ESS Tech, Inc.

Q4 2023 Earnings Conference Call

3/13/2024

spk11: 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. At that time, if you have a question, you will need to press star 1 on your telephone keypad. I would now like to turn the conference over to our host, Eric Bilen.
spk05: Please go ahead.
spk00: Welcome to ESS's fourth quarter and fiscal year 2023 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&A session. Earlier today, ESS released financial results for the fiscal year 2023. The 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 2024 and beyond. The forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results different 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 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 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'll turn the call over to ESS's CEO, Eric Joslas.
spk03: Welcome and thanks for joining the call. ESS continues to make substantial progress on our strategy, building a world-class scalable company that is well positioned to serve the immense long duration energy storage market in front of us. Although we had numerous accomplishments and grew the business to record levels in 2023, due to unforeseen customer delays, we ultimately came up short of our revenue goal for the year. In spite of the shortfall, I expect the milestones achieved in the course of the year bode well for our future. Our market opportunity and customer engagement remain robust. Energy providers are increasingly recognizing that there is a vast hole in their plans to get to carbon neutral that only long duration storage can fill. And I believe utilities are increasingly recognizing the limited options they have to supplement their renewable portfolio with a commercially viable LDES solution. Thanks to the decision ESS made more than a decade ago to hone in on our iron flow technology, we have a seat at the table with many of the largest, most forward-thinking utilities today. As you have seen from our announcements, we delivered numerous systems to these partners in 2023, including SMUD, Army Corps of Engineers, Burbank Water and Power, and more. We see extraordinary opportunity for ESS in the near term and well into the future, and Thanks to the great work of the team here, even with the intentionally measured pace we are developing the business, I believe we can make the case that we are ahead of other Elda's companies as we look across the landscape today. Indeed, we are poised to ramp our shipments and revenue late in 2024 and into 2025 while maintaining a sizable financial cushion which should bolster our market position. The road to building a company in a new space is bumpy, particularly during the early stages when companies are more reliant on the timing of revenue and shipments, and often things don't happen as quickly as one would like. And certainly we've experienced that as we've been ramping up here at ESS. However, the behind the scenes work to execute on our strategy has progressed to plan. Our near term challenges to maintain moderate and consistent scale shipping and installing energy warehouses have led to inconsistent financial results. As we have shared on virtually every earnings call, Most of these challenges are caused by customer-related delays that are unavoidable in our industry and not a reflection of customer engagement or market demand. That said, we as a team ultimately take ownership of the outcomes, and we are certainly disappointed we were not able to deliver the expectations we set for the back half of 2023. Two key customers, ESI and Honeywell, were expected to be material contributors to achieving our fourth quarter revenue target. but were delayed and not able to be included as part of Q4 revenue. However, I can share that we did clear these delays in the first quarter. While we were expecting roughly $2 million in revenue from these two customers in the fourth quarter to meet our full year objective of $9 million, we now expect to include that revenue as a part of our Q1 results. In fact, we continue to make great progress with these customers, and I'll share more on that in a moment. While delays are frustrating in the near term, Especially as an early stage company, we expect that as we grow and diversify our business across customers and work to continue to standardize our contracts and operations, these bumps will smooth and our path to scale remains intact. We are building ESS with a very distinct strategy in mind, focusing on refining our iron flow battery design for optimal manufacturability, namely the lowest cost coupled with the highest quality and throughput while conserving our cash. This should allow us to capitalize on the fundamental cost advantage we enjoy using iron, salt, and water to store electricity. As we work to reduce our product costs, we strategically chose to moderate the number of energy warehouses we build and ship, focusing on the customers in the segments that provide the greatest long-term opportunity. This strategy is working, as it has allowed us to conserve our cash balance while making great strides on the design initiatives to lower material and labor costs and enable us to reach non-GAAP gross margin profitability on a unit basis, an objective we still believe is achievable by the back half of the year. Given our strong cash balance and the progress we've made with the design of our products and operations, I feel the team has been extremely successful. In parallel, we are proving the necessity of long-duration energy storage by signing large multi-year deals that could deliver well north of a billion dollars in revenue from future orders as we execute on scaling our technology. Let me repeat, simply executing on our existing customers and partners can deliver all of the volume we need over the next few years. In 2022, we landed Sacramento Municipal Utility District, a utility with one of the most aggressive and detailed plans to get to carbon neutral, and we have already delivered and commissioned our first six units with them. We signed a partnership with Energy Storage Industries Asia Pacific and Australia whose initial customers include Stanwell and Energy Queensland in support of a very exciting initiative announced by the government of Queensland to deploy over three gigawatts of batteries to reach their decarbonization goals. In 2023, we signed an agreement with LIAG, the second largest electricity generator in Germany, whose plan is to deploy 500 megawatt hour iron flow battery building blocks coupled to renewables to supplant coal generation plants. All told, they expect to build 20 to 30 gigawatt hours of storage. We're pleased to share that we have now completed the first stage of engineering design with LIAG. While these are extraordinary validations of our market and technology, the deal we completed with Honeywell in September of last year is probably the most transformative. Honeywell took an equity position in ESS at a premium to the market price, entered into a co-development agreement for energy storage and, most importantly, plans to resell our technology into their channels with an initial target of $300 million in the first six years, which included a prepayment of $15 million. In the fourth quarter, we hit the ground running and, as mentioned, we have already delivered their initial order. Our go-to-market teams are deeply engaged and we are moving towards our first joint development projects. all designed to improve the cost, performance, and scalability of our solutions. This partnership was more than six months in the making, and Honeywell did extensive due diligence into our technology, operations, IP, and customer base. So this rings true as an incredible proof point for our technology, our operations, and the progress we've made. Encouraged by the belief of these influential customers and partners, we remain convinced that ESS has a strong right to win in the market. The long-duration energy storage market has tremendous tailwinds, and the primary alternative technology, lithium ion, is rife with flaws. There are numerous nascent technologies trying to climb that mountain to scale viability, but ESS has a substantial lead on all of them, improving our solutions and scaling our processes. We have been developing a unique technology for more than a decade and have surrounded it with an incredible IP moat. ESS is blessed with a solution that stores energy in some of the most abundant and inexpensive raw materials available, iron, salt, and water. It doesn't catch fire, explode, or require difficult to source raw materials and is manufactured with a very capital efficient process, creating a fundamental cost advantage at scale. Executing on our manufacturability initiatives and our customer relationships is the key to our success, and that is why I am so pleased with our operational progress. While we have given you glimpses into the progress we have been making operationally, I would like to recap some of the highlights from our accomplishments in 2023. At the top of the list, our cost-out initiatives have resulted in tremendous savings for each EW we build. We brought down the cost to build an EW by almost 60% in 2023. This improvement included numerous noteworthy highlights, including lowering labor hours to build the balance of system by 45% and decreasing cycle times for power modules by 52% and proton pumps by almost 70%, all of which lowered EW build cycle time by 73% while reducing the hours required by more than a third. We improved our electrolyte so that our energy density increased by 25%. Additionally, we did great work optimizing our bill of materials and vendor base. Our customer success team dropped the time to commission an EW at a customer site by 50%. We continued to fortify our intellectual property mode and filed an additional 82 patents while also having 52 patents granted within the year. bringing the total to 367 patents filed and 77 patents granted. We vastly improved our revenue recognition process and shifted out of development accounting. We accomplished this while almost cutting our Q4 adjusted EBITDA loss in half year over year, which enabled us to end the year with $108 million in cash on our balance sheet. Our rate of operational execution improved dramatically in 2023. And with the team hitting their stride, we have detailed plans to lower the cost to build an EW by up to another 40% in 2024. This includes further dramatic simplification of the design and assembly, along with optimization of our power module automation. In fact, as we move to our next rev of our EW design, I can share some details that you listed how we are lowering cost and time of assembly. Simplifying the design to make it easier to manufacture means lowering the number of touches and pieces. And as we move through 2024, we are lowering our pipe couplings by 34% and pipe bonds by 18%, lowering our hardware count by 44%, and lowering the wiring in any W by 28%. This simplifies every step of the manufacturing process, from procurement to assembly to final test. All told, should also increase our capacity by another 20 percent without further investment simply from optimizing the design perhaps most importantly as we shared last quarter we are building our first energy center with portland general electric this process has gone well and we are currently testing the cc and expect to complete validation this quarter the energy center delivers greater energy capacity and density, and we expect it to be a preferred incarnation of our technology for utilities and other large energy providers due to its scalability and value proposition. We expect to start delivering the first commercial energy centers late this year to Tico and Sacramento Municipal Utility District. And with this, we remain on track to start ramping ECs as we head out of 2024 and into 2025. I hope I conveyed our excitement about the progress we've made this year and the trajectory we are on. As we look forward to this fiscal year, our focus remains consistent. We plan to develop scalable processes that lower costs, manage our growth to conserve cash, build our long-term book of business, and continue to demonstrate the critical role we expect Eldez to play in the energy transition. The lessons we learned in 2023 as we made progress scaling the business should be invaluable in helping us successfully execute on our vast long-term potential. Given the variability with our customers' deployment activity, we are taking a conservative view toward our external projections in 2024 and will defer giving specific guidance at this time. But we'll share that we expect to grow substantially in 2024 driven by an inflection point in the second half that is enabled by achieving our cost out targets and beginning the initial commercial shipments of our energy center, allowing us to dramatically increase our growth rate and drive efficiencies across the business. We expect to triple or quadruple our 2023 levels in the coming year, but project timing is still in flight. As our visibility improves during the year, we hope to be more specific about our ramp plans. This is an exciting and dynamic market space, and we look forward to continuing to scale our business to meet the growing demand. We feel that with the team we've built, the technology we're developing, and a market driven by the strong tailwinds provided by the IRA and increasing regulatory imperatives, ESS is positioned to capitalize on its first mover advantage in this new category of long duration storage. And as we've seen in other industries, early leadership can deliver enduring competitive advantage long into the future. And with that, I'll turn it over to Tony.
spk07: Thanks, Eric. Unless otherwise noted, all numbers we discussed today will be on a non-GAAP basis. You'll find the reconciliation of GAAP to the non-GAAP financial measures in our earnings release, which is posted on our investor relations website. In the fourth quarter, we delivered eight energy warehouses across a number of customers. However, there were certain delays that caused revenue we expected to come in during Q4 to get pushed out to the first quarter. This was across two customers, Honeywell and ESI, and amounted to approximately $2 million in revenue. As a result, our revenue fell short of expectations, coming in at $2.8 million for the fourth quarter and $7.5 million for the full year. In spite of these disappointing top line results, I'd like to reiterate what Eric said about the significant headway we've made in the last year in scaling the business, streamlining our revenue recognition process, reducing costs, and improving manufacturing efficiency. The team has worked tirelessly to position ESS for continued growth in the coming year, and we remain confident in our ability to execute successfully on our long-term strategy. As a reminder, 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 $10.3 million in the fourth quarter. In addition, as we detailed last quarter, as part of the transition from R&D accounting to inventory accounting and the associated LCNRV adjustment, There are a fair number of items included in COGS that dramatically impact our current COGS results that would not be material contributors as we reach scale. Due to this, our COGS results will not fully reflect our cost reduction progress, thereby making it difficult to assess our progress towards profitability. As we increase scale and approach adjusted gross margin breakeven on our EWs in the second half of 2024, we expect the impact of the LCNRV adjustment to our non-GAAP gross margins to decrease. Our non-GAAP operating expenses for Q4 were in line with our expectations at $9.5 million, and our non-GAAP R&D came in at $3.5 million, which we believe is reflective of our current run rate. With that, we reported Q4 adjusted EBITDA of negative $12.8 million another significant sequential and year-over-year improvement and indicative of our trajectory to profitability. Following the cash infusion of $42.5 million in Q3 from Honeywell, we ended the fourth quarter with $108.1 million in cash and short-term investments. We plan to 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 expect to 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. We feel very good about our current cash position and liquidity and the extended runway we now have to push towards our longer-term goal of getting to cash flow breakeven.
spk05: And with that, I'll open it up for questions.
spk11: If you'd like to queue for a question, please press star followed by one on your telephone keypad. If for any reason you'd like to remove your question, you can press star followed by two. Again, to join the queue for a question, please press star one.
spk05: We'll pause here briefly as questions are registered. Our first question is from Thomas Boyce.
spk11: with TD Cohen. Your line is now open.
spk10: Perfect. Thanks for taking the questions. Maybe first I wanted to just touch on the project delays. With customers, is this primarily an interconnection issue or are there supply chain impacts? I mean, we've heard kind of from a lot of project developers that are being stymied by transformer availability, you know, since some of those lead times are over the, you know, two years at this point. So just wondering if you could kind of talk through maybe the nature of some of those delays, or at the market at large, what you're seeing.
spk03: Sure, Thomas. Eric here. I'll take that. It's a great question, and it's, I think, as you point out, something that's happening across the industry. It's a combination of impacts. There's no one thing. In some cases, it's inverters and transformers and delays. Other delays related to site readiness. So we'll have a project plan with a customer, and they'll say, I'm ready for the products to arrive on a certain date. And then they'll call at the 11th hour and say, well, wait a minute. The civil works aren't done yet, and the pads aren't in place. So sometimes it's things as simple as that. In some cases, it's delays in getting contracting done. or other kind of operational things in terms of the logistics of the planning. So far, we haven't had any short-term problems with interconnect, but as the projects are getting bigger, we're paying a lot of attention to that because we've seen what other folks have gone through.
spk10: Okay, that's helpful. And maybe as my follow-up, I just wanted to maybe understand how you're thinking about, you know, 45X credits. Is this something that you would think about, you know, self-consuming or are there plans to take advantage of the transferability of the credit? We've been hearing about ranges of, you know, a 10% to 5% discounts on the dollar, you know, pennies on the dollar there, depending on the size of the credits that, you know, one would be able to transfer. Just wondering if you have any thoughts.
spk07: Hey, Thomas. Yeah, this is Tony. Yeah, so we've elected to go with direct pay on the production tax credits. We've already realized some in 2023, and the expectation with our volume ramping up this year would be substantially bigger impact. And based on some conversations we've had with folks, we do believe that there will be a a market for us to be able to finance and those production tax credits.
spk08: And so we're evaluating those options and alternatives now.
spk05: Great. Appreciate it. I'll pop back in the queue. Our next question is from George Gianarchos with Canaccord.
spk11: Your line is now open.
spk04: Hi, everyone. Thank you for taking my questions. I just want to make sure I heard correctly. Did you say that you expect a tripling or quadrupling of revenue in calendar 24?
spk03: Yeah, George, Eric here. That's kind of a range that we expect to see as we've, you know, shared because of some of these lumps in the timing. We're being a little cautious on being too specific about it, but it's certainly going to be substantial growth in the year.
spk04: Got it. And I think you also said that you expect that to kind of ramp in the back half of the year. Which specific projects do you expect to push the revenue higher in the back half? You can share that. Thank you.
spk03: Yeah, I think about it from our standpoint, the two biggest drivers to it are where we are on our cost out curve. As we shared, we made really great progress on driving costs out of the product in 23 and have a very ambitious plan to continue that here in 24. So the EW on the existing EW products, hitting that trigger to hitting the lower cost points is frankly more important than any one customer or another customer in driving our ambitions for volume. And then the second thing is starting to shift the ECs. So as we've shared, we've got the initial project with Portland General Electric that's going to pace, and we feel great about that. And the current plan is for TECO and SMUD to receive their first EC units in the second half of the year. So it's really the combination of those two things that drives that inflection point in the second half.
spk04: Got it. And maybe as a follow-up, I'm just curious on pricing. Given the pretty much a collapse that we've seen in lithium prices and in lithium ion cell prices. Are you seeing a kind of a stable pricing environment from your perspective, or has that pricing umbrella impacted you? Thank you.
spk03: Sure. So far, I think it's been pretty stable on our side, but we're certainly watching what's happening in the lithium market. and monitoring the impact that that will have. We have a very ambitious cost-out plan that extends through this year and beyond, and we know that we've got a great long-term cost entitlement, but certainly competitive prices falling continues to drive the imperative to stay on schedule.
spk05: Thank you. Our next question is from Colin Ruch with Oppenheimer.
spk11: Your line is now open.
spk02: Thanks so much, guys. You know, with these adjustments on the design, can you talk a little bit about how different the supply chain is and, you know, what the supply chain looks like in terms of, you know, single source components and your ability to kind of navigate to, you know, a complete set with the existing suppliers?
spk03: Sure, I'll take a crack at that and Tony can add in if need be. We certainly have transformed a lot of our supply chain to try to take out some of the risk and variability that we've seen in the past. And we've talked about that on these calls a number of times. So that equates to a lot more domestication. It also equates to a lot of our transformation has been to higher volume manufacturers who have, by definition in most cases, multiple facilities. So what we've been trying to do is drive lower prices with more reliable suppliers who have built in redundancy into their products. And then separately, we've been looking to find places to have alternative sources of supply for key components wherever that's practical. Now, as we get to higher and higher volumes, the idea of diversification in the supplier base gets a little easier to execute than it is for us today. But we think we can get a lot of that diversification and kind of surety of supply by working with larger vendors who have multiple facilities in the first place.
spk02: That's actually super helpful. And then in terms of debt providers and underwriting standards along with potential insurance providers for some of these projects. Can you talk about the maturity of those processes to really look at performance of the assets in the field and how comfortable those underwriters are getting with the technology and how these assets are performing at this point?
spk03: Yeah, sure. So I answer it in two parts, really. We've had a lot of engagement with people who do underwriting at the project level. And that's both for independent power producers, but also kind of more traditional legacy producers. And we've broken that out into two parts. There's one kind of just a general product breakdown where I think we're very mature. And certainly the agreement we have with Munich RE and all of the diligence we've been sharing with people for years gives a lot of comfort on that front. as we get more and more operating cycles in the field, that helps drive the bankability study in terms of performance, the number of cycles that we get. And I look at that, I think it's getting increasingly comfortable for people, but there's almost no limit to it. The more product you get in the field, the more different operating environments that you demonstrate, and the more cycles you put on the unit, the better that gets. And so it's just kind of part of our everyday work.
spk05: Thanks so much, guys. Our next question is from Karen Blanchard with Deutsche Bank.
spk11: Your line is now open.
spk01: Hey, good afternoon. Could you talk, two days ago there was a finding saying that the stock price basically doesn't further much up, I think there is maybe a risk of you being deleted or going on the OTC. So, just trying to get a little bit of color and, you know, what could be the different scenario happening from that finding?
spk03: Sure. No, thanks for the question. Yeah, we've received a notice from the NYSE, which we've responded to. It's got a relatively long kind of observation and cure period to it of about six months. So there's no immediate action that's required. So we're monitoring that. We have a number of options to address it if it doesn't kind of cure on its own. But we certainly don't have any intention of being delisted or trading down to alternative platforms.
spk01: OK, thank you. Maybe the second question, and sorry if I missed it earlier in the Q&A, but can you give a little bit more color as well about the 40% cost reduction, like maybe the timing and how you're thinking of implementing it?
spk07: Yeah. Hey, Corinne. This is Tony. The 40% cost reductions that we're expecting to achieve this year, or similar to what we saw last year in terms of the various projects that we have associated with cost reduction initiatives. So again, there's going to be some more design-related initiatives and generation changes that will simplify the EWs as well as remove some of the material that's in there. and and we also expect to continue to reduce the cost of our electrolyte so there's a number of projects that are all going to be realized throughout the year as there are multiple of these projects in addition to some supply chain related projects where we're continue to evaluate alternative vendors who can provide us better or cheaper materials. And so, as we realize those throughout the year, that's how we're going to be able to take the cost of the product down by 40 percent by the end of the year.
spk01: Great. Thank you very much. That's it for me.
spk05: Thanks.
spk11: Our next question is from Brian Dobson with Chardon Capital Markets. Your line is now open.
spk09: Yeah, thanks very much. So you had mentioned earlier in the call that your 4Q delivery misses were mostly from client disruptions. Would it be safe to assume that we should view those deliveries as delayed rather than missed entirely?
spk03: No, absolutely. In fact, both of those have already subsequently been delivered, and we expect to recognize them in Q1.
spk09: Yeah, very good. I think that that's an important point. And just shifting gears a little bit to your agreement with Honeywell, have you seen any, I know it's early, but have you seen any early synergies from having access to that company's sales channels, or have you received any early feedback from your new partners?
spk03: Sure. No, I think there's been really positive feedback and a couple of things kind of have popped up. Certainly, Honeywell has a vast experience technically on products similar to ours across a range of industries. And so, you know, the interactions with our technical teams have had on a joint development project basis and evaluating things to do together is, you know, the first thing. From a channel's perspective, they have great access to tons of channels across the space. I'd say two things have kind of come up. One, of course, very large customers sometimes have a strong preference to dealing with very large suppliers. And so Honeywell has a lot of great relationships with very large customers, and that's opening up some doors. But then also things like, you know, I think military bases and government contracts, there's a lot of connections into those. I think you're absolutely right. It's early days and they're a big ship. So we're working hard across the teams on both the commercial and the technical side to kind of get specific things locked in and ramped up. But we feel really good about the progress we've made so far.
spk05: Excellent. Good to hear. Thanks very much. We have a follow-up from Thomas Boyce with TD Cohen. Your line is now open.
spk10: Yeah, thanks again. Just one more. You know, it was great to see the improvements on the system commissioning times. I was wondering if you could kind of rank order the actions that kind of led to those improvements. You know, changing to the contracts, kind of the overwhelming component there, or is a lot of it the team that you had put in place to assist with commissioning?
spk07: Yeah, Thomas, this is Tony. A lot of it has to do with how we're out in the field as we're getting set up to do the startup and the commissioning. So it's productivity on our field service engineers part, and part of it is productivity from just implementing more units throughout the year. Part of it is that we've changed some of the procedures that we follow as we are out in the field and starting up and commissioning the units. And then it's also because of the simplification and the work we've done to improve the reliability and durability of the units as they're put out there. So it's a number of things, but a lot of it is a testament to the learnings that our customer success team has been able to realize throughout the year from the early units that were installed to the units later in the year. And more specifically, with something like SMUD, where there's multiple units out at a site and you're able to get quite a bit of productivity when you're working through multiple units at one time. And so as we see that type of increase going forward, we would anticipate that we'd be able to continue to make progress on those types of field initiatives, and that will significantly reduce our cost and allow us to spend – be a lot more productive with our field service engineers as we scale up the business.
spk05: I appreciate the color there. Thanks again. I'll now pass the call back to the management team for any closing remarks.
spk03: Well, we'd like to thank everybody for joining the call today and for your interest in ESS. We are now almost a quarter into 2024 and really excited about how the business continues to progress. Our really great progress around the key initiatives around driving costs out and keeping us on our path to profitability. We look forward to talking to everybody again in just a few weeks as we talk about Q1 results.
spk05: That concludes today's conference call. Thank you all for your participation. You may now disconnect your line. you may now disconnect your line.
Disclaimer

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