American Superconductor Corporation (AMSC) Q3 2022 Earnings Call Transcript

American Superconductor Corporation (NASDAQ:AMSC) Q3 2022 Earnings Conference Call February 2, 2023 10:00 AM ET

Company Participants

John Heilshorn - LHA IR

Daniel McGahn - Chairman, President and CEO

John Kosiba - SVP, CFO and Treasurer

Conference Call Participants

Eric Stine - Craig Hallum

Colin Rusch - Oppenheimer

Justin Clare - ROTH Capital Partners

Chip Moore - EF Hutton

Operator

Good morning, and welcome to the AMSC Third Quarter Fiscal Year 2022 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to John Heilshorn from LHA. Please go ahead.

John Heilshorn

Thank you, Gerry. Good morning, everyone . And welcome to American Superconductor Corporation's third quarter of fiscal 2022 earnings conference call. I am John Heilshorn of LHA Investor Relations, AMSC's Investor Relations agency of record.

With us on today's call are Daniel McGahn, Chairman, President and Chief Executive Officer; and John Kosiba, Senior Vice President, Chief Financial Officer and Treasurer.

American Superconductor issued its earnings release for the third quarter of fiscal 2022 yesterday after the market closed. For those of you who have not been able to see the release, a copy is available at the Investors page of the company's website at www.amsc.com.

Before starting the call, I'd like to remind you that various remarks that management may make during today's call about American Superconductor's future expectations, including expectations regarding the company's fourth quarter of fiscal 2022 financial performance, plans and prospects, constitute forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those set forth in the Risk Factors section of American Superconductor's annual report on Form 10-K for the year ended March 31, 2022, which the company filed with the Securities and Exchange Commission on June 1, 2022, and the company's other reports filed with the SEC.

These forward-looking statements represent management's expectations only as of today and should not be relied upon as representing management views as of any date subsequent date to today. While the company anticipates that subsequent events and developments may cause the company's views to change, the company specifically disclaims any obligation to update these forward-looking statements.

Also on today's call, management will refer to non-GAAP net loss, a non-GAAP financial measure. The company believes that non-GAAP net loss assists management and investors in comparing the company's performance across reporting periods on a consistent basis by excluding these noncash, nonrecurring or other charges that it does not believe are indicative of its core operating performance.

The reconciliation of GAAP net loss to non-GAAP net loss can be found in the third quarter of fiscal '22 earnings press release that the company issued and furnished to the SEC last night on Form 8-K. All of American Superconductor's press release and SEC filings can be accessed from the Investors page of its website at www.amsc.com.

With that, I will now turn the call over to Chairman, President and Chief Executive Officer,

Daniel McGahn. Daniel?

Daniel McGahn

Thanks, John, and good morning, everyone, and thank you for joining us.

I'll begin today by providing an update and sharing a few remarks on our business. John Kosiba will then provide a detailed review of our financial results for the third fiscal quarter, which ended December 31, 2022. And we'll provide guidance for the fourth fiscal quarter, which will end March 31, 2022. Separately, John will update our operating models and talk about actions we took that are expected to lower operating expenses. Following our comments, we'll open up the line to questions from our analysts.

During our third quarter of fiscal year 2022, we are delivering on our strategic priority of a more diversified business. Total revenues for the third quarter of fiscal year 2022 came in within our guidance range. Our third quarter revenue of nearly $24 billion was driven by new energy power system shipments.

Our grid segment revenue for the third quarter of fiscal year 2022 accounted for over 85% of AMSCs total revenue. The remainder of the revenues came from our wind business. During our third quarter, we saw a diverse set of product shipments. We shipped voltage compensators capacitor banks, harmonic filters, transformers rectifiers, volt-var optimizers, ship protection systems and electrical control systems. These products went into renewables and a variety of industrials markets, including semiconductor mining, as well as our navy projects.

We ended the third quarter with more than $30 million in cash. And I'm happy to announce that we have met our obligations in the Chicago project. The $5 million of restricted cash for the resilient electric grid project in Chicago are expected to become unrestricted and hit our books during our fourth quarter of this fiscal year 2022.

During our third quarter, we booked $43 million of new orders and grew our backlog to over $110 million. Our backlog at the end of the third quarter increased by nearly 40%, when compared to the same quarter, a year ago. We announced our ship protection system contract with Huntington Ingalls to be deployed on the San Antonio Class Amphibious ship LPD-32. The LPD-32 contract marks AMSCs fifth ship protection system for the San Antonio class ship platform.

Over the past several years, we've taken a series of very deliberate actions to diversify our business and grow through our grid business. Over a four year period, we doubled our business. Over the same period, we nearly tripled our grid business. Fiscal year 2022 has been a year of transition for the company to a broader product portfolio, pricing and cost changes were possible and aligning our fixed costs better with historical revenues. John Kosiba will provide more color on this today.

We have expanded the markets we serve and that has translated into a higher order intake rate. We do not intend to stop here. We have a lot of work ahead of us but our longer term priority is to build a sustainable business that's well positioned to not only take advantage in renewables, but also in semiconductor, mining and materials, as well as in defense. We believe that this sustainable business is not so far off in the future. John is going to update our operating models later in the call. I will provide a deeper review of some of the drivers of our business going forward.

For now, I'll turn the call over to John Kosiba to review our financial results for the third quarter of fiscal year 2022 and provide guidance for the fourth quarter of fiscal year 2022 which will end March 31, 2023. John?

John Kosiba

Thanks, Daniel. And good morning everyone.

AMSC generated revenues of $23.9 million for the third quarter of fiscal 2022 compared to $26.8 million in the year ago quarter. Our grid business unit accounted for 87% of total revenues, while our win business unit accounted for 13%. Grid business unit revenues decreased by 17% in the third quarter versus the year ago quarter, while our win business units increased by 76% over the same time period.

Looking at the P&L in more detail, gross margin for the third quarter of fiscal 2022 was 2% compared to 13% in the year ago quarter. Gross margin for this quarter was adversely impacted by the continued drag on logins associated with acquired Neeltran backlog. Additionally, one of our larger projects at Neeltran required additional cost to complete than we had originally planned. This required approximately 900,000 of additional unanticipated costs in the quarter.

We do not anticipate any of these costs reoccurring in Q4 as that project is now in the final stages of production. To help provide some quantitative reference as a result of several lost contracts associated with our acquired Neeltran backlog which includes the project I just discussed. Our third quarter reported consolidated gross margins have been adversely impacted by approximately 660 basis points. We believe that Q3 fiscal 2022 will be the peak of the drag from Neeltran acquired backlog. We anticipate Neeltran gross margins to improve in Q4 and further strengthen into fiscal 2023 as we begin to execute on the new project sold post production - post acquisition, sorry.

Moving on to operating expenses, R&D and SG&A expenses for the third quarter of fiscal 2022 were $9.3 million, compared to $9.4 million in the year-ago quarter. Approximately 15% of R&D and SG&A expenses in the third quarter of fiscal 2022 were non-cash. Our non-GAAP net loss for the third quarter of fiscal 2022 was $7.7 million or $0.27 per share, compared with $4.6 million or $0.17 per share in the year-ago quarter.

Our net loss in the third quarter of fiscal 2022 was $9.6 million or $0.34 per share. This compares to a net loss of $4.3 million or $0.16 per share in the year-ago quarter. Please see a press release issued last night for a reconciliation of GAAP to non-GAAP results. We ended the third quarter of fiscal 2022 with $31.4 million in cash, cash equivalents and restricted cash. This compares with $37.4 million on September 30 2022. Our operating cash burn in the third quarter of fiscal 2022 was $5.5 million.

Now turning to our financial guidance. For the fourth quarter of fiscal 2022, we expect that our revenues will be in the range of $27 million to $30 million on net losses expected not to exceed $8 million or $0.28 per share. Our non-GAAP net loss is expected not to exceed $6 million or $0.21 per share. We expect operating cash flow to be a burn of $4 million to $6 million in the fourth quarter of fiscal 2022.

We expect to end the fourth quarter with greater than $25 million in cash, cash equivalents and restricted cash. Now I'd like to take a few moments to update you on several strategic steps we have undertaken over the past 30 days that are expected to lower our cash flow breakeven revenue targets. Our revenue product mix has evolved as a result of the two acquisitions from what was once heavily dependent on the renewable market to a much more diversified revenue stream.

It took some time to integrate both NEPSI and Neeltran to the point that we have now experienced some operating leverage across the Grid segment. As a result, we have taken several steps that are expected to lower both our manufacturing and SG&A overhead costs. These steps ranged from combining positions which were redundant across multiple product lines to leveraging our engineering and SG&A costs across the entire company. This has in part enabled us to undertake an organizational realignment and to reduce our workforce across multiple product lines.

We anticipate an annualized savings of $5 million resulting from these actions. Our business outlook for the fourth quarter does not contemplate any severance related costs for the reduction in workforce actions, which are expected to be no more than $1 million. We expect to experience the full impact of these anticipated savings starting in Q1 FY 2023. Now let me further elaborate and how this is expected to impact our cash flow breakeven scenarios moving forward. As we move into the start of FY 2023, we expect short-term cash gross margins to approach the upper teens. As we move further into FY 2023, we see scenarios where cash gross margins could reach 20%, if our revenue approaches $30 million, and we have several scenarios where cash gross margins approach 25%, if revenue approaches $35 million.

These cash gross margin scenarios are a result of actions we have taken over the past year to raise our prices, coupled with what we believe is stabilized raw material costs. We will continue to be vigilant in both our pricing models and proactive to any changes in raw material costs as we move into FY 2023.

Moving along to our operating expense models, we anticipate our cash operating expenses will be approximately $9 million a quarter, once the full extent of our recent cost reduction steps are realized. When you combine the anticipated gross margin improvement with our updated operating expense profile, we see revenue breakeven scenarios in the $35 million quarterly range.

These scenarios are based on current assumptions which are subject to change. Please note this is not financial guidance. This is meant more to help our shareholders understand our current forecast and operating model. We will continue to provide our current quarterly financial guidance when we announced our earnings for the prior quarter.

With that, I'll turn the call back over to Daniel.

Daniel McGahn

Thanks, John.

We have macro trends in the market that are starting to drive our business. Our backlog is over $110 million and our pipeline of prospective orders reflects our growing and diversified company. We have doubled our new energy power systems order intake rate. These macro trends are driven by climate and environmental policies, which raised demand for our new energy power systems.

More specifically, our diversified pipeline of orders come from investments in renewables, and industrial markets such as semiconductors, and mining, metals, and materials. Our company has transitioned from almost a pure play in wind, to a company that's focusing on grid resiliency. We now have multiple plays at multiple points in the power infrastructure.

Our voltage compensators, capacitors, harmonic filters, transformers and rectifiers can power the energy intensive factories of the future without the risk of costly power interruptions. Today, our business is about a quarter based upon renewable energy. We've grown the business that's supporting power management at the substation level for the utility as well as supporting customers in the semiconductor industry.

We have a variety of applications for industrial processes, and manufacturing, like mining, metals extraction, metal processing, and chemical plants. The company is moving in a direction where expects to provide more new energy power systems for more industrial users, more than half of our new energy power systems orders during the third quarter of fiscal 2022 come from industrial markets, one fourth is from renewables.

In the past, we've talked about sales leverage with our acquisitions. For example, if we get a $5 million order for D-VAR in semiconductor, we have the ability via NEPSI to get an additional 20% or $1 million in this case of additional revenue at similar margin in profit. When we look at the sales leverage in the mining and materials space, if we get a $1 million order from a mining project for NEPSI, we have the ability to get another $5 million from the leverage of Neeltran's product line.

This is five times expansion of revenues. I state the example with NEPSI first followed by Neeltran because that was the order in which we acquired the two companies and part of what drove us to like the potential sales leverage of both companies. You can reverse the example and see similar potential leverage for mining when comparing two semiconductor projects. For a mining and materials project that Neeltran would generate, say $5 million, we're able to expand those revenues by another $1 million from NEPSI, we are working to make those also be at similar margin levels.

We believe that we are almost through that. We have a handful of Neeltran projects we need to deliver on in our fourth quarter of fiscal 2022 which is part of the guidance. I have been asked about potential operating leverage and synergies between the operations that were acquired, and the historical business. My answer has been no up until now. The team has worked diligently on driving operational leverage between the business lines, we are seeing that now coming to fruition due in part to this leverage.

During the fourth quarter, we were able to tremble we expect to be approximately $5 million from our annual operational expenses beginning in fiscal 2023. This is expected to help us get better financial leverage from the business. We believe that this helps put us on a better foot forward financially. We discussed the impact of the Neeltran backlog on our financials. This is something we have largely worked through. And I want to reassure you that going forward, we feel very confident about prospective margins. With that, I'll move on to our ship protection systems.

In an age of increasing global tensions, we're helping to move U.S. Navy ships into the future by installing protection systems that help them stay hidden from our enemy's threats. Our ship protection systems or SPS provides a solution that masks the ship from harm's way, when an operation like stuff. We announced our fifth ship protection system contract for LPD-32 which has become the baseline design for the San Antonio Class Amphibious Ship Platform.

Right now, we are installing our first ship protection system on the USS Fort Lauderdale. This is something the Navy and our shipyard partner are monitoring closely. We are preparing to deliver on our second ship contract the USS Harrisburg.

We currently have orders for the USS Harrisburg, the USS Pittsburgh, the USS Richard McCool and the recently added LPD-32. SPS contributed nearly 10% of revenues in the third quarter of fiscal 2022 and has been a very consistent source of grid revenue for several quarters. Our team is focused on continuing to expand our ship protection systems into other end vessels while we install our initial systems.

As I have mentioned in the past, we are working on developing additional content that could be inserted in the future fleet. We hope to have some news very soon on our progress here. On our resilient electric grid or REG system in Chicago, it continues to perform very well. In fact, we received notification from the utility that the system met specify performance requirements, and as a result, we expect to see the return of a $5 million bond which was held until the REG system passed this important accomplishment.

The performance bond was structured as a letter of credit. This letter of credit is expected to hit our books during the fourth quarter of fiscal year 2022. We continue to see strong desire from this utility, as well as others to further deploy Reg into the power grid. It is clear at least to us that Reg offers the capability and functionality to solve some of the nation's current critical grid infrastructure problems right now. This initial project has provided tremendous learning and it's clear to me that utilities are thinking about Reg as a viable product.

Turning to wind, we are supporting Inox with the initial prototype of a three megawatt class wind turbine and Doosan with the initial wind farm of 5.5 megawatt wind turbines. During the third quarter of fiscal 2022, we shipped two megawatt electrical control systems to our partner in India Inox Wind. You can see that Inox was just over 10% of our revenues this quarter. The design certificate of the three megawatt class wind turbine prototype for the Indian market is complete.

We are now working on the type certification and hopefully will report back to you soon on our progress. Type certification means that the three megawatt class wind turbine will be able to connect to the power grid. It's worth noting that towards the end of 2022 Inox did announce the completion of a capital raise of about 15 billion rupee, which translates into something on the order of about $180 million.

We believe Inox is closer to expanding its business with the three megawatt class wind turbine this calendar year, which we expect will translate into an expanded order book for us. We hope to be reporting progress in the near future.

To conclude, we have built a diversified business that we believe is well positioned to capitalize on future investments in renewables, future investments in semiconductors, future investments in electric vehicles, and the mining of the materials that go into these three markets, as well as the defense business. We are driven by the opportunities that climate change, present to us, as well as the electrification of transportation.

Our products provide support to the grid at the power consumption point of the electric vehicle, as well as the operations that provide the metals and materials used to build the vehicles. We evolve from being a very concentrated business with both customer and market concentration to a more diverse business, all at the same time growing revenues.

We are focused on improving the financial performance of the business, continuing to deliver a diversified business and making progress towards our longer term priority of building a sustainable business. I think the team has done a terrific job of achieving this. We understand the broader geopolitical environment is mixed with uncertainty surrounding the supply chain constraints, inflation, recession, and stock market volatility.

When we look at our prospects, our sales pipeline appears to be strengthening, not weakening. Orders are becoming larger, not smaller. The types of markets we serve are becoming more diverse, less concentrated. So when I look at the near term, say the next year or so, I think our prospects are great. As we look ahead into the fiscal year 2023. I am optimistic that our recently announced backlog will result in a more diversified and financially stronger AMSC.

You can see from the backlog, and John's commentary on our operating models, that we are nearly there. We believe that our differentiated solutions and set of capabilities are a significant advantage that will allow us to serve our customers even more efficiently. I want to thank our team for their hard work and support. And I look forward to reporting back to you, at the completion of our fourth fiscal quarter and fiscal year end of 2022.

Gary will now take questions from our analysts.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Eric Stine with Craig Hallum. Please go ahead.

Eric Stine

Hi, Daniel, hi, John.

Daniel McGahn

Hi Eric, good morning nice having -

Eric Stine

Hi good morning. Maybe just on the Reg milestone if you're able to maybe some details on exactly what that milestone is. And, you know, potential read through to next steps. You know, I recently actually yesterday saw that Chicago and ComEd announced a pretty wide ranging agreement it included a lot of energy initiatives and grid investments. So curious, you know, maybe your confidence level or what type of visibility you might get that for this milestone into the next steps?

Daniel McGahn

Yes, I mean, to be blunt, my confidence is very, very high. I think you know, the good news about Reg is and we've designed the business in a way financially, the Reg is not necessary to meet, you know, our margin projections and kind of the near term financial aspects of the business. But looking at the longer term, this is a huge milestone for the company it means the systems performed as advertised.

It means that the utility has been able to work with their constituents, specifically regulators and all the local politics they have to deal with, where this is now a permanent part of the grid it has been accepted. The number of people that they brought there that work for the utility, the number of people that they brought there that work for other utilities has been staggering. Their efforts all along have been to look at this first project as a stepping stone to a future with superconductivity.

Everything that we see everything that we're told, everything we've been shown, leads us to believe that there's a very bright future for Reg in many, many cities in the country. This is a huge milestone for the company. I think the hardest challenge, though, is to predict or handicap over time, how will this progress? Utilities are notoriously slow. You know, negotiating contracts that we do today for any of our other products take a longer time than many of the markets that we serve.

But, you know, I think when we look back about embarking on to this product Reg, we really have met a tremendous milestone we have a system that's in the grid that's been accepted by the utility and expected - and accepted by, you know, all of their constituencies, which I think is huge for the product it means we really have a product we can go and sell going forward.

Eric Stine

Got it. And I can appreciate the lack of, you know, timing visibility. But if you had to handicap it, I mean, do you think especially given all of the parties that have come in and looked at this deployment? I mean, do you think that that second Chicago project is next or would you expect, you know, as you've talked about diversity and diversity of customer, would you expect it to potentially be another utility?

Daniel McGahn

I really can't handicap that - other than saying we're working in parallel with multiple cities right now on projects that solve compelling problems in the grid right now. And we see Reg as really the only solution, if they want to solve these in the near term.

Eric Stine

Got it, okay. Maybe last one, from me just appreciate the commentary on the breakeven given your backlog pipeline, and you know, the potential for quicker turn business. I mean, when you think about that breakeven number you think that you can get there, you know, on the grid momentum alone, with wind kind of in its current state, or when you get there, do you anticipate that wind would be a meaningful part of it as well?

Daniel McGahn

Yes, I think that's probably the question of the day. Eric, you nailed it. I think we have both paths open to us. I think obviously, if there's a rapid rebound, and when we get there much faster, meaning that that rebound comes or really almost there with the backlog today, right? So incrementally growing, the new energy part of the business is happening, if we can continue at the current rate, we've been bumping those orders, we're basically there. We have to deliver on it right, and we have to deliver it on time and on cost.

And we've been able to successfully do that throughout the business. And we've improved the Neeltran pretty significantly quarter-on-quarter with our operating efficiency capability. So, I think, when I look at this, I see the backlog. And I see the comments that John made about where the operating leverage comes from. And I think we already have the backlog to get there. I think time will be the, tell.

And I think certainly additional win would make it easier might make it faster. But it you know, today as we sit here, I feel better than I ever have, that we're now at the point where we're talking about potentially achieving these milestones, not in the next year, or two or three, but in the next quarters or a year or so. So we have a much brighter future right in front of us right now.

Eric Stine

Okay, thank you.

Operator

The next question is from Colin Rusch with Oppenheimer. Please go ahead.

Colin Rusch

Thanks so much, guys. Can you talk a little bit about the raw material impact on your margins? And what you're seeing in terms of the cadence of some of those lower raw materials starting to flow through your, through your COGS line?

Daniel McGahn

Yes, I think Colin, that the challenge for the business has is the rate at which we take orders and the rate of weeks we deliver them. So, for some products, we're out, we're booking orders as early as six months, maybe nine months, for many of the products, we're out a year plus at this point. And that compared to where the business was say a couple years ago, certainly has extended by at least a quarter or more for many of the product lines.

And that's a bit of the kind of constipation of the backlog. If I use that term so please don't write that, but I don't have a better language, is that we're kind of stuck with this backlog. We're trying to get it out. And the good news is, as we've priced in new orders, a new backlog as John said that those are as we model them going forward, that certainly margins that we - have hoped for and expected.

For material prices, specifically in John's commentary, we see a stabilization of those costs, which means now as we've priced in new orders, it's just the time it takes from when we receive that order to when we deliver on it and we're kind of in that cadence now in the coming quarters.

Colin Rusch

Okay and - that's helpful, I may ask some clarifying questions later. But next, I'm just curious about the bid activity. Obviously, there's a lot that's happened from regulatory perspective around capacity building, domestically. And so, I'd love to get a better sense of, how much sales activity there is and what your conversion rate is on what you've seen so far, I guess called over the last six to 12 months?

Daniel McGahn

I think, you know, the bid activity has exploded, I think the number of projects that we've looked at, certainly is at the highest point, since I can remember. So the prospects for the - business are greater than they've been, certainly in the past years. When we look at the order intake, we have been announcing today we close more than 40 million of orders last quarter.

When we look at the run rate of what we're just doing in new energy over the past three quarters, it's about 30 million, just for new energy, right. So then you got to add in what we're doing with the Navy, you got to add in what we're doing with wind as well. Is there any other commentary you want to talk about John? Is that helped Colin?

Colin Rusch

Yes, I'm just curious about the win rate in any delta around that?

Daniel McGahn

Well, the hard part we have with the win rate is most projects down [ph] and this is what we've done. You know, even with Neeltran and to some extent with NEPSI. We try never to compete directly. So the way we do it, it's a very early decision if we're going to win or not. And then it depends upon how the project goes forward is, we make things smaller and less complex.

And if we're able to design that in with the engineering company, which is usually the engineering procurement construction company, then we really eliminate a lot of competition. I wouldn't say all, but almost all. So we're - today in this version of the business, we're really never in the decision making by purchasing an engineer has made a design that requires our smaller footprint, which means that it's hard to go out and get an alternative.

So when we look at direct project win rate is extremely high, right. But to be transparent, there's a lot of work that happens in the quarters before even getting the order. We were trying to get designed and on the print, be it for a ship or for a substation. And really those are the two that we're focused on.

And the same techniques we use for the ship we use for the substation, which is how do we make it smaller, more and more energy dense? How do we add more feature function than what the alternatives are? And that's true across everything that we do.

Colin Rusch

That's incredible helpful. Thanks so much, guys.

John Kosiba

Colin, there are two indicators we're looking at is pipeline growth, which is Dan just highlighted. And we do, especially for the last year, as we had to address our prices based on the raw material inputs going up. We have been carefully watching our customers and making sure that we remain competitive and across the board and the businesses, there's no evidence to suggest that the bids we're doing are making us uncompetitive. There's, isolated pockets we're watching and we're concerned about whether there's a more competitive landscape to it. And but as of now, there's no...

Daniel McGahn

And that's actually going to happen we're much more focused on margin going forward, right. I mean, that's the thing that people need to hear is we're trying to grow the business, but we're trying to expand margins as well. And that means that and that's I think why Colin's get that the question is, well, now are you running up to a competitive pressure with this current pricing? We haven't seen it for the business that we want to take. And that's really, I think the key point we want to make today

Colin Rusch

Appreciate the detail guys.

Daniel McGahn

Sure.

Operator

The next question is from Justin Clare with ROTH Capital Partners. Please go ahead.

Justin Clare

Yes hi, thanks for taking our questions.

Daniel McGahn

Hi Justin.

Justin Clare

Hi Daniel. So I guess the first one here, the $5 million of annual savings that you expect from cost reduction actions, just wondering if you could talk through how much of that is expected to impact your cost of goods sold versus OpEx and maybe what the impact to you know, either R&D or SG&A might be?

Daniel McGahn

I can talk about the impact. John you want to take the financial part of it.

John Kosiba

Yes, so good morning Justin. The vast majority of this is going to be OpEx. We didn't break it down publicly, but what I will say is on the scale call it north of 75% will be OpEx related versus less than 25% will be COGS.

Daniel McGahn

I think from a capability standpoint. I'll reiterate paraphrase something I said earlier as we are expecting more content per ship from the Navy, which means that when that happens, that means we've met certain development milestones, which means unless we have something else to develop, those are not cost that we need to continue to carry. I think when we look at the substation type products.

We're at a point now I think we've learned a lot about the sales leverage. I think we're now going to demonstrate some operating leverage particularly in the back office. We need to continue to digest what we have, which means the need to go to develop something over the next quarters is very limited. So, but going forward, we still have the capability to be able to service our customers. We still have the capability to be able to make changes or make adjustments.

And we still have the capability to develop some new technology, which could translate into future products. But right now on our roadmap really is, we have to focus on the financial leverage that the revenue will bring. And that's the near term focus for the team. And that allowed us to take maybe a very different look at our operating expense.

Justin Clare

Got you, okay. Thanks - for the color there. I guess then, just on the gross margin here, so it looks like gross margins are expected to improve in Q4. Just wondering is a high single-digit number for the gross margin reasonable there? And then is the improvement primarily due to the Neeltran kind of lower margin backlog rolling off or are there other factors like a change in the product mix are where this Q4, where you're going to start to see some of these pricing actions that you've taken, you know, benefit the margin?

John Kosiba

So help [ph] with the second question, the first question, we don't guide the gross margin. So I want to be careful not to give too much clarity on that. But what I will tell you is the gross margin improvements in Q4 will be driven by all three of those right we said Neeltran, gross margins are going to improve. We do have a healthy expectation of D-VAR revenue in the fourth quarter.

So that's inherently going to help the mix. And then as we continue to ship backlog in particulars so far the NEPSI product line has the quickest lead times. And so the pricing that we've been able to implement at NEPSI will flow through the P&L the quickest. And so you're going to see it in all three areas, you're going to see pricing, improve the margin, you're going to see mix, improve the margin, and you're going to see the impact of Neeltran improve the margin. And that's just isolated its Q4, that's really what we're talking about as - and throughout FY 2023.

Justin Clare

Got you, okay. And then I guess just lastly, here. I wanted to understand the kind of cash flow, breakeven scenario and the model you're thinking about, I think I heard that it was $35 million in revenue with gross margins, near 20% but correct me if I'm wrong, so it'd be about $7 million in gross profit. And then, cash off exit say $7 million would get you to a breakeven? Is that the right way to think about it or are there different pieces?

John Kosiba

And I think, I think you might have misheard that part of the script. So what I said was, we see scenarios where gross margin can approach 25%. And we see operating and expense models closer to $9 million. So the breakeven is assuming a 25% gross profit with $9 million of cash on books.

Justin Clare

Got you, okay. Thanks for the clarification. I'll pass it on.

Operator

[Operator Instructions] The next question is from Chip Moore with EF Hutton. Please go ahead.

Chip Moore

Good morning, hi Daniel, John.

Daniel McGahn

Hi, Chip.

Chip Moore

How are doing?

Daniel McGahn

Great.

Chip Moore

Wanted to follow up on the sales leverage potential from NEPSI and Neeltran you did a good job of outlining that again, Daniel, I guess, just curious on that cross selling, how has that progressed but versus expectations better than you expected outlook looking forward?

Daniel McGahn

Yes, I think that's exactly what we're trying to get at, as we set an expectation we did this that we thought that these things would happen. Now we're seeing them, right. And we're seeing this specifically in semiconductor. And we're seeing them specifically in this new space for us the metals, mining and material space. The good news is when we look at semi, which is really a combination of D-VAR, and the offerings that we inherit from NEPSI.

Those today are at similar margin, which is great and that's what we had expected. When we look at the mining in the metal material space, which is the example we've been using for Neeltran, that's a combination in MC and Neeltran and I tried to do it both ways, depending upon how people think about it. Because as we looked at it, I did - in the prepared remarks, I looked at this we looked at it as a additional expansion of what we already have begun with NEPSI that we saw Neeltran kind of continuing on that theme with even greater lead sales like a trend.

But then I brought it back to just kind of compare directly those two markets and just we get $5 million of one, we'll get another 20% or $1 million of another. And we set all these things when we did the deals. And now we have in examples, and it's not one or two, it's quite a few of them in the backlog, the challenge, as I pointed out, and the challenge that everybody, obviously seeing here is, how do we have the backlog that we have on the books with Neeltran.

How do we digest that process and move to better priced higher margin our backlog. And that's really why we're confident today, in updating operating models, talking about breakeven, these are things we have not done in a couple of years, right, maybe three years. We want people to understand that John and I are highly confident, based upon our backlog. And based upon how we're usually able to deliver product at a pace, that if those things can both happen, we're not really far away.

Chip Moore

That's great color, great to hear, Daniel. And maybe another question with that strong backlog, the inventory position just continues to build, any way to think about working capital over the next call 12 months or so?

John Kosiba

Yes, so the inventory has built over the last year, some of its due just to the backlog growth. And some of it has been kind of some shipments. We do have a fair amount of shipments going out in D-VAR, this quarter, where we had some inventory build up to that. So the expectation is we should leave that project out of whip. And we should start to see that. On the working capital strain - this quarter and assumes we have some working capital.

So the guidance I gave you four to six, you know if you look, we got it to non-GAAP up six, you know, there's about a million and a half or so of depreciation. So, in theory would be closer to four and a half, I gave a pretty wide range because of working capital that could impact that up to $6 million or so. But moving forward after that I see working capital, probably in Q1, if it's negative in Q4, it's probably going to be positive in Q1, and it will net out to zero.

So I expect working capital to be closer to flat and have no impact just because the way our milestone structure is Q4 and Q1, we may have a little bit of swing from one quarter to the other. But that's already incorporated into guidance.

Chip Moore

Yes, that's perfect. And there might be that larger D-VAR project that pushed out last quarter, you still expect that to hit in the current quarter?

John Kosiba

That project is included in our guidance, yes.

Chip Moore

Perfect all right. Thanks very much.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Daniel McGann for any closing remarks.

Daniel McGahn

Thanks, Gary, I just want to wrap up by saying that we're a much broader and more vibrant company today than we were just a few years ago. We've been able to add new pieces of new markets. We've been able to manage pricing. We've positioned ourselves to grow. And we're hoping to see that start to pay off as early as next fiscal year. We think there's a series of tailwinds driven by climate change that are here in to stay and are pushing the business forward.

As I mentioned earlier, our pipeline is growing and becoming more diverse. Our order book has gone from delivering at a rate of $20 million in new energy power systems orders per quarter, to now delivering at a rate of over $30 million for the past three quarters. This is just for the new energy power systems. So our ability to convert that potential pipeline into actual orders is really starting to happen.

I think it felt great prospects for us as we look at 2023 and we're even looking at quoting products for delivery already in 2024. So we think the next years look very bright for the company. Thanks, everybody.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.