QuantumScape Corp Q3 FY2022 Earnings Call

Good day, and welcome to QuantumScape’s Third Quarter 2022 Earnings Conference Call. John Saager, QuantumScape’s Head of Investor Relations, you may begin your conference.

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.

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 this 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 film. In addition, we've worked on several 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, frozen major design parameters, and are now ramping film production to enable larger volumes of sales to test and collect data on performance and quality. It's important to note that while we've 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. 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 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 progress 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 in the automotive sector. Additionally, 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 are pleased to report we've shipped dozens of zero externally applied pressure signal 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 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. 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.

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 to $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 toward 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 to $225 million. We continue to try to maximize capital efficiency at 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. We now expect to enter 2023 with over $1 billion in liquidity above previous guidance of over $950 million.

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 on your timeline this year?

So the impact was it required a cross-functional team to identify a root cause and fix the issue, all in a highly compressed schedule. The team was able to do all this while not giving up on the goal of delivering 24-layer cells by year-end, which we believe is 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. This does increase the degree of difficulty of achieving our A-sample goal on schedule. They also put more work ahead of us, even though we believe we have resolved the contaminant itself, because anytime you make a change like this, you have to validate the fixes you implement and that can take time. I should 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, we would already be on the market. So this is not the first time we faced a challenge like this, and I'm sure it won't be the last.

Okay, thanks. And 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?

So John, as we laid out in the shareholder letter, we have a plan that we're executing under which we believe it remains possible to deliver the 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 a normal issue comes up, it will present a challenge relative to the near-term timeline. Having said that, when we do deliver 24-layer cells, it will be a massive milestone.

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

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 there for spending: near term and long term, and we're exploring both. Near term on OpEx, things like flattening headcount growth relative to plan or interesting services we were previously outsourcing and given greater internal capabilities. On CapEx, it's looking at ways to be more efficient with our spend. An example we provided 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, substantial opportunities include evaluating 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. As our letter references, we are continuing to look for additional opportunities both near term and long term to reduce these cash expenditures.

Okay, thanks, Kevin. Our next series of questions comes from José Asumendi, of JP Morgan. He writes, when comparing the product development between automotive and consumer electronics products, what are the commonalities in product development or the synergies in the product learning curve for both products and end markets? What are the largest differences in terms of the end product, size of cells, charging time, charging discharge, intensity, cycle time, etc.? And do you foresee a larger chance to obtain commercial success earlier in consumer electronics products versus automotive? Or is it more or less the same? To summarize, he is really asking the three questions, what are their commonalities? What are the differences? And then what does the timeline look like?

Yes, this is a great question about the consumer market. So in most ways, the consumer electronics market has easier specifications than automotive. For example, the charge rates are lower, the operating temperature requirements are not as stringent, and their cycle counts are lower. So although those are good things, offsetting these benefits, I believe this application requires zero externally applied pressure because physical space is limited in most consumer devices. We believe this feature is hard to implement on 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. 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 add value in consumer electronics, and this is also why we believe we're seeing strong demand from 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. But this is also offset by the fact that it might provide a more direct and, as you point out, José, potentially earlier path to market. Relative to commonalities, what I would say is that many of the things we need to do, such as more efficient packaging, cathodes and so on apply to both markets. So we don't believe that serving this segment will take us far off our long-term metric.

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

Our first question comes from Chris Snyder with UBS. Your line is now open.

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

Yes. So 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. So there's not a single sort of test that covers all customers. The cells we reported on this summer were the very first 24-layer cells we built, and we were very pleased that we will be able to assemble them and get cycling results. But before we can deliver cells to customers, they need to have a much higher level of confidence in terms of performance and reliability. We have a process map for how we get there; that process involves design tweaks to improve performance and overall behavior. At some point, when we're ready to start making cells to ship, we run what's called a sampling campaign. That starts by freezing many of the key parameters of the design. Once we freeze the parameters, we can start ramping up production volumes of our separator films and cells. As we make more films, we then build more cells with those films and put those cells on tests. We try to test them under the same protocol that the customer will use to test the cells. Based on those test results, we assess whether we're ready to ship or not. Once we determine we're ready, we build cells for customers and will select the ones we want to ship based on the data generated from previous testing. That's the process, and our current stage is that we've frozen the major design parameters and are ramping up production to start building these cells to test internally.

We really appreciate that color regarding that process. I guess following up on potential tweaks to the parameters, would they come internally from QuantumScape as you're analyzing the test results and making tweaks, or could feedback from the customer after the A-sample checks also contribute?

Yes. Initially, this will be our own testing that will help determine whether changes are needed. Ideally, there are no tweaks at all; we freeze the design and it works exactly as it's supposed to. But usually, in the real world, you discover things as you start to make larger volumes. Once we ship cells to customers, they will test them in their labs and provide additional feedback. The hope is that the cells we deliver to them will work as advertised, and their feedback will be more about the longer-term maturity of the cells, such as the B-samples and C-samples.

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

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

Yes. The contaminant appeared in our separator film and our material. Our film is based on several precursors we obtain from suppliers. When our suppliers change the way they prepare their materials, those changes might improve the behavior of the materials but can also have side effects. Sometimes, we don't detect the side effects until we make films out of them, put them into cells, find issues, and then have to reverse engineer what changed. In this case, the team did an amazing job. This contaminant wasn't easily visible, so the team had to first identify that these issues were related to other contaminants in the film. They had to identify its chemical composition and then work with the supplier to reformulate the precursor material to eliminate the contaminant. They confirmed that reducing this contaminant delivered better performance. All of this work resulted in our timeline being tighter than we would have preferred, but our goal of shipping 24-layer cells this year remains intact, thanks to the team's efforts.

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

That's a great question. The decision will be based on operational aspects such as cost and availability of inputs, and quite relevantly, the prevalence and applicability of different incentive packages. The recently passed IRA establishes incentives in the U.S. for closed-loop domestic production to support a battery supply chain, which is something both teams are evaluating in that site selection decision.

Our next line of questions comes from the line of Lynn Jordan Levy with Truist Securities. Your line is now open.

Good afternoon, all. Thanks for taking my questions. Clearly, you're all taking a strategic approach to the pace of the process. Can you maybe talk to the importance of doing the comprehensive internal sample campaign you discussed? And what sort of flow-through that could have through the rest of the OEM qualification process?

Yes. This is an important point. At our stage, we must be very cognizant of the fact that A-cells and any samples we deliver to customers will potentially indicate lasting impressions. We just need to ensure a high probability that the cells we deliver work as advertised. We've developed this campaign methodology to ensure a relatively high level of product quality. Generally speaking, the product tends to work as expected, and that's the goal here. Once this A-sample is delivered, and the product works as intended, we will turn our attention to subsequent milestones, including the B-sample or C-samples. But for now, our immediate focus should remain on delivering the A-sample without getting distracted.

And just as a quick follow-up. You talked about the hybrid cell architecture. I was just wondering if that design introduces any additional considerations in your collaborations with the OEMs, or is this something that you address in later stages?

No, that's a good point. The design we outlined in the shareholder letter is in some ways a template. It shows the architecture and the cell's potential looks. Every OEM will have customized battery packs and therefore, customized needs concerning cell dimensions. We may take this architecture and implement it in different sizes to meet the various OEM module designs. These are relatively small changes that can continue to dimensions while maintaining the overall architecture. If an OEM has a brilliant idea or another way to package lithium metal cells while meeting the goals we laid out in the letter, like addressing lithium metal expansion, dissipating heat, and having an efficient manufacturing package, we would be open to that input. Based on our work, we see this design as an innovative way to meet all these requirements. Customers we've spoken to have provided encouraging feedback, recognizing that specifics may vary by the OEM's needs.

There are no additional questions at this time.

I just want to 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 the technology to market, and of course, our amazing team of incredibly talented and dedicated members for overcoming the high problems associated with bringing a new technology like ours to market. We look forward to reporting on further progress in the coming quarters.

And with that, we will conclude today's QuantumScape Corp third quarter 2022 earnings call. Thank you for your participation. You may now disconnect your lines.