Good day everyone and welcome to American Superconductor second quarter conference call. All participants will be in a listen-only mode until we reach the question-and-answer section. With us on the call this morning are American Superconductor’s founder and CEO, Greg Yurek; Senior Vice President and CFO, Dave Henry; and Investor Relations Director, Jason Fredette. For openings remarks, I would now like to turn the call over to Mr. Jason Fredette; please go ahead, sir.
Thanks Anthony and welcome to the call everyone. Before we begin, we’d like to note that various remarks we make this morning on this conference call with American Superconductor’s future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.
Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors including those discussed in the “risk factors,” section of the company’s annual report filed with the SEC on Form 10-K for the fiscal year ended March 31, 2008 and subsequent reports filed with the SEC.
In addition, these forward-looking statements represent the company’s expectations only as of today; while American Superconductor anticipates that subsequent events and developments may cause the company’s views to change, the company specifically disclaims any obligation to update these forward-looking statements. These forward-looking statements should not be relied upon as representing the company’s views as of any subsequent date to today.
I also would like to note that we’ll be referring to EBITDAS this morning or earnings before interest income, other non-operating expense, incomes, taxes, depreciation, amortization, and stock compensation. EBITDAS is non-GAAP financial metric, a reconciliation of EBITDAS to net loss on a GAAP basis is included in the press release we issued and filed with the SEC this morning on Form 8K. All of our SEC filings can be accessed in the Investor section of our web site at www.amsc.com.
Now I will turn the call over to Greg.
Thanks Jason and good morning everyone. It’s a pleasure to be speaking with you once again. I’ll leave it to Dave to you through the financial particulars for the quarter, but here are a few notable highlights.
Amidst the backdrop of the most challenging global economic downturn in years, AMSC grew its revenues by nearly 90% year-over-year to a record $40.4 million in our second fiscal quarter, and we cut our net loss significantly for the quarter as we continue to drive to GAAP profitability. We also delivered our second consecutive quarter of positive operating cash flows.
These accomplishments are all the more noteworthy, because we face challenging foreign exchange headwinds in the second quarter. This is because approximately two thirds of our revenues are received in Euros and the dollar strengthened significantly against the Euro in the last several months. Despite the uncertainty hanging over the global economy, AMSC’s position for a strong second half of fiscal 2008, including the achievement of GAAP profitability for the first time in our fiscal fourth quarter.
Before discussing our outlook for the wind power and electric utility market, let me first touch on the Superconductors business. Over the past year, our AMSC Superconductors business unit has been sharply focused on running our pilot wire manufacture line for 344 Superconductors ramping production on this line and improving wire manufacturing yield.
As you know, 344 Superconductors is AMSC’s brand name for second generation, high temperature superconductor wire. Significant progress has been achieved and during the second quarter we made our first volume shipment of this new HTS wire. The shipment was made to cable manufacture, Ultera, a joint venture between Southwire Company of Georgia, here in the US and NKT in Germany to be utilized for project Hydra.
Ultera has since woven that wire into one of its triaxial cable systems and has shipped that system to Oak Ridge National lab, where it will begin tests in the early 2009 period and a special rig designed for project Hydra. We are in the process of making smaller HTS wire shipments to various companies around the world while also producing 344 Superconductors for our fault current limiter project with Siemens and Southern California Edison.
Later this fiscal year, our attention will focus on building inventory for the full scale cable system for project Hydra which is scheduled to be deployed in Manhattan in 2010. We will also start producing 344 Superconductors for the second phase of the Long Island Power Authority HTS cable project while working to win new HTS wire orders for identified projects in the US and abroad.
While continuing to meet our customer commitments, our Superconductor’s engineering and R&D teams will work hard to further enhance the performance of our 344 Superconductors and maximize manufacturing yield; objectives that will guide us from years to come as we commercialize this business and further differentiate our HTS products from the competition.
Now let’s move onto power systems where the pace of business continues to accelerate. Since reporting our first quarter financial results in August, our AMSC Windtec division in Austria has signed a series of new customers, the first is Model Enerji. Based in Turkey, Model Enerji lies within our standard, 1.65 megawatt doubly fed induction wind turbine, for sale in this domestic market as well as surrounding Mediterranean and Eastern European countries.
Turkey has some of the world’s best wind patterns. In fact, the Turkish Energy Market Regulatory Agency is expected to offer licenses for up to 10 giga watts of wind energy in the years ahead and that agency says 30 giga watts would eventually be seasonable in the country as the country works aggressively to enhance its energy independence.
Utilizing AMSC Windtec’s designs and expertise, Model Enerji will be that nation’s first wind turbine manufacturer. In addition to an upfront license fee, we will receive a royalty payment for the first 425 wind turbines manufactured by Model Enerji. We also have the right of first refusal to provide the electrical systems needed for all of the wind turbines manufactured by them. Model Enerji expects to begin shipping wind turbines in 2010.
In October, China’s XJ Group joined our base of customers. Under this new contract, XJ purchased manufacturing rights to our standard two megawatt doubly fed induction wind turbine design. In addition to this standard design, AMSC and XJ will jointly adapt the turbine for specific environmental and wind conditions such as low average wind speeds, low air density and severe climates encountered in certain regions of China.
Founded in 1970, XJ Group is a state owned enterprise that has grown to be one of China’s largest manufacturers of power equipment and transmission and distribution technologies for the electric utility industry. So they are entering the wind market with the reputation and relationships necessary to succeed in China’s burgeoning wind industry.
Now with more than 5,000 employees operating in 30 countries, the worldwide rights to our two megawatt wind turbine, their aspirations are clearly global. XJ Group plans to have its first proto-type wind turbines installed and commissioned by the end of 2009 and expect to begin shipping wind turbines to customers in 2010.
Now our most recent customer; Hyundai Heavy Industries may be our most important new licensee this year. Not every day that a global 500 corporation turns view to help launch a $1 billion multinational line of business and that’s precisely what Hyundai Heavy Industries has done with AMSC.
Just a few weeks ago, Hyundai licensed our 1.65 and our two-megawatt doubly fed induction wind turbines. As is the case with all of our AMSC Windtec customers we will not only provide Hyundai with our proprietary designs, we will also help them establish their manufacturing line, localize their supply chain and test their first proto-types and of course we have been named the supplier of the core electrical component for Hyundai’s wind turbines, which we expect to be a significant source of revenue for us in 2010 and beyond.
Hyundai’s plans are aggressive. They intend to complete their first 1.65 megawatt proto-type within the next nine months and plan to begin shipping wind turbines to customers by the end of 2009. With $27 billion in annual sales, Hyundai clearly has the scale, manufacturing capability and the financing to be a major player in the industry. The most important aspect of this relationship is that Hyundai has set its sights on the US market.
According to a recent report from the American Wind Energy Association, the US is on pace in 2008 to be the world’s fastest growing wind power market for the fourth consecutive year.
How big is the US market? Well, American Wind Energy Association expects about 7.5 giga watt of wind power to be added to the US in 2008. That translates into an addressable market of over $8 billion for Hyundai in the US alone or to look at it another way, in 2008, the US market required about 4,000 wind turbines of the size we are setting up Hyundai to manufacture; because we will be selling core electrical components that go into each and every Hyundai wind turbine, even a 10% US market share would be significant business for us.
With the recent extension of the production tax credit in the US, a new President that supports renewable electricity generation, no matter who wins today’s election and plans from Pickens and BP to install multi-giga watt wind farms here, we expect the US to remain one of the leading wind markets for many more years.
Of course the question that’s on all of your minds these days is how will the wind market in the US and overseas change in the context of the global economic crisis and how might that expect AMSC’s prospects? That is something we will have to continue to investigate and analyze on a daily basis primarily through discussions with our current and potential customers. Discussions with the CEOs of our wind turbine customers and other information we have gathered allow us to confirm our financial forecast for this fiscal year and provide us with visibility for growth in our next fiscal year.
We have seen reports from FPL, the world’s largest wind farm developer, as well as Gamesa and Suzlon, two of the world’s largest wind turbine manufacturers. That growth in the overall wind market is likely to slow in 2009, but growth is the operative word here. Of a global wind power growth rate may not exceed 25% as it has for several years running. We can still expect double-digit growth during the economic downturn.
Both presidential candidates have put alternative energy at the forefront of their campaigns and European governments have firm commitments in place to generate 20% of their electricity from renewable sources by 2020.
Naturally, some of our smaller Windtec customers outside of China may have to slow their production plans until credit becomes more widely available particularly start-up companies and those in emerging economies where markets may be more unstable. It is important to remember, that these types of customers were not expected even before the economic downturn to drive meaningful AMSC revenues in the next 12 to 18 months.
Beyond these few cases we currently do not expect wind turbine production plans of our AMSC Windtec customers to change. Our growth during this fiscal year is being driven by our Chinese customers and they are expected to continue to drive strong growth over the next 12 to 18 months and beyond.
Of course China has not been able to avoid the effects of the global economic downturn altogether. Recent reports indicate that the Chinese economy slowed from 10% GDP growth to 9% in the third quarter and a report out yesterday showed general manufacturing activity in China contracting.
China’s rate of GDP growth may well slow further in Q4 due to reduced exports, although the CEOs of our customers in China tell us that the government there is taking action to maintain its GDP growth rate. Although China’s exports of goods generally are driven by the global economy, the wind business in China is not an export business today and particularly when it comes to financing the wind business in China is fundamentally different from that in the west. The contrast in the wind business in China versus the rest of the world is becoming clearer and clearer with each passing day.
North America and Europe, most wind farms require some type of private equity or debt financing. Financing debt is harder to come by in the current market. In contrast, nearly all of China’s major wind farms are state financed and in fact, the country’s five state-owned electric utilities are developing most of China’s wind farms and those wind farms are purchasing wind turbines from a select number of manufacturers, namely Sinovel, Dongfang and Goldwin.
Our recent conversations with our Chinese customers, including Sinovel, Dongfang, CSR-ZELRI and XJ Group indicate that they expect little, if any impact from the global economic crisis on their business or on their growth rates both near and longer-term. Our customers tell us that they do not require private financing to accomplish their plans. Their financing needs are met from a combination of down payments on turbine purchases, government subsidiaries and cash generated from operations.
While their plans to export turbines may get delayed in the very near-term, these companies are serving only their domestic market today, which will also be their primary market over the next 12 to 18 months and they are not slowing their production plans at all.
In fact, in discussions last week with Han Junliang, the CEO of Sinovel, we confirmed that Sinovel is on pace to double its production of 1.5 megawatt wind turbines in 2008 and expects to produce a much larger number of these machines in 2009.
We asked Mr. Han, whether their pace of production might slow next year; he stated emphatically that there will be “no slowdown” and that we should plan for even faster ramp-up in our production to make sure we meet their needs. In fact, our staff at AMSC China, the Chinese Wind Energy Association and our customers in China, all say Chinese Wind Turbine manufacturers, in general are speeding up to capitalize on foreign competitors weakness during the economic downturn and take market share.
A sizable contingent from AMSC was at that the Global Wind Power 2008 Show in Beijing last week and these bullish sentiments were heard time and time again. At the event, the Chinese Wind Energy Association confirmed what many industry experts have been predicting for months now that China will have 10 giga watt of wind installed by the end of calendar 2008, two years earlier than the previous government objective stated.
Sinovel’s Han Junliang took part in a CEO roundtable at the conference along with CEOs of Goldwin and Nordic and ahead of Siemens Wind Division among others. In this discussion, Mr. Hong suggested that the conservative consensus is that China will add another seven giga watts every year on average for the next five years.
The Global Wind Energy Council also issued its Annual Global Outlook report at the event. The report estimates that China, China’s install base could grow to 101 giga watts by 2020 under its so-called moderate scenario and 201 giga watts under its advanced scenario. To provide additional perspective, a report by the Global Wind Energy Council just 12 months ago estimated the number at 70 giga watt and 122 giga watt respectively.
As we have discussed in the past, growth in electricity demand closely paroled off economic growth. In fact, growth in electricity generation and delivery systems is necessary to enable economic growth. When you couple this with the global call for reduced pollution and greenhouse gas emissions, as well as the Chinese Government’s drive to reduce pollution, to increase the health and productivity of workforce, you have a perfect storm driving China’s Wind market.
In fact, with the demand for more wind generated electricity in China continues to grow, we believe the opportunity exists for at least one more AMSC windtec licensee in China within this fiscal year. So while we must continue to diligently assess the business climate, all signs today indicate that AMSC’s Wind business will continue growing in the face of the global economic downturn.
We also anticipate that most of our other current wind turbine licensee will begin ramping up production of their wind turbines around this time next year which we expect to lead to incremental growth in revenues starting in the calendar 2010 time frame. So look for new orders for wind turbine core electrical components from those customers to start coming in around six to nine months from now to meet their production needs 12 to 18 months from now.
Now let’s touch on the electric utility market where we also have been keeping close tabs on our customers. Investment plans have not altered significantly in recent weeks if at all for the grid operators we work with. While it’s logical to assume that rate cases for power grid upgrades would face additional scrutiny in the near-term, we expect our utility D-VAR and SVC business to grow steadily.
Looking further out into the 2010 time frame, we expect to accelerate our growth in this sector not only here in the US but also overseas, with China again being a big focus for us.
Our power grid market penetration strategy outside of the US is the following: first, establish a reference base for new grid technologies such as D-VAR and HTS power cables in the US; second, get a foot in the door in a fast-growing economy such as China, India and Turkey with our wind business; and third, penetrate the local power grid market opportunities from this base. We believe we are on track with our implementation of this strategy and we expect our first power grid orders from outside the US in the next six to 12 months.
So in summary, our fundamental business continues to strengthen; spending in our core markets remains steady; financially, AMSC is a stronger today than ever before in our 21 year history. We have nearly $130 million in cash, marketable securities and restricted cash and we have no debt.
We set a new revenue record in Q2 and are on track to meet our financial objectives for fiscal 2008 and to continue to grow our top line in our next fiscal year and very importantly, we expect to turn profitable on a GAAP basis for the first time in AMSC history in our fourth fiscal quarter.
Now I will turn the call over to Dave for his review. Dave.
Thanks Greg and good morning everyone. As you have all heard, AMSC continued to execute solidly in the second quarter delivering revenues and managing expenses according to our plan. We have of course faced challenges in the area of foreign exchange in the recent months.
As a reminder our company generates approximately two thirds of its revenue today in Euro. The costs associated from those sales are split fairly evenly between Euro and US dollars. This results in upside when the dollar weakens compared to the Euro, but downside when it strengthens.
Looking at average exchange rates, the dollar strengthened approximately 4% against the Euro in the second quarter as compared to the first quarter which negatively impacted our revenues, margins and our bottom line. We expect a further degradation in the average exchange rates in the third quarter.
Our exposure to the Euro will be reduced significantly in January when our new contract from Sinovel begins and we start billing our largest customer in China’s local currency, the Renminbi or RMB. The value of the RMB has been much less volatile versus the dollar in recent months compared to the Euro, a trend that we expect will continue. To address the near term volatility in the Euro we began hedging the Euro in our early October.
Turning to our Q2 financials, I’m pleased to report we delivered record revenues yet again. Revenue for the second quarter of fiscal 2008 was $40.4 million, up 87% from $21.6 million in the year ago quarter and up slightly from Q1. Foreign exchange reduced revenues for the second quarter of fiscal 2008 by approximately $1 million when compared to the prior quarter. AMSC Power Systems generated $35.6 million or about 88% of our total revenue in the second quarter of fiscal 2008. This is up 85% from $19.2 million in the second quarter of fiscal 2007.
Our AMSC Superconductor segment generated the remaining 12% of sales. AMSC Superconductors revenue in the second quarter was $4.8 million which is double the $2.4 million achieved in the year ago quarter. This increase is primarily the result of greater contributions from project Hydra, our fault current limiter project with Southern California Edison and our US Navy ship propulsion motor program.
We exited the second quarter of fiscal 2008 with approximately $597 million of backlog, that’s up from $180 million as of September 30, 2007 but down from $634 million on June 30, 2008. Contributing to the sequential decline was an $8 million reduction due to foreign exchange.
Backlog denominated in foreign currency is translated into dollars using the end of quarter exchange rate which was 1.44 for the Euro and $0.146 for the RMB at September 30, 2008. The $450 million order we received from Sinovel in June was the major factor in the year-over-year increase.
Gross profit for the second quarter was $10.7 million resulting in a gross margin of 26.5%. This compares to a gross margin of 26% for the year ago quarter and 29.2% for the first quarter of fiscal 2008. Sequential decline in gross margin was primarily the result of the foreign exchange impact and a greater amount of unabsorbed internal labor costs in Superconductors.
In general, a greater proportion of subcontract costs to total costs in Superconductors will result in lower gross and operating margins as a result of the mark ups under our contracts. This was the case in the second quarter. We expect second quarter gross margin to be the low point for the year and to see steadily improving gross margins during the second half of the fiscal year.
Taking results for the first half for the year into consideration, we now expect full year fiscal 2008 gross margin to be in the range of 28% to 30%. R&D expenses for the second quarter were $4.7 million or 12% of revenue. This is up from $3.8 million or 18% of revenue for the second quarter of fiscal 2007, but down slightly from $4.9 million or 12% of revenue in the first quarter.
SG&A expenses for the second quarter of fiscal 2008 were $8.8 million or 22% of revenue. This is up from $7.2 million or 33% of revenue for the second quarter of fiscal 2007, but down slightly from $8.9 million or 22% of revenue in the first quarter.
The year-over-year expense growth in both R&D and SG&A is in line with our plan and our previous guidance to increase operating expenses in dollar terms while decreasing them as percent of revenue. We are focusing on maximizing fall through on incremental revenue while also maintaining our strong revenue growth rate.
In Q2, we incurred approximately $480,000 in amortization of acquisition related intangibles relating to our acquisitions of Windtec and PQS. This is down from $1.8 million in the year-ago quarter due to the fact that we have nearly fully amortized the portion of our Windtec intangibles that were tied to purchase backlog. Intangible amortization should remain roughly flat in the near term.
We incurred $500,000 in restructuring and impairment charges in the second quarter of fiscal 2008, as additional costs were identified during the quarter to complete the closure of our Westborough facility and return the building to the landlord. In the year ago quarter, we incurred a restructuring charge of approximately $100,000 related to a previously completed restructuring project.
Our operating loss was $3.8 million in the second quarter of fiscal 2008. This compares to a operating loss of $7.2 million in the second quarter of fiscal 2007. Our operating loss for the first quarter of fiscal 2008 was $2.7 million. Lower sequential gross margin and the additional restructuring charge were the drivers for the increased sequential operating loss.
AMSC Power Systems generated operating income of $5.5 million or a 15% operating margin in the second quarter of fiscal 2008. This compares with $800,000 of operating income in the second quarter of fiscal 2007 or a 4% operating margin. The year-over-year improvement in Power Systems operating income is due primarily to incremental sales of our wind turbine core electrical components. Power Systems operating income was $4.9 million or a 14% operating margin in the first quarter of fiscal 2008.
AMSC Superconductors generated an operating loss of $5.9 million in the second quarter of fiscal 2008. This compares with an operating loss of $5.4 million in the second quarter of fiscal 2007. AMSC’s Superconductors operating loss was $5.1 million in the first quarter of fiscal 2008.
The primary drivers for the change in operating loss for both periods is higher subcontractor and utility cost in the second quarter of fiscal 2008. We also had lower 1G wire sales on previously written down wire inventory, when compared to the first quarter of fiscal 2008. Please note that stock compensation expense is not allocated to our reporting segments.
In August, the holder of a 200,000 share stock warrant exercised that warrant in full. This increased our outstanding shares by approximately 148,000 shares; net of shares withheld as part of the cashless exercise and resulted in a one-time gain of $1.1 million reported in other income in the P&L. Partially offsetting that gain were foreign exchange translation losses.
Income tax expense increased to $1.5 million from approximately $500,000 in the year ago quarter to the growth in sales and profits and foreign jurisdictions. International sales were 79% of revenue in the second quarter of fiscal 2008, compared to 80% in the year-ago quarter.
For the second quarter of fiscal 2008 we reported a net loss of $4.1 million or $0.10 per share. This compares to a net loss of $6.7 million or $0.17 per share in the second quarter of fiscal 2007 and a net loss of $6.1 million or $0.15 per share for the first quarter of fiscal 2008. Our net loss includes non-cash pretax charges for amortization of acquisition-related intangibles, stock compensation expense and the stock warrant I mentioned a moment ago.
These charges totaled $2.3 million for the second quarter of fiscal 2008, compared with $4 million in the second quarter of 2007. These same charges were $5.2 million for the first quarter of fiscal 2008. The lower charges and our most recent quarter compared to the first quarter were due primarily to a $3.5 million swing quarter-to-quarter and the financial impact of the mark-to-market of the stock warrant.
EBITDAS of the non-GAAP financial metric we’ve been tracking to gauge our financial progress. We report EBITDAS results each quarter and also provide annual forecast using this metric. These numbers are reconciled to GAAP and tabled at the end of the earnings press release.
For the third consecutive quarter AMSC generated EBITDAS positive results. EBITDAS for the second quarter of fiscal 2008 was approximately $1.1 million which includes a $500,000 in restructuring charges I mentioned a moment ago. This compares to a $2.3 million EBITDAS loss for the second quarter 2007 and EBITDAS profit of $1.7 million for the first quarter of fiscal 2008.
Because we are confident that we will achieve positive EBITDAS results this fiscal year and we are beginning to generate positive operating cash flows, we are planning to replace EBITDAS with a non-GAAP measure of net income and earnings per share that will reflect ongoing operations on a cash basis starting in fiscal 2009. We will discuss this further at our Analyst Day in December.
Turning to the balance sheet; cash, cash equivalents, marketable securities and restricted cash on September 30, 2008 were $128.9 million. That is down from $131.5 million on June 30, 2008 but is up from $119.4 million at the end of fiscal 2007. The sequential quarterly decrease in cash was primarily driven by a lower dollar value of our Euro denominated cash balances due to the strengthening dollar. In the second quarter we generated approximately $300,000 of positive cash flow from operations, our second consecutive quarter of positive operating cash flow.
Now let’s review our latest financial expectations for the remainder of fiscal 2008. As you saw in our press release, based on the scheduling of our existing backlog, we are expecting a strong finish to our fiscal year which is expected to culminate at much higher revenues and our first GAAP profit in the fourth quarter.
In the interim, we expect our revenues in the third quarter to be essentially flat with second quarter levels based on the strengthening of the dollar and lower D-VAR product revenues in our third quarter compared with our second and fourth quarters. Since we received a one-time benefit in the second quarter for the final valuation of the warrant, our net loss in the third quarter is expected to increase slightly on a sequential basis.
We are maintaining our forecast for the full year of fiscal 2008. We continue to expect that revenues will be in the range of $175 million to $185 million. We expect that AMSC Power System’s revenues will represent between 87% and 90% of total sales for the year. We also expect that approximately 75% of our revenues will come from International markets and that approximately 75% of sales will come from the wind energy market.
We continue to expect that our net loss will be from a range of $13 million to $15 million or $0.30 to $0.35 per share for the full fiscal year. We are also maintaining our guidance for fiscal 2008 EBITDAS to be in the range of $7 million to $10 million and finally, capital expenditures were $3.3 million for the first six months of the year.
Due to additional investment and engineering tools and manufacturing capacity required to support our growth, we now expect capital expenditures in the range of $7 million to 8 million for the full year, which is higher than our previous forecast of $5 million to $7 million.
With that we’ll open the call to questions. Anthony would you please provide the instructions?
(Operator Instructions) Your first question comes from Jim Ricchiuti - Needham & Company.
Jim Ricchiuti - Needham & Company
A question about the concentration of revenues among customers; can you talk about what Sinovel represented in the quarter and then the follow-up question is just how do you see that changing over the next year, year and a half? Thank you.
Jim, it was about 62% of our revenues in the second quarter for Sinovel and Jim we keep trying to, I’ll call it dilute Sinovel and term it as a percentage of revenue and every time we added new licensees, Sinovel seems to give us more orders, so it’s a problem of higher order that we have to deal with here.
Over this next year, Sinovel will continue to be a significant fraction of our revenue in that 60%, 65% range because of what we’ve been saying, but other customers will start to ramp up about 12 months from now. We have the schedule out there in our various investor presentations; take a look at that and so as we add more licensees in the wind market, then I expect Sinovel to be diluted.
Also don’t forget our utility business is just starting to ramp up now. We expect more orders there and the percentage of total revenues will bring Sinovel down a bit we believe.
Your next question comes from Timothy Arcuri - Citigroup.
Timothy Arcuri - Citigroup
Can you walk us through how the next contract next year with Sinovel lays out from a revenue point of view? It seems like it’s going to basically replace the existing contract at kind of a similar, quarterly run rate, yet when I look at the consensus revenue, it seems like people are assuming that it layers on top of the existing contract. So I’m wondering if you can kind of tell us how it will layer into what your existing run rate already is with Sinovel.
This is Greg Yurek speaking. Let me give some clarity here Tim and maybe Dave wants to comment on order score, but we received a $90 million order in September ‘07 for core electrical components from Sinovel, all to be delivered in calendar ‘08 and that’s basically linear month-over-month in terms of the number of core electrical components we’ve shipped to Sinovel, but that’s all done as of December 31, 2008.
The new order from Sinovel starts in January 2009. It’s not layered on top of, it’s a new order, a new start point if you will and that goes out through a three year period of time through December of 2011. We said in our press release that that will ramp year-over-year, we did not give specifics on that, so I can’t say linear over the three year period of time, but it does ramp year-over-year and is a mixture of PM1,000s and PM3000 Ws. The ratio may change over time depending on the customers needs, but that’s the story out there.
Timothy Arcuri - Citigroup
Okay and Greg just one quick one. Has there been any request from Sinovel to basically obtain better pricing vis-à-vis what they signed with you initially?
Well and back in the spring when we closed this new order, a $450 million order, we wanted to get a multiyear order from them to allow us to plan better and order components ahead of schedule and line up our suppliers. Sinovel understood that. We ended up negotiating a three-year deal and that they negotiated from us what I would call a nonmaterial reduction in the pricing of the core electrical components.
Your next question comes from Carter Shoop - Deutsche Bank.
Carter Shoop - Deutsche Bank
I wanted to briefly discuss the guidance here for the December quarter. If we back out the impact from the warrants, will we see EPS be roughly the same as it was in the September quarter? Is that the main part of the downward EPS guidance for the December quarter?
Yes, what we are saying is revenue is expected to be roughly flat with the second quarter and the third quarter and so the rest of the P&L should follow except in the second quarter we had the gain on the warrants and so that goes away. We don’t get that benefit in our third-quarter results.
So if we are expecting basically flat revenues and roughly everything else not changing materially, we would expect quarter on quarter to have a higher sequential net loss and net loss per share in the third quarter over the second quarter and that is what we are guiding to today, but we are maintaining our full-year guidance for revenue loss, earnings per share and EBITDAS and so that then means based on the information we are providing that we expect to be GAAP profitable in the fourth quarter.
Your next question comes from Paul Clegg - Jefferies & Company.
Paul Clegg - Jefferies & Company
Can you address the declining backlog figure in perhaps a little more detail? Obviously part of that was currency related, but should we be reading anything into that about the near term market conditions for end users outside of China?
Now Paul, first of all I stated in the call that about $8 million of that decline is due to the foreign exchange problem. I guess I’ll call it the strengthening dollar versus the Euro, so about $8 million and the rest is of course we’ve eaten up some of the backlogs in shipments in the second quarter and now we expect in the third and fourth quarters to add to our backlog and as we go into the next year as we mentioned in the remarks earlier as we look out in sort of the 6 to 9 month period of time, look for new orders to be coming in from our new Windtec licensees that are going to be going into production about 12, 15 months from now leading into 2010.
So our business tends to be lumpy. That’s always been the case in the electric utility industry and right now we are looking for that period where we’ve signed on new licensees, that get through the proto-type stage and we’d expect to see orders in the next 6 to 9 months adding to our backlog.
Paul Clegg - Jefferies & Company
It’s more of a timing issue in replacing shipments with new orders.
Yes. I mean there’s absolutely nothing to read into that whatsoever.
And there is about an $8 million quarter on quarter decrease in backlog just driven by the different exchange rate.
Your next question comes from Corey Tobin - William Blair.
Corey Tobin - William Blair
A quick question; can you give us a feeling for the meters of wire sold or Superconductor rather sold during the quarter as well as the dollar amount of D-VAR sold. Thanks.
Well, we don’t normally break those things out. So the only thing we have out there publicly Corey is the 17 kilometers of wire that we shipped for project Hydra. Beyond that we have nothing else that we’ve broken out and we have not broken out even the D-VAR sales; we don’t normally do that.
One thing we did say here is though D-VAR set out in the third quarter are expected to be lower than they were in the second quarter and in the fourth quarter coming up. That’s just to get a timing issue, don’t read anything into that, but it’s just a matter of timing with respect to customer needs and our ability to produce and ship the product here, but it’s normal course of business I would say.
Your next question comes from Michael Carboy - Signal Hill.
Michael Carboy - Signal Hill
Coming back to the backlog issue Greg, you signed up Hyundai, XJ and Model. If you can elaborate a little bit on what conditions takes place when dollar amounts enter into backlog. You must have some idea as to what the total contract is at this point and in the past you talked about 12 to 15 month backlog visibility and I’m kind of curious to why you’re not putting some dollars in from some of those winds.
Right, so our slide number nine in our investor presentation which is on our web site is something you might want to refer to here. It’s the standard, the AMSC Windtec customer time lines and these are based on our knowledge on what our customer time lines are to get into the proto-type; get the proto-type up and running; get Germanischer Lloyd Certification and then go into production.
Since we help the customers set up their factories, localize their supply chains and so forth, we have a pretty good idea what the time lines are. So that’s our latest understanding on slide number nine on the web site in our investor presentation.
If you look at that and draw a vertical line in 2009 about November 1, the beginning of November 2009, you will see that a number of customers, including the ones you mentioned, are just getting through the proto-type stage, just starting up serial production and so when do they need the core electrical components to get into that serial production.
We are saying look for new orders to come in six to nine months from now from those customers so that they can meet their needs. Might they come in with an order earlier, yes they might, but six to nine months would be a rational time frame to look for order so that they are lined up, ready to go into serial production 10, 15 months from this time frame; especially for those three customers that you asked about.
You also see others in there like Ghodawat Energy in India, for example; Dongfang for their 2.5 megawatt wind turbine, also in that same time frame. The ordered backlog will increase out in the six to nine month time frame as these new licensees are going to go into their serial production mode.
So one other thing to note Michael is that when we take an order for a license or when the new license is booked, the value of that license enters into our backlog, but generally there are no core component orders that come right along with that license rate away. So all you see entering our backlog at the time we announce our license is just the value of the license and the core component orders follow later which will draw over time the eventual value of the license.
So if you’re looking for a huge increase in backlog right away with the new licensee announced, we won’t put any core component orders into backlog associated with that new license until we actually see a purchase order from the customer.
You might see an intermediate before that six to nine month time frame. You might see an intermediate order, a few steps of core electrical components because they typically will make two to four of the proto type wind turbines. Get them up and running, post them up to the grid and get the Germanischer Lloyd Certification (GLC), but that’s not the kind of backlog you are interested in. You’re interested in the more material backlog which would come after the proto-types have been up and running already.
Again, with an aggressive customer like Sinovel or even a Hyundai I would suggest, I think you’d probably see those orders coming in even before the proto-types. We’ll see how that works out.
Your next question comes from Pavel Molchanov - Raymond James.
Pavel Molchanov - Raymond James
Some of your licensing partners that you have signed agreements with this year are what might be considered new entrants into the wind industry. Do you worry within the context of the credit crisis that some of them may not be able to get adequate financing to begin production or at least begin it on schedule?
None of those in China for sure, Pavel. We mentioned in our remarks here that some of the smaller start-up kind of companies, maybe those in some economies that are a little bit more challenged, would in fact have some start-up problems. We don’t have any indication of that, so that’s our assumption if you will or guess based on current market conditions, but this is really a minor number of licensees that we have.
Once again, we’ve gone around and checked with each one of our customers, both the CEO level, the financial people in those companies and for our major players for sure in China, we see no slowdown whatsoever but again looking at a couple of smaller companies on there, maybe somebody in Turkey for example. Who knows whether they will get started up on time, but in any case we have not included any revenue forecast for assumption of revenue growth from those kind of customers in our next 12 to 18 months any way. So you don’t see any need to change anything in terms of our outlook this year and certainly even next year.
Your next question comes from Walter Nasdeo - Ardour Capital Investments.
Walter Nasdeo - Ardour Capital Investments
I’d like to just go back to the Superconductor wire side again for a quick question. What is the current capacity and can you give any color or information on what you’re doing as far as trying to get some inroads into Europe on this side the business.
Well, the gross capacity remains at the 720,000 meters per year in our pilot operation, so that has not changed. We’re working through this first year producing wire, working as we said in our remarks, focusing our engineering and R&D teams and continuously looking for ways to improve and increase yield and so forth; so we are in that period.
In Europe specifically, there are a number of opportunities and we’re in discussions with specific customers in Europe, both for, let’s say, industrial applications, as wells as power cable applications. So I think there’s some interesting and good prospects in the European scene for HTS .
Your next question comes from Stuart Bush - RBC Capital Markets.
Stuart Bush - RBC Capitla Markets
Can you give us some color on the reduced guidance on the gross margin, that 28 to 30 from 30 to 35 previously? I know in this quarter you had an impact of Superconductor cost and currency, but if we assume currency levels remain stable from here, should we be modeling lower on a go-forward basis?
Yes, year to date our gross margin is just under 28%. So we said that as gross margins we expect to see some steady improvement on a quarterly basis as we exit the year. So what we have guided to is a gross margin in the range for the full year of 28% to 30%. So I mentioned in some of my remarks what impacted gross margin.
Gross margin during the second quarter was probably impacted by 100 basis points because of foreign exchange and then the rest of what happened in the second quarter was because Superconductors had higher revenue and as you know Superconductors is negative gross margin and when Superconductors is a bigger portion of our overall revenues, our gross margin will decline and that on top of the fact that the mix of costs that were part of what were booked in Superconductors in Q2 were primarily coming from outside contractors and not necessarily from internal labor sources, and when there is not that much markup on contracts when we are marking up subcontractors as compared to when we are marking up internal labor.
So those are the reasons for what you saw in second quarter, and what we said for the rest of the year is we expect steadily improving gross margin and then coming off of a base where we are at about 27.8% roughly for the first six months of the year. We expect the full year to be in the range of 28% to 30%.
Your next question comes from Brian Yerger - Jesup & Lamont.
Brian Yerger - Jesup & Lamont
Just looking at your visibility for 2009 and your forecasting Q4 GAAP profitability. I’m just wondering if you feel like that will continue and if not, why wouldn’t 2009 be GAAP profitable?
Yes, we are not looking out to full year 2009 at this time. We have a lot of road to cover between here and then, but all we are saying right now is that, based on what we are seeing, based on the scheduling of our backlog and how that looks, we expect to be able to turn a GAAP profit in the fourth quarter, but other than that, we are not prepared at this time to talk any more about that for 2009.
We traditionally give our next fiscal year guidance and our May earnings call will we close out the year-ending March 31, and given guidance for the new fiscal year at that time.
Your next question comes from Carter Shoop - Deutsche Bank.
Carter Shoop - Deutsche Bank
Can you discuss how much time you’ve spent looking into potentially splitting the company into two entities and what you view as the pros and cons for that?
No we can’t, Carter. I’m sorry to be flip on that. You’re asking how much time we spend looking at splitting out Superconductors from the rest of the company. We take a look at all of our business options on a regular basis. We discuss all of our options with our Board of Directors, certainly at the Executive Team level, but let me put it this way, we think in terms three ways of growth. We are on the steep part of the growth curve with wind right now, that’s pretty clear. We expect that to continue for a good number of years to come.
We think we are just at the bottom knee of the S-shaped growth curve for the utility markets both in US and abroad and look’s like we’ll have to start getting out of the steep part of the curve over the next year and we’ve commented on that in our remarks.
Then the third wave of growth is in the Superconductors business, tied both to wind through offshore wind generators and wind turbines, 10 megawatt class that ties to the power grid, the Superconductor power cables and fault currant limiters, so strategically it all fits together and that third wave of growth in wire sales, from this company we are saying we think is in the 2011, ‘12 time frame and beyond and the Board of Directors and the executive team have determined in our infinite wisdom, based on the knowledge we have with our products and customers and the markets, that we should continue to invest in this business called Superconductors and enjoy the third wave of growth for this company out in the future.
Your next question comes from Jim Ricchiuti - Needham & Company.
Jim Ricchiuti - Needham & Company
Yes, a question is just with respect to D-VAR. It seems like the revenues are coming in a little lower than expected; I don’t know how much is due to the normal lumpiness of that business. I don’t know if you can characterize the bookings in that area and it seems like you are more optimistic of a pick-up over the next couple of quarters, looking beyond Q4.
Well, Jim, our expectation for Q2 was met in terms of revenue. So we are not disappointed and Q2 recommends sequential growth continues on quarter-over-quarter, but in Q3 we said we expect revenues to be flat for a number reasons; one is that just timing. Shipments of D-VARs occurred in the second quarter. We expect more shipments of D-VAR, a good number actually in the fourth quarter. Those are higher gross margin products, so that will contribute to our strengthening to our bottom line in the fourth quarter.
We see no slowdown in this, Jim. Look for new orders and for D-VAR coming from both the utility sector as well as from the wind sector for grid interconnection of wind farms. So D-VAR is part of this company’s future, and look for more growth in that area.
Your next question comes from Michael Carboy - Signal Hill.
Michael Carboy - Signal Hill
David if you can elaborate a little bit on the tax outlook given the change in the Sinovel functional currency that comes in January; anything that is going to happen there with regard to foreign taxes that we should be aware of?
Yes, a tax standpoint, as It’s a [inaudible] and regarding as I said, it’s I tried to explain last quarter, it is a by convoluted when we are recording tax expense when we have a loss. So I am not going to go there and try to explain it again, but at the high level, when we moved the contract from Windtec in Austria to our AMSC China and have them service it, we have a better ability to manage the transfer pricing than we currently have with Austria.
That will help us in terms of and how the mix of the income falls out between our jurisdictions. So we think to get a little bit better result from the tax line when we move to AMSC China here in the fourth quarter and start to see some -- a little bit more positive result on the tax line.
Your next question comes from Timothy Arcuri -Citigroup.
Timothy Arcuri - Citigroup
Can you give us what gross margins was in the power systems business and as the new Sinovel contract layers in next year. Can you maybe hold our hand a little bit why that is not pressure gross margin, given that they are coming in and already asking for marginal price concessions, it would seem there would be seen that there was going to be S that moving the manufacturing over to China will help for sure, but it seems like there could be some, pressure on margins as that shift happens, and just wanted to get your thoughts on that, thanks.
Tim, you asked several questions and this is Greg and I will take the first part of it and they end hand it back over to Dave. Following up on your earlier question, so again, there was a very minor price concession that was negotiated with.
Sinovel back in I guess it was May time frame of this year. Really not material and that is from our perspective getting a three-year order, that is worth doing, in particular because we are lowering our cost business producing product in China now. One hundred percent virtually 100% of our power modules 1,000s are now manufactured in Zhuzhou operations in AMSC China and that has lowered our cost of manufacture.
We had now, just also a week in a meeting with the CEO of Sinovel and his operating leadership team and so forth, there is no pressure whatsoever. There is a good Sinovel to seek any price reductions. They got a good price. We are making good margins and I don’t see why there would be any price erosion here over the next period, certainly with this current order. It is all under contract and we are going forward.
I think you asked another questions what our gross margins are. I will let Dave handle that to the best of his ability.
Yes, one other thing we don’t disclose what gross margins are for each of our reporting segments, but let me tell you since you are new to doing the research, let me kind of go back through what we have said regarding gross margins for the company. So we have given the guidance for the full fiscal year of around 28% to 30%. We set our near-term operating target. What we are trying to achieve overall in the near-term is somewhere between 30% and 35%.
How that breaks down by segment? We have said that Superconductors is generally at this stage of its life a negative gross margin business. If the company’s operating target is 30% to 35% and Superconductors is negative and power systems needs to be somewhere above that 30% to 35% target.
Disclosing what gross margin was by business segment because it is competitive information. I can tell that you directionally, power systems gross margin was better actually in the second quarter compared to the first quarter, but the overall company gross margin was down because Superconductors was a bigger part of our revenue. So that’s all I am prepared to go through with gross margin now, thanks.
That does conclude the question-and-answer section today. At this time, Mr. Yurek, I will now turn the conference back over to you for any additional or closing remarks.
We thank you for your attention and your great questions, and we are looking forward to meeting all of our expectations for the rest of this fiscal year. Thank you. Goodbye
That does conclude today’s teleconference. We thank you for your participation and you may now disconnect your lines.
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