Enovix Corporation (ENVX) Earnings Call Transcript

Hi, everyone. Thanks for joining us. I'm George Gianarikas, one of Canaccord Genuity's sustainability analysts. And we're incredibly excited and grateful to have members of the Enovix management team with us here today. From the company are Dr. Raj Talluri, President and CEO; and Farhan Ahmad, CFO. Thank you both for agreeing to join us after we ask to put this event together in order really to clear what we at least think are misconceptions and misinterpretations in the marketplace. So Raj, please I'll turn the floor to you for a minute for an overview of the company and to give you an opportunity to discuss actions that you've taken since becoming CEO.

Yes,George. Thank you so much for having us and all the listeners for joining in. Before I get started, I just wanted to say that I'll make some comments today. It will contain some forward-looking statements that are subject to risks and uncertainties that are based on the current expectations. Now please refer to our filings with the SEC for all our disclosures for the details on this. So George, thank you for hosting this call. There's been -- it's been 9 months now since I've been at Enovix. We've made tremendous progress on many fronts. I couldn't be more excited by the stage of the company now and where our manufacturing technology is coming up and the increase in energy density that we are able to deliver to our customers in terms of samples and all the excitement around that. I've made a few changes since I've joined, and we made a press release recently about some restructuring that we did. We also talked about an acquisition that we did. And we got some feedback that some of that may not have been properly understood by all the investors. So George, thank you for hosting this call, so I can clear up any confusion on that.

So Raj, I have to start with a question that I've been getting a lot. And then frankly, I had 2 when I first saw your press release, why is a company that has great technology but has had questions, especially in the past around manufacturability, talking about lowering its manufacturing targets for the year, as if that's a good thing. Clearly, this headline around the guidance reduction is at first glance a negative. But I think the truth lies in the nuances of what you've announced. So can you please talk about those nuances and explain to us why we should look past the headline and look at this recent announcement as a positive.

Yes, absolutely. When I started the company, there were -- there was a Gen1 that we had in Fremont, and we were producing batteries there, and the yields were kind of low single digit. It's the first time the factory that had come up. It wasn't quite where it needed to be. And we had been working diligently since then to improve the yields to improve the throughput to improve the uptime of the machines, so that we could accomplish 3 things. One was we wanted to make sure that all the customers that really like the initial technology that we brought had enough samples to actually qualify the products, our technology, the products that they're going to make. And the second thing was we always knew that this factory in Fremont was not a cost-effective factory. It was very expensive to run the machines had some issues that I think we've discussed at line even TJ in January mentioned that the machines that we bought weren't quite where they were needed to be and we had -- we were going to fix all the issues with the machines and build Gen2 machines, which actually can produce the millions of batteries that we need to be successful. But to be able to do that, we really have to understand what was going on with Gen1. I mean, why were the yields dropping in some places? Why was it throughput not where it needed to be? Why was the uptime problem? And we kept shipping away at it, and we were able to -- we were really pleased with the progress we were making. We kept increasing the number of batteries we're making quarter-on-quarter. But they are very expensive batteries. At the same time, we had a few customers, again, when you're producing only tens and thousands of -- tens of thousands of batteries, the people who can go to production with that are low-volume IoT-type customers a medical device here and maybe available, maybe headset, something like that, not the millions of units kind of customers. And to -- for them to get to production, we had to give them build enough sample. So the first product that launched had the volume that they needed. So we accomplished that, and we also understood exactly what was going wrong with the factory in terms of yields and throughputs. And we had -- again, our goal is to get to close to 60%. At that rate, we felt like we know what we need to do. We can make the deal go up more, but it was kind of like throwing good money after bad because that's not the machines where we're going to manufacture high volume. We wanted to take that learning and really make sure that Gen2 worked well. And when we made this announcement, I felt very comfortable that we understood what is going on is the machines in Gen1. And we had fixed all those issues in Gen2 and the FAT Gen2 was going well. And all the customers that we needed to give samples to were quite happy and they really wanted samples now from our actual manufacturing facility that they will be launching from, not more from Fremont anymore. And the couple of customers that we talked about who launched small volume IoT devices, we had built up enough cells. So once we accomplished all 3 of those objectives, which I said about, I felt there's really no reason to continue to make more cells in this facility because it wasn't really solving in any real problem that we wanted to. And the third thing that happened was -- the final thing that happened was we found, as we started looking at all the customers that we were sampling to -- there were a few customers in that funnel that really had applications that needed this energy density problem to be solved, which was basically customers who are making products with larger screens. So what I mean by that is people who use smartphones or people who are using laptops, they really needed a much higher energy density because of all the -- the display itself is consuming so much of the battery and the AI applications are coming in so fast. So we were getting a lot more requests for producing larger cells quickly to sample. Unfortunately, the factor we had in Fremont that was producing cells could only produce one size small cell. Now we could retrofit the factory to make larger cells, but that was never going to produce in the millions, so it didn't really make any sense. So we needed to quickly move the Fremont line -- Fremont facility into an R&D facility where we could sample these large cells. At the same time, we got this great order from Army for using our break for technology in large cells. So the demand was also increasing on larger cells. And on supply side for the small cells, we built what we needed. So it kind of made sense that we should stop the production.

So you mentioned specifically before, and then you mentioned recently, and this is in January from TJ, you wanted to get to 60% yields at -- in Fremont. And then you mentioned, I think, at a conference that you actually got to the 60% what's special about 60%, why 70%, why not 50%, why not 80%. What is that magic about that number that gives you confidence that you can leverage those learnings into the manufacturing and the late?

Yes, great question. I mean, look, 60% yield is nothing to feel proud about, honestly. When we want to produce batteries and high-volume we need to be at 95-plus 98-plus kind of levels. And that's where all my experience of 30 years in doing chips is that's where we run our factories. That's where you make money, and that's where we need to get to. But if you look at our Fremont factory, it was never going to get there to the 90-plus percentage. And the reason is it's never been fully built to that level. I'll give you a simple example. If you look at our battery, there's a place in our battery where we actually insert a busbar through all the D slots, which are actually the holes that we make in the anodes and cathodes and valve them. In the Fremont factory, we have people threading that manually. I'm not kidding -- we have a person sitting and threading that through. It was never gonna get to that kind of yields. And you could stop. But in our Malaysia factory that is completely automatic. We have a machine that does that, and at a very higher throughput. so this factory in Fremont was never going to get there. But what our judgment when, we looked at it at the beginning of the year and the same thing what T.J. mentioned was, if we could get to 60%, we would have found out all the key bottlenecks that we're stopping it from getting into 95-plus somewhere in the high number, high 90s number in Malaysia. So that was how we had calculated that. And we calculated by looking at every area, like this busbar insert is one area. Then Cathode to Anode distance to which we cut is another area. The constrained application that we put on to hold the battery down, it's another area. There's many, many areas where we were losing yield. But all those areas, we have done proof-of-concept experiments to improve the yields. So we felt if Gen1 could get to cumulative yield of 60%, we were very confident that Gen2 will get to where we need it in the high 90s. So that was really the magic about that number. And some people misunderstood, I see some messages on Twitter saying, well, they got to 60%, how will they ever be competitive. That's not our goal for the factory in a high-volume factory. This is just all we want to do in this Fremont factory, so we understood what is going on. So we could make our high-volume factory run at the level it needed to run.

So just to put words in your mouth, moving from 60% to 95% is basically removing those bottlenecks like the busbar insert that become automated when you move to Gen2. Now how confident are you that you can get to the right units per hour, the UPH by -- in that automation process. Have you tested the equipment enough just that specifically just a focus on this example, that busbar insert and the equipment that you have at the factory acceptance.

Yes. That is exactly what we'll be testing at factory acceptance to make sure that, in fact, our Malaysia factory yield should start in the high 60s to start from and then go up from there. And we have given ourselves enough time. We were saying April is when we'll be producing -- April next year. Our first batteries will come from our Malaysia factory, and we're on track for that. And we have given ourselves until third quarter next year in the late third quarter to get to full output. So we have given ourselves enough time to improve that. But we expect them to start at a very high number. Again, there's 3 things in getting factories to operate at high capacity. One is the yields. Other is, as you mentioned, the throughput, how many units per hour. And there's a third important one, which is downtime. All machines go on for a little bit of time in during manufacturing process. How quickly can you bring them back up? We have made improvements on all of them and the proof-of-concept experiments we were running, which we now feel very confident that they've all done well is that we feel very confident about all those 3 aspects in the Malaysia factory. And then what we do is we do the factory acceptance test, which is we -- zone by zone, as Ajay put out in his podcast, zone by zone will make sure that we accept from the vendor. Then we ship all of them to Malaysia, then we accept at site, then we get to the yields that we want. That's when we pay the vendor, the rest of the money, and then we work through the year to get to the high volume. It's a standard process of how chips are made and how manufacturing is done and we are following the process to the team.

Maybe I'll switch gears for a second. There seems to be a lot more discussion by you in your press releases about smartphones. And the way I understood the company is that wearables are better, your competitive advantage from an energy density perspective, is better when you make smaller devices. But you switched. It seems at least to us, that's happened. So can you explain -- can you first tell us if that's right and second, why you've been switching more to a smartphone focus?

Yes. It's a very good question. It's not really about switching. It's about accelerating the smartphones. The company initially started off by actually sampling batteries to a large number of customers, 100 customers. Some were making watches, some were making smartphones some wanted to make -- use our battery in smartphones. Some wanted to use them in laptops. Some wanted to use them in medical devices, some wanted to use them in robotics. I mean, you name it huge spectrum. But what I found when I looked at that whole funnel and I've been here for 9 months, and I've had a chance to meet many of those customers, look at it deeply. What I found was there are a few key areas where the energy density we provide has the most advantage to our customers. So what do I mean by that I'll actually tell you with a little anecdote. So I went to visit one of my customers -- smartphone customers in China. By the way, most of the watches are made by smartwatches are made by smartphone customers. They make both of them, most of them. So I visited one of them and I said, "Hey, I got this battery. I really want to be in your smartwatch. And this is the head of procurement of this company, somebody I've worked with for many, many years. He looked at me and he said, "That's great, Raj, that you want to be in that, but I want you in my smartphone. And I looked at him and said, why is that? he said, well, you can improve the battery life of a watch going from 2 to 3 years, make it go to like a week or something. That is definitely valuable. But if you can make my smartphone go longer, it's huge because the problem right now in smartphones is the rate of increase of the battery amount of milliampere-hours a battery delivers has tapered out. Like if you look at Samsung S22 to S23, or you look at iPhone 14 iPhone 15, I'll make my case, their battery went up by 2% to 3%, 2% to 3%. And I was promising them 30% increase with my battery. And so that was tremendous in terms of they're like, look, if you can produce 30%, you've got to be in smartphones first because that's where our biggest problem is. And then as i dug deeper, I found out the reason there is so much value in smartphones for a better battery is because of size of the display. The bigger the display gets, the more of the battery it eats and now 2K display is going to 4K and so on, it'll only eat more. And the applications that are coming into the smartphones, the camera applications, the video applications, all the AI-based generative AI applications need so much more battery, but the display is taking a big part of it. So the process and the memory is getting starved. In a watch that happens too, but it's a much smaller display. So the value that you can unlock in a smartphone or a laptop or a tablet by a better battery is huge and the customers are happy to pay us for it. So again, I'm not moving away from wearables, we'll absolutely win in wearables too because the people who make the smartwatches are the same people who make the wearables. But starting with -- in accelerating and pulling in the smartphones made a lot of sense because of this reason. And the other interesting thing is the smartphone batteries are much bigger. Our ASPs are much higher. And we only have to -- and we have -- we can get our material costs down faster because we buy more material. Our revenue goes up faster, our scale goes up faster. So in all ways, it really seemed like the right business strategy. Plus, I've had 20-plus years selling into smartphones. I started selling them -- the smartphones. When I was at TI sold in Micron at Qualcomm, Sold at Micron. And I've been in this industry for a long time, and I know exactly how this industry works. So it seemed to make perfect sense to me that, that's where we should really focus right away instead of waiting for wearables to happen.

You've also talked about being more vertical as opposed to horizontal, which I think means concentrating on fewer customers. As a matter of fact, I think you at a recent conference at an inferior brokerage firms Q&A. And you mentioned that there would be an 80-20, right? I think in the future Okay. So what does that -- first of all, what does that mean going from horizontal to vertical. And does that mean -- I can at get this afterwards more, but does that mean that the revenue funnel that you've given us in this past is $1.6 billion, that's sort of irrelevant.

No, I mean, absolutely. I think I probably should -- when you're in chip business for a long time, you get used to this jargon like horizontal, vertical, but for your listeners, maybe it's not such an obvious one. So let me add a little color into what that means. And it kind of goes back to kind of my background and how I started my career. I started my career at Texas Instruments in the DSP division. And Texas Instruments made DSPs. And these DSPs were programmable signal processing engines. They made wonderful ones, and they made them -- they made a big yellow book that told you how to use them, put on their website. And anybody could order it and you got it through a distribution, and you could use it for any application you want it. you could make an electric motor, you could make a smartphone in those days. The smartphone didn't exist, so they started making some modems that run into phones. You can make a broadband modem or you could make a -- in any kind of single processing one. And Texas spent didn't really care what to use it for as long as you bought it. That is a horizontal market. Now to succeed in a horizontal monitor market, you make one sized product and sell it to many, many, many hundreds and thousands of customers and you put the collateral out there of how to use it. That works when that one particular product can be used everywhere without any modifications. I think that is what is the definition of horizontal business. A-to-D converters, operational amplifiers. Those are all horizontal businesses. A vertical business, on the other hand, is a business where you have a form fit function specific product. Take Qualcomm for example, Snapdragon. That is a product that goes into vertically into smartphones. And there it is. Now in smartphones, there's 10 customers, each of them ship millions of units, but every product is tailor-made for smartphones. You try to take a smartphone product and use it in, I don't know, electrical mix or something. It's not -- doesn't fit very well. So vertical businesses have this advantage that you concentrated your R&D on a few products, and you have a few customers, and each of them ship multiple millions of units. So what happens is your net operating income is going to be much higher because you're not spending as much on supporting thousands and thousands of customers. What I found out after I spent some time with Enovix is that we had this huge funnel of customers, $1.5 billion revenue or something like that. Fantastic business, and we absolutely have the capability to support all of them. But what's going to happen if I went after every single customer there is that I will have to make custom cells which are form fit function optimal for that one customer. I'll have to change some customers need fast charge. Some customers need higher energy density. So you're going to fragment your road map and you're going to satisfy that funnel. But what I thought is a better strategy is you look at the funnel and you pick half a dozen to 10 customers who are already in the funnel by the way, who are our smartphone customers, who are laptops customers, who are our wearable customers that have millions of units per product and focus our technology on them first. So then you get the revenue faster and you're able to build your factory quicker, you're able to get a return on investment faster. And then what you do, you take the exact same cell and offer it to all the other IoT customers in that funnel, some will find it useful and use it, some may not. But now you haven't spent extra R&D for every low-volume customer. And this is exactly what I did at Qualcomm. I did the Snapdragon processor and then I built the IoT business, which is basically a broad 500 customers that took the Snapdragon Processor and the WiFi and the Bluetooth and sold it -- but the majority of the revenue came from a few verticals, right? Which is exactly what I believe Enovix needs to do and which is what the strategy change that I've done since I've come here -- is to really make sure we build batteries that hit these few verticals and then comes a question, which are these few verticals. I think the ones that have the bigger displays where AI is a big function are the verticals we need to focus on because that's where we get our best revenue that's where we get our best gross margin highest operating income. And then absolutely, we'll get as many of the broad customers after that. So this is called vertical first horizontal next strategy, where TI was doing horizontal first vertical next strategy. So that is -- since I've done both of this, this is a better fit for the company.

Would you say that the vertical strategy is maybe a little riskier because you're concentrating for us on just a few or 5, 6, 7, 8 customers as opposed to the hundreds that you had before in the pipeline?

I wouldn't say it's riskier. It needs better product management discipline, which means you need to really understand what do these customers want and make the right product, which means you need the right kind of relationship with the key customers. So I'll give you an example. If you go into a smartphone, yes, you need the energy density, but you also need fast charge. You need to make sure the battery charge is really fast. You also needs to make sure it has 800 cycles. You also need to make sure in time, it goes to 1,000 cycles. And then you also need to make sure that you understand how the processor and the power management inside the phone, drive energy from the battery. How is the battery charged? How is the battery discharged? What happens when you're doing video encoding to the battery versus what happens to the battery when the phone's on standby? Similarly, with laptops, what happens to the battery when it's plugged in? What happens to the battery when the screen is closed? So vertical strategy, your product management discipline has to be much stronger because you really need to understand that. Your customer relationship can be much tighter. You have to have tie-ins at the highest level of the customer because they give you that. And that's why I built a new product management team here with people who have come from vertical businesses. I built a new sales organization with somebody who's come from Qualcomm. And I met the right people at these top levels to actually get the specifications. We actually have the exact specifications of how the phone charges and discharges in using the battery from our customers. So now we are making products that are a lot more tailored for these applications. And by the way, 1,200 million smartphones in the world, 250 million, something like that, laptops in the world, each takes 3 batteries. Even if we get to 20% market share, 15% to 20% market share in each of those segments, you're talking a multibillion dollar company. And that's what I'm focused on. I'm focused on building a large profitable company with a few customers that drive the volume great gross margins drops nicely to the operating income because we're not spending all our money in customizing to many, many, many customers and then sell that technology to many other customers because now it's a lower hanging fruit to take it.

Is it fair to say that you've been here for, I think, about 9 months or so plus. Is it fair to say that this shift in strategy is based on a significantly higher degree of conviction that you can actually land some of those very large smartphone-ish customers?

Absolutely, absolutely. And in fact, I knew this would be some concern for the investor community. So I ask them are very comfortable that I tell in my earnings call that I'm working with them, and they gave me permission to do it. And I did announce them at my, I think, second quarter earnings call. And I think some of those things are probably not fully picked up by everybody in the audience. But for people who make hundreds of millions of smartphones to let California, small companies announced publicly that we're working with them is a big deal, and it only happens because of the conviction they have in how good our technology is and how much value it can bring to them. And I feel really good about it.

One question I get a lot after the announcement is whether or not you can make cells for the Army in Malaysia versus the United States. And so can you?

Yes, absolutely. Absolutely. Again, like I said, I think we make the cells, but these cells go into a pack leg, go into another third party. They put it inside the vest and so on, and it's really not a problem. We did check that. That's not an issue. But I do want to make one other comment about the Fremont facility. We only reduced and shut down the high-volume manufacturing element of that, right? So the people that we let go are people who are running 24/7 operation of the factory and so on. We're actually going to continue to increase, our hiring in R&D because I believe that the way this company is going to be successful is continuing to provide innovation after innovation. Our first product right now, produces 30% higher energy density, and we're able to charge 50% higher for ASP. But the next generation will improve on that with another 10% or so energy density and so on because silicon has a lot more -- a lot more distance to go. And we are using an older cathode. We have a new cathode coming in and newer anodes. I mean the other interesting thing that's happened and the reason we needed to have the Fremont facility set up to do this, is the amount of investment that's going into materials is huge compared to everyone else. I mean, there is, I think, 5 semiconductor anode companies that we have samples from or something like that. We had one before. There's a bunch of new cathodes we have now. There's a whole new set of electrolytes that we have now. So we are able to now put together very good recipes. We are material agnostic. So we don't make materials. But my R&D team in Fremont has to be able to quickly try different cathodes, different anodes, different electrolytes, to keep increasing the energy density. And I'm singularly focused on that. And one of the gaps we had was we didn't have our own coating and that was limiting how quickly we could change the materials because these material companies give you powders, anode powder, cathode powder we have then mix slurry out of them and coat them on top of copper, aluminum and so on. So this acquisition we made recently really helps us get that down very, very fast. And we started this effort in Hyderabad who will now be able to very quickly help us with which material stack actually is expected to give what kind of cycle life, what kind of energy density so we can cut that cycle time. Batteries R&D has traditionally moved very slowly. Not what I'm used to in semiconductors. So my goal is to bring that speed of execution semiconductors and the focus on a few vertical businesses so we can unlock the potential this technology has of producing -- really a lot of value for our shareholders.

Speaking of technology, I get this question too. Some of the metrics that you share, energy density, cycle time, extend sort of flat for the last couple of years. And so you mentioned changing the materials -- are you standing still? Or has there been any improvement? Have you allowed some of your competitors to kind of catch up? Or do you expect to kind of leapfrog what you've put in place in terms of metrics over the next couple of years based on these changes in materials.

Yes. You will see from us definitely more aggressive R&D plans. I mean some of our R&D teams unfortunately had to spend time fixing the issues we had with the factory. So we couldn't move as fast as we could. I'll fix that since I came on board, and now we have R&D team staffed fully. And also, we've beefed up our supply chain team, so they're able to get a lot more materials and we hired a guy from Lam Research, who was able to really get us a lot of great materials. I've spent a lot of time with the CEOs of some of these companies, and they're giving us materials very quickly. So we are moving at a good clip now, and you will see us producing better and better recipes that address not just energy density but also fast charge and cycle life to address these markets. In terms of competition, interestingly, Graphite cells haven't made the progress they needed to make. People thought they would, it's kind of at the end of the road. And you can see -- I mean, I've seen some data Graphite sales going up like that and totally plateauing. And I gave the example of 2% to 3% on the latest one. And that's actually creating a lot of interest from all the customers, the entire cell phone space asking us "hey when can we get silicon anode into our products. " And the only real competition I've seen is people taking an existing graphite cell and sprinkling some amount of silicon -- engineered silicon powder to get some energy density increased because if they put any more of that, it dwells. The advantage we have is we can take the same powders that these companies are using, and we can use 100% of it, literally 100% of it. And even for the anode companies that are making this, they're super excited to work with us because we can take more of their material and accelerate their traction to market.

In your press release, the recent one, regarding the change in strategy. You also had the small mention about EVs, I'm curious if you could discuss any progress you made there? And also what your cells bring to the table? I don't think you're necessarily talking about radical improvements in energy density, but more fast charge. Is that right?

Correct. So firstly, what is the advantage or cell architecture, I would say, more than cell or cell architecture brings to EVs. The advantage it brings is that because we have this unique architecture of making really thin anodes and cathodes and stacking them together with separated in between, we are able to get rid of the heat very quickly. The heat, it is generated when you charge them. And that is the -- so we are able to charge it very fast. So when you charge fast, the battery heats up and we are able to charge fast and not heat up as fast because we're able to dissipate the heat. And that is of a lot of interest to EV customers because for them that is the, I would say, the #1 problem more than energy density. And I kind of jokingly mention that it's not just about putting a bigger and bigger battery because if that was the case, we should all have cars with hundred gallons engines, but we don't. We only have 70 or 20 gallons. It kind of stop because it's a gas station nearby. And that is how the EV stuff is going to go is that we're going to have charge stations very close by. So that means that how quickly you can charge and not waste time at the charge station is the key metric. And for that, we need to be able to dissipate the heat fast, and that's the unique advantage we bring. We've had a lot of requests from EV manufacturers to make ourselves and to give them samples. Honestly, I've been crunched for really engineering and space in the factory to do those quickly. And because to do those EV cells, there's a different material stack. Customers sometimes give us lithium and some of them -- some of the material. And for us to use that, we have to expand our clean room. I'm sorry, our dry room -- and our dry room is tied up making these cells for the small cells. So this reduction of the units that we're going to make and shutting down of the Fremont factory, is now going to give us the opportunity to expand that space to actually make a lot more TV samples for our customers quickly. With the material stack they give us so that we can validate that, and then we can use that to then figure out what the next steps are. Are we going to do license, are we going to manufacture elsewhere and so on. So that's another good thing that comes out of this move.

You said you've had a lot of requests for cells from EV companies.

Yes. And I've not been able to do it because I don't have the space and requests from our Army, the requests from the EV companies, request from the cell phone makers, the question the laptop makers for bigger batteries -- the demand has been crazy, but most of energy was being built on making small cells and getting our derisking our factories. So the moment we were able to do that, we had to make that call.