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Executives

Jason Fredette – Director, Corporate Communications

Greg Yurek – Founder, Chairman and CEO

David Henry – SVP, CFO and Treasurer

Analysts

Timothy Arcuri – Citi

Carter Shoop – Deutsche Bank

Ben Schuman – Pacific Crest Securities

Ben Kallo – Robert W. Baird

Jim Ricchiuti – Needham & Company

John Hardy – Broadpoint AmTech

Patrick McElroy [ph] – Jefferies & Co.

Jesse Pichel – Piper Jaffray

Pavel Molchanov – Raymond James

Vishal Shah – Barclays Capital

Megan Moreland – Ardour Capital Investments

American Superconductor Corporation (AMSC) F3Q09 (Qtr End 12/31/09) Earnings Call Transcript February 2, 2010 10:00 AM ET

Operator

Good day everyone and welcome to American Superconductor's third quarter conference call. This call is being recorded. All participants will be in a listen-only mode until we reach the question-and-answer session.

With us on the call this morning are American Superconductor's Founder and CEO, Greg Yurek; Senior Vice President and CFO, David Henry; and Corporate Communications Director, Jason Fredette.

For opening remarks, I would now like to turn the call over to Mr. Jason Fredette. Please go ahead, sir.

Jason Fredette

Thank you, Pamela, and welcome to the call everyone. Before we being, please note that various remarks management may make on this conference call about American Superconductor's future expectations, plans and prospects constitute forward-looking statements for the proposes 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 factors, including those discussed in the ‘Risk Factors’ section of the company's annual report on Form 10-K for the fiscal year ended March 31, 2009, and subsequent reports filed with the SEC. These forward-looking statements represent the company's expectations only as of today and should not be relied upon as representing the company's views as of any subsequent date to 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.

I also would like to note that we will be referring on today's call non-GAAP net income or net income before amortization of acquisition related intangibles, restructuring and impairments, stock-based compensation, revaluation of stock warrants, other unusual charges and any tax effects related to those items. Non-GAAP net income is a non-GAAP financial metric, a reconciliation of non-GAAP to GAAP net income can be found in the press release we issued and filed with the SEC this morning on Form 8-K. All of our SEC filings can be accessed from the ‘Document’ section of investors’ page at www.amsc.com.

And finally, I would like to mention that we will be taking part in several upcoming financial conferences. These include the Deutsche Bank Small and Mid Cap Conference on February 10; the Piper Jaffray’s CleanTech Conference on February 23, and the Kaufman Brothers Green Tech Conference on February 24.

And now, I'll turn the call over to Greg.

Greg Yurek

Thanks, Jason, and good morning everyone. I am pleased to report back to you on the achievement of another successful quarter at AMSC. We’ve now increased revenues sequentially for each of the past 12 quarters, and we expect to make that 13 in a row as of March 31, 2010, the end of our current fiscal year. We also generated better margins and net income than we had earlier forecasted because of a change in product mix in the second half of the quarter and a faster-than-expected benefit from our cost reduction efforts in our Chinese operation. Dave will address our third quarter results in more detail in a moment.

Based on the strength of our third quarter results and our positive outlook for Q4, we are increasing our revenue and earnings forecast for the full-year fiscal 2009. We now expect to increase our revenues in fiscal 2009 by more than 70% compared with fiscal 2008. We also expect to be profitable on a GAAP basis for full-year fiscal 2009 and to be net cash flow positive for the fiscal year. And as we described at our Analyst Day in November, the stake has already been set for another year of solid growth in fiscal 2010.

Underlying this ongoing success is our unique mix of offerings for the wind power and smart grid markets. Our approach to the wind power market, of course begins with our AMSC Windtec business in Austria, which designed megawatt-scale wind turbines and licenses those designed to existing wind turbine manufacturers or companies who would like to become wind turbine manufacturers. We then sell the proprietary electrical control systems or the core electrical components to our licensees for each and every wind turbine they manufacture. Today, AMSC Windtec has customers in eight countries around the world; however, Asia and China in particular has been the real catalyst for our wind business thus far.

Sinovel, our largest customer is also China’s largest wind turbine manufacturers today, and they have plans to be the world’s largest turbine manufacturer within the next five years. Sinovel has manufactured several thousand wind turbines since they entered the market in 2005, and every single one of them contains a set of core electrical components from AMSC. If Sinovel is to accomplish its objective to be the world’s top wind turbine manufacturer, they must at least double its annual capacity, which we expect would translate into substantial additional growth for AMSC.

While Sinovel is our biggest and most mature wind customer, each of our four other Chinese wind turbine manufacturing customers has either placed a large electrical system order with us or have signed a new wind turbine development contract with us in recent months. This ramp in production by our other customers will help us further diversify our sales in the years ahead.

In November, we announced that CSR-ZELRI had placed a follow-on order with us for more than $10 million worth of core electrical components for the 1.65 megawatt wind turbine its manufacturing under a license from AMSC Windtec. This is the fourth time we have announced an order from CSR-ZELRI. Repeat orders such as these are an inherent part of the AMSC Windtec business model. So we expect to see the same with XJ Group and Shenyang Blower Works in the future. We announced initial electrical system orders from each of these customers over the past week.

While Sinovel and CSR initially placed small orders with AMSC for 10 or 20 sets of core components, XJ Group and Shenyang Blower Works both started off with a bang. On January 26, we announced that China’s XJ Group has ordered an initial 100 sets of wind turbine core electrical components. The core components XJ ordered will be deployed in their first production run of 2 megawatt doubly fed induction wind turbines, which were designed by and co-developed with AMSC Windtec. XJ Group erected its first 2 megawatt wind turbine in December 2009 and just completed construction of a new wind turbine manufacturing plant with an annual capacity of 1,000 megawatts. We expect to begin shipments under this contract in March, and to complete shipments in our fiscal year 2010, which begins on April 1, 2010.

Similar to XJ, Shenyang Blower Works or SBW is a large Chinese state-owned enterprise with thousands of employees and decades of manufacturing expertise. They expect to begin volume production later this year of 2 megawatt doubly fed induction wind turbines that were designed by and co-developed with AMSC Windtec. Just yesterday, we announced that we have closed a $70 million order from SBW for hundreds of full electrical control systems for these turbines. We expect to begin low volume shipments to SBW in the second half of calendar 2010 and to increase shipments year-over-year through the contracts in early 2013.

So our business relationships with our Chinese licensees, Sinovel, CSR-ZELRI, XJ Group and SBW are now starting to pay dividends in the form of large-scale orders for core electrical components and electrical control systems. We expect the same will be true for our fifth Chinese customer, Dongfang Steam Turbine Works, Dongfang already is the third largest wind turbine manufacturer in China. Later in 2010, Dongfang plans to enter production of 2.5 megawatt doubly fed induction wind turbines, which were designed by and co-developed with AMSC Windtec. Earlier this month, we signed a new contract with them to design and jointly develop a 5 megawatt wind turbine that will use full-conversion permanent magnet generators for the offshore wind power market. Dongfang plans to begin supplying these 5 megawatt wind turbines for the worldwide offshore market in 2012.

Further diversification of our sales is occurring now in the wind market and will increase in the future through orders in the power grid sector, which now also extends to China. During our third fiscal quarter, AMSC China landed its third and fourth D-VAR orders. Both of these smart grid solutions are intended to help China Southern Power Grid Company increase its grid reliability. According to China's National Energy Administration, nearly $60 billion were spent on China’s grid in 2009 to improve grid reliability and capacity and to build out the system. And the amount of investment in China’s grid is expected to increase this year and in the future. So while the D-VAR orders we have closed thus far in China are quite small in comparison to our wind power orders they demonstrate that we have started tapping into another enormous market opportunity.

With that said, AMSC’s business overall is clearly China-centric with over 75% of our revenues now coming from China. We expect that our China business focus will continue to serve as our primary engine for growth for the next 12 months to 24 months. However, we also expect to soon be enjoying accelerating returns from the investments we have made in India and Korea.

We have two Windtec licensees in each of these countries, which we expect will lead to more orders for wind turbine core electrical components in the year ahead. We also expect our grid-related sales in particular for the superconductor power cable market will start to take hold in Korea with our strategic alliance partner, LS Cable Company. In fact, we have shipped 80 kilometers of HTS wire to LS Cable this fiscal year based on commercial wire order we received in April 2009. LS Cable remains on track to deploy its first superconductor power cable in Korea Electric Power Corporation’s commercial power delivery network near the city of Seoul later this year. We expect our backlog of orders from Korea and other non-China Asia Pacific countries to start growing later in 2010 and in 2011.

Our backlog of firm orders for shipment in fiscal 2010 and 2011 is already quite strong, which provides a solid foundation to meet the near-term business plans and financial forecast that Dave will discuss in a moment. However, let us now look to the future of our business. Not since the time of Thomas Edison, George Westinghouse, and Nikolai Tesla a century ago has there been so much potential for growth in the electric industry, renewable energy, smart grid solutions and rapid growth in the demands for electricity in developing economies such as China are the driving forces behind this growth. These new rapidly growing markets are creating new growth opportunities for AMSC.

Opportunity is the key word to focus on here. As Edison once said “Opportunity is missed by most people because it is dressed up in overalls and it looks like work.” So we got our overalls on so to speak and we are deriving hard day in day out to address a series of powerful additional growth opportunities for our company. One of the new growth opportunities we are pursuing is the US wind power market. In 2009, a record 10 gigawatts of wind power was installed in the United States. Although we currently do not have a Windtec licensee in the United States, we expect current customers like Sinovel and Hyundai Heavy Industries to begin penetrating the US market in 2010 and 2011. This will provide the initial channel for our wind turbine design and core electrical components into the US wind market. We also see opportunities to add a US-based wind turbine licensee over the next one to two years. With nearly $1 billion being spent annually on wind turbine electrical systems in the US alone, this is clearly a market that’s worth going after.

A second tremendous new opportunity we are pursuing is offshore wind. While the global installed base for onshore wind power now exceeds a 150 gigawatts, offshore capacity stands at just 2 gigawatts or just over 1% of the overall wind power market today. All signs, however point to this being a significant growth market by the middle of this decade. Just a few weeks ago, in fact, the British Crown Estate announced 32 gigawatts of new offshore wind power development awards. And the European Wind Energy Association recently said that it expects Europe’s offshore wind power capacity to exceed 150 gigawatts by 2030. We view this as the next great frontier for wind.

We already have a host of offshore wind turbine development relationships with companies like Sinovel, Dongfang and Doosan Heavy Industries. And we are making good progress on our sea-tide [ph] and superconductor wind turbine development program. Sea-tide and wind turbines will utilize direct drive superconductor generators to significantly reduce the top-head weight and size of wind turbines. The end result will be the ability to produce 10 megawatts of power or more from a single wind turbine. This would essentially double the power output of today’s highest power rated wind turbines with a key expected advantage being a significant reduction in the overall cost of offshore wind energy.

While most of our work today on this program is focused on modeling shifting cost with a National Renewable Energy Lab and the developing the technologies needed for the wind turbine generator with TECO-Westinghouse Motor Company, our focus is now shifting more heavily to the actual wind turbine design. We plan to not go and develop offshore wind turbines but also build a knowledge base, capabilities and alliance around subsea structures, offshore towers and offshore installation services, which is going to account for 70% or more of offshore wind firm costs. By taking this holistic approach, we believe we will position AMSC as a dominant force in offshore wind and capitalize fully on what we expect to be a $1 billion annual addressable market for electrical systems and superconductor components in the second half of this decade.

While the wind energy market is tremendous, our growth opportunities aren’t limited to the wind market. Our D-VAR solution, which has become the de facto standard for connecting wind farms to the power grid, also provides the foundation for growth in the solar energy sector. Of course, photovoltaic or PV solar has been a big business for years. Until now, however, solar has primarily been adopted as an energy solution for residences and individual commercial operations, not utilities. That is now beginning to change as solar panel prices have continued to decline and renewable energy standards are being implemented around the world.

Projects are now underway for solar farms consisting of dozens or hundreds of megawatts and China has plans in place for its first gigawatt-scale PV solar farm. While there is an ample supply of solar panels to meet this demand, solar panel manufacturers are seeking a way to reliably and economically interconnect these large solar farms to the grid. They have begun investing in products to fill this void and plan to fill their first system within the next 12 months. The opportunity here is sizable. In a report in late 2009, industry research firm Yole Development said it expected that more than $2 billion could be spent annually on utility-scale solar power electronic components and inverter systems by 2015. We are working hard to capture a significant share of this new market opportunity.

And then there is a superconductor growth opportunity, which Mr. Edison certainly will be excited about, just as we are at AMSC. Superconductor products and systems of course have the potential to be the largest growth opportunity for our company. We are continuing to invest aggressively in superconductor technology and wire manufacturing. In addition to sea-tide and superconductor wind turbines, we are developing multiple superconductor power cable projects which we believe will be the largest market for HTS wire. With Korea moving forward aggressively to deploy superconductor power cables, China following close on with – its heels and US utilities and companies like Tres Amigas recognizing the unique advantage of HTS, we are expanding our business development and sales activities for superconductor cables and we are preparing to gear up HTS wire manufacturing.

In summary, we currently have a tremendous business with proven wind power and power grid offerings that are expected to fuel strong growth in earnings in fiscal 2010 and beyond. While we are resting on our laurels, we are making strategic investments in technologies and products that complement our existing solutions and are aimed at opening multiple new addressable markets. These initiatives are intended to enable AMSC to become a multi-billion dollar power technologies company with superior operating margins in this new decade.

Finally, I would like to make a note of one other significant recent development. In December, we have promoted Dan McGahn to the position of President and Chief Operating Officer. Dan joined AMSC in 2006 and focused initially on establishing AMSC China, including its sales, service, supply chain management, and manufacturing operations. AMSC China of course has had a tremendous success and has now grown to nearly 200 employees. In 2008, Dan was promoted to the position of Senior Vice President and General Manager of AMSC Superconductors. In this role he has been developing strong strategic business alliances in the area of superconductor applications to create near and long-term demand for the company’s 344 superconductors. He has also led efforts to significantly enhance AMSCs wire performance and production processes and he has strengthened the AMSC Superconductors’ team to ensure we are prepared for a rapid scale up in production. As President and COO, Dan has assumed the responsibility for day-to-day global operations, which includes our business units, manufacturing, sales, facilities and customer service. He is the right guy for the job and we are lucky to have him.

And now, I will turn the call over to Dave Henry for a review of the quarter’s financial results. Dave?

David Henry

Thanks Greg and good morning everyone. It was another successful quarter for AMSC financially as we once again delivered sequential revenue growth and we maintained stronger gross margin than expected due to a more favorable product mix for the quarter and further cost reductions realized from our successful localization efforts in China. These stronger-than-expected results in the third quarter have also enabled to us to raise our full-year fiscal 2009 revenue and earnings guidance once again. And as Greg mentioned, we expect further growth in fiscal 2010.

First let’s go through the details of our third quarter results. AMSC generated revenue of $80.7 million in Q3, an 8% increase from $74.7 million for the second quarter of fiscal 2009 and a 95% increase from $41.3 million for the third quarter of fiscal 2008. Wind turbine core component shipments remained a primary contributor to our 12th consecutive quarter of sequential revenue growth.

AMSC Power Systems represented 95% of total revenues and sales more than doubled to $77 million from $38.3 million for the third quarter of fiscal 2008. Our AMSC Superconductor segment generated the remaining 5% of sales. AMSC Superconductor’s revenue in the third quarter was $3.6 million, which compares with $3.1 million in the year-ago quarter.

Backlog as of December 31, 2009 was approximately $546 million. That was down from $587 million at September 30, 2009. As we said in the past, we would expect our quarterly backlog to decline more often than not as we make scheduled shipments and recognize revenue under our large multi-year wind turbine core electrical component contracts with Sinovel.

Recall that last quarter we said that we expected a decline in gross margin in the third quarter, while gross margin did decline compared to second quarter, our more favorable product mix and accelerated reductions in material costs in our China operation enabled us to achieve better-than-planned gross margin in the third quarter of fiscal 2009. Gross profit for Q3 was $30.2 million resulting in a gross margin of 37.5%. This compares with 38.9% for the second quarter of fiscal 2009 and 23.2% gross margin for the third quarter of fiscal 2008. Operating expenses increased as planned in the third fiscal quarter as we continue to invest to support our long-term growth.

R&D expenses in the third quarter of fiscal 2009 were $6.4 million or 8% of revenue. This is an increase from R&D spending of $5.4 million, or 7% of revenue for the second quarter of fiscal 2009 and $5.3 million, or 13% of revenue for the third quarter of fiscal 2008. The sequential increase in R&D expenses was driven by engineering headcount increases and other costs in support of the new development programs Greg described earlier.

SG&A expenses for the third quarter of fiscal 2009 increased to $12.9 million or 16% of revenue from $12.7 million or 17% of revenue for the second quarter of fiscal 2009. SG&A expenses for the year-ago quarter were $9.4 million or 23% of total revenue.

In the third quarter, we incurred approximately 473,000 in amortization of acquisition-related intangibles related to our acquisitions of Windtec and PQS. This is up slightly from 430,000 in the year-ago quarter due to foreign currency translation effects. Intangibles amortization should remain roughly flat at 400,000 to 500,000 per quarter in the near term.

Our operating income for the third quarter of fiscal 2009 was $10.4 million, resulting in an operating margin of 13% for the quarter. This compares with an operating income of $10.3 million or 14% of total revenue for the second quarter of fiscal 2009 and an operating loss of $5.7 million for the third quarter of fiscal 2008.

AMSC Power Systems generated operating income of $19.9 million or 26% operating margin for the third fiscal quarter. This compares with a 28% operating margin in the second quarter of fiscal 2009 and an 8% operating margin for the year-ago quarter. AMSC Superconductors generated an operating loss of $5.9 million for the third quarter of fiscal 2009. This compares with an operating loss of $5.6 million in the second quarter of fiscal 2009 and $6.3 million in the third quarter of fiscal 2008.

As a reminder, stock-based compensation expense is not allocated to our reporting segments. Amounts reported in other income or expense are primarily related to foreign currency transaction and balance sheet translation gains and losses net of hedging effects. These effects were favorable in the third quarter as we generated other income of approximately $200,000 compared to other expense of approximately $900,000 in the second quarter.

Income tax expense increased to $5.6 million for the third fiscal quarter. Income expense for the year-ago quarter was $2.3 million. Our income tax expense represented a 52% effective tax rate in the third quarter, which is skewed by the fact that we do not record a tax benefit on losses incurred in the US. This compares to an effective tax rate of 55% in the second quarter. With foreign profits expected to continue to increase and US losses expected to remain relatively stable in the near term we would expect our effective tax rate to gradually decline in future quarters.

For the third quarter of fiscal 2009, we reported GAAP net income of $5.2 million or a $0.11 per diluted share. This compares with GAAP net income of $4.3 million or $0.10 per diluted share for the second quarter of fiscal 2009 and a GAAP net loss of $7.8 million or $0.18 per share for the third quarter of fiscal 2008. We use non-GAAP net income, which approximates cash-based earnings from continuing operations to track our financial progress and we report this metric each quarter. We also provide guidance for non-GAAP net income on an annualized basis. These numbers are reconciled to GAAP in tables at the end of our earnings press release.

Our non-GAAP net income for the third quarter of fiscal 2009 was a record $9.1 million or $0.20 per diluted share. This compares with non-GAAP income of $8.7 million or $0.19 per diluted share for the second quarter of fiscal 2009 and a non-GAAP net loss of $4.9 million or $0.11 per share for the third quarter of fiscal 2008.

AMSC ended the third quarter with $112.8 million in cash, cash equivalents, marketable securities and restricting cash. This compares with $141.1 million as of September 30, 2009 and $117.2 million as of March 31, 2009. The sequential decline was primarily due to growth in accounts receivable from Sinovel, a majority of which was subsequently collected in January 2010. As of January 31, 2010, our balance of cash, cash equivalents, marketable securities and restricted cash had increased to more than $135 million.

Our higher level of accounts receivable resulted in DSO increasing to 90 days for the third fiscal quarter from 58 days for the second fiscal quarter. We expect DSO to return closer to second quarter levels in the fourth quarter. Our days of inventory for the third quarter increased to 66 days from 59 days in Q2 of fiscal 2009. This was primarily the result of the accumulation of buffer inventories in advance of fourth quarter shipments.

Now I would like to discuss our financial guidance for fiscal 2009. We are increasing our revenue forecast for full-year fiscal 2009 from a range of $300 million to $310 million to a range of $312 million to $315 million. We continue to expect that AMSC Power Systems revenues will represent more than 95% of total sales for the full fiscal year. And we continue to expect that international sales and wind power sales will each represent approximately 80% to 85% of our total revenues for full-year fiscal 2009. It represented 89% and 84% of our total revenues respectively in the third quarter of fiscal 2009.

We expect gross margin for the full fiscal year to be approximately 36%. This is up from our prior forecast range of 34% to 35%. We have increased our guidance for GAAP net income for fiscal 2009 to a range of $11 million to $13 million or $0.24 million to $0.29 per diluted share to a range of $14 million to $15 million or $0.31 to $0.33 per diluted share. AMSC’s non-GAAP net income forecast meanwhile has increased from a range of $27 million to $29 million or $0.59 to $0.64 per diluted share to a range of $29.5 million to $30.5 million or $0.65 to $0.67 per diluted share.

We now expect capital expenditures in the range of $16 million to $18 million for full-year fiscal 2009 compared to our prior forecast of $11 million to $15 million. This increase is driven by CapEx to support additional IT infrastructure, further manufacturing capacity expansion in Power Systems, and investments we are making to begin migrating to our 100 millimeter production process for 344 superconductors. Despite this increase, we continue to expect that we will be net cash flow positive for full-fiscal year 2009.

The updated full-year guidance that I just laid out indicates that we expect our revenues to grow to a range of $84 million to $87 million in the fourth fiscal quarter. We expect our GAAP and non-GAAP net income to decline quarter over quarter. This is primarily related to operating expense increases we are in the process of making to continue growing in fiscal-year 2010 and beyond, as well as an assumption of less favorable foreign currency effects.

At our Analyst Day in November 2009, we provided our initial glimpse into fiscal 2010. We continue to expect that our revenues for fiscal 2010 will exceed $400 million and that our non-GAAP earnings for the full fiscal year will exceed $1.15 per diluted share, an increase of more than 70% over forecasted fiscal 2009 earnings. We will provide more detailed financial guidance for fiscal 2010 on our next conference call in May.

With that we will open the call to questions. Pamela, would you please provide the instructions?

Question-and-Answer Session

Operator

My pleasure, sir. (Operator instructions) Our first question comes from Timothy Arcuri of Citi. Please proceed, sir.

Timothy Arcuri – Citi

Hi, couple of things. Just to clarify both the XJ and the SBW bookings, those were not included in backlog as of the end of December, is that correct?

David Henry

That’s correct.

Timothy Arcuri – Citi

And you would expect those to be included in backlog as of the end of March?

David Henry

That’s correct.

Timothy Arcuri – Citi

Okay. So can you give us A, some idea of what the bookings will be just in the March quarter? So I am just trying to quantify what the trend will be versus what it was this quarter. And secondly, I am wondering whether some of the recent regulatory rulings against FPL here in the US, whether those make you a little concerned about the pace of the global wind build out, and certainly the wind build out here in the US as your Chinese customers try to move into the US. Thanks.

Greg Yurek

Tim, we don’t give forecast on our build up of backlog as you will know. So keep watching this page as they say for orders that are expect to come through the rest of this quarter. And in terms of the US wind market, most people think it’s going to be down a bit maybe in 2010 or at least stable. But it is hard to say with the US. The regulatory environment is always changing as you will know; however, in the rest of the world we see continued growth. We don’t see any slowdown by our customers in China; quite a contrary. We continue to see acceleration. And with respect to our customers, in particular, Hyundai Heavy Industries and Sinovel penetrating the US, we said in our comments just a moment ago that we expect them to start penetrating in 2010, 2011. I think they are going to do that on the basis of both good quality wind turbines, equal quality to their competitors in the US, and at least Sinovel surely will compete on the basis of price. So I think they have some very interesting strategies for penetration and they are bringing along, in the case of Sinovel, Chinese bank financing. So they have a number of ways to attack this market that are interesting and I think going to be quite effective.

Operator

Thank you. Our next question comes from Carter Shoop of Deutsche Bank. Please proceed.

Carter Shoop – Deutsche Bank

Good morning. Congratulations on a good quarter.

Greg Yurek

Thank you.

Carter Shoop – Deutsche Bank

Just in regards to Sinovel, I am hoping you guys disclosed what that was in the quarter, if you guys could mention that, that will be helpful. And then my question is AMSC on track to start shipping components to Sinovel’s 3 megawatt turbines in the March quarter, and does that have any impact to gross margins to the March quarter?

Greg Yurek

Dave, you want to take the question on the Sinovel?

David Henry

Yes, on the Sinovel percentage, it was 76% in the third quarter and 69% year to date. And then on the 3 megawatt shipments we might have a few that go into the March quarter and it is going to have a negligible effect on gross margins in the fourth quarter.

Greg Yurek

Sinovel is continuing to construct the total of 34 3-megawatt wind turbines offshore in Shanghai, and in fact they probably are approaching at least half of those already installed at this stage of the game. So, they'll continue to go forward and as – I agree with Dave (inaudible) terms of gross margin impact in the fourth quarter.

Operator

Thank you, sir. Our next question comes from Ben Schuman of Pacific Crest. Please proceed.

Ben Schuman – Pacific Crest Securities

Good morning, guys. Dave, can you talk about if the cash dip in the quarter is something that’s indicative of maybe a re-occurring pattern of Sinovel going forward? Maybe you give some color around what your terms are for receivables at Sinovel?

Greg Yurek

Yes, I think it was just, as we mentioned in the call, the timing difference in the shipments. Shipments occurred later in the quarter than they had and prior quarters. So as a result, some of the shipments that we made and recorded revenue on didn't get paid. But as we told you because the dip was fairly large we wanted to reassure people that it doesn’t signal any change with our business with Sinovel, how we conduct business with them, any payment terms with them or anything like that. Our cash at the end of January is a bit more than $135 million. So that has come back to basically where it was. How we do business with them is, for the most part, on letters of credit. So, meaning that we will – when there is a scheduled delivery we will await instructions from Sinovel that they have proceeded to issue a letter of credit with their bank and once that is done we then deliver the products, and then generally maybe 10 days or two weeks later we get paid. Sometimes though depending on what is going in the quarter and the particular timing of the quarter, we may also ship under just opening credit terms and the timing on those might be a little bit later than under letter of credit but not significantly so.

Operator

Thank you. Our next question comes from Ben Kallo of Baird. Please proceed, sir.

Ben Kallo – Robert W. Baird

Good morning, guys. Could you give us little more detail on Hyundai Heavy Industries’ production capacity and how you see their orders being placed throughout the year?

Greg Yurek

Which company again? Hyundai?

Ben Kallo – Robert W. Baird

Hyundai.

Greg Yurek

You are wondering about their ramp up, is that the question?

Ben Kallo – Robert W. Baird

Right, and their overall capacity currently?

Greg Yurek

If I remember correctly, the new factory they put up has a capacity of about 600 megawatts per year, annual capacity of 600 megawatts per year. That factory was up and running in September of 2009, and they’re continuing to produce wind turbines and they are working on deals, orders quite a bit in the United States but also in Korea and also China for that matter. So they are moving forward, and I think they will have the capacity to grow quite significantly in 2010 and beyond.

Operator

Thank you. Our next question comes from Jim Ricchiuti of Needham and Company. Please proceed.

Jim Ricchiuti – Needham & Company

Hi, thank you. Dave, can you give a little bit more color on the increases you are seeing in OpEx in the quarter?

David Henry

In the third quarter?

Jim Ricchiuti – Needham & Company

Well, your implied guidance for Q4 suggests that OpEx is going to be up?

David Henry

Well, the increase in – I will start with third quarter, I will hit forward.

Jim Ricchiuti – Needham & Company

Sure.

David Henry

The increase in third quarter was primarily R&D driven, as we talked about some of the programs we are investing in. We're adding headcount, engineering headcount, to support those programs. There’s also outside costs that we are incurring in support of those programs as well. In the fourth quarter, it’s a continuation of our headcount ramp. A lot of those plans were already in place. So we expected actually a little bit higher OpEx in the third quarter, but some of those things are going to get pushed out to fourth quarter, and it's just in further continuation of our growth plans that we’ve already discussed, but we are always keeping our eye on the OpEx ball and we want to make sure that overall we don’t put our OpEx faster than the rate of revenue.

Operator

Thank you. Our next question comes from John Hardy of Broadpoint. Please proceed.

John Hardy – Broadpoint AmTech

Good morning and thanks for taking my question. Dave, I was hoping you could talk a little bit more about the anticipated gross margin decline in Q4. As well as I think you usually breakout operating margins by segment, if you could do that in the quarter that will be great. Thank you.

David Henry

So, what we talked about – our gross margin was 37.5% in the third quarter. We guided to 36% for the full year. That implies that maybe gross margin in the fourth quarter might be flat to slightly down, maybe a little bit. Nothing significant going on with gross margin in the fourth quarter, we are just looking at the mix of what’s in the backlog and what’s to be shipped; nothing really more than that. I did give the operating margin for Power Systems in my remarks in the script. It was 26% in the third quarter. That was Power Systems. And then Superconductors had an operating loss that was $5.9 million, I believe in the third quarter.

Operator

Thank you. Our next question comes from Patrick McElroy [ph] of Jefferies. Please proceed, sir.

Patrick McElroy – Jefferies & Co.

Hi, guys. Congrats on a great quarter. This is Pat calling for Paul Clegg.

David Henry

Hi, Pat.

Patrick McElroy – Jefferies & Co.

I just have couple of quick questions about recent developments in China. Do you have any thoughts on China’s recent legislator to motivate grid operators to connect to the grid or pay a penalty impacting your customers’ business? And what feedback do you get from your Chinese licensees about recent moves from the Chinese government towards tighter monetary policy?

Greg Yurek

I will take the latter one first. We addressed both of these questions at our Analyst Day back on November 19. But our current Chinese licensees are thrilled with the moves by the government to tighten up credit. There are some 80 or so wind turbine manufacturers in China, that’s not sustainable, everybody knows that. And the Chinese government is tightening up credit to force some of those out of business. Our current customers are happy about that because they believe that’s going to be more business for them and from everything we’ve seen we agree with them on that. In terms of the grid operators in being forced to hookup wind farms to the grid and later solar farms to the grid, the utilities or the grid operators don’t like that, of course, but they will have to pay a penalty.

And it’s just another thing we addressed at the Analyst Day – this parallel processing, building out wind farms at a very rapid rate. There is some 20%, 30% of the wind farms in China are not actually hooked up to the grid right now. But all indications are quite clear that the grid operators will catch up to that. And I think just part of the parallel processing that the Chinese are famous for. Putting penalties on grid operators if they don’t hookup to the gird is just another way of making sure that parallel processing works. So we are very confident that this will move forward. But XJ Group, which we announced first order from, last week is owned by state grid, which operates some 80% plus of the grid in China. So clearly the grid operators are also onboard with adopting wins in bringing the material to grid.

Operator

Thank you. Our next question comes from Jesse Pichel of Piper Jaffray. Please proceed, sir.

Jesse Pichel – Piper Jaffray

Good morning, Mr. Yurek and Mr. Henry. Congratulations on a strong quarter.

Greg Yurek

Good morning, Mr. Pichel.

David Henry

Good morning.

Jesse Pichel – Piper Jaffray

Kind of a most important question, which know has asked is what do you expect for the China’s market in 2010 and 2011? The market just did 9 Gigs, and they are setting a presumably 20:20 target of 100 Gigs, which doesn’t really leave much growth than I think that upside from the 30 Gig target today is probably priced into the stocks. So what do you think?

Greg Yurek

Well, I think it looks like – was more like about 10 Gigs they installed in 2009. Official numbers aren't quite out there yet, so it looks 9 Gigs, 10 Gigs or so. At worst, I would expect it to be flat in 2010. And I could tell you our customers are gearing up, Sinovel certainly has four factories up and operating, working on a fifth one right now. So they don’t foresee any slowing down from their perspective to be short. And the 100 gigawatts in 2020, Jesse, I think is clearly a low number. Even the Chinese government has upped that a bit and they talk about a range I think up to 150 gigawatts now at the high end, a number of industry analysts look at this and say 150 gigawatts to 200 gigawatts. So it’s going to be well over 100 gigawatts we believe, and we think we will continue to see a ramp certainly through the first half of this decade to be sure.

Operator

Our next question is from Pavel Molchanov of Raymond James.

Pavel Molchanov – Raymond James

Thanks, just another kind of macro question for you. We’ve seen a lot of new entrants into the turbine arena in China. Are you worried about an oversupply at some point down the road?

Greg Yurek

No, I think we answered that just on one or two questions that the Chinese government takes care of things so to speak and they are going to, through variety of means including holding back credit for some the wind turbine manufacturers, force a consolidation. And as I said, our current Chinese customers are happy about this because they believe they are in a leadership position and that means they will gain market share. As of end of 2009, for example, Sinovel is somewhere in the high 30% to 40% market share in China. That probably will grow a bit more in 2010. And we think SBW, XJ as they start kicking in are going to grow smartly thereafter. And CSR-ZELRI, though a smaller player, but also doing quite well. Dongfang, number three in the market as they start going into production of 2.5 megawatt machines, I think they are in a very special position within China as well. So we don’t see any negative effect on our customers, quite the contrary we see consolidation doing a benefit.

Operator

Our next question comes from Vishal Shah of Barclays Capital.

Vishal Shah – Barclays Capital

Thanks for taking my question. Good quarter, guys. I wanted to just as a follow up on Sinovel, can you remind us what percentage of Sinovel business is in the backlog today? Is there a pull in from Sinovel that’s leading you to the upside in this quarter and the previous couple of quarters?

Greg Yurek

Dave?

David Henry

On the – we don’t really disclose our backlog by customer. But when you look at this quarter, our revenue in the third quarter was really – I think it really met our expectations. There wasn’t any special – anything special or additional that happened with respect to Sinovel compared to what we expected at the beginning of the quarter and looking ahead to the fourth quarter, what's – we can see ahead as to what's really in our backlog. We got a pretty good feeling about what’s there and what’s going to ship and there is really nothing unusual about what we are going to do with Sinovel in the fourth quarter either.

Operator

(Operator instructions) Sir, our next question comes from Megan Moreland of Ardour Capital. Please proceed.

Megan Moreland – Ardour Capital Investments

Good morning. Could you just give an update on how establishing operations in South Korea and India is going?

Greg Yurek

We are going quite well. We are hiring people in both of those countries. They are very actively engaged with two Windtec licensees in those countries. The particular additional activity in Korea of course surrounds LS Cable and Korea Electric Power Company where the activity is strong. As we mentioned in our comments that LS Cable expects to be installing their first superconductor cable in commercial grid near Seoul later this year. So lot of activity in both of those countries and both represents huge growth opportunities, I would say in particular India is going to be tremendous for AMSC based not just on wind but also the solar which I think India probably ends up having more solar power generation in India than wind generation. So we think we will be ready for that break out of solar in India with our team on the ground and our new products that we are going to be introducing within the next 12 months.

Operator

Our follow-up question comes from Timothy Arcuri of Citi. Please proceed, sir.

Timothy Arcuri – Citi

Hi, can you give us some idea, last quarter you gave us some idea how much of the bookings were grid related? Or not last quarter but the quarter before that how much of this quarter was grid related?

Greg Yurek

I don’t think we’ve given that before, but I think we said at our Analyst Day of course that about $80 million of new grid orders over the last 12 months. Dave, am I remembering it correctly? I don't believe we will give the break down.

David Henry

It’s somewhere in that ballpark. I would just – looking at third quarter I would say $3 million or $4 million in bookings were grid related in third quarter and fourth quarter – or in third quarter I should say.

Operator

We now have another follow-up question coming from Jim Ricchiuti of Needham & Company.

Jim Ricchiuti – Needham & Company

Greg, given that the ConEd project and Entergy Cable projects look like they are in a back burner, when would you expect to see some potential follow-on business from LS Cable?

Greg Yurek

Again, we have a strategic alliance when we signed with them in September of 2009, and at that time we commented or stated that they expect to install about 10 kilometers or 6 miles of superconductor cable in Korea in the next few years. What they're talking about publicly, as well as KEPCO, the grid operator, is that they expect superconductor cables to be fully commercial and ramping from 2012 on. So hope that answers the question, Jim. But we at Analyst Day, again I'm going to refer back to that here. We tried to lay out pretty clearly that we see Korea as the first adopter here in HTS for the grid. The reasons that Entergy and ConEd pulled back and by the way we are very close to closing a commercial order here in the US and the economic downturn has had all of these utilities pull back both from development projects as well as the first commercial projects. Now until the economic downturn settles out and we get some growth here in the US, growth in electricity demand, the US is going to be a laggard. And that gives Korea the opportunity to be the first adopter, and that’s what we think is going to happen. China is following closely on the heels of Korea at this time.

Operator

Thank you, sir. And a follow-up question coming from Vishal Shah of Barclays Capital. Please proceed

Vishal Shah – Barclays Capital

Yes, thanks. Dongfang just signed a new agreement with The Switch. Do you think that impacts your current plans with Dongfang or can you just elaborate on that agreement? Thanks.

Greg Yurek

The new 5 megawatt wind turbine that we are developing for Dongfang is a full conversion dive train, which in fact uses permanent magnet generators. So we don’t make permanent magnet generators. We help our customers source these. And certainly The Switch would be a good source of permanent magnet generators for Dongfang and other companies. But there are other sources of permanent magnet generators, but we think The Switch is one of the best around.

Operator

(Operator instructions) And we do have another question coming from Jesse Pichel of Piper Jaffray.

Jesse Pichel – Piper Jaffray

Hi, thanks for the follow up. The solar inverter market is quite robust with very few competitors. What do you think AMSC’s competitive advantage would be for entering the inverter market? Do you target a particular market share and do you have an alpha or anchor customer there that can help you design a winning product? Thank you.

Greg Yurek

In terms of market share, Jesse, all's I'll say about that is we're after a dominant market share. And, the reason we think we can achieve that in the next few year is we do in fact have a number of the large-scale customers that clearly cannot find what they need on the market for large-scale inverters, in particular those that will hookup to the grid and provide both the proper AC megawatts and reactive compensation as needed. So in discussions with these large-scale customers, we have learned what the features and functionalities that they require and that’s baked into our engineering program, our product development activities for the solar market. So we think we have the opportunity here at this early stage to be – to develop a first-mover advantage. So when that solar market takes off, utility-scale solar, really takes off in 2012, we'll be fully ready for that and already be in the market well ahead of that at that time. So dominant market share is all we are after Jesse.

Jason Fredette

So, Pamela, we will take one more question if there is one out there.

Operator

Actually, there are no further questions, sir. So I’d like to turn the call back over to our CEO, Greg Yurek, please proceed, sir.

Greg Yurek

Thank you very much, and thanks for your attention and your good question today. It was a terrific quarter for us and we have a terrific quarter for the fourth quarter and the year ahead. So look forward to that. Thanks, bye-bye now.

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Source: American Superconductor Corporation F3Q09 (Qtr End 12/31/09) Earnings Call Transcript
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