ESS Tech, Inc. (NYSE:GWH) Q4 2023 Earnings Call Transcript March 13, 2024
ESS Tech, Inc. beats earnings expectations. Reported EPS is $-0.09, expectations were $-0.13. GWH isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Ladies and gentlemen, thank you for standing by. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session. [Operator Instructions]. I would now like to turn the conference over to our host, Erik Bylin. Please go ahead.
Erik Bylin: Welcome to ESS’ Fourth Quarter and Fiscal Year 2023 Financial Results Conference Call. Joining me on the call today from ESS are Eric Dresselhuys, CEO; and Tony Rabb, CFO. Following management’s prepared remarks, we will hold a Q&A session. Earlier today, ESS released financial results for the fiscal year 2023. The earnings release is available 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, partnerships, financial performance, and strategy for 2024 and beyond. The forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those projected or implied during this call.
In particular, those described in our Risk Factors set forth in more detail on our most recent periodic reports filed with the Securities 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 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’ CEO, Eric Dresselhuys.
Eric Dresselhuys: Welcome, and thanks for joining the call. ESS continues to make substantial progress on our strategy, building a world-class, scalable company that is well-positioned to serve the immense long-duration energy storage market in front of us. Although we had numerous accomplishments and grew the business to record levels in 2023, due to unforeseen customer delays, we ultimately came up short of our revenue goal for the year. In spite of this shortfall, I expect the milestones achieved in the course of the year bode well for our future. Our market opportunity and customer engagement remain robust. Energy providers are increasingly recognizing that there is a vast hole in their plans to get to carbon neutral that only long-duration storage can fill.
And I believe utilities are increasingly recognizing the limited options they have to supplement their renewable portfolio with a commercially viable LEAG’S solution. Thanks to the decision ESS made more than a decade ago to hone in on our iron flow technology, we have a seat at the table with many of the largest, most forward-thinking utilities today. As you have seen from our announcements, we delivered numerous systems to these partners in 2023, including SMUD, Army Corps of Engineers, Burbank Water and Power, and more. We see extraordinary opportunity for ESS in the near term and well into the future. And thanks to the great work of the team here, even with the intentionally measured pace we are developing the business, I believe we can make the case that we are ahead of other LEAG’S companies as we look across the landscape today.
Indeed, we are poised to ramp our shipments and revenue late in 2024 and into 2025 while maintaining a sizable financial cushion which should bolster our market position. The road to building a company in a new space is bumpy, particularly during the early stages when companies are more reliant on the timing of revenue and shipments, and often things don’t happen as quickly as one would like. And certainly, we’ve experienced that as we’ve been ramping up here at ESS. However, the behind-the-scenes work to execute on our strategy has progressed to plan. Our near-term challenges to maintain moderate and consistent scale shipping and installing energy warehouses have led to inconsistent financial results. As we have shared on virtually every earnings call, most of these challenges are caused by customer-related delays that are unavoidable in our industry and not a reflection of customer engagement or market demand.
That said, we as a team ultimately take ownership of the outcomes, and we are certainly disappointed we were not able to deliver the expectations we set for the back half of 2023. Two key customers, ESI and Honeywell, were expected to be material contributors to achieving our fourth-quarter revenue target but were delayed and not able to be included as part of Q4 revenue. However, I can share that we did clear these delays in the first quarter. While we were expecting roughly $2 million in revenue from these two customers in the fourth quarter to meet our full-year objective of $9 million, we now expect to include that revenue as a part of our Q1 results. In fact, we continue to make great progress with these customers, and I’ll share more on that in a moment.
While delays are frustrating in the near term, especially as an early-stage company, we expect that as we grow and diversify our business across customers and work to continue to standardize our contracts and operations, these bumps will smooth and our path to scale remains intact. We are building ESS with a very distinct strategy in mind, focusing on refining our iron flow battery design for optimal manufacturability, namely the lowest cost coupled with the highest quality and throughput, while conserving our cash. This should allow us to capitalize on the fundamental cost advantage we enjoy using iron, salt, and water to store electricity. As we work to reduce our product costs, we strategically chose to moderate the number of energy warehouses we build and ship, focusing on the customers in the segments that provide the greatest long-term opportunity.
This strategy is working, as it has allowed us to conserve our cash balance while making great strides on the design initiatives to lower material and labor costs and enable us to reach non-GAAP gross margin profitability on a unit basis, an objective we still believe is achievable by the back half of the year. Given our strong cash balance and the progress we’ve made with the design of our products and operations, I feel the team has been extremely successful. In parallel, we are proving the necessity of long-duration energy storage by signing large multi-year deals that could deliver well north of a billion dollars in revenue from future orders as we execute on scaling our technology. Let me repeat, simply executing on our existing customers and partners can deliver all of the volume we need over the next few years.
In 2022, we land at Sacramento Municipal Utility District, a utility with one of the most aggressive and detailed plans to get to carbon neutral, and we have already delivered and commissioned our first six units with them. We signed a partnership with Energy Storage Industries Asia Pacific and Australia, whose initial customers include Stanwell and Energy Queensland, in support of a very exciting initiative announced by the government of Queensland to deploy over three gigawatts of batteries to reach their decarbonization goals. In 2023, we signed an agreement with LEAG, the second largest electricity generator in Germany, whose plan is to deploy 500-megawatt-hour Iron flow battery building blocks coupled to renewables to supplant coal generation plants.
All told, they expect to build 20 gigawatt to 30 gigawatt hours of storage. We’re pleased to share that we have now completed the first stage of engineering design with LEAG. While these are extraordinary validations of our market and technology, the deal we completed with Honeywell in September of last year is probably the most transformative. Honeywell took an equity position in ESS at a premium to the market price, entered into a co-development agreement for energy storage, and, most importantly, plans to resell our technology into their channels with an initial target of $300 million in the first six years, which included a prepayment of $15 million. In the fourth quarter, we hit the ground running, and, as mentioned, we have already delivered their initial order.
Our go-to-market teams are deeply engaged, and we are moving towards our first joint development projects, all designed to improve the cost, performance, and scalability of our solutions. This partnership was more than six months in the making, and Honeywell did extensive due diligence into our technology, operations, IP, and customer base. So, this rings true as an incredible proof point for our technology, our operations, and the progress we’ve made. Encouraged by the belief of these influential customers and partners, we remain convinced that ESS has a strong right to win in the market. The long-duration energy storage market has tremendous tailwinds, and the primary alternative technology, lithium-ion, is rife with flaws. There are numerous nascent technologies trying to climb that mountain to scale viability, but ESS has a substantial lead on all of them, improving our solutions and scaling our processes.
We have been developing a unique technology for more than a decade and have surrounded it with an incredible IP moat. ESS is blessed with a solution that stores energy in some of the most abundant and inexpensive raw materials available, iron, salt, and water. It doesn’t catch fire, explode, or require difficult-to-source raw materials, and is manufactured with a very capital-efficient process, creating a fundamental cost advantage at scale. Executing on our manufacturability initiatives and our customer relationships is the key to our success, and that is why I am so pleased with our operational progress. While we have given you glimpses into the progress we have been making operationally, I would like to recap some of the highlights from our accomplishments in 2023.
At the top of the list, our cost-out initiatives have resulted in tremendous savings for each EW we build. We brought down the cost to build an EW by almost 60% in 2023. This improvement included numerous noteworthy highlights, including lowering labor hours to build the balance of system by 45% and decreasing cycle times for power modules by 52% and proton pumps by almost 70%, all of which lowered EW build cycle time by 73% while reducing the hours required by more than a third. We improved our electrolyte so that our energy density increased by 25%. Additionally, we did great work optimizing our bill of materials and vendor base. Our customer success team dropped the time to commission an EW at a customer size by 50%. We continued to fortify our intellectual property mode and filed an additional 82 patents, while also having 52 patents granted within the year, bringing the total to 367 patents filed and 77 patents granted.
We vastly improved our revenue recognition process and shifted out of development accounting. We accomplished this while almost cutting our Q4 adjusted EBITDA loss in half year-over-year, which enabled us to end the year with $108 million in cash on our balance sheet. Our rate of operational execution improved dramatically in 2023. And with the team hitting their stride, we have detailed plans to lower the cost to build an EW by up to another 40% in 2024. This includes further dramatic simplification of the design and assembly along with optimization of our power module automation. In fact, as we move to our next rev of our EW design, I can share some details that should elicit how we are lowering cost and time of assembly, simplifying the design to make it easier to manufacture means lowering the number of touches and pieces.
And as we move through 2024, we are lowering our pipe couplings by 34% and pipe bonds by 18%, lowering our hardware count by 44% and lowering the wiring in an EW by 28%. This simplifies every step of the manufacturing process from procurement to assembly to final test. All told, this should also increase our capacity by another 20% without further investment, simply from optimizing the design. Perhaps most importantly, as we shared last quarter, we are building our first energy center with Portland General Electric. This process has gone well and we are currently testing the CC and expect to complete validation this quarter. The energy center delivers greater energy capacity and density and we expect it to be a preferred incarnation of our technology for utilities and other large energy providers due to its scalability and value proposition.
We expect to start delivering the first commercial energy centers late this year to TECO and Sacramento Municipal Utility District. And with this, we remain on track to start ramping ECs as we head out of 2024 and into 2025. I hope I’ve conveyed our excitement about the progress we’ve made this year and the trajectory we are on. As we look forward to this fiscal year, our focus remains consistent. We plan to develop scalable processes that lower costs, manage our growth to conserve cash, build our long-term book of business, and continue to demonstrate the critical role we expect LEAG’s to play in the energy transition. The lessons we learned in 2023 as we made progress scaling the business should be invaluable in helping us successfully execute on our vast long-term potential.
Given the variability with our customers’ deployment activity, we are taking a conservative view toward our external projections in 2024 and will defer giving specific guidance at this time. But we’ll share that we expect to grow substantially in 2024, driven by an inflection point in the second half that is enabled by achieving our cost-out targets and beginning the initial commercial shipments of our energy center, allowing us to dramatically increase our growth rate and drive efficiencies across the business. We expect to triple or quadruple our 2023 levels in the coming year. But project timing is still in flight. As our visibility improves during the year, we hope to be more specific about our ramp plans. This is an exciting and dynamic market space, and we look forward to continuing to scale our business to meet the growing demand.
We feel that with the team we’ve built, the technology we’re developing, and a market driven by the strong tailwinds provided by the IRA and increasing regulatory imperatives, ESS is positioned to capitalize on its first mover advantage in this new category of long-duration storage. And as we’ve seen in other industries, early leadership can deliver enduring competitive advantage long into the future. And with that, I’ll turn it over to Tony.
Tony Rabb: Thanks, Eric. Well, as otherwise noted, all numbers we discuss today will be on a non-GAAP basis. You’ll find the reconciliation of GAAP to the non-GAAP financial measures in our earnings release, which is posted on our investor relations website. In the fourth quarter, we delivered eight energy warehouses across a number of customers. However, there were certain delays that caused revenue we expected to come in during Q4 to get pushed out to the first quarter. This was across two customers, Honeywell and ESI, and amounted to approximately $2 million in revenue. As a result, our revenue fell short of expectations, coming in at $2.8 million for the fourth quarter and $7.5 million for the full year. In spite of these disappointing top line results, I’d like to reiterate what Eric said about the significant headway we’ve made in the last year in scaling the business, rewinding our revenue recognition process, reducing costs, and improving manufacturing efficiency.
The team has worked tirelessly to position ESS for continued growth in the coming year, and we remain confident in our ability to execute successfully on our long-term strategy. As a reminder, beginning in Q3, we transitioned out of development accounting and into commercial inventory accounting. So we are now reporting our cost of revenue separately from our operating expenses and beginning to report inventory on our balance sheet. Our cost of revenue was $10.3 million in the fourth quarter. In addition, as we detailed last quarter, as part of the transition from R&D accounting to inventory accounting and the associated LCNRV adjustment, there are a fair number of items included in COGS that dramatically impact our current COGS results that would not be material contributors as we reach scale.
Due to this, our COGS results will not fully reflect our cost reduction progress, thereby making it difficult to assess our progress towards profitability. As we increase scale and approach adjusted gross margin break-even on our EWs in the second half of 2024, we expect the impact of the LCNRV adjustment to our non-GAAP gross margins to decrease. Our non-GAAP operating expenses for Q4 were in line with our expectations at $9.5 million and our non-GAAP R&D came in at $3.5 million, which we believe is reflective of our current run rate. With that, we reported Q4 adjusted EBITDA of negative $12.8 million, another significant sequential and year-over-year improvement and indicative of our trajectory to profitability. Following the cash infusion of $42.5 million in Q3 from Honeywell, we ended the fourth quarter with $108.1 million in cash and short-term investments.
We plan to continue to effectively manage our cash burn rate in the coming quarters and the cash on hand should last us well into the first half of 2025. While not pressing, we expect to continue to opportunistically look to strengthen our balance sheet through dilutive and non-dilutive means to provide the necessary capital to give us operational flexibility to respond to market demands. We feel very good about our current cash position and liquidity and the extended runway we now have to push towards our longer-term goal of getting to cash flow break-even. And with that, I’ll open it up for questions.
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