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Item 4. Controls and Procedures

2024-08-05 compared with 2023-02-14 · 40 added, 90 removed, 13 unchanged (91% of the section changed)

1 unchanged sentence

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including the Chief Executive Officer and Interim Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this report.

Based upon that evaluation, our Chief Executive Officer and our Interim Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective as of December 31, 2022.

The term “disclosure controls and procedures” means controls and other procedures of ours that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within required time periods.

Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Interim Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

We maintain disclosure controls and procedures that are designed to ensure that the information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure.

In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

In connection with the preparation of this Form 10-Q for the three-months ended September 30, 2023, an evaluation was performed under the supervision and with the participation of our management, including the CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in and pursuant to Rules 13a-15(e) and 15d-15(e) under the Exchange Act).

Based on this evaluation, our CEO and CFO have concluded that, as of September 30, 2023, due to the material weaknesses in our internal control over financial reporting described below, our disclosure controls and procedures were not effective.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Our management is responsible for establishing and maintaining adequate internal control over our financial reporting.

Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, our CEO and CFO and effected by our board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S.

GAAP and includes those policies and procedures that:

● Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

● Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S.

GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors;

● Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

We conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework).

Based on this evaluation, management concluded that our internal control over financial reporting was not effective as of September 30, 2023 because of the material weaknesses described below.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual and interim financial statements will not be detected or prevented on a timely basis.

The following material weaknesses were identified:

● There was an inappropriate tone at the top established by certain former senior executives.

For example, certain former senior executives delayed shipments of parts under the FPP service contracts, which because of our incorrect accounting for our FPP program resulted in delayed recording of the associated expense and liabilities on the Company’s financial statements.

These business practices were also not properly communicated to our Board, Audit Committee, or independent registered public accounting firm.

● We lacked sufficient qualified professionals with an appropriate level of accounting and internal control knowledge, training and experience to (i) appropriately analyze, record and disclose accounting matters timely and accurately and (ii) design and maintain effective internal control over financial reporting.

● We did not perform a sufficient review of accounting policies to ensure ongoing adherence with U.S.

● We did not design and maintain effective controls over financial reporting for systems, products, parts, and accessories sales subject to bill and hold arrangements with customers.

● We did not design and maintain effective controls over financial reporting related to the proper accounting, presentation and disclosure for FPP service contracts, including the cost recognition of parts and labor associated with FPP service contracts.

Management’s Remediation Plan

Management, with the direction and oversight of the Audit Committee and the Board of Directors, is engaged in remediation actions to address the material weaknesses described above.

The Company’s remediation actions include, but are not limited to the following:

● The Company has reinforced and will continue to reinforce its tone at the top through enhanced communication of the Company’s values and expected business conduct to their personnel directly from the Company’s senior leadership.

● Management is enhancing our quarterly disclosure committee meetings to require additional communication of business activities to the appropriate finance and accounting personnel and to our Board and Audit Committee as required.

● The Company has hired and continues to hire additional accounting and compliance personnel as is necessary to maintain an effective control environment commensurate with our financial reporting requirements.

Management will continue to assess the composition of its resource needs, both internal and external, which may include hiring additional accounting and compliance resources, including engaging in third-party advisors when necessary.

● Management is implementing a formal process to periodically review and update accounting policies.

● Management has reviewed and refined the Company’s current accounting memorandums related to product, parts, and accessories sales and FPP service contracts to address the proper financial reporting considerations.

Additionally, management is enhancing the design of and implementing controls over financial reporting for (i) systems, products, parts, and accessories sales subject to bill and hold arrangements with customers and (ii) FPP service contracts, including the cost recognition of parts and labor associated with FPP service contracts.

We believe these measures will remediate the material weaknesses, but management is assessing the need for any additional steps to remediate the underlying causes that gave rise to these weaknesses.

The material weaknesses will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.

There is no assurance that additional remediation steps will not be necessary.

Except as described above, there were no changes in our internal control over financial reporting during the most recent fiscal quarter that were identified in connection with management’s evaluation required by paragraph (d) of Rules 13d-15 and 15d-15 under the Exchange Act that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent limitations of the Effectiveness of Internal Control

4 unchanged sentences

Refer to Note 15 – Commitments and Contingencies — Legal Matters, in the Notes to Condensed Consolidated Financial Statements (Part I, Item 1 of this Form 10-Q) for information regarding legal proceedings in which we are involved.

From time-to-time, we are involved in other pending and threatened litigation in the normal course of business in which claims for monetary damages are asserted.

In the opinion of management, the ultimate liability, if any, arising from such pending or threatened litigation is not expected to have a material effect on our results of operations, liquidity, or financial position.

The Company is from time to time a party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of business.

In addition, the Company and certain of its former and current directors and officers are a party to several material legal proceedings.

The outcome of litigation is inherently uncertain.

If one or more legal matters were to be resolved against the Company in a reporting period for amounts in excess of management’s expectations, the Company’s financial condition and operating results for that reporting period could be materially adversely affected.

Risk Factor s

2 unchanged sentences

Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results

Our success depends in significant part upon the continuing service of management and key employees, and several key management and other employees have recently left Capstone.

In March 2022, we implemented an expense reduction plan, which included furloughs, employment terminations, pay cuts and the elimination of various management positions.

We also recently suffered departures of other key personnel, including in accounting/finance and information technology.

This has placed additional strain on the remaining personnel, and we do not expect to replace all of the departed employees, so the increased burdens on the remaining personnel are expected to continue for the foreseeable future.

Accordingly, our recent losses of key employees could adversely impact our business, financial condition and results of operations.

SEC regulations limit the amount of funds we can raise during any 12-month period pursuant to our shelf registration statement on Form S-3.

SEC regulations limit the amount that companies with a public float of less than $75 million may raise during any 12-month period pursuant to a shelf registration statement on Form S-3.

We are currently subject to General Instruction I.B.6 to Form S-3, or the Baby Shelf Rule.

Since the filing of our Annual Report on Form 10-K on July 13, 2022, we have been subject to the Baby Shelf Rule.

Under the Baby Shelf Rule the amount of funds we can raise through primary public offerings of securities in any 12-month period using a registration statement on Form S-3 pursuant to the Baby Shelf Rule is limited to one-third of the aggregate market value of the shares of our common stock held by non-affiliates of the Company.

Therefore, we will be limited in the amount of proceeds we are able to raise by selling shares of our common stock using our Form S-3 until such time as our public float exceeds $75 million.

Prior to such time as our public float exceeds $75 million, if our public float decreases, the amount of securities we may sell under our Form S-3 shelf registration statement will also decrease.

At the conclusion of our public offering in August of 2022, we had no remaining shares available for issuance with respect to this ATM Program.

Even if sufficient funding is available, there can be no assurance that it will be available on terms acceptable to us or our stockholders.

Furthermore, if we are required or choose to file a new registration statement on a form other than Form S-3, we may incur additional costs and be subject to delays due to review by the SEC staff.

There is substantial doubt about the Company's ability to continue as a going concern, and this may adversely affect the Company's stock price and the Company's ability to raise capital.

In connection with the preparation of these condensed consolidated financial statements for the three and nine months ended December 31, 2022, management evaluated whether there were conditions and events, considered in the aggregate, that raised substantial doubt about our ability to meet obligations as they became due over the next twelve months from the date of issuance of our third quarter of Fiscal 2023 interim condensed consolidated financial statements.

Management assessed that there were such conditions and events, primarily the October 1, 2023 due date for Goldman Sachs Specialty Lending Group L.P.

outstanding debt of $51.0 million at fair value (see Note 10 – Term Note Payable in the Notes to the Condensed Consolidated Financial Statements for further discussion of the outstanding debt).

There will not be sufficient internally generated cash, nor does the Company expect that it could obtain sufficient financing through underwritten public offerings, at-the market offerings or other similar methods, to retire the outstanding debt of $51.0 million.

The Company has engaged Greenhill and Company, a Global Investment Banking firm, to assist in refinancing the outstanding Notes;

however there can be assurance that the Company will be successful in refinancing the Notes.

Whether the Company will be able to successfully refinance the Notes will depend on market conditions, the Company’s financial performance and other factors.

Any refinancing of the Notes, may also lead to increased costs, increased interest rates, additional financial covenants and other lender protections.

The substantial doubt about the Company's ability to continue as a going concern may affect the price of the Company's common stock and the grade of its credit rating, may negatively impact relationships with third parties with whom the Company does business, including customers, vendors and lenders, may impact the Company's ability to raise additional capital or implement its business plan.

Our products involve a lengthy sales cycle, and we may not anticipate sales levels appropriately, which could impair our results of operations.

The sale of our products typically involves a significant commitment of capital by customers, which can result in the typical delays associated with large capital expenditures.

For these and other reasons, the sales cycle associated with our products is typically lengthy and subject to several significant risks over which we have little or no control.

We plan our production and inventory levels based on internal forecasts of customer demand, which is highly unpredictable and can fluctuate if sales in any period fall significantly below anticipated levels, our financial condition, results of operations and cash flow would 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, which would negatively impact our operations.

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 materially from period to period.

Further, our inventory balance as of December 31, 2022 was $25.6 million, compared to $18.5 million as of December 31, 2021.

This increase was due to purchases of long lead time inventory, and there is a risk that our inventory balances continue to rise, and consequently see a backlog of obsolete or excess inventory.

Net product orders for Fiscal 2022 were $31.8 million and contributed to an ending backlog of $25.3 million at March 31, 2022.

The book-to-bill ratio was 1.1:1 for Fiscal 2022.

Net product orders were approximately $1.7 million and $4.5 million for the three months ended December 31, 2022 and 2021, respectively.

The gross book-to-bill ratio was 0.8:1 and 0.5:1 for the three months ended December 31, 2022 and 2021, respectively.

Book-to-bill ratio is the ratio of new orders we received to units shipped and billed during a period.

However, because our backlog represents only the estimated amount of future product revenue to be recognized under negotiated contracts as shipments convert backlog to recognized revenue for accounting purposes, we may not be able to fully realize the revenue value reported in our backlog, and our backlog may not be indicative of future revenues.

A portion of our backlog is concentrated in the international oil and gas market which may impact the overall timing of shipments or the conversion of backlog to revenue.

The timing of the backlog is based on the requirement date indicated by our customers.

Based on historical experience, management expects that a significant portion of our backlog may not be shipped within the next 18 months.

The timing of shipments is subject to change based on several variables (including customer deposits, payments, availability of credit and customer delivery schedule changes), most of which are not in our control and can affect the timing of our revenue.

As a result, management believes the book-to-bill ratio better demonstrates the current demand for our products in the given period.

We may be unable to fund our future operating requirements, which could force us to further curtail our operations;

we were in breach of our secured note purchase agreement as of May 27, 2022.

To the extent that the funds we now have on hand are insufficient to fund our future operating requirements, we would need to raise additional funds, through further public or private equity or debt financings depending upon prevailing market conditions.

These financings may not be available or, if available, may be on terms that are not favorable to us and could result in dilution to our stockholders and reduction of the trading price of our stock.

The state of capital markets when we seek to raise additional capital could also impede our ability to raise additional capital on favorable terms or at all.

If adequate capital were not available to us, we likely would be required to significantly curtail our operations or possibly even cease our operations.

In March 2022, we implemented an expense reduction plan, which included furloughs, employment terminations and pay cuts.

See “— Our recently implemented expenses reduction plan and organizational changes undertaken to align to our focus on our EaaS business and achieving profitability may not be successful.”

We are party to an Amended and Restated Note Purchase Agreement (the “A&R Note Purchase Agreement”) dated October 1, 2020 (the “Closing Date”) among the Company, certain subsidiaries of the Company, Goldman Sachs Specialty Lending Group, L.P.

(as successor in interest to Goldman Sachs Specialty Lending Holdings, Inc.), as collateral agent (“Goldman” or the “Collateral Agent”) and the purchasers party thereto (the “Purchasers”).

The A&R Note Purchase Agreement amended and restated our Note Purchase Agreement dated February 4, 2019, by and among the Company, certain subsidiaries of the Company, Goldman Sachs Specialty Lending Holdings, Inc.

and the purchasers party thereto under which we sold $30.0 million aggregate principal amount of senior secured notes (the “Notes”) bearing an interest of 13.0% per annum.

Pursuant to the A&R Note Purchase Agreement, the Company issued $20.0 million in additional Notes and all outstanding Notes under the A&R Note Purchase Agreement bear interest at the Adjusted (London Interbank Offer) LIBO Rate (as defined in the A&R Note Purchase Agreement) plus 8.75% per annum, payable on the last day of each interest period of one-, two-, three- or six-months (but, in the case of a six-month interest period, every three-months).

The Notes do not amortize and the entire principal balance is due and payable on October 1, 2023.

As of March 31, 2022, $51.0 million in borrowings were outstanding under the Notes, which includes the accrual for an exit fee to be paid at maturity or upon pre-payment.

Obligations under the A&R Note Purchase Agreement are secured by all of the Company’s assets, including intellectual property and general intangibles.

The A&R Note Purchase Agreement contains customary covenants, including, among others, covenants that restrict our ability to incur debt, grant liens, make certain investments and acquisitions, pay dividends, repurchase equity interests, repay certain debt, amend certain contracts, enter into affiliate transactions and asset sales or make certain equity issuances (including equity issuances that would cause an ownership change within the meaning of Section 382 of the Internal Revenue Code), and covenants that require us to, among other things, provide annual, quarterly and monthly financial statements, together with related compliance certificates, maintain our property in good repair, maintain insurance and comply with applicable laws.

On May 13, 2021, the Company, and the collateral agent, entered into a First Amendment, dated as of May 13, 2021 (the “Amendment”), to the A&R Note Purchase Agreement.

The Amendment amended certain provisions of the A&R Note Purchase Agreement, including to (a) require the Company to expand its Rental Fleet (as defined in the A&R Note Purchase Agreement) by (i) at least 2.00 MW by the 9-month anniversary of the Closing Date (instead of 6.25 MW as provided in the A&R Note Purchase Agreement prior to the Amendment), and (ii) at least 12.50 MW by the 18-month anniversary of the Closing Date (which is unchanged from the covenant set forth in the A&R Note Purchase Agreement prior to the Amendment), and (b) increase the Company’s minimum consolidated liquidity requirement from $9 million to $12.2 million, for the period from May 13, 2021 to March 31, 2022, and $9 million thereafter.

The financial covenants of the A&R Note Purchase Agreement require the Company not to exceed specified levels of Adjusted EBITDA losses relative to its financial model, beginning with the fiscal quarter ending September 30, 2021.

As of March 31, 2022, we were not in compliance with the Adjusted EBITDA covenant contained in the A&R Note Purchase Agreement and did not cure such non-compliance by prepaying the Notes.

As a result, we were in breach of the Adjusted EBITDA covenant as of May 27, 2022.

On July 13, 2022 we entered into the Second Amendment to the A&R Note Purchase Agreement (the “A&R NPA Second Amendment”) with the purchaser thereunder (the “Purchaser”) and Goldman Sachs Specialty Lending Group, L.P.

as collateral agent (the “Collateral Agent”), pursuant to which (i) the Purchaser and the Collateral Agent waived our breach of the Adjusted EBITDA covenant and (ii) the A&R Note Purchase Agreement has been amended to, among other things, add certain new covenants, including requirements that we use our commercially reasonable best efforts to both (a) raise at least $10 million through a sale of our common stock by September 14, 2022 and (b) refinance the Notes by October 1, 2022.

See Item 9B “Other Information” for a summary of the A&R NPA Second Amendment.

Although we are currently in compliance with the covenants under the A&R Note Purchase Agreement, as we continue to use cash for operations and expansion of our rental fleet, there is the possibility that our consolidated liquidity could fall

below the minimum balance required under the A&R Note Purchase Agreement if we do not raise additional capital and/or obtain an adjustment to that covenant.

The A&R Note Purchase Agreement, as amended, also defines an event of default as, among other things, payment default, bankruptcy events, cross defaults, breaches of covenants (including the liquidity covenant) and representations and warranties, changes of control, judgment defaults and an ownership change within the meaning of Section 382 of the Internal Revenue Code.

An event of default, if not waived, could have a material adverse effect on us.

Our obligations under the A&R Note Purchase Agreement, as amended, have important consequences, including the following:

● We may have difficulty obtaining additional financing at favorable interest rates to meet our requirements for operations, capital expenditures, general corporate or other purposes.

● We will be required to dedicate a substantial portion of our cash flow to the payment of principal and interest on the Notes, which will reduce the amount of funds available for operations, capital expenditures and future acquisitions.

● Goldman Sachs Specialty Lending Holdings, Inc., as collateral agent under the Note Purchase Agreement, may enforce any and all liens and security interests on the collateral we have used to secure the Notes and we may forfeit our right to such collateral.

● In order to avoid breaches of the Note Purchase Agreement covenant relating to Section 382 changes of ownership, we may be limited in the amount of additional equity securities we are able to sell to raise capital.

Accordingly, our desire to preserve our federal and state net operating loss (“NOL”) carryforwards may cause us to forgo otherwise attractive funding opportunities.

We may be required to repay the Notes immediately if we again default on any of the numerous financial and other covenants contained in the A&R Note Purchase Agreement, including any of those added pursuant to the A&R NPA Second Amendment, and Goldman does not waive such default.

It is not certain whether we will have, or will be able to obtain, sufficient funds to make any such accelerated payments.

If any outstanding indebtedness under the Notes is accelerated, our assets may not be sufficient to repay such indebtedness.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 4. Controls and Procedures