Eighteen months ago, Capstone Turbine Corp. was generating a good deal of interest.


The Chatsworth maker of microturbine generators was poised to capitalize on the massive disruptions to the nation's energy supplies caused by Hurricane Katrina. Shares cracked the $5 barrier as the company looked to move out of the red.


Since then, it has sputtered and chugged.


The company has posted eight consecutive losing quarters. Its shares barely trade above $1, and most of the orders for its advanced generators including a huge deal with Wal-Mart Stores Inc. never materialized or remain a long way off.


Even the company's new chief executive, who's been on board for just 10 weeks, doesn't mince words.


"Capstone is a company with a tremendous product that really should dominate the market. But it has failed to execute on the front end and the back end of the business cycle," said Chief Executive Darren Jamison, during a brutally honest first conference call with Wall Street analysts recently.


Much of the damage was self-inflicted, analysts say, as the company failed to follow through on prospective orders, made some fundamental errors and has undergone frequent strategy shifts as it cycled through four chief executives in five years.


As a result, Capstone was unable to capitalize on the window of opportunity that opened up after Katrina, and now, as interest in back-up power supplies has waned, the road ahead is much harder.


Jamison, however, believes he can pave the way. In his February conference call, Jamison unveiled a 100-day recovery plan for the company, including focusing more intensely on sales and distribution networks with a goal of profitability by the end of March 2008. (Jamison was unavailable for comment, and company representatives did not want to comment beyond the conference call.)


Capstone does have some breathing room, since it netted $46 million in a public stock offering in January. But with more shares outstanding, the value of existing shares has been diluted by 60 percent, a source of concern for Wall Street.


Walter Nasdeo, research analyst with Ardour Capital Investments and one of the few remaining analysts who covers Capstone, said that in order for shareholder value to recover, the company has to show significant improvement in sales and must continue to cut sales and production costs.


Nasdeo downgraded his rating for Capstone to "sell" in November after a disappointing earnings report, although he later upgraded it.


Sales problems

This is not the first roller-coaster ride for Capstone. The 18-year-old company, which has about 200 employees, has had a long history of surges and brownouts as it has tried to bring its microturbine technology to market. The machines range from $60,000 to $100,000 including installation.


Capstone's miniature turbine pushes air through a combustion chamber to generate electricity. It's meant to be an alternative to massive gas-powered generators that have long been the standard for backup power supplies. Customers include industrial operations, hospitals, universities and public agencies.


Capstone's fortunes soared during and immediately after the California power crisis of 2000-01 and then crashed. It rebounded again after the major East Coast blackout of 2003, only to sink again in 2004. Each time, while some new orders trickled in, Capstone was unable to get a large volume of orders before the crisis atmosphere dissipated.


"Whenever you have an event like a major power blackout or the California energy crisis, companies look for reliable backup power supplies. But given the tremendous investment that requires, the longer you go without such an event, the harder the sell," said Severin Borenstein, a professor at the Haas School of Business at the University of California Berkeley and director of the University of California Energy Institute.


To generate orders, Capstone long relied on a network of distributors, such as companies that sell big heating and ventilation systems or power systems. But Capstone had a policy of signing up distributors who agreed to sell the Capstone microturbines exclusively. That eliminated most of the well-capitalized distributors who rely on a diverse stream of products from several manufacturers.


What's more, Capstone didn't provide much technical support to its distributors, as Jamison found out first-hand. He was a Capstone distributor while serving as president of Northern Power Systems Inc., a subsidiary of Wallingford, Conn.-based Distributed Energy Systems Corp.


"The problem we had is that Capstone management at that time handed out fishing licenses, so to speak, but didn't teach distributors how to fish," Jamison said.


Capstone's former chief executive John Tucker pulled away from the distribution model and reoriented the company around a direct sales force. But maintaining an in-house sales force is much more costly than operating a distribution network. What's more, during the transition, Capstone found itself unable to respond rapidly to close sales when the latest window of opportunity opened after Hurricane Katrina, which hit in August 2005.


Jamison is now promising to re-introduce the distribution network, this time with non-exclusive distributors who he said will be better capitalized.


Strategic blunder

The sales problem was compounded by what analyst Nasdeo called a major strategic blunder: focusing on getting a blanket approval from the city of New York for installation permits for the microturbines. That way, when orders came in, the units could be installed quickly without going through all of the cumbersome permitting process.


"While this process was going on and everybody was waiting for this whole agreement thing, they had dozens of prospective orders that weren't being converted into final orders. By the time the agreement was wrapped up, the orders went away. The customers simply weren't willing to wait," Nasdeo said.


In the conference call, Jamison said that 12 projects in the New York City area are still in negotiations for final contracts. But it may be too late. Two competitors Elliott Energy Systems Inc., a subsidiary of Tokyo-based Ebara Corp., and Hamilton, Bermuda-based Ingersoll Rand Co. Ltd. have swooped into the New York City market.


Elliott obtained a blanket city permit just like Capstone, but it also announced it had a major contract to supply its gas-driven microturbines to an unnamed New York City entity. The much larger Ingersoll Rand is also seeking a blanket city permit, which would put Capstone at a major disadvantage because of Ingersoll's production capacity.


In the meantime, the lack of sales in the much-coveted New York market hit Capstone hard, especially in the fiscal second quarter 2007, which ended last September. Revenues plunged 47 percent to $3 million while the company's losses remained stubbornly high at around $10 million.


Sales improved in the fiscal third quarter to $5.7 million, while the loss narrowed to $8.5 million. And the critical order backlog figure ticked up for the first time in a year, reaching $8.1 million. These improved results prompted an upgrade to "neutral" from Nasdeo.


However, Capstone is still by its own estimate a year away from profitability and that assumes that the company is able to maintain progress in boosting sales. The company is pinning much of its hopes on distribution partners such as UTC Power, a division of Hartford-based United Technologies Corp. that last year installed Capstone microturbines at the Ronald Reagan Presidential Library in Simi Valley.


Yet even this relationship has been rocky. In a Sept. 2005 8-K filing, Capstone threatened to end its partnership with UTC Power, citing UTC's failure to meet sales targets. (The threat was not acted upon.) And it is UTC that has the direct relationship with Wal-Mart, testing one Capstone microturbine at a Wal-Mart store in Colorado. Jamison said the machine is performing well, but that progress on a broader deal with Wal-Mart "is up to UTC."


Capstone also hopes to attract interest with another microturbine under development that can generate 200 kilowatts of power, three times the power of its current units.


But in the long run, Borenstein said Capstone will have to make its microturbines more affordable so that customers won't be as hesitant to make the investment.


"The key issue is if the microturbines can be made economical for the customers. Right now, it's a tough sell, especially if the customer doesn't feel the threat of an impending blackout," he said.

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