Earnings Transcript for GRNWF - Q4 Fiscal Year 2022

Operator: Good afternoon, ladies and gentlemen and welcome to the Greenlane Renewables Fourth Quarter and Fiscal Year 2022 Conference Call. At this time, all participants are in a listen-only mode. Following the results, we will conduct a question-and-answer session. [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. Please go ahead.

Darren Seed: 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's 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. 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 the 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: Good afternoon. Thank you everyone for participating on today's call. I would 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 and less stated otherwise. The Greenlane team delivered another year of record revenue in 2022, a solid accomplishment given some challenges in the RNG 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 two 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 off take 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 wins, 25% of which was for food waste to 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 announced 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 waterwash system for upgrading biogas from food waste streams in direct -- 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. For 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 have seen a recent shift in contracting activity towards food waste RNG projects as compared with dairy derived RNG projects. The challenges I referred to a minute ago in the RNG market in the U.S. that emerged during 2022 are related to price. 2022 began with strong RNG spot prices near the highs of the five-year range in the U.S. However, prices began to moderate throughout the year, ultimately ending below their five-year average, largely due to a surplus of credits under the California Low Carbon Fuel Standard, or LCFS, program. U.S. dairy projects were particularly hard hit. At the beginning of 2022, spot prices for dairy derived RNG were more than US$115 dollars per MMBtu. But by the end of 2022, prices dropped to around US$70 per MMBtu. These effects combined with inflationary pressures, rising interest rates, and lack of [indiscernible] 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're 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, deploying 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 under debt free, which means we're 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.

Monty Balderston: 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 31st, 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 drawn 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 31st, 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 our 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'll continually focus on prudently managing our cash to maintain a stable financial footing. We look forward to keeping shareholders apprised of our progress. And with that, I will open the call to questions. Operator?

Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Nick Boychuk with Cormark Securities. Please go ahead.

Nicholas Boychuk: Thanks. Afternoon guys. 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 what's happened in the LCFS market. 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.?

Brad Douville: Yeah. Hi, Nick. So yeah, what we're trying to shine a light on here is a little bit is, is the diversification that we've seen in our sales activity from 2021 and 2022, just to show a little bit of the trends we're seeing. So, as I mentioned that the trend from 2022, sorry, 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 trend, a shift in our recent contracting activity towards food waste for the U.S. market away from dairy. And I think that's obviously a consequence of some of the pricing dynamics we've seen in RNG as impact of the LCFS and 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.

Nicholas Boychuk: Okay. Thanks. Shifting to growth margins, can you walk us through what happened on the two projects you noted this quarter, and kind of talk through the potential of that occurring again, or if those are just completely one-off events.

Monty Balderston: 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 there are a one-time event, 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 cost impacting margin, and give perspective. We operate in different environments, so we're exposed to site conditions, which sometimes things happen that you wish didn't. And then in regards to the contracting scope, that is where we are much more laser focused and I wouldn't want to stay with certainty. It's a one-time event, but it's definitely very unusual to experience what occurred there. And so, we do not expect that to be something that shows its head again.

Brad Douville: Yeah. 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 says, 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 know.

Nicholas Boychuk: Okay. That's helpful. Thanks. 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 on 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 now covered by governments, are you seeing more flexibility to potentially increase your prices?

Monty Balderston: Well, it's a good question, Nick. I mean, we look for opportunities where we can uniquely take advantage of some pricing that's 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 as trade answer, I realize that, but there's 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.

Nicholas Boychuk: Okay. Thanks guys.

Brad Douville: Thanks Nick.

Operator: Your next question comes from David Quezada with Raymond James. Please go ahead.

David Quezada: Thanks. Good afternoon everyone. 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 timeline 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?

Brad Douville: Yeah. Firstly, hi David. Good questions. Thanks for those. And I also want to say is, 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 Resources Board has held, the most recent one being, a week or so ago or whenever that was. And so they've -- 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 of the transportation fuel mix in California. And they've -- 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, I'll call. And that in this case was changing the reduction requirements, the compliance targets that takes effect. My understanding, again, this is, you know, need to double check the fine detail on the ARBs publish documents, but that would take effect in 2024. But I think what they're ultimately doing is sending a price signal so that people get clear view of transparency of what's happening in the program. And that sets pricing now rather than having to wait till 2024 until that 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 1st. 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. So that's caused certainly when the IRA was went into law in August, I think there was a bit of a pause for people to say, well, what does this mean and how do we protect our position for the investment tax credits under that new law? That wasn't very clear. It's still not a hundred percent 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 those final rules are. You would've thought they would've been published before January 1st. But here we find ourselves in March and there's still not fully released.

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

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

David Quezada: Great. Thanks for that. I'll turn it over. Thanks guys.

Operator: Your next question comes to Aaron MacNeil with TD Cowen. Please go ahead.

Aaron MacNeil: Hey, afternoon all. Thanks for taking my questions. 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?

Brad Douville: Yeah. 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 brilliantly manage the cash. That's mission number one to make sure that we do that. Right now, we're focused on the top line. So, we think that, 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'll be helpful for a focus for us. But we'll take the appropriate actions that if and if and when those need to happen.

Aaron MacNeil: 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?

Brad Douville: As it relates to biogas projects, there's a couple main things. So one is there's the labor law component. So, this is the apprentice and the -- let's -- just slip my mind the other piece of it. So there's the wage, the fair wage 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 into 2023, so was not to erode the ability for the project to capture the IDCs under the IRA.

Aaron MacNeil: 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?

Monty Balderston: Yeah. So, it's Monty speaking. When we enter into any contracts, we do a KYC process, know your client process similar to lots of other industries. Obviously, there's lots of judgment in there, but we do spend a bunch of time. This situation I would suggest was, I don't want to call it unique, but a little bit different. And unfortunately, left us in a bad place. But in general, on our projects, we are getting paid by the customer in advance of when we are paying for those supply of the goods. So, we're in a net positive cash position, but obviously there is some risk that an entity could go upside down. But for the most part, we've been pretty good with dealing with big parties. And then also in the case of some of our larger contracts where they have bonding capacity, our financial partner being the lending institution, and then EDC, they do their own KYC process as well before they green light with it. So, there's also a third-party mechanism in there as well.

Aaron MacNeil: That's helpful. Thanks guys. I'll turn it over.

Operator: Your next question comes from Adam Gill with Paradigm Capital. Please go ahead.

Adam Gill: Good afternoon, everyone. Just on your recent order announced this morning, Synthica has quite a number of projects on top of the St Bernard project, 15 more similar scale food to RNG, food waste RNG projects. Do you think you're in good position to be bidding on these projects given they liked what they saw on your initial bid? And do you have any color on their timing of potentially additional orders for their project rollout?

Brad Douville: Yeah. Hi, Adam. I think, hopefully, the order speaks for itself that, that we are in good position to work with them on additional projects. I think what they've published on their website is, is probably the best information that's out there. Obviously, we can't speak on their behalf in terms of timing. In the development phase of projects, there's often uncontrollables, but we do know that they're very committed to the space. They're motivated to move forward. They wanted to work with us, and we're proud to have won that order. And for us, what we intend to do is to look for those developers who are capable, well capitalized, and that we can add value and support and support them through their -- ideally, through their whole portfolio. So, I don't know what else to say. Yes, we'd like more business from them and we're hoping to achieve that.

Adam Gill: Great. Second question for me, just on the current order backlog, given it has been kind of coming down through the year. What -- how long do you think it would take you to grind through the backlogs that are currently in place at the end of the year, not including the recent order?

Brad Douville: Well, we've disclosed publicly before, our projects typically run between nine and 18 months, so obviously it's -- some of it's driven by the schedule of the project. I would suggest that very macro picture, the backlog that you see should be materially used in fiscal 2023, obviously, loaded towards the first half versus the back half. But there's a lot of moving parts. Projects do move in timing, and so it's not an exact science. But I would suggest that we should be through the vast, vast, vast majority of that backlog in 2023.

Adam Gill: Okay. Sounds good. That's all for me. Thank you.

Operator: Your next question comes from Ahmad Shaath with Beacon Securities. Please go ahead.

Ahmad Shaath: Hi, guys. Maybe just a one for me on, if you're able to help us understand the split between the one project that had a change of scope and the one project that has some cost inflation related to the commissioning stage impact on margins each. And on the commissioning project, what specifically happened there in terms of the cost increase?

Brad Douville: I apologize, I couldn't hear some of what you said. But if I interpreted right on the two large initiatives, you're looking to get a little bit more color as to what specifically occurred.

Ahmad Shaath: Yeah. On the two projects that had an impact on gross margin this quarter today, to help us understand the order of magnitude of the impact between.

Brad Douville: Well, I don't want to get into specifics as to how much on each project, but I would suggest in general, they loosely were about half each. So, if you look at the grind from 25%-ish to 19%, that's loosely a million dollars. And it was about half the impacts were about half each for those two projects, obviously there's about 10,000 other moving parts in there that go on. But I think directionally that would be a good proxy. And then, getting into the specifics on the commissioning costs, just to give you perspective, we're doing this outside in the field in different environments. You have issues such as weather, you have issues such as preventative maintenance, and you always need to work with your contractor being typically an EPC. And there's always debate as to who's responsible when things don't go well. And so, obviously, we actively manage that, but you don't win a hundred percent of those conversations. And so that's what happened there. And then in the case of the project scope, there was an issue where there's a different interpretation made, and ultimately, the decision was is that we -- we're going to have to eat that cost. And so, absolutely we don't like those things occurring, but in this case, it did occur and it was of an order of a magnitude that it stands out.

Monty Balderston: And I'll just add to that, Ahmad, that the scope control piece, that's something that we've got tight internal controls and had really good success doing that. We've had a bit of an anomaly in Q4 with this particular project, but that's unfortunate. The commissioning one, we do have a lot of variability when you arrive at site. So that's not necessarily a new thing for us. You've seen our past performance on gross margins. They've been quite steady and solid. And so, this is something that just happened as a more variability than we would've liked in Q4. But previous to that we've had a solid track record of being able to manage and control that.

Ahmad Shaath: That's great. That's very, very helpful. I appreciate that. And maybe you'll follow up on deployment of project development capital. Maybe give us an update. I see you guys maybe didn't do much in Q4, but has the change in the environment in the U.S. changed the way you think about that initiative or, and what you allocated, if any, amount of money is there allocated for that in 2023?

Brad Douville: Yeah. Great question, Ahmad. So, in the MD&A, I believe it's -- I think we said it somewhere around $10 million that's slotted for our deployment of development capital model. And that's we did the first two deals, they're in the U.S., but we didn't limit it to the U.S. market. We've been quite active in markets outside of the U.S. for the same concept to deploy that. In the development phase, there's a lot of moving parts. We've had a number of discussions. We intend to continue down that program path. And I think it's fair to say that the two deals that we did in 2022, that is a -- it's a pilot phase of the project. We want to be able to demonstrate the value that we bring to the development teams, while at the same time securing the orders and seeing our recurring revenue and profits be realized through this opportunity. So, we intend to do more. We intend to evolve the model as the market speaks back to us in terms of what's helpful and what's not so helpful. But so far, I think for these first two deals, it's been positive response from our developer partners and we're looking to do more as there's opportunities.

Ahmad Shaath: That's great. And last one for me, and I'll hand it over. Back to your comments on continuing to be focused on revenue growth, which we appreciate that. Should we expect maybe G&A cost to check up as well just in support of the revenue growth pursuit that you guys are at? Or are we at a good level with G&A right now?

Brad Douville: Well, obviously, we always want G&A to be smaller, so if you're ask the accountant, I would say we're focused on it. But based on the -- obviously if there's a step change in our revenue profile. There would need to be a corresponding change of some nature in G&A. We are seeing some efficiencies being gained, as we mentioned, on systems and processes. We're not to the promised line as of yet, but we're starting to see some of that. So, my expectation is that if we had the corresponding revenue going in the direction we want, the pace of G&A should not follow, it should be smaller as we start to see some benefits from the work we've been doing here over the last x number of months that we're continuing to work on over this year.

Ahmad Shaath: Sounds good. Thanks just answering our questions. I'll jump back in into queue.

Brad Douville: Thanks Ahmad.

Operator: Your next question comes from Colin Healey with Haywood Securities. Please go ahead.

Colin Healey: Hey, guys. I guess we covered quite a bit of ground here, but maybe just looking for an update on the potential M&A activity. And if you're seeing many emerging opportunities that compliment the business like Airdep. And just wondering if you're seeing valuations come down on potential targets, or if you have any comment around that. And also maybe just a quick comment on Airdep itself and if it's kind of meeting expectations in terms of opening doors overseas, any color like that.

Brad Douville: Yeah. Yeah. Good question, Colin. So, start with Airdep meeting our expectations, I'd say, yes, absolutely. So that was favorable deal for us. It did what we wanted to do. It added some incremental revenue and growing revenue to the business with some growing margin opportunities, plus the compelling product to make our portfolio that much stronger. So, checks all the boxes for us, and we're pretty pleased with the outcome. We think that was a really great deal. Set a high bar for us now in terms of other deals we want to do. We want to be as good or better. We do continue to look around. I guess, we did see -- well, I don't know how to say this. I mean, there was a bit more activity I'd say a year ago in terms of availability of targets or deal flow possibilities. But there's a few things still out there. I think we have raised our bar in terms of what we want to accomplish and what we want to see. Had a great experience going through that. We went through some -- some others that didn't that's normal when you're doing M&A activity. But yeah, we continue to keep our eyes wide open for new M&As that continue to propel the business forward. So, look for more as we find some.

Colin Healey: Yeah. Thanks. I appreciate the update. I'll leave it there.

Brad Douville: Thanks Colin.

Operator: [Operator Instructions] There are no further questions at this time. Please proceed.

End of Q&A:

Darren Seed: Thanks everyone. I look forward to seeing everybody on the next conference call. And please feel free to submit any questions you want to the website as well.

Operator: Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.