Preliminary 2Q21 Results and Adjustment of Debt Agreement

Key Points

  • Capstone is positioned in the distributed energy generation (DEG) – or microgrid industry – with a proprietary microturbine technology platform.
  • According to Capstone, its platform can reduce energy costs, ensure power availability, and meet CO2 reduction goals with a near-zero emissions profile, which also positions the product within the customer’s Environmental, Social & Governance (ESG) framework.
  • Broader industry trends should continue to favor technologies and services that will help companies reduce their carbon footprint driven by regulation as well as corporate responsibility.
  • The global microgrid industry is expected to grow over 10% CAGR between 2020 and 2025 and the industry should continue to benefit from long-term trends.
  • Capstone’s business has pivoted over the last 12 months to increasingly focus on developing an energy as a services business (EaaS) around its core energy technology platform.
  • If the company can continue to execute on an EaaS strategy, it should lead to more predictable and stable cash flows, despite product orders and backlog experiencing variability quarter to quarter.
  • The company recently reached adjusted EBITDA breakeven following a multi-year costcutting effort, but also shows the positive impact EaaS can have on profitability.
  • In addition to the existing distributor sales model, Capstone has initiated a National Account effort, which management believes will better target more substantial corporate accounts with the potential to land larger orders for multiple locations.

What Happened?

On Friday, 10/2/20, the company reported preliminary financial results for 2Q21showing positive cash generated from operations and total cash on hand increasing to $16.7 million, up from $16.2 million. The cash increase was generated without proceeds from any type of financing, loans, or government grants during the period. Additionally, on 10/30/20 the company announced gross product orders increased 73% in 2Q21 from 1Q21.

On October 5th, the company announced it entered into an amended Note Purchase Agreement (NPA) in which Capstone issued $20M in additional notes, to total $50M up from $30M. All $50M now bears an interest at LIBOR Rate plus 8.75% per annum and is due on October 1, 2023. At today’s rates that translates into approximately 9.75%. This compares to the 13% rate previously paid on the $30M note. Capstone agreed to use the $20M to expand its high-margin, long-term rental fleet from today’s 8.6 MW to 21 MW and for general corporate purposes. The covenants include requiring Capstone to expand its long-term rental fleet by at least 6.25 MW by the 9-month anniversary of the closing date and 12.5 MW by the 18-month anniversary of the closing date.

Our Insight

The Opportunities

Preliminary 2Q21 results were announced on 10/2/20 and on 9/30/20, but with limited information. On November 30th Capstone announced new microturbine gross product orders were approximately $9.5 million for the 2Q21 ending September 30, 2020, compared to $5.5 million in 1Q21, representing a 73% improvement in bookings. On October 2nd, the company announced that for the second quarter ended September 30, 2020, it posted positive cash generated from operations and total cash on hand increased to $16.7 million, up from $16.2 million in the prior quarter ended June 30, 2020. The takeaways are that business is recovering off the pandemic bottom as shown by bookings and importantly the company’s cash balance managed to increase without any dilution. Management attributed the positive cash flow to lower operating expenses and better management of working capital in combination with improving aftermarket service margins and a further rebound in product shipments. It is worth noting that this is the first time the company has produced positive cash from operations since the quarter ended March 31, 2018.

As we pointed out in our Initiation of Coverage Report on September 30, maintaining cash levels and reaching positive operational cash flow are key milestones. Although results could fluctuate quarter to quarter, holding around breakeven on operational cash flow should reduce the need for any dilutive capital unless required for additional growth opportunities.

The second notable event occurred today when the company announced it has refinanced and expanded its Note Purchase Agreement (NPA) with Goldman Sachs in which Capstone issued $20 million in additional notes from the $30 million in place already to a total of $50 million. The overall rate on the $50 million note is now LIBOR Rate plus 8.75% per annum (approximately 9.75% based on current rates) and is due on October 1, 2023 compared to 13% before. More importantly however, is that Capstone now has access to additional capital, which is critical to the company’s ability to grow its Energy as a Service (EaaS) platform. Specifically, the expanded $20 million note will be used to grow the long-term rental fleet from today’s 8.6 MW to 21 MW as well as some corporate expenses. The covenants include requiring Capstone to expand its long-term rental fleet by at least 6.25 MW by the 9-month anniversary of the closing date and 12.5 MW by the 18-month anniversary of the closing date.

The EaaS strategy, if successful, could have numerous benefits including more predictable and stable cash flows and margin expansion, despite product orders and backlog experiencing variability quarter to quarter. A critical factor in making this an attractive business to Capstone is having access to capital at a reasonable rate, which this amended agreement facilitates.

The Obstacles

Execution and the economy remain important variables. Specifically, to meet the covenants of the note, Capstone must secure additional wins as cited above. The company will also have to absorb approximately $1 million in additional interest expense on an annual basis. However, to add perspective, the cash returns on the rental business are attractive and successful execution on the additional 12.5 MW of rental business should boost cashflow meaningfully above the additional cash interest payment.