ESS Tech Q2 2023 Earnings Call Transcript

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August 8, 2023

There are 8 speakers on the call.

Operator

I would now like to turn the conference over to Eric Bylin. Please go ahead, sir.

Speaker 1

Welcome to ESS' 2nd quarter financial results conference call. Joining me on the call today from ESS are Eric Dresselhaus, CEO and Tony Robb, CFO. Following management's prepared remarks, we will hold a Q and A session. Earlier today, ESS released financial results for the Q2 of 2023. The earnings release is available in the Investor Relations section of the company's website.

Speaker 1

As a reminder, the information presented today will include forward looking statements, including without limitation, statements about our growth prospects, partnerships, Financial performance and strategy for the remainder of 2023 and beyond. The forward looking statements are subject to known and unknown risks And uncertainties that could cause actual results to differ materially from those projected or implied during this call. In particular, those described in our risk factors Set forth in more detail in our most recent periodic reports filed with the Securities and Exchange Commission, as well as the Current uncertainty and unpredictability in our business, issues with our partnerships, inflation, the markets, the economy And the current geopolitical situation, you should not rely on forward looking statements as predictions of future events. All forward looking statements that we make on this call are based on assumptions and beliefs as of the date hereof, and we disclaim any obligation to update Any forward looking statements except as required by law. During the call, we will also present certain financial information on a non GAAP basis.

Speaker 1

Management believes that non GAAP financial measures taken in conjunction with U. S. GAAP Financial Measures provide useful information management and investors by excluding certain items that are not indicative of our core operating results. Management uses non GAAP measures internally Reconciliations between U. S.

Speaker 1

GAAP and non GAAP results are presented within our earnings release. With that, I will turn the call over to ESS's CEO, Erik Dresselhaus.

Speaker 2

Thank you, Eric, and thank you all for joining us for our Q2 earnings call. Today, I'll review our financial results, operational progress, recent customer successes and the impact of the Inflation Reduction Act. I'm joined by Tony Robb, our CFO. Our results for Q2 demonstrate the ongoing and rapid progress ESS is making across many fronts of the business. During last quarter's earnings, we shared quite a bit of behind the scenes detail to help those who follow ESS understand what's involved in bringing our revolutionary Technology to market.

Speaker 2

We have assembled a highly skilled and dedicated team and they are working tirelessly to optimize the product design, Improve the speed of manufacturing throughput and deliver a great product for our customers. We feel this quarter is another positive step on this journey. We delivered 9 energy warehouses to 4 different customers in the Q2. Importantly, we began shipments for the 1st phase of our relationship With Sacramento Municipal Utility District for what we expect to be a long and mutually beneficial relationship. We recognized a record $2,800,000 in revenue as we continue to make progress on deliveries and improve our revenue recognition process.

Speaker 2

Importantly, we maintained fiscal prudence and tightly managed our balance sheet and in the quarter with just under $100,000,000 in cash And equivalent. We have continued to drive great progress optimizing our internal operations, most importantly, Sourcing components for our product and streamlining assembly and test processes. Our automated and semi automated lines are performing well And the effort we put into optimizing the injection molding vendor and assembly technique has resulted in improved efficiency and consistency. As mentioned last quarter, we are implementing lean manufacturing techniques to continue to perfect the processes for assembly of our balance of system And this is yielding strong results. While our capabilities to serve the long duration energy storage market has the potential to make us a market leader, We have an engineering roadmap to further optimize the numerous components of our systems across the electrolyte, power modules, Proton pumps and balance of system to improve energy density and field performance.

Speaker 2

We are innovating within the core components and IP Proton pumps and power modules to improve the capacity while we design further enhancements to the balance of system To simplify and speed assembly and maximize durability for transport and longevity. As a sign of our progress on these fronts, in the Q2 alone, we were granted 10 new patents and filed an additional 13. We now have a total of 238 patents granted, pending or an application. We feel confident that the mode around our IP portfolio will safeguard our Iron Flow technology approach for years to come. As we perfect our processes around our Gen 2 Rev 2 design, we lowered our build time by 29% and reduced direct costs by 30% in the 2nd quarter alone.

Speaker 2

These are impressive accomplishments in a short time And I am proud of the great work our team has performed to drive these improvements. We intend to continue to push on innovation as we lower cost We began 2023 with the intent to carefully manage our manufacturing output So that we can focus on optimizing design and assembly and I am pleased with our results. Our team is aligned to maximize the assembly efficiency and quality of our product We're continually improving our processes to lower unit cost on our drive to profitability. While these are clearly steps to scaling a profitable company, they also allow us to deliver to customer needs in a more timely and predictable manner. Our customer facing team is hitting its stride as well.

Speaker 2

To scale our ability to support deployments across the globe, The customer success team is building out its infrastructure with a CRM platform to expand our field service capabilities through knowledge sharing and Enable deeper customer engagement through the customer portal. The team has reduced the time required to commission individual EWs by 70% compared to a year ago and is driving to take it down by another 30% to 2 weeks by the end of the year. On the new business front, we were thrilled to announce another transformative deal in the 2nd quarter. Subject to finalizing the contract, which we expect this quarter, Liag, a major German energy provider and EFS plan to build A 500 Megawatt hour iron flow battery system at Leag's Boxburg power plant site with design work beginning this year and plans to commission by 2027. This installation is expected to create a repeatable building block for Liag Liag operates many large scale lignite mining and coal fired generation sites in Eastern Germany And is implementing a vision to transform the coal dependent region into Germany's green powerhouse.

Speaker 2

The company plans to develop 7 to 14 gigawatts of renewable generation paired with 2 to 3 gigawatts of energy storage and 2 gigawatts of green hydrogen production. Combined, these technologies will create a net zero carbon baseload energy system. With the Sacramento Municipal Utility District, Energy Storage Industries Asia Pacific and now LIAG, ESS has 3 transformational customer relationships with well respected energy transition pioneers, each of which could generate significant revenue in the coming years. We congratulate ESI For the recent Queensland Government announcement regarding the project with Energy Queensland. We are grateful that these forward thinking customers put their trust in ESS As they embark on a path to a clean sustainable energy future and believe their work will serve as a model for many others around the world.

Speaker 2

Although we are pleased with the improved pace of our deployments and gratified for the trust these leading operators are placing in ESS, We are keenly aware that launching new technologies in this industry is often a bumpy road. Last quarter, we mentioned the delay of an overseas project. And although there has been good progress, we remain delayed with hope of resolution soon. Other legacy projects some signed years ago Have struggled with delays or project requirements have shifted. We try to keep everybody appropriately informed of our activities, But remain committed to abiding by our customers' requirements on disclosure.

Speaker 2

We've learned a lot over the last As our recent Leag announcement shows, our opportunities worldwide are expanding rapidly. Here in the U. S, we continue to actively engage in the implementation of the Inflation Reduction Act, the bipartisan infrastructure bill and various state level initiatives to accelerate the deployment of energy storage. These are large initiatives and the pace of activity isn't as fast as I'd like. That said, we're very encouraged by some of the recent IRS guidance on domestic content, which strongly favors companies like ESS, Which actually build battery modules here in the U.

Speaker 2

S. As well as the DOE's recent announcement on the Energy Storage Grand Challenge, which we hope will accelerate implementation of the many initiatives in the infrastructure bill and the IRA. On top of those national efforts, Many states are taking action. As an example, California has just included over $170,000,000 in additional incentives And with that, I'll turn it over to Tony to cover our results.

Speaker 3

Thank you, Eric. Unless otherwise noted, All numbers we discuss today will be on a non GAAP basis. You will find a reconciliation of GAAP to the non GAAP financial measures in our earnings release, which is posted on our Investor Relations website. We recognized $2,800,000 in revenue in the Q2 and we delivered 9 Energy Warehouses to As we discussed last quarter, we've made tremendous progress with our revenue recognition process. During the remainder of 2023, We expect to recognize revenue once control of the energy warehouses are transferred to the customer.

Speaker 3

Under the contractual shipping and transfer terms of most of our newer contracts, revenue recognition could occur as soon as the energy warehouse is picked up by the customer from our dock in the case of X Works terms or upon delivery to the customer site in the case of delivered at place or DAP terms. We expect these kind of terms to apply to all of our deliveries during the second half of this year. We remained under development accounting rules in Q2, So the material overhead and labor costs we incurred in producing the products we've delivered fall into OpEx, resulting in 0 cost of goods sold. We have also determined that we will be transitioning out of R and D accounting and into commercial inventory accounting in the Q3. So we will be reporting our cost of goods separately from our operating expenses.

Speaker 3

Our non GAAP operating expenses for Q2 We're in line with our expectations at $24,300,000 With that, we reported Q2 adjusted EBITDA Of negative $20,500,000 We ended the 2nd quarter with $99,500,000 in cash and short term investments. We will continue to effectively manage our cash burn rate in the coming quarters and the cash on hand should last us well into 2024. With the continued operational progress Eric discussed, we were able to reduce the direct variable cost of our EWs by 30% In the Q2 related to the benefits and results of our cost out initiatives. With that progress and the additional ongoing and future cost out initiatives we are planning. We continue to expect EWs to be profitable on a non GAAP gross margin basis in the second half of twenty twenty four.

Speaker 3

We expect the average of our quarterly revenue for the second half of the year to be similar to our second quarter revenue. However, we may experience some variability in our quarterly revenues due to timing of completion of various customer projects until we reach greater scale. In addition, we expect our cash burn rates to be similar to or slightly below what we experienced in the Q2 as well. This aligns with what we have stated previously about curbing our production volume levels to mitigate our cash usage, while progressing on our cost reduction and efficiency improvement initiatives. And with that, I'll open it up for questions.

Operator

Our first question today comes from the line of Thomas Boyes from T. B. Cowen. Please go ahead, Thomas. Your line is now open.

Speaker 4

Thank you very much for taking the questions. Maybe the first one just talking about kind of expectations for revenue for the balance of the year. It sounds like the end of the whole approach here is just to do as pre lien as possible while you Continue to make gains on the cost side of the equation. There's no limiting factors here around access to components. I know Couple of quarters ago, obviously, there were some challenges and you've gone through the process of onboarding new suppliers.

Speaker 4

So just wondering how that process is going? Those vendors coming online still in the second half of the year.

Speaker 3

Yes. This is Tony Raff. Thanks for that. So, we continue to make progress with our vendors and the constraints That we've put in place are primarily based on the fact that we wanted to curb production to minimize Our cash burn as it relates to the material cost on the EWs. And while there are Intermittent types of supply chain and vendor type delays, A lot of that has been mitigated, but it is something that we continue to deal with, but it's progressing nicely.

Speaker 4

Got it. And then just as my follow-up, I kind of wanted to check-in on the revenue recognition of the legacy units. I saw Deferred revenue declined in June around 9 units, but I'm sure I wasn't sure if those were the 9 units that were shipped this quarter. So any color that you could provide there would be helpful. And then maybe just what is the current rev rec timing for the units that were kind of shipped This quarter, is it still intra quarter?

Speaker 4

Are we in intra quarter? Or where are you now?

Speaker 3

So just so I'm understanding your question regarding the first part, Were you referring to just the change in the balance in the deferred revenue?

Speaker 4

Well, first, it was just around The revenue recognition of the legacy units, those kind of first 3 to 5 units that had gone out that were the ones that were kind of the challenge. And then I was just trying to better assess if the 9 units that were shipped and delivered today were also the 9 units that about were recognized as revenue this quarter that are still again

Speaker 3

Yes. Look, we're not going to talk about specific customers in terms of the units That was shipped, but I will say that we feel like we've resolved The revenue recognition challenges that we've been facing and we do anticipate that the customers that we make deliveries to Within the second half of the year, those will all be under our updated and newer contract terms and conditions.

Speaker 4

Great. Thanks.

Operator

Thank you. Our next question today comes from the line Colin Rusch from Oppenheimer. Please go ahead, Colin. Your line is now open.

Speaker 5

Thanks so much. Now, yes, I'm curious about the Assembly strategy going forward, you've been able to announce a couple of different avenues to having central manufacturing on How you plan to replicate that and how much that's contributing to some of these potential customers or the existing customers that you have right now?

Speaker 2

Sure, Colin. Thanks for the question. Eric here, I'll take that. You're right. I think For the foreseeable future, we anticipate building all the battery modules in Wilsonville.

Speaker 2

It's very efficient for us to do that In a central location because of the automation requirements and of course we like building those in the U. S. Because of PTC implications that we get with the IRA. On the system side, for the very near term, we expect to build Those units also on Wilsonville and we've got plenty of capacity to do that to meet our near term delivery needs Out of that facility and we've announced the project with ESI to eventually start building balance system in Australia. I expect that maybe not out of the blocks, we'll look to Europe to do that as well in the future, Simply because it's more efficient to do the assembly and not ship completed units overseas when we can avoid it.

Speaker 2

To get to that, we want to get to some level of volume and we want to perfect the repeatability of the process that we're doing here in Oregon.

Speaker 5

Excellent. And then if you look at the fleet of systems that are out in the field right now, can you just speak to the performance Relative to nameplate and what you're seeing right now in terms of how those systems are operating relative to expectations?

Speaker 2

Yes, they're generally working well. The one thing we've learned a lot about is how customers use the battery, Which isn't always in the straight linear, turn it on, charge it up, discharge it all the way, way that you would So one of the things that's been really interesting is to see the usage patterns. We've had some great results in places where units are deployed, where They're now fully integrated in with the microgrid operations. And so as the customers are experiencing power outages, the units are dropping right in, Immediately recharging the customer site. But one of the things we're hoping now as we start to increase the unit shipments is to get more and more units out The field and operating because we're learning something new every time we go to the field.

Speaker 5

Excellent. Really appreciate it. Thanks so much.

Operator

The next question today comes from the line of Corinne Blanther from Deutsche Bank. Please go ahead Corinne. Your line is now open.

Speaker 6

Hi, good afternoon. Thank you for taking my question. So maybe just trying actually to focus More into the medium term or long term, like maybe what maybe if you can talk a little bit about what we should expect for 2024 and 2025 In terms of maybe like the energy warehouse and the energy center that I believe was supposed to come maybe like later on next year. Just trying to get an idea basically where you want to see the business going over the next 18 months 24 months.

Speaker 2

Yes, Karim, thanks for the question. We have not given any guidance yet for 2024. We certainly expect, As we've said in the past that, we'll continue to ship at a more modest pace, as Tony said, roughly at the pace we're doing right now through the end of this year. And then we'd expect as we get into 'twenty four and beyond, and we get to the cost points on our cost of goods that we're targeting Then we would then feel more comfortable ramping that up. And then of course the EC as you mentioned is a big part of that as well.

Speaker 2

Our ability to ship energy centers and core components, we see ramping up in the later part of next year, but we haven't put a number to it at this point.

Speaker 6

Okay. Thank you. And then maybe the second question and look, you are from cash burn, right? Except that maybe a little bit curbing out on the production, like is there anything else you intend to do? Like do you expect to go on the market and Already there is already equity on like what's the plan here?

Speaker 3

Yes. Hi. It's Tony. Thanks for that question. Look, we are always You're going to be considering any ways that we could add to and strengthen our balance sheet as long as we can do that on favorable terms.

Speaker 3

At this point, we are very comfortable with our cash balance and our cash burn rate where we are and the fact that the cash balances that we have on hand and our We will highlight the folks exactly how and when we plan to supplement that.

Speaker 6

Thank you. I appreciate that. I will take the rest of my question offline.

Operator

Thank Our next question today comes from the line of Lian

Speaker 7

Just to start, can you please help us understand the level of customer interest you're currently seeing in the marketplace and what sort of projects you're being invited to bid on currently?

Speaker 2

Sure. I'll take that and thanks for the question. It's really a variety. Mostly what we're seeing now Is this drive to for in terms of the front of the meter business, drive to green base What's becoming increasingly clear through all of the regulatory mandate, the 12 or 13 states now in the U. S.

Speaker 2

That have Come out with specific targets is the need to create 20 fourseven green energy. And so that's been the biggest driver. The project at LIEG that we announced is interesting in German when you have to do the translation, but they call it green baseload, Which is how do you replicate what you used to get out of coal fired or a combination of coal and gas to create a 24 hour, 7 day a week baseload. And then the second driver that we're seeing in the behind the meter business is really all about resiliency. We're fortunate that The West Coast has been spared this year from some of the worst weather that's going on.

Speaker 2

But if you look across the rest of the country, power outages And grid resiliency are really getting pressured. So we're seeing a lot of demand from large commercial industrial customers Who of course have an interest in de carbonization, but are really focused on resiliency and reliability as their primary driver. So in some cases, Those are paired with renewables on-site. But in other cases, some of the projects that we've announced and I think of things like the Burbank project As a good example, some parts of the SMUD project are really just designed towards resiliency and reliability. How can we make sure that we're going to have power In this world where we're going to rely more and more on electricity as the fuel that drives the economy.

Speaker 7

Okay, great. Thank you very much. And just a second question, do you still intend to become non GAAP gross margin positive over the next 12 to 15 months or Has that timeline changed? Can you offer any color on that?

Speaker 3

Yes. Hi, it's Tony. Our timeline is that we still expect to be Non GAAP gross margin positive in the second half of next year. We've got a number of ongoing initiatives That we're making very good progress on and a number of additional projects and initiatives that we'll be launching later this That are going to progress us towards achieving that objective in the second half of next year.

Speaker 7

All right, great. Thank you both so much.

Operator

The next question today comes from the line of David Sunderland from Baird. Please go ahead. Your line is now open.

Speaker 3

Hey, guys. Thanks for taking my question. Just one quick one for me. You talked a little bit about the state initiative from California having a specific carve up for stationary storage, and I think particularly long duration energy storage. Could you maybe talk about anything you're seeing outside of IRA maybe in Europe, Australia or maybe any incentives you guys could be getting The project or anything else?

Speaker 3

Thanks.

Speaker 2

Sure. Thanks, David. Thanks for the question. It's frankly a lot, But it's not one thing. So you're right, the IRA is the single largest initiative in terms of incentives that's driving the business.

Speaker 2

As we get more and more IRS rulings, we expect that to continue to gain traction. Of course, there is also money at a federal level In the infrastructure bill that's starting to come through and get realized in actual projects. You've got States, specific states, some states are like California putting $170,000,000 you're correct, is Specifically targeted towards long duration storage and that gets combined in California with a mandate that the public utility commissions put out To all of the load serving entities to hit certain targets by 2,030, and then some further targets that go into the 2030s. If you look around the world, the incentive structures change a little bit based on what the regulatory structures are. So if you look in Australia as an example, they don't have an IRA equivalent.

Speaker 2

They just do it as grant money. And the project that ESI announced Last week was actually announced if you saw by the state of Queensland, who is the sponsor and They're the one that puts the bill because we have a vertically integrated market in Queensland, Australia. That will be a little bit different in some of the other states because And then finally in the case of Liag, there are a number of different pools of money that exist in Europe to help Defray the cost of what's known as the kind of the green premium to help with capital reductions, but they are more on the kind of grant model. So the utilities including Leag or others would apply for the grants and then use those as CapEx reduction. It's not a tax Based on the way it is here in the U.

Speaker 2

S. So I know it's a lot to manage. What we like to see is the combination of the regulatory mandate Plus a financial mechanism, whether that's as a tax mechanism or as a grant mechanism to help defray cost and we think that's the thing that's going to start to really accelerate The deployment.

Speaker 3

That's helpful. Appreciate it, Eric. Thank you very much.

Speaker 2

Thank you.

Operator

Thank you. There are no additional questions waiting at this time. So I'd like to pass the call back to Erik Dusshouse for any closing remarks.

Speaker 2

I'd just like to thank everybody for joining the call and for your support. We're making great progress as you saw this quarter and are thank you again for your support and have a safe and pleasant evening. Thanks everybody.

Operator

This concludes today's conference call. Thank you all for your participation. You may now disconnect your

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