ESS Tech, Inc. (NYSE:GWH) Q3 2023 Earnings Call Transcript

ESS Tech, Inc. (NYSE:GWH) Q3 2023 Earnings Call Transcript November 7, 2023

Operator: Ladies and gentlemen, thank you for standing by. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session. [Operator Instructions]. I would now like to turn the conference over to Erik Bylin. Please go ahead, sir.

Erik Bylin: Welcome to ESS’ 2023 Third Quarter Financial Results Conference Call. Joining me on the call today from ESS are Eric Dresselhuys, CEO; and Tony Rabb, CFO. Following management’s prepared remarks, we will hold a Q&A session. Earlier today, ESS released financial results for the third quarter of 2023. The earnings release is available on the Investor Relations section of the company’s website. 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. 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 on 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. Management believes that non-GAAP financial measures taken in conjunction with U.S. GAAP financial measures provide useful information for both management and investors by excluding certain items that are not indicative of our core operating results.

Management uses non-GAAP measures internally to understand, manage and evaluate our business and make operating decisions. Reconciliations between U.S. GAAP and non-GAAP results are presented within our earnings release. With that, I will turn the call over to ESS’ CEO, Eric Dresselhuys.

Eric Dresselhuys: Thank you, Erik, and thank you all for joining us for our third quarter earnings call. Today, I’ll review our financial results, Honeywell partnership, customer success, and additions to the leadership team. I am joined by Tony Rabb, our CFO. We continue to make solid progress across the business, driving customer deliveries, signing significant partnership agreements, and efficiently managing our resources as we drive to profitability. While we came in somewhat light on revenue in Q3, due to a timing delayed with one project, we remain confident in our ability to deliver on the projections we shared last quarter, namely achieving $9 million in revenue this fiscal year. As a reminder of the progress we’ve made, our year-to-date revenue of $4.7 million is an increase of about 700% from last year.

We have sufficient product and demand to be able to deliver on a material increase in revenue in the fourth quarter and achieve our objectives. We are a burgeoning company with large customers and complex projects. Delays that may seem slight or insignificant at our customers can cause shifts in when we ship product and recognize revenue in the short-term as happened in the third quarter the be should even out over time. In late September, ESS entered a transformational partnership with Honeywell, an industrial powerhouse with strengths across technologies and markets that align tightly with those that ESS is pursuing. Recognizing the importance of long duration storage and ESS’ advantages with iron flow technology in solving for a clean energy future, Honeywell first engaged with ESS at the beginning of the year.

After exhaustive diligence into our operations, customer relationships and intellectual property, Honeywell became convinced that ESS has developed a truly differentiated technology to serve this market and we are thrilled to enter into the synergistic partnership. The relationship is wide ranging, but I will provide a brief recap of the highlights. First, Honeywell plans to incorporate our technology into their clean energy go-to-market efforts and have an initial target to purchase up to $300 million of our product in the coming years. They already put down a $15 million prepayment towards those purchases and have made a direct equity investment of $27.5 million at a 24% premium through ESS’ then current stock price, adding $42.5 million to our balance sheet immediately.

Through warrants, Honeywell can make further investments in ESS at an even more significant premium, which would add almost $40 million more to the balance sheet. ESS will integrate Honeywell’s low battery IP into our own extensive IP portfolio and will collaborate through a joint development agreement to further progress the technology. In total, we believe this to be an industry defining relationship. Collaboration is already underway and we can’t wait to share our progress. While we are shipping energy warehouses today over time, we see the majority of our revenue shifting to energy centers or ECs. Our EC solution utilizes the same patent protected technology and design approach as the EW, but at much greater scale. Our EC solution is modular and designed to scale to tens of megawatts per installation with greater flexibility and much lower costs per kilowatt hour to enable the utility scale solutions necessary to achieve a carbon neutral grid.

We’ve been developing this product for some time and we’re excited that our operations and engineering teams have been hard at work with Portland General Electric building the first energy center right here in Oregon. It’s exciting to see this come to life and we expect to be testing an operational EC this quarter. With full commissioning slated for the first half of 2024, we believe, we are on track to begin shipping ECs to commercial customers in the second half of 2024. We’re excited to be bringing the EC to life; a product that we expect will fuel our long-term growth trajectory. On the customer front, I would like to congratulate our Australian partner, Energy Storage Industries Asia Pacific, or ESI, on their expanded agreement with Stanwell Corporation, a major electricity generator owned by the Queensland Government.

Announced by the Queensland Premier during her recent State of the State address, Stanwell detailed its intent to develop what will be the largest iron flow battery energy storage system in the world. After deployment of the previously announced initial project, they plan to expand to 150 megawatt installation and have already taken an option to buy up to 200 megawatts per year thereafter. This deal comes on the heels of Energy Queensland’s announcement in August that it will deploy a 1 megawatt iron flow battery from ESI in the Wide Bay region to support in the development of lithium ion alternatives. Stanwell and Energy Queensland are driving forward in the mission to fulfill the Queensland Energy and Jobs Plan that will call for 3 to 3.5 gigawatts of storage to achieve the state’s target of 80% renewable energy in the grid by 2035.

To follow-up on our announcement last quarter, we’re pleased to share that we finalized the agreement with LEAG for the first phase of our groundbreaking project to bring green baseload energy to Germany. As you’ll recall, this project is intended to deliver a 500 megawatt hour iron flow battery system at LEAG’s Boxberg power plant site. The installation would create a repeatable building block to support LEAG’s objective to create up to 20 gigawatt hours of storage to be paired with solar and local hydrogen production, creating the largest green energy hub in Europe. We continue to enjoy great validation from our existing customer base. We successfully commissioned our first deployment of six energy warehouses at Sacramento Municipal Utility District.

These six EWs represent the first phase of an agreement that will deliver up to 200 megawatt of long duration energy storage to support SMUD’s aggressive 2030 clean energy vision. As another sign of the progress our customer success team is making, we recently commissioned an EW for Nevada Energy in just 2.5 weeks among the other projects we delivered this quarter. Four of these customers, Honeywell, ESI, LEAG and SMUD have signed agreements with ESS that could, if fully realized, result in shipping hundreds of megawatts of storage, which would translate to well north of $1 billion in total revenue. To realize this potential, we need to balance managing our cash position, optimizing our operations, and ramping the production of energy centers, which is the best form factor to deliver megawatts of storage most efficiently.

To accomplish these objectives together, ESS expects to maintain our relatively modest rate of EW shipments early next year and then to start delivering ECs in the second half of 2024. We have sufficient power module capacity in place today to meet our 2024 demand, and we’ll look to add additional capacity late in 2024 to enable further ramping into 2025. As you can tell, we’re excited about the great progress we’re making as we ramp the business, but the progress is not always linear. I want to share that the collaboration we have with San Diego Gas & Electric at the Cameron Corners site has ended. The project was conceived several years ago and as we built it out, the parties recognized a mismatch related to the specific technical requirements at the site and we jointly agreed to move on at the end of the quarter.

I’ll admit this is a disappointing outcome, but a reflection of the transformation of ESS as a company. We are now delivering EWs to customers, largely recognizing revenue upon shipment and seamlessly commissioning our technology at customer sites. We sincerely appreciate the collaboration with SDG&E and hope to find new opportunities to work with them in the future. We continue to build out and strengthen the ESS team. I am pleased to welcome Harry Quarls to the Board and Jeff Loebbaka as our Chief Commercial Officer. Harry assumed the role of Chairman and brings vast strategic, financial, and operational experience to help guide ESS in our continued progress. Jeff will run all of our go-to-market efforts and will leverage his experiences from numerous leadership positions running sales and marketing, including five years at Enphase to drive our revenue growth.

And with that, I’ll turn it over to Tony to cover our results.

Tony Rabb: Thank you, Eric. Unless otherwise noted, all numbers we discuss today will be on a non-GAAP basis. You will find the reconciliation of GAAP to the non-GAAP financial measures in our earnings release, which is posted on our Investor Relations website. We recognized $1.5 million in revenue in the third quarter and we still believe we can deliver on $9 million in revenue for the full-year. As noted previously, the timing of activities for our customers can cause delays in the timing of shipments and revenue recognition, as happened in Q3. But this is something that we are working to improve and as we grow we expect that these variations will smooth over time on a collective basis. Beginning in Q3, we transitioned out of development accounting and into commercial inventory accounting, so we are now reporting our cost of revenue separately from our operating expenses and beginning to record inventory on our balance sheet.

Our cost of revenue was $10.2 million in the third quarter. As part of this transition in Q3, we are required to record a lower of cost or net realizable value or LCNRV adjustment to write down the value of inventory on hand at the end of the quarter to the amount we anticipate receiving upon customer delivery after considering all future costs of completion. This is a significant adjustment to our cost of revenue line and has a corresponding decrease to our inventory value. This is very similar to the accounting requirements impacting other energy storage and EV manufacturers. As we have discussed previously, we have moderated our production volumes this year to mitigate our cash usage while we advance our extensive cost reduction initiatives.

While this achieves our objective regarding cash conservation, operating our manufacturing lines at a fraction of our 800 megawatt hours of annual capacity creates an impact to our cost of revenue and inventory values. Lower manufacturing throughput and therefore lower capacity utilization results in overhead designed to support much higher production volumes being spread over fewer EWs. In the near-term, as we increase our shipments to our customers, scaling the business toward the current full capacity of our factory and personnel, our purchase commitments and inventories on hand will increase as well. Because these factors impact the value that would be subject to the LCNRV inventory adjustment, we expect this LCNRV adjustment will continue to occur in the coming quarters and anticipate that this adjustment will serve as a material headwind to our gross margin in the near-term.

However, as we expect to further ramp up our production towards the back half of 2024, increasing the utilization of our fixed manufacturing overhead and eventually achieving scale and continuing to reduce our unit production costs while driving operational efficiencies, we anticipate that the total charge per unit will decline over time. We expect this effect to accelerate once we achieve adjusted gross margin breakeven on our EWs in the second half of 2024. Our non-GAAP operating expenses for Q3 were in line with our expectations at $7.5 million. With that, we reported Q3 adjusted EBITDA of negative $14.2 million, a significant sequential and year-over-year improvement. With a cash infusion of $42.5 million in Q3, we ended the quarter with $124.5 million 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 the first half of 2025. While not pressing, we will continue to opportunistically look to strengthen our balance sheet through dilutive and non-dilutive means to provide the necessary capital to give us operational flexibility to respond to market demands. The bottom line is that we feel very good about our cash position and liquidity and the extended runway we now have to push towards our longer-term goal of getting to cash flow breakeven. And with that, I’ll open it up for questions.

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Q&A Session

Operator: [Operator Instructions]. Your first question comes from the line of Corinne Blanchard with Deutsche Bank. Your line is now open.

Corinne Blanchard: Hey, good afternoon, guys. Thanks for taking my question. Could you try to talk again about the timing for the revenue recognition? And how now is it flowing through? I think you have been improving since the last two quarter, but just wanted to get a sense as we go into 2024. And then, maybe the second question would be if you can speak like high level or how much detail you feel comfortable, but what we should be expecting through 2024. Thank you.

Tony Rabb: So, hey, it’s Tony Rabb. Thanks for that. Relative to revenue recognition, things are continuing in the same manner that we described before, where we are able to recognize revenue in a fairly normal manner. Once the product, the energy warehouses are transferred to control the customer. And that is either happening once it leaves our warehouse here, or once it arrives at a customers’ location, depending on the contractual terms. But generally speaking, once all the obligations are met, that’s how we’re recognizing revenue on a fairly regular basis.

Eric Dresselhuys: Hey, Corinne, it’s Eric here. I’ll take the second one. We’ve not set a firm goal for 2024 at this point. We do see substantial growth, but we have not locked in on a number. It’ll be a mini multiples growth of where we’re going to land on 2023. But we have not set a final target at this point.

Corinne Blanchard: Okay.

Eric Dresselhuys: And I think, as we said in the prepared — yes, Corinne, just add a little — just a little color to that.

Corinne Blanchard: Yes, please, go ahead.

Eric Dresselhuys: As we said in our call, we expect the EW shipments to stay relatively modest in the first half of the year in terms of the rate, kind of at the run rate, or plus or minus from where we’ve been. And then as we hit the second half of the year, as our costs flip over and we start to hit unit profitability, we’ll start to ship more EWs plus, as we said on the call in the prepared remarks, we’ll start to ship ECs on top of that.

Operator: Thank you for your question. Next question is from the line of Leanne Hayden with Canaccord. Your line is now open.

Leanne Hayden: Good evening, everyone. Thanks so much for taking my question. Just to start from me, can you talk about when you’re being approached by a potential customer who’s evaluating your solution? Which technologies are you primarily up against? Is it lithium ion? Is it hydrogen? Who do you view as the primary technological competitor? And has this changed at all over the past, let’s say, six or nine months?

Eric Dresselhuys: Sure. Eric here, I’ll take that. It’s really primarily lithium ion today still, so and that really hasn’t changed much. I think what is — what has changed is that more and more people are coming to us very proactively, intentionally seeking a lithium ion alternative. So, a year ago or more, we would have been having a conversation of us trying to convince someone why they needed a non-lithium alternative. Whereas today, a lot of the contacts we have are people who have specifically decided to seek a non-lithium alternative and are looking for something, particularly around longer duration, which has led them to the conversation with us.

Leanne Hayden: Okay.

Eric Dresselhuys: As relative to your hydrogen question, I don’t — we don’t see that as really competition at all. I think we’ve talked this in the past, but as a reminder, our view is that there is a short duration energy storage market that will probably continue for some time. And there is an ultra-long category within the world of energy storage, which there are different technologies, including hydrogen, that are intended to become the seasonal or multi, multi-day storage. The part that we’re absolutely laser focused on is the intradural or the inter-day kind of 8 to 12-hour range, which we see as the fastest growing part of the market right now.

Leanne Hayden: Right. Right. Okay, that’s great. Thank you so much. Just as a follow-up for me, do you have any updates on the Honeywell transaction? I understand they’ve had a recent change in corporate structure. What does this mean for you? How do you expect to fit into their solutions? Any color you could provide on that would be great.