Fluence Energy - Q3 2023

Transcript

Operator (participant)

As a reminder, today's call is being recorded. I'll now turn the call over to your host, Mr. Lexington May, Vice President of Investor Relations. Please go ahead.

Lex May (VP of Investor Relations)

Thank you. Good morning, welcome to Fluence Energy's third quarter 2023 earnings conference call. A copy of our earnings presentation, press release, and supplementary metric sheet covering financial results, along with supporting statements and schedules, including reconciliations and disclosures regarding non-GAAP financial measures, are posted on the investor relations section of our website at fluenceenergy.com. Joining me on this morning's call are Julian Nebreda, our President and Chief Executive Officer; Manu Sial, our Chief Financial Officer; and Rebecca Boll, our Chief Product Officer. During the course of this call, Fluence management may make certain forward-looking statements regarding various matters relating to our business and company that are not historical facts.

Such statements are based upon the current expectations and certain assumptions and are therefore subject to certain risks and uncertainties. Many factors could cause actual results to differ materially. Please refer to our SEC filings for our forward-looking statements and for more information regarding certain risks and uncertainties that could impact our future results. You are cautioned to not place undue reliance on these forward-looking statements, which speak only as of today. Also, please note that the company undertakes no duty to update or revise forward-looking statements for new information.

This call will also reference non-GAAP measures, which we view as important in assessing the performance of our business. A reconciliation of these non-GAAP measures to the most comparable GAAP measure is available in our earnings materials on the company's investor relations website. Following our prepared comments, we will conduct a question-and-answer session with our team. During this time, to give more participants an opportunity to speak on this call, please limit yourself to one initial question and one follow-up. Thank you very much. I'll now turn the call over to Julian.

Julian Nebreda (President and CEO)

Thank you, Lex. I would like to send a warm welcome to our investors, analysts, and employees who are participating on today's call. This morning, I will provide a brief update on our business and then review our progress on our strategic objectives. Following my remarks, Manu will discuss our financial performance for the third quarter, as well as our outlook for the rest of the fiscal year. Starting on slide four with the key highlights. I'm pleased to report that in the quarter, we recognized $536 million of revenue. We continue to experience strong demand as new orders were approximately $565 million, highlighted by our solution business contracting 1.4 GW hours and our digital business adding nearly 1 gigawatt of new contracts. Furthermore, our signed contract backlogs as of June 30th increased to $2.9 billion.

Turning to adjusted gross profit, we delivered $24 million or a margin of approximately 4.4% for the quarter. This is slightly lower than the Q2 level of 4.6%, primarily because of one project that experienced delayed from a non-core supplier. This was an isolated incident, which should not hinder us from our expectation of achieving double-digit gross profit margins in Q4. Our services and digital business, which represent the sum of our recurring businesses, continue to see traction. Our deployed service attachment rate, which is based on our cumulative active service contract relative to our deployed storage, remains above 90%. As we have noted previously, we typically see a lag between signing solution contracts and entering into a service contract, which is why we believe the cumulative attachment rate is a better metric. Turning to our digital business.

We had a very strong quarter as we were able to contract nearly 1 GW. However, our digital assets under management at the end of the third quarter was slightly lower than the second quarter level as a result of a customer not renewing its contract with us. This slight decline will be more than offset as the new contracts not yet deployed move from our digital backlog to our digital assets under management. While we don't like losing customers, the non-renewal is within our expected 5% rate for churn or customer attrition. Our low churn rates highlights the general stickiness of our customer base. Overall, we still have a lot of work to do regarding our digital business, but we're on track to deliver on our commitments.

Turning to slide five, I'd like to discuss the five strategic objectives that we highlighted previously and provide you with an update on our progress. First, on delivering profitable growth. I'm pleased to report that we are raising our fiscal year 2023 guidance for both revenue and adjusted gross profit. Manu Sial will discuss in more detail, we're able to raise our guidance due to better project execution, thanks in a large part to our supply chain improving. Additionally, we are reaffirming our expectations that we will be close to adjusted EBITDA breakeven in our fiscal fourth quarter. Second, we will continue to develop products and solutions that our customers need. As such, I'm pleased to report that we signed a 400 MW hour contract that will utilize Northvolt batteries.

This is a significant milestone, as this will mark our first major project that will utilize European-manufactured batteries, and illustrates our commitment to diversifying our supply chain. Third, we will convert our supply chains into a competitive advantage. I'm pleased to say that we have signed a US cell supply agreement with AESC, under which we will procure US-manufactured battery cells. This is a tremendous achievement for us, as we believe this will position Fluence to be one of the first companies to provide customers with a storage product that qualifies for the 10% investment tax credit bonus under the IRA domestic content rules. This contract provides us access to the limited early US cell supply and give us a first-mover advantage, which position us to potentially increase our existing market share.

As I mentioned previously, this agreement supports our domestic module manufacturing, for which we expect we will capture the incentive of $10 per kilowatt-hour, which I will touch on more shortly. Four, we will use Fluence Digital as a competitive differentiator and a margin driver. I'm pleased to report that we continue to make progress on our Nispera product roadmap. This quarter, we launched an artificial intelligence-based predictive maintenance tool, our first artificial intelligence tool for battery storage on the Nispera platform. I will also discuss this in more detail momentarily. Finally, our fifth objective is to work better. I'm proud to state that Fluence has increased its total cash position by more than $30 million from the second quarter level, further bolstering our liquidity. Our total cash includes cash, cash equivalents, restricted cash, and short-term investments.

Turning to slide six, demand for energy storage continues to accelerate. In fact, our pipeline now sits at $12.4 billion, which is an increase of more than $1 billion from last quarter. Additionally, as I mentioned, we saw our backlog increase to approximately $2.9 billion. We expect to see some initial project awards in the second half of this calendar year that are directly attributed to the Inflation Reduction Act. Such, we reaffirm our belief that consolidated revenue growth will be between 35%-40% in fiscal year 2024, relative to our increased revenue guidance for fiscal year 2023. Turning to slide seven. As I mentioned earlier, we have secured an offtake agreement with AESC for U.S. made battery cells.

This agreement strengthens our capacity to offer customers a storage product that we expect to qualify for the additional 10% investment tax credit, a bonus granted to products complying with the prescribed criteria for domestic content under the IRA. We expect the first U.S. cells to be delivered in calendar Q4 of 2024. Additionally, we're still on track to begin manufacturing our battery modules at our facility in Utah in the summer of 2024. We know that the battery modules we produce starting in the summer of 2024, should qualify for the $10 per kilowatt-hour incentive, and will support the offering of a product compliant with the IRA's domestic content requirements upon the integration of U.S. manufactured cells in Q4 of 2024.

In regard to our U.S. module manufacturing, we do not expect that we will capture incremental margin as a result of manufacturing our own modules in the U.S. Instead, we expect the $10 per kWh incentive will go towards offsetting the cost of reaching economies of scale. From an accounting standpoint, our current expectation is that we will account for the $10 per kWh incentive on our income statements as a reduction to cost of goods and services. We expect to elect the direct pay provision for the first 5 years of the credit. The exact timing of the cash payment is expected to lag our accounting recognition, thus we expect it to be in conjunction with our federal income tax reform.

With respect to the U.S. manufactured product, we're exploring whether our first-mover advantage will allow us to share some of the benefits our customers will enjoy from our offering, and thus provide us with incremental margin. It's too early to define a concrete view, but as the situation evolves, we will provide more color on this potential upside. As you may have seen earlier this summer, the U.S. Department of the Treasury released its domestic content regulation. Overall, we're pleased to see the regulations. However, there are still outstanding questions that we're hoping the IRS will clarify by the end of the calendar year. Turning to slide eight.

I'm pleased to announce we recently launched an artificial intelligence-based predictive maintenance feature for battery energy storage as part of our Nispera offering. This is our first Nispera artificial intelligence-based feature, following the success of the AI capabilities on our Mosaic bidding application. Nispera AI-based predictive maintenance feature is an advanced solution, designed to upgrade the performance and reliability of any storage system. By harnessing the power of artificial intelligence models, this cutting-edge technology prioritizes and acts upon the storage performance issues, thereby significantly reducing downtime and ensuring our interrupted power supply.

From a customer standpoint, the AI-based predictive maintenance feature offered by Nispera will provide numerous benefits, including minimized downtime, significant maintenance cost savings, enhanced asset reliability, optimized maintenance scheduling, and improved safety. I'm pleased to say that we've deployed this solution onto its first project in California. More importantly, this feature provides another tangible proof point that we're on track with our digital business commitments, which we say will not be meaningful before 2025. In conclusion, I am pleased with the achievement of the third quarter. Although we're mindful there's still work to be done, we will look to continue this momentum as we progress through the remainder of the year. I will now turn the call over to Manu.

Manu Sial (CFO)

Thank you, Julian. I will begin by reviewing our financial performance for the third quarter and then discuss our guidance for fiscal year 2023. Please turn to slide 10. Our third quarter revenue was $536 million, 124% above prior year. We continue to execute well as we work through our legacy backlog, which accounted for more than half of our revenue in the third quarter. As we alluded to on our last call, third quarter had a larger impact from the roll-off of our remaining legacy contracts than we expect to occur in the fourth quarter. We continue to anticipate majority of our low-margin legacy backlog will be turned over by the end of this fiscal year, though, as I've indicated previously, a small portion will bleed into fiscal year 2024.

We generated approximately $24 million of adjusted gross profit in the third quarter, which was an adjusted gross margin of 4.4%, slightly lower than the second quarter level. As Julian mentioned, the driver of the decline was one specific legacy project that incurred delays driven by a non-core supplier. More importantly, for the fourth quarter, we expect our margin to be about 10%, which reflects an increased weighting of the higher quality, higher margin orders that we have recently signed relative to prior years, and expect this to be a good proxy for the expected margins in fiscal 2024. Third quarter operating expense, excluding stock compensation, was $54 million or approximately 10% of revenue, which is lower than prior quarter in absolute terms, though up just slightly as a percentage of revenue.

We remain disciplined about holding our operating expense growth to less than 50% of revenue growth and expect this model to create operating leverage in 2023 and beyond. This is also reflected in the year-to-date third quarter operating expense as a percentage of revenue, which is 10.9%, down from 17.2% in year-to-date third quarter 2022. Turning to our cash balance, I'm pleased to report we ended the third quarter with $416 million of total cash, including short-term investments and restricted cash. This represents an increase of more than $30 million from the second quarter. Rounding out the balance sheet discussion and in line with previous communication, we saw a decrease in inventory of approximately $250 million in the third quarter relative to the second, and continue to see improvements in inventory turns.

This, coupled with improved collections, drove the increase in our cash balance. In addition, we ended the third quarter with $165 million of undrawn revolver capacity and $80 million of unused supply chain financing, providing us additional sources of liquidity. Please turn to slide 11. I'm pleased to report we have increased and narrowed our fiscal year 2023 guidance ranges for both revenue and adjusted gross profit. We now expect our total revenue to be between $2 billion and $2.1 billion, which is up from our previous revenue guidance of $1.85 billion-$2 billion. As Julian indicated, we are maintaining our outlook for 35%-40% revenue growth in 2024, despite the higher 2023 revenue guide.

As we continue to benefit from growing demand and strong supply chain assurance, though, we expect roughly 75% of 2024 revenue to be generated in the second half of the fiscal year based on the current contract schedules we are seeing. We have all of 2024 battery supply secured, The continued improvements in our supply chain position also helped support incremental increase in 2023 revenue guidance compared to prior estimates. We have also narrowed our guidance for adjusted gross profit to be between $117 million and $132 million, which implies a slight increase at the midpoint from our previous guidance of $110 million to $135 million.

As we have indicated on our second quarter conference call, we expect to be close to adjusted EBITDA breakeven in the fourth quarter of 2023. As we focus on achieving adjusted EBITDA profitability for fiscal year 2024 and beyond, we intend to provide formal guidance for fiscal 2024 for both revenue and adjusted EBITDA on our next earnings call, while continuing to provide transparency of other key operating and modeling assumptions. From a cash standpoint, we expect our fourth quarter total cash levels to be near breakeven, and we believe we have ample liquidity to meet our 2024 revenue targets.

Please note that our U.S. battery cell supply agreement currently calls for a down payment of $150 million to reserve this capacity, which will be paid in installments over fiscal year 2024 and fiscal year 2025, and will be funded by our liquidity and customer deposits for these batteries. The first $35 million will be paid in the first quarter of fiscal year 2024, and another $35 million will be paid in the second quarter of fiscal year 2024. Before I turn the call back to Julian for final comments, I would like to reiterate that we continue to see strong demand, which is reflected in the significant growth of our pipeline, which gives us confidence that we will be close to adjusted EBITDA breakeven in the fourth quarter and generate positive adjusted EBITDA in 2024. With that, I will turn the call back to Julian.

Julian Nebreda (President and CEO)

Thank you, Manu. In closing, I would like to reiterate what I consider to be the key takeaways from this quarter results. First, we had a solid quarter in terms of our financial performance, clearing out much of our legacy low-margin contracts, while generating cash and raising our guidance yet again. We have also reiterated our expectations that we will be close to adjusted EBITDA breakeven in our fourth quarter. Second, we have taken steps to secure our future by locking up our fiscal year 2024 battery supply, as well as locking up early domestic battery cell production, providing us a clear first-mover advantage. Third, we launched our new AI-based feature for Nispera to help provide our customers with additional tools necessary to lower the total cost of ownership. This concludes my prepared remarks. Operator, we're now ready to take questions.

Operator (participant)

Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star one one on your telephone. Again, to ask a question, please press star one one. One moment for our first question. Our first question comes from the line of James West of Evercore ISI. Your line is open.

Julian Nebreda (President and CEO)

Good morning, James. How are you? Good morning. How are you?

James West (Senior Managing Director)

I'm doing well, Julian. How are you?

Julian Nebreda (President and CEO)

Doing well. Very happy today.

James West (Senior Managing Director)

I'm sure you are. It's a good quarter, and the outlook looks very strong. I'm curious, as we've had IRA guidance provided now, and we obviously know. Well, you and I know kind of the demand drivers here for energy storage. Has there been any net change in that demand, you know, either up or probably, up or down, but probably up, with, you know, pure guidance out there, for the U.S.? How are you guys thinking about, also the European markets as they start to figure out, you know, the Green Industrial Plan that they've put out there? In terms of the U.S., I don't think we have seen a major movement since the guidelines came out. It's in line with what we said, you know that, for a total demand, 35-40, and that's what we're, we're guiding revenue for next year. Right.

Julian Nebreda (President and CEO)

The US, a little bit higher than that. For Europeans, we are seeing some, you know, a little, the markets being a lot more, I would say, moving a lot. Where are, where are... First, Germany, I think. Germany was a market where it was incipient. Now we see a lot more, more activity. The Nordic countries is, are, are the another group.

James West (Senior Managing Director)

Okay.

Julian Nebreda (President and CEO)

Where we are seeing now a lot more demand. I don't think this is enough today to go for a review in our 35-40, but, you know, good signs, especially Germany being such a big economy. I'm sure it's going to be a competitive market, so it'll be a fun ride for us, but, that, that might be a meaningful, no? That's kind of where we are. I think we feel very confident about 35-40 for next year and, you know, positive that, you know, we will see demand getting better. The other one we're seeing.

James West (Senior Managing Director)

Okay.

Julian Nebreda (President and CEO)

Sorry, that I, that I maybe, Canada, which was something that I think I talked about with some of you before. Since we start seeing demand in Canada, mostly in mostly in Ontario, and that has been very you know, that's also very, I think, meaningful, and it could be a, a huge market, no? You know. And that proves a point, I think, that, if I can make maybe a little bit of an ad. You know, as you know the Canada, the Canada electric system has a lot of hydropower. A lot of people when they see hydropower, they don't see, you know, a need for battery storage. Our view is that, you know, reservoirs do their jobs. You know, our job is completely different, no? We provide services to the grid to ensure stability, to move capacity faster or fast response.

James West (Senior Managing Director)

Right.

Julian Nebreda (President and CEO)

To provide, you know, black, you know, black start. You know, these are things that, you know, not necessarily, you know, reservoirs can do. You know, it really proves the point that, even hydro systems or systems that have a lot of hydro capacity need battery storage to ensure that they can, you know, adapt to a new, power sector landscape, so.

James West (Senior Managing Director)

Okay. That, that's very interesting. Thanks for that, Julian. Question on the Nispera, the adoption of Nispera. How is that? You know, you've put more, much more emphasis the last couple of quarters on that, the adoption rate on the software side of the business. How is that progressing?

Julian Nebreda (President and CEO)

We signed, like, around one giga. It was mostly Nispera. It's doing very well. I think the fact that we have the, you know, the first, you know, integrated portfolio management, asset performance management tool that covers all the, the, the renewal technologies: storage, wind, solar, really makes a difference. It has really, you know, really helped us. You know, we're very, very happy with it. I think this new tool that we just announced, the, the maintenance tool, just the beginning. You know, this one is based on temperature readings. You know, there's voltage charts, state of charge. There's a lot more.

James West (Senior Managing Director)

Right.

Julian Nebreda (President and CEO)

The batteries are very, very rich in data, so there's a lot of value we will create by, by harnessing that data and convert it into information that our customers can use to, to manage their, our systems a lot better, so.

James West (Senior Managing Director)

Got it. Thanks, Julian.

Julian Nebreda (President and CEO)

Great. Great.

Manu Sial (CFO)

Thanks, James.

Julian Nebreda (President and CEO)

Thanks, James.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Brian Lee of Goldman Sachs. Your line is open.

Brian Lee (Research Analyst)

Hey, guys. Good morning. Thanks for taking the questions. Kudos, kudos on the solid execution here again.

Julian Nebreda (President and CEO)

Yeah, good morning, Brian. How are you?

Manu Sial (CFO)

Hey, Brian.

Brian Lee (Research Analyst)

Good. Good, thank you. Question, I guess, on margins. You know, it's a high-quality problem to have, but, you know, you, you, you seem to have gotten through a lot of the backlogs that had some of the lower margin, less profitable projects. Q4 guide, or I guess, the annual guide here for the rest of the year implies Q4 is gonna be somewhere in the, like, 11% range, if my math is right.

I know you're talking more about, like, 10% for 2024, and you're gonna give us more of an official view here in the next quarter. What are, what are kind of some of the puts and takes between the 10% and 15% long-term guide, and then, you know, mapping that to 2024, given you're sort of at a good exit rate here, for, for 2023, and it seems like a lot of the legacy projects are now, you know, off the books or mostly off the books?

Julian Nebreda (President and CEO)

Yeah.

Manu Sial (CFO)

I'll take it. Yeah, absolutely. Brian Lee, there's a lot to unpack in your question, so let me go take it piece by piece. I think just from how to think about the 2024 margins, we are signing contracts in the 10%-15% margin range, and that's that is still the case. The Q4 margin is a good proxy for how to think about 2024 margins, right? As we have a little bit more contribution from our services business and our digital business, maybe it ticks up a little bit. Q4 is a good proxy for, for 2024, and that will continue to increase as we go from 2024 to 2025. That's one. In terms of legacy, you're right, we are done with most of our legacy projects.

I think there's about $100 million to $150 million that trickles into 2024, mostly done in the first half of the year. As you do the quarterly profiling and the calculus of 2024 margins, keep that in mind. Then, you're right, the business is performing really well. You know I would want to point out the fact that, one, we've been fairly disciplined from an overhead perspective, and that's important because as we turn the page to 2024, the focus is gonna be a lot on EBITDA dollars, right? That is a better measure of profitability than gross margin or gross margin %. I think that's what we want the investor community to be focused on. That's reflected in our comments that we get close to EBITDA breakeven in the current quarter or in the fourth quarter.

Then I'll round out my comments from a cash perspective. You know, we generated cash in the third quarter. My comments talk about a cash breakeven in the fourth quarter, which means we generate cash in the back half of the year. That is another area we are focused on. EBITDA and cash becomes much more relevant than gross margin, gross margin percent. My last comment, before I pass it on back to you is, you know, we've been very pleased with the performance of the business, and what that's got us is, it's got us to be, WKSI enabled. WKSI is a well-known seasoned issuer, and we intend to file a universal shelf tomorrow after the market for Good Housekeeping. You know, that's really reflective of the confidence that the shareholders have placed in our business that allows us to be WKSI now.

Julian Nebreda (President and CEO)

My only comment on the, on the filing is that we do not intend to raise- we have no plans to raise, you know, capital in any way during, you know, for 2024. We don't need it and but I think this is just for housekeeping.

Manu Sial (CFO)

Yeah, that's consistent with the comments that we had in my script.

Julian Nebreda (President and CEO)

Great.

Brian Lee (Research Analyst)

Okay. Yeah, fair enough. No, appreciate all that additional color. I guess, second question, shifting to, to maybe the, the top line here. I know, even with the, pull forward, it seems like you had here and being able to raise the 2023 guidance, you're comfortable with the 35%-40% growth trajectory into 2024. Can you maybe give us a sense of how much of that is just, you know, additional demand, bookings activity you're comfortable with heading into next year? How much of that is, maybe, conversion timelines? It seems like some of those are maybe pulling in a little bit. If you can provide a little bit more color around that, and then I'll pass it on. Thanks, guys.

Julian Nebreda (President and CEO)

Yeah. I think we are, you know, the way I will, you know, maybe phrase it is that when you looked at our backlog and you looked at our 2024 revenue, we're covered right in line with where we were last year. You know, we feel very, very confident that for what, you know, the backlog that we will convert in 2024 is what we will do this quarter and next. That we will be, you know, more than enough to, to, to meet the 35-40. We feel very, very confident about it.

You know. We will provide you exactly how much of our 2024 back you know, of our revenue is covered by backlog. In our next earnings call, we will provide guidance on 2024. I don't wanna, you know, get ahead of ourselves, but we are in a, in a similar position to where we were last year, you know, when, when we were doing this year's planning process, so.

Brian Lee (Research Analyst)

Okay, I appreciate.

Julian Nebreda (President and CEO)

Our plan is to provide guidance on 2024 in the next earnings call in November, late November.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Justin Clare of Roth. Your line is open.

Justin Clare (Managing Director)

Yeah, hi, everyone. Thanks for taking the questions.

Julian Nebreda (President and CEO)

Hey, Justin. How are you?

Justin Clare (Managing Director)

I'm doing well. I wanted to ask you about project timeline. You know, this quarter, you increased the revenue guide again here, and I was wondering if you're seeing project timelines further compress. You know, I think you were at around 18 months a little while back here, but things have been trending lower. Where, where are timelines today? You know, do you see a path to continuing to shorten the timelines potentially to, you know, a timeframe of 12 months, say?

Julian Nebreda (President and CEO)

You know, in general, we don't see timelines compressing, you know. You know, I think that as we looked our, you know, our, you know, our financial planning, we see still projects around the 18 months that we, that we told, that we told you. This is a line that we wanna work on, and, and I think this is something that's work to be done. It clearly, you know, there are two drivers for this.

One is supply chain and the, the lead times we need for our supply chain to deliver the products on time, and the other one is, you know, ensuring that our, our customers are ready with their, you know, with their, you know, infrastructure. Between the two, I think that today, I think we can, I think we can work with the supply chains to accelerate it. There are customers, we can also help them to ascend, but there's a limit to, to that. Today what we have is an 18-month, you know, plan. I mean, I think it, it hasn't gotten any better.

Justin Clare (Managing Director)

Got it. Okay. Just wanna ask also about your U.S. manufacturing. You signed an agreement here with AESC. How much of that agreement really covers your need for U.S. cells? Does that cover, you know, all of your anticipated US cell supply, or are you looking for additional suppliers potentially? Also, maybe if you could just speak more broadly about the plan for potentially expanding your capacity footprint in the US. I think your plan is 6 GW hours in fiscal 2024. How should we think about potentially moving above that?

Julian Nebreda (President and CEO)

Yeah, I think that in terms of we believe this deal, which assigned, will, will essentially cover or, you know, a large amount of our U.S., our U.S. demand. We believe that the U.S. market will there will be a competition between U.S. manufactured or U.S.-manufactured cells and imported cells, and we will be working on, on both sides of that fence. But we believe that what we have is, is enough for our expected demand for, you know, for the, for you know, for the next years. Sorry, your second question, if you don't mind repeating, Justin, you know, I don't know if I got it.

Ah, sorry, on module manufacturing, sorry. On module manufacturing, we are, we are, you know, we build this plan with the ability to, increase the, the output if we want. For the module manufacturing, we most likely, depends on how it goes, we can very, very quickly, you know, this is a, you know, we can double the, the production very, very quickly and maybe triple it. We are, you know, but we will see how it goes and then make the decisions around that so we know. That's the way we.

Justin Clare (Managing Director)

Okay, got it. Thank you.

Julian Nebreda (President and CEO)

looking at that, you know?

Justin Clare (Managing Director)

Okay. Thanks very much.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Julian Dumoulin-Smith of Bank of America. Your line is open.

Julian Dumoulin-Smith (Equity Research Analyst)

Good morning, Julian. How are you?

Alex Probert (Equity Research Analyst)

Hey, Julian, it's, it's actually Alex Probert for, for Julian.

Julian Dumoulin-Smith (Equity Research Analyst)

Hey, Alex, how are you?

Alex Probert (Equity Research Analyst)

Thanks for taking the question.

Julian Dumoulin-Smith (Equity Research Analyst)

How are you?

Alex Probert (Equity Research Analyst)

I'm well, thank you. Listen, keeping on the theme on sort of the US piece here, congrats on the AESC, I guess, announcement. Let me ask you this: How sustainable of an advantage do you think that this is? Is there any sort of, I guess, value wedge that you think you can create there relative to, you know, pricing and where you're able to get those batteries? And then, I'm not sure if you mentioned it, but are those raw material indexed? I know that you have some sort of indexation on some of the other contracts. Just curious, as far as, you know, you guys having an early mover advantage, if you could elaborate on that a little bit.

Julian Dumoulin-Smith (Equity Research Analyst)

Yeah. I mean I'll tell you, talking to customers. What I hear from them is that we are the only ones offering this, that we are the only ones talking to them about this, or, you know. That's, that's my view. How long of a, you know, of an advantage? How, you know, how far away are the other, the other suppliers? I don't know. We you know, you hear different things from different people. Some people say that they do not believe that a U.S. battery manufacturer will be competitive. I disagree, and we disagree, and we think we'll show it to them. And we'll see. How long, how long how far away, how far away are they? I think that it will be, in my opinion, it will be very simple.

Julian Nebreda (President and CEO)

Once they see that we're here, that we can do it, that we can offer a project that's very competitive, that, you know, we can put the U.S. flag on top of it, that, you know, When they can see that, I'll see them trying to copy it and, you know, they'll probably be a few years behind, a couple of years behind. It's, it's difficult to know. Clearly, people don't, you know, don't announce they have I haven't seen any announcements, what I hear from my customers that nobody's talking about this, you know. How much, you know, I guess your, your second question goes to, can we, can we capture higher margin on this? Your, the second part of your question. Well, you know, we, we believe that you can.

We have to, you know, we just started doing this conversation with our customers, and, and this is a plan that, you know, is a little bit complex. It's very difficult to give a concrete view of where we see that happening. We do see that our customers are gonna get a significant upside and, you know, that we should share part of it with them as we are delivering this, this to them, you know? It will also, for sure, what I, like we said, for sure it will convert into higher volume, you know, and that because as I said earlier, we will work on both offering imported cells and the U.S. content cells. We will be playing on both sides of the fence, and that's what I think will be the trick here.

We're not, we're not only riding one horse. We work so customers who have you know, the customer have different preference. The customers who do not prefer, you know, a U.S. content, a U.S. domestic content compliant solution, we will offer them also a solution that does not meet that so. Really, you know, we're really excited about this prospect, and, you know, I think that it will solidify our position in the U.S. market, you know, with, you know.

Julian Dumoulin-Smith (Equity Research Analyst)

Yeah. No, no, fair enough. Just two quick follow-ups, sort of clean up questions, if you will, for me, maybe for Manu Sial. Just on the, the delays in, in 2Q, should we expect any deferred flow back of LDs? I know you guys have some, you know, seen that in some historical examples. And then on the deposits piece, I mean, do you expect that to be entirely fronted by, by customers, or is there some sort of, you know, working capital dynamics between cash in from them versus cash or, or from you guys on the deposits piece, if you can clarify? Thanks.

Manu Sial (CFO)

Yeah. I think, let me take the two questions in order. From a margins perspective, I think, you know, any potential LDs, we've kind of boxed it in really well in our third quarter actuals and our fourth quarter guidance. I think, that kind of clears that. In terms of how to finance the $70 million of deposits for the first half of 2024, I think a good assumption from a modeling perspective is a little over half funded by the customers and the rest funded by our liquidity or any working capital lines that we have.

Julian Dumoulin-Smith (Equity Research Analyst)

Got it. Appreciate the clarifications. Thanks, guys.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Ben Kallo of Baird. Your line is open.

Ben Kallo (Senior Research Analyst)

Hey, good morning, guys. Thanks for taking the question.

Manu Sial (CFO)

Good morning, Ben. How are you?

Ben Kallo (Senior Research Analyst)

Good morning. Good. Thank you. Sticking on AESC, could you guys talk a little bit about your, your diligence with them and how you chose them? I think they, they have one plant that's operating and one under construction, but where you would be getting the cells from, with them? I have a follow-up on a different topic.

Julian Nebreda (President and CEO)

Yeah. You know, we don't want to disclose too much, but I'll tell you is one of the main reasons why we picked them and decided to work with them, because these batteries will come out of a reconverted plant, a plant that's just going through. It is, it is producing, and it will reconvert to produce battery cells for the, the stationary storage. We believe that in the current, you know, environment, that, you know, they, they were further ahead than anybody else in, in, in offering this.

You know, they already have the employees, they already have, as you know, which is a major issue for some of these plants. They already have the technology. They have the supply chains working very, very well. You know that, I mean, very, very good, and, you know, and clearly also AESC is one of the tier one, you know, battery manufacturers. They have been working, you know, globally or in the U.S. for some time.

That's, that's the reason why we think that they were the, the, a good partner, and they are in a very, very good position to offer these batteries today. My follow-up question on a different topic is just market dynamics. I'm thinking about Tesla talking about having pricing power in the market for their, their storage business. I just want to understand, you know, if you guys are seeing that and what's causing that, and just the competitive dynamics and how it's changed. Either some of your competitors are not as financially strong as you guys or new competitors or anything like that, but then more so on the pricing power. Thanks. I don't think the, the competitive landscape has improved to our advantage. You know, let me put it that way. I think this is a very competitive market.

Tesla is a very, very strong competitor, and there are others, as you said. There are a lot of small players who do not have the capacity to do a lot of the stuff we can offer. I think we're far away still. I think we're far, I'm gonna say far away, but far from a, from the point where the industry consolidates in a way that we are a limited number of players, that, you know, I don't think we're there too. For us, competitiveness is, you know, a driver internally, to ensure that we beat everybody, clear, you know, on price, but not only on price. Price is a driver, it's not the main driver. On ensuring our customers have a product that meets their needs, you know?

Price being one, our performance, what we do, how they can bank or finance our investments, the type of, the type of guarantees we provide them to ensure that they, they feel comfortable owning our assets going forward. I think that, you know, we work very, very hard, and we work hard every day, and we have everybody looking internally how to ensure, we beat Tesla and any other one, that's around, you know.

Ben Kallo (Senior Research Analyst)

All right. Congrats on the results, guys. Thank you.

Manu Sial (CFO)

Thank, thanks, Ben. Thanks.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Pavel Molchanov of Raymond James. Your line is open.

Pavel Molchanov (Senior Investment Strategist)

Hey, Pavel.

Julian Nebreda (President and CEO)

How are you?

Pavel Molchanov (Senior Investment Strategist)

Good morning,

Julian Nebreda (President and CEO)

Good morning.

Pavel Molchanov (Senior Investment Strategist)

2024. Recognizing you're gonna give kind of more detailed guidance a bit later, but much more back-end weighted revenue picture compared to this year, and I'm just kind of curious, what why the difference in sequencing?

Julian Nebreda (President and CEO)

Yeah. I think the way to think about 2024, from a first half, second half perspective, is as follows, right? If you look at how the 2023 guidance has evolved, as we have gone about from our original guidance, which I think the midpoint was $1.55 or $1.6, to where we are, which is closer to $2.05, we've kept the growth rate the same, roughly at 35%-40%, right? That adds incremental between $600 million to $700 million of margin, give and, so sorry, of revenue, and given the cycle times of our projects, that's more back-end loaded compared to the first half, right?

I think the, the split between first half and second half is, is largely driven by the strength of our order book as we've gone through 2023. That has resulted in a higher revenue for 2024. It's coming in the back half of the year. We feel really confident, and I'll point to the fact that we have $2.9 billion in backlog as we enter the fourth quarter, and more importantly, we have close to $12.5 billion in pipeline. We feel very good about where we sit for 2024.

Pavel Molchanov (Senior Investment Strategist)

Okay. Let, let me follow up on the digital AUM kind of coming down in the quarter. You mentioned there was a non-renewal by a particular customer. Is there a certain churn rate or, you know, some other way to just think about digital-

Julian Nebreda (President and CEO)

Yeah

Pavel Molchanov (Senior Investment Strategist)

AUM more broadly?

Julian Nebreda (President and CEO)

I mean, our churn rate is fairly low, about 5%. You know, this customer that, that didn't renew, essentially is an asset that was sold. You know, that they were part of a, they were sold to a, to another company. The company had their own system, they decided to, which, you know, in a way makes sense. They decided to use the system they use for the other assets, you know? I think that, this was within our, within our 5% churn. Churn is very, very low, you know, Obviously, I just raised it because it, it appeared in the, in the numbers, I wanted you to be aware of what happened.

We signed more than 1, almost 1 giga, and so we did very. I think it was a good quarter from, for, for a digital business in general. These things will happen from time to time, and as long as they're within, and they are, we have no indications that they that we will end the year within the 5% churn rate that we usually have, that we too have for this business.

Pavel Molchanov (Senior Investment Strategist)

Understood. Thanks very much.

Julian Nebreda (President and CEO)

Yeah, great. Thank you.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Kashy Harrison of Piper Sandler. Your line is open.

Julian Nebreda (President and CEO)

Hey, Cassie.

Kashy Harrison (Senior Research Analyst)

Good morning, and hey, good morning, guys.

Julian Nebreda (President and CEO)

Good morning. How are you?

Kashy Harrison (Senior Research Analyst)

Doing well.

Julian Nebreda (President and CEO)

Thank you.

Kashy Harrison (Senior Research Analyst)

Thank you. You know, I wanted to go back to just this discussion on cell sourcing. You know, you're, you're highlighting U.S. cell capacity from AESC, you're highlighting Northvolt as well. You know, obviously, you still have a lot of Chinese cell exposure today. You know, maybe if you, if you look out a few years from now, is your expectation that your U.S. that you will sign enough U.S. cell capacity just for U.S. projects, and then European cells solely support European projects? You know, what does that mean for your Chinese exposure, again, a few years out from where we are today?

Julian Nebreda (President and CEO)

This is I think that, I don't see today, in, in, in our planning scenario, we don't see a world where the U.S. will be fully supplied by U.S. manufacturer cells, nor in Europe. That will take some time. The U.S., the Chinese manufacturers are, you know, they do investing need. They have invest, they had, they started earlier, they have invested a lot in technology. It will take a long time for, you know, European and U.S. manufacturers to get there. That, that's the way I see it, and that's the way you know, we wanna continue working with our Chinese suppliers, and hope to continue working with them for some time.

They, they provide us with very, very good product that, you know, they have good product roadmap, and we work with them well, and so we, we wanna continue working with them. That, that's the reality. The other point I will say is that, hey, I want a world where there's free trade. I want a world where, you know, we can buy batteries from many places, because I think that's a world that's better for all of us. A world where our technology will continue evolving, where, you know, we'll have the ingenuity and the capacity of the U.S. engineers coming up with new ideas and making, but also competing with what Chinese and Europeans are doing. That's the world I hope that we will have for our industry, no? Not, you know, so that, you know, a little bit our planning reflects that concept.

We, we want that world. That's a world we think that is a world that's a better, better for our technology and better for, you know, our standard of living, for we need to. You know, I don't think we will be able to, properly address the challenges of, climate change if we try to do this, each region or each country apart. We need to cooperate and work together, that's what, you know, so I wanna do. That's the way we see it.

Kashy Harrison (Senior Research Analyst)

Thanks for the thoughts there, Julian. Then, maybe a follow-up question for Manu. Appreciate the commentary on cash for Q4. Maybe just on a multi-year basis or maybe even a target basis, can you just help us think through what you think the cash conversion of this business is once you, you know, hit your targeted long-term margins? Do you think this is a 50% EBITDA to free cash flow business? Is it 60%, 70%? Just some thoughts on how you expect EBITDA to convert to free cash long term.

Manu Sial (CFO)

I think we laid out a cash model, maybe 2, 2 earnings calls back. I think that's a good way to think about the, the model going forward, right? The model goes something like this, right? We have our EBITDA, we have some amount of CapEx, and, you know, in the last few years, it's been high single digit, low double digit. That'll oscillate a little bit depending on specific needs of the business. From a working capital piece, which is the heart of your question, I think what we've said is, take the revenue growth year-over-year and take 10% of that as a proxy for the working capital usage. I think that's a pretty good model to think about as you plot out the next couple of years when we get to positive EBITDA territory and beyond.

Kashy Harrison (Senior Research Analyst)

Thank you.

Operator (participant)

Thank you. One moment, please. Our next question comes from the line of Tom Curran of Seaport Research. Your line is open.

Tom Curran (Senior Analyst)

Good morning.

Julian Nebreda (President and CEO)

Good morning, Tom. How are you?

Tom Curran (Senior Analyst)

Good, Julian. Good. Over in the E.U., when it comes to this churning stew of policy proposals, initiatives, regulatory changes that the European Commission has been cooking up in Brussels, you know, whether it's the Green Deal Industrial Plan, REPowerEU, or this just passed Renewable Energy Directive, is there anything in there that's specifically targeted towards the storage as transmission market and expected to expand and/or accelerate your, your set of storage as transmission opportunities?

Julian Nebreda (President and CEO)

That, you know, the transmission rules are very, very local. We have to work market by market. There, as you know, there is a transmission system for all of Europe, but we had worked, the work we're doing today is market by market, what we have done in Germany, what do, what done in Lithuania. We have not, we have not engaged from a, you know, from a pan-European type of process. I think that will take us, you know, time. The way generally, the way you should think about Europeans is that the, the way they regulate the transmission system is free access and, you know, essentially free access, let's put it that way, you know. That means that it allows for, you know, you need to allow energy coming from third parties.

In terms of what we are trying to do, our regulatory challenge when we go into this asset it's a simple one, is the following: Is that most regulatory systems restrict transmission operators from dispatching assets. However, when you put the battery support, the transmission line, the system operator or the transmission owner needs to dispatch the assets, needs to use the battery storage as a, you know, demand or as or dispatch it or charge it. That has created some sort of, you know, a legal question for that we were able to resolve in Lithuania, we were able to resolve in Germany, and that we're working to resolve in other places, you know, in the U.K. and in Ireland.

It is a challenge for, for some of the regulators because it, it, in a way, it questions the segmentation of our industry. Our industry is segmented, as you know, in demand or, or distribution, transmission, and, and generation, and the views that the three should be very, very separated. The way to create value is by having them be very, very independent. Demand cannot have own transmit- distribution, transmission cannot dispatch, generation, you know, all these things that, all these rules. I think as our technology goes into the grid, that, that segmentation blurs, and that's a challenge we have, you know?

A challenge we have in the U.S., and that's a challenge we have, you know, I think that this will happen, and there will have to be a regulatory. We have been able to successfully resolve it in Germany and, and, and in Europe, but it is something that we need to work with all the regulatory players as we move forward. I don't see a pan-European solution for this. This is more of a local issue, where we need to work with the local, you know, system operators and system regulators.

Tom Curran (Senior Analyst)

This is a very helpful clarification. Thank you for that. Then, Manu, in the quarter, you incurred CapEx of $7.3 million related to software investments. Would you expound upon the nature of that spending and provide us with an estimate of software CapEx for fiscal 2024?

Manu Sial (CFO)

Yeah. Let me help start with your 24 question first, and then kind of bring it back, because I think it goes to our long-term view on how we think about software and, as a key driver of the business, right? I think we've talked about, you know, call it double digits, low double digits type of CapEx spend. That includes capitalized software as well. I think it's both our own parties, our employees, as well as any third parties that kind of help develop from a software perspective.

It covers both our operating system projects that we are doing, as well as the digital initiatives to advance both Nispera and Mosaic, and that adds more capabilities to our current functionality. That kind of encapsulates where we've been spending money for this quarter and going forward, but I think it's the overall capitalized software is part of our $10 million to $15 million.

Rebecca Boll (Chief Product Officer)

Yeah, sure. This is Rebecca, and I'll tell you from my perspective of leading the technology team. We have a large group of people who create the operating system software platform, and we're actually reinvigorating that platform right now, and that's a big part of how we feed the money, the estimates in for capitalization. We follow along our product development plans to create new functionality on that software for the different markets, and that mostly is labor, and that labor turns into an opportunity to capitalize it. As Manu Sial mentioned, that's also paired with the investment that we make in our cloud-based software, and again, mostly that's labor and delivering some of the new functionality as discussed today, some of that artificial intelligence-based functionality. It's all that labor that goes into creating the different software offerings and leads into a capitalization effort.

Tom Curran (Senior Analyst)

Got it. Thanks, Manu. Thanks for that additional color, Rebecca.

Manu Sial (CFO)

Yeah. Excellent.

Julian Nebreda (President and CEO)

Yeah, great.

Operator (participant)

Thank you. One moment, please. Our last question comes from the line of Craig Shere of Tuohy Brothers. Your line is open.

Julian Nebreda (President and CEO)

Hey, Craig. How are you?

Craig Shere (Research Analyst)

Hi. Thank, thanks for squeezing me in. First, I wanted to dig in a little bit on the European transmission answer to Tom's question. I did notice the New York ISO was studying energy storage as a transmission asset, and I think you opined a little bit on the last earnings call about other markets having to address this and, and having issues, I believe you were mentioning Latin America at the time. Could you, could you opine on the prospects of working through this system-by-system issue worldwide and being one of the top three or four companies in the world that can even do this, how big a market this could be in five years?

Julian Nebreda (President and CEO)

Well, let's start with the last part of your questions. This, we believe, could be a material driver for our performance. You know, we have the Standard and Poor analysis, a little bit stale. I think it was 30 gigas by 2030, but I think it's stale when you really look at the challenges that transmission has globally. In terms of our, you know, I understood your, the first part of your questions, you know, how's our lobbying effort, and are we making progress?

This is, as I said earlier, this has to be I don't think we, we need to do this regulator by regulator, you know, and, and, and one by one, and, you know, our team identifies where we believe we have the highest chances of, you know, and, and the highest chances of success, and then that's where we work. We, on our team and this is what, we did this with AES as a, as a partner. With AES, we have been very successful in, in, in, in Chile, as well as Spain, you know. We're working in, in several jurisdictions in the U.S. You know, we have success depending on where we are.

I think after this summer, and all the transmission challenges that we have seen, this is gonna become a more urgent matter. As people will see our projects coming online in Germany, I think we're gonna see the U.S. system operators, they can go and watch this. They can see it work, and they see all the value it can create. I think that we will see a major, major acceleration of this. That's the way I see it. You know, we're very happy. Unfortunately, today, I cannot, you know, announce anything yet, but we're working on a few concepts that hopefully will become into reality soon.

Craig Shere (Research Analyst)

Thank you for that.

Julian Nebreda (President and CEO)

I'm sure that when S&P Global Ratings's takes another look at this market, it will, it will significantly increase it, you know, from what, what they were expecting. I think that the, that analysis, that it's a couple of years back. It's a, it's a little bit stale.

Craig Shere (Research Analyst)

Thank you for that. I wanted to dig in a little more on the answer to Pavel Molchanov's digital question. Is there a trend of customers increasing or decreasing their use of internal systems? Or is the market kind of deciding that, you know, specialized third-party digital services is the way to go, or is it still kind of, you know, case by case?

Rebecca Boll (Chief Product Officer)

When we talk to customers, we hear the need state for us to provide digital solutions that help them operate these battery systems better. That's an open space in the market, and that's the one that we're focused on. When you talk about third-party software systems, usually that's related to people that have decided to self-integrate, and that's a very specific section of the market. We're really not competing with that. We're playing with customers, developers, and IPPs that are consuming our products, and they're asking us to provide these digital solutions to help them operate the batteries over the long term. If your question is, are, are we competing with self-provided software? I would say not really.

Julian Nebreda (President and CEO)

Yeah. If I can add one thing. From a product roadmap view, our concept is to integrate our software solutions into our hardware solutions in a way that, you know, there's significant value by having the two, you know? To really create that additional concept. As you know, we sell our Mosaic technology to third parties. We sell our portfolio asset performance management system to third parties. We really think that, you know, fully integrating into our assets will create the ownership of our assets a lot more. It will help our customers reduce the total cost of ownership and make our assets more competitive in the market, that's conceptually what we're doing. Yeah.

I would say that today, clearly, our system, everybody, you know, buy from us, our battery management system, as we deploy, they will come from us. Where, where you see that people might have different systems are in the bidding application, because there are other players, even though ours integrates, as I said, very, very well with our infrastructure and in performance management tools, that there are not that many players who can offer what we do, which is, you know, integrating your solar, your renewables, and your, and your battery storage systems into one system. That's one way, so.

Craig Shere (Research Analyst)

As you. Just a quick follow-up. Like, two, three, four years out, as you morph this into a more fully integrated business line that historically wasn't necessarily, do you see the churn that you experienced in this last quarter kind of reducing or going away?

Julian Nebreda (President and CEO)

No, I think that the 5% a year is kind of the way we'll go. Remember, because this here applies to our whole offering. You know, bidding applications are competitive. In the market, there will be some, some people that do it, and then there is also the, the asset, the performance management tools also you have third-party competitors. I think 5% is a good number, and, you know. For digital applications, it's fairly, fairly low.

Craig Shere (Research Analyst)

Great. Thank you.

Julian Nebreda (President and CEO)

Great. Well, I think that this ends it for today, so maybe I can, you know, just say a parting remarks. We're very, very, you know, proud of the work that our team has done here. The, the turnaround, you know, Manu Sial was asking me earlier today, it's been almost a year since we, you know, we arrived here. We're very, very happy for the, you know, the turnaround that our team has done here, really, you know, their eye on the ball, on all the drivers that we needed to bring this company to where we are. We're in the brink of getting to our double-digit gross margin and our break-even point in the fourth quarter of 2024. You know, very, very happy with the, with the progress.

You know, this is, this is an industry that is evolving. It's a competitive industry, but we have the desire, the capacity, and the ambition to, you know, to make this great. You know, I really thank all of you for your questions, your support, and the insights you provide us every time we engage with you, because that helps us to do our jobs here every day. Thank you very much, and talk to you soon.

Operator (participant)

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.