flow will open up more fortune 500, fortune 1000 customers and really underpins the value of our Factory Protection Plan. We offer this amazing up to 20 year Factory Protection Plan, which is all in bumper-to-bumper, but without a profitable company or a solid balance sheet, it's a little bit of a hollow insurance policy for lack of a better term.So goal number one is to stop the cash burn, get EBITDA positive, get profitable and then obviously, we're going to spend money where it makes sense. We'll spend money on product development. Jim mentioned hydrogen. We see the hydrogen future in a lot of areas in the world. We are in process of testing hydrogen right now and it grew up to about 40%, hydrogen and natural gas blend operating in a lab. So we definitely want to move on that and then the solar version of our product and a few other new product developments. So we will spend more in R&D, we'll spend more in marketing, but we're not going to increase our spend until we're cash flow positive.

Thank you very much.

And our next question comes from Robert Brown with Lake Street Capital Markets. Please go ahead.

Good afternoon. Can you just us an update on the oil and gas market? How that's doing, how the demand environment is and is that still a rental market at this point?

Yeah, definitely the oil and gas market - I'll let Jim jump in and add some more color. It's approximately 40% of our business today. We are seeing obviously pressures for CapEx spend. So we are selling product in that market, but we're also - most of our rentals have gone to that market and most of the pending rentals that we're developing are in that market. So I think they are looking to use somebody else's dollars and focus their CapEx on production and frankly managing a CapEx spend with today's low prices, but let me let me throw it over to Jim for a little more detailed color.

Yeah. No, I think that Darren's spot on. The E&P companies are looking to use their capital for exploration and production and the equipment associated with that if they can rent it or lease it, there's much more attractive, we still see a lot of activity around flare gas reduction. We have actually customers in today for a factory acceptance test for a flare gas reduction project in France. We have stuff going on in Algeria. So it's not what it would be if oil were $110 a barrel, but there's still activity in customers that are looking to solve problems.

I think we're seeing more and more customers voluntarily come out and offer to say we're going to stop flaring by 2030, we're going to cut it half by 2025 and the Shell, Total, a lot of these big companies are coming to that conclusion on their own and putting in target dates which is great.

And then in terms of the California market and the wildfire situation and the power shutdown, how have you sort of experienced in the past these natural disaster markets and do people act quickly or just take time to kind of sink in what's the - what sort of the experience you have?

Sure. So this is Jim. It tends to go through the cycle. I think immediately customers look to diesel or backup generators to solve the immediate emergency and then they look for longer term solutions. We saw that in Super storm Sandy, we've seen it in the Caribbean, other places where natural disasters have been very disruptive to the power supply. So again, I think we'll - yeah, we have increased deal flow or opportunity, currently. And as Darren mentioned some of the customers - this will be the catalyst that drives them to make a decision sooner than they might have otherwise.

Yeah, I think that's what we saw in New York. A lot of people that were contemplating projects this became the seminal event to kind of push them across where they may have spent their money on an X-Ray machine or redoing the lobby of the hotel that decided that the CapEx spent on the Capstone CHP system was critical because of the event. I think the difference here in California is we know this is not going to change anytime soon. This could be something that California is dealing with for the next 10 years. And so I think that's really going to change the landscape plus energy is already expensive in California and not getting cheaper, so that that helps us as well.

Thank you, I'll turn it over.

Thanks Rob.

[Operator Instructions] And our next question comes from Sameer Joshi with H.C. Wainwright. Please go ahead.

Hi, Darren, hi, Eric thanks for taking my question. In regards to the marketing initiative that you launched with the social media and other stuff, print advertising, should we expect a little spike in the marketing costs for this quarter?

No, the marketing budget we have was fairly low this quarter anyway. We've done any marketing earlier in the fiscal year. Obviously, we looked at that turning that back in this period and will continue to go back a little bit. So I think, yeah, you're not going to see anything abnormal this quarter from our typical levels. We've got a big trade show going on in ADIPEC, next week, and then we don't have a trade show for that size for several more months. So obviously, Jim, do you want to say a word about ADIPEC.

Sure. No, ADIPEC is one of the largest oil and gas trade shows in the world focused on the Middle East, Africa, Indian markets, which is a great growing market for us. We're getting ready to ship a couple of our C600s to Iraq for a project with Shell and Basrah. So we're starting to see some of the initial projects lead to additional projects in the region. So we're excited. Good meeting set up around the show. It's a growing and interesting market for us.

Thanks for that color. On the - in your prepared remarks, I think I heard that 250 megawatts was already under the FPP versus 265 megawatts which was not. That is almost 45%, 50% of the deployment. So then how do you juxtapose that with your target attach rate of 45%, which is right now at 38%?

Yeah, so the difference between the - that's a good point, between the megawatts we have under FPP, which is about 250 megawatts versus the 265 megawatts FPP, that is excluding the Russian business, we don't sign long-term service contracts in Russia today. So that's part of the difference you're seeing there. Plus one of those is attachment rate of a microturbine under FPP and the other ones and megawatts and so a single 1000, C1000 mega machine counts as one as of the C30 and so you get that little bit of apples and oranges. But I think the important thing is we want as much of our product under Factory Protection Plan as possible, and for as long as possible. And so I'll go throw over Jeff here for a second to maybe just talk about what we're doing to increases attachment rates and what we've seen the last couple quarters as we've seen an escalation in the oil and gas industry.

Sure, thanks Darren. I think if you look at the press releases that we put out of our larger FPP awards over the last year, they map very closely to the total awards we've gotten in terms of the context from where the awards came. Early in the year you start a lot of transitions of oil and gas customers over to the FPP. The oil and gas market started to stabilize and they began capital expenditures again. Later in the year, you started to see new awards in oil and gas and then also what we expect, which is no awards in the energy efficiency market. So if you look at those awards, you get a pretty good idea of where FPP is coming from.In addition to that, because of the concerns with the macroeconomic and geopolitical environment right now everybody understands that there's cost pressures around the world for raw materials. And the FPP is a way to sign up for long-term predictable capital expenditures in your business. And people are beginning to recognize that. So initially, they were willing to gamble on the high reliability of the product and that was, in many cases works out very well for customers. But as they see the pressure macro-economically and geopolitically, they are more inclined now to sign up to a fixed cost for a long period of time. So I think that's really what's driving the conversions over and the new awards.

Thank you, Jeff.

Understood, just a couple of questions on costs, the direct material cost reduction of $3 million. It is related to what level like what is the - relative to what basically?

Yeah. No, let me - let Kirk Petty answer that because it's his area responsibility to lower the DMC $3 million and we've already got a significant chunk of it realized and a lot of it is in process of being realized as we transfer over from one vendor to another. Kirk?

Yeah, sort of alluding to what Jeff was saying earlier. A lot of the materials that we use in a highly reliable product require materials that have a long lead time and can only be sourced from special places. So a lot of the direct material costs that we were focused on reducing for the 3 million have to do with those long lead times. And a lot of the vendors that we had had previous problems with from payment standpoint and prepay and things like that. So we were working with vendors who were more prone to working with us on a positive way. So we've been pretty successful with that. It's an annual goal that we're going to keep reducing the direct material costs of the product, specifically focusing on the aftermarket parts first, and those are being realized into product margin now, so several successful new vendor relationships have been developed over the last couple of years and we look forward to developing more.

Also, I think that the remanufacturing of our parts is loss for a lot of people. If I can remanufacturer a part of 30% the cost of new and put that into my long-term service contract fleet. That's very, very good from a cost perspective. Our challenge there has been the ability of cores remanufacturer and so as the 9,000 units gets more hours on ages will get more cores and more parts to bring back. And then more importantly, we're opening a secondary manufacturing center in the UK to double our capacity of remanufacturing those parts and rebuilding those engines. So as that matures, we're going to see much better margin rates in our service contracts, which are already good today, but they'll go from good to great.

Right, great and the UK Hub that you're going to bring online for the parts center will entail any capital expenditure?

You will have capital expenditures.

Capital expenditures, yeah, those were baked into our plans for this year. So there are obviously capital expenditures. We're putting in - we're going to a full grid connect capability adding an ISO test cell, as well as setting up the test cells for multiple configurations of the product, but that was that was baked into our plan for this year, and into our three year expenditure plan, so we're three years into a five year plan. The first year was the outsourcing of remanufacturing in some cases because we have a high industrial base and location where the Hub is situated. The second year was an increase in our ability to produce remanufactured parts. The third year is increasing our test capabilities. And then it will end with ISO certification in the fifth year. So we're making great progress on it. We've already seen significant reductions in our service parts costs, and we've also seen a reduction in the cycle time for repairs which improves overall availability for the products.

And it should be noted that those remanufactured parts aren't sold directly to our distributors they are only used and as cost of goods in our FPP contracts and so that makes our FPP contracts that much more competitive in the marketplace. And so that's one thing that confuses customers a little bit when they look how price competitive our service contracts are. That's because we're using remanufactured kind of factory certified parts in our service contracts where if they buy parts directly from a distributor and do their own service work, everything they're buying is brand new off the shelf.

Yeah, maybe to add to that the growth of the FPP in total as Darren alluded to earlier increases the amount of hardware that we can bring back and run through the remaining factoring pool. So it's the kind of business that kind of grows on itself over time. And you needed to reach a certain economy of scale before you started to see the return. But that's what you see reflected in the numbers over the next year is that large increase in FPP, a higher percentage of remanufactured parts going back into the FPP which then reduces the overall costs and increases the margin for the company, so not the sexiest things in the world to remanufacturer parts, but definitely nice from a margin standpoint and cash flow standpoint.

Yeah, no, we do recognize the value of remanufacturing for the FPP. One last question from me on accounts receivable, slightly higher this quarter. You said nothing to worry about, right. No bank accounts there or just a delay in collection.

Yeah. No, definitely we were - probably our biggest disappointment for the quarter was the cash burn. We had over $6 million of past two accounts receivable, about 12 to 14 different distributors. We've been actively collecting those dollars this quarter. We'll look to get that cleaned up. That should reverse itself this quarter, we should see cash burn precipitously lower this quarter than the prior two quarters as we kind of reverse the working capital swing. That's something that's always challenging. Our distributors work really hard on our behalf but a lot of them are smaller companies and when they have a delay in payment that can impact their business or if they have other macroeconomic things going on. But we see very little bad debt historically knock on wood, besides our Russian distributor, we've had very little over the last 10 plus years. Obviously, our distributors sell mostly Capstone in most cases, so not paying out something that they're not going to do or take very, very lightly in doing. So we're focused on it. And we'll work hard to make sure we turn that around this quarter.

Thanks for taking my question.

Thank you.

And our next question comes from Eric Stine with Craig Hallum Capital Group.

Hey, good afternoon. It's Aaron Spychalla on for Eric. Thanks for taking the questions.

Hey, Aaron.

Maybe first, can you just kind of talk a little bit more about the CHP opportunity? What percentage of the business that is today and just kind of the growth outlook there?

Yeah, CHP is about half our business today. I think if you look at different quarters it varies, but CHP is between 45 to 50% of our business, oil and gas is usually 35 to 40 and then we've seen a bigger growth in kind of the renewable space for us, which is renewable natural gas, bio gas, cabin or pigment or wastewater treatment plants, landfills. But let me throw it over to Jim to talk about the CHPs in general and what we're seeing going on.

Yeah. No, the project cycle is longer. So it's a little less predictable, because there's a lot of things that can happen through the sales process. But the sales opportunity pipeline continues to grow. Our distributors are getting more proficient at selling it in different parts of the world. And I think the other thing that that's helping is, when you look at the US as an example, there used to be two or three regions that CHP made good economic sense. And as energy prices continue to go up, as resiliency in the advent of micro grids continues, we're seeing areas in the country that three, four years ago didn't have a simple payback that was acceptable to most customers. And today those the simple paybacks are getting down into the range where customers will consider buying the solution. So, the market is growing in part because the project economics across the country are getting better for CHP.

Yeah, if you told me five years ago that our largest CHP installation in the US would be in Tennessee, I would think you're crazy. So we were just commissioning infinity, our great distributor in the Mid Atlantic area is just commissioning a five megawatt Mohawk tight tile and carpet installation in Tennessee, which is not typically where do you think of CHP applications and good spark spread.

Got you, thanks for the color and then I notice kind of the decrease in backlog, can you just maybe give a little color there please?

Yeah. No, we talked about gross bookings and boo-to-bill for a reason. Our backlog is something that we're constantly looking at scrubbing, trying to decide whether - how solid it is and when it's going to ship until there's some cases where customers will change their backlog, modify their orders. With the Russian distributor, we've been looking at that backlog and try to rationalize that over a period of time with our new five new Russian distributors. We also remove large orders from backlog from company called Gifs [ph] where we've seen some changes in their business, so we've got some concerns about their viability, so they haven't cancelled the orders, but we took it out of the backlog to be proactive. So that's, that's something we're going to kind of take a look at. I know a lot of people in our space like to put up billion dollar backlog members and crazy stuff. I'd rather be more conservative on the backlog and make sure that the customer is going to go ahead with the project and the project's not going to be delayed. And so we take a pretty hard look at it every quarter and so you'll see changes in the net backlog numbers as we scrub through it every quarter.

Alright, thanks for the color there maybe last for me. I mean, you kind of touched on it on the first question just RND and I know gas was kind of involved in that space. But can you just maybe talk about the growth outlook there and kind of how you see that opportunity unfolding over the next year or two?

Yeah. No, I think I'll allow Jim answer that one in detail, but I look at the world today as natural gas as 70% of the installations that we do worldwide and then you look at propane and some of the bio gas applications, but that is changing. And I think you're going to see a shift into more renewable natural gas, more bio gas, and then eventually more toward I think hydrogen, and then fuels that are - or solutions that don't have any fuel [indiscernible] right. So I'll throw it over to Jim to get more color on that.

Yeah. No, I think bio gas that gets treated and converted to renewable natural gas. There's a lot of momentum. Right now the focus is transportation fuel, the low carbon fuel standards drive the market in that the price that you can get for a transportation renewable natural gas is far greater than you can get by converting it on site to electricity and selling it into the grid. The nice thing is a lot of those processes for treating bio gas and making it natural gas quality, have loads and flip streams or waste stream gases that fit the microturbine very well. So we see a lot of opportunity and in smaller sizes, not multi-megawatts, but multiple C65s and bio gas applications where the gas has been cleaned up to put into the pipeline. So it's an interesting and evolving market, one that's challenged with incentives and rebates and government regulation, but absolutely growing and will continue to.

Understood, thanks for the color. I'll hop back in queue.