Earnings Transcript for GRNWF - Q2 Fiscal Year 2023

Operator: Good afternoon, ladies and gentlemen. Welcome to the Greenlane Renewables Inc. Second Quarter 2023 Results Conference Call. [Operator Instructions]. Today's 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. You may begin your conference.

Darren Seed: Thank you, operator, and good afternoon. Welcome to Greenlane Renewables Second Quarter 2023 Conference Call. I'm joined today by Brad Douville, Greenlane's Chief Executive Officer; and Stephanie Mason, Greenlane's Director of Finance, sitting in for Monty Balderston Greenlane's Chief Financial Officer, who is unavailable today due to medical reasons. 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. Any 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 statements 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 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 over to Brad.

Brad Douville: Thank you, Darren. Good afternoon, and thank you, everyone, for participating on today's call. I'd like to start off with a brief recap of our business progress and updated outlook along with some industry commentary before I turn the call over to Stephanie for a more detailed review of the numbers. During the second quarter, we continued to work toward our goal of becoming cash flow and adjusted EBITDA positive in the next nine months. Our plans include streamlining the number of products we offer across each of our three product lines rooted in each of the three core upgrading technologies, namely water wash, pressure swing absorption, and membrane separation. Our plans also include ramping up sales of our proprietary biogas desulphurization products outside of Europe from the strong base of sales we currently enjoy within Europe. With its more focused product portfolio approach, we are targeting the different market segments where each of Greenlane's products are most attractive to customers and partners and can realize volume opportunities. At the same time, we are continuing to invest this year in the necessary systems and processes that will allow us to scale the business as we take on more of these contracts. Our agreement with big biogas is emblematic of the type of opportunity that will create operating leverage in our business. During the quarter, we announced an exciting collaborative agreement with ZEG Biogás, a company 50% owned by Vibra Energia, previously, the fuel distribution unit of Petrobras. Under the agreement, ZEG Biogás is to establish industrial-scale volume production of one of Greenlane's largest and most popular upgrading products in Brazil. ZEG Biogás's goal is to deliver 75 of these systems over the next five years. To put that in perspective, that represents installing more biogas processing capacity in the next five years than the more than 140 units Greenlane has delivered over the past 30 years. ZEG Biogás will phase in production capacity over time, and the agreement includes minimum volume commitments in the first two years. This transaction is a shift in our standard business model. It provides revenue under a new royalty-like business model, together with a supply of components from outside of Brazil and ongoing local service contracts. In addition to the ZEG Biogás deal, the second quarter was an extremely busy one for us as we continued to successfully build and commission over 20 separate upgrading projects. We delivered strong gross margins this quarter. Additionally, our sales team has been active in building relationships with strategic customers interested in placing large orders. We are looking forward to adding additional sales to our backlog through the remainder of 2023. Our plans for becoming cash flow positive and adjusted EBITDA positive in the next nine months also includes bringing in Ian Kane as new President and CEO, who will oversee execution of Greenlane's strategic plan. Ian is a proven leader with demonstrated skill and optimizing company growth and financial performance after the startup phase. As I transition into my new role as Executive Vice Chair of the company, I look forward to driving continued growth and success, focusing on key strategic initiatives, aiming to unlock the tremendous untapped potential the company sees in the global RNG industry. Both appointments will take effect later today. The market for RNG continues to offer tremendous growth opportunities for Greenlane's products and services. Not only are we excited about the growing sales opportunities that we see for biogas upgrading equipment, but we believe the expansion of our traditional business model to include a royalty-like structure offering standardized system will support further sales growth. During the second quarter, the company took control of one of the projects in its deployment of development capital program as a result of unforeseen circumstances and associated delays. Initially under the convertible note that we issued, we had the opportunity to receive a return on our invested capital and to convert the note into a minority equity interest in that particular RNG project. As a result of this transaction, we have now acquired 100% of this preconstruction project and are advancing the opportunity. Accordingly, the convertible note was canceled, and the company recorded a corresponding impairment in the note in the amount of $1.1 million. Greenlane has also evaluated its deployment of development capital program in the context of the rapidly evolving RNG market and our strategic growth plan. We have determined that funds previously allocated to this program should be reallocated to working capital. This shift better positions us to leverage our product and execution expertise over repeatable, high-volume, high-value opportunities globally. In recent industry developments, in late June, the US Environmental Protection Agency or EPA released its final rulemaking for their renewable fuel volumes for 2023 through 2025 under the Renewable Fuel Standard Program. The new rule was published without inclusion of the controversial eRIN program and was positive for RNG. eRINs as initially proposed, would have offered a substantial new source of revenue for biogas producers in the waste industry, many of which generate electricity and not RNG. The EPA's deferral of the eRINs resulted in a 30% jump in D3 RIN prices. It's important to note that according to EPA data, 99.8% of D3 RIN generation for the first half of 2023 was from RNG. Additionally, in the same EPA rulemaking, the issue of co-digestion was fixed. Historically, anaerobic digesters processing food waste and producing RNG were automatically assigned to lower value D5 RIN, while digestion facilities processing manure and other biosolids to generate RNG were allocated the higher-value D3 RIN. Through the apportionment mechanism and the EPA rule, mixed waste stream digestion facilities that accept food waste, manure, and biosolids will be eligible for D3 RINs, which is a big win for the industry as the separation and processing of food waste is a growing source of feedstock. Furthermore, recently released data demonstrates that the commercial transportation sectors continued to turn to RNG as a driver of its decarbonization strategy. 69% of all US on-road fuel used in natural gas vehicles in calendar 2022 was RNG, surpassing the previous year's record-breaking level. RNG used as transportation fuel grew 17% over 2021 volumes and up 218% from 2018 levels. And in California, the entire fleet of vehicles fueled with RNG were carbon negative in 2022 for the third straight year. In closing, I want to thank all of those who have supported Greenlane in building our business as a leading global provider of biogas upgrading systems and joining us in our mission to help clean up two of the largest and most difficult to decarbonize sectors of the global energy system, the natural gas grid and commercial transportation. I'll now pass the call over to Stephanie.

Stephanie Mason: Thanks, Brad, and good afternoon, everyone. As a reminder, all figures are in Canadian dollars unless otherwise stated, and all comparisons are for the second quarter of 2023 against the second quarter of 2022. Greenlane's revenue in the second quarter was $14.9 million compared to $18.1 million in the same period one year ago. System sales revenue accounted for 84% of total revenue in the quarter, which is recognized in accordance with the stage of completion of projects, with the remaining 16% of revenue coming from aftercare services. We delivered a gross margin in Q2 with 29% or $4.3 million compared to $4.6 million or 25% in the second quarter of 2022. The improvement in gross margin was primarily driven from more efficient project execution and a reversal of warranty provisions that have expired. Excluding the reversal of warranty provisions, the gross margin was 26%, in line with our historical range. We reported an adjusted EBITDA loss in the second quarter of $1.5 million versus a $0.4 million loss in the second quarter of 2022. Net loss in Q2 2023 was $4.3 million compared to a loss of $2.7 million in the comparative quarter of 2022. As at June 30, the company's sales order backlog was $16.3 million. As a reminder, the sales order backlog is a snapshot at a moment in time, which varies from quarter to quarter. The sales order backlog increases by the value of new system sales contracts and is drawn down over time as projects progress towards completion with amounts recognized in revenue. The company's reported sales order backlog does not include amounts under the collaborative agreement with ZEG Biogás due to the nature of the agreement or Airdep sales, given the smaller individual contract values and shorter delivery periods. Our balance sheet remains healthy as we exited the quarter with a cash balance of $16.1 million and no debt, providing flexibility for remain to invest in and grow our core RNG business as well as pursue other strategic initiatives. We look forward to keeping shareholders apprised of our progress. And with that, I open the call to questions.

Operator: [Operator Instructions]. The first question comes from Aaron MacNeil with TD Cowen.

Aaron MacNeil: Hey. Good afternoon, and thanks for taking my questions. I hope Monty is doing okay. I'm hoping we can dig in a bit on this development capital project and the broader strategy. And I guess -- I've got a handful of questions, but I'm wondering, one, what exactly were the unforeseen delays? Two, what exactly do you own 100% of now? Three, you mentioned you're advancing the opportunity, what exactly do you plan to do with project going forward and if there are any incremental capital investments required? And four, can you remind any other development, capital investments, and their current performance relative to your expectations?

Brad Douville: All right. Hi, Aaron. Well, quite a lot. That's good. So let's unpack this deployment of development capital topic a little bit. So firstly, I'm going to get into the specifics of the anticipated delays and the circumstances other than to say there were delays, and that resulted in an opportunity for Greenlane to take 100% of the project assets. So what does that mean? So the original construct of this deal was such that the developer pursuing the preconstruction projects -- so that's in the phase of putting contracts together, feedstock, land lease, and all the associated development assets necessary to be able to construct a project -- all of those contracts and any of the other development activities are now wholly owned by Greenlane. So what that means in terms of the next steps of us advancing that? That means to monetize it in whatever way that makes sense. Greenlane is not a developer; the developers are our customers. So that means working with existing developers that are -- we have pre-existing relationships with. It may mean working with certain counterparties that will help us get the project to FID. All along, this program was meant to provide capital to those developers in the space that don't have the capital necessary to advance projects, get the Greenlane equipment specified, and then take a portion of the proceeds of the project once it was generating value from the sales of the resulting RNG. So if you think about it in the context of the original construct, whereby we would have a minority share in partnership with the original developer of the project, we have now 100% of the assets, which would generate, in theory, possibly more of revenue to Greenlane. However, we do have now a situation where we have to take it to market and engage developers to help us get it over the goal line. So with all that said, the underlying document that the note agreement, given that that's now been canceled with the original developer, that is the result of the $1.1 million impairment on the balance sheet. So that's the mechanism that happened there. Hopefully, that answered all four. I hope I answered all four.

Aaron MacNeil: I just -- maybe you could also just include where this -- or like, what the status with the other development capital investments are today, if at all?

Brad Douville: Yes, that's right. That was the fourth one. So I didn't got three out of four five. So there's two programs that we invested in to date. So one was on the West Coast of the US, and the other was in the Midwest. So those were the two programs that we had developed or provided development capital in the form of a convertible note. And at this time, our plan is to see those through and realize the value from those. And right now, we expect to pause on initiating new projects. And partly why we're redeploying the capital into working cap or redeploying the funds that we had allocated towards the development deployment of development program is because of ZAGGmate deals and other activities that we're working on in our pipeline to be able to generate the necessary working capital to realize the volume opportunities that we're pursuing. That's fundamentally core to our business where we knew the deployment of development capital was somewhat adjacent to our core business.

Aaron MacNeil: That's actually a good segue into my next question on the ZEG relationship. I know there's a minimum volume commitment. When do you expect that will show up in the backlog? And what do you think your working capital investment will be for that relationship? Or what do you think it will peak at, I guess?

Brad Douville: Yes, good point. The technicality there is we don't actually expect the ZEG volumes to show up in the backlog. And the reason for that is because it's a different way of doing business for us. And historically what shows up in our backlog is contracted system sales. The nature of ZEG deal is that we'll be providing certain parts from outside of Brazil. ZEG will be responsible for local sourcing of parts within Brazil. And therefore, it's more of a production model if we're looking at 75 units over the next five years, which is ZEG's target. So like I said, it's not going to show up in our backlog per se. However, we will expect to see revenue contribution from that beginning soon. So the minimum volume commitment is in the first year. We also said that over the five years, the 75 will ramp over time. So the first steps are to put the production -- well, the very first step is tech transfer and simultaneous with that is setting up the local supply chain. So we're in that phase right now.

Aaron MacNeil: Got it. I'll turn it over. Thanks.

Brad Douville: Thanks.

Operator: The next question comes from David Quezada with Raymond James.

David Quezada: Thanks. Morning, guys. Maybe I'll just start with some of the commentary that you provided. Brad, that was really interesting about the industry in general and the lack of -- moving forward on the eRINs and the corresponding jump in D3 RINs. Do you have some sense of when that might or when you expect that might translate into, I guess, more project originations in the US? And do you think that -- or could you speculate on whether or not higher D3 RIN pricing is what project developers want to see in order to start looking at new projects? Or is there some other policy, maybe looking forward down the line here, like uncertain -- or sorry, like more certainty under the IRA or something like that?

Brad Douville: Yes, good question. Thank you, David. Why don't we start in reverse order? So the IRA, there was a big focus on that last August, so a year ago already that it was announced by the Biden Administration. And we have to remember that that program had significant uncertainties for a significant amount of time before the Treasury Department released how it was all going to work. And that caused a bit of, I'd say, some confusion and anticipation in the market. But as people have become more familiar with it, the more sophisticated developers in our realm have concluded that it doesn't add a time to the overall financial performance. So really what they are after, and this is the earlier part of your question is

David Quezada: Yes. No, that's great color. Thanks, Brad. So maybe just a follow up there. Just in terms of the LCFS pricing, I think it was a 30%. It was moved from 20% to 30% in terms of the carbon intensity reduction. Maybe if you could just provide -- whatever you're hearing in the industry, has that change happened? And is that starting to -- do you still expect -- is it still widely expected that that would push the LCFS price higher?

Brad Douville: Well, the question, there was a modeling piece of work that was done by the EPA -- sorry, by the ARB six months ago. So they had done a piece of work to say that if they did lower the carbon intensity target, that that would result in a higher price. So that's the lever that they have; it's a bit of a course lever. It takes a bit of time to work through. And the expectation was that that would send a signal to project developers that they would see higher pricing over time. So how has that happened? Well, we haven't quite seen LCFS pricing, credit pricing on a spot basis increased significantly because of that. So I think it's going to take a little bit of time for that to work through the system. But what we do know for certain is that the ARB is behind the program and is taking the action to ensure there is a floor level of price.

David Quezada: Okay, excellent. Thanks for that. That's good news. And then maybe just one other one for me. Just in terms of your target of reaching cash flow breakeven by first quarter. I mean, seems like you made some pretty good progress based on first-half results here. Would you say that things are kind of evolving in line with your expectations there? Any puts and takes you're seeing and/or any comment on how far through those cost reductions you are?

Brad Douville: Yes, good question. We obviously are partway through that plan, if not earlier in the plan. So we had announced that one quarter ago that -- one quarter ago, we said 12 months that we would expect to be EBITDA and cash flow positive. So that's now nine months away. So we're working through a number of initiatives. And the initiatives are twofold. So one is the top line because there is no bottom line without the top line. And hence, the move to create more focus on some of the bigger, larger, more significant deals that we can translate. AS part of that, it's bringing in Ian Kane to take on my days from a day-to-day CEO perspective, free my time up to focus on those strategic initiatives and areas of the business that we think will contribute more fulsomely to the top line. On the bottom line, obviously, our mission there is to make sure that we align the resources accordingly with the top line. So our ambition is to grow the top line, and therefore, we'll be in a situation of needing more or not less people. Obviously, we'll monitor that over time. And the other thing I can say is if we bring it back to the ZEG deal, that's clearly a Brazilian focus. We know in Brazil, it has a very different dynamic, a very different interaction with the governments and policymakers than we see here in North America and in Europe. And for us, that's really exciting that there is a market-based opportunity. We're already taking advantage of that. We are the market leader in Brazil, and that is a particular focus area for us to maintain that market leadership. So there's been significant amounts of effort, not just this past quarter, but prior to that, beyond the ZEG opportunity that we think we can realize in the near term here.

David Quezada: Excellent. Thanks for that, Brad. Appreciate it, and I'll turn it over.

Operator: The next question comes from Nicholas Butcher with Cormark Securities.

Nicholas Boychuk: Thanks. Coming back to the prior commentary on the development program, I'm wondering if you can expand a little bit, Brad, on how much capital and internal resources you're going to need or deploy to get that project to FID? And then what the potential return is on that? Like is it a meaningful potential bump? Or is this more like a recovery of dollars already deployed?

Brad Douville: Firstly, hi, Nick. Can you just restate your first question? Because to be honest, I'm not sure I'm understanding what you're asking.

Nicholas Boychuk: I'm curious how much capital you'll have to deploy or other working capital you have to use in order to get that project from its current state to FID level where you could then sell it off to another party.

Brad Douville: Okay. All right. Good. So the impairment that was taken, $1.1 million, that reflects the amount of money that was invested in that project to date. That gets it pretty far along. As of now, we are looking at our options as to whether we invest further funds or we bring a partner in that will fund the remaining portions to take it all the way to FID. So we think that the investment made to date takes that project quite far down the road. However, there is more and more investment to go. So I think it's very safe to say that the majority of the investments are -- have been made and there is a minority left to go. So we haven't yet taken a decision as to whether Greenlane will invest more.

Nicholas Boychuk: Got it. Thanks. And then just on the sales forecast, you had mentioned a couple of times that you're looking forward to announcing additional sales in 2024. I'm curious if the revamping of product sales and making things a little bit simpler and streamlined has increased the visibility that you have, or is giving you the opportunity to high-grade prior opportunities that were already in your pipeline, such that you could now potentially bring them forward? Is there a better return profile or the margins are better? Any color on the sales outlook would be good.

Brad Douville: Yes, that's a great question, Nick. Thanks for that. It gives me an opportunity to expand a little bit more on what we're up to here. So what we're trying to accomplish with this is a reflection. Over the last three years, we had tremendous growth in the business. We also had quite a proliferation in a positive way of our product portfolio. So we expanded out the product line. We already had three years ago a very fulsome water-wash product line. We expanded significantly our PSA product line or pressure swing adsorption, as well as our membrane product line. The point is we learned a lot. We learned a lot about the market segments. We learned a lot about the customer appetite and what customers are looking for across the four key sectors that we serve, which are landfill, wastewater, agriculture, and food waste. So each of those has a different characteristic. And what we've learned as well as the market has evolved and become a bit more sophisticated in understanding the needs, we're able to target our products towards each of those sectors using the different technologies. And we've learned that our technologies, they're more relevant in certain markets than others. And that goes across all three of the technologies. So to answer your question around improved margins, that's the endgame is that we believe that the smarter we are -- because we're we've been at this for decades and particularly over the last three years, we had an opportunity to learn an awful lot in the projects that we've deployed. And remember, we're currently actively working on more than 20 right now, that gets us a unique position in the market. It gives us a vantage point that not others -- our competitors have and the ideas that we have, attractive products targeted towards each of those sectors. We don't expect to sell multiple technologies in each sector, but rather preselect for the customers the technology that we've learned is the right one for them. The synergy there also is that that should result hopefully into a better gross margin profile for Greenlane.

Nicholas Boychuk: Okay. Thank you.

Operator: The next question comes from Ahmad Shaath with Beacon Securities.

Ahmad Shaath: Hi, Brad and team. Thanks for taking my question. I guess, back to the one project that you guys now own, are you able to give us a little more color on what stage of development this is in in terms of just getting -- I know I didn't ask before, but maybe some of the key things that are required to get the project going. Have you already secured feedstock to the site allocated? Like just give us a general sense of how far is it along the development to kind of make our own assumptions in terms of how much money is needed?

Brad Douville: Thanks for the question, Ahmad. Interesting question on the feedstock. So partly in the development phase, so firstly, what phase is it in? It's definitely preconstruction, so pre-FID, and that's always a continuum. So the main point, I would say, in terms of when do you call it done, when do you know you're done, that's not so clear because it's aggregating feedstocks in this case from a number of different -- in this case farms -- to pull feedstock in. We do have -- there's a target in mind. And whether you exceed that target or stop slightly shy of that target, that's the thesis that you need. There's nothing extremely magical about the target other than that's what's deemed at a given time to make the pro forma work and function. But as you add more and more feedstock, the project gets some larger and more attractive. So that's the phase it in. So we will -- as we continue to advance this project, whether we invest ourselves or get a partner, then we'll be making that determination, when is done done when it relates to the feedstock. There are other aspects of the project in terms of the lease side; that's in good shape. Pipeline interconnect. The basic elements of the development cycle are pretty much done. The focus is on feedstock aggregation, as I just mentioned.

Ahmad Shaath: That's very helpful. And maybe one more on the same topic and sorry to harp on the same issue. Would you say that -- the fact that the RIN and LCFS environment kind of -- the project is a little bit stagnant and then you're able to get your hands on it. And now, these things are picking up again; the projects become super attractive and I guess reignite the initial reason that you guys got involved with the project to begin with. Is that a fair statement or really the environment had nothing to do it and it was just intrinsic to the project developer that you are dealing with?

Brad Douville: I like the way you framed that up. But I don't think we can say that. I think we can say that we're going to benefit from that with some lower LCFS pricing over the last little while because we -- and certainly from where we sit at Greenlane, we think the price will go up. So we think we'll benefit from that. But I don't think it's safe to say that the reason for us acquiring 100% of the assets is a direct line to the drop in LCFS pricing. So I don't think we can say that.

Ahmad Shaath: That's very helpful. Thanks. And last one, I haven't got a chance just to go through the full financials yet because it's disclosed; we'll go through it. But do you guys disclose the contribution from Airdep for this quarter?

Brad Douville: Do you mean did we disclose it on its own -- as a division? Is that your question?

Ahmad Shaath: No, no. I mean, did you guys point out to the amount that you guys generated Airdep for this quarter? Or are you able to give us that number by any chance?

Brad Douville: Yes. So last year, we disclosed Airdep uniquely because of it being an acquisition within the year. This year, we're not splitting it out as its own segment. So we have -- the segments that we report publicly are system sales and the aftermarket. So the answer is that sorry.

Ahmad Shaath: All good. Fair enough. Thanks for answering my questions. I'll jump back into queue, guys.

Brad Douville: All right. Thanks, Ahmad.

Operator: This concludes the question-and-answer session. I would like to turn the conference back over to Darren Seed for any closing remarks.

Darren Seed: Thank you very much, everyone, and we look forward to seeing everybody on the next conference call.

Operator: This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.