ESS Tech, Inc. (NYSE:GWH) Q3 2022 Earnings Conference Call November 3, 2022 5:00 PM ET
Company Participants
Erik Bylin – Investor Relations
Eric Dresselhuys – Chief Executive Officer
Amir Moftakhar – Chief Financial Officer
Conference Call Participants
Colin Rusch – Oppenheimer
Thomas Boyes – Cowen & Co.
Joseph Osha – Guggenheim Partners
Chip Moore – EF Hutton
Operator
Ladies and gentlemen, thank you for standing by. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]
I would now like to turn the conference over to Erik Bylin. Please go ahead, sir.
Erik Bylin
Welcome to ESS’s 2022 Third Quarter Financial Results Conference Call. Joining me on the call from ESS are Eric Dresselhuys, CEO; and Amir Moftakhar, CFO. Following management’s prepared remarks, we will hold a Q&A session. Earlier today, ESS released financial results for the third quarter of 2022. This earnings release is available in the Investor Relations section of the company’s website.
As a reminder, the information presented today will include forward-looking statements, including without limitation, statements about our growth prospects, partnerships, financial performance and strategy for 2022 and beyond. Forward-looking statements are subject to known to unknown risks and uncertainties that could cause actual results to differ materially from those projected or implied during this call. In particular, those described in our risk factors set forth in more detail in our most recent periodic reports filed with the Securities and Exchange Commission as well as the current uncertainty and unpredictability in our business, issues with our partnerships, inflation, the markets, the economy, and the current geopolitical situation. You should not rely on our forward-looking statements as predictions of future events. All forward-looking statements that we make on this call are based on assumptions and beliefs as of the date hereof. And we disclaim any obligation to update any forward-looking statements, except as required by law.
During the call, we will also present certain financial information on a non-GAAP basis. Management believes that non-GAAP financial measures taken in conjunction with U.S. GAAP financial measures provide useful information for both management and investors by excluding certain items that are not indicative of our core operating results. Management uses non-GAAP measures internally to understand, manage and evaluate our business, and make operating decisions. Reconciliations between U.S. GAAP and non-GAAP results are presented within our earnings release.
With that, I will now turn the call over to ESS’s CEO, Eric Dresselhuys.
Eric Dresselhuys
Thank you for joining us. Today, I will discuss our success with current and new customers, our operational challenges and successes, as well as recent market trends we’re seeing, including the impact of the Inflation Reduction Act.
ESS continued to gain traction across multiple fronts of the business in the third quarter, and the entire team here was thrilled to see our market buoyed by the tailwind of the Inflation Reduction Act. It’s clear that ESS is at an important juncture as a company. We continue to build a cohesive, highly skilled team capable of delivering a differentiated storage technology at scale that is ideally suited to couple with renewable generation in the global drive to carbon neutral. We’re doing this in an unprecedented supply environment, just as the market we serve is expanding dramatically.
First, I’m pleased to share that ESS has made great progress on our extremely important initiative to expedite the time between product shipment and revenue recognition. On the shipment front, we delivered an Energy Warehouse to our partner TerraSol Energies near the end of Q2 for Sycamore International, a Pennsylvania based technology recycler that integrated it with a solar array, and we were able to recognize revenue on that unit in less than three months. The commissioning of EW was accompanied by a ribbon cutting ceremony with the congressional delegation in attendance. Importantly, TerraSol placed a follow on order for another Energy Warehouse at the Sycamore site to double their storage capacity, a strong indication of the unique value we can deliver.
With that said, we have continued to experience supply challenges with a variety of components across the Energy Warehouse balance of plant. This is driven by the broad-based supply chain issues that are facing so many companies and compounded by our need to purchase in increasing volumes and incorporate new vendors as we scale. Even with this ongoing challenge, we are pushing ahead with production. We continue to build Energy Warehouses, but the nearly finished units are sitting in our production bay awaiting the parts that are delayed. We expect these units to be quickly completed and tested once we receive the final parts.
While we didn’t ship as many units in Q3 as we had hoped, we had many others in various stages of completion in the third quarter and we feel we can ship 20 or more EWs in the fourth quarter. That will leave us below our original target for 2022. But importantly, we still feel confident in our ability to get to our exit run rate by the end of the year.
These challenges obscure the progress we are making with our production processes. As a reminder, we generally speak about production in two categories: battery modules, which represent our core intellectual property; and balance of plant.
On the battery module side, we now have two semi-automated lines running and have our fully automated line slated to be up and running before the end of the year. As our team works to optimize each of these lines to improve cycle time, scalability and cost, we now have line of sight to exit 2022 with a capacity greater than our original target of 750 megawatt hours per year.
On the balance of plant, we continue to make progress with our design for manufacturability initiatives that speed throughput, improve quality and lower labor and its associated costs. At the end of the third quarter, we have already cut the labor inputs to Energy Warehouses by half from the start of the year and expect considerable additional improvements by the end of the year. We are in the midst of transitioning from batch to scale manufacturing and are optimizing our processes as we grow capacity. Importantly, I want to give a big shout out to the team that is working tirelessly to execute these improvements against the challenging supply backdrop.
I would also like to welcome Vince Canino to the team. Vince joined us as Chief Operating Officer in September and brings a wealth of experience leading high growth manufacturing organizations. I am thrilled to see the many new faces that have joined ESS in 2022, gel with the existing team to drive our progress. It’s certainly an exciting time to be at ESS.
We continue to make significant progress with customers. As you likely saw, last month, we announced a transformative deal with the Sacramento Municipal Utility District or SMUD. This deal calls for ESS to supply up to 2 gigawatt hours of long duration energy storage over the next five years in the form of Energy Warehouses and Energy Centers. SMUD is a leader in decarbonizing the electric grid. While California’s objective is to have a carbon free electricity generation by 2045, SMUD is targeting 2030, 15 years earlier than the rest of the state. Additionally, as another sign of the significance of this transaction, ESS and SMUD will team up with local colleges and universities to establish a center of excellence to educate the workforce needed to install and service the burgeoning long duration energy storage market. We’re thrilled this progressive utility has chosen ESS as their partner as they drive forward with their zero-carbon plan.
And as exciting and transformative as this deal is, let’s put in perspective in terms of the market size. SMUD provides electricity to 1.5 million homes and this deal will only supply a fraction of their needs. And SMUD serves only about 10% of the 15 million homes in California. In fact, California represents roughly one-tenth of the storage power needed in the U.S. which is estimated to be about 50 gigawatts. As utilities in jurisdictions around the world progress their decarbonization plans, it will quickly recognize the critical role of long duration energy storage in achieving their goals. This deal comes on the heels of the announcement of our supply partnership with Australia-based Energy Storage International Asia Pacific or ESI. In fact, I was in Australia just last week, attending the All-Energy Australia Conference and could not have been more impressed with how the entire market is moving forward to drive decarbonization and accelerate the demand for long duration energy storage. The ESI relationship expands our reach into a new and fast growing geographic region when we expect to offer significant opportunities over the years to come. When combined with the SMUD agreement, we’ve established a meaningful base of business for ESS.
And the last time I spoke to you, the Inflation Reduction Act had just passed the Senate. Now that it has been signed into law, it is clear that the IRA will have a dramatic impact on deploying technologies like ours along with many others to decarbonize the domestic energy system. We can expect our customers to receive a baseline investment tax credit of 30% for a battery project and that incentive should increase by another 10% for deploying domestically sourced ESS iron flow batteries. With an additional kicker possible for siting the project in an economic or energy development zone, our customers could receive a total tax credit of 50% or more. These are benefits our customers can access without any application process for the next decade. On top of that, our customers can also apply for certain available grants; and if approved, that can knock more than two-thirds off their total project costs, approaching 70% savings.
Additionally, ESS is expected to receive a production tax credit of about $45 per kilowatt hour that we ship, while solar plus storage without incentives was already regarded by many as a better capital investment than other generation options. The combined impact of these initiatives produces a dramatic improvement in the ROI of investing in carbon-free energy projects. Coupled with the increasing prices for storage that we’re seeing in the market today, we believe this can provide a considerable accelerant to our growth and profitability objectives. The combination of incentives represents an unprecedented catalyst to our market, both customers and suppliers. We are excited to capitalize on the opportunity it presents.
With all of this excitement in our business and the market, it’s bittersweet to announce that the Amir Moftakhar will be leaving ESS. Amir has been a significant contributor to the early development of the company and we thank him for his many efforts. We are very excited to announce that Tony Rabb has agreed to join as our new CFO and look forward to everyone getting to know Tony over the coming weeks and months. We’ve included details in the press release, but I’ll quickly say that Tony brings extensive experience across a range of industries and we are delighted to have him join the leadership team.
And with that, I’ll hand it off to Amir to discuss the financials.
Amir Moftakhar
Thank you, Eric. Before I review the financials, let me say that it’s been my unique pleasure to serve as the CFO of ESS for the past four years. I’m proud of how much the company has accomplished and know that the best is yet to come. As I transition other opportunities, I’m proud of the team we’ve built and have confidence that my successor, Tony Rabb, will continue and accelerate on the momentum we’ve built.
Now, I’ll review our financial.
Unless otherwise noted, all numbers we talk about today will be on a non-GAAP basis. You will find the reconciliation of GAAP to non-GAAP financial measures in our earnings release, which is posted on our Investor Relations website. As Eric shared, ESS continues to gain momentum with our manufacturing initiatives, as well as with customers. I’m pleased to share that we’ve also made good progress on advancing the revenue recognition process. Near the end of Q2, we shipped the unit to developer TerraSol Energies, and we were able to commission, gain acceptance and recognize revenue on this unit in less than three months. This resulted in revenue of $189,000 for the third quarter.
As we’ve shared, we’ve been very purposeful on our process in achieving revenue recognition as we balance legacy customer contracts, initial field experience deploying our S200 battery module and ramping up our Customer Success organization. This accelerated revenue recognition timing reflects progress that we’ve made across each of these fronts, and we are committed to honing our process further and working with our customers to further speed up the process.
As a reminder, we remained under development accounting rules in Q3, so the material overhead and labor costs we incurred in producing the products we shipped fall into OpEx resulting in zero cost of goods sold. Our non-GAAP operating expenses for Q3 were in line with our expectations at $24.5 million. With that, we reported Q3 adjusted EBITDA of negative $24 million. We ended the third quarter with $166.7 million in cash and short-term investments. In the third quarter cash used by operations was $22.1 million. We continue to make great progress in our cost reduction efforts. We have many new people on the team both on the floor and in the leadership ranks. And they continue to make outstanding progress not only improving our current manufacturing operations, but also setting the stage to scale manufacturing as we move beyond our two semi-automated lines to our first fully automated manufacturing line.
As Eric mentioned, we believe the team’s innovation and focus on optimizing processes should result in ESS exiting 2022 with a capacity greater than our initial goal of 750 megawatt hours.
Given our current plan, and the assumption that we will remain under development accounting for the rest of the year, we continue to expect our non-GAAP operating expenses for the year to come in at around $100 million. As we execute our plan in the coming 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.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from the line of Colin Rusch with Oppenheimer.
Colin Rusch
Could you talk about the number of customers you have that are testing or qualifying the product at this point?
Eric Dresselhuys
Sure, Colin. Good to hear from you. One — about half a dozen at this point.
Colin Rusch
And then in terms of operating data off the systems that you’ve got out in the field, can you talk a little bit about how the systems are performing relative to expectations and any surprises that you’re seeing that you’ve had them out in the field for a little bit longer?
Eric Dresselhuys
Well, it’s still a relatively limited data set, so I don’t know that we’ve learned anything entirely conclusive. We have learned a lot about the system deliveries, shipments, hardening the product, so it goes through the transport process. But at this point, I don’t know that we have any broad conclusion around system performance over any extended period of time.
Colin Rusch
And then just with the couple of lines up and running, can you speak to yields that you’re getting off of those lines and how that’s tracking relative to expectations?
Eric Dresselhuys
Yes, it’s a little ahead of expectations. So as Amir mentioned on the call, we’re tracking for slightly better total capacity availability at the end of the year than we had anticipated. And that really comes from a better yield off of the lines that we had than what we had anticipated. So we feel great about that. It’s really been more a case of ensuring that we have the supply chain to feed the lines as the limiting factor at this point.
Operator
The next question comes from the line of Thomas Boyes with Cowen and Company.
Thomas Boyes
First one for me, maybe just to piggyback off of Colin’s. It’s just around the labor cost reductions with the lines, I mean, it’s great to see the 50% recognized as of this quarter. I think the long-term target was closer to 80%. Is that still a fair target? Is it better just because of the better yields? And maybe kind of over what timeframe do you think that we would kind of see the balance of those improvements with the automated line up and running?
Eric Dresselhuys
Yes. I mean, look, we’re in the process of commissioning our automated line now. So I think, — directionally, I think that those targets still hold. I think once we get the line up and running and finalize some of the processes around that, we’d be able to better speak to if that number would need to be updated or not. I think the summary is, there’s a significant cost out opportunity that remains with what’s driving labor out and we’re right in the middle, right in the heart of determining exactly what that is.
Thomas Boyes
And then maybe again if you could just kind of give some color around the uptick in demand that you’re seeing following the passage of IRA 2022. And I’m wondering is it still a lot of the increase, four systems that would be kind of in that still two-four hour range. You’re already seeing kind of more pronounced shift to longer generation, six plus power systems?
Eric Dresselhuys
Yes, I’ll take it. I think, Thomas, we’ve seen more longer duration requests certainly in some of the more advanced markets, whether it’s California or Australia where it just was last week. Any of the markets that are further developed on the renewable penetration curve are all starting to ask for longer six, eight, 10 hour duration storage. And I think that would have happened irrespective of IRA. What’s happened now is that people are doing the math and figuring what the impact on the IRI or the return on their ROI on their projects would be. And if there was something that was maybe on the margin before, it kind of easily goes into the money after the IRA incentives, the ITCs kick in. And so I think that’s really been an accelerant to the amount of — to the inquiries and frankly the scale and the size of the projects.
Thomas Boyes
Perfect. And maybe if I could sneak one more in, I’ll hop back in the queue. I just saw that you after the close had filed a shelf offering. So I just wonder if you could give some color around that would be helpful.
Eric Dresselhuys
Sure. Well, as you know, we’ve just come on the one-year anniversary of the listing. So it’s kind of time to move through that next generation of what I would considered kind of good corporate housekeeping. So we filed the S-3 with the shelf. There are no immediate plans to take on any specific fundraising activities around that, but we wanted to ensure that we’re in the right position to act if and when the time comes.
Operator
Your next question comes from the line of Joseph Osha with Guggenheim Partners. Your line is now open.
Joseph Osha
A couple of questions. First, just to go back to some of those parts that you are — products that you’re waiting for final parts. And I’m wondering how many warehouse units you may have just sitting there waiting to ship? And then on a related note, obviously, you’ve recognized one for revenue. But can you update us on how many units you currently have in the field that you’re still working to achieve revenue recognition on?
Eric Dresselhuys
Yes. So in terms of the units we have here, we’ve got seven or eight units that are effectively complete waiting final acceptance and about another 20 units that are on the floor kind of in various stages of completion waiting for those overdue parts. So certainly relative to what’s been deployed, which is in total now about 10 units, it’s a pretty substantial step up.
Joseph Osha
Okay. And of the 10, can you remind me of how many you’ve recognized revenue for it at this point?
Amir Moftakhar
Hi, Joe. We’ve recognized revenue for four of those units, so it would be the initial SoftBank unit, the two Applied Medical units and then the TerraSol unit that we’ve shipped, the SDG&E project because that’s a microgrid. That is still in process of being commissioned.
Joseph Osha
Okay, okay. And then of that, call it, seven or eight that are kind of sitting there in the loading dock, is it your hope to maybe have those on trucks or boats by the end of the year?
Eric Dresselhuys
Yes, correct. We don’t know what the final exact number will be, but our hope is to get something in the neighborhood of 20 of those rolling to customers before the end of the year.
Joseph Osha
20, okay, great. And then my last question. It’s nice that you just recognized revenue on one unit because now we know what the ASP is, even I can figure that out. I’m wondering whether this $192,000 price tag is perhaps how we should — is that representative of pricing that we’re going to see going forward?
Eric Dresselhuys
It’s difficult to say. Some of these early units that we’re shipping are against contracts that were signed in some cases a year or two ago. And so I think the market has moved considerably both because of things like the Inflation Reduction Act, but just the general market pricing. So it also depends, of course, a little bit on what the scope of our deliverables are under a contract if it’s just a standalone unit, or if there are other services and components along with that. So it’s not a mile off, but it would probably be to the lower side of what we would expect going forward.
Joseph Osha
To the lower side. Thank you, that clarifies then.
Operator
[Operator Instructions] Our next question comes from line of Chip Moore with EF Hutton.
Chip Moore
Kind of curious, nice to see that acceleration in revenue recognition for the unit in Pennsylvania. And you just touched on SDG&E microgrid situation and maybe that takes a little longer. Can you just kind of walk us through, what might be unique to different types of projects in terms of being able to follow that type of timeframe for future rev rec? Is that unique, is that type of project in Pennsylvania or should we think about future projects following that type of timeframe?
Amir Moftakhar
Yes, this is Amir, I’ll take that question. So I think we’re certainly broadly working on the acceleration of revenue recognition for all projects. I would say there will be some more straightforward single unit projects where we’re delivering a small number of EWs with no larger project component behind the EWs. It’s really just delivering those to the customers. With our newer contract terms, I think those will accelerate the way that the most recent unit did. I think to the extent that they are legacy customer contracts and/or there’s a larger microgrid project component, I think those need a little bit more time and care just to get them up and running and commissioned in a little bit more purposeful cycle. So certainly, over time, I think what you’ll see is, our contract terms have changed, those will get more favorable through the revenue recognition process. And just as we build a history of delivering and shipping to these customers, it will all continue to accelerate, whether it’s a single unit or a project, then we’ll just take some time to work through.
Chip Moore
And maybe my follow-up on IRA, you did a great job outlining pretty compelling economics there from some of those benefits. Any way to sort of hindcast or think about any potential for delays as customers contemplate some of those savings into their decision-making, or how you’re thinking about that?
Eric Dresselhuys
Yes, thanks, Chip, Eric here. We haven’t had anybody call us and say please don’t ship the product, because I’m waiting for IRA. So I don’t think that any delays or shifts in our shipment schedule are expected as a result of the order. I know the detailed IRS rules are being worked right now. We expect that those will be published before the end of the calendar year, and that the tax impacts on both the ITC and the PTC will be in effect for the full length of calendar year ’23 and tax year ’23 maybe in this case more specifically. So if anything, I think we’re seeing people feel urgency now to say, “Am I going to be able to get products?” Because the anticipation is that there will be a surge in demand and there will be a near-term scramble for capacity — product capacity for projects they need to deploy in the ‘23 and ‘24 time frame.
Operator
Your next question is a follow-up from the line of Thomas Boyse with Cowen and Company.
Thomas Boyse
I just had one more. Just wondering if you could give some insight into what you’re seeing as it relates to the interconnection queues. Is there anything that might give you confidence that might be seeing that the congestion there might be relaxed and rolled? Or is it still going to be tight for the foreseeable future?
Eric Dresselhuys
I think it really depends on projects. I suspect that if you did a survey of people across the spectrum of project developers, they would tell you that they expected to continue to be tight in the near-term. For us, we’re fortunate in two regards. The first is a lot of our projects get deployed downstream on distribution networks where the interconnect queue is not nearly the burden that it is for large transmission projects. And the second advantage that we have is for some of the larger projects that we’re involved in, the partner — the developer partner is taking care of or already managing that interconnect queue. So we’re not waiting out that whole project — process the way that the developer is. We’re coming in at the construction phase after the interconnect queue has been determined.
Operator
There are no further questions at this time. So, I’d like to turn the call back over to the presenters.
Eric Dresselhuys
Thank you, and thank you all for joining the call today. We’re very excited about the continued progress in the market, excited that we’re building at an accelerating rate, and look forward to finishing the year strongly as we head into 2023, which we believe will be a very important year of growth for ESS. So thank you for your support and we’ll look forward to talking to you soon.
Operator
This concludes today’s conference. You may now disconnect.
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