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 June 30, 2003
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
Delaware (State or other jurisdiction of incorporation or organization) |
95-4180883 (I.R.S. Employer Identification No.) |
21211 Nordhoff Street, Chatsworth, California 91311
(Address of principal executive offices and zip code)
818-734-5300
(Registrants 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]
The number of outstanding shares of the registrants common stock as of June 30, 2003 was 81,257,247.
1
CAPSTONE TURBINE CORPORATION
INDEX
Page | ||||
Number | ||||
PART I FINANCIAL INFORMATION | ||||
Item 1. | Consolidated Financial Statements (Unaudited) | |||
Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002 | 3 | |||
Consolidated Statements of Operations for the Three Months and Six Months Ended June 30, 2003 and June 30, 2002 | 4 | |||
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2003 and June 30, 2002 | 5 | |||
Notes to Consolidated Financial Statements | 6 | |||
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations | 10 | ||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 12 | ||
Item 4. | Controls and Procedures | 12 | ||
PART II OTHER INFORMATION | ||||
Item 1. | Legal Proceedings | 13 | ||
Item 4. | Submission of Matters to a Vote of Security Holders | 13 | ||
Item 5. | Other Information Business Risks | 14 | ||
Item 6. | Exhibits and Reports on Form 8-K | 23 | ||
Signatures | 25 |
2
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
CAPSTONE TURBINE CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, | December 31, | |||||||||||
2003 | 2002 | |||||||||||
Assets |
||||||||||||
Current Assets: |
||||||||||||
Cash and cash equivalents |
$ | 126,369,000 | $ | 140,310,000 | ||||||||
Accounts receivable, net of allowance for doubtful accounts and sales returns of $589,000 at
June 30, 2003 and $194,000 at December 31, 2002 |
2,983,000 | 4,893,000 | ||||||||||
Inventory |
13,299,000 | 9,124,000 | ||||||||||
Prepaid expenses and other current assets |
2,484,000 | 2,331,000 | ||||||||||
Total current assets |
145,135,000 | 156,658,000 | ||||||||||
Equipment and Leasehold Improvements: |
||||||||||||
Machinery, equipment, and furniture |
23,157,000 | 22,996,000 | ||||||||||
Leasehold improvements |
8,482,000 | 8,480,000 | ||||||||||
Molds and tooling |
4,281,000 | 4,350,000 | ||||||||||
35,920,000 | 35,826,000 | |||||||||||
Less accumulated depreciation and amortization |
17,442,000 | 15,346,000 | ||||||||||
Total equipment and leasehold improvements, net |
18,478,000 | 20,480,000 | ||||||||||
Non-Current Portion of Inventory |
1,147,000 | 6,784,000 | ||||||||||
Intangible Asset, net |
1,894,000 | 2,029,000 | ||||||||||
Other Assets |
500,000 | 1,240,000 | ||||||||||
Total |
$ | 167,154,000 | $ | 187,191,000 | ||||||||
Liabilities and Stockholders Equity |
||||||||||||
Current Liabilities: |
||||||||||||
Accounts payable |
$ | 1,675,000 | $ | 4,321,000 | ||||||||
Accrued salaries and wages |
1,648,000 | 2,088,000 | ||||||||||
Other accrued liabilities |
1,496,000 | 1,132,000 | ||||||||||
Accrued warranty reserve |
6,785,000 | 6,913,000 | ||||||||||
Deferred revenue |
1,252,000 | 734,000 | ||||||||||
Current portion of capital lease obligations |
1,253,000 | 1,522,000 | ||||||||||
Total current liabilities |
14,109,000 | 16,710,000 | ||||||||||
Long-Term Portion of Capital Lease Obligations |
502,000 | 974,000 | ||||||||||
Other Long-Term Liabilities |
1,199,000 | 1,325,000 | ||||||||||
Commitments and Contingencies |
| | ||||||||||
Stockholders Equity: |
||||||||||||
Common stock, $.001 par value; 415,000,000 shares authorized; 81,808,455 shares issued
and 81,257,247 shares outstanding at June 30, 2003; 81,635,035 shares issued
and 81,437,822 shares outstanding at December 31, 2002 |
82,000 | 82,000 | ||||||||||
Additional paid-in capital |
527,454,000 | 526,952,000 | ||||||||||
Accumulated deficit |
(375,679,000 | ) | (358,646,000 | ) | ||||||||
Less Treasury stock, at cost; 551,208 shares at June 30, 2003;
197,213 shares at December 31, 2002 |
(513,000 | ) | (206,000 | ) | ||||||||
Total stockholders equity |
151,344,000 | 168,182,000 | ||||||||||
Total |
$ | 167,154,000 | $ | 187,191,000 | ||||||||
See accompanying notes to consolidated financial statements.
3
CAPSTONE TURBINE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three | Six | |||||||||||||||||
Months Ended | Months Ended | |||||||||||||||||
June 30, | June 30, | |||||||||||||||||
2003 | 2002 | 2003 | 2002 | |||||||||||||||
Revenues |
$ | 4,132,000 | $ | 7,408,000 | $ | 6,914,000 | $ | 11,999,000 | ||||||||||
Cost of Goods Sold |
6,739,000 | 11,631,000 | 11,695,000 | 19,180,000 | ||||||||||||||
Gross Loss |
(2,607,000 | ) | (4,223,000 | ) | (4,781,000 | ) | (7,181,000 | ) | ||||||||||
Operating Expenses: |
||||||||||||||||||
Research and development |
2,450,000 | 1,619,000 | 3,456,000 | 3,058,000 | ||||||||||||||
Selling, general and administrative |
4,676,000 | 9,650,000 | 9,497,000 | 18,010,000 | ||||||||||||||
Impairment loss on Marketing Rights |
| 15,999,000 | | 15,999,000 | ||||||||||||||
Total operating costs and expenses |
7,126,000 | 27,268,000 | 12,953,000 | 37,067,000 | ||||||||||||||
Loss from Operations |
(9,733,000 | ) | (31,491,000 | ) | (17,734,000 | ) | (44,248,000 | ) | ||||||||||
Interest Income |
400,000 | 756,000 | 839,000 | 1,579,000 | ||||||||||||||
Interest Expense |
(64,000 | ) | (105,000 | ) | (137,000 | ) | (219,000 | ) | ||||||||||
Other Income (Expense), net |
(1,000 | ) | 5,000 | 1,000 | 25,000 | |||||||||||||
Loss Before Income Taxes |
(9,398,000 | ) | (30,835,000 | ) | (17,031,000 | ) | (42,863,000 | ) | ||||||||||
Provision for Income Taxes |
| | 2,000 | 2,000 | ||||||||||||||
Net Loss |
$ | (9,398,000 | ) | $ | (30,835,000 | ) | $ | (17,033,000 | ) | $ | (42,865,000 | ) | ||||||
Weighted Average Common Shares Outstanding |
81,231,192 | 77,453,602 | 81,289,027 | 77,420,588 | ||||||||||||||
Net Loss Per Share of Common Stock Basic and Diluted |
$ | (0.12 | ) | $ | (0.40 | ) | $ | (0.21 | ) | $ | (0.55 | ) | ||||||
See accompanying notes to consolidated financial statements.
4
CAPSTONE TURBINE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended | ||||||||||||
June 30, | ||||||||||||
2003 | 2002 | |||||||||||
Cash Flows from Operating Activities: |
||||||||||||
Net loss |
$ | (17,033,000 | ) | $ | (42,865,000 | ) | ||||||
Adjustments to reconcile net loss to net cash used in operating activities: |
||||||||||||
Depreciation and amortization |
3,201,000 | 6,229,000 | ||||||||||
Impairment loss on marketing rights |
| 15,999,000 | ||||||||||
Non-cash reversal of administrative expenses |
(1,099,000 | ) | | |||||||||
Provision for doubtful accounts and sales returns |
534,000 | 125,000 | ||||||||||
Inventory write-down |
167,000 | 2,853,000 | ||||||||||
Provision for warranty expenses |
1,441,000 | 1,532,000 | ||||||||||
Loss on disposal of equipment |
188,000 | 86,000 | ||||||||||
Non-employee stock compensation |
7,000 | | ||||||||||
Employee and director stock compensation |
403,000 | 528,000 | ||||||||||
Changes in operating assets and liabilities: |
||||||||||||
Accounts receivable |
1,376,000 | (100,000 | ) | |||||||||
Inventory |
1,295,000 | 2,206,000 | ||||||||||
Prepaid expenses and other current assets |
(153,000 | ) | (1,509,000 | ) | ||||||||
Other assets |
| 100,000 | ||||||||||
Accounts payable |
(1,547,000 | ) | 1,953,000 | |||||||||
Accrued salaries and wages and deferred compensation |
(478,000 | ) | 466,000 | |||||||||
Other accrued liabilities |
276,000 | (145,000 | ) | |||||||||
Accrued warranty reserve |
(1,569,000 | ) | (1,056,000 | ) | ||||||||
Deferred revenue |
518,000 | (409,000 | ) | |||||||||
Net cash used in operating activities |
(12,473,000 | ) | (14,007,000 | ) | ||||||||
Cash Flows from Investing Activities: |
||||||||||||
Acquisition of and deposits on fixed assets |
(561,000 | ) | (1,289,000 | ) | ||||||||
Proceeds from disposal of fixed assets |
26,000 | | ||||||||||
Net cash used in investing activities |
(535,000 | ) | (1,289,000 | ) | ||||||||
Cash Flows from Financing Activities: |
||||||||||||
Repayment of capital lease obligations |
(718,000 | ) | (654,000 | ) | ||||||||
Exercise of stock options and employee stock purchases |
92,000 | 208,000 | ||||||||||
Acquisition of treasury stock |
(307,000 | ) | | |||||||||
Net cash used in financing activities |
(933,000 | ) | (446,000 | ) | ||||||||
Net Decrease in Cash and Cash Equivalents |
(13,941,000 | ) | (15,742,000 | ) | ||||||||
Cash and Cash Equivalents, Beginning of Period |
140,310,000 | 170,868,000 | ||||||||||
Cash and Cash Equivalents, End of Period |
$ | 126,369,000 | $ | 155,126,000 | ||||||||
Supplemental Disclosures of Cash Flow Information: |
||||||||||||
Cash paid during the period for: |
||||||||||||
Interest |
$ | 137,000 | $ | 219,000 | ||||||||
Income taxes |
$ | 2,000 | $ | 2,000 |
See accompanying notes to consolidated financial statements.
5
CAPSTONE TURBINE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. | Business and Organization |
Capstone Turbine Corporation (the Company) develops, manufactures and sells microturbine generator sets for use in combined heat and power generation, resource recovery, hybrid electric vehicles and other power, heat and cooling applications in the markets for distributed power generation around the world. The Company was organized in 1988 and has been commercially producing its microturbine generators 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 and expenses. To date, the Company has funded its activities primarily through private and public equity offerings.
2. | Basis of Presentation |
The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (generally accepted accounting principles) for interim financial information and with the instructions to Form 10-Q and Regulation S-X promulgated under the Securities Exchange Act of 1934. 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, 2002 was derived from audited financial statements included in the Companys Annual Report on Form 10-K for the year ended December 31, 2002. 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, stockholders equity 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 Companys Annual Report on Form 10-K for the year ended December 31, 2002.
3. | New Accounting Pronouncements |
In May 2003, SFAS No. 150, Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity, was issued. The standard establishes how an issuer classifies and measures certain freestanding financial instruments with characteristics of liabilities and equity and requires that such instruments be classified as liabilities. The standard is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of the standard is not expected to have a material impact on the Companys consolidated financial position, results of operations or cash flows.
In April 2003, Statement of Financial Accounting Standards (SFAS) No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, was issued. The standard amends and clarifies financial reporting for derivative instruments and for hedging activities accounted for under SFAS No. 133 and is effective for contracts entered into or modified, and for hedges designated, after June 30, 2003. Adoption of the standard is not expected to have a material impact on the Companys consolidated financial position, results of operations or cash flows.
In January 2003, the Emerging Issues Task Force (EITF) released EITF 00-21: Accounting for Revenue Arrangements with Multiple Deliverables. EITF 00-21 clarifies the timing and recognition of revenue from certain transactions that include the delivery and performance of multiple products or services. EITF 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Alternatively, entities may elect to report the change in accounting as a cumulative-effect adjustment in accordance with APB Opinion 20, Accounting Changes. If so elected, disclosure should be made in periods subsequent to the date of initial application of this consensus of the amount of the recognized revenue that was previously included in the cumulative-effect adjustments. The adoption of EITF 00-21 did not have a material impact on the Companys consolidated financial position or results of operations.
6
CAPSTONE TURBINE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
4. | Inventory |
Inventory is stated at the lower of standard cost (which approximates actual cost on the first-in, first-out method) or market and consists of the following:
June 30, | December 31, | ||||||||
2003 | 2002 | ||||||||
Raw materials |
$ | 10,920,000 | $ | 12,623,000 | |||||
Work in process |
1,989,000 | 1,831,000 | |||||||
Finished goods |
1,537,000 | 1,454,000 | |||||||
Total |
14,446,000 | 15,908,000 | |||||||
Less non-current portion |
1,147,000 | 6,784,000 | |||||||
Current portion |
$ | 13,299,000 | $ | 9,124,000 | |||||
The non-current portion of inventory represents that portion of the inventory in excess of amounts expected to be sold or used in the next twelve months.
5. | Intangible Asset |
The intangible asset represents the license granted to the Company to use a former suppliers intellectual property for the design and manufacture of licensed product for use in microturbines. Additional information is as follows:
June 30, | December 31, | ||||||||
2003 | 2002 | ||||||||
Gross carrying amount |
$ | 3,663,000 | $ | 3,663,000 | |||||
Less accumulated amortization and impairment loss |
1,769,000 | 1,634,000 | |||||||
Net |
$ | 1,894,000 | $ | 2,029,000 | |||||
This intangible asset, which was acquired in 2000, is being amortized over its estimated useful life of ten years. Related amortization expense for the quarter and six-month periods ended June 30, 2003 was $67,000 and $135,000, respectively, compared with $93,000 and $187,000 for the same periods last year. This intangible asset is scheduled to be fully amortized by 2010 with corresponding amortization estimated to be $132,000, $267,000, $267,000, $267,000, $267,000 and $694,000, for the remainder of 2003, calendar years 2004, 2005, 2006 and 2007, and thereafter, respectively.
6. | Stock-Based Compensation |
The following table is presented in accordance with SFAS No. 148 and illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123:
Three Months Ended | Six Months Ended | ||||||||||||||||
June 30, | June 30, | ||||||||||||||||
2003 | 2002 | 2003 | 2002 | ||||||||||||||
In Thousands (except per share amounts) | |||||||||||||||||
Net loss, as reported |
$ | ( 9,398 | ) | $ | (30,835 | ) | $ | (17,033 | ) | $ | (42,865 | ) | |||||
Add: Stock-based employee and director compensation
included in reported net loss |
193 | 263 | 403 | 528 | |||||||||||||
Deduct: Total stock-based employee and director
compensation expense determined under Black-Scholes
Option pricing model |
(1,755 | ) | (2,376 | ) | (3,652 | ) | (4,617 | ) | |||||||||
Pro forma net loss |
$ | (10,960 | ) | $ | (32,948 | ) | $ | (20,282 | ) | $ | (46,954 | ) | |||||
Net loss per share Basic and Diluted: |
|||||||||||||||||
As reported |
$ | (0.12 | ) | $ | (0.40 | ) | $ | (0.21 | ) | $ | (0.55 | ) | |||||
Pro forma |
$ | (0.13 | ) | $ | (0.43 | ) | $ | (0.25 | ) | $ | (0.61 | ) |
7
CAPSTONE TURBINE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
During 1999 and 2000, the Company granted options at less than the fair value of its common stock. Accordingly, the Company recorded stock-based compensation expense based on the vesting of these grants as follows:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||
2003 | 2002 | 2003 | 2002 | ||||||||||||||
Cost of goods sold |
$ | 16,000 | $ | 11,000 | $ | 25,000 | $ | 22,000 | |||||||||
Research and development |
57,000 | 69,000 | 116,000 | 138,000 | |||||||||||||
Selling, general and administrative |
120,000 | 183,000 | 262,000 | 368,000 | |||||||||||||
Total |
$ | 193,000 | $ | 263,000 | $ | 403,000 | $ | 528,000 | |||||||||
As of June 30, 2003, the Company had $293,000 in deferred employee and director stock-based compensation, which will be amortized through 2004 based on the vesting period.
On August 1, 2003, the Company issued 2,000,000 non-qualified common stock options outside of the 2000 Equity Incentive Plan (2000 Plan) at an exercise price of $1.18 per share. In addition, on August 4, 2003, the Company sold 500,000 restricted common stock at a price of $0.001 per share. Both issuances were part of the compensation package for the Companys new President and Chief Executive Officer. Both issuances are subject to the following vesting provisions: 1/4th vests one year after the issuance date and 1/48th vests on the first day of each full month thereafter, so that all shall be vested on the first day of the 48th month after the issuance date; provided, however, that if he is terminated by the Company other than for cause prior to one-year anniversary of the date of the issuance, 1/48th vests on the one-month anniversary of the issuance date until the termination date.
On June 25, 2003, the Company made a tender offer to eligible employees to exchange options with exercise prices greater than or equal to $2.00 per share. 610,950 options were tendered by eligible employees in the exchange offer. The tendered options were cancelled on July 25, 2003, and new options will be granted at least six months and one day from cancellation date, with the new grant date expected to be on January 26, 2004. The terms and conditions of the new options will vary from the terms and conditions of the tendered options in several ways, including (a) the exercise price of the new options will be the closing price of our common stock on the date of the new option grant, (b) each new option will be a non-statutory stock option, even if the tendered option was an incentive stock option, and (c) the vesting schedule of each new option will be as follows: 12.5% of the shares subject to the new option will be vested on the new option grant date, and 1/48 of the shares subject to the new option will vest monthly thereafter, subject to the option holders continued employment through each relevant vesting date.
On March 20, 2003, the Board of Directors approved an amendment to the 2000 Plan to increase the number of shares of common stock available for grant by 2,500,000 shares. The grants under this increase will be non-statutory stock options. As a result of this amendment, the 2000 Plan now provides for awards of up to 6,200,000 shares, plus the number of shares previously authorized and remaining available under the 1993 Incentive Stock Plan (the 1993 Plan), plus any shares covered by options granted under the 1993 Plan that are forfeited or expire unexercised.
7. | Accrued Warranty Reserve |
The following table represents the changes in the product warranty liability for the six months ended June 30, 2003:
Balance, January 1, 2003 |
$ | 6,913,000 | ||
Reductions for payments made in cash or in kind |
(1,523,000 | ) | ||
Changes for accruals related to warranties issued during the period |
821,000 | |||
Changes for accruals related to preexisting warranties |
620,000 | |||
Changes in deferred revenue associated with extended warranties |
(46,000 | ) | ||
Balance, June 30, 2003 |
$ | 6,785,000 | ||
8. | Commitments and Contingencies |
As of June 30, 2003, the Company had firm commitments to purchase inventories of approximately $4,800,000.
In December 2001, a purported shareholder class action lawsuit was filed against the Company, two of its officers, and the underwriters of the Companys initial public offering. The suit purports to be a class action filed on behalf of purchasers of the Companys common stock during the period from June 28, 2000 to December 6, 2000. An amended complaint was filed on April 19, 2002. No date has been set for the Company to respond to the complaint. Plaintiffs allege that the underwriter defendants agreed to allocate stock in the Companys June 28, 2000 initial public offering and November 16, 2000 secondary offering to certain investors in exchange for excessive and undisclosed commissions and agreements by those investors to make additional purchases of stock in the aftermarket at pre-determined prices. Plaintiffs allege that the prospectuses for these two public offerings were false and misleading in violation of the securities laws because they did not disclose these arrangements. A committee of the Companys Board of Directors conditionally approved a proposed partial settlement with the plaintiffs in this matter. The settlement would provide, among other things, a release of the Company and of the individual defendants for the conduct alleged in the action to be wrongful in the Amended Complaint. The Company would agree to undertake other responsibilities under the partial settlement, including agreeing to assign away, not assert, or release certain potential claims the Company may have against its underwriters. Any direct financial impact of the proposed
8
CAPSTONE TURBINE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
settlement is expected to be borne by the Companys insurers. The committee agreed to approve the settlement subject to a number of conditions, including the participation of a substantial number of other Issuer Defendants in the proposed settlement, the consent of the Companys insurers to the settlement, and the completion of acceptable final settlement documentation. Furthermore, the settlement is subject to a hearing on fairness and approval by the Court.
The Company is a defendant in a breach of contract lawsuit, brought by a party that conducts business with the Company, claiming damages in excess of $10 million. The Company intends to vigorously defend against this lawsuit. As with any litigation, the ultimate outcome of this lawsuit is uncertain.
9. | Related Party Transactions |
Mr. Eliot Protsch, the Chairman of the Companys Board of Directors, is the President of Alliant Energy-Interstate Power and Light, and Executive Vice-President of Energy Delivery at Alliant Energy Corporation. Alliant Energy Resources, Inc., a subsidiary of Alliant Energy Corporation, is a distributor for the Company. Sales to Alliant Energy Resources, Inc. for the quarter and six-month periods ended June 30, 2003 were $25,000 and $25,000, respectively, compared with $1,434,000 and $1,434,000 under a firm purchase contract for the same periods last year.
10. | Selling, General and Administrative Expenses |
As a result of a settlement agreement with a professional services firm, liabilities for $1,099,000 of administrative expenses recorded in prior years were reversed in the first quarter of 2003.
11. | Net Loss Per Common Share |
Basic loss per common share is computed using the weighted-average number of common shares outstanding for the period. The impact of common stock options has not been included in the computation of diluted loss per common share as their inclusion would have had an anti-dilutive effect on the per-share amounts for the periods presented; therefore, diluted loss per common share is equal to basic loss per common share. Outstanding stock options at June 30, 2003 and 2002 of 9.8 million and 7.9 million, respectively, were excluded because the effect would be anti-dilutive.
9
Item 2. Managements 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 within the Companys Annual Report on Form 10-K for the year ended December 31, 2002. When used in the following discussion, the words believes, anticipates, intends, expects, plans 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 Other Information - Business Risks in Item 5 of this Form 10-Q. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. We undertake no obligation to revise or update publicly 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.
Critical Accounting Policies
The preparation of the Companys financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Management believes the most complex and sensitive judgments, because of their significance to the consolidated financial statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Managements Discussion and Analysis and Note 2 to the Consolidated Financial Statements in the Companys Annual Report on Form 10-K for the year ended December 31, 2002, describe the significant accounting policies used in preparation of the Consolidated Financial Statements. Actual results could differ from managements estimates. There have been no significant changes in the Companys critical accounting policies during the six months ended June 30, 2003.
Results of Operations
Quarters Ended June 30, 2003 and 2002
Revenues. Revenues for the quarter ended June 30, 2003 decreased $3.3 million to $4.1 million from $7.4 million for the same period last year. Revenues from product shipments for the quarter decreased $2.1 million to $3.5 million from $5.6 million last year. Shipments during the quarter of 4.7 megawatts consisted of 60 units of C30 products and 48 units of C60 products, compared with 7.4 megawatts consisting of 165 units of C30 products and 41 units of C60 products for the same period last year. Revenues from accessories, parts and service for the quarter ended June 30, 2003 decreased $0.4 million to $1.4 million from $1.8 million for the same period last year. Revenues are reported net of sales returns and allowances.
Sales to four customers accounted for approximately 65% of revenues for the second quarter of 2003, compared with 41% of revenues coming from three customers for the same period last year. Each of these customers accounted for 10% or more of revenues.
We exited the period with 5.1 megawatts of outstanding orders scheduled for shipment mostly during the third quarter of 2003.
Gross Loss. We had a gross loss of $2.6 million for the quarter ended June 30, 2003, compared with $4.2 million for the same period last year. The change in gross loss was largely attributable to a $1.8 million charge for excess inventories recorded in the second quarter of 2002, $0.4 million lower production overhead in the current period, a net charge of $0.4 million for sales returns and allowances in the current quarter and higher warranty charges offset by lower charge for inventory scrap.
Our cost of goods sold has exceeded revenues each period. We expect this trend to continue until such time that we can sell a sufficient number of units to achieve a break-even margin.
Research and Development (R&D) Expenses. R&D expenses were $2.4 million for the quarter ended June 30, 2003, compared to $1.6 million for the same period last year. R&D expenses are reported net of benefits from cost sharing programs. These benefits were $0.1 million for the quarter ended June 30, 2003, compared with $1.3 million for the same period last year. The benefits from cost sharing programs vary from period-to-period due to timing of allocation of funds from the government. Our gross R&D spending for the second quarter of this year was $0.4 million lower than our gross R&D spending for the same period a year ago.
Selling, General, and Administrative (SG&A) Expenses and Impairment Loss. SG&A expenses for the quarter ended June 30, 2003 decreased $5.0 million to $4.7 million, compared with $9.7 million for the same period last year. Overall spending was lower in 2003 as a result of our actions to reduce our cost structure. Also, there was no amortization expense from marketing rights in the quarter ended June 30, 2003, compared with $1.3 million for the same period last year. The marketing rights were fully impaired at the
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end of the second quarter of 2002. An impairment loss of $16.0 million, representing the remaining carrying value of the marketing rights, was recorded in the second quarter of 2002.
Interest Income. Interest income decreased $0.4 million to $0.4 million for the quarter ended June 30, 2003, compared with $0.8 million for the same period last year. The decrease was primarily attributable to lower cash balances and lower interest rates. We expect decreasing cash balances from our use of funds will continue to diminish our interest income.
Six Months Ended June 30, 2003 and 2002
Revenues. Revenues for the six months ended June 30, 2003 decreased $5.1 million to $6.9 million from $12.0 million for the same period last year. Revenues from product shipments for the six months ended June 30, 2003 decreased $4.5 million to $4.9 million from $9.4 million last year. Shipments during the first six months of 2003 consisted of 92 units of C30 products and 54 units of C60 products, compared with 264 units of C30 products and 69 units of C60 products for the same period last year. Revenues from accessories, parts and service for the six months ended June 30, 2003 increased $0.2 million to $2.8 million from $2.6 million for the same period last year. Revenues are reported net of sales returns and allowances. Sales to four customers, which individually accounted for 10% or more of revenues, accounted for approximately 55% of revenues in each of the six-month periods.
Gross Loss. We had a gross loss of $4.8 million for the six months ended June 30, 2003, compared with $7.2 million for the same period last year. The change in gross loss was largely attributable to a $1.8 million charge for excess inventories last year and $0.9 million lower charge for inventory scrap in the first six months of 2003.
R&D Expenses. R&D expenses were $3.5 million for the six months ended June 30, 2003, compared to $3.1 million for the same period last year. R&D expenses are reported net of benefits from cost sharing programs. These benefits were $1.8 million for the six months ended June 30, 2003, compared with $2.6 million for the same period last year. The benefits from cost sharing programs vary from period-to-period due to timing of allocation of funds from the government. Our gross R&D spending for the first six months of this year was $0.4 million lower than last year.
SG&A Expenses and Impairment Loss. SG&A expenses for the six months ended June 30, 2003 decreased $8.5 million to $9.5 million, compared with $18.0 million for the same period last year. Overall spending was lower in 2003 as a result of our actions to reduce our cost structure. Other factors include:
| There was no amortization expense from marketing rights in the first six months of 2003, compared with $2.6 million for the same period last year. An impairment loss of $16.0 million, representing the remaining carrying value of the marketing rights, was recorded in the second quarter of 2002. | ||
| As a result of a settlement agreement with a professional services firm, liabilities for $1.1 million of administrative expenses recorded in prior years were reversed in the first quarter of 2003. |
Interest Income. Interest income decreased $0.8 million to $0.8 million for the six months ended June 30, 2003, compared with $1.6 million for the same period last year. The decrease was primarily attributable to the lower cash balances and lower interest rates.
Liquidity and Capital Resources
Our cash requirements depend on many factors, including our product development activities and our commercialization efforts. While we are working to reduce our cash usage, we expect to continue to devote substantial capital resources to running our business, including continuing the development of our sales and marketing programs and continuing our R&D activities. We have invested our cash in an institutional fund that invests in high quality short-term money market instruments to provide liquidity for operations and for capital preservation.
We used cash of $13.9 million during six months ended June 30, 2003, compared with $15.7 million for the same period last year.
Our net cash used in operating activities was $12.5 million for the first six months of 2003, compared with $14.0 million for the same period last year. This decrease of $1.5 million was from a $3.3 million lower net loss, adjusted on a cash basis, offset by a $1.8 million higher use for working capital.
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Accounts receivable decreased $1.9 million to $3.0 million as of June 30, 2003 from $4.9 million as of December 31, 2002, as a result of improved collections. Total inventory decreased $1.5 million to $14.4 million as of June 30, 2003 from $15.9 million as of December 31, 2002. At June 30, 2003, non-current inventory of $1.1 million represents that portion of the inventory in excess of amounts expected to be sold or used in the next twelve months. As of June 30, 2003, the Company had firm commitments to purchase inventories of approximately $4.8 million.
Net cash used in investing activities for acquisition of fixed assets was $0.6 million for the six months ended June 30, 2003, compared to $1.3 million for the same period last year.
Our net cash used in financing activities of $0.9 million for the six months ended June 30, 2003, compared to $0.4 million for the same period last year primarily due to purchases of treasury stock of $0.3 million this year. In October 2002, the Companys Board of Directors approved a stock repurchase program under which the Company may purchase up to $10 million of the Companys common stock. The Company may purchase shares from time to time through open market and privately negotiated transactions at prices deemed appropriate by management. The program has no termination date. Since the inception of the program, we have repurchased 551,208 shares for an aggregate price of $0.5 million.
There have been no material changes in the Companys remaining commitments under non-cancelable operating leases and capital leases as disclosed in the Companys Annual Report on Form 10-K for the year ended December 31, 2002.
Impact of Recently Issued Accounting Standards
In May 2003, SFAS No. 150, Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity was issued. The standard establishes how an issuer classifies and measures certain freestanding financial instruments with characteristics of liabilities and equity and requires that such instruments be classified as liabilities. The standard is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. Adoption of the standard is not expected to have a material impact on the Companys consolidated financial position, results of operations or cash flows.
In April 2003, Statement of Financial Accounting Standards (SFAS) No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities was issued. The standard amends and clarifies financial reporting for derivative instruments and for hedging activities accounted for under SFAS No. 133 and is effective for contracts entered into or modified, and for hedges designated, after June 30, 2003. Adoption of the standard is not expected to have a material impact on the Companys consolidated financial position, results of operations or cash flows.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
No material changes have occurred in the quantitative and qualitative market risk disclosure of the Company as presented in its Annual Report on Form 10-K for the year ended December 31, 2002.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
An evaluation was performed under the supervision and with the participation of our management team, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, have concluded that our disclosure controls and procedures were effective as of June 30, 2003 to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
Changes in Internal Controls
There were no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2003, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II OTHER INFORMATION
Item 1. Legal Proceedings
In December 2001, a purported shareholder class action lawsuit was filed against the Company, two of its officers, and the underwriters of our initial public offering. The suit purports to be a class action filed on behalf of purchasers of our common stock during the period from June 28, 2000 to December 6, 2000. An amended complaint was filed on April 19, 2002. No date has been set for the Company to respond to the complaint. Plaintiffs allege that the underwriter defendants agreed to allocate stock in the Companys June 28, 2000 initial public offering and November 16, 2000 secondary offering to certain investors in exchange for excessive and undisclosed commissions and agreements by those investors to make additional purchases of stock in the aftermarket at pre-determined prices. Plaintiffs allege that the prospectuses for these two public offerings were false and misleading in violation of the securities laws because they did not disclose these arrangements. A committee of the Companys Board of Directors conditionally approved a proposed partial settlement with the plaintiffs in this matter. The settlement would provide, among other things, a release of the Company and of the individual defendants for the conduct alleged in the action to be wrongful in the Amended Complaint. The Company would agree to undertake other responsibilities under the partial settlement, including agreeing to assign away, not assert, or release certain potential claims the Company may have against its underwriters. Any direct financial impact of the proposed settlement is expected to be borne by the Companys insurers. The committee agreed to approve the settlement subject to a number of conditions, including the participation of a substantial number of other Issuer Defendants in the proposed settlement, the consent of the Companys insurers to the settlement, and the completion of acceptable final settlement documentation. Furthermore, the settlement is subject to a hearing on fairness and approval by the Court.
The Company is a defendant in a breach of contract lawsuit, brought by a party that conducts business with the Company, claiming damages in excess of $10 million. The Company intends to vigorously defend against this lawsuit. As with any litigation, the ultimate outcome of this lawsuit is uncertain.
Item 4. Submission of Matters to a Vote of Security Holders
(a) | The annual meeting of stockholders of the Company was held on May 30, 2003. | ||
(b) | All director nominees were elected. | ||
(c) | Certain matters voted upon at the meeting and the votes cast with respect to such matters are as follows: |
Votes Cast | ||||||||||||||||
Broker | ||||||||||||||||
For | Against | Abstain | Non-votes | |||||||||||||
Management Proposals: |
||||||||||||||||
Proposal to approve an amendment to the Companys Certificate of Incorporation to authorize a reverse stock split within the range from one-for-five to one-for-twenty | 58,492,777 | 2,523,916 | 113,761 | -0- | ||||||||||||
Election of Directors |
Director | For | Withheld | ||||||
Eliot Protsch |
53,552,677 | 7,577,777 | ||||||
Richard Donnelly |
58,974,480 | 2,155,974 | ||||||
John Jaggers |
59,075,931 | 2,054,523 | ||||||
Jean-Rene Marcoux |
59,220,756 | 1,909,698 | ||||||
John G. McDonald |
59,725,352 | 1,405,102 | ||||||
Eric Young |
58,848,352 | 2,282,102 |
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Item 5. Other Information-Business Risks
This document contains certain 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 Securities Exchange Act of 1934, as amended (the Exchange Act)) pertaining to, among other things, Capstones future results of operations, R&D activities, sales expectations, our ability to develop markets for our products, sources for parts, federal, state and local regulations, and general business, industry and economic conditions applicable to Capstone. These statements are based largely on Capstones current expectations, estimates and forecasts 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. We undertake no obligation to revise or update publicly 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 except as required by law.
Investors should carefully consider the risks described below before making an investment decision. In addition, these risks are not the only ones facing our Company. Additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations. Our business could be harmed by any of these risks. The trading price of our common stock has and could continue to decline due to any of these risks, and investors may lose all or part of their investment. In assessing these risks, investors should also refer to the other information contained or incorporated by reference in this Quarterly Report on Form 10-Q, or in our Annual Report on Form 10-K for the year ended December 31, 2002 and other documents filed by us from time to time.
We have a limited operating history characterized by net losses, we anticipate continued losses and we may never become profitable.
We have generated cumulative operating losses since inception. We expect this trend to continue through at least 2004. Our business is such that we have relatively few customers and limited repeat business. While the Company commenced a program to decrease expenses, there can be no assurance that expenses have been, or will be, decreased sufficiently for the Company to reach profitability, that the Company will not increase expenses in the future or that the Company will maintain or increase revenues. Even if we do achieve profitability, we may be unable to increase our sales and sustain or increase our profitability in the future.
Our success depends in significant part upon the service of management and key employees.
Our success depends in significant part upon the service of our executive officers, senior management, and sales and technical personnel. We have undergone numerous personnel changes in all levels of the organization. If our personnel do not execute our strategy, or we are unable to retain appropriate management and personnel, the Company could experience a material adverse effect on its business. If we are unable to develop and implement our strategy in a timely manner, our market penetration may be negatively impacted, which could have a material adverse effect on our business and results of operations. Our success will be dependent on our continued ability to attract, retain and motivate highly skilled employees. There can be no assurance that we can do so.
Our internal control systems are highly dependent on detective controls performed by specific individuals in key positions at the Company. Detective controls are those designed to detect mistakes that have occurred and correct them. Loss of these key people or our inability to replace them with similarly skilled individuals or new processes in a timely manner could adversely impact our internal control mechanisms.
We have reduced our personnel in order to reduce our operating costs. If we have terminated individuals whose skills we subsequently need or if demand for our product significantly exceeds our expectations, our ability to generate revenues and maintain customer relationships could be adversely affected.
The economic downturn has made potential customers hesitant to make capital expenditures.
The global economic climate has made potential customers hesitant to make capital expenditures. As a result, we have seen reluctance on the part of customers to buy our products. As a result of the economic uncertainty and the desire by companies to tighten capital expenditures, along with fluctuations in energy prices, political disruptions or the risk of higher interest rates, we may not be able to sustain or expand our customer base and sales, which would negatively impact our financial position and results of
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operations. The impact of continued lower capital spending may result in increased risk of excess and obsolete inventories, excess facilities and manufacturing capacity and higher overhead costs as a percentage of revenues.
If we do not effectively implement our sales and marketing plans, our sales will not grow and our profitability will suffer.
Our sales and marketing efforts may not succeed and therefore may not generate the revenues anticipated. We have decided to focus our resources on select vertical markets we believe have near term potential. We may change our focus to other markets or applications in the future. There can be no assurance that our plans will be successful. If we are not able to successfully address markets for our products, we may not be able to grow our business, compete effectively or achieve profitability.
A sustainable 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 sustainable 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 have further impairment of assets, we may be unable to meet our operational expenses and we may be unable to achieve profitability. The development of a sustainable market for our systems may be impacted by many factors including some that are out of our control. Examples include:
| the cost competitiveness of our microturbines; | ||
| costs associated with the installation and commissioning of our microturbines by third parties; | ||
| maintenance costs associated with 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 and quality; | ||
| regulatory requirements; | ||
| economic downturns and reduction in capital spending; and | ||
| the emergence of newer, more competitive technologies and products. |
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. 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 or may have difficulty meeting local standards. As a result, our products may require redesign. Any redesign of the product may delay sales or cause quality issues. 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; | ||
| difficulties in recruiting and retaining individuals skilled in international business operations; |
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| 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; | ||
| global political and economic instability; and | ||
| difficulties in enforcement of intellectual property rights. |
Product quality expectations may not be met causing slower market acceptance.
Despite our continuous quality improvement initiatives, if we do not meet customer expectations, we may experience slower market acceptance of our products. Any significant quality issues with our products could have a material adverse effect on our results of operations and financial position. Moreover, as we develop new configurations for our microturbines or as our customers place existing configurations in commercial use, we may experience product malfunctions that cause our products to perform below expectations. Any significant malfunctions could adversely affect our operating results and financial position and affect the marketability of our products.
We depend upon the development of new products and enhancements of existing products.
Our operating results may depend on our ability to develop and introduce new products, such as the C200 Microturbine, for existing and emerging markets and to reduce the costs to produce existing products. The success of new products is dependent on several factors, including proper new product definition, product cost, timely completion and introduction of new products, differentiation of new products from those of our competitors, meeting changing customer requirements, emerging industry standards and market acceptance of these products. The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation, as well as the accurate anticipation of technological and market trends. There can be no assurance that we will successfully identify new product opportunities, develop and bring new products to market in a timely manner, and achieve market acceptance of our products, or that products and technologies developed by others will not render our products or technologies obsolete or noncompetitive.
A key element of the Companys strategy is the development of its C200 Microturbine planned for release in 2004. However, the Company has on occasion experienced delays in the introduction of new products and product enhancements. Such delays may have, and any future delays could have, a material adverse effect on the Companys business, operating results and financial condition. Furthermore, from time to time, the Company may announce new products or product enhancements, capabilities or technologies that have the potential to replace the Companys existing product offerings and that may cause customers to defer purchasing existing Company products. Any failure to introduce new products or product enhancements on a timely basis, customer delays in purchasing products in anticipation of new product introductions or any inability of the Company to respond effectively to product announcements by competitors, technological changes or emerging industry standards could have a material adverse effect on the Companys business, operating results and financial condition.
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; |
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| 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.
In addition, competing technologies may get certain benefits, like governmental subsidies or promotion, that we do not enjoy or do not benefit from to the same extent. This could enhance their abilities to fund research or penetrate our markets.
Our competitors, some of which 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 worldwide presence. Ingersoll-Rand Company and Elliott Power Systems are competitors of Capstone that benefit from larger corporate resources, including technical and engineering resources, and which have microturbines in various stages of development and commercialization. Ingersoll-Rand Company has commercialized its microturbine units, including a 250-kilowatt product which will directly compete with our C200 product targeted for release in 2004. Many of these companies sell directly to end-users, which we believe may provide some competitive advantages over our sales strategy. Furthermore, many of these companies offer a more comprehensive solution to their customers.
In addition to these competitors, Turbec, a joint venture in Europe of AB Volvo and ABB Ltd., develops, produces and sells microturbines. Turbecs first product, a combined heat and power microturbine, is currently available. A number of other major automotive and industrial companies have in-house microturbine development efforts, including Ishikawajima-Harima Heavy Industries, Turbo Genset Inc., Toyota Motor Corporation and Kawasaki Heavy Industries. Furthermore, 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 larger microturbines than Capstones current MicroTurbine products, ranging up to 280 kilowatts.
Capstone MicroTurbines also compete with other existing technologies, including the electric utility grid, reciprocating engines, fuel cells and photovoltaic systems. Many of the competitors producing these technologies also have greater resources than we have. For instance, reciprocating engine generator sets are produced and sold by, among others, Caterpillar Inc., Interstate Companies, Cummins Inc., Yanmar, Hess and MAN. We cannot assure you that the market for distributed power generation products will not ultimately be dominated by technologies other than ours. Furthermore, electric utility companies may impose fees or other barriers that make microturbines less competitive.
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, to devote greater resources to the promotion and sale of their products than we can or introduce governmental regulations and policies to create competitive advantage vis-à-vis our products. We believe that developing and maintaining a competitive advantage will require continued investment by us in product development and quality, as well as attention to product performance, our product prices, our conformance to industry standards, manufacturing capability and sales and marketing. In addition, current and potential competitors have established or may in the future establish collaborative relationships among
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themselves or with third parties, including third parties with whom we have business relationships. Accordingly, new competitors or alliances may emerge and rapidly acquire significant market share.
There is no assurance that we will be able to successfully compete against either current or potential competitors or that competition will not have a material adverse effect on our business, operating results and financial condition.
Changes in government regulations and the electric utility industry restructuring may affect demand for our microturbines.
The market for electricity and generation products is heavily influenced by federal and state government regulations and policies. The deregulation and restructuring of the electric industry in the United States and elsewhere may aid the desirability of alternative power sources. However, problems associated with such deregulation and restructuring may cause rule changes that may reduce or eliminate advantages of such deregulation and restructuring. We cannot predict how the deregulation and the restructuring of the electric utility industry will ultimately affect the market for our microturbines. Additional competition from utilities and other power sources that may take advantage of these regulations could diminish the demand for our products. While we have seen some increase in government support for distributed power, we cannot assure that this support will continue or that it will be maintained in its current form or that it will have any near-term impact on our operating results. For example, the California Self Generation Program is due to expire in December 2004 and could be terminated earlier by the California legislature. Changes in regulatory standards or policies could reduce the level of investment in the research and development of alternative power sources, including microturbines or funds from such sources may go solely to technologies other than microturbines. Any reduction or termination of such programs can increase the cost to our potential customers, making our systems less desirable and thereby harm our revenue and potential profitability.
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. For example, our current products do not comply with the 2007 proposed emission standards of the California Air Resources Board. 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 Japanese regulators. We can provide no assurances that we will be able to obtain these approvals and changes in a timely manner, or at all.
Utility companies could place barriers to our entry into the marketplace and we may not be able to effectively sell our product.
Utility companies may charge additional fees to commercial and industrial customers who reduce the electricity they take from the utility by installing on-site generation and who subsequently use the utility grid for back-up or standby purposes. For example, the New York Public Service Commission is currently in the process of adopting new standby charges and the California Public Utilities Commission is determining new rates for Southern California Edison that could increase standby rates and other utility customer charges while reducing the price of utility supplied power. These charges could reduce the competitiveness of our products, thereby harming our revenue and profitability potential
We may not be able to retain or develop additional strategic partners and distributors in our targeted markets, in which case our sales would not increase as expected.
In order to expand our customer base, we believe that we must enter into strategic sales and 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. We believe that developing strategic partners in our targeted markets can improve the rate of adoption as well as reduce the direct financial burden of introducing a new technology and creating a new market. We may provide volume price discounts or otherwise incur significant costs that may reduce the potential profitability of these relationships. We may not be able to retain or develop appropriate distributors or strategic partners on a timely basis, and we cannot assure you that the partners with which
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we form alliances will focus adequate resources on selling our products or will be successful in selling them. In addition, some of the relationships may require that we grant exclusive distribution rights in defined territories. These exclusive distribution arrangements could result in us being unable to enter into other arrangements at a time when the distributor or partner with whom we form a relationship is not successful in selling our products or has reduced its commitment to market our products. We cannot assure you that we will be able to negotiate collaborative relationships on favorable terms or at all. The inability of the Company to develop strategic partners or a lack of success of our strategic partners in marketing our products may adversely affect our financial condition and results of operations.
We are subject to risks associated with our strategic alliance with United Technologies Corporation (UTC).
In October 2002, we entered into a strategic alliance with UTC through its UTC Power Division. The strategic alliance between UTC and Capstone is a ten-year agreement that involves the integration, marketing, sales and service of CHP solutions targeted for commercial buildings. The UTC Agreement provides for the combination of our microturbine products with their absorption chillers. We cannot assure that we can complete this integration in a cost effective manner or consistent with UTCs or our timing expectations. UTC will be the exclusive distributor for the combined Capstone MicroTurbines with UTC absorption chillers, but they will also be a non-exclusive distributor generally for Capstone MicroTurbines. The UTC Agreement is limited to North America and most of Europe. However, this alliance may not be successful and may create channel conflict with our other distributors. If this relationship fails to materialize as expected then this may impede our future growth and a sustainable market may fail to develop. Furthermore, although both parties have certain competitive restrictions, UTC may offer alternative solutions, designed by themselves or third parties. There can be no assurance that UTC will give a high priority to the marketing of the Companys products as compared to its other products or alternative solutions. Both UTC and Capstone have options to terminate the relationship if the other company fails to meet its development, product purchase or other goals in the UTC Agreement. There can be no assurance that the Company will retain its relationship with UTC. We do not expect short-term operating benefits from the UTC relationship but we have incurred and will incur short-term costs to create this alliance and fulfill our obligations under the UTC Agreement.
As part of the UTC Agreement, UTC purchased 3,994,817 shares of Capstones common stock (the UTC Shares) in October 2002 for an aggregate price of approximately $4.0 million. The UTC shares are subject to a lock-up period of nine months subject to certain exceptions provided for in the UTC Agreement. Any sale by UTC of the UTC Shares may be viewed by the investing public as a drawback to the relationship that could have a material adverse effect on the Companys stock price and financial condition.
Our ability to identify and develop Authorized Service Providers (ASPs) can significantly impact our success.
Our ability to identify and develop business relationships with ASPs who can provide quality, cost effective installations and service can significantly impact our success. We need to reduce the total installed cost of our microturbines to enhance market opportunities. Our inability to improve our ASPs quality of installation and commissioning standards while reducing associated costs could affect the marketability of our products.
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 limited sources. We may experience delays in production if we fail to identify alternative vendors, or any parts supply is interrupted, each of which could materially adversely affect our business and operations. In order to reduce manufacturing lead times and ensure adequate component supply, we enter into agreements with certain contract manufacturers and supply partners that allow them to procure inventory based upon criteria defined by us. If we fail to anticipate customer demand properly, an oversupply of parts could result in excess or obsolete inventories, which could adversely affect our business. A reduction or interruption in supply, a significant increase in price of one or more components or a decrease in demand of products could materially adversely affect our business and operations and could materially damage our customer relationships. Also, we cannot guarantee that any of the parts or components that we are obligated to purchase will be of adequate quality or that the prices we pay for the parts or components will not increase. Our inability to meet volume commitments with suppliers could affect the availability or pricing of our parts and components. Financial problems of contract manufacturers on whom we rely could limit our supply or increase our costs.
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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, 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 failure to achieve such cost reductions could have a material adverse effect on our business and results of 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. 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. If demand in any period increases well above anticipated levels, we may have difficulties in responding, incur greater costs to respond, or be unable to fulfill the demand in sufficient time to retain the order. 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 may not effectively expand our production capabilities, which would negatively impact our sales.
We may experience unanticipated growth in our business operations, which may require expansion of our internal and external production capabilities. We may experience delays or problems in expanding production that could significantly impact our business. Several factors could delay or prevent 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 with whom we can build product distribution, marketing, or development relationships; and | ||
| inability to manufacture recuperator cores or air bearings on schedule, in quantities or with the quality that we require. |
If we are unable to manufacture recuperator cores internally, our assembly and production of microturbines may suffer delays and interruptions.
Solar Turbines Incorporated (Solar) was 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. In 2001, we started to manufacture recuperator cores under contractual rights to use Solars intellectual property. We cannot assure you that we will be able to successfully implement this technology in developing a sustainable manufacturing process at higher volumes. Inherent in the manufacturing process are a number of risks. Manufacturing of the recuperator cores is a complex process requiring high levels of innovation and skill. At present, we are not aware of any other supplier that could produce these cores to our specifications within our time requirements. Our inability to manufacture recuperator cores could have a material adverse effect on the Companys operating results.
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Our business is subject to the risk of earthquake.
Our Company headquarters and our manufacturing facilities are located in Southern California, a region known for seismic activity. A significant natural disaster, such as an earthquake, could have a material adverse impact on our business, operating results and financial condition.
We may not be able to effectively manage our growth or improve our operational, financial and 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 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. In particular, we believe that our patents and patents pending for our air-bearing systems, power electronics and controls 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 or require us to develop a non-infringing technology or enter into royalty or license agreements. 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. In 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.
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. Any unfavorable outcome of litigation could have a material adverse effect on the Companys financial position and results of operations.
Our intellectual property is one of our principal assets. A negative outcome in 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.
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. 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.
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We may encounter greater business risks in the future as we manage cash resources differently. In 2002, we initiated efforts to lower our cash burn rate. As a result of those and ongoing efforts, we may not spend money in areas that ultimately prove important to the business. We may incur greater risks through lower spending rates for insurance, intellectual property protection, total employee compensation and other areas.
We face potentially significant fluctuations in operating results, which could impact our stock price.
As a result of variety of factors discussed herein, operating results for a particular quarter are difficult to predict. Given the continued uncertainty surrounding many variables that may impact the industry in which we operate, our visibility into future periods is limited. Our operating results have been in the past, will continue to be, subject to quarterly and annual fluctuations as a result of a number of factors, including:
| Fluctuations in demand for our products and services; | ||
| The timing of the introduction or enhancement of products by us or our competitors; | ||
| Quality of installation and commissioning of our products by our ASPs and customers; | ||
| Our reliance on a small number of customers; | ||
| The size, timing, shipment and pricing of individual orders; | ||
| Market acceptance of new products; | ||
| Changes in sales channels, the mix of products sold, or product pricing; | ||
| The ability of our suppliers to deliver quality parts when we need them; | ||
| Manufacturing leadtimes; | ||
| Change in management and loss of key personnel; | ||
| Political unrest or changes in the trade policies, tariffs or other regulations in the US and other countries in which we do business that could lower demand for our products; | ||
| Changes in environmental regulations; | ||
| Changes in market prices for natural resources that could lower the desirability of our products; and | ||
| How well we execute our strategy and operating plans. |
We expect our order flow to continue to be uneven from period to period. In addition, we have few customers that we can rely on for repeat sales. 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. Any of the above factors could have a material adverse effect on our results of operations and financial results.
Our announced stock repurchase program may not produce benefits for stockholders.
Capstone may not purchase the approved maximum $10 million under the repurchase program announced in October 2002 or may not acquire shares at prices that later appear advantageous. We cannot assure stockholders that using cash for this purpose will result in short-term or long-term benefits for our stockholders.
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Item 6. Exhibits and Reports on Form 8-K:
(a) Index to Exhibits.
The following exhibits are filed with, or incorporated by reference into, this Quarterly Report on Form 10-Q:
Exhibit | ||
Number | Description | |
3.1(2) | Second Amended and Restated Certificate of Incorporation of Capstone Turbine. | |
3.2(1) | Third Amended and Restated Bylaws of Capstone Turbine. | |
4.1(2) | Specimen stock certificate. | |
9.1(2) | Investors Rights Agreement. | |
9.2(2) | Amendment No. 1 to Investors Rights Agreement. | |
9.3(3) | Amendment No. 2 to Investors Rights Agreement. | |
9.4(3) | Amendment No. 3 to Investors Rights Agreement. | |
10.1(2) | Lease between Capstone Turbine and Northpark Industrial Leahy Division LLC, dated December 1, 1999, for leased premises at 21211 Nordhoff Street, Chatsworth, California. | |
10.2(2) | 1993 Incentive Stock Option Plan. | |
10.3(2) | Employee Stock Purchase Plan. | |
10.4(9) | Amended and Restated 2000 Equity Incentive Plan | |
10.5(4) | Transition Agreement, dated August 2, 2000, by and between Capstone Turbine and Solar Turbines Incorporated. | |
10.6(4) | Amended and Restated License Agreement, dated August 2, 2000, by and between Solar Turbines Incorporated and Capstone Turbine. | |
10.7(6) | Lease between Capstone Turbine and AMB Property, L.P., dated September 25, 2000, for leased premises at 16640 Stagg Street, Van Nuys, California. | |
10.8(6) | Lease between Capstone Turbine and AH Warner Center Properties, Limited Liability Company, dated February 16, 2001, for leased premises at 21700 Oxnard Street, Woodland Hills, California. | |
10.9(5) | Deferred Compensation Plan of Capstone Turbine | |
10.10(7) | Executive Incentive Compensation Plan | |
10.11(7) | Change of Control Severance Plan | |
10.12(8) | Transition Agreement and Mutual Release between Dr. Ake Almgren and Capstone Turbine Corporation dated October 31, 2002 and February 26, 2003 | |
10.13(8) | The Interim CEO Network Agreement between Emily Liggett and ICN dated November 21, 2002 | |
10.14(9) | Severance Pay Plan and First Amendment to the Severance Pay Plan | |
31.1(1) | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2(1) | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32(1) | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
(1) | Filed herewith. | |
(2) | Incorporated by reference to Capstone Turbines Registration Statement on Form S-1 (File No. 333-33024). | |
(3) | Incorporated by reference to Capstone Turbines Registration Statement on Form S-1 (File No. 333-48524). | |
(4) | Incorporated by reference to Capstone Turbines Current Report on Form 8-K filed on October 16, 2000. | |
(5) | Incorporated by reference to Capstone Turbines Registration Statement on Form S-8 (File No. 333-66390). | |
(6) | Incorporated by reference to Capstone Turbines Annual Report on Form 10-K for the year ended December 31, 2001 (File No. 001-15957). | |
(7) | Incorporated by reference to Capstone Turbines Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2002 (File No. 001-15957). | |
(8) | Incorporated by reference to Capstone Turbines Annual Report on Form 10-K for the year ended December 31, 2002 (File No. 001-15957). |
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(9) | Incorporated by reference to Capstone Turbines Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2003 (File No. 001-15957). |
(b) Reports on Form 8-K.
On April 30, 2003, the Company filed a Report on Form 8-K, furnishing under Item 12 an April 30, 2003 press release announcing its first quarter 2003 financial results. (Such press release is not incorporated by reference herein or deemed filed within the meaning of Section 18 of the Securities Act.)
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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 | ||||
Date: August 14, 2003 | By: | /s/ KAREN CLARK Karen Clark Senior Vice President, Chief Financial Officer (Principal Financial and Accounting Officer) |
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