Welcome to American Superconductor’s first quarter fiscal year 2008 conference call. (Operator Instructions) With us on the call this morning are American Superconductor’s Founder and CEO, Greg Yurek; Senior Vice President and CFO, David Henry and Investor Relations Director, Jason Fredette.
For opening remarks, I would like to turn the call over to Mr. Fredette.
I’d like to point out that certain remarks we make this morning regarding our financial forecasts and other beliefs, plans and expectations constitute forward-looking statements. There are a number of risks and uncertainties that may cause actual results to differ significantly from these statements. Please refer to our 10-K, which was filed with the SEC on May 29, for information about these risks and uncertainties.
I’d also like to note that we will be referring to EBITDAS this morning or earnings before interest income, other non-operating expense, income taxes, depreciation, amortization and stock compensation. EBITDAS is a non-GAAP financial metric. A reconciliation of EBITDAS to net loss on a GAAP basis is included in the press release we issued and filed with the SEC this morning on Form 8-K. All of our SEC filings can be accessed in the Investor Section of our website at www.amsc.com.
Now I’ll turn the call over to Greg.
I’m happy to report back to you on our first quarter results. We had a very good quarter, one in which we generated record revenue and record positive operating cash flow and we are tracking quite well to our business plan enabling us to once again increase our revenue and EBITDAS forecast. We now expect our fiscal 2008 revenue to grow approximately 60% year-over-year and we expect to achieve higher positive EBITDAS showing that we are executing well on an operating basis. Dave will get into the detail and we expect forecast later in the call.
In addition to achieving our financial objectives in the first quarter, we also energized the world’s first superconductor power transmission cable in a commercial power grid and we closed the largest single order in AMSC history. That order was for our proprietary core electrical components for the wind power market, which continues to be the biggest catalyst for our growth.
The wind market accounted for roughly three quarters of our Q1 sales as we increased shipments of our wind turbine electrical systems and core components and we forged ahead on a number of wind turbine license and design contracts we have underway. In June, we added another new Wind Turbine Licensee, TECO Electric & Machinery Company, the world’s third largest motor manufacturer.
This brings the total number of AMSC Windtec customers to eight; three quarters of which are located in the Asia Pacific region. As you may recall, we’ve being working with TECO’s subsidiary, TECO Westinghouse Motor Company in Texas to develop the technologies needed for 10 megawatt class direct drive superconductor wind generators. We’re now expanding this relationship by providing TECO with designs for our proprietary two megawatt full conversion wind turbine that utilizes a permanent magnet generator.
TECO’s objective is to become Taiwan’s leading producer of wind turbines and with over five decades of manufacturing experience; they are well equipped to accomplish that goal. In addition to Taiwan, the license we granted to TECO enables them to sell into mainland China making them our fourth wind turbine manufacturing customer for the Chinese market. Of course the largest of the four Chinese customers today is Sinovel Wind.
Sinovel is China’s second largest domestic wind turbine manufacturer and all signs point to them ascending to the top of that list. Sinovel has been a customer of AMSC Windtec for several years now. Our proprietary electrical systems and core electrical components service as the branch for each and every wind turbine produced by Sinovel. These components monitor the wind turbines performance, maximize the efficiency and condition its power for the grid.
Since 2006 more than 1000 sets of these electrical systems and core components have been shipped by us to Sinovel for its 1.5 megawatt wind turbines, which utilize a doubly-fed induction generator drive train. In fact, Sinovel has these wind turbines in more than 30 wind farms in China as of today and that number will continue to grow rapidly.
With the new $450 million order we received from Sinovel in June we’ll be shipping thousands of additional sets of core electrical components over the next three years beginning in January 2009. These will go into more than 10 gigawatts worth of wind turbines. We’ve heard skepticism from some circles regarding Sinovel’s ability to produce this many wind turbines and the Chinese market’s ability to support this type of expansion. At first glance, the numbers are a bit staggering, but only by western standards.
Business in China is fundamentally different than it is here in the United States. The wind power market in the U.S. and Europe is growing strongly to be sure; in China it’s booming. Chine had six gigawatts of wind power online at the end of 2007 and is aiming to reach 100 gigawatts of capacity by 2020.
In fact, our latest information from China is that the Chinese government intends to produce 10 gigawatts of wind generating zero-emission electricity per year and to do so, as soon as they can. That will put them on the path to their objective to have installed base of 100 gigawatt in 2020 and inline with this aggressive plan, we are now seeing plans in China to develop a single wind farm that will have the capacity of 10 gigawatts; that’s 2.5 times the size of the wind farm T. Boone Pickens is developing here in the U.S.; now that’s what I call booming.
Unlike here in the U.S., our production tax credits remain in Limbo, the Chinese government is actually spearheading the wind effort to bolster the countries supply of electricity while reducing pollution. To make that happen, state owned Electric utilities are building an increasing number of State owned wind farms.
The government has instituted a strong support structure for a selected group of domestic wind turbine manufacturers including Sinovel, Goldwind and Dong Fang, the largest domestic manufactures in China. That is the policy now in place in China and as a communist nation, policy rules the day not necessarily profit.
With the firm order that we now have in place from Sinovel, we will begin shipments in January 2009 and they will increase year-over-year through December 2011 providing us with a significant platform for growth in the years ahead. Do know that the contract for this order is specific in calling for the delivery of these core components over a three year period ending December 2011.
Sinovel has the ability under the contract to modify month-to-month delivery schedules that the contracts calls for, but not to reduce the total number of systems to be delivered in the three year period of time. The full term of the contract is five years, which encompasses the 24 month warranty period. Under this contract we will be shipping both PowerModule 1000 power converters and PowerModule 3000 power converters.
The PM3000 is a new proprietary wind specific power converter product that we are on schedule to start shipping to customers late this year. Our PM3000 will include more functionality for wind turbines and this product will be manufactured in our Wisconsin and China operations. Manufacturing of our PM1000 is now shifting increasingly to AMSC China, where our infrastructure continues to expand. We now have over 80 employees in China that our sales at field service officers in Beijing and Shanghai and our assembly and test facility in Suzhou.
The sales and business development team is addressing not only the wind market in China, but also the new power grid business opportunities. China’s rising demands for power to support growth for their economy require massive grid investments and our D-VAR and SVC voltage regulation systems as well as our superconductor solution can and will play a roll in this build out.
We expect to report back to you on initial orders in China’s power grid sector by the end of this fiscal year. Back here in the United States there is increasing recognition that after 20 years of development high temperature superconductor solutions are ready for deployment.
Last week I was in Washington D.C. to give testimony to the House of Representatives Select Committee on Energy Independence and Global Warming, on the role that superconductors will play in increasing our energy independence and strengthening our electricity infrastructure. Questions from the Select Committee focused on superconductor wind generators and superconductor power grid solutions.
The theme that emerged from this Committee hearing is that there is strong congressional support for new energy technologies that will help the U.S. achieve energy independence and reduce pollution and very importantly there is a growing recognition of the need to vastly improve our aging and outdated power grid to enable new sources of generation such as wind and solar, to increase their contribution to our total energy mix.
While progress on the federal level always tends to move at a slow if not glacial pace, whether we’re talking about Production Tax Credits for wind and solar power generation or fixing the power grids, it seems clear that recognition of the problems is increasing and an action is being developed at both State and Federal levels.
Now AMSC’s approach to all of this is a practical one; that is where we support these U.S. government backed initiatives and stand ready to serve with our products and to develop new products, our focus remains on the faster growing and more lucrative international wind and power grid markets. This year again about 70% of our revenues are expected to be generated from international sales with the lion’s share of these sales being to China.
Approximately 65% to 70% of our sales will be to the Global Wind market. We expect our sales to the power grid market to continue to grow, especially once we penetrate the power grid markets in China, India, Turkey and other fast growing economies. While we expect our international sales to remain strong in the U.S. we do expect to see continued strong support for further development of superconductor power cables, full current limiters, wind generators and navy ship degaussing systems among others and as these products are developed and demonstrated we expect to sell these solutions globally.
At the heart of the superconductor wind and power grid solutions to our core product HTS wire, our power manufacturing operation for the production of 344 superconductors has continued through the shakedown phase during the first half of calendar 2008. We encountered a good number of start-up challenges during the phase, all of which had assignable causes and were basically mechanical in nature.
By mechanical, I mean we had to do deal with problems such as gas valves and temperature gauge malfunctions on some of our equipment, control issues that management smooth operation of payoff and take-up reels in some of our manufacturing steps and we had contamination of some of the incoming materials to the process. I think you got the idea.
The point is, these are all fixable problems, not scientific problems and the fixes are in. As a result, we are now producing good quality wire on a regular basis and despite some of these challenges we expect to meet all of our customer deliverables this fiscal year. Most importantly, we expect that all of this has prepared us well for migrating to high-volume wire production on schedule over the next couple of years as anticipated customer demand starts picking in.
Indeed, we are currently engaged in discussions with potential customers for commercial applications of our wire; all of which indicate that we must be ready to meet that growth in demand over the next couple of years. In the meantime, as we invest in the future of our superconductor business, we remained focused on posting strong growth and enhancing our bottom line as we march toward GAAP profitability based on our growing power systems business.
With that I’ll now turn over the mic to Dave for his review.
In the first quarter of fiscal 2008 we continued to improve our financial performance and we made strong progress toward the achievement of longer-term financial benchmarks we’ve set for ourselves. On top of another quarter of sequential revenue growth, we were solidly EBITDAS positive in Q1. We cut our net loss significantly year-over-year despite a substantial non-cash charge for our mark-to-market adjustment on an outstanding stock warrant and we delivered record positive operating cash flow.
Looking closer at the numbers, we delivered our sixth consecutive quarter of sequential revenue growth. Revenue for the first quarter of fiscal 2008 was a record $39.8 million, up 4% sequentially and up 101% from $19.8 million in the year ago quarter. Of this total, AMSC power systems generated a record $35.9 million in revenue, which was up 150% from $14.4 million in the first quarter of fiscal 2007.
The major driver of the increase is sales of core electrical components for wind turbines. AMSC power systems accounted for approximately 90% of our total sales in Q1, at the high-end of our 87% to 90% target range for fiscal 2008. Our AMSC superconductor segment generated the remaining 10% of sales.
AMSC superconductors revenue in the first quarter was $3.9 million down 28% compared to $5.4 million in the year ago quarter. This decline is primarily the result of the completion of our HTS motor contract with the U.S. Navy last year and lower contribution from the LIPA project which was completed in April of this year.
We exit the first quarter of fiscal 2008 with approximately $634 million of backlog. That’s up from $109 million on March 31 2008 and $73 million for the year-ago quarter. Our $450 million order for Sinovel of course was the major factor in the sequential increase.
Gross profit for the first quarter was $11.6 million resulting in a gross margin of 29.2%. This compares to a gross margin of 18.1% for the first quarter of fiscal 2007. Gross margin for the fourth quarter of fiscal 2007 was 33.2%. Year-over-year increase in gross margin was primarily the result of higher power system sales as a percent of total revenue.
As you might recall, our fourth quarter fiscal 2007 gross margins were unusually strong due to the fulfillment of a power systems order that contributed a particularly high gross margin. In Q1, we also had higher warranty costs and a lower mix of D-VAR revenues, which contributes gross margins that are above the company average. For fiscal 2008 as forecasted earlier, we expect gross margin to be at the lower end of our target operating range of between 30% and 35%.
R&D expenses for the first quarter were $4.9 million or 12% of revenue. This compares with $4.2 million or 21% of revenue for the first quarter of fiscal 2007. SG&A expenses for the first quarter of fiscal 2008 were $8.9 million or 22% of revenue. This compares with $6.1 million or 31% of revenue for the quarter of fiscal 2007. The increase in SG&A expenses is primarily the result of operating expense growth required for our higher revenue levels and higher stock-based compensation expense.
The expense growth in both R&D and SG&A is inline with our plan and our previous guidance to increase operating expenses and dollar terms, while decreasing them as a percent of revenue. We are focusing on maximizing fall through on incremental revenue, while also maximizing our strong revenue growth rate.
In Q1 we incurred approximately $500,000 in amortization of acquisition related intangibles, related to our acquisitions of Windtec and PQS. This is down from $1.2 million in the year-ago quarter due to the fact that we have nearly fully amortized a portion of our Windtec intangibles that were tied to purchase backlog. As a result, intangibles amortization should remain roughly flat in the near-term.
We did not incur any restructuring and impairment charges in the first quarter of fiscal 2008, though we continue to work on finalizing the closure of our Westborough facility and returning the building to the landlord. Costs associated with completing this effort were improved in the fourth quarter of fiscal 2007.
In the year-ago quarter we incurred approximately $800,000 in restructuring charges associated with the consolidation of our AMSC wires and AMSC SuperMachines business units. Our operating loss was $2.7 million in the first quarter of fiscal 2008. This compares to an operating loss of $8.7 million in the first quarter of fiscal 2007. Our operating loss in the fourth quarter of fiscal 2007 was $2.8 million.
The AMSC power systems generated operating income of $4.9 million or 14% of revenue in the first quarter of fiscal 2008. This compares with an operating loss of $600,000 or negative 4% of revenue for the year-ago quarter. The year-over-year improvement and power systems operating income is due primarily to incremental profit generated from higher revenues.
Power systems operating income was $6.6 million or 19% of revenue in the fourth quarter of fiscal 2008. The sequential decline in power systems operating income is driven by an unusually high gross margin sale in the fourth quarter as well as an increased allocation of corporate expenses effective for this fiscal year.
AMSC superconductors generated an operating loss of $5.1 million in the first quarter of fiscal 2008. This compares with an operating loss of $6.5 million in the first quarter of fiscal 2007. A year-over-year improvement was due primarily to inventory write-offs and asset impairment charges incurred in the year-ago quarter.
Superconductors operating loss was $4.3 million in the fourth quarter of fiscal 2007. The sequential increase in superconductors operating loss was driven primarily by lower revenues and higher subcontractor expenses in the first quarter of fiscal 2008. Please note that stock compensation expense is not allocated to our reporting segments.
Given the significant increase in our stock valuation during the first fiscal quarter we incurred a $2.4 million charge related to a non-cash charges mark-to-market adjustment on an outstanding stock warrant, which increased our net loss by $0.06 per share. This charge will be reflected in other expense in the P&L. In the year ago quarter, we incurred a $1 million charge for the mark-to-market on the warrant.
Income tax expense increased to $1.7 million from approximately $300,000 at the year ago quarter due to the growth in the sales and profits in foreign jurisdictions. International sales were 81% of revenue in the first quarter of fiscal 2008, compared to 71% in the year ago quarter.
Factoring these items in, we’ve reported a net loss of $6.1 million or $0.15 per share for the first quarter of fiscal 2008. This compares to a net loss of $9.7 million or $0.27 per share in the first quarter of fiscal 2007. The net loss in the fourth quarter of fiscal 2007 was $1.8 million or $0.04 per share.
In addition to the mark-to-market adjustment I mentioned earlier, our net loss also includes non-cash free tax charges for amortization of acquisition related tangibles and stock-based compensation expense. Such charges totaled $5.2 million for the first quarter of fiscal 2008 compared to $3.2 million in the first quarter of fiscal 2007 and $1 million for the fourth quarter of fiscal 2007. The sequential increase of these non-cash charges almost entirely drives a sequential change in our net loss.
To paint a clearer picture of the financial progress being made here at AMSC, each quarter we provide a breakout of EBITDAS, as well as forecast for EBITDAS, all of which is reconciled to GAAP at end tables at the end of our earnings press release. For the second consecutive quarter, AMSC generated EBITDAS positive results in Q1. EBITDAS for the first quarter of fiscal 2008 was a record $1.7 million, which compares to $400,000 in the fourth quarter of fiscal 2007 and a loss of $5.3 million in the first quarter of fiscal 2007.
Turning to the balance sheet, cash, cash equivalents, marketable securities and restricted cash on June 30, 2008 were $131.5 million. That’s up over $12 million for March 31, 2008. Nearly $11 million of that increase is related to proceeds from stock option exercises during the quarter, but we also had a particularly strong collections quarter in Q1. As a result of this and our record positive EBITDAS, cash flow from operations in Q1 was a positive $3.2 million, a new company record.
Now, let’s review our latest financial expectations for the remainder of fiscal 2008. We expect that our financial results will continue to improve as we progress through the year and we anticipate stronger result from the second half of the year relative to the first half from the both the top and bottom line perspective.
In terms our annual numbers back in May, we said we expected revenues for fiscal 2008 in the range of $165 million to $175 million. As a result of our improved visibility resulting from our strong bookings in the first quarter, we are now raising our revenue forecast for fiscal 2008 to a range of $175 million to $185 million.
We continue to expect that AMSC power systems revenues will represent between 87% and 90% of total sales for the year. We also continue to expect that approximately 65% to 70% of our revenues will come from international markets and that 65% to 70% of sales will come from the wind energy market. We expect that each of these metrics to trend though to the upper end these ranges.
As a result of higher revenues, EBITDA should be better than previously forecasted. We now expect EBITDAS for fiscal 2008 to be in the range of $7 million to $10 million up from our previous guidance of $3 million to $7 million. Our net loss forecast for the year is being impacted by higher non-cash charges associated with stock-based compensation and the mark-to-market adjustment on outstanding warrant that we discussed earlier.
Non-operating factors such as lower interest income and higher taxes compared to our previous expectations are impacting our net loss forecast for the year as well. As a result, we are increasing our net loss guidance to a range of $13 million to $15 million or $0.30 to $0.35 per share compared with our previous range of $9 million to $12 million or $0.21 to $0.28 per share.
Capital expenditures were $1.5 million for the first quarter of fiscal 2008 and we continue to expect that we will invest between $5 million and $7 million globally in fiscal 2008 related to systems and facilities to support our continued growth.
With that, we’ll open the call to questions.
(Operator Instructions) Your first question comes from Jim Ricchiuti at Needham & Co.
Jim Ricchiuti - Needham & Co
What percent of sales was Sinovel and are you beginning to see the ramp up from some of the newer customers including Ghodawat and the other customers in China?
Sinovel is a huge fraction.
Sinovel represented about two-thirds of our sales in the first quarter.
And the second part of your question was about sales or orders from newer licensees. We’ll expect to see more of that happening later in this fiscal year because if you remember the production schedules we published from our various customers, licensees, AMSC Windtec licensees, those will be starting up mainly next year.
CSR-ZELRI from China though as you know has already given us orders, AAER; Canada has given us order; Dongfang in China has started give us orders as well. So, there are already offering running, but we’ll see that ramping more as we go toward the end of our fiscal year. So, providing revenue growth as our models always said revenue growth or the subsequent years going forward.
Your next question comes from Theodore O'Neill at Kaufman Brothers.
Theodore O'Neill - Kaufman Brothers
For having a great quarter, you’re not getting any credit for it on the tape today because it looks like a miss and the variance seems to be coming under other income and expense and the taxes. So, I was wondering if you could talk about those two things to the extent that we could do a better job of forecasting those into a numbers, so that it doesn’t look so bad on the tape the next time around?
Other income and expense, that’s where that mark-to-market is located in the warrant. That stock warrant was issued back in 2005, as a result of some litigation settlement that we had and so the accounting rules require that you have to revalue that warrant each and every quarter and the change in that value results in a P&L charge or a P&L income depending on where our stock price goes.
So, the way to model it is that really for every dollar change in our stock price, one way or the other, that line will be impacted by about $200,000. So, in the first quarter, when our stock increased to $12 per share between the end of the fourth quarter and the end of the first quarter that resulted in about $2.4 million mark-to-market hit. Based on the stock price today and if it stayed that way, we would have a pick up in the second quarter, so that’s the other income and expense line.
On the taxes, it’s kind of the convoluted sort of discussion, so if you’ll bear with me for a seconds. Our cash situation is that in the U.S. we do not tax benefit any losses. We incur losses in the U.S. and we reserve any tax benefits that are associated with those losses, so NOLs or future deductions that we might have for things like stock compensation expense, timing differences between book and tax, all of those things get reserved, whereas in our foreign jurisdictions, we have taxes that we have to pay both in cash and that we have to record on our books.
So, the way to think about it is, if you look down our P&L, you look at things like the mark-to-markets in the U.S., interest income, all of that is generated in the U.S.; stock-based compensation expense, all of that is in the U.S.; operating losses and superconductors all of that is in the U.S.; so, you add up those things there is about $10 million of pre-tax charges that are included in our pre-tax income that you see for the first quarter which happens to be about $4.4 million.
You back all of those things out and then you tax affect that at some 25% to 30% sort of rates, which will be the effective rate in our foreign jurisdictions that’s how you can model income tax expense on a go forward basis. So, look for some of those things in our P&L like interest income, the mark-to-market, operating losses and superconductors and stock-based compensation expense. Back them out of your model, when you’re trying to compute taxes because those are expenses are generated in the U.S. and we do not record a tax benefit on them.
So, that was a sort of a convoluted explanation, but I hope that it was clear enough for you and I’d be happy to talk to you about it later about it, just to make sure you to understand.
Your next question comes from Paul Clegg at Jefferies.
Paul Clegg - Jefferies
Just a question about gross margin; if I understood you correctly, you said that you’re guiding towards the lower end of your annual guidance, by your annual guidance for gross margin. I wasn’t clear if that was due to the allocation of non-cash comp in there or if there were some other explanations for that?
No Paul, last time in the fourth quarter when we gave our guidance we said that we haven’t really changed it. We said that our guidance was at the low end of our 30% to 35% and we haven’t changed that.
The sequential change in our gross margin from Q4 to Q1 if you recall last quarter, we said that there was a high margin D-VAR sale that occurred in the fourth quarter that made our gross margins unusually high. So, in the fourth quarter we had a 33% gross margin, but we told you that the gross margins for the full-year this year would be at the low end of our range of 30% to 35%.
So, we anticipated the gross margin would be lower in the first quarter as compared to what we saw in the fourth and that D-VAR sale had about a 300 basis point favorable impact on our gross margin in the fourth quarter. So, if you normalize that we had roughly a 30% gross margin in the fourth quarter compared to 29% gross margins in the first quarter and that particular change would be due then to the lower mix of D-VAR in the first quarter and some higher warranty costs.
Your next question comes from Carter Shoop at Deutsche Bank.
Carter Shoop - Deutsche Bank
I wanted to first better understand why the total taxes paid will be decreasing throughout the year if we assume that power systems business, which is primarily in foreign jurisdictions continues to increase and my question is, what is your outlook for losses in superconductor business for the remainder of the year?
Our outlook first, superconductors has been generally posting operating losses somewhere in the $4 million to $5 million to $6 million range per quarter and those operating losses are going to continue here for the rest of this year in sort of that kind of a range. So those operating losses and superconductors will be not tax benefit.
So, as you look at your modeling for taxes for the rest of this year, you should be backing out superconductors operating losses in that kind of a range and then backing out on some of these expenses like I mentioned earlier like the mark-to-market, interest income, stock-based compensation, which are all U.S. denominated expenses in trying to determine the model for your taxes on a go forward basis.
Your next question comes from Walter Nasdeo at Ardour Capital.
Walter Nasdeo - Ardour Capital
I’d like to talk about the superconducting business for a second; also can you give me a little bit more information on how the Con Edison project here in New York is developing and then as you’re done with that discussion, if you could just give me where we are as far as current capacity and then what you expect in the year end and maybe on into next year? Thanks.
Project HYDRA in New York City is moving forward a pace. We fully expect to have the cable system in the ground in Manhattan in 2010 on schedule, so that’s moving forward.
In terms of our gross capacity, nothing really changed there; effectively 720,000 meters per year gross capacity as we speak and we don’t plan to see that change as we go through the end of our fiscal year. We are ready to ramp up that capacity as we’ve always said dictated by customer demand.
Right now our focus is on improving yield in our manufacturing process, which of course increases our total amount of wire that’s available for sale. So, we don’t have a plan for increasing that capacity until we see that customer demand pickup as I mentioned in my comments.
Your next question comes from Michael Carboy at Signal Hill.
Michael Carboy - Signal Hill
David, I’d like you to elaborate a little bit on the gross margin issue. It looks like on an incremental basis here, the incremental gross margin was actually remarkably negative on the $1.4 million incremental revenue change. Could you breakout for us, what portion of non-cash comp increases hit the costs of goods sold line and what are you seeing with regard to your other input costs; whether it be it energy or component cost; what inflationary trends you’re seeing there? Thank you.
Yes, I think Michael as I mentioned earlier, as the gross margin change when you look back at fourth quarter I think you should be comparing it sort of on an apples-to-apples basis; more like a 30% gross margin for the fourth quarter compared to a 29% gross margin for the first quarter, so that sort of backs out the affects of that high margin sale that we had in the fourth quarter.
It’s the minimus; maybe a few $100,000 of affect from stock-based compensation expense that goes into the cost of sales, most of that falls into the operating expense line, primarily SG&A, so that’s really not the driver. As I mentioned earlier, the driver for our gross margin change quarter-on-quarter, when you normalize for that high margin sale is due to the lower margin D-VAR sales and higher warranty cost that we recorded in the first quarter as compared to the fourth quarter.
Just to correct you, you said there, just that lower margin D-VAR sales David; it’s a higher margin D-VAR sales and we had less of those in the first quarter.
Your next question comes from Corey Tobin at William Blair.
Corey Tobin - William Blair
A quick question on the Sinovel 3 megawatt turbine and the 5 megawatt turbine designs; any updates as to when you expect the orders from those products? Thanks.
We had an order we announced I think end of March, or beginning of April, somewhere in that timeframe that we had $18 million worth of new orders from Sinovel for the 3 megawatt system. So, Sinovel expects to go into production of the 3 megawatts wind turbines in 2009. They already got the order in for us and we’ll be shipping those to meet their schedule next year.
So, this is not a revenue impact for this year; it’s really a revenue impact, a positive impact obviously for next year, so that’s the story, but really the 5 megawatts year plan is to be in prototype stage somewhere around 2010 timeframe and we don’t see any slowing down of that one either, so that’s the schedule.
In the meantime of course they’re really ramping up their production of the 1.5 megawatts wind turbines as we all known.
Your next question comes from Pavel Molchanov at Raymond James.
Pavel Molchanov - Raymond James
A couple of questions about China; can you mention as of your March 31 backlog, $199 million; what percentage of that was either Sinovel or just to China more broadly?
Yes, we don’t really breakout our backlog by customer or even by country, but given our revenues are half implements by Sinovel, they makeup certainly a least of that portion of our backlog, but we don’t intend to breakout our backlog by customer.
Your next question comes from Stuart Bush at RBC Capital Markets.
Stuart Bush - RBC Capital Markets
I was hoping you could clarify the details of this Sinovel contract; this $460 million quote does that include the 17% value added tax or not?
No, it does not.
Stuart Bush - RBC Capital Markets
It does not. So, if they export would you recognize that 17% additional value added tax as revenue?
You don’t recognize VAT as revenue; it’s cash in and cash out. So, there is a price in the contract that’s Ex without VAT and there is a price in the contract that‘s with VAT and if we charge VAT that would not go through the revenue line, that’s just through the balance sheet; its cash we collect and then cash we give to the government.
Your next question comes from Brian Yerger at Jesup & Lamont.
Brian Yerger - Jesup & Lamont
I was just wondering what’s the mix of the power modules 1,000 versus the 3,000 going forward into 2009.
We haven’t published that. What we said at analyst day last November ’07 is that by the end of this year, we’d expect to start shipping our PM3000. So, we’re ramping or starting to ramp up production of PM3000; PM1000 is carrying the day today and through the rest of this year.
As we go into calendar ’09 starting in January, we’ll start shipping both PM1000 and PM3000 to Sinovel, part of that $250 million orders, but the mix is going to be up. We’re not publishing a specific mix, but there’ll be primarily 1000s and then by the end of the three year period, it’s going to be primarily 3000. So that switchover will occur for that particular customer in that three year period of time.
So, primarily PM1000’s now starting to ramp up production and starting to ship the PM3000 by the end of the year and remember PM3000 is a wind specific design, based on all of our years of working with the wind industry. So, the primary, in fact maybe lets say the primary market for this is the wind market which is obviously booming for us right now.
Your next question comes from Jim Ricchiuti at Needham & Company.
Jim Ricchiuti - Needham & Co
Yes, I wonder if you could just comment on the lower sales for D-VAR in the quarter and what the outlook looks like for that product family.
That was just a matter of timing, Jim. We expected to see continued growth in D-VAR sales through this year. More orders coming through, of course shipments, we’ll recognize revenue on D-VAR shipments, but we also expect to see more orders coming in for D-VAR not just for wind which has been the growth sector for us for grid interconnection of wind farms, but also for utilities for voltage regulation, increasing reliability of the grid.
As I mentioned in my comments, we’re expecting by the end of this fiscal year to get our first grid related orders from China and some of that’s going to be D-VAR as well. So look for D-VAR sales to continue to grow through the rest of this year and certainly going forward.
Your next question comes from Paul Clegg at Jefferies.
Paul Clegg – Jefferies
Just another follow-up on the gross margins; what kinds of impact are you looking for as a result of the new Sinovel order rolling through your numbers. I think that’s in the last quarter of the year and I think if I’m not mistaken you’re going to be delivering most of that from your China facility?
Yes, what we said is that to get an order of the size that we do we obviously gave Sinovel some concessions on price, but we’re continuing to maintain that we will be generating, company average gross margins, so the 30% to 35% range gross margins when we sell core electrical components to Sinovel once we start shipping them from China. So, even though we gave some price, we will have to order some cost reductions that we will be able to offset that way.
Your next question comes from Michael Carboy at Signal Hill.
Michael Carboy - Signal Hill
Could I ask you Dave to elaborate on what’s happening with the higher warranty expense?
Yes, Michael when we sell more products it has a warranty that’s attached with it. Sometimes those warranties will have 12 month periods; sometimes they will have 24 month periods. We accrue warranties based on our actual experience and we project that forward. So, it’s just more of a modeling exercise based on what we expect our future expenses to be based on the product that we have in the field and what our historical costs have been to repair what’s already there?
Your next question comes from Peter Shipland at William Blair.
Peter Shipland – William Blair
Yes, I was wondering if there’s any update on power module sales to some of the more established manufacturers.
Okay, you’re talking on the wind industry. As we’ve mentioned before, probably at analyst day for sure, we do of course approach the established wind turbine manufacturers, like Vestas and Gamesa and so forth, but they do have their incumbent groups in place, so it’s pretty hard to break it.
Will we have sales to the established wind turbine manufactures in the future? I think the answer is going to be yes, but don’t look for that this year or next year. Our wind specific PM3000 I think provides us with a tremendous advantage there, so it’s worth continuing to call on those customers, but by far, nearly 100% of our power module sales are going to be to the new entrants which are the ones that are growing very rapidly and taking market share from the established players.
Your next question comes from Carter Shoop at Deutsche Bank
Carter Shoop - Deutsche Bank
Can you comment on the expected linearity in revenue throughout the remainder of the year? Do you expect 2Q to be roughly at the same level and then pick up dramatically in the back half of the year or will it be relative linear ramp throughout the year?
Yes Carter, we expect that when you look at our second half revenue as apposed to the first half revenue, our second half revenue, the growth of that will be higher. So to answer your question more directly a bit more back end loaded the growth in the second quarter we do expect, but when you look at that growth in second quarter over first and you compare that to what we expect in the second half, we expect the second half growth rate to be higher than that growth rate that we expect in the second quarter over the first quarter.
Your final comes from Pavel Molchanov from Raymond James.
Pavel Molchanov - Raymond James
You mentioned earlier about the 100 gigawatt wind market in China; can you just mention the stage that’s in, in terms of the governmental process?
It’s in progress. There are plans that are being put together and we’d expect that to become a reality in the next year or a couple of years.
This does conclude today’s question-and-answer session.
Well thank you and thanks for all your attention and questions today. We had a good quarter. We expect this year to be continued strong growth and we’re looking forward to reporting back to you on our full-year results and quarterly results on the way there. Thanks very much.
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