American Superconductor Corporation (NASDAQ:AMSC)
F2Q2010 (Qtr 09/30/10) Earnings Conference Call
November 2, 2010 10:00 AM ET
Jason Fredette – Director, Corporate Communications
Greg Yurek – Founder, Chairman and CEO
David Henry – SVP, CFO and Treasurer
Daniel Patrick McGahn – President and COO
Colin Rusch – ThinkEquity
Jesse Pichel – Piper Jaffray Companies
Paul Clegg – Mizuho Securities USA, Inc.
Carter Shoop – Deutsche Bank
Carter Driscoll – Capstone Investments
Vishal Shah – Barclays Capital
Theodore O’Neill with Wunderlich Securities
Ben Schuman – Pacific Crest Securities
Jim Ricchiuti – Needham and Company
Stewart Bush – RBC Capital Markets
John Hardy – Gleacher and Company
Good day, everyone, and welcome American Superconductor’s Second Quarter Conference Call.
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.
Thanks, Natasha, 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 the 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.
Finally, I would like to mention that we’ll be taking part in the Citigroup Small and Mid-Cap Conference in Las Vegas and the Jefferies & Company to Clean Tech Conference in London, both of these events will take place on November the 16th, and the Jefferies event will be webcast, more details on that webcast will be available next week.
With that, let me now turn the call over to CEO, Greg.
Thanks, Jason, and good morning to all of you, who have joined us on today’s call. Before I begin my comments, I’d like to note that Dan McGahn, who was promoted to the position of President and Chief Operating Officer in December 2009, is with us on the call today.
Dan has done a terrific job in his new position over the last 10 months. In the question and answer period later in this call, I may call on Dan in order for you to get his perspective regarding certain questions.
Now, let me review some of our key results and provide some insights regarding our future directions and forecast. In the past few months, the past few months have been particularly eventful period for our company. Most importantly, the second quarter, we celebrated the coming of age for Superconductors by booking the world’s largest high temperature superconductor wire order.
I’ll discuss this seminal event and other key highlights in more detail in just a moment. But first, here are the high points on the financial results.
The industry continued at solid performance in the second fiscal quarter, achieving its 15th consecutive quarter of revenue growth while also generating record earnings. We are the only power technology company in the U.S. market to have grown revenues for 15 consecutive quarters, right through the great recession.
We are one of only three industrial companies worldwide to achieve this level of performance. In the category of, what have you done for me lately? We are positioned to continue revenue and earnings growth for years to come based on our strategy of first focusing on and energy and power grid market, and second focusing on doing business in the growth economies of China and Asia Pacific region.
In our fiscal second quarter, we achieved a record cross margin of 40.7% and an operating margin of 16%. We still have room for growth in both metrics indeed, as our superconductor business reduces its losses and becomes profitable over the next few years. We expect we will achieve operating margins well in excess of 20%.
In the second fiscal quarter, we also increased our total backlog quarter over quarter to a new record level of $956 million. This backlog provides us with great visibility into what we expect will be a strong second half of fiscal 2010 as well as providing a solid base for continued growth in fiscal 2011.
We are raising our financial forecast again for the fiscal year now expect to grow revenues in excess of 36% year-over-year while increasing non-GAAP net income by more than 86% year-over-year.
Our wind powers segment continues to be the primary driver of this strong growth today. However, our second fiscal quarter officially marked the coming of the age of superconductors and the start of our third wave of growth. The timing couldn’t be better. Over taxed power grids around the world are being charged like never before.
Here in the U.S., the requirements for a modern intelligent grid to meet the needs of our – far more in renewable energy and to enable widespread adoption of plug-in electric vehicles is becoming critically important, simply as a practical matter.
In China, the country’s booming economy has spawned booming power demands and although they don’t have the power grid needed to meet this growing demand, the Chinese are actually taking action to build out a very modern grid. Superconductors are part of the solution.
In India, where we already have our foot in the door through our wind business, power outages occurred during the everyday in major cities because of their incredibly weak grid providing tremendous growth opportunities for our company.
And in Korea, a highly coordinated smart grid roll out plan is underway and we are right in the middle of it. Meanwhile countries around the world continue to promote renewable energy and more specifically offshore wind power as means to increase energy independence and reduce pollution. Superconductors can and will play pivotal role in making all these challenges, and AMSC will continue to lead the charge.
American Superconductor is the world’s leading producer of high temperature superconductor or HTS wire. In early October, we introduced a new brand name for this wire, Imperium. The name Imperium reflects these products ability to conduct more than 100 times electric current or amperage of the copper wire of the same dimensions. In fact, transmission voltages, a single Imperium wire can carry enough electricity to power more than 10,000 U.S. homes making Imperium truly be optical fiber power.
During the second quarter, Korea’s LS Cable, the world’s third-largest cable manufacturer placed an order with us for 3 million meters of Imperium wire. In U.S. terms, that’s nearly 10 million feet of wire. They plan to utilize this wire for A.C. and D.C. superconductor power cable systems for the Korean and global marketplaces.
Shipments of Imperium wire to LS Cable are scheduled to begin in 2012 to meet initial demand for Korea’s smart grid infrastructure build out. But this is just the tip of the iceberg in terms of what we see as the business potential here.
Earlier this year, we formed a strategic alliance with LS Cable to work together to commercialize at least 50 circuit kilometers of superconductor cable systems by the end of 2015. An additional 3 million meters of Imperium wire at a minimum would be required to meet this initial objective.
Beyond Korea, there are many superconductor power cable opportunities we have been focused on. In fact, we are interacting today with customers on well over a dozen superconductor cable projects in North America, Europe and Asian. So these projects are involved in ranges from managing an entire project which will produce the greatest amount of revenue and gross profit dollars to being a wire supplier only, which involves less revenue that would generate a higher risk margin.
Today, we have about $80 million in total superconductors’ backlog. On top of that, the additional pipeline of projects we are engaged in amounts to more than 300 million of revenue just for our whole scope of supply. We expect this pipeline of projects and wire orders to drive the continued need for expansion of our Imperium wire manufacturing operations and to reduce the losses in our superconductor business over the next few years.
In addition to this pipeline business for power grid applications, we expect our Sea Titan and wind turbine, the next-generation offshore wind turbine platform will also lead to substantial growth for our superconductors business. The Sea Titan incorporates our Imperium wire in the generator to effectively double the power rating of today’s largest commercial wind turbine with 10 megawatts or more, just what the market is demanding to reduce wind farm project cost and accelerate returns on investment, especially for offshore wind.
Sea Titan continues to garner more and more attention around the world. In fact, Sea Titan and Superconductor wind turbine generators were among the hottest topics at the China Wind 2010 Trade Show in Beijing, a few weeks ago.
Given China’s huge potential offshore wind market, we expect China to be one of the primary opportunities for Sea Titan Superconductor wind turbines. We are continuing discussions with potential Sea Titan and generate our licensees and aim to have our first licensee on board over the next several months.
Now, let’s take a look at the broader wind market we are addressing today. AMSC’s success the past few years has been highly linked to China’s wind power market, which continues to grow robustly. China installed over 13 gigawatts of wind power in 2009 raising total installations in the country to over 25 gigawatts.
In 2010, we are expecting at least another 16 gigawatts to be installed bringing the total installations to more than 14 gigawatts. This expectation was recently confirmed by the World Wind Energy Association. This group reported that nearly 8 gigawatts of wind power was installed in China during the first six months of 2010, which will exceed the total amount of wind power installed in the US for all of 2010.
As of June 30th, 2010, the World Wind Energy Association estimates that the U.S. lead the world with a total install base of 36.3 gigawatts of wind power, while China was coming on strong with an install base of 33.8 gigawatts by June 30th. As a result, China is likely to surpass the U.S. as the world’s largest wind power market this year.
Looking further out, industry analysts generally expect that China will achieve a total install base of 200 gigawatts or more of wind power by 2020. And some estimates have it as high as 300 gigawatts.
With five Chinese wind turbine manufacturers as AMSC customers, we are benefiting in a substantial way from this growth and expect to continue to benefit for many years to come. One important reason for this is our close relationship with Sinovel. Sinovel, of course, is AMSC’s largest customer. China’s wind turbine manufacturer and the third-largest wind turbine manufacturer in the world based on 2009 data.
A host of new information was issued by Sinovel when it filed for its IPO on the Shanghai Exchange in late October. For example, Sinovel’s draft perspective said that they have 10 gigawatts of backlog in place as of June 30th, 2010 and that they aim to produce 10 gigawatts of wind power annually within the next five years.
Over this past summer, Sinovel’s 3-megawatt wind turbines, which were designed by AMSC Windtec began powering China’s first offshore wind farm located near Shanghai. Since then, Sinovel has won 60% of a new 1 gigawatt offshore wind farm tender in China. These wind farms will utilize Sinovel’s 3-megawatt wind turbines and will increase Sinovel’s total installed base of offshore wind power to nearly a gigawatt.
As a reminder, the world’s total installed base of offshore wind power at the end of 2009 was only 2 gigawatts. We, of course, will continue to do everything we can to support Sinovel in its mission to be number one globally.
Through June 30th, 2010, we have helped Sinovel successfully scale production of 1.5 megawatt and 3-megawatt wind turbines that utilize doubly-fed induction drive trans, and we have already long-term contracts in place with Sinovel for the supply of core electrical components and control systems for those wind turbines. More orders for 3-megawatt wind turbine core electrical components and control systems are expected from Sinovel in the next six to 12 months.
In addition, at the China Wind show a couple of weeks ago, Sinovel announced that it has successfully completed the assembly and factory test that’s first doubly-fed induction, 5-megawatt wind turbine and will be erecting its first prototype later this year. Sinovel’s 5-megawatt turbine was, of course, designed by and co-developed with AMSC. So, we also expect a first volume order for 5-megawatt core electrical components over the next six to 12 months.
And the future growth of the Sinovel-AMSC juggernaut doesn’t stop there by any means. A few months ago, we disclosed that we are working with Sinovel on a whole new range of multi-megawatt wind turbines that incorporated different drive train. At that time, Sinovel had asked that we refrain from describing the details of these wind turbines for competitive reasons.
However, in Sinovel’s draft prospectus, more information was revealed. The 1.5-megawatt, 3-megawatt and 5-megawatt wind turbines that Sinovel has produced does for all incorporate doubly-fed induction drive trans, which today are the predominant wind turbine platform in China and around the world. In order to effectively serve the global market however, Sinovel plans to offer an array of both drive trans and power ratings.
To help Sinovel achieve these objectives, we are now working with them to develop a double wind turbine with an even higher power rating of 6 megawatts, which Sinovel sees as a way to further differentiate itself in the all-important Chinese wind market. in addition, we are now developing for Sinovel 2, 3, 5, and 6-megawatt systems that incorporate state of the art full conversion drive trans. Geared full conversion drive trans are typically more efficient, more readily compliant with global grid connection standards and often have a lower cost of energy depending on site conditions and wind speed than doubly-fed induction drive trans.
Sinovel sees the addition of turbines with full conversion drive trans as a way to further differentiate itself in the Chinese market as well as enable and get to provide additional highly competitive products to the western wind market. As many of you know, we have always been Sinovel’s preferred supplier of core electrical components and control systems.
For all of the new full conversion wind turbine platforms, however, AMSC is the exclusive supplier of core electrical components and control systems. So, we expect to continue to grow our sales to Sinovel for years to come.
Beyond Sinovel, we are seeing more revenue streams come online as newer wind turbine licensees begin to ramp production. This list now includes India’s Inox Wind. During the second fiscal quarter, Inox ordered an initial 17 full electrical control systems from AMSC for its first doubly-fed induction 2-megawatt wind turbines. Under our license agreement, Inox had us the right to manufacture and sell these wind turbines globally and they already have started volume production.
Hyundai Heavy Industries in Korea is another partner from whom we expect to see substantial growth going forward. In fact today, it was announced that Korea is investing approximately $10 billion in a 2.5-gigawatt offshore wind farm. We believe Hyundai is well-positioned to be one of the wind turbine producers for this massive wind farm in Korea.
You can expect to see new orders from Inox, Hyundai and other AMSC Windtec licensees in the quarters ahead, which will continue to help diversify our revenue streams.
Now, let me turn to our continuous and relentless focus on innovation across all of our product lines, which is essential to our strategy to continue growing our wind and grew [ph] businesses. Our objective is to provide our customers with highly optimized, highly differentiated wind turbines in order for them to become every man market leaders.
Technological innovations are achieved at AMSC on a daily basis, of course, by our company wide team of highly talented engineers. However, we often also tap into and collaborate with other companies who have complementary technologies and products. Blade Dynamics is a great example of this.
Blade Dynamics is a U.K. based designer and manufacturer of advanced wind turbine blades. Using proprietary materials and structural technologies, this company has developed blades that can increase the efficiency and performance of multi-megawatt wind turbines while also reducing cost. In August, AMSC and Dow Chemical Company both took a minority stake in Blade Dynamics.
In conjunction with these investments, the state of Louisiana provided Blade Dynamics provided Blade Dynamics with an incentive package worth up to $30 million. Utilizing this funding, Blade Dynamics recently opened a new production facility near New Orleans. Blade Dynamics will completely set this factory out in early 2011 and it will produce and qualify this factory’s first production blades later in 2011.
The company plans to begin volume production of its wind turbine blades in 2011. AMSC Windtec turbine licensees will have first access to these proprietary competitively differentiated blades, which we believe will give them a clear market advantage. We also believe that Blade Dynamics can provide blades and hubs suitable for our Sea Titan wind turbine. Blade Dynamics is just one part of a holistic effort we have underway AMSC to continue enhancing our wind turbines from the ground, while the sub-sea floors, the case maybe all the way through the blades.
The reason we are making investments like this is simple. By further optimizing and differentiating our customers’ turbines, we’ll be helping them capture greater market share and in turn we’ll be receiving more orders for AMSC’s power electronics and control systems.
We’re also expanding our capabilities on the grid side of our business. Over the past decade our D-VAR solution has emerged as the defacto standard for grid interconnection of megawatt scale renewable power. The system is helping more than 70 wind turbines around the world connect the grid and we recently landed our first D-VAR order for a utility scale solar photovoltaic of PV power plant.
We believe many more contracts like this will be coming thanks to our recently SolarTie grid interconnection solution. The SolarTie solution combines two of our proven proprietary technologies, our power module power converters and our D-VAR solutions into one package. In other words, these products inverts the direct parameter D.C. power that you get from solar panels into the alternate current or A.C. power required by the grid.
And then also provides reactive compensation and dynamic voltage control in order for solar PV power plants to meet grid interconnection standards. The end result is what we believe is the industry’s first fully optimize solution for grid interconnection of utility scale PV power plants.
We are now pursuing our initial SolarTie sales and expect our first revenues from this product within the next 12 months. Industry analysts expect the market for utility scale solar inverters and grid interconnection solutions alone, which see $2 billion by 2015. We expect to get more than our fair share of this market with SolarTie of solutions.
So, in summary, we are quite pleased with our financial results for the second fiscal quarter and we see further growth through the remainder of fiscal 2010 and beyond. We’re also broadening our capabilities, our product lines and addressable markets to insure AMSC’s strong track record of profitable growth which stands for many years to come and with that, let me turn the call onto Dave for our financial review. Dave?
Thanks Greg, and good morning everyone. As you’ve all heard, AMSC delivered its strongest financial performance to date in the second fiscal quarter.
We generated a 36% year-over-year increase in revenues and achieved our 15th consecutive quarter of sequential revenue growth. We also maintained solid growth and operating margins, which helped us grow our earnings to a new record level. AMSC generated $101.5 million in revenues for the second quarter of fiscal year 2010. This is up approximately 4% from $97.2 million for the first quarter of fiscal 2010 and 36% from $74.7 million for the second quarter of fiscal 2009.
Shipments of our wind turbine power electronic control systems and components to customers in the Asia Pacific region accounted for the majority of this growth. We expect this market to continue to be very strong for us through the remainder of this year, next year and beyond.
Sales to Sinovel represented 79% of total revenues in the second fiscal quarter with winds representing 91% of total revenues. Geographically, we generated 94% of our revenues outside of the U.S., so we certainly do not depend on the U.S. and European wind markets, which have been challenging for other companies in 2010. We do believe, however, that we can look forward to significant additional growth on our business when the U.S. and European wind markets get back on track as discussed by Greg earlier.
Gross profit for the second quarter of fiscal 2010 was $41.3 million and our gross margin was a record 40.7%. This compares with a gross margin for the first quarter of fiscal 2010 of 40.1 % and a gross margin for the second quarter of fiscal 2009 of 38.9%. The sequential improvement in gross margin was primarily the result of a favorable product mix.
As we have highlighted in the past, unlike many companies in the renewable energy industry, AMSC generates a majority of its revenues in renminbi, while cost associated with those revenues are split fairly evenly between the renminbi and the euro. So, a strengthening of the renminbi in relation to the euro and the dollar has a beneficial effect on our gross margin and profitability.
We have hedges in place to provide a more predictable U.S. dollar value for a substantial portion of our euro denominated cost for our wind core component sales. Approximately 67% of our estimated third euro cost exposure is hedged at a rate of approximately $1.27 per euro.
Net of hedging activity gross margin in the second quarter was favorably impacted by foreign exchange by approximately 10 basis points or approximately 1/6 of the gross margin improvement compared to first quarter.
R&D expenses for the second quarter were $7.9 million or 8% of revenue. This is an increase $7.3 million or 8% of revenue from the prior quarter and from $5.4 million or 7% of revenue for the second quarter of 2009. We plan to continue increasing R&D expenses as we bring new products to markets such us our Sea Titan superconductor wind turbine, SolarTie grid interconnection solution and PM-3100 W wind turbine power converter system.
The same can be said for SG&A expense. SG&A for the second fiscal quarter were $17.1 million or 17% of total revenue. This compares to SG&A spending of $15.2 million or 16% of total revenue for the prior quarter and $12.7 million or 17% of revenue for the second quarter of fiscal 2009. The sequential and year-over-year increases were driven primarily by headcount and payroll increases in support of our continued growth.
While we have grown our headcount in the past 12 months to support our growth, we have also continued to increase earnings. In fact, our net income per employee for the past 12 months is approximately $36,000, which is better than nearly all of our peers including GE, Siemens, ABB, Sun Power and Itron. So, while we continue to expand our horizons, we are also doing so with a sharp eye on the bottom line.
For fiscal year 2010, we continue to expect that operating expenses will increase in total, but will decrease slightly as a percentage of revenue compared to the prior year.
AMSC’s operating income for the second quarter of fiscal 2010 was $15.9 million and our operating margin was a record 16%. This compares with an operating margin of 17% in the first quarter of fiscal 2010 and a 14% operating margin for the year-ago quarter. The slight sequential decrease in operating margin was due to planned operating expense growth in the quarter.
In the longer term, as already mentioned by Greg, we expect our consolidated operating margin to be well in excess of 20%. This will be achieved as we reduce our losses in superconductors and as we achieve greater operating leverage going forward.
We reported other income of $2.4 million in the second quarter of fiscal 2010 compared to other income of $200,000 in the first quarter of fiscal 2010 and other expense of $900,000 for the second quarter of fiscal 2009. The sequential increase in other income was driven by net gains from balance sheet hedging activities in our Austria subsidiary and a balance sheet revaluation gain on our China books resulting from the recent strengthening of the renminbi versus the U.S. dollar.
We’ve structured our business in China to enable us to deliver higher earnings as the renminbi strengthens, which is consistent with the consensus opinion of those who forecast exchange rate movements.
Our income tax expense for the second quarter of fiscal 2010 was $8.6 million resulting in effective tax rate of 46%. This is up from 44% in the first quarter of fiscal 2010, but down from 55% for the second quarter of fiscal 2009. The increase in our effective tax rate quarter-over-quarter is primarily the result of increased losses in the U.S. or we do not report a tax benefit on losses. In general, we would expect our tax rate to decline in future quarters as we increase our foreign profits and keep U.S. losses relatively flat.
For the second quarter of fiscal 2010, AMSC reported GAAP net income of $10 million or $0.22 per diluted share. This is up from 9% – this is up 9% from $9.2 million of $0.20 per diluted share for the first quarter and is an increase of over 130% from $4.3 million or $0.10 per diluted share for the second quarter of fiscal 2009. We use non-GAAP net income, which approximates cash based earnings from operations to track our financial progress and we report this metrics each. We 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 $14.6 million or $0.32 per diluted share. This is up 13% from $13 million or $0.28 per diluted share for the first quarter of fiscal 2010 and is up 68% from $8.7 million or $0.19 per diluted share for the second quarter of fiscal 2009.
Looking for a moment at our business units, AMSC Power Systems contributed revenue of $98.5 million or 97% of our second quarter revenues. This is a 37% increase from $71.8 million in the year ago quarter. AMSC Power Systems generated operating income of 26.8 million and an operating margin of 27% for the second quarter. This compares with a 28% operating margin in the second quarter of fiscal 2009.
Our AMSC Superconductor segment contributed $3 million or 3% of revenues. AMSC Superconductors generated $2.9 million in revenues for the second quarter of fiscal 2009. The operating loss in superconductor for the second fiscal quarter was $6.5 million. This compares with an operating loss of $5.6 million for the second quarter of fiscal 2009. The increase operating loss is primarily the result of higher HTS wire development costs.
As a reminder stock-based compensation expenses is not allocated to our reporting segments. As of September 30th, 2010, AMSC had $131.2 million in cash, cash equivalence, marketable securities and restricted cash. This compares with $120.7 million as of June 30th, 2010 and $155.1 million as of March 31st, 2010. Our cash balance as of September 30th was reduced by $8 million in cash that we spent during the second fiscal quarter, the purchase of minority interest in Blade Dynamics.
Our day sales outstanding for the quarter increased to 84 days in the second fiscal quarter from 71 days in the first fiscal quarter of 2010. As a reminder, we use average accounts receivable to calculate DSO. The payments we received from Sinovel increased in the second quarter compared to the second quarter, however, billing increased as well resulting in higher receivables compared to second quarter.
Our days of inventory for the second quarter of 2010 increased to 69 days from 64 days in Q1 of fiscal 2010. This was primarily the result of inventory growth to support third quarter shipments.
Moving on to our financial forecast. Based on the orders we received in the second quarter, strong visibility into our business pipeline and favorable foreign exchange tailwinds from the recent strengthening of the renminbi, we our increasing our fiscal 2010 financial forecast for both revenues and earnings.
Our revenue forecast for the full-year fiscal has increased from a range of $420 million to $430 million to a range of $430 million to $440 million representing growth in excess of 36% compared with fiscal 2009. We have 99% of the orders needed to reach the low end of this guidance range either ship or on backlog as of September 30th.
As a result of increased revenue guidance, our net forecast for the full fiscal year has increased from a range of $39.5 million to $42 million or $0.85 to $0.90 per diluted share to a range of $44 million to $46.5 million or $0.95 to $1 per diluted share.
And our non-GAAP net income guidance has increased from a range of $56 million to $58.5 million or $1.20 to $1.25 per diluted share to a range of $60.5 million to $63 million or $1.30 to $1.35 per diluted share. We continue to expect that CapEx will be in the range of $40 to 50 million for the full fiscal year.
Looking forward to the second half of the fiscal year, we expect continued sequential revenue growth. With revenues up modestly in the third quarter and stronger growth for the fourth quarter, and we expect growth to continue in our next fiscal year because of our focus on the Chinese and broader Asia Pacific wind energy and power grid markets.
With that, we will be happy to take your questions. Natasha, would you please provide the instructions.
Certainly. (Operator Instructions) We’ll take our first question from Colin Rusch with ThinkEquity. Please, go ahead.
Colin Rusch – ThinkEquity
Thanks so much. Congratulations, guys.
Colin Rusch – ThinkEquity
Can you give us some additional detail on the dozen or so HTS projects you’re working on and what stages or development you’re at, how many of those are in pilots, how many of those are kind of in conversation stage and how many are in full [inaudible] mode.
It’s a variety of stages. Some are well-advanced because we’ve been working on those in the U.S., for example, before the great recession hit. And so, we have made a lot of progress and we thought we were in fact going to wrap up those projects in order in the last year or two. The recession slowed that all down, but those are in advance stage.
One of those includes Project Hydra for the deployment of fault locker cables in the grid in New York, which was delayed because of the recession. But as I think we said in the last call, we and Con Ed and Department of Homeland Security have identified the new site and we’re seeking financing and we’re optimistic about that.
We expect that the State Grid in China is going to put out a request for bid for wire and cable systems in the next three to four months, somewhere in that timeframe. That’s been under development by State Grid for a good year now, so that’s coming to a – it will be a positive conclusion for our company in the relatively near future.
There are some that have been worked in Europe for quite a long time now. So, sites have been defined. The site walk downs have occurred and so forth. So, it’s a pipeline of $300 million in revenue for just our scope of supply. We expect that some of this will start hitting over the next year and beyond and start reducing our losses and superconductors.
Colin Rusch – ThinkEquity
Perfect. And then two questions on the solar business, can you just give us initial calculations [ph] for sales on the solar business and calendar 2011 and by geography. And then, if you could talk a little bit about the functionality of integrating your product with the communication systems for grid operators, if you’ve got anything really concretely in place there in terms of transferring information on performance of those systems back to grid operators, right now. Just kind of how you expect that road, the technology roadmap to play out over the next couple of years.
Well, Colin, I’m going to be nice to you here because you broke the rules. You asked the second question and a third one. But SolarTie is a product that we said I think in our call earlier; we expect to get our first order in about a year. We certainly expect to see revenue in about a year. Let’s say from SolarTie, we already have our first D-VAR that we announced back in May for a solar scale form here in the U.S.
Now, all of that is based on our debar solution that we use for grid interconnection of wind farms. So, we have of highly differentiated product from those who just sell plain old-fashioned inverters. Inverters to take D.C. turn them to A.C. What’s missing in the equation there for these large scale utility scale that is PV plat is the reactive compensation and voltage control needed both on the grid side and on the solar farm side, we provide that through our D-VAR capability.
And in terms of communications, everything we put in a wind farm today is having all of the wind turbines communicating with each other, our SCADA systems that we included in all of these systems, all of that experience base will be brought to bear in the solar farms. So, I hope that helps on your question. We’ll go to the next one.
(Operator Instructions) Jesse Pichel with Jaffray’s. Please, go ahead.
Jesse Pichel – Piper Jaffray Companies
Good morning, Mr. Yurek. Congratulations there on a strong quarter and multiple successes. I don’t know if I can limit myself to one, you have a lot going on.
Well, Mr. Pichel, pick a winner Mr. Pichel.
Jesse Pichel – Piper Jaffray Companies
Has Sinovel booked this 3-megawatt order for the 1-gigawatt offshore program because the May press release seems to cover just the 1.5s. And can we expect that the western traditional turbine makers may either license Sea Titan or at least buy the Imperium wire? And I do have a follow-up?
Well, let me take the first part of this and then I’ll ask Dan to take the second part on Sea Titan. Dan McGahn that is.
So, yes, Sinovel just won 60% of the 1-gigawatt tender that offshore wind farm tender that was occurred in China. 60% and 600 megawatts, all of that’s going to be the 3-megawatt wind turbines that they’ve already deployed offshore in Shanghai. So, with the full year, highly successful product and that’s what they’re going to be deploying in the 600-megawatt of offshore in the next stage.
Dan, there was a second question here on Sea Titan and what the scope of supply basically, I think it is.
Daniel Patrick McGahn
Hi. Yes, we have a broad IP estate when it comes to rotating machines using superconductors. So, we’re actively out promoting, licensing that technology as well as scope of supply for mass [ph] that could be the wire, it could be value at a component that use that wire and we’re looking also to couple the two together. So, to take our scope of supply to the superconductor components plus the converters. So, we see our overall dollars per megawatt per turbine actually being able to increase with Sea Titan.
We talked a bit about China already on the call, but obviously there’s going to be a need in Europe for offshore and America, if we ever get our act together and the western companies show similar interest as the Chinese companies do today.
Next question, please.
Our next question comes from the side of Paul Clegg with Mizuho. Please, go ahead.
Paul Clegg – Mizuho Securities USA, Inc.
Hi, guys. First of all, congratulations on everything. You got a lot of stuff to be happy about this quarter. Question about the full conversion drives for Sinovel. How should we think about that in the context of your existing agreements with Sinovel? Is it kind of technology upgrade or diversification, if you will, to allow Sinovel to capture more market share and then you benefit from the volumes? Or is there any real sort of revenue per turbine enhancement on your part?
It’s both, Paul. So, yes, to further differentiate your product that Sinovel – I think will allow Sinovel to capture more market share in China and certainly, as they now go up into the western world. I think most of you know that Sinovel just landed a $6.5 billion line of credit from a Chinese bank to expand offshore and it’s going there. It’s already have offices in Houston, in Toronto and London. So, this is going to be helpful to them to increase their market share offshore, from China that is.
So, the first part of the question was, lost it already.
No, the revenue for turbine enhancement.
Yes, it’s revenue per turbine enhancement. Normally, because full conversion means that all of the electricity from the generated goes right through the converter. It’s a higher power rating inverter system that has to be used here, control system as well. So, we’d expect more revenue per turbine for full conversion.
Next question, please.
Our next question comes from the side of Carter Shoop with Deutsche Bank. Please, go ahead.
Carter Shoop – Deutsche Bank
Good morning. Congratulations on a nice quarter. I have one question, a couple of different parts to it. The first part is was there any noticeable shift at Sinovel in the quarter sequentially between the 3-megawatt and 1.5-megawatt shipment in the quarter. And then as a follow-up, can you discuss your outlook for 3-megawatt turbines for the onshore market in China on the next six to 12 months. And then lastly, is the current level of profitability, at least, that the right to gross margins sustainable?
So, we’re shipping core electrical components and control systems for both 1.5-megawatt and 3-megawatt on predetermined schedules, Carter. So, there’s been no shift from our contracts that are in place here. Of course you know Sinovel has always surprised us by accelerating things in the past, but that’s not the case right now. We’re shipping on schedule for both of those.
As I said earlier on the call though and I think this maybe partly what you’re getting at and that is the new offshore tender that Sinovel won 600-megawatt is all going to be 3-megawatt wind turbine. So, as soon as those get going that will flood in off of the current orders and we said, we expect more orders for 3-megawatt wind turbines in the next six to 12 months. We think, and Sinovel has clearly stated, it’s also going to deploy 3 megawatts for onshore applications in China as well.
So, I think that answer your question. Last part, Dan?
Daniel Patrick McGahn
We’re seeing a stronger trend 2 to 3 megawatts in China for onshore, just in general from the wind show and from all of our partners and he asked about the sustainability of the profit. I mean that’s the whole point you heard in the last answer where were looking at ways to increase the number of absolute megawatts globally that used our technology and we’re trying to increase our dollar per megawatts as well and that all relates to increases in profitability.
Our next question Carter Driscoll with Capstone Investments. Please, go ahead.
Carter Driscoll – Capstone Investments
Good morning, gentlemen. I was hoping maybe compare and contrast kind of the LSP as you begin to target the soil utility space and obviously expand your developments in the smart grid, maybe talk about timing, number of bidders and just kind of the competitive environment between those two markets.
Between those two markets, that’s an interesting question. So, look we’re really entering the solar, large-scale, utility scale solar PV sector. So, it’s hard for us to state exactly what the timescale is going to be. But I can tell you that one of the reasons we are in this market are entering this market is because the developers of the solar PV farms and even those produced panels and some of them are becoming developers or forms as well have come to us and say they don’t have a solution out in the marketplace that’s going to meet their needs.
So, that has driven us to take our expertise for wind farm grid interconnection control systems and pull that together into SolarTie. So, we feel we’re in a very strong position. We do have to get our first alpha sites and this is all in our press release that we put out about SolarTie, get those through the beta sites stages as well and then we expect to see our first revenue from SolarTie within about 12 months from now. So then at that time we’ll have a better idea about the cycle from initial contact through booking and billing the SolarTie.
In terms of the power grid, Dan, you may take a whack at that? It’s a little bit different sector altogether. So, more use the term smart grid, but in fact were talking about smart grid infrastructure, we don’t make muse. I think everybody knows that. We do the real stuff that makes things work.
Daniel Patrick McGahn
Well, what you’re seeing at [inaudible] solar and one is kind of the same theme that’s happened on a different time scale. So, what we’ve experienced over the past decade with D-VAR and wind, we’re trying to be in position to do that again the solar. So, the bid out for solar looking out into the future is going to be in excess of 100-megawatt type projects and there seems to be a technology project gap there to have a solution that’s really grid friendly to make all that work.
When you look at them on the grid side for the wind products, you know those cycles all kind of beginning and end within about 12 months. We’ve been able to build a brand there, where people come to us, turbine manufacturers come to us, developers come to us. It’s kind of a requested solution many of the time.
So, you’re seeing a mature business not that 10 years in the making, on the D-VAR side, for grid and for wind and we hope to try to repeat that with solar.
Our next comes from the side of Vishal Shah with Barclays Capital. Please, go ahead.
Vishal Shah – Barclays Capital
Yes. Hi, thanks for taking my question. Two questions basically on the China web or just overall backlog, can you provide a breakdown between Sinovel and non-Sinovel. I think you said 80 million of backlog to superconductors. And then is your guidance implying sequential improvements in gross margins or operating margins in the third and fourth quarter? Thank you.
All right, Vishal. This is Dave Henry. Your question on the backlog, the key because we refrain from breaking out the components of our backlog. I mean Sinovel is 79% of our revenues in the quarter, so you – I mean you can pursuing that the majority of our backlog does relate to Sinovel. And as it relates to gross margin in our guidance we don’t guide forward gross margin.
I mean there was questions earlier about are the gross margins sustainable? They’re our improvement opportunities that are there I mean that’s why we’re here. I think it’s our job as a management team to do everything we can to sustain growth or gross margin. And so, while I can’t – while I guess not I can’t, I choose not to give gross margin guidance forward. I would say that there is opportunities though, for continuing gross margin improvements just from operationally as we look at our cost, and as also the R&D continues to strengthen as well which is what everybody believes that to be the case.
Our next question comes from the side of Theodore O’Neill with Wunderlich Securities. Please, go ahead.
Theodore O’Neill with Wunderlich Securities
Thanks very much. There’s been a number reports that there’s excess capacity of wind turbines production in China. And it looks like the Chinese government is trying to promote the export markets for their manufacturers there, and given that you’ve got Windtec customers in other countries, India, Turkey, et cetera. How do you think this plays out?
Does Sonivel’s growth cannibalize sales you’d otherwise get in other countries or do you think they’re all going to grow?
First of all, being part of a long-term plan by the Chinese government and Chinese companies, state owned enterprises to be very specific. It’s all one team working together and the long term plan has been to establish a base, a manufacturing base for wind turbines in China we domestic analogies they could get from companies like Windtec. And once they have that base established and meeting their own needs, which is a continued growth market, I mean we just commented in the call, it’s going to be the largest, I think, in 2011 the largest installed base in the world and 200 gigawatts by 2020, maybe 300 gigawatts according to some analysts. So, a lot of growth in China here.
The Chinese government recognize that it had something like 80 different wind turbine manufacturers that have popped up in the last five years in China and that kept us sustainable even with the great growth market and so, they’ve put in, they some loss to whittle that down, probably gets down to around a dozen or so wind turbine manufacturers and certainly the licensees that we have, the five customers we have in China is going to be part of that dozen or so as the smoke clears.
And by the way part of the way that they’re cutting this back is that they already don’t have a wind farm that you’re populating today with wind turbines then you’re not getting into the business, you’re not going to get the financing you need to get into the business and grow. You have to have at least 2-megawatt wind turbines that you’ve already developed and demonstrated and deployed and so forth. So, I mean that makes it tough for up starts to get in.
So, China has really been shaping this up. They are creating a new export business, as far as where the impression [ph] is going and quite clearly the Chinese and for that matter our customers in Korea, Hyundai Heavy Industries in particular, have their sight set on the North American market. While the U.S. and North America market becomes number two behind China next year, still a substantial market.
Yes, it’s slowed down a lot in this last year, but that’s because of confusion in Washington and poor policies and what have you. I think that will get cleared up going forward. But even if it stays at 5 gigawatts a year, but I expect to happen is that the Sinovel and the Hyundai’s of the world are going to take market share away from the existing leaders into Western markets. They’re going to do that by having the best technology, high efficiency, this our curves in the industry and they’re going to have a very competitive price, if they learn how to take cost out of these wind turbines.
So, I think that’s the way it’s going to go. In terms of where we have licensees in different countries, we’ve laid out the agreements with our different licensees in that India’s, the Korea’s, the China’s and so forth, very carefully, so we know where customers can tread and not tread and I think that’s all been worked out quite nicely. Let the games to begin.
Our next question comes from the side with Ben Schuman with Pacific Crest Securities. Please, go ahead.
Ben Schuman – Pacific Crest Securities
Hi, guys. Can you clarify the difference between preferred supplier and exclusive supplier at Sinovel, specifically if they’re selling anyone else’s core electrical components on the current doubly-fed designers, if they plan to do so? And then also take the update on the Dong Fong and the 2.5-megawatt design there would be helpful.
So, preferred supplier – we’ve only used the term right of first refusal. In turns out when you go back and look at the contracts, it actually says we’re in the preferred suppliers and so that’s just the language thing there. And then so what does it mean? It means that we are going to be supplying the core electrical components and control systems for Sinovel as we have been.
Now, would they try to knock us out and maybe replace one of the core components with somebody else’s core component? We anticipate that companies will try that. We said this many, many times in the past. We have designed a full system, the full electrical control systems such that it’s virtually impossible to replace one of our components with another because we make them all work together. But we’re paranoid enough to believe that maybe they can even solve that problem down the road.
So, we’ve encrypted, highly encrypted our software that runs all the control system. We made the very tough, and then we’re still paranoid, and so we made that they can’t break the encryption codes and the way that you really get around to make sure you are at the preferred and the only supplier is to you’ve been constantly innovate. So, you go from PM1000 power module to the PM3000 W. We’re now bringing out the PM-3100 W, you’re bringing low voltage wire through capability, which we’d now demonstrate it in China quite effectively and you bring on the next level of software version 2.0, 3.0 and so forth.
You could constantly innovate which means you’ve get your clause into your customers and may depend on you to be the preferred supplier.
In the new contract on the full conversion systems, we made sure the language was exclusive supplier. Because even with all those protections in there, I don’t like the wording. So, I like exclusive and Sinovel acknowledges that. We should be the exclusive supplier and has so named us in the contracts, pure and simple.
Dong Fong, 2.5-megawatt. Dong Fong is the third-largest wind turbine manufacturer in China that’s based on a 1.5-megawatt wind turbine and earlier design to have from somebody else. They now have a 2.5-megawatt design from us, which has gone through the early prototyping stages. It’s been erected as a wind turbine actually, and has since license from us a 3-megawatt design and a 5-megawatt design.
Dong Fong has now concluded that they’re not going to continue to push forward with the 2.5-megawatt. They’re probably put up a relatively small number of those, but they’re going to focus on the 3-megawatt, why? Because they know the convenient to be a strong player in the Chinese made market, they need to be in that 3 to 5-megawatt category for both onshore and offshore wind farms.
Our next question comes from the side of Jim Ricchiuti with Needham and Company. Please, go ahead.
Jim Ricchiuti – Needham and Company
Hi, thank you. Greg, shipper conductor backlog that you talked about the $80 million, can you say how much of that in terms of revenue would be recognized in the next 12 months and roughly how many customers and where do you see that backlog going over the next 12 months? Thank you.
Well, Jim, no, we can’t break that out for you. And so, we choose not to, as the way David said. So, we just don’t want to do that because that could lead pretty quickly getting to numbers like dollars per meter that we’ve priced in for some of our customer and so forth. And so, for competitive reasons, we certainly don’t want to put that out there.
In terms of going forward, off of that additional pipeline we’re working on, I’m going to ask Dan to address that, give his perspective.
Daniel Patrick McGahn
Yes, these are things that we’re working on Jim. We’re looking at projects that the earliest would start a year or so out. These are things from a backlog standpoint. We’re trying to be the kind of contract writers that we’ve been where we look at things that recognize revenue over multiple years. But it’s still kind of really start trying to put out a line in the sand for how were going to build backlog on the superconductor side.
What we really want to do is to move that part of the business to be generating profits as soon as we possibly can.
So, we look forward for the end of this fiscal year, maybe Dan will say to give you a better picture on that.
Our next question comes from the line of Stewart Bush with RBC Capital Markets. Please, go ahead.
Stewart Bush – RBC Capital Markets
Yes. Hi, guys. For the superconducting business, are we still under the metric that 3 to 4 million meters a year are needed for breakeven? With the LS Cable contract in place, do we expect to see that? In the meantime, should we see actual losses grow with the shipments to that LS contract before it reaches breakeven point? Thanks.
Yes, 3 to 4 million meters of wire per year is the P&L breakeven, the gap P&L breakeven for our superconductors business, Stewart. So that remains the same. Our cost models really haven’t altered that metric. But I’m going to ask Dan to comment more broadly because we don’t just intend to be just a wire supplier and maybe his remarks during the call as well, but it’s probably useful to emphasize that Dan, you want to comment also?
Daniel Patrick McGahn
Yes, these are the kind of things we’ve talked about analyst day, kind of positioning the superconductor part of our business. Everybody’s always focused on the wire, but the business model at least in the near-term are to do a project installation of cable. We’re not going to make the cable, but we’re going to aid and facilitate in the installation of that.
Similar to what we do in the Windtec part of our business, we don’t make the wind turbine, but we certainly help a lot there to make those happen. We said in the past that we’re targeting to get to a couple, to a few different cable projects that would generate profit of the segment. We’re positioning on the Sea Titan standpoint that only within the low 10s of units, we would profitability out a segment and again for cable projects in the 10s of miles, we get to profitability.
So, we’re trying to skin the cat a bunch of different ways, and the hope is superconductors can actually be an accelerator for our overall growth to both the wind and the grid parts of our business.
So, Stewart, just one other thing, you’d ask whether increasing sales or as we ship wire to LS Cable to meet that order, will our losses grow and to answer affirmatively to that question would mean that we’re basically going to sell wire at below our variable cost and that’s not just the case. So, even though we’re ramping up superconductors and we’re still – we never sell our wire below variable cost so.
Can we have time for one more question?
Our last question comes from the side of John Hardy with Gleacher and Company. Please, go ahead.
John Hardy – Gleacher and Company
Yes, thanks. Thanks for sneaking me in guys. I have a couple of questions around the booking. I mean the quarter, obviously, it was very strong. I was wondering [ph] if you can give a little bit more detail on what’s in that number and maybe that’s a different way how much of that is maybe bookings that should be recognized in the next 12 months and maybe the same for total backlog. I think you’ve given that number before Dave.
Well, we did say in the call that as compared to our revenue guidance or revised guidance of 430 to 440 million, we have 99% of that, of a low end of that range either shipped or on backlogs. So, you can kind of do some math there to kind of figure out maybe what’s left in backlog for the rest of this fiscal year, but in terms of going out pass that, we don’t provide any guidance, I’m sorry, with respect to how much backlog might be shippable in FY ‘11, for example.
Great. Thank you everybody for participating in the call today and your great questions. We’re very excited and very proud that we’ve achieved 15 quarters of consecutive revenue growth along with that profitable growth now. Of course, we expect, of course to continue that record and can’t wait to tell you about number 16 and number 17 quarters in a row coming up soon. Thanks and make sure you go vote.
This concludes today’s conference call. You may now disconnect, and have a wonderful day.
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