Fluence Energy Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 10, 2023

There are 13 speakers on the call.

Operator

A reminder, today's call is being recorded. I would now like to turn the call over to your host, Mr. Lex May, Vice President of Investor Relations. Please go ahead.

Speaker 1

Thank you. Good morning, and welcome to Fluence Energy's Q3 2023 earnings conference call. A copy of our earnings presentation, press release and supplementary metric sheet 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 atfluenceenergy.com. Joining me on this morning's call are Julian Nobreda, our President and Chief Executive Officer Manu Sial, our Chief Financial Officer and Rebecca Bull, our Chief Products Officer. During the course of this call, Fluent's management may make certain forward looking statements regarding various matters relating to our business and company That are not historical facts.

Speaker 1

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, which we view as important in assessing the performance of our business.

Speaker 1

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, Thank you very much. I'll now turn the call over to Julian.

Speaker 2

Thank you, Lex. I would like to send a warm welcome to our investors, analysts and employees who are participating on today's call. This morning, I will provide a brief update on our business and then review our progress on our strategic objectives. Following my remarks, Manu will discuss our financial performance for the Q3 as well as our outlook for the rest of the fiscal year. Starting on Slide 4 with the key highlights.

Speaker 2

I'm pleased to report that in the quarter we recognized $536,000,000 of revenue. We continue to experience strong demand as new orders were approximately $565,000,000 Highlighted by our solution business contracting 1.4 gigawatt hours and our digital business adding nearly 1 gigawatt of new contracts. Furthermore, our signed contract backlog as of June 30 increased to $2,900,000,000 Turning to adjusted gross profit. We delivered $24,000,000 or a margin of approximately 4.4% for the quarter. This is slightly lower than the Q2 level of 4.6%, primarily because of one project that experienced delayed from a non core supplier.

Speaker 2

This was an isolated incident, which should not hinder us from our expectation of achieving double digit gross profit margins in Q4. Lastly, our services and digital business, which represent the sum of our recurring businesses, continue to see traction. Our deployed service attachment rate, which is based on our cumulative active service contract, relative to our deployed storage Remains above 90%. As we have noted previously, we typically see a lag between signing solution contracts And entering into a service contract, which is why we believe that cumulative attachment rate is a better metric. Turning to our digital business.

Speaker 2

We had a very strong quarter as we were able to contract nearly 1 gigawatt. However, our digital assets under management at the end of the 3rd quarter was slightly lower than the 2nd quarter level as a result of a customer not renewing its contract with us. This slight decline will be more than offset as a new contract not yet deployed Move from our digital backlog to our digital assets under management. While we don't like losing customers, The non renewal is within our expected 5% rate for churn or customer attrition. Our low churn rates Highlights the general stickiness of our customer base.

Speaker 2

Overall, we still have a lot of work to do regarding our digital business, Well, we're on track to deliver on our commitments. Turning to Slide 5, I'd like to discuss the 5 strategic objectives that we highlighted previously I'll provide you with an update on our progress. 1st, on delivering profitable growth. I'm pleased to that we are raising our fiscal year 2023 guidance for both revenue and adjusted gross profit. As Manu will discuss in more detail, We're able to raise our guidance due to better project execution, thanks in a large part to our supply change improvement.

Speaker 2

Additionally, we are reaffirming our expectations that we will be close to adjusted EBITDA breakeven in our fiscal 4th quarter. 2nd, we will continue to develop products and solutions that our customers need. As such, I'm pleased to report that we signed a 400 megawatt hour contract that will utilize Northwell batteries. This is a significant milestone. This will mark our first major project that will utilize European manufactured batteries And illustrates our commitment to diversifying our supply chain.

Speaker 2

3rd, we will convert our supply chains into a competitive advantage. I'm pleased to say that we have signed a U. S. Sales supply agreement with ASC, under which we will procure U. S.

Speaker 2

Manufactured battery cell. This is a tremendous achievement for us as we believe this will position Fluence to be one of the first companies to provide customers With a storage product that qualifies for the 10% investment tax credit bonus under the IRA domestic content rules. This contract provides us access to the limited early U. S. Sales supply and give us a 1st mover advantage, which position us As I mentioned previously, this agreement supports our domestic module manufacturing, For which we expect we will capture the incentive of $10 per kilowatt hour, which I will touch on more shortly.

Speaker 2

4, we will use Fluence Digital as a competitive differentiator and a margin driver. I'm pleased to report that we continue to make progress on our NISPERA product roadmap. This quarter, we launched an artificial intelligence based predictive maintenance tool, Our first artificial intelligence tool for battery storage on the Nispera platform. I will also discuss this in more detail momentarily. And finally, our 5th objective is to work better.

Speaker 2

I'm proud to state that Fluent has increased its total cash position By more than $30,000,000 from the 2nd quarter level, further bolstering our liquidity. Our total cash includes cash, cash equivalents, restricted cash and short term investments. Turning to Slide 6. Demand for energy storage continues to accelerate. In fact, our pipeline now sits at 12,400,000,000 Which is an increase of more than $1,000,000,000 from last quarter.

Speaker 2

Additionally, as I mentioned, we saw our backlog increase to approximately 2,900,000,000 We expect to see some initial project awards in the second half of this calendar year that are directly attributed to the inflation reduction. As such, we reaffirm our belief that consolidated revenue growth will be between 35% to 40% In fiscal year 2024 relative to our increased revenue guidance for fiscal year 2020 3. Turning to Slide 7. As I mentioned earlier, we have secured an offtake agreement with ASC for U. S.-made battery cells.

Speaker 2

This agreement strengthens our capacity to offer customers a storage product that we expect to qualify for the additional 10% Investment tax credit, a bonus granted to products complying with the prescribed criteria for domestic content under the IRA. We expect the 1st U. S. Sales to be delivered in calendar year in calendar Q4 of 2024. Additionally, we're still on track to begin manufacturing our battery modules at our facility in Utah in the summer of 2024.

Speaker 2

We know that the battery modules we produce starting in the summer of 2024 should qualify for the $10 per kilowatt hour incentive And we'll support the offering of a product compliant with the IRA's domestic content requirements upon the integration of U. S. Manufacturer sales In Q4 of 2024. In regard to our U. S.

Speaker 2

Module manufacturing, we do not expect That we will capture incremental margin as a result of manufacturing our own modules in the U. S. Instead, we expect the $10 per kilowatt hour Incentive will go towards offsetting the cost of reaching economies of scale. From an accounting standpoint, Our current expectation is that we will account for the $10 per kilowatt hour incentive on our income statement as a reduction to cost of goods and services. Furthermore, we expect to elect the direct pay provision for the 1st 5 years of the credit.

Speaker 2

The exact timing of the cash payment is expected to lag our accounting recognition. Thus, we expect it to be in conjunction with our federal income tax With respect to the U. S. Manufacturer product, we're exploring whether our first mover advantage We'll allow us to share some of the benefits our customers will enjoy from our offering and thus provide us with incremental margin. It's too early to define a concrete view.

Speaker 2

But as the situation evolves, we will provide more color on this potential upside. As you may have seen earlier this summer, the U. S. Treasury Department released its domestic content regulation. Overall, we're pleased to see the regulations.

Speaker 2

However, there are still outstanding questions that we're hoping the IRS will clarify by the end of the calendar year. Turning to Slide 8. I'm pleased to announce we recently launched an artificial intelligence based predictive maintenance feature for battery and air storage as part of our Inspira offering. This is our first Inspira artificial intelligence based feature, following the success of the AI capabilities in our Mosaic Billing application. The Spera AI based predictive maintenance feature is an advanced solution designed to upgrade the performance and reliability of of any storage systems.

Speaker 2

By harnessing the power of artificial intelligence models, this cutting edge technology prioritizes And acts upon the storage performance issues, thereby significantly reducing downtime and ensuring our interrupted power supply. From a customer standpoint, the AI based predictive maintenance feature offered by Nispera will provide numerous benefits, including Minimize downtime, significant maintenance cost savings, enhance asset reliability, optimize maintenance scheduling and improve safety. I'm pleased to say that we've deployed this solution onto its first project in California. More importantly, This feature provides another tangible proof point that we're on track with our digital business commitments, which we say will not be meaningful before 2025. In conclusion, I'm pleased with the achievement of the 3rd quarter.

Speaker 2

Although we're mindful there's still work to be done, We will look to continue this momentum as we progress through the remainder of the year. I will now turn the call over to Manu.

Speaker 3

Thank you, William. I will begin by reviewing our financial performance for the Q3 and then discuss our guidance for fiscal year 2023. Please turn to Slide 10. Our 3rd quarter revenue was $536,000,000 124% above prior year. We continue to execute well as we work through our legacy backlog, which accounted for more than half of our revenue in the 3rd quarter.

Speaker 3

As we alluded to on our last call, 3rd quarter had a larger impact from the roll off of our remaining legacy contracts Dan, we expect to occur in the Q4. We continue to anticipate majority of our low margin legacy backlog We'll be turned over by the end of this fiscal year, though as I've indicated previously, a small portion will bleed into fiscal year 2024. We generated approximately $24,000,000 of adjusted gross profit in the 3rd quarter, Which was an adjusted gross margin of 4.4%, slightly lower than the 2nd quarter level. As Julian mentioned, the driver of the decline was one specific legacy project that incurred delays driven by a non core supplier. More importantly, for the Q4, we expect our margin to be about 10%, which reflects an increased weighting of the higher quality, higher margin orders that we have recently signed relative to prior years And expect this to be a good proxy for the expected margins in fiscal 2024.

Speaker 3

3rd quarter operating expense, Excluding stock compensation was $54,000,000 or approximately 10% of revenue, which is lower than prior quarter in absolute term, Though up just slightly as a percentage of revenue, we remain disciplined about holding our operating expense growth to less than 50% of revenue growth and expect this model to create operating leverage in 2023 and beyond. This is also reflected in the year to date 3rd quarter operating expense as a percentage of revenue, which is 10.9%, Down from 17.2% in year to date Q3 2022. Turning to our cash balance. I'm pleased to report we ended the 3rd quarter with $416,000,000 of total cash, Including short term investments and restricted cash. This represents an increase of more than $30,000,000 from the 2nd quarter.

Speaker 3

Rounding out the balance sheet discussion and in line with previous communication, we saw a decrease in inventory of Approximately $250,000,000 in the 3rd quarter relative to the second and continue to see improvements in inventory turns. This, coupled with improved collections, drove the increase in our cash balance. In addition, We ended the Q3 with $165,000,000 of undrawn revolver capacity and $80,000,000 of unused Supply chain financing providing us additional sources of liquidity. Please turn to Slide 11. I'm pleased to report we have increased and narrowed our fiscal year 2023 guidance ranges for both revenue And adjusted gross profit, we now expect our total revenue to be between $2,000,000,000 $2,100,000,000 Which is up from our previous revenue guidance of $1,850,000,000 to $2,000,000,000 As Julian indicated, we are maintaining our outlook for 35% to 40% revenue growth in 2024 Despite the higher 2023 revenue guide, as we continue to benefit from growing demand and strong supply chain assurance, Though we expect roughly 75% of 2024 revenue to be generated in the second half of the fiscal year Based on the current contract schedules we are seeing, we have all of 2024 battery supply secured And the continued improvements in our supply chain position also helped support incremental increase in 2023 revenue guidance Compared to prior estimate.

Speaker 3

We have also narrowed our guidance for adjusted gross profit to be between $170,000,000 And $132,000,000 which implies a slight increase at the midpoint from our previous guidance of $110,000,000 $135,000,000 As we have indicated on our Q2 conference call, we expect to be close to adjusted EBITDA breakeven In the Q4 2023, as we focus on achieving adjusted EBITDA profitability for fiscal year 2024 and beyond, We intend to provide formal guidance for fiscal 2024 for both revenue and adjusted EBITDA on our next earnings call, While continuing to provide transparency of other key operating and modeling assumptions. From a cash standpoint, We expect our 4th quarter total cash levels to be near breakeven and we believe we have ample liquidity to meet our 2024 revenue targets. Please note that our U. S. Battery cell supply agreement currently calls For a down payment of $150,000,000 to reserve this capacity, which will be paid in installments over fiscal year 2024 And fiscal year 2025 and will be funded by our liquidity and customer deposits for these batteries.

Speaker 3

The first $35,000,000 will be paid in the Q1 of fiscal year 2024 and another $35,000,000 will be paid In the Q2 of fiscal year 2024. Before I turn the call back to Julian for final comments, I would like to reiterate That we continue to see strong demand, which is reflected in the significant growth of our pipeline, which gives us confidence That we will be close to adjusted EBITDA breakeven in the 4th quarter and generate positive adjusted EBITDA in 2024. With that, I will turn the call back to Julio.

Speaker 2

Thank you, Manu. In closing, I would like to reiterate what I consider to be the Key takeaways from this quarter results. First, we had a solid quarter in terms of our financial performance, clearing out much of our legacy Low margin contracts, while generating cash and raising our guidance yet again. We have also reiterated our expectations That we will be close to adjusted EBITDA breakeven in our Q4. 2nd, we have taken steps to secure our future By locking up our fiscal year 2020 4 battery supply as well as locking up early domestic battery cell production, providing us a clear first mover advantage.

Speaker 2

3rd, we launched our new AI based feature for Nispera to help provide our customers with additional tools necessary To lower the total cost of ownership. This concludes my prepared remarks. Operator, we're now ready to take questions.

Operator

Thank you. One moment for our first question. Our first question comes from the line of James West of Evercore ISI. Your line is open.

Speaker 2

Good morning, James. How are you? Good morning. How are you?

Speaker 4

I'm doing well, Julian. How are you?

Speaker 2

Doing well. Very happy today.

Speaker 4

I'm sure you are. It's a good quarter and the outlook looks very strong. I'm curious as we've had IRA guidance Provided now, and we obviously know, you and I know the demand drivers here for Energy storage, has there been any net change in that demand either up or Probably up or down, but probably up with pure guidance out there For the U. S. And then how are you guys thinking about also the European markets as they Start to figure out the green industrial plan that they've put out there.

Speaker 2

In terms of the U. S, I don't think we have seen a major movement since the guidelines came out. So is it in line with what we said, that For our total demand, 35 to 40 and that's what we're guiding revenue for next year. And the U. S, a little bit higher than that.

Speaker 2

For Europeans, we do we are seeing some a little the markets being a lot more, I would say, moving a lot. So where are First, Germany, I think. Germany was a market where it was incipient. Now we see a lot more activity. And then the Nordic countries is another group where we are seeing now a lot more demand.

Speaker 2

I don't think this is enough today To go for a review in our 35 to 40, but good signs, especially Germany being such a big economy. I'm sure it's going to be a competitive market, so it will be a fun ride for us, but that might be a meaningful. But That's kind of where we are. I think we're very confident about 35% to 40% for next year and positive that we will see demand getting better. The other one we're seeing, sorry, that I maybe is Canada, which was something that I think I talked about with some of you before.

Speaker 2

We start seeing demand in Canada, mostly in Ontario. And that has been very, very that's also very, I think, meaningful And it could be a huge market. And that proves a point, I think, that if I can make maybe a little bit of an add. As you know, the Canada electric system has a lot of hydro power. And a lot of people when they see hydro power, they don't see A need for battery storage.

Speaker 2

And our view is that reservoirs do their jobs. Our job is Completely different. We provide services to the grid to ensure stability, to move capacity faster or fast response, To provide black SARTs, these are things that not necessarily reservoirs can do. So it really proves a point That even hydro systems or systems that have a lot of hydro capacity need battery storage to ensure that they can You know, add up to a new power sector landscape.

Speaker 4

Okay. That's very interesting. Thanks for that, Julio. And then a question on the Naspersa, the adoption of Naspersa. How is that You put much more emphasis last couple of quarters on that, the adoption rate on the software side of the business.

Speaker 4

How is that progressing?

Speaker 2

We signed like around 1 giga. It was mostly Nispera. We have some that Mosaic there. And it's doing very well. I think the fact that we have The first integrated portfolio management, asset performance management tool That covers all the renewal technologies, storage, wind, solar.

Speaker 2

Really makes a difference and Really helpful. So we're very, very happy with the U. S. I think this new tool that we just announced, the maintenance tool, just the beginning. No, this one is based on temperature readings, but there's both the charge, state of charge.

Speaker 2

There's a lot more The batteries are very, very rich in data. So there's a lot of value we will create by harnessing that data and convert it into Information that our customers can use to manage our systems a lot better.

Speaker 4

Got it. Thanks, Julian.

Speaker 2

Great. Thanks, Jim. Thanks, Jim.

Operator

Thank you. One moment, please. Our next question comes from the line of Brian Lee of Goldman Sachs. Your line is open.

Speaker 5

Hey guys, good morning. Thanks for taking the questions. Kudos on the solid execution here again.

Speaker 2

Yes. Good morning, Brian. How are you? Hey, Brian.

Speaker 5

Good, good. Thank you. Question, I guess, on margins. It's a high quality problem to have, but you seem to have gotten through a lot of the backlog that had some of the lower margin less Profitable projects Q4 guide or I guess the annual guide here for the rest of the year implies Q4 is going to be somewhere in the like 11% range, if my math is right. So I know you're talking more about like 10% for 24 And you're going to give us more of an official view here in the next quarter, but what are kind of some of the puts and takes between the 10% 15% Long term guide and then mapping that to 2024 given you're sort of at a good exit rate Here for 23, and it seems like a lot of those legacy projects are now off the books or mostly off the books.

Speaker 2

Yes. No problem, I will take it.

Speaker 3

Yes, absolutely. So, Brian, there's a lot to unpack in your question. So let me go take it piece by piece. So I think Just from how to think about the 24 margins, we are signing contracts in the 10% to 15% margin range And that is still the case. And but the Q4 margin is a good proxy for how to think about 24 margins, right?

Speaker 3

And then as we have a little bit more contribution from our services business and our digital business maybe ticks up a little bit, but Q4 is a good For 'twenty four and that will continue to increase as we go from 'twenty four to 'twenty five. So that's one. In terms of legacy, you're right, we are done with Most of our legacy projects, I think there's about $100,000,000 to $150,000,000 that trickles into $24,000,000 mostly done in the first half of the year. So As you do the quarterly profiling in the calculus of 24 margins, keep that in mind. And then you're right, the business is performing really well.

Speaker 3

I would want to point out the fact that, one, we've been fairly disciplined from an overhead perspective. That's important because as we turn the page to 24, the focus is going to be a lot on EBITDA dollars, right? That Is a better measure of profitability than gross margin or gross margin percent. And I think that's what we want the investor community to be focused on. And that's reflected in our comments that we get close to EBITDA breakeven in the current quarter or in the Q4.

Speaker 3

And then I'll round up my comments from a cash perspective. We generated cash in the Q3. My comments talk about cash breakeven in the 4th quarter, which means we will generate cash in the back half of the year. So that is another area we are focused on. So EBITDA and cash becomes much more relevant than gross margin and gross margin percent.

Speaker 3

My last comment Before I pass it on back to you is, we've been very pleased with the performance of the business. And what that's got us is, it's got us To be a Vixi enabled, so Vixi is well known seasoned issuer. And we intend to file a universal shelf tomorrow after the market Good housekeeping. And that's really reflective of the confidence that the shareholders have Placed in our business that allows us to be a VIXENA.

Speaker 2

My only comment on the filing is that we do not intend to raise we have no plans to raise Capital in any way for 2024. We don't need it and but I think this is just for housekeeping.

Speaker 3

Yes. And that's consistent with the comment that We had it in my script.

Speaker 1

Great. Okay. Yes, fair enough.

Speaker 5

No, I appreciate all that additional color. I guess second question shifting to maybe the top line here. I know even with the Pull forward, it seems like you had here and being able to raise the 23% guidance, you're comfortable with the 35% to 40% growth Trajectory into 2024. Can you maybe give us a sense of how much of that is just additional demand Bookings activity you're comfortable with heading into next year and how much of that is maybe Conversion timelines, it seems like some of those are maybe pulling in a little bit. If you can provide a little bit more color around that, and then I'll pass it on.

Speaker 5

Thanks, guys.

Speaker 2

Yes. I think we are kind of the way I will maybe phrase it is that when you looked at our backlog And you looked at our 2024 revenue. We're covered right in line with where we were last year. So we feel very, very confident that For what the backlog that we will convert in 2024 is what we will do this quarter and next, that we will be More than enough to meet the 35 to 40. So we feel very, very confident about it.

Speaker 2

So We will provide you exactly how much of our $24,000,000 of our revenue is covered by backlog In our next earnings call, we will provide guidance on 2024. So I don't want to get ahead of ourselves, but we are in a similar position to where we were last year, No, when we were doing this year's planning process. So And that sounds

Speaker 3

great. I appreciate.

Speaker 2

Our plan is to provide guidance on 2024 in the next earnings call in late November.

Operator

Thank you. One moment please. Our next question comes from the line of Justin Clare of Roth. Your line is open.

Speaker 6

Yes. Hi, everyone. Thanks for taking the questions.

Speaker 2

Hey, Justin. How are you? I'm

Speaker 6

doing well. I wanted to ask you about a project timeline. So this quarter you increased the revenue guide again here. And So I was wondering if you're seeing project timelines further compress. I think you were at around 18 months A little while back here, but things have been trending lower.

Speaker 6

So where are timelines today? And do you see a path To continuing to shorten the time lines potentially to a time frame of 12 months, say?

Speaker 2

In general, we don't see timelines compressing. So we're I think that As we looked our financial planning, we see still projects around the 18 months that we told you. This is a line that we want to work on, and I think there's something there's work to be done. Clearly, There are 2 drivers for this. 1 is supply chain and the lead times we need for our supply chains to deliver the products on time.

Speaker 2

And the other one is ensuring that our customers are ready with their infrastructure. So Between the 2, I think that today, I think we can work with supply chains to accelerate it. There are customers. We can also help them to extend, but there's a limit to that. But today what we have is an 18 month plan.

Speaker 2

I mean, I think it hasn't gotten any better.

Speaker 6

Got it. Okay. And then just want to ask also about your U. S. Manufacturing.

Speaker 6

You signed an agreement here with AEC. How much of that agreement really covers your need for U. S. Sales? Does that cover all of your anticipated U.

Speaker 6

S. Sales supply or are you looking for additional suppliers potentially? And then also maybe if you could just speak more broadly about the Plan for potentially expanding your capacity footprints in the U. S. I think your plan is 6 gigawatt hours In fiscal 2024, how should we think about potentially moving above that?

Speaker 2

Yes. I think that in terms of we believe this deal which is signed will We believe that the U. S. Market will there will be a competition between U. S.

Speaker 2

Manufactured sales and imported sales, and we will be working on both sides of that fence. So but we believe that what we have is enough for our expected demand for the next years. Sorry, your second question, if you don't mind repeating your thing, I don't know if I got it. Sorry, on module manufacturing, sorry. On module manufacturing, we are we build this plan with the ability to Increase the output if we want for the module manufacturing, we most likely depends on how it goes, we can very, very quickly This is a we can double the production very, very quickly, even maybe triple it.

Speaker 2

So we are But we will see how it goes and then make decisions around that. So that's

Speaker 6

how we're going to be

Speaker 2

looking at that.

Speaker 6

Okay. Thanks very much.

Operator

Thank you. One moment please. Our next question comes from the line of Julien Dolan Smith of Bank of America. Your line is open.

Speaker 2

Good morning, Julien. How are you?

Speaker 6

Hey, Julien. It's actually Alex Braidwood for Julien. Yes, Alex, how are you? Thank you for taking the question. I'm well.

Speaker 6

Thank you. Listen, keeping on the theme on sort of the U. S. Piece here, congrats on the AASC, I guess, announcement. Let me ask you this.

Speaker 6

How sustainable of an advantage do

Speaker 2

you think that this is?

Speaker 6

Is there any sort of, I guess, value wedge that you think you can create there relative To pricing and where you're able to get those batteries? And then I'm not sure if you mentioned it, but are those raw material indexed? I know that you have some sort of indexation on some of the other contracts. Just curious as far as you guys having an early mover advantage, if you could elaborate on that a little bit?

Speaker 2

Yes. I mean, I'll tell you talking to customers, what I hear from them is that we are the only ones offering this, We're the only ones talking to them about these words. So that's my view. How long of an How far away are the other suppliers? I don't know.

Speaker 2

We you hear different things from different people. Some people say that they do not believe that the U. S. Battery manufacturer will be competitive. I disagree and we disagree and we think we'll show it to them.

Speaker 2

I will see how long how far away are them. I think that it will be in my opinion, it will be very simple. Once they see that we're here, that we can do and that we can offer a project that's very competitive that we can put the U. S. Flag on top of that, it really Well, they can see that.

Speaker 2

I'll see them trying to copy it. And they'll probably be a few years a couple of years behind. It's difficult to know. Clearly, people don't announce I haven't seen any announcements. And what I hear from my customers that nobody is talking about this.

Speaker 2

But That's what I can how much a I guess your second question goes to a can we capture higher margin on this or the second part of Well, we believe that you can. We have to, but we're just starting doing this conversation with our customers and this is A plan that is a little bit complex. It's very difficult to give a concrete view of where we see that happen. But we do see that our customers are going to get a significant Upside and we should share part of it with them as we are delivering this to them. It will also for sure what I would like to say, for sure it will convert into higher volume.

Speaker 2

And that because as I said earlier, We will work on both offering imported sales and the U. S. Content sales. So we will be playing on both sides of the fence. And that's what I think Will be the trick here.

Speaker 2

We're not going only we're not only riding 1 horse. We work so customers who The customer have different preference. The customers who do not prefer a U. S. Content U.

Speaker 2

S. Domestic content Compliant solution, we will offer them also a solution that does not beat that. So So really, we're really excited about this prospect and I think that it will solidify our position in the U. S. Market with

Speaker 6

Yes. No, fair enough. Just two quick follow ups, sort of cleanup questions, if you will, for me, maybe for Manu. Just on the delays in 2Q, should we expect any deferred flowback of LDs? I know you guys have seen that In some historical examples, and then on the deposits piece, I mean, do you expect that to be entirely fronted By customers or is there some sort of working capital dynamics between cash in from them versus cash out from you guys on the deposits piece, if you can clarify?

Speaker 6

Thanks.

Speaker 3

Yes. So I think let me take the 2 questions in order. From a margins perspective, I think any potential LDV Kind of boxed it in really well in our Q3 actuals and our Q4 guidance. So I think that kind of clears that. In terms of how to finance the $70,000,000 of deposits for the first half of twenty twenty four, I think a good assumption from a modeling perspective is a little over half funded by the customers and the rest funded by our liquidity or any working capital lines that

Operator

Our next question comes from the line of Ben Kallo of Baird. Your line is open.

Speaker 7

Hey, good morning guys. Thanks for taking the question.

Speaker 2

Good morning, Ben. How are you? Good morning. Good. Thank you.

Speaker 2

So sticking on ASE, could you guys talk a little

Speaker 7

bit about your diligence with them And how you chose them and then I think they have one plant that's operating and one under construction, but where you would be getting the sales From with them and then I have a follow-up on different topics.

Speaker 2

Yes. We don't want to disclose too much, but I'll tell you is the one of the main reasons why we Picked them and decided to work with them because we are these batteries will come out of our reconverted plan, a plan that needs Just going through, it is producing and it will reconvert to produce battery cells for the stationary storage. So We believe that in the current environment that they were further ahead than anybody else in offering this. And they already have employees, already have, as you know, which is a major issue for some of these plants. They already have the technology.

Speaker 2

They have the supply chains working very, very well. So Very, very good. And clearly also ASC is one of the Tier 1 battery manufacturers. They have been working Globally or in the U. S.

Speaker 2

For some time. So that's the reason why we say that they were a good partner and they are in a very, very good position to offer This matters today.

Speaker 7

My follow-up question on a different topic is just market dynamics. And I'm thinking about Tesla talking about Having pricing power in the market for their storage business, I just wanted to understand if you guys are seeing that and what's causing that and just The competitive dynamics and how it's changed, either some of your competitors have not as financially strong as you guys Or new competitors, anything like that, but then more so on the pricing power? Thanks.

Speaker 2

I don't think the competitive landscape has Improve to our advantage, let me put it that way. I think this is a very competitive market. Tesla It's a very, very strong competitor and there are others. As you said, there are a lot of small players who might not do not have the capacity to We can offer, but I think we're far away still. I think we're far.

Speaker 2

I'm going to say far away, but far From the point where the industry consolidates in a way that we are a limited Players that I was in there too. So for us, competitiveness is a driver internally to ensure that we Beat everybody on price, but not only on price, price is a driver is not the main driver, on ensuring our customers Have a product that meets their needs. Price being 1, our performance, what we do, how they can bank or finance our investments, The type of guarantees we provide and to ensure that they feel comfortable owning our assets going forward. So And I think that we work very, very hard and we work out every day and we have everybody looking internally. I don't ensure we beat Tesla and any other one.

Speaker 2

That's around.

Speaker 7

All right. Congrats on the results guys. Thank you.

Speaker 2

Thanks, Ben. Thanks.

Operator

Thank you. One moment please. Our next question comes from the line of Pavel Molchanov of Raymond James, your line is open.

Speaker 2

Hi Pavel. Hi Pavel. How are you?

Speaker 8

Good morning.

Speaker 2

Good morning.

Speaker 8

2020 4, so recognizing you're going to give kind of more detailed guidance a bit later, but Much more backend weighted revenue picture compared to this year. And I'm just kind of curious Why the difference in sequencing?

Speaker 3

Yes. So I think the way to think about 24 From a first half, second half perspective is as follows, right? If you look at how the 2023 guidance has evolved, As we have gone about from our original guidance, which I think the midpoint was 1.55 or 1.6 To where we are, which is closer to 2.05, we've kept the growth rate the same, Roughly at 35% to 40%, right. And that adds incremental between $600,000,000 $700,000,000 of margin give and So sorry, of revenue. And given the cycle times of our projects, that's more back end loaded compared to the first half, Right.

Speaker 3

So I think the split between first half and second half is largely driven by the strength of our order book As we've gone through 2023 that has resulted in a higher revenue for 2024, but it's coming in the back half We feel really confident and I'll point to the fact that we have $2,900,000,000 in backlog as we enter the 4th quarter. And more importantly, we have close to $12,500,000,000 in pipeline. So we feel very good about where we sit for 2024.

Speaker 8

Okay. Let me follow-up on the digital AUM kind of Coming down in the quarter, you mentioned there was a non renewal by a particular customer. Is there a certain Churn rate or some other way to just think about digital AUM more broadly?

Speaker 2

I mean, our churn rate is fairly low, about 5%. So and this customer that didn't renew essentially is an asset that was sold. You know that they were part of or they were sold to another company. The company had their own system and they decided to which in a way makes sense. They decided to use the system they use for the other assets.

Speaker 2

I think that this was within our 5% churn. Churn is very, very low. And obviously, I just raised it because it appeared in the numbers. So I wanted you to be aware of what happened, but we Signed more than 1 almost 1 giga. And so we did very I think it was a good quarter for our digital business in general.

Speaker 2

And these things will happen from time to time and as long as they are within and they are, we have no indications that we will end the year within the 5% churn rate We usually have that we do have for this business.

Speaker 8

Understood. Thanks very much.

Speaker 2

Great. Thanks.

Operator

Thank you. One moment please. Our next question comes from the line of Kashy Harrison Piper Stanley, your line is open.

Speaker 2

Hey, guys. Hi, good morning.

Speaker 9

Hey, good morning, guys. Good morning.

Speaker 6

Good morning. Thanks for taking my question.

Speaker 9

Doing well. Thank you. So I wanted to go back to just this discussion on sales sourcing. You're highlighting U. S.

Speaker 9

Tasi from ASE. You're highlighting Northvolt as well, but obviously you still have a lot Of Chinese cell exposure today. And so maybe if you look out a few years from now, is your expectation that your U. S. That you will sign enough U.

Speaker 9

S. Cell capacity just for U. S. Projects and then European sales solely support European projects and then what does that mean for your Chinese exposure again a few years out from where we are today?

Speaker 2

This is my I think that I don't see Today, in our planning scenario, we don't see a world where the U. S. Will be fully supplied by U. S. Manufacturer sales Nor in Europe.

Speaker 2

So that will take some time. The U. S. The Chinese manufacturers are They do invest significantly. They have invested.

Speaker 2

They had a they started earlier. They have invested a lot in technology. It will take a long time For European and U. S. Manufacturers to get there.

Speaker 2

So that's the way I see and that's the way as we want to continue working with our Chinese suppliers I hope to continue working with them for some time. They provide us with very, very good product that they have Good road map and we work with them well and so we want to continue working with them. So that's The only point I will say is that, hey, I want a world where there's free trade. So I want a world where we can buy batteries from many places Because I think that's a world that's better for all of us, a world where our technology will continue evolving, where We'll have the ingenuity and the capacity of the U. S.

Speaker 2

Engineers coming up with new ideas and making, but also competing with what Chinese and Europeans are doing. So That's what I hope that we will have for our industry. So that a little bit of our planning Reflects that concept. We want that word. That's a word we think that is a word that's better for our technology and better for our standard of living I think we will be able to properly address the challenges Of climate change, if we try to do this each region or each country apart, we need to cooperate and work together and that's what So that's the way we see it.

Speaker 9

Thanks for the thoughts there, Julian. And then Maybe a follow-up question for Manu. Appreciate the commentary on cash for Q4. But maybe just On a multiyear basis or maybe even a target basis, can you just help us think through what you think the cash conversion of this Businesses once you hit your targeted long term margins, do you think this is a 50% EBITDA to free cash flow business? Is 60%, 70%, just some thoughts

Speaker 3

on how you expect EBITDA

Speaker 9

to convert to free cash long term?

Speaker 3

So, Kash, I think we laid out a cash model Maybe 2 earnings calls back. And I think that's a good way to think about the model going forward, right? The model goes something like this, right? We have our EBITDA. We have some amount of CapEx.

Speaker 3

And in the last few years, it's been High single digit, low double digit that will oscillate a little bit depending on specific needs of the business. And then from a working capital piece, which is the heart of your question, I think what we've said is, take the revenue growth year on year and take 10% of that as a proxy for the working capital usage. And I think that's a pretty good model to think about as you blot out the next couple of years when we get to positive EBITDA territory and beyond.

Speaker 2

Thank you.

Operator

Thank you. One moment please. Our next question comes from the line of Tom Curran of Seaport Research. Your line is open.

Speaker 10

Good morning.

Speaker 2

Good morning, Tom. How are you?

Speaker 10

Good, Helane. Good. Over in the EU, when it comes to this churning stew of Policy proposals, initiatives, regulatory changes that the European Commission has been cooking up in Brussels, Whether it's the Green Industrial Plan, Repower EU or this just passed Renewable Energy Directive, is there anything in there That's specifically targeted towards the storage as transmission market and expected to expand And or accelerate your set of storage as transmission opportunities?

Speaker 2

That The transformation rules are very, very local. So we have to work market by market. As you know, there is a Transmission systems for all of Europe, but we had worked the work we're doing today is market by market, what we have done in Germany, what we've done in Lithuania. We have not engaged from a pan European type of process. I think that will take us The way that you're generally the way you should think about Europeans is that the way they regulate the transmission system is free access And essentially free access, let's put it that way.

Speaker 2

And that means that it allows for You need to allow energy coming from 3rd parties. In terms of what we are trying to do, our regulatory challenge when we go into this It's a simple one. It's the following is that most regulatory systems restrict transmission operators From dispatching assets. However, when you put the battery support in transmission line, the system operator or the transmission owner needs to dispatch the assets, Needs to use the battery storage as a demand or as a or dispatch it or charge it. And that has created some sort of A legal question for that we were able to resolve in Lithuania, we were able to resolve in Germany and that we're working to resolve in other places, In the U.

Speaker 2

K. And in Ireland, but it is a challenge for some of the regulators because it in a way It questions the segmentation of our industry. Our industry segmented, as you know, in demand or distribution, Transmission and generation and the views that the 3 should be very, very separated. The way to create value is by having them be very, very independent. So demand cannot own transmission, transmission cannot dispatch generation, all these things that all these rules.

Speaker 2

I think as our Technology goes into the grid, that segmentation blurs. And that's what that's a challenge we have. And the challenge we have in the U. S. That's a challenge we have to I think that this will happen and there will have to be a regulatory and we have been able to successfully resolve it In Germany and in Europe, but it is something that we need to work with all the regulatory players as we move forward.

Speaker 2

But I don't see a pan European solution for this. This is more of a local issue where we need to work with the local System operators and system regulators.

Speaker 10

It's a very helpful clarification. Thank you for that. And then, Manu, in the quarter, you incurred CapEx of $7,300,000 related to software investments. Would you Sound upon the nature of that spending and provide us with an estimate of software CapEx for fiscal 2024?

Speaker 3

Yes. So let me help start with your 24 question first and then kind of bring it back because I think it goes to our long term view on how we think about software And as a key driver of the business, right. So I think we've talked about, call it, Double digits, low double digits type of CapEx spend that includes capitalized software as well. And I think it's both our own parties, our employees as well as any third parties that kind of help Develop from a software perspective, it covers both our operating system projects that we are doing as well as The digital initiatives to advance both Naspersa and Mosaic and that adds more capabilities to our current functionality. So that kind of encapsulates where we've been spending money for this quarter and going forward, but I think the overall capitalized software is part of our $10,000,000 $15,000,000

Speaker 11

Yes, sure. So this is Rebecca and I'll tell you from my perspective of leading the technology team. We have a large group of people who create the operating system software And we're actually reinvigorating that platform right now and that's a big part of how we feed the money, the estimates in for capitalization. We follow along our product development plans to create new functionality on that software for the different markets and that mostly is labor And that labor turns into an opportunity to capitalize it. As Manu mentioned, that's also paired with the investment that we make in our cloud based software.

Speaker 11

And again, mostly that's labor and delivering some of the new functionality as discussed today, some of that artificial intelligence based functionality. It's all that labor that goes into creating the different software offerings and leads into a capitalization effort.

Speaker 10

Got it. Thanks, Manu. Thanks for that additional color, Rebecca.

Speaker 3

Excellent. Great.

Operator

Thank you. One moment please. Our last question comes from the line of Craig Shere of Tuohy Brothers, your line is open.

Speaker 2

Hey, Craig. How are you?

Speaker 12

Hi. Thanks for squeezing me in. So first, I want to dig in a little bit on the European transmission answer to Tom's question. I did notice the New York ISO was studying Energy Storage's transmission asset. And I think you'll find a little bit on the last earnings call about Other markets having to address this and having issues, I believe you were mentioning Latin America at the time.

Speaker 12

Could you opine on the prospects of Working through the system by system issue worldwide and being one of the top 3 or 4 companies in the world that can even do this, How big a market this could be in 5 years?

Speaker 2

Well, let's start with the last part of your question. This, we believe, could be a material driver for our performance. We have the standard and poor analysis, a little bit stale. It was 30 gigas by 2,030, but I think it's tail when you really look at the challenges that transmission has globally. In terms of our I understood the first part of your questions.

Speaker 2

How is our lobbying effort and are we making progress? This is as I said earlier, this has to be the I don't think we need to do this Regulator by regulator and 1 by 1. And our team identifies where we believe we have the highest chances of And the highest chances of success and then that's what we work. So on our team in and this is what we did this with AES as a partner. With AES, we have been very successful in Chile.

Speaker 2

It was great. We're working in Some of you are in several jurisdictions in the U. S. And we have success depending on where we are. But I think after this summer And all the transmission challenges that we have seen, this is going to become a more urgent matter.

Speaker 2

And as people will see our Projects coming online in Germany. I think we're going to see the U. S. System operators, they can go and watch They can see it work and they see all the value you can create. I think that we will see a major, major acceleration of this.

Speaker 2

That's the way I think. So we're very happy. Unfortunately, today I cannot announce anything yet, but we're working on a few concepts that hopefully will become Into reality.

Speaker 3

Thank you for that.

Speaker 2

In order that when Standard and Poor's takes another look at this market, it will Significantly increased from what they were expecting. I think that the that analysis that is a couple of years back is a little bit stale.

Speaker 12

Thank you for that. And I want to dig in a little more on the answer to Pavel's digital question. Is there a trend of customers increasing or decreasing their use of Internal systems, is the market kind of deciding that specialized 3rd party digital services is the way to go or is it still kind of case by case?

Speaker 11

So when we talk to customers, we hear the need state for us to provide digital solutions that help them operate these battery So that's an open space in the market and that's the one that we're focused on. When you talk about 3rd party software systems, usually that's related to People that have decided to self integrate and that's a very specific section of the market, we're Really not competing with that. So we're playing with customers, developers and ITPs that are consuming our products and they're asking us provide these digital solutions to help them operate the batteries over the long term. So if your question is, are we competing with self provided software? I would say not really.

Speaker 2

I can add one thing. From a product roadmap view, Our concept is to integrate our software solutions into our hardware solutions in a way that there is Significant value by having the 2 to really create that additional cost. As you know, we sell Our Mosaic technology to 3rd parties, we sell our portfolio asset performance management system To 3rd parties, but we really think that fully integrated into our assets makes will create the ownership of our assets a lot more. It will help our customers reduce the total cost of ownership and make our assets more competitive in the market. And also that's conceptually what we're doing.

Speaker 2

Well, I will say that today, clearly our system everybody buys from us, our battery management system as we deploy it will come from us. Where you see that people might have different systems are in the bidding application. There are other players. Even though ours integrates, as I said, very, very well with our infrastructure And in performance management tools that there are not that many players who can offer what we do, Which is integrating your solar, your renewables and your battery storage systems into one system. That's one way.

Speaker 12

As you just a quick follow-up. So like 2, 3, 4 years out as you morph this into a more fully integrated business Historically, it wasn't necessarily. Do you see the churn that you experienced in this last quarter kind of Reducing or going away?

Speaker 2

No, I think that the 5% a year is kind of the way we'll go. Remember, The bidding application because this applies to our whole offering. The bidding application is a competitive market. There will be some people that do it and then they will Mark, there will be some people that do it and then there is also the asset the performance management tools also you have third party 5% is a good number. And for digital applications, it's fairly, fairly low.

Speaker 12

Great. Thank you.

Speaker 1

Great.

Speaker 2

Well, I think that this ends it for today. So maybe I Just a parting remark. So we're very, very proud of the work that our team has done here. The Turnaround, Manu was asking me earlier today, it's been almost a year since we arrived here. We're very, very happy For the turnaround that our team has done here, really their eye on the ball on all the drivers that we needed to bring this company to where we are.

Speaker 2

We're in the brink of getting to our double digit gross margin and our breakeven point In 2,000 in the Q4 of 2024. And so very, very happy with the progress. And this This is an industry that is evolving. It's a competitive industry, but we have the desire, the capacity and the ambition To make this great. And I really thank all of you for your questions, your support and the insights you provide us every time we engage with you because that help us To do our jobs here every day.

Speaker 2

Thank you very much and talk to you soon.

Operator

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.

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Fluence Energy Q3 2023
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