Greenlane Renewables Inc. (GRN) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen, and welcome to the Greenlane Renewables Fourth Quarter and Fiscal Year 2022 Conference Call. [Operator Instructions] This call is being recorded, and a replay will be available on the Greenlane website. I will now turn the call over to Darren Seed from Incite Capital Markets. Please go ahead.

Thank you, operator, and good afternoon. Welcome to the Greenlane Renewables' Fourth Quarter and Fiscal Year 2022 Conference Call. I'm joined today by Brad Douville, Greenlane President and Chief Executive Officer; and Monty Balderston, Greenlane's Chief Financial Officer. Before beginning our formal remarks, we'd like to remind listeners that today's discussion may contain forward-looking statements that reflect current views with respect to future events and each such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in these forward-looking statements. Greenlane Renewables does not undertake to update any forward-looking statement except as may be required by applicable laws. Listeners are urged to review the full discussion of risk factors in the company's annual information form, which has been filed with the Canadian securities regulators. Lastly, while this conference call is open to the public, and for the sake of brevity, questions will be prioritized for analysts. Now I'll turn the call to over to Brad.

Good afternoon. Thank you, everyone, for participating on today's call. I'd like to start off with a few financial and business highlights from our fiscal year 2022 as well as provide some industry perspectives before I turn the call over to Monty for a more detailed review of the numbers. All figures are in Canadian dollars unless stated otherwise. The Greenlane team delivered another year of record revenue in 2022, a solid accomplishment given some challenges in the energy market in the U.S. that emerged during the year. Early in 2022, we completed our acquisition of Airdep in Italy, and we went on to launch our deployment of Development Capital Program as we advanced funds of $1.6 million to 2 separate RNG project development teams in the U.S. As a reminder, we launched this program to assist project developers in accelerating their projects to the ready-for-construction phase while, at the same time, adding new recurring revenue and profits to Greenlane's business by gaining exposure to RNG offtake contracts, along with generating additional sales of Greenlane systems and services. In 2022, Greenlane announced over $45 million in new biogas upgrading system sale contract win, 25% of which was for food waste RNG projects in the U.S.; the remaining 75% split roughly evenly between dairy-derived RNG projects in the U.S. and RNG projects in South America. Today, we also announce that Greenlane was awarded a $7.2 million contract for a food waste to pipeline project in Ohio where we'll be supplying an integrated sulfur removal unit from our subsidiary in Italy and water wash system for upgrading biogas from food waste streams for direct injection to the local natural gas pipeline network. In 2022, 40% of our system sales revenue was generated outside of the U.S. versus only 14% in 2021, while our non-U.S. system sales revenue in 2022 was 14% from Canada, 12% from Brazil, 11% from Europe and the remaining 3% from other countries. Within the U.S., we've seen a recent shift in contracting activity towards food waste to RNG projects as compared with dairy-derived RNG projects. The challenges I referred to a minute ago, when the RNG market in the U.S. had emerged during 2022, are related to price. 2022 began with strong RNG spot prices near the highs of the 5-year range in the U.S. However, prices began to moderate throughout the year, ultimately ending below their 5-year average, largely due to a surplus of credit under the California Low Carbon Fuel Standard, or LCFS, program. U.S. dairy projects were particularly hard hit. By the beginning of 2022, spot prices for dairy-derived RNG were more than USD 115 per MMBtu, but by the end of 2022, prices dropped to around USD 70 per MMBtu. These effects, combined with inflationary pressures, rising interest rates and lack of fulsome rules issued by the Department of Treasury for the investment tax credits available under the recently passed Inflation Reduction Act, or IRA, impacted our growth in the second half of 2022. Having recognized that low LCFS credit prices may not achieve the greenhouse gas reductions they are looking for, the California Air Resources Board, or CARB, has indicated that they will update their LCFS program, including introducing more aggressive compliance targets for carbon intensity reduction in 2030 and beyond, with the objective to support continued investment in low-carbon technologies. While we anticipate that these and other regulatory developments in the U.S., such as the IRA, will support RNG demand with improved economics for Greenlane's current and future customers, we are also increasing our focus in other markets where we see growth opportunities. Outside of North America, Greenlane continues to invest for growth in Europe, building on our acquisition in Italy in February of 2022 and in South America by expanding our local presence. We see 2023 as a pivotal year for Greenlane as we actively diversify our global footprint and invest in systems and processes that will allow us to scale the business. Our investments to grow in key international markets include strengthening local supply chains, employing local talent and partnering with industry participants that have strong relationships locally within the region. We are well capitalized with more than $21 million in the bank and are debt-free, which means we are well positioned to pursue our strategic plan. I would once again like to take this opportunity to thank the Greenlane team for their dedication and commitment to our mission of helping to decarbonize the world's energy systems as well as our customers for choosing Greenlane as a trusted partner. I'll now pass the call over to Monty.

Thanks, Brad, and good afternoon, everyone. As a reminder, all figures are in Canadian dollars unless otherwise stated, and all comparisons are for the fourth quarter and fiscal year of 2022 against the respective periods of 2021. Greenlane generated revenue in the fourth quarter of $17 million compared to $17.1 million in the prior period of 2021. For the fiscal year 2022, revenue of $71.2 million increased 29% over 2021 revenue of $55.4 million. System sales revenue accounted for 92% of our total revenue, which is recognized in accordance with the stage of completion of projects, with the remaining 8% of revenue being generated from aftercare services. Our gross margin, excluding amortization in the fourth quarter of 2022, was 19% or $3.3 million compared to $4.3 million or 25% in the fourth quarter of 2021. For the full year, we delivered gross margin, excluding amortization, of 24% or $16.8 million compared to 25% or $14.1 million in 2021. The company has a portfolio of active projects all at different stages of completion and different gross margin levels. However, during the fourth quarter, gross margin before amortization was adversely impacted as compared to the previous quarters on a percentage basis on one project where we had commissioning costs that were beyond our control and on another project where we saw some scope changes that were not recoverable. Adjusted EBITDA in the fourth quarter was a loss of $2 million versus a $300,000 profit in the fourth quarter of 2021. And for the full year, adjusted EBITDA was a loss of $2 million versus a profit of $1 million in 2021. In light of our growth in 2022, the company added staff which, coupled with the Q4 gross margin impacts I already mentioned, weighed negatively on adjusted EBITDA. As Brad mentioned, we had a successful year in 2022 on the contracting front, announcing over $45 million in new system sales contract wins. And at December 31, the company's sales order backlog was $27.7 million. As a reminder, the sales order backlog is a snapshot at one moment in time which varies from quarter-to-quarter. And the sales order backlog increases by the value of new system sale contracts and is drawing down over time as the projects progress towards completion with amounts recognized in revenue. Our sales pipeline of prospective projects is approximately $900 million as at December 31, 2022, and we continually update our pipeline of active system sale opportunities based on quote activity which represents visibility into a significant number of opportunities that funnel down through our sales process, and those opportunities successfully are converted into contract wins then moving to a sales order backlog. Our balance sheet remains healthy as we exited the year with cash of $21.4 million and no debt, providing flexibility for Greenlane to strategically invest in and grow our core RNG business as well as pursue other strategic initiatives. We will continue to focus on prudently managing our cash to maintain a stable financial footing. We look forward to keeping shareholders appraised of our progress. And with that, I will open the call to questions. Operator?

[Operator Instructions] Your first question comes from Nick Boychuk with Cormark Securities.

You discussed the importance of obviously diversifying cash flows away from the U.S. market given the concentration of the U.S. dairy business and given what's happened in the LCFS method. Can you expand a little bit on the diversification of the $900 million pipeline by geography? How much right now is outside of the U.S?

So yes, what we're trying to lay on here is a little bit of the diversification that we've seen in our sales activity from 2021 and 2022, just to show a little bit of the trends we are seeing. So as I mentioned, the trend from 2021 of roughly 14% of the sales being outside of the U.S. versus 2022 being 40%, then that same trend is reflective of the kind of trend that we're seeing in our sales pipeline. Also, we're seeing a shift in our recent contracting activity towards food waste for the U.S. market away from dairy. I think that's obviously a consequence of some of the pricing dynamics we've seen in RNG as an impact of the LCFS what's driving that shift. So I think in short, I think it's fair to say that the mix that we're seeing in our pipeline is not dissimilar from the trends that we've seen over the recent times.

Okay. Shifting to gross margins, can you walk us through what happened on the 2 projects you had in this quarter and kind of talk through the potential of that occurring again or if those are just completely one-off events?

It's Monty speaking. In regards to the commissioning costs, obviously, we don't like to see it happen over and over and over again but just say that they're a onetime event and never going to happen. That's just not realistic. But in this case, on that project, there's just been a lot of things that have been outside of our control that have ultimately resulted in us having to eat some costs, impacting margins. And in perspective, we operate in different environments, so we're exposed to site conditions, which sometimes things happen that we wish didn't. And then in regards to the contracting scope, that is where we're much more laser-focused. And I wouldn't want to say with certainty it's a onetime event, but it's definitely very unusual to experience what occurred there. And so we do not expect that to be something that shows up again.

Yes, I think I'll add to that, Nick, that these are not dissimilar, certainly, the commissioning one, from challenges we've had in prior quarters. So as you know, we've been quite consistent at the gross margin level. So the impacts we saw in Q4 were outside the norm for us in terms of our past performance. I think that's important to note there.

Okay. That's helpful. And last for me, just curious, with you guys shifting geographies and including that comment on gross margins, how much flexibility do you have to increase the prices in your projects? And in particular, I'm curious how governmental support and things like tax credits might be supporting that. If your developers are receiving a good portion of their CapEx not covered by governments, are you seeing more flexibility to potentially increase your prices?

Well, it's a good question, Nick. I mean, we look for opportunities where we can. We may take advantage if some pricing is more favorable on margin. We don't always have the luxury of that if we're in a competitive bid situation because, in that case, the market decides. But generally, our strategy is to look for those key opportunities where it's beyond just price as the main competitive feature and where we can show the customer the value that we provide. So not a straight answer, I realize that, but there are certain situations where we'll be able to increase margins on a deal-by-deal basis and certain ones where it's going to be more of a competitive environment.

Your next question comes from David Quezada with Raymond James.

Just a question for me, I think just on your view of changes to the LCFS and, I guess, clarity on the rules under the IRA. Do you have any sense of roughly what the time line will be? Like, do you think that you'll get clarity on those IRA stipulations this year? And do you think that those things will result in, I guess, recovery of order activity in the U.S. or increase?

David, good questions, thanks for those. And I also want to say we're not policy experts, of course, but we monitor it very closely. And starting with the LCFS, there's obviously been a number of workshops that the California Air Resources Board has held, the most recent one being a week or so ago, whenever that was. And so what's important to note there is that they've designed this program. The intent of the program is to ultimately see reductions of the greenhouse gas footprint to the transportation fuel mix in California. And they have the ability to modify if the outcomes aren't heading in the right direction. And so that's what we've seen is they've had a healthy credit environment until 2022 where the prices started dropping off and they have an ability to pull the lever on costs. And that, in this case, was changing the reduction requirement, the compliance targets. In my understanding, again, we need to double check the fine detail in the ARB's published documents, but that will take effect in 2024. But I think what they're ultimately doing is sending a price signal, so that people get a clear view, a transparency of what's happening in the program, and that sets pricing now rather than having to wait until 2024, until that event occurs. So that's our understanding of the LCFS program and the ability of the ARB to make adjustments. As it relates to the final prescriptive rules published by the Department of Treasury related to the IRA, the IRA, of course, came into effect January 1. And some of the rules, but not all of them, have been published by the IRA, which is a bit frustrating for people active in the industry. Certainly, when the IRA went into law in August, I think there was a bit of a pause for people to say, "Well, what does this mean? How do we protect our position for the investment tax credits under that new law?" That wasn't very clear. It's still not 100% clear. More clarity has been driven by the rules that have been released to date by the Department of Treasury, but there's still more rules to come. So nobody, as far as I can tell, has any indication of timing when the final rules are. We would have thought they would have been published before January 1, but here we find ourselves in March, and they're still not fully released.

Okay. That's great color, Brad, appreciate that. And then maybe just one more for me on your new order that you announced earlier today. It sounds like the sulfur removal and that sort of integrated product offering from the Airdep acquisition, well, I guess my question would be, is that something that helps you win that order? And is that sort of a new capability that you've realized as a result of that acquisition that's going to help you in the future?

Yes. We did that acquisition for a whole host of reasons. I think we can simplify it to two main things. One is it's a compelling technology that we have in that division in Italy for particularly applicable to certain desulfurization biogas compositions. So piece one, yes, it's compelling. It gives us an advantage from a product and a price perspective. And then piece two is it does give us some incremental margins rather than purchasing outright, which would have been the case prior to the acquisition. So I think, yes, it helped us win the order, and it's helping the business too in terms of contributing to margins that we were hoping to see.

Your next question comes from Aaron MacNeil with TD Cowen.

Brad, what's your approach to your sort of overarching run rate cost structure in 2023? Obviously, in the outlook commentary, you speak to scaling up and investing in systems and processes. But some may look at the backlog and interpret that near-term sales could be down sequentially. So I guess what I'm really driving at is how comfortable are you in terms of maintaining that cost structure if revenues decrease into 2023? And how long would you be willing to sustain a cost structure like that?

Yes. So it's a great question, Aaron. So what I can say is, over the last few years, we've seen a dramatic change in our revenue. It's been climbing significantly, so we've been adding staff to be able to accommodate that and fulfill our contract obligations. Monty had mentioned in his comments that we'll continue to prudently manage the cash. That's mission #1, to make sure that we do that. Right now, we're focused on the top line. So we think that the opportunities are out there. We think that, with our diversification beyond what's currently a bit of a lull in the U.S. dairy sector, that, that will be helpful, a focus for us. But we'll take the appropriate actions if any of those need to happen.

Okay. Maybe a bit of a different spin on Nick's question, of the sales pipeline that is associated with the LCFS program, based on your conversations with your customers, what do they need to get comfort on the outlook and ultimately go ahead with an order?

As it relates to biogas projects, there's a couple of main things. So one is there's the labor law component. So this is the apprentice, and it just slipped my mind, the other piece of it. So the wage, the fair wage, the apprentice components of that, that was recently published by the Department of Treasury, so that's helpful. The domestic content piece is still not published. So there's a bit of a lack of clarity on how you content your programs. So that comes from local use of steel for infrastructure. There's a very defined term of manufactured components and the interpretation of what that means. So that's still driving a little bit of confusion, I would say. So I'd say that comfort is growing. The other thing that we did find in Q4 was some pushout of activities from 2022 to 2023 so as not to erode the ability for the project to capture the ITCs under the IRA.

Okay. And then maybe one just quick housekeeping question, as it relates to the bad debt expense in the quarter, what type of credit analysis are you performing on your customers? And are you becoming more vigilant in terms of who you provide credit to in the context of reduced RNG pricing under the LCFS program?