American Superconductor Corp (AMSC) 2004 Q2 法說會逐字稿

Good morning, and welcome to American Superconductor's fiscal-year 2004 second-quarter conference call. With us today is Greg Yurek, President and CEO, and Kevin Bisson, Senior Vice President and CFO of American Superconductor.

I would now like to turn the call over to Greg Yurek.

Thanks, Leo. Welcome to our conference call. In addition to Kevin Bisson, our Chief Financial Officer, I also have here with me John Howe, our Vice President of Electric Industry Affairs.

In our conference call today I'm going to provide some very brief updates on operations and some key metrics and benchmarks to look forward to, and then we will open up the session to your questions.

But first I would like to ask Kevin to give some highlights on the second-quarter financials. Kevin?

Thanks, Greg, and good morning everyone. (technical difficulty) results (technical difficulty) quarter, and our outlook for the remainder of the fiscal year. Let me provide the following guidance.

In our attempt to share information with you to provide insight to help you understand our business plan, we may use statements containing our beliefs, plans, and expectations, which constitute forward-looking statements. There are a number of factors and uncertainties that may cause actual results to differ significantly. Please also refer to our SEC filings and, in particular, Management's Discussion and Analysis for more information on these factors and uncertainties.

Now turning to our second quarter results, revenue for the second quarter was 9.6 million, which was 5.1 million, or 115 percent, higher than revenue of 4.5 million in the second quarter of fiscal 2003. It should also be noted that the 9.6 million in revenue for the quarter represented the second highest quarterly revenue number in the company's history. Strong year-over-year revenue growth is driven principally by our SuperMachines business unit, with continued progress on the 36.5 megawatt HTS motor program with the Navy that began in the fourth quarter of the previous fiscal year.

In addition, our AMSC Wires segment generated second quarter revenues that were more than six times the level recorded in the prior year's second quarter. Fueling this substantial increase was higher shipments of our HTS wire, as well as the ramp up of our power cable project with the Long Island Power Authority, or LIPA, which completed its first full quarter of work.

Revenue for the first half of fiscal 2004 amounted to 17.4 million, which was 10.1 million, or 137 percent, higher than revenue of 7.3 million in the first half of fiscal 2003. Similar to the second quarter, the first half revenue growth relative to the prior year's first half was due primarily to increased revenue from the 36.5 megawatt Navy motor program at SuperMachines, and increased wire deliveries and LIPA related revenue at AMSC Wires.

Orders received during the second quarter amounted to 4.8 million, which was nearly double the 2.5 million of orders generated in the second quarter of 2003. Order growth in the quarter was driven by Power Electronics Systems D-VAR orders from Scottish (ph) and Southern Energy, and Bendota Hills (ph), LLC, both of which were for connections of wind farms to the grid, as well as HTS wire orders from the European Council for Nuclear Research, or CERN, C-E-R-N, and also from a large generator manufacturer.

Backlog as of September 30th stood at 82.1 million. Of this amount, 23 million is expected to be recognized as revenue in the second half of this fiscal year.

Orders for the first half of this fiscal year totaled $22 million, which was significantly higher than the $5.3 million of orders generated in the first half of fiscal 2003. In addition to increased orders for HTS wire, the Long Island Power Authority power cable contract was a sizable contributor to the first half's order performance.

Operating loss for the quarter of 6 million was 4.5 million, or 43 percent, favorable to the operating loss of 10.5 million in the second quarter of fiscal 2003. The smaller loss between quarters was spearheaded by the second consecutive quarterly profit for the SuperMachines business due to continued progress on the Navy motor contract, as well as a significant reduction in the losses generated by AMSC Wires due to higher year-over-year product revenues.

In addition, as we announced early last quarter, the company in July implemented approximately $5 million of reductions in its operating and capital budget for fiscal 2004 -- primarily through the elimination of 34 positions, including a reduction in force of 23 employees, or 8 percent, of the workforce. Reductions were also made in controllable expenses.

The company achieved its planned cost reduction targets in the second quarter, and is on track to achieve the $5 million target for fiscal 2004.

Operating loss for the first six months of fiscal 2004 was 14.4 million, which was 7.3 million, or 33 percent, favorable to the operating loss of 21.7 million for the first half of fiscal 2003. Similar to the second quarter, the smaller first half losses this fiscal year compared to last year stem from the return (ph) to profitability this fiscal year at SuperMachines due to the Navy motor contract, and higher HTS wire shipments and LIPA-related revenue at AMSC Wires.

Net nonoperating expenses of 1.3 million in the second quarter derive mainly from $1.4 million of various fees and expenses in connection with a previously disclosed debt financing transaction that was abandoned during the second quarter in favor of a public equity offering. None of these expenses relate to the press release issued yesterday concerning TM Capital.

Undoubtedly, many of you may have read this press release issued last evening announcing that the company had received notice yesterday afternoon of a lawsuit filed against it by TM Capital. Our business relationship with TM Capital, who we engaged to provide financial advisory services that led to a proposed debt financing transaction, was terminated on August 22nd. Their lawsuit alleges that they are entitled to a transaction fee related to the company's successful public equity offering. Specifically, they allege that they are due compensation -- cash compensation of $1.6 million, plus warrants to purchase over 170,000 shares of the company's common stock at an exercise price of $9.50 per share as part of the company's decision to not pursue the proposed debt transaction and instead, complete a public stock offering. The company believes it has meritorious defenses to this lawsuit, and intends to defend itself vigorously.

Turning to the bottom line for the quarter, net loss for the quarter was 7.3 million, which was 2.9 million, or 28 percent, favorable to the net loss of 10.2 million in last year's second quarter. Net loss per share for the quarter of 34 cents per share, which included 6 cents per share of non-recurring expenses associated with the abandoned debt transaction, was 16 cents per share favorable to the 50 cents per share loss generated ins last year's second quarter. Net loss and net loss per share for the first half of fiscal 2004 was 15.7 million and 73 cents per share, respectively. Both amounts compare favorably to net loss and net loss per share of 21.1 million and $1.02 per share, respectively, for fiscal 2003.

Turning to the balance sheet. The company ended the second quarter with 8.8 million in cash, cash equivalents and long-term investments, which was 3.3 million lower than the $12.1 million balance at June 30th, 2003. The company's cash burn in the second quarter was the lowest quarterly cash burn in the last 14 quarters. The net loss of 7.3 million for the quarter was offset primarily by $2 million in non-cash depreciation and amortization expense, as well as lower working capital of 1.7 million.

No doubt, most of you are aware that, following the end of the second quarter, the company issued 5.7 million shares of common stock in a public equity offering that raised $51.1 million, after deducting for underwriting commissions and discounts. This infusion of cash not only improved our liquidity and strengthened our balance sheet but also provides us the financial flexibility to execute our business plan as we strive for consolidated near-term profitability and cash flow generation.

For the full year, we reaffirm our revenue guidance for the company to be in the range of 45 million to 50 million, with roughly half of that amount deriving from our SuperMachines business. In addition, we reiterate our net loss guidance for the year to be in the range of $22 million to $27 million. With the inclusion of an additional 5.7 million shares from our public equity offering in October, we have updated our loss per share guidance for fiscal 2004 to be in the range of 90 cents per share to $1.12 per share.

Before I turn it back to Greg for his remarks, I'd like to remind everyone that, consistent with our prior earnings conference calls, during the question-and-answer portion of the call, we suggest that you ask only one question at a time. If you have an immediate follow-up question to clarify our response, we will be happy to answer that question as well. Otherwise, we ask that you return to the queue if you have more than one question in order to allow as many people as possible to participate in the question-and-answer session.

Thanks, and I will turn it back to Greg.

Thanks, Kevin. I'd like to provide some brief highlights and specific guidance on each of our businesses. And I will start with the AMSC Wires business.

Since we began production of HTS wires in our new factory in Devens, Massachusetts, we have received a significant amount of new wire orders. Specifically, we have received orders for over 700,000 nears (ph) from 21 customers in nine countries in the nine months that ended September 30. It is clear to us that the new HTS industry could not really get underway until a commitment was made to commercial volume production of the core product, which is the wire. It is gratifying to receive this confirmation in the form of a significant ramp up in wire orders since January.

I would like to turn to revenue guidance for the AMSC wires business unit. We are maintaining our previous guidance for fiscal 2004 revenue for AMSC wires at $10 million to $12 million. We recognized about 3.5 million in revenue for the first six months of fiscal 2004, and as of September 30th, we had about 5.8 million in backlog that is shippable in fiscal 2004. Thus, as of September 30th, we have very good visibility to a total of about 9.25 million in revenue for fiscal 2004, or about 92 percent of the low end of the $10 to $12 million range.

I will now provide you with some AMSC Wires benchmarks to watch for during the remainder of this fiscal year. First, watch for AMSC Wires to close at least one additional wire order for a cable project this fiscal year, which will bring the total to four wire orders for four separate cable projects in fiscal 2004. We already have the wire orders for the Long Island cable project, a Chinese cable project, and a wire order for a small cable demonstration in Mexico.

Watch for AMSC Wires to achieve at least $10 million in revenue this year, an increase by a factor of about 2.5 over last fiscal year. In the fiscal year, we expect AMSC wires to increase the average electrical performance of its production wires from 140 times that of copper wires of the same dimensions to more than 170 times that of copper, a key additional step in enhancing the competitive position of AMSC wire in the marketplace.

Finally, a key benchmark for fiscal 2004 will be the demonstration of small electromagnetic coils made with second-generation wire. These coils will be the next significant step in device demonstrations beyond the 1-meter cable conductor that was demonstrated with our 2G wire earlier this fiscal year. Our progress on 2G wire scale-up has been significant, and it is now time to turn to practical device demonstrations using this wires in order to continue to create the pathway to commercial success with 2G wire.

Let me moved now to our Power Electronics Systems business. This business (technical difficulty) is responsible for the development and sales of our power module, power electronic converters, and the assembly, test, and sale of our dynamic VAR, or D-VAR, integrated power electronic systems. D-VAR systems are dynamic reactive power grid stabilization products that are used for increasing the reliability of power grids, thereby preventing power blackouts.

We are maintaining our revenue guidance for the Power Electronics Systems business at $10 million to $12 million in revenue for fiscal 2004. As of September 30th, halfway through the fiscal year, Power Electronics Systems has recognized about 2 million in revenue, and as of September 30th, it had an additional 2.1 million in shippable backlog for fiscal 2004. Thus, we have very good visibility to about 40 percent of the low end of the targeted revenue range for Power Electronics Systems.

Based on the level and quality of the customer interactions that we are experiencing in Power Electronics Systems -- which is the best that we have ever experienced in this business -- we expect we will close orders this quarter and next, and will ship product to customers that will allow us to achieve our revenue goal for this year.

We are currently actively engaged in addressing over $80 million of new business for D-VAR systems, and we expect customers to make buying decisions within the next weeks to six months on this (ph) business of $80 million. We note that we have -- that we had half that level of customer interactions and quoting a year ago, so business activity has definitely ramped over the last year.

We expect, based on our track record of having won about 90 percent of the power electronics systems sales in North America over the last three years, that we will win a good share of this new business. In fact, based on customer indications, as of today, it would not be unreasonable to expect Power Electronics Systems to close several additional D-VAR orders this quarter.

The key benchmarks to watch for in our Power Electronics Systems business include -- near-term orders from multiple customers, and second, achievement of the targeted revenue range of $10 to $12 million.

Finally, I will turn to our SuperMachines business. This business is responsible for the development and manufacture of large superconductor rotating machines. In fact, this business is the dominant supplier of such rotating machines worldwide, and this includes -- rotating machines include ship propulsion motors and generators and dynamic synchronous condensers for grid reliability.

During the second quarter, SuperMachines delivered the first 5 megawatt HTS ship propulsion motor to the U.S. Navy. This motor has undergone successful factory testing, and is now in land-based testing at a Navy-designated test site. We are currently working with about a half a dozen potential customers for 5 megawatt class (ph) ship propulsion motors, and expect to receive our first order for such a motor within the next six months.

This business is also responsible for the development of sales of a new reactive power grid reliability product called SuperVAR dynamic synchronous condensers. SuperVAR rotating machines are based on the same product platform as our HTS ship propulsion motors. They are installed in electrical substations to provide instantaneous dynamic reactive power, to ensure high reliability of transmission grids, and to increase power throughput of existing transmission infrastructure.

This week, we shipped our first SuperVAR machine to TVA for installation in a substation near Nashville, Tennessee. After evaluation of this first machine, we expect to start production of the first commercial SuperVAR machines, which should start within the next twelve months. As you know, TVA has already given us a purchase order for the first five production units.

Our revenue guidance for the SuperMachines business remains the same -- $24 to $26 million for the year, based primarily on our contract from the Navy to design, build, and deliver a 36.5 megawatt ship propulsion motor by March 2006.

The key benchmarks to watch for in this business include the following -- first, achievement of the revenue targets, which would be an increase in revenue by over a factor of four compared with the revenues for this business last year; second, a first order for a 5 megawatt class ship propulsion motor for commercial application; third, successful operation of the first SuperVAR machine in the TVA grid; and four, watch for this business to generate at least $1.5 million in cash by March 31st, 2004. This business will remain profitable for the remainder of the fiscal year, and will generate cash.

In conclusion, we are on-track to achieve our targeted revenue range of $45 to $50 million by March 31st, 2004 with the contributions from these three separate business units.

I want to thank you for your attention. And now I would like to open up the session to your questions.

(OPERATOR INSTRUCTIONS) Bill Benton, William Blair.

Hello, Bill.

It appears that he has disconnected. Jarett Carson, RBC.

With regard to the energy bill -- and it's still kind of kicking around -- anything there that you see that could maybe push things off a little bit potentially? Or where do you see things firming there?

Well, the energy bill is an interesting saga, isn't it? Ethanol taxes and so forth and so on -- I'm sure we're all reading about in the paper. I won't try to predict when the energy bill gets passed. I guess the latest is perhaps this fall -- before Thanksgiving, even.

The reason we are interested in the energy bill is a part of the bill called the "electricity title." And within the electricity title, we understand -- although this thing is within a cone of silence, so nobody knows for sure. But in that electricity title, we understand that a key feature of that is called something called the power delivery research initiative. (technical difficulty) that would be significant dollars being spent specifically on superconductor solutions for the power grid.

Now we haven't planned that into our near-term revenue. So, if it comes, that's fantastic. I'm sure we're in a very strong competitive position to tap into that.

In parallel, I think people should be knowledgeable and understand that there is a separate energy and water appropriations bill -- again, it's separate. This would be for the DOE budget. And this year, it looks like they're going to come out with a separate line item for superconductivity. And both the President, the Senate, and the Congress agree on a number of around $48 million for this. So no assurances that that's what the actual number will be coming out of conference. But it seems to be good agreement.

So those are separate, parallel tracks. The energy bill gets passed, it seems highly likely the electricity title of that bill will contain provisions that will be highly favorable to American Superconductor. We will have to wait and see.

Jim Ricchiuti, Needham and Company.

Kevin, I wonder if you could give us some more detail on the P&L, just in terms of operating expense, SG&A and R&D?

Yes. Jim, basically what we are looking at for the quarter was R&D of roughly 3.1 million. SG&A came in about 2.4 million, and gross margin was around a negative a half a million.

And the expense, the non-recurring expense -- so you would expect, going forward -- I'm just trying to see where that expense hit you in the --?

In other expense, below the operating line.

Peter Paterson (ph), Green Mountain Investments (ph).

Congratulations. Just addressing, for a moment, the potential market for the SuperVAR business. What's the size of that market?

Well, the utility industry is telling us some very, very big numbers there, Pete. It's -- I guess a variety of different ways you can cut this thing. If you look at some 35,000 substations, electrical substations in the United States, and take about 10 percent of that for -- that would be outfitted with SuperVAR machines, that would be about 3,500 substations. You think the average selling price is somewhere in the million (multiple speakers) dollar range. That's a lot of sales for SuperVAR.

A variety of other ways you can look at that, but you'd basically come out to about the same amount. And by the way, I am actually talking about some of the utilities. What they are telling us is -- it's thousands of units per year -- per year.

So we're obviously very excited about this new product. We shipped it yesterday. You should be able to see a picture of this on our web site. So if you go to our homepage, amsuper.com web page, you are going to see a picture of this SuperVAR machine. So take a look at that. It just got shipped this week. And we are expecting that it's going to go successfully through its evaluation period. And we are talking with other utilities beyond TVA here for additional orders. So I think this is going to ramp pretty fast.

Thank you. Congratulations, again.

Michael O'Brien, Osco Graf (ph).

I had just one question. Realistically, how long do you expect the TVA (ph) evaluation of the first SuperVAR machine to take?

The evaluation?

Yes.

They said officially, 6 to 12 months. And --

What's your guess?

(laughter) I've never seen a group of utility guys as excited and as anxious to move forward as these folks from TVA. And by the way, some of these are involved in the blackout analysis team here for the NRC (ph) and the Department of Energy -- the Canadian/U.S. joint task force.

This is highly unusual for utility guys -- I hope there are none on the line. I wouldn't be surprised to see it come in less than that. But ultimately, we have to be cautious with utilities. They tend to be slow in their -- in actually moving forward. So you know -- four months, six months would be the short side.

Robert J. Smith (ph), Center Floor (ph) Performance Investing.

I was wondering if John Howe could give his assessment of the Wall Street Journal article about the energy bill that appeared a couple of days ago. John, are you familiar with that article?

Yes, I did see the article, and it is not surprising. This was the article that highlighted the fact that the states seem to be split on the future of standard market design. What we actually -- just my personal perspective is standard market design is going forward in several regions of the country. These issues are going to be sorted out. But it looks like the direction that is being taken will allow regions to opt into standard market design rather than mandating it. So I don't take quite as negative a view on the outlook for these reforms as you might have drawn simply from the headline.

But just -- but beyond that, the reality is -- I don't think that that article really goes to -- it does not undermine the basic business that we're in. Utilities are ramping up their investments in transmission at this time. And there's no question that in the wake of the recent blackouts, they're being spurred to make investments, particularly in the kinds of technology where we already have a strong position with D-VAR, for example.

That's encouraging, because it seemed -- the article seemed to suggest that nothing much would be done till the beginning of 2007. But that's not the reality?

(multiple speakers) And there's two separate items here, Bob. Standard market design -- SMD, as they call in the industry -- is going to happen -- as John said, it's already happening in some places in the country. But it doesn't undermine the current sales ramp that's currently in transmission grid products -- totally separate from it.

And by the way, SMD is totally separate from the components of the electricity title that I was mentioning in an answer just a bit earlier, which we see as upside potential for our company if it does come through.

So there's a lot of things going on in parallel paths. And you have to be able to, I think, sort those out.

Thanks for the clarification. Good luck.

Jim Ricchiuti, Needham and Company.

Greg, as you look at the business you are pursuing in -- at PES, you talked about something along the lines of north of $80 million. There is some seasonality, it appears, to that business. And I mean, you talked about the potential for some orders this quarter. But as you look out, given the utility customer base that you're pursuing, do they need to have these systems in place by going out to the early part of summer? In which case, would you expect an acceleration of orders in Q4?

Well, yes, it is seasonal. It has been seasonal. I will tell you in a moment why I actually think that's going to smooth out as we go forward. But it's still been a lumpy business this year.

Seasonality with respect to the North American market has to do with getting systems in place in substations by the summertime -- and usually, typically in the spring, so they're up and operating for the peak load summertime period. So for example, last year, we got a rush of orders in our fourth quarter. We had built an inventory. We were able to turn those around and ship them out the door by March 31st. And we had a great quarter, a record quarter for Power Electronics Systems sales.

The good news is we got them out the door fast and we depleted our inventory. We started the new year with almost no backlog. So it's been a slow start for the first half of this fiscal year with no backlog buildup.

So there's the seasonality factor. I remind people that when it's winter here, it's summer down in South America and South Africa and so forth. And we are addressing customer opportunities actively, right now, in those regions. So, eventually that will smooth out.

The other factor that is starting to show up -- and I think I've mentioned this before. I never thought wind farms would really catch on. But, lo and behold, they truly have. It is a huge, growing market. A lot of big companies like GE Power Systems are actively engaged -- Adestis (ph) from Europe and so forth. The two orders we got in September were for wind farm applications. And I wouldn't be surprised to see us get a couple of more orders this quarter for wind farm applications as well. So that would be kind of ahead of the curve in terms of the summer of 2004, because it's a separate market opportunity.

So this year, we're still experiencing the lumpiness, the seasonality. I think we're going to start seeing that smooth out over the next year and going forward. But it's part of the package this year. Because of the large quantity -- again, it's more than doubled here in terms of the customer activity and business we are addressing -- I wouldn't be surprised to see us enter the new fiscal year with some healthy backlog in place. So I'm looking forward to getting into that situation as of April.

Okay, and Greg, I have one follow-up to that. The large increase you are seeing in the interest level -- has that been in the wake of the blackout of August 14th? Or is this something that's been building through the summer prior to that?

Yeah, I think the good news is it's -- the $80 million is almost entirely pre-blackout. In other words, these are -- this is part of the buildup that John Howe just mentioned in transmission grid investments that has been going on anyway. There has clearly been an increase in intensity level post-blackout -- not just, by the way, the U.S. blackout on August 14th, but the huge blackout in Italy that came about a month later.

So a lot of interest, a lot of activity. We're turning down opportunities to do transmission grid analysis. We can't handle them all, quite frankly. The pipeline is definitely filled at this stage. And we're looking at what we have to do to expand our capabilities to address the new opportunities caused by the blackouts.

Robert J. Smith, Center Floor Performance Investing.

Greg, I was wondering -- what is the subsequent step to making coils for -- from 2G wire? What is the step after that?

Well, I think, Bob, it's going to parallel our experience with the first-generation wire. I mean I think we are the most highly experienced company in manufacturing high-temperature superconductor wire in the world. And we were the first to have the wire, and we were the first to make electromagnetic coils. So you have that a pan itch (ph) in a sense.

So I think we're going to see a parallel. But what we did with first generation wires -- we built the first small coils, found out they worked, found out what the problems were. We've addressed those. It's quite clear that the same technology and manufacturing capabilities we have developed for first generation directly apply to second generation. So we've actually got a bunch of barriers already behind us in that sense.

We will build the small test coils. We'll report on them in various venues. We'll be using that to show the data to customers -- potential customers for our wire. And we'll start ramping up our sales of second-generation wire.

As we said before, there was going to be limited quantities of 2G wire over the next 1, 2 years here. We don't expect to do any significant investment in pilot scale (ph) for probably a good twelve months from now. There is enough that we can do with the development scale wire production we are doing, which will include these small devices -- these electromagnetic coils. Get them in the hands of potential customers and then start building some larger coils -- either ourselves, if we have to -- but I think our customers are going to take up the banner not too long from now.

David Hurwitz, SC Fundamental.

Just a quick question. Versus last quarter, it looked like your new orders were down a bit and your backlog was down a little bit and wire sales were down a bit as well. Can you just walk through each of those?

Yes, the backlog was about 17 million last quarter -- I should say, the first fiscal quarter. And a lot of that had to do with the Long Island Power Authority contract that was signed. And obviously, that was a significant chunk of it. I don't think that we believe that we could replicate that level of orders going forward.

But again, as I pointed out in my remarks, the orders for this quarter were significantly higher than in the prior quarter -- prior year's quarter, primarily because of the Wires business. So I think we are seeing some healthy order growth. And I think Greg alluded to the fact that during the first nine months of this calendar year, we've had 700,000 meters of wire that's been ordered versus 20,000 meters of wire ordered in the nine-month period ending December of '02. So I think we've shown some fairly significant progress in order growth from the Wires business. And I didn't catch your second part of your question.

I think that was it. It was new orders, backlog, and wire sales. I think you covered it all. Thank you.

Harry Adler (ph), private investor.

Is Detroit's goose cooked, and is that the cooling problem that they had -- is that an isolated situation? Or is it something that has to be solved down the road?

You're asking about the old Detroit Edison cable project. Again, that ended some time ago. I think it was the summer of 2002 when that project ended. They took out to cables. They were playing with still (ph) one of them in the substation several months down the road. They stopped doing anything with that cable, as well.

The answer to your question about the cooling system -- it's really the -- as they call it, the cryogenic envelope, or the cryostat -- it's kind of like a thermos bottles along the length of the cable. Yeah, that was clearly an isolated case. Out of the half-dozen other cable demonstrations, both laboratory and field tests, that occurred in the '96 to 2002 period, that's the only one that experienced leaks in that thermos bottle, that cryostat.

Clearly, the utilities and other, you know, customers for power cables, HTS power cables, have not let that slow them down. I mentioned we have orders for wire for three different cable projects -- LIPA, Long Island Power Authority, being one of them here. I mentioned Mexico. China. There are some other -- seven or so cable projects that we know about that are getting started up and should be going -- cable installed in 2005. None of these are being held up because of the cryostat kind of problem. So it was an episodic sort of thing, and we are moving forward.

Jim Ricchiuti, Needham and Company.

Greg, can you comment on the yields that you're seeing in the Wires business? And just how satisfied are you with the progress you're making in the area, particularly as you look out into the second half of the fiscal year when you expect the wire shipments to accelerate?

Yes, Jim, I have -- had a board member that always said to me, however long you think it's going to take to start up a plant, multiply by pi. And we actually did that when we started building this plant back in 2000. We've got our best plan and then we multiplied by some factor.

So it covered a lot of the ground. However, during this startup, and we talked about this in the previous two earnings calls, I believe -- but you find problems that you simply don't anticipate. For example, we found where we specified stainless steel for a heat treatment furnace, the vendor put in carbon steel, and it of course corroded and created contamination. You have to find that, and then you have to clean it up. We found other contamination situations. We've found bottlenecks that, in the process, that we didn't think were going to be bottlenecks. And so, you know, you address those things.

So to answer your first part of your question -- it has not gone 100 percent smoothly. It never does. And this is no exception, I guess. But they're all problems that are directly addressable. You have a -- they're cleanup problems. They're stupid things, I call them, sometimes. And you find them, you clean them up, and you move forward.

So we're moving ahead. We've increased our capacity in the plant. We are pushing this in many different ways, seeing how much we can get -- without putting in more capital equipment, by the way, although we do plan to spend more on capital equipment over the next 18 months to relieve some bottlenecks.

So we're moving forward. And we believe we're going to be meeting most, if not all, of our customer expectations. We're sticking with our revenue guidance -- I guess that is the bottom line -- of this $10 to $12 million for the fiscal year.

Mark Plunkett (ph), Atlas Capital.

I just had a quick question on the cash flow front. I know the forecast was for 15 million in cash flow burn, maximum, this year. Does that imply about a 4.7 million for the second half of '04? Am I looking at that right?

Yes, we've had a little over $11 million of cash burn through the first half of the year. Obviously, to get to the 15, we are expecting cash burn to be reduced in the second half versus the first half.

I think what's driving that is two things. One is obviously, as our revenue guidance points out, we are looking at a sizable ramp up in revenue in the second half of the year versus the first half of the year, which we expect will continue to reduce the level of losses that we've shown sequentially over the last couple of quarters. And that will obviously enhance our cash burn position.

And also we'll continue to, as we say, religiously look at cap-ex. And although we have had working capital reductions in the first half of this year to the tune of about $2.3 million of cash contribution from working capital reductions, clearly that's going to -- that trend is not going to continue in the second half with the ramp up in revenue.

But we think that we can control it to a point where the $15 million cash burn for the year is attainable. It is not -- clearly, we think a reasonable but aggressive goal. And we're committed to hitting it at this point.

And do you have any goals for cash flow -- doing (ph) cash flow positive in the other businesses? I know you didn't -- you guys are in the SuperMachines.

Yes, I think clearly the next business to get to the cash flow positive is Power Electronics Systems. I think we've said in prior conference calls that the Power Electronics Systems business essentially, we believe, gets to profitability and generation of cash at an annualize revenue of about 16 million. So I think we are not there yet. Obviously, our guidance for this year doesn't get us to that level. But we think going into next year with the momentum that Greg had talked about earlier, we see that business to getting cash flow positive, probably in the fiscal '05 or calendar '04 time frame.

I think beyond that -- it's several more years out before the Wires business becomes cash flow positive.

Eric Prouty, Adams, Harkness & Hill.

Kevin, a quick question for you. Just -- obviously, we are only halfway through -- a little more than halfway through the fiscal year, but can you give us any visibility into '05? How much of your remaining backlog is set to ship in '05? And obviously, any visibility it sounds like is determined on your conversion of the pipeline on the Power Electronics side, but what do you at least have in hand now that will be shipping in fiscal '05?

Well, as we said, we had 82 million of backlog as of the end of September. And we said 23 million, we expect, of that backlog to be shippable in the back end of this fiscal year. So you do the math, that's around $50 million, so to speak, or 55 million that we think -- we believe will be shipped -- not all in '05, I mean it's also in '06 as well.

I think the visibility from our perspective into '05 is fairly good on the SuperMachines business in terms of replicating at least what we have this year.

And I think that going forward, you know, on the Wires business, we, you know, a portion of that 55-odd million is the Wires business. Obviously, the one that we have the least visibility to is Power Electronics Systems because of the -- more of the commercial nature and the order patterns that we are seeing at utilities.

But I think, again, as Greg pointed out, when you look at the $80 million of potential order opportunities out there, I think it bodes well for potential buildup of backlog by the end of this fiscal year to support a higher level of revenues in Power Electronics Systems next year versus this year.

So, I don't want to go too much into '05, yet. We're still trying to make sure we're sizing up '04 and achieving our objectives. But I think the point here is that we've got a fairly nice backlog to support increasing revenue growth into '05 and beyond.

Kevin, could you -- you know, again, we're not looking for any forward guidance, but just -- SuperMachines, it sounds like, kind of the same run rate, probably primarily around the Navy contract. I mean, do you have a dollar figure on -- for HTS wire, what's supposed to -- what's already committed to ship in now fiscal '05?

It's -- I don't know if I want to get into that, yet. I think it's -- I think maybe by the time we have this call next quarter, we might be able to talk with a little more visibility. I think -- it suffices to say that we expect revenue in the Wires business to be up from this year's level. But I'd prefer at this point, Eric, if we wait another quarter before we have a little more visibility into that.

Sure. Definitely. Fair enough. And then, Greg, just a quick question on competitive positioning of the D-VAR systems -- obviously a fairly unique product. Who are the other people generally are you bidding against?

And then -- I guess as compared to some past products, what is the greater value proposition of the D-VAR as compared to, say, the older D-SMES product? Is it just a lower-cost proposition?

Well, let me start with that last point. A D-SMES is actually a D-VAR with a superconducting storage device plugged into it.

That's right.

Okay, so you know, it depends -- let me go and do the grid analysis. Every grid -- and in fact, every part of a big grid, are different. If you go to a TVA, you know, one place they've put in D-VAR -- we're quoting in other D-VAR opportunities for them. Another part of the grid, the SuperVAR is a better solution.

So each grid is different. Each part of a grid is different. You've got to do the analysis. You know, and in some places, you need a D-SMES. You need some real power in addition to that reactive power. So that's why D-SMES remains part of our product line, by the way.

The ASPs for these D-VAR type products run from a D-VAR light (ph) -- somewhere like 400,000 -- up to 1.8 million for a D-SMES. So clearly adding the superconducting storage device adds more cost. I'm not sure that that is the driving factor in buying decisions, although it is always somewhat of a factor.

So, I guess, Eric, I was coming backwards on your question. I think I may have missed the first part of it. What was that first part, again?

The first part was just kind of competitive analysis (multiple speakers) who are you guys bumping into (multiple speakers) against on the products?

Yes, sorry. The competitors are pretty darn consistent. We're typically competitively bidding against ABB out of Europe, of course. Mitsubishi Electric out of Japan, and then there's a private company out of Chicago called S&C Electric out of Chicago.

So invariably, we're competitively betting against one, or in fact, all three of them. I mentioned a percentage -- in the last three years, since we first started installing reactive power devices in the grid in July of 2000, we have installed some 18 units in the North American grid. And there's only two other -- two that -- competitive bid processes that we have lost, one to Mitsubishi, one to ABB during that period of time.

So competitive position has been pretty darn strong, I would say. I think the key reason is that our solution is a dynamic reactive power solution. It has overload capability that the others do not have, and quite frankly, the pricing is right. We're making very good gross margins on this product. We're not giving them away, but still, we're very price-competitive compared to the competition.

Brad Heinrichs, private investor.

I had a quick question. I've been a long investor since 1999, and saw the whole California crisis, where I thought the SMES and D-SMES would sell there. And hopefully, now, with all the attention on the regulatory environment, we'll get some of the going through.

I don't have a sense of what the foreign regulatory environments are, since that has been the biggest governor or obstacle as far as American sales go. I wonder if you or John could give a quick sense of a few of the regulatory environments over in Europe or Mexico, what have you?

Yes, I will start out; John may add something to this. In '99, I think it was February of 1999, they started deregulation of the European market. And they started with the largest power users that could select their source of electricity. That continued over time, and they've broken it up to larger and larger number of users of electricity.

I think when you look at the Italian blackout that occurred here recently -- 57 million people without electricity in the entire country of Italy -- had to do with a couple of factors. One was the way they're trying to interconnect between countries in an open market, now, and well, the connections are weak. I think that provides a tremendous opportunity for our very low impedance, or VLI, superconductor cables that we're bring into the marketplace. The other part is that Italy went down because of a low reactive power content. When they got a voltage disturbance, reactive power caused the problem.

Now I bring all that up because Europe for a long time has said, you know, we don't really need new technologies because we have such a strong grid and so forth. But that was all pre opening up of the market, pre-deregulation. And what they are now finding is that they are trying to trade power and move power around -- they are experiencing new problems.

By the way, the other thing in Europe is that they also never believe in air-conditioning. And, you know, we don't believe in air-conditioning, and -- turn yours off -- (laughter) all sorts of complaints. Well, they are now putting a lot of air-conditioning in. And Italy, in particular, with this very hot summer this last year, the installation rate of air conditioners has gone way up.

Air conditioners suck reactive power out of the grid. And if you don't put it back in by some other source like a D-VAR or a SuperVAR, you are going to go down.

So a lot of factors come into play here. Japan -- also going through deregulation. They're also starting to realize that their grid may not be as strong as it needs to be in a more open market.

John, I don't know if you want to comment further?

Yeah, just a couple of points that I would add to what Greg has said and that I certainly agree with. If you look on a worldwide basis, notwithstanding what happened in California a few years ago, most regions of the world tend to be moving in the direction of more open markets in order to attract capital into this industry. So although there was certainly the major hiccup with the way deregulation was very badly introduced into the California marketplace, we expect that we're going to -- that this trend toward open markets is going to continue and is going to drive different patterns of investment in the energy sector.

I would bring your attention to a new report that has come out from the International Energy Agency just this week. There is a lot of concern about where investment capital is going to come from for the energy sector over next 20 or 30 years. People are well-familiar that we need additional investment in oil and gas, for example. The IEA report highlights the fact that the vast bulk of investment that is expected to be necessary in the next 30 years is going to be in the electricity sector, because worldwide, the economy is moving toward an electricity basis. This is going to drive a tremendous need for electricity infrastructure.

Ron Vinucci (ph), Wachovia.

Are you aware of any additional tax incentives for utilities that are built into the pending energy legislation?

Well, there's a lot of discussion about that -- again, earlier versions that we have seen had some of this in -- tax incentives for -- and particularly new technologies being brought into the grid to stimulate their use to improve the performance of the grid. The cone of silence that has gone around the energy bill and the electricity title part of it has been virtually impenetrable at this point. So I don't know if that has survived or not. John, you have any other comments on that?

I know there -- utilities have been interested in getting a change in the law that would provide accelerated write-off for transmission assets. I think it's very clear that, both in the House and Senate, there is not an appetite to provide accelerated write-down for existing transmissions. So to the extent there is any new provisions for accelerated write-down, it would apply to new transmission investments only.

I think that's certainly an important feature. Obviously, having to write-downs transmission assets over a prolonged period of time has been one of the major factors that has deterred investment in the last several years, because people didn't know where these assets were going to end up.

But once the rules become clear sometimes over the next few years, I think everybody's agreed. There's no question. We're going to need to put a lot of investment into the grid.

Although this issue has been delayed for several years, actually, that has not been -- that has not affected us, I think, adversely, because from a long-term perspective, we have used this time to develop many new solutions that are going to be fully ready for market as the rules of the game become clear.

We have time for one more question, perhaps.

(OPERATOR INSTRUCTIONS) And it appears we have no further questions. I will turn the program back over to you.

Well, thank you very much for your attention and your good questions today. We appreciate your support, and we look forward to speaking with you on the next earnings conference call. Thank you.

This concludes our conference call for today. You may now disconnect your lines, and thank you for participating.