- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
---------------------
COMMISSION FILE NUMBER: 001-15957
---------------------
CAPSTONE TURBINE CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 95-4180883
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
21211 NORDHOFF STREET, CHATSWORTH, CALIFORNIA 91311
(Address of principal executive offices) (Zip code)
818-734-5300
(Registrant's telephone number including area code)
---------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE REGISTRANTS:
The number of shares outstanding of the registrant's common stock as of
October 31, 2001 was 77,033,993.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
CAPSTONE TURBINE CORPORATION
INDEX
PAGE
NUMBER
------
PART I -- FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets as of December 31, 2000 and
September 30, 2001.......................................... 2
Consolidated Statements of Operations for the Three Months
and Nine Months Ended September 30, 2000 and September 30,
2001........................................................ 3
Consolidated Statement of Stockholders' Equity for the Nine
Months Ended September 30, 2000 and September 30, 2001...... 4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2000 and September 30, 2001............. 5
Notes to Consolidated Financial Statements.................. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Overview.................................................... 9
Three Months Ended September 30, 2001 Compared to Three
Months Ended September 30, 2000............................. 9
Nine Months Ended September 30, 2001 Compared to Nine Months
Ended September 30, 2000.................................... 10
Liquidity and Capital Resources............................. 11
Item 3. Qualitative and Quantitative Disclosures About Market
Risk........................................................ 12
Business Risks.............................................. 13
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings........................................... 22
Item 2. Changes in Securities and Use of Proceeds................... 22
Item 3. Defaults Upon Senior Securities............................. 22
Item 4. Submission of Matters to a Vote of Security Holders......... 22
Item 5. Other Information........................................... 22
Item 6. Exhibits and Reports on Form 8-K............................ 22
Signatures........................................................... 23
1
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CAPSTONE TURBINE CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------- -------------
(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 236,947,000 $ 181,692,000
Accounts receivable, net of allowance for doubtful
accounts of $85,000 at December 31, 2000 and $131,000 at
September 30, 2001...................................... 3,664,000 7,561,000
Inventory................................................. 14,123,000 26,981,000
Prepaid expenses and other current assets................. 1,689,000 1,792,000
------------- -------------
Total current assets.................................... 256,423,000 218,026,000
------------- -------------
Equipment and Leasehold Improvements:
Machinery, equipment and furniture........................ 13,664,000 22,347,000
Leasehold improvements.................................... 3,055,000 9,155,000
Molds and tooling......................................... 1,331,000 4,277,000
------------- -------------
18,050,000 35,779,000
Less accumulated depreciation and amortization.............. 6,434,000 7,874,000
------------- -------------
Total equipment and leasehold improvements.............. 11,616,000 27,905,000
------------- -------------
Deposits on fixed assets.................................... 6,649,000 1,977,000
Other assets................................................ 302,000 243,000
Intangible assets, net...................................... 27,028,000 23,308,000
------------- -------------
Total................................................... $ 302,018,000 $ 271,459,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $ 4,728,000 $ 5,020,000
Accrued salaries and wages................................ 1,135,000 1,156,000
Other accrued liabilities................................. 1,282,000 3,193,000
Accrued warranty reserve.................................. 5,589,000 4,454,000
Deferred revenue.......................................... 4,064,000 2,199,000
Current portion of capital lease obligations.............. 1,497,000 1,281,000
------------- -------------
Total current liabilities............................... 18,295,000 17,303,000
------------- -------------
Non-current Liabilities:
Long-term portion of capital lease obligations............ 3,999,000 2,864,000
Other long-term liabilities............................... 342,000 511,000
------------- -------------
Total non-current liabilities........................... 4,341,000 3,375,000
------------- -------------
Commitments and Contingencies............................... -- --
Stockholders' Equity:
Common stock, $.001 par value; 415,000,000 shares
authorized; 75,771,303 and 77,014,259 shares issued and
outstanding at December 31, 2000 and September 30, 2001,
respectively............................................ 76,000 77,000
Additional paid-in capital................................ 516,738,000 520,353,000
Accumulated deficit....................................... (237,432,000) (269,649,000)
------------- -------------
Total stockholders' equity.............................. 279,382,000 250,781,000
------------- -------------
Total................................................... $ 302,018,000 $ 271,459,000
============= =============
See accompanying notes to financial statements.
2
CAPSTONE TURBINE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ----------------------------
2000 2001 2000 2001
------------ ------------ ------------- ------------
Revenues............................ $ 6,197,000 $ 3,346,000 $ 16,029,000 $ 25,811,000
Cost of Goods Sold.................. 7,278,000 5,468,000 20,658,000 27,033,000
------------ ------------ ------------- ------------
Gross Loss........................ (1,081,000) (2,122,000) (4,629,000) (1,222,000)
Operating Costs and Expenses:
Research and development.......... 2,953,000 2,512,000 8,416,000 8,171,000
Selling, general and
administrative................. 7,203,000 9,210,000 17,264,000 30,015,000
------------ ------------ ------------- ------------
Total operating costs and
expenses..................... 10,156,000 11,722,000 25,680,000 38,186,000
------------ ------------ ------------- ------------
Loss from Operations................ (11,237,000) (13,844,000) (30,309,000) (39,408,000)
Interest Income..................... 3,385,000 1,485,000 6,007,000 7,611,000
Interest Expense.................... (197,000) (137,000) (733,000) (457,000)
Other Income (Expense).............. (32,000) 11,000 (31,000) 38,000
------------ ------------ ------------- ------------
Loss Before Income Taxes............ (8,081,000) (12,485,000) (25,066,000) (32,216,000)
Provision for Income Taxes.......... 1,000 1,000
------------ ------------ ------------- ------------
Net Loss............................ (8,081,000) (12,485,000) (25,067,000) (32,217,000)
------------ ------------ ------------- ------------
Preferred Stock Dividends,
Accretion, and Repurchase......... (559,862,000)
------------ ------------ ------------- ------------
Net Loss Attributable to Common
Stockholders...................... $ (8,081,000) $(12,485,000) $(584,929,000) $(32,217,000)
============ ============ ============= ============
Weighted Average Common Shares
Outstanding....................... 74,931,668 76,976,934 36,317,944 76,560,247
============ ============ ============= ============
Net Loss Per Share of Common
Stock -- Basic and Diluted........ $ (0.11) $ (0.16) $ (16.11) $ (0.42)
============ ============ ============= ============
See accompanying notes to financial statements.
3
CAPSTONE TURBINE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND SEPTEMBER 30, 2001
(UNAUDITED)
COMMON STOCK
--------------------- ADDITIONAL
SHARES PAID IN ACCUMULATED
OUTSTANDING AMOUNT CAPITAL DEFICIT TOTAL
----------- ------- ------------ ------------- -------------
BALANCE, DECEMBER 31,
1999..................... 2,377,826 $ 2,000 $ -- $(144,227,000) $(144,225,000)
Common stock warrants
granted.................. 8,132,000 8,132,000
Stock-based compensation... 1,239,000 1,239,000
Exercise of stock options
and warrants............. 10,793,693 12,000 2,831,000 2,843,000
Repurchase of preferred
stock.................... 2,209,000 454,000 2,663,000
Accretion of preferred
stock.................... (13,883,000) (457,593,000) (471,476,000)
Dividends accrued for
preferred stock.......... (1,028,000) (1,028,000)
Beneficial conversion
feature for Series G
preferred stock.......... (89,567,000) (89,567,000)
Dividends waived on
preferred stock.......... 440,000 6,309,000 6,749,000
Conversion of preferred
stock.................... 51,312,037 51,000 341,296,000 479,645,000 820,992,000
Issuance of common stock... 10,455,046 10,000 153,554,000 153,564,000
Net loss................... (25,067,000) (25,067,000)
---------- ------- ------------ ------------- -------------
BALANCE, SEPTEMBER 30,
2000..................... 74,938,602 $75,000 $495,818,000 $(231,074,000) $ 264,819,000
========== ======= ============ ============= =============
BALANCE, DECEMBER 31,
2000..................... 75,771,303 $76,000 $516,738,000 $(237,432,000) $ 279,382,000
Stock-based compensation... 1,591,000 1,591,000
Exercise of stock
options.................. 1,242,956 1,000 2,134,000 2,135,000
Stock issuance costs....... (110,000) (110,000)
Net loss................... (32,217,000) (32,217,000)
---------- ------- ------------ ------------- -------------
BALANCE, SEPTEMBER 30,
2001..................... 77,014,259 $77,000 $520,353,000 $(269,649,000) $ 250,781,000
========== ======= ============ ============= =============
See accompanying notes to financial statements.
4
CAPSTONE TURBINE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS
ENDED
SEPTEMBER 30,
---------------------------
2000 2001
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(25,067,000) $(32,217,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.......................... 4,847,000 7,489,000
Provision for doubtful accounts........................ 74,000
Loss on disposal of equipment.......................... 35,000 68,000
Non-employee stock compensation........................ 60,000 361,000
Employee stock compensation............................ 1,239,000 1,230,000
Changes in operating assets and liabilities:
Accounts receivable.................................. (959,000) (3,921,000)
Prepaid expenses and other assets.................... 447,000 (125,000)
Inventory............................................ (2,173,000) (12,858,000)
Accounts payable..................................... 2,853,000 292,000
Other accrued liabilities............................ (852,000) 2,102,000
Accrued warranty reserve............................. 2,869,000 (1,136,000)
Deferred revenue..................................... 1,255,000 (1,865,000)
------------ ------------
Net cash used in operating activities............. (15,446,000) (40,506,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Deposits and acquisition of equipment and leasehold
improvements........................................... (7,173,000) (15,172,000)
Proceeds from sale of equipment........................... 1,253,000 1,000
Intangible assets......................................... (16,550,000) (557,000)
------------ ------------
Net cash used in investing activities............. (22,470,000) (15,728,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of capital lease obligations.................... (1,150,000) (1,046,000)
Exercise of stock options and warrants.................... 3,549,000 2,135,000
Net proceeds from issuance of common stock................ 153,572,000
Stock issuance costs...................................... (110,000)
Net proceeds from issuance of Series G preferred stock.... 120,362,000
Repurchase of preferred stock............................. (15,492,000)
------------ ------------
Net cash provided by financing activities......... 260,841,000 979,000
------------ ------------
Net Increase (Decrease) in Cash and Cash Equivalents........ 222,925,000 (55,255,000)
Cash and Cash Equivalents, Beginning of Period.............. 6,858,000 236,947,000
------------ ------------
Cash and Cash Equivalents, End of Period.................... $229,783,000 $181,692,000
============ ============
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest............................................... $ 588,000 $ 457,000
Income taxes........................................... $ 1,000 $ 1,000
See accompanying notes to financial statements.
5
CAPSTONE TURBINE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BUSINESS AND ORGANIZATION
Business. Capstone Turbine Corporation (the "Company") develops,
manufactures, and markets microturbine generator sets for use in stationary,
vehicular, and other electrical distributed generation applications. The Company
was organized in 1988 and has been commercially producing its microturbine
generator since 1998. The Company has incurred significant operating losses
since its inception. Management anticipates incurring additional losses until
the Company can produce sufficient revenues to cover costs. To date, the Company
has funded its activities primarily through private and public equity offerings.
Organization. In February 2001, the Company formed a wholly owned
subsidiary, Capstone California Corporation, to provide direct sales of products
to the California market.
Basis of Consolidation. The consolidated financial statements include the
accounts of the parent company and its wholly owned subsidiary, after
elimination of inter-company transactions.
2. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Regulation S-X
promulgated under the Securities and Exchange Act of 1934, as amended. They do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. The balance sheet at
December 31, 2000 was derived from audited financial statements included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2000. In
the opinion of management the interim financial statements include all
adjustments (consisting of normal recurring adjustments) necessary for a fair
presentation of the financial condition, results of operations and cash flows
for such periods. Results of operations for any interim period are not
necessarily indicative of results for any other interim period or for the full
year. These financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended December 31, 2000.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
New Accounting Pronouncement -- SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," is effective for all fiscal years beginning
after June 15, 2000. SFAS 133, as amended, establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities. The Company adopted SFAS
133 effective January 1, 2001. The adoption of SFAS 133 did not have a
significant impact on the financial position, results of operations, or cash
flows of the Company.
During July 2001, SFAS No. 142, "Goodwill and Other Intangible Assets" was
issued by the Financial Accounting Standards Board. SFAS 142 applies to all
acquired intangible assets whether acquired singly, as part of a group, or in a
business combination. SFAS 142 specifies that goodwill and indefinite lived
intangible assets will no longer be amortized but instead will be subject to
periodic impairment testing. Intangible assets with a determinable useful life
will continue to be amortized over that period. The Company is required to
implement SFAS 142 on January 1, 2002 and it has not determined the impact, if
any, that this statement will have on its consolidated financial position or
results of operations.
In August 2001, the FASB issued a new pronouncement SFAS No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS 144
addresses the financial accounting and reporting issues for the impairment or
disposal of long-lived assets. This statement supersedes SFAS 121 but retains
the fundamental provisions for (a) recognition/measurement of impairment of
long-lived assets to be held and used and (b) measurement of long-lived assets
to be disposed of by sales. It is effective for fiscal years beginning after
6
CAPSTONE TURBINE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 15, 2001, and interim periods within those fiscal years, with early
application encouraged. We are currently evaluating the provisions of SFAS 144
and have not determined the impact, if any, that this statement will have on its
consolidated financial position or results of operations.
4. SEGMENT REPORTING
The Company is considered to be a single operating segment in conformity
with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." The business activities of the operating segment are the
development, manufacture and sale of turbine generator sets. Following is the
geographic revenue information:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -------------------------
2000 2001 2000 2001
---------- ---------- ----------- -----------
North America...................... $4,009,000 $2,277,000 $10,261,000 $16,535,000
Asia............................... 1,867,000 692,000 5,264,000 5,828,000
Europe............................. 321,000 328,000 504,000 1,719,000
South America...................... -- 16,000 -- 989,000
Africa............................. -- 33,000 -- 740,000
---------- ---------- ----------- -----------
Total............................ $6,197,000 $3,346,000 $16,029,000 $25,811,000
========== ========== =========== ===========
5. INVENTORY
Inventory is stated at the lower of standard cost (which approximates
actual cost on the first-in, first-out method) or market.
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ -------------
Raw materials.............................................. $10,133,000 $16,117,000
Work in process............................................ 3,354,000 3,165,000
Finished goods............................................. 636,000 7,699,000
----------- -----------
Total.................................................... $14,123,000 $26,981,000
=========== ===========
6. STOCK-BASED COMPENSATION
During 1999 and 2000, the Company issued common stock options at less than
the fair value of its common stock. Accordingly, the Company recorded
stock-based compensation expense of $488,000 and $357,000 for the three-month
period ended September 30, 2000 and 2001, and $1,239,000 and $1,230,000 for the
nine-month period ended September 30, 2000 and 2001, respectively. Stock-based
compensation expense for the three-month period ended September 30, 2000 was
included in cost of goods sold, research and development and selling, general,
and administrative expenses in the amounts of $11,000, $89,000 and $388,000,
respectively. Stock-based compensation expense for the three-month period ended
September 30, 2001 was included in cost of goods sold, research and development,
and selling, general, and administrative expenses in the amounts of $16,000,
$77,000 and $264,000, respectively. Stock-based compensation expense for the
nine-month period ended September 30, 2000 was included in cost of goods sold,
research and development and selling, general, and administrative expenses in
the amounts of $43,000, $233,000 and $963,000, respectively. Stock-based
compensation expense for the nine-month period ended September 30, 2001 was
included in cost of goods sold, research and development, and selling, general,
and administrative expenses in the amounts of $50,000, $241,000 and $939,000,
respectively.
7
CAPSTONE TURBINE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of September 30, 2001, the Company had $2.1 million in deferred stock
compensation related to stock options, which will be recognized as stock-based
compensation expense through 2004, as the amortization is based on the vesting
period.
7. COMMITMENTS AND CONTINGENCIES
In August 2000, the Company entered into a Transition Agreement and Amended
and Restated License Agreement with a supplier, requiring a total of $9.1
million in upfront payments. Under the terms of the Agreements, the Company
acquired fixed assets and manufacturing technology, which provide the Company
with the ability to manufacture components previously purchased from the
supplier. In February 2001, the Company completed its upfront payments under the
Agreements. The Company is required to pay a per unit royalty fee over a
seventeen-year period.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Financial
Statements and Notes included in this Form 10-Q and Capstone's Annual Report on
Form 10-K for the year ended December 31, 2000. When used in the following
discussion, the words "believes", "anticipates", "intends", "expects" and
similar expressions are intended to identify forward-looking statements. Such
statements are subject to certain risks and uncertainties, which could cause
actual results to differ materially from those projected. These risks include
those identified under "Business Risks" in this Form 10-Q. Readers are cautioned
not to place undue reliance on forward-looking statements, which speak only as
of the date hereof. Forward-looking statements contained in this Form 10-Q speak
only as of its date. We assume no obligation to update any of the forward-
looking statements after the filing of this Form 10-Q to conform such statements
to actual results or to changes in our expectations.
OVERVIEW
Capstone develops, manufactures and markets microturbine technology for use
in stationary, combined heat and power generation, resource recovery, hybrid
electric vehicle, and other power and heat applications in the multi-billion
dollar market for distributed power generation. Our microturbines provide power
at the site of consumption and to hybrid electric vehicles that combine a
primary source battery with an auxiliary power source, such as a microturbine,
to enhance performance. We believe the simple and flexible design of our
microturbines will enable our distributors and end users to develop an
increasingly broad range of applications to fit their particular power needs.
Capstone expects its microturbines to provide the commercial power generation
industry with clean, multifunctional, and scalable distributed power sources.
We began commercial sales of our units in 1998, targeting the emerging
distributed generation industry that is being driven by fundamental changes in
power requirements. We are currently focusing on our sales and marketing
efforts, development of new products, acquisition of intellectual property
rights and manufacturing facility expansion, which will result in higher
operating expenses. We intend to achieve long-run profitability through
production efficiencies and economies of scale. In February 2001, we completed
our upfront payments to acquire intellectual property from a former supplier. In
June 2001, we started to manufacture recuperator cores at our new facility. We
continue working to develop new, higher profit-margin products.
We sell complete microturbine units, subassemblies and components. Our
microturbines can be fueled by various sources including natural gas, propane,
sour gas, kerosene and diesel. We will continue investing significant resources
to develop new products and enhancements, including enhancements that enable
greater kilowatt power production, additional fuel capabilities and additional
distributed power generation solutions such as co-generation applications.
We continue to generate operating losses and we expect to continue to
sustain operating losses through at least fiscal year 2002. Our sales cycles
vary by application and geographic region, and in many cases require long lead
times between identifying customer needs and providing commercially available
solutions. As a result of anticipated increases in our operating expenses
resulting from our expansion and the difficulty in forecasting revenue levels,
we expect our quarterly performance to fluctuate. We are also a young company
and therefore period-to-period comparisons between years may not necessarily be
meaningful.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2000
Revenues. Revenues for the three months ended September 30, 2001 decreased
$2.9 million to $3.3 million compared to $6.2 million for the three months ended
September 30, 2000. During the three months ended September 30, 2001, we shipped
80 units, a decrease of 131 units from the 211 units we shipped in the three
months ended September 30, 2000. During the three months ended September 30,
2001, we shipped 62 units of our 30-kilowatt products and 18 units of our
60-kilowatt products. During the three months
9
ended September 30, 2000, we shipped 210 units of our 30-kilowatt products and
one unit of our 60-kilowatt products.
The decrease in revenues is attributable to several factors that
contributed to the drop-off in demand in the third quarter of 2001 including the
overall deterioration in economic conditions. Given the increased focus by
companies to tighten their capital expenditures, we saw reluctance on the part
of potentially large customers to make the investment required to achieve the
benefits of our microturbines. In addition, the predicted energy shortages in
California have not materialized. In the beginning of the year, widely-held
expectations were that large portions of California would be subject to
brownouts and rolling blackouts, motivating large numbers of businesses to adopt
the clean, blackout protection capabilities of our microturbine systems. This
scenario did not occur to the degree anticipated.
Gross Loss. Cost of goods sold includes direct material costs, assembly
and testing, compensation and benefits, overhead allocations for facilities and
administration, and warranty reserve charges. Our gross loss for the three
months ended September 30, 2001 increased to $2.1 million compared to a gross
loss of $1.1 million for the three months ended September 30, 2000. Gross loss
as a percentage of revenue increased as production overhead costs were allocated
over lesser volumes of production. Costs for replacement parts and systems are
charged against our warranty reserve, which is accrued through charges to cost
of goods sold. The warranty reserve charge decreased $811,000 to $240,000 for
the three months ended September 30, 2001 from $1.1 million for the three months
ended September 30, 2000 as estimated warranty costs have declined based on our
actual warranty cost experience and lesser number of units sold in the three
months ended September 30, 2001.
Research and Development Expenses. Research and development expenses
include compensation, the engineering department overhead allocations for
administration and facilities, and material costs associated with development.
Research and development expenses were primarily for expanding the functionality
of our 60-kilowatt family of products and for next generation products. Research
and development expenses for the three months ended September 30, 2001 decreased
$0.5 million, or 17%, to $2.5 million compared to $3.0 million for the three
months ended September 30, 2000. Research and development expenses for the three
months ended September 30, 2001 are reported net of a $1 million benefit from
cost sharing programs such as the Department of Energy Advanced Microturbine
Program.
Selling, General, and Administrative Expenses. Selling, general, and
administrative expenses include compensation and related expenses in support of
our sales, marketing and general corporate functions, which include human
resources, finance and accounting, information systems and legal services.
Selling, general, and administrative expenses for the three months ended
September 30, 2001 increased $2 million, or 28%, to $9.2 million compared to
$7.2 million for the three months ended September 30, 2000. The Company
continues to expand its selling and marketing efforts through increases in staff
headcount and related overhead expenses, and we anticipate this trend to
continue as we enter into new markets and develop new sales and marketing
programs. In addition, legal expenses increased to support our patent pursuit
efforts.
Interest Income. Interest income, net of interest expense for the three
months ended September 30, 2001 decreased $1.8 million to $1.4 million compared
to $3.2 million for the three months ended September 30, 2000. The decrease is
primarily attributable to lower average investment balances and lower interest
rates in the three months ended September 30, 2001.
NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 2000
Revenues. Revenues for the nine months ended September 30, 2001 increased
$9.8 million to $25.8 million compared to $16 million for the nine months ended
September 30, 2000. The increase in revenues is attributable to greater sales to
a larger customer base, which has resulted from expanding our marketing efforts.
During the nine months ended September 30, 2001, we shipped 808 units, an
increase of 260 units over the 548 units we shipped in the nine months ended
September 30, 2000. During the nine months ended September 30, 2001, we shipped
715 units of our 30-kilowatt products and 93 units of our 60-kilowatt products.
During the nine months ended September 30, 2000, we shipped 547 units of our
30-kilowatt products and one unit of our 60-kilowatt products.
10
Gross Loss. Cost of goods sold includes direct material costs, assembly
and testing, compensation and benefits, overhead allocations for facilities and
administration, and warranty reserve charges. Our gross loss for the nine months
ended September 30, 2001 decreased to $1.2 million compared to $4.6 million for
the nine months ended September 30, 2000. Gross loss as a percentage of revenue
decreased as production overhead costs were allocated over larger volumes of
production. Costs for replacement parts and systems are charged against our
warranty reserve, which is accrued through charges to cost of goods sold. The
warranty reserve charge decreased $2.5 million to $1.6 million for the nine
months ended September 30, 2001 from $4.1 million for the nine months ended
September 30, 2000 as estimated warranty costs have declined based on our actual
warranty cost experience.
Research and Development Expenses. Research and development expenses
include compensation, the engineering department overhead allocations for
administration and facilities, and material costs associated with development.
Research and development expenses were primarily for expanding the functionality
of our 60-kilowatt family of products and for next generation products. Research
and development expenses for the nine months ended September 30, 2001 decreased
$0.2 million, or 3%, to $8.2 million compared to $8.4 million for the nine
months ended September 30, 2000. Research and development expenses for the nine
months ended September 30, 2001 are reported net of a $1.5 million benefit from
cost sharing programs such as the Department of Energy Advanced Microturbine
Program.
Selling, General, and Administrative Expenses. Selling, general, and
administrative expenses include compensation and related expenses in support of
our sales, marketing and general corporate functions, which include human
resources, finance and accounting, information systems and legal services.
Selling, general, and administrative expenses for the nine months ended
September 30, 2001 increased $12.8 million, or 74%, to $30 million compared to
$17.2 million for the nine months ended September 30, 2000. The Company
continues to expand its selling and marketing efforts through increases in staff
headcount and related overhead expenses, and we anticipate this trend to
continue as we enter into new markets and develop new sales and marketing
programs. Of the increase, $2.9 million was attributable to pre-production costs
associated with the Company's core manufacturing and $1.3 million to marketing
rights amortization expense related to the repurchase of marketing rights from
Fletcher Challenge Limited. Marketing rights amortization expense will continue
through 2005, as the expense is being amortized over the original term of the
contract. In addition, legal expenses increased to support our patent pursuit
efforts.
Interest Income. Interest income, net of interest expense for the nine
months ended September 30, 2001 increased $1.9 million to $7.1 million compared
to $5.2 million for the nine months ended September 30, 2000. The increase is
primarily attributable to higher average investment balances due to the funds
received from the Series G preferred stock issuance in February 2000, our
initial public offering in July 2000 and our secondary public offering in
November 2000.
LIQUIDITY AND CAPITAL RESOURCES
Our cash requirements depend on many factors, including our product
development activities, our product expansion and our commercialization efforts.
We expect to continue to devote substantial capital resources to continue the
development of our sales and marketing programs, to hire and train production
staff and to expand our research and development activities. We believe that our
current cash balance of $181.7 million is sufficient to fund operations at least
through 2002.
Accounts receivable increased to $7.6 million as of September 30, 2001
compared to $3.7 million as of December 31, 2000. Accounts receivable included
$1 million from Department of Energy, of which $0.7 million was collected
subsequent to September 30, 2001. We also have about $0.6 million of receivables
from two foreign customers, secured by irrevocable letters of credits. We do not
anticipate any significant bad debt write-offs arising out of our receivables.
Inventory increased to $27 million as of September 30, 2001 compared to
$14.1 million as of December 31, 2000, attributable to an inventory build-up due
to slower-than-anticipated sales. Inventory included $7.7 million of finished
microturbine systems ready for shipment.
11
Equipment and leasehold improvements, net of accumulated depreciation and
amortization, increased to $27.9 million as of September 30, 2001 compared to
$11.6 million as of December 31, 2000. The increase was primarily from leasehold
improvements, tooling and equipment in our new facility in Van Nuys, California.
Deposits on fixed assets decreased to $2 million as of September 30, 2001
compared to $6.6 million as of December 31, 2000 due to the application of down
payments on fixed assets received during 2001.
Deferred revenue decreased to $2.2 million compared to $4.1 million as of
December 31, 2000, attributable to application of deposits from customers on
shipments during the nine months ended September 30, 2001.
Our net cash used in operating activities was $40.5 million for the nine
months ended September 30, 2001 compared to $15.4 million for the nine months
ended September 30, 2000. During the nine months ended September 30, 2001, cash
used in operating activities included a $32.2 million Net Loss, a $12.9 million
increase in inventory and $4.6 million increase in other operating assets and
liabilities, less non cash operating activities of $9.2 million. Net cash used
in investing activities was $15.7 million for the nine months ended September
30, 2001 compared to $22.5 million for the nine months ended September 30, 2000.
Investing activities in 2001 primarily consisted of equipment and tooling
purchases, intangible purchases and leasehold improvements associated with our
recuperator core manufacturing and facility.
Our net cash provided by financing activities was $1 million for the nine
months ended September 30, 2001 compared to $260.8 million for the nine months
ended September 30, 2000. We have financed our operations and investing
activities primarily through private and public equity issuances. The primary
source of our cash and cash equivalents as of September 30, 2001 were provided
by financing activities during 2000 from the issuance of Series G preferred
stock with net proceeds of $120.4 million, the issuance of common stock in our
initial public offering with net proceeds of $153.6 million and the issuance of
common stock in our secondary offering with net proceeds of $19.6 million.
We have invested proceeds from the issuances of securities to provide
liquidity for operations and for capital preservation. In addition, we use
capital lease commitments to sell and leaseback various fixed assets. During the
nine months ended September 30, 2001, we repaid our capital lease obligations in
the amount of $1.0 million. As of September 30, 2001, we had $4.1 million
outstanding under various leases with Transamerica and $5,000 outstanding to
other leasing institutions.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
We do not currently use derivative financial instruments that expose us to
market risk.
FOREIGN CURRENCY
We currently develop products in the United States and market our products
in North America, South America, Asia, Europe and Africa. As a result, factors
such as changes in foreign currency exchange rates or weak economic conditions
in foreign markets could affect our financial results. As all of our sales and
supplies are currently made in U.S. Dollars, we do not utilize foreign exchange
contracts to reduce our exposure to foreign currency fluctuations. In the
future, as our customers and vendor bases expand, we anticipate that we will
enter into transactions that are denominated in foreign currencies.
INTEREST
We have no long-term debt outstanding and do not use any derivative
instruments.
INFLATION
We do not believe that inflation has had a material effect on our financial
position or results of operations. However, we cannot predict the future effects
of inflation, including interest rate fluctuations and market fluctuations.
12
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for
Derivative Instruments and Hedging Activities, is effective for all fiscal years
beginning after June 15, 2000. SFAS 133, as amended, establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. Under SFAS
133, certain contracts that were not formerly considered derivatives may now
meet the definition of a derivative. The Company adopted SFAS 133 effective
January 1, 2001. The adoption of SFAS 133 did not have a significant impact on
the financial position, results of operations, or cash flows of the Company.
During July 2001, SFAS No. 142, "Goodwill and Other Intangible Assets" was
issued by the Financial Accounting Standards Board. SFAS 142 applies to all
acquired intangible assets whether acquired singly, as part of a group, or in a
business combination. SFAS 142 specifies that goodwill and indefinite lived
intangible assets will no longer be amortized but instead will be subject to
periodic impairment testing. Intangible assets with a determinable useful life
will continue to be amortized over that period. The Company is required to
implement SFAS 142 on January 1, 2002 and it has not determined the impact, if
any, that this statement will have on its consolidated financial position or
results of operations.
In August 2001, the FASB issued a new pronouncement SFAS No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS 144
addresses the financial accounting and reporting issues for the impairment or
disposal of long-lived assets. This statement supersedes SFAS 121 but retains
the fundamental provisions for (a) recognition/measurement of impairment of
long-lived assets to be held and used and (b) measurement of long-lived assets
to be disposed of by sales. It is effective for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years, with early
application encouraged. We are currently evaluating the provisions of SFAS 144
and have not determined the impact, if any, that this statement will have on its
consolidated financial position or results of operations.
BUSINESS RISKS
This Form 10-Q and other public statements and announcements made by
Capstone and its representatives from time to time contain or may contain
forward-looking statements, as such term is defined in Section 27A of the
Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the
Exchange Act of 1934, as amended (the "Exchange Act"), pertaining to, among
other things, Capstone's future results of operations, research and development
activities, including the development of our 60-kilowatt unit and our
125-kilowatt unit, sales expectations, sources for parts, federal, state and
local regulations, and general business, industry and economic conditions
applicable to Capstone. These statements are based largely on Capstone's current
expectations and are subject to a number of risks and uncertainties. Actual
results could differ materially from these forward-looking statements. Factors
that can cause actual results to differ materially include, but are not limited
to, those discussed below. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date hereof. The
following factors should be considered in addition to the other information
contained herein in evaluating Capstone and its business. Forward-looking
statements contained in this Form 10-Q speak only as of its date. We assume no
obligation to update any of the forward-looking statements after the filing of
this Form 10-Q to conform such statements to actual results or to changes in our
expectations.
WE HAVE A LIMITED OPERATING HISTORY CHARACTERIZED BY NET LOSSES, WE ANTICIPATE
CONTINUED LOSSES THROUGH AT LEAST 2002 AND WE MAY NEVER BECOME PROFITABLE.
Since our inception in 1988, we have reported net losses for each year. Our
net losses were $30.6 million in 1997, $33.1 million in 1998, $29.5 million in
1999, $31.4 million in 2000 and $32.2 million for the nine months ended
September 30, 2001. We anticipate incurring additional net losses through at
least 2002. Since inception through September 30, 2001, we have recorded
cumulative losses of approximately $180 million. We have only been commercially
producing Capstone MicroTurbines since December 1998 and have made only limited
sales to date. Also, because we are in the early stages of selling our products,
we have relatively few
13
customers. Even if we do achieve profitability, we may be unable to increase our
sales and sustain or increase our profitability in the future.
A MASS MARKET FOR MICROTURBINES MAY NEVER DEVELOP OR MAY TAKE LONGER TO
DEVELOP THAN WE ANTICIPATE, WHICH WOULD ADVERSELY IMPACT OUR REVENUES AND
PROFITABILITY.
Our products represent an emerging market, and we do not know whether our
targeted customers will accept our technology or will purchase our products in
sufficient quantities to grow our business. If a mass market fails to develop or
develops more slowly than we anticipate, we may be unable to recover the losses
we have incurred to develop our products, we may be unable to meet our
operational expenses and we may be unable to achieve profitability. The
development of a mass market for our systems may be impacted by many factors
which are out of our control, including:
- the cost competitiveness of our microturbines;
- the future costs and availability of fuels used by our microturbines;
- consumer reluctance to try a new product;
- consumer perceptions of our microturbines' safety;
- regulatory requirements; and
- the emergence of newer, more competitive technologies and products.
IF WE ARE UNABLE TO MANUFACTURE RECUPERATOR CORES INTERNALLY, OUR ASSEMBLY AND
PRODUCTION OF MICROTURBINES MAY SUFFER DELAYS AND INTERRUPTIONS.
Solar Turbines Incorporated had been our sole supplier of recuperator
cores, which are heat exchangers that preheat incoming air before it enters the
combustion chamber and are an essential component of our microturbines. Solar is
a wholly owned subsidiary of Caterpillar Inc. At present, we are not aware of
any other suppliers that could produce these cores to our specifications within
our time requirements. In September 2000, we exercised contractual rights to
begin using Solar's intellectual property to manufacture recuperator cores. In
June 2001, we started to manufacture recuperator cores. We cannot assure you
that this transition from purchasing recuperator cores to manufacturing them
ourselves will be without disruption. Also, we cannot assure you that Solar will
honor the license agreement, that a court would enforce it, or that we will be
able to meet our obligations under it. If we had to develop and produce our own
recuperator cores without using Solar's intellectual property, we estimate it
could take up to three years to begin production.
WE MAY NOT BE ABLE TO CONTROL OUR WARRANTY EXPOSURE AND OUR WARRANTY RESERVE
MAY NOT BE SUFFICIENT TO MEET OUR WARRANTY EXPENSE, WHICH COULD IMPAIR OUR
FINANCIAL CONDITION.
We sell our products with warranties. However, these warranties vary from
product to product with respect to the time period covered and the extent of the
warranty protection. Malfunctions of our product could expose us to significant
warranty expenses. Because we are in the early stages of production and few of
our products have completed a full warranty term, we cannot be certain that we
have adequately determined our warranty exposure. Moreover, as we develop new
configurations for our microturbines or as our customers place existing
configurations in commercial use for long periods of time, we expect to
experience product malfunctions that cause our products to fall substantially
below our 98% availability target level. While our microturbines have often
achieved this availability target when using high-pressure natural gas, we are
still working to achieve this availability target across all of our units and
for all fuel sources. While management believes that the recorded warranty
reserve is reasonable, there can be no assurance that the reserve will be
sufficient to cover our warranty expenses in the future. Although we attempt to
reduce our risk of warranty claims through warranty disclaimers, we cannot
assure you that our efforts will effectively limit our liability. Any
significant incurrence of warranty expense could have a material adverse effect
on our financial condition.
14
WE MAY NOT BE ABLE TO RETAIN KEY MANAGEMENT AND THE LOSS OF KEY MANAGEMENT
COULD PREVENT EFFECTIVE IMPLEMENTATION OF OUR EXPANSION PLAN.
Our success depends in significant part upon the continued service of key
management personnel, such as Dr. Ake Almgren, our Chief Executive Officer, Mr.
Norman Chambers, our Chief Operating Officer, Mr. Jeffrey Watts, our Chief
Financial Officer and Mr. William Treece, our Senior Vice President of Strategic
Technology Development. Currently, the competition for qualified personnel is
intense and we cannot assure you that we can retain our existing management
team. The loss of Dr. Almgren, Mr. Chambers, Mr. Watts, Mr. Treece or any other
key management personnel could materially adversely affect our operations.
WE MAY NOT BE ABLE TO HIRE AND RETAIN THE TECHNICAL PERSONNEL NECESSARY TO
BUILD OUR PRODUCTS, WHICH COULD DELAY PRODUCT DEVELOPMENT AND LOWER
PRODUCTION.
We have historically experienced, and expect to continue to experience,
delays in filling technical positions. Competition is intense for qualified
technical personnel, and in particular skilled engineers. As a result, we may
not be able to hire and retain engineering personnel that we need. Our failure
to do so could delay product development cycles, affect the quality of our
products, reduce the number of microturbines we can produce and/or otherwise
negatively affect our business.
IF WE DO NOT EFFECTIVELY IMPLEMENT OUR SALES AND MARKETING EXPANSION PROGRAM,
OUR SALES WILL NOT GROW AND OUR PROFITABILITY WILL SUFFER.
We need to increase our internal sales and marketing staff in order to
enhance our sales efforts. We cannot assure you that the expense of such
internal expansion will not exceed the net revenues generated, or that our sales
and marketing team will successfully compete against the more extensive and
well-funded sales and marketing operations of our current and future
competitors. In addition, to grow our sales, we have begun to hire new
management team members to provide more sales and marketing expertise. Since
these management team members will not have a proven track record with us, we
cannot assure you that they will be successful in overseeing their functional
areas. Our inability to recruit, or our loss of, important sales and marketing
personnel, or the inability of new sales personnel to effectively sell and
market our microturbine system could materially adversely affect our business
and results of operations.
Our sales during the third quarter of 2001 were less than we expected.
These trends appear to be continuing into the fourth quarter. As a result, it is
difficult for us to forecast the level of sales that may occur in the fourth
quarter and, if sales during the latter part of the quarter do not once again
substantially exceed the sales early in the quarter, we could experience a
material shortfall relative to our expectations and targets.
THE CALIFORNIA ENERGY SITUATION MAY CHANGE AND NEGATIVELY IMPACT OUR SALES.
Problems associated with deregulation of the electric industry in
California have resulted in intermittent service interruptions, significantly
higher costs in some areas of the state and uncertainty regarding future
regulation. To alleviate these problems, emergency procedures have been
implemented in California to provide for expedited review and approval of the
construction and operation of new power plants in California on favorable terms.
Additional competition from these power plants or other power sources that may
take advantage of favorable legislation as well as unforeseen changes in the
California market could diminish the demand for our products. We cannot assure
you that significant sales will arise from this potential market.
WORLD ECONOMIC FACTORS MAY CHANGE AND NEGATIVELY IMPACT OUR GROWTH AND SALES.
It is predicted that there will be a significant slowdown in growth in the
U.S. economy for the remainder of 2001 and a portion of 2002. As a consequence
of the September 11th terrorist attack on the U.S., and any extended U.S.
recession or worldwide slowdown, we may not be able to expand our customer base
and sales, which would negatively impact our results. As a result of the
economic uncertainty, and a desire by companies to tighten capital expenditures,
we have seen reluctance on the part of potentially large customers to buy our
products. The economic uncertainty, along with fluctuations in energy prices and
political disruptions or higher interest rates could result in weaker than
anticipated business growth and worldwide sales of our products.
15
WE MAY NOT BE ABLE TO ESTABLISH STRATEGIC MARKETING RELATIONSHIPS, IN WHICH
CASE OUR SALES WOULD NOT INCREASE AS EXPECTED.
We are in the early stages of developing our distribution network. In order
to expand our customer base, we believe that we must enter into strategic
marketing alliances or similar collaborative relationships, in which we ally
ourselves with companies that have particular expertise in or more extensive
access to desirable markets. Providing volume price discounts and other
allowances along with significant costs incurred in customizing our products may
reduce the potential profitability of these relationships. We may not be able to
identify appropriate distributors on a timely basis, and we cannot assure you
that the distributors with which we partner will focus adequate resources on
selling our products or will be successful in selling them. In addition, we
cannot assure you that we will be able to negotiate collaborative relationships
on favorable terms or at all. The lack of success of our collaborators in
marketing our products may adversely affect our financial condition and results
of operations.
WE HAVE LIMITED EXPERIENCE IN INTERNATIONAL SALES AND MAY NOT SUCCEED IN
GROWING OUR INTERNATIONAL SALES.
We have limited experience in international sales and will depend on our
international marketing partners for these sales. Most of our marketing
partnerships are recently created and, accordingly, may not achieve the results
that we expect. If a dispute arises between us and any of our partners, we may
not achieve our desired sales results and we may be delayed or completely fail
to penetrate some international markets, and our revenue and operations could be
materially adversely affected. Any inability to obtain foreign regulatory
approvals or quality standard certifications on a timely basis could negatively
impact our business and results of operations. Also, as we seek to expand into
the international markets, customers may have difficulty or be unable to
integrate our products into their existing systems. As a result, our products
may require redesign. In addition, we may be subject to a variety of other risks
associated with international business, including:
- delays in establishing international distribution channels;
- difficulties in collecting international accounts receivables;
- difficulties in complying with foreign regulatory and commercial
requirements;
- increased costs associated with maintaining international marketing
efforts;
- compliance with U.S. Department of Commerce export controls;
- increases in duty rates;
- the introduction of non-tariff trade barriers;
- fluctuations in currency exchange rates;
- political and economic instability; and
- difficulties in enforcement of intellectual property rights.
THE 60-KILOWATT CAPSTONE MICROTURBINE MAY NOT REACH THE LEVEL OF SALES THAT WE
ANTICIPATE OR IT MAY ERODE SALES OF OUR 30-KILOWATT UNIT.
The successful launch of our next generation 60-kilowatt microturbine, the
Capstone 60, is very important to our market penetration strategy. Factors that
could hinder the successful launch of our Capstone 60 microturbine include
potential engineering, production or performance problems, including problems in
developing the ability to operate on multiple fuels or in multiple modes of
operation and an unstable supply or unsatisfactory quality of components from
vendors. We cannot guarantee you that demand for our 60-kilowatt unit will
develop or that if it does develop, that it will not diminish over time. It is
also possible that production of the 60-kilowatt unit could replace or diminish
the sales of our 30-kilowatt unit. If so, our results of operations would be
adversely affected.
16
WE MAY BE UNABLE TO FUND OUR FUTURE OPERATING REQUIREMENTS, WHICH COULD FORCE
US TO CURTAIL OUR OPERATIONS.
We are a capital-intensive company and may need additional financing to
fund our operations. In 2000, our net cash used in operations was $23.8 million
and our net cash used in investing activities totaled $26.9 million. For the
nine months ended September 30, 2001, our net cash used in operations was $40.5
million and our net cash used in investing activities was $15.7 million. As of
September 30, 2001, we had approximately $181.7 million in cash and cash
equivalents on hand. Our future capital requirements will depend on many
factors, including our ability to successfully market and sell our products. To
the extent that the funds we now have on hand are insufficient to fund our
future operating requirements, we will need to raise additional funds, through
further public or private equity or debt financings. These financings may not be
available or, if available, may be on terms that are not favorable to us and
could result in further dilution to our stockholders. Downturns in worldwide
capital markets may also impede our ability to raise additional capital on
favorable terms or at all. If adequate capital were not available to us, we
would likely be required to significantly curtail or possibly even cease our
operations.
WE MAY NOT BE ABLE TO EFFECTIVELY PREDICT OR REACT TO RAPID TECHNOLOGICAL
CHANGES THAT COULD RENDER OUR PRODUCTS OBSOLETE.
The market for our products is characterized by rapidly changing
technologies, extensive research and new product introductions. We believe that
our future success will depend in large part upon our ability to enhance our
existing products and to develop, introduce and market new products. As a
result, we expect to continue to make a significant investment in product
development. We have in the past experienced setbacks in the development of our
products and our anticipated roll out of our products has accordingly been
delayed. If we are unable to develop and introduce new products or enhancements
to our existing products that satisfy customer needs and address technological
changes in target markets in a timely manner, our products will become
noncompetitive or obsolete.
WE MAY NOT BE ABLE TO EFFECTIVELY MANAGE OUR GROWTH OR IMPROVE OUR MANAGEMENT
INFORMATION SYSTEMS, WHICH WOULD IMPAIR OUR PROFITABILITY.
If we are successful in executing our business plan, we will experience
growth in our business that could place a significant strain on our management
and other resources. Our ability to manage our growth will require us to
continue to improve our operational, financial and management information
systems, to implement new systems and to motivate and effectively manage our
employees. We cannot assure you that our management will be able to effectively
manage this growth.
WE MAY NOT EFFECTIVELY EXPAND OUR PRODUCTION CAPABILITIES, WHICH WOULD
NEGATIVELY IMPACT OUR SALES.
We anticipate a significant increase in our business operations, which will
require expansion of our internal and external production capabilities. We may
experience delays or problems in our expected production expansion that could
significantly impact our business. Several factors could delay or prevent our
expected production expansion, including our:
- inability to purchase parts or components in adequate quantities or
sufficient quality;
- failure to increase our assembly and test operations;
- failure to hire and train additional personnel;
- failure to develop and implement manufacturing processes and equipment;
- inability to find and train proper partner companies in other countries
with whom we can build product
- distribution, marketing, or development relationships;
17
- inability to manufacture recuperator cores on schedule, in quantities or
with the quality that we require; and
- inability to acquire new space for additional production capacity.
WE MAY NOT ACHIEVE PRODUCTION COST REDUCTIONS NECESSARY TO COMPETITIVELY PRICE
OUR PRODUCT, WHICH WOULD IMPAIR OUR SALES.
We believe that we will need to reduce the unit production cost of our
products over time to maintain our ability to offer competitively priced
products. Our ability to achieve cost reductions will depend on our ability to
develop low cost design enhancements that lower costs, to obtain necessary
tooling and favorable vendor contracts, as well as to increase sales volumes so
we can achieve economies of scale. We cannot assure you that we will be able to
achieve any production cost reductions.
OUR SUPPLIERS AND MANUFACTURERS MAY NOT SUPPLY US WITH A SUFFICIENT AMOUNT OF
COMPONENTS OR COMPONENTS OF ADEQUATE QUALITY, AND WE MAY NOT BE ABLE TO
PRODUCE OUR PRODUCT.
Although we generally attempt to use standard parts and components for our
products, some of our components are currently available only from a single
source or from limited sources. Also, we cannot guarantee that any of the parts
or components that we purchase will be of adequate quality or that the prices we
pay for these parts or components will not increase. For example, there is
currently an industry-wide shortage of several electronic components, some of
which we use in our products. We may experience delays in production of our
Capstone MicroTurbine if we fail to identify alternative vendors, or any parts
supply is interrupted or reduced or there is a significant increase in
production costs, each of which could materially adversely affect our business
and operations.
OUR PRODUCTS INVOLVE A LENGTHY SALES CYCLE AND WE MAY NOT ANTICIPATE SALES
LEVELS APPROPRIATELY, WHICH COULD IMPAIR OUR PROFITABILITY.
The sale of our products typically involves a significant commitment of
capital by customers, with the attendant delays frequently associated with large
capital expenditures. We are targeting, in part, customers in the utility
industry, which generally commit to a larger number of products when ordering
and which have a lengthy process for approving capital expenditures. We have
also targeted the hybrid electric vehicle market, which requires a significant
amount of lead-time due to the implementation costs incurred. For these and
other reasons, the sales cycle associated with our products is typically lengthy
and subject to a number of significant risks over which we have little or no
control. We expect to plan our production and inventory levels based on internal
forecasts of customer demand, which is highly unpredictable and can fluctuate
substantially.
If sales in any period fall significantly below anticipated levels, our
financial condition and results of operations could suffer. In addition, our
operating expenses are based on anticipated sales levels, and a high percentage
of our expenses are generally fixed in the short term. As a result of these
factors, a small fluctuation in timing of sales can cause operating results to
vary from period to period.
WE FACE POTENTIALLY SIGNIFICANT FLUCTUATIONS IN OPERATING RESULTS, WHICH COULD
IMPACT OUR STOCK PRICE.
A number of factors could affect our operating results and thereby impact
our stock price, including:
- the timing of the introduction or enhancement of products by us or our
competitors;
- our reliance on a small number of customers;
- the size, timing and shipment of individual orders;
- market acceptance of new products;
- potential delays in production as a result of the commencement of our
manufacturing of recuperator cores;
- customers delaying orders of our products because of the anticipated
release of new products by us;
18
- changes in our operating expenses, the mix of products sold, or product
pricing;
- the ability of our suppliers to deliver quality parts when we need them;
- development of our direct and indirect sales channels;
- loss of key personnel;
- political unrest or changes in the trade policies, tariffs or other
regulations of countries in which we do business that could lower demand
for our products; and
- changes in market prices for natural resources that could lower the
desirability of our products.
Because we are in the early stages of selling our products, with relatively
few customers, we expect our order flow to continue to be uneven from period to
period. Because a significant portion of our expenses is fixed, a small
variation in the timing of recognition of revenue can cause significant
variations in operating results from quarter to quarter.
POTENTIAL INTELLECTUAL PROPERTY, SHAREHOLDER OR OTHER LITIGATION MAY ADVERSELY
IMPACT OUR BUSINESS.
Because of the nature of our business, we may face litigation relating to
intellectual property matters, labor matters, product liability and shareholder
disputes. Our intellectual property is one of our principal assets. A negative
outcome in a litigation relating to our intellectual property could have a
material adverse effect on our business and operating results. An adverse
judgment could negatively impact the price of our common stock and our ability
to obtain future financing on favorable terms or at all. Any litigation could be
costly, divert management attention or result in increased costs of doing
business.
OUR COMPETITORS, WHO HAVE SIGNIFICANTLY GREATER RESOURCES THAN WE HAVE, MAY BE
ABLE TO ADAPT MORE QUICKLY TO NEW OR EMERGING TECHNOLOGIES OR TO DEVOTE
GREATER RESOURCES TO THE PROMOTION AND SALE OF THEIR PRODUCTS, AND WE MAY BE
UNABLE TO COMPETE EFFECTIVELY.
Our competitors include several well-established companies that have
substantially greater resources than we have and that benefit from larger
economies of scale and worldwide presence. NREC (Ingersoll-Rand Company), and
Elliot are domestically based competitors of Capstone who we believe have
microturbines in various stages of development. NREC (Ingersoll-Rand Company)
has announced that it expects to begin to commercially ship microturbine units
in 2001. In addition to these domestic microturbine competitors, AB Volvo and
ABB Ltd. have a joint venture in Europe, called Turbec, to develop a
microturbine. A number of other major automotive and industrial companies have
in-house microturbine development efforts, including Ishikawajima-Harima Heavy
Industries, Mitsubishi Heavy Industries, Ltd. and Turbo Genset Inc. We believe
that all of these companies will eventually have products that will compete with
our microturbines. Some of our competitors are currently developing and testing
microturbines which they expect to produce greater amounts of power than
Capstone MicroTurbines, ranging from 75 kilowatts up to 350 kilowatts, and which
may have longer useful lives than Capstone MicroTurbines. Capstone MicroTurbines
also compete with other existing technologies, including the electric utility
grid, reciprocating engines, fuel cells, and solar and wind powered systems.
Many of the competitors producing these technologies also have greater resources
than we have. For instance, reciprocating engines are produced by, among others,
Caterpillar Inc., Interstate companies and Cummins Inc. We cannot assure you
that the market for distributed power generation products will not ultimately be
dominated by technologies other than ours.
Because of greater resources, some of our competitors may be able to adapt
more quickly to new or emerging technologies and changes in customer
requirements, or to devote greater resources to the promotion and sale of their
products than we can. We believe that developing and maintaining a competitive
advantage will require continued investment by us in product development,
manufacturing capability and sales and marketing. We cannot assure you that we
will have sufficient resources to make the necessary investments to do so. In
addition, current and potential competitors have established or may in the
future establish collaborative relationships among themselves or with third
parties, including third parties with whom we have
19
strategic relationships. Accordingly, new competitors or alliances may emerge
and rapidly acquire significant market share.
WE OPERATE IN A HIGHLY COMPETITIVE MARKET AND MAY NOT BE ABLE TO COMPETE
EFFECTIVELY DUE TO FACTORS AFFECTING THE MARKET FOR OUR PRODUCTS.
The market for our products is highly competitive and is changing rapidly.
We believe that the primary competitive factors affecting the market for our
products include:
- operating efficiency;
- reliability;
- product quality and performance;
- life cycle costs;
- development of new products and features;
- quality and experience of sales, marketing and service organizations;
- availability and price of fuel;
- product price;
- emissions levels;
- name recognition; and
- quality of distribution channels.
Several of these factors are outside our control. We cannot assure you that
we will be able to compete successfully in the future with respect to these or
any other competitive factors.
UTILITY COMPANIES COULD PLACE BARRIERS TO OUR ENTRY INTO THE MARKETPLACE AND
WE MAY NOT BE ABLE TO EFFECTIVELY SELL OUR PRODUCT.
Utility companies commonly charge fees to industrial customers for
disconnecting from the grid, for using less electricity, or for having the
capacity to use power from the grid for back-up purposes. These types of fees
could increase the cost to our potential customers of using our systems and
could make our systems less desirable, thereby harming our revenue and
profitability.
WE DEPEND ON OUR INTELLECTUAL PROPERTY TO MAKE OUR PRODUCTS COMPETITIVE AND IF
WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, OUR BUSINESS WILL SUFFER.
We rely on a combination of patent, trade secret, copyright and trademark
law, and nondisclosure agreements to establish and protect our intellectual
property rights in our products. At September 30, 2001, we possessed 45 United
States patents and 15 international patents and additional patents pending. In
particular, we believe that our patents and patents pending for our air-bearing
systems, digital power controller and our combustion systems are key to our
business. We believe that, due to the rapid pace of technological innovation in
turbine products, our ability to establish and maintain a position among the
technology leaders in the industry depends on both our patents and other
intellectual property and the skills of our development personnel. We cannot
assure you that any patent, trademark, copyright or license owned or held by us
will not be invalidated, circumvented or challenged, that the rights granted
thereunder will provide competitive advantages to us or that any of our future
patent applications will be issued with the scope of the claims asserted by us,
if at all. Further, we cannot assure you that third parties or competitors will
not develop technologies that are similar or superior to our technology,
including our air bearing technology, duplicate our technology or design around
our patents. Also, another party may be able to reverse engineer our technology
and discover our intellectual property and trade secrets. We may be subject to
or may initiate proceedings in the U.S. Patent and Trademark Office, which can
require significant financial and management resources. In
20
addition, the laws of foreign countries in which our products are or may be
developed, manufactured or sold may not protect our products and intellectual
property rights to the same extent as the laws of the United States. Our
inability to protect our intellectual property adequately could have a material
adverse effect on our financial condition or results of operations.
IF WE ARE FOUND TO INFRINGE UPON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS,
WE MAY NOT BE ABLE TO PRODUCE OUR PRODUCTS OR MAY HAVE TO ENTER INTO COSTLY
LICENSE AGREEMENTS.
Third parties may claim infringement by us with respect to past, current or
future proprietary rights. In particular, Honeywell (AlliedSignal), Sundstrand
Corporation and Solar Turbines Incorporated have patents in areas related to our
business and core technologies. Any infringement claim, whether meritorious or
not, could be time-consuming, result in costly litigation or arbitration and
diversion of technical and management personnel or require us to develop
non-infringing technology or to enter into royalty or licensing agreements.
Royalty or licensing agreements, if required, may not be available on terms
acceptable to us, or at all, and could significantly harm our business and
operating results. Litigation may also be necessary in the future to enforce our
patent or other intellectual property rights, to protect our trade secrets and
to determine the validity and scope of proprietary rights of others. For
example, in 1997, we were involved in a dispute with Honeywell (AlliedSignal)
regarding various disputed intellectual property rights. We entered into a
settlement agreement regarding these issues. These types of disputes could
result in substantial costs and diversion of resources and could materially
adversely affect our financial condition and results of operations.
WE OPERATE IN A HIGHLY REGULATED BUSINESS ENVIRONMENT AND CHANGES IN
REGULATION COULD IMPOSE COSTS ON US OR MAKE OUR PRODUCTS LESS ECONOMICAL.
Our products are subject to federal, state, local and foreign laws and
regulations, governing, among other things, emissions to air as well as laws
relating to occupational health and safety. Regulatory agencies may impose
special requirements for implementation and operation of our products (e.g.
connection with the electric grid) or may significantly impact or even eliminate
some of our target markets. We may incur material costs or liabilities in
complying with government regulations. In addition, potentially significant
expenditures could be required in order to comply with evolving environmental
and health and safety laws, regulations and requirements that may be adopted or
imposed in the future. Furthermore, our potential utility customers must comply
with numerous laws and regulations. The deregulation of the utility industry may
also create challenges for our marketing efforts. For example, as part of
electric utility deregulation, federal, state and local governmental authorities
may impose transitional charges or exit fees, which would make it less
economical for some potential customers to switch to our products. Further, our
ability to penetrate the Japanese market will depend on our receipt of approvals
and changes to regulatory requirements surrounding power generation by Japan's
Ministry of International Trade and Industry, or MITI. We can provide no
assurances that we will be able to obtain these approvals and changes in a
timely manner, or at all.
THE MARKET PRICE OF OUR COMMON STOCK IS HIGHLY VOLATILE AND MAY DECLINE
REGARDLESS OF OUR OPERATING PERFORMANCE.
The market price of our common stock is highly volatile. Factors that could
cause fluctuation in our stock price may include, among other things:
- actual or anticipated variations in quarterly operating results;
- changes in financial estimates by securities analysts;
- conditions or trends in our industry;
- changes in the market valuations of other technology companies;
- the listing for trading of options on our common stock;
- announcements by us or our competitors of significant acquisitions,
strategic partnerships, divestitures, joint ventures or other strategic
initiatives;
21
- capital commitments;
- additions or departures of key personnel; and
- sales of common stock.
Many of these factors are beyond our control. These factors may cause the
market price of our common stock to decline, regardless of our operating
performance.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On July 5, 2000, we completed the initial public offering of our common
stock. The shares of common stock sold in the offering were registered under the
Securities Act on a Registration Statement on Form S-1/A (No. 333-33024). The
Securities and Exchange Commission declared the Registration Statement effective
on June 28, 2000.
In our initial public offering, we sold an aggregate of 10,454,545 shares
our common stock for net proceeds of approximately $153.6 million. Since our
initial public offering, we have used from the general corporate funds, which
includes proceeds from a previous offering of the Series G preferred stock,
approximately $23 million to purchase tooling and manufacturing equipment, $11
million to repurchase marketing rights and $55 million to fund operating
activities, including sales and marketing and research and development. As of
September 30, 2001, remaining net proceeds from the offering were primarily held
in cash equivalents. With the exception of marketing rights acquired from
Fletcher Challenge Limited, none of the net proceeds of the offering were paid,
directly or indirectly, to any director or officer of Capstone or any of their
associates, or to persons owning ten percent or more of any class of our equity
securities, or any affiliates.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K:
(a) Index to Exhibits.
The following exhibits are incorporated by reference into this Form 10-Q:
None
(b) Reports on Form 8-K.
None
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
CAPSTONE TURBINE CORPORATION
BY: /s/ JEFFREY WATTS
------------------------------------
Jeffrey Watts,
Senior Vice President Finance and
Administration and Chief Financial
Officer
Date: November 13, 2001
23