EnSync, Inc. d/b/a EnSync Energy Systems [ESNC]
Second-Quarter 2017 Earnings Conference Call
Tuesday, February 14, 2017 4:30 PM ET
Company Representatives:
Robert Blum; Lytham Partners; IR
Brad Hansen; President, CEO and Director
Fred Vaske; Chief Administrative Officer
Analysts:
Eric Stine; Craig-Hallum Capital Group
Jim McIlree; Chardan Capital Markets
Presentation
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. 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 were sent out earlier this afternoon and may also be found on the Company's website at
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'll now turn the call over to Brad Hansen, CEO of EnSync Energy Systems. Brad?
Brad Hansen: Thank you, Robert, and good afternoon.
I'll begin the call today with a description of the current operating and market environment, and then Fred will cover our Q2 financial results. Following that, I'll detail some of the recent accomplishments, as well as provide a business outlook for the balance of the year. Finally, I'll 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 our 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 eight 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 and 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 position 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 and to 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 50 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 lag, the price of oil. I'll 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 above 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%.
Other 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. Nonrecurring legal expenses in the current quarter were approximately $97,000 and, as noted earlier, we have encountered nonrecurring charges related to bringing new products to market.
Our cash expense run rate, which we define 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'll 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 improve the 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 shipped a Matrix Energy Management system to a recognized leader in the energy management systems and services market, with more than $20 billion in US dollars 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 in Hawaii. The Time Warner Cable Company last year combined with legacy Charter and are presently transitioning to their 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 SuperModule containerized energy storage and energy management system. The SuperModules reduce installation and commissioning time and expense by more than 80%.
As part of the SuperModule 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 and I market. Our opportunity pipeline supports enough potential projects in the balance of the fiscal year to fill a second and third tranche of PPAs. Alternatively, the projects may be 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 a second tranche or as individual projects.
Contract closure time and securing of interconnect permits are ongoing challenges that we're 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 the 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 dropping 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 upward 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 one and a half years. We're expecting them to rise to $0.276 per kilowatt hour this month and to $0.296 per kilowatt hour in the second half of the year.
So we're 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 SuperModule 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 for 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're 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 and 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'd now like to spend time discussing our relationship and status with SPI.
Many of you are aware that we've 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 26th 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'd 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 13th SPI reported that on January 10th it had 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 recognize 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 expensive 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're 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'll update the shareholders as any relevant events unfold.
In summary, since our last call we've made good progress towards our Company goals. As our earnings release notes, we've already achieved a sales level throughout Q2 beyond any full fiscal year in Company history. We continued to close PPAs and contracts, including with some of the top companies operating in North America and Hawaii.