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 third quarter fiscal year 2023 that ended on December 31st, 2022. All lines have been placed on 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 third 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 for its fiscal 2023 third quarter ended December 31st, 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, February 13th, 2023. 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 safe harbor provisions set forth on slide two of the slides accompanying this presentation 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're referring to adjusted EBITDA and the reconciliations in the earnings release and the appendix to the presentation slides. I would like to now 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 third quarter fiscal 2023 results, ending December 31, 2022. If you would now turn to slide three. I'd like to run through today's agenda. I will start with a brief business environment discussion, and then update you on our strategic energy as a service rental fleet growth. As a reminder, our energy as a service, or EAS, business remains the foundation upon which we are building a stronger capstone. Next, Scott will provide more details on the third quarter financial results, and then I will dive deeper into the electric vehicle charging market, where we're seeing very exciting opportunities for us. We will then conclude with questions from our analysts, and I also want to remind you that there is an appendix to today's presentation providing more details and additional information on our products and the new IRA bill. Let's go ahead and jump to slide five. Slide five shows our current business environment that we're in today. Third quarter revenue was off $1 million compared to the same period last year, but to date revenue is up 9.5%. This revenue growth can be attributed to our energy as a service or ES business which has grown approximately 18% and continues to outperform the rest of the business. As you know, the energy service business, which is our FPP long-term service contracts, our spare parts and long-term rentals is our critical foundation. And what I am happy to say, the revenues are up 18% for the first nine months of fiscal 23, mainly due to higher rental revenues of almost 4 million at 3.9 and an FPP maintenance contracts of approximately 900,000. In addition, we have navigated a very tough supply chain environment and we are expecting to see significant improvements in the area this year. Looking ahead, I'm excited about what we've seen to start our fiscal fourth quarter and what I expect for the rest of calendar 2023. For the first nine months of fiscal 23, gross margins expanded to 16% from 14% for the first nine months of fiscal 22. However, I'll note that this was less than anticipated as ongoing supply chain expenses Freight costs and expediting charges continue to plague us more than we anticipated. Now let's move on to slide six. On slide six, you can see that on December 31st, 2022, there was about 40 megawatts of energies of service long-term rentals under contract and re-rental units under contract, which is a substantial increase from 17.7 megawatts on December 31st, 2021, which represents a 126% increase year over year. I'm proud to say that we're still on schedule to meet the company's target of 50 megawatts under contract by March 31st, 2023. I'll now turn the call over to Scott, our interim 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 third quarter of fiscal 2023. Moving to slide 8, you can see our Q3 23 results compared to Q2 23. Financial results for the third quarter of fiscal 23 had revenue of $19.6 million compared to $20.8 million in the second quarter of fiscal 23. Product and accessory revenues were $10 million, down from $10.6 million in the second quarter of fiscal 23. Parts, services, and rental revenue, which includes the rental, FTP long-term service contracts, and distributor support subscription fees, were $9.6 million down from $10.2 million in the second quarter of fiscal 23. This was primarily due to a decrease in our spare parts revenue due to Russian sanctions. Gross margin as a percentage of revenue was 14% in Q3 23, up from 11% in Q2 23, primarily due to the easing of supply chain challenges. Total operating expenses increased slightly to 2.6 million from 5.7 million in the previous quarter. Net loss was 5.2 million for the quarter compared to a net loss of 4.9 in the second quarter of fiscal 23. Adjusted EBITDA was a negative 1.7 compared to adjusted EBITDA of a negative 2.2 in the second quarter of fiscal 23. Turning to slide 9, you will see the financial results for the third quarter of the fiscal year 23 compared to the prior year period, which were revenue at $19.6 million compared to $20.6 million in the third quarter of fiscal 22. Product and accessory revenue was $10 million, down from $12.3 million last year. Parts, services, and rental revenue was $9.6 million, up from $8.3 million in the same period last year. Gross margin as a percentage of revenue was 14%, up from 11% in the year-ago period, primarily due to greater contribution from a higher margin rental business. Total operating expenses were stagnant at $6 million from $6 million in the year-ago period. The current year expenses include costs for investment banking and other fees relating to our debt refinancing activities. Net loss was $5.2 million for the three months into December 31st compared to a net loss of $5.1 million in the prior period. Adjusted EBITDA was a loss of $1.7 million compared to adjusted EBITDA of a negative $3 million in the prior year period. Slide 10 shows the year-to-date fiscal 23 versus the year-to-date fiscal year 22 financial results. Top line revenue increased from $53.9 million to $59 million due to growth in our energy as a service business. Gross margin increased from 14% to 16% due to contributions from the energy as a service product line offset by the direct material price increases previously mentioned. Operating expenses decreased from $19.7 million to $17.2 million due to cost reduction efforts. and adjusted EBITDA approved from $8.1 million loss to a $3.4 million loss. Turning to slide 11, you will see selected balance sheet and cash flow items. Cash decreased to $16.6 million from $23.8 million at September 30, 2022, driven primarily by net loss funding, investments in our rental fleet, and purchase of long lead time inventory. Cash used in operating activities in the December quarter was $4.9 million compared to cash provided of $900,000 in the September quarter. The variation was largely due to net loss funding and inventory purchases. Accounts receivable declined nearly from $19.3 million to $15.2 million as our DSO dropped from 85 days to 66 days during the quarter. This reduction was due to collection efforts and also benefited from offsetting certain accounts receivable accounts against the purchase price of rental units that were additions to our rental fleet. Total inventory levels increased by 4.5 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. In addition, we do need more inventory as we ramp production of both new products and focus on growing the rental fleet to 50 megawatts by March 31st. 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're working to achieve our profitability goals. Let's go ahead and turn to slide 13. Slide 13 is the technology and markets we are now concentrating on and are showing on this slide. I include this because I want to remind our investors of the various diversified industries and applications in which our solutions are currently being deployed. I won't go over every detail in each category, but I do want to draw your attention to smart microgrids, renewable energy, and especially EV charging. We're seeing new demand for both stationary and portable EV charging solutions. Let's go ahead and move on to slide 14. Slide 14 displays the projected revenues for the global EV infrastructure market, and our plan is to be there to take advantage of as much of that market as we can. This market will generate opportunity for DERs and for smart microgrids. There is demand for EV charging solutions in both the United States and Europe right now, and we look forward to providing energy to customers who cannot readily get a charging solution from their local utility. Slide 15 shows you a key new solution we are developing to meet the needs and we're starting to see from EV charging opportunities around the industry. This solution can substantially reduce stress on the grid and the environment when coupled with intelligent EV charging solutions using natural gas, renewable natural gas, or renewable biogas to power the EV charging infrastructure. This gives users the option to charge a bus or a truck fleet without the need for extra grid infrastructure, grid payments, and enables fleets to provide electric vehicles and deploy them much quicker. Some key points are that it's scalable and transportable and avoids high utility demand fees. Furthermore, most places have access to natural gas pipelines or users can use a virtual natural gas pipeline, not to mention Capstone EAS allows for the rental of these units so that costly capital expenditures can be avoided. Before turning it over for questions from our analysts, I want to leave you with some thoughts. Even though our bottom line was essentially unchanged, we were able to survive an extremely challenging supply chain climate. I am enthusiastic about what I observed in the beginning of our fiscal fourth quarter and what I anticipate for the remainder of the calendar year 2023 as we look ahead. We are still dealing with supply chain problems and rising prices, but I anticipate that our pricing hikes from January will start to balance this out. As input costs stabilize, we continue to anticipate the adjusted EBITDA results return to more normal levels that we saw in Q1, hopefully in the fourth quarter and the first quarter and beyond. We anticipate over the next 12 months there will be a convergence of favorable developments, including our price hikes taking effect, the implementation of the new Inflation Reduction Act, and the growth of new markets like EV charging. As we move away from being solely a manufacturing firm, our energy as a service rental business will continue to be our main focus and should deliver us benefits like profitability, predictable revenues, and strong cash flows. As we get closer to our target, 50 megawatts under contract, our results show that we have made progress in making this significant strategy shift. The facts demonstrate that our customers need the solution and that we can deliver it, meeting their needs and generating profits for our shareholders. Now with that, I'd like to open the call up for questions from our analyst operator.

Certainly. At this time, we'll be conducting a question and answer session. If you have any questions or comments, please press star 1 on your phone at this time. We do ask that while posing your question, please pick up your handset, if you're listening on speakerphone, to provide optimum sound quality. Once again, if you have any questions or comments, please press star 1 on your phone.

Please hold while we poll for questions. Your first question is coming from Rob Brown from Lake Street Capital Markets.

Your line is live. Hi, Darren.

Hi, Scott. Hi.

Just wanted to talk a little bit about your confidence in your rental trajectory there to the 50 megawatts. How's the pipeline look at this point? And I think you've had some announcements recently that get you close, but just an update on how you get from the 40 at the end of the year to the 50 in your goal.

Yeah, no, it's a great question. We've got a 100-plus megawatt pipeline of projects. Obviously, we're trying to fill a 10-megawatt gap between 40 and 50. We're in negotiation with several projects right now, mostly in the U.S. oil and gas space. I would expect that we'll be at 45 megawatts under contract by the end of this month, and then we'll need to fill 5 megawatts between into February and into March. So highly confident on the trajectory that we're on. You should expect to see more press releases, you know, between now and the end of the quarter. And I think that's, you know, definitely we've seen a softening, I would say, of the crypto market. But I would say oil and gas is more than made up for that. Most of the opportunities we're seeing right now are in the oil and gas space, especially since January.

Okay, great. And then have you seen any of the IRA-driven demand yet? I assume it's still coming. But if you haven't seen it yet, how does that play out in the next few months?

Yeah, we had great bookings in January. In fact, we actually booked more product sales in January than we did the entire third quarter. one month so i would say we're starting to see the leading indicator of some of those opportunities um i think that you know we've got to rerun numbers for customers uh and people need to get you know comfortable with the new bill but i think it's going to be very significant if you look at you know the u.s market is is well more than half of our business and the biggest piece of that has been chp uh renewables so that that's uh definitely hitting our biggest market with a huge incentive so taking that uh you know ira tax Incentive from 10% to 40% is very significant. But again, I'd say oil and gas is very strong. I just got back from Europe. We're seeing actually oil and gas activity in Europe for the first time in years, as well as the U.S. market also being strong. We've also got projects going on in Latin America, Australia, and parts of Asia.

My last question is on the pricing that you took at the end of January. What's sort of the magnitude of that, and does that happen pretty quickly, or does that take time to roll out?

No, it definitely happens. I mean, we implement it quickly, and we update Salesforce, but there is a lag, obviously, because we typically book products one quarter and ship them a couple quarters later. So there's going to be a lag between new orders at higher pricing and when those will go through our P&L. So January 31st was a new price increase. In the U.S. market, it was 10%. Overseas, it was more like 7% just because the IRA bill being the U.S. influence, and then obviously the dollar's been fairly strong as well. So fairly significant price increase. We did one last year as well. We're still working on the other side of the equation, which is getting costs down from our vendors. We are seeing freight costs and freight shipping times come down nicely. We still got some work to do, though, on some of the other commodities, especially printed circuit boards, IGBTs, fans, some high-grade wiring and things like that. The costs need to come back down. So I would say we're on the backside of the bell curve when it comes to supply chain issues, but we still have some work to do to get there.

Okay, thank you. I'll turn it over. Thanks, Rob. Great questions.

Thank you. Your next question is coming from Sean Severson from Water Tower Research. Your line is live.

Hey, Sean. Hi, Sean.

Once again, Sean, your line is live.

Thank you. Just a couple questions, Darren. I wanted to follow up on Rob's question a little bit about the pathway you're seeing from the IRA and how it's been showing up in the orders. I know you said you started a strong calendar year, but I'm trying to understand when I look out and modeling the year, where do you see the bulk of this coming in, and do we have any big surges that we would look for later in the year as this really starts to develop?

Yeah, I think you definitely have to look at our normal project life cycle, which for, you know, product sales where it's a capital purchase, you know, these projects can be 12 to 18 months, in some cases even longer. So it's definitely a longer sales cycle, but we've seen an uptick in inquiries. We're seeing projects move through, you know, Salesforce at a better clip. And so I think, you know, we're starting to see the leading indicator of it, but it should really strengthen the summer into the fall. That's exciting for us. As Scott mentioned, we're trying to build inventory for what we see as a growing product sales pipeline, especially in the US this year, as well as trying to get to 50 megawatts. We're pulling pretty hard on our supply chain. In defense of our supply chain, our purchases are up dramatically year over year, much more than our revenue because of the build on the EAS side. Definitely, I'd look, though, for the back half of the year to be very strong. The first half of this year, we're really focused on getting to that 50 megawatts under contract and then getting all 50 megawatts deployed. I think that's another important point is that there is a lag between signing a rental contract and actually getting the product built, shipped, and commissioned, and that can be anywhere from 45 to 60 days typically.

My last question is just, has there been any bias towards the types of customers that are responding to this? I know, obviously, the push towards the large global customers and national customers with the internal sales force specifically. Are you seeing any differences in appetite between the types of customers that are engaging on this? And then I'll step back and cue.

Now, Sean, it's an interesting question. I don't think we have enough data to make a statement. I mean, most of the folks we're talking to right now are people that had projects that didn't go forward because of paybacks being too long, so we're reaching back out to those folks. So those are people we've touched in the last couple years, rerunning the economics. In general, the IRA bill drops the simple payback by two years, so it was a six-year payback. It's now a four-year payback, or seven years, now a five. So we've got to reach out to those customers. We run economics and see if we can get them interested in moving forward in the project. And if they're not interested in a capital purchase, are they interested in looking at an EAS solution? I think what's also interesting, I just returned from Europe, and they're pretty stunned by the IRA bill. I think it puts the U.S. ahead of Europe as far as developing green energy and energy transformation. I think that's a place that they're not used to being. So I do think you're going to see more come out of Europe as they try to catch up to the U.S. and hopefully, you know, try to get ahead of the U.S. And so I think there's more opportunities there. And it's also mentioned because of the war in Ukraine, we're seeing oil and gas activity pick back up in Europe as they realize they can't get all their, you know, natural gas, you know, from Russia and that the cost of other natural gas and supply is very challenging to find other locations. So interesting times in Europe and interesting times in the U.S., I think, between the IRA bill and then the impacts of the Ukraine war.

Thank you. Your next question is coming from Sameer Joshi from HC Wainwright. Your line is live.

Hey, Dan, Scott. Thanks for taking my question. So just following up on the EAS discussion, you are on track to get to your target for 50 megawatts. Does the IRA and the increased incentives for upfront benefits change your strategy long-term and like are you increasing your targeted EAS deployment next year in the fiscal 2024 year?

So it's a great question. I think right now we're really focused on getting to 50 megawatts. If you look at the numbers in the queue, if we were just kind of neutral on margins for our products, we'd be kind of EBITDA neutral for the year. So the negative gross margin on our products because of supply chain issues has drugged down our ability to be EBITDA positive or just EBITDA positive. If we get back to just zero gross margin or just slightly positive and we get the 50 megawatts deployed, you know, we're solidly EBITDA positive. So that's really the short-term growth and the short-term goal. We need to really see cost of capital going forward. And so how we work on refinancing Goldman and what that looks like, I think will drive what we do going forward beyond 50 megawatts. So I think, you know, when we talk again about, You know, after the fourth quarter, I hope to have a solid plan in place to say we're already at 50 megawatts deployed. We're, you know, back into positive EVA dot territory like we were in Q1 of this year. And then hopefully have a rollout strategy on where we go next beyond the 50. But today, we're fairly focused on executing on that 50. And it's not insignificant. We think about it as a business we started three years ago and really had trouble getting lift off because of COVID. This is accelerating very quickly. And so, deploying 50 megawatts, which is closer to 75 or 80 machines around the U.S. and now moving internationally, that's a lot of activity to undertake for us in a short period of time.

Understood. Thanks for that. Moving to the EV initiative, the first question is, what is the status of the development of the product, and is this development being done with certain customers in mind and target audiences in mind, or are you independently developing and then will present it to any potential customers?

No, we're working with one of the largest commercial REITs in the U.S. as kind of our partner right now. They're providing the chargers. We're providing the microturbines. We've also generated, as you saw a picture in the presentation, a portable version of that. So it's a 180 kilowatt charger. with the C200 microturbine. We've got a little bit of a battery on board for black starting and some solar PV. But the goal is to be able to deploy these around the country as people bring in electric fleets. We're finding a lot of folks getting buses and trucks and then they turn to the utility and they can't get the additional utility feed and power that they need. And so they all of a sudden find themselves with a fleet brand new, but they can't charge it. And so we've got, you know, opportunities here in California. We're doing stuff in New Jersey. We've got some stuff going on in Chicago right now. So they're a big company. We're kind of riding their coattails a little bit. They've obviously got a pretty big indentured customer base, as large as they are, and so I think it's a good natural fit for us. But it's early days, so we'll see how this expands. Obviously, portable is great. We'd rather do more permanent infrastructure, and I think it's demand for EV charging increases and we electrify more buildings, the number of utilities that are unable to keep up with that demand is only going to grow. And so I think that's a great opportunity for us. But we'll look, you know, at the landscape as it adjusts and grows and figure out if we want to partner with somebody or continue to just work with a few key clients.

Understood. Should we expect initial revenues during calendar year 2023 or 2024 from this?

Yeah, no, absolutely. We've got 7 or 8 megawatts out on rent right now on trailers. We've got some permanent installations that we've quoted that we think will move forward here this quarter. We've done a couple installations in Europe for permanent EV charging solutions. So, yeah, this is something that's driving revenue both new product sales and through our EAS business. And I think the real exciting part is how this could grow over the next several years if – electric vehicle infrastructure is not put in place and EVs continue to grow at the pace that they're projected to grow, then this is going to be a huge opportunity for us.

Understood. Just a few on the parts revenues which were slightly impacted by these Russian sanctions. Was that impact in like sub-million dollar range or was it like a couple million dollars? How should we think of the scale of this impact?

Yeah, no, you know, Russia once upon a time was one of our biggest markets. We've got 2,500 microturbines over there, so the ability to not sell new product over there or, you know, the struggle to get spare parts and make sure that we, you know, stay in line with all the U.S. sanctions is definitely impacting us, you know, a few million dollars a quarter, if not more. You know, I'd say some of the supply chain issues definitely impacted a couple megawatts shipments last quarter, so there's probably another couple million dollars there as well. So those two things are definitely challenging for us. On the supply chain side, we continue to meet with our various vendors. Unfortunately, when some vendors can't meet deliveries and others can, we get kind of the imbalance in our inventories that we're seeing today where we've got too much of one part and not enough of the other and inability to hit our target production levels. So that will be a major focus for us. It has been the last quarter. It will continue to be a major focus for the next couple quarters until we get to our, you know, supply chain, you know, more balanced and our inventory turns back to, you know, three and a half, four, uh, where, where we want to see them and not compared to where we are today. Uh, very happy though, on the, on the, uh, receivable side, we've really focused on receivables coming out of COVID. Uh, as you recall, we were, you know, 65 days going into COVID kind of DSO. We hit 156 days as a high during COVID. Uh, we're back down to 66 days today. So that's been a lot of work by the finance team and myself to, clean up the receivables and work with the distributors and these customers to make that happen. So good success story there. Now we need to focus on the supply chain side, the balance sheet side, and then continue to keep growing that energy service business. Got it.

Thanks for taking my questions, and good luck. Thank you.

Thank you. That concludes our Q&A session. I will now hand the conference back to Darren Jamieson for closing remarks. Please go ahead.

Great. Well, thank you. Great questions by the analysts. I think you touched on a lot of the things I wanted to touch on. I think, you know, the most important thing for me as I look at this quarter is that we're, you know, still hitting our target to be at 50 megawatts under contract by March 31st. That's the most important thing, the most transformational thing we can do for our business. And so as we grow that energy to service business, we need to keep hitting those target dates, make sure we get that product deployed, and make sure the fleet is running well so we get more repeat customers. We are in process, as you know, of refinancing a Goldman note with Greenhill and Company. We do need to drive that to conclusion here in the next two or three months at least, and then figure out what we're doing for long-term capital needs to keep growing the energy as a service business. Inventory is a bit out of whack, as we said, and supply chain issues have been challenging, like many manufacturers around the world. But that's not an excuse. We need to do a better job, and our vendors need to do a better job, and hopefully the fourth quarter and the first quarter this new year, we'll get that behind us as well. So I'll be looking for more Energy to Service press releases, and we look forward to talking to everybody soon at the conclusion of our fourth quarter. Thank you.

Thank you, everyone. This concludes today's event. You may disconnect at this time and have a wonderful day. Thank you for your participation.