American Superconductor Corp (AMSC) 2007 Q3 法說會逐字稿

Welcome to American Superconductor's third quarter fiscal 2007 conference call. All participants will be in a listen only mode until we reach the question and answer session. With us on the call this morning are American Superconductor's founder and CEO, Greg Yurek; we have Vice President and CFO Tom Rosa, and Investor Relations Manager Jason Fredette. For opening remarks I would like to turn the call over to Greg Yurek. Please go ahead sir.

Thanks very much Enola. And good morning to all of you who have joined us on today's conference call. We have made significant progress on a number of fronts at AMSC, and we're looking forward to getting you fully up to speed. But first I'll turn the call over to IR Manager Jason Fredette for a reading of our safe harbor statement. Jason?

Thanks Greg. I would 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 10K, which was filed with the SEC on June 14, as well as our subsequent 10Q filings for information about these risks and uncertainties.

I also would like to note that we'll be referring to EBITDAS this morning, or earnings before interest, 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 8K. All of our SEC filings can be accessed in the investor section of our website at www.amsuper.com. And now CFO Tom Rosa will begin our discussion of the quarter. Tom?

Thanks Jason, and good morning everyone. Looking at our top line results, revenue for the third quarter came in at $9.5 million, slightly above the $9 million forecast we provided in December. This compares with $13.5 million in the third quarter of fiscal 2006. For the first nine months of the year we generated $33.1 million in revenues compared with $36.6 million for the first nine months of the prior fiscal year.

As we explained in our December 18 news release, revenues were down year-over-year due to factors we'll discuss, by business unit, in just a minute. We continue to expect that total revenues for fiscal '07 will be in the range of $50 million to $52 million, meaning that we expect at least $17 million in Q4 revenues.

Breaking Q3 sales down by business unit, AMSC wires generated $1.3 million of revenue, which is down from $3.2 million in the prior year quarter. This year-over-year decline is primarily the result of significantly lower revenues associated with our Long Island Power Authority cable project, which is scheduled for completion this summer. As we announced in December, we have not yet received previously expected levels of incremental funding from the Department of Energy, and have received only partial payments for costs incurred under this LIPA program.

Payments from the deal have been delayed and reduced on a monthly basis because the U.S. Congress has not passed the Energy and Water Appropriations Bill. As a result, funding from the DOE is being handled under a continuing resolution until at least February 15, 2007, and could continue to be handled as such through the remainder of the government's fiscal year.

The impact is that $2.7 million of LIPA program costs have been inventoried pending the receipt of more incremental funding, instead of being recognized as revenue. In addition, another $1.9 million of program costs were written off in Q3 pending an expected adjustment to the contract value. DOE continues to be very supportive about the program and prospects for future funding, $800,000 of which was provided in January, too late for Q3 revenue recognition.

Moving on to super machines, this business unit generated $1 million of Q3 revenue, which is down significantly from $8.9 million in Q3 of fiscal '06. The decline is directly related to a lower level of work performed on the motor program in Q3 compared with a year ago, as well as the delay in the completion date for the U.S. Navy's 36.5 megawatt ship propulsion motor. We anticipate that the navy will accept delivery of this motor in March. Therefore, given that revenues for this program are recognized on a percentage of completion bases, we expect an increase in super machines revenue in the fourth quarter compared with Q3.

And finally there's our power electronic systems business, which continues to grow quite rapidly. This business unit generated $7.1 million in Q3 revenues, up significantly from $1.4 million in the prior year quarter. We believe revenues from power electronic systems will increase further in Q4 compared to Q3. We remain firmly on track to grow this business by 67% year-over-year to $25 million in fiscal '07. And this growth rate is being achieved organically, without consideration of Windtec revenues, which are expected to ramp up in the first quarter of fiscal '08.

Backlog as of December 31 stood at $43.2 million. This compares with $37.1 million in backlog as of December 31, 2005, and $23.8 million of backlog at the beginning of fiscal '07. As we stated in the press release, announcing the completion of our Windtec acquisition, backlog grew to more than $65 million as of January 5, 2007. At least $17 million of backlog is expected to be recognized as revenue in our fourth fiscal quarter, and an additional $46 million is expected to be recognized as revenue next fiscal year.

Our power electronic systems business generated more than a $400,000 operating profit for the third quarter. We believe we can grow our operating margin in the quarters ahead.

AMSC wires and super machines, meanwhile, incurred operating losses of $4.8 million and $4.5 million respectively. These actual operating loss results were unfavorable to our original budget, due to the aforementioned funding issues on the LIPA program, as well as the cost overrun on the navy motor program related to the technical delay we announced in December.

Our total cost and expenses in the quarter were $19.7 million, with the preliminary break out as follows; $11.5 million for cost of revenue, which includes the write offs on the navy and LIPA programs; $4.1 million for R&D expense; and $4.1 million for SG&A. More detailed information will be available in our 10Q, which will be filed with the SEC on February 9.

For the third quarter the company reported a net loss of $9.5 million or $0.29 per share. We had forecast a loss range of $0.28 to $0.33 per share in December. This compares with a net loss of $7.5 million or $0.23 per share for the third quarter of fiscal '06. Again the increased loss is primarily a function of delays in our navy motor program, and the DOE funding issues on LIPA. Our adoption of the FAS123R accounting standard at the beginning of fiscal 2007 also had a stock compensation expense impact.

Beginning this quarter we are including EBITDAS in our financial discussion. We believe this will become an increasingly important measurement for management and investors going forward, given the increasing effect that non-cash charges such as amortization related to acquisitions, taxes associated with Windtec, depreciation of capital equipment purchased for the scale up of our 344 superconductors, and stock compensation expense, will have on the company's bottom line.

Our EBITDAS for the third quarter of fiscal '07 was negative $8.1 million, and it was negative $6.2 million in the third quarter a year ago. EBITDAS was negative $19.2 million for the first nine months of fiscal '07 and negative $15.7 million for the first nine months of fiscal '06. We expect that revenue growth and the implementation of various initiatives, which we're currently evaluating, will enable us to achieve positive EBITDAS on a consolidated basis within two years.

At December 31, AMSC had no debt and $41.6 million in cash, cash equivalents and investments. This compares with $46.1 million on September 30, and $65.7 million on March 31, 2006. In terms of our outlook, based on the strength of our existing backlog, we remain confident in our forecast for total FY '07 revenues in the range of $50 million to $52 million. For full year 2007 we continue to expect that our net loss will be in the range of $29 million to $32 million, or $0.87 to $0.96 per share.

As we stated in our December 18 press release, as of March 31, 2007 we may have less than the $38 million in cash, cash equivalents and marketable securities, that we had previously expected, due to the possible deferred cash collections from the navy and DOE to the first quarter of fiscal '08. Cash not collected from the navy and DOE in Q4 is expected to be collected in the next quarter, so cash collections are only a matter of timing.

As we also previously forecast, we expect capital expenditures for fiscal '07 will be in the range of $12.5 million to $14.5 million. Almost all of this cap ex is for manufacturing scale up of our 344 superconductors. And now I'll turn the call back over to Greg.

Thanks Tom. I'd like to start by providing an update on two of the superconductor rotating machine products that have been under development in our super machines business unit. One is the 36.5 megawatt HTS ship propulsion motor we have been developing, and are about to finalize and ship to the U.S. Navy; and the second is the 12 megavar version of our SuperVAR synchronous condenser, the first two of which are about to be shipped to the Tennessee Valley Authority, making them the first commercial HTS product on the power grid.

I'll also provide an update on the HTS power transmission cable we are installing in the power grid on Long Island, which is a project managed under our AMSC wires business unit. All three of these projects were the subject of an update we provided in the news release on December 18, 2006, in which we identified and discussed product development and timing issues with respect to funding or customer readiness. These issues are essentially behind us at this stage.

Let's start with the HTS ship propulsion motor. We are closing in rapidly on the completion of the manufacture and factory testing of the world's first full scale 36.5 megawatt HTS motor at the naval shipyard in Philadelphia. We've come a long way over the course of the past six weeks since we reported that a crack was detected in a non-superconductor component of the motor. We determined the root cause of the problem and formulated a plan with our partner, Northrop Grumman Marine Systems, regarding the best way to repair the component. I'm happy to report that the component has been fully repaired.

Also earlier this week, a joint AMSC/Northrop Grumman risk review meetings was held with an independent panel of experts. The purpose of the risk review meeting was to assess the adequacy of the repair, to make any necessary recommendations regarding the support testing. No major issues were identified by the risk review panel.

Thus, we're on our way to completing the motor, and I'm happy to report that static electrical tests are already underway. We expect full factory acceptance testing to be running through February. Our expectation is that all of the factory testing will be completed in March, at which time the motor is expected to be handed off to the navy in Philadelphia.

Our super machines business is also in the final stages of manufacturing two SuperVAR synchronous condensers, which are grid reliability machines. In December we reported a delay by one month in the completion and manufacture of the rotors for the SuperVAR machine, because of an electrical insulation problem we experienced in our process of inserting and removing certain test probes on the rotor. That problem was quickly solved, and we have shipped the first HTS rotor to our motor subcontractor for final assembly. We expect both full machines to be delivered to our customer, the Tennessee Valley Authority, or TVA, by end of March 2007.

As you might recall, these units are going to one of TVA's customers, an aluminum mill in Kentucky that needs to have the voltage stabilized on the lines supplying power to the mill in order to enhance manufacturing productivity. Revenue on these two SuperVARs most likely will be recognized in the first quarter of fiscal 2008, as opposed to this quarter, due to a delay by TVA in preparing the site for installation this quarter.

Once site preparation is complete, we will install the machines and initiate operation. After successful operation and customer acceptance, we expect to recognize revenue for these two SuperVAR machines, again, most likely in the June quarter of this year.

Now let's move to our HTS wire business and our power transmission cable on Long Island. We're moving forward aggressively on this project, despite the funding delays that Tom alluded to a couple of minutes ago. That's because the LIPA cable is a critical step on the path to commercialization of HTS cables. As the world's first transmission voltage HTS cable, this half-mile system will be more powerful than all previous HTS cables combined and will be able to serve more than 300,000 Long Island Power Authority customers.

The site on Long Island has now been fully prepared and the cryogenic system has been completed and is operating. The manufacturing of the last of the three cables for this cable system is expected to be completed this week at a Nexans' facility in Europe. And the cables will begin going into the ground in the spring of 2007. We expect to commission the cable system this summer.

All of the projects I just mentioned, the Ship Propulsion motors, SuperVar synchronous condensers and the LIPA cable project utilize our first generation HTS wire. Just 10 months from now, we expect to initiate volume production of our new 344 super conductors. We'll be utilizing our 4 centimeter production line in employing all full-scale manufacturing equipment at that time.

At the Department of Energy's 2007 wire development workshop in mid-January, we reported that we have now demonstrated world record level production rates for the 344 super conductors, with commercial grade electrical performance. These demonstrated production rates exceed the levels required to meet commercial cost targets. So this achievement is a critical one in the process of qualifying our proprietary manufacturing process for the 344 super conductors.

It is not sufficient to just have commercial grade performance. We must be able to produce 344 super conductors at manufacturing costs that will allow us to effectively penetrate the market and make money for our shareholders. We now have a clear pathway toward that objective.

Where are we on that pathway as of today? The answer is, we're on track to achieve our objectives to have 70% of our full scale manufacturing equipment in place by March 31st. That puts us on schedule to be ready in December, 2007 to turn on the full scale manufacturing facility that will have a gross capacity of 720,000 meters of 344 super conductors annually.

This fiscal year, of course, our gross capacity has only been about 30,000 meters due to the limitations of the R&D equipment that is still being used in some of our manufacturing steps as we scale up. Our plant expects to sell 10,000 meters of that wire to customers who are designing products based on 344 super conductors. The point here, of course, is to help them make the transition from the 1G wire to 344 super conductors so they can design us into the products coming through their pipelines. And also, to support customers who are developing new products, such as fault current limiters that require the specific properties of 344 super conductors.

So far this fiscal year, we have shipped 344 super conductors to 33 customers in 11 countries around the world and we firmly believe we will achieve our fiscal 2007 shipment objectives of 344 super conductors of 10,000 meters.

I just mentioned fault current limiters as one of the new products that require the special properties of 344 super conductors. Let me amplify on that for a minute. Fault current limiters are especially high voltage surge protectors for power grids. Utilities don't have such a product today and they really need this kind of solution in urban and metropolitan areas to expand their grids and have a more electrical generation capacity that is being installed to meet growing demands for electricity. So, you can imagine that there's a lot of interest in seeing super conductor fault current limiters developed and commercialized.

In fact, the Department of Energy says the market size is in the billions of dollars over the next 15 years. Given the needs and the size of the addressable market, and the fact that 1G wire was not suitable for fault current limiters, it's not surprising that a majority of the 344 super conductors we have shipped this fiscal year are being used by companies to develop fault current limiters. In fact, eight companies around the world, including major corporations, are using our 344 super conductors for just this purpose.

One of them is Siemens. Early this week, AMSC and Siemens reported achieving commercial grade performance levels for a medium voltage fault current limiter, utilizing our 344 super conductors and Siemens' proprietary super conductor switching module technology. This is a significant result because it shows we were able to bring together all of the key elements of a commercially viable fault current limiter product. By commercially viable, we mean we have not only demonstrated commercial grade performance but also a path to achieve manufacturing cost targets needed to make money selling these devices.

So, this was a very important step toward developing another HTS product with a substantial market size. And, in fact, it is one more example of the many HTS products coming through our product pipeline at various stages of development. This particular HTS product is expected to emerge from the pipeline onto the commercial market in just a few years.

Now, let's switch over and discuss our Power Electronics Systems business. This business has been picking up steam for quite some time. The growth of the Power Electronics Systems business has been accelerating and is on the verge of achieving 67% organic revenue growth for the full year, ending March 31st, 2007. As a result of this growth, it achieved an operating profit of more than $400,000 in the third fiscal quarter. We expect this business to continue growing profitably in the quarters ahead.

A lot of the growth in revenues and the achievement of profitability in Power Electronics Systems can be attributed to the growth in sales of D-VAR in power module power electronic converters into the global wind energy market. The wind energy market is one of the most exciting growth sectors in energy today and we have positioned ourselves as a key player in this market.

Our sales in this market over the last several years have been D-VAR systems. These systems enable wind farms to meet standards that have been put in place in several countries to connect to power grids. So, electricity generated in the wind farms can be safely shipped to customers. In fact, with more than 20 wind farms online in the U.S., Canada, New Zealand, Australia and the UK with our D-VAR grid connectors, I think it's safe to say that AMSC is the de facto standard for meeting grid interconnection standards.

In addition, to continue the growth in the wind energy sector, we expect orders from utilities to begin gaining momentum in fiscal 2008, based primarily on traction with our dynamic VAR compensator, or DVC solution. Here, we provide a solution to increased grid reliability and throughput of electricity in existing power lines. Utilities in the U.S. have started to reinvest in the grid and our DVC provides an attractive solution.

And, of course, our acquisition of Windtec provides our Power Electronics Systems business within an additional catalyst for growth. As you may know, AMSC completed its acquisition of Windtec in January. This wholly owned subsidiary of AMSC designs wind energy systems from the ground up but it actually does not make any physical products. Windtec licenses its design to companies that want to become wind turbine manufacturers. And it typically collects a royalty stream from licensees and sells those sophisticated electrical systems to those licensees. The electrical systems it sells are actually an assembly of electrical components Windtec sources from other companies, marks them up and resells at a health profit.

In fact, until the acquisition, AMSC was a supplier of power electronic converters to Windtec. Now, we supply the full electrical system through Windtec and capture the profit margins, along with the license fees, royalties and fees for consulting services. It's a great business model that we are considering for other parts of our business.

At the time of the acquisition, Windtec brought to us a dowry of $35 million in backlog, more than $20 million of which we expect to recognize in our next fiscal year, which starts in just two months. During the past couple of weeks, this backlog has continued to grow, thanks to two major contracts. The first was with Duson Heavy Industries and Construction. This is a South Korean company that manages large engineering construction projects worldwide.

Duson recognized the huge growth opportunity in the wind energy market and wanted to get into the turbine manufacturing business but didn't have a wind turbine system design until they recently licensed one from AMSC-Windtec.

Under the terms of the contract, Windtec will develop a 3-Megawatt wind energy system for Duson and will also support the assembly and installation of the first prototype. Duson plans to begin serious production of these units in 2009 and will be purchasing Windtec's electrical systems. So, we will get about $2 million for the development work and expect many millions more, down the road, from electrical system sales.

Also in January, we announced the sale of a Windtec license for a model WT 1650 Wind Energy system to ZELRI, a Chinese manufacturer of electrical drive systems for locomotives and inverter technologies for industrial and civil use. ZELRI wants to manufacture wind energy systems but didn't have a design and specific know how to be successful. The contract includes a $2 million up front license fee, as well as a royalty payment for each WT 1650 system installed.

And, we also expect to be selling the electrical systems for the WT 1650 Wind energy systems to ZELRI. The potential revenue opportunity for AMSC from this one contract with ZELRI, exceeds $30 million over the next several years for the first traunch of wind energy systems and we believe there is additional business potential for us with ZELRI as well as Duson.

ZELRI, by the way, is the second large Windtec customer in China. The first is Dalian Heavy Industries or DHI. In November of 2005, more than a year ago, we received our first order from DHI for 20 wind turbine electrical systems. And new orders kept coming in over the next 12 months until, in November 2006, we had received orders for 785 systems. So, we went from zero orders to 785 in just 12 months. And I expect we'll be receiving more orders from DHI going forward. And, given China's enormous energy demands, we see this as a key target market for our broader suite of energy technologies in the years ahead. The integration of Windtec has gone very smoothly and we are hiring more people for operations in Austria, Wisconsin and China to support the growth of this segment of our business.

In summary, AMSC is moving forward on a different financial path today. We expect to grow our revenues and reduce our losses in fiscal 2008. About 75% of our revenues in fiscal 2008 are expected to come from commercial sales and well over half of our sales are going to be outside the U.S. next year.

So, I believe it is fair to say today that AMSC is at a turning point financially. However, the proof, as they say, is in the pudding. As we come to the end of fiscal 2007, we expect to meet our forecasts for revenues and earnings for this fiscal year while also fulfilling our objectives for technology and product development. The logical question is, what about next year and beyond?

It's a fair question and one that we'll answer more fully at our year-end earnings call in May as we do each year. However, we concluded that it would be useful for our shareholders to get a glimpse of the future today. So, we've provided some forecasts in our news release this morning, regarding backlog, revenue growth as well as EBITDAS.

With respect to backlog, by the end of our fourth quarter just two months from now, we expect that our total consolidated backlog will be about $70 million, after recognizing at least $17 million in revenue in Q4. Of this total backlog at March 31st, $70 million, we would expect $60 million to be recognized, as well, as revenue in fiscal 2008. That will provide a fee with a strong platform for revenue growth in our new fiscal year and we think that's just the beginning in terms of growth trajectory.

Now, while revenue growth is certainly important, this management team's overarching objective, going forward, is driving to profitability. In addition to continuing to grow profits in our Power Electronics Systems business, which will reduce our consolidated losses next year, we expect to implement initiatives during the next 12 months that will enable us to achieve positive EBITDAS on a consolidated basis within two years. And, we intend to achieve this objective as we continue to scale up manufacturing of 344 super conductors, meet customer needs for super conductor rotating machines and expand our Power Electronics Systems and wind energy business globally.

We're eager to get on with our business plans, but for now, let's open up this call to questions. Enola, would you please provide the instructions?

[OPERATOR INSTRUCTIONS]

We'll take our first question from Stewart Bush, RBC Capital Markets.

Good morning, guys. Can you talk more specifically about the trend in gross margin for Power Electronics Systems? Like, what's your outlook for how much price will change, year-over-year for fiscal '08 and your changes in costs?

And then, what are your targets for how gross margin will progress in this business and what sort of stabilized level should we expect to achieve over time?

Well, we haven't given a lot of specifics on that so I'm going to keep it to what we've disclosed publicly so far. The good news is, in our Power Electronics Systems business we have focused over the last year-and-a-half in particular on reducing our cost of our D-VAR and Power Electronics converters, our power modules. So, we've been able to protect our margins.

D-VAR systems have been selling for an ASP on the order of $500,000 - $600,000 with gross margins in the 40% to 50% region, and we don't see that going down Stuart. Again, because of efforts we've made over the past year and a half to continue to reduce costs.

The power modules, typically 20% to 25% gross margins on those. Windtec with the electrical systems, including the mark ups they do, typically 30% to 35% gross margins, although the licenses and royalties tend to pull that up just a little bit. So you've got a breadth of gross margins here and again, we haven't given anything specific in terms of our revenue forecast specifically for power electronic systems next year, we said about $50 million in revenues. We said it looks like on the order of 8% to 10% operating profit for that particular business unit, so I'm assuming you can back calculate from there.

And Stuart I'll just add that our Q3 results for PES, power electronic systems, was in the, the gross margin was in the 40% range, which is within our expectations.

Okay so maybe I can just ask, how do you see prices trending over the next year?

Well we don't see much in the way of price erosion here. There's clearly, on the wind side, a huge demand for electrical systems, starting with wind energy systems of course, but the electrical systems that go into them. So there's a huge demand. Some of the larger companies are experiencing supply chain issues. We think we're avoiding that because we're licensing to companies in foreign countries like China, Korea, the Czech Republic and so forth that have their own supply chains.

But still there's a high demand for the electrical systems, so I don't see price erosion there. As we go into the electric utilities with our DVC, again we've taken out cost so we're going to be very price competitive, and I don't see us having to reduce our prices to compete in the utility market, which is also growing now because U.S. utilities in particular are really now starting to reinvest.

So I don't see anything near term, Stuart, in terms of price erosion for our power electronic systems business.

Okay, great. The next question is, what is your cash burn expectations for '08? How much cap ex should we expect? Should it be in a somewhat similar range to fiscal '07?

We haven't given any specific guidance on that. On the other hand, we have said generally we expect to cut our total use of cash in fiscal '08 compared to fiscal '07 by a substantial amount. And that's clearly going to be driven by cash generated, the power electronic systems business unit, as well as the dramatic drop off in capital investments for our scale up of the 344 superconductors. A lot of that, most of that's going to be behind us at the end of this fiscal year. So we're going to be in good shape cash wise, in terms of cash burn for next fiscal year.

Okay, great. And then just any more color you can give on the progress of the second generation manufacturing efforts. Are you guys on track? Is there anything that's sort of exceeded your plan or challenges that you've seen that you hadn't expected? If you can just talk a little bit about that.

Well as I said in the call a little bit earlier, our objective by March 31 is to have 70% of our full scale manufacturing equipment installed, commissioned and qualified in the overall process, and we're very much on track to do that. We're also very much on track to be in full scale manufacturing with all full scale manufacturing equipment of course, in December 2007.

That original target, that we went out and raised money to buy that equipment, the original target was 300,000 meters per year, gross capacity in December '07. Because of productivity enhancements, that's now more than double at 720,000 meters per year capacity. We've announced during this fiscal year improvements in performance to commercial grade electrical performance. So when we turn on the factory in December it's going to be churning out commercial grade electrical performance.

And we just announced a couple of weeks ago, in mid January, that we've achieved high rates of production, which means that we're clearly going to meet our manufacturing cost objectives for this 344 superconductor. So everything's been hitting on target if not ahead of target. So I think we're in pretty good shape, very good shape, for December '07.

Okay, great. Thanks a lot guys.

We'll take our next question from Walter Nasdeo with Ardour Capital.

Good morning. I'd like to kind of just bounce something off you guys. As far as the development that you're seeing through Windtec and the acquisition and the way orders are in the backlog, do you see any difference in the focus now, or any future changes in the focus of the business that you previously established in the different lines? Going forward as far as putting more focus on the wind and what's developing in those areas?

Well if I understand your question, Walter, we're riding the wave here with wind. We entered the wind energy business about three, three and a half years ago, when we sold our first DVAR to PacifiCorp for the wind farm in Wyoming. DVAR sales have continued to grow, as I said, we're serving over 20 wind farms with our DVAR grid interconnection device.

I expect more orders for DVARs this quarter and going forward, that's not stopping. I consider that strong organic growth. Windtec is clearly on a tear here. We started on January 5 with $35 million in backlog, we've been adding to that. We look for Windtec to continue to come through this quarter, next, and beyond, with additional licenses, electrical system sales for wind energy systems. And if you look at the global marketplace and all the forecasts, there's nothing but growth in the wind energy business.

So we have the products, we have the capabilities, we have the infrastructure in terms of sales force, field service, all of which are being built up to continue to serve that need. Wind is going to be a big part of our business going forward. In fact, if you look at U.S. companies, traded on the U.S. markets that is, I think we're probably one of the only companies that is a pretty pure play in terms of the wind energy business.

That's kind of the crux of my question, and I'm certainly one of the guys out there saying that to my readers also. Do you see, because there's such -- what I perceive to be quite a bit of low hanging fruit around the world in the wind business, do you see any of your other lines of business taking a bit of a back seat while you execute into these other markets?

Quite the contrary. As we continue we're fully on our plans, I mentioned look what we just announced with Siemens, there's a demand for that product. A lot of HTS products coming through the pipeline here. And here's a really good piece of news I think, with respect to your question, as we establish these business relationships with the dolly and heavy industries, the [Nusan], heavy industries in construction and others in other countries, in India, Brazil, the Czech Republic, etc., those are channels to market for our HTS products as well. So we're very excited about Windtec power electronic systems providing the lead.

And oh, by the way, power electronic systems is where we have the expertise to do all of the grid and industrial analysis that we've been using for years to support our HTS product introduction. So it all fits together very, very nice. By the way, give you one example, Nusan heavy industries and construction is not only a customer now for wind energy systems through Windtec, we've been selling them wire, HTS wire through our distributor in Korea for now a couple of years.

So there's just a very concrete example of the synergies we're going to get through these customers.

What, as far as capacity goes to fill these power module orders going forward, are you in good shape there?

Yes we're in very good shape. Don't forget we outsource a lot of the production of those power modules so we've been keeping up. Here's the other part of the good news there, Walter, and that is to expand there's very little capital investment needed. I like when you can expand without more capital investment. Capital investment goes into the wires business, power electronic systems you rent another warehouse and fit it out a little bit, and you just put the product through there and outsource the rest.

And Walter one thing I'll add, Greg already alluded to this in his remarks earlier, but we're expecting 75% of our sales next year to be commercial, which is I think the highest we've ever been at. I think Greg also mentioned 50% plus of our sales next year will be international, and that's another first for us. So there are some changes coming.

Interesting. Alright well listen guys, thank you very much for that.

We'll take our next question from Corey Tobin with William Blair & Company.

Hi, congratulations, and congratulations on all the success you have going forward with the products. I want to touch on a couple of things here. You mentioned some initiatives in the press release, and also in your prepared remarks, to push toward profitability. And you went into great detail on the revenue side. Can you provide us some detail on what we should expect to see on the expense side, and any new initiatives that might be underway there?

As we said Corey, we'll reveal those as we start to initiate and implement our plans. But I'll give you one simple example; here in Massachusetts we have three buildings that we're operating out of, super machines, wire, and R&D and corporate and so forth. By this time next year that will all be consolidated into one facility that we own outright called [Devons]. That's just one example, a simple example, but we think there's a lot of opportunity here now that we're turning the corner financially. And it's time to strike. So you'll be hearing about those plans as we initiate and implement those going forward.

Great. And just to clarify, you're talking about turning the corner financially here, just to clarify this, the press release says EBITDAS positive in two years. So are you referring to for the full year fiscal year end 2009 or is that more Q3 2008? Can you just provide a little bit of clarity as to an exact timeframe there?

We expect that fiscal year '09, which ends in about two years from now, that full fiscal year we will be EBITDAS positive.

For the full year of fiscal year 2009?

Correct, exactly right. And you know if following right behind that is cash flow positive and then ultimately with all these expenses that we have to deal with from taxes, we're now going to be paying taxes in Austria through Windtec, it's a profitable business. We'll do our best of course to minimize all that. But when you're looking at how you measure our performance going forward, certainly how we measure it here internally in the management team, we feel it's important to separate out those factors.

I know its non-GAAP; we recognize that, that's why we put the reconciliation table in the press release this morning. But we think it's an important way to track our progress going forward. It's the leading edge of going cash flow positive, which I don't think will be far behind EBITDAS positive.

Great, excellent. Let me hit on a couple of specific product areas if I could. Any update on, you mentioned that you expect to see the utility market here kick in for DVCs. I know there were a few bits out there that people were going after, any update on those?

We've shipped off a DVC to utility back in the September/October timeframe. We have small DVCs out there in some of the wind farm applications actually. In terms of what's coming up, we have quotes out there to customers and I would say if not this quarter, next quarter we're going to start seeing some of those come to fruition and then look for growth of orders throughout fiscal '08.

These can be rather large in terms of the revenue and how much revenue we see from new orders coming in fiscal '08 is unclear. I would look for more of that revenue coming into FY '09 because of [inaudible] of the projects in terms of revenue recognition. So look for some near-term orders coming in that will give us revenue recognition in FY '08, and then more orders coming in FY '08 that will be building up for revenue recognition primarily FY '09 and going forward.

Okay, but in terms of the quote activity again, just to reaffirm, you think that we may hear something here in the next couple of quarters?

Oh absolutely, definitely.

Okay, great. And then finally one last thing on the first generation wire; I think entering this quarter we were running around 200,000 or so in inventory on generation one wire. Can you just give us an update on where that stands?

We're still about that same level Corey; we're looking at which customers are actually going to get that going forward over the next year. That's our bridge to full production and of full sales only of 344 superconductors, which you know really starts up just about a year from now, December of '07, we start shipping in the January quarter of next year. And there are a lot of projects out there, and so we're trying to manage this bridge carefully here and not just give it all to one customer, for example.

I think we'll be in good shape. I think we'll sell all of it and, by the way, we're beyond the point now. We're totally into wire that's been written down. So, anything we sell from this point forward is pure profit.

Excellent.

By the way, we have not had the need to reduce the ASP of this first generation wire. It's holding up quite nicely.

And just remind us real quick, again, the price point you're referring to?

About $17 in meters, the ASP.

$17.00 a meter, great. Thank you very much.

We'll take our next question from Jim Ricchiuti of Needham and Company.

Yes, thank you. Good morning; I just wanted to ask some follow up questions on the backlog numbers that you've referenced in the call today. You expect to be at $70 million in backlog by the end of the fiscal fourth quarter. It sounds like much of that is being driven by the PES business. Can you say what percentage of that backlog that you reference is going to be Power Electronics Systems?

We haven't given the specifics on that, but you're on the right track. I mean, the lion's share of that is going to be Power Electronics Systems backlog that's added in through this quarter. And I think you'll be seeing announcements that show you the way that gets to March 31st.

And at this point -

I'm just saying, we haven't given any specific breakout on any of that. Tom, do you want to add to that at all?

No, I think that's right, that we have about 46; that's solid, even right now, Jim. And the vast majority of that is PES related, as Greg said.

Okay and it doesn't sound like you expect much of a slowdown in PES activity over the next several quarters. So, I would like to just get a sense as to what you're seeing out there in potential orders coming out of super machines and the wires business. You've talked about potential follow on business with the Navy. Where do you see that over the next couple of quarters? And also, on the wires business, can you maybe update us on what might be out there?

Sure, starting with super machines, U.S. Navy, the motor is going to be, I believe, accepted by the Navy here in March. We have an additional contract that we received already from the Navy back, I think it was, October or November of '06. Quite frankly, we haven't been able to work much on it as we've been finalizing the current 36.5-Megawatt motor. So, that starts picking up now.

We believe there is additional contract opportunity and we think we'll see some of that coming our way, certainly by the fall of this year. The competition for the whole number three of the DDG 1000 is going to be on and underway certainly by this time next year, probably this coming fall. We think we're going to be competing for that business. We think there are generator opportunities as well as the motor opportunities on these all-electric warships. We're going after that, and we're going after that, of course with our partner, Northrop Grumman Marine systems.

So, I think there's a lot of opportunity there. It's not going to happen next month; it's not going to happen next quarter. But that opportunity will materialize in the form of development contracts, demonstration contracts, for militarized versions of the motor. We already have one of those, as I said. And then now, we're going to be competing for procurement contracts, with Northrop Grumman as our partner, as I said. So, that changes during this year.

On the cable side, Department of Energy has a solicitation out there. Proposals are due at the Department of Energy on February 13th, and we certainly will be submitting a number of proposals. The solicitation, specifically, number one for power cables, number for fault current limiters and number three for other applications.

So, those proposals will be going in and DOE - again, we're talking about Department of Energy. We're talking about Washington; don't get me going on that subject. But they're supposed to make the awards in the summertime and the projects will be underway in the fall. You may remember Jim; we talked about that even last summer. DOE has delayed the time for submission. So I don't want to have us counting on those things. So I'm really thrilled that we have the growth in power electronic systems that is supporting us going through this year.

It's going to support some pretty strong top line revenue growth, which will include growth on the wire side and the super machine side as well.

Also on your, with respect to your commercial customers, what's the outlook for SuperVAR?

Well as we said on the last call here, it's hard for me to imagine customers putting in orders here until they see these first couple of units operating, in Kentucky, our TVA customer in Kentucky, and it's also going with that assumption. We do have a customer who has a bid spec out for synchronous condensers, they don't want any other solution, they only want synchronous condensers, we're bidding on that project.

So there's at least activity there, but I think we need to get those SuperVARs up and operating in Kentucky to in fact -- the proof is in the pudding as they say, once again, and I think our customers are watching that carefully.

Okay and just a final question for you, Tom. In terms of the fiscal fourth quarter guidance that you've given, can you say how much of that is, I assume baked into that guidance is, you expect the funding to come through for LIPA and I wonder if you could just say how much of the revenues you expect from the navy this quarter?

Well we expect super machines revenues to be up by at least a factor of three over what they were this past quarter, Jim, as we complete the motor program. LIPA we're actually, we're trying to be conservative and we're not betting on the funding. So we think the $17 million is achievable even if the funding does not occur this quarter. That would represent some amount of upside. We'd obviously like to see it come through this quarter.

Thanks very much.

We'll take our next question from Robert Smith with Performance Investing.

Hi Bob.

Hi, good morning. Most of my questions have been answered, but I have two that are sort of still hanging there. One, the change in the Congress, what do you hear from Washington as far as the possible implications of this?

As I said, don't get me started on Washington. Well look you can read in the Wall Street Journal this morning, just yesterday the House of Representatives passed a funding bill that includes energy and water appropriation that Tom was referring to a moment ago. Now it has to go to the Senate and whether they maintain the continuing resolution after February 15 or not, I don't know. But clearly they're moving and shaking now in a different way, and so we see that as good news, but my rule of thumb is, don't count on Washington for anything.

So it looks good, in terms of the broader picture, which I think you probably are asking about, I think clearly you have a Congress that is going to be driving in the direction of alternative energies, of higher efficiencies, and we bring something to the party across the board for the green environment. So I think that only can be good for us, Bob, I don't see any downside, that's for darn sure.

Greg about the area of ship propulsion motors, how do you see this unfolding in the commercial sector? How dependent upon this is the selection of the technology for the destroyer program?

I think it's very important. We've said this before that we thought earlier, and there were some pretty strong indications that we were right, that the commercial marine industry would pick up on HTS ship propulsion motors and generators even before the navy would. But then it just kind of collapsed into the old fashioned way, "Hey let's let the military demonstrate it first." So I think it's important to get our 36.5 megawatt motor up and operating, which soon will be. Get it to the full load testing in Philadelphia, and more importantly, get selected for the third hull of the DVG1000, let alone the CGX, which is the cruiser class ships that are coming.

So we're actively engaged in Washington with the Department of Defense, the Department of the Navy, with our partner Northrop Grumman Marine Systems, and others, going after this business. And I think clearly commercial marine will follow that at this stage of the game.

Thanks, good luck.

We'll take our next question from Michael Carboy with Signal Hill.

Good morning gentlemen, congratulations on a good quarter here. A couple of questions, let's first start just on the simple administrative mechanics. You look at the operating profit here for the power electronic systems business, it looks like the operating profit margin doubled from about 3.3% to 6.2%, I was hoping you might be able to elaborate as to what proportion of that improvement came from internal cost efficiencies versus scaled economies. Then I've got several other follow ups. Thanks.

We saw improved profits, Michael, in that area despite some cost increases that we noticed in capacitors and other areas. As I mentioned earlier in the call, we're seeing approximately 40% gross margins. As far as the bottom line operating margin, we're expecting that to grow going forward, based on the maintenance of the margins that Greg alluded to earlier.

I'm not sure exactly where your question was going with regard to the percentages, but we're optimistic we can maintain both the margins and the operating profit, and in fact, increase profits going forward.

Michael Carboy Certainly revenues have picked up, which would suggest volume has picked up, so I'm just trying to understand what proportion of the margin improvement came from operating leverage versus simple cost improvements.

We are driving costs down in certain areas, I'm not at a point where I could probably quantify that on a percentage basis. But the volume is driving this business, we've gone, I think over the last four years, from $7 million to 15, and we're projecting that the organic growth in this business unit, without Windtec, will take them to $25 million or above this year. So you know, volume, operating leverage associated with those volume increases is clearly the biggest single factor that's driving the margins up and the bottom line up for that business unit as well.

We said that before, that that is going to be the key factor to go from on the order of $25 million this year to on the order of $50 million in revenues next year. We expect that operating profit, as a percentage, to be up toward 10% area.

Okay. Sort of moving on, on the motor front we talked before about the crack issue and the delay and the pain that that has caused you. Could you update us, please, as to whether you've been able to negotiate any reimbursement from the subcontractor that was responsible for the crack?

No we can't really report anything at this time, but we're taking actions in that direction.

Good, good. And lastly on ZELRI, you talked about the $30 million potential over the next several years on the first traunch. Could you remind us, or tell us, sort of how big that first traunch is, in terms of total number of units that ZELRI might be contemplating?

I could try, but we haven't put a number out there. And look, for competitive reasons we really don't feel comfortable putting out such numbers. So it's a good size, we'll be competing pretty directly with DHI, let's put it that way.

Okay. My last question concerns some of the rare earth elements. Some of the other groups of the technology sector have been unsettled here this quarter over unexpected pinches in some of the rare earth, in particular [resenium], we see a potential hafnium being a problem. I know those are not constituents of your superconducting material, but I'm wondering whether you're starting to see any, or have any concerns about tightness for the yttrium that's used in your products?

The answer is we have not, and let me put it also in perspective, the film that we use are on the order of one micron in thickness and it's just not a heck of a lot of yttrium that's used there. So when you add it all up to even the kind of production lines that we see going forward, it's just not a lot of yttrium. And yttrium is one of the less rare of the rare elements. So we haven't seen any impact at all.

Okay. Well look, terrific, thank you very much.

Thank you. That does conclude the question and answer session today. At this time I would like to turn the call back over to Mr. Yurek for any additional or closing remarks.

Thank you Enola, and thank all of you for listening and participating in the call today. We're very excited about where we're at, and even more excited about where we're heading. So keep watching this spot. We'll talk to you soon. Bye now.

Thank you. Ladies and gentlemen, that does conclude today's conference. We do appreciate your participation.