QuantumScape - Q3 2022

Transcript

John Saager (Head of Investor Relations)

Thank you, operator. Good afternoon and thank you to everyone for joining QuantumScape's Third Quarter 2022 Earnings Call. To supplement today's discussion, please go to our IR website at ir.quantumscape.com to view our shareholder letter. Before we begin, I want to call your attention to the safe harbor provision for forward-looking statements that is posted on our website as part of our quarterly update. Forward-looking statements generally relate to future events, future technology progress, or future financial or operating performance. Our expectations and beliefs regarding these matters may not materialize. Actual results and financial periods are subject to risks and uncertainties that could cause actual results to differ materially from those projected.

There are risk factors that may cause actual results to differ materially from the content of our forward-looking statements for the reasons that we cite in our shareholder letter, Form 10-K and other SEC filings, including uncertainties posed by the difficulty in predicting future outcomes. Joining us today will be QuantumScape's Co-founder, CEO, and Chairman, Jagdeep Singh, and our CFO, Kevin Hettrich. Jagdeep will provide a strategic update on the business, and then Kevin will cover the financial results and our outlook in more detail. With that, I'd like to turn the call over to Jagdeep.

Jagdeep Singh (Co-founder, CEO and Chairman)

Thank you, John. We're pleased to share an update on our progress since our last call. I'd like to start with progress towards our 24-layer A sample. This sample is our next major milestone and is intended to demonstrate our commercially relevant battery cell format and a meaningful increase in layer count relative to previous generations of customer samples. As we discussed on our Q2 earnings call, earlier in the year, we encountered a contaminant in our material. Over the summer, our team focused on identifying the root cause, and as a result of these efforts, we're pleased to report we've dramatically reduced the level of this contaminant in our films. In addition, we've also rolled in a number of other process improvements that we believe will produce better performing cells.

This progress has allowed us to freeze the major design parameters of the film itself and turn our full attention to building 24-layer test cells. Before we deliver a new generation of battery cells to customers, we run what we refer to as a sample campaign involving several successive phases designed to build the necessary confidence and quality to ship cells to customers. We've kicked off our 24-layer sample campaign and frozen major design parameters and are now ramping field production to enable larger volumes of cells to test and collect data on performance and quality. It's important to note that while we have frozen the major design parameters, other parameters may still change as we learn more from our testing process and address any knock-on effects resulting from these improvements, so much work remains to be done.

We will not begin shipping cells for customer sampling until we've gathered data that establishes confidence in the performance of finished cells. We'll report progress on this front on our next quarterly earnings call. One key aspect of the A-sample design is the cell architecture. All lithium metal batteries experience uniaxial expansion and contraction during charge and discharge, and we believe existing cell formats are not well equipped to handle this expansion. To address the requirements for our A-sample cells, we've been developing a new hybrid cell architecture. In our shareholder letter, we've shared the first public renderings of this architecture, which is in certain respects, a cross between a prismatic cell and a pouch cell. We've progressed through multiple iterations of the design with the goal of improving its manufacturability and long-term robustness and expect to continue iterating on this design.

Next, I'd like to provide an update on our customer engagement. We continue to see strong interest from the automotive sector. In addition, on previous earnings calls, we've described potential markets for our technology beyond the automotive sector, including consumer electronics. We believe a key selling point for consumer electronics is the ability of our battery cells to run with zero externally applied pressure, since volume constraints within the consumer device make it difficult to apply significant pressure. We're engaged with some of the leading global consumer electronics companies, and I'm pleased to report we've shipped dozens of zero externally applied pressure, single-layer pouch cells for customer testing within this sector. Sister cells made with the same design and tested under the same test conditions in our own labs show the leading cells have achieved over 500 cycles.

While we remain focused on the automotive sector to drive our long-term growth and demand from this sector remains robust, we believe the consumer electronics market represents an interesting opportunity that could potentially provide additional revenue and field validation of our technology. I'd like to end with a look at the big picture. While the world is currently facing macroeconomic headwinds and geopolitical disruptions, we believe the fundamentals driving the demand for energy storage remain unchanged. In fact, we believe the need for better batteries has never been more urgent. We've taken important steps forward over the past quarter, and our progress is thanks to the incredible work of our team to overcome challenges, solve new problems, and deliver results as we build momentum towards commercialization. On that note, I'll hand things over to our CFO, Kevin Hettrich.

Kevin Hettrich (CFO)

Thank you, Jagdeep. In the third quarter, our operating expenses were $121 million. Our GAAP net loss for the quarter was $118 million. This level of spend was in line with our expectations entering the quarter. Cash operating expenses defined as operating expenses less stock-based compensation and depreciation were $79 million for the quarter. For full year 2022, we reiterate our cash OpEx guidance of $225 million-$275 million. CapEx in the third quarter was approximately $54 million. The majority of Q3 CapEx was directed towards facility investments. Other large payments went towards our Phase 2 engineering line, medium-scale continuous kiln, cell assembly and testing equipment, and QS-0 coating equipment.

In terms of full year 2022 CapEx, we expect to be on the lower end of our guidance of $175 million-$225 million. We continue to try to maximize capital efficiency in our ongoing build-out of the QS-0 pre-pilot line. For example, a significant number of tools that we will use as part of our Phase 2 engineering line can also be used for initial low volume production as part of our QS-0 line. Including these tools, we continue to target year-end delivery of the majority of equipment needed for this early production on our QS-0 line.

With respect to cash, we spent $110 million on operations and CapEx in the third quarter, and we now expect to enter 2023 with over $1 billion in liquidity above previous guidance of over $950 million. With that, I'll pass it over to you, John.

John Saager (Head of Investor Relations)

Thanks, Kevin. We'll begin today's Q&A portion with a few questions we've received from investors. Jagdeep, we'll start with you. What was the impact of the contaminant discovery to your timeline this year?

Jagdeep Singh (Co-founder, CEO and Chairman)

The impact was it required a cross-functional team to identify a root cause and fix the issue, all on a highly compressed schedule. Now, the team was able to do all this while not giving up on the goal of delivering a 24-layer cell by year-end is, we think, a testament to the quality and commitment of the team. Resolving this issue did, however, require additional work that took time away from our sampling campaign, so it does increase the degree of difficulty of achieving our A-sample goal on schedule. It also puts more work ahead of us, even though we believe we've resolved the contaminant itself, because any time you make a change like this, you have to validate the fixes you implemented, and that can take time.

I'd like to add that this is the kind of challenge the team has overcome repeatedly over the years. Making a lithium metal anode cell is not easy. If it were, it would already be on the market. This is not the first time we faced a challenge like this, and I'm sure it won't be the last.

John Saager (Head of Investor Relations)

Okay, thanks. That leads us into our next question. We have roughly eight weeks remaining in the quarter. How confident are you in your ability to hit the A-sample goal by year-end?

Jagdeep Singh (Co-founder, CEO and Chairman)

John, as we laid out in the shareholder letter, we have a plan that we're executing to, under which we believe it remains possible to deliver an A sample by year-end. However, it's not a slam dunk. The timeline is now tight. Things need to go right, and there's not a lot of margin for error. If unknowable issues come up, it will present a challenge relative to the near-term timeline. Having said that, when we do deliver 24-layer cells, it'll be a massive milestone.

John Saager (Head of Investor Relations)

Okay, great. Turning over to you, Kevin, how does the continued macroeconomic uncertainty and challenging capital markets environment affect QuantumScape plans and strategy?

Kevin Hettrich (CFO)

We can't control macroeconomics or the health of capital markets, which continue to be challenging and uncertain. What we can control is our cash use. There are two classes of opportunities to reduce spending, near term and long term, and we're exploring both. Near term on OpEx, it's things like flattening headcount growth relative to plan or insourcing services we were previously outsourcing, given greater internal capabilities. On CapEx, it's looking at ways to be more efficient with our spend. An example we gave in the letter is finding ways to utilize our Phase 2 engineering line equipment for the initial low volume production on our QS-0 line. Long term, it's potential opportunities include the evaluation of entry into other markets and more capital efficient business models. We do plan to end the year with over $1 billion in liquidity.

We're not taking that for granted, and as our letter references, we are continuing to look for additional opportunities, both near term and long term, to reduce these CapEx expenditures.

John Saager (Head of Investor Relations)

Okay, thanks, Kevin. Our next series of questions come from Jose Asumendi of J.P. Morgan. He writes: When comparing the product development between automotive and consumer electronics end products, what are the commonalities in the product development or the synergies in the product learning curve for both products and end markets? What are the largest differences in the terms of the end product, size of cell, charging time, charging discharge intensity, cycle times, et cetera? And then finally, do you foresee a larger chance to obtain commercial success earlier in consumer electronics products versus auto, or is it more or less the same? To summarize, he's really asking three questions. What are the commonalities? What are the differences? And then what does the timing look like?

Jagdeep Singh (Co-founder, CEO and Chairman)

These are great questions about the consumer market. In most ways, the consumer electronics market has easier specs than automotive. For example, the charge rates are lower, the operating temperature requirements are not as stringent, the layer counts are lower. All those are good things. Offsetting these benefits is, I believe, this application requires zero externally applied pressure because physical space is limited in most consumer devices, and we believe this feature is hard to implement with lithium metal anodes, which in the past have generally required pressure to operate.

In fact, many groups over the decades have published papers suggesting that lithium metal intrinsically requires pressure to work, and so we see this as a scientific breakthrough. The fact that we've shown zero applied pressure in customer labs is what gives us confidence that we can in fact add value in consumer electronics. This is also why we believe we're seeing strong demand pull from the consumer electronics companies. Now, the market size for consumer devices, while it's over $10 billion in size, is somewhat smaller than the potential market for automotive batteries. This is also offset by the fact that it might provide a more direct and, as you pointed out, José, a potentially earlier path to market.

Relative to commonalities, what I would say is that, a lot of the things that we need to do, such as a more efficient packaging, thicker cathodes and so on, apply to both markets. We don't actually believe that, serving this segment will take us too far off our long-term vector.

John Saager (Head of Investor Relations)

Okay. Thanks so much, guys. We're now ready to begin the live Q&A portion of today's call. Operator, open the line for questions.

Operator (participant)

Thank you, sir. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. As a reminder, if you're using a speakerphone, please remember to pick up your handset before asking your question. Our first question comes from the line of Chris Snyder with UBS. Your line is now open.

Chris Snyder (Executive Director)

Thank you, and appreciate all the updates today. You know, back in July, the company provided test results for the 24-layer prototype, which I think got to a bit over 100 cycles. Can you talk about, you know, what needs to be done to go from, you know, those results to the delivery of the A-sample to the customer? Is it a, you know, kind of getting the results up to the gold standard test results which the company's talked about in the past?

Jagdeep Singh (Co-founder, CEO and Chairman)

Yeah. First of all, every customer has a different set of tests that they plan to run on the A-sample, the 24-layer A-sample. There's not a single sort of test that covers all customers. Now the cells we reported on this summer were the very first 24-layer cells we had built, and we're very pleased that we were able to assemble them and actually get you know cycling results. Before we can deliver cells to customers, they need to obviously have a much higher level of confidence in terms of both performance and reliability and so on. We have a process mapped out for how we get there, right? That process is as follows.

You know, while we're in the development phase, we're doing a lot of design tweaks to try and improve performance and overall behavior. At some point when we're ready to start making sales to ship, we run what's called the sampling campaign. That starts by freezing many of the key parameters of the design itself. Because once we freeze the parameters, that's when we can start ramping up production volumes internally of our separator films of cells. As we make more films, we then build more cells with those films. We then put those cells on test. We try and test under the same protocol that the customer will test the cells.

Based on those test results, we assess whether we're ready to ship or not, and once we've said we're ready to ship, we build cells for customers and basically select the ones that we wanna ship based on the data that we've generated through the previous testing internally. That's the process that we have, and where we are in the process right now is we've, as we said in the letter, we have in fact frozen the major design parameters. I wanna make clear that there are other parameters that we will continue to be improving based on these test results. As we put cells on test, and we learn things, we will in fact incorporate insights.

Freezing the parameters doesn't mean that there are gonna be no tweaks at all being made, but the major parameters are already selected. We will use those separator films to make cells, 24-layer cells, which we will put on test. We're in the process right now of ramping up film production. We've said before our goal for the year is to ramp up to around 8,000 films per week for the peak week. That still remains our goal and we wanna get to that goal because that's what will allow us to make enough cells to test internally to get the confidence that we need.

Finally, when we do all that, if the cells perform the way that we believe they need to to give us confidence, that's when we ship to customers. That's kinda the process, and where we are right now is in the stage where we've frozen the major parameters and are ramping up production to start building these cells to test internally.

Chris Snyder (Executive Director)

Yeah. We really appreciate that color and around that process. I guess kind of just following up on potential tweaks to the parameters. You know, would those come, you know, internally from QuantumScape, you know, as you're analyzing the test results and you're making tweaks? Or would they come, or could they also come from, you know, feedback from the customer after the A sample has shipped?

Jagdeep Singh (Co-founder, CEO and Chairman)

Yeah. Initially, obviously, this will be our own testing that will allow us to, you know, determine whether anything needs to be changed or not. I mean, ideally, there's no tweaks at all, right? We freeze the design and it works exactly as it's supposed to. Usually in the real world, you know, you discover things as you start to make, you know, larger volumes and so on. Once we ship cells to customers, of course, they will test them in their labs, and they will provide additional feedback.

The hope is that the cells we deliver to them will work as advertised, and the feedback that they have will be largely in terms of, you know, longer term maturity of the cells, things like the B samples and C samples and so on.

Chris Snyder (Executive Director)

Thank you. Appreciate all that.

Jagdeep Singh (Co-founder, CEO and Chairman)

Absolutely.

Operator (participant)

Thank you for your question, sir. Our next question comes from the line of Winnie Dong with Deutsche Bank. Your line is now open.

Winnie Dong (VP of Equity Research)

Hi, thank you so much. I wanted to sort of zero in on this contaminant issue. Could you help us understand why it sort of only appears, or if that's the case, in the 24 layer count cell and not, you know, the earlier version of the cells, just technically if that's possible to explain?

Jagdeep Singh (Co-founder, CEO and Chairman)

The contaminant appeared in our separator film in our material. You know, our film is based on a number of precursors that we get from suppliers. Now, when our suppliers change things with the way they process their materials, and they sometimes make changes to improve the behavior of the materials, sometimes those changes have side effects. Sometimes we don't detect those side effects until we've made films out of them, put them in the cells, find the cells are, you know, having issues, and then have to essentially reverse engineer what changed. Actually the team did a really amazing job.

This particular contaminant wasn't easily visible, so the team had to first identify if these issues were related to this other contaminant in the film. It then had to identify what the chemical composition of that was, then identify which potential precursor material was the source of that contaminant. They had to work with the supplier to reformulate that source, the precursor material, then had to get the new material, remake films, remake cells, test it, confirm that in fact those cells did not have a meaningful amount of that contaminant left, and that reducing that contaminant in fact delivered better performance. All those things had to get done, and were done, and that's what we're excited about.

The team did a great job with that. Now obviously that, as I mentioned earlier, you know, results in our timelines being a little tighter than we would have liked. The fact that, you know, our goal of shipping 24 cells this year remains intact is again a testament to just the work the team did.

Winnie Dong (VP of Equity Research)

Thank you so much. I just have a follow-up. With regard to the JV pilot facility, the QS-1, it was mentioned in the shareholder letter that the decision will be either Germany or the U.S. Could you provide us with some, you know, considerations of factors that would tilt your decision towards either way, either Germany or the U.S.?

Kevin Hettrich (CFO)

Hi, Winnie Dong. That's a great question. I think the decisions there would be the ones that you would come up with operationally in terms of the cost and availability of inputs, and also quite relevantly, the prevalence and applicability of different incentive packages. As you know, recently passed was the IRA, which establishes incentives in the U.S., for closed loop domestic U.S. production to support a battery supply chain. That's of course something that both teams are evaluating in that site selection decision.

Winnie Dong (VP of Equity Research)

Thank you for taking my question.

Kevin Hettrich (CFO)

Absolutely. You're welcome.

Operator (participant)

Thank you for your question, ma'am. Our next line of questions comes from the line of Jordan Levy with Truist Securities. Your line is now open.

Jordan Levy (VP Equity Research)

Afternoon all, and thanks for taking my questions. Clearly, you're all taking a strategic approach to the A-sample process. Can you maybe talk to the importance of doing the comprehensive internal sample campaign that you talked about and what sort of flow-through that could have through the rest of the OEM qualification process?

Jagdeep Singh (Co-founder, CEO and Chairman)

Yeah, no, this is an important point. I mean, you know, a company at our stage, you know, has to be very cognizant of the fact that any cells, any samples we deliver to customers, will, you know, be the basis of potentially lasting impressions that they get. We just need to make sure that the probability is very high that the cells we do deliver, you know, work as advertised. In order to do that, we've developed this campaign methodology that I took you through. What we found in the past with previous deliveries is this methodology allows us to really ensure a relatively high level of product quality that goes to the customer.

Generally speaking, the product tended to work as advertised. That is again the goal here. The reason why this is important is because once this A-sample is delivered and the product works as it's expected to work, it does in fact turn the focus to subsequent milestones. Those will in fact include the things that you mentioned, like the B-sample and the C-sample. At this point, to be honest, our immediate focus is delivering the A-sample. We don't wanna get distracted by things that are beyond that right now. We just have essentially, you know, all eyes on trying to deliver this sample.

Once we do that, we'll be in a position to then work with the OEMs on subsequent milestones.

Jordan Levy (VP Equity Research)

Yeah. No, I appreciate the space for that. Just as a quick follow-up, you talked about the hybrid cell architecture. I'm just wondering if that design introduces any additional things that need to be addressed in your collaborations with the OEMs, or is this something that you'd work through kind of later stages once you get the B and C samples?

Jagdeep Singh (Co-founder, CEO and Chairman)

No. That's a good point. You know, the design that we outline in the shareholder letter is, in some ways, a template. It shows you what this architecture, you know, can do and what this all might look like. You know, every OEM is gonna have, to some extent, a relatively customized battery pack, and therefore customized needs relative to cell dimensions. So, you know, we may well take this architecture and implement it in a somewhat different size to accommodate the different packs that are, or module design that the OEM has.

Those are relatively, I would say, relatively small changes, you know, changing the dimensions, but keeping the same overall, you know, architecture. If an OEM has, you know, a brilliant idea for another way to package lithium metal cells while meeting the goals that we lay out in the letter, like dealing with lithium metal expansion, dissipating heat, you know, having an efficient package that's manufacturable and so on, of course, we'd be very open to that. In fact, we welcome that input. Based on the work we've done, you know, we see this design as an innovative way to address all those requirements.

The customers we've spoken to, you know, have given us very encouraging feedback on it, recognizing that the specific form factor may vary by the specific OEM's needs.

Jordan Levy (VP Equity Research)

Sure. Thanks so much for the update, Jagdeep.

Jagdeep Singh (Co-founder, CEO and Chairman)

Absolutely.

Operator (participant)

Thank you for your question, sir. Our next question comes from the line of Ben Kallo with Baird. Your line is now open.

Ben Kallo (Senior Research Analyst)

Hey, thanks for taking my question. Good afternoon, good evening. Just maybe along the same lines on the cell architecture. Could you talk about how, I guess, that applies, to just, you know, the customers that you have started working with on the OEM side, and, you know, how you prioritize them based on, you know, on that architecture, if that changes at all? Then also on, the consumer electronics, you know, how the, that cell architecture impacts consumer electronics and, you know, when you have the total addressable market, if there's a, you know, a subset of that with that can be, reached with the architecture needed? Thank you very much.

Jagdeep Singh (Co-founder, CEO and Chairman)

Yeah, absolutely, Ben. So, you know, the beauty of this architecture from our perspective is it is an architecture, as opposed to a point design. What that means is that, you know, we believe this architecture actually applies across the full spectrum of applications for what we're doing. For example, you know, the A-sample could be a specific set of dimensions with the same design. The C-sample or some production cell that a certain OEM needs could be a different set of dimensions, but with the same basic design. A consumer cell, we believe also could be built in the same basic architecture. It would be a smaller cell.

It wouldn't be as big as one of these automotive cells shown in the rendering in the letter, but you could imagine the same basic design. Remember that the key aspect of the design is that you take your cell stack, which is the active layers, the cathodes, the separators, and so on, and you have this metal frame that goes around the stack. Doesn't need to be metal, it's just a frame, a rigid frame that goes around the stack. You wrap the whole thing in a laminate that's similar to pouch cell material.

With that approach, what happens is that as you can see in the laminate, the offset between the frame and the face of the cell itself becomes a region that can be filled as the cell expands. When the cell is fully discharged, the face of the cell is recessed a little bit from the frame, as the image on the left shows in the shareholder. When you charge it up, as the lithium comes out of the cathode and plates onto the anode, forming the anode in situ, it essentially expands, and the face of the cell becomes close to flush with the frame.

That basic design, you know, can work independently of how big it is, or what application, you know, it's deployed in. That's the part that we're excited about. We think that this is a really innovative way to solve the issue of lithium metal expansion. We talk about this particular package architecture in this letter because we've gotten a lot of questions from investors, you know, over the last couple years on how we will deal with, how we plan to deal with lithium metal expansion. That's a characteristic of lithium metal anode cells. If you want the energy density that lithium metal can potentially offer, you have to address this expansion of the cell.

Because the expansion is uniaxial, it's along one dimension, it can in fact be accommodated through a design like the one that we presented here. We believe this is, you know, an exciting package, an exciting architecture, that should provide investors with a good idea relative to how we deal with lithium expansion.

Operator (participant)

Thank you for your question, sir. There are no additional questions waiting at this time. Again, if you would like to ask a question, it is star 1 on your telephone keypad.

Jagdeep Singh (Co-founder, CEO and Chairman)

Okay. I just wanna thank you all for joining today's call. In closing, I'd like to thank our investors for their ongoing support of our mission, our forward-thinking customers for their commitment to helping us get this technology to market, and of course, our amazing team of incredibly talented and dedicated team members to overcome the hard problems associated with bringing a new technology like ours to market. We look forward to reporting on further progress in the coming quarters.

Operator (participant)

With that, we'll conclude today's QuantumScape Corporation Third Quarter 2022 Earnings Call. Thank you for your participation. You may now disconnect your line.