American Superconductor Corporation
Q3 2023 Earnings Call Transcript

Published: 2 Feb 2023

[Operator:]

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

[I would now like to turn the conference over to John Heilshorn of LHA. Please go ahead.:]

[John Heilshorn:]

Thank you, Gary. Good morning, everyone, and thank you. Welcome to American Superconductor Corporation's Third Quarter of Fiscal 2022 Earnings Conference Call. I am John Heilshorn, one of LHA Investor Relations, AMSC's Investor Relations agency of record. With us on today's call are Daniel McGahn, Chairman, President and Chief Executive Officer; and John Kosiba, Senior Vice President, Chief Financial Officer and Treasurer.

[American Superconductor issued its earnings release for the third quarter of fiscal 2022 yesterday after the market closed. For those of you who have not yet seen the release, a copy is available in the Investors page of the company's website at www.amsc.com. Before starting the call, I would like to remind you that various remarks that management may make during today's call about American Superconductor's future expectations, including expectations regarding the company's fourth quarter of fiscal 2022 financial performance, plans and prospects constitute forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995.:]

[Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those set forth in the Risk Factors section of American Superconductor's annual report on Form 10-K for the year ended March 31, 2022, which the company filed with the Securities and Exchange Commission on June 1, 2022, and the company's other reports filed with the SEC.:]

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

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

[The reconciliation of GAAP net loss to non-GAAP net loss can be found in the third quarter fiscal 2020 earnings press release that the company issued and furnished to the SEC last night on Form 10 -- 8-K pardon me. 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?:]

[Daniel McGahn:]

Thanks, John, and good morning, everyone, and thank you for joining us. I will begin today by providing an update and sharing a few remarks on our business. John Kosiba will then provide a detailed review of our financial results for the third fiscal quarter, which ended December 31, 2022, and we'll provide guidance for the fourth fiscal quarter, which will end March 31, 2023. Separately, John will update our operating models and talk about actions we took that are expected to lower operating expenses. Following our comments, we'll open up the line to questions from our analysts.

[During our third quarter of fiscal year 2022, we are delivering on our strategic priority of a more diversified business. Total revenues for the third quarter of fiscal year 2022 came in within our guidance range. Our third quarter revenue of nearly $24 million was driven by new energy power system shipments. Our grid segment revenue for the third quarter of fiscal year 2022 accounted for over 85% of AMSC's total revenue. The remainder of the revenues came from our wind business.:]

[During our third quarter, we saw a diverse set of product shipments. We shipped voltage compensators, capacitor banks, harmonic filters, transformers, rectifiers, Volt VaR optimizers, ship protection systems and electrical control systems. These products went into renewables and a variety of industrial markets, including semiconductor, mining as well as our Navy projects.:]

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

[During our third quarter, we booked $43 million of new orders and grew our backlog to over $110 million. Our backlog at the end of the third quarter increased by nearly 40% when compared to the same quarter a year ago. We announced our Ship Protection System contract with Huntington Ingalls to be deployed on the San Antonio Class amphibious ship LPD 32. The LPD 32 contract marks AMSC's fifth ship protection system for the San Antonio Class ship platform. Over the past several years, we've taken a series of very deliberate actions to diversify our business and grow through our grid business. Over a 4-year period, we doubled our business. Over the same period, we nearly tripled our grid business.:]

[Fiscal year 2022 has been a year of transition for the company to a broader product portfolio, pricing and cost changes where possible and aligning our fixed costs better with historical revenues. John Kosiba will provide more color on this today. We have expanded the markets we serve, and that has translated into a higher order intake rate. We do not intend to stop here. We have a lot of work ahead of us, but our longer-term priority is to build a sustainable business that's well positioned to not only take advantage in renewables, but also in semiconductor, mining and materials as well as in defense. We believe that this sustainable business is not so far off in the future. John is going to update our operating models later in the call. I will provide a deeper review of some of the drivers of our business going forward.:]

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

[John Kosiba:]

Thanks, Daniel, and good morning, everyone. AMSC generated revenues of $23.9 million for the third quarter of fiscal 2022 compared to $26.8 million in the year ago quarter. Our Grid business unit accounted for 87% of total revenues, while our wind business unit accounted for 13%. Grid business unit revenues decreased by 17% in the third quarter versus the year ago quarter, while our Wind business unit increased by 76% over the same time period.

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

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

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

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

[Now turning to our financial guidance for the fourth quarter of fiscal 2022. We expect that our revenues will be in the range of $27 million to $30 million on net loss is expected not to exceed $8 million or $0.28 per share. Our non-GAAP net loss is expected not to exceed $6 million or $0.21 per share. We expect operating cash flow to be a burn of $4 million to $6 million in the fourth quarter of fiscal 2022. We expect to end the fourth quarter with greater than $25 million in cash, cash equivalents and restricted cash.:]

[Now I'd like to take a few moments to update you on several strategic steps we have undertaken over the past 30 days that are expected to lower our cash flow breakeven revenue targets. Our revenue product mix has evolved as a result of the 2 acquisitions from what was once heavily dependent on the renewable market to a much more diversified revenue stream. It took some time to integrate both NEPSI and Neeltran to the point that we have now experienced some operating leverage across the grid segment.:]

[As a result, we have taken several steps that are expected to lower both our manufacturing and SG&A overhead costs. These steps range from combining positions, which were redundant across multiple product lines to leveraging our engineering and SG&A cost across the entire company. This has, in part, enabled us to undertake an organizational realignment and to reduce our workforce across multiple product lines.:]

[We anticipate an annualized savings of $5 million resulting from these actions. Our business outlook for the fourth quarter does not contemplate any summit-related costs for the reduction in workforce actions, which are expected to be no more than $1 million. We expect to experience the full impact of these anticipated savings starting in Q1 FY 2023.:]

[Now let me further elaborate on how this is expected to impact our cash flow breakeven scenarios moving forward. As we move into the start of FY 2023, we expect short-term cash gross margins to approach the upper teens. As we move further into FY 2023, we see scenarios where cash gross margins could reach 20% if our revenue approaches $30 million. And we have several scenarios where cash gross margins approached 25% if revenue approaches $35 million. These cash gross margin scenarios are a result of actions we have taken over the past year to raise our prices, coupled with what we believe is stabilized raw material costs. We will continue to be vigilant in both our pricing models and proactive to any changes in raw material costs as we move into FY 2023.:]

[Moving along to our operating expense models. We anticipate our cash operating expenses will be approximately $9 million a quarter once the full extent of our recent cost reduction steps are realized. When you combine the anticipated gross margin improvement with our updated operating expense profile, we see revenue breakeven scenarios in the $35 million quarterly range. These scenarios are based on current assumptions, which are subject to change. Please note, this is not financial guidance. This has meant more to help our shareholders understand our current forecast and operating model. We will continue to provide our current quarter -- quarterly financial guidance when we announced our earnings for the prior quarter.:]

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

[Daniel McGahn:]

Thanks, John. We have macro trends in the market that are starting to drive our business. Our backlog is over $110 million and our pipeline of prospective orders reflects our growing and diversified company. We have doubled our new Energy Power Systems order intake rate. These macro trends are driven by climate and environmental policies, which raised demand for our new energy power systems. More specifically, our diversified pipeline of orders come from investments in renewables and industrial markets such as semiconductors and mining, metals and materials. Our company has transitioned from almost a pure play in wind to a company that's focusing on grid resiliency.

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

[We have a variety of applications for industrial processes and manufacturing, like mining, metals extraction, metal processing and chemical plants. The company is moving in a direction where it expects to provide more new energy power systems for more industrial uses. More than half of our new Energy Power Systems orders during the third quarter of fiscal 2022 come from industrial markets. 1/4 is from renewables.:]

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

[I state the example with NEPSI followed by Neeltran because that was the order in which we acquired the 2 companies and part of what drove us to like the potential sales leverage of both companies. You can reverse the example and see similar potential leverage for mining when comparing to semiconductor projects.:]

[For our mining and materials project that Neeltran would generate, say, $5 million, we're able to expand those revenues by another $1 million from NEPSI. We are working to make those also be at similar margin levels. We believe that we are almost through that. We have a handful of Neeltran projects we need to deliver on in our fourth quarter of fiscal 2022, which is part of the guidance.:]

[I've been asked about potential operating leverage and synergies between the operations that were acquired and the historical business. My answer has been no, up until now. The team has worked diligently on driving operational leverage between the business lines. We are seeing that now coming to fruition, due in part to this leverage. During the fourth quarter, we were able to trim what we expect to be approximately $5 million from our annual operational expenses beginning in fiscal 2023. This is expected to help us get better financial leverage from the business. We believe that this helps put us on a better foot forward financially. We discussed the impact of the Neeltran backlog on our financials. This is something we have largely worked through, and I want to reassure you that going forward, we feel very confident about prospective margins.:]

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

[Right now, we are installing our first ship protection system on the U.S.S. Fort Lauderdale. This is something the Navy and our shipyard partner are monitoring closely. We are preparing to deliver on our second ship contract, the USS Harrisburg. We currently have orders for the U.S. of Harrisburg, the USS Pittsburgh, the U.S.S. Richard McCool and the recently added LPD 32. SPS contributed nearly 10% of revenues in the third quarter of fiscal 2022 and has been a very consistent source of grid revenue for several quarters.:]

[Our team is focused on continuing to expand our ship protection systems into other vessels while we install our initial systems. As I have mentioned in the past, we are working on developing additional content that could be inserted in a future fleet. We hope to have some news very soon on our progress here.:]

[On our Resilient Electric Grid or REG system in Chicago, it continues to perform very well. In fact, we received notification from the utility that the system met specified performance requirements. And as a result, we expect to see the return of a $5 million bond, which was held until the REG system passed this important accomplishment. The performance bond was structured as a letter of credit. This letter of credit is expected to hit our books during the fourth quarter of fiscal year 2022.:]

[We continue to see strong desire from this utility as well as others to further deploy REG into the power grid. It is clear, at least to us, that REG offers the capability and functionality to solve some of the nation's current critical grid infrastructure problems right now. This initial project has provided tremendous learning, and it is clear to me that utilities are thinking about REG as a viable product.:]

[Turning to wind. We are supporting Inox with the initial prototype of a 3-megawatt class wind turbine and Dongfang with the initial wind farm of 5.5-megawatt wind turbines. During the third quarter of fiscal 2022, we shipped 2-megawatt electrical control systems to our partner in India, Inox Wind. You can see that Inox was just over 10% of our revenues this quarter. The design certificate of the 3-megawatt class wind turbine prototype for the Indian market is complete. We are now working on the type certification and hopefully, we'll report back to you soon on our progress.:]

[Type certification means that the 3-megawatt class wind turbine will be able to connect to the power grid. It's worth noting that towards the end of 2022, Inox did announce the completion of a capital raise of about INR 15 billion, which translates into something on the order of about $180 billion. We believe Inox is closer to expanding its business with the 3-megawatt class wind turbine this calendar year, which we expect will translate into an expanded order book for us. We hope to be reporting progress in the near future.:]

[To conclude, we have built a diversified business that we believe is well positioned to capitalize on future investments in renewables, future investments in semiconductors, future investments in electric vehicles and the mining of the materials that go into these 3 markets as well as the defense business.:]

[We are driven by the opportunities that climate change presents to us as well as the electrification of transportation. Our products provide support to the grid at the power consumption point of the electric vehicle as well as the operations that provide the metals and materials used to build the vehicles. We evolved from being a very concentrated business with both customer and market concentration to a more diverse business while at the same time growing revenues.:]

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

[When we look at our prospects, our sales pipeline appears to be strengthening, not weakening. Orders are becoming larger, not smaller. The types of markets we serve are becoming more diverse, less concentrated. So when I look at the near term, say, the next year or so, I think our prospects are great. As we look ahead into the fiscal year 2023, I am optimistic that our recently announced backlog will result in a more diversified and financially stronger AMSC. You can see from the backlog and John's commentary on our operating models that we are nearly there. We believe that our differentiated solutions and set of capabilities are a significant advantage that will allow us to serve our customers even more efficiently. I want to thank our team for their hard work and support, and I look forward to reporting back to you at the completion of our fourth fiscal quarter and fiscal year-end of 2022.:]

[Gary, we'll now take questions from our analysts.:]

[Operator:]

[Operator Instructions] Our first question comes from Eric Stine with Craig-Hallum.

[Eric Stine:]

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

[Daniel McGahn:]

Yes. I mean to my confidence is very, very high. I think the good news about REG is that we've designed the business in a way financially that REG is not necessary to meet our margin projections and kind of the near-term financial aspects of the business. But looking at the longer term, this is a huge milestone for the company. It means the systems performed as advertised. It means that the utility has been able to work with their constituents, specifically regulators and all the local politics that they have to deal with, where this is now a permanent part of the grid, it has been accepted.

[The number of people that they brought there that work for the utility, the number of people that they brought there that work for other utilities has been staggering. Their efforts all along have been to look at this first project as a stepping stone to a future with superconductivity. Everything that we see, everything that we're told, everything we've been shown leads us to believe that there's a very bright future for REG in many, many cities in the country. This is a huge milestone for the company. I think the hardest challenge though is to predict or handicap over time, how will this progress?:]

[Utilities are notoriously slow, negotiating contracts that we do today for any of our other products take a longer time than many of the other markets that we serve. But I think when we look back about embarking on to this product, REG, we really have met a tremendous milestone. We have a system that's in the grid that's been accepted by the utility and expect an accepted by all of their constituencies, which I think is huge for the product. That means we really have a product we can go and sell going forward.:]

[Eric Stine:]

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

[Daniel McGahn:]

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

[Eric Stine:]

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

[Daniel McGahn:]

Yes, I think that's probably the question of the day, Eric. I think you nailed it. I think we have both paths open to us. I think, obviously, if there's a rapid rebound in when we get there much faster, meaning that effect rebound comes, we're really almost there with the backlog today, right? So incrementally growing the new energy part of the business is happening. If we can continue at the current rate we've been booking those orders, we're basically there. We have to deliver on it, right, and we have to deliver it on time and on cost. And we've been able to successfully do that throughout the business, and we've improved Neeltran pretty significantly quarter-on-quarter with our operating efficiency capability.

[So I think when I look at this, I see the backlog and I see the comments that John made about where the operating leverage comes from. And I think we already have the backlog to get there. I think time will be the tell. And I think certainly additional wind would make it easier, might make it faster. But today, as we sit here, I feel better than I ever have that we're now at the point where we're talking about potentially achieving these milestones, not in the next year or 2 or 3, but in the next quarters or a year or so. So we have a much brighter future right in front of us right now.:]

[Operator:]

The next question is from Colin Rusch with Oppenheimer.

[Colin Rusch:]

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

[Daniel McGahn:]

Yes. I think, Colin, the challenge for the business has is the rate at which we take orders and the rate that we deliver them. So for some products, we're booking orders as early as 6 months, maybe 9 months for many of the products we're out a year plus at this point. And that compared to where the business was, say, a couple of years ago, certainly has extended by at least a quarter or more for many of the product lines.

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

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

[Colin Rusch:]

Okay. And that's helpful. I may ask some clarifying questions later. But next, I'm just curious about the bid activity. Obviously, there's a lot that's happened from a regulatory perspective around capacity building domestically. And so I'd love to get a better sense of how much sales activity there is and what your conversion rate is on what you've seen so far, I guess, call it over the last 6 to 12 months.

[Daniel McGahn:]

Yes. I think the bid activity has exploded. I think the number of projects that we've looked at certainly is at the highest point since as I can remember. So the prospects for the business are greater than they've been certainly in the past years. When we look at the order intake, we have announced today, we closed more than $40 million of orders last quarter. When we look at the run rate of what we're just doing the new energy over the past 3 quarters, it's about $30 million, just for new energy, right? So then you got to add in what we're doing with the Navy, you got to add and what we're doing with wind as well. Is there any other commentary you want to talk about, John? Does that help, Colin?

[Colin Rusch:]

Yes. I'm just curious about the win rate and any delta around that.

[Daniel McGahn:]

Well, the hard part we have with the win rate is most projects down, and this is what we've done even with entrant and to some extent with NEPSI. We try never to compete directly. So the way we do it, it's a very early decision if we're going to win or not, and then it depends upon how the project goes for it is we make things smaller and less complex. And if we're able to design that in with the engineering company, which is usually the engineering procurement construction company, then we really eliminate a lot of competition. I won't say all, but almost all.

[So we're -- we -- today in this version of the business, we're really never in the decision-making by purchasing. An engineer has made a design that requires our smaller footprint which means that it's hard to go out and get an alternative. So when we look at direct project win rate, it's extremely high, right? But to be transparent, there's a lot of work that happens in the quarters before even getting the order, where we're trying to get designed in on the print, be it for a ship or for a substation. And really, those are the 2 that we're focused on. And the same techniques we use for the ship, we use for the substation, which is how do we make it smaller, more and more energy dense, how do we add more feature function than what the alternatives are. And that's true across everything that we do.:]

[Colin Rusch:]

That's incredibly...

[John Kosiba:]

[indiscernible] there are the 2 indicators we're looking at is pipeline growth, which as Dan just highlighted, and we do -- especially over the last year as we had to adjust our prices based on the raw material inputs going up. we have been carefully watching our customers and making sure that we remain competitive. And across the board in the business, there's no evidence to suggest that the bids we're doing are making us uncompetitive.

[There's isolated pockets where we're watching and we're concerned about where there is a more competitive landscape to it. And -- but as of now, there's no --:]

[John Heilshorn:]

It's actually going to happen.

[Daniel McGahn:]

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

[Operator:]

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

[Justin Clare:]

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

[Daniel McGahn:]

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

[John Kosiba:]

Yes. So Justin, the vast majority of this is going to be in OpEx. We didn't break it down publicly, but what I will say is on the scale, call it, north of 75% will be OpEx related versus less than 25% will be COGS. I think from a capability standpoint, I'll reiterate paraphrase something I said earlier is we are expecting more content per ship from the Navy, which means that when that happens, that means we've met certain development milestones, which means unless we have something else to develop, those are not costs that we need to continue to carry. I think when we look at the substation type products, we're at a point now, I think we've learned a lot about the sales leverage. I think we're now going to demonstrate some operating leverage, particularly in the back office.

[We need to continue to digest what we have, which means the need to go develop something over the next quarters is very limited. But going forward, we still have the capability to be able to service our customers. We still have the capability to be able to make changes or make adjustments. And we still have the capability to develop some new technology, which could translate into future products. But right now on our road map really is we have to focus on the financial leverage that the revenue will bring. And that's the near-term focus for the team, and that allowed us to take maybe a very different look at our operating expense.:]

[Justin Clare:]

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

[Daniel McGahn:]

Sure. So I'll answer the second question. The first question, we don't guide to gross margin. So I want to be careful not to give too much clarity on that. But what I will tell you is the gross margin improvement in Q4 will be driven by all 3 of those, right? We said Neeltran gross margins are going to improve. We do have a healthy expectation of D-VAR revenue in the fourth quarter, so that's inherently going to help the mix. And then as we continue to shift backlog, in particular for the NEPSI product line has the quickest lead times. And so the pricing that we've been able to implement at NEPSI will flow through the P&L but quickest.

[And so you're going to see it in all 3 areas. You're going to see pricing improve the margin. You're going to see mix improve the margin, and you're going to see the impact of Neeltran improve the margin. And that's not just isolated to Q4. That's really what we're talking about is to end throughout FY 2023.:]

[Justin Clare:]

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

[Daniel McGahn:]

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

[Operator:]

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

[Chip Moore:]

Daniel, John. I wanted to follow up on the sales leverage potential from NIPS and Neeltran. You did a good job of outlining that again, Daniel. I guess just curious on that cross-selling, how does that progress versus expectations, better than you expected? And how is it looking forward?

[Daniel McGahn:]

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

[When we look at the mining and the metal and material space, which is the example we've been using for Neeltran, that's a combination of NEPSI Neeltran. And I try to do it both ways depending upon how people think about it because as we looked at it, I did in the prepared remarks, I looked at it as we looked at it, as an additional expansion of what we already have begun with NEPSI that we saw Neeltran kind of continuing on that theme with even greater sales leverage rate. But then I brought it back to just kind of compare directly those 2 markets and just say, if we get $5 million of one, we'll get another 20% or $1 million of another. And we set all these things when we did the deals and now we have been examples, and it's not 1 or 2, it's quite a few of them in the backlog.:]

[The challenge, as I pointed out and the challenge that everybody obviously seeing here is, how do we have the backlog that we have on the books for the Neeltran. How do we digest that process at move on to better priced, higher-margin backlog. And that's really why we're confident today in obtaining operating models, talking about breakeven. These are things we have not done in a couple of years, right, maybe 3 years. We want people to understand that John and I are highly confident based upon our backlog and based upon how we're usually able to deliver product at a pace that if those things can both happen, we're not really far away.:]

[Chip Moore:]

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

[John Kosiba:]

Yes. So the inventory has built over the last year. Some of it is due just to the backlog growth, and some of it has been timing of some shipments. We do have a fair amount of shipments going out in D-VAR this quarter where we had some inventory buildup for that. So the expectation is we should leave that project out of WIP, and we should start to see that. On the working capital stream, we -- this quarter assumes we have some working capital. So the guidance I gave you of 4% to 6%. If you look, we guided to non-GAAP of 6, there's about $1.5 million of depreciation. So in theory, we'd be closer to $4.5 million I gave a pretty wide range because of working capital that could impact that up to $6 million or so.

[But moving forward after that, I see working capital probably in Q1, if it's negative in Q4, it's probably going to be positive in Q1, and it will net out to 0. So I expect working capital to be closer to flat and have no impact just because of the way our milestone structure is Q4 and Q1, we may have a little bit of swing from one quarter to the other, but that's already incorporated into the guidance.:]

[Chip Moore:]

Yes, that's perfect. And remind me, that larger D-VAR project has been pushed out last quarter. Do you still expect that to hit in the current quarter.

[John Kosiba:]

That project is included in our guidance, yes.

[Operator:]

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

[Daniel McGahn:]

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

[As I mentioned earlier, our pipeline is growing and becoming more diverse. Our order book has gone from delivering at a rate of $20 million in new Energy Power Systems orders per quarter to now delivering at a rate of over $30 million for the past 3 quarters. This is just for the new energy power systems. So our ability to convert that potential pipeline into actual orders is really starting to happen. I think it felt great prospects for us as we look at 2023, and we're even looking at quoting products for delivery already in 2024. So we think the next years look very bright for the company. Thanks, everybody.:]

[Operator:]

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