ESS Tech, Inc. (NYSE:GWH) Q4 2022 Earnings Call Transcript

ESS Tech, Inc. (NYSE:GWH) Q4 2022 Earnings Call Transcript March 1, 2023

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

Erik Bylin: Welcome to ESS’s 2022 Fourth Quarter and Full Year Financial Results Conference Call. Joining me on the call 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 fourth quarter of 2022. This earnings release is available in 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 2022 and beyond. The forward-looking statements are subject to known to 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 SEC, 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 our 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 now turn the call over to ESS’s CEO, Eric Dresselhuys.

Eric Dresselhuys: Thank you, Erik and thank you all for joining us for our fourth quarter and full year 2022 earnings call. Today, I will review our financial results, operational progress, recent wins and the impact of the Inflation Reduction Act. I’m joining Tony Rabb who recently joint ESS as fiscal Chief Financial Officer and he’s joining us for his first earnings call. We delivered 14 energy warehouses in Q4 and 20 for the full year. The 14 EWs in Q4 is a record for ESS and we’re extremely excited to see this growth. Although it is a bit less than the higher end we had targeted, it reflects our increasing ability to navigate a challenging supply environment and drive an upward trajectory in our production capacity. We expect to recognize substantially all of the revenues from the 14 EWs we delivered in Q4 later this year.

And I’ll let Tony cover that. We finished out the year having made strong progress on our operational initiatives. On the power module front. Our target was to end the year at 750 megawatt hours of annual capacity. And we exceeded that achieving 800 megawatt hours of annual capacity. The team did a great job of getting the fully automated line up and operational and delivering efficiencies across all three lines to help us achieve the additional capacity. During the fourth quarter, we successfully finalized a number of important designs for manufacturability initiatives that lowered the labor we used to build EGW. With better processes and a second-generation design that is easier to manufacture, we have also been able to dramatically reduce the time required for our final testing process.

Another key facet of getting our products out the door more quickly. All of this is difficult and complicated work. We started the year with aggressive ambitions to take costs and labor out of each unit we build as we aim to dramatically increase capacity. That effort unfortunately coincided with one of the worst supply environments and tightest labor markets the U.S. has ever seen. ESS persevered and we expanded and strengthened the team. We redesigned a number of assemblies within our EWs to simplify manufacturing. While looking to onboard new vendors that we believe could deliver reliably at lower cost and higher volume. We brought on new automated manufacturing processes, we built and trained a team from scratch to help customers deploy our products at their sites.

Our technology team has increased the energy density of our electrolyte by 25%, improving our cost per kilowatt hour and increasing performance. Again, this has been hard work, and there have been bumps in the road as we scale a unique patent protected technology in a fast-growing market that demands a new solution. But we’ve made significant progress in reducing cost, improving quality across the board. To accomplish this through 2022. We had a key leader across engineering, operations, finance, legal and customer success that bring deep experience to the challenge of scaling a company for growth and profitability. These new leaders are professional operators that are accelerating the progress we’re seeing the ESS. As a notable example our customer success team is working collaboratively with customers in the field and is making great progress accelerating the EW commissioning process for Consumers Energy.

Despite temperatures as low as six degrees Fahrenheit at the customer site, the team was able to deliver and test the energy, energy warehouse a great sign for the team and our ability to manage the process to implement our technology on a customer site. Our internal collaboration between our customer success team and our WILSONVILLE operations team has played a critical role in this progress. In a virtuous cycle, our customer success team has provided valuable feedback from the customer sites to our ops team on changes they could implement to packaging and delivery to speed commissioning. It’s great to see the teams working together to improve the customer experience. I’d also like to share some detail on two very interesting customer wins we recently secured.

In the fourth quarter, we signed a deal with Schiphol Airport in Amsterdam, the second largest airport in Mainland Europe. Triple is driving to be emission free by 2030 and is looking to replace the diesel ground power units that provide electricity to airplanes while they’re at the gates with fully electric versions. In this pilot program our EW will charge these electric ground power units with clean, renewable electricity. Forward thinking airport simple also leads the tulips consortium of European airports, that is working to accelerate the implementation of innovative and sustainable technologies to reduce emissions at airports. I had a chance to visit with the shipping team in mid-February and was impressed with their vision and the critical role they believe.

battery storage will play in decarbonizing airports. We believe this initial installation has the potential to unlock a huge market opportunity across Europe and beyond. We also signed a deal to deliver to EWs to Turlock Irrigation District, quaint project Nexus Turlock Irrigation District will conduct the test installing solar panel canopies over its irrigation comments are first in the United States. This installation is expected to create the double benefit of producing clean electricity as well as mitigating the evaporation that occurs from irrigation canals to critical needs in California. In fact, the cooling effect of the water can actually increase the solar panels efficiency funded by the state of California. The pilot project is expected to be underway earlier this year, and completed by the end of next year.

This project creates an opportunity for up to 3 gigawatts of our environmentally safe nontoxic batteries to be paired with 13 gigawatts of potential solar that could be installed over California’s canals as well. We are proud to have been chosen to be paired with the solar installation and excited about our opportunity from this innovative approach to decarbonizing the grid. Each of these winds elicits a unique and valuable application for long duration energy storage. That represents opportunities for projects that could generate significant additional revenue for ESS. ESS is certainly fortunate to have such a compelling technology to address a critical and burgeoning market of applications so broad that we could not begin to imagine them all today.

And as such ESS shaped its go-to-market strategy to leverage our unique position in the market. We are focused on customer relationships and applications that once the technology proves itself and the use case have the potential for considerable upside. We are excited about these two programs and look forward to the many that come as we strive to help decarbonize the grid, I would like to quickly revisit the anticipated impact that the Inflation Reduction Act or IRA will have on ESS in our market. We are still waiting for the IRS to enact the IRA rules, so the full impact likely won’t be known until that is done. But we are excited about how discussions around long duration energy storage programs are accelerating with customers. With customer investment tax credits, that could save them up to 50% off our product cost coupled with a production tax credit of about $45 per kilowatt hour for ESS.

The economic viability of any battery storage project has dramatically improved. I’ll give one example. Everyone has likely read stories recently about grid congestion issues across the United States and around the world. With incentives for standalone storage in the IRA, we’re getting a lot of interest from traditional utilities to use long duration storage as a deferral of grid investments, an application ideally suited for our solutions. With proprietary technology based on abundant and inexpensive iron, salt and water, we believe ESS remains very well positioned to capitalize on the opportunities to come. Moving on to our plans for 2023, we aim to continue the progress we’re making across manufacturing operations and market penetration.

We built substantial capacity during 2022. But we’re hindered from achieving our potential like continuing supply challenges largely across the balance of plant. Our focus in the coming year is clear. We are aiming to strengthen our supply base for consistent timely delivery at greater scale, while driving down costs across labor and cost of goods as we drive toward unit profitability. We also intend to take a responsible approach to growth in the coming year as we balance delivering product with managing operating costs. We find landmark deals in 2022. Firstly, SMUD for 2 gigawatt hours, which has now given us notice to proceed in the first phase of this multiyear project and ESIAP with potential to be even larger. This in addition to the numerous other initial deployment opportunities that have the potential for considerable upside, we entered 2023 completely booked for the year and buoyed by the impact of the IRA.

We expect to sign deals to book out our capacity in 2024 and beyond. Given the ongoing uncertainties we will defer providing guidance at this time, we look to provide further updates in the coming quarters. We plan to ramp deliveries and installations throughout the year, and remain tremendously excited about how the prospects for the business continue to grow. Given the current environment, we believe it is best to refrain from giving specific guidance for the coming quarters or the year. And before I hand it off to Tony, I’d like to address the short seller report that was released in December. I want to set the record straight. The central claims that the report are that our customer ESIAP is a related party of ours, and that its new manufacturing facility that will complete final assembly of our EW systems in the future is not being built.

That is simply not true. Let me be clear, ESS has no ownership interest in ESI zero, and we would direct you to our SEC filings for further proof. As to the new facility, ESI broke ground last year and say preparations are progressing. The balance of the short seller report is mostly a combination of hearsay, misleading statements of facts we have already shared publicly, and various disparaging statements about members of our team. As the author’s clearly stated in the introduction, and I quote, this report and all statements contained herein are the opinions of Grizzly Research LLC, and are not statements of fact. We continue to explore our legal options and will vigorously defend ourselves against the false claims made in the short seller report.

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

Tony Rabb: Thank you, Eric. I’m very excited to be on the team. Unless otherwise noted. All numbers we talked about today will be on a non-GAAP basis. You will find the reconciliation of GAAP to non-GAAP financial measures in our earnings release, which is posted on our Investor Relations website. Is there a shared we deliver energy warehouses which met all the contractual requirements of our customers, including title passing and risk of loss? However, four criteria for revenue recognition under GAAP had not been met as the customers did not take full control of the units, which occurs once the units are transferred via the shipping method. As a result, we did not recognize material revenues in the fourth quarter. Revenue will be recognized based upon contractual shipping terms.

Unless unique customer specific acceptance terms exist. We remained under development accounting rules in Q4. So, the material overhead and labor costs we incurred in producing the products we’ve delivered fall into OpEx, resulting in zero cost of goods sold. Our non-GAAP operating expenses in Q4 were in line with our expectations at $28.2 million. With that we reported Q4 adjusted EBITDA negative $27.5 million. We ended the fourth quarter with $139.8 million in cash and short-term investments, which was well above our prior expectations and puts us on very solid footing from a cash and liquidity standpoint leading into 2023. We plan to take a prudent approach to our ongoing ramp this fiscal year, we are balancing our customer commitments with our desire to scale up our operations in what continues to be a challenging supply environment, and our plans to further reduce our cost of goods sold.

As we execute our plan in the coming year. We believe, we have ample liquidity to operate the business through the balance of this year and into 2024. And with that, I’ll open it up for questions.

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Q&A Session

Operator: Your first question comes from the line of Thomas Boyes with Cown.

Thomas Boyes: Thanks for taking my question. Obviously, I appreciate you guys aren’t giving any guidance ’23 at this time. But I was just maybe wondering if you could kind of walk us through what maybe some reasonable non-GAAP gross margin expectations would be for the energy warehouse, just thinking about the margin profile there. And now that you have both the semi-automated and fully automated lines up and running, you have the initiatives for design for manufacturing starting to kind of reduce costs, just wondering how we should think about that product?

Eric Dresselhuys: So, I’ll jump in Eric here to take that because there’s a little bit of history involved. We’ve been very focused, as you noted on driving costs out and so we’ve made really substantial progress, our unit costs have been more than half in the last year, year and a half. Since I’ve joined in, I think it’s also important to note that when we look at total costs, it kind of comes in four categories. If you think about the GAAP implications. Of course, there’s direct materials, costs, which we’re driving out through improved designs, vendor upgrades, and of course better volumes. We’re taking out direct labor costs that comes from improved design for manufacturability, putting in those automation lines. And we’ve noted that we’ve made substantial progress and taken out labor content there.

And then, of course, as we get up to production, normal production operations, we take out scrap and warranty, which is really positive, and of course, reflects in higher quality. The last thing and this is where it gets a little bit complicated is that there are indirect and allocated costs, the building the facility, the supporting teams those really self-cures in terms of the margin contribution, as we get to higher and higher volume. So, we’re talking about driving to unit profitability on the first three, knowing that the fourth category takes care of itself with volume. And we’re in a great place with the cost would come out, we hadn’t set a specific announced a specific target, but I think the way to think about it is we’ll cross that line on unit profitability in the next 12 to maybe 18 months on the long side.

It’s very much the focus of the company watching inflation along the way. But a good piece of news for us is, since our product doesn’t really have a lot of high volatility, commodities in it. We don’t have lithium, or nickel or cobalt, or any of the things that are subjected to wild commodity price swings, we have a very clear line of sight to get into that unit profitability.

Thomas Boyes: No, I appreciate the color and then maybe just for my follow-up, because you talked about some of the challenges around just the manufacturing of the EWs, you know, heading into the end of the year, I believe the original target in the high-end was closer to 20 units. But what type of supply chain issues or logistical challenges were there I know kind of semiconductor supply chain challenges have been a perennial issue? I was just wondering if there were specific shortages that you can highlight that you think will ultimately resolve themselves maybe the next 12 months?

Eric Dresselhuys: Yeah, sure that well, most of the challenges have been on the balance system. So, it’s not the core stack. Battery stack part of it, it isn’t the balance of system, and it is the things that have been problematic and really skipped around. So, chips, as we’ve talked about in the past, are an issue. Anything with power electronics has got supply chain challenges, we’ve had some smaller challenges with things like pumps that I think are mostly resolved. Part of what we’ve tried to do, and I think we felt much better at the end of the quarter and going into this quarter is that as we move through an upgraded to more reliable, more scalable vendors, we hope that we’ve laid in enough visibility to take care of those problems going forward, we didn’t see anything that we felt was a systemic problem or was going to be an ongoing drag.