Fluence Energy, Inc. (FLNC) Q3 2022 Earnings Call Transcript

Good day. And welcome to Fluence Energy's Third Quarter Earnings Conference Call. As a reminder, this call may be recorded. I'd now like to turn the call over to Lex May, Director of Investor Relations. You may begin.

Thank you, operator. Good morning. And welcome to Fluence Energy's Third Quarter 2022 Earnings Conference Call. A copy of our earnings presentation and press release 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 Manuel Pérez Dubuc, our Chief Executive Officer; Dennis Fehr, our Chief Financial Officer; Rebecca Boll, our Chief Product Officer; and Julian Nebreda, our incoming Chief Executive 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 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 not to 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 that 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 yourselves to one initial question and one follow-up. Thank you very much. I'll now turn the call over to Manuel.

Thank you, Lex. I would like to extend a warm welcome to our investors, analysts, and employees who are participating on today's call. As we announced last week, I was stepping down from my role as CEO effective August 31st. This is a decision that the Board and I have been discussing for a while. We both felt that now was a good time to make this change, given the stability and upward momentum of the company. The Board and I are totally aligned on this decision, and it will be a smooth and seamless transition. It's been a privilege to serve as Fluence CEO. I am incredibly proud of all that we have accomplished during the past few years at this amazing company. Like so many of our dedicated employees, I decided to work at Fluence because of the company's mission, which is to transform the way we power our world for a more sustainable future. I am forever grateful for the opportunity to lead this company through its Initial Public Offering. As I pass the torch to Julian Nebreda, I am confident that I am handing it to someone who will take Fluence to the next level. I am pleased to introduce you to the next Fluence CEO, Julian, please go ahead.

Thank you, Manuel. It is an honor and a privilege to be here with you today. Although I do not become CEO until September 1st, I thought I would share with you a bit about my background and my initial thoughts and priorities for Fluence. I'm not new to the Fluence family as I have been involved with the company since its creation and have been on the Fluence Board for the past year. For the past 23 years, I have served around the globe in different leadership roles for AES. Most recently, I was President of AES U.S. and global business lines. I have a keen interest and experience in growing renewable businesses. And I am proud to have led AES Europe when we introduced the first battery and energy storage projects there. I have a good understanding of the key issues for Fluence from my role as a director. Although I'm still getting up to speed on the details of Fluence day-to-day operations, at this time, I do not foresee any major changes to Fluence's strategy. I would like to share with you some high-level thoughts on key priorities. My overall objective is to drive increased shareholder value by focusing on achieving profitable growth and ensuring continued strong liquidity. I will do this through three initial areas of focus. First, our supply chains, where I intend to support our efforts to secure and diversify from whom and where we buy these, to transform this from a challenge currently to a competitive advantage in the future. The recent approval of the Inflation Reduction Act provides additional incentives on this front that we will work very hard to capture. Second, product roadmap. I want to ensure we have a clear strategy that can generate strong margins as it relates to our offerings. I would like to emphasize products that meet the growing demands of our customers, while also allowing us to capture healthy gross profit. A key element of this is to ensure that we have well-planned and implemented product rollouts. Third, Fluence digital. This is an area with tremendous potential, and I am committed to ensuring that it has the proper resources and structure. I've been involved in the selection process for the new Chief Digital Officer that Manuel will discuss later in the call. I am excited with my new responsibilities at Fluence. Its mission aligns with what motivates my professional life. The combination of a growing platform providing innovative solutions and value to shareholders, customers, and society makes it a unique place to work. I will do my best to contribute to the great mission of this company and fulfill the trust that the Fluence Board has bestowed upon me. I'd like to conclude by thanking my good friend, Manuel. We have been friends for more than 30 years and have worked together many times over our professional lives. Manuel's leadership has been fundamental in elevating Fluence to a strong and market-leading position. Manuel, you can be confident that I will do my best to continue the company's momentum. Additionally, I would like to thank all our employees across the world. Your continued devotion to Fluence is remarkable and inspiring. You are the cornerstone of the company and enable our success. I would also like to emphasize that maintaining a strong corporate culture that is centered around our values is critical, and you can expect me to support that as we continue our journey. I would now like to turn back the call to Manuel to discuss the quarter.

Thank you, Julian. Turning to the quarter. Today, I will provide an update of our business and share our preliminary views of the Inflation Reduction Act. Our CFO, Dennis Fehr, will then review our financial performance and guidance. Beginning with the key highlights of the quarter, I’m pleased to report that our team continued to make strong progress mitigating operational headwinds. As a result, we have improved our gross profit quarter-over-quarter and in line with our guidance. Additionally, we increased our cash balance for the second consecutive quarter, enhancing our balance sheet and ended the quarter with more than $760 million in cash. Looking now at our business performance, we delivered a solid quarter in line with our expectations. We generated $239 million in total revenue, and our gross profit improved from negative 4% in Q2 to negative 2% in Q3. Despite the expected challenges resulting from the COVID-driven lockdowns in China, we continue to make progress in reducing COVID and shipping-related impacts on our margin. Our backlog now stands at $2.1 billion, providing us strong visibility to future revenue. During the third quarter, we achieved solid order intake despite price increases, which highlights the unwavering demand for energy storage. Overall, we have now contracted more product megawatts through the first nine months of fiscal year 2022 than we did during the entire fiscal year 2021, which is evidence of the strong growth we are experiencing globally. In terms of new data contracts, Fluence IQ delivered another robust quarter; approximately 60% of the Q3 order intake was attributable to Nispera. We are pleased to have grown our market share with our recent acquisitions. On the regulatory front, we expect the US Inflation Reduction Act should provide significant upside to Fluence in the coming years. One of the key provisions of the bill is a 30% standalone storage investment tax credit. We also see other benefits resulting from the bill, which I will discuss shortly. As a reminder, our financial plans have not assumed these tax credits or other incentives. As we announced earlier this month, we have established a contract manufacturing location in Utah, which is expected to start production in late September. This will enable us to finalize assembly of our products here in the United States, closer to our customer sites. This will also allow us to avoid some of the supply chain issues we have encountered in other locations. More importantly, we expect to be able to capitalize on some of the incentives provided under the Inflation Reduction Act for our Utah facility. I'm excited to share that we have officially signed our joint venture with ReNew Power, a world-class IPP located in India. This partnership is a historic move for Fluence as it provides us with a strategic first mover advantage in this important and growing market. Additionally, we recently opened our India Technology Centre, which will allow us to drive research, innovation, and the development of energy storage in India. This launch underscores our commitment to the region as we execute our global product strategy and complements our joint venture with ReNew. Shifting to our digital business, I'm excited to announce we have hired Krishna Vanka as our new Chief Digital Officer. Krishna brings a high level of energy and experience to the team and has demonstrated a history of successfully building software businesses. Krishna most recently served as the Chief Product Officer of In-Charge Energy. We are thrilled to have someone of his caliber lead our Fluence digital team. Krishna will join us in a few weeks, and we'll hit the ground running. Staying with our digital business, I'm pleased to announce we have rebranded our bidding application as Fluence Mosaic. This wholesale energy and ancillary service bidding engine provides our customers with higher revenue, thanks to its optimization powered by artificial intelligence. Currently, Mosaic is available in the CAISO and Australian markets. Turning now to our view on climate change, we are encouraged by governments, including the United States, taking serious steps to address it. The Inflation Reduction Act represents one of the most significant and consequential pieces of economic policy in recent US history. There are several elements of the bill that will directly and indirectly benefit Fluence, including a 30% investment tax credit for standalone storage. The 30% tax credit will help spur investment decisions by customers and greenlight more projects, creating significantly more domestic demand for energy storage. We believe that the industry will see at least 20% growth in annual installations, thanks to the tax credit. This represents a significant opportunity for Fluence, both from a demand and profitability standpoint as a result of the boost to customer business cases. While we are pleased to see the tax credits for storage, there are other elements of the bill that provide significant upside for Fluence. Fluence had already positioned itself to capitalize on the bill by expanding its supply chain to include domestic contract manufacturing. Let me elaborate further. Section 48C of the bill discusses the extension of advanced energy project credits, now providing investment tax credits for projects that equip or expand manufacturing facilities that produce specified renewable energy equipment. This includes facilities that manufacture energy storage systems, electric grid modernization equipment, and their components. The provision carries a base credit of 6%, with an increased credit rate of up to 30% if prevailing wage and apprenticeship requirements are met. By opening a contract manufacturing facility in Utah, we will be able to benefit from provisions of Section 48C. We are encouraged by the support for domestic contract manufacturing at a time when that is a key aspect of our supply chain strategy. It is too early for us to quantify this potential benefit as we will need to see the IRS interpretation and guidelines first. As we have said before, our financial plan did not assume benefits from any tax provisions or incentives. Therefore, the IRA is pure upside. Now turning to our progress on mitigating various operational headwinds. I'm pleased to report we are seeing shipping rates plateau and in some cases, regress. Furthermore, we are starting to see the benefit of the relationships we have developed with multiple shipping companies. As a result, we are now seeing better terms and more optionality for our shipping partners. This is a welcome reprieve from the challenges we faced six months ago. I would like to emphasize that our margin improvement quarter-over-quarter was driven by reducing the adverse margin impact we have discussed on previous calls. We are confident in Julian's ability to continue our progress. I would now like to turn the call over to Dennis to review our financial performance.

Thank you, Manuel. Before I begin, I would like to express my gratitude to Manuel for his leadership and commitment to Fluence. Additionally, I'd like to extend a warm welcome to Julian. Julian and I have known each other since 2018, and I'm excited to continue our working relationship on a deeper level as we together strive to increase value for our shareholders. Now moving to our financial performance, we had a solid quarter in line with our expectations and previous guidance despite challenges we faced as a result of COVID lockdowns in China in Q2 and early Q3. We further improved our margins quarter-over-quarter, increasing the GAAP gross profit margin from negative 4% in Q2 to negative 2% in Q3 and turning to positive adjusted gross profit in Q3, thus demonstrating the successful execution of our improvement actions. The margin improvement quarter-over-quarter was driven by the reduction of the adverse margin impact we have discussed on previous calls. We have been successful in reducing these by about half for each quarter with the Q2 level being 43% of Q1 and Q3 48% of Q2. We are focused on ensuring this positive trend continues into the fourth quarter. During the third quarter, we were once again cash flow positive and added nearly $40 million to our cash balance, further bolstering our liquidity to more than $760 million. Finally, we are reaffirming our fiscal year 2022 revenue guidance of approximately $1.1 billion. This is predicated on seeing on-time arrival of products which are currently in transit and timely transfer of products to our customers. Turning to our order intake, despite price increases throughout fiscal year 2022, the 1,493 megawatts of new orders for the first three quarters combined already exceeds the 1,311 megawatts of new orders for the entire fiscal year 2021, demonstrating the growing demand for energy storage worldwide and the resilience of our customers' business cases. Additionally, we have done an excellent job diversifying our customer base. In fact, of the 1,493 megawatts that we've contracted during the first three quarters, more than 95% is from unrelated third parties. Services contracting continues to be pushed out, and therefore, the service attachment rate during Q3 was lower than we had hoped. We expect a similar catch-up event will occur in either Q4 or Q1 fiscal year '23, moving our aggregate attachment rate closer to our 70% high. Our digital business also performed well, with more than 800 megawatts of order intake, including Nispera. We now have nearly 17 gigawatts contracted or under management. Additionally, we saw significant growth in our digital pipeline, mostly attributable to the inclusion of Nispera in our metrics this quarter. We delivered a solid quarter in line with our expectations in terms of revenue, considering the recent challenges. The $239 million generated during the quarter represents a 14% decrease year-over-year, which is mostly attributable to revenue we accelerated in Q2 fiscal year '22 and the aforementioned COVID-driven lockdowns in China, which delayed shipments of our products into Q4 fiscal '22 and fiscal year '23. In addition to the solid revenue recognition in Q3, we made progress on our gross profit and gross margins. Our GAAP gross profit of negative $15 million in Q2 fiscal '22 improved approximately 67% to negative $5 million in Q3. On an adjusted basis, our gross profit improved from negative $11 million in Q2 to positive $2 million in Q3. Adjusted gross margin improved from negative 4% in Q2 to positive 0.7% in Q3. These gross profit improvements are driven mostly by a reduction of adverse margin impacts. As a management team, we are keenly focused on profitable growth while improving our profit margins as we grow with the market. We expect to see additional demand due to the Inflation Reduction Act, which will enhance the overall business case for energy storage and enable higher pricing for our products and services. While it is too early to quantify the expected margin upside as we await guidance from the IRS, we are positive about the direction this is moving. Looking at our cash position, I am pleased to report our total cash balance increased approximately $39 million to a total of $762 million. This increase in cash was due to strong collections from our customers, coupled with customer prepayments for certain contracts, partially offset by approximately $30 million for the Nispera acquisition. We continue to remain focused on our cash balance when we deploy our capital in line with our strategic framework. In line with our comments on the Q2 earnings call, we still expect that our cash balance will close around $500 million at the end of this fiscal year, with the majority of the decrease due to an expected working capital shift into the fourth quarter. Our strong cash balance enables us to position ourselves for the favorable long-term outlook for energy storage. As a management team, we're intensely focused on improving the bottom line and achieving adjusted EBITDA and cash flow breakeven in fiscal year '24. We continue to be bullish on the longer term and are excited about the prospects for our business. This concludes my prepared remarks. I will now turn the call back to Manuel.

Thank you, Dennis. It has been a pleasure working with you and the rest of the team for the past several years. I want to thank the Fluence Board for the opportunity to lead such an amazing company. I also want to thank the entire executive leadership team for their support. And most of all, I want to thank our Fluence employees for their dedication, passion, and energy. Without you, none of this would have been possible. This concludes my prepared remarks. I will now turn the call over to Lex.

Thank you, Manuel. We are about to start the Q&A session. Before we begin, I would like to note that while Julian is participating on our call, he is not yet a member of the management team. As such, he will not answer any questions today. All questions should be directed to Manuel, Dennis, and Rebecca. Operator, we are now ready to begin Q&A.

Our first question comes from Julien Dumoulin-Smith with Bank of America.

Maybe just to start off, first off here with Utah and just expanding a little bit on the relative economics pro forma for the IRA here. Can you elaborate a little bit more? I know in the remarks, you commented about Section 48, et cetera. But can you provide a little bit more meat on this one, if you will, around quantifying some of those benefits and sort of the NPV around IRA there? And then if you can follow that up with some of the commentary about just the scope and acceleration in '24. I know you said it was a little bit of a delayed impact on order book, but just quantify that a little bit more on what you expect in '24 as a consequence.

First is that, obviously, we need to get into more of the details of the new act. But certainly, this is great news. I'm very happy that we decided to go regional on the manufacturing a while ago. So we're much ahead of many of our competitors. We already have the facility in Utah. It's going to be up and running probably in a month. We see the benefits not just in the demand, better pricing, and opportunity for cross-selling, but the standalone tax rate for standalone energy storage. There's going to be significant improvements for our customers and all of those elements are very encouraging.

Got it. And I think the sound quality came through a little bit off on our side. Just if I can, just a quick follow-up here. With respect to the commentary on the guidance and predicating on-time arrival of products, and just you commented about needing to improve some quality of the items. What are you doing to diversify your suppliers to ensure execution?

So Julien, your question is primarily about supplier diversification, correct?

Again, I know there are a few different angles that you could speak to here just with respect to some of the challenges you face, but it seems like many of them are abating already, whether it's shipping or some of the Chinese considerations. But one of the other elements that you alluded to was substandard components, et cetera. Just what are you doing to mitigate that? How much could we see that impact here, or how could that manifest? And then more importantly, how do you mitigate that impact going into '23 here?

I think I'll answer it in three parts. One is supplier diversification of our major components. So as we consider our product roadmap and where we invest some of our R&D resources, it is, in fact, to ensure that we are capable of expanding that supplier diversity. So that's one way to handle it is to make sure that we have more than one choice. We would focus there mainly on batteries and inverters, which are target areas. That leads me to the second point, which is about batteries or supplier diversity—this is a major goal for us that we've talked to you about before. We've had a significant sort of session with eight battery OEMs, most of whom we have not worked with before. We are expanding beyond the OEMs that we currently do business with to additional OEMs. We have down-selected based on technical and quality features of those OEMs and we'll be pulling additional OEMs into the mix of our products moving into 2024 and 2025. When we talk about geographic diversity, the story continues to be the same. Most batteries are currently from China. By the end of 2023, around 30% of our battery supply will be from outside of China, from areas such as Europe and Korea. The third part of the answer is regarding specific quality issues. We have developed methodology to manage those supplier quality issues better. We just issued a press release about a systems test lab that we are putting in Pennsylvania right outside of Pittsburgh. A big part of the reason for that lab is to be able to test our products, test their components, and test their designs, both before launch and when out in the field so we can recreate issues and solve them quickly. That goes hand in hand with some supplier quality methodologies and processes that we've put in place over the last 12 months. So we have the processes and the facility to tackle these things more efficiently.

Our next question comes from Maheep Mandloi with Credit Suisse.

Just quickly on the IRS aspect, I mean just to dig deeper on that. How much capacity do you have planned in Utah? I mean just calculating on the 75 to 150 units per week—I calculate around 4 to 8 gigawatts, but is that correct? And how should we think about gigawatt hours, and does that $10 per kilowatt hour kind of apply to this, or is there anything else on the IRA we should expect from this?

So I think we really set ourselves up for, with the initial stage of the facility size, we can capture higher demand, which we have contemplated for calendar year '23. That means we are really utilizing 100% coverage out of that capacity with a flexible setup, which we can increase to over 10 gigawatt hours down the road. It's not that much of an effort to increase the capacity over time. The major step is making that first initiation, which has taken a while. The timing is excellent for launching that now with the IRA kicking in.

And I appreciate the color there. Just looking more on Slide 12, the margin upside from the IRA—you talked about that coming in FY '24. Is that the right way to think about it? I'm just trying to understand like this facility comes on in September, when can we expect that margin upside or pricing power from IRA for you guys in '23?

Let's keep in mind, we have two items under the IRA, the 30% ITC for standalone storage and then Section 48C. We believe the ITC standalone storage tax credit will create demand, which also will lift our margins. This is what we illustrated on the chart. The manufacturing side needs more details from the IRS in terms of how this will work. It's too early to quantify the margin upsides from the manufacturing benefits.

Our next question comes from David Peters with Wolfe Research.

First question I have is just on the order intake during the quarter, down versus what you guys did the previous quarter and even year-over-year for storage and services. Wondering what drove the softness this quarter particularly on the storage product side? And then just I think you said the services attach rate is kind of a timing issue, but I wanted to clarify that.

In general, we feel that this year is a little different than previous years. We typically would have seen very strong Q3 and Q4 in terms of contracting and revenue, but with everything going on in the market and macroeconomic and supply chain topics, this year is very different in terms of how quarters come together. I wouldn’t read too much into it, and would say that this was just an average quarter. On the services side, some customers are very keen to sign contracts when they also sign for products, while others may sign one to two months ahead of time, which explains the lower attachment rate during Q3. We expect a catch-up event either in Q4 or Q1 fiscal year '23.

Our next question comes from George Gianarikas with Canaccord Genuity.

I'd like to ask first about your gross margin targets. Have those still metrics changed since your IPO? Are the targets still viable at a steady state or has something changed structurally about the business?

Absolutely, these are the targets we are going after. The structuring that may have changed is with the IRA; that hasn’t been baked into our previous financial modeling. I would say especially on the product side, the growth targets remain clear. We expect to see in FY '23 low to mid-single digits, and during FY '24 high single digits, before considering any IRA upside.

In general, we have been receiving a lot of calls from customers. Many competitors had decided to slow down their participation. We became more selective in our customer base and markets we participate in; this helps us on the margin side. The fact that we haven't had any project cancellations and have been able to reprice contracts indicates our customer's loyalty and satisfaction. We feel very comfortable with prospects around the world. The market in Europe has seen strong demand, and the push for reshoring manufacturing will likely lead to additional demand.

Our last question comes from Craig Shere with Tuohy Brothers.

First, I'm trying to reconcile the guidance that we could end the force majeure possibly by the first quarter of fiscal '23 while still expecting tight battery and inverter market conditions. Looking in the mid-decade, do you see tight lithium battery market conditions accelerating interest in alternative technologies?

I think that solid-state battery technology is very interesting as it could significantly reduce overall costs while being more efficient. While there are options out there, to meet larger demand we need large-scale production capabilities. There are still discussions about other potential technologies like sodium batteries, but there is work to be done before they become viable. However, the bottleneck will likely be the existing infrastructure rather than battery technology itself.

In general, we see ongoing supply-demand imbalances as a positive driver for margin upside. However, it may elongate our revenue cycles. We have secured supply for fiscal year '23, and we are positioning ourselves well for the future.

There are no further questions. I would like to turn the call back over to Lex May for any closing remarks.

Thank you, Michelle. And thank you, everyone, for your participation in today's call. If you have further questions, please feel free to contact me. We look forward to talking with you again when we report our fourth quarter results. Have a good day.

This concludes the program. You may now disconnect.