Ask Management

Capstone is reducing its R&D expense approximately 50% year-over-year. Capstone will still spend approximately $5.5-$6.0 million annually on product enhancements, cost reduction, reliability improvements, parts obsolescence and future product development. With the continued rollout of the C1000 Signature Series and the completion of several lingering reliability improvements, Management believes it can efficiently and successfully scale back R&D efforts without having an adverse impact on the company and its future growth potential.

Capstone believes EXIM Bank export financing and insurance products are a very valuable tool to support the competitiveness of U.S. businesses in global trade. In our specific case, we benefit from EXIM indirectly in two ways. First, we see EXIM Bank products mainly as tools for our distribution partners and we provide education to them on how to access these products to support execution of their international projects. Second, the international portion of our $20 million dollar asset-based credit facility with Wells Fargo is guaranteed by EXIM Bank. Because of this guarantee, Wells Fargo’s risk exposure on international receivables is lowered, which allows us to maximize our borrowing ability on international receivables.

The timing and ability to effectively lower operating expenses approximately 35% from historic levels was driven by several internal and external factors, including the successful completion of the C1000 Signature Series product, certain product reliability improvements, and the continued maturation of the Capstone distribution channel. Reducing the operating expenses faster would have limited the ability of the company to launch the Signature Series product that is targeted for the CHP and CCHP markets, delayed product reliability improvements, which would have impacted warranty spend and customer satisfaction, and restrained the maturation of the distributor channel, which is required to fully transition sales, marketing and service activities seamlessly into the channel.

Capstone markets and sells its microturbine products and services through a two-step distribution model. Capstone has a very small Sales & Marketing Department and relies heavily on the performance of its 95 distributors located in 73 countries. Our distribution channel currently has 787 Capstone-dedicated employees and has accepted the challenge to hire an additional 100 salespeople worldwide as part of the new C1000 Signature Series product launch. Unfortunately, as great as the Capstone product is, no product “sells itself”, and distributors must market the product, educate architects and engineers, and complete the application work required for properly sizing and installing the systems. Capstone management believes its growing and maturing distribution channel is a tremendous asset and affords the company great future business leverage.

Capstone management is very aware that China does not strictly enforce foreign intellectual property rights within its borders. Capstone also has a business relationship with the CEO of American Superconductor, which was featured recently on 60 Minutes.  Capstone has worked diligently over the years to put in place the necessary contract and legal protections and IP strategies to adequately protect its intellectual property. However, no strategy is foolproof and many American technology companies have been hacked at some level. We believe we have the necessary protections in place. We have direct knowledge of only one attempt to reverse engineer our C30 product, which was done several years ago, but that attempt failed. The market in China is so large, especially since distributed power and clean air are huge growth areas, that the company believes that selling into China is worth the potential IP risks if the proper precautions are taken.

We are continuing to work with Kenworth and both the San Joaquin Valley APCD and South Coast AQMD to develop and demonstrate a Class 7 CNG-powered turbine range extender series hybrid electric truck.  The truck’s electric drivetrain, battery system and microturbine have been installed and we are currently making final adjustments to the vehicle control system.  The refrigerated box body was installed at the end of March of this year.  We are working directly with the air districts and end-use customers in preparation for the demonstration phase of this project, which is expected to begin within the next couple of months.

Capstone has considered licensing and/or selling air bearings in the past but has been reluctant to do so due to the sensitive proprietary nature of the design. Also, the design is custom to our microturbine application that it is engineered specifically for, so any adaptation of the air bearing would require detailed design work for specific third-party products. Another consideration of the air bearing is that it operates at very high speeds to function properly (rotor group liftoff at 17,500 rpm, idle at 30,000 rpm, and full power from 60,000 to 96,000 rpm). Many industrial products do not currently operate at such high speeds and would require additional design changes to the third-party product. These changes would drive major design efforts on existing third party products to the point that only a new product application would potentially make financial sense to a third party. However, if a reputable company approached Capstone and was willing to undertake this work, we would consider a licensing arrangement.

Capstone believes EXIM Bank export financing and insurance products are a very valuable tool to support the competitiveness of U.S. businesses in global trade. In our specific case, we benefit from EXIM indirectly in two ways. First, we see EXIM Bank products mainly as tools for our distribution partners and we provide education to them on how to access these products to support execution of their international projects. Second, the international portion of our $20 million dollar asset-based credit facility with Wells Fargo is guaranteed by EXIM Bank. Because of this guarantee, Wells Fargo’s risk exposure on international receivables is lowered, which allows us to maximize our borrowing ability on international receivables.

AFA is an alternative alloy material we are testing specifically to be used for our recuperator, and if proven successful would be beneficial to Capstone as we project would provide cost savings. The AFA program is still active and ongoing. A C65 with the AFA material is currently running an endurance life test at Oakridge National Laboratory. Based on the results of the life testing, we will then decide if the AFA material makes good business sense to move forward with it as a cost saving measure while still avoiding any product life or reliability issues.

Capstone historically lost an estimated $50 million in annual sales opportunities due to not having a factory-backed long-term financing solution. The new Capstone Energy Finance entity is designed to exclusively provide long-term power purchase agreements (PPAs) to well-qualified customers with qualified U.S. projects. Capstone launched the joint venture in December 2015 and has a pipeline of approximately $12.5M in opportunities. We recently submitted our first term sheets and hope to close our initial contracts with customers in late summer of 2016.