Fluence Energy, Inc. (NASDAQ:FLNC) Q4 2022 Earnings Call Transcript

Fluence Energy, Inc. (NASDAQ:FLNC) Q4 2022 Earnings Call Transcript December 13, 2022

Operator: Good day, and thank you for standing by. Welcome to the Fluence Energy Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Lexington May, Vice President of Investor Relations. Please go ahead.

Lexington May: Thank you. Good morning, and welcome to Fluence Energy’s fourth quarter 2022 earnings conference call. A copy of our earnings presentation, press release and supplementary metric 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 Web site at fluenceenergy.com. Joining me on this morning’s call are Julian Nebreda, our President and Chief Executive Officer; Manu Sial, our Chief Financial Officer; and Rebecca Boll, our Chief Product Officer. During the course of this call, Fluence management may make certain forward-looking statements regarding various matters relating to our business and company that are not historical facts.

Such statements are based upon the current expectations and certain assumptions and are, therefore, subject to certain risks and uncertainties. Many factors could cause actual results to differ materially. Please refer to our SEC filings for our forward-looking statements and for more information regarding certain risks and uncertainties that could impact our future results. You are cautioned to not place undue reliance on these forward-looking statements, which speak only as of today. Also, please note that the company undertakes no duty to update or revise forward-looking statements for new information. This call will also reference non-GAAP measures that we view as important in assessing the performance of our business. A reconciliation of these non-GAAP measures to the most comparable GAAP measures is available in our earnings materials on the company’s Investor Relations Web site.

Following our prepared comments, we will conduct a question-and-answer session with our team. During this time to give more participants an opportunity to speak on this call, please limit yourself to one initial question and one follow-up. Thank you very much. I’ll now turn the call over to Julian.

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Julian Nebreda: Thank you, Lex. I’d like to extend a warm welcome to our investors, analysts and employees who are participating on today’s call. Additionally, I would like to welcome Manu Sial, our new CFO. Manu joined us in September and has already made a significant impact on the organization in a short period of time. Welcome, Manu. Today, I will provide a brief update on our business and then review our strategic objectives, as well as some examples of the actions we’ve already taken towards these goals. Following my remarks, Manu will discuss our financial performance, as well as our outlook for fiscal year €˜23. Starting on Slide 4 with the key highlights of the fourth quarter, I’m pleased to report that our team recognized $442 million of revenue during the quarter, delivering our highest quarterly revenue in Fluence’s history and deploying more than 1 gigawatt hour of energy storage solutions.

More importantly, we achieved positive gross margins for the quarter, both on an adjusted and GAAP basis. Our demand was strong across all three of our business lines and new orders were approximately $560 million. Furthermore, our signed contract backlog as of September 30 was $2.2 billion, a year-to-year increase of around 30%. Lastly, our recurring revenue businesses, which consists of our services and digital businesses experienced strong growth in the quarter. Notably, our services attachment rate of 119% for the fourth quarter was in line with our expectations, illustrating the catch up in service contracting, we anticipated during our previous earnings call. Our digital business added nearly 1 gigawatt of assets under management since the third quarter, providing us visibility to future revenue.

Turning to Slide 5. Over the past 90 days, the senior management team and I have conducted a deep dive of our business. During this deep dive, we reaffirmed those aspects of the business that are working well and identified several areas that have significant upside potential but need some work. We confirmed that Fluence’s Energy storage solution business has tremendous tailwinds across the globe, including from the Inflation Reduction Act in the United States, also known as IRA, and Europe is growing desire for increased energy security and independence. Although, our digital business has strong potential, they have determined that the platform and business model would benefit from simplification and tighter integration with our storage solutions business.

For example, our current Mosaic product is not able to expand into new markets quickly due to its current tech architecture that will be addressed. Going forward, we will concentrate on accelerating the integration of our offerings, including digital and services with our storage in order to serve customers, with an end-to-end bundled solution. Concentrating on executing and strengthening our risk management capabilities to ensure we monetize our contracting margins. Additionally, we are simplifying our digital platform and retooling our go-to-market strategy in order to increase the scale of both Mosaic and Nispera and to roll out these products more quickly and at a lower cost. Furthermore, we will convert our supply chain into a competitive advantage by leveraging our size and scale to drive margin and support for easier implementation of solutions.

I’ll provide more color on each of these initiatives in a few minutes. After meetings with hundreds of our Fluence people in the past 90 days and I’m confident in our ability to maintain our leadership position in the market, deliver multiyear profitable revenue growth rates of more than 30% and we adjusted EBITDA breakeven in fiscal year ’24. I believe our team’s tenure passion and resilience will set Fluence for long-term success, unlocking significant value for our customers and shareholders. Turning to Slide 6. Coming out on this process, I’m bearing an even more complete that our strategy of using our ecosystem provide energy store solution to our customers is the right one. Our ecosystem gives us access to the largest energy infrastructure providers in the world and importantly, it provides opportunities to further integrate with our customers at any point of the value chain.

Our revised go-to-market approach is simple, we will utilize one sales channel for our entire ecosystem. This is different from our past, where we will use multiple cell channels across our business organization. This turned out to be an ineffective strategy when it comes to attaching our services and digital solutions to an energy storage sale. An integrated sales channel will give us a better ability to integrate our customers into our ecosystem. As we have seen our digital software is valuable beyond its own P&L contribution, as it supports hardware and services creating a flywheel effect of value. Additionally, we will work to integrate our technology more closely, so our digital offerings, interface with our storage solutions, seamlessly thus increasing the attractiveness to our customers of choosing bundle solutions.

Our ability to offer an integrated, energy storage solutions, one of the key reasons our customers select us. We’re increasingly recognized as one of the premier energy solutions providers in the world by large multinational developers, or IPPs, many of which are planning on deploying significant amounts of gigawatts. The integration of these offerings is a key tool in retaining customers beyond day one sales. So we can access them anywhere along the value chain. We have visibility to multiyear high revenue growth rates. We operate with an asset lite business model with high returns on invested capital. We have significant technical dept which helps us to monetize data and help our customers drive returns. We also have a rapidly improving cost structure with high revenue per employee.

And ultimately, we believe we have a business model and strategy set of up for success. Turning to Slide 7. I would like to discuss the five strategic objectives that will provide the framework for the actions we will be taking over the next few years. First, we will deliver profitable growth. Both profitability and growth are essential to maximizing shareholder value. We will focus on those market segment that provide continuous growth and where our complex solutions allow us to maximize profitability. Second, we will develop the products and solutions that our customers’ needs. Understanding our customers’ challenges is the driving force behind our continuous technological advancement. We expect to provide customers with the most sought-after solutions rooted in our industry leading experience.

Third, we will convert our supply chain into a competitive advantage. We’re establishing a best-in-class supply chain that is centered around diversifying our suppliers, capturing incentives from the IRA and improving the delivery times for our solutions, all of which will ultimately increase margins and drive value for our customers. Fourth, we will use Fluence Digital as a competitive differentiator and a margin driver. Harnessing is the power of artificial intelligence and machine learning and our integrated solutions, we can uniquely provide our customers with the ability to both maximize their revenues and lower their overall cost ownership. This will increase visibility into our growing and profitable recurring revenue stream. And finally, our fifth objective is to work better.

This starts with being disciplined with our capital spending and contract underwriting, optimizing and using our resources efficiently and a strong corporate risk management capabilities, controlling our costs and maximizing our financial performance for our shareholders. We have already taken actions towards these objectives, some of which I would like to highlight. Turning to Slide 8. I’m pleased to announce, we’re launching a new energy storage solution, geared towards the transmission segment. We are calling it the Fluence Ultrastack. The transmission segment is a growing market that currently sits at 450 megawatts, which we expect will grow to 17 gigawatts by 2030.We expect demand for this product will be driven by our customers’ need to reduce transmission congestion resulting from growth in distributed energy resources.

Furthermore, the transmission segment is highly complex and requires the bast performance and highest safety features, thus creating a barrier to entry in the market some of which are proprietary. More importantly, higher complexity commands a higher premium for our products and services and often results in higher margins. We will continue to lean into the transmission segment as we deliver profitable growth and develop new products and solutions that our customer needs. Turning to Slide 9. I’m pleased to report we’ve recently signed a contract for more than $500 million with Orsted, under which we will deliver 1.2 gigawatt hour energy storage facility in the United States complete with our Gen 6 Gridstack solution. By further increasing our scale, we’ll be able to better capture value from our supply chain.

We also note that Orsted selected us as they were looking for a trusted partner with strong experience, delivering complex solutions. As a comprehensive solutions provider, we continue to outpace our competition due to our scale, industry-leading experience and our ability to solve highly complex problems. We’re quickly establishing ourselves as a leader among the mega project segment. Turning to Slide 10. Including the Orsted contract, which was signed to subsequent to our fiscal year-end, our backlog now sits at more than $2.5 billion. This highlights the strong demand we’re seeing at the top of our funnel, that is now providing us greater uncertainty with respect to our multiyear revenue up. Looking at the chart, you can see that even before any impacts from the IRA, we have a pipeline that is nearly 3 times our current backlog.

It is also important to note that we’re expanding our sales to non1-related parties and as a result, a majority of our backlog today is with this customer segment. Turning now to Slide 11. As we mentioned earlier, we are experiencing tremendous tailwinds from the Inflation Reduction Act. BNEF has estimated that the TAM for energy storage increased by more than 100 gigawatt hours or around $35 billion as a result of the IRA. That is a significant. The expected ITC improves overall project returns for customer, this benefit is expected to accrue to us through improved pricing power or increased volumes. Furthermore, the production tax credit provides margin uplift for Fluence from capturing benefits associated with manufacturing our own battery.

It’s also important to note that the IRA benefits are not necessary for achieving our adjusted EBITDA breakeven target in fiscal year ’24 and thus represent upside potential. We currently see the IRA impacting Fluence through in three areas. The first is the ITC for standalone storage. This benefit accrues to our customers and we expect it will incentivize more projects to move forward and to green light other projects that were previously not economic for our customers. As a result, we anticipate the U.S. market growth to increase from 30% per year to around 40% to 50% per year. Based on our conversations with customers, we expect to enter into the first of these contracts attributable to the IRA about mid-calendar year ’23. We would expect to see the impact on our financial results in the second half of ’24.

Second, the production tax credit under Section 45X of the IRA provides significant opportunities for Fluence, as we’re launching our own battery module manufacturing, which I’ll discuss further shortly. As a result, we expect to qualify for the $10 per kilowatt hour incentive from the IRA. It’s important to note that this is an uncapped incentive and carriers a direct pay option. As a reminder, we opened our Utah production facility in September, which will have an expected cube output of nearly 6 gigawatt hours per year by ’24. We expect we’ll be able to begin battery module production starting in the summer of €˜24, thus capturing the $10 per kilowatt hour incentive. The PTC further supports our mid-teens gross margin target. And third, Section 48C provides for the onetime reimbursement for onshoring or establishing qualifying manufacturing facilities in the U.S. As a result, we’re currently looking at the possibility of expanding our operations in the U.S. with an additional facility.

Turning to Slide 12. I’m pleased to announce that we’re launching our own battery module and battery pack manufacturing at our new Utah facility. This gives us greater control over the global supply chain and allows us to capitalize on the incentive under the IRA. One of the key benefit to the Fluence Battery Pack that it is easier to incorporate new cells and diversifying our cells supplier base creating competition at a cell level. Our Battery Pack makes it easier to swap packs in and out of new product variants. It also allows us to incorporate our own battery management system technology with more granular data access and system controls and it expands Fluence’s battery intelligence capabilities. We expect to see initial battery module production coming out of our Utah facility during the summer of ’24.

Looking at Slide 13. We further illustrate our supply chain and how our battery module and battery pack fit together. Starting on the left-hand side, we will continue to purchase battery cells from multiple battery manufacturers. Battery cells by themselves are useless and to a great extent a commodity. We take those battery cells and integrate them into our battery modules complete with our own battery management system or BMS. Thus, we’re taking those commoditized battery cells and turning them into smart batteries capable of performing the tasks in our solutions demand. These battery modules will qualify for the $10 per kilowatt incentive under the IRA. We then put several battery modules together to make a battery pack that is combined with our DCPM, which is a the brain of the pack system.

This DCPM collects battery data for communication with the Fluence operating system and it’s a point of contact for a cloud-based digital solutions, providing value-added integration for our customer. Turning now to Slide 14. As I briefly mentioned earlier, we have assessed our digital business and have refocused the model and go-to-market strategy. Now I’d like to discuss what this means for Fluence Digital and where we’re going. First, we ensure we’re offering an integrated and holistic end-to-end bundled solution to our customers through one sales channel. As I mentioned, this is a major change for our prior sales efforts. Second, we will simplify our suite of digital offerings by focusing on our existing two applications, Fluence Mosaic and Nispera.

We plan to roll out Mosaic to four additional U.S. markets over the next three years and improve the ability of Nispera to integrate with battery based energy storage system. By taking a more focused approach, we expect to reduce the cost complexity and time to market for these application. We do not plan to build out any additional applications at this time. Third, we’re accelerating the Nispera platforms ability to be deployed onto battery energy storage systems by the end of this year. Thus enabling our new bundled solutions to be more integrated with our batteries. What do we expect to achieve a result of these actions? Improved attachment rates for services and digital through a bundled approach, increased annual recurring revenue or ARR of our digital and services business; a low rate of customer churn though I would note that our churn rate is already very low.

Going forward, starting later in this fiscal year 2023, we will report our progress these initiatives by disclosing the relevant KPIs. We expect that this retooling will have a relative small investment of $5 million to $10 million. As it relates to the financial outlook for our digital business, we do not expect meaningful contributions from our digital business in ’23 or ’24. We expect to have positive gross margin in fiscal year ’23 and onwards and expect adjusted EBITDA to be at/or near breakeven in fiscal year ’25. Moving to Slide 15, we’re enhancing our India Technology segment, increasing utilization through a workforce optimization that will augment roles in India in 2023 to the benefit of our onshore overhead. This contributes to our operating numbers, with our operating expenses expected to grow at less than half the rate of revenue growth which Manu will explain further.

Turning to Slide 16 for a summary of recent action. As a management team, we’re committed to delivering and increased shareholder value and to executing the five strategic objectives that I have discussed as the foundation of our plan. We will provide you with quarterly updates on our progress towards strategic objectives as we transform the way we operate and price drive our sustainable returns. Overall, we continue to see strong demand that is expected to be amplifying by the core IRA build that will start adding to our backlog in mid-€˜23. We are committed to breaking even on an adjusted EBITDA basis in fiscal year ’24 as we enter into higher margin contracts. We’re committed to improving our project execution and our overall risk management.

I’m pleased with the early results of our efforts, but there is still work to be done. As we move forward, we will continue to focus on executing a high growth, capital-light solution business model and expect to make Fluence the optimal investment vehicle in our sector. That being said, I will now turn the call over to Manu.

Manavendra Sial: Thank you, Julian. Before I begin I would like to express my gratitude to Julian and the Fluence’s Board for their confidence and trust in me. The last couple of months have been a period of rapid learning for me. I continue to believe that Fluence is positioned well to take advantage of, as untapped dam that was enhanced by the Inflation Reduction Act by more than $35 billion. My focus is to strengthen the organizational foundation to enable profitable growth, and this includes enhancing our deal underwriting, risk management and execution capabilities. Let me now review the financial performance for the fourth quarter of 2022. Please turn to Slide 18. In the fourth quarter, we delivered our highest ever quarter with $442 million in revenue, representing an increase of 85% from the third quarter.

This record revenue generation was primarily driven by strong project execution as several projects achieved significant milestones. We also achieved positive gross margins in the fourth quarter, 3% on an adjusted basis and 2% on a GAAP basis, driven by strong revenue performance and improvement in our ability to pass through to the customer increases its certain input and supply chain costs. This is a significant turning point for us. And while 2022 was a challenging year, we ended the fourth quarter with positive gross profit and believe that issues confronted are well understood and now largely behind us. Compared to 2022, we expect new contract margins in 2023 will be positively impacted improvements in a deal underwriting process, such as implementation of index-based pricing.

We’ve also improved execution on product rollout, including leveraging our lab to test and de-bug solutions before we launch them in the field. Moving from gross profit to operating expense. We improved our operating leverage in the fourth quarter 2022 by lowering our operating expense as a percentage of revenue compared to prior quarter and prior year. Our operating expense can be divided into two categories: the first is SG&A spend, which is a required amount of overhead spend to operate our business, both at corporate and at the regional level. We do not expect that corporate OpEx will scale with the growth of the business. The second area of spend is what we refer to as platform investments, which represents primarily R&D spend, which we view as a type of growth CapEx. Full year 2022 operating spend was 15.5% of revenue, which we expect will be a high annual watermark.

Looking at 2023 and beyond, although we expect to continue to grow our operating expense in absolute dollar terms, but we expect it to grow at a rate less than half of the rate of our revenue growth. We expect this operating leverage to be one of the drivers of the improvement in adjusted EBITDA we see over the next few years. In the interest of greater transparency, this quarter, we have begun providing a supplemental quarterly metric sheet on our Investor Relations website that is designed to provide analysts and investors with a deeper understanding of our financial and operating performance. Please turn to Slide 19. I’m pleased to report that we ended 2022 with total cash of $540 million, which includes our short-term investments and restricted cash and is in line with what we have guided.

As shown on this cash bridge, a majority of our cash usage in 2022 was driven by negative adjusted EBITDA, that trend is expected to continue in fiscal year 2023. Let me also provide some color on the other drivers of our 2023 cash outlook. We expect to incur modest CapEx spend, including for our digital business retooling. In addition, as we did in 2022, we will use some operating cash in 2023 at a rate of roughly 10% of our year-on-year revenue growth. We believe that we have ample liquidity to meet our 2023 cash needs. Please turn to Slide 20. We are initiating guidance for fiscal year 2023, a total revenue of between $1.4 billion and $1.7 billion. Additionally, we expect our adjusted gross profit to be between $60 million and $100 million.

We are coming into 2023 with approximately 90% of expected revenue at the midpoint of our fiscal year 2023 guidance already in our backlog. We have also secured additional supply chain commitments for 2023. This gives us confidence in our revenue guidance. On the next slide, I will provide additional color on why we are confident of achieving our 2023 adjusted gross profit guidance. Please note that our guidance does not assume any financial benefit from the Inflation Reduction Act as we see — as we expect to see order growth in 2023 with a benefit to sales partly mostly in 2024 and beyond. In terms of revenue seasonality, we expect to see a split of approximately 40% in the first half and 60% in the second half. Furthermore, we expect operating expense to grow at less than 50% of our revenue growth, providing a significant operating leverage.

As Julian mentioned, we’ll be utilizing our India Technology Center more, enabling us to scale at a much lower cost. Please turn to Slide 21, where I’ll walk you through key drivers of our 2023 adjusted gross profit guidance when compared to 2022 actuals. We’re confident in our 2023 adjusted gross profit guidance of $60 million to $100 million, driven by improved contract underwriting and execution. This reflects a combination of signing new contracts at margins that are at or close to double-digit, an improvement compared to the past, our ability to recoup some of the increase in our supply chain costs and improved execution. I would note that we expect our exit 2023 gross margin run rate to be higher than the full year 2022 margin rates as our legacy contracts as completion and new deals start to have a larger impact on them.

Before we open the call for questions, I want to reiterate that we have visibility to achieve 2024 breakeven adjusted EBITDA as well as multiyear 30% plus revenue growth and are positioned to take advantage of the upside from the Inflation Reduction Act. With that, we will open the call for questions.

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Julian Nebreda: Good morning. This is Julian. I want to apologize for the way the sound work, it looks like my voice accent did not mix very well with the mic and the biggest . So in order to correct this, Lex will be sending — we will be posting our script on the website to ensure that we already have access to it, and Lex will sent it by e-mail to his content all of it. And we will be open, if you have any questions on the script later on after this you will — you can send — contact Lex directly. Let me tell you this before we start, which I think is important. The quality of the requirement was an inverse proportion to the quality of the message. So unfortunately, it did not come through, but it was in direct — or indirect proportion just quite the opposite.

So going to quick Q&A. And I’m really apologize for that, it won’t happen again. We’re testing and you might that does not fix well when my voice and accents. So we start, operator, if you want to open it for questions, please, Q&A.

Q&A Session

Operator: Thank you. Our first question comes from James West with Evercore ISI. Your line is open.

James West: Hey. Good morning, Julian and Manu.

Julian Nebreda: Good morning, James.

James West: Julian, as you’ve stepped into your leadership role here at Fluence, you’re focused much more on profitable growth and profit being, of course, the keen were there. Has your bidding strategy changed? Obviously, there’s a huge amount of growth in the business itself, but have you adjusted kind of the way the company bids on projects?

Julian Nebreda: What we have done, James, this is a question we get all the time, James that we segmented the market. It’s in more detail to identify where we — which market segments and geographies we could actually aim for our 10 or double-digit margins. So every time we engage with a new customer or engage in a new project, we know that customers, business case will allow and the value we’re creating, we’re allowed for our profit objectives to read which, so that’s how our work — we have been working on. We also — the addition of Manavendra leadership we have put in place a new contract review process internally to ensure not only that, that we reach our double-digit margins, but also that the risk profile of the projects we entered into a reason, we will allow us to monetize the full margin.

So now we have worked generally, we have — it means that we have dropped some segments on or at least we’re not very active in those segment or at the end of the day, has allow us to keep our volumes and reach or offset our profit objective as we move forward.

James West: Okay. Makes sense. And then another key differentiator with your strategy is more focused on the digital aspects of the business? And could you maybe highlight is that a lot of internal kind of R&D and maximizing what you have or are you looking at external kind of M&A opportunities as well?

Julian Nebreda: What we want to do now we’re kind of integrated, I think the work that we looked at is integration. So while we’re integrating the sales channel that is — that requires training and some investments, some capability impact. We are integrating our OAS and our operating systems with our digital offerings. And that’s not that there will be one, but they will communicate more effectively. And so our customers will have a seem less experience when they buy our hardware solutions than they may hire our digital solution as a second. And then we’re working, and that’s where the R&D comes in, is on improving the platform of Mosaic. I guess it’s normal in the SaaS business but we really — we need to invest to ensure that we can actually continue expanding that project at a lower cost point and a lower complexity point, so we can do this much cheaper and much faster.

In terms of M&A, we are not planning to do M&A. We’re going to on constant — not plan, I’ll tell you until when. But for now, what we will do, we will concentrate on our runoff. These are — we believe these are the two territories that are the most attractive today where the business cases are very, very clear and that coincides with our market segments. And as we move over, we are able to reach our breakeven point for our digital business in ’25, we will then look at well, we should develop other apps. But I think that at the end of the day, we will look at us that are based on our commercial capabilities, that our ag that are our customers can use and can monitor. Part of the problem is some of the apps we had before is that they were connected with customer segments where we’re not there.

So we have been put in place a new sales channel and additional fixed cost that we think that is not a good idea at this time.

James West: Okay. Yes. Thanks, Julian

Julian Nebreda: Right. Thank you, James.