GWH - ESS Technology: A Disappointing Second Quarter

2023-08-10 16:57:00 ET

Summary

• ESS Technology just reported record revenues of $2.8mm and the transition to conventional accounting in the upcoming 3Q.
• The company reported a warranty reserve charge that eclipses its entire cumulative revenue since its SPAC merger two years ago.
• I'm enthusiastic about the technology but nervous about the stock price and am moving from a buy back to a hold.

ESS Tech ( GWH ) reported second quarter earnings on August 8. This report was a mixture of great news and terrible news. While I remain positive on the technology, my nervousness about the company h as moved me from a Buy in July back to a Hold on the stock .

Background on the company. ESS went public via a SPAC merger two years ago. Their product is a containerized battery suitable for grid use to balance peak usage, and store renewable production for consumption when the wind isn't blowing or the sun isn't shining. Unlike the market leading technology for grid batteries, the lithium ion chemistry "LiON", ESS makes an iron and salt flow battery. This chemistry is much less toxic than lithium ion and is far more environmentally friendly vis a vis extraction of the base components. Ultimately this technology should prove cheaper than LiON.

Peppy Positives. As mentioned above, the earnings call had some dramatic positives and equally dramatic negatives. Here are some of the positives:

• record quarterly revenue of $2.8mm
• A dramatic decrease in deferred revenue of $2.095 million from the year end $8.61 million.
• the company announced they will transition to normal accounting from R&D accounting by the end of the third quarter. Under R&D accounting there is no visibility on margins and inventories as everything is expensed. This has made it very difficult to model projections or understand their position relative to other public energy storage companies.
• contracts from this point forward will record revenue when the unit is shipped or placed at the site of use. This lifts a cloud from revenue recognition, which has been a riddle analysts have asked about on each earnings call.
• the company announced their build time is down by 29%
• the company announced their commissioning time is down 70%
• the company announced their flagship Energy Warehouse product will be gross margin profitable in the second half of the year.
• cash and equivalents were just shy of $100 million
• a good overview presentation was published.

Gloomy Negatives. Salted in with the positives were an overwhelming number of negatives:

• $37.5 million of net cash was used for operating activities for the six months, or almost $19 million per quarter. At this rate the company will be out of cash in five quarters.
• The company reported Accrued Product Warranty of $5.1 million, up $3.6 million since year end. There was no discussion of this on the earnings call and no analyst questions about it.
• The warranty accrual is after recording cash replacement expense (see note 8 of the 10k and Note 5 of the 10Q financials )of $2.031million for the last 18 months. And this is a huge percentage of reported revenue for the last 18 months of $4.091 million.
• The flip side of decreased commissioning time, listed in the positives, is that it is still 3 weeks. I believe this compares poorly with competing LiON technology.
• The overview presentation mentioned above includes a slide on the upcoming Energy Center product which is much larger than the current Energy Warehouse. No cost model or cost reasoning for a customer to switch to this product have been mentioned on this or any other call.

Transparency. The company continues to claim confidentiality agreements prevent it from commenting on previous installations. Fortunately Google Earth Pro continues to put out timestamped images of the SDG&E ( SRE ) Cameron Corners microgrid like this pair of images:

[Authors note: The two northernmost units, painted with an "S" and "D", are missing one year later, in the second image.]

Since publicly available images show 2 units now missing from the company's largest, and one of its earliest, installations, shouldn't Sempra or ESS provide some comment? Doesn't the company owe shareholders regular updates on the approximate 46 EW units they have press released in the past?

An opportunity missed to discuss the Energy Center. The company presented a conceptual image of its future Energy Center in an investor presentation of August 2021 which unfortunately has disappeared from its archived presentations. Here's that picture:

And here's the picture from the new overview just posted:

Why has the company decided to stack expensive containers? Why has the earlier concept of a cheap utility building and external tanks, all easily accessible at ground level, disappeared? Who knows?

But the real point is yet another earnings call and the next day's presentation have missed an opportunity to present the compelling advantages of this next product offering. Today's existing Energy Warehouse is in a 40' container that contains a 5000 gallon electrolyte tank and delivers, typically, 75kw/500kwh. And we know from the 3Q earnings call that a unit of that size is priced at around $189,000 or $378/kwh. Some of the real magic of this technology is that to increase the number of kwh, one merely adds pretty plain vanilla poly tanks that can be had for $5000 per 5000 gallon tank. So conceptually a 3,000kwh Energy Center would need 25,000 gallons of additional tanks or $25,000. When added to the known price of an Energy Warehouse and divided by kwh of this larger capacity, one gets $71/kwh, just 19% or today's offering.

Without changing the power electronics this 3000kwh/75kw would be a 40 hour battery. This discharge time is beyond the design of the current electrochemical stack that sits between the two electrolytes, but I believe is readily achievable. 40 hour discharge life is also beyond the sweet spot most customers are focused on at present. If a 300kw inverter was substituted , this would become a 3000kwh/300kw = 10 hour battery, well within the specs of the current stack. This cost would still be only $96/kwh, or 25% of today's EW offering. By comparison, this link from April puts the cost of the leading technology, the 3.9Mwh Tesla ( TSLA ) Megapack at $482/kwh. And you'd only have to wait 2 years, which ESS would happily beat.

This larger format battery is the type announced utility customers like LEAG, SDG&E sub of Sempra, Consumers Energy ( CME ), Portland General Electric ( POR ), and SMUD want to install, not today's offering of an Energy Warehouse. Its the one investors and customers need to hear about in terms of its significant potential cost reduction. I believe it is very competitive with LiON technology which has no such cheap scale advantage. This takes no technological leap, just larger tanks.

Conclusions. While this earnings call unveiled some strong positives and the technology is very promising, the enormous cash burn and continued lack of transparency are great concerns. I'm back to a hold. I will re-evaluate a return to a buy with better transparency, a shift to normal accounting, a solution to the burn rate in relationship to cash balances, and more installations.

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