Eguana Technologies Inc. (OTCQB:EGTYF) Q3 2022 Earnings Conference Call August 29, 2022 5:30 PM ET
Company Participants
Brent Harris – COO
Justin Holland – CEO
Conference Call Participants
Brent Harris
Good afternoon. Thank you for joining us for Eguana’s Third Quarter 2022 Earnings Call. My name is Brent Harris, Chief Operating Officer of Eguana. On the call today, we also have Justin Holland Eguana’s Chief Executive Officer.
Please note that today’s call is being recorded and participants will be in listen only mode. If you have any questions during the presentation, please type them into the Q&A box at the bottom of your zoom screen and we will address them at the end of the call.
Before we begin, please note that certain remarks made on this conference call constitute forward-looking statement. Although we believe although we believe these statements reflect our best judgement based on factors currently known to us, actual results may differ materially from them.
Please refer to the company’s filings on SEDAR a more inclusive discussion of risks and other factors that may cause our actual results to differ from projections made in any forward-looking statement. Please also note these statements are being made as of today, and we disclaim any obligation to update or revise them. All financial data disclosed is represented in Canadian dollars unless otherwise note.
I will now turn the call over Justin.
Justin Holland
Thanks, Brent. Thanks, everyone for joining us today to discuss the Q3 results and the future outlook for Eguana. And quickly due to a scheduling change, CFO Sonja Kuehnle will not be with us. On the call today, however, has provided all the details for the financial discussion which we will get into shortly.
As we previously noted, at Eguana, our mission is to be a global leader in grid time energy storage, which we see as a critical component of the power grid transformation. Through the third quarter, we broaden this mission with the addition of the infused microinverter product line. Combined, the energy storage solutions and microinverters provide greater access to two key pieces in the transformation of the power grid through a distributed model, and give Eguana the largest product portfolio in the sector.
After transitioning manufacturing and supply chain to San Jose, California through the second quarter, our focus was squarely placed on plant commissioning and scale up. Step one was the introduction and installation of a new state-of-the-art inverter functional test station or IFT. This station is critical for the company as it defines Eguana’s manufacturing capacity. Each IFT station can test up to 400 energy storage systems per month across each two shift operation. It was key for the development team to update not only our testing equipment, but our testing processes as well.
Job well done to Daljit and the team as we’re seeing consistent improvement in first pass yield numbers since the first full turnkey production began this past June.
Additionally, we have a second fully commissioned IFT in-transit to San Jose for installation in September. Combined, this will provide up to 800 units of production capacity monthly. Our third station is in the procurement process with a target installation date of March 2023, which will bring annualized production capacity across two shift operation to 14,400 systems.
Alongside the operational focus was of course supply chain management. Although global supply chains remain challenging, we have been able to mitigate any immediate supply chain availability concerns through combined efforts with the Omega team. The alternate parts program in strategic inventory investments have also aided in mitigating further risks.
Having the right materials in the right place at the right time will allow a steady state manufacturing environment, where first pass yield improvements will continue until we reach our target metric of greater than 95%. We are also happy to report two recently announced financings totaling approximately CAD40 million. The longstanding partners the ITOCHU Corporation, and Western Technology Investment.
The transactions are broken down into a CAD33 million convertible debenture note with ITOCHU and the second $5 million draw from our previously announced loan agreement with lending partner WTI. These funds will be immediately put to use with respect to battery module and microinverter inventory positioning. Projected growth rates look very good and we will start eliminating risk factors now for future orders and rapid growth.
The blindside optimization was clearly the focus. To summarize we have now completed Phase 1 plant commissioning an IFT installation for full turnkey production, built and commissioned second IFT stations which is to be installed in September, and continued improvements in first pass yield and metric that ultimately drives manufacturers product availability. It is worth noting that recent supply optimization objectives were driven by expected order increases for the U.S. market under both premium Eguana-branded products, the expectations of rolling out an additional white label partnership later this calendar year, and increased volume expectation coming in from the Australian market. We will touch on the demand outlook and development after a quick financial review for the third quarter of 2022.
On an overall revenue basis, Q3 product sales increased 73.5% or CAD2.3 million versus prior year product sales 1.3 for the same quarter, and CAD0.3 million in the previous quarter. These numbers came within a few thousand dollars of our second highest revenue quarter over the history of the company, which was set in fiscal Q1 of 2021. The achievement we were looking for given full turnkey production did not start until the last month of the quarter.
The increase is directly related to relocating operations to San Jose and beginning to scale the facility as well as the expansion of our power controls platform to include the micro inverter solutions, which also saw their first sales during the third quarter. As expected, demand continues to steadily grow for the microinverters which can be attributed to a couple of factors we will discuss later on the call.
Gross margins for the quarter decreased from 3.6% in Q3 of last year, to 0.04% for Q3 this year. That decrease the due primarily to the inventory rationalization associated with winding down Canadian supply chain activities and the full transition to Omega. When removing the inventory adjustments, margins would have seen an improvement when compared to prior year at an estimated 7.8%.
We are still experiencing the impact of significant increases in global freight, particularly with expedited shipments, as well as large duty fees on products and materials coming in from Asia, which both impact margins. Our expectations global freight lane costs will begin easing in the next few quarters. However, we did expedite the microinverter shipments in the June quarter to look after immediate customer needs.
Operating expense, increased by CAD0.3 million in comparison to the same period last year. increases from fiscal 2021 are due to continued team expansion, particularly for sales after sales service and research and development, which are all in-line with Eguana’s market growth objectives and expectations.
With respect to the balance sheet, we have continued to build inventory positions as well as having secured future raw material inventory for growth by way of deposits. We will continue to hedge these risks associated with global product availability, particularly for battery modules and microinverters. Alongside the growth in assets, we saw an increase in our debt structures as we received additional financing with WTI in April, drawing on $5 million, which was used as part of the inventory positioning strategy.
As with previous WTI financing, warrants granted in consideration for the loan hold and exchange option, which is recorded as a warrant derivative liability. Fluctuations in fair value of the derivative liability are seen through our profit and loss statements. Post quarter-end, WTI approved the second tranche of the loan, providing an additional $5 million waiving all previous financial milestones required under the original loan agreement from this past April.
Lastly, our positive working capital trend continued, closing out Q3, 2022 at a positive CAD7.4 million, an increase from the previous quarter which sat at CAD4.4 million.
Last quarter, we covered in detail changes to the virtual power plant program in Hawaii. Essentially, the program was established to address gaps and peaking capacity on the island of Oahu, which were driven by a scheduled retirement of the islands on the coal facility. Phase 1 of the program targeted retrofits to existing rooftop solar systems that were installed under the original net metering tariff system. This was somewhat limiting in scope and energy storage adaption. Battery bonus program rules have since been modified to encourage system owners under CGS and CGS terrif program to take part in the islands that battery bonus program.
The recent changes have brought additional momentum to this program which has resulted in new orders coming in from our partner Pineapple Energy, formerly known as Hawaii Energy Connection, totaling 2.4 million. Happy to add the first 100 units of that order have shipped since the changes with plant shipments totaling an additional 200 systems for the end of the calendar year.
We will continue to work closely with Pineapple management to address U.S. mainland opportunities, as they achieved their growth objectives and our two companies remain aligned.
Staying with the U.S. market for a moment. The sales team executed the power center plus distribution expansion through the second and third quarters to include national distributors across the nation in all key regions. Demand will continue increasing as additional branch doors are opened up.
We will maintain a systematic approach to distribution tied tightly to product availability, and internal branch product and installation training programs. In addition to this focus, we have recently augmented our sales leadership functions to have specific support for distributors and branches and installers and consumers. We expect this will result in better branch management, increase branch opening and drive installer consumer pull through.
Order uptake looks strong for the 5-kilowatt LFP, the microinverter lineup, particularly in the dual configuration, and the 10k Max product for home products. As expected near term demand for the micros is beginning to outpace energy storage system demand. The micro market is much more mature with many more installers familiar with the installation processes. It is also a competition light marketplace at the moment with very few players andthe market growth forecast has 17% compounding annual growth rate. As a result, the company has invested approximately CAD10 million to support the launch and growth opportunity relative to the microinverters.
The product line is inclusive of the single, the dual and the quad configuration which provides ultimate flexibility to the installer and enhance reliability to the consumer. Energy storage system growth is expected to be pulled through distribution from the microinverter positioning in the short term. It is also expected that demand will come in the form of 5-kilowatt until 10-kilowatt product orders. The 10k Max for home product recently completed all certification and will be formally launched in conjunction with an additional white label partner later this year. It is currently available under the Eguana and the premium brands through distribution.
Certification of the 10k Max was a crucial milestone for a Eguana, providing the market with its first true full home backup capable product solution. Product was tested to UL 95/40 second edition standards. And as a result of our advanced power electronics platform flexibility, the 10k Max was also successful in reaching UL 9540A fire test standards. This is a critical piece to understand as it allows us to put more than 20 kilowatt hours of storage together in one installation.
Typically, in California, energy storage systems require a minimum three foot spacing for every 20-kilowatt hours of storage. Due to the 10k Max certification achievements, Eguana can avoid this, simplifying installations by allowing larger systems to be installed in smaller spaces, providing the company with a significant market advantage for full home backup solution.
The Max product is also a better fit for grid infrastructure improvements with higher power and higher capacity. It’s management’s belief that grid infrastructure advancement will be put into overdrive to support the electric vehicle growth coming from the auto sector.
Keeping with this theme, we’ve also begun development of our next product cycle to further enhance our power electronics platform. The products which will be in a tower format for wall or floor mount installations can be used single or in series to create ultimate flexibility in residential and commercial energy storage applications. The product will also have higher power than the Max and easily accommodate three phase application. Additionally, the product will have an outer skin that can be easily modified to support white label opportunities and allow product differentiation. The development team has the new product on schedule to enter certification on or before the end of this calendar year.
Following previously noted applications to the 10k Max certification process, the company took steps to simplify certifications on a go forward basis. Following our recent investment in lab expansion at the head office in Calgary, we set out to be qualified under CSAs supervised manufacturers testing for certification program for the SMTP. Program which was completed and qualified allows the company to conduct internal certification testing and submit results for approval to CSA. This provides significantly more control over testing timeline and remove major uncertainty with respect to the certifiers scheduling process.
The program has already had immediate effect and rapid certification of alternative component requirements driven through the alternative parts program. Under CSA’s timeline qualification process would have taken much more time than what was achieved with SMTP. The SMTP along with the alternative parts program allows us to stay on top of supply chain risks and continue to mitigate future issues as we continue scaling.
Maintaining product certifications is a critical aspect of our business across all markets and all products. The SMTP will also simplify and mitigate risks on product portfolio management as a result.
Moving on to Australia, we have revised our business model to include full system sales inclusive of all parts of a residential renewable home energy system. Our home builder and VPP program partners expressed strong interest in Eguana providing installation and support services alongside our industry leading product offering. Having the ability to control the sale start to finish, as well as providing the hardware and software solutions provides a one-stop-shop for our key partners. We are happy to confirm initial full bundle sales in Australia have commenced and are now being installed.
Additionally, the frequency controlled ancillary services market regulations or FCAS, for short, have recently been published. The company is in the process of demonstrating our product compliance through self-reported verification. This will be a challenging process with respect to energy storage system functionality, and as such should open up opportunities within the Australian VPP the market. Eguana’s expected timeline to complete is within the next two to four months, at which point we expect to hit the VPP market running with a leading position alongside our Australian utility partner Simply Energy.
In Europe, we’re continuing discussions with the French utility for white label solar plus storage solutions. Our expectation is we will see microinverters move first, followed by the energy storage solution. The utility has been clear, they will have multiple supplying partners to meet their demand and we expect to see first micro pilots go out later this year.
At this point, I will turn the mic back over to Brent for an update on battery module and Eguana cloud advancements. Afterwards, we’re happy to answer some questions from the group on what is presented here today. Brent, over to you.
Brent Harris
Thanks Justin. The team continues to add new battery options to our ESS platform through integration and verification efforts. Given the current supply chain uncertainty, and the demand coming out of the electric vehicle segment, keeping multiple battery options available across product lines is critical to our ability to provide consistent supply to our customers. Our partner, ITOCHU assist us with qualification of additional suppliers, and as mentioned previously, will align the company up with promising new battery technologies, using our BMS to integrate these next generation cells into our product without requiring a certified module. There’s a starting with the 24M technology.
We’ve had questions also about the use of our BMS to extend the life of automotive batteries in second life applications. This is very feasible technically, but through our experience with major automotive manufacturers is determined there’s a limited market opportunity for second life batteries, prefer to focus our efforts on commercializing new battery technology for stationary markets.
At the other end of the technology stack is the Eguana Cloud, which has now been launched and is operational supporting our premium brand partners. The Eguana Cloud provides us with direct control over our customer experience and better visibility for our service teams. We’ve also begun defining the process of API integration for fleet management with several fleet aggregation in white label partners. And our first infield demonstration is in progress.
Back to you, Justin.
Justin Holland
Thanks, Brett. Before taking some questions, just a quick summary of where we are positioned. Obviously a very difficult market situation out there and we’re recently successful in negotiating new capital to not only accelerate our growth objectives, but also to continue investing in the future of Eguana. We have the widest product suite in residential solar plus storage markets across energy storage and microinverter solutions. We have Eguana and premium-branded products with additional white label partners on the horizon and in multiple geographies. Key objectives are all advancing in all areas. And we’re really looking forward to consistent quarter-over-quarter growth.
With that, we’ll open up for a few questions.
Question-and-Answer Session
A – Justin Holland
First question ties directly in line with that, which is on revenue stability. We can talk a little bit about revenue stability here today as we do have now microinverters and energy storage systems. And if you recall from prior calls, the microinverter supply chain is significantly less complex in the energy storage supply chain. Both products are driven through advanced power electronics. However, the advanced power electronics and the microinverter has 50 to 60 components and the advanced power electronics on the energy storage system has closer to 900.
So to manage the supply chain of 50 to 60 components, you can mitigate supply chain risk quite easily and start to bring predictability to the revenue, that will help stabilize Eguana’s revenue growth in the coming quarters. It also ties in nicely with the fact that we are seeing the early demand increases on the microinverter at a growth rate faster than the energy storage system. This was the plan. This is what we’re seeing in the market with the expectation that as more microinverters go through distribution, it will pull the energy storage system sales up we are also seeing that trend.
With that, it does drive the critical nature of supply side optimization, which we started the call with today and continuing to make sure we focus on first pass yield through the IFT, so that we maximize throughput relative to the production capacity.
We’ve got several questions coming in on production capacity. So just a few minutes on that. Production capacity is, how many units we can process through the IFT on a monthly basis? It does not suggest that production capacity equals production throughput. From an operational perspective, you want to maximize your plant capacity, which is the number of IFTs, after the second IFTs goes in that nameplate capacity will be 800 units per month across a two-shift operation.
The actual throughput which drives product availability is driven by a number of factors, primarily first pass yield. How many times did the unit go through IFT on the first time? Was there an issue that had to be resolved? The other system has to get processed more than one time? These are the types of things that limit production capacity and frame the difference between throughput and capacity.
But right now, we’re focused on increasing the capacity in general. We do want to get to three IFTs by March. We do want to be in that 14,000 to 15,000 units annualized capacity. And as we continue to focus on first pass yield, throughput will increase. That’s the primary metric we’ll utilize through contract manufacturing is first pass yield, because that will determine how many IFTs we need relative to future demand.
Question on the 10k certification and why it’s up longer than predicted? Again, we have discussed this previously. It took significantly longer than predicted. However, it has left the company in a much better position with the SMTP with CSA. We will be able to keep certified and certify new products much faster as well as components certifications much faster than we have in the past.
With respect to the 10k unit itself, there were a host of factors which I’ll just rhyme off a couple. One, due to the COVID restrictions, no Eguana Tech were allowed inside the certification facility, which you are then bound by the technical capability of the certifier on test setup and performance. Once we were able to send one of our tech in, we ran through all testing processes in just under one week.
The second part of the process was a regulatory change midway through the certification, which forced the company to pull the product back, improve to the new standards and resubmit to certification which we have details in the past. But again, the product is now certified. There will be a formal launch in the coming months. And we have now set the company up to self-certified most of the requirements for full product certification.
Question on the assembly facility in Calgary? Great question. We have already transitioned the assembly area in Calgary to what we call the prototype for the model shop. This is how we’re working through the new product development. It is significantly shrinking time to market for the company. And we will continue to push additional products through that prototype shop.
The other side of the facility here in Calgary we did another further expansion of lab stations, which I believe we now have eight?
Brent Harris
Correct.
Justin Holland
Eight stations. Keep in mind that our previous location we had two stations. So a significant improvement in development capability, a significant improvement in the ability to certify products and a significant advancement in time to market working with internal prototype remodelling shop.
Question on insight — question from the MD&A actually, insight into whether the next white label partner is largely finalized? Is the partner known and what industry are they in? And unfortunately, I can’t go into that level of detail. Yes, it’s largely finalized, but due to respect for our partner, we will have to leave that there.
Another question on capacity. Are we operating at 400? The number of units hooked up to the IFT and being tested at last check was around 87% of the capacity. We are running at one shift operation currently, which means the throughput would be 200 systems per month but we are running out about in the high-80%s for capacity which given we just started to ramp up full turnkey production in June, we are quite happy with.
A question on the split between storage and lightweight motors [ph], it’s a great question. Currently, the split was roughly 50-50. This was what we were hoping to see as we do see a near term larger opportunity on the micro again due to reasons that were pointed out. Supply chain is simpler, market is more mature, less competitors. So we do expect to see that. We did we did expedite the inventory for those shipments which did impact the gross margins as we noted in the financial section. But right now we’re seeing a 50-50 split. I do expect to see micros take a higher percentage of the revenue going into the next fiscal quarter.
Target gross margins. Again, we look for a target gross margin in the mid-20s, blended across all products. Obviously, that’s also factored against standardized — standardized across all of the products and the offering. So we do want to have a blended gross margin of around — in the mid-20s.
Update on the ITOCHU investment for BMS [ph], obviously. With the recent financing news, we do have a longstanding partnership with ITOCHU. We do have a number of objectives with them. BMS is certainly one. We are looking at new battery technology in the semi-solid state with the ITOCHU.
We have objectives ongoing with homebuilders in Australia. Being asked specifically about FREYR. FREYR is one of the companies that are taking the 24M cells. Our initial discussions with FREYR was focused on residential applications. FREYR is going to do utility applications first, and then transition into residential. At that time, the engagement with FREYR will start moving forward.
The breakdown of funds on the two financing transactions. Again, one was in the form of a CAD33 million debenture note. And the second was the second half of the CAD10 million loan we completed with Western Technology Investments last April, so $5 million. The funds that we’re bringing in obviously will go to mitigating supply chain risks against future orders. The current order book which currently stands at around $27 million. We do feel very good about the supply chain pipeline on the components side, as well as the battery module and microsite. Again, tremendous work between the Eguana and Omega teams going through and identifying risk items, spinning boards in a matter of days, not weeks and working with the certifier through the self-certification process to make sure we have all the components we need, particularly in a difficult supply chain situation.
Chris Alessio and his team at Omega, as we’ve said, top notch operationally. The design teams are very well integrated. And we continue to solve challenges. The difference is we’re solving challenges that are now out month instead of imminent and damaging to the revenue opportunity. So we do expect to see a quarter-over-quarter growth now that we’ve mitigated all near term supply chain issues.
Question on milestones. And what should we look forward to, the milestones that we were looking forward to the internal milestones, obviously, we’re getting full turnkey manufacturing in San Jose. And we did the transition in the second quarter. We went full turnkey, kind of midway through the third quarter, albeit with some bumps and bruises. And then into June, we were able to go full turnkey steady state production, which is where you’ll start seeing energy storage revenues climbed quarter-over-quarter. So we’re — what to look forward to is that growth rate.
The second piece to look forward to is an investment in the battery module and the microinverter inventories. We want product availability on the North American side. It’s a tricky supply chain and logistics world out there. We invest in inventory strategically. We can then backfill inventory investment, rather than have gaps in revenue opportunity. This is something that the distributors and large installers are keying in on.
They want to make sure that product availability particularly under the premium brand is available and accessible when they start rolling out. We now have four national and leading distributors in the stable so we need to get this right. The new capital provides us that opportunity to make much larger investments to make sure future orders are met on time and with expectation of the distributors.
I think with that, we’ll wrap up for the day. I’d like to thank everyone for taking the time. Great questions today. Thanks for sending those in. We look forward to additional growth in the next quarter. And we feel very confident with the position of the company. The new capital, the channels and the partners to start to scale this business at a much more significant rate. Thanks everybody.
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