American Superconductor Corp (AMSC) 2008 Q1 法說會逐字稿

Good day, everyone. Welcome to American Superconductor's first quarter fiscal year 2008 conference call. All participants are in a listen-only mode until we have reached the question and answer session. As a reminder, today's call is being recorded.

With us on the call are the Founder and CEO, Mr. Greg Yurek, Senior Vice President and CFO, Mr. David Henry, and Investor Relations Director, Mr. Jason Fredette.

For opening remarks, I would like to turn the call over to Mr. Jason Fredette, please go ahead sir.

Thanks, Anthony. I would like to point out 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 significantly from these statements. Please refer to our 10-K, which was filed with the SEC on May 29 for information about these risks and uncertainties.

I would also like to note we will be referring to EBITDAS this morning, or earnings before interest, income, other non-operating expense, income taxes, depreciation, amortization, and stock compensation. EBITDAS is a non-GAAP financial metric. A reconciliation of EBITDAS on a GAAP basis, is included in the press release we issued and filed with the SEC this morning on Form 8-K. All of our SEC filings can be accessed in the Investor section of our website at www.AMSC.com.

And now I will turn the call over to Greg.

Thanks Jason, and good morning everyone.

I am happy to report back to you on our first quarter results. We had a very good quarter, one in which we generated record revenue, and record positive operating cash flow, and we are tracking quite well to our business plan, enabling us to once again increase our revenue and EBITDAS forecast. We now expect our fiscal 2008 revenue to grow approximately 60% year-over-year, and we expect to achieve higher positive EBITDAS, showing that we are executing well on an operating basis. Dave will get into the details regarding our forecast later in the call.

In addition to achieving our financial objectives in the first quarter, we also energized the world's first superconductor power transmission cable in a commercial power grid, and we closed the largest single order in AMSC history. That order was for our proprietary core electrical components for the wind power market, which continues to be the biggest catalyst for our growth.

The wind market accounted for roughly three-quarters of our Q1 sales, as we increased shipments of our wind turbine electrical systems and core components, and we forged ahead on a number of wind turbine license and design contracts we have under way. In June, we added another new wind turbine licensee, TECO Electric & Machinery Company, the world's third largest motor manufacturer. This brings the total number of AMSC Windtec customers to eight, three-quarters of which are located in the Asia Pacific region.

As you may recall we have been working with TECO's subsidiary, TECO Westinghouse Motor Company in Texas, to develop the technologies needed for 10-megawatt class, direct drive, superconductor wind generators. We are now expanding this relationship by providing TECO with designs for our proprietary 2-megawatt full convention wind turbine, that utilizes a permanent magnet generator. TECO's objective is to become Taiwan's leading producer of wind turbines, and with over five decades of manufacturing experience, they are well-equipped to accomplish that goal.

In addition to Taiwan, the license we granted to TECO enables them to sell into mainland China, making them our fourth wind turbine manufacturing customer for the Chinese market. Of course, the largest of the four Chinese customers today is Sinovel Wind.

Sinovel is China' second largest domestic wind turbine manufacturer, and all signs point to them ascending to the top of that list. Sinovel has been a customer of AMSC Windtec for several years now. Our proprietary electrical systems and core electrical components serve as the brains for each and every wind turbine produced by Sinovel. These components monitor the wind turbines performance, maximizes efficiency, and conditions it's power for the grid. Since 2006, more than 1,000 sets of these electrical systems and core components have been shipped by us to Sinovel for it's 1.5-megawatt wind turbines, which utilize a doubly set induction generator drivetrain.

In fact, Sinovel has these wind turbines in more than 30 wind farms in China as of today, and that number will continue to grow rapidly. With the new $450 million order we received from Sinovel in June, we will be shipping thousands of additional sets of core electrical components over the next three years, beginning in January 2009. These will go into more than 10 gigawatts worth of wind turbines. We have heard skepticism from some circles regarding Sinovel's ability to produce this many wind turbines, and the Chinese market's ability to support this type of expansion. At first glance the numbers are a bit staggering, but only by western standards.

Business in China is fundamentally different than it is here in the United States. The wind power market in the US and Europe is growing strongly, to be sure, in China it is booming. China had 6 gigawatts of wind power online at the end of 2007, and is aiming to reach 100 gigawatts of capacity by 2020. In fact, our latest information from China is that the Chinese government intends to produce 10 gigawatts of wind generated zero emission electricity per year, and to do so, as soon as they can. That will put them on the path to their objective to have an installed base of 100 gigawatt in 2020.

And in-line with this aggressive plan we are now seeing plans in China to develop a single wind farm that will have a capacity of 10 gigawatts. That is 2.5 times the size of the wind farm T. Boone Pickens is developing here in the US. Now that is what I call booming. Unlike here in the US, with production tax credits remain in limbo, the Chinese government is actually spearheading the wind effort, to bolster the countries supply of electricity while reducing pollution.

To make that happen, State owned Electric utilities are building an increasing number of State owned wind farms, and the government has instituted a strong support structure for a select group of domestic wind turbine manufacturers, including Sinovel, Goldwind, and Dongfang, the largest domestic manufacturers in China. That is the policy now in place in China, and as a communist nation, policy rules the day, not necessarily profit.

With the firm order we now have in place from Sinovel, we will begin shipment in January 2009, and they will increase year-over-year through December 2011 providing us with a significant platform for growth in the years ahead. Do note that the contract for this order is specific in calling for the delivery of these core components over a three year period ending December 2011. Sinovel has the ability under the contract to modify month to month delivery schedules that the contract calls for, but not to reduce the total number of systems to be delivered in the three year period of time.

The full term of the contract is five years, which encompasses the 24-month warranty period. Under this contract, we will be shipping both Power Module 1000 and power converters, and Power Module 3000 power converters. The PM3000 is a new proprietary wind specific power converter product, that we are on schedule to start shipping to customers late this year. Our PM3000 will include more functionality for wind turbines, and this product will be manufactured in our Wisconsin and China operations.

Manufacturing of our PM 1000 is now shifting increasingly to AMSC China, where our infrastructure continues to expand. We now have over 80 employees in China at our sales and field service offices in Beijing and Shanghai, and our assembly and test facility in Zhuzhou. The sales and business development team is addressing not only the wind market in China, but also new power grid business opportunities.

China's rising demands for power to support growth of their economy, require massive grid investments and our D-VAR and SVC voltage regulation systems, as well as our superconductor solutions, can and will play a role in this buildout. We expect to report back to you on initial orders in China's power grid sector by the end of this fiscal year.

Back here in the United States, there is increasing recognition that after 20 years of development, high temperature superconductor solutions are ready for deployment. Last week I was in Washington D.C. to give testimony to the House of Representatives Select Committee on Energy Independence and Global Warming, on the role that superconductors will play in increasing our energy independence, and strengthening our electricity infrastructure. Questions from the Select Committee focused on superconductor wind generators and superconductor power grid solutions.

The theme that emerged from this Committee hearing is that there is strong Congressional support for new energy technologies that will help the US achieve energy independence and reduce pollution, and very importantly, there is a growing recognition of the need to vastly improve our aging and outdated power grid, to enable new sources of generation, such as wind and solar, to increase their contribution to our total energy mix. While progress on the Federal level always tends to move at a slow, if not glacial pace, whether we are talking about production tax credits for wind and solar power generation, or fixing the power grid, it seems clear that recognition of the problems is increasing, and an action plan is being developed at both State and Federal levels.

Now AMSC's approach to all of this is a practical one. That is what we support these US government backed initiatives, and stand ready to serve with our products and to develop new products, our focus remains on the faster growing and more lucrative international wind and power grid markets. This year again about 70% of our revenues are expected to be generated from international sales, with the lions share of these sales being to China.

Approximately 65% to 70% of our sales will be to the global wind market. We expect our sales, the power grid market to continue to grow, especially once we penetrate the power grid markets in China, India, Turkey, and other fast growing economies. While we expect our international sales to remain strong in the US, we do expect to see continued strong support for further development of superconductor power cables, full current limiters, wind generators, and Navy ship degaussing systems, among others. And as these products are developed and demonstrated, we expect to sell these solutions globally.

At the heart of these superconductor wind and power grid solutions is our core product, HTS Wire. Our pilot manufacturing operation for the production of 344 superconductors has continued through the shakedown phase during the first half of calendar 2008. We encountered a good number of start-up challenges during this phase, all of which had assignable causes, and were basically mechanical in nature.

By mechanical, I knew we had to deal with problems such as gas valves and temperature gauge malfunctions on some of our equipment, control issues that manage the smooth operation of payoff and take-up reels, and some of our manufacturing steps, and then we had contamination of some of the incoming materials to the process. I think you get the idea. The point is these are all fixable problems, not scientific problems, and the fixes are in. As a result we are now producing good quality wire on a regular basis, and despite some of these challenges, we expect to meet all of our customer deliverables this fiscal year.

Most importantly, we expect that all of this has prepared us well for migrating to high volume wire production on schedule over the next couple of years, as anticipated customer demand starts kicking in. Indeed, we are currently engaged in discussions with potential customers for commercial applications of our wire, all of which indicate that we must be ready to meet that growth in demand over the next couple of years. In the meantime, as we invest in the future of our super conductor business, we remain focused on posting strong growth and enhancing our bottom line, as we march toward GAAP profitability based on our growing power systems business.

And with that I will now turnover the mic to Dave for his review. Dave?

Thanks Greg, and good morning everyone.

In the first quarter of fiscal 2008 we continued to improve our financial performance, and we made strong progress toward the achievement of the longer term financial benchmarks we set for ourselves. On top of another quarter of sequential revenue growth, we were solidly EBITDAS positive in Q1. We cut our net loss significantly year-over-year, despite a substantial non-cash charge for a mark-to-market adjustment on an outstanding stock warrant, and we delivered positive, record positive operating cash flow. Looking closer at the numbers we delivered our sixth consecutive quarter of sequential revenue growth.

Revenue for the first quarter of fiscal 2008 was a record 39.8 million, up 4% sequentially, and up 101%, from 19.8 million in the year ago quarter. Of this total, AMSC power systems generated a record 35.9 million in revenue, which was up 150% from 14.4 million in the first quarter of fiscal 2007. The major driver of the increase is sales of core electrical components for wind turbines. AMSC power systems accounted for approximately 90% of total sales in Q1, at the high end of our 87 to 90% target range for fiscal 2008.

Our AMSC superconductor segment generated the remaining 10% of sales. AMSC superconductors revenue in the first quarter was 3.9 million, down 28% compared to 5.4 million in the year ago quarter. This decline is primarily result of the completion of our HTS motor contract with the US Navy last year, and lower contribution from the LIPA project, which was completed in April of this year. We exited the first quarter of fiscal 2008 with approximately $634 million of backlog, that is up from 199 million on March 31, 2008, and 73 million for the year ago quarter. Our $450 million order from Sinovel of course was the major factor in the sequential increase.

Gross profit for the first quarter was $11.6 million, resulting in a gross margin of 29.2%. This compares to a gross margin of 18.1% for the first quarter of fiscal 2007. Gross margin for the fourth quarter of fiscal 2007 was 33.2%. Year-over-year increase in gross margin was primarily the result of higher power system sales as a percent of total revenue. As you might recall, our fourth quarter fiscal 2007 gross margins were usually strong, due to the fulfillment of a power systems order that contributed a particularly high gross margin.

In Q1, we also had higher warranty costs, and a lower mix of D-VAR revenues, which contributes gross margins that are above the Company average. For fiscal 2008 as forecasted earlier, we expect gross margin to be at the lower end of our targeted operating range of between 30 and 35%. R&D expenses for the first quarter were $4.9 million, or 12% of revenue. This compares to 4.2 million, or 21% of revenue for the first quarter of fiscal 2007.

SG&A expenses for the first quarter of fiscal 2008 were $8.9 million, or 22% of revenue. This compares with 6.1 million, or 31% of revenue for the first quarter of fiscal 2007. The increase in SG&A expenses is primarily the result of operating expense growth required for higher revenue levels, and higher stock based compensation expense.

The expense growth in both R&D and SG&A is in-line with our plan and our previous guidance, to increase operating expenses and dollar terms, while decreasing them as a percent of revenue. We are focusing on maximizing fall-through on incremental revenue, while also maximizing our strong revenue growth rate.

In Q1, we incurred approximately $500,000 in amortization of acquisition related intangibles, related to our acquisition of Windtec and TQS. This is down from 1.2 million in the year ago quarter, due to the fact that we have nearly fully amortized a portion of our Windtec intangibles that were tied to purchase backlog. As a result, intangibles amortization should remain roughly flat in the near term.

We did not incur any restructuring and impairment charges in the first quarter of fiscal 2008, though we continue to work on finalizing the closure of our Westborough facility, and returning the building to the landlord. Costs associated with completing this effort were improved in the fourth quarter of fiscal 2007. In the year ago quarter we incurred approximately $800,000 in restructuring charges, associated with the consolidation of our AMSC Wires and AMSC Supermachines business units.

Our operating loss was $2.7 million in the first quarter of fiscal 2008. This compares to an operating loss of 8.7 million in the first quarter of fiscal 2007. Our operating loss in the fourth quarter of fiscal 2007 was 2.8 million. AMSC Power Systems generated operating income of $4.9 million, or 14% of revenue in the first quarter of fiscal 2008. This compares with an operating loss of $600,000, or negative 4% of revenue for the year ago quarter. The year-over-year improvement in power systems operating income is due primarily to incremental profit generated from higher revenues.

Power systems operating income was $6.6 million, or 19% of revenue in the fourth quarter of fiscal 2008. The sequential decline in power systems operating income is driven by an unusually high gross margin sale in the fourth quarter, as well as an increased allocation of corporate expenses effective for this fiscal year. AMSC Superconductors generated an operating loss of $5.1 million in the first quarter of fiscal 2008. This compares with an operating loss of 6.5 million in the first quarter of fiscal 2007.

The year-over-year improvement was due primarily to inventory write-offs and asset impairment charges incurred in the year ago quarter. Superconductors operating loss was 4.3 million in the Fourth Quarter of Fiscal 2007. The sequential increase in super conductors operating loss was driven primarily by lower revenues, and higher subcontractor expenses in the first quarter of fiscal 2008.

Please note that stock compensation expense is not allocated to our reporting segments. Given the significant increase in our stock valuation during the first fiscal quarter, we incurred a $2.4 million charge, related to a non-cash mark-to-market adjustment on an outstanding stock warrant, which increased our net loss by $0.06 per share. This charge is reflected in other expense in the P&L. In the year ago quarter, we incurred a $1 million charge for the mark-to-market on the warrant. Income tax expense increased to $1.7 million from approximately 300,000 in the year ago quarter, due to the growth in sales and profits in foreign jurisdictions. International sales were 81% of revenue in the first quarter of fiscal 2008, compared to 71% in the year ago quarter.

Factoring these items in we have reported a net loss of $6.1 million, or $0.15 per share for the first quarter of fiscal 2008. This compares to a net loss of $9.7 million, or $0.27 per share in the first quarter of fiscal 2007. The net loss in the fourth quarter of fiscal 2007 was $1.8 million, or $0.04 per share.

In addition to the mark-to-market adjustment I mentioned earlier, our net loss also includes non-cash pre-tax charges for amortization of acquisition related intangibles and stock based compensation expense. Thus charges totaled $5.2 million for the first quarter of fiscal 2008, compared to $3.2 million in the first quarter of fiscal 2007, and 1 million for the fourth quarter of fiscal 2007. The sequential increase in these non-cash charges almost entirely drives the sequential change in our net loss.

To paint a clearer picture of the financial progress being made here at AMSC, each quarter we provide a break out of EBITDAS, as well as forecasts for EBITDAS, all of which is reconciled to GAAP at end tables at the end of our earnings press release. For the second consecutive quarter, AMSC generated EBITDAS positive results in Q1. EBITDAS for the first quarter of fiscal 2008 was a record $1.7 million, which compares to $400,000 in the fourth quarter of fiscal 2007, and a loss of $5.3 million in the first quarter of fiscal 2007.

Turning to the balance sheet, cash, cash equivalents, marketable securities, and restricted cash on June 30, 2008 were $131.5 million. That is up over 12 million from March 31, 2008. Nearly 11 million of that increase is related to proceeds from stock option exercises during the quarter, but we also had a particularly strong collections quarter in Q1. As a result of this, and our record positive EBITDAS, cash flow from operations in Q1 was a positive $3.2 million, a new Company record.

Now let's review our latest financial expectations for the remainder of fiscal 2008. We expect that our financial results will continue to improve as we progress through the year, and we anticipate stronger results in the second half of the year relative to the first half, from both the top and bottom line perspective. In terms of our annual numbers back in May, we said we expected revenues for fiscal 2008 in the range of 165 to $175 million.

As a result of our improved visibility resulting from our strong bookings in the first quarter, we are now raising our revenue forecast for fiscal 2008 to a range of 175 million to $185 million. We continue to expect that AMSC power systems revenues will represent between 87% and 90% of total sales for the year. We also continue to expect that approximately 65 to 70% of our revenues will come from international markets, and 65 to 70% of sales will come from the wind energy market. We expect each of these metrics to trend to the upper end of these ranges. As a result of higher revenues, EBITDAS should be better than previously forecasted.

We now expect EBITDAS for fiscal 2008 to be in the range of 7 to $10 million, up from our previous guidance of 3 to $7 million. Our net loss forecast for the year is being impacted by higher non-cash charges associated with stock based compensation, and the mark-to-market adjustment on an outstanding warrant that we discussed earlier. Non-operating factors such as lower interest income and higher taxes compared to our previous expectations, are impacting our net loss forecast for the year as well.

As a result, we are increasing our net loss guidance to a range of 13 to $15 million, or $0.30 to $0.35 per share, compared with our previous range of 9 to 12 million, or $0.21 to $0.28 per share. Capital Expenditures were 1.5 million for the first quarter of fiscal 2008, and we continue to expect that we will invest between 5 and $7 million globally in fiscal 2008, related to systems and facilities to support our continued growth.

With that, we will open the call to questions. Anthony would you please provide the instructions?

Absolutely. Thank you, sir. (OPERATOR INSTRUCTIONS).

We will take our first question from Jim Ricchiuti at Needham & Company.

Yes, good morning.

Hi, Jim.

Greg, I wonder if you, a few things. What percent of sales was Sinovel, and are you beginning to see the ramp up from some of the newer customers, including Ghodowat, and the other customers in China?

Sinovel was a huge fraction. I will let Dave answer that.

Yes, Sinovel represented about two-thirds of our sales in first quarter.

And the second part of your question was about sales or orders from newer licensees. We will expect to see more of that happening later in this fiscal year, because if you remember the production schedules we have published from our various customers, licensees when AMSC Windtec licensees, those will be starting up maybe, mainly next year.

CSR ZELRI from China though, as you know has already given us order, AAER in Canada has given us orders, Dongfang in China has started to give us orders as well, so they are already off and running, but we will see that ramping more as we go toward the end of our fiscal year, so providing revenue growth as our model, we have always said revenue growth for the subsequent years going forward.

And we will take our next question from Theodore O'Neill at Kaufman Brothers.

Thanks very much. For having a great quarter, you are not getting any credit for it on the tape today, because it looks like a miss, and the variance seems to be coming at other income and expense and the taxes, so I was wondering if you could talk about those two things, to the extent that we could do a better job of forecasting those into our numbers, so that it doesn't look so bad on the tape the next time around?

Okay, let me start with other income and expense. Other income and expense, that is where that mark-to-market is located, on the warrant. That stock warrant was issued back in 2005. It was as a result of some litigation settlement that we had, and so the accounting rules require that you have to revalue that warrant each and every quarter, and the change in that value results in a P&L charge, or a P&L income, depending on where our stock price goes, so the way to model it is that really for every dollar change in our stock price, one way or the other, that line will be impacted by about $ 200,000.

So in the first quarter, when our stock price increased $12 per share between the end of the fourth quarter, and the end of the first quarter, that resulted in about a $2.4 million mark-to-market hit. Based on the stock price today, it could stay that way we would have a pick up in the second quarter, so that is the other income and expense line.

On the taxes, it is kind of the convoluted sort of discussion , so if you will bear with me for a second. Our tax situation is that in the US, we do not tax benefit any losses. We incur losses in the US, and we reserve any tax benefits that are associated with those losses, so NOLs, or future deductions that we might have for things like stock compensation expense, timing differences between book and tax, all of those things get reserved, whereas in our foreign jurisdictions, we have taxes that we have to pay both in cash, and that we have to record on our books.

So the way to think about it is if you look down our P&L, you look at things like the mark-to-market in the US, interest income, all of that is generated in the US, stock based compensation expense, all of that is in the US, operating losses in superconductors all of that is in the US, so you add up all those things there is about $10 million of pre-tax charges that are included in our pre-tax income, that you see for the first quarter, which happened to be about $4.4 million.

You back all of those things out, and then you tax effect that at some 25 to 30% sort of rate, which would be the effective rate in our foreign jurisdictions, that is how you can model income tax expense on a go forward basis. So look for some of those than in our P&L, like interest income, the mark-to-market, operating losses and superconductors, and stock based compensation expense. Back them out of your model when you are trying to compute taxes, because those are expenses all generated in the US, and we do not record a tax benefit on them.

So I am hoping, that was sort of a convoluted explanation, but I hope that it was clear enough for you and I would be happy to talk to you later about it, to make sure

We'll go next to Paul Clegg at Jefferies.

Hi, guys, just a question about gross margin. If I understood you correctly, you said you were guiding towards the lower end your annual guidance for gross margin. I wasn't clear if that was due to the allocation of non-cash comp in there, or if of there were some other explanations for that?

No, Paul. Last time in fourth quarter when we gave our guidance, we said that we haven't really changed it. We said that our guidance was at the low end of our 30 to 35%, and we haven't changed that.

The sequential change in our gross margin from Q4 to Q1 if you will recall, last quarter we said that there was a high margin D-VAR sale that occurred in the fourth quarter, that made our gross margins unusually high, so in the fourth quarter we had a 33% gross margin, but we told you that the gross margins for the full year this year would be at the low end of our range of 30 to 35%, so we anticipated that gross margin would be lower in first quarter, as compared to what we saw in the fourth quarter.

That D-VAR sale had about a 300 basis point favorable impact on our gross margin in the fourth quarter, so if you normalize that, we had roughly a 30% gross margin in the fourth quarter, compared to a 29% gross margin in the first quarter, and then that particular change would be due then to the lower mix of D-VAR sales in the first quarter, and some higher warranty costs.

We will go next to Carter Shoop at Deutsche Bank.

Good morning. Wanted to first understand why the tax, the total taxes paid will be decreasing throughout the year, if we assume that the power systems business, which is primarily in foreign jurisdictions continues to increase, and then my question is, what is your outlook for losses in the superconductor business the remainder of the year?

Our outlook for superconductors has been generally posting operating losses somewhere in the 4 to 5 to $6 million range per quarter, and those operating losses are going to continue here for the rest of this year, sort of at that kind of range. So those operating losses in superconductors will not be tax benefited.

So as you look at your modeling for taxes for the rest of this year, you should be backing out superconductors operating losses in that kind of a range, and then backing out some of these other expenses like I mentioned earlier, like the mark-to-market interest income, stock based compensation, which are all US denominated expenses, and trying to determine the model for your taxes on a go-forward basis.

We will go next to Walter Nasdeo at Ardour Capital.

Good morning, thank you. Guys, I would like to talk about the superconducting business for a second also. Can you give me a little bit more information on how the Con Edison project in New York is developing, and as you are done with that discussion, if you you could give me where we are as far as current capacity, and then what you expect to end the year at, and maybe on into next year? Thanks.

So Project HYDRA in New York City is moving forward a pace. We fully expect to have the cable system in the ground in Manhattan in 2010 on schedule, so that is moving forward.

In terms of our gross capacity, nothing really changed there, effectively 720,000 meters per year of gross capacity as we speak, and I don't see that, or we don't plan to see that change as we go to the end of our fiscal year, we are ready to ramp up that capacity as we have always said, dictated by customer demand.

Right now our focus is on improving our yield and our manufacturing process, which of course increases our total amount of wire that is available to sale. So we don't have a plan for increasing that capacity, until we see that customer demand pick up as I mentioned in my comments.

We will go next to Michael Carboy at Signal Hill.

Good morning, Ladies and Gentlemen. David, I would like you to elaborate a little bit on the gross margin issue. It looks like on the incremental basis here, the incremental gross margin was actually remarkably negative on the $1.4 million incremental revenue change. Could you break out for us what portion of non-cash comp increases hit the cost of goods sold line, and what are you seeing with regard to your other input costs, whether it be energy or component costs, what inflationary trends are you seeing there? Thank you.

Yes, I think, Michael, as I mentioned earlier as the gross margin changed, when you look back at fourth quarter, I think you should back out about, you should be comparing on sort of an apples-to-apples basis, more like a 30% gross margin for the fourth quarter, compared to a 29% gross margin for the first quarter. So that sort of backs out the effect of that incremental, of that high margin sale that we had in the fourth quarter.

There is really no, it is de minimus, maybe a few $100,000 of effect from stock based compensation expense that goes into cost of sales. Most of that falls into the operating expense line, primarily SG&A, so that is really not the driver. As I mentioned earlier, the driver for our gross margin changed quarter on quarter, when you normalize for that high margin sale, is due the lower margin D-VAR sales and higher warranty costs that we have recorded in the first quarter, as compared to the Fourth Quarter.

Just to correct what you said there, you said lower margin D-VAR sales, David, it is higher margin D-VAR sales, and we had less of those in the first quarter.

Right. Sorry.

We will go next to Corey Tobin at William Blair.

Hi, good morning. Quick question on the Sinovel 3 megawatt turbine and the 5 megawatt turbine designs. Any update as to when you expect orders from those products? Thanks.

Well, we had an order we announced I think end of March, or beginning of April, or somewhere in that timeframe, that we had $18 million worth of new orders from Sinovel for the 3 megawatt system. So Sinovel expect to go into production of the 3 megawatt wind turbines in 2009, and they already got the order in for us, and we will be shipping those to meet their schedule next year, so this is not a revenue impact for this year. It is really a revenue impact, a positive impact obviously for next year, so that is the story.

But through the 5 megawatt, their plan is to be in prototype stage somewhere around 2010 timeframe, and we don't see any slowing down of that one either. So that is the schedule. In the meantime of course, they are really ramping up their production of the 1.5 megawatt wind turbines, as I think we all know.

We will go next to Pavel Molchanov at Raymond James.

Good morning, guys. A couple of questions about China. Can you mention as of your March 31 backlog, 199 million, what percentage of that was either Sinovel, or just China more broadly?

Yes, we don't really break out our backlog by customer, or even by country, but you could certainly given our revenues, or half influenced by Sinovel, they make up certainly at least that portion of our backlog, but we don't intend to break out our backlog by customer.

We will go next to Stuart Bush at RBC Capital Markets.

Yes, good morning. Greg, I was hoping you could clarify the details of the Sinovel contract. This $450 million quote, does that include the 17% value-added tax or not?

No, it does not.

It does not, so if they export, would you recognize that 17% additional value-added tax as revenue?

You don't recognize VAT as revenue. It is cash in and cash out.

Okay.

So there is a price in the contract that is without VAT, and there is a price in the contract that is with VAT, and if we charge VAT, that will not go through the revenue line, that is just running through the balance sheet, it is cash we collect and then cash we give to the government.

We will go next to Brian Yerger at Jesup Lamont.

Good morning. Thanks for taking my call. I was wondering with the mix of the power system, Power Modules 1000 versus the 3000 going forward in 2009?

Well we haven't published that. What we said at Analyst Day last November, November '07 is that by the end of this year we would expect to start shipping our PM3000, so we are going to be ramping up or starting to ramp up production of PM3000. PM1000 is carrying the date today, and through the rest of this year.

As we go into calendar '09 starting in January, we will start shipping both PM1000 and PM3000 to Sinovel, part of that $450 million order, but the mix is going to be, we are not publishing the specific mix, but it will be primarily 1000s, and then by the end of the three year period it is going to be primarily 3000s, so that switchover will occur for that particular customer in that three year period of time.

So primarily PM1000 is now starting to ramp up production, and starting to ship, the PM3000s by the end of the year. Remember, PM3000 is a wind specific design, based on all of of our years of working with the wind industry, so the primary, in fact maybe let's say the primary market for this is the wind market, which is obviously booming for us right now.

We will go next to Jim Ricchiuti at Needham & Company.

Yes, I wonder if you would just comment on the lower sales for D-VAR in the quarter, and what the outlook looks like for that product family?

That was just a matter of timing, Jim. We expect to see continued growth in D-VAR sales through this year, more orders coming through, sales being of course shipments, we will recognize revenue in D-VAR shipments, but we also expect to see more orders coming in for D-VAR, not just for wind which has been the growth sector for us for grid interconnection of wind farms, but also for utilities, for voltage regulation, increasing reliability of the grid, and as I mentioned in my comments, we are expecting by the end of this fiscal year to get our first grid orders, grid related orders from China, and some of that is going to be D-VAR as well, so look for D-VAR sales to continue to grow through the rest of this year, and certainly going forward.

We will go next to Paul Clegg at Jefferies.

Hi, guys, thanks, another follow-up on gross margins. What kind of impacts are you looking for as a result of the new Sinovel order rolling through your numbers? I think that's the last quarter of the year, and I think you are going to be delivering most of that from your China facility?

Yes. What we have said is that to get an order of the size that we did , we obviously gave Sinovel some concessions on price, but we are continuing to maintain that we will be generating Company average gross margins, so the 30 to 35% range gross margins when we sell core electrical components to Sinovel once we start shipping them from China, so even though we gave some price, there will be some cost reductions that with we will be able to offset

We will go next to Michael Carboy at Signal Hill.

Thanks for the follow-up. Could you ask you to elaborate on what is happening with the higher warranty expense?

Well, yes, Michael. When we sell more product, it has a warranty that is attached with it. Sometimes those warranties will have 12 month periods, sometimes it will have 24 month periods.

We accrue warranties based on our actual experience, and then we project that forward. So it is just more of a modeling exercise, based on what we expect our future expenses to be based on product that we have in the field, and what our historical costs have been to repair what is already there.

We will go next to [Peter Shipland] at William Blair.

Yes, hi. I was wondering, is there any update on power module sales to some of the more established manufacturers?

Power module sales to the established, okay you are talking about the wind industry?

Right.

As we have mentioned before, probably at Analyst Day for sure, we do of course approach the established wind turbine manufacturers, like Vestas and Gamesa, and so forth, but they do have their incumbent groups in place, so it is pretty hard to break in. Will we have sales to the established wind turbine manufacturers in the future? I think the answer is going to be yes, but don't look for that this year or next year.

Our wind specific PM3000 provides us with a tremendous advantage there, so it is worth continuing to call on those customers, but by far, nearly 100% of our power module sales are going to be to the new entrants, which are the ones that are growing very rapidly, and taking market share from the established players.

We will go next to Carter Shoop at Deutsche Bank.

Hi. Can you comment on the expected linearity in revenue throughout the remainder of the year, do you expect Q2 to be roughly at the same levels, and then pick up dramatically in the back half of the year, or will it be a relative linear ramp throughout the year?

Yes, Carter. We expect that the second half, when you look at our second half revenue, as opposed to our first half revenue, the second half revenue, the growth rate of that will be higher, to answer your question more directly, a bit more back end loaded growth in second quarter, we do expect growth in the second quarter, but when you look at that growth in the second quarter over first and you compare that to what we expect in the second half, we expect the second half growth rate to be higher, than that growth rate that we expect in the second quarter over the first quarter.

We will take our final question from Pavel Molchanov from Raymond James.

Thanks for the follow-up. You mentioned earlier about the 100 gigawatt wind market in China. Can you just mention the stage that is in, in terms of the governmental process?

It is in progress. There are plans that are being put together, and we would expect that to become a reality in the next couple of years.

Ladies and gentlemen, that does conclude today's question and answer session. I would like to turn the conference over to Mr. Yurek for any additional or closing remarks.

Thank you, and thanks for your attention and questions today. We had a good quarter. We expect this year to be continued strong growth, and we are looking forward to reporting back to you on our full year results, and quarterly results on the way there. Thanks very much.

This does conclude today's presentation. We thank everyone for their participation. You may disconnect your lines at any time. Have a good day.