Fluence Energy, Inc.

Good day, and thank you for standing by. Welcome to the Fluence Energy First Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during this session, you'll need to press star 1 on your telephone. Please be advised that today's conference may be recorded. I would now like to hand the conference over to your speaker today, Sam Chung, Treasurer and Head of Investment Relations. Please go ahead.

I would like to welcome everyone to our earnings call for the first quarter of fiscal year 2022. On the call today are Manuel Perez Dubuc, our Chief Executive Officer, Dennis Fehr, our Chief Financial Officer, Rebecca Ball, our Chief Products Officer, and Syed Madani, our Chief Digital Officer. Before we begin, I would like to remind you that management will make statements during this call that include forward-looking statements within the meaning of federal securities laws which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward-looking statements are neither promises nor guarantees and based upon our current estimates and various assumptions and are subject to material risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements. These and other risks are described in our filings made with the Securities and Exchange Commission. We encourage you to review these filings for a discussion of these factors, including our annual report on Form 10-K for the fiscal year ended September 30, 2021, and our other filings with the SEC. You are cautioned not to place undue reliance on these forward-looking statements which speak only as of today. and the company disclaims any obligation to update such statements for new information. This call will also reference non-GAAP measures that we view as important in assessing the performance of our business. A reconciliation of these non-GAAP measures to the most comparable GAAP measures is available in our earnings materials on the company's investor relations page at ir.fluenceenergy.com. I will now turn the call over to Manuel Perez Dubuc, our CEO.

Thank you, Sam. I would like to extend a warm welcome to our investors, analysts, and employees who are participating on today's call. Let's start on slide four on the earnings presentation found on our investor relations website. This morning, I will provide an update of our market outlook, which remains strong and and demonstrate the significant progress we have made since our last earnings call. During the quarter, we have seen a tremendous increase in demand for our energy storage products, as evidenced by our recent contracting activity. The market for energy storage products, service, and digital applications continues to grow at a rapid pace, with Fluence solidifying itself as an industry leader. We expect this strong demand to continue and we are on track to deliver our fiscal year 2022 revenue guidance of 1.1 to 1.3 billion, despite some recent headwinds. Finally, I'm excited to share some additional details with you regarding our recently announced strategic initiatives, including our India joint venture with RenewPower the expansion of our digital ecosystem through our partnership with Pexa Park, and our collaboration with QuantumScape on solid-state battery technology. Moving on to slide five. We continue to contract increasing amounts of megawatts across each of our three business lines. Industry appetite for applications of energy storage remains robust, suggesting continued momentum for orders throughout 2022. As we have seen, energy storage is key to providing clean energy for a sustainable future. I am pleased to report that during the first quarter, we contracted 600 megawatts of energy storage products, which is a 525% increase from a year ago. This amount exceeded our expectations as the first quarter has historically been a seasonally lower one for contracting. We continue to experience very strong demand for energy storage products across the globe as companies and countries seek long-term solutions for grid stability and reliability as more renewables come online, creating challenges for grids around the world. As of December 31st, we deployed or contracted more than 4.2 gigawatts of energy storage products. Turning to our Fluent Services business, we added 250 megawatts of contracts during the first quarter. We also signed 335 megawatts of contracts for our Fluent IQ bidding application. More importantly, after the end of the quarter, we signed an additional 1.1 gigawatts with AES Clean Energy, which represents our single largest Fluence IQ order ever. This contract highlights the value that Fluence IQ can deliver. With this, we have already achieved our fiscal year 22 annual recurring revenue target for Fluence IQ. seven months ahead of schedule. Turning to slide six, I would like to update you on the headwinds that we discussed in our last earnings call and the steps we're taking to mitigate their impact. This mostly stems from supply chain disruptions as a result of COVID-19, as well as some cost overruns in the rollout of our first generation six product installations and commissioning. Our team has acted swiftly to implement corrective actions that provide us the confidence to further execute on our plan. Some of these mitigation efforts include securing shipping capacity for our high volume routes on a two to four month forward looking basis, giving us better visibility to deliver our product to our customers on time. Furthermore, we have increased the size of our supply chain and manufacturing teams by 57% to provide us with the resources necessary to meet the robust demand we see. And finally, we are documenting lessons learned from our teams around the world and providing additional training so they can deliver our Gen 6 product installation and commissioning more effectively. During the second quarter, we will continue to catch up on some of the installations that were delayed in the first quarter. As of today, a vast majority of the products required to fulfill our anticipated Q2 deployments have already made landfall in their respective countries and are going through installation, commissioning, and acceptance testing as we speak. I would also like to address another topic that is a concern for many in our industry. Inflationary pressures and raw material price increases. Our current backlog is hedged through the fixed price contracts we have signed with our suppliers and customers. Given the substantial volatility in commodity prices, we are introducing raw material indices, or RMI-based pricing for future contracts. By implementing RMI on both the supply side and the demand side, we are further minimizing our exposure to future commodity price fluctuations. I would also like to provide a brief update on month's landing. Although we cannot comment on the press release issued by Vistra in late January regarding its alleged technical findings about the overheating event last September, we can say that we continue to work with VISTA on the repair of the facility. Our own technical investigation is still actively in progress, and we will provide you an update once it has concluded. Turning now to slide seven. As I noted earlier, we continue to execute on our business plan during the quarter to position ourselves for long-term success. I will cover a few examples. Let's start with one of our key wins in the new transmission enhancement segment of the market. As you might have seen last year, we were selected to provide a small one megawatt pilot to lead grid in Lithuania. This pilot program was designed to test the concept of utilizing energy storage to an enhanced transmission and distribution network rather than incur the costly expense of installing additional transmission lines. The pilot turned out to be so successful that we were awarded a follow-on 200 megawatts order for virtual transmission lines. This outcome aligns well with our strategic effort to be the leader in this market segment. The transmission and distribution enhancement market requires a highly redundant and resilient technical architecture that supports advanced grid forming applications. This suggests a high margin potential compared to other segments. We continue to be bullish of this growing market segment as there are numerous areas around the world that can benefit from this technology, and we are proud to be among the first companies to bring it to the market. Additionally, we selected our contract manufacturer for our North American and European locations. We are on track to start seeing initial production for our North American facility in our fourth quarter. For our European facility, we expect to see initial production in the first quarter of our fiscal year 2023. Both of these contract manufacturing facilities will alleviate the burden of a single manufacturing location. On the software development side, we made several key additions that further strengthened our deep talent pool. These additions were part of the 139 full-time employees added during the first quarter, providing us with the knowledge and experience to keep the pace with the extraordinary demand we are seeing. Now, I would like to provide you with some color on our recently announced strategic partnerships. Turning to slide eight. In January, we signed a term sheet to enter into a 50-50 joint venture in India with Renew Power, which is one of the largest pure renewable IPPs in the country. Renew Power is a well-respected renewables player, and by establishing a joint venture, we will collectively leverage our first mover advantage in this significant market. India currently has just 24 megawatts of energy storage deployed. Almost half of that comes from an affluence pilot that we built in 2019. Even more importantly, The Indian government has stated that we'll need at least 27 gigawatts by 2030, which provides Fluence a tremendous opportunity to be the industry leader in this significant market. The joint venture will serve as our primary sales outlet in India by licensing Fluence products and services. As a leading IPP, Renew Power will also be a significant customer to the JV, beginning with a recently announced first contract for 150 megawatt hours. Now, turning to slide nine, I would like to highlight the recent expansion of our digital ecosystem. As you may recall, we are developing several in-house applications to complement our flagship digital application, the Beating App. We are paving the way for third parties to build their own applications for the Fluence IQ platform. In January, we entered into a long-term strategic partnership with PexaPark, an award-winning provider of software and advisory services for renewable energy sales and risk management. PexaPark has supported 20 gigawatts worth of renewable PPA transactions and are currently in 18 markets with a large presence in the EMEA region. By partnering with tech support, we will bring together our unique insights that will help investors, IPP, and utilities make better decisions as they navigate merchant markets while trying to maximize revenue. In addition, their significant EMEA presence will also help to accelerate the coverage for our bidding app in that region. This partnership is a significant milestone for Fluence, as it corroborates our vision for our ecosystem. Through this partnership, we will commercially introduce PEG support and its four apps to our customer base via our digital platform. In turn, we expect to receive customer referrals for our products and services from PEXAPART. And finally, turning to slide 10. In January, we entered into a collaboration agreement with QuantumScape, a leader in solid-state battery technology. This agreement strengthens the advancement of solid-state battery technology in stationary storage applications. We will test QuantumScape solid-state technology in Fluence smart energy storage products. This collaboration sets the stage for Fluence and QuantumScape to potentially enter into a large-scale supply agreement once commercialization is determined. We are encouraged by the benefit we see in solid-state battery, specifically around density and performance. And we remain battery technology and committed to providing our customers with the most economic and efficient product possible. I would like to take the opportunity to send our gratitude and admiration to our people during this pandemic. Thank you for your passion, hard work, and commitment. I will now turn the call over to Dennis to cover our financial performance and fiscal year 2022 revenue guidance.

Thank you, Manuel, and good morning to everyone on the call. As Manuel stated, we delivered a very strong quarter of new orders for our energy storage products. In addition, we were able to execute on some of our near-term strategic initiatives, which position us for continued growth. Turning to slide 12, we continue to deploy capital in line with our investment framework with a strong focus on supply chain and talent acquisition. In the first quarter, We prepaid $60 million into our supply chain to support capacity buildup for calendar year 2022 and calendar year 2023 battery supply. And this manual already explained in detail. In January, we entered into agreements with Renew, QuantumScape, and Paxapark, which I would like to financially highlight in more detail. Our 50-50 joint venture agreement with Renew is projected to be aligned with our capital light approach, as we will be licensing our technology to the JVs. We anticipate that the JV will be mostly self-funded when operational with nominal amounts of paternal support, while the terms of the transactions are not yet publicly disclosed. This investment and expected results are in line with our previous expectations. The collaboration agreement with QuantumScape will be accounted for as R&D expense and is consistent with our previous expectations. At this juncture, we expect that it will be a few years until we can have a mass-produced solid-state storage battery. Upon production, We expect that a future solid-state-based energy storage product will contribute to achieving our long-term product margin targets. The Paxapark partnership is a validation of commercial relationships being built on our digital platform. As part of the partnership, we have a revenue share agreement in place for sales of Paxapark applications made through our App Store. As our previous expectations did not include any such revenue share incomes, This partnership will be accretive to our financials from calendar year 23 onwards. Furthermore, we continue to add talent and resources necessary to keep pace with the robust demand we are seeing. As such, during the quarter, we increased our supply chain organization by close to 60%, our service organization by approximately 20%, and acquired key talent to strengthen our software development team. These additions are in line with our model and are important steps for executing our plans. turning to slide 13. Before we move on to our Q1 results, I would like to remind everyone of the seasonality of our revenues and order intake. This seasonality is due to customers' desires to have products operational in time for summer in the Northern Hemisphere. Historically, we recognized approximately 70% of our revenue mostly in our fiscal second half. This aligned with our patterns for order intake. As a result, fiscal first half results are usually lower compared to our second half. However, As Manuel mentioned, for our current Q2, there is a caveat to the seasonality in that we expect the portion of the delayed revenue from the fourth quarter of fiscal year 21 and fourth quarter of fiscal year 22 will be recognized during Q2, therefore leading to a higher revenue contribution than typical in the second quarter. Moving on to slide 14, starting with the table on top of the slide. In Q1, we contracted 600 megawatt of energy storage products. which was an increase of 525% from Q1 of fiscal year 21. We are encouraged by the high demand for products in the seasonally slower quarter. Energy storage services added 250 megawatt of contracts, which was a 10% decline from Q1 fiscal year 21. We sold higher levels of products to utility customers, which typically acquire service at the later date, as they did in Q4 of last year. We do expect an attachment rate of at least 70% for the products sold in Q1. Finally, we contracted 335 MW for Fluence IQ bidding applications in Q1, which was a decline of 36% from Q1 of fiscal year 21. However, in January, we entered into a 1.1 GW contract with AES Clean Energy. With this order, we have already achieved our fiscal year 22 Fluence IQ annual recurring revenue target. about seven months ahead of time. Now moving to the second table on the slide. Despite impacts on our supply chain, the number of megawatts that we deployed for our energy storage products grew 6% sequentially. Due to our strong contracting results, contract backlog megawatts increased 20% from the fourth quarter. Our product pipeline is being driven by strong tailwinds from the market and demand for our proprietary Gen 6 product. It stood at almost 14,000 megawatts at the end of Q1. Turning to energy storage services. Assets under management grew 8% and contracted backlog grew 10% from Q4. Similar to our storage products, our services pipeline remains robust, standing at almost 12,000 megawatts at the end of Q1. Moving to our Fluence IQ digital platform. In Q1, digital assets under management grew 25% to almost 3,900 megawatts from Q4, while contracted backlog declined 26% due to successful transitioning to assets under management. Our digital pipeline achieved a new high of 4,500 MW at the end of Q1, which increased by almost 1,200 MW from Q4. Turning to slide 15. Our Q1 fiscal year 2022 revenue grew 50% to $175 million versus $116 million for Q1 fiscal year 2021. Q1 fiscal year 2022 revenue is below expectations, driven by the already discussed headwinds. We view the delays of revenue recognition as temporary, with expectation to largely catch up within Q2 fiscal year 2022. On the last 12 months' basis, total revenue grew 9% versus Q4 to $739 million in Q1. Turning to page 16. In the first quarter, cross-profit was negative 53 million versus positive 5 million in Q1 fiscal year 21. This decrease was driven by 41 million of non-recurring expenses in Q1 fiscal year 22, which included 31.3 million related to project charges and other costs attributable to the compounding effects of COVID-19 pandemic, 5.6 million related to non-recurring excess shipping costs and other non-recurring costs. In our last earnings call, We forecasted non-recurring expenses related to shipping and other COVID-related items of at least 50 million to 55 million in the first half of fiscal year 2022. In Q1, these expenses totaled about 37 million. We continued to forecast an impact of 50 million to 55 million in the first half. Adjusting for these non-recurring items, we generated adjusted gross loss of 8 million in Q1 fiscal year 2022 versus positive 5 million in Q1 fiscal year 2021. Adjusted gross profit was negative in Q1 due to $13 million of costs associated with first time deploying our Gen 6 product. As Manuel noted, we have taken significant corrective actions. However, we expect to see some trailing cost overrun amounts in Q2. Continuing on to slide 17. EBITDR in Q1 was impacted largely by the same non-recurring expenses as the gross profit. Adjusted EBITDA excludes these non-recurring expenses and additional $24.9 million of stock-based compensation, which we have started to record since our successful IPO. However, the $24.9 million includes catch-up entries since April 2021. Therefore, future quarters will see significantly lower stock-based compensation expense. Moving on to page 18. Our cash and cash equivalents as of December 31st was $632 million. We raised about $940 million in IPO proceeds in October, net of offering costs. Immediately following the IPO, we repaid a total of $100 million in debt. Our short-term working capital in the quarter was negatively affected by the shift in revenue recognition and by the $60 million prepayment to secure battery capacities. However, we expect to catch up on cash flow later in the year. Our strong balance sheet is now enabling us to keep pace with the robust demand we see for our entire ecosystems. Going forward, we will continue to deploy our capital in line with our investment framework of enhancing unit economics, expanding recurring revenues, and developing structured offerings to deliver attractive value for our shareholders. Turning to slide 19 and our fiscal year 2022 outlook. Our contracted backlog as of December 31st was $1.9 billion. Our guidance for fiscal year 2022 revenue in the range of $1.1 billion to $1.3 billion takes into consideration risks and uncertainties related to our ability to recognize revenue from our energy storage products on a timely basis in H2 fiscal year 22. Despite a challenging Q1, we expect our H1 fiscal year 22 revenue to be in line with our historic seasonality of 30% of full year revenue plus the majority of the 125 million delayed revenue from Q4 fiscal 21. As previously discussed, We also reconfirm our forecast of 50 million to 55 million of non-recurring expenses related to shipping and COVID-19 compounding effects. Lastly, we have already achieved our fiscal year 2022 Fluence IQ annual recurring revenue objective ahead of time and have created upside to our digital plan through the PEXA-PAC partnership. At this time, I would like to turn the call back to Manuel.

Thank you, Dennis. The first quarter proved to be exciting as we continue to execute on our mission to transform the way we power our world for a more sustainable future. We continue to see robust demand for our products, services, and digital solutions as society continues to implement more renewables and reduce its reliance on fossil fuels, providing unique opportunities for Fluence. We are at a better place now that we were three or six months ago, with improved visibility, more capabilities, and more resources that we can deploy to meet the growing demand we are seeing. We are still in the very early stages of the clean energy transition, and I can say the future looks bright for Fluence as we look to deliver attractive value for our shareholders. We are now ready to take questions.

Thank you. As a reminder, to ask a question, you'll need to press star 1 on your telephone. To withdraw your question, press the pound key. Our first question comes from James West with Evercore. Your line is open.

Hey, good morning, guys. Good morning. I'm curious, so looking at the order intake for Q1 down year over year, but of course you had the AES order that came in in January. So how should we think about order intake? Should we be looking at that on a quarterly basis, or should we be looking at it on kind of a rolling 12-month basis? Is it lumpy and seasonal? And so I guess... It doesn't seem to spark a concern at all from you guys. From your commentary, it sounds like things are very robust, but just curious how we should be thinking about that as we kind of monitor the business on a quarterly basis.

Good morning. Thank you very much for your question. First, I see you're looking more at the FluenceIQ platform and not the overall backlog. First is that we are extremely happy and excited that we achieved our goal seven months ahead of our plan, which is fantastic. The best way to see Fluence IQ is on a rolling basis. It's a product that we are expanding to other markets. We enter into the California. We're making inroads in that market. In Australia, we solidify our presence there with 20% of market share, incorporating additional projects in Australia. California is an open market for us, so you will see more coming. And it would take a few months until you, you know, first you test and you model the product for the customer. We incorporate the portfolio into the platform. We do some – sometimes we do some modeling in parallel so they can see what is the upside and the revenue uplift potential. And then you sign a contract that usually is a significant amount of megawatts because the fact that we are just not using – Fluence IQ for energy storage, but also for renewables, make the market more significant, the addressable market more significant, and also the growth is becoming the standard in the market. So the more people they start testing off, the more people that they see the benefits, they will keep coming. So I would say that, you know, very excited, extremely happy about the outcome. and we keep moving forward and developing new applications. So, yeah, do you want to share any?

No, I think that answers the question. As Manuel mentioned, we had great momentum over the past last 12 months. So if you want to think about it of a rolling basis, we're super excited about the progress of the application. As Manuel mentioned, we're very penetrated deeply in Australia, continue to grow, In California, you'll see us growing into adjacent markets here in the U.S., and the landscape has been great for us. So if there are any further questions, happy to take them, but I think, Manuel, you covered it. Thank you. Thanks, Ayed.

Okay. Okay, that makes perfect sense. And then I guess, Manuel, you know, the momentum in the business seems to be exceptionally strong. strong right now. I mean, every time we speak, you're on an airplane or heading to an airplane or going somewhere to see a customer. Could you maybe describe kind of how the market is developing, what type of a, where we are in kind of the land grab for storage and kind of where the customer acceptance and understanding of this as being a necessity stands today versus, you know, three, six, 12 months ago?

Thank you. Thank you very much for the question. Yes, I mean, the market is exceptionally strong. Even if you consider all the headwinds that we see in a supply chain and some of the concerns in some markets about the capacity to deliver, but the market is there. The more they test the technology, the more they like it. We see a lot of recurring customers coming back to us and repeating their orders and looking at additional applications because this is a compound effect on growth. First, The sites are becoming bigger and bigger because the technology is being understood and really they see the benefit. So now you see more and more companies, IPBs out there and utilities, they're combining renewables with energy storage, but they're also replacing traditional fossil fuel generation facilities. with energy storage. So then the sites are getting bigger in megawatts in capacity, but also the sites are getting bigger in hours. So the total megawatt hours is a compound. the combination of both. But on top of that, look at what happens with the, you know, we have been working for some time on the virtual transmission line concept. We developed the architecture, which is extremely complex and very, very unique. There are very, very little people that really understand how to do that. We did a test, just a pile of one megawatt, and immediately when they saw that operational, they came back to us and say, well, we need 200 megawatts. So that is 200 times the pilot. And then you see transmission line bottlenecks everywhere in the world, Germany, Chile, Vietnam. There are so many places where you have offshore and onshore wind that that energy cannot be delivered to the low centers because transmission constraints. If we can solve that equation without the problem We all know how difficult it is to build a transmission lab without building a new transmission lab. That is a whole segment with hard margins, and we are extremely uniquely positioned to take advantage of that.

I don't know, Roberto, you want to say something? Sure, Manuel. Thanks again. I think you covered a lot of it. I would summarize it that the market does continue to grow, and the buckets of growth are in segments. And the transmission opportunity is an example of that kind of segment. Another segment is data centers. So more segments is more upward movement of that total available market. We also see growth in new geographic regions, so regions that didn't – like India is an example – regions that previously didn't adopt energy storage and the associated services in digital, and they are now ready to adopt that. So clearly in our story, we're on top of that with India and actually some other countries as well that we're moving into. Something about the regions is that they move from short-duration to long-duration solutions, so that helps us grow that total available market as well. And then, of course, to summarize, as Manuel said, just the penetration of renewables. I think it's clear in the market right now that to make the renewable story work, we need to pair renewables with battery energy storage. So, great news.

Yeah. Allow me just to make a very, very short sample, because this is, you know, we are so happy and so proud that we are part of this story. Last weekend in Ireland, they broke the all-time record of renewable generation of 89% of renewables in the system last weekend. During a storm, our ultra-fast response energy storage solutions in that market, we are the only ones in that market. If you see the performance of our site with ultra-fast, which is the only one that is in the market right now, how we absorb the ups and downs of the wind generation and keep the lights on and reliable, 20% of the load, 20% of the load in Ireland or close to that is data centers. And you know the need of the five nines of reliability and availability, and we supported that market. If you look at, if you go to the, to the statistics and you look the way that the system operated, we are really, really enabling the high penetration of renewables in a sustainable and reliable way.

Great. Thanks, everyone. Thanks, Rebecca. Thanks, guys.

Thank you. Our next question comes from Mahib Nenbloy with Credit Suisse. Your line is open.

Hi, this is Chandni on behalf of Maheep. Can you talk a little bit about the near-term headwinds that you're seeing? Could you help us think through the impact on margin and cash flow through the rest of the year?

Yes, absolutely. Let me take this. This is Dennis speaking. So first of all, when we think about especially the second half of the financial year, We look ahead with confidence. When we say confidence, that's stemming from two parts. First of all, it's about the measures and the actions which Manuel outlined in his prepared remarks that we are seeing to have them taking traction. Second, that overall we are seeing that the Omicron wave is going down. So that means while we have seen stronger headwinds from the pandemic before, that's declining. So in that regard, we're looking ahead with confidence. What that now means in terms of the margin development and the cash. So on the profit side, gross profit side, we are seeing that gross profit margins are to be improving and increasing on a quarter by quarter basis to come back to the level of our previous expectations by the year end on a rolling basis. But also just to be clear on that, on the full year basis, considering the full 12 months, we won't be able to recover on what we have debated in the first half. On the cash flow side, in the first quarter, we have made the prepayment to secure battery capacities, which is an important step for us to secure our backlog and the demand till the end of the calendar year 2023. In addition to that, cash flow has been also impacted by the delays and the shifting in the revenue recognition from the first quarter into the second quarter. As we are catching up and looking forward with confidence on that, on the revenue recognition, we will also catch up on the cash side and on the working capital side in the later part of this year.

Thanks, Dennis. That's very helpful. Switching gears a bit, we're expecting to perhaps see changes in the net metering policy in California. which could potentially drive significant demand for residential batteries. As that market potentially grows at a much faster pace, would it be of increased affluence to bring your capabilities of manufacturing and modular batteries to residential markets?

So we see the same thing in the market, that there is potential for residential. I would say shortly that we're evaluating it. So we're not in the market today, but we're evaluating it.

That's about it for me.

Thank you. Thank you. Our next question comes from Mark Strauss with J.P. Morgan. Your line is open.

Yeah, good morning. Thanks very much for taking our questions. When thinking about the India market, are there any local manufacturing requirements that we need to be aware of, and how are you planning for that, if so, and how does that impact the potential market? ramp that we might see in orders in that market.

Yeah, thank you. Good morning, Mark, and thank you. India, very, very excited about India. You know, we established our first pilot of 10 megawatts in India in 2019. We waited for several months or even a few years to the right moment to find the right time, the right partner, and be ready for such a big market. Because it's not just that we have the technology, it's also that do we have the capacity to ramp up production and to really, really be able to penetrate a market with a reliable and enough resources to fulfill the demand that we might see there. We found the right partner. Very, very happy with the J.B., we renew power, the leaders in pure renewable projects in India. Initially, there's no requirement of localizing, but you know how competitive that market is. So eventually, when the time is right, we will be publishing and letting you know about how we are going to be starting to use local suppliers to complement our technology. But the target is just to fully localize the production. We have all this tremendous first mover advantage. Imagine our pilot, the actual amount of energy storage in India is very, very small. And we represent right now 50%. of what is already operating in India. They will do a multi-gigawatts demand. We see that coming. The good thing is that the government already did a local tender for battery manufacturing, giving them a price subsidy on energy for those who will want to establish up to 50 gigawatts of energy, of battery manufacturing. So the government is already thinking about that. In the short term, there will be most of the equipment is going to come for abroad. There are some inverters, manufacturers in India. We're already talking to them. We're already exchanging some technical specifications with them. I don't know, Rebecca, if you want to give us some color about that. Very exciting. Right partner, right time. The government is supporting. There's some very, very strong political, economic and political support, economic incentive. So I think that the time is right for us to enter into that market.

Okay. Thank you very much. And you kind of touched on this earlier about the opportunity for more transmission upgrades over time. Just curious though, just kind of looking out kind of more near term, do you have any similar size projects in your kind of late stage pipeline?

Yeah, I cannot disclose exactly, you know, who are we working with, but yes, we are working with world-class developers and energy companies actively participating in bidding processes that are already taking place in Europe and in America. There are some more, you know, certainly, I mean, if we get this right, there will be a very, very good segment for us opening up with good margins. And we are, so far, we are the only one we have developed so many applications in the past we will know that others will follow but we keep innovating we keep having this first mover advantage and creating more and more applications Rebecca you want to say something about the transmission again I think you summarized it well there certainly are opportunities that currently exist particularly in Europe and we have bids going on right now thank you we'll take the rest offline thank you

Thank you, Mark.

Thank you. Our next question comes from Brian Dredd with Goldman Sachs. Your line is open.

Hey, guys. Good morning. Thanks for taking the questions. Maybe the first one, just going back to the margins, I know there's some pressures here near term. It sounds like they should ease moving through the, you know, back of the fiscal year, but it sounds like we should expect sort of steady state margins by year end. So, Dennis, I think based on your prior model, that would imply like positive mid-single-digit adjusted gross margins by, you know, let's call it fiscal Q4. First, is that fair? And then maybe can you give us a bit of the bridge here? That's about a 1,500 basis point expansion from today's level over just the next couple quarters. And then I had a follow-up.

Yeah, hey, good morning, Brian. Thanks for the question. So in that regard, think it like where we started in Q1. So in Q1 has been impacted by the non-recurring expenses as well as by the cost overruns, which we disclosed on the call. So if you're thinking forward into the second quarter, we will still have some portion of the non-recurring expenses where we had reconfirmed our outlook of $50 million to $55 million. And then we said we will still have a smaller amount, a trailing off amount of that cost overrun. So that means in that regard, we will see a reduction in the non-recurring expenses as well as in the cost overruns in the second quarter. And then while we are entering in third quarter and into the fourth quarter into the second half of the year, we are seeing that we are moving back towards this previous expectation levels into the mid-single digits as we had previously discussed.

Okay, fair enough, but it's all the non-recurring going away, or it seems like there's a bit more to the bridge than just that?

Yeah, on the non-recurring side, let's say like this. I mentioned before that we have high confidence in the measures which we put out. Nevertheless, we had stated the $50 million to $55 million as the guidance for the first half. At the end, we're just through quarter one of this year, and therefore... We will give you an update on potential non-recurring expenses in our next earnings call.

Okay, fair enough. And then just a second question around this Fluence IQ contract with AES. Congrats on the scale of that. Just wondering, it sounds like clearly this is a big deal, the biggest one you guys have ever done over one gigawatt. I recall you had like a $3 or $4 million revenue target for the digital business this year. So if I kind of back into it, this one gigawatt deal is worth maybe a million or two annually since it adds about 25% to your assets under management for that piece of the business. Is that the right way to kind of think about the scale of? the revenue opportunity every time you're getting like a gigawatt into the IQ business segment.

Yeah, I mean, I'll pass it to Dennis in terms of going to more details about our targets. All I can tell you, it's been a great deal for us, very energizing to see the rate of adoption of Fluence IQ in California. As Dennis mentioned, we've already achieved our expected ARR targets for this year, way ahead of the schedule, and we're building a lot of momentum. I also want to note that I'm really proud and excited about the diversity of our customer base. Obviously, the deal with AES is very exciting. It's over a gigawatt. But if you look at the six gigawatts that we have contracted and the diversity of our customer base, we have utilities. We have community choice aggregators. We're helping communities with Fluence IQ. We have IPPs. We have renewable developers. We have renewable asset managers, and most importantly, we have investment banks involved in Fluence IQ. So a lot of great momentum. Maybe I'll pass it to Dennis if you want to speak more about the revenue targets.

Right. Let me take that, Brian. So what makes this deal so attractive for us are two things. So first of all, it has a high share of battery storage. So that means in that regard, we typically – Going out with Fluence IQ to also go after the renewable side, this deal also includes renewable, but it has a high share of the energy storage, which brings a higher ESP in terms of dollar per kilowatt. That makes it attractive first. And then the second portion is that it has also a highly attractive performance-sharing revenue portion to it, which, as you may recall from previous discussion, we have been very conservative on how we have put that into our model. And so therefore... We are seeing an upside here on our digital side.

Okay, fair enough. I'll take it offline. Thanks, guys.

Something that I would like to add, because I think this is important, you know, every market is different. I mean, just the same proportion by, you know, percentage of the portfolio increase. There are markets with higher volatility. There are markets with higher price points. There are contracts that they include renewables. They are not just renewables. And remember that the revenue uplift potential for just renewables is between 10% to 15%. But when you have energy storage or you add energy storage, that number goes up to 50%. And if you have the revenue sharing potential, And you know that they uplift at 50%, so that is not linear. You actually have the possibility of exponentially higher revenue sharing when you have a higher revenue uplift capacity for the AI system or software, but also by the dynamics of the market.

Thank you. And our next question comes from Julian Dumoulin-Smith with Bank of America. Your line is open.

Hey, good morning, team. Thanks for the time. I'll make it quick here. Just two follow-up questions, if I can. First, on AES, how do you think about the future backlog from AES? Just As you think about the percent exposure to AES as a counterparty both in the quarter and then in terms of your future backlog and sales, you know, both in the context of IQ but also overall in your business, how do you see that evolving here, right? Obviously things were fairly elevated. We've talked a lot about it on this call, for instance, with the IQ. But how would you frame that 22 onwards, you know, from what you know already with your backlog and otherwise?

Yeah, thank you. Good morning, Julian, and thanks for your question, Anthony. Yeah, we saw you wrote this morning about our call and your first impressions, and you highlighted that in this quarter we had a high concentration on Fluence IQ on AES. First, let's say that we're extremely happy that AES, as one of our sponsors and main shareholders, but also one of our very, very important customers. They are ramping up. They are expanding aggressively their renewable targets, and they have done that in a very solid way. So we're very happy to be linked to them. That's one element. Second, we have customers all over the world, and the fact that California is such an important market for AES and we will keep capturing market share in California. Well, I mean, AES will be in the mix. There's no way that, you know, with their huge portfolio that they have in California, we will not be there. So that's one element. But we will see and we are expecting that that number will go back to the traditional, you know, long-term numbers that we have seen in the last three or four years in terms of, you know, what is the contribution from AES on the overall ecosystem platform expansion and populating process that we are achieving. So I'm very, very excited about AES, and we will see them in California, obviously, but as we expand to other markets on Fluence IQ, well, even that proportion might change.

Got it. Yeah, clearly always good to write on the code sales of a company expanding like AES. All right, no doubt about that. And then other companies will follow, Julian. You know that. Yes, totally, totally. Well, so if I can, actually, I'm just curious on, if you think about the balance of this year, certainly talked about some delays from 4Q from last year here. Can you talk about, you know, when you get some of the $130 million back, if you will,

Yeah, let me take this high level. I want to send a message to you and the rest of our investors and customers out there. First is that the demand is very strong. We're working very close to each one of our customers to overcome those delays, to close the gaps. We've seen already that happening in many of our projects. We developed our technology for the first time, the Gen 6. So, you know, it's normal that you will see some things that you need to find, you need to fine-tune. The size of the mega sites that we have is a significant step up in the company. We brought, you know, new talent, which in these times is really difficult, and we have been able to attract very, very good talent. They like Fluence. They like our mission. They like that we are the leaders. So in that sense, things are going in the right direction. We haven't had any cancellation, which is a very, very good sign. And Dennis, do you want to add something?

Yeah, Julian, to your question. So we expect to recognize the majority of the $125 million of revenue, which shifted over from Q4 2021 in our first half, plus being back in line with our historic seasonality of 30%. of our annual guidance.

All right. Thank you for that. All right, excellent. I appreciate both the context and the direct answer there. Thank you, Julian.

Thank you. Thank you. And our next question comes from George Gianricas with Baird. Your line is open.

Hey, good morning, everyone. First, can you talk about your service attach rate at 69%? some of the dynamics that went into that and your confidence of that improving over time?

Yeah. First, we are very confident that the attachment rate that we have seen in the past is stable. It's going forward, so it's going to stay there. As you know, in general, the Fluent services, they lag a bit after you get the signing of the the systems and the products for the energy storage and smart solutions. And it will take some time to get those contracts up on sign and then, you know, incorporate it into our metrics. You saw that in our last earnings call that we had an increase of 750%. So you will probably see that coming. But we look – The way that we see it is that around 70%, 75% attachment rate is going to stay at those levels.

And just one follow-up, just to make sure that we all understand your guidance for the year and the context around it. Are you assuming that the world continues to improve from a COVID perspective, that supply chain disruptions, get better, and that's how you'll hit your guidance, or do you assume continued disruption? I just want to make sure we all understand the context around it and what to look for to understand it.

Yeah, my first reaction, and thank you for your question, is we're cautiously optimistic as we see the Omicron variant subsiding and we see less port congestions for example, in the west coast of the United States, as we have a vast majority of our products already in-country in the different locations where we have to install and commission for Q2. So we are cautiously optimistic. And we do see an improvement for the second half of the year. but we are also accounting that there might be some still places where things will delay their process to get back to normal. But we are considering both.

Right, so we maybe internally would call that like considered a new normal. That means like... pandemic slash post-pandemic kind of level of supply chain reliability. That means not as good as pre-pandemic, but also not as bad as we have seen, especially over the end of the last calendar year with the high levels of Omicron. Thank you.

I also would like to add that the fact that we already selected our contract manufacturers for Europe and the U.S., That will also help us on the supply chain and logistics.

Thanks, guys.

Thank you. Our next question comes from Graham Price with Raymond James. Your line is open.

Hi. Good morning, and thanks for taking the questions. Just on the newly announced PECSA partnership, I was wondering if you could talk a little bit about how that expands coverage for the IQ platform and maybe specifically what that does for the addressable market for the bid app side of that.

Yeah, thank you. Great question. So let me take you all back to what we shared during our roadshow and analyst day conversation. So with Fluence IQ, our flagship application has been the bidding application. but we have been contemplating and in the process of developing new applications. Well, we also noted that an upside for us is to create opportunities for third parties to integrate or get into partnerships with us for additional applications. Now, I should also note none of that was built into our financial models in terms of revenue upside by the fact that we have actually announced this partnership We're way ahead of the schedule in terms of creating that momentum around third-party applications. Obviously, Paxapark, with their presence of Europe, that gives us a greater insight into the European market and allows us to get into that European market with deeper customer relationships. So all great, ahead of schedule, and let me pause there if there's any follow-ups, but I should say it's very positive momentum in the right directions.

Got it. Understood. Thank you for that. And then I guess quickly on the cost overruns that you saw for the Gen 6 product installations, just wondering, are those largely due to commodity price inflation, kind of the typical logistics issues? Is there one thing you can point to, or is it just kind of a combination?

Sure, I'll take that. So we've kind of separated the cost overruns from the logistics issues. And on the cost overruns, they are temporary and they are associated with installation and commissioning. So the way that we have addressed that is we have done root cause analysis of either operational issues or technical issues that we could optimize to ensure that those cost overruns get to zero closer to the end of this quarter. We've implemented those fixes either in our field installation manuals or in our factory, and those are in play right now. So we've identified the issues and we've implemented the fixes. We've also hired a significant number of more people to be able to handle the installation and commissioning. So that was one of the lessons learned is that we needed more people, and we have trained those people in the installation procedures and updated our installation manuals.

Okay. Understood. Thank you very much.

Thank you. Our next question comes from Ryan Levine with Citi. Your line is open.

Good morning. Has the AES Fluence IQ contract duration compared to the existing portfolio, and are there any material term differences in that agreement versus other contracts that you've signed?

So it's actually more on the longer duration side in terms of the contract length, which is more exciting. So that gives us further momentum to really adapt IQ with the dynamics of the California market. And like I said, it's more on the longer duration side.

Okay, thanks. And then in terms of your hiring ability or trends, can you update us to your ability to hire new people both on the engineering and Salesforce side throughout the organization? Sure.

Yeah, as I mentioned, I mean, we're very pleased that in such a difficult market, and we all know that the labor market is, especially for high-qualified engineers and professionals, it's very tight. And it has been a quite nice surprise to us that the number of people that they want to come, they want to be part of Fluent's story, They like our mission and our purpose. They like what we're doing and our global presence and that we are truly, truly enabling more and more renewables around the world. So we increase our teams in supply chain and manufacturing, logistics by 57%. We hire a significant amount of engineers and control engineers and commissioning engineers. Honestly, the demand has been tremendous. We have an extremely high volume. We might call it growing pains. We are surprised by the amount of demand that we have. And the simultaneously effect that having all those sites being commissioned and installing that simultaneously, well, it was a big challenge. I think that, you know, by the almost 150 people that we added in a very, very, you know, tight market is remarkable. So thank you very much for asking. And we, I mean, an opportunity for us to welcome all of them and thank them for all their hard work

And then just to clarify, the comment around fourth quarter achieving single-digit margin, is that referring to on a gap basis or is that on an incremental contract signed or incremental sales basis given the revenue recognition that you have throughout your organization?

So that's referring to the in-quarter numbers on an adjusted cross-profit level.

When do you think you'll be able to achieve single-digit on a gap basis?

We will see that same trend on the gap basis as on the adjusted basis, as mentioned before. We're a bit early in the year, and we therefore will give you a more concrete answer on that one in the next earnings call.

Okay, appreciate it. Thank you.

Thank you. And our last question comes from Steve Fleischman with Wolf Research. Your line is open.

Yeah, hey, good morning. Thank you. Just I guess just on the shipping costs and the like, how are you thinking about as we move on kind of what to consider one time versus ongoing to the degree that we stay in kind of a higher inflation environment?

Let me take that. In general, we are seeing that prices have been stabilized on a high level in the shipping market. Since Q4 fiscal year 2021, we have been including these higher logistic costs into our customer prices and have been pushing them, therefore, into the market. That means overall, in terms of the shipping cost side, we're seeing actually a light at the end of the tunnel. and seeing that these type of non-recurring expenses are subsiding throughout this fiscal year.

Okay. So we should assume those costs, we shouldn't have non-recurring shipping costs pulled out as we get later in the year?

That is correct.

Okay. Great. And then could you just clarify the comments that you made about Moss Landing? And are you implying that you may disagree with the report that was issued on most landing? And are you – there's plans to build a lot more storage there. Like, are you in the running for that or not? Or just, like, more clarity on what's going on there.

Yeah, I can – I just want to repeat what I stated in my initial remarks is that we are conducting first we're helping and we are working with Vistra putting that facility back in operation and fixing the installations. We are conducting our own investigation and it's too early once we have the the final results, well, we will share that with the market. It's too early to say exactly what it is. And so we will be informing you on the market when that happens.

Okay. Great. Thank you. Thank you.

And that's all the questions we have for today. I'd like to turn the call back to Sam Chung for any closing remarks.

Thank you. We would like to thank everybody for listening to our earnings call today. If you have any further questions, please contact us at investorrelations at energy.com. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.