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Executives

Jayme L. Brooks - Chief Accounting Officer and Vice President of Finance

Darren R. Jamison - Chief Executive Officer, President and Director

Edward I. Reich - Chief Financial Officer, Executive Vice President and Secretary

Analysts

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Philip Shen - Roth Capital Partners, LLC, Research Division

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Robert W. Stone - Cowen and Company, LLC, Research Division

Colin W. Rusch - Northland Capital Markets, Research Division

Capstone Turbine (CPST) Q4 2013 Earnings Call June 13, 2013 4:45 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter Capstone Turbine Earnings Conference Call. My name is Phillip, and I'll be your operator for today. [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, Ms. Jayme Brooks, Vice President, Finance and Chief Accounting Officer. Please proceed.

Jayme L. Brooks

Thank you. Good afternoon, and welcome to Capstone Turbine Corp.'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 fiscal -- 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.

Darren R. Jamison

Thank you, Jayme. Good afternoon and welcome, everyone, to 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 Capstone's website under Investor Relations.

Let's go ahead and start with Slide 2. I'm extremely proud to report that fiscal 2013, that 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 6 years to position the company for profitable growth and to create value for our shareholders. Our fiscal 2013 results include 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 to 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 1.1:1 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 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 and development, customer service, sales and marketing to position the company for long-term growth and profitable success.

In operations, we've implemented lean manufacturing principles which have led to dramatically improved production efficiencies and the elimination of unnecessary waste in our processes. We are now able to manufacture and sell large 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 and development, we have implemented a structured phase/gate product development process, an industry-recognized project management methodology, 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 U.S. Department of Energy, in high-efficiency CHP and other applications.

Working together with our authorized service providers, we have a customer service team of nearly 400 trained technicians that 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 life cycle.

And in sales and marketing, our compounded annual growth of 35% over the past 6 years simply speaks for itself. We are focused on markets with maximum potential and the most compelling microeconomic 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 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'd like to make a couple 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 company history, I'm 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 margin. Our book-to-bill ratio is excellent at 1.4:1 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 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 some comments about markets and orders after that. Ed?

Edward I. Reich

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 1 year ago.

As Darren mentioned in the past, we've typically seen a sequential margin dip from the third quarter to the fourth quarter due to year-end adjustments, primarily related to physical inventory. However, it has really held our margin consistent with Q3. What's more important 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 of product sales, higher parts and service revenue and lower direct material costs offset by an increase in warranty expense, production, 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 C200 units, which drove a $400,000 increase in UTC carrier royalty from the Q3 levels. The run rate for royalty had been approximately $1 million per quarter at recent revenue levels. Please note, we expect the royalty rate 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 C200 development. Based on a 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 to 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 is $4.1 million or $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 fiscal 2013 decreased to $3.9 million, an improvement from the $4.4 million operating loss for the third quarter, as well as $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, May 15, derivatives and hedging, which 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 reported 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 of warrant liability, would have been $8.9 million or $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 turn to a discussion of our performance for the full year 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 continue 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 an anticipated higher sales volume with improved pricing, continued success with our initiatives to address warranty issues, further reduction in direct material costs and a reduced royalty rate.

Please refer to Slide 10 which shows our path to expected operating model margin.

Slide 11 demonstrates a significant operating leverage that we have in our business model. As we've grown our revenue by over $100 million over the last 6 years, our operating costs have remained relatively consistent over the same time period. Even our manufacturing, labor and overhead had been fairly stable over the last several years despite our increased revenue in 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 and 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 and expense, offset by increased salaries and related expenses, travel and marketing expense.

Net loss was $22.6 million or $0.07 loss per share for fiscal 2013, compared to a net loss of $18.8 million or $0.07 per share last year. However, remember that the net loss for both years was also affected by the adoption of accounting standards quantification, May 15, which affects our accounting for warrants with anti-dilution provisions. 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 have been $23.3 million or $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 $0.12 loss per share. Please refer to the non-cash warrant charges slide in the appendix, again, for a reconciliation.

I'll 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 1 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 flow, we used $3.6 million in cash from 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 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 $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 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 31. Inventory turns were 5.4x compared to 5.0 in Q3 and 5.1x 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. As Darren mentioned, we ended fiscal 2013 with record backlog of $148.9 million, indicating another strong year growth in fiscal '14.

That concludes my comments, and now back to Darren.

Darren R. Jamison

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. Q4 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 10 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 U.S. 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 continued 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're 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 2 dedicated products for the secure power or EPS market. Our presence in green buildings and the transportation sector continued to expand. [indiscernible] 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, with 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 2 years, and the next decade, it's 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 incentive 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 in South America, Asia and Australia. With 17% revenue growth in fiscal 2013, despite the heavy headwinds in Europe and Russia, this show that our other markets are really thriving. 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 2 new orders in Germany, as well as an order for 100 microturbines from a 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 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 on the CHP space.

Over the last few years, we've 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 and our increasing familiarity of our brand and the superiority of our technology here in the U.S.

Turning to the last side, Slide 15. Here is a spotlight of some of our most recent contracts. In February, we added the U.S. coal bed methane market to our portfolio of oil and gas applications with an installation of the country's first methane-fueled C200, at CONSOL Energy gas processing plant in Pennsylvania. As government regulations for methane emissions become stricter, we anticipate more companies will turn to microturbines for their ability to operate on methane gas and produce extremely low emission rates.

Back in March, we received a 5-megawatt order for some key CHP and CCHP projects in Mexico. In April, we announced several significant orders. I've mentioned a $6.4 million order from a Russian distributor. We also received an order for 34 liquid fuel C30s from DesignLine for the Denver Regional Transportation Districts' electric bus fleet. And in China, we sold multiple C30s, 65s, C200s that will be installed at various oil and gas sites.

In May, we announced a major order from one of the most prominent privately held real estate and investment firms in the U.S. 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 3 C65 hybrid UPS units for installation at a data center owned and operated by the 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 SoCalGas. They provide safe and 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. GreenWorld Partners, which is an internationally recognized technology innovator in the anaerobic digestion technology and by-product utilization area, they ordered a C800 and a Capstone Clean Cycle 125-kilowatt weight 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 2 C65s and 8 C30 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 megayacht, a 144-foot schooner that is using a liquid fuel Capstone C30 for onboard 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 has even greater opportunity head as we continue to work toward our long-term goal.

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.

That concludes my prepared remarks. Operator, we are now ready to open the call up to analysts' questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Sanjay Shrestha from Lazard Capital Markets.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

First question that I had was on the margin front, right? So if I take out all the -- sort of, the onetime items, you guys had 20% gross margin this quarter. And what I'm looking at that slide, getting to 35% and majority of that coming from sort of the material cost reduction, right? 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?

Darren R. Jamison

Yes. Absolutely, Sanjay. Well, 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 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 a $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 by Q2 that, that royalty will drop in half.

Edward I. Reich

During Q2.

Darren R. Jamison

During Q2, correct. And so really the focus then is warranty, which as you saw, again, in the quarter is stabilizing and, we believe, trending down. And so the biggest focus is the area of cost reduction. We did cut in a lower price C1000 enclosure during the quarter and we have several other cost reductions that should be hitting in the current quarter, right 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 C200s our [indiscernible] Service and Accessories mix were 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, some year-end adjustments and the unfavorable mix, to still pull a 14 points of margin was very impressive.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

I agree. So one point of clarification on this one, guys, right? So when I'm looking at this cost reduction of 12%, right, pricing sounds like this is something you have much control over. Given the warranty of that 3% impact, it sounds like it's pretty well within control, and what I'm looking at is 12%. So would I be putting word in your mouth if I say maybe, let's say, half of that gets recognized over 12 months, another half is maybe another 12 months out, so if you add all that up, we're probably looking at ending fiscal '14 by at least sort of like 25% kind of a gross margin number?

Darren R. Jamison

Yes, that's a reasonable expectation.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

Okay. Great. Two quick follow-up then, guys. So, Darren, you talked about this big real estate development company and that reminded me of sort of a first oil and gas order or the shale gas order that you guys had, I think, with Pioneer 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 year 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.

Darren R. Jamison

Yes, Sanjay, you absolutely hit the nail on the head. The related properties order, initial order is going to be a multiyear order, multiple buildings in New York. They're looking at the rest of their portfolio where it makes sense to putt 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 spent 2 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 the 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.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

Great. One last question then, guys, 2 parts. One, how much is Europe in your current product backlog and, two, the Tier 4 emission, how big that could turn -- I know, Darren, you talked about that a little bit in your 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?

Darren R. Jamison

Yes, we're already seeing -- I'll take the second one first. The Tier 4 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 is 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 C200 on an offshore platform. It's diesel-powered. The 34-unit order we have this -- in Q4 was all diesel powered for Mexico. We're seeing a lot more inquiries for diesel product. We sold recently a C1000 diesel product into China. So I think you're going to see not only buses, trucks, 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 U.S. is fairly abundant, but in 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 10x the size of the natural gas market. The natural gas market for us is $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 in 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 3 or 4 years, but they're still cautiously optimistic. I would say, it's still a slow comeback for Europe. I would say, we're probably 2 years away from full recovery.

Edward I. Reich

On the Russian side, we are still seeing a lot of activities, Sanjay. And we're seeing a good part of the backlog is the BPC.

Darren R. Jamison

Correct.

Edward I. Reich

So that's still very healthy, just a little bit slow on the revenue side.

Darren R. Jamison

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 in the U.K., 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 have 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 or no penetration where we can actually gain some market share.

Operator

And your next question comes from the line of Eric Stine from Craig-Hallum.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Wondering if we can 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 -- where we may see a specific big step-up or this is just going to be gradual throughout the year?

Darren R. Jamison

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 1 quarter to the next. We saw it a little bit from Q2 to Q3. But probably, the safest way to model it, Eric, is just to assume a slow growth in each quarter as pricing comes in and as cost comes down on the product. But I think, again, for Q4, it's safe to say you had at least a 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, we'd probably be at 17% to a 14%. You saw the chart in 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.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

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

Darren R. Jamison

We're still thinking high teens. 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 breakeven within the next couple of quarters, so that's around 21%, 21.5% at these revenue levels. So we should be somewhere, in the next 2 quarters, breaking the 20% barrier.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Got it. Okay. Maybe we could touch on -- you 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 2 to 3 years. This one was in oil and gas. And just curious how you think that market plays out given that they're few years behind in terms of shale?

Darren R. Jamison

Yes. They're definitely behind in terms of shale, they're behind in terms of emission standards and other items. I think we're seeing them slowly turn the corner. We've got 6 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, when it relates to cleaning the air, cleaning the water, energy efficiency and all 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 U.S. markets. I think you're going to see Russia 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've mentioned in my prepared remarks, we have a new distributor who's already turned in several orders. And so I think Australia could be a very nice market for us.

Eric Stine - Craig-Hallum Capital Group LLC, Research Division

Got it. Let me just sneak in one more question just on the new product. So it sounds like there's a lot the 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?

Darren R. Jamison

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 2 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 cost, and both of those are ongoing. We're very confident we're going to have a -- up to -- our standard solution for the life cycle 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 an electrical need, we want to have a solution for. I mean, obviously, oil and gas is our strongest market. We've got some great partners, whether it's Shell, BP, Marathon, Gazprom, PEMEX, Petronas or the Anadarko, Pioneer Natural Resources, Talisman, we want as much of their business and be able to address as many of their needs, solve as many of their problems as possible. And pump jack is just another way that we can do that for them.

Operator

Your next question comes from the line of Philip Shen from Roth Capital.

Philip Shen - Roth Capital Partners, LLC, Research Division

My first question is on future product developments. You've had some nice revenue growth and backlog growth, based on a lot of those C200 activity. As we look forward, can you give us an update on progress with the C250 as well as the C370, the timing associated with that as well.

Darren R. Jamison

Yes, absolutely. C250, both of these are part of a DOE program. That 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, it's complete. We'll look at kind of preproduction, 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 C200 is about 85%, the same build material. So part of what we're doing is making sure the C200 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 C1000s. We'll have 4 on the box versus 5. The build material is 5% to 8% higher for a 250 versus 200 with 20% more output, so that's very exciting for us. On the 370, we're still doing a lot of analytical cycle decks and performance testing. We don't have any hardware yet, we are working on some bimetal 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 C65 and C200 as we develop that program. But overall, I think we're very excited about both programs, the 250 is obviously much closer than the 370. The 370 is a very big step for us from a power and efficiency standpoint.

Philip Shen - Roth Capital Partners, LLC, Research Division

Can you talk about the timing of when the 250 commercial release might be?

Darren R. Jamison

Yes, I mean, the 250 really is, I keep saying, roughly 18 months. It really depends on what happens over the next, I would say, 9 months. If the C200 continues to mature from a reliability standpoint, like we're predicting, 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. It could be as late as probably 24 months. But definitely, you're going to see it at least in field demonstrations here very shortly.

Philip Shen - Roth Capital Partners, LLC, Research Division

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?

Darren R. Jamison

Yes, I think the mobile market is one where we've always been interested. The company was founded on automotive platforms. I'm sure you know that's a market that's 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 a 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, 7 days a week for a delivery vehicle for Costco or for Wal-Mart or for FedEx or something that's going to be on the road again 6, 7 days a week, 18, 20 hours a day. Electric vehicle, regenerative brakes, batteries onboard. And instead of going back after 2 hours, 3 hours and charging, the microturbine fires up and charges the batteries. So we're excited about what Simon [ph] 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 are out there in 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. So we're very excited about those 2 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't 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, a 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.

Philip Shen - Roth Capital Partners, LLC, Research Division

Great. One last question and I'll jump back in queue. What percentage of your backlog is based on follow-on orders and how is that compared to 1 year ago?

Darren R. Jamison

Yes, that's a hard one for us, Philip. I mean, 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 end-use customer is more difficult. Obviously, our biggest customers today would be Origin Energy in Australia. It has close to 200 C30s. Anadarko, Chesapeake, Pioneer, Marathon, Shell, all huge follow-on orders in the last year here in the U.S.. We had several hotel chains that have had multiple orders. Tesco has 20-some grocery stores with our product. But I think beyond that, there's a lot of customers that have 1 or 2 orders or 3 orders. Related, we think, obviously will be multiple orders and with a lot of follow-on opportunity. And also, Related will get us again the other folks in the 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 very robust pipeline. They are up to over $1.4 billion in pending orders. That's up significantly, obviously, from just a couple of years. 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 micro drivers around the world. I mean, Europe is still a concern for us, Russia, less so, but we need to see those markets come back to really turbocharge the growth of our company.

Operator

And your next question comes from the line of Ajay Kejriwal from FBR Capital Markets.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

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 into the current year. I thought I heard you say that things looked to be improving in several markets in Europe. So assuming you'll 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 2000 -- the current fiscal year.

Darren R. Jamison

Yes, yes. I guess, I mean we don't give hard guidance. The soft guidance we kind of said is 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 would 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 will come back. So said 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 that 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 2 years ago. So it's not out of the question that we get a couple of 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, we're planning kind 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.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

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?

Darren R. Jamison

Yes. I mean, our marine penetration has been virtually 0, so it's definitely opening up new opportunities. We've been out beating the street on some more workboat shows. We'll be doing some of the yacht shows. We do some marine advertising. We got the videos 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. But some of those boat builds can be 2-year builds or 18-month builds, so it may take a little bit of time to convert some of that to revenue. But I would expect 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 workboats, the ferries, some of the tankers and then the mega yachts are great opportunities for us.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

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

Darren R. Jamison

Yes, I mean, that's a coal mine gas opportunity where they needed to extract the gas from the mine and burn it. Traditionally, you would either flare that gas, so there's an 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 2 areas of potential heat expansion for us around the world, people again. In general, flaring is becoming a 4-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 get 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 Tatneft and Gazprom and LUKOIL. I think that that's going to be a trend that's going to continue just like the Tier 4 emissions and other requirements.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Got it. And maybe last one, a clarification question for me. So that $400,000 a quarter benefit on royalties, do we just do the math straight annualizing that to $1.6 million benefit for next year? Is that how we should be thinking or -- 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?

Edward I. Reich

Let me just clarify, Sanjay, it was -- the run rate -- or Ajay, sorry, at the recent revenue levels was about $1 million a quarter in royalty. And because of the high concentration of C200s in this current 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 $1 million run rate, you'd pick up about $0.5 million in benefit at this revenue level.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Yes. So it's an annual benefit of about $2 million?

Edward I. Reich

At current revenue levels.

Darren R. Jamison

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

Operator

Your next question comes from the line of Rob Stone from Cowen and Company.

Robert W. Stone - Cowen and Company, LLC, Research Division

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?

Darren R. Jamison

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 1:1 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 are pretty comfortable Q4 would come back. I'd say Q4 came back in a very big way with a $41 million of 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 1:1 book-to-bill is a reasonable expectation.

Robert W. Stone - Cowen and Company, LLC, Research Division

Yes. I wasn't looking so much looking for a specific number, it's just kind of directional. And it sounds like, I mean, you talked about rough order of magnitude, $150 million, plus/minus, depending on what happens this year for revenue. It sounds like with some premier wins in areas like CHP and marine and maybe Europe 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 reasonable?

Darren R. Jamison

That's definitely reasonable expectation. I mean, 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 in 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 pointing in our direction. So I think, we feel very good about that. I mean, the California Self-Generation Incentive Program is just providing some nice lift for us. There's new incentives in New Jersey that are very favorable. I think there's $100 million put towards CHP, some special funds set aside. There's a new PON in New York that should drive some revenue for us. And the Palace Hotel is going online here shortly. Marquee customers like that, almost everybody who 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, and we feel very good coming in the new year.

Robert W. Stone - Cowen and Company, LLC, Research Division

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 2-year, 3-year exercise? When might we see that as a more meaningful slice on the pie chart?

Darren R. Jamison

Yes, we started marketing in that area about 2 years. We've had 1 C30 running on a megayacht for about a year. We've had a larger vessel running for about 9 months, so we've seeded the market a little bit. We've started doing some marketing activity. But really as we come back on the second and third year doing some of these workboat shows and pleasure boat shows, getting some more wins, we'll start the momentum growing. And that's really the challenge of getting those first kind of adoptive customers, to take the leap is the hardest part. So we recently announced an order for a couple of C55s and 8 C30s. I think once we get a dozen customers out there with 6 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.

Robert W. Stone - Cowen and Company, LLC, Research Division

A couple of housekeeping questions for Ed, if I may. You mentioned you had some favorable variance in bad debt expense and other things helped you on SG&A this year. Do you have a 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?

Edward I. Reich

Yes, I mean, the bad debt side -- or 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.

Robert W. Stone - Cowen and Company, LLC, Research Division

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

Edward I. Reich

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

Robert W. Stone - Cowen and Company, LLC, Research Division

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

Edward I. Reich

We 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 statement, so it's a more traditional turns, beginning and ending average cost of sales.

Operator

Your next question comes from the line of Colin Rusch with Northland Capital Markets.

Colin W. Rusch - Northland Capital Markets, Research Division

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

Darren R. Jamison

No. I mean, from a microturbine space, we're 90% market share, we're not seeing much out of our competitors there. Engines, traditionally, are our biggest competitor in that space, so I think that's where the challenge is from a CHP, CCHP. The Palace Hotel doesn't want 8 Caterpillar slobbering engines that are making much noise in the 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 paybacks low. And with low natural gas prices, we're seeing paybacks closer to 3 years. That's really kind of the magic number. I think with this economy, you need to be down on a 3-year range, 4 maybe, but definitely the closer to 3, you get the better off you are. FuelCell, we still don't see them as a competitor. They have 3 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 efficiencies close to 85% and use the heat out of the machines at CHP, use low price, available natural gas, that's definitely the right way to go. So for us in CHP, really the utilities are probably our biggest competitor. Oil and gas is definitely reciprocating engines, Caterpillar and GE.

Colin W. Rusch - Northland Capital Markets, Research Division

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

Edward I. Reich

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

Colin W. Rusch - Northland Capital Markets, Research Division

Yes, I'm wondering how big an impact that has going forward. I mean it seems like if you're running down these materials, they'll probably run through your COGS as well as you go for.

Edward I. Reich

Yes. And it's really hard to forecast because it depends how much of the material we have on hand and how the standard cost will change at any given quarter end, so I can't really talk about how it would work. But ideally, you're right, we turn the inventories fast, and we don't have a big effect from that.

Colin W. Rusch - Northland Capital Markets, Research Division

Okay, great. And one last quick one. Just -- you mentioned Africa. When you're looking at the opportunity set 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?

Darren R. Jamison

Yes. Today, it's mostly all mining, oil and gas. I think we're moving to more traditional CHP. But almost all of it is prime power.

Operator

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.

Darren R. Jamison

Thank you, everyone. I think we had a lot of questions, so I don't need to put too much time on my closing remarks. We're very excited about the record year that we just closed and all the great opportunities and 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.

Operator

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

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