Capstone Green Energy Corp (CGRN) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Capstone Turbine Corporation earnings conference call for fourth-quarter and fiscal-year 2012 financial results ending March 31, 2012. My name is Caris, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. During today's call, Capstone Management will be referencing slides that can be located at www.capstoneturbine.com under the Investor Relations section. Later we will conduct a question-and-answer session.

(Operator Instructions)

At this time, I would now like to hand the call over to your host for today, Ms. Jayme Brooks, Vice President, Finance and Chief Accounting Officer. Please proceed.

Thank you. Good afternoon and welcome to Capstone Turbine Corporation's conference call for the fourth quarter and fiscal year ended March 31, 2012. I am Jayme Brooks, your contact for today's conference call. Capstone filed its Annual Report on Form 10-K with the Securities and Exchange Commission today, June 14, 2012. If you do not have access to this document and would like one, please contact Investor Relations via telephone at 818-407-3628 or e-mail IR@capstoneturbine.com. Or you can view all of our public filings on the SEC website at www.SEC.gov or on our website at www.capstoneturbine.com.

During the course of this conference call, Management may make projections or other forward-looking statements regarding future events or financial performance of the Company within the meaning of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These statements relate to, among other things, market expansion, new product development, growth in revenue, gross margin backlog, attaining profitability, improvement in certain key performance indicators and strategic initiatives, low cost of ownership, and advantages over competing technologies. Forward-looking statements may be identified by words such as expects, objectives, intends, targeted, plan, and similar phrases. These forward-looking statements are subject to numerous assumptions, risks, and uncertainties described in Capstone's Form 10-K, Form 10-Q, and other recent filings with the Securities and Exchange Commission that may cause Capstone's actual results to be materially different from any future results expressed or implied in such statements. Because of the risks and uncertainties, Capstone cautions you not to place undue reliance on these statements, which speak only as of today. We undertake no obligation and specifically disclaim any obligation to release any revision to any forward-looking statements to reflect events or circumstances after the date of this conference call or to reflect the occurrence of unanticipated events. I will now turn the call over to Darren Jamison, our President and Chief Executive Officer.

Thank you, Jayme. Good afternoon and welcome, everyone, to Capstone's fourth-quarter and fiscal year-end 2012 earnings call. With us today are Ed Reich, our Executive Vice President and Chief Financial Officer, and Mark Gilbreth, our Executive Vice President and Chief Technical Officer. Today I will again start the call with a general overview of our fourth-quarter and full-year achievements and then turn the call over to Ed, who will review the detailed financial results. Ed will then turn the call back over to me, and I will discuss what is happening in some of our key market verticals and update you on our growth strategies designed to improve gross margin, generate positive cash flow, and achieve profitability. During our remarks, we will be referring to presentation slides that can be found on the Capstone website under Investor Relations.

Fiscal 2012 was an outstanding year for Capstone. Despite a challenging economy our business is thriving and this is reflected in our exceptional growth rates and expansion in key markets. I'd like to mention a few of the important metrics that we showcase our achievements beginning on Slide 2. First, we delivered record revenue of $109.4 million, up 34% year-over-year. We've now delivered consecutive quarterly revenue growth over the last 20 quarters when compared to the same period in the prior year and a compounded annual growth rate of 39% since fiscal 2007. Second, we delivered positive gross margins of 5% for fiscal 2012, up 6 percentage points over fiscal 2011, and up 19 percentage points over fiscal 2010. Fiscal 2012 was the first year in the Company's long history with positive gross margins in all four quarters. While our operating model target is 35% gross margin over time, it's important to note that profitability can be achieved at lower gross margins based on continued strong revenue growth.

Third, accelerating order momentum drove record backlog of $139 million at March 31, 2012, up 31% year-over-year and reflecting a compounded annual growth rate of approximately 34% since 2009. In fiscal 2012, we received new orders of $123 million, up 42% year-over-year. Shipments totaled 96.1 megawatts, up from 69.7 megawatts in fiscal 2011. Key performance indicators, such as production rates and average selling prices, are all trending in the right direction. And I'll discuss those in more detail later in the call.

Let's turn our focus to Slide 3. We also delivered strong operating performance in the fourth quarter, with shipments of 27.1 megawatts, up from 23.5 megawatts in the third quarter. New orders totaled a record $49 million, up an outstanding 109% quarter-over-quarter. This drove record product revenue of $25 million, up 14% quarter-over-quarter and 30% year-over-year. We managed to increase our C200 engine build to 99 units, up from 88 in the third quarter. We again delivered positive gross margin, which we have done for six of the last seven quarters. Both inventory turns and accounts receivable collections improved during the quarter, and quarter-over-quarter results were $4.5 million in positive operating cash. Obviously this leaves Capstone with a very strong balance sheet of $50 million at year-end. We also made considerable progress during the fourth quarter in major market sector penetration.

Let's turn to Slide 4. We continue to expand our reach into the key Asia-Pacific market with the recent sale of the Capstone C1000 unit that will be installed in a combined heat and power, or CHP application, at a very progressive high-tech chicken egg farm in Singapore. The power package which is fueled by biogas generated from the animal waste and an anaromic digester will generate reliable low-emission electricity and thermal power. The clean and green on-site electricity purchased -- produced by the C1000 will power the farm's six large climate-controlled layer houses and two grower houses that span 32 acres. And the exhaust heat from the Capstone power package will be used to dry spent grain used for chicken feed.

Let's turn our focus closer to home in the US, where we are making great strides in penetrating the booming shale gas industry. Capstone recently received orders totaling approximately 10 megawatts from two oil and gas producers in the Eagle Ford Shale play. One of these was from a new customer that ordered five C1000 power packages for five separate remote central gathering sites. The second was from a producer with multiple Capstone MicroTurbines already operating in the field. This latest follow-on order includes seven C600s and one C800 package that will begin shipments in the first quarter.

And only about a week later, we announced the sale of 30 more C65 MicroTurbines to the same Eagle Ford Shale play, pushing the number of C65s in the Eagle Ford Shale play to approximately 200 units. These multiple follow-on orders indicate that Capstone MicroTurbines are quickly becoming the chosen preferred power systems to meeting growing needs in major oil and gas producers operating in that region. The oil and gas market continues to be our fastest growing market worldwide, accounting for approximately 58% of total revenue in fiscal '12, up from 39% in fiscal 2011.

Now let's turn our focus to Slide 5. For fiscal-year 2012, our product shipments were 58% oil and gas like I mentioned, 25% for energy efficiency applications, 16% for use in renewable applications, and 1% in other applications, including critical power and mobile products. Our revenue growth in fiscal 2012 included increases in revenues of $18 million from North American markets, and $11 million from the European market, and nearly $1 million each from South America and Africa. The increase in the North American European markets was primarily the result of sales in the US shale gas market and into the Russian associated oil and gas markets.

In the broader oil and gas and other natural resource segments, Capstone's MicroTurbine products were installed at oil and gas exploration, production, compression, and transmission sites, both onshore and offshore worldwide. Typically, these oil and gas mining operations have no electric utility grid and rely solely on Capstone's MicroTurbines to produce highly reliable critical power with low emissions on site. With record lows in natural gas prices, Capstone MicroTurbines can produce the energy on site at roughly $0.03 to $0.04 a kilowatt hour today. This is a huge economic advantage for managing on-site power, heating, cooling, and steam processing requirements.

In fiscal 2012, we added major independent oil and gas producers in the US and high-profile gas to energy projects overseas, and momentum continues to build. US shale gas development is soaring, and according to the US Energy Sector report from the EIC consult, the Market Research and Consultancy arm of the Energy Institute Council, shale gas production is projected to reach 30 billion cubic feet per day by 2020. We believe the oil and gas and other natural resource segment will continue to be a key driver of our business in fiscal 2013 and beyond.

Let's look at the energy efficiency segment of our business, where we're powering hotels, office buildings, hospitals, retail, and industrial applications on five continents. Energy efficiency represented 25% of our revenue in fiscal 2012, and a study conducted by the US Department of Energy calculated potential energy efficiency CHP market in the United States alone to be over 35.5 gigawatts through 2020, which obviously is a tremendous domestic market opportunity for Capstone for CHP and CCHP applications.

Let's turn our focus to renewable energy, which continues to be an important segment of our business, representing 16% of our revenue for the year. Today we're making the lowest emission combustion products for landfill gas, digester gas, biodiesel, and biogas applications around the globe.

In the critical power supply segment, which was less than 1% of our revenue in fiscal 2012, Capstone provides the world's only MicroTurbine-powered uninterruptible power source solution that offered clean IT-grade power. As the continuing in electric power becomes more critical to business success and the potential for extended utility power outages increases, critical power security is driving rapid growth in the UPS industry. Based on customer demand, we are now marketing a new C1000 hybrid UPS solution in addition to our current C65 offering. With explosive growth in computing and data storage requirements globally, the global UPS market is expected to achieve revenues of around $15 billion by 2020 according to Global Data. We believe our Capstone Data Center solution can capture meaningful market share and drive significant future growth for our Company.

And finally, in the mobile product segment, we are implementing a multiple-step plan to develop commercially available MicroTurbine-based hybrid heavy-duty truck and transit bus solutions over the next several years. This is still a relatively small market segment at less than 1% of revenue for fiscal 2012; however, with ever-rising gasoline prices, this industry is setting new records for hybrid electric vehicle usage in sales, creating potentially lucrative market opportunity for Capstone. We believe we are well positioned and will be well positioned for future growth, as awareness of the efficiency and economic benefits of our MicroTurbine-based hybrid solution expands throughout this industry.

In total, the global market opportunity for MicroTurbine-based solutions is projected at approximately $14.6 billion annually. As the world leader in MicroTurbine technology, our clean, green, reliable, and cost-efficient energy management solutions position us well to be the global leader moving forward in the increasingly stringent emissions standards. Based on the markets we serve, we estimate Capstone's potential market share could be as high as $1.5 billion of the $14.6 billion current market opportunity. However, to continue to grow our share of the high-growth markets I just discussed, we are continuing to invest in strategic product development.

In engineering and R&D, we are developing a more efficient MicroTurbine, combined heat and power system solution, the first phase of which the development program is expected to improve our existing C200 engine to increase power output and electrical efficiency. The targeted power output is 250 kilowatts with projected electrical efficiency of 35%. The second phase of this development program is expected to incorporate further engine efficiency improvements, resulting in a product with a projected electrical efficiency of 42% and total power output of 370 kilowatts. The DOE awarded Capstone a grant of $5 million in support of this critical development program. We are also developing and testing a fuel-flexible MicroTurbine capable of operating on synthetic fuel mixtures, containing various amounts of hydrogen. For this program we have a DOE grant of $2.5 million. I will now take a break and turn the call over to Ed to review our specific financial results for the fourth quarter and full year 2012. Ed?

Thanks, Darren. Good afternoon, everyone. I'd like to provide you with our financial results for the fourth quarter and full fiscal year 2012, which ended March 31, 2012. Let's begin with the fourth-quarter results on Slide 6. Revenue for the fourth quarter of fiscal 2012 was $30.1 million, increased 10% from $27.5 million for the third quarter of fiscal 2012 and increased 32% from $22.8 million for the fourth quarter of fiscal 2011. Product revenue increased 14% sequentially and 30% year-over-year.

We shipped 149 units for the quarter, up 10% from the third quarter but down 11% from the fourth quarter of fiscal 2011; however, on a megawatt basis, this year's fourth-quarter shipments were up 32% year-over-year at 27.1 megawatts versus 20.5 megawatts in last year's fourth quarter. This is a result of having more large-capacity MicroTurbines in the revenue mix than we did last year. Average selling price per unit was $167,000, an increase of 4% from the third quarter and 46% from last year's fourth quarter. The significant year-over-year increase is the result of both higher pricing and the shift in the mix to our larger-capacity products.

Gross margin for the quarter was $900,000, or 3% of revenue compared to gross margin of $2.3 million, or 8% of revenue for the third quarter, and a gross loss of $1.1 million or 5% of revenue for the fourth quarter of fiscal 2011. The sequential decrease in gross margin for the quarter was primarily due to year-end accounting inventory adjustments and scrap costs, manufacturing overhead, materials adjustments, as well as a moderate shift in product mix. Every year the fourth quarter has year-end adjustments that make a sequential comparison with the third quarter less meaningful. What is more important is that our gross margin percentage in the quarter increased by 800 basis points year-over-year, driven by higher volumes, increased pricing, and lower materials costs. Please refer to Slide 7 which outlines the fourth-quarter adjustments, which when backed out reflects the gross margin of 9% as was the case in Q3.

Our product direct materials costs were flat from the third quarter. The Company has now posted positive gross margins for all four quarters in fiscal 2012 and in six of the last seven quarters. R&D expenses were $2 million for the fourth quarter of fiscal 2012, compared to $1.8 million for the third quarter and $2 million for the fourth quarter of fiscal 2011. SG&A expenses were $7.4 million for Q4, compared to $8.3 million for the third quarter and $7.2 million for the fourth quarter of fiscal 2011. The increased SG&A expense in the third quarter is primarily related to a bad debt reserve.

Capstone's net loss was $8.3 million, or a $0.03 loss per share for the fourth quarter of fiscal 2012, compared to $8.8 million, or a $0.03 loss per share for the third quarter and $28.8 million, or a $0.12 loss per share for the fourth quarter of 2011. Capstone's net loss of $8.3 million, or $0.03 per share for the fourth quarter of fiscal 2012 is an improvement of $20.5 million from the $28.8 million or $0.12 loss that was recorded last year. Remember that the net loss for both fiscal years was affected by the adoption of Accounting Standards Quantification 815 Derivatives and Hedging, which affects our accounting for warrants with anti-dilution provisions. We recorded a non-cash benefit of $500,000 to change in fair value of warrant liability during the fourth quarter of fiscal 2012. Our net loss for the fourth quarter of fiscal 2012, before considering the non-cash benefit to the change in warrant liability, would have been $8.8 million, or a $0.03 loss per share.

We recorded a non-cash charge of $18.7 million to change in fair value of warrant liability during the fourth quarter of fiscal 2011. Our net loss for the fourth quarter of fiscal 2011 before considering the non-cash charges to the change in warrant liability would have been $10.1 million, or $0.04 loss per share. Please refer to the non-cash warrant charge slide in the appendix for a reconciliation.

Let me now provide some of the balance sheet activity for the quarter. Cash increased to $50 million in Q4 from $22.9 million in Q3. The increase was primarily due to our successful registered direct placement of securities in March, which raised $23.1 million in net proceeds and cash generated from operating activities in the quarter of $4.5 million, which was primarily due to increased accounts receivable collection and lower inventories. Receivables decreased to $18.6 million from $25.8 at the end of the third quarter, as we experienced strong collections of $37 million in the quarter. As a result of the strong collections, our day sales outstanding improved substantially to 56 days in the fourth quarter from 86 days in Q3. Inventories declined by $6.5 million in the quarter to $20.2 million, with inventory turns improving to 4.1 times from 3.3 times in the third quarter. ¶ Now let's turn to the fiscal 2012 operating results, which are on Slide 8. Total revenue for fiscal 2012 was $109.4 million, an increase of 34% from $81.9 million for the prior fiscal year. Product revenue increased 36% from fiscal 2011 levels to $89.9 million. Capstone shipped 627 units, or 96.1 megawatts, in fiscal 2012, compared to 611 units or 69.7 megawatts in the prior year. Our average selling price per unit improved to $143,400 in fiscal 2012, compared to $109,000 a year ago. Similar to the fourth quarter, the significant year-over-year increase is the result of both higher pricing and the shift in the sales mix to our larger C200 and C1000 series MicroTurbines.

Accessories, parts, and service revenue for the year grew by 25% to $19.5 million as a result of higher sales of MicroTurbine parts, increased enrollments in our factory protection plan, and additional service work. Gross margin for the year was $5.4 million, or 5% of revenue, compared to a fiscal 2011 gross loss of $500,000, or 1% of revenue. The increase in gross margin of 600 basis points was the result of higher overall volume, increased average selling prices, lower direct material costs, which were offset by higher production and service center expenses, warranty, royalty, and inventory charges.

Our Research and Development expenses were $8.2 million for fiscal 2012, compared to $7 million for fiscal 2011. The overall increase in R&D expenses of $1.2 million resulted from increased salaries, supplies, and reduced cost sharing benefits, which were offset by lower consulting-related expenses. SG&A expenses were $28.9 million for fiscal 2012, compared to $26.2 million for fiscal 2011. $2.7 million net increase in SG&A expenses resulted from an increase in bad debt expense, professional services, marketing, and consulting, offset by a lower salary and travel expenditure.

Capstone's net loss of $18.8 million, or $0.07 loss per share for fiscal 2012 is an improvement in $19.7 million from the net loss of $38.5 million, or $0.16 per share we recorded last year. Remember again that the net loss for both fiscal years was affected by the adoption of Accounting Standards Quantification 815, which affects our accounting for warrants with anti-dilution provisions. We recorded a non-cash benefit of $14 million to change in fair value of warrant liability during fiscal 2012. Our net loss for fiscal 2012 before considering the non-cash warrant liability benefit would have been $32.8 million or a $0.12 loss per share. We recorded non-cash charges of $3.7 million, the change in fair value of warrant liabilities during fiscal 2011. Our net loss for fiscal 2011, before considering the non-cash warrant liability charges would have been $34.8 million or $0.14 per share. Again please refer to the non-cash warrant charge slide that is in the appendix for the slides for a reconciliation.

During the year, Capstone used $21.4 million of cash in operating activities, used $200,000 of cash in investing activities, and generated $38.1 million in cash from financing activities. The funds generated from financing activities during the year were primarily from proceeds related to our registered direct placement of securities in March that generated $23.1 million, the exercise of common stock warrants and borrowings under our credit facility. That concludes my comments on Q4 and the fiscal year-end 2012 results. Now back to Darren.

Thank you, Ed. I'd now like to talk about some of our key strategic initiatives as we proceed into fiscal 2013 and beyond. Let's now turn to Slide 9. First, we're focused on increasing our sales mix toward larger units. The recent sale of our C1000 units reflects our success in this endeavor. Revenue from our C1000s increased more than any other unit in our portfolio in 2012, with growth of 75% over 2011. In fiscal 2012, we also successfully ramped C200 engine production rates to 328 units for the year, compared to 185 in fiscal 2011, and only 145 in fiscal 2010. All of our MicroTurbine products commanded better margins in fiscal 2012, compared to fiscal 2011 as a result of higher average selling prices and overall lower direct material costs.

Average revenue per unit increased to $143,000 compared to $109,000 per unit in fiscal 2011, an increase of 32%. At the same time, direct material costs decreased 5% year-over-year due to our ongoing cost reduction program. Further expansion in both new and existing markets is also a primary goal this year, as our engineering team works to further improve the electrical and emissions efficiency of our products. Our sales team is very focused on building brand awareness through strengthening distribution relationships and global marketing efforts like the recently announced UN Rio Plus 20 event, which will have 50,000 participants and 130 world leaders in attendance.

Our focus is on products and solutions that provide near-term opportunities to drive repeatable business, not discrete projects for niche markets. Our increased activity in South America and African markets in fiscal 2012 is a very good example of these continuing efforts to improve worldwide distribution of our products. We are also working toward solidifying our production efficiencies by implementing LEAN product manufacturing practices Companywide. Overall today, we are at less than 35% capacity utilization as of year-end, so we have ample room for production expansion as we further our penetration into new and existing markets. Maintaining a strong balance sheet is another primary area of focus. With $50 million in cash at year-end, we believe we have ample liquidity to carry out our initiatives in 2013 and beyond.

Let's turn our focus to the key performance indicators highlighted on Slide 10. Key performance indicators, or KPIs, are the best measure of the underlying foundation of our business and are critical to reaching our goal of improved gross margins and positive cash flow. I've already discussed each of these items, but this slide shows you a summary of these most critical metrics.

To sum it up, there are a few main points that I'd like to emphasize on Slide 11. Fiscal 2012 was an excellent year for Capstone with market expansion across all of our high-growth market segments, and our new product and marketing development initiatives are well under way to continue this momentum. Our results demonstrated strong growth trends in revenue, strong trends in gross margin, and strong trends in backlog, which we expect to continue into fiscal 2013 and beyond. Capstone is making steady progress towards profitability through the substantial operating leverage of our business model, coupled with our margin expansion initiative or direct material cost reduction initiative. As you see that each of our key performance indicators trended in the right direction in fiscal 2012, we're well positioned for continuing progress and look forward to an even more promising and even more productive fiscal 2013.

Operator, with that I'd like to open it up to questions from our analysts.

(Operator Instructions)

Our first question comes from the line of Shawn Seaverson with JMP Securities. Please proceed.

I want to dig in a little bit into the oil and gas segment. And obviously, there are a lot of attributes and MicroTurbines are attractive to those customers, but have you seen any shifts or push outs at all because of the CapEx budget, specifically on the shale gas side have been coming in? And I'm just wondering if you're seeing any effect from that, or is it still such a small percentage of the total install base out there that you're not really sensitive to that yet?

No, just to the contrary. We're seeing increased demand for our product. I think as you pointed out, we still have a fairly small market share in the segment. And I think a lot of producers are turning to our technology. As you know, we started with Anadarko, which got us Chesapeake, which got us Marathon Oil, Talisman, then Shell. We continue to get repeat orders from almost all of these customers. And in most cases, they are looking for relatively quick turnaround, quick by oil and gas standards being six months or less. So I think, obviously very low natural gas prices may slowdown some operations, but crude oil prices are still relatively high. And I think there's still a lot of liquids being drilled for. So I think overall you're going to see tremendous growth in that shale gas in US and worldwide. I think we're very well positioned to continue to penetrate that market.

Okay, thanks. And can you talk a little bit about the gross margin targets and the progress you made in this quarter? Obviously, it was a messy quarter with some of the things in there. But can you talk about going forward where you are in some of those benchmarks you're trying to hit?

Absolutely. I think you use the term messy quarter. Year-end is always a time where you shut the business down for a prolonged period of time. You sweep the corners and let the dust settle. Having 39% compounded growth rate for the last five years does drive a certain level of scrap and inventory adjustments. Obviously, we would like those to be less each year. And they are trending down every year, but somewhat that's a result of the heavy growth rates that we're experiencing. Not an excuse, just an explanation.

We'll continue to try to improve our operational efficiencies and lower any Q4 impact that we have. Obviously, much better than last year's fourth quarter. Ed showed a slide that took you back to, if you took out those things that were over Q3 levels, our actual margins within the product DMC wise were relatively flat in the quarter. And we would have thrown off in a normal quarter about 9%. That being said, Q1 we should see some more DMC reductions, as well as in Q2 and Q3. And we're looking for some nice margin improvements over the next three to four quarters. I think our team is very focused. If you look at each product line, there's about a dozen discrete parts that we're going after, and I think we're working very hard to make sure we accomplish each one of those DMC cost reduction efforts.

I think the other important note is again, you look quarter to quarter. It's hard to see if you look at what we've done over the last two years with a 19% margin improvement; if we manage to do just that for the next two years, we'll be at 24%. Obviously, we think we can do better than that over the next two years.

Great, thank you.

The next question comes from the line of Ajay Kejriwal with FBR Capital Markets. Please proceed.

Hi. So on that -- following up on the DMC reduction, Darren, so maybe talk about what's the opportunity? You mentioned a couple discrete parts. Is it just a function of higher volume, and you're going back to suppliers and getting volume discounts, or is there anything else in that equation?

Yes, it's really a mix, Ajay. We've got some parts that are engineered to be lower costs. We've got a combustion liner change that's doing that. We have got an LCM and GCM power electronics modules that are redesigns using some lower-price components. Other cases, it's just higher volumes or giving purchase commitments to some of our vendors. So we give them a three-year purchase commitment and volume commitment, and we're getting some better pricing.

Obviously we've talked before about the C1000 package. That represents in one part number, about 4.5%, 5% cost reduction for us, so we're working that one very hard with our current vendor who is building the package. So that's a heavy impact. As I mentioned in the call, the C1000 is our fastest-growing product, so getting that package down. In addition, we've got cables in that package that are another 1% or 2%. So I think there's lots of opportunity in just those two part numbers, but this is not the end. This is to achieve the 30% cost reduction that we have targeted.

Beyond that, the C250 will generate another level of cost reduction for us as we go from five units in the box to four in the box. So again, always lumpy in trying to get cost reduction, lots of challenges with UL and outside services that have to approve these changes to our UL filings, but I think going into the year, we feel very good about the cost reductions we have teed up. We've made some personnel changes and improved our bench. And I think we're going to have better performance this year than we did even last year or the last two years.

That's a good point on lumpiness. And I know you mentioned 5% improvement last year, so based on all of the work that you've done and what you see in terms of how things would play out this year, is there a level of reduction that you think if you did not achieve you'd be disappointed this year?

Yes, we are targeting about a 14% DMC reduction this year in the new fiscal year, so that would be definitely our goal. We've got another 6% to 7% of pricing that should be flowing through this year as well. So those few things alone will give us a 21% increase by the end of the year in our DMC. Now, obviously, there's other issues, inflationary factors and other things that may impact us, but if we don't make significant progress on both those pricing and cost reduction fronts, we would be disappointed.

Okay, and then on pricing, so did I hear right that your product revenue was up 36% for the full year?

Yes.

So your product revenue is up 36%; your shipment is up 38%. So is the math that your realization per megawatt, is that flattish?

No, I'm not sure I understand the question, Ajay, but I think--

Because you shipped 96 megawatts. That's up 38% year-over-year. And if your product revenue is up 36%, I'm just doing rough math here, per megawatt, is the realization roughly flat?

Yes, it's hard to look at that because you've got different mixes and different units. So one megawatt may be $900,000 if it's full, all options and everything else. If we have a stripped-down grid connect unit, that could be a $750,000 model. So it's a little bit like comparing apples and oranges from a megawatt perspective. So we have pretty wide pricing variation depending on features and benefits of the systems.

Okay, and then maybe just we are almost wrapping up 1Q. Any color on the order trends, anything you're seeing in Europe? I know Europe is a small portion of revenues outside Russia, but any color there?

Yes, let me, obviously, I don't want to give too much forward-looking statements on Q1, but I think it's important to note that the Europe itself as we look at it, including Russia, was up year-over-year, despite the softness. And that was really on the power of our Russian distributer. Europe itself, if you take out Russia, it's about 16% of our revenue. We do expect that to be flat this year, but we think that we're going to get substantial growth in the rest of our market segment. So even with a flat Europe, which was 16% of our revenue last year, we expect to see 30% plus growth again this year.

So we're monitoring the situation. We have two distributors that we're monitoring very closely. Two of them are on credit hold. But in general, we think Germany, France, the UK, are going to perform relatively well for the year. Our concerns are more Spain and obviously Greece, Italy, are the areas we're most concerned about.

Good, and then maybe one last one from me on the warranty expense. What's the expectation for this year? Seems like there was a pick up in the fourth quarter?

There was a pick up in the fourth quarter. Again, we go through and look at all of our accruals and potential work. We did a lot of work during the quarter on the 180 systems we've been upgrading. I'd expect Q1 that we'll run still fairly hot, but then Q2, we should start dropping down. Year-over-year as a percentage of revenue, warranty should be down for the fiscal year.

Got it, thank you.

Your next question comes from the line of Sanjay Shrestha with Lazard Capital Markets. Please proceed.

Two questions. First, when you talk about improving electrical efficiency and the emission improvement, Darren, can you elaborate on that a little bit as to what level of electrical efficiency can we get to?

Yes, if you look at it with the C250 we're going to 35%, and the 370 we're going to 42%. And I'll let Mark jump in a little bit on how we're doing that, but definitely going to the 250, we're very comfortable, we're very far along in that design. We have hardware coming in in the first quarter, and we'll have units running in the lab here shortly. I'll let Mark jump in and give some more color on that.

Yes, Sanjay, when we look at the C250, the primary drivers for the improvement there are really sealing up leaks and clearances within the C250 engine, and also providing improved efficiency in some of the internal components. And again, as Darren said, that's going to get us to 35% efficiency for the C250 product. As we look forward to the 370 product, basically, the ways to improve efficiency in turbine and even in combustion engines, is to increase temperatures and to increase pressure ratios, and so that's what we're looking at. We're going to go to a dual spool, or two-stage compressor. And putting an inner cooler in between there, as well as operating at slightly higher temperatures. And so for the 370, that thermodynamics cycle predicts 42% efficiency.

Wow that's pretty impressive. Now one point. I just want to make sure that I've got this right. So in terms of your 250 KW product, right? As you're selling your C1000 product, is the majority of that is going to be four packets instead of five, like it is right now in fiscal '13? Or when does this really become the 250 product turning into a C1000, and therefore you have the higher efficiency, you have a dramatic direct material savings, when does that actually start to flow through your P&L?

I don't think you're going to see it in fiscal '13. It would be the following year before you actually see that flowing through the P&L. What you should be looking for this year is us actually having operating units in the lab. We'll come back and confirm the efficiency and the output, and we'll start doing field tests and qualification of the product. Obviously, we want to make sure it's as robust as possible before it gets launched. But really this year, the story is going to be to finish our DMC cost reduction that we have been working on for two years, get that realized, which is another 14% reduction and improvement of margin, get the pricing fresh in the backlog, get another 5 or 6 points there. And then the next year, we drop in the C250 and get even more margin improvement at that point, which obviously our goal is to get to 35% gross margin as fast as possible. But as I said on the call, we keep growing revenue at 30% a year, we'll hit breakeven and call it the mid 20% gross margin range.

Got it. A few more questions, guys, if I may. So this was a fully impressive booking here in Q4. And obviously, the shale gas is a meaningful contributor here. So as you look out over next 12 months, so the book of business that's out there for you, obviously, conversion rate is going to be tricky as to exactly what the conversion rate is going to be. But how should we think about the booking pattern for fiscal '13? And I have one more question after that.

Again, it's hard to go quarter-through-quarter sequentially. If you look year-over-year though, you should see revenue continue to beat prior years' revenue. From a book-to-bill standpoint, as long as we're positive on growing revenue, we'll be happy. We do get lumpy orders and bigger orders. As I mentioned the recent oil and gas order of five C1000s for one customer and seven C1000 packages from another, those moved the needle quite a bit. So I think we know that Origin Energy is looking at another 100-plus unit order. Those orders will move any individual quarter. But overall I think positive book-to-bill, continuing revenue on a year-over-year basis, and improving gross margins should be what shareholders expect and what people are looking for.

Got it. One last point then, guys. So in terms of the backlog, which is again up pretty nicely, how much of that is you define as the 12-month backlog, of course it's the long-term backlog?

100% that is considered 12-months or short-term backlog. Also being year-end, we went through and scrubbed out any orders that we thought had some softness to them, so this is a net number you're seeing in the $49 million, not a gross number. So that's also a good thing.

Okay, so this total backlog of $139 million is really the 12-month backlog?

Absolutely, correct.

Okay got it. That's all I have guys. Thank you so much.

I think the other important point, if you look historically over the last several years, the backlog that we start the year with is a good indication of what the next year's revenue is going to look like. And so I think to have another 20%, 30% growth year over $109 million, you'd expect the backlog to be about where it is right now. So I think that's also comforting for us.

Okay, that's great. Thanks again.

The next question comes from the line of Eric Stine with Northland Capital Markets. Please proceed.

Just wanted to confirm, so the orders you called out, the ones that were announced in April, so those are first-quarter orders?

Those are first-quarter orders, that is correct.

Okay, so definitely in 4Q, very strong order quarter. Looks like it was, if I'm doing the math right, particularly strong for C65 and C1000s. I know a lot of that is oil and gas. Can you just talk about what's going on in some of the other end markets, what drove that order number?

Yes, I'd say we're seeing very strong oil and gas orders from both Russia and the US shale gas. What's really driving the big fourth-quarter number though is we're seeing very nice orders out of the US. We're seeing that the California Self-Generation Incentive is starting to have an impact. We're seeing low natural gas prices starting to equate to orders. I think we announced two hospital orders recently, C1000s, which are a new territory for us. Plus we're seeing the Asian market pick up. Australia is starting to pick back up. We're penetrating Africa for the first time. And South America and Mexico, we're also starting to produce.

So as much as we are concerned about Europe and as we mentioned might be flat, the rest of the world is doing extremely well. And I think oil and gas both liquids and gaseous fuels are only going to grow I think over the next several years. I think you're going to see data centers and Telecom grow. You're going to see the opportunities for us in renewables continue to grow. So we feel very good about the market verticals that we're in, and we feel good about most of the geographies, with the exception of certain parts of Europe. And so I think record-low natural gas prices and continued just general penetration of each market segment and vertical is great for us.

Okay, and then in light you just get those orders, the orders you called out that those were first-quarter orders, pretty good start to the year. Is it fair to say that probably not to where you were in 4Q, but still should expect a pretty strong order quarter?

Yes, again, Ed kicks me every time I start talking about Q1 under the table, but obviously those 10 megawatts that's in Q1, so you should expect a reasonable book-to-bill ratio in Q1, and I'll leave it at that.

Okay. It was worth a try.

Not seeing any slowdown or anything that concerns us that Q1 is off to a bad start from a booking standpoint.

Okay. Got it. That's great. One last one for me. Just wondering if you can provide an update on where things stand with the MOU with Tatneft. How many, what that constituted in 4Q? Has there been anything more in the first quarter, and when you see potential timing of that additional 20 megawatts? Thanks a lot.

That's a great question. We didn't detail that out. We did ship I believe five megawatts in Q4 to Tatneft. They've committed for several more megawatts, so majority of the 16 megawatts that they've committed to in the MOU has been firmed up on POs, not the entire thing, but I'd say north of $10 million has been committed. They have the follow-on $20 million option that they can exercise by December 31. Obviously we're very hopeful that they continue with the original 16 and take the 20 as well, so nothing negative has occurred that would change our position on that happening.

Okay, thanks a lot. Congrats on the quarter.

Your next question comes from the line of Walter Nasdeo with Ardour Capital. Please proceed.

Most of my questions have been answered. However, I would like to, if we could, talk about your distributor network and how that's firmed up. And have you been -- where it stands right now as far as numbers, and how is the calling process going?

Yes, we're at 93 I think distributors worldwide. We were at 95 last quarter, so we've had two folks that we weeded out. And in both cases we had neighboring distributors and geographies that took up that area. I think from a coverage perspective short of a little bit of Africa, the entire world is covered, so we really are truly in a weed-and-feed stage. I think that the number of distributors will probably drift down over the next year as we consolidate some distributors to make them stronger, give them more business.

I think overall, the number of distributors that are over $1 million in purchases and heading toward the magic number of $3 million is increasing. But I think the other trend we're seeing is the ones that have put in hard work over the last two years are really starting to polarize and move away from some of the other ones that maybe didn't have the level of effort they needed to. So I think it's becoming more and more visible as we get two years into these new distributors, which ones are performing, which ones aren't. So I think it won't be difficult to figure out which ones to focus, but I think overall, we're happy with where we're at. We have more work to do. Until we can get $3 million plus out of every distributer, we're going to still be looking to make improvements and be pushing them.

Are you looking at like an 80/20 rule, or are you smoothing that out a little bit more?

I think the reality is with the size of our bigger machines, if you look at Macon in Africa, they went from $0 sales to $2 million in about 18 months. So you don't have to do very many projects to be meaningful to our business. So I think if each distributer would do one or two projects a quarter, and one of those two projects was a C1000, they would be at that $3 million level that we're looking for and probably a little higher. So really it's level of effort, it's deal flow, it's marketing the product, doing all of the things we think a model distributor should be doing. And that's selling the entire portfolio into as many verticals as they can. So we look -- all of our distributors use salesforce.com. We look at how many new orders they put in a week, in a month, how they are moving those orders from opportunities through the gated process to actual orders.

If you look at our total product pipeline out there with our distributors, I think last quarter we crossed the $1 billion mark. So we probably started with about $100 million five years ago. Now we've seen that funnel, that pipeline surpass $1 billion of opportunities that we're chasing as a distribution organization, so that's very good. Obviously, you want to see that trend bigger every quarter. We also want to see reasonable close rates and make sure projects are moving through the pipeline.

Okay, good. And then if I could just jump over to your supplier chain, your supply chain. Is that pretty well established now and no blips on the future expected?

No. We always have some hiccups. I think every time we make a step change in revenue, we tend to have a little bit of some supplier hiccups. We had some of that in Q4. As I mentioned, our DMC was flat. It actually would have been a little better, but we had two suppliers we had to expedite parts, which drove some overtime. In some cases we had to go to second suppliers that are higher priced, but that's not abnormal when we turn the wick up a little bit more from a quarter-to-quarter basis. Overall I think we're happy with the supply base. They are growing with us. Most of it's coordination. You notice we finally topped 4 turns; we're up to 4.1. As we continue to get the turns up and we source more globally, that's going to be a more challenging operation every quarter.

But in general, if you look at the like I said the C1000, C200 cost reduction, the 14, 15 discrete parts we're looking at are all with suppliers that we're currently doing business with or already got that on board fairly recently. So not huge changes in our supply chain, just getting them to grow with us.

Great, that's all I had. Thanks.

At this time there are no further questions in queue.

Well thank you, everybody. Great questions from our analysts. I think they've hit all of the topical areas that we have. Obviously, we're as a Management team, we're very excited about finishing up this fiscal 2012 fourth quarter. To break the $30 million revenue mark was exciting for us. Obviously we've seen great growth on a year-over-year basis and compounded over the last several years.

The gross margin of $900,000 is disappointing if you look at it on a sequential basis, but if you look year-over-year and if you back out some of the year-end charges, we think that the -- Management is happy with that number. Obviously we're going to do better in Q1 and Q2 and continue to drive that toward our targets.

From a cash flow perspective, very happy with recent improvements in our DSO, very happy with the inventory reduction and the inventory turns increasing. Throwing off $4.5 million in positive working capital for the quarter was great. And entering the year with a $50 million balance sheet is the highest cash level since I've been the CEO at Capstone the last 5.5 years. Gives our vendors more comfort, gives our customers more comfort. And I think we're competing with big companies. We're competing with Caterpillar and GE, and having a bigger balance sheet is very important to us and for achieving our goals.

So we look for fiscal 2013 to be another exciting year. We look for another minimum 25%, hopefully 35% revenue growth. We expect to improve gross margins substantially from where they are, and obviously we're going to watch our cash position as closely as we can. We're going to minimize our spend as best we can and working capital requirements because I think maintaining a strong balance sheet as we grow this business is going to be critical to our success. But again overall, I think we've got a good plan in place.

I think we're very happy with the Management team that we have and our plan is not changing. It may not be rolling out always as fast as we want, but we are not changing our business strategy or our plan or our key performance indicators from year to year or quarter to quarter. We're executing against the same plan as consistently and as quickly as we can to build what we think is going to be a world-class business. So with that, I want to thank everybody, and we'll talk to you after Q1.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a wonderful day.