ESS Tech, Inc.

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 push-button phone. I would now like to turn the conference over to Eric Byland. Please go ahead, sir.

Welcome to ESS's 2022 Second Quarter Financial Results Conference Call. Joining me on the call from ESS are Eric Dresselhaus, CEO, and Amir Mostakar, CFO. Following management's prepared remarks, we will hold a Q&A session. Earlier today, ESS released financial results for the second quarter of 2022. This earnings release is available on the investor relations section of the company's website. As a reminder, the information presented today will include forward-looking statements, including, without limitation, statements about our growth prospects and strategy for 2022 and beyond. The forward-looking statements that will be made on this call are based on information currently available to us as of today's date. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ maturely from those projected or implied on 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 current uncertainty and unpredictability in our business, 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 turn the call over to ESS's CEO, Derek Jesselhaus.

Thank you for joining us. Today, I will discuss our progress with installations, customer wins, and production initiatives, and then hand it over to Amir to cover the financials. Q2 was another quarter of strong execution by the team and continued progress for ESS. Notably, we cleared the final milestones with our two initial energy warehouse customers and recognized revenue on these units. We worked collaboratively with these customers through the process and learned a great deal about installation and deployment that will carry into future projects. We are confident that the steps we navigated to achieve final sign-off were necessary for our growth as a company. We have built critical institutional knowledge and will contribute to our ongoing success. We also built and shipped additional units in the second quarter, including those for SDG&E and our partner, Terrasol. With all six of the EWs they've ordered now on-site, we are working with SDG&E to complete commissioning and to couple our batteries with on-site solar array to power the Cameron Corners microgrid to mitigate the effects of public safety power shutoffs, or PSPS, a tool of last resort to reduce wildfire risk during extreme fire weather conditions. We continue to see microgrids as being an integral part of the solution to California's climate and wildfire challenges because they can operate independently of the grid at large and provide continuous power during PSPS and other emergencies. Our delivery to our partner Terrasol is deployed next to Sycamore International, a technology recycling firm in Pennsylvania, where it will complement a solar installation to provide business continuity and energy cost savings. In fact, Curacao has contracted for a second unit so that Sycamore can participate in the local frequency regulation market. And we certainly have some promising news from Washington recently. We are delighted that over the weekend, the Senate found a path forward with the passage of the inflation reduction act or IRA, a groundbreaking piece of legislation that can provide meaningful incentives across a range of technologies and applications to accelerate decarbonization in the U.S. energy system. For energy storage in ESS, there are a number of important provisions, including an extension of the renewable energy ITC, which includes storage when coupled with wind and solar, the creation of an ITC for standalone energy storage projects, an advanced manufacturing credit for domestically manufactured energy storage technology, And finally, a number of really smart provisions like direct pay and tax credit transferability, which will ensure more money goes to doing the job and will allow everyone to move faster. In most cases, the incentives available increase meaningfully when the manufacturer meets certain domestic content and workforce requirements, all of which are currently met by ESS. This would leave us extremely well positioned to be a vendor of choice for those implementing energy storage. We remain optimistic that this important legislation will proceed through the House and be enacted quickly. While our business plan does not rely on these provisions, we believe there is an opportunity for it to provide meaningful financial tailwinds to our plans. We continue to monitor the bill's progress and hope to share more on its potential benefit to ESS should it pass. And just two days ago, we were delighted to host the Secretary of Energy, Jennifer Granholm, along with Oregon Senators Ron Wyden and Jeff Merkley, and Oregon Governor Kate Brown for a tour of our advanced manufacturing facilities. As a tireless advocate of the energy transition, Secretary Granholm has been a staunch supporter of the drive to a carbon neutral economy by 2050 while creating American jobs. Given the passage of the Inflation Reduction Act in the Senate, we were particularly excited to be the first stop for the Secretary, the Governor, and the Senators. But we think that makes sense. ESS embodies everything that the IRA is intended to support, domestic manufacturing of the key technologies required to address climate change. On the customer front, we are excited to share details of two new important relationships. We are proud to announce a landmark partnership with Energy Storage Industries Asia Pacific, or ESI, where we will initially sell ESI energy warehouses and, in the next two years, put in place the infrastructure to sell, assemble, and service EWs and ECs. As currently planned, this agreement would result in ESS delivering over a gigawatt hour of energy storage to ESI in the next five years. ESI has already placed multiple orders for more than 70 energy warehouses, and we began shipping them EWs last month. In the coming quarters, ESI will ramp facilities in Queensland, Australia that will take key components that ESS will ship from our Oregon factory, like energy modules and proton pumps, and assemble them with the balance of plant. ESI conducted an exhaustive evaluation of technologies to address the need for long-duration energy storage in Australia, and we are thrilled to be working with them as partners. This agreement provides further validation of ESS's technology and the global market opportunity in front of us, and we believe this relationship will be foundational to driving scale in our U.S. manufacturing facility, as well as creating a sales and support foothold in an extremely important market. I'm also thrilled to announce that we've signed a contract to deliver an energy center to the Tampa Electric Company, or TECO. This installation will support TECO's Big Bend solar project, which powers 3,300 homes. Expected to ship early next year, the energy center will deliver 10 hours of energy storage and will be used for solar peak shifting and fossil fuel displacement. We're thrilled to be working with this forward-thinking utility in an important market, and we see this as great progress towards our goal of supporting a decarbonized grid. On the operational front, we continue to implement our design for manufacturability initiatives and are confident that the numerous improvements queued up for the remainder of this year will continue to drive reductions in unit economics. However, as we work to improve our supply base, we continue to battle various supply issues with components that make up our EWs. As we have ramped new vendors, we have seen their delivery times push out due to their own supply challenges. This has already slowed our production schedule, and while we still see a path to our original plan of shipping 40 to 50 energy warehouses this year, we would likely be near the low end of the range and possibly below it, depending on our ability to resolve these supply chain issues. With that said, the expansion of our manufacturing capacity remains on track. And regardless of the number of EWs we ship in 2022, we expect our production exit velocity to remain the same as we cross into 2023. We received our second semi-automated line in the second quarter, and I am pleased to share that we have it up and running. This line doubles our annual production capability to 500 megawatt hours. We have already begun to receive our next fully automated line and expect to have it up and running in the fourth quarter, which will bring our annual capacity to 750 megawatt hours, triple where we started the year. The development of our customer success team has progressed well. As mentioned last quarter, we brought on a leader for this team, and I am thrilled with the energy and focus he has brought to the effort. This team will bring a wide gamut of disciplines to maximizing our success with customers, from early engagement and site preparation to onsite installation and grid connection, final testing, commissioning, and support. Importantly, as ESS broadens its customer base, this team will drive the expand activities in our land and expand strategy. The team is not only working with existing customers who have received their units, but also customers we've contracted to ship EWs to, and even customers we're exploring agreements with. In working on our initial energy center installation with Portland General Electric later this year, the team will build the blueprint to ensure future Energy Center deployments go smoothly. At the highest level, this team will create the recipe for success and repeatability across our products that will be critical to ensuring customers realize the value of our solutions quickly and seamlessly. And I'm thrilled with the progress they've made in a short time. We're pleased to see market dynamics continue to move in our favor, and the team at ESS is working hard to execute on our operational objectives. While supply externalities may impact our progress near term, we're confident in the trajectory of our business and how we are perfectly suited to solve the grid-scale energy storage challenges in front of us. And with that, I'll pass it on to Amir to discuss the financials.

Thank you, Eric. Now I'll review our results. Unless otherwise noted, all members we talk about 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. As Eric shared, we continue to make strong operational progress across the business and with customers. In previous calls, we've shared with you that we've taken a deliberate approach to revenue recognition, working to balance legacy customer contracts, initial field experience deploying our S-200 battery modules, and ramping up our customer success organization. We're very happy to report that we've met all of the revenue recognition criteria for our first three energy warehouse units and have recognized revenue of $686,000 in Q2. Additionally, we have made significant progress aligning new and existing customer contracts, internal manufacturing, testing, and shipping processes, and customer success initiatives to begin the process of optimizing our revenue recognition process moving forward. We expect to continue to make progress on this front in the coming quarters. As a reminder, we remained under development accounting rules for Q2, so the material, overhead, and labor costs we incurred in producing the products we've shipped fall into OpEx, resulting in zero cost of goods sold. Our non-GAAP operating expenses for Q2 were in line with our expectations at $21.9 million. With that, we reported Q2 adjusted EBITDA of negative $21 million. We ended the second quarter with $192.2 million in cash, cash equivalents, and short-term investments. In the second quarter, cash used by operations was $15.2 million. Our current cost reduction efforts remain largely on track, and we still expect to take 80% of the labor out of manufacturing and EW by the end of the year. We have brought up our second semi-automated line and remain on track for the fully automated line to be operational in Q4, which in total will bring our production capacity to 750 megawatt hours. With this additional capacity, combined with many of the process improvements I mentioned previously, the team is now working with the next wave of customers to receive EWs to help ensure smooth site prep and bring up processes for our product deliveries. Given our current plan and the assumption that we'll remain under development accounting for the rest of the year, we continue to expect our non-GAAP operating expenses to come in at about $100 million. As we execute our plan this year, we currently have ample liquidity to run the business and expect to end the year with cash, cash equivalents, and short-term investments in excess of $120 million. And with that, we can open up the line for questions.

At this time, I would like to remind everyone in order to ask a question, please press star and the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Colin Rush. Colin, your line is now open.

Congratulations on all the progress. So with this ESI relationship, can we just talk about the financial implications? So you're outright selling a number of systems later this year, but primarily next year, and then you're working with them on a manufacturing facility. Am I understanding that right?

Thanks. Yeah, Eric or Colin, I'll take that. You're exactly right. So in the near term, through the balance of this year and through next year, the relationship is largely about us building fully completed products here in Oregon and shipping them to Australia. The facility is being built in Queensland, Australia today, soon. They've broken ground. They had a ceremony on it. And as that gets up and running, the idea will be we'll ship power modules, proton pumps, all of the core IP, and they will assemble what we think of as the balance of plants. So the tanks and the pumps, the containers in Australia.

And the unit economics for you guys, are those just sales of components to them with the licensing revenue on top of that? Or is there... something more substantial in this from an investment perspective from you guys?

No, it's a super straightforward agreement. We sell them those components at an agreed-to price. They license the IP on top of it. They expend the capital to build their facility out and take on the delivery and the local service work.

Okay, excellent. That's exactly what I needed. Appreciate that. And so then in terms of the rest of the sales pipeline, you know, it's great to see some conversion here and the ability to recognize some revenue. Can you talk a little bit about the breadth and depth of the customer pipeline at this point and how that's evolved over the last quarter?

Sure. The pipeline continues to grow. The top line pipeline is just a little under $9 billion in total at this point. And it's, you know, we're largely focused on the U.S., Australia, New Zealand, and Europe as our core markets, although, as you know, there are some deals that are coming up in other parts of the world as well. I would say that we think it's going to change even more or accelerate now that IRA has been passed. We think that the push from the domestic market will increase even more because of these tax incentives that have been put forth.

Great. I've got a handful more questions on the demand side, but I'll take those offline. Thanks so much, guys.

Your next question comes from the line of one Corian Bremshaw. Your line is now open.

Hey, guys. Thank you for taking the time in my question. The first one would be on the supply challenges that you have been experiencing. Can you just give a little bit more detail in what exactly you can do through your supplier, what can be done to improve this?

Sure, I'll take a shot and Amir can chime in afterwards. I don't think there's any silver bullet here. It's really just coming down to planning and frankly not trying to work on too much of a just-in-time basis. So we're trying to place in orders and make sure that we have alternative sources of supply for all of the critical components as we start to ramp up our volume. As you appreciate, our volumes have been relatively small historically. And so we're trying to get ahead of that going forward with additional sources of supply and more confirmed pipelines with our suppliers to take out the risk going forward.

Thank you. And just another one on pricing. I mean, obviously there is some inflation, cost increases from the supply. Are you able to increase your price on the center and the warehouse and to pass it through? And if yes, which kind of feedback have you gotten so far?

Sure. So, yes, there has been a little bit of ability to exert some pricing power in the market, both in part because of the of inflation in the broad sense, but also the limitations and the very specific inflationary pressures that have come to lithium have changed the market dynamics for storage. So it isn't too dramatic at this point, but it's noticeable. We expect that there is some potential in the very near term that as the Inflation Reduction Act comes into play in 2023, that could continue regardless of inflation, specifically simply because of the demand that we think will be put into the market.

All right. Thank you. That's it for me.

Your next question comes from the line of one, Thomas Boyes. Your line is now open.

Great. Thank you for taking my questions. Maybe the first one, you know, to kind of build off maybe the pipeline question that Colin asked is just around kind of what duration requirements that you're looking at from customers. You know, how quickly are we moving beyond, say, you know, the traditional two to four hours and what kind of systems are you being asked to look at one return?

Yeah, great question. So I would say, you know, increasingly we are seeing specific RFPs coming out calling for six, eight, and 10 hours. We don't see too much in the 12 hour yet, although a few RFPs and specific solicitations have come in in the 12 hour range. I would say that the vast majority of what we're seeing now is coming in in the eight to 10 hour range. But it is interesting that we are now starting to see RFPs, you know, formal RFP processes come out looking for that longer duration. Whereas a year or more ago, you wouldn't have seen that. The people who were interested in long duration would have probably been more in direct, you know, bilateral conversations with a vendor about a specific project or target.

Got it. No, I appreciate the color there. And then maybe could you just give us a sense what you're seeing kind of on the interconnection side of the equation? Certainly, it's been an issue for solar and wind and everyone. I was just kind of wondering what your view was of the current landscape.

We've been fortunate to this point. We haven't had too many interconnection issues based on the projects we've done to date and to have queued up over the next few months. But we're certainly very sensitive to the issue. And as the projects get larger in scale, that interconnect queue challenge will come up more and more. Lucky for us, good news for us is many of the times the customers that we're dealing with have been in that process for some time. And in most cases, in many cases, Those interconnect queues have already been cleared, and they already have clearance to go.

Got it. And then if you could sneak one more, and then I'll hop back in the queue. Maybe I might have missed it, but on those supply chain shortages, is this for semiconductor equipment? I was just wondering if you could kind of frame what the specific items were that were in delay.

Yeah, fair question. And I wish there was a single thing we could point to that we say that's the issue, but it's really been kind of a low grade or what we say around the supply chain team whack-a-mole. It depends on week to week. Different components will be delayed. None of this is long-term concern to us. It's really more related to ramp up. But as an example, we have had PCBs and other electronics components that rely on chips. And the chip supply constraints to our suppliers have caused the delay of the delivery to us. So that certainly has happened a number of times.

Got it. And that's helpful. I'll hand it back to Nikita. Thanks.

Thank you.

As a gentle reminder, if you would like to ask a question, press star, then the number one on your telephone keypad. Your next question comes from the line of one, Joseph Osha. Your line is open.

Hi, guys. Congratulations on the results. A couple questions. First, you talked a lot about the revenue recognition issues that came up on those first few units and talked about some of the learning from that in terms of the contracts that you're writing now. I'm wondering, are you feeling comfortable that revenue recognition on the unit that you're talking about shipping now is going to go a little more smoothly?

Yeah. Hey, Joe. It's Amir. I'm happy to take that question. We do feel like it's going to go more smoothly. There are a handful of legacy contracts with some key strategic customers that we have remaining that may follow the more purposeful route that we described before, but certainly the we have revamped not only our internal process, but the contracting process and some of the existing contracts that we have out there. So, like I said on the call, I do anticipate over the next couple of quarters here that that process will get much more efficient.

And just to put a finer point on that, let's imagine it's the first quarter of next year. Do you imagine we would be able to expect that revenue gets booked in the same quarter a product gets on site, just kind of a general rule?

Yeah, I'd be hesitant to put an exact date on it, but that is certainly what we're looking for in terms of aligning the customer contracts and the shipment to be able to do that in a much tighter period of time, including the same quarter. So that's certainly what we're working towards.

Okay. Next question. question that Eric this might be more for you I know there's been a number of cost down initiatives but you know there are a couple of really interesting ones you're trying to get precious metal out of the you know the catalyst and the proton pump for example I'm wondering if you can update us on some of the cost reduction initiatives and how they're going yeah we're making we're making progress we feel like we're on track part of that is related to some of the supply chain issues by the way we're moving we've redesigned some components

to take out costs, and that runs the gamut from rebalancing systems to tanks and beyond. So every time you change to a new supplier, you're adding a small amount of risk into that conversion, and so we're working through those. The biggest cost reductions we've had for this year, and this was always the plan, is on the labor side, and we're making great progress against that. And the good news is it's not only more efficient, but we build faster with less labor, so of course it helps increase our velocity.

That always helps. Just one or two more quick ones. Can we expect perhaps that you'll be out of development accounting next year? Would that be a reasonable expectation?

Yeah, I think that's probably a reasonable expectation. I mean, certainly when you start shipping more units and recognizing revenue, I think it'd be logical next step to pull out of development accounting in the first of the year is always a logical time to do that. So I think that's a fair expectation.

Okay. And then the last one, just looking at, you know, you've got 750 megawatt hours coming out of the end of this year, lots of learning, lots of things to digest. Could we maybe expect that that cadence of expansion moderate a little next year? Or you get things sorted out? Or is this going to continue to sort of double and redouble over the course of 2023?

We haven't made any announcements on that at this point, Joe. A very dynamic market environment right now. With the IRA bill coming in, we're going to be very keen to see how the market demand starts to shift. And we certainly feel like we've got a kind of a time to market advantage versus others. So we want to make sure we fully exploit our opportunity there, but do it in a very measured and rational way.

Okay. That was my... backdoor way of trying to get a 2020. No worries. Thanks very much. I'll jump back in queue. Thank you, Joe.

There are no further questions at this time. I will now pass the call over to the presenters.

We want to thank everybody for joining us on our Q2 call and for your support of our business. And we'll look forward to talking to you again next quarter.

That concludes today's conference call. You may now disconnect.