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American Superconductor Corporation (NASDAQ:AMSC)

F1Q10 (Qtr End 06/30/2010) Earnings Conference Call

July 29, 2010 10:00 AM ET

Executives

Jason Fredette – Director, Corporate Communications

Greg Yurek – Founder, Chairman and CEO

David Henry – SVP, CFO and Treasurer

Analysts

Carter Shoop – Deutsche Bank

Jesse Pichel – Jeffries

Theodore O’Neil – Wunderlich SEZ

Ben Schuman – Pacific Crest

Jake Green Black – Barclays Capital

Jim Ricchiuti – Needham and Company

Stewart Bush – RBC Capital Markets

John Hardy – Gleacher and Company

Seth – Citi

Ben Kallo – Baird

JinMing Liu – Ardour Capital

Jeremy Hellman – Divine Capital Markets

Pavel Molchanov – Raymond James

Carter Driscoll – Capstone Investments

Timothy Arcuri – Citi

Operator

Good day, everyone, and welcome American Superconductor’s First 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 Managing Director of Corporate Communications, Jason Fredette.

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

Jason Fredette

Thanks, Jennifer, and welcome to the call everyone. Before we begin, 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 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 our annual report on Form 10-K for the fiscal year ended March 31, 2010, which is 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. While American Superconductor anticipates that the 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’ll be referring on today’s call to non-GAAP net income, or net income before amortization of acquisition-related intangibles, restructuring and impairments, stock-based compensation, other unusual charges and any tax effects related to those items. Non-GAAP net income with 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 Investors’ page of our website at amsc.com.

And finally, I would like to mention that we’ll be taking part in the Needham Clean Technology Conference in New York on August 9, and the Pacific Crest Technology Leadership Forum in Vail, Colorado on August 10. We’ll provide a live webcast from the Needham event that can be accessed on our website, more details on that webcast will be published next week.

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

Greg Yurek

Thanks, Jason, and good morning, everyone. We’ve gone out to a great start in fiscal year 2010, and Dave Henry and I are looking forward to filling you in on all of the details.

From a financial perspective, our first quarter was impressive. We generated a strong increase in revenues in both quarter-over-quarter and year-over-year. We increased backlog to a new record level approaching $1 billion, providing us with a substantial platform for profitable growth over the next several years. We delivered gross margins of 40% and operating margins approaching 17%, both new company records, and we more than doubled our earning year-over-year. All impressive results, indeed.

As a result of the strong start and the strength of the markets we are serving, we have increased our financial forecast for the full fiscal year. Dave will go over all of the financial details in just a few moments.

Under lined numbers are the following (ph) key facts; first, the spending in our end markets remains robust and is projected to continue increasing over the next decade; second, the demand for our differentiated solutions is as strong as ever, and getting stronger; third, our execution is excellent; and fourth, our solid balance sheet and cash generation are enabling us to make strategic investments to accelerate our near- and long-term profitable growth. I’ll touch on each of these points further, but let’s start with our primary market, Wind Power, in the Asia-Pacific region.

The U.S. and European economies remain bogged down following the great recession, and the wind market in the U.S. is temporarily contracted due to the economic slowdown. In the meantime, Asia’s wind market has remained vibrant, thanks in large part to China. China boosted its annual wind power installations from 6 gigawatts in 2008 to 14 gigawatts in 2009. In 2010, we are expecting this figure to rise to 16 to 18 gigawatts, and to potentially exceed 20 gigawatts in 2011 and beyond.

This growth is driven by a number of factors. We’d include the need for more electricity in China to fuel GDP growth, the drive to maintain a high degree of energy independence and the desire to create thousands of new jobs in China on a dynamic new export market. China also has set ambitious targets to reduce emissions, not only because of global warming concerns, but also because pollution is having a very real impact on its domestic workforce.

Last week, an executive from China’s National Energy Administration said that the country likely will spend nearly $740 billion over the next decade to develop and deploy clean energy solutions in the country. China aims to use these investments to double the percentage of power it gets from non-hydro renewables to 15% by 2020. That’s no small feat considering China’s total power demands are increasing by nearly 10% annually. Though nuclear and solar power will share the load, wind power will be the primary means for reaching these kinds of numbers.

This provides AMSC and inspired (ph) the Chinese wind turbine manufacturing customers with a tremendous long-term opportunity. And we’re already capitalizing on a somewhat significant way. Leading our pack of customers in force is Sinovel, China’s largest and the world’s third largest wind turbine manufacturer. Sinovel installed approximately 35,000 megawatts of wind power in 2009, accounting for about 25% market share in China and about 10% globally. Sinovel has publicly stated its intent to increase its market share and nearly doubling its installations in 2010. A little light there for (ph) Sinovel, providing the advanced wind turbine designs, power electronics and control systems they need to accomplish their goal of being number one in the market globally.

On the design side, following the highly successful 3-megawatt product launch with Sinovel, our full attention has recently been on the company’s new 5-megawatt wind turbine platform, while they’re currently going through factory testing of Sinovel’s first 5-megawatt turbine, which would be China’s most powerful domestically-produced wind turbine. Sinovel plans to erect its first prototype 5-megawatt machine by the end of 2010. As you might recall, 34 of Sinovel’s 3-megawatt turbines are powering the first offshore wind form outside of Europe, the Donghai Bridge wind form in Shanghai harbor.

Plans are now underway for the second phase of this project and Sinovel’s 5-megawatt wind turbines are in contention for this order. We are expecting these 5-megawatt doubly fed induction systems to be Sinovel’s primary platform for the offshore market for the next several years. Having said that, Sinovel has recently stated it expects to deploy both 3-megawatt and 5-megawatt wind turbines on shore, which we expect to account for the bulk of their growth in sales in the next couple of years.

And as we announced at the American Wind Energy Association show in Dallas a couple of months ago, we now are developing a whole new range of wind turbines for Sinovel. This new product development effort will cover multiple power ways and new drive trains. For competitive reasons, we’re not permitted to discuss which drive trains will be utilized. However, I’d like to reiterate that our 10-megawatt SeaTitan is not one of the turbines included in this new product development effort. I will come back to the licensing of SeaTitan super conductor wind turbines in a few moments. Of course, each new wind turbine platform we develop creates a new channel to market for our power electronics and control systems, which is what really drives our top and bottom lines.

In May, we announced that we had expanded our supply of core components for Sinovel’s 1.5-megawatt wind turbines out (ph) through September 2013 under a new $445 million contract. Over the next 12 months, we expect to bring in significant follow-on core component contracts for Sinovel’s 3-megawatt and 5-megawatt wind turbines. Outside of China, we’re expecting a similar mix of business from Korea’s Hyundai Heavy Industries going forward. HHI has been in early volume production of 1.65-megawatt wind turbines for approximately nine months now, and we already have seen several small orders from them for this month. In June, HHI erected and commissioned its first 2-megawatt wind turbine and testing of this prototype is progressing well, both of these models approach for license from AMSC Windtec.

As we announced a few weeks ago, we are now helping HHI launch its own proprietary 5-megawatt wind turbine. HHI plans to erect its first 5-megawatt wind turbine by the end of 2011, and intends to be a major player in the global offshore wind power market starting with this 5-megawatt model.

As we progress through the remainder of 2010 and 2011, we expect to see Hyundai order additional 1.65-megawatt sets of core components along with its initial volume orders for 2-megawatt and then 5-megawatt turbines. And we expect to continue diversifying our business by bringing in orders from many of other licensees including Inox in India, Model Enerji in Turkey and Doosan in Korea. So we expect our Wind business to continue to thrive this year, and in the years ahead, as the wind industry continues its impressive globalized growth.

Our unique AMSC Windtec business model has embraced (ph) the platform. One key reason for this is that we do everything in our power to help our customers differentiate their wind turbines and gain share in their target markets. This is done in many ways. Within our portfolio of customers’, licenses are often sold by geography. So while Model Enerji is manufacturing and selling AMSC Windtec’s 1.65-megawatt wind turbines in Turkey, they won’t be facing competition from CSR-ZELRI for a similar right to the 1.65-megawatt design in China. We also differentiate through the drive trains. For instance, the Sinovel’s 5-megawatt wind turbines will employ a doubly fed induction generator and drive train, Hyundai’s 5-megawatt turbines will utilize a full-conversion drive train with a permanent magnet generator. Each system has its own distinctive managers in terms of power, quality, efficiency and cost of energy.

While it’s important to differentiate operators among our customers, it is even more important for us to help our customers differentiate their wind turbines from those produced by manufacturers outside the AMSC Windtec pool. This is accomplished through high performance, high efficiency designs, effective low proration and cutting edge components.

We have discussed AMSC Windtec’s best-in-class wind turbine designs before, which backed up (ph) with the industry new leads in terms of performance, efficiency and reliability under a wide range of conditions. We also spoke in a great detail about AMSC Windtec’s ability to arm its customers with a cost advantage by effectively localizing their supply chains. The third way we help to differentiate our customers’ turbines is by delivering proprietary components that provide distinct competitive advantages. You might recall that we accomplished a major step in differentiation with our introduction of the power module 3000W in September 2008. This proprietary wind-specific system remains the world’s most scalable and most highly optimized power converter for the wind energy market. The PM3000W provides a customer’s turbines with the ability to remain online through severe weather events, ground faults and low voltage events on the power grid. We now plan to expand these capabilities with our next generation power converter, the PM3100W, which introduces additional features and functionalities in particular for higher power wind turbines.

This is just one of the product development efforts we are investing in today at AMSC. We have also identified opportunities in other areas of the wind turbine supply chain to further differentiate our customers’ turbines, and in turn, drive greater sales volumes for our power electronics solutions. We’ll update you more on that front soon.

Now, let me take a few moments to bring you up to speed on the activity we have under way in our super conductors business. Over the past year, the level of activity on this side of our business has increased dramatically. The Tres Amigas project here in the U.S. remains solidly on track to start construction in 2012. As a reminder, the objective for Tres Amigas is to tie together America’s three power grids using high voltage direct current, or HVDC, super conductor power cables. In doing so, Tres Amigas will enable the transfer of gigawatts and power from grid to grid for the first time ever. So a wind farm in Texas could, for instance, new life (ph) with Tres Amigas super station will export its power to California in the western interconnection and Chicago in the eastern interconnection to generate a higher rate of return.

Tres Amigas LLC, which intends to utilize all the private financing for the project, in other words, no government funding required, as we receive general approvals from FERC to move forward, and has been quite active in working with potential customers, qualifying vendors and attracting financing.

Under our agreement with Tres Amigas LLC, AMSC is expected to provide transmission planning services and the super conductor cable system for our project and our responsibility is to evaluate and select one or more qualified manufacturers of super conductor power cables. With cables, of course, we’ll utilize wire produced by AMSC. However, the bulk of the revenue we expect to recognize when the Tres Amigas project goes forward, which for (ph) the supply of the full cable system. The competition for the supply of the cable has been under way now for some time and it’s heating up. For instance, earlier this week, Nexans, the world’s largest cable manufacturer, announced that it has successfully manufactured and tested the world’s first 200-kilovolt HVDC super conductor cable system, the required voltage for the Tres Amigas project. This prototype cable system is powered by AMSC’s HTS wire. LS Cable out of Korea, the world’s third largest cable manufacturer, is moving forward just vigorously. LS has teamed with AMSC to watch an aggressive global roll-out plan for super conductor cable that includes HVDC systems as well as alternating current transmission and distribution system. Under this strategic alliance, we aim to help them deploy over 30 miles of with the super conductor cable systems over the next five years. The first of these AC cables will be energized in Korea Electronic Power Corporation’s grid, near the city of Seoul, late this year.

Back in the U.S., you might recall that Project Hydra in New York City was temporarily halted because of the economic slowdown. We have continued to work with Con Ed and the Department of Homeland Security on this very important project. At this stage, I’m happy to report that a new site has been identified, and new sources of financing for the project are being pursued. We’ll update you on the progress we are making on Project Hydra in future calls.

In parallel to all of this superconductor power cable activity, our SeaTitan product development efforts continue to move smartly forward. SeaTitan is a wind turbine platform that utilizes a superconductor generator to produce 10 megawatts or more of power per turbine. We will be utilizing the AMSC Windtec business model for SeaTitan and plan to license designs for the complete wind turbine to wind turbine manufacturers and separately licensed designs for the superconductor generator to rotating machine manufacturers.

This would result in licensing fees, royalty payments and most importantly the sale of core power electronics and superconductor components for each SeaTitan wind turbine. In fact, those licensing discussions are already underway. We continue to expect we will have our first Sea Titan licensee by the end of 2010. We are delighted of course by all of the sales and licensing activity on this side of our business. But when we speak to our customers today, whether it be one of our cable partners or potential superconductor wind turbine generator licensees, the one question we invariably get asked today is how can we be sure that AMSC will be able to meet our needs for commercial volumes of wire over the next few years, which is precisely the reason we have begun investing in the full migration to our 100-millimeter manufacturing technology for the production of 344 Superconductors.

Those of you who have followed AMSC for sometime know that we have been producing our 344 Superconductors using a 40-millimeter substrate for the past couple of years. This manufacturing line has extended our leadership position in the industry and is enabling us to meet our immediate wire requirements but it is not sufficient to meet the demand that is coming.

Migrating to a 100-millimeter process will enable us to significantly increase our output and significantly lower manufacturing cost. And since our manufacturing process is inherently modular, we will be able to add more manufacturing modules to incrementally expand capacity as demand increases. We now have ordered most of the equipment we will need for our new 100-millimeter manufacturing line. We already have received the first pieces of the equipment and are in the process of installing those today. Once all of the equipment is commissioned, qualified and producing high quality wire, we will then upgrade our existing 40-millimeter production equipment to 100 millimeters.

As you might recall, our 40-millimeter equipment was designed to also operate as 100-millimeters. The bottom line on all this is our superconductors investment and expansion plans are on track. Of course, as we discussed in our last conference call, this wire production investment was less than half of the total corporate-wide capital expenditures for fiscal 2010. We are also utilizing the cash we are generating from operations to significantly upgrade our IT infrastructure, increase the manufacturing capacity of our power systems business unit, expand our AMSC Windtec facilities, and install two wind turbines, one near our facility in Wisconsin and one near our Windtec facility in Austria. And these will serve as qualification platforms for future generations of wind turbine design, power electronics and other core components.

We also plan to increase our headcount by about 40% this fiscal year to more than 1,000 employees worldwide. So, while we are tracking for another impressive year of profitable growth in fiscal 2010, we also are making aggressive investments to continue our rapid revenue and earnings growth in fiscal 2011 and beyond.

Now, let me turn the call over to Dave for his financial review, Dave?

David Henry

Thanks Greg, and good morning everyone. We got fiscal year 2010 off to a strong start, generating a 33% year-over-year increase in revenues and record growth of operating margins, by more than doubling our earnings in the first fiscal quarter. The strength of these results is owed to solid end-market demand for our wind and power grid offerings, crisp execution on our growth plan as well as some favorable foreign exchange tailwinds during the quarter.

AMSC generated $97.2 million in revenues for the first quarter in fiscal year 2010, which is up approximately 11% from $87.6 million for the first quarter of fiscal 2009 and 33% from $73 million for the first quarter of fiscal 2009. Higher wind turbine component shipments were the main factor in our sequential and year-over-year growth.

ASMC power systems contributed $94.9 million or 98% of our total first quarter revenues. This was a 34% increase from $70.7 million in power system revenues for the year-ago quarter. Our AMSC superconductor segment contributed the remaining $2.3 million or 2% of revenues. AMSC superconductors also generated $2.3 million in revenues for the first quarter of fiscal 2009. Sales to Sinovel represented 72% of total revenues in the first fiscal quarter, wind in total representing 84% of total revenues.

Geographically, we generated 94% of our revenues outside of the U.S.

Gross profit for the first quarter of fiscal 2010 was $39 million and our gross margin was a record 40.1%. This compares with a gross margin for the fourth quarter of fiscal 2009 of 37.8% and a gross margin for the first quarter of fiscal 2009 of 30.9%.

As we highlighted on our last conference call, unlike many companies in the renewable energy industry, the recent weakening of the euro against both the renminbi and dollar has a beneficial effect on our gross margin and profitability because most of our revenue is denominated in renminbi while about half of our costs related to that revenue are denominated in euro. The strengthening dollar and renminbi versus the euro for the quarter effectively increased our gross margin by approximately 170 basis points in Q1.

In response to the recent volatility in exchange rates, we have put hedges in place for the next few quarters in order to provide a more predictable US dollar value for a substantial portion of our euro-denominated costs. Exchange rates on these hedges are roughly similar to the current dollar-euro exchange rate. As a result, this minimizes both downside risk and upside potential from exchange rate fluctuations.

R&D expenses for the first quarter were $7.3 million or 8% of revenue. This is up from $7.2 million or 8% of revenue for the prior quarter and $4.5 million or 6% of revenue for the first quarter of fiscal 2009. The sequential and year-over-year increases in R&D expenses were driven by engineering headcount increases and other costs in support of product development efforts for the wind and solar power markets.

SG&A expenses for the first fiscal quarter were $15.2 million or 16% of total revenue. This compares with SG&A spending of $14 million or 16% of total revenue for the prior quarter and $10.9 million or 15% of revenue for the first quarter of fiscal 2009. The sequential and year-over-year increases were again driven by headcount and payroll increases in support of our continued growth.

In aggregate, operating expenses increased on a dollar basis but remained relatively steady on a percentage basis both on a sequential and year-over-year basis.

As we discussed last quarter, we would expect our operating expenses in fiscal year 2010 to decline slightly on a percentage basis from fiscal 2009 levels even as we increase our headcount by approximately 40% and develop new product offerings to drive future revenue growth.

AMSC’s operating income for the first quarter of fiscal 2010 was $16.1 million and our operating margin was a record 17%. This compares with an operating margin of 13% in the fourth quarter of fiscal 2009 and a 9% operating margin for the year-ago quarter. AMSC power systems generated operating income of $25.5 million and an operating margin of 27% for the first quarter. This compares with a 26% operating margin for the fourth fiscal quarter of 2009 and a 22% operating margin for the first quarter of fiscal 2009.

The sequential and year-over-year increases were the results of more favorable product mix and foreign exchange effects.

The operating loss at AMSC Superconductors for the first fiscal quarter was $5.9 million. This compares with operating losses of $7.3 million and $5.5 million for the fourth quarter and first quarter of fiscal 2009 respectively. Sequential reduction in operating loss was driven primarily by improved wire manufacturing performance. As a reminder, stock-based compensation expense is not allocated to our reporting segments.

Our income tax expense for the first quarter of fiscal 2010 was $7.3 million resulting in an effective tax rate of 44%. This is down from 58% in the prior quarter and 62% in the year-ago quarter. With foreign profits expected to continue to increase and US losses expected to remain relatively stable in the near-term, we continue to expect that our effective tax rate will decline in fiscal 2010 compared with the prior fiscal year.

For the first quarter of fiscal 2010, AMSC reported GAAP net income of $9.2 million or $0.20 per diluted share. This is up approximately 86% from $4.9 million or $0.11 per diluted share for the fourth quarter and is up more than fivefold from $1.8 million or $0.04 per diluted share for the first quarter of fiscal 2009. We use non-GAAP net income which approximates cash based or earnings from operations to track our financial progress and we reversed this metric into quarter, and also provide guidance for non-GAAP net income on an annualized basis. These numbers are reconciled to GAAP in the tables at the end of our earnings press release. Our non-GAAP net income for the first quarter of fiscal 2010 was a record $13 million or $0.28 per diluted share. This is up 55% from $8.4 million or $0.18 per diluted share in the fourth quarter of fiscal 2009 and is up more than 130% from $5.5 million or $0.12 per diluted share from the first quarter of fiscal 2009.

As of June 30, 2010 AMSC has $120.7 million in cash, cash equivalence, marketable securities and restricted cash. This is compared with $155.1 million as of March 31, 2010. As we experienced two quarters ago, the decline in cash was driven primarily by timing differences and payments from Sinovel. Other significant factors include payments for planned capital expenditures and changes for the dollar value of cash held in foreign currency.

I’d like to point out that the sizable portion of the receivables we have with Sinovel as of June 30 are subsequently collected in July. Also note we will be continuing to expect that we’ll be cash flow positive for the full fiscal year. Our days sales outstanding for the quarter declined from 72 days in the fourth quarter of fiscal 2009 to 71 days for the first fiscal quarter of 2010.

As a remainder, we use average accounts receivable to calculate DSO. Our days of inventory for the first fiscal quarter of 2010 increased to 64 days from 59 days in fourth quarter of fiscal 2009. This was primarily the result of increased copper inventories in anticipation of higher demand for wind turbine electrical components.

Let me turn now to our financial forecast. Based on the strength of our first fiscal quarter and our core markets, we are increasing our revenue and EPS forecasts for the full fiscal year. We are increasing our revenue forecast for full-year fiscal 2010 from the range of $415 million to $425 million to a range of $420 million to $430 million. We are also increasing our net income forecast for the full fiscal year in the range of $37.5 million to $40 million or $0.80 to $0.85 per diluted share to a range of $39.5 million to $42 million or $0.85 to $0.90 per diluted share.

And our non-GAAP net income guidance has been increased from a range of $54 million to $56.5 million or $1.15 to $1.20 per diluted share to a range of $56.5 million to $59 million or $1.20 to $1.25 per diluted share. In terms of the quarters ahead we would expect revenues in the second fiscal quarter to be slightly higher than in our first fiscal quarter with earnings remaining flat quarter-over-quarter due to higher planned operating expenses and a lack of incremental foreign exchange benefits due to hedges recently put in place.

We expect stronger revenue and earnings growth in both our third and fourth fiscal quarters in line with the increased revenue and earnings forecast we have provided today.

With that we’ll open the call to questions. Jennifer, would you please provide the instructions.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions). We’ll take our first question from Carter Shoop with Deutsche Bank.

Carter Shoop – Deutsche Bank

Good morning and congratulations on a good quarter.

Greg Yurek

Thanks Carter.

David Henry

Thank you.

Carter Shoop – Deutsche Bank

As for my first question, can you tell us what the breakdown was for Sinovel in regards to 1.5 megawatt versus 2 megawatt turbines in the quarter?

David Henry

No, we don’t give that breakout, Carter. That’s – never have and that’s a competition sensitive information right now.

Operator

We’ll go next to Jesse Pichel with Jeffries.

Jesse Pichel – Jeffries

Yes, good morning, Jesse Pichel from Jeffries. Congratulations on the strong quarter, gentlemen. In our polling of certain wind developers in Europe and the US, we were surprised to hear that many will be placing orders for Chinese turbines using Chinese bank debt. And can you share with us your view on Chinese turbine ability to capture global share of the market outside of China using bank debt? And have you been involved in any of the conversations there with potential developers, since it was relying on your technology?

Greg Yurek

Yes Jesse. Well, first of all, we have been in discussions over time with, for example Sinovel US sales force, which they had on the grounds here in the US for over a year now actually. They have an office in Houston, opening one in Toronto as well, also one in London. So they’re going for the export market, that’s quite clear. We think they compete on equal quality, actually higher performance on the power curve as well.

So the question is, do they have a bankable wind turbine? And the way I think they overcome that and steps are all ready going in place just to bring along the Chinese bank financing, so by definition they are therefore bankable.

In support of all that, Jesse, you’re going to see here in this calendar year wind turbine is going in the United States from Sinovel 3 megawatt and 1.5 megawatt machines, so that’s underway. And, by the way, let’s not forget Hyundai for the industries. Their focus is on the North American market and they will be shipping turbines to the US, the 1.65 megawatt wind turbines to start.

So, on top of all that, when you speak about Europe, I think we’re all thinking about the offshore market in the North Sea, primarily now around the UK and our customers, our licenses clearly have their sights set on the offshore market with the 3 megawatt, but primarily the 5 megawatt machines, and here I would point you to Sinovel, Hyundai and Dongfong for that matter who are now moving forward with their 5 megawatt machines.

Future, of course, for the offshore, the dominant force we think is going to be the Sea Titan superconductor wind turbines, but more on that later.

Operator

We’ll go next to Theodore O’Neil with Wunderlich SEZ.

Theodore O’Neil – Wunderlich SEZ

Thank you. Greg, when do you plan to have a 10 megawatt superconducting generator for us to see? And how do you plan to address reliability issues created when you add a refrigeration system to the mix?

Greg Yurek

Well, Theodor, we don’t think it’s that difficult at all to scale down from a 36.5 megawatt motor which was fully low tested by the US Navy about 18 months ago to a 10 megawatt size for a wind turbine, the higher torque, but we completely – clearly know how to handle that.

I’ll tell you, the requirements for the refrigeration system are there, but we’ve been through a very tight screen with the US Navy. I’ve been in many a meeting with the US Admirals who’ve asked exactly the same question you have, and over a decade of work has been used on that using the base of cryo-refrigerators that have been in the market for a very long time from a semiconductor processing industry, for example for MRIs 8.9 mean – 8.9 years meantime between failure has been established there over time.

So I think the answer is that’s reliable technology, it’s available, it’ll be used and we don’t see any issue with it whatsoever.

Operator

We’ll go next to Ben Schuman with Pacific Crest.

Ben Schuman – Pacific Crest

Hi, guys. Two-part question on the D-VAR business; first, if you could tell us how much of the 12% non-Sinovel win business came from D-VARs for wind interconnection, that would be great; and then if you could just discuss kind of the trajectory of the D-VAR business by region and by application as you look out this year and beyond?

Greg Yurek

Well, on the first one, I’m not going to give you a detailed breakout on that, but I will say it’s mostly D-VAR for the grid market. And, in fact, this year we planned to be shipping a record number of D-VARs to our customers. And what was the second part of the question, Ben? I guess we lost him. Yes, and just a breakout of the D-VARs by market I believe.

Jason Fredette

Yes, so Ben, this is Jason Fredette. Our D-VAR is always in the grid side of the business, even though if it’s connecting a wind farm to the grid, it’s a grid application. So the remaining 12% of our wind business has all components there and licensing and development types of revenues to other customers.

Greg Yurek

Thank you. Next question.

Operator

We’ll go next to Vishal Shah with Barclays Capital.

Jake Green Black – Barclays Capital

Hi guys, this is Jay Greenblatt for Vishal, congratulations on a nice quarter.

Greg Yurek

Thank you, Jake.

Jake Green Black – Barclays Capital

Just a couple quick questions; looks like on the gross margins, I know you mentioned that 170 basis points on FX. It looks like there was some additional improvement. Could you give a little color on that? And any progress with the solar motor market?

David Henry

Now, on the gross margins, I think that we just continue to execute well. We had – I mentioned superconductors, the operating loss there quarter-on-quarter and that’s because of improved wire manufacturing performance which has a favorable effect on our gross margins. So I will turn over to –

Greg Yurek

Yes, on the solar side, we announced in our last earnings call, a first the order for the solar industry basically a D-VAR solution for a solar power plant here in the United States and we are in a lot of discussions with many solar power plant developers, we’re very enthusiastic about this area, and I think you’ll hear more in terms of orders by the end of this fiscal year for sure.

Operator

We’ll go next to Jim Ricchiuti with Needham and Company.

Jim Ricchiuti – Needham and Company

Thank you and good morning.

Greg Yurek

Good morning, Jim.

Jim Ricchiuti – Needham and Company

Greg, just a question on the superconductor wire side of the business. Can you talk about where you are in terms of gross capacity now and where do you see yourself as you move forward with this next phase of investment for this new process, manufacturing for 100 millimeter? Is this something that will take over the next couple of quarters and a year? Maybe you can give us a sense of the timeline.

Greg Yurek

So, Jim, in the last few calls, we’ve stopped talking about gross capacity and all that sort of thing. Now that we’re entering a commercial market place, this is competition sensitive information. We don’t want to put out that information in the public for our competitors who do listen to these calls by the way.

So I’m not going to be able to answer that question, but I can tell you that, as I said in my remarks that we’re moving forward on plan, tracking the plan, and do expect to be able to meet our customers’ demand. And, as I said, the question that we’re getting now from our customers and potential customers, our partners is, will we have the capacity to meet their demand? Our answer is a solid yes and I think we’re doing all the right things to be able to meet that demand in the years ahead.

Operator

We’ll go next to Stewart Bush with RBC Capital Markets.

Stewart Bush – RBC Capital Markets

Yes, hi, good morning, guys.

Greg Yurek

Good morning.

Stewart Bush – RBC Capital Markets

When you sign a contract with a wind customer to license a design, does that customer pay royalties on units that they ship indefinitely or is it limited to a certain number of units as it is with Hitachi? And to that point, do I understand correctly that a contract value that you announced includes both power electronic sales and royalties embedded together?

Greg Yurek

So, Stewart, I’m not sure what you’re talking about Hitachi, but that aside, we’ve said for years now that indicates where we do have royalties and it’s not every day. So we do development contracts, we do specific development and designs for certain customers and obviously they’re paying for that and there’s no royalty.

But when we do license a design, especially the 1.65 megawatt to a CSR mobile energy and so forth, there is a royalty. And as we’ve again said, every time we put those announcements out, it’s for the first several hundred units maybe 300, 400, 500 wind turbines, they pay a royalty and then that goes away.

In any case, the upfront payment, the upfront license fee and the royalty payments we’ve consistently said that that’s a very small amount of revenue relatively speaking; it’s very nice revenue because it mostly drops to the bottom line. But the real driver for our top and bottom line is the sales of the core components, which obviously have some pretty decent gross margins I would say.

David Henry

The other thing to note, Stewart, is that we separate. Royalties are generally included on the licensing contracts when we have them. Any component contract we entered into, there’s no royalty component to it, it’s just the straight value for the components that we saw.

Operator

We’ll go next to John Hardy with Gleacher and Company.

John Hardy – Gleacher and Company

Yes, thank you for taking my question. Maybe if I could ask Jim's question in a bit of a different way. So, you basically have three big components for HCS [ph] over the next year or two, we have Korean and China grid market, Tres Amigas, and as well as Sea Titan. I was wondering what you thought – what type of volume growth you would expect in maybe '11 and '12 based on those maybe three buckets? And during that ramp phase, what potential impact do you think that that could have on gross margins in '11 and '12?

Greg Yurek

Well, let’s step back. First of all, it’s not just Tres Amigas and the Korean grid, which we think is going to be huge for us obviously and not just Sea Titans for that matter. So we were addressing cable opportunities actively and have them in Europe. China, we’ve talked about state grid and their request for information out on the street. We think they’ll be putting their first order out in the next 12 months for the Chinese grid. So that’s we think it’s going to be obviously huge once that gets going, and we talked in the call here in my remarks about project hydro. So there’s a lot of activity going on not just in the ones you mentioned to start with.

Beyond that, we don’t get into what our projected volumes are and the volumes for market at this stage of the game. But let me point out and I’ll just say the wire side and then I’m going to talk about what’s really going to tie to our top line and bottom line.

On the wire side, it’s roughly 200,000 meters of wire per circuit mile of cable and that’s pretty much the case with DC or AC systems, and that’s I think a conservative number, it should be a bit more actually, and it’s about at least 200,000 meters of wire curve Sea Titan wind generator. So lot of wires gets involved. We’ve talked in the past about 3 million to 4 million meters of wire shipped out the door is our P&L breakeven, I don’t think we’re that many years away from achieving that now, but let me step back.

The answers that I want to give you is that what’s going to drive our top line in the near term is not just the wire sales, but the revenue associated with the projects. We’re running the hydro-project in New York City, we will be supplying the cable system for Tres Amigas. So those project revenues are going to drive our top line and bottom line in addition to of course making money on the wire sales going forward.

Operator

We’ll go next to Timothy Arcuri with Citi.

Seth – Citi

Hi guys, it’s Seth. Can you just talk about a little bit more color, hopefully, I guess, on what your outlook is for gross margins?

David Henry

Yes. Seth, on the gross margin, we fully kind of stopped giving guidance on gross margin. We talked about it in our last call, but it was competition sensitive, sensitive information, so we preferred to not talk about gross margin guidance going forward. But, that being said, we've also talked about in the past opportunities to improve gross margins.

We instituted cost reduction plans last year that we're still realizing the benefits from. So when you look at our gross margins on a year-over-year basis, you're seeing some of the effects of that and there's future gross margin opportunities that we think that are available to us to improve them going forward, and of course we'll look to pursue those. But we're shying away from right now giving any outlook on future gross margin.

Operator

We’ll go next to Ben Kallo with Baird.

Ben Kallo – Baird

Hi, good morning, thanks for taking my question. I have two questions. And following on to that gross margin conversation, can you give us any kind of directional outlook for the wind business? As Sinovel becomes more of a larger portion of your revenue and the orders get bigger and you sign on different types of turbines with them, how should we think about margins going directionally there? Is there any pressure on pricing there? And then secondly, in the past you've given a percentage of your revenue guidance in backlog, could you update us on that?

Greg Yurek

So, we really have not seen the pricing pressure that you might be thinking about or might guess about in these orders with Sinovel or others. And I think the reason for that is that we are providing a highly proprietary, highly differentiated set of product, the core components, the control systems for these wind turbines. So – but having done that, and don’t anticipate that’ll be there.

Obviously, as Dave said, we always prepare for that sort of thing by taking the cost out and we have an additional efforts and opportunities to remove more cost this year and going forward, we’re doing that. Since we go along with the PM-3100, I think that’s going to give us more opportunity there. So we think we’re in great shape in terms of our margins going forward. And, I guess I forgot, what was the rest of the question?

How we change with bigger sizes?

David Henry

I mean there was really not a significant difference in gross margin, if that was your question. There is not a significant difference in gross margin between say a 1.5 megawatt set of core components to say 3 megawatts set of core components, it doesn’t look a deal.

Greg Yurek

Next question.

Operator

We’ll go next to JinMing Liu with Ardour Capital.

JinMing Liu – Ardour Capital

Good morning, nice quarter.

Greg Yurek

Thank you.

JinMing Liu – Ardour Capital

In China, I noticed there are potentially two senders are regulating the connection between wind farms and the grid will come out in the very near future. Can you comment what impact that will have on your business? And also, David, can you give us any color on the dollar amount on the receivable collected from Sinovel in July?

Greg Yurek

So, I’ll take the first part of that. Your question was about great interconnection of wind farms in China. So for at least four years now, we have been in China speaking to State Grid which runs 88% of the power grid in China and Southern China as well, China [inaudible] as well, China Wind Energy Association and all of those discussions have been focused on, that they are going to need to take care of dynamic voltage control for the interconnection of wind farms to the grid in China as wind becomes a larger fraction of the total power generator.

I think we started to get some really nice traction in the last year. We have three sites in China now, where our D-VAR is providing the grid interconnection, the Chinese customers, the grid operators are very happy with it. So I think we’re just getting started there. Through that entire process, you may now that part of our sales process is that these are transmission planning engineers, we call it our network solutions team, to provide the reasons and the ways you protect a grid from the wind farms and how the wind farms can be protected from the grid. You don’t set a [inaudible] on the grid.

We’ve taken that team over to China. They’ve been in extensive meetings and providing seminars and so forth. So we think we’re actually helping to set the grid interconnection standards in China. So with those reference sites in place and influencing the grid interconnection standards, we see a very good future for D-VAR grid interconnection solutions going forward. And, by the way, not just for wind, but China is also doing large scale solar power plants, and we think we have our foot in the doors quite forwardly on that end.

Dave, you want to comment on the receivables?

David Henry

Yes, on the receivables, we’ve received a payment from Sinovel as I mentioned, roughly around the first week of July. But when you back out the BAT, which we just basically turn around in and remit to the government, net of $20 million we received.

Operator

We’ll go next to Jeremy Hellman with Divine Capital Markets.

Jeremy Hellman – Divine Capital Markets

Hi, good morning, everybody.

Greg Yurek

Good morning.

Jeremy Hellman – Divine Capital Markets

I just wanted to speak more broadly, given the shifting winds here in the US, Kerry-Lieberman bill is off the table, draft of bill from Senator Reed is out there. What broadly and also backing that up, was some commentary out of AWEA earlier this week that of course is going to cast things in more of a direr light as they try and advocate for a renewable energy standard here in the US. But when you speak to Sinovel and HHI or any of your other customers, what is your sense of their outlook for the US market?

Greg Yurek

Well, as I mentioned in my remarks, the US market is in a temporary slowdown. The forecast for this year, at least 40% lower, installations in last year, that looks to be the case. So everybody seems to be on board with that kind of forecast. Having said that, we’re starting to see some traction in terms of wind farm developers moving forward. And the industry expects, not just us that it’s going to pick up in 2011 and 2012 and beyond. Ultimately, we see and I think the industry sees a very healthy, very strong market in the US and our licensees with Sinovel and Hyundai, they’ll sure look at this and say, “Gee, that’s great, it’s slowing down, that gives us time to get our turbines fully qualified, you know, 60 hertz application here in the United States and so forth, get our financing lined, whatever it takes. Get our first reference sites here in the United States in 2010 and 2011.”

So I think our licensees are going to take full advantage of this slowdown to be ready to go when the market starts picking up here again in the year. So we can fully look for whether there is something in the new energy bill or not, I think you can absolutely count on there being an extension of a production tax credits for wind farms on a going forward basis, there is actually absolutely no stoppage of that whatsoever.

Look at the Wall Street Journal this morning and the reports on affirmation of the global warming, I think that’s going to resonate in Washington. And again, don’t look for an energy bill; I think that’s probably gone by the wayside. But look for a continuation of production tax credits in the future for sure.

David Henry

Just to add on top of that, in Sinovel, [inaudible] talked about a substantially increasing their production capacity this year. And, just to be clear, that’s really not dependent upon anything going on with the US market. That’s really for internal consumption in China. So Sinovel is preparing, in terms of their capacity for meeting the demands that they see into their backlog and the growth of the China market is typical.

Greg Yurek

Yes, let me add, there was an earlier question I think as well on that remark that Sinovel is about a 25% market share in China as of now and we all see that growing. So basically growth I mentioned in our remarks, Sinovel publicly talking about doubling its output this year, that should get them up around 7 gigawatts. And so, as the China market for wind continues to grow strongly, look for Sinovel and I think our other Chinese licensees to contribute – take more market share. So, right now, we’re in more than 25% of the wind turbines in China. On a going forward basis, we see that going up to the 50% plus range.

Operator

We’ll go next to Pavel Molchanov with Raymond James.

Pavel Molchanov – Raymond James

Thank you for taking my question. You said before that you're targeting signing up a US wind licensee. And given your comments about the comparatively slower opportunities in the US market, how does that play into that strategy?

Greg Yurek

Well, first of all, let me affirm that we expect to have our first US licensee, our wind licensee within the next – what is it, probably now 16, 17 months and pre-first that 24 months last November. So we are very much on track to accomplish our objective.

And, once again, just like our foreign licensees, the US – potential US licensees are saying, “Look at the slowdown, that fuels up the chance to get into the market, get our production setup, and be ready to participate in the strong growth that we all see in the US market.” So – but we expect to have that licensee and more forward and smartly lift them.

Operator

We’ll go next to Carter Shoop with Deutsche Bank.

Carter Shoop – Deutsche Bank

Hi. As a follow-up question, can you elaborate on your outlook for the superconductors business through the remainder of the year? Do you expect the loss per quarter to remain consistent with current levels?

Greg Yurek

Yes, we said that consistently that should be about the same quarter-over-quarter for this year.

David Henry

On a full-year basis, we would expect superconductor’s operating loss to be roughly in line with the amounts that you saw last year.

Greg Yurek

And that’s consistent with what we said early. And, obviously, we’re in that investment and scale up mode right now, so I don’t think that’s a surprise.

Operator

We’ll go next to Carter Driscoll with Capstone.

Carter Driscoll – Capstone

Hi, good morning, gentlemen. First question, just on the CapEx side, I think you said last quarter targeting roughly $40 million to $50 million for expenditures. Has that allocation shifted between plant expenditures or some of your planned projects, maybe on the ERP? Has anything changed meaningfully, gone up or down?

Greg Yurek

No that really hasn't changed. We're still expecting around $40 million to $50 million in CapEx. And we're talking about the superconductors’ investment in this call, because we see things and we'd like you to understand the reasons for the investment. But that being said, that doesn't mean the magnitude of the investment has changed any. It's still – so a component of that $40 million to $50 million it's not the majority of it, but it's a sizable component of it.

We talked about other investments we're making. The ERP system you mentioned, we're going to be putting up wind turbines both in the US and in Europe to be able to test and qualify the next generation components. So, those plans have not changed. And as we said before and we continue to expect, the capital that we're seeing this year, we expect it to be substantially lower in fiscal ‘11.

David Henry

And I think it’s worth repeating that that $40 million to $50 million is going to come from cash we generate from our operation. And at the end of the year, we expect to be net cash flow positive.

Operator

We’ll go next to Timothy Arcuri with Citi.

Timothy Arcuri – Citi

Can you guys comment on your outlook? I mean, there's supposed to be a number of customers coming on line and going into production this year. Can you possibly give any status generally as to whether those timelines are still consistent with previous expectations?

Greg Yurek

Yes, we are. So no changes really on that going through. Everything’s on track.

Operator

We’ll take our final question from Ben Kallo with Baird.

Ben Kallo – Baird

Guys, in the past you've given a percentage of your revenue guidance that 's all ready in backlog. Could you update us on that?

Greg Yurek

Yes, we typically give that at the beginning of the year and we don’t typically update that on a quarter-to-quarter basis. But we do have felt that we still need to get further – in terms of orders that we need to get in China for the rest of this year, but we wouldn’t have updated our revenue guidance today if we didn’t feel pretty confident about getting those orders, booking them, and being able to ship them.

Operator

And, at this time, there are no further questions. I’ll turn the call back to Mr. Greg Yurek.

Greg Yurek

Thanks for listening in today and for your great questions and we look forward to talking with you on the next quarterly call. Bye.

Operator

This does conclude today’s conference call. We thank you for your participation.

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Source: American Superconductor Corporation F1Q10 (Qtr. End 06/30/2010) Earnings Call Transcript
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