Earnings Call Transcript - EOSE Q1 2021

Operator, Operator

Greetings. Welcome to Eos Energy Enterprises First Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to Jared Ehm, Investor Relations, Eos Energy. Thank you. You may begin.

Jared Ehm, Investor Relations

Thank you. Good morning, everyone, and thank you for joining us for Eos’ financial results conference call for the first quarter ending March 31, 2021. On the call today we have Eos CEO, Joe Mastrangelo; and CFO, Sagar Kurada. Before we begin, allow me to provide a disclaimer regarding forward-looking statements. This call, including the Q&A portion of the call, may include forward-looking statements related to the expected future results for our company, which are subject to certain risks, uncertainties and assumptions.

Joe Mastrangelo, CEO

Thanks, Jared, and welcome everyone to our 1Q 2021 financial results call. I would like to thank everybody for joining us today. And jump in on page three to walk through some operating highlights. This page, I think, is the snapshot that we like to use to track how we’re progressing on building the company. To get all starts on the upper left-hand side of our page, we look at discharge energy and that’s how the product and the technology is operating out in the field and how it’s performing in our test facility in Edison, New Jersey. Since our last earnings call, we’ve added 20% to the discharge energy and we’re now over 2 million cycles of operation. So this technology is proving itself, not only in the lab, but also out in the field. At the same time, we’re very proud of being able to report that we’re at $33 million of orders with a $51 million order backlog.

Sagar Kurada, CFO

Thanks, Joe. Good morning, everyone. Over the next two pages, I’ll be discussing a summary of our first quarter 2021 reported financials. Detailed financial statements and relevant management discussions are available in our 10-Q and supplemental disclosures. Page five is a summary of our first quarter income statement. We reached an important milestone in the quarter as we recognized revenue of $164,000 from our first container shipped out of Hi-Power to a micro grid storage solution in Nigeria, powered by Nayo and the Shell foundation. Our cost of sales in the first quarter, with $0.1 million, was favorably impacted by the reversal of $1.6 million reserved for losses on firm purchase commitments that we had recorded in Q4 2020. We reversed this accrual because the batteries that we acquired under the firm purchase commitment in Q1 were ultimately used for R&D purposes, and therefore, we expensed these costs with R&D in the first quarter. This reversal largely was offset by the cost of sale of $1.7 million that are included within disposition. We recorded $5 million in R&D expenses for the quarter. R&D expenses increased mainly for two reasons. First, we incurred $2.2 million higher battery testing costs than the prior year due to our UL Certification process, partially offset by the accrual reversal in cost of sales I discussed earlier. Second, as we are continuing our investment in new technologies, specifically our Gen 3 or Z3 program. We increased our investment in R&D headcount and thus incurred $0.5 million of higher payroll and personnel costs.

Joe Mastrangelo, CEO

Thanks, Sagar. Now, let’s focus for a second on UL Certification, which is critical to deliver on those growth numbers that Sagar just talked about. So moving on to page 13, there are two UL Certifications that we go after. One of them is on the battery module itself, which is the 9540A, which is safety for thermal runaway or the risk of fire and explosion. We’ve completely passed that testing and I’ll walk through some results on that testing in a moment. The second is the overall storage system, which is UL1973, which we have gone through the testing for that certification and are now just qualifying the materials, the plastics that we use in our frames for the RTI, a Relative Temperature Index of 80 degrees C. We’re halfway through that testing as we speak and we anticipate that we’ll be able to close out the UL1973 Certification by the end of June. Tremendous results by the team. A lot of this was done virtually and over Zoom and Microsoft Teams. So really great work by the team to get us to this point in this period of time. If we flip quickly to page 14, just want to talk quickly about the results of our 9540A tests. We like to say our battery is inherently fireproof, in that it will not catch on fire or explode and does not need ancillary systems like HVAC cooling systems or software to manage the risk of thermal runaway. If you look at the four main tests here, the first one is over-discharge; if you over-discharge the battery down to zero voltage, you don’t see any degradation in the battery itself. There’s no loss of capacity or performance and you can rest the battery and get it back to continued operation. So you’re not going to damage or destroy the battery in and of itself by doing this test. The second one is shooting a 2.5-inch nail into the battery. Again, nothing happens. These tests were relatively boring because you’d watch the nail go in; the temperature would go up a little bit, but there’s no flame, there’s no explosion, there’s no thermal runaway. Then the two on the right-hand side, which are really critical, are overcharging the battery two times its normal capacity. The battery gets up to 90 degrees C. Again, no flame, no explosion; there’s a little bit of electrolyte and steam release from the battery, which we managed through a capture system to be able to mitigate the unlikely event this should happen. And the second test is on a battery short circuit test, where we’re short-circuiting the battery into itself. Again, you see the thermal dynamics take over; the temperature rises to 80 degrees C. When you look at these two tests and the curves that come out of these two tests, and you lay them over what you would see from a lithium-ion battery, the curves look exactly the same, but there’s one important difference: our battery doesn’t go above 100 degrees C, whereas lithium-ion, when you separate it out, its temperature will rise to 700 degrees Celsius or 800 degrees Celsius. So what we see in our battery is a battery that’s inherently safe and fireproof and allows you to operate in the harshest conditions with the simplest ancillary systems and the least amount of parasitic load to protect the safety of your product to keep it operating out in the field. So it’s something that we see as a competitive advantage and we see as something that our customers can rely upon us to provide reliable energy storage in any environment. Moving forward now, shifting gears to our manufacturing capacity. So if we go to page 16, there are four key things that we want to talk about today. The first one is the facility or factory itself. We have fully repurposed the factory in 11 months. Our equipment today, our yields coming off the line are above 90%, a tremendous amount of work done by the team to both ramp up production and improve the quality of our product. The third one is material availability and product cost. We’ve been able to reduce 40% of our battery costs in the last five months and secure multiple sources of supply to keep the factory flowing. The last one, which is actually the most important, is bringing in great people. And as I talked about earlier in the presentation, we’ve been able to double the size of our team over the last five months and we’re proud of the work that they’re doing. We’ll continue to recruit, hire, and train the best to deliver our product to the marketplace. If we go to page 17 and look at the left-hand side of the page, what the facility looked like 11 months ago, the right-hand side of the page shows screenshots from various parts of our factory. What the team has been able to do is ramp up production on our electrode line and improve the yields and quality to single-digit scrap rates on how we produce this critical component of our battery. We’ve ramped up a new technology in how we build the mechanical enclosure of the battery using infrared welders and continue to expand that production to increase throughput in the factory. We’re optimizing the processes of quality control and filling our battery with electrolyte and are now working on a lean manufacturing roadmap across the factory from manufacturing batteries to getting batteries into the container and shipping them to customers. So really a great amount of work and a ton of progress here in 11 short months from going from an empty facility to a factory that is shipping product out into the field. If we look at page 18, what has always been a strength of our system is that we have abundant raw materials that can be locally sourced at a lower cost point than other technologies. I wanted to show you how our 14 raw materials that go into our battery are utilized and where they are sourced. If you look at the percent of the global demand for those raw materials, if we’re producing a gigawatt of production out of our factory, you can see that we have a minimal demand on the overall global supply chain for each one of our raw materials. But we don’t just sit back and rely upon that. The team continues to work to prevent any supply chain risk as we look at sourcing our electrolytes and reduce costs and accelerate cycle times. On titanium, we are a very small percentage of the global demand, but we are cautious of this as a key component in the aerospace industry, and as aerospace becomes more active, we are looking at alternative materials to titanium to mitigate any supply chain risk. On graphite felt, we’re testing new material specifications to open ourselves up to new sources of supply to reduce costs further. It was critical for us to ensure we have multiple sources of raw material to ramp up production and keep the supply chain flowing. We are planning for future scaling by integrating lessons learned from our current production. If we move forward to page 19, this page discusses how we’re ramping up production. Today, we are getting up to 50% capacity in our existing factory. We’re optimizing the electrode line, expanding capacity on our IR welding, and conducting increased product testing. We’re running at a lower utilization rate to ensure that the products going out into the field are of high quality. In the coming months, we’ll continue to add resources and hire workers for our production line. We anticipate moving to 70% output by mid-summer and then from July to September, we expect to reach 100% capacity by continuing to streamline our production processes. This September timeline relates to the current equipment we have, and starting in October, November, and December, we will begin adding new capacity to meet our 800-megawatt hour target for 2021. At the same time, if we move to page 20, it’s essential to consider the cost management strategies we are implementing to ensure profitability. Today, we’ve already secured two-thirds of our 2021 cost-out plan by the end of the first half of the year. The actions we’re taking focus on building strategic agreements with suppliers, optimizing our equipment, and enhancing our manufacturing processes. We remain committed to cost management efforts, specifically as we anticipate blending the costs of our Gen 3 and Gen 2.3 product line to gain volume discounts and continue investments in automation and our factory capacity to improve our margins moving forward. Transitioning from a look at the work we’ve been doing on cost management, let’s talk about the development of our next-gen product, the Z3 battery, and how it enhances the performance of our Eos Q 20-foot container, our primary market product. We currently have prototypes being tested. If you look at the Z3 battery on page 22, it’s about one-third smaller in size compared to our Gen 2 battery and has fewer cells—28 instead of 40—while delivering 15% higher energy discharge. This allows us to provide 40% more power out of a smaller footprint, while still maintaining the inherent fireproof characteristics of our product. The lower temperature characteristics result in a 25% reduction in the levelized cost of storage for a UL system, as a simpler and more robust design enables efficient operations and maintains safety. We’re still in early testing of the product, but the initial feedback is promising, and we’ll provide updates in our next call regarding both product performance and manufacturing processes. Now, on page 23, I'd like to focus on key customer deals. The first one is a project we signed with Hecate, which is providing locational capacity for the ERCOT market in Texas. It’s a significant project for us as we have received an LOI leading to an order. We have another 47-megawatt hours of similar opportunities coming from the Hecate project. The second deals with the shipment of our first four containers to Motor Oil in Greece, which supports oil refinery operations with lower-cost energy. There’s another 250-megawatt hours of similar opportunities related to the Motor Oil project. We plan to start commissioning those containers in the next week to get that project online early this summer. Lastly, I want to highlight the container sitting in Nigeria for the Shell Nayo project. This image illustrates the potential of providing reliable power to remote locations in microgrid applications, emphasizing the need for simplicity and security. We expect to complete the commissioning of this project within the next 30 days, and we have another 100 hours of projects similar to the Shell Nayo project in our pipeline. These are projects we take great pride in as we seek to enhance our operational metrics that we discussed at the start of today’s presentation. In closing, we will continue to execute on the same six priorities. We need to expand our pipeline coverage globally, obtain a green bond rating that will provide a competitive advantage for our customers, reach $50 million in revenue, and commission tank containers while shipping $10 million in sales in the upcoming five months. Additionally, we will finalize our UL1973 certification and commence our CE Mark certification for the European market. We aim to achieve our target of 800-megawatt hours capacity and will keep our stakeholders updated on our raw material sourcing and the lean improvements in our factory. As for the Z3 product launch, we will demonstrate its performance and configurations as we ramp up production in the coming months. Ultimately, we are committed to investing in top talent and fostering an excellent company culture. All the work we are doing and the careful allocation of our cash are focused on strengthening the company and capturing the growth opportunities in the energy storage market. With that, I’ll turn it back over to the Operator and open up for some Q&A here this morning. Thanks for listening.

Operator, Operator

Thank you. Our first question is from Chris Souther with B Riley. Please proceed.

Chris Souther, Analyst

Hey, guys. Thanks for taking my question here. So based on the slide deck, we are looking at about $10 million in sales over the next five months. I’m curious, are all those Gen 2.3 products? Any sense to split between second and third-quarter recognition? Should we assume the rest of the $50 million in revenue that we’re targeting for this year will be that Z3 coming in the fourth quarter?

Joe Mastrangelo, CEO

Hey, Chris. Good morning. So the $10 million that we talked about here will be a mix of Gen 2.3 products shipping throughout the year. It’s not a hard stop; there will be a transition depending on customer requirements. Sagar, could you elaborate on the split over the next five months?

Sagar Kurada, CFO

Hey, Chris. Good morning. To answer your first question, the deliveries that we have over the next five months will all be Gen 2.3. At this point, we’re not giving any additional quarterly guidance. So as shipments progress along, we’ll be sure to keep you updated as they fall into the quarter they occur. The rest of the year after that, the fourth quarter will be a combination, as Joe mentioned, of both 2.3 and 3.0. The split will depend on customer needs and our delivery schedule, but we intend to be fully functional on both products.

Chris Souther, Analyst

That makes a lot of sense. We’ve seen nice product progress on building the order book; 50% of the 2021 targeted orders are booked at this point. Could you talk about the balance you’re looking to close for revenue this year that is either late stage, LOI, or firm commitments? How should we think about the coverage there?

Sagar Kurada, CFO

Yes. There are indicators that we can discuss. As we mentioned on page either, we have a $3.9 billion pipeline, of which $600 million represents LOIs and firm commitments. As discussed, $13 million of that $0.6 billion has already been converted. There will be a portion of that continuing to transition to booked orders, and we feel good about our team’s momentum. The remaining portion will stem from our active pipeline discussions, and various projects are in different stages. Timing will be determined by the economic benefits to both customers and ourselves.

Chris Souther, Analyst

And Sagar, just one point. The way we build our model assumes a 20% to 30% transition rate from the pipeline into orders. So when you think about the $50 million, we have more than enough opportunities to be able to close that. As Sagar mentioned, we just need to work through the timing of how projects close and customers finalize their financing. Got it. That’s very helpful. Are any customers waiting on full system UL before placing orders, or is it mostly typical customer-related factors that will hit the $50 million and $300 million targets?

Sagar Kurada, CFO

UL testing is expected to be complete in the second quarter. All booked orders are contingent on UL testing and certification, as part of our overall commercial operating rhythm.

Chris Souther, Analyst

Okay. That makes sense. As the pipeline expands for earlier stage opportunities, how many customers through those upticks in lead generation non-binding quotes represent? Is it more about having existing customers returning with other potential projects?

Sagar Kurada, CFO

Yes. There are a few repeat customers; however, most of our booked orders are from new customers, which is driving our backlog improvement by two times in the last 100 days. Currently, over 90% of our pipeline is in the U.S. and, as Joe mentioned, we are focusing on expanding this globally.

Joe Mastrangelo, CEO

I would just add that we’re seeing a good uptick in repeat customers returning with new projects, and I want us to continue expanding our customer base. We have some traction, but there’s more opportunity to pursue, especially as we grow our commercial efforts and pipeline.

Chris Souther, Analyst

Okay. Given the discussion in the market about lithium-ion shortage issues, are there any incremental near-term opportunities appearing for you, and how is it impacting pricing?

Sagar Kurada, CFO

Our pricing remains steady and firm as per our previous guidance. Any improvements regarding pricing will be communicated as more information is available. As for our supply chain, we’re monitoring components involved in our battery management systems; however, right now, we do not foresee shortages.

Joe Mastrangelo, CEO

Chris, from my perspective on the supply chain, we’re not seeing shortages in materials inside our product. What we are trying to monitor are power electronics to ensure stable supply to our battery management systems. While there are new near-term projects receiving inquiries from us, we also need to educate potential customers on how our technology provides value compared to traditional solutions.

Chris Souther, Analyst

Great, that’s very helpful. Regarding the joint venture buyout, how does that impact the path towards positive margins, and what’s your perspective on gross margin breakeven points?

Sagar Kurada, CFO

As you know, we have purchased the remaining 51%. The payments are scheduled over the next five years, amounting to $15 million in 2021. The impact of this buyout has been positive, allowing us to maintain a vertically integrated supply chain focused on reducing costs. We are not altering our prior financial guidance concerning margin projections.

Chris Souther, Analyst

Just to wrap up about the CapEx cadence for the remainder of the year and the expected cash burn for 2021?

Sagar Kurada, CFO

Certainly. From a customer perspective, we have committed capital between development and project financing of about $15 million. We continue to evaluate the right financial strategies going forward. Regarding CapEx, we maintained guidance of $40 million for manufacturing capacity expansion. Given our recent acquisition of the Holtec facility, we will incur incremental investments of about $15 million to cover the portion of the joint venture they invested in. Regarding operating cash flow, our G&A has a run rate of about $3 million quarterly, and we project a steady state as we seek to balance between mandatory expenses and necessary cash allocation.

Chris Souther, Analyst

Thank you for the detailed insights; I appreciate it. I’ll hop in the queue.

Sagar Kurada, CFO

Thanks, Chris. Good luck with the baby!

Joe Mastrangelo, CEO

Thanks, Chris.

Operator, Operator

Our next question is from Subash Chandra with Northland Securities. Please proceed.

Subash Chandra, Analyst

Good morning, everyone. Just to clarify, the revenue guidance includes service revenue. So, of the $50 million, should we consider around $42 million as product revenue with the balance recognized quarterly?

Sagar Kurada, CFO

Great question, Subash. From our booked orders, called out at $50 million, approximately $8.5 million is service revenue. Of the $33 million year-to-date, $6.3 million is service revenue. This revenue is not projected to impact our P&L until year three and beyond, shaping long-term value propositions and margins.

Joe Mastrangelo, CEO

Just to clarify, service models only activate from year three after shipments, so revenues this year will solely consist of product shipments.

Subash Chandra, Analyst

Got it, thank you. About gross margins—not positive this quarter, but what do you see for breakeven throughout the year?

Sagar Kurada, CFO

We do not expect gross margin to turn positive in 2021. We anticipate achieving positive gross margins starting in the fourth quarter of 2022, with ongoing improvement into 2023.

Subash Chandra, Analyst

Regarding titanium alternatives, I understand there’s potential competitiveness, but has cost management been an issue as of late?

Joe Mastrangelo, CEO

The titanium alternatives we are evaluating are still undergoing testing. Once we validate functionality, we’ll need to establish supply sources. It’s an opportunity for cost reduction longer-term. However, our existing capacity plans remain our focus.

Sagar Kurada, CFO

Material substitutions are an ongoing effort and part of our optimization strategy. The transition timing to go live with alternatives isn’t currently defined; our priority is to establish manufacturability with the Z3 product.

Subash Chandra, Analyst

Understood. Any updates on certifications based on location requirements in New York or Florida?

Joe Mastrangelo, CEO

There are additional certifications for both fire and building departments required in New York City, and we are actively pursuing those processes. For now, our primary focus is completing the UL certification, which is critical for our backlog and pipeline.

Subash Chandra, Analyst

Thank you for the updates and insights.

Joe Mastrangelo, CEO

Thank you to everyone for listening. We’re excited about the progress we’re making and look forward to updating you after the second quarter.

Operator, Operator

Thank you. This concludes today’s conference call. You may disconnect your lines at this time and thank you for your participation.