ADBE - Enovix: The AI Megatrend Needs A Better Battery

2023-07-28 09:12:25 ET

Summary

• Enovix Corporation produced 25% more units in Fab-1 in Q2 2023, highlighting the continued operational improvements made in the quarter.
• The company received a purchase order from the U.S. Army, grew its revenue funnel to $1.59 billion, and established smartphone engagements with Lenovo, Xiaomi and Vivo in the quarter.
• Management stated that they are on track to start Factory Acceptance Testing next month, and subsequently, to start battery sample production from the first Gen2 Autoline starting April 2024.
• With the growing demand for AI, Enovix's value proposition improves significantly, as its customers are seeing Enovix's batteries as necessary for their future product roadmaps.
• After reviewing the Q2 2023 report, I am raising my intrinsic value and price targets for ENVX stock given the improving fundamentals of the company.

Enovix Corporation ( ENVX ) recently reported its Q2 2023 results .

After reviewing the quarter, I do appreciate what the management has achieved in the quarter, having not just beaten its own production target, brought in a purchase order from the U.S. army, added to the revenue funnel, lowered capital expenditure requirements for the year, and continued to strengthen the quality and calibre of the team that will enable Enovix to scale up.

Enovix Q2 2023 Earnings Review

In 2Q23 , Enovix produced 22,502 units, 25% more than its own target of 18,000. This was a result of continued operational improvements in Fab-1.

The near-term financials of the company are not meaningful, as they do not represent scaled production given that Enovix is so early in its development stage, but I summarize the key financial figures below.

The total revenue in Q2 2023 was $42,000, which came from shipping of 10,000 cells. The gross margin for the quarter was around 67%, generating $28,000 in gross profits. Operating expenses came in at $38 million, lower than the $51 million from the prior quarter.

Exiting Q2 2023, Enovix has $409 million in cash on its balance sheet .

Commercialization

I think the message for commercialization in the second quarter of 2022 is that Enovix is making progress with advancing customer qualifications and also attracting new engagements.

Enovix currently has $737 million for the bottom of its funnel which are the closest to revenue, which it names "Active Designs and Design Wins." This is about 10% higher than when compared to in 4Q22.

The total revenue funnel increased to $1.59 billion, up 9% from $1.46 billion in the prior quarter as a result of its customer opportunities growing 14% sequentially to 121.

During the quarter, Enovix announced that it received a purchase order for BrakeFlow-enabled cells for the U.S. army. This is for the production of commercial cells by Enovix for use for the U.S. army's soldier central power source, also known as the Conformal Wearable Battery ("CWB"). The Enovix cells will be used to build pre-production CWB packs at the end of the year, with more details on this in the manufacturing section. I think this order highlights the quality, reliability and the value add the Enovix battery technology brings and will certainly contribute meaningfully to the company's own high volume production plans.

I think the company is looking for global opportunities, as evident from the agreements with Japan's Elematec and South Korean Semicomtech in the quarter.

During the second quarter of 2023, CEO Raj Talluri also made his first trip to Asia after becoming CEO of the company. He got to meet with smartphone and smartwatch customers and also shared that Enovix has established smartphone engagements with leading OEMs Xiaomi, Vivo, and Lenovo.

With these programs starting with leading OEMs, this will enable Enovix to get into the finer details about how they can design the battery to suit the unique needs of these customers and the planning of its manufacturing capacity.

In particular, I found it very useful commentary from Raj during the Q2 2023 quarter about the strong interest from these customers for an advanced battery. This is what Raj said in the Q2 2023 earnings call :

Now, this point actually was further solidified to me recently when I was in Asia, and I was visiting all these customers and I talked to them about Enovix battery and asked that is there a way we can actually start working with them on this?

And the interest level I saw from them for advanced battery was amazing to see because they also know that AI moves to the Edge into phones, into laptops into wearable devices. You just need a better battery because the next generation used cases, it's very hard to support them with the current used cases.

I will explain further in a later section about the huge tailwind that the AI trend is bringing to an advanced battery player like Enovix, but the key message here is I think we will see an acceleration in the progress of these interests into actual production as more customers realize the strong value proposition of Enovix batteries.

Manufacturing

In terms of manufacturing, the company is on track to start Factory Acceptance Testing next month and eventually to start battery sample production from the first Gen2 Autoline starting April 2024 and subsequently high-volume production in 2024.

Also, during the quarter, more than 20 process, product and equipment engineers who will be working in Fab-2 in Malaysia went through training in Fab-1 in Fremont. They will then go back to Asia later in 2023 to oversee the Factory Acceptance Testing and subsequently, Site Acceptance Testing in Malaysia.

Also, Enovix remains on track for the installation of its Agility Line by the end of 2023 for customer qualification of custom battery programs. Guidance and outlook

In terms of the third quarter 2023 guidance, Enovix expects production of 36,000 units as a result of the continued operational improvements in Fab-1. The company plans to make as many small cells needed for the commercial launches of its customers for the remainder of 2023 and also deliver to customers the needed cells for qualifications. On top of that, the team is focused on higher value opportunities that they have recently come across from larger cells as well as the interest in BrakeFlow, that is gathering interest from the US army and other customers.

For the U.S. army order includes pre-production cells that will be put into early prototypes that will deliver $600,000 revenue to Enovix, mostly in the fourth quarter of 2023. This is just the early stage of what I think will be a very significant business in the long-term, with the real opportunity being in the multiple tens of millions of dollars in the long-term.

Enovix delivered wonderful news in terms of its cash forecasts, as it is reducing its total full year cash used guidance for 2023 from $240 million to $190 million. This mostly comes from its capital expenditure forecast, as they are reducing this from $120 million to $70 million as a result of the first Gen2 Autoline being covered by local funding in Malaysia as a result of the YBS transaction.

Enovix entered into a manufacturing agreement with YBS and thus, YBS will be its assembly subcontractor and YBS is financing $70 million for the first Gen2 Autoline and the funding is obtained from OCBC Bank. Enovix has also already hired the necessary talent and leaders in Malaysia and its Fab-2 site will be in Penang Science Park.

After the Factory Acceptance Testing in South Korea and Site Acceptance Testing in Malaysia, Enovix expects to deliver the first samples produced from Gen2 Autoline 1 by April of 2024.

A better battery needed for the new AI age

One of the key emphases by CEO Raj Talluri was that Enovix's value proposition is ever more prominent today as the recent focus on the AI mega trend takes off.

While there are lots of investments being made into AI to bring about better sensors, processors, memories and more, one of the key improvements that is necessary for AI to fulfill its true potential is to have a much better battery than what is in the market today.

For CEO Raj Talluri, he said that the increased battery requirements needed by AI is literally why he joined Enovix, given he has a Ph.D in Computer Vision and AI. Given that there is demand for things like generative AI applications to be run on a battery-operated device such as a smartphone or laptop, AI and edge will require a breakthrough in our battery technology.

I think what is amazing is that Raj did not just talk about the need for a better battery, but also got the Enovix team to do multiple tests to show how much more battery power generative AI applications require.

First, Raj asked his team to test how much battery power is needed to run stable diffusion, which is essentially a text-to-image generation program. The team found that after 68 minutes of running the program, the laptop ran out of battery. However, when running it on the cloud, while you can go on for 11 hours, there are other issues to it as well, including costs and privacy.

Second, Raj also highlighted that when running Adobe's ( ADBE ) AI-powered noise filter, it required 30 times more battery than the standard non-AI powered noise filter.

I think that Raj really made a compelling point about how the battery technology today of our battery-operated devices is insufficient for the AI and edge future that we are moving towards. Smartphone and laptop OEMs recognize this and are increasingly looking for that differentiating battery that will deliver better performance and experience for its users.

Unique value proposition delivers premium price and higher margins

I do think that Enovix deserves a premium and its customers are willing to pay a premium for Enovix batteries because of the better performance that Enovix batteries enable for their own end customers. Furthermore, if customers require a breakthrough in battery technology and there is only one unique player that is able to ensure that batteries no longer become the bottleneck or barrier to high performance for AI and edge, I think that these customers will be willing to pay that premium for the technology.

Raj highlighted that he has seen in his career in semiconductors that the price of processors that goes into phones went from $15 to $65 because end consumers valued the better user experience that comes in the form of built-in cameras in their phones, phones that delivered great video, audio and provide GPS capabilities. At the end of the day, the smartphone OEMs were willing to pay more for these processors because it improved the user experience and customers wanted that better user experience and are willing to pay for it.

For Enovix, the premium that it commands comes from the unique battery technology that brings not just unrivalled battery energy density, but also better charge rates, safety and others, which I have mentioned in my deep dive .

Furthermore, I know that Raj and the team are super focused on understanding what their customer needs are, what are the key parameters they are working with. I think Raj has the perfect mentality when it comes to this because he appears to understand that when his customers win, Enovix also win.

All in all, Enovix delivers improved battery technology that enables its customers to take advantage of that technology to bring better products to the market. For the better performance characteristics in the battery, end users and customers will be willing to pay a premium for it, and thus, Enovix will command a premium and earn healthier margins that competitors.

Retirement of Ralph Schmitt and new CFO

It was announced in the second quarter earnings call that Ralph Schmitt, Enovix's current Chief Commercial Officer has chosen to retire.

In terms of the reason for his retirement, it seems like it has to do with health issues, as I will quote what he mentioned in the earnings call:

So for me, it's a difficult decision to leave, but sometimes kind of life throws things your way and I sort of need to stop and prioritize my health at this point.

Ralph Schmitt has been one of the key members of the management team in Enovix, as he was essentially the one leading the team to set up the commercialization engine that Enovix has today over the past two years.

He has worked with TJ Rodgers for more than 15 years as he was also involved in the ramping up of Cypress and SunPower, so clearly, he is seen as a highly capable and trusted man for the job by TJ Rodgers.

In terms of the future prospects of Enovix, Ralph Schmitt had this to say about the business opportunity Enovix has:

But Enovix has been the most exciting business opportunity that I've had in my career, and frankly, I've run some pretty interesting tech companies, but I believe there's just amazing opportunity here. The team that I have put together has positively, I think impacted the long-term prospects of the company, but I've never been involved in a business situation where there's an insatiable demand for product that has a clear market leadership, and we're engaged with every market leader in the consumer world.

As a result of the retirement of Ralph Schmitt, Enovix 's commercialization team continues to be in good hands, with Samira Naraghi as Vice President of Product Management and Dave Cech as Vice President of Sales, both of which has worked with Raj prior to this.

Dave recently joined Enovix from Qualcomm ( QCOM ), and needless to say, he was hired for the job in Enovix because Enovix CEO Raj Talluri thinks highly of him and worked with him before in Qualcomm. Even Ralph Schmitt had high praises for Dave Cech, as he has known Dave for 20 years and said that Dave is known for his stellar business acumen and customer engagements.

Enovix also announced the hiring of Farhan Ahmand as Chief Financial Officer . Farhan is a seasoned operator in Micron ( MU ) and someone Raj has worked with before as well.

Farhan sees the large addressable market opportunity, breakthrough innovation as key differentiating factors for Enovix.

In addition, he believes that Enovix can command a premium price and deliver strong margins, as I alluded to earlier.

I wanted to share one sentence that Farhan shared in the earnings call about his goals for his CFO position in Enovix:

But at a high level, I aim for Enovix to be a careful steward of shareholder cash and to make the investments to grow this into a great business that delivers strong growth and attractive margin profile.

I think this demonstrates the quality CFO that Farhan strives to be, and I am confident about Farhan as a member of the key management team in Enovix.

ENVX Stock Valuation

I am raising my intrinsic value estimates for Enovix after adjusting some of my assumptions, which can be found in my service.

In addition, I am also raising my 1-year price target for Enovix.

These price targets are based on a discounted cash flow ("DCF") model discounted to 2024F.

My 1-year price target is raised to $22.65, which implies 22% upside potential.

Conclusion

This earnings review article was certainly longer than usual.

With a company like Enovix so early in its development stage and poised for strong growth, the financials itself matter less than the progress the company is making as well as the continued evidence that there is strong demand for its products, progress in manufacturing, and that the company is transitioning well towards scaled and high-volume production.

I continue to be positive on Enovix after this quarter's results and the management team has exceeded my expectations once again.

My previous price targets and intrinsic values were calculated in February 2023, and so much has changed for the company since then.

My 1-year price target is raised to $22.65, which implies 22% upside potential for Enovix Corporation.

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