Should You Exit Capstone Turbine Corporation Shares This Week?

After watching Capstone Turbine (CPST) shares tank 25% last month, investors are desperately waiting for some good news when the company reports its fourth-quarter and full-year earnings this Thursday. Capstone's upcoming earnings report isn't an ordinary one: The loss-making microturbine maker expects to break even on its operating earnings in the fourth quarter.

With competitive renewable energy companies like FuelCell Energy (FCEL -5.23%) hogging the limelight lately, Capstone is under tremendous pressure to prove its microturbines as a profitable solution to the world's energy problems. And with FuelCell Energy hitting the brick wall last week with huge quarterly losses, this could be Capstone's best chance to draw the market's attention like never before.

Unfortunately, Thursday may not be that day; and like FuelCell investors, Capstone investors too may get ready to be disappointed this week. Here's why, and what you should do next if the company fails to deliver.

Another missed target?
Capstone may have hoped to break even on its earnings before interest, taxes, depreciation, and amortization, or EBITDA, by the fourth quarter, but its preliminary numbers reported last month suggest a miss.

Are Capstone's microturbines losing steam? Source: Capstone Turbine

In the preliminary report, Capstone projected to end its financial year with $133.1 million in revenue. Breaking down, that implies Q4 revenue worth only $36.4 million, which is 10% short of what the company needs to break even. Consequently, I see slim chances of Capstone's full-year gross margin hitting the break-even level of around 21%, considering that it generated only 16% gross margin for the nine months ended Dec. 31, 2013.

The question is whether you should write Capstone Turbine off if it fails to break even in the fourth quarter. Not until you see what the company reports about the following metrics in its upcoming earnings report.

Order book, backlog, and average revenue per machine
Like in most quarters, Capstone received several orders throughout its fourth quarter. Its backlog hit a record high of $160.4 million in the third quarter. Since a growing order book and backlog is an indicator of future potential revenue, investors should watch for those metrics.

Also, Capstone reported 16% higher average revenue per turbine in the third quarter. So keep an eye on whether the company continues to churn out more from each unit it sells, as that could pave the way to bigger top-line and margin growth in the near future. Capstone is banking big on its C200 microturbines, so expect some details on whether the company's proposed April price hike for the turbines was implemented as planned, and how that could help the company going forward.

Gross margin
It will be worth watching whether Capstone can extend its gross margin expansion streak and hit 20% or more in the fourth quarter. Investors may recall how the company was all upbeat when its gross margin expanded six percentage points, both sequentially and year over year, to hit record 20% in Q3.

Capstone primarily attributed higher selling prices and low costs for the sharp increase in gross profit, and it's important to see whether the trend continues. Growing gross margin is one of the most promising signs for a loss making company.

Cash position
During its last earnings call, Capstone had projected its cash balance for the full year to be between $33 million and $36 million. But its May preliminary report indicated cash and cash equivalents of only $27.9 million for the year. Surely, such a huge gap between projections and actual results call for closer scrutiny, and I'd expect to see valid reasons behind the fall in Capstone's upcoming earnings report.

It's also worth noting that Capstone sold shares worth net $30.2 million last month in a dilutive offering to raise proceeds for "general working capital requirements." It's scary if a company has to raise money to run its day-to-day operations, and I'd keep a close eye on its cash usage patterns if I were a Capstone investor.

Stay cautious
Capstone's weak preliminary numbers, which is also what investors are most likely to see being reported again this Thursday, raises an alarming question: Does management lack foresight for a period even as short as a quarter? That appears to be the case, and investors will do best to take Capstone's projections in its upcoming earnings call with a grain of salt.