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11/10/2021
Good day, ladies and gentlemen, and welcome to your Capstone Green Energy Earnings Conference call and webcast for the financial results for the second quarter fiscal year 2022 ended on September 30, 2021. All lines have been placed in a listen-only mode, and there will be a question and answer session following the presentation. As a reminder, today's program will be recorded. At this time, it's my pleasure to turn the floor over to Mr. Colby Peterson, Corporate Counsel. Sir, the floor is yours.
Thank you very much. Good afternoon, and thank you for joining today's fiscal 2022 second quarter conference call. On the call with me today is Darren Jamieson, Capstone Green Energy's president and chief executive officer, and Eric Hankin, chief financial officer. Today, Capstone Green Energy issued its earnings release and filed its quarterly 10-key report with the Securities and Exchange Commission for the fiscal 2022 second quarter and its September 30th, 2021. We will be referring to slides that can be found on our website under the Investor Relations section during the call today. I want to remind everyone that this conference call contains estimates and forward-looking statements representing the company's views as of today, November 10, 2021. Capstone disclaims any obligations 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.
beyond our control.
Please refer to the Safe Harbor provisions set forth on slide two in today's earnings release and in Capstone's filings with the Securities and Exchange Commission for information concerning factors that could cause actual results that differ materially from those expressed or implied by such statements. Please note that as Darren and Eric go through the discussion today, when they mention EBITDA, they are referring to adjusted EBITDA and the reconciliations in the earnings release and the appendix to the presentation slides. I would now like to turn the call over to Darren Jameson, President and Chief Executive Officer.
Thank you, Colby. Good afternoon, everyone. Thank you for joining today for a review of our second quarter fiscal 2022 results ending September 30th, 2021. You can now go ahead and please turn to slide four. On slide four, I wanted to remind everyone of our fiscal 2022 goals and then reinforce some of the things we've been doing and will continue to do since becoming Capstone Green Energy back on Earth Day last April. We remain sharply focused on delivering our strategic business goals, enhancing our competitive advantages, and expanding our total addressable markets around the globe. Capstone is at the epicenter of a significant shift toward distributed energy and microgrids as the primary way to meet our growing demand for cleaner power and the need for energy security. According to Global Markets Insights, the microgrid market size exceeded 6 billion in 2020 and is anticipated to register over 27% compounded annual growth rate, or CAGR, between 2021 and 2027. Set in this backdrop, we have positioned ourselves to leverage the sea change in energy to meet the needs of our customers with a clean, reliable solutions encompassing microgrids, hydrogen energy systems, and improving customers' overall energy efficiency. A perfect example of how Capstone and microgrid solutions can meet these needs is our recent announcement where we are providing our technology for a cutting-edge microgrid with integrated electric vehicle or EV charging stations in Italy. Capstone distributor IBT Systems partnered with S4E Systems, a national ESCO provider, to develop the combined cooling, heat, and power microgrid solution one of the first of its kind in Italy. Our strategic initiatives are built around driving growth, but equally important, if not more so, is the type and quality of growth. We are intensely focused on increasing our recurring revenue as part of our Energy as a Service, or EAS, strategy. We're focused on achieving our goals here because it translates into meaningfully improving our cash flow and also the predictability of our cash flows. Our fiscal 22 goals are to continue to leverage the global shift and include the following items. First, broadening our diverse energy products and service offerings. I'll discuss this in more detail later in the presentation. Second, is our new direct solution sales team focused on growing top line revenue. We continue to add headcount into the direct solution sales team, and we continue to be pleased with the pipeline being generated by the team, both with traditional micro turbine products, long term rentals, and the newer green energy product offerings as well. Third is expanding the long-term rental fleet to 21 megawatts. We grew the fleet to 13.1 megawatts during the second quarter and subsequently announced in October that we expect to grow the fleet to 17.1 megawatts by December 31st, 2021. Next is increasing our aftermarket margins and escalating parts availability to drive customer satisfaction and repeat orders. In the quarter ended March 31st, 2021, we set up a reserve for $4.9 million to replace affected supplier parts that were defected parts in the field. We expect to have this program completed in our third quarter, and we've already seen the impact in the business with significantly reduced failure rates on our powerheads, which has lower warranty expense. Obviously, lower failure rates lead to happier customers. Happier customers lead to repeat orders. Focusing on managing working capital inventory turns is next on our list. Cash used in operating activities and specifically for working capital inventory has been heavier than expected, partially due to ramping up parts to build the rental fleet and also to ensure we can continue to manufacture product in these extremely challenging COVID-19 supply chain environment. Next is growing our distributor support system or DSS subscription fee program, which is driving marketing and customer acquisition efforts. As a reminder, we charge our global distributors a fee of 3% of their prior year's revenue and also helps us grow our reoccurring revenue. We then take that DSS fee that we collect and put it back into the business to help promote our overall capstone story, which benefits all capstone partners in the value chain. Because the fee is tied to revenue, as our overall revenue goes, the DSS fee will grow with it. Now let's turn to slide five. There is no doubt that the world is moving towards decarbonization and greener energy solutions. This is one of the drivers around our repositioning to Capstone Green Energy Corporation. This slide highlights the types of solutions we can now provide to address the end customer's needs as the world moves towards those greener solutions. First, we can provide a complete microgrid solution that can run standalone or connected to the grid. In addition to our traditional microturbines, we now offer solar and battery storage solutions in partnership with new network partners. Combining these products with our capstone microturbine technology can create a complete custom-tailored on- or off-grid microgrid solution. We continue to develop our offerings in the hydrogen space as the hydrogen economy is here and a key pillar in the future of green energy. Our micro-turbine based systems can commercially run on 10% hydrogen, 90% natural gas blend today. We've publicly said we have goal for our systems to be able to operate on 30% blend by March 31st, 2022. And then beyond that, we intend to spend money on development towards 100% hydrogen as the market dictates. The key point here is that we want the products we offer to be fuel flexible and not just meet the needs of where the market is today, but where the market will be in the future when it comes to decarbonization solutions. We also now offer solutions that can help commercial and industrial or CNI customers with their energy efficiency and resiliency needs, both saving them money and providing energy security, whether it's with the combined heat and power of our C65 to 5 megawatt microturbine solutions, or the new Baker Hughes 5 megawatt to 16 megawatt turbines, or the custom heat recovery solutions through new partner, Alpha Laval, or food waste management and recycling solutions through new partner, Waste2ES. Now let's turn our attention to slide six. Slide six offers some images of both our traditional microturb product as well as some of the new product offerings. This slide shows our microturbine systems, our hybrid DC energy microgrid solution, which is very similar to the polar power product, the core power battery storage solutions, and Alpha Laval heat recovery system and one of the Baker Hughes industrial turbine products. Capstone Green Energy continues to expand its green energy suite of innovative products to provide customers with a custom-tailored energy solution that will meet their individual carbon reduction needs, cost reduction targets, and resiliency requirements. Now, let's go ahead and turn to slide seven. As I mentioned on Earth Day in 2021, we expanded our portfolio of products and services and transitioned from Capstone Turbine Corporation to Capstone Green Energy. We now view our business in four key strategic business lines. This is important because it goes hand in hand with our strategic goal of growing our offerings to expand the revenue opportunity in each end use customer and meaningfully accelerate top line growth and reoccurring revenue. Let's begin with the first column, Energy as a Service, or EAAS. This business line is built on the base of reoccurring revenue and includes long-term rental contracts, long-term service contracts, or our Factory Protection Plan, or FPP, installation services, customer service, spare parts, leasing, PPAs, and project financing. It also includes our aforementioned DSS, distributor subscription fees. The common elements among all of these business lines are steadier cash flows, visibility, higher margin rates. This is critical to continuing our transition to be a more predictable cash flow and higher margin business. The next business line is Energy Generation Technologies, or EGT. This is the foundation of which Capstone was built and is based on Capstone's core microturbine technology that you're all familiar with, and they can operate on a wide range of fuels from natural gas to biogas to blended hydrogen. These products produce high-efficiency CHP and CCHP generating electricity and multiple forms of thermal energy. The EGT line now includes small hybrid DC microgrid product and our larger Baker Hughes industrial gas turbine solution for CHP and CCHP applications. Moving to the next pillar, energy storage solutions, or ESS. We continue to evaluate solar module suppliers that have new arrangements in place for energy storage, which is one of the most essential additions to microgrid or even a nanogrid. We'll be using custom-tailored combination of multiple technologies, energy storage, and monitoring software that will maximize energy efficiencies, lower customers' emissions, and create resilient microgrid systems that meet customer-specific resiliency needs. Last but not least is our hydrogen and sustainable product business line, or H2S. Fuel flexibility has always been a critical element to Capstone, and so hydrogen is the next big fuel source we need to address. Our new hydrogen solution business line is leveraging the recently released commercially available hydrogen-based combined heat and power product, micro turbine, which can run safely on 10% hydrogen and 90% natural gas. Most importantly, we now have a target for commercial release of 30% hydrogen, 70% natural gas mix by March 31st, 2022. We are also working with our network partners like Baker Hughes and B plus K to advance our hydrogen solutions. We're also actively working with 24-7 Solar to help commercialize their concentrated solar and thermal storage solutions and soon look to enter into a contract manufacturing services and global marketing agreement. Now let's turn our attention to the most recently recorded results for the quarter, slide nine. I'll give you just a quick overview of the second quarter financial highlights as I see them. I'll only focus on top line highlights here and Eric will provide a more complete financial detail in just a minute. Total revenue in the second quarter is $17.2 million, up 15% compared to $14.9 million in the second quarter last year, as orders and shipments continue to rebound despite the ongoing continued negative impacts from the COVID-19 global pandemic. The book-to-bill ratio was good at 1.3 to 1 for the quarter, and new gross product orders were $10.8 million, up from $8.2 million in the first quarter. As a reminder, we view anything over 1 to 1 as a favorable book-to-bill ratio. as anything over one-to-one can be an indicator of future revenue growth. Long-term microchip rental fleet increased 1 megawatt to 13.1 megawatts from 12.1 megawatts during the quarter, as the company continues to execute against its plan to increase the rental fleet to 21.1 megawatts by the end of our fiscal year or March 31, 2022. However, more recently, in October, we announced new contracts for an additional 3.2 megawatts of long-term rentals and our plan to take the rental fleet up to 17.1 megawatts by December 31st, 2021. With that in mind, we do not expect to have any issues getting to the 21.1 megawatts by the end of our fiscal year, which Eric will highlight why that's so critical. If you will now turn to slide 10. On slide 10, we want to show you the last four quarters of revenue in an easy to understand chart. I'll point out two things. One, over the last four quarters, each quarter has been better than its previous year quarter. And two, if you look at the last 12 months of revenue, we are up 24% compared to the same period in the previous year, which is not good enough, but a good step in the right direction. Based on these results, we think the revenue growth strategy is starting to take hold. And if you moved on to slide 11, I'll quickly remind investors on the six key growth factors that are helping grow our top-line revenue. First is our new capstone direct sales team led by Jim Krause, which is one of our strategic goals for the year. We are targeting new microgrid projects, long-term rental growth, large customer rollouts, All part of this initiative, they're tasked in securing partnerships with large national and even global customers. We have a better opportunity to win larger scale deployments. Second is the new parts supplier. This is about better build quality leading to improved reliability, lower warranty costs, and higher FPP margin rates. Simply put, drive more, repeat customers. Third on our growth list is new target pricing programs. This is a focus on national and key accounts. We've developed a new gold key account program that is targeted at customers that can deploy at least four megawatts per year. Next is adding new distributors and new geographies, particularly in Eastern Europe, Africa, and the Middle East. These are large markets and are prime for our microgrid services, and we need to fire more shots on goal, which means more and better trained distributors. Fifth is our new hydrogen product release. with the ultimate goal of operating on 100% hydrogen as we continue to see ever-increasing interest in hydrogen-based CHP and CCHP solutions. Sixth is expanding our digital marketing to reach more potential customers that might not be familiar with our products and services. We are accomplishing this through our website updates, customized marketing campaigns, unique IndyCar branding strategy, and by building awareness of Capstone Green Energy and what we do which cannot be overlooked in today's energy markets. With these growth factors, I believe Capstone will be positioned as a green energy leader in fiscal 2022 and beyond by executing against these six goals. I'll now turn the call over to Eric to discuss the details of our financial results for the second quarter. Eric.
Thanks, Darren. I'll now review in more detail our financial results for the second quarter of fiscal 2022. Turning to slide 13, You will see the financial results for the second quarter of fiscal 2022, which had revenue at $17.2 million, up 15%, compared to $14.9 million in the second quarter of fiscal 2021, as the prior year quarter was more heavily impacted by COVID-19 project delays. Product and accessories revenue was $8.5 million, up 18%, from $7.2 million in the second quarter of fiscal 2021, While parts and service revenue, which includes our FPP long-term service contracts, rentals, and distributed support subscription fee was 8.7 million, up 13%, 7.7 million in the second quarter of fiscal 2021. Gross margin as a percentage of revenue was 16%, down from 17% in the year-ago period, primarily due to expenses being lower in the prior year due to our COVID-19 business continuity plan. where we implemented cost saving measures such as furloughs, pay cuts, and travel restrictions, among other things. It was partially offset by a higher volume of product and parts. Total operating expenses increased $1.9 million to $7.4 million from $5.5 million in the year-ago period. Again, costs were lower in the prior year due to our COVID-19 business continuity plan. Additionally, we had a non-recurring employment-related legal settlement of 0.8 million in fiscal 2022 second quarter. Net loss was 6 million for the quarter compared to a net loss of 4.2 million in the second quarter of fiscal 2021. The increase in net loss was primarily due to the increase in operating expenses just discussed. Adjusted EBITDA was negative 2.7 million compared to adjusted EBITDA of negative 1.9 million in the second quarter of fiscal 2021. The second quarter of fiscal 2021 benefited from expense reductions from the COVID-19 business continuity plan, plus the gross margin benefits discussed above. The employment-related legal settlements expense of $0.8 million was removed from adjusted EBITDA. Turning to slide 14, you'll see the financial results for the six months ended September 30, 2021, which had revenue at $33.3 million, up 14%. compared to 29.1 million in the first six months of fiscal 2021, as the prior year period was more heavily impacted by COVID-19 project delays. Project and accessories revenue was 16.9 million, up 22% from 13.8 million in the first six months of fiscal 2021, while parts and service revenue was 16.4 million, up 7% from 15.3 million in the first six months of fiscal 2021. Gross margin as a percentage of revenue with 16% down from 20% in the year ago period. Primarily due to lower expenses in the prior year. Due to the COVID-19 business continuity plan. Total operating expenses increased 4.2 million to 13.6 million from 9.4 million in the year ago period. Again, costs were lower in the prior year due to the business continuity plan. Additionally, we had the 0.8 million employment related legal settlements in the second quarter. That loss was 8.2 million for the six months ended September 30th, 2021. Compared to a net loss of 6 million in the prior year period. Increase in that loss is primarily due to the increase in operating expenses just discussed, partially offset by 2.6 million of income related to the forgiveness of our PPP loan. Last quarter. Adjusted EBITDA was negative $5 million compared to adjusted EBITDA of negative $1.8 million in the prior year period. Once again, the prior year period benefited from expense reductions from the COVID-19 business continuity plan. That was partially offset by higher revenue. Turning to slide 15, you'll see select balance sheet and cash flow items. Cash decreased $11.2 million to $38.3 million. compared to $49.5 million at March 31st, 2021. Cash use and operating activities was $9.2 million for the quarter. The cash use was primarily driven by our net loss, as well as working capital changes driven by increases in inventory, partially due to lower than planned product sales for the quarter, as well as a buildup for the anticipated growth of product sales and building the rental fleet in the coming quarters. Additionally, we experienced delays accounts receivable collections due to the COVID-19 pandemic, and we continued our remediation plan to replace an effective vendor part in the field, which was accrued in the fourth quarter of fiscal 2021. Slide 16. Darren mentioned the rental fleet earlier. We want to continue to highlight the financial impact of the rental fleet. This slide shows both revenue and margin over a five year period for a C-1000 product sale with spare part sales. a C-1000 product sale with an FPP contract and a C-1000 rental. Over that five-year period, a C-1000 product sale with spare parts can generate approximately $1 million of revenue with approximately $200,000 of margin with a 20% margin as a percentage of revenue. A C-1000 product sale with an FPP contract can generate approximately $1.2 million of revenue with a 25% margin But a C-1000 rental can generate approximately $1.8 million of revenue and approximately $1.1 million of margin with a 61% margin as a percentage of revenue. We think the numbers speak for themselves here to illustrate why we've been building our rental fleet and why it's one of our key strategic goals for the year. On slide 17, we wanted to show the impact of growing the rental fleet to 21.1 megawatts on a recent P&L. In the right column, we took the actuals from fiscal 2021 Q3, the quarter ending December 31st, 2020. In the left column, we assume that we have a 21.1 megawatt rental fleet with all units on rent. You can see in the variance column, we would have generated an additional 1.5 million of revenue and 1.4 million of EBITDA. We were negative 1.3 million adjusted EBITDA in the quarter. but the as-if model shows positive EBITDA with a 21.1 megawatt rental fleet. On slide 18, we wanted to take the illustration one step further and show the same fiscal 2021 Q3 P&L and then what the impact of a 50 megawatt rental fleet would have on the result. You can see in the as-if model that it would have added 4.1 million of revenue in the quarter and would have generated an additional 3.6 million making adjusted EBITDA in that quarter 2.3 million positive or approximately 9% of revenue. At this point, I'll turn the call back to Darren. Darren?
Thank you, Eric. That's very helpful. At the end of the day, the name of the game for capstone green energy is top line revenue growth and increased profitability from our energy as a service business model and recurring revenue. As we continue our transformation to caps on green energy, we expect to realize higher growth levels. As discussed previously, we are laser focused on higher growth rates as it's essential to leveraging our fixed costs and driving recurring quarterly profitability. When we think about future revenue growth, we need to look at it for each part of our business segments and evaluate the future growth potential. Based on that, let's turn to slide 20. First image highlights our traditional global distributor business. That is a relatively mature business at this point, and we expect to grow at a lower rate than other newer portions of our business. We expect our energy as a service business to expand quickly as we build out the long-term rental fleet. And as Eric pointed out, we are targeting this as a key driver for sustained profitability and positive cash flows. Our new direct solution sales team that is focused on larger customer rollouts and our new expanded microgrid product offerings we view as having high potential growth as well as most countries are similar to the US and want to build back green after the global pandemic. Lastly, we view our strategic M&A initiatives led by Jeff Foster as having a high growth potential and it could help us grow our portfolio of products and services and leverage our underutilized manufacturing facilities in both the US and the UK. Let's turn to slide 21. By 21, we've highlighted some of the key consumer statistics, keeping in mind that helping our customers reach carbon reduction goals is what we do, and this enables our customers to align with their customers. Today, younger buyers are increasingly more eco-aware and concerned with the environmental impact of their purchases. According to Nielsen's study, Gen Z, which comprises one-third of the world's population, is willing to pay up to 50% to 100% more for sustainable products compared to older generations. Seventy-three percent of consumers said that they would likely change behavior to reduce their impact on the environment and that eco-aware mindsets and behavior adoption have only increased in recent years. Sustainability also feeds into customer loyalty. Sustainable and ethical business practices are the second highest reasons most consumers return to a brand. This is second only to product quality. Turn to slide 22. Slide 22, we want to summarize what we hear from most of our CNI customers when it comes to their energy needs today. Most customers want a reliable and a flexible power supply, a self-sufficient plant with higher reliability at a competitive cost. They want to significantly lower their carbon footprint, and they want to monitor the plant and be able to analyze the operation remotely. Today, Capstone Green Energy can deliver a green energy solution that meets all of these needs. Working as an energy solutions provider, Capstone will work with end users as a trusted long-term partner. This means that we are with our customers every step of the way to the design, to the delivery, and then manage the comprehensive energy package for each customer. From microturbines to microgrid solutions to strategic energy management, Capstone helps customers build and maintain a smarter energy infrastructure. Not only can we help customers with their green energy needs, we can also save them money. If you turn to slide 23. Slide 23, you can see that over the last three years, we have saved our end-use customers an estimated $700 million and approximately one million tons of carbon. Let's go ahead and go to slide 24. Slide 24 is our last slide, and it sets out some of the business catalysts I expect for Caps on Green Energy. I will not run through every line item, but want to highlight some of the key points. First of all, when we transformed to Caps on Green Energy and added the various new products discussed today in our portfolio, we significantly grew our total addressable market, or our TAM. We discussed the rental business in detail earlier, but once again, I want to stress the importance of the rental business growth. With all things being equal, rentals are by far the fastest path to consistent positive EBITDA and strong recurring revenue characteristics. The direct solution sales team has generated a very nice pipeline of projects, and we are extremely excited to see some of these close in the second half of fiscal 2022. And lastly, we have discussed it before, but I want to highlight again that we're dedicated, one of our senior executives, Jeff Foster, to strategic M&A. And that's all in front of us as well. With that, I'd like to take a few questions from our analyst. Operator?
Thank you. Thank you, ladies and gentlemen. The floor is open for questions. If you have any questions or comments, please indicate so by pressing star 1. Lastly, while posing your question, please pick up your handset if listening on speakerphone to provide optimum sound quality. And the first question is coming from Rob Brown from Lake Street Capital Markets. Your line is live.
Hey, Rob.
Hi, good afternoon. Good progress in the quarter, nice top line growth. I just wondered if you could give us some more detail on kind of the rental opportunities you kind of got in the back half of the year and how that leads into the confidence for your 20-wood megawatt goal?
Yeah, no, absolutely. As we pointed out in the call, and we keep stressing over and over, rentals are a huge growth opportunity for us from both the top line revenue growth and, more importantly, from an EBITDA and a margin level. In October, we announced another 3.2 megawatts of contracts. We've got a very robust pipeline through our distributors as well as our new direct sales organization. I want to say the total pipeline today of quoted rentals is over 130 megawatts, with the expectation of closing a significant portion of those. Our close rates on rentals is higher than traditional product sales, and the length of close is much, much shorter. So we're highly confident that we can grow that fleet to 17 megawatts by the end of December and then 21 megawatts by the end of March. Then the question is going to be how much we want to grow beyond that. But I think 50 megawatts feels like the right answer for where we are as a business today, and so we'll look to continue to grow it. We're seeing growth opportunities across the board from traditional CHP, from hospitality to C&I customers, industrial customers. We're seeing an upswing in some of our oil and gas business in the Permian and elsewhere where you've got oil and gas users starting to put product back to work as the oil prices maintain about $80 per barrel. And most recently we've seen cannabis and Bitcoin miners as kind of a unique market that's starting to grow for us. Two very energy intense market verticals and lots of opportunity there as well.
Okay, great. Thank you. And then maybe on the cost structure, do you sort of feel like this cost structure is where things will stabilize here, or do you see some kind of direction one way or another?
Yeah, I'll let Eric jump on that one.
Yeah, if you look specifically at the quarter, you know, I mentioned we had the legal settlements. That was $0.8 million in the quarter. And then also, if you remember, we've got the racing expense, which hits our Q1 and our Q2. So if you pull those both out of the quarter, you're looking at around $6 million of quarterly OpEx.
One of the reasons we use Q3 in the analysis with the rentals, it's probably the cleanest quarter we've had in the last several quarters where we didn't have any big one-time expenses in there. But I think in general, from an actual tactical standpoint, we continue to add sales resources in the direct sales solution team, but not much else. There isn't significant CapEx we need. We've expanded both facilities here in the U.S. and the U.K. recently, so I don't see a lot of new costs compared to what we've seen the last year.
Okay, thank you. Again, I'll turn it over. Thanks, Rob.
Okay, the next question is coming from Samir Josi from HC Wainwright. Your line is live.
Hey, Dan and Eric. Thanks for taking my call. Congratulations on a great quarter. Going forward, should we expect the gross margin profile to be similar to what you see in the respective markets or segments that you sell into? For example, these 5 to 16 megawatt micropurbines or the storage systems, if they are sold, do you expect to see similar margins as your product sales? And if they're rented, do you expect to see a similar profile there?
Yeah, I think our margins are going to be an interesting conversation as the company grows into its new structure. Obviously, when we're selling the Baker Hughes 5-, 12-, and 16-megawatt turbines, they're going to have a different margin rate than the products we manufacture ourselves. The solar module manufacturers we're looking at That's a very challenging cost market, so those are going to be somewhat tight on margin. But I think when we put it all together with battery storage, solar, and then bring the energy solution and then obviously controls around that and the FPP, we can bring a very unique, I think, product benefits and offering to our customers. So I think we'll get a positive margin uplift just from that compared to our competitors. But I think it's going to depend on mix. The faster we grow rentals, obviously, that's our highest margin business. So as rentals grow faster than other parts of the business, that's going to help. But I think in general, we want to see blended margins in the 20% to 25% range. But more importantly, we want to grow top line and we want good cash flow. And so I think that's going to be key for us. Our OpEx is not going to change very significantly. We could double or triple revenue with very little change to our OpEx line, which I think is key. One of the nice things also with our network providers, we don't have to inventory all this product in most cases. It's not as long lead as some of our stuff, so I think it does give us a unique dynamic. We're also looking at manufacturing. Kirk Petty and his team in ops has done a great job at increasing our capacity at the plants, and so we can maybe do some manufacturing for some of our network partners, and that'll help absorb some of our overhead today, which is very helpful. Our product margins, as you know, are very driven on overhead absorption and how many products we can put through the quarter.
Yeah, yeah. No, that was a helpful color. And you mentioned inventory, and I actually have a two- or three-part question on inventory. I think both you and Eric mentioned some supply chain guarding against supply chain issues. but also build up for the rental fleet. So as you move into fiscal 2023 and may have a target of 50 megawatt at that point in time, should we see some cash flow pressure because of inventory buildup?
Well, definitely. We've already seen cash flow pressure because of inventory buildup. This year you've had kind of three things happening at once. We had the $5 million settlement for the defective part, which we got the money last year, but we're spending the money this year. So that's taking inventory to replace that part in the field. So that's happening in this fiscal year. And as I mentioned in my prepared remarks, we should finish that in this current third quarter that we're in by December 31st. We obviously are building for new product sales, but then simultaneously building the rental fleet up. We always need to make sure that we have more units built in the rental fleet than we have deployed to make sure that any short-term rentals we can handle, not lose any business. And so that's happening. And then this COVID supply chain issue is extremely challenging. And it's everything from printed circuit boards, electronics, you know, controls, batteries, steel, stainless steel, copper, wood. It's shipping costs are through the roof. There's not many things that it's not impacting, and so definitely we've had to get creative, find second sources of supply, go out in the open market and buy whatever materials we can get our hands on. So, yeah, definitely Kirk and his ops team have been scrambling to, you know, grab whatever inventory we can get, you know, regardless of inventory turns, just to make sure we have it. As we hit this, what we think is a fairly significant growth cycle of our business, we'd hate to not be able to fulfill those orders or those rentals because of supply chain issues.
Understood. Got it. And then this one last one from me. The direct sales team that is targeting larger customers, is it also targeting larger orders for these customers in terms of the size of the systems that have been sold? Just wanted to get a color on.
Yeah, no, so they're tasked with selling to larger customers. We specifically are going after customers who already have experience with the Capstone technology. So, you know, hospitals, hotels, industrial customers, folks that maybe have done a project in one part of the world with one of our distributors. We're now trying to take that relationship to a higher level and see if we can't leverage a larger scale rollout. We've developed a kind of gold key account program Specifically for customers, we think they can do at least four megawatts per year in multiple year rollouts. And so that kind of limits some of the folks we're looking at. And so I think it's really targeting those folks, trying to find the ones that have set carbon reduction goals, who have ESG pressures, and already have a capsule microturbine, a good experience. So if we find a customer, DHL is a great example. It's an IndyCar relationship we have as well. They've got a project in New York. We'd love to help them and are talking about other sites in North America. But it can be, you know, a lot of folks from Pepsi to Mohawk brand carpets. It can be, you know, any of the hotel chains, Marriott. I mean, anybody who's got capstone experience, who's got some good ideas as far as ESG and carbon reduction, and then we want to flange up with them and help them across that goal line. So I think As far as size of product, bigger customers tend toward bigger products and projects, but that doesn't always have to be the case. We're going to help them wherever they want help. Honda is another great example, another IndyCar partner we're talking to about helping them meet some of their carbon goals. I think as we look at customers, we want to be their one-stop shop for green energy, microgrid-based solutions, whether it's battery storage, solar, or microturbines. Baker Hughes, biogas, whatever their requirements are, we want to put the best solution in place. And more importantly, we're not going to just sell them a product or a project. We want to be their long-term partner. We want to put a 10-, 15-, 20-year FPP program around the project and maintain a close relationship to them, monitor the equipment, and make sure that they get the carbon savings and financial savings they're looking for.
Yeah, that makes sense. Thanks, Darren, for taking my call.
Once again, if you have a question or a comment, please indicate so by pressing star one. The next question is coming from Sean Severson from Water Tower Research. Your line is live.
Hey, hello, everyone. Yeah, yeah, yeah, I was particularly intrigued about the EV win. And, you know, obviously, I think everybody's aware that you're gonna have massive, you know, utility problems with with if anybody's even close to what the expectations of growth are for EV. So, I mean, is this something that you can really pick up and run with, or do you view this as a one-off, or would you be partnering with people to do this, coming from like a charging company like ChargePoint or a parking garage? I'm just trying to understand how this could develop or if it will develop for you as a meaningful application.
Yeah, no, I think definitely electric vehicle charging is an area we've seen as a growth area for us. We play best in CHP, CCHP combined with electric vehicle charging or in remote locations where there's not enough power and you've got demand. So parts of infrastructure where there's limited utility and you need additional utility to charge trucks or big rigs or larger consumers. I don't see us playing on a retail or a residential space. But definitely I think also with campuses, You think of large customers who've got a large amount of employees. They want to charge those vehicles. It's a great application to put in a vehicle charging station and then put in some battery storage, some solar, and then a CHP system. And so definitely I think this is an area of expansion for us. I think the market's going to change quite a bit if we hit some of the, as you pointed out, some of the standards and requirements we're going to need because the local utilities are not ready for the amount of electric vehicles that could be on the streets.
But for you, it's really going to need the CHP part of it, right? So like you said, campuses or industrial complexes or something like that.
That would be our sweet spot, absolutely, or remote applications. If we can run on hydrogen, that's great. Or if we can set up a renewable source and create hydrogen and charge vehicles, that would be a neat solution. But definitely remote applications or biogas applications
or campus settings are the perfect fit.
This next question on rentals, if you were to put your crystal ball out there and say getting from the 21 to 50, right, which I think is reasonable, is it going to look like the same mix in the next tranche here in terms of the size of the rental agreements? Is there room to go bigger? Would it be the same mix of customers? Do you see any trends in terms of industries that would be more likely to fill that pipeline through next year?
Yeah, I think as we look at it, we're seeing bigger opportunities in the rental side that we didn't realize were out there. So I think there's a very high likelihood we end up with a Baker Hughes LT5 or a bigger machine in our rental fleet. There's some interesting rental opportunities, especially in the Caribbean or certain parts of the world, for larger power. Or another area we've seen is rentals with a purchase later, or they rent the machine for 18 months and then put in a permanent plant. So I think that's very interesting. I think the Bitcoin and cannabis markets are still too new for us to really get our arms around how big an opportunity that can be. I think the, you know, kind of the CNI and the more traditional oil and gas opportunities, we know what those look like. But definitely it's expanding, it's evolving. You know, this is a business that we weren't in, you know, 18 months ago, two years ago. And so to have a a pipeline of over 130 megawatts for essentially what's a startup business for us that we're still kind of finding our way and we've definitely found you know issues and and flat spots that we need to address and to be more competitive in the market or treat customers better but you know very very excited about where this can go and it really fits our product better we've got a better mousetrap than traditional internal combustion engines our life cycle costs are superior to most anything on the market Our rental rates are much more competitive with older, dirtier technologies than our product sales prices are. So I think it's a very good growth area for us and obviously has a huge margin recurring revenue and cash flow impact for us.
Thanks, Darren. My last question is around rentals and bigger picture, I guess, and microgrid deployment. So when you're talking about... you know, solar and storage and all the things that are wrapped around the microgrid and you being the, you know, one of the power sources, power generators. How does the rental business fit into that? Does it fit into that? Are there opportunities to, you know, supply other things in that context? I mean, energy as a service in a broader context of somebody basically renting a microgrid, you know, from companies and using the same principles behind what you're doing in rentals. Is that
that make any sense or is that just it's too much too big of a balance sheet strain and and not up your alley yet no definitely it's an area we're looking at i think that a lot of our customers lease their properties and that becomes a hindrance for them and so if they don't own the the property and they've only got you know x amount of years left on their lease and they're not sure especially with the uncertainty of the world today, uh, if they're going to stay in that facility, but they do want to be green and want to cut their energy costs, you know, definitely looking at leasing them a system or renting them a system makes a lot of sense. And so I think, uh, we haven't rented a battery storage solution yet, or, or PV solution yet, or a complete micro grid, but there's no reason we couldn't. And I think we're going to, we'll see that happen the next year. Uh, we'll see a customer that says, look, I need to reduce my carbon footprint and I'm in a high energy cost market. but I've only got a five-year lease, so give me a five-year rental on a microgrid solution that meets my carbon reduction and my energy efficiency needs. And I think that is certainly going to happen. We're looking for, you know, the right partners for those products that are, you know, long-term products that we could move around from customer to customer. So I think that, you know, the more we get into energy as a service, the more flexible we can become, but still stand behind our product. I think that's what customers want. They want, you know, kind of the, you know, one-stop shop of green energy and somebody who really cares about their business is going to be there at 2 o'clock in the morning when they have an issue and that will make sure they have the right results and the right outcome of the product they either rent or buy.
Great. Thanks, Darren.
Thank you.
Okay. The next question is coming from Michael Heim from Noble Capital Markets. Michael, your line is live.
Thanks. I was going to ask about the negative gross margins for the product division, but I think you might have kind of answered that in talking about overhead timing issues or inventory builds. Let me maybe rephrase the question this way. When we get past some of the timing issues, do you see that division as getting back to gross margins near the double digits, or should we really view this more as a division that's a low margin business that's there to kind of help grow the other, uh, the parts and service.
No, it, when we were, you know, when oil was $130 a barrel and we were cranking out, you know, two to three times the level of products a quarter we're doing today, uh, we were seeing, you know, margins in the low to mid twenties. Um, it's never going to be a 40 or 50% margin business just because we're building a Mercedes and selling it against Chevy. But I think that definitely we can see positive margins in the mid-teens, if not 20%. But definitely having that product enables our spare parts, our very profitable FPP program, and our rental fleet. And so having those products really does enable, as you said in the second part of your question, the higher margin parts for our business. I think as energy changes and becomes greener, When the utility rates go up, when internal combustion engines are limited in their ability to run continuously without huge amounts of after treatment, our cost competitiveness will improve. Obviously, you know, Caterpillar builds more megawatt engines in a day than I do in a year. So the fact that we're competing against these huge scale companies with such small batch build is actually pretty impressive. But definitely, I think, you know, 20% to 25% margin is probably a reasonable expectation when we scale this business again.
Okay. And then, Eric, would you address the large rise in share count quarter over quarter?
We didn't use our at-the-market offering or do any offering during the quarter, so I don't think it went up very much.
I guess I'm looking at average numbers that were around 15 million versus 13 million in the June quarter. Am I wrong on those?
I think we were around 15 in the June quarter as well.
Okay. And then maybe finally, as we see the cash position get a little bit lower, at what level do you start to be a little uncomfortable with your cash position?
Yeah, I think if you look at Cash flow for this fiscal year, the first two quarters were heavy cash usage. We planned that in our internal plan. Again, we got the $5 million last year for the settlements. We're spending it this year. Building the rental fleet is a cash out in the beginning, and then you get the cash back over time. Our simple payback on our rental units is, depending on the contract, is about two years at the shortest and three years at the longest with a 20-plus year asset. So we expected this to be a fairly heavy cash flow year. Obviously, working capital with the supply chain issues has been more challenging than we thought, as I mentioned. Eric mentioned that, you know, AR has been sluggish because of COVID, and obviously COVID means different things depending where you are in the world, but a lot of our distributors are still fairly heavily impacted. If you're in India, if you're in Italy, if you're in Australia, you know, Colombia, even Mexico is struggling. So I think Those are small, you know, shorter-term issues. I think Q3 will be better from a cash burn perspective in Q4. And as we approach that 21 megawatts, we should be moving into the, you know, EBITDA neutral range and cash should be even better in Q4. So we're not overly concerned about cash going forward because as we get profitable and EBITDA positive and the rental units are throwing off a fair amount of cash every quarter, we're pretty confident that we're going to be okay from a balance sheet perspective.
Okay, thank you.
Thank you.
I'd now like to turn the call back to Darren Jamieson for closing remarks.
Well, thanks, guys. A lot of good questions. You kind of hit a lot of things I was going to talk about in our closing remarks. I guess the simplest thing I would say is the business is performing as we have planned. I'm very happy with the leadership team that we've assembled and the work we're doing despite still some challenging environments with COVID and COVID-related supply chain issues. Still haven't met every one of our direct sales folks in person yet because of limitations on flights, but that should be getting better. We're starting to see more customers here at the plant. We're starting to be able to get on airplanes and go see customers. I think what is interesting is there's a lot of great things we've done over the last two to three quarters that haven't shown themselves yet in our results. Even with where the rental fleet is today, a lot of the units are under contract and are still being commissioned or in process of being commissioned, so you haven't seen the impact on our revenue or our EBITDA. Obviously, we're building the rental fleet fairly substantially the next couple quarters, so the rental revenue and margins are going to pick up fairly significantly in Q3, Q4, Q1. A lot of the new network partners, you haven't seen a press release. on a battery storage project yet or a large PV project or a complete microgrid solution yet. Those are all coming. I think that the Baker Hughes relationship is very strong. They're very happy with our pipeline we've developed. We've got some very interesting projects that are coming down the pipe that we hope to have a Baker Hughes win. To give you an idea, You know, you start selling 12 and 16 megawatt turbines, that could increase our revenue, you know, 10% year over year with one order, right, with these revenue levels. So very excited to expand that relationship. Excited to look at getting one of their products into our rental fleet, as I mentioned. You should see more biogas, more hydrogen projects, you know, increasing every quarter. Those are areas of strength for us. Don and our engineering team are doing a great job at getting us prepared for that 30% hydrogen. I'm highly confident we'll be there by March 31st. And then we'll have to discuss at a board level how fast we want to develop that 100% hydrogen product, which will really be driven by market factors and, frankly, the price of hydrogen. As the governments spend money to reduce the price of hydrogen, that's very important. We're hearing big numbers that look like will be poured into the US DOE to help reduce hydrogen and hydrogen projects, hydrogen blending. So that's very interesting. We haven't seen really any impact of the new administration in the US. limited impact on Europe's Build Back Green program, but I think we're going to see those coming up. Obviously, the framework that Biden is looking to do in his Build Back Better has got a lot of stuff that would be very positive for Capstone and for our customers and our distributors. And so I think positive EBITDA is on the horizon. We're very excited to get back there. We've been there three times, but we want to be there every quarter, quarter in, quarter out. I think that'll be a different result for us and for our shareholders. And again, seeing the Build Back Better program go into place, all the green energy focus worldwide we think is game changing. And then on the M&A side, I think there's some interesting things we can do to build out our portfolio solutions. We're just getting started with Jeff and his team to really look at the right opportunities. And so for me, there's a lot of hard work we're doing right now that we unfortunately can't see yet in our results, but we will see shortly. And I'm very excited to see that. If you look at Form 4s, the last window that opened, I bought more stock than I've ever bought in 15 years. So that tells you how excited I am to add to my personal position of Capstone shares, because I see the future as extraordinarily bright, not only for Capstone, but for anybody in the green energy space, energy efficiency, energy resiliency. That is where the world is going, and we're excited to be part of it. With that, I'll go ahead and close the call and look forward to talking to everybody in our third quarter. Thank you.
Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.