ZBB’s Relationship with Lotte Chemical Corp
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With the strong growth in renewable energy, demand is expected to grow strongly for environmentally friendly energy storage solutions with high energy densities in order to allow for significant size and weight savings over traditional batteries. In a recent article, we highlighted ZBB Energy Corporation (NYSEMKT:ZBB) and their “zinc bromine battery“ which is said to address all of the requirements for a viable grid energy storage solution. We also highlighted a development partnership ZBB engaged in with Lotte Chemical Corporation (Lotte) on December 2013. Lotte Chemical Corporation (KRX:011170) is one of Asia’s top chemical companies with 2012 annual revenues of $14.8 billion.
Digging into the detail behind this agreement leads to some interesting findings. On December 16, 2013, ZBB and Lotte entered into a Research and Development Agreement and an Amended Licence Agreement in which ZBB agreed to develop and provide to Lotte a Zinc Bromide chemical flow battery system, with the project scheduled to continue until December 16, 2015. Lotte is required to make payments to the Company under the R&D Agreement totaling $3 million over the term of the project in the following manner:
- $375 thousand 20 days after December 16, 2013
- $375 thousand expected Feb 2014
- $375 thousand expected May 2014
- $375 thousand expected Aug 2014
- $375 thousand expected Nov 2014
- $175 thousand on product shipment
- $200 thousand for final project report, product performance tests, and filing one patent application
- $750 thousand for delivery to LOTTE of an invoice for ZBB’s purchase of materials used in the battery system
ZBB also granted to Lotte (1) an exclusive and royalty-free limited license to manufacture or sell a Zinc Bromide flow battery in Korea and (2) a non-exclusive royalty-free limited license for Lotte to use the battery system internally in all locations other than China and Korea and (3) a royalty-bearing limited license to sell the battery system in all locations other than China, the United States, and Korea. An additional $1 million payment will also be made if certain performance milestones are successfully achieved. In addition, Lotte is required to make ongoing royalty payments to the Company on Lotte’s sales of the battery system outside of Korea until December 31, 2019. The royalty percentages are not disclosed but will be based on “net sales”. The R&D agreement also states the following:
As soon as practicable following the execution of this Agreement, ZBB and LOTTE agree to negotiate in good faith and enter into a supply agreement, pursuant to which LOTTE will agree to be the primary manufacturer of the Product on behalf of ZBB.
These agreements raise a number of questions. Firstly, if Lotte does begin manufacturing and selling ZBB batteries following the completion of this agreement, they will be incented to sell into Korea, their native country, and a territory where they do not have to pay royalties to ZBB. For sales outside of Korea, they only have to pay royalties to ZBB until December 2019. Can ZBB really expect meaningful royalty income as a result of this agreement? Secondly, it appears that it will take over a year for ZBB to deliver a single flow battery system to a key partner. In the Zbb Q2 earnings call several weeks ago, the CEO stated that this would actually be an 18-month duration project developing a new generation battery that will result in the most energy-dense and low-cost flow battery available in the market. Is Lotte not satisfied then with the current battery offering available today from ZBB? Thirdly, if Lotte does become the primary manufacturer of the battery system for ZBB, where does that leave ZBB? Do they simply collect royalties and spend them on R&D to continue to improve their product?
It seems that Lotte has all the negotiation strength here and therefore incurs very little risk based on the terms of the agreement. Although this agreement implies questionable future royalty payments, it does provide ZBB with much-needed milestone payments that should provide the Company’s operating capital throughout most of fiscal year 2015.
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