Capstone Green Energy Corp (CGRN) 2014 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 and full fiscal year 2014 Capstone Turbine Corporation earnings conference call.

(Operator Instructions)

During today's call, Capstone's management will be referencing slides that can be located at www.CapstoneTurbine.com under the Investor Relations section. This call, as a reminder, this call is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Jayme Brooks, Vice President, Finance and Chief Accounting Officer. Please proceed.

Thank you. Good afternoon, welcome to Capstone Turbine Corporation's conference call for the fourth quarter and fiscal year ended March 31, 2014. I am Jamie 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 12, 2014. If you don't have access to this document and would like one, please contact Investor Relations via telephone 818-407-3628 or e-mail IR@CapstoneTurbinecom, 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 our end markets, increased production rates, higher average selling prices, ongoing new order [flow], reduced cash usage, and growth in revenue, gross margin and backlog, attaining profitability, improvement in certain key performance indicators and strategic initiatives, achievement of our EBITDA and cash goals, improved operating leverage, new product development, shifts to larger markets for our products, benefits from our cost reduction initiatives, and opportunities from our relationships with the Department of Energy and Oak Ridge National Laboratory.

Forward-looking statements may be identified by words such as expects, projects, tend, targeted, plan and similar phrases. These forward-looking statements are subject to numerous assumptions, risks and uncertainties described in Capstone's Form 10-K and 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 these risks and uncertainties, Capstone cautions you not to replace undue reliance on these statements which speak only as of today. We undertake no obligation, and specifically disclaim any obligation to release any revisions 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 2014 earnings call. With me today is also Ed Reich, our Executive Vice President and Chief Financial Officer. I will start the call with a recap of our fiscal 2014 highlights, and then turn the call over to Ed who will review our detailed financial results for the fourth quarter and the full-year. After Ed's remarks, I will talk about product development, and key orders, and we will take questions from our analysts. As Jayme said, 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 very proud to report the Capstone achieved another banner year of business development and margin expansion in fiscal 2014. The strength and maturity of our operations reflects the comprehensive internal improvements made in recent years. We have also expanded significantly in existing markets, and made inroads into promising new markets. We have been successful in bringing down costs on increasing revenues, while holding production, labor and manufacturing costs in line, as we continue on our path to profitability. We set a new annual records for revenue, new annual records for gross margin. Annual revenue growth was 4% which is slower than recent years, but still reflects a strong compounded annual growth rate of 30% since fiscal 2007.

But more importantly, we achieved substantial gross margin expansion of 500 basis points to 16%, despite this modest revenue growth. Operating results decreased 30%, and net loss decreased 28%. We had new product orders of $131.5 million, resulting in a healthy book-to-bill ratio of 1.2 to 1, and we shipped 110 megawatts of product. This healthy new order flow pushed our backlog to a record $171.6 million at the end of the fiscal year. On a megawatt basis, we had188 megawatts in total backlog, compared to 163 megawatts at the end of last year. Cash at year-end was $28 million, but with the offering we completed in May, we added net proceeds of approximately $30 million to that balance. As a result, we are in very good position, in terms of our financial flexibility and needed fuel for our continued revenue growth.

Let's go ahead and turn to slide 3. Slide 3 shows our global market segment mix for fiscal 2014 by product shipments, 60% are using oil and gas and other natural resources, 25% in energy efficiency, 6% to renewable energy, and 9% in other applications including critical power supply and mobile, which includes transportation and marine. Overall, the oil and gas market continues their path is growing and largest market worldwide. Natural gas production has experienced a significant boom in recent years, with no apparent slow down in sight. With global shale gas development expected to continue to grow for years to come, we are ideally positioned to serve all facets of this market including exploration, production, compression and transmission.

Geographically after several years of volatility in our markets across Europe, revenue this past year has finally rebounded to fiscal 2012 levels. The change in total revenue for fiscal 2014, compared to fiscal 2013 included increases in revenue of $15.2 million from the European market, $6.1 million from the African market, and $2.3 million from the Asian market. The total mix was 51% North America, 31% Europe, 8% Asia, 4% Australia, and 6% other, which is primarily Africa. The increase in the European market was 59% over fiscal 2013. This is primarily driven from increased sales into the Russian natural gas and oil industry. It is very important to note, we have not seen a slow down in our Russian business. Our Russian distributor in the region, BPC Energy has sold only 2 megawatts or roughly $2 million in the Ukraine. So overall, sales have not been affected by the political unrest, and it is more or less business as usual. Elsewhere in Europe, we experienced 48% year-over-year growth, which came largely from Austria, Slovenia and Switzerland, with some more recent strength in Germany, Italy and Poland.

Let's go and turn to slide 4. Looking at slide 4, which shows our market terms in shipments by megawatts for fiscal 2014. Globally, our geographic reach is extending further into a number of markets, where rapidly rising power needs require expanded distributed energy resources. In North America, for example, the Industrial CHP and CCHP market in Mexico is strong, and [our] solutions offer an attractive payback as replacement for less efficient on-site equipment and reliance on the electric grid. Our leading distributor in Mexico is among the top ten overall in sales in fiscal 2014, and we are very pleased with the ongoing order flow from that country. We also made headway into the energy efficiency, renewable energy and natural resources markets in South America and parts of Africa throughout the year.

Turning to slide 5. Slide 5 shows our megawatts and units shipment by product for fiscal 2014. The increased shipments over fiscal 2013 were the result of higher sales volume of our C65 microturbines, and the change in product mix in the C1000 Series systems, offset by lower sales volume in the C30, C100, and C200 microturbines.

During fiscal 2014, we really focused on getting more aggressive, and refining our distribution channels to address our specific targeted markets, and speed of the maturation process of our distribution base. We cut back territories in some places, and merged them in other places, and in two places we have actually taken Capstone sales assets, actual personnel, and set them up as distributors, one in Europe and one in the US. Today, we have a total of approximately 90 distributors and OEMs worldwide, with approximately 400 customer service technicians and 742 certified authorized personnel. I will talk more about product and major orders in a few moments. But first I will pause, and turn the call over to Ed for the fourth-quarter and full-year financial review. 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 2014 was $36.4 million, compared to $37 million for the third quarter, and $35.4 million for the same period last year. Product revenue was $30 million, compared to $29.9 million for the third quarter, and $29.1 million for the year ago quarter. For the fourth quarter of fiscal 2014 revenue from accessories, parts and service was $6.4 million, compared to $7.1 million in the prior quarter, $[6.3] million for the fourth quarter of last year.

Gross margin for the fourth quarter was $6.1 million or 17% of revenue, compared to $7.3 million or 20% of revenue for the third quarter, and $5 million or 14% of revenue for the same period last year. It is not unusual for us to see a sequential margin dip from the third quarter to the fourth quarter, due to the year-end adjustments. However, the 300 basis point year-over-year increase in gross margin primarily reflects a shift in mix to larger units and lower royalties and working expense. Fourth-quarter R&D expenses were $2.5 million, compared to $2.3 million last quarter, and $2.2 million for the fourth quarter of last year. SG&A expenses were $6.8 million for the fourth quarter of fiscal 2014, compared to $7 million for the third quarter, and $6.7 million for the same period last year. The net loss was $3.4 million, a $0.01 loss per share for the fourth quarter of fiscal 2014, compared to a net loss of $2.2 million or $0.01 last quarter, and a net loss of $4.1 million or $0.01 for the fourth quarter of last year. The loss from operations for the fourth quarter of fiscal 2014 was $3.1 million, compared to $1.9 million for the third quarter, and $3.9 million for the fourth quarter last year.

Now I will turn to a discussion of our performance for the full fiscal year of 2014. On slide 7, you can see a graph of our consistent revenue growth over the last seven years under our current management team. Annual revenue growth of 4% in fiscal 2014 was lower than in recent years, but still reflects an impressive compounded annual growth rate of 30% since fiscal 2007. Total revenue for fiscal 2014 set a new record at $133.1 million, and product revenue was up 6% to $108.8 million. We are cautiously optimistic that we will return to higher revenue growth rates in fiscal 2015, given the positive momentum that we are seeing in Europe, and the growth and traction we are getting in a number of our other markets.

Slide 8 shows our annual gross margin improvement. Gross margin was $21.7 million or 16% of revenue for fiscal 2014, compared to $14.4 million or 11% of revenue for fiscal 2013. We continue to move forward along our path to higher margins, through a combination of higher sales volume, lower direct material costs and decreasing warranty expense. Warranty expense for the year was down in absolute dollars, while revenue was up. This decrease in warranty is attributable to C200 and C1000 series products, and reflects a similar trend to what the Company has experienced with introductions of the C30 and C65. Our experience has been that roughly four years after commercial introduction, warranty has peaked, and begins to trend down. Overall, we expect to achieve similar gains in our gross margin percentage in fiscal 2015, based on many of the same drivers that occurred in fiscal 2014.

Turning to slide 9, this slide demonstrates the operating leverage that we have in our business model. While revenues have increased by over $110 million in the last seven years, our operating profits have remained relatively consistent over that same time frame. This not only demonstrates the operating leverage that we have in our business model, but also the ongoing focus that we have in implementing cost reductions, and controlling our overall cost structure. Manufacturing labor and overhead expenses were $14.7 million for fiscal 2014, compared to $14.6 million the year before. Research and development expenses were $9 million for both fiscal 2014 and fiscal 2013.

Selling, general and administrative expenses were $28 million for fiscal 2014, compared to $27.4 million the prior year. The net decrease in SG&A expenses was comprised of increases in salaries, facilities, consulting and supplies expense that were partially offset by a decrease in marketing. The net loss decreased 28% to $16.3 million or a $0.05 loss per share for fiscal 2014, compared to a net loss of $22.6 million or $0.07 loss per share for fiscal 2013. The loss from operations for fiscal 2014 was $15.3 million, down 30% from the prior year.

I will now provide some comments on balance sheet and cash flow activity. Please turn to slide 10. Cash and cash equivalents totaled $27.9 million at March 31, 2014, as compared to $31.6 million of the end of the prior quarter, and $38.8 million one year ago. After year-end, we [closed] a public offering for 18.8 million shares of common stock, which were sold to a single institutional investor. Net proceeds after deducting fees and other offering expenses were approximately $30 million. So our pro forma year-end cash balance if you were to add the proceeds from the offering, would have been approximately $58 million.

In addition, on June 9, we extended the maturity of our credit facility with Wells Fargo Bank, and increased the maximum borrowing capacity by $5 million to $20 million. We also amended the financial covenants, and extended the maturity date to September 30, 2017. Between our cash on hand and our extended credit facility, we believe we have ample liquidity to fund our growth plans, and to meet our increasing working capital requirements that would be required with larger orders. We continue focus on reducing our cash requirements. We used $15.4 million of cash in operating activities and spent $1.2 million in capital expenditures in fiscal 2014, as compared to cash used in operating activities of $17.1 million and $1.2 million in CapEx during fiscal 2013. We expect to make additional progress in operations in fiscal 2015.

Receivables of $28 million at March 31, compared to $22 million at the end of the prior quarter, and $18 million a year ago. DSO was 70 days for Q4, compared 54 days in Q3, and 46 days for the same period last year. The increase in DSO for the fourth quarter of fiscal 2014 was primarily due to timing issues, and we expect to return to more typical levels in Q1 of fiscal 2015. Inventories were $21 million at March 31, down from $25.1 million at December 31, and $21.8 million a year ago. Inventory turns were 5.3 times, compared to 4.9 in Q3, and 5.4 times at the end of fiscal 2013.

Finally, slide 11 shows our growth in backlog since the beginning of fiscal 2007. Backlog increased to a record $171.6 million as of March 31, 2014, compared to $160.4 million at December 31, and $148.9 million at the end of the prior fiscal year, representing a 15% year-over-year increase. Ending backlog is a leading indicator of our future revenue growth, and current trends bode well for our revenue margin expansion opportunity in fiscal 2015 and beyond. As customers continue to migrate to our larger units and larger projects, we anticipate margin expansion to continue at a similar pace for fiscal 2015, and to cross over to positive EBITDA during the year. That conclude my comments, now back to Darren.

Great. Thank you, Ed. Let's go ahead and turn to slide 12. In research and development, we have begun the second phase of our C250 program with the US Department of Energy. We have successfully demonstrated the low pressures [spool] C250 in the lab, while achieving the California Air Resources Board or CARB level of emissions, without any after treatment. I am proud to say that C250 will soon enter beta field testing later this year. Phase two of the program is expected to incorporate further engine efficiency improvement, resulting in a product with a projected electrical efficiency of 42%, and a targeted power output of 370 kilowatts for the C370.

In partnership with the Oak Ridge National Laboratory, we have successfully built a new C65 recuperator with an advanced AFA steel material. AFA offers a superior oxidation and creep resistance to the commercial heat-resistant steel alloys. The C65 is currently in the accelerated thermal and cyclic life testing in the lab. This new alloy could be used for several high temperature applications within the Capstone MicroTurbine product at a significantly reduced cost. In addition, we are working diligently on upgrading all Capstone product lines to be compliant with the new low and medium voltage grid interconnect requirements in Europe. These improvements require both hardware and software changes to our inverters, to allow power that can be fed seamlessly into the grid, smoothly and efficiently. These enhancements further the smart grid capability of our products, and position us well for future regulatory changes in both Europe, the US, and in the other emerging markets.

Now turning to slide 13, 13 with some comments on some key projects. Among our vertical markets, we are particularly enthusiastic about our opportunities in the transportation market, especially in the [HUV] buses and trucks, as well as auxiliary power for marine applications. We are very proud of our participation of the Walmart Advanced Vehicle Experience or WAVE concept truck, the latest from Walmart's fleet efficiency program. The MicroTurbine acts as a range extender in the series hybrid powertrain, and features the latest in green truck technology.

In the marine market, we have expanded our product offering with MicroTurbines that run on cleaner and less costly liquid natural gas or LNG, or traditional diesel fuel that can provide all onboard electrical power. We have seven different Capstone distributors targeting the small and midsize commercial ship and boat fleet category, where Capstone's innovative product is needed most. As evidenced by projects like these in transportation, our technology advantages and vertical market strategies have been enabled Capstone to further strengthen our position as the global leader in clean and green distributive power generation technology.

Go ahead, and turn to slide 14. Throughout fiscal 2014, we talked about five key performance indicators or KPIs, to measure investors to track the progress of Capstone. I will wrap up my remarks today with a recap where we stand on each of these measures. First, we ended the year on a strong note in terms of ASPs. In the fourth quarter, average revenue per unit increased 15% to approximately $175,000, compared to approximately $151,000 a year ago. The price reflects a change of mix of C1000 series systems and more C65 MicroTurbines shipped during fiscal 2014 compared to the prior year.

The second KPI, was the measure of the C200 engine production rates. Our production for C200 engines increased to 398 in fiscal 2014, up from 384 last fiscal year, which not include engines for the service organization, obviously with plenty of additional capacity remaining in our factory for future growth. Third, direct material costs have continued to improve steadily, as reflected in our annual margin improvements. Fourth KPI, as of March 31, we have 820 units or 188 megawatts, which represents a15% increase in our total backlog on a megawatt basis, compared to 816 units or 160 megawatts at the same time last year.

And finally, reduced cash usage. Cash used for operating activities was down 10% year-over-year, and further reducing cash burn remains a major area of focus for the leadership team. Overall, we are very pleased with our execution and financial results for fiscal 2014, which positions us well for continued success in fiscal 2015. Thanks for your attention, and operator, we are now ready to open the call up to questions from our analysts.

(Operator Instructions)

Your first question comes from the line of Rob Stone with Cowen and Company. Please proceed.

Hello, I have two questions if I may. The first one is related to growth, Darren. Sales really kind of slowing down. Backlog increase in the fourth quarter was nice to see, but the shipments were a little bit disappointing. What factors might allow growth to accelerate this year as Ed alluded to in the script?

Sure. Let me comment first about your comments on the backlog and the shipments. As obviously, Q4 was a little lower on shipments than we anticipated, but again as you have said many times, shipments are really driven by the pull from our customers. So as customer requirements go, so does our shipments to customers. So the second highest revenue in Company history. Obviously, we were hoping for the highest revenue, but still a very good quarter. As you said, backlog did go up. We had a nice booking quarter. We closed the year with the highest backlog in Company history. I think more importantly, backlog is up 15% year-over-year, which sets us up nicely for hopefully double-digit growth, and strong double-digit growth going into fiscal 2015.

Okay. And my second question relates to gross margins, which also we like to see trending in the other direction, and Ed mentioned year-end adjustments. But how much of the 300 basis points or so sequential decline was related to year-end factors? And does that mean, we should be looking for a bounce back in the first quarter of fiscal 2015?

Yes. I mean, again, our margin rates can bounce around quarter to quarter depending on revenue levels and mix. Obviously, Q4 is typically not our best margin quarter because of year-end activities. Of the 300 basis points, this year I would say approximately half were related to year-end adjustments, mostly inventory. But the other half of that was just mix. We had no C1D2 offshore units in this quarter. We did in Q3. We had some higher margin C200 and C65 business in Q3 in Q4. So some of this was natural mix, a little bit of it was from end of year adjustments, mostly in the inventory area.

So as you look at the backlog, what is the -- is the margin composition of backlog generally better then? I think you talked about achieving let's say, another 300 basis points of expansion this year?

Yes. I mean, if you look back to fiscal 2010, fiscal 2010, we were a negative 14%, 2011 was negative 12%. We picked up 10 points. We went from negative 2% to positive 5%, that was 700 basis points in fiscal 2012, picked up another 600 basis points in fiscal 2013, and then another 500 basis points this year. So I think, we would love to see 10% growth or 800 or 900 basis points. I don't think that is reasonable. We should see 400 to 500 basis points a year for the next couple of years, which should get us close to that 30% to low 30% range of margin. Obviously, we are going to do everything we can, to do it quicker. We are doing price increases. We are attacking direct material costs. We are looking at logistics expenses, still trying to lean out the plant. But I think a reasonable expectation for the year, would be another 500 to 600 basis point improvement.

Right. So you should exit the year at a 20% to 21% gross margin full year.

Yes, full year. Yes, obviously, much higher than that on a quarterly run rate.

Okay. Do you think at some point price increases are working against the objective of faster revenue growth?

I don't think so today. Obviously, it is a question we ask a lot. We are a premium priced product. Our competitors, every January raise their price. We raise them in March, after we see their price increase, so we are matching kind of their heart rate. We are seeing discounts more frequently. We are on a competitive basis, we are looking to maybe discount the product a little bit. But I think the reality is people are buying our technology, because they believe in the technology, the emissions, the reliability, and the total cost of ownership, not first cost. So I think lowering the first costs, would only lower our margin rates at this point.

Okay. Thank you.

Thanks, Rob.

Thanks, Rob.

Your next question comes from the line of Eric Stine with Craig-Hallum. Please proceed.

Hello, Darren and Ed. I was wondering if you could talk just about some of the larger projects that are in your pipeline, that the 10-megawatt plus, maybe just characterize those by application or geography? And then any thoughts, I mean, as much as you can, but also any thoughts on potential timing, when we could start to see some of that?

Yes. No, great point. I think that that ties into our recent equity raise that a lot of folks I think misunderstood. We finished the year at $28 million in cash, which puts us if you look at a $13 million bank line balance at very low cash levels. We are seeing, as you said, looks at larger load regimes, sourcing a lot of projects that are 10 megawatts, 20 megawatts. We have a couple 40 to 50 megawatts, and I believe even an 80 megawatt. So to think that a customer is going to give us a $40 million PO, when we have $13 million of free cash on the balance sheet is probably fool's gold. So I think for us, to get a larger balance sheet, as we look to move into these larger load regimes is very key.

We are seeing US projects. We are seeing South America mostly. We are seeing a lot of oil and gas opportunities, and as well some merchant plant applications, where grids are looking for power on the distributed basis, on a time of the use, very flexible, large load regimes. And so I think as we move into these areas, are we going to book one of these next quarter? Probably unlikely. Are we going to book one in the next year? I would say that is fairly likely. And I think which one we book, will depend on how many opportunities we get, our balance sheet, and our sales ability to close those projects.

Got it. All right. That's helpful. Maybe just turning to the distributors. I see that you took that number down by 10, I think sequentially. And so, just wondering kind of an early verdict there -- I have heard that you are trying to align or get distributors -- not just focused on one application, but focused on oil and gas, CHP and everything else. So just kind of what you are seeing early on in the process?

Yes, I think, when I came to Capstone in December 2006, we had 20 distributors, half of which were in litigation with the Company. We have done a lot to grow the distribution channel to -- I think it was 99 recently. And as we have got to the point now, where we are weeding and feeding and trying to speed up the maturation process of the distribution channel, I think Capstone has reached a point where our product is strong enough. Our brand is good enough, that we can be a little stronger with the distributors. We can take away territory. We can eliminate contracts, or just require that they invest or reinvest more of their profits into the business on Capstone's behalf. So I think what you have seen is, some distributors getting bigger, some getting smaller, some going away. And in a couple cases, we are actually putting some of our own assets into the field to try that as well.

At the end of the day, our best distributors are ones that wake up everyday, trying to sell a MicroTurbine and service to a customer. If they are selling other products, even if they are non-competing, if they are not careful, and the intention is not there, the attention to detail and the work effort, then we have a problem. It is pretty easy for us. You see our growth rate, our 30% compounded annual growth rate. If our distributors are growing at a similar rate with Capstone business, we are happy. If they are growing faster, we are thrilled. But if they are growing slower, then we are going to question their ability to grow the business, and what is going on in their market.

We have done some things to mix geographies, to where most of our key markets have some oil and gas, or some very good CHP markets. We realize distributors have to make money, and it needs to be win-win. But I think you are going to see over the next year to 18 months, us, be a little more prescriptive, a little more forceful with our distribution base. Even though they are our partners, we need to move forward. The economy has returned globally, we need to take advantage of the macro factors that are out there.

Got it. Okay. Last one for me maybe, just based on the backlog or the timing of what you see in backlog. Just any thoughts on directionally, how we should think about revenues in Q1 sequentially? Thanks.

Yes. I mean, I try to hesitate giving the short-term guidance. We haven't fared very well doing that. We would much rather give you annual guidance. But I will say, you can look at historical trends. Q1 is normally not our best quarter. Q2 usually builds, Q3 is our strongest, and Q4 is close to Q3, but margin rates usually slip a little bit. So I wouldn't expect a gangbuster Q1. But I do think we -- our goal is going to be again year-over-year improvement on revenue, year-over-year improvement on margin, and hold our expenses flat. For a total year, our backlog is up 15%. We would like to grow much faster than the 4% last year. So our goal is to be solidly into double-digit growth for the year. Again as I have said, put 400 to 500 basis points of margin improvement, and keep our operating expenses flat. So I think, if we can keep doing that year in and year out, if we can keep growing revenue and double-digit top line growth, and adding 400 to 500 basis points of margin and control our expenses, we are going to have a very good business here in a very few years.

Okay. Thanks a lot.

Your next question comes from the line of Aditya Satghare with FBR Capital Markets. Please proceed.

Thank you, it's [Mitesh Thakkar] on for Aditya. Good afternoon, all.

Good afternoon.

So I had two questions. First, I mean how should we think about the contribution from some of the key international markets? Maybe if you could touch on some of the Middle East, as well as Europe? And is there any difference in terms of order sizes or shipment mix, which potentially benefit margins from these markets?

Yes, I think what we are seeing is --North America has been a very strong market for us. Europe and Russia has traditionally been a strong market. This year we are back to where we were in 2012. So it has taken us a couple of years just to get back to where we were, but we are very happy to be back to that level of revenue. We are expecting further growth in Europe this year. We have seen very strong orders recently in Q1 and Q4 out of Germany. We are seeing nice orders out of Italy, Slovenia, Austria. Poland is picking up. Russia has not slowed down. Despite some of the recent unsubstantiated articles that have been put out there, we have seen no change in our Russian business. So we are very excited that Europe is going to finally grow again past 2012 levels.

We have made some changes in our distributor in Australia. We are expecting some nice growth there. Asia is slowly growing for us. I think eventually we will see a tipping point in Asia, where emissions and air quality finally become such a problem that they do something real, as opposed to small incremental changes. Africa is all virgin territory for us. Middle East is all upside for us. I think there is lots of opportunity there. As you can see in South America, we have done very little in the last couple of years, but we have huge opportunities in South America. Whether that is Brazil, Colombia, Ecuador or Chile, even Central America we have opportunities.

So I think the number of markets, that we are just scratching the surface or have done one or two projects is huge. I was recently in Haiti with our first opportunity there. If you look at the Dominican Republic, Jamaica, Haiti, all great opportunities for our technology and desperately needed, frankly. So I think you are going to see more global expansion, more sales and markets that we have traditionally not played big roles in, and as well as continued growth in our current markets. From a margin standpoint, the only real difference is some of the offshore stuff that we do. So the offshore class 1 division 2 oil and gas product is higher margin. But the rest of our business is very similar in a contribution margin perspective.

Got it. And then, just I had a follow-up question on the margins. If we were to sort of strip out the year end adjustments, would we -- and then if we think about the positive benefit from material costs, what would sort of margin have looked like in the current quarter?

Yes. I think again, as I have said before, if you look at the 300 basis points difference from Q3 to Q4 or 3%, about half of that was year-end adjustments or 1.5% or 150 basis points, the other half was mix difference. So you are really not going to see a difference in D&C. You are going to see a difference in mix, and some end of year physical inventory adjustments and some other adjustments. So again, I think it is not uncommon for us, in Q2 we were at 14%. So we have gone from 14% to 20%, and then slip back a little bit to 17%. But again, if you look at a year-over-year basis, we have gone from 11% to 16%, and definitely trending in the right direction. So again, I caution people to -- put too much energy in quarterly results, and look at annual results.

Thank you. That's all I had.

Your next question comes from the line of Chris McDougall with Westlake Securities. Please proceed.

Hello. This is [Mohnish] on for Chris. I just had really one pretty big question. Could you shed some light on what is happening in Russia? You spoke a little bit about it, but I am trying to see like where this -- how the revenue is doing this quarter, and what the demand is looking like going forward?

Yes. As I said on the -- in prepared comments, our business in Russia hasn't changed. Our megawatt shipments per quarter have been fairly flat the last two or three quarters, which have been good. The numbers have been up. Payments have been typically Russian, which could be a little bit hit and miss, but obviously we have seen really no change. And talking to our Russian distributor, he deals -- this is much more an American issue than a Russian issue. The sanctions that have been put in place have not impacted our business. And even if they did put further sanctions in place, it could take a long time before it impacted our business, even if it did. So we are monitoring the situation. Obviously, we monitor any kind of geopolitical situation around the world, and how it could impacts our business. But today as I said in my prepared remarks, our Russian business, is business as usual. No changes than what we have seen over the last several years.

All right, thank you.

Thank you.

Your next question comes from the line of Philip Shen with ROTH Capital. Please proceed.

Darren and Ed, thank you for taking my questions.

No problem. How are you doing?

Good, thanks. Hey, just as a follow-up on the gross margin thinking. You talked about 500, 600 basis points in margin improvement year-on-year. Can you break down, what the sources of the improvement might be?

Yes. We have talked about it before in the (inaudible) chart. I will let Ed kind of go over that a little bit.

Yes, some of it -- it is the same sources that we have been talking about for quite a while. So expect to see increasing average selling prices as we move throughout the year, right? Because we -- as we have said, we have about 4 points roughly in backlog with improved pricing. Expect to see improvements related to direct material cost reductions that will flow through, and as you recall, last time we updated that chart, that was worth about another 10 points of margin going forward. And then finally, expect to see the warranty come down. As I had commented earlier, as the C200 and C1000 series product continues to mature, we should see at least a couple points of benefit flow through from that so.

Right. I guess, my -- more specifically, what I was looking for is for contribution by source. So in, let's say 500 basis points of improvement in -- fiscal 2015, and what do you -- of the 500, what do you see from pricing, and from materials and from warranty for 2015 specifically?

Yes. We don't break it down about level, but I would say, at least half of that is going to be direct material related. As you know recently, we hired [Richard Lewis] to come on board to bolster up our operations group. And the main reason for hiring this gentleman was his supply chain background. So as we look at reducing direct material costs, aggregating suppliers, putting long-term agreements in place, trying to rationalize shipping expenses, and those kinds of expenses. I think that is the kind of stuff we have to do. We have targeted as you know, specific direct material cost reductions, but executing those have been challenging for us in the past, to do it in the time frame we want. So I think we made the right changes from a leadership standpoint to get there. But as Ed said, it is going to be direct material costs, warranty continuing to come down, and then some impact on the recent price increases.

Great. Thanks, Darren. With some of the other companies that we follow, we have noticed that as a megawatts and project sizes get larger, turnaround times and lead times get longer, resulting in lumpier revenues. As you migrate to larger systems, could we see some lumpier revenues for you on a quarterly basis? What is the risk there?

No, I mean, absolutely. I mean, I think that we use production slots, so that will limit some level of lumps. But if we got a 30 or 40 megawatts order going through the pipeline, that is going to add lumps. There is no doubt about it I mean, again, I know lumps is a bad word on Wall Street. But the reality is we are a project-based business, and we sell product to customers for their projects. And as projects go, so do our shipments. So it is hard to tell a Chevron or a [Tatneft] or a LUKOIL or PEMEX that they are taking product before they need it. It is not just going to happen in today's world. So when you are Caterpillar or GE, those months aren't so bad. When you are a smaller company like us that is purely distributed generation, power generation, you are going to see those lumps. But again, I encourage you to look year-over-year, and you are not going to see nearly the impact of the lumps, as you will quarter to quarter.

Great. One last one, and I will jump back in queue. So when you look at your backlog, $171 million, what is the mix by megawatts? Or megawatt categories if you will, less than 500 kilowatts, maybe or less than 1 megawatt, 1 to 5, 5 to 10, and then greater than 10?

Right. So it is all laid out in the K, but the bulk of the megawatts, right, 127 of the 188 are sitting in the C1000 product. And then from there, it is a little bit here and there. Our second biggest one is C65 at about 34 megawatts, but there is a table in the K that you can go --

Yes, and I have seen it before. We just haven't gotten a chance to check it out yet. (Multiple Speakers).

No. Again, to your point, if we sell more C1000 as a bigger part of our business, then we are selling million dollar blocks versus $40,000 blocks. So having a C1000 slip in and out of the quarter is much more significant than a C30 obviously.

Great. Thank you, both. I will jump back in queue.

Okay. Thanks, Philip.

Your next question comes from the line of JinMing Liu of Ardour Capital. Please proceed.

Thanks for taking my question.

Of course, no problem.

Yes, I would also like to know, have you changed any terms, credit terms you have with your distributors, especially with what happened last year?

We always are evaluating the creditworthiness of our respective distributors, and making decisions based on those evaluations. So I would say, have there been any significant changes to any of the large distribution partners? No, but there is always some ongoing churning going on.

Yes, as the distributors grow, obviously we look to evaluate their line, look at their payment history, their balance sheet, and hopefully grant them more credits to support their growth. If they are slowing their growth, if they are having challenges in their business, and then we will tighten credit, or in many cases, put them on cash up front. But that is, with 90 distributors, it is 90 different special cases that we review on a one-off basis. But I would say, no macro level changes in our credit terms.

Okay. Regarding the increase in the accounts receivables at the quarter end, year-end, how much of those increase was related to like your price increase? Was there any pull-forward effect?

Not -- I would -- obviously, there is going to be some portion related to a price increase, but it would be minimal. The change was really based on the mix of credit versus cash upfront payments. So there was one distributor this particular quarter, that took about -- over $5 million on credit, and that is what drove the difference. The debt will be collected, expect to collect it all in this June ending quarter.

Yes, there is another way -- if we have large shipments to a distributor with open credit versus a distributor on cash up front, that is going to have an impact short-term on our receivable balance. But again, those things will cycle back and forth through the working capital process.

Okay, got that. Thanks a lot.

There are no further questions in queue. I would now like to turn the conference over to Darren Jamison for closing remarks.

Great, thank you, everybody. Good list of questions as usual. I know everybody wants to see strong sequential growth quarter-over-quarter in a perfect world. But as we have just talked about, we are project-based business, and we are really driven by the timing of our customers, especially our larger oil and gas customers that are driving 60% of our revenue. As I continue to say, and I will say every quarter probably for the rest of my career, please look at us on a year-over-year basis. I think you will see the real substantive changes in our business, and the improvements we have had. When you do that, you see the record revenue growth, you see the record margin improvements, the record product revenue. Gross margin improving 24% on only a 4% revenue increase, so stop and think about that. We managed to improve our gross margins 500 basis points or 24% with a minor increase in revenue.

So it shows you the underlying improvements we are making to our business. As revenue grows, you will see even more benefit from those -- the hard work that we have achieved. Operating loss down 30%, on a net basis, 28%. Record backlog, healthy book-to-bill, 1.2 to 1. Anything over a 1 to 1 with growing revenue, we are happy with. Backlog up 15%. If you look at backlog a year ago, you could see it was fairly flat over the previous year. We can see we saw that -- and it come out in revenue this year. Now with backlog being up15%, we hope to see the benefit of that increase.

Record [SEP] revenue, we haven't talked a lot about the service business. Paul Campbell and his team have done a tremendous job of building an international service organization. We have got record SEP revenue, record SEP backlog, SEP backlog is up 35% year-over-year. So even though revenue was up only up 4% on a shipped basis or 15% on a booked basis, SEP backlog is up 35%. So that says that we are booking SEP revenue faster than they are selling product, which is excellent.

If you look at our balance sheet, which I think is so critical. As we are competing with Caterpillar, and GE, and other large multi-international customers or competitors, we have to have a balance sheet. I know a lot of folks are concerned about dilution. But today, we ended the quarter with $28 million. We now have pro forma of $58 million as Ed said. That is the largest balance sheet we have had, I think for most of my career here at Capstone. But that also allowed us to go back to Wells Fargo and renegotiate our credit line with them, at a -- from a position of strength, not a position of weakness. So today, we have a $20 million credit line, up from the $15 million we had in the past.

So that credit facility gives us even more flexibility, when it comes to larger load regimes, larger projects, and larger customers. So we think we are well-positioned, with the record backlog, a healthy balance sheet, a great leadership team, and an improving maturing distribution channel, that we are well-positioned for an excellent 2015. So with that, I will end my remarks, and look forward to talking to everybody next quarter. Thank you.

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