Capstone Green Energy Corp (CGRN) 2013 Q4 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Fourth Quarter Capstone Turbine Earnings Conference Call. My name is Philip, and I will be your operator for today. At this time, all participants are in listen only mode. Later, we will conduct a question and answer session.

(Operator Instructions)

During today's call, Capstone Management will be referencing slides that can be located at www.capstoneturbine.com under the Investor Relations section. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Miss Jayme Brooks, Vice President in 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 full-year fiscal 2013. 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 13, 2013. 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, growth of the oil and gas, secure power, green building, and transportation markets, increased operational efficiency, new product development, distributor network expansion, growth in revenue, gross margin and backlog, attaining profitability, improvement in certain key performance indicators and strategic initiatives, increased sales in Europe, South America, Asia, and Australia, the availability of incentive funds for our products, compliance with governmental regulations, decreased royalty rates, and benefits from our cost reduction initiatives.

Forward-looking statements may be identified by words such as expects, objective, intend, 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 the Capstone's fourth-quarter and full fiscal 2013 earnings call. With me today is Ed Reich, our Executive Vice President and Chief Financial Officer. Today, as usual, I will start the call with a general overview of the fourth quarter and our 2013 achievements, and then I'll turn the call over to Ed who will review the detailed financial results. I will close with some comments about the market dynamics that are driving our business in fiscal 2014, and providing a rich environment for our continued growth and expansion. During our remarks, we will be referring to presentation slides that can be found on the Capstone website under Investor Relations.

Let's go ahead and start with slide 2. I am extremely proud to report that fiscal 2013 of this Capstone team delivered the best annual performance in the Company's history. It's a tremendous achievement, and a direct result of the strategic work that we have done over the past six years to position the Company for profitable growth and to create value for our shareholders. Our fiscal 2013 results including record revenue of $127.6 million, up 17% year over year, despite Europe including Russia being down $21 million year-over- year.

Let's take a second and put that into perspective. If Europe and Russia had just been flat year-over-year, our top line growth for fiscal 2013 would have been about 34%. That shows how powerful our performance is in the rest of the world and our other markets. We had new product orders of $112.6 million, resulting in a book-to-bill ratio of 1.1 to 1 for fiscal 2013. We shipped 103.2 megawatts of new product.

Gross margin improved to $14.4 million, or 11% of revenue, up from only $5.4 million or 5% of revenue just a year ago. We ended the fiscal year with a record backlog of $148.9 million, which historically has been a good indicator of growth for the year ahead. And we maintained a healthy cash balance of $38.8 million at year-end.

Now, let's take a second and turn to slide 3. Leading up to this record performance for fiscal 2013, over the past several years, we have injected much greater predictability into our operations, which has resulted in improved cost controls, increasing margin, reduced cash burn, and heightened visibility. We have worked diligently to align all of our resources and operations, research & development, customer service, sales & marketing, to position the Company for long-term growth and profitable success.

In operations, we've implemented lean manufacturing principles, which have lead to dramatically improved production efficiencies and the elimination of unnecessary waste in our processes. We are now able to manufacture and sell larger units at higher prices without significant increase to production, labor, and overhead costs. We have improved our annual inventory turns to 5.4, while roughly doubling our unit output.

In research & development, we have implemented a structured phase gate product development process and industry recognized project management methodologies to ensure that we deliver the technology maturity our customers expect. The focus has been on improving our existing product portfolio, and ensuring that the products continue to comply with the most stringent distributed generation and engine emission standards worldwide.

We recently received our UL certification of our C65 UPS product line to support the growing demand for secure power and data centers. We are working in the emerging markets for mobile applications, and we continue to work closely with key partners such as the US Department of Energy, and high-efficiency CHP and other applications.

Working together with our authorized service providers, we have a customer service team of nearly 400 trained technicians the strive to provide the most value possible to our customers. Our comprehensive factory protection program has been a great success, and makes us more competitive on maintenance costs and ensures optimal system performance over the product lifecycle.

And in sales & marketing, our compounded annual growth of 35% over the past six years simply speaks for itself. We have a focus on markets with maximum potential and the most compelling macroeconomic drivers, and the outlook today in most of our markets is very robust. By focusing our resources in these key areas, we have built a solid foundation for continued success.

Slide 4 shows our global market segment's mix for fiscal 2013 by dollar amount. Oil and gas and other natural resource applications represented 55% of shipments, energy efficiency was 25%, critical power supply 14%, renewable energy 6%, and mobile products still less than 1%.

And turning to slide 5, I would like to make a couple of general comments on the fourth-quarter of fiscal 2013 before I turn the call over to Ed for the financial review.

In addition to delivering the best year in the Company history, I am pleased to report that the fourth quarter of fiscal 2013 was also the best year-end quarter in Company history. We delivered record quarterly revenue, and the second consecutive quarter of double-digit gross margins. Our book to bill ratio was excellent at 1.4 to 1 on product orders of $41.5 million, and our operating loss was reduced by half year over year. Every year, the fourth quarter has year end adjustments, primarily related to annual physical inventory that make it tougher for a quarterly sequential basis. We did very well this year and turned in a very strong fourth quarter on virtually all fronts.

I'll stop there and turn the call over to Ed for the financial review, and I'll finish with a few comments about markets and orders after that. Ed?

Thanks Darren. Good afternoon everyone.

Let's begin on slide 6 with a review of the fourth quarter. Revenue for the fourth quarter of fiscal 2013 was $35.4 million up 6% from $33.3 million in the third quarter, and up 18% from $30.1 million for the same period last year. Product revenue was $29.1 million, up 11%, quarter-over-quarter, and 17%, year-over-year.

For the fourth quarter of fiscal 2013 revenue from accessories, parts, and service was $6.3 million, compared to $7 million in the prior quarter, and $5.2 million for the fourth quarter of last year. The year-over-year improvement was due to increased parts and service sales. Gross margin for the fourth quarter was $5 million or 14% of revenue, compared to $4.6 million or 14% of revenue for the third quarter, and $900,000 or 3% of revenue for the same period one year ago.

Darren mentioned in the past, we've typically seen a sequential typical margin dip from the third quarter to the fourth quarter due to year-end adjustments primarily related to physical inventory. However this year, we held our margin consistent with Q3. What's more impressive, was the 1,100 basis point improvement over the fourth quarter of last year. The year-over-year increase was driven by higher overall volume in product sales, higher parts and service revenue, and lower direct material costs offset by an increase in warranty expense, production and service center labor, and overhead expenses.

Slide 7 shows our current gross margin analysis. Our 14% gross margin for the fourth quarter was primarily affected by the shipment of 35 C-200 units which drove a $400,000 increase in UTC carrier royalty from the Q3 levels. The run rate for royalty has been approximately $1 million per quarter at recent revenue levels. Please note that we expect the royalty rates to decrease by half during the second quarter of this fiscal 2014 as a result of the completion of the repayment to carrier for its contribution of cash and in kind services of $12.5 million related to the C-200 development. Based on our revenue run rate for Q4 of fiscal '13, that would be a $400,000 margin benefit.

R&D expenses were $2.2 million for the fourth quarter of fiscal 2013, flat compared to last quarter and up slightly from $2 million for the fourth quarter last year.

SG&A expenses were $6.7 million for the fourth quarter of fiscal 2013, down from $6.8 million last quarter, and $7.4 million from the fourth quarter last year. The year-over-year improvement was primarily due to decreased bad debt, trade show, professional services expenses.

Our net loss was $4.1 million or a $0.01 loss per share for the fourth quarter of fiscal 2013, compared to a net loss of $4.5 million or $0.01 per share last quarter, and a net loss of $8.3 million or $0.03 per share for the fourth quarter of last year. The loss from operations for the fourth quarter of fiscal 2013 decreased to $3.9 million, an improvement from the $4.4 million operating loss for the third quarter, as well as the $8.5 million operating loss for the same period last year. Net loss for both fiscal years was affected by the adoption of Accounting Standards Quantification 815, derivatives and hedging, which it affects our accounting for warrants with anti-dilution provision.

We recorded a non-cash benefit of $26,000 to the change in fair value of warrant liability during the fourth quarter of fiscal '13, which had a negligible impact on our net loss for the quarter. Same period last year, we recorded a non-cash benefit of approximately $500,000 to the change in fair value of warrant liability. Our net loss for Q4 of last year before considering the non-cash benefit to the change in warrant liability would have been $8.9 million or a $0.03 loss per share. Please refer to the non-cash warrant charges slide in the appendix of the presentation for a reconciliation.

Now, I'll try and give you a discussion of our performance for the full year of fiscal 2013. Turning to slide 8, you can see a visual representation of our consistent revenue growth since fiscal 2007, with an impressive compounded annual growth rate of 35%. We generated record revenue of $127.6 million for fiscal '13, a year-over-year increase of 17%, despite the downturn we experienced in the European market.

Slide 9 shows our annual gross margin improvement. We continued to improve our annual margin in fiscal 2013, posting $14.4 million or 11% of revenue compared to 5% last year. As we work to achieve profitability, we expect to see ongoing improvement in gross margin based on our anticipated higher sales volume with improved pricing, continued success with our initiatives to address warranty issues, for the reduction in direct material costs, and the reduced royalty rate. Please refer to slide ten which shows our path to expected operating [mallow] margin.

Slide 11 demonstrates the significant operating leverage that we have in our business model as we've grown our revenue by over $100 million over the last six years, our operating costs have remained relatively consistent over the same time period. Even our manufacturing, labor, and overhead has been fairly stable over the last several years despite our increased revenue and volume. This operating leverage is the result of a high portion of fixed costs in our business model, as well as our ongoing focus on controlling our overall cost structure.

Fiscal 2013 research & development expenses were $9 million compared to $8.2 million for fiscal 2012. The overall increase in R&D expenses of $800,000 resulted from increased supplies, salaries and consulting expense, which were offset by increased cost sharing benefits related to Department of Energy programs.

SG&A expenses were $27.4 million for fiscal 2013, compared to $28.9 million for fiscal 2012. The net decrease in SG&A expenses of $1.5 million was comprised of a decrease in bad debt and professional services expense, including accounting, legal and facilities expense, offset by increased salaries and related expenses, travel and marketing expense.

Net loss was $22.6 million or a $0.07 loss per share for fiscal 2013, compared to a net loss of $18.8 million dollars or $0.07 per share last year. However, remember that the net loss for both years was also affected by the adoption of the Accounting Standards Quantification 815, which affects our accounting for warrants with anti-dilution provision. The change in fair value of warrant liability was a benefit of $800,000 in fiscal '13, so our net loss before considering the non-cash warrant liability benefit would've been $23.3 million or an $0.08 loss per share.

For fiscal 2012, we recorded a non-cash benefit of $14 million to the change in fair value of warrant liability. 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. There's non-cash warrant charges slide in the appendix again for a reconciliation.

I will now provide some comments on the balance sheet and cash flow activity. Please turn to slide 12. Cash and cash equivalents totaled $38.8 million at year-end, as compared to $41.9 million at the end of the prior quarter, and $50 million one year ago. We've been very conservative in our cash usage. Total cash used in operations for fiscal 2013 was $17.1 million, down from $21.4 million in the prior year. In terms of quarterly cash flows, we used $3.6 million in cash and operating activities in the fourth quarter, compared to cash generated from operations of $4.5 million last year. During last year's fourth quarter, we experienced a more pronounced sequential decrease in inventory and an extraordinarily strong pace of collections off of a fairly high receivables balance in the third quarter of fiscal '12.

Capital expenditures for the fourth quarter of fiscal 2013 were at $300,000, down from $600,000 for the fourth-quarter last year. Receivables were $17.9 million, compared to $19.3 million in the prior quarter, and $18.6 million a year ago. Days sales outstanding or DSO improved on a sequential comparison to 46 days for Q4, compared to 53 last quarter, and 56 days for the same period of last year. The sequential and year-over-year improvement is due to our continued focus on cash management, which is resulting in improved collections.

Inventories were $21.8 million at March 31st. Inventory turns were 5.4 times, compared to 5.0 in Q3, and 5.1 times for fiscal 2012. Please note on slide 12 that we've updated our inventory turns calculation. And finally on slide 13, you can see a visual record of our growth in backlog since the beginning of '09. And as Darren mentioned, we ended fiscal 2013 with a record backlog of $148.9 million, indicating another strong year of growth in fiscal '14.

That concludes my comments, and now back to Darren.

Thank you Ed. Let's now turn to slide 14 for a summary of the primary market drivers that are fueling our business momentum. I'd like to make some comments on some of these that are particularly important for fiscal 2013.

Tier 4 emission standards are driving demand for Capstone's liquid fuel solutions for customers that must comply with heightened regulations and new clean fuel initiatives. When you consider that the global diesel generator market is approximately ten times the natural gas generator market on a per unit basis, this is a tremendous opportunity that's unfolding in terms of emission requirements for Capstone. Record low natural gas prices and the shale gas boom have created a massive market for onshore and offshore oil and gas production areas. Capstone solutions satisfy the need for highly reliable sources of power generation.

The boom in US gas production is expected to continue to accelerate for the next several decades. In fiscal 2013, 55% of our revenue was generated from oil and gas industry, and it continues to be our fastest growing and most vibrant market segment.

Power security is more crucial than ever. More and more, our customers are buying power reliability. When they are evaluating relationships between efficiency, reliability, total system availability, and cost per kilowatt hour, they're beginning to understand the total cost of ownership value of the Capstone product. The Capstone product is increasingly attractive, and more competitive from an ROI perspective than our competition. Capstone continues to capture market share with two dedicated products for the secure power or EPS market.

Our presence in green buildings and the transportation sector continues to expand. [Croger] (inaudible) from cost reduction through energy efficiency and green building practices are working in our favor globally.

In the transportation market, we are seeing new demand from the marine industry, which opportunities in North America and Europe across coastal and inland waterways. As the marine industry transitions to LNG, the world's LNG fleet is forecasted to double every two years. And the next decade it is expected that 90,000 vessels will use LNG as a fuel.

We're seeing new subsidies in California New Jersey, New York, Texas, and many other states that are driving combined cooling heat and power activity. Legislators in these states are promoting incentives that go beyond the federal level to drive cleaner and more efficient ways of producing electricity. And the promotion of CHP plants in many key markets has been given a new urgency in the wake of Hurricane Sandy. We are seeing significant growth in our North American markets overall, as well as continuing growth and South America, Asia, and Australia.

With 17% revenue growth in fiscal 2013, despite the heavy headwinds in Europe and Russia, this shows that our other markets our really driving. I'm happy to say that Europe is beginning to show signs of economic recovery, especially in Germany. But as well as in Italy and Spain, Poland, Slovenia, and some other areas in Europe. We've recently secured two new orders in Germany, as well as an order for 100 micro turbines from our Russian distributor for a new pipeline project.

In looking at Latin America, it's becoming a very vibrant market for us, especially in Mexico, Colombia, Peru, and Bolivia. Asia had a lot of open-ended potential, and we have received a number of recent orders from Thailand and the Philippines. Australia continues to be a good market for us, and we recently added a new partner there focused primarily on the CHP space.

Over the last few years, we have worked toward striking more of a diversified balance between domestic and international shipments. In 2012, we were at approximately 70% exports. But I'm proud to say today our shipments are roughly 50/50. This is another good indicator of our momentum that and increasing familiarity of our brand and the superiority of our technology here in the US.

Turning to the last slide, slide 15, here is a spotlight of some of our most recent contracts. In February, we added the US coal-bed methane market to our portfolio of oil and gas applications with an installation of country's first methane fueled C-200 at Consol Energy Gas Processing Plant in Pennsylvania. As government regulations for methane emissions become stricter, we anticipate more companies will turn to micro turbines for their ability to operate on methane gas, and produce extremely low emission rates.

Back and March, we received a 5-megawatt order for some key CHP and the CCHP projects in Mexico. In April, we announced several significant orders. I've mentioned the $6.4 million order from our Russian distributor. We also received an order for 34 liquid fuel C-30s from DesignLine for the Denver Regional Transportation District's electric bus fleet. And in China, we sold multiple C-30s, 65 C-200s that will be installed at various oil and gas sites.

In May, we announced a major order for one of the most prominent privately held real estate and investment firms in the US, New York-based Related Companies. This multi-building order includes 65s, 200s, MicroTurbines for office buildings, apartments, and mixed-use properties. And they have expressed interest in installing additional Capstone MicroTurbines in other properties within their large portfolio. Related Companies is a bellwether in environmental consciousness and real estate development, so this was a very important, strategic order for us.

In California, we received an order for three C-55 hybrid UPS units for installation at a data center owned and operated by Southern California Gas Company, which is our nation's largest natural gas distribution utility. This is very significant when you consider the coverage and reach of SoCal Gas. They provide safe, reliable energy to 20.9 million consumers in more than 500 Southern California communities across 20,000 square miles.

We've also made a couple of very well-received announcements so far here in June. Clean Road Partners, which is an internationally recognized technology innovator in the anaerobic digestion technology and byproduct utilization area, they ordered a C-800 and Capstone Clean Cycle 125-kilowatt waste heat recovery generator to fuel their grid connected system. This system will be installed this summer in a CHP application at an innovative, organic waste to renewable energy facility located at a prestigious California University.

Finally, we announced a major order in the marine market. This is a follow-on order of two C-65s and eight C-30 Capstone MicroTurbines from German-based MicroTurbine Marine Energy, which just recently entered into an OEM agreement with Capstone. This marine auxiliary application provides a completely clean and quiet experience for luxury yachts and commercial vessels. And if you go on our website you can see a video clip that shows the world's first MicroTurbine powered mega-yacht. A 144-foot schooner that is using a liquid fuel Capstone C-30 for on board power and heat.

Overall, we are seeing substantial untapped opportunity in the markets we serve, and our distributors are extremely motivated to sell as many of our products as possible. Capstone has come a long way toward broadening our reach and optimizing our potential, and there is even greater opportunity ahead as we continue to work toward our long-term goals. As we enter fiscal 2014 with brisk order momentum, expanding market drivers, we are more determined than ever to deliver another banner year of growth and margin expansion.

Well that concludes my prepared remarks. Operator, we are now ready to open the call up to analyst questions.

Of course sir.

(Operator Instructions)

Sanjay Shrestha from Lazard Capital Markets.

Great, thank you. Good afternoon guys, and congratulations on a pretty strong quarter here. First question that I had was on the margin front. So I wanted to take out all the sort of the one-time items, you guys had 20% gross margin in this quarter. And when I'm looking at that slide of getting to 35% and the majority of that coming from sort of the material cost reduction, how should we think about sort of margin build up over the next 12 months guys? Can you sort of walk us through that a little bit?

Yes absolutely, Sanjay. No, I think you hit the nail on the head. We continue to see strength in improving our margins. The key is that waterfall chart that we continue to use.

Exactly.

Will flow in the 4% over the next call it 12 months. Ed mentioned in his prepared remarks, we had very high royalty expense in Q4, about $1.4 million so about $0.5 million more than we typically spend just because of our mix. That gets us very close to paying off the initial level of that UTC royalty, so expect that by Q2 that that royalty will drop in half.

During Q2.

During Q2, correct. And so really the focus then is warranty, which as you saw again in the quarter is stabilizing what we believe trending down. And so the biggest focus is the area is cost reduction. We did cut in a lower price C-1000 enclosure during the quarter, and we have several other cost reductions that should be hitting in the current quarter that we're in now. So I think as we go forward, each quarter we should be looking for continued DMC reductions. Now some of it is obviously dependent on mix.

If you look at this quarter, our mix was unfavorable from a royalty standpoint because we shipped a lot of C-200's. Our charts and service and accessories mix was down a little bit, and product was up. But I think overall if you look at this quarter with the amount of money we spent on additional warranties and year end adjustments and the unfavorable mix, to still pull 14 points of margin was very impressive.

Great. So one point of clarification on this then guys. So when I'm looking at this cost reduction of 12%, pricing sounds like this is something you have much control over, given the warranty of that 3% impact sounds like it's pretty well within control. And when I'm looking at this 12%, so, would I'd be putting words in your mouth if I said maybe up to half of that gets recognized over 12 months, another half is maybe another 12 months out. And so, you add all that up, we're probably looking at ending fiscal '14 by at least sort of 25% gross margin number.

Yes, that's a reasonable expectation.

Okay, great two quick follow-ups then guys. So then you talked about this big real estate development Company and that reminded me of sort of the first oil and gas order or the shale gas order you guys had I think with [Pine] here which ended up becoming sort of a reference customer and then that business started to really boom for you guys. Is there a potential for something like this here, and is there any more color you can provide us as to how big it was and how big could it be? And I have one last question after that.

Yes, Sanjay. You absolutely hit the nail on the head. The Related Properties order, initial order, is going to be a multi-year order, multiple buildings in New York. They are looking at the rest of the portfolio where it makes sense to put in combined heat and power. It's basically a shift for their thinking on how they look at electricity, cooling and heat in their properties, and how to be more environmentally friendly in their buildings.

I think as you said, this is our first major win in the space and it's hardest to get the first customer. So we've spent two years trying to get our first order into the shale gas market. We finally got Pioneer, which led to Anadarko, which led to Shell, which led to Marathon, Talisman. And so as you start getting that first marquee customer, that second and third customer become much easier. So we see this as very strategic by Related themselves, but this is also a great opportunity to leverage that relationship into more relationships.

Great, one last question. It's two parts. One, how much is Europe in your current product backlog? And two, the tier four emission, how big that could -- I know Darren that you've talked about that a little bit in you prepared remarks, but how big are the booking opportunities that could sort of evolve into for you guys over the next 12 to 18 months?

Yes, we're already seeing -- I'll take the second one first. The tier four emissions, Caterpillar, Cummins, the other engine manufacturers are now coming out with what their product is going to look like to meet those emissions. And you're seeing SCR catalysts on top of the engines, urea tanks holding urea for urea injection. It's expensive, it's cumbersome, it's going to be a reliability issue.

So we're now seeing oil and gas companies looking to us for diesel product we put our first C-200 on an offshore platform. It's diesel powered. The 34 unit order we had in Q4 was all diesel powered from Mexico. We're seeing a lot more inquiries for the diesel product. We sold recently a C-1000 diesel product into China. So I think you're going to see not only buses, trucks, and boats looking to go diesel, low emission technology but you're going to see more off-road applications especially where natural gas is not available. Natural gas infrastructure here in the US is fairly abundant, but other parts of the world it's not. And so, if you're running on diesel but need to clean the air and have no other choice unless you want to bring in LNG or propane, clean diesel is a great way to go.

So as I mentioned in my prepared statements, the diesel market is about ten times the size of the natural gas market. The natural gas market for us is a $14 billion annual market, so there's no shortage of target rich environments for us to go off with our diesel product. So, we're very excited about that.

As far as Europe and the backlog, we don't specifically break that out. But you can imagine, you haven't seen a lot of Europe related press releases. I was just in Power-Gen Europe in Vienna for a week. I will say that the morale amongst our distributors is the highest it's been in probably three or four years. But they're still cautiously optimistic I'd say. It's still a slow comeback for Europe. I would say we're probably two years away from full recovery.

On the Russian side, we are still seeing a lot of activity, Sanjay. And we're seeing a good part of the backlog is the BPC. So, that's still very healthy just a little bit slow on the revenue side.

Yes, I think Russia will come back faster. Germany will come back faster. I think where we're going to see a slower recovery is going to be the UK. It's going to be France. It's going to be Spain, those countries. That being said, there's opportunities in Poland that we're seeing that we had not had opportunities before. Slovenia, we just got a nice order. So there's other parts of Eastern Europe I think where we've had little to no penetration where we can actually gain some market share.

Got it. That's all I had guys. Congratulations.

Eric Stine from Craig-Hallum.

Hello guys, thanks for taking the questions. I wonder if we could just touch quick on gross margin again. Just curious how we should think about linearity there. You touched on royalty, just curious are there any sizable parts that you plan on cutting in where you can point to a specific quarter? Where you may see a specific big step up, or is this just going to be gradual throughout the year?

I would point more to gradual. We may see some -- if you get a couple parts cut in plus a favorable mix that may give you a bigger bump one quarter to the next. We saw the little from Q2 to Q3, but probably the safest way to model it Eric is just assume a slow growth each quarter as pricing comes in and as cost comes out of the product.

But I think again for Q4, it's safe to say you had at least 1% impact because of the increased royalty. 1% impact because of year-end adjustments, and probably another 1% for mix and some other items. So, that, if you try to normalize Q3 to Q4 it would probably be 17 to a 14. You saw the chart, and here we go back all the way to Q3 a year ago, and try to show you without the noise what the underlying strength of the margin improvement is.

Okay. And getting now a full quarter of the enclosure and some of these other things, 20% is a possibility in this next quarter? Is that how you're thinking about it?

We're still thinking high teens, and we don't want to give specific guidance. The quarter is still in process. It really depends on if we get all of our slots filled and what the orders look like. But definitely we're talking about an EBITDA break even within the next couple quarters, so that's around 21%, 21.5% of these revenue levels. So we should be somewhere in the next two quarters, we'll break in the 20% barrier.

Got it, okay. Maybe we can touch on -- you'd talked about oil and gas a little bit in Russia. I'm curious about China. I know you had your first order there in probably the last two to three years. This one was in oil and gas. And just curious how you think that market plays out given that they're a few years behind in terms of shale?

Yes. They're definitely behind in terms of shale. Their behind in terms of emission standards, and other items. I think we're seen them slowly turn the corner. We've got six distributors in China, our China business is picking up. I still think we're a year away from them being a very significant player for us. I think they are still going to walk before they run. But that being said, the Chinese government has got some very ambitious plans whether it relates to cleaning the air, cleaning the water, energy efficiency and all of those would be macro drivers for us.

I think in the next 12 months we're going to see continued strength in growth in the US market. So I think we're going to see Russia just come back a little bit. Europe will probably be somewhat flat to up. South America and Mexico should be very good for us. We're seeing lots of opportunities there. Africa is starting to pick up, and Australia, I mentioned in my prepared remarks, we have a new distributor who has already turned in several orders. And so I think Australia could be a very nice market us.

Got it. Let me just sneak in one more question just on the new product front. It sounds like there's a lot of demand especially here in North America for a product that you can use on pump jacks. Just curious where that stands in development, and how you view the overall market opportunity for that. Thanks a lot.

Yes. No, the pump jack market is a huge opportunity for us. It would probably double our addressable market in oil and gas. We have two sites running right now with MicroTurbines on pump jacks. The issue is not our ability to operate pump jacks, it's really the battery life in our machine. So we've got a two-pronged approach to improve the battery life and the maintenance costs, and both of those are ongoing. We're very confident we're going to have a up to our standard solution from a lifecycle cost perspective here very shortly.

So we're definitely looking at the entire oil and gas market from associated gas, pump jacks, every place we can put the product where there's electrical need we want to have a solution for. Obviously oil and gas is our strongest market. We've got some great partners whether it's Shell, BP, Marathon, Gazprom, [P-NEX], Petronas, or the Anadarkos, Pioneer Natural Resources, to [haligroup], we want as much of their business and to be able to address as many of their needs, solve as many of their problems as possible. And pump jacks is just another way that we can do that for them.

Got it, thanks a lot.

Thanks Eric.

Philip Shin from Roth Capital.

Darren and Ed, thank you for taking my questions. My first question is on future product development. You've had some nice revenue growth and backlog growth, based on a lot of those C-200 activity. As we look forward, can you give us an update on progress with the C-250 as well as the C-370?

Yes. (multiple speakers)

The timing associated with that as well. No, absolutely. The C-250, both of these are part of a DOE program. In fact, DOE will be here in a few months. The 250 is still operating in the lab, proving power and efficiency. We're very happy with the initial kind of beta unit and the performance so far. We're still putting it through performance testing, and then the DOE will be here shortly to kind of buy off on that phase of the program development.

After that's complete, we'll look at kind of pre-production, early commercialization, getting some hours on the unit out in the field before we go to complete commercial launch. I think from a technology standpoint though, we feel very good about the risk. The C-200 is about 85% the same build material, so part of what we're doing is making sure the C-200 build material is completely settled down and robust, and then we get some field time on the 250 and we'll go ahead and launch that product. Which will obviously help us on the C-1000, and well have four in the box versus 5. The build material is 5% to 8% higher for a 250 versus a 200 with 20% more output. So that's very exciting for us.

On the 370, we're still doing a lot of analytical cycle backs and performance testing. We do not have any hardware yet. We are working on some bio-metal turbine wheels, some other technology that we need to do. I would say we'll probably be a year away from having that in the lab from an operational perspective. But there's some parts of the 370 design that will trickle into other C-65 and C-200 as we develop that program. But overall, I think we're very excited about both programs. The 250 is obviously much closer that the 370. The 370 is a very big step for us from a power and efficiency standpoint. Can you talk about the timing of when the 250 commercial release might be?

Yes, the 250 really is -- I keep saying roughly 18 months. It really depends on what happens over the next I would say nine months. If the C-200 continues to mature from a reliability standpoint like we're projecting, and if the early field trials go well, then I would say we're definitely 18 months maybe sooner on the 250. Things aren't as smooth as we want them, they could be as late as probably 24 months. But definitely, you're going to see it at least in field demonstrations here, very shortly.

Great, that's helpful. You mentioned in your prepared remarks the Denver order with the electric bus fleets. Can you just comment on what you see for the future of mobile, and what you could expect to do going forward?

Yes, no I think the mobile market is one where we've always been interested. the Company was founded on an automotive platform, as I'm sure you know. That the market is still kind of evolving and developing. We believe electric vehicles will have a place in our society and the value to the world at large.

The real challenge is range. And so we can offer solution for range, especially in work vehicles. And I think where we're seeing the most opportunity for our product is in a large transit bus that works 20 hours a day seven days a week, for a delivery vehicle for Costco, or for Walmart, or for FedEx, or something that's going to be on the road again six, seven days a week 18, 20 hours a day. An electric vehicle, regenerative brakes, batteries on board. And instead of going back, after two hours, three hours and charging, the MicroTurbine fires up and charges the batteries.

So, we're excited about what DesignLine is doing. We're very excited about the Denver order. That will be our largest fleet of Capstone powered buses in the world in any single property, a little larger than Denver and some of the other folks that our out there, I mean Baltimore. But on the truck side, we're still working with Peterbilt and Kenworth. The Kenworth truck is about to go into field demos with a large box store. The Peterbilt truck is almost, built and should be unveiled here shortly, again with another large box store customer. And so we're very excited about those two demonstrations, and how that product can eventually be commercialized.

Obviously on the marine side, in my prepared remarks, I talked about LNG as a fuel. And we're seeing both diesel as an opportunity and LNG in the Marine space. And if you think about Marine market, reliability is key. Obviously you can be stranded without power. We've seen that in cruise ships and in other areas, so that fits well with our value proposition. But more importantly, no vibration, no smoke, no soot, no oil, low maintenance. All those things play very well. So as the Marine market evolves becomes lower emission and moves toward alternative fuels, it should be open up a lot of opportunities for us.

Great. One last question and I'll jump back in queue. What percentage of your backlog is based on follow-on orders and how does that compare to one year ago?

Yes, that's a hard one for us, Philip and we -- all of our orders are through distribution for the most part. So essentially they're all follow-on orders unless it's a brand new distributor. Trying to get -- to measure that by a end-use customer is more difficult. Obviously our biggest customers today would be Origin energy in Australia has close to 200 C-30's, Anadarko, Chesapeake, Pioneer, Marathon, Shell, all huge follow-on orders in the last year here in the US.

We've got several hotel chains that have multiple orders. Tesco has 20 some grocery stores with our product. But I think beyond that, that there's a lot of customers that have one or two orders or three orders, there related we think obviously it would be multiple orders and a lot of follow-on opportunity. And hopefully Related will get us and getting other folks in this space whether it's equity office or other large REITs that are looking to follow the same suit.

But we don't track that specifically, we track our pipeline. We track our pipeline by market. We track our close rates. We see a very robust pipeline, we're up to over $1.4 billion in pending orders. That's up significantly obviously from just a couple of years ago. And so for us, the biggest key for future growth is happy customers, the strength of our distribution channel, and then just making sure that we look at the macro drivers around the world. Europe is still a concern for us, but Russia less so, but we need to see those markets come back to really turbo-charge the growth of our Company.

Ajay Kerjiwal, FBR Capital Markets.

Thank you, good afternoon.

Hello Ajay. I hope you have some questions left. Those guys didn't leave you any.

I know, but you'd be surprised. I do you have some questions. So Darren, I thought you hit on a very important point on Europe, Russia, despite them being down as much as they were, you were still very nicely up on the year. So maybe talk a little bit about expectations. And to the current year, I thought I heard you say that things looked to be improving in several markets in Europe. So assuming you see some growth here, and your backlog is at a record level, and I know you don't give guidance, I'm not asking for that, but just maybe directionally help us think about the current fiscal year.

Yes, I guess we don't give hard guidance. The soft guidance we kind of set as our ending year backlog is a good indicator of the next year's revenue. That backlog has a lot of Russian orders in it, not a lot of European orders. So I'd say, whether you think we're going to be above or below that number would really depend on how fast you believe the European market would come back.

So, said and more specifically if you believe Europe is still going to struggle then probably a number lower than the $150 million is a good place to be if you think it's fairly status quo then around that number. And if you think Europe is going to come back, then we could be over the number.

So, and there's a lot of other factors. We're getting looks at opportunities, 10 megawatts, 7 megawatts, 5 megawatts, that we just didn't see two years ago. So it's not out of the question that we get a couple very large orders that would move the needle even more than what we're seeing today. But I think overall, we look at our business plan and we're planning of a moderate nice, steady growth year again this year. Obviously we'll strive to do better than that, But our biggest concern is still just the health of the European condition.

That's very helpful. And then on the Marine market, to me it seems like a showcase project win for you. Maybe talk a little bit about follow-on opportunities, could this be something, this project, could this be opening up newer markets, newer customers for you?

Yes, our marine penetration has been virtually zero, so it's definitely opening up new opportunities. We've been out beating the street on some work boat shows. We'll be doing some of the yacht shows. We'll do some marine advertising. We've got the video, it's up on our website now. We just signed an OEM. So I think it's an area we're going to be marketing and advertising fairly heavily this year.

Some of those boat builds can be two year builds or 18 month builds. So it may take a little bit of time to convert some of that to revenue. But I'd expect it at least to build some nice order backlog this year, maybe not drive a lot of revenue but at least drive some order backlog that will lead to revenue the following year. I think again the work boats, the ferry's, some of the tankers and then the mega-yachts are great opportunities for us.

Good. And then on that methane based project with CONSOL that's first and seems like an impressive win. Just maybe just a little more color on what that project is, and then any follow-on opportunities with CONSOL?

Yes, that's a coal mine gas opportunity where they needed to extract the gas from the mine and burn it. Traditionally either flare that gas and lose opportunity to actually turn it into useful energy. They're actually giving some of the power I think to a local school, which is great from a community standpoint. But I think coal mine and coal-bed methane are two areas of potential huge expansion for us around the world with people again.

In general, flaring is becoming a four letter word. And I think as more countries realize that there's technologies like Capstone that can take flare gas and turn it into something valuable and something that's meaningful to the economy and to the user, we'll see more and more of that happening. So we've got some nice flaring opportunities up in Canada. We've got some opportunities in South America. We've done a lot in Russia, as you know with [tapnet] and Gazprom and [Lukeoil]. I think that that's going to be a trend that's going to continue just like the tier 4 emissions and other requirements.

Got it. And maybe a last one clarification question for me. So that $400,000 a quarter benefit on royalties, do we just do the math straight annualizing that $1.6 million benefit for next year? Is that how we should be thinking? And I know you said it starts in the second quarter, so we'll adjust for that. But on an annual basis, is that roughly the benefit?

Let me just clarify Ajay. It was -- the run rate -- or Ajay sorry, at recent revenue levels was about $1 million a quarter in royalty. And because of the high concentration of C-200s in this quarter that we just reported, it ran $1.4 million. So, we're saying based on current run rate it's about a $400,000 difference. And then if you take that going forward, let's just assume the mix is it returns to normal and it's a $1 million run rate, you'd pick up about $0.5 million benefit at these revenue levels.

So an annual benefit of about $2 million?

At current revenue levels.

Yes, as revenue grows the benefit would increase. But yes, looking backwards that's correct.

Excellent, thank you very much.

Thanks.

Thanks Ajay.

Rob Stone from Cowen & Company.

Hello guys. So Darren, you mentioned a pipeline of potential orders something like $1.4 billion, and a good bit of the June quarter is already behind you, not over yet. But in terms of your booking activity, you had a nice strong Q4, has that trend continued through the quarter to date?

Yes, I don't want to specifically talk about Q1. But I think we were -- I think we -- I'd say we're pretty confident that we'll have another one to one book to bill. That's something we've traditionally been able to do. Q3 was a little soft, if you remember, and we said in that call that we were pretty comfortable Q4 would come back. I'd say Q4 came back in a very big way with $41 million in bookings and a 1.4 book to bill on the biggest product revenue shipment quarter we've ever had.

So, all the macro drivers are strong. I think again the only area we're seeing softness is the European area. We've had a lot of recent wins that we've announced. So, I won't specifically say what it's going to be, but I'll say that assume another one to one book to bill is a reasonable expectation.

Yes, I wasn't so much looking for a specific number. It's just kind of directional. And it sounds like --you talked about a rough order of magnitude $150 million plus minus depending on what happens this year for revenue,.

Correct.

It sounds like with some premier wins in areas like CHP and Marine and maybe Europe is starting to come back that from a bookings perspective maybe you could have an acceleration this year versus last year. Do you feel like there's more areas of potential contribution is that a reasonable?

That's definitely a reasonable expectation. Not only are our good distributors getting better, I think we're penetrating new customers like Related. We're getting into new market opportunities. First orders in Africa, and Chile, and in parts of Eastern Europe. So there's definitely new customers and verticals we're penetrating, and new geographies. And again, all the macro drivers that we look at are virtually all pointed in our direction. So I think we feel very good about that.

The California Self Generation Incentive Program is providing some nice lift for us. There's new incentives in New Jersey that are very favorable. I think there's $100 million to put towards CHP. A special fund set aside. There's a new PON that should drive some revenue for us, and the Palace Hotel is going online here shortly. Marquis customers like that. Almost everybody is a New Yorker knows that hotel. It's a very prestigious hotel.

Being able to take customers through other hotel chains, that will be very helpful for us. And so I think to your point, barring any major changes in the economy or any changes in some of our verticals that we're in, we feel very good coming into the new year.

So in a new market like marine, how do you think about the process of sort of building from a flagship first instance to multiple customers. Is that a two-year or three-year exercise? When might we see that as a more meaningful slice on the pie chart?

Yes. We started marketing in that area about two years ago. We've had one C-30 running on a mega-yacht for about a year. We've had a larger vessel running for about nine months. So we've seeded the market a little bit. We've started doing the marketing activity. But really as we come back on the second and third year and doing some of these work boat shows and pleasure boat shows getting some more wins, we'll start the momentum growing.

And that's really the challenge is getting those first kind of adaptive customers to take the leap is the hardest part. So, we recently announced an order for a couple C-65's and eight C-30's. I think once we get a dozen customers out there with six months worth of experience, the word will spread pretty quickly. Because customers are definitely looking for something different besides loud, leaking, dirty diesel engines on their ships.

A couple of housekeeping questions for Ed if I may. You mentioned you had some favorable variance in bad debt and expense in other things helps you on SG&A this year. Do you have thought on what you might be able to do in terms of levers you can pull for expense run rate in fiscal '14 relative to the year just ended?

Yes, the bad debt side of the -- the recoveries of previous bad debt reserves should slow down in '14. But I'd expect the run rates on the operating expenses to be very similar to '13 levels.

Okay. And any comment on -- I know it's not a big number, but how to think about CapEx for the coming year?

Yes, we generally are spending $1.5 million to $2 million year, and again I don't see any reason for that to change. So, I would model $2 million or less for CapEx.

And finally, you noted that you'd changed the way you were calculating inventory turns and you adjusted the prior year. What's the mechanics of that?

We're just went to a -- we were using a pretty complicated internal calculation that you needed to have access to the general ledger to run. So, we've changed it to where you can do it off the publicly filed statements. So it's a more traditional turns, beginning and ending averaged, cost of sales.

Right. Thanks very much guys.

You're welcome.

Colin Rusch from Northland Capital Markets.

Thanks guys. You mentioned some of the other solutions that you're seeing other for ultra low emissions, are there any viable products that you're seeing particularly in CHP with the ultra low emissions that aren't quite as complicated or are more elegant solutions?

No I mean from a MicroTurbine space, we're 90% market share we're not seeing much of our competitors there. Engines traditionally are our biggest competitor in that space, and so I think that's where the challenges from a CHP, CCHP, the Palace Hotel doesn't want eight Caterpillars slobbering engines that are making a bunch of noise on their roof and leaking oil. I think a more elegant solution is better.

I think where our biggest challenge in CHP is really just the grid, and getting the pricing and the payback low. And with low natural gas prices we're seeing paybacks closer to three years, and that's really kind of the magic number I think. With this economy, you need to be down on a three-year range four maybe, but definitely the closer to three you get the better off you are.

Fuel sales we still don't see them as a competitor. They have three markets in the world for the most part California, Connecticut and Korea. Where you have huge government incentives that make them economical, and it's a great technology. But for us, where we can get total system efficiency as close to 85% and use the heat off the machine in CHP use low price available natural gas, that's definitely the right way to go. So for us and CHP really the utilities are probably our biggest competitor. Oil and gas is definitely reciprocating engines, Caterpillar and GE.

Okay. Great. And then, on the material cost adjustments, was there a particular area or a particular part of the inventory that was driving that?

No, it's definitely on raw materials. Mainly on metals that we use in the process that the standard costs came down so it requires an adjustment which is cost of goods sold. So it's actually a good thing in the long run.

Yes, and I'm wondering how big an impact that has going forward? It seems like if you're running down these materials they probably run through your COGS as well?

Yes. It's really hard to forecast because it depends how much of the material we have on hand and how the standard cost would change at any given quarter end. So I can't really talk about how would work. But --

Okay.

But ideally, return inventories fast and we don't have a big effect from that.

Okay, great. And one last quick one, just you mentioned Africa and when you're looking at the opportunities out there, could you talk about whether it's mostly backup power with buildings or is it more related to the mining oil and gas industry? How should we think about that opportunity and the timing?

Yes, today it's mostly all mining, oil and gas. And I think we'll move into more traditional CHP, but almost all of it is prime power.

Okay, perfect, guys. Thanks so much.

Welcome.

Ladies and gentlemen this concludes today's question-and-answer session of today's conference. I would now like to turn the call over to Darren Jamison for closing remarks.

Thank you everyone. I think we had a lot of great questions, so I don't need to put too much to time on my closing remarks. We're very excited about the record year that we just closed, and all of the great opportunities, great successes that we had. We're very excited about our cash balance, our inventory turns, our revenue growth, our backlog, our improvements in our margin, and we're looking forward to another great year in fiscal 2014. So with that, we'll talk to everybody at the end of the first quarter.

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