Northeast Power Systems, Inc. (AMSC) Earnings Call Transcript & Summary

Good day, and welcome to the American Superconductor conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. John Heilshorn of LHA. Please go ahead, sir.

Thank you, Jonathan. Good morning, everyone, and welcome to American Superconductor Corporation's conference call. I am John Heilshorn of LHA Investor Relations, AMSC's Investor Relations agency of record. With us on today's call are Daniel McGahn, Chairman, President and Chief Executive Officer; and John Kosiba, Senior Vice President, Chief Financial Officer and Treasurer. American Superconductor issued a press release yesterday after the market closed announcing the acquisition of Northeast Power Systems, Inc., NEPSI; fiscal quarter 2020 preliminary results; and fiscal third quarter 2020 business outlook. Those of you who have not yet seen the release, a copy is available on the Investors page of the company's website at www.amsc.com. Before turning the call, I would like to remind you that various remarks that management may make during today's call about American Superconductor's acquisition of NEPSI and future expectations, plans and prospects constitute forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those set forth in the Risk Factors section of American Superconductor's annual report on Form 10-K for the year ending March 31, 2020, which the company filed with the SEC on June 2, 2020, and subsequent reports that the company has filed with the Securities and Exchange Commission. These forward-looking statements represent management's expectations only as of today and should not be relied upon as representing management's views as of any date subsequent to today. While the company anticipates that subsequent events and developments may cause the company's views to change, the company specifically disclaims any obligation to update these forward-looking statements. All of American Superconductor's press releases and SEC filings can be accessed from the Investors page of its website at www.amsc.com. With that, I will now turn the call over to Chairman, President and Chief Executive Officer, Daniel McGahn. Daniel?

Thanks, John, and good morning, everyone. Today, we want to talk to you about 3 things. First, we want to provide an update on our second quarter, which just ended on September 30, 2020. Second, we want to explain the acquisition that we just announced last night, how we believe it fills a product line gap and how it fills a financial gap in our near-term business. And third, we want to provide a guidance for the third quarter, which will include the combined company with the acquisition. So to be clear, September numbers do not include the acquisition, December numbers do. John, why don't you update folks on our Q2?

Thanks, Daniel. Good morning, everyone. For the second quarter of fiscal 2020, we expect revenues will be in the range of $20.5 million to $21.5 million, compared to our previous second quarter revenue guidance of $17 million to $21 million. Our net loss and non-GAAP net loss for the second quarter of fiscal 2020 are both expected to be lower, which means better than our previous guidance provided on August 5, 2020. We expect cash, cash equivalents, marketable securities and restricted cash at September 30, 2020, to be approximately $57 million, which is in line with our previous guidance provided on August 5, 2020. Please note this does not include the acquisition cost as that was closed after the second quarter on October 1, 2020. The preliminary unaudited information is based on our current estimates of results from operations for the second quarter of 2020 and our cash, cash equivalents, marketable securities and restricted cash at September 30, 2020, and remain subject to change based on our closing procedures, including execution of its internal controls over financial reporting and the subsequent occurrence or identification of events prior to the formal issuance of the unaudited quarterly financial statement. I will now turn the call over to Daniel to discuss the acquisition of NEPSI.

Thank you, John. That's really great. We tightened the revenue range to the high end of our previous guidance, and it currently looks like the bottom line is expected to come in better than we planned. We're higher on cash as well by about $2 million. Now moving on to the acquisition. Yesterday, we announced the acquisition of Northeast Power Systems, Inc., a private company based in Upstate New York, for $26 million in cash and just over 873,000 restricted shares of AMSC common stock at closing. Northeast Power Systems, Inc., also known as NEPSI, is a leading provider of medium-voltage, metal-enclosed power capacitor banks and harmonic filter products for use on electric power systems. Founded in 1995, the New York-based company has grown to be a market leader and trusted name for the supply of steady-state power factor correction and harmonic filter systems. NEPSI's products helped deliver electric power more efficiently and reliably by improving power factor, reducing voltage distortion and leveling the load voltage profile to large power producers and consumers. All NEPSI products are designed and built in Upstate New York, just about 3 hours away from our headquarters here in Massachusetts. As an alternate to elevated open rack of equipment, NEPSI products provide significant cost savings to engineering and procurement companies as well as end users. Much like our D-VAR, their products are fully designed, tested, assembled and shipped ready for interconnection. We acquired NEPSI because it directly aligns with our strategic priorities to accelerate profitable growth independent of our wind business, broaden our product offerings and expand both market reach and market share. Moreover, NEPSI has been a supplier partner of AMSC for many years, and we believe that this close working relationship mitigates normal-course acquisition risk. Strategically, we acquired NEPSI to further diversify our revenue and margin mix by region, customer and products and with the expectation that NEPSI will improve the long-term power and quality of our revenue growth and profitability, and most importantly, to accelerate our ability to achieve our goal of profitability. NEPSI has a history of profitable revenue with a 3-year average of approximately $25 million in annual revenue and operating margins approaching 20%. NEPSI is a high gross margin business. It's also a high operating margin business. In addition to the expected improvement in the power and scale of our revenues and earnings, we believe the acquisition of NEPSI can expand the market penetration of our D-VAR product. NEPSI extends our product offerings in the industrial sector of our Grid business. As we have been focused on growth for our D-VAR segment, we have learned that we have applicability in segments of the industrial market like semiconductor. However, we believe there's a much larger market out there for voltage management. We see our voltage management total addressable market doubling with the addition of NEPSI products. The additional markets served by NEPSI will provide immediate access to customers we do not have access to today. By leveraging NEPSI's leadership position in the static voltage management market for industrial applications, AMSC expects to expand its offerings and deliver greater value to existing and new customers, business partners and shareholders. The transaction is expected to be accretive to earnings per share beginning in the third or December quarter of fiscal 2020. With that, I'll have John Kosiba discuss the NEPSI transaction and our business outlook going forward. John?

Thank you, Daniel. We are very excited to announce the acquisition of NEPSI, and I would like to take a moment to summarize the financial terms of the acquisition. On October 1, 2020, we acquired Northeast Power Systems. Pursuant to the terms of the stock purchase agreement, we paid $26 million in cash and issued 873,657 restricted shares of AMSC common stock at closing. In addition, the sell-in stockholders of NEPSI may receive up to 1 million additional shares of restricted AMSC common stock upon the achievement of specified revenue objectives during varying periods of up to 4 years following the closing. For more information about the stock purchase agreement, please refer to AMSC's Form 8-K filed with the SEC yesterday. It is our intent to have NEPSI continue to operate from the Queensbury, New York facility. For the calendar years 2017 through 2019, NEPSI averaged approximately $25 million in annual revenue. For the same 3-year period, NEPSI operating margins were approaching 20%. Again, NEPSI financials will be consolidated into AMSC's financial statements beginning with the third quarter of fiscal 2020. Realize that we will be able to consolidate NEPSI results for half of our fiscal year, meaning the third and fourth quarters of fiscal 2020. Daniel will now provide further insight into the markets NEPSI serve and how the acquisition further solidifies our growth through grid strategy. Daniel?

Thanks, John. NEPSI is a natural fit for us. In fact, we believe NEPSI might be a perfect fit for us. We expect NEPSI to extend our offering in power correction and expand our reach in the industrial sector. NEPSI is a leader in steady-state power correction, and AMSC is a leader in dynamic power correction. With NEPSI, we can service both the static and dynamic power correction needs of industrial customers. We believe there is not only potential for incremental static power correction business from the addition of NEPSI, but also the potential for increasing the content per installation of our dynamic power correction or D-VAR projects. NEPSI is expected to expand our market reach and double our addressable market for voltage management. NEPSI serves and competes within a $3 billion a year FACTS, or Flexible AC Transmission System, market. The FACTS market is basically evenly split between variable compensation and static compensation. Our D-VAR product serves the variable compensation market. AMSC did not have a product offering serving the estimated $1.5 billion static compensation market. NEPSI's product portfolio directly addresses the static compensation market. We estimate AMSC's total addressable market will double with the addition of NEPSI. AMSC believes NEPSI creates a strategic opportunity to expand the Grid business into new industrial markets. NEPSI is expected to accelerate our goal of profitability on a quarterly basis independent of our wind business. NEPSI's high operating margin is expected to help narrow the operating cash flow gap needed to be consistently cash flow positive. We've just guided to third quarter revenues that show exactly our scenario of positive operating cash flow at around $25 million in a quarter. Granted we've only guided 1 quarter out, but we're very excited by the possibilities the acquisition presents. As you know, we at AMSC have unique system offerings that have developed system-level understanding, system-level differentiation and system-level know-how. In recent years, we have accomplished this organically within our Grid business. The addition of NEPSI's turnkey steady-state power correction product line brings additional system-level know-how, differentiation and value through the acquisition. From an operational perspective, we believe the acquisition of NEPSI has the opportunity to provide immediate synergies with AMSC. NEPSI manufactures and provides the supply chain with competitive products. It's flexible and it can be leveraged. NEPSI's manufacturing is not capital-intensive. Additionally, NEPSI has certain manufacturing capabilities which we believe has the potential to be leveraged to enhance gross margin across product lines. In conclusion, we're executing on our strategy to grow and diversify through grid. NEPSI will be integrated into AMSC immediately. Our plan is to combine our sales teams and efforts and keep the New York factory delivering NEPSI products. AMSC welcomes the addition of NEPSI to our Grid business, and we look forward to growing the Grid business together. Now for the third topic, which really shows how much the business has improved and what it can look like with the addition of the acquisition, John, you get to steal the show and really get people to understand the possible leverage of our business. Do you want to go through the guidance for December?

Sure, Dan. Thank you. Turning to the financial guidance for the third quarter of fiscal 2020. We expect that our revenues will be in the range of $22 million to $25 million, and we expect to generate positive operating cash flow on net revenue. This guidance includes NEPSI's expected impact on the financial results for the third quarter ending December 31, 2020. Now I'll turn the call back over to Daniel.

Hey, that's a lot to cover today. So Q2 looks like it will be better than planned. We acquired a company we know well and have been working with for years. This is going to expand our total addressable market and market reach, especially in the industrial sector. And as John said, we expect to generate positive operating cash flow for our December quarter. We're only really looking 1 quarter out so that you know. We're very happy with the acquisition. The team is very thrilled. We're very happy to be able to work with folks we've known for a number of years. I don't want to get too far ahead, but we're really focused now on how we get the combined company to work very well together. I'm very proud we're able to get this done in the middle of a pandemic. And I look forward to reporting back to you when we announce our financial results for the second fiscal quarter of fiscal 2020, which ended September 30, 2020. This announcement should take place sometime in early November. Jonathan, we'll now take questions from our covering analysts.

[Operator Instructions] We'll take our first question from Eric Stine from Craig-Hallum.

So I realize this may be a little tough during COVID and maybe it kind of clouds the picture a little bit. But is there any way you could step back a little bit? I know you gave a 3-year average for revenues and operating margins, but maybe how that's trended over time. And then I would love to hear how you think that might be accelerated or changed when it's part of your platform.

Yes. I think the general trend has been up over the past years. When we look at the immediate situation, we do have COVID in front of us. So we've talked about an acceleration in our business. I'm not familiar enough with their financials at this time to say what they've done directly in the past on a quarterly basis. But going forward, we think we have a real nice Grid business that's positioned to continue to grow. Is that growth going to continue into Q4, Q1? Again, with the pandemic, I can't really give you degrees of certainty. But we think from a macro standpoint, we're going to see growth coming through Grid for it to continue just as it has for the past several years. This gives us more scale, gives us more market, gives us more reach, and that should really translate into, we think, growth. Additionally, kind of what you're getting at, Eric, is we've done some large installations. We've done them alongside NEPSI. And what it means for some of our D-VAR business, we're actually going to be able to deliver more content and more margin per installation. To give you kind of a rough math, think of it as something like 10% to 20% more content. And then you can apply the margin as you're looking to model this part of the business for us. So we think it's going to expand us in industrial, and it will expand our content for installation, not for all, but for many, of our installation of D-VAR.

Got it. Okay. And then any seasonality we should think about with NEPSI? I guess I'm in part from that question trying to figure out what their contribution may be in the third quarter and maybe what that means or implies about the other parts of your business, grid and wind.

Yes. I think, from a seasonality standpoint, we don't really see anything directly. We do see industrial cycles. So depending upon the application, they deliver hardware into a variety of industrial applications. We think it's very well-diversified among a bunch of different industrials from chemicals to cars to data to what have you, right? There's a series of applications that they deliver. So what we're looking at is how do we take advantage of capital cycles like we do in semiconductor. And that's some of the work that we'll probably talk about going forward, but I'm not ready to present today.

Eric, this is John. Just 2 things. I just want to remind you that the guidance we provided includes the contribution for the quarter and Q3. I don't want you to add it on top of -- okay.

Yes. No, that's great. And then maybe last thing. We've seen some filings over the last couple of weeks. I know this is about the acquisition, but just kind of an update on Inox. It seems like that may be trending in the right direction. That's it for me.

Yes. That's a good question, Eric. So we've been able to get to the point with Inox where they've been able to cure against the contract. The numbers have been disclosed last quarter, what they were able to get to. We extended the date to early date in October, and they were able to cure what we asked them to do or what the contract asked them to do. So we think there's also some good news here with Inox. But again, I'll defer that. So we'll have a call probably in a month, and we'll talk a bit more about that. Really, today, here, we're trying to focus on the acquisition, what it means for the business, so you guys can all understand it and why we did this and where we're headed.

We'll take our next question from Colin Rusch of Oppenheimer & Co.

Can you talk a little bit about your initial thoughts on the product road map? Obviously, you mentioned the semiconductor industry. But how far down the road are you guys in terms of evaluating the opportunity sort of leveraging the new IP that you're going to be able to bring in-house?

I think we think of this as a drop-in product line extension as is, and then I think there's some synergies going forward. Those synergies will kind of ease out as we better understand them. But if you think about it simply, the D-VAR product line, most of its business comes from grid interconnection of renewable sources of power. That's really where the business comes from. In the case of VVO it comes principally from interconnection of distributed generation solutions like residential solar, to some extent, electric vehicles. We've seen some extension of both of those products in industrial, right? So D-VAR, we've done industrial power quality for semiconductor fabs. VVO, we've done a variety of, I'll call it, more NEPSI-like applications in industrial. We think the NEPSI product line fits very nicely this need for persistent voltage management and power correction. That's really ultimately what the industrial market needs. If we wanted to go after this, we probably have to develop an additional product alongside D-VAR. And what we saw with NEPSI is exactly that product being delivered at very nice margins and said, "Well, why don't we buy this instead of build it?" We inherit what we think is a really exceptional team. They're very strong technically. They're very good at marketing. And they really deliver a very high-performing, high-quality product. So we're very proud of having NEPSI as part of our Grid business.

And with the increased scale that you guys are going to end up having with this combined business, what do you think the impact is for your ability to work with customers and leverage those relationships? Obviously, you're -- you've got the public company element to this, but you're talking about a very large market with a company that has a fairly small market share at this point. Does the combined entity structurally have some new dimension that the separate entities don't have?

Yes. I think that's exactly right, Colin. That's kind of the feedback I've got initially from some of our closer customers and partners since we announced this, that they see us as being very similar in the market from a quality, from a perception, from a technical acuity providing different products that really meet kind of different demand criteria. So the combination of getting those from the same provider, I think, will be received very positively by the market, and it may need some additional growth for us, but that's still all to be determined. But I think you're getting on to one of the fundamental things that we think could be a potential here. But I'd rather prove it first and then tell you about it, but I think it's a thoughtful thesis.

We'll take our next question from Philip Shen of ROTH Capital Partners.

Congrats on the acquisition. I'd like to follow on, on the margin question that Eric had there. As it relates to the higher operating margins, can you talk about what enables them to hit those higher margins? And then as a combined entity, do you think there is margin expansion potential? So it's more than just feathering in their higher margins, but do you see synergies that -- and you may have alluded to some of this already, but if you can quantify or talk through what kind of margin expansion over what time frame and what those drivers might be, Daniel, that would be great.

Yes. I think what gives them the leverage is they really don't do R&D like we do. I think that's an asset to them on our side. So they run very lean. Their operating expenses is very, very thin and very light. We want to be able to keep that in place so we can continue to get the leverage out of the business that we get. From a synergy, from a margin standpoint, I kind of hinted at it. I can't quantify it today. It's something that we're going to explore. They have a supply chain that's compatible with ours. There may be some leverage there. They do some build-out in a way that's maybe a bit more integrated than what we do, which may be able to be savings across not only D-VAR, but potentially ECS. But I don't know if those are material savings at this point, so I just want to give you some directional and color that there may be things. As we prove them out, we'll talk to them, and we'll try to quantify them. I think the way to model this is you're dropping in a nice slug of revenue that's very compatible with what we're doing with grid. Grid itself now has probably a bigger potential to grow, a bigger market to go after. And it's really our job to make sure we continue that growth over the coming years.

Great. We understand the rationale, but wanted to get into their heads a bit, if you can provide any color there. What is the rationale on their side to do this? And how did this come about? Did you guys initiate? Did you guys just end up collaborating a bunch and so it's a natural process? Any color there would be interesting.

Sure. We've known them for a while. John Kosiba got involved a while back because he saw them being very similar to us as just human beings. As we start to do more work, John developed a relationship with them. So we've been in kind of constant contact with them. Where -- you guys know we're not shy, so we asked them what we think it's worth. And at the time, we said that's probably not a price that we're willing to pay. This is a while back. I think one of the things that really changed was COVID. And I think it's the performance of American Superconductor during this challenging time that makes us even more attractive to NEPSI. The fact that we can continue to operate the business, do well overall, do well by our customers, just as they themselves are doing. It really made sense to say, "Okay. How do we get more scale? How do we combine? Can we get more out of this business?" And I think that was kind of the icing on the cake. John, do you want to highlight anything that you...

I mean, Phil, this is -- these guys have worked closely with us for many years. So it's one of these things where you stay close to your partners, and when the timing is right, you advance those conversations. And it happened to be the right time over the last few months. But this is a relationship that's been strong for many years. So it was just good timing at the right time.

We try to structure the deal in a way where these guys feel they're rewarded for their effort, but they're also heavily linked to us in the longer term. You can see there's a piece of the deal that's also an earn-out where we're trying to keep them engaged for the next 3 to 4 years. We're trying to not be disruptive to their business and try to add leverage on top of it. If you think about how we sell, we sell typically to renewables. They sell typically to industrials. So I think there's some cross-leverage there. We have some reference sites for D-VAR and utilities. Who knows where that business will go? And maybe combined, there's more of an attack there, but we'll see how that plays out. We just think it really fits really nicely into what we do and how we do it.

Great. One last housekeeping question. Can you share if NEPSI had any debt and how much they had?

So they had a small amount of debt on the books for the building, but that was paid off at closing. So there's no debt.

We'll take our next question from Jed Dorsheimer of Canaccord Genuity.

Congratulations on the acquisition. It looks like a good one. I guess most of my questions have been asked already, but maybe just if I could reframe 2 that I think we -- you've touched on. So I guess, first, the acquisition, does this change your -- the customer base that you would be pitching to? And specifically, it seems like, with D-VAR and REG, your primary customer base would be the wind turbine or the utility. And I'm just wondering with the combination of this, when we see Amazon, for example, talk about going to net 0, does this offer you a greater solution to go directly to the end user for data centers, for example?

That's exactly right, Jed. I think you nailed it. There's leverage. If you think about where D-VAR goes today, typically, it's, as you said, we're connecting wind to the grid. There is a play for what NEPSI does there in combination with what we do. So think of it as content expansion per order or per system placement. On the industrial side, they're very strong in a number of markets. Data centers would be one that we certainly want to try to explore. That's not a market we could get after typically with D-VAR because simply the overload capability of D-VAR is too much for the situation. It's kind of a Cadillac when you just need a regular car. In the case of data centers, you're going to need persistent power management and we think the NEPSI offering may have applicability there. So it's really kind of leveraging the industrial channel on their side for what we've been doing. It's leveraging our renewable channel for what they've been doing. And then REG really is focused on utilities. We've done some business with utilities. They've done some business with utilities, not to any material level in the business, but that opens up a whole another channel. We think that we've been working on focusing on REG, but also trying to sell D-VAR and VVO there. We've been able to sell VVO to a number of utilities. So we think there's a lot of synergy in the front end. And then we're going to keep making the products we do in Massachusetts and keeping -- making the products that they make in New York.

That's great. That's helpful. Separate question away from the acquisition. But as we start to -- we're seeing increased interest around fusion technology on the generation side. And I know this is a ways out, right? But if superconductor materials are kind of core to that, I was just wondering whether or not you have any activity in that. And again, I totally understand that, one, this conference is really for the acquisition; and two, that's further away. But it seems like that would be -- it seems interesting, at least to me.

Yes. No. And I share a lot of your thoughts, I think, Jed, on, directionally, we think about 2025 and beyond. We used to be a company that would highlight anything that happened in the world of superconductor and comment on it and find it interesting or not. We tend not to do that now because so many people have really been focused on the financials of the business. We think that this acquisition really fits nicely to help fill in part that financial gap. We have talked in the past about other applications for superconductors. But we're really focused on the here and now. We have to be able to continue to grow the business to meet our financial objectives. And I think after we've done all that consistently, we can then think of ourselves as a different kind of platform company. We'll have different types of investors involved. There will be other things that we could think about investing in. And things like power generation are certainly on our radar map, particularly when it involves a superconductor.

At this time, there are no further questions in the queue. I would like to turn the call back over to Mr. John McGahn (sic) [ Daniel McGahn ], Chairman and President and CEO, for closing remarks.

Thanks, Jonathan. I think you just -- that's probably my great, great, great grandfather. But we've got a lot of Johns in the room, for sure. You probably can hear it in our voice. We're absolutely thrilled and excited. This is a group we know well. They know us well. There's a lot of compatibility with the product line. There's a lot of synergies in the channel. You know how we act. We tend to do and then celebrate. We have a lot of work ahead of us to integrate this, make it all work. And we hope to come back to you with a lot more positive directional anecdotes around growth and what other potentials could be for the combined business. But right now, we're focused on how in the middle of this world that we're in do we continue to be able to service our customers in a way that's going to benefit the business in the long term. So thank you for your attention. Appreciate those that were part of the call. And it looks like we'll probably be talking to you again maybe in a month, which is when we're due to report the actual results. We're very happy with what Q2 looked like, which I think is part of the message as well. Thanks, everybody.

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect.