EnSync's (ESNC) CEO Brad Hansen on Q2 2017 Results - Earnings Call Transcript

| About: EnSync, Inc. (ESNC)
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EnSync, Inc. (NYSEMKT:ESNC) Q2 2017 Earnings Conference Call February 14, 2017 4:30 PM ET

Executives

Robert Blum - Lytham Partners

Brad Hansen - Chief Executive Officer

Fred Vaske - Chief Administrative Officer

Analysts

Eric Stine - Craig-Hallum

Jim McIlree - Chardan Capital

Operator

Good afternoon, everyone and welcome to the EnSync reports Second Quarter Fiscal Year 2017 Financial Results Conference Call. [Operator Instructions] Please also note that today’s event is being recorded. At this time, I would like to turn the conference call over to Mr. Robert Blum with Lytham Partners. Sir, please go ahead.

Robert Blum

Thank you, Jamie and good afternoon and welcome to the EnSync Energy Systems’ quarterly conference call. On the call with me today are Brad Hansen, CEO of EnSync Energy Systems and Fred Vaske, Chief Administrative Officer.

The EnSync Energy Systems press release and 10-Q containing the second quarter fiscal year 2017 results and commentary was sent out earlier this afternoon and may also be found on the company’s website at www.ensync.com. Please also take note of the Safe Harbor paragraph that appears at the end of the press release covering the company’s financial results and that any forward-looking statements that we make only apply as of the date made and are subject to inherent risks and uncertainties, including those described in our Annual Report on Form 10-K and should not be unduly relied upon. Except as otherwise required by the federal securities laws, the company disclaims any obligation or undertaking to publicly release any updates or revisions to any forward-looking statements.

I will now turn the call over to Brad Hansen, CEO of EnSync Energy Systems. Brad?

Brad Hansen

Thank you, Robert and good afternoon. I will begin the call today with a discussion of the current operating and market environment and then Fred will cover our Q2 financial results. Following that, I will detail some of the recent accomplishments as well as provide a business outlook for the balance of the year. Finally, I will provide some comments on where we stand with Solar Power, Inc. We continue to see an expanding market for our business model, which is to understand the market-specific energy needs now and in the coming years, design, develop and install differentiated and proprietary products, services and electricity-generating projects to meet those needs, source of various products at a highly competitive cost with strategic suppliers and partners; develop a market leading applications portfolio; monetize these applications for customers over the lifetime of their projects; and finally, in the case of electricity-generating projects, sell these projects to meet investor expected returns.

Included in the Q2 results were the sale of our final two projects that were part of the initial group of 8 power purchase agreements, or PPAs. Each of these distributed energy resources, or DERs, are installed and operating in commercial and industrial buildings. In addition to the C&I segment, we also serve the utility and residential distributed energy resource systems market. It’s noteworthy that we recently closed our first contract in the residential market segment. Our systems design expertise, intellectual property and innovative business models positioned us perfectly for these markets. We believe that despite macroeconomic and political uncertainties, the market environment for our products and services continues to be positive driven by a shifting of the energy production mix from carbon-emitting sources to renewable sources and by increasingly favorable economics for solar energy, energy storage and combined solar plus storage systems. State and utility-specific programs and importantly, average retail electricity rates make our business highly localized in nature.

Local policy trends such as increasing demand charges, time of use rates, net metering reductions and state tax credits are generally favorable. At the macroeconomic level, our business is influenced by the federal solar ITC into a large degree in Hawaii by the price of oil. On the former, we don’t believe that the solar ITC will change through at least the end of next year. According to Greentech Media, 1 in 15 new jobs created in 2016 were from the solar industry. So, we also believe that the fact that solar-related jobs have a significant positive impact to the economy will favorably impact policy. With respect to the price of oil, our Hawaii business was somewhat impacted in the fourth quarter of last year due to retail electricity rate changes that are connected to, but slightly lagged the price of oil. I will speak to that impact more a little bit later in the call.

The energy information administration, or EIA, recently reported that the global oil market is on track to be relatively balanced between supply and demand this year and next. We think that this will occur at a level that will be neutral to somewhat positive for our business prospects in Hawaii.

I will now turn the call over to Fred to discuss the Q2 financials.

Fred Vaske

Thank you, Brad and I would like to add my welcome to those on the call. Today, I will go through an overview of the financial results and provide some added color on the quarter. For the second quarter of fiscal 2017, we recorded total revenue of $1.7 million compared to $382,000 in the year ago period, an increase of approximately $1.35 million. The growth in revenue for the quarter was primarily driven by the sale of the last two Tranche 1 power purchase agreements to two different Hawaii-based investors in November 2016 for $1.3 million as well as product sales of $239,000 to Lotte and other customers. We also recognized the final installment of $175,000 under our research and development contract with Lotte.

Total costs and expenses for the second quarter were $6.0 million. Cost of product sales were $1.7 million, of which just under $1.3 million were associated with the two PPA projects sold to investors. These PPAs provided a combined margin about 5%. And as we discussed during prior quarters’ conference calls, there were nonrecurring charges that had to be incurred with the sale of this initial tranche as part of entering the market with this business model. On Tranche 2 and beyond, it is our expectation that gross profit margins for future PPA sales should be between 10% and 20%.

Our operating expenses continue to come in under prior year numbers. Advanced engineering and development expense and SG&A combined have declined from $4.3 million in the second quarter of 2016 to $4.1 million in the current quarter. Non-recurring legal expenses in the current quarter were approximately $97,000. And as noted earlier, we have encountered non-recurring charges related to bringing new products to market. Our cash expense run-rate, which we defined as these costs less equity compensation, was approximately $3.4 million this quarter. We intend to continue to work to bring that number in, at or below that level as we go forward.

Turning to our balance sheet. Our cash balance at December 31, 2016 was $17.6 million compared to $19.9 million at the end of September 2016 and $17.2 million at the end of June 2016.

With that, I will turn the call back over to Brad.

Brad Hansen

Thanks, Fred. I’d like to highlight a few of our noteworthy accomplishments since the November conference call. First, as Fred highlighted, we recognized sale of the final two projects in our first group or tranche of PPAs. These two projects were sold to two different Hawaiian investors at a profit. Second, we closed a key energy storage system order with ENMAX, a top vertically integrated Calgary, Alberta utility with more than $2.5 million in annual sales. ENMAX is wholly-owned by the city of Calgary and has been in business for more than 100 years. It has generation assets across the province and manages more than 300 kilometers of transmission wires and 7,600 kilometers of distribution lines. This system will be demonstrating the value of our Matrix Energy Management system to perform supply response on demand in conjunction with our Internet of Energy platform.

Our Matrix system will control various energy sources and prove that interconnectivity between the distributed energy resource and the utility network. Additionally, this project validates that there is also strong value for EnSync’s Matrix system and Internet of Energy platform for markets and applications in locations that have retail electricity rates at the single-digit cents per kilowatt hour level. The installation will be located in the District Energy Centre in downtown Calgary, which utilizes highly efficient district heating to supply up to 10 million square feet of residential and commercial properties. We will put a link on our website to the District Energy Centre portion of the ENMAX website.

Third, we shift the Matrix Energy Management system to a recognized global leader in the energy management systems and services market with more than $20 billion in global annual sales. As we noted on the last conference call, this system is intended to be the beginning of a bigger and broader collaboration. We expect this system to yield follow-on orders later in the calendar year. Fourth, we closed a PPA with Oceanic Time Warner Cable in Hawaii. The Time Warner Cable companies last year combined with legacy Charter and are presently transitioning to the Spectrum brand, a leading broadband services and technology company serving over 25 million customers in 41 states. The EnSync solar plus storage system will be installed in an office and operations center on the Island of Hawaii and will shift energy from daytime to nighttime hours in addition to providing resiliency.

Fifth, we completed engineering and manufacturing release for our EnSync’s super module containerized energy storage and energy management system. The super modules reduced installation and commissioning time in expense by more than 80%. As part of the super module release, we also introduced our large capacity Matrix platform that will allow us to reduce our cost per DC to DC, or DC to AC conversion function to be reduced by more than 50%. Finally, we have closed on our first residential market penetration for a multiple structure decentralized installation in Hawaii. This installation will be covered under a single PPA. Our momentum continues in Hawaii where we are the clear leader in the C&I market. Our opportunity pipeline supports enough potential projects in the balance of the fiscal year to fill the second and third tranche of PPAs. Alternatively, the projects maybe sold individually if it reduces our time to cash or improves our gross margin.

We now have a backlog of approximately $6.3 million in signed PPA projects that can be sold as part of the second tranche or as individual projects. Contract closure time and securing of interconnect permits are ongoing challenges that we are working to improve upon. The contract closure time has been impacted in the last few months for several projects in the pipeline due to oil price changes and a subsequent Hawaiian Electric Company retail electricity rate adjustments, which somewhat lagged oil price changes. In August and September, HECO rates appeared to be recovering off of the lows of last spring, but a slight drop back in oil prices in September ended up resulting in a double-dip and drop in HECO residential rates in October and November. Several projects in our pipeline needed to be reworked in order to remain viable at the lower electricity rates.

As oil prices have recently trended upwards and stabilized somewhat, HECO rates are now beginning to rise. A change of even $0.01 in the retail electricity rate has a significant impact to the PPA economics both positively and negatively. Just to put this into context, HECO rates on Oahu have moved between a high of $0.28 per kilowatt hour and a low of about $0.235 per kilowatt hour in the last 1.5 years. We are expecting them to rise to $0.276 per kilowatt hour this month, then to $0.296 per kilowatt hour in the second half of the year. So, we are now moving into an electricity rate regime that’s not only healthier, but should actually accelerate our business in the second half of the year.

The cost reductions achieved to our super module product transition will help to insulate us from impacts of future electricity rate changes like those I’ve described or stated more positively will open up new opportunities for projects in the present electricity rate regime. Given this more favorable market environment, we have also recently doubled the size of our sales organization at our Hawaiian subsidiary in order to more aggressively drive projects to contract signing. Securing of interconnection permits will be an ongoing challenge as the time required to get the permits through HECO is somewhat beyond our control. As the interconnection permit is the trigger for us procuring materials for the project as well as selling the project, it’s an obvious driver of our financial performance.

Despite the challenges described, we are extremely optimistic regarding the Hawaii market and our position there. The momentum outside of Hawaii continues to build. There are several additional Matrix and Internet of Energy platform penetrations expected to close in the near-term. The release of our large capacity Matrix with higher power building blocks for bigger installations is a key addition to our Matrix product family. These larger capacity modules enable our cost per kilowatt to be lowered for bigger C&I installations, while retaining the modularity and control capability that differentiates the product. We will soon have building blocks from a few kilowatts to 250 kilowatts guaranteeing that we always have the most optimum configuration for any behind the meter installation. Finally, we also recently added David Eisenbud, a seasoned sales executive with deep industry experience to the EnSync team. David’s primary focus in the coming year will be the market in the Northeastern United States.

I would now like to spend time discussing our relationship and status with SPI. Many of you are aware that we have given SPI multiple extensions of the cure period for its breach of the supply agreement. The agreement commits them to 40 megawatts of business in four annual tranches, the first of which passed in July 2016 without any shipment taking place. On January 26, we extended the deadline again this time to July 13, 2017, the second anniversary of the effective start date of the supply agreement. By that time, SPI will have been required to provide a total of 15 megawatts of business defined as shipment and full payment under the agreement.

I would like to explain some of the reasoning behind the extensions. In December, SPI attempted to place an order with us for a 5 megawatt energy storage system that would be installed in a project in California. We had been supporting this effort for months leading up to this point. While the pricing for the order was acceptable, the order was not compliant with the terms and conditions governed by the supply agreement. We chose to continue the negotiations on this order and work with SPI to achieve compliance with the terms and conditions of the supply agreement rather than terminate the agreement, a process that continued into January. However, on January 13, SPI reported that on January 10 that it received a delisting notice from Nasdaq, because it had not filed the required financial statements by the SEC’s December 31, 2016 due date.

The supply agreement allows EnSync to adjust payment terms for individual orders and as such, we notified SPI that we believed it had an increased level of credit risk. And due to this, we could not accept any orders from them without being assured of the payment be it significant deposit, letter of credit or similar mechanism. The terms proposed by SPI to-date have not met this requirement. While we would be thrilled to receive an order for a 5-megawatt project, we cannot accept an order that puts EnSync at risk due to unfavorable terms and conditions or due to an unacceptable level of credit risk. We recognized that the future disposition of the SPI preferred shares and warrants both determined by execution of the supply agreement creates an uncertainty to new and existing EnSync shareholders. However, we are also mindful of the potential for expense and litigation and so have decided to go the extra mile to allow for the chance to reach a mutually agreeable resolution. Please bear in mind that as we try to reach resolution with SPI, we are only acting according to what we believe is in the best interest of the EnSync shareholders and the company. We will continue to keep all options open, including litigation as we move forward. And we will update the shareholders as any relevant events unfold.

In summary, since our last call, we have made good progress towards our company goals. As our earning release announced, we have already achieved the sales level through our Q2 beyond any full fiscal year in company history. We continued to close PPAs in contracts, including with some of the top companies operating in North America and Hawaii. We released products that will radically lower the cost per function of our distributed energy resource systems and we closed our first multi-structure residential solar plus storage system contract. As the opportunity for our products and services continues to expand, we are very pleased with the progress we have made on all fronts in our operation. When combined with our differentiation in business model and intellectual property, we are poised to lead the high growth distributed energy resources market in the coming years. We appreciate you calling in today and I am happy to now take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today comes from Eric Stine from Craig-Hallum. Please go ahead with your question.

Eric Stine

Hi, Brad. Hi, Fred.

Brad Hansen

Hi, Eric.

Eric Stine

Hi. First question, I just wanted to touch on the PPA business and you gave a lot of detail and some positives and negatives going on in the market. But just to clarify, so you gave the number for Tranche 2, the $6.3 million. Is that – I mean, is your plan with both Tranche 2 and Tranche 3 that those are to be in that $10 million to $20 million range knowing that you could sell those as separate projects?

Brad Hansen

Yes, that’s correct.

Eric Stine

Okay. And then, I mean it sounds like obviously a lot of the delays that you are seeing in the market, a lot of that’s out of your control. I mean, should we take that, is that maybe your previous plan of monetizing both Tranche 2 and Tranche 3 in fiscal ‘17, that maybe that’s a little aggressive, more timing, more than anything else, but that might not occur in the fiscal year?

Brad Hansen

I think, Eric, there is still a possibility it could happen, but essentially with the dip in rates, we did have 2 or 3 months there where we had to essentially go back and go through and re-look at a couple of projects. And what I mean by that is in these cases, we may have to go back out to EPCs and get new bids for the solar and take it back out to market to drive the cost down so that it stays viable. So that did have a bit of an impact on us for 2 or 3 months, but we like where the rates are headed. Like I said, we are back about to the point, that’s the 18-month high in Oahu and it’s according to HECO and what they have said publicly, it’s going to go up from there in the second half of the year. So, we may have a bit of delay in what we are trying to do, but the pipeline is still strong and the rates are headed in the right direction. And honestly, I think the rates are going to be pretty supportive in the second half. So, I think it just slowed us up a bit.

Eric Stine

Yes. And then you mentioned that you monetized the last two projects in Tranche 1. Just maybe it sounds like its pretty positive, but just commentary on what the appetite is out there for people buying these projects setting aside just what’s going on in the market to get those closed in the tranches?

Brad Hansen

Fred, I’ll let you take.

Fred Vaske

Sure. Eric, we see it – that’s I think the same as it’s been in prior quarters. So, the appetite is good. The two projects we sold to local investors were well received. Those investors made that investment for their 2016 tax bill and are actually back and we are in dialogue with them about opportunities for 2017 for them. So I still view that market as positive and supportive for the business.

Eric Stine

Okay, thanks for that. Maybe we can just talk about the residential PPA that you signed. I am very interested in that. I know to this point you have really been focused on C&I. So maybe can you talk about how the residential market maybe different in terms of the PPA process and just thoughts on how that expands the market opportunity? And I can’t – I am not sure, was that in Hawaii? I would assume it was. But more details would be great.

Brad Hansen

Yes, it was in fact in Hawaii and this was a project that we had already in our pipeline that when we went through and looked at how best to optimize with it, it became clear that it was best to decentralize the PV and storage and put it in multiple units within the development rather than do a centralized system. So, it’s still covered by 1 PPA, but you have essentially got residential units and residential storage across multiple units in the development. And then I think when we talked about how we address – will address residential, it’s a bit different than us just going out and trying to get individual houses. We think the opportunity is very good in Hawaii to do an entire development like this, where each of the units will have individual assets that roll up into 1 PPA. So that’s sort of at the high level, the architecture of this particular PPA.

Eric Stine

Okay. So, but you are – in that scenario, you are dealing with even though decentralized setup, you are dealing with a centralized party as part of this, because I would think it would be difficult if you were dealing with each individual party as part of the transaction?

Brad Hansen

Correct. In this case, that’s correct.

Eric Stine

Okay. Maybe just on the announcement today, the PPA announcement with Oceanic Time Warner, I was just curious was that a decision that was made at the local level or is that something that as you look out into the future you see that potentially expanding within the parent company?

Brad Hansen

Well, I think it’s going to be a very good reference site within the parent company. Specifically, this center is the location on the Big Island where everything flows through on the Big Island. So if you are doing something like streaming on the Big Island through Time Warner, it would go through this particular site. So, it’s a very sensitive site and it has to stay up. It can’t have any kind of outages and so one of the things that we are doing with them is adding the resiliency that will give them capability to have no interruption in their operation. So these types of sites for Time Warner and others exist all over the place and have the same requirements of high uptime. So I think it’s a great reference in Time Warner, but also it’s something we can point to with other similar types of customers where uptime and access to data is the utmost priority.

Eric Stine

Got it. Maybe I will just sneak in one last one, just on ENMAX, any thoughts here initially on how long the pilot might be and I mean is there kind of a timeframe where you think this could be rolled out more broadly?

Brad Hansen

I think we will have to see how it goes. Any time that you deal with a utility and things don’t move at tremendous speed. That being said, there was a huge amount of pull from them on getting this system as soon as possible at that site. And they are excited about this system for a number of reasons. They like the idea, obviously of being able to connect what they are doing and the communication and control to their distributed assets, they also looked at it from a standpoint of transmission and distribution spending deferral, being able to utilize the existing assets they had more productively so that the supply response on demand is really key and they are serious. But the speed that they move out, we will have to see, but there is a lot of pull to get the systems shut ASAP.

Eric Stine

Got it. Thank you very much.

Brad Hansen

Thanks Eric.

Fred Vaske

Thanks Eric.

Operator

[Operator Instructions] Our next question comes from Jim McIlree from Chardan Capital. Please go ahead with your question.

Jim McIlree

Thank you and good afternoon.

Brad Hansen

Hi Jim.

Jim McIlree

On the backlog, how much – how many projects are in that backlog and I think you have talked about the gross margins normalizing at a higher level, are you confident that the existing backlog has that gross margin profile that you spoke about earlier?

Brad Hansen

Yes, we are. There is currently six of those – six projects within that backlog inside the $6.3 million. And we have looked at all of them multiple times. We are comfortable with the margin splitting in the range that we have guided to.

Jim McIlree

And the residential project that you referenced in the press release, is that in that $6.3 million?

Brad Hansen

It is. It was actually a project we had that when we went through and reanalyzed it and used – looked at it through the way to get the best economics and best performance for the customer, it made sense to re-architect it as a distributed system in each residence. So that one was a project that we went back and essentially did another turn on.

Jim McIlree

Got it, okay. Fred, I think in your commentary you talked about bringing some cost down, did I hear you correctly on that or were you talking about you have brought costs down and they are kind of at a normalized level here?

Fred Vaske

We have brought costs down, but the focus is still on bringing that down further. So we are looking at parts of the organization and how we are set up and just trying to run everything more efficiently on that front.

Brad Hansen

Yes. I think there is a little bit more that we can do on the cost side. We did have some non-recurring events this quarter such as some legal expense that we wouldn’t ordinarily get. But I think as far as our cash burn rate, we want to see that number down in the $3.1 million to $3.3 million or so per quarter. So I think we can get there and we will continue to push to get there.

Jim McIlree

Okay. Thanks. And on the competitive side, has there been any new entrants or additional or existing competitors who have become more or less price aggressive?

Brad Hansen

I would say in the C&I space, at least in our primary market of Hawaii, it’s – there is a little bit of a push in the C&I right now from some of the residential players. But those installations are quite a bit more complicated than residential installation, so I think it will – there is going to have to be a learning curve associated with those entrants. I think C&I logically gives us a bit of protection from very large competitors because a lot of times, the transaction cost for them is too high on smaller projects, whereas for us, we don’t have that issue. We can do them quickly and effectively. And for us, they are big projects. So I think the C&I market is still the sweet spot for us, although with the changes in the residential market around net metering and some of the different rate structures occurring in different states, we are getting more and more interested in that market. So I think you will see entities like us get more interested in residential and the residential competitors start to get more interested in the C&I space. I think that’s going to be the trend for our distributed energy resources in the coming 2 years. We just have to maintain our differentiation and execute well.

Jim McIlree

Right, got it. And maybe I misheard, but it kind of sounded like when you entered this fiscal year, you had a certain plan, but maybe things are about a quarter behind, is that fair or am I trying to read too much in your remarks?

Brad Hansen

No. I think we were slowed up a bit by what essentially was a double-dip in rates at HECO. And – but the rates are recovering and like I said, I think the rates are going to be in a place that actually accelerates our business as we get into the second half of this year. So I think we were slowed up a little bit, but the fundamentals are still solid, our pipeline still looks really good and we are confident in the business overall in Hawaii.

Jim McIlree

Right. And last one, so on this new tranche of projects, when do you expect – or when would be a reasonable time to expect those to start turning to cash?

Brad Hansen

Well, we are trying to get those – that to happen as soon as possible, which is why we said we would look at tranche level or individual project level, whichever shorten that time to cash. Some of these projects we may actually do locally in Hawaii because there is entities with tax appetites in Hawaii that the economics are a little bit better in Hawaii than outside of Hawaii because of some nuances in the state tax credit. So we are going to turn them as quickly as they can be turned. The key for us is getting interconnect permits done because that’s really the point where you can go sell and it’s also the point where we deploy cash to buy the components to build the project out. So that’s really – we are going to try and improve the velocity and go as quickly as we can. And if the backlog supports doing it at the tranche level and we get the right buyer to come in, then we will do it that way. If we can turn them quickly and get cash on an individual basis, we will do that, too.

Jim McIlree

Okay. If I can just press you a little bit though, we are talking six months to nine months or nine months to 12 months, 15 months?

Brad Hansen

No, we have multiple where – from a permitting standpoint, we are going to be in a good position in the near-term. So if we find buyers for those and we think they are out there, we will move those quickly. So I don’t think it’s at all at the outer end of what you talked about.

Jim McIlree

Okay, very good. Thanks a lot of. I appreciate your patience with me and good luck with everything.

Brad Hansen

Okay, thank you.

Fred Vaske

Thanks, Jim.

Operator

And ladies and gentlemen, we have reached the end of today’s question-and-answer session. I would like to turn the conference call back over to management for any closing remarks.

Brad Hansen

Thank you, operator and thanks for everyone for participating on the call today. As we discussed, we are pleased with our progress since the November call and with our ongoing market penetration for Matrix as well as the PPA business model with penetration with Time Warner. Local renewable energy policies and cost reductions for solar modules are continuing to create an inflection point for the distributed energy resource market and our products, services, business models and intellectual property provide us with a great position to take advantage of and drive this inflection point. We look forward to speaking with you again after the current quarter. Thank you, again for your support and interest in EnSync Energy Systems.

Operator

Ladies and gentlemen, that does conclude today’s conference call. We do thank you for attending. You may now disconnect your lines.

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