Capstone Green Energy Corporation

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 30th, 2022. 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. Don Ayers, Vice President of Technology. Sir, the floor is yours.

Thank you very much. Good afternoon and thank you for joining today's fiscal 2023 second quarter conference call. On the call with me today are Darren Jamieson, Capstone Green Energy's President and Chief Executive Officer, and Scott Robinson, Interim Chief Financial Officer. Today, Capstone Green Energy issued its earnings release and filed its quarterly 10-Q report with the Security and Exchange Commission for its fiscal 2023 second quarter ended September 30th, 2022. We will be referring to slides that can be found on our website under the investor relations section during the call today. This conference call contains estimates and forward looking statements representing the company's views as of today, November 14th, 2022. 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, uncertainties, and other factors that are in some cases 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 to differ materially from those expressed or implied by such statements. Please note that as Darren and Scott 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 Jamieson, President and Chief Executive Officer. Thank you, Don.

Good afternoon, everyone. Thank you for joining today for a review of our second quarter fiscal 2023 results ending September 30th, 2022. If you turn to slide three, I'd like to run through today's agenda. We'll start with the quarter's financial highlights and then review our positive EBITDA plan followed by an overview of our energy as a service or EASS business. I would like to then provide a brief overview of our financial results and then a review of the company and then the recent US policy changes including the Inflation Reduction Act or IRA Act, and then conclude with a business summary. We'll then be open to take questions from our analysts. Let's go ahead and jump to slide five. Slide five shows revenues of 20.8 million for the quarter, an increase of 11% sequentially from 18.7 million in the first quarter, and up 21% from the second quarter in the year-ago quarter. I remain extremely encouraged by our team's ability to grow revenue in a tough macro and supply chain backdrop. Revenues for the first half of fiscal 2023 totaled $39.4 million, up 18% from $33.3 million for the first half of fiscal 2022. This revenue growth is being led by our energy as a service growth strategy. However, gross margins for the quarter fell to 11% compared to 25% in the first quarter due to increased supply chain costs specifically related to the C-1000 enclosures and the need to source alternative recuperator materials to meet customer delivery requirements during the quarter. Our net loss was $4.9 million, an 18% improvement from a net loss of $6 million last year. Sequentially, the net loss increased from $2.1 million in the first quarter, which was impacted by approximately $1.6 million of additional supply chain expenses quarter to quarter. Adjusted EBITDA improved 19% to negative 2.2 million from negative 2.7 million versus last year, but sequentially again was down from a positive 400,000 in the first quarter. Again, this is due to the approximately 1.6 million of additional supply chain expenses, freight, and expediting charges. On a first half basis, though, EBITDA improved 66%. to negative 1.7 million for the first half of fiscal 23, compared to negative 5 million last year. The improvement was driven by growth in the high-margin energy-to-service, or EAS, business, offset by increased supply chain costs, freight, and expediting charges, as discussed. Lastly, and perhaps most importantly, the total energy-to-service long-term rental fleet under contract on September 30, 2022, was approximately 34 megawatts versus 12.7 megawatts on September 31. 30th, 2021, this represents 168% growth year over year. Today, the EAS long-term rental fleet under contract is approximately 39 megawatts. And as a reminder, as we've been saying for several quarters, our goal is to get to 50 megawatts under contract by March 31st, 2023. Let's continue over to slide six. You can see the EAS rental revenue was 1.8 million for the second quarter, up 1.2 million or 200% from 0.6 million or 600,000 a year ago. Also importantly, the EAS rental gross margin was extremely strong during the quarter at 72%. Gross new product bookings for the second quarter were solid at 15.4 million, up from 12.4 million sequentially, and product book-to-bill ratio improved to 1.6 to 1. Ending product backlog of September 30, 2022 was $28.9 million, up $4.1 million, or 16.5%, from $24.8 million in the June quarter. Also extremely important is cash. Total cash as of September 30, 2022 was $23.8 million, up from $16.9 million as of June 30, due primarily to net proceeds of $7.3 million from the Lake Street public offering on August 23, 2022. This was offset by working capital needs to manufacture new rental assets for the quarter. As a result, net cash provided by operating activities was positive $900,000 compared to a loss of $3.4 million in the June quarter. As I mentioned earlier, the supply chain has presented some challenging headwinds this quarter, To mitigate this, we're implementing a new price increase for all of our products, spare parts, and factory protection plan or FPP service contracts. That price increase will go into effect January 30th, 2023. Let's go ahead and move to slide eight. I want to review our fiscal year 2023 positive adjusted EBITDA plan. We have outlined four key pillars in this strategy and have fully executed on three of them. with significant progress in the fourth. The first pillar was to reduce operating expenses by 4.3 million for the full fiscal year, led by restructuring the business around our energy as a service model. This was spread across the board from reductions to executive personnel, board of directors, moving assets to our distribution partners, and active labor force management. The second pillar was a price increase, as we need to keep pace with inflation Effective May 1st, we did a price increase in the range of 7% to 10%. We also increased existing FPP contracts by 5% for CPI increase. And the pricing on new FPP contracts is also increased by 5% as well as spare parts to offset the inflation factors and to focus on the supply chain integrity. Also noted earlier, we're implementing a second round of price increases in January 23. Third pillar was the increase of the distributor DSS fee from 3% to 5%, which is an annual fee we charge our global distributors for training, marketing, branding, customer acquisition, and trade shows. And the fourth and last pillar is the more significant strategy change to include additional energies of service business in our business mix. The numbers show progress from 7 megawatts under contract to 39 megawatts under contract today, well away to our target of 50 megawatts by March. Let's go ahead and turn to slide 9. Slide 9 shows the details of our adjusted EBITDA first half through the second quarter of fiscal 23 versus the first half of fiscal 22, showing our improvements in negative $5 million last year to negative $1.7 million this year in adjusted EBITDA. and it shows the components from which we expect will lead us to successfully achieving our 2003 goal of positive adjusted EBITDA for the full year. Next, I'll provide you with an EAS update. I'm sure you've seen slide 11 before in previous presentations, but it's worth reviewing again as it is the cornerstone to our positive EBITDA strategy. The fact is the economics heavily favor the EAS business versus traditional product sales for our type of technology. In case one on the left of the graph is a traditional product sales model, which had been the existing way of doing things for many years. The middle bars show what that model looks like with our capstone long-term service offering, or FPP, which was our first strong move to drive long-term predictable income and cash flow. And the last third set of bars to the far right of the slide illustrates what the EAS model can do and how powerful it is and can be for us. For the same C1000 unit, we can generate 1.8 million in revenues at a 60% gross margin over five years, and this compares to a product sale with spare parts for five years at 1 million or 20%. Let's go ahead and move to slide 12. Slide 12 sets out the growth picture for us. On March 2021, we had seven megawatts under contract in our rental fleet, and as of October 31-22, we had 39 megawatts under contract in our rental fleet. We believe we are well on our way on track to reach our 50 megawatt goal by the end of March 2023. It is important to note that supply chain constraints and working capital limitations require the 15 megawatts of the rentals to date have been re-rented equipment, which does negatively impact our margins, but we had to do this to meet customer demand. To the extent we can achieve some more working capital improvements and some supply chain relief, our goal is to return to shipping primarily new units for rentals and at even higher margin rates. I'll now turn the call over to Scott, our CFO, to go through some of the specific financial results.

Scott? Thank you, Darren, and good afternoon, everyone. I will now review in more detail our financial results for the second quarter of fiscal 2023. Moving to slide 14, you can see our Q2 23 results compared to Q1 23. Financial results for the second quarter of fiscal 23 had revenue of $20.8 million, compared to $18.7 million in the first quarter of fiscal 23. Product and accessory revenues were $10.6 million, up from $9.2 million in the first quarter of fiscal 23. Parts, service, and rental revenue, which includes rentals, FPP long-term service contracts, and distributor support subscription fees, were $10.2 million, up from $9.5 million in the first quarter of fiscal 23. This is primarily due to an increase in our rental revenue. Gross margin as a percentage of revenue was 11% in Q2 23, down from 25% in Q1 23, primarily due to the aforementioned supply chain challenges. Total operating expenses increased slightly to $5.7 million from $5.4 million in the previous quarter. Net loss was $4.9 million for the quarter compared to a net loss of $2.1 million in the first quarter of fiscal 23. Adjusted EBITDA was a negative $2.2 million compared to adjusted EBITDA of a positive $400,000 in the first quarter of fiscal 23. Turning to slide 15, you will see the financial results for the second quarter of the fiscal year 23 compared to the prior year period, which had revenue at $20.8 million compared to $17.2 million. in the second quarter of fiscal 22. This is driven by higher product sales activity across all product lines. Product and accessory revenue was $10.6 million, up from $8.5 million last year, while parts, service, and rental revenue was $10.2 million, up from $8.7 million in the same period last year. Gross margin as a percentage of revenue was 11%, down from 16% in the year-ago period. primarily due to the previously cited supply chain issues, which were partially offset by selling price increases from earlier in the year. Total operating expenses decreased to $5.7 million from $7.4 million in the year-ago period, benefiting from cost reduction activities. Net loss was $4.9 million for the three months into September 30th, compared to a net loss of $6 million in the prior year period. Adjusted EBITDA was a loss of $2.2 million compared to adjusted EBITDA of a negative $2.7 million in the prior year period. Slide 16 shows year-to-date fiscal year 23 versus year-to-date fiscal year 22 financial results. Top line revenue has increased from $33.3 million to $39.4 million due to growth in all product lines and selling price increases. Gross margin has increased from 16 to 17 percent due to contributions from the energy as a service product line, offset by the direct material price increases previously mentioned. Operating expenses reduced from 13.6 million to 11.1 million due to cost reduction activities. And adjusted EBITDA approved from a 5 million loss to a 1.7 million loss. Turning to slide 17, you will see select balance sheet and cash flow items. Cash increased significantly to $23.8 million from $16.9 million at June 30, 2022, driven primarily by the recent capital raise. Cash provided in operating activities in the September quarter was approximately $900,000 compared to a negative $3.4 million in the June quarter. The variation was largely due to improved accounts receivable collections. Accounts receivable declined nearly $6 million to $16.3 million as our DSO dropped from 123 days to 85 days during the quarter. Total inventory levels increased by $3.5 million due to the previously mentioned price increases from vendors and due to the necessity to purchase inventory in advance of forecasted demand due to continued shortages and other supply chain challenges. Despite the increase in inventory values, inventory returns improved from 2.9 times to 3.4 times. In addition, we do need more inventory as we ramp up production of both new products and focus on growing the rental fleet to 50 megawatts by March 31, 2023. I will turn it back over to you, Darren. Thank you, Scott.

As part of our quarterly update, I'd like to take a few minutes to remind investors of our overall strategy and how we are working to achieve our profitability goals. Let's go to slide 19 to set out those goals. First is the direct sales force. We continue to adjust our direct sales force to maximize our EAS rental growth and the sale of our new network partner products. As direct sales force continues to grow and mature, I anticipate a couple more quarters until we reach our desired efficiency and output with this team. Next is our distributor partner network. Now that the worldwide impacts of COVID-19 are beginning to subside and relax, we are pushing hard our global distributors to add additional sales resources, drive EAS rental growth, and continue to increase the attachment rate of our industry-leading FPP service contract business. Next is to grow the mix of our EAS in our business. We have been focused on this transformation for quite a while and will continue to do so. It is key to our profitability, it's key to our growth, and it will drive higher valuation of our business. The near-term goal for the rental fleet is 50 megawatts, but we are only limited by our balance sheet and the ability to get capital regarding how fast we can grow this business. Next, we need to be flexible and diversify our energy products and service offerings, provide custom solutions to our customers. We operate in a dynamic market. and with a wide range of solutions, and we are expanding our business to ensure that we can be flexible and be a problem solver for our customers. This means helping customers with energy efficiency, resiliency, carbon reduction, and integrating multiple clean energy products into smart microgrids. We also need to increase the aftermarket margins and escalate parts availability to drive customer satisfaction and repeat orders. We need to continue the growth of our parts remanufacturing program in the US and our recently upgraded facility in the UK. Remanufactured parts are not only good for the environment, but they're also typically 40% less expensive than a new part. We continue looking for additional ways to remanufacture parts to drive margins and make more parts available to our customers in this somewhat challenging supply chain environment. Next, we are focusing on managing working capital and inventory turns, as Scott mentioned. Our DSO dropped in the quarter to 85 days, which is excellent, but we still have several million dollars of past due receivables we need to collect. Our target is to reduce DSO back to approximately 65 days, which is where it was pre-COVID. Reducing our DSO and tight inventory management would free up additional cash from our balance sheet to build more high-margin rental units. Lastly is the growth of the Distributor Support System, or DSS, program. This subscription program is to drive marketing and customer acquisition efforts. We have increased the distributor support system annual fee from 3% to 5% this year, which affords us more dollars for marketing, dollars for branding, customer acquisition efforts, as we look to grow both the EAS business as well as our traditional product business. Now let's turn to slide 20. Slide 20, it shows the markets we operate in. I put this slide in as I want to remind our investors of how our solutions are being used across several industries and several applications. I won't go through each detail, but I do want to highlight renewable energy, smart microgrids, EV charging as our next potential growth markets on top of our traditional energy efficiency and oil and gas markets. As the push toward electrification and the move to the lower carbon world, these new markets should continue to grow for capstone. Moving on to slide 21. In slide 21, I set out an example of the smart microgrid. Microgrids are seeing unprecedented growth as the broader trend towards distributed energy resources, or DERs, takes hold and are becoming a critical part of the global energy infrastructure going forward. As you can see, we can provide a complete microgrid energy system to a customer through Capstone and our network partners. This is important as we want to make customers our partners and we want to help develop their short-term and long-term energy needs. We can do this by adding a new dimension to how we can sell and engage with our end-use customers. A cornerstone of the proliferation of DERs will be the electricity demand created by the EV industry. If you move on to slide 22, slide 22 shows the forecast for the global EV infrastructure revenues. This will create substantial demand for DERs and smart microgrids, and we will be there to leverage this demand. In fact, we are seeing demand today both in the U.S. and Europe for EV charging solutions, and we are currently working on a portable EV charging solution for the largest industrial real estate company in the world. Slide 24 summarizes key elements of the Infrastructure Investment and Jobs Act, which touches on several of our applications as you tie them together from the previous slides. Microgrids, EV charging, renewables, and critical power supply should all be bolstered by this bill, providing tailwinds for our solutions and our business. Moving on to slide 25. Slide 25 is the Inflation Reduction Act. This should be a significant tailwind for us, as it's expected to raise $739 billion, of which $369 billion would be dedicated to climate and energy programs. The most significant impact for us is related to tax credits, section 45 production tax credit and section 48 investment tax credit. You can see the details on this slide in the most simplest form. In conclusion, I'd like to spend a couple minutes reviewing our business and what I believe are the key factors to focus on as an investor. Let's turn to slide 27. Slide 27 shows what we believe are the key catalysts impacting our business today. First, are the new U.S. policies I just reviewed with you. These are significant and can be meaningful to enhance our economics of our products and can be truly transformational, especially for our U.S. businesses, U.S. customers. The second is to create a larger total addressable market. This is done by adding technologies to our platform, including storage to our microgrid solutions for customers. This would increase our revenue per project and allow us to be true partners with our end-use customers. Third is our growing EAAS strategy. This is important on many levels as it's critical to reaching profitability and consistent profitable cash flow. Fourth, as part of our EAAS strategy is our rental business, which is growing and has become the cornerstone of the cash flow and margins as they're extremely accretive and attractive for us. Fifth is the development of our direct sales team. This is strategic as it enables us to target larger customers, and more importantly, larger customer rollouts. Six is the recent $7.3 million net equity offering with Lake Street that strengthens the balance sheet and reduces customers' perception of risk of doing business with Capstone and buying and renting our products. Lastly is leveraging our network partners. And by leveraging our partners, I mean working with them to jointly develop projects and coordinating our various business development efforts for maximum success in the marketplace. Now, with that, I'd like to open the call up for questions from our analysts. Operator?

Thank you. Ladies and gentlemen, if you have a question or a comment, please press star 1 on your touchtone phone at this time. Pressing star 2 will remove you from the queue should your question be answered. And lastly, while posing your question, please pick up your handset if listening on speakerphone to provide optimum sound quality. Please hold while we poll for questions. First question is coming from Samir Josi with HC Wainwright. Your line is live.

Hey, good afternoon, guys. Thanks for taking my question. The price increases 5% to 7% that were implemented in May. Can you remind us how customers received that? And in that context, what is the expected percentage or range of price increases in the January revision? And how do you expect customers to react to that?

yeah i know great quick questions amir i think the first price increase we did back in may was actually very well received i think uh everybody is is reading the newspapers and online and seeing the eight percent inflation uh they're feeling it at the grocery store or the gas pump and so i don't think it was a big surprise to folks um we've seen about a four percent increase from march to now across the board just in all of our commodities that we purchased from 130 vendors worldwide. So definitely inflation is real. I think people were anticipating something like that to the price increase you put in place. Last week, we just announced the new price increase. I think, you know, distributors are being, you know, understanding, obviously doing two price increases in less than 12 months is not optimal. But the new IRA Act will substantially improve the economics for projects here in the US. And so we did our price increase in two phases. We did an international version and a US version. And so the US version was as high as 10%. And the international version was a little more subdued in the 4% to 5% range. And so I think we tried to make the The price increase targeted to the customers where the economics would still support the price, but we do need to offset the higher costs of our materials. The two major components we had, the DC-1000 enclosures and the recuperator material we had to buy, those were kind of one-time anomalies. We've already got the enclosure price back down to more reasonable levels. We still have some work to do, but that was really a result of changing vendors midstream. And so the new vendor had higher costs as they came online to manufacture the product. So we're already going to see in Q3 lower enclosure prices, and hopefully Q4 we'll see another drop. The recuperated material we had to buy was really an issue of customer demand versus ability to get material. As you can see, our book to bill is 1.6 to 1. Our revenue's up year over year, quarter over quarter. And so we're seeing higher demands for our products. Plus, we're trying to build the rental fleet simultaneously. So we're pulling on the supply chain harder than we have in years. And the supply chain has global challenges. And so we had to buy some more expensive material than our traditional HR 120 material we buy from Hanes. So that was a one-time purchase to fill the gap and make sure we still met the customer's demands for the quarter. As challenging as the supply chain is, we still haven't missed a customer delivery yet, and that's our goal to keep that trend going and keep growing the business despite the global supply chain issues.

Yeah, no, it certainly seems and comes across from the commentary that there is interest from customers and continued interest from customers. That's good to see. Just a question on the re-rental model. Of this 39 megawatts, I think around 15 megawatts is re-rent. What percent of the more recent 5 megawatts is included in this re-rent jump from 34 megawatts to 39 megawatts?

Yeah, so we're, you know, it's fairly dynamic that, you know, as we, you know, we have over 100 megawatts quoted. I think we're close to about 130 megawatts right now pending, and so I'm trying to close another 11 megawatts by March out of 130 megawatt pipeline. So it shouldn't be that challenging. It's just a matter of figuring out which 11 megawatts are going to close and which customers, configurations, models, and timing. Based on parts availability and re-rentability, we decide how much is going to be new versus re-rent. We're also looking at buying used units, older, we call them R packages, which is the older version before our current version. and then upgrading those packages to our more current signature series. And so it's definitely a mix, and I'd say it's definitely fluid, but our goal is to build as many new units as we possibly can but still manage our cash. As you saw, we had a really good receivables quarter. We dropped our DSO from 123 days to 85 days, but that's still elevated from where we want to be. So how much we can build new will depend on how much cash we can get out of our balance sheet. I was very happy with the $900,000. positive cash from operations for the quarter. That was well-timed. As we continue to build the energy service rental fleet, generating cash from operations is very helpful. And if you look at our cash balance for the quarter, essentially we kept all the money that we raised during the quarter through the equity raise. So that was also beneficial.

Yeah, yeah. Thanks for that, Conor. Last one from me. Can you give a little bit more insight or details on the portable EV charging solution that you're working on? How large, what is the scale of that? Will it support multiple chargers at the location or just any kind of color would be helpful?

Yeah, no, it's great. That's a great question, Sameer. So it is a 200 kilowatt portable EV fast charging station. And so it's trailer mounted. And so it has the ability to be moved from place to place to do vehicle charging and, you know, with supercharger. I think we've seen other stationary opportunities for EV charging, both in the U.S. and in Europe. And so I think that's a market we see as definitely a growth area for us. And as I mentioned in my prepared remarks, it's one of the largest companies in their sector that's doing this. So definitely we're playing with the right kind of folks. But a huge opportunity. And I think if you look at electrification of both vehicles and buildings today, the amount of energy that's going to need to be produced is going to far outstrip what the grid can do. In fact, as you all know here in California, about a month ago we announced that it'll be illegal to sell internal combustion engine vehicles in 2035. The next day we had flex alerts being texted to everybody in Southern California saying, don't charge your car. So I think that just graphically highlights the challenge you're going to have from the infrastructure and the grids. As more and more vehicles, more and more buildings get electrified, you're going to need more power generation charging solutions. Fortunately, there's abundance of natural gas in the U.S. and other fuels like renewable fuels and biogas or even hydrogen where capstone machines can be put in place to support that infrastructure and quickly scale both vehicle charging and building electrification.

Yeah, no, that looks like, and you did point out to the three new sectors that will be a future growth opportunity, this being one of them. Good luck on that. Thanks for taking my question.

No, thank you, Samir.

Okay, up next we have Rob Brown with Lake Street Capital. Please proceed.

Good afternoon.

Hey, Rob.

Hi. Nice progress in getting the rental fleet built out. I guess at the 50 megawatt level, what's sort of the revenue level that you can generate there, and how is the margins looking at that point in time?

Yeah, the kind of target margins, I'll take that first, is 60%. You saw for the quarter, we announced we're at 72%, and that's obviously got re-rents in the mix. We think as we add more re-rents and as the fleet ages, 60% is a reasonable number, but we have been running above that since inception of the rental fleet. But again, as the mix changes between re-rents or re-manufactured product versus 100% new and as the fleet ages a little bit, we should see 60% as a reasonable expectation. But still, much better than anything else we have been in our business. You know, I'd say on the expectations on revenue growth, I would expect, you know, half a million dollars kind of growth per quarter, each quarter as we kind of move up toward that 50 megawatts. That's about what it looks like internally for us right now, and so we'll continue to report those numbers. The most important thing is at 50 megawatts, we should be throwing off positive EBITDA every quarter, quarter in, quarter out, and positive cash flow from ops. that's really kind of the golden ticket for us is to be EBITDA positive, cash flow positive, quarter in, quarter out, and the only question is how much product we can sell on top of that. So as I look at the quarter, lots of highlights, but I think to your point, growing that rental fleet is the most strategic, important part of our business, and everything else is a little bit secondary right now for us.

Okay, great. Thank you for that color. And then the margins, I think you said much of the margin hit in the quarter was one time. How do you see the margins recovering throughout the year? And I guess do those issues take a little time to play through, or does that snap back pretty quickly?

Yeah, it should snap back fairly quickly. I think, you know, I don't see it's a 25% margin again in this current quarter we're in. I think it'll probably be Q4 before we get back to the Q1 levels. So I think you're going to see some bleed into Q3. The good news is the vast majority of that supply chain hit and then an increase was in two parts, so it's very easy for the team and myself to jump on it and remediate it. As I said, the new enclosure manufacturers already lowered their price substantially, and we've got some more work to do there, but we'll be much better. And then the additional material we had to buy because of lead times and growth in the business was a one-time purchase. And so we'll see some more costs for that material this quarter, but then by Q4 it'll be gone. So I think Q3 will be better than Q2, but probably not as good as Q1. And Q4 should be back to kind of Q1 levels. And obviously the more rental units we can build and the more rental units that are 100% new, those margins will even go beyond the 25% we saw in Q1 as we continue to grow that business.

Okay, great. And then on the demand environment, it's quite strong right now, and I presume you have not seen much from the IRA yet, but how do you think about the IRA impact helping demand and the timing when you should start to see that?

Yeah, no, that's a really good question. The IRA bill should improve our paybacks close to two years in the U.S. for CHP projects, and so if you had a six-year payback project, it should be closer to four-year payback, or five would be three. We see that as a dramatic shift and transformational for the economics of our machines, and it's the biggest incentive we've ever had in the history of the company. So for U.S. CHP projects, we should see substantial growth. We've analyzed it, and it looks like if truly it's a two-year improvement, we should see close rates go from roughly 13% in the U.S. to about 20% in the U.S., and so that would be you know, $40 to $50 million of improved business results on an annual basis. So it's significant. Now, it is U.S. only. It is CHP. It's not oil and gas, though we are seeing an uptick in the oil and gas business in the U.S. as well. So we're very bullish on what next year would look like from a product revenue U.S. standpoint. From a timing perspective, you know, typically our projects can be anywhere from six months to, you know, 14, 15 months from quote to closed. So this definitely will be a next year phenomenon. But again, book to bill is 1.6 to 1 this quarter. Our product backlog is already up quarter over quarter, year over year. So I think that's just going to give us more tailwinds for next year. I think as I look at demand environment, the U.S. should still be very strong next year across the board. Both rentals and products. Europe is struggling. Obviously, the ground war in Ukraine has kind of roiled the energy markets, and we've seen renewable projects continuing, but a lot of the CHP projects have been hampered because of the spark spread issues and natural gas issues over there. Asia is doing good. Australia is doing good. Latin America is starting to pick up. Mexico is pretty sound. So the biggest issues we have right now is definitely Europe. And the strong dollar doesn't help either. But in general, I'd say most of our markets, we're seeing strong demand and we're looking for, you know, continued growth year over year.

Okay. Thank you. I'll turn it over.

Thanks, Rob.

Okay. Up next, we have Sean Severson with Watertower Research. Please proceed.

Hi. Hello, everyone. Darren, I'm curious how a high rate environment affects the EAS business because obviously it's a return, a rate of return business, right? So as we get into this environment and everybody wants to predict how long interest rates are going to stay high, but just curious, how does this impact and how do you manage through the economics of that business as rates change like this?

Yeah, no, definitely. I think as the energy of the service business grows, our biggest factor is going to be cost of capital. And so if we can generate our own capital, that's great. If we have to go out for capital and the capital is more expensive because of the interest rate environment, that's going to be more impactful. I think the good news is when you're looking at a business with over 30% IRR and over 60% margins, you can withstand a little bit of rate increase. But that being said, I think a lot of folks know we've got a $50 million note with Goldman Sachs that expires a year from October, so next October. We've hired Greenhill and Company to go out and refinance that note for us. That note was at LIBOR plus eight, three quarters, which seemed expensive a year ago. Now it doesn't seem quite so expensive. So I think that will be very important in the next quarter or two as we refinance that note, what that cost of capital is going to look like and then the ability to get additional debt on top of that. So that's something we are keenly focused on and not just refinancing Goldman, but what that cost of capital is going to be as we kind of grow that relationship.

Thanks for that. My next question is on the direct sales. effort. And, you know, when you approach these larger customers, obviously, the goal to get a big international rollout, national rollout, large customers, are you approaching them with the EAF strategy with energy as a service or product, I assume everything, but I'm trying to understand where's their appetite, do you think coming in on what we should expect? So you make a big announcement with a hotel chain, for example, Would we expect to see that as product and equipment rollouts, or would we expect to see that in the EAS wrap?

Yeah, that's a great question, Sean. So obviously we offer the full suite of products and services and solutions to the customers, and our goal is to custom tailor a solution that meets their needs. Most of our bigger customers obviously have access to capital, and so the energy service business may not make as much sense for them from a cost standpoint. That being said, we're working with the hotel chain in the Caribbean, which we've done our first megawatt energy service agreement with, and we're working on several more. So it just depends. I think for a very large customer like a Marriott, that may be one answer. If it's a smaller regional hotel with 30 properties throughout the Caribbean and Mexico, that may be more of an energy service play. So it really depends on what the customer is looking for. But our goal is to really go in and say, look, we can be your one-stop shop solution provider. If we sell you the product, we'll wrap it in a 20-year factory protection plan. We'll guarantee the lifecycle costs. We'll be your partner and be really married to you for 20 years in the performance of your fleet. Or if you want to do an energy-to-service solution, we can do that as well. So I think, you know, flexibility is key. And I think markets change. Obviously, the hospitality industry was really damaged during COVID. And so they're very limited with capital spend. Some other industrial customers are the same. Hospitals obviously had a lot on their plate during COVID. But other customers, you know, did better during COVID and have plenty of capital dollars to spend. So we want to be flexible. And more importantly, we just want to make sure that we, you know, tailor a solution that meets their needs. and makes them realize this is the only business we're in. We don't make, you know, V9 earth moving equipment. We're not in other products. We are in, you know, energy as a service and distributed generation and microgrids, and we're here to give you a great product and stand behind it.

Thanks. My last question is the plan to get from 39 to 50, what do you need? Is there going to be a mix in there of re-rents, you know, again, in order to fulfill the demand there? And then lastly, as part of that, how much cash can you get out of those targeted receivables that you still have?

Yeah, no, you heard Scott's numbers on how we brought down the AR for the quarter and generated cash from operations, so that was great. We still have probably another $4 million or $5 million we can get out of the receivables to get down to that 65 days, which would build almost half of what we need to build for the growth to 50 megawatts. Inventories are up, as Scott mentioned. Some of that is just the price increase we got from those two vendors. Some of it is, you know, obviously anticipatory, you know, purchasing to keep growing product and rental at the same time. But inventory turns are, you know, over three, which is good, but we've been over five before. So I think if we can really focus on inventory turns going into next year, that'll free up another $3 or $4 million of cash. So I think all of that is is helpful i think the number of re-rents we do will probably you know really be driven more by availability as we're trying to grow both the product side and the rental side it's you know it's pulling out supply chain harder than we have in the past and so the availability of components may drive more more re-rents but i think it's important to say that each re-rent we do with the exception i think of one We've got a purchase option after three years, and so even if we re-rent the product for three years, we can then buy it at the end, put it on our balance sheet, and see those kind of margins we get from new equipment. Also, as we bring back re-rent equipment or used equipment, we're refurbishing it, putting it to like-new type conditions, so the customer sees virtually a new machine, whether it's a re-rent or a used piece of equipment that we've purchased and refurbished or built it new. From a customer perspective, they're getting a great result regardless of what the product is. The re-rent strategy is one I know that confuses people a little bit, but the reality is as we grow this rental business, we don't know how many contracts we're going to get when. When you've got parts that are a year lead time and you're trying to grow both the product business and the rental business, you've got to build in some flexibility. The re-rents have allowed us to do that. In some cases, these are projects where the project was canceled because of COVID or or equipment maybe was older and the business changed for the customer and they don't have a need for it anymore. So there's actually kind of a silver lining to getting some of these products out of the market and put back into revenue generation and creating value for us and our customers.

Great, thanks. I'll get back to you. Thanks, John.

Okay, we have no further questions in queue. I'd like to turn the floor back to Darren Jamieson for any closing remarks.

Well, I had some really great closing remarks, but the questions were really excellent and really touched on most of them. I guess what I'll say is, you know, as I look at the quarter, I'm obviously very critical of our performance. I have very high standards for myself and the team. Disappointed with the gross margins for the quarter, down from 25% in Q1, which has been our target. But really it was two vendors and two issues that we see as short-term and can be mitigated. Global supply chain challenges are real and we're facing those, but I think our team is doing a good job to work through those. So I'm highly confident we'll see margin improvement back in Q3 and hopefully get back to our target levels in Q4 and beyond. Inventory is up a little bit, but I think that's also understandable with some of the price increases we saw as well as needing to build both rental units and product. But if I look at the rest of the quarter, you know, revenue is up quarter-over-quarter and year-over-year. OpEx is down quarter-over-quarter, year-over-year. Just to even improve year over year, we're seeing growth in the EAS business as well as the rental business hitting that 50 megawatts. I think we're very well positioned at 39 megawatts today and a lot of pending orders. Very happy with the gross product bookings at 1.6 to 1 book to bill on top of a growth quarter. Product backlog being at 4.1 million is great. Cash is important, especially when we're trying to grow this energy to service business, which is a capital-intensive business. So keeping all the money that we did for the quarter that we had during the equity raise, $900,000 from operations is positive. It was a big improvement quarter over quarter. We're seeing... You know, the DSO come down from 123 days to 85. If you go back a quarter, it was 150 days. And so we've gone from 150 days to 123 days to 85 days. And if we get back to 65 days, that'll free up more cash to build more rental units, and that's where we really want to be. I can't overstate... you know, how transformational the new U.S. government incentives are going to be. The tax incentives, especially the IRA bill, should be a very big improvement to our business next year, and we're very excited about that and what that does for our customers and the viability of our product and profitability it will drive for our customers. You know, I think, you know, DSS, you know, increasing that fee from 3% to 5% is always, you know, not always, you know, thrilled by our distributors, but it really allows us to get back to doing trade shows, B2B events, really getting aggressive to get customer acquisition. We just finished Attapec in Abu Dhabi. Had a great booth there and really great show traffic. We've got MJ BizCon, which is a cannabis show in Vegas this week as well. So we're back to doing heavy marketing, heavy branding, trade shows and media events. And so that's obviously good timing as we come out of COVID and continue to grow the business. You know, couldn't be happier with the job Greenhill and company is doing for us. We looked at 12 different investment banks, Scott and I did, to interview to see who can refinance Goldman for us, and they definitely came out on top and have not disappointed. And so I look forward to them launching shortly and seeing what kind of pricing we can get for some additional debt and the refinance at Goldman note that's up in a little under a year. You know, continue to work, Don and his team, on hydrogen development. You know, we're at 30% commercial hydrogen today, heading to 100%. There's going to be a lot of money that's going to come through the Department of Energy and other government resources for hydrogen development and hydrogen hubs. And we want to make sure we're part of that as well. So that's also very exciting. We'll be heading over to our UK facility here with... Tracy and Jen and team here shortly and see the great work they've done in the last year at the UK hub. Building remanufacturing capacity doesn't sound very exciting, but 40% cheaper components is exciting and more of them is exciting. And so as we bring that hub online and it gets more ability to be more of a full service organization and those folks have done an amazing job and look forward to seeing them again. And then really this next couple of quarters, we'll be focusing on strengthening our supply chain, supply chain integrity, mitigating cost increases, and more importantly, make sure we can get the parts we need to keep our customers happy and not miss any deliveries. And so we want to keep growing the business, keep growing the rental fleet, despite the global supply chain challenges that every manufacturer in the world is facing. And so overall balance, a very good quarter, especially coming off Q1, which was an excellent quarter. We want to keep that momentum going in the back half of the year, and I look forward to talking to everybody after the 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.