Ameresco, Inc. (AMRC) Q3 2022 Earnings Call Transcript

Perfect. Good day, and thank you for standing by. Welcome to the Ameresco Q3 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference call is being recorded. I would now like to hand the conference over to your speaker today, Leila Dillon, SVP of Marketing. Please go ahead.

Thank you, Haley, and good afternoon everyone. We appreciate you joining us for today's call. Joining me here are George Sakellaris, Ameresco’s Chairman, President, and Chief Executive Officer; Doran Hole, Executive Vice President and Chief Financial Officer; and Mark Chiplock, Senior Vice President and Chief Accounting Officer. Before I turn the call over to George, I would like to make a brief statement regarding forward-looking remarks. Today's earnings materials contain forward-looking statements, including statements regarding our expectations. All forward-looking statements are subject to risks and uncertainties. Please refer to today's earnings materials, the Safe Harbor language on slide two, and our SEC filings for a discussion of the major risk factors that could cause our actual results to differ from those in our forward-looking statements. In addition, we use several non-GAAP measures when presenting our financial results. We have included the reconciliations to these measures in our supplemental financial information. I will now turn the call over to George. George?

Thank you, Leila and good afternoon everyone. I am pleased to report that the Ameresco team delivered another quarter of excellent performance with growth across all four of our business lines, driving an impressive increase in revenue and profits. We have made great progress since we met at our Investor Day at the end of March. We continue to expand our addressable markets both domestically and internationally. You will notice that an increasing number of our projects and assets incorporate more comprehensive advanced technologies, such as energy storage systems and complex microgrids. In addition, we are deploying smart solutions for buildings, lighting, and water systems. Our recently awarded critical microgrid projects at both Fort Campbell at the White Sands Missile Range, and our $92 million Joint Base McGuire energy savings performance contract are great examples of our latest advanced technologies projects supporting federal customers' energy security strategy. And on the asset side, we recently announced a combined five megawatt PV and 15 megawatt-hour battery energy storage system at Colorado Mountain College, which will be the largest subsystem in the State of Colorado. We also continue to expand our business in Europe, where there is a pressing need for clean energy solutions, given the geopolitical situation and spiking energy prices. In the third quarter, we were selected together with a local partner as a contractor for 100 megawatt PV projects in Drama, Greece. This represents the largest project for us in Continental Europe, and we believe it's only the beginning. We are aggressively pursuing multiple other opportunities and we expect to grow in Europe, both organically and through strategic partnerships and acquisitions. Recent R&D market activity demonstrates the growing interest and importance of this asset class with significant investment and acquisition activity. Ameresco is one of the most experienced players in the biogas industry with a large portfolio of operating assets and a robust development pipeline. Just this quarter, we added two RNG plants to our assets and development. We believe that RNG is an important clean tech solution and will continue to be a significant value driver for Ameresco's shareholders. We also believe the Inflation Reduction Act, or IRA, which was enacted in the third quarter, will be the most impactful environmental legislation affecting the company's long-term performance since our founding. The IRA provides unprecedented amounts of clean energy incentives to ensure energy security, reduce carbon emissions, increase energy innovation, and support environmental justice objectives. The bill includes a wide range of clean energy provisions that support energy efficiency, solar, energy storage, microgrids, electric vehicles, and more, with a goal of reducing U.S. carbon emissions by approximately 40% by 2030. This legislation not only creates a 10-year runway for many energy tax incentives, but it also fundamentally revises the tax code to create a technology-neutral approach to incentivize the development of zero-emission technologies. Some specific provisions that will have a direct impact on our business include production tax credits for renewable or zero-carbon electricity and clean hydrogen; investment tax credits for clean electricity and energy projects, including standalone energy storage, biogas, microgrids, and geothermal heating and cooling; clean vehicle and charging infrastructure tax credits; as well as carbon capture credits. It also expands the energy efficiency tax reduction. While everyone is still evaluating the breadth and depth of the incentives, grants, and other benefits from this bill, we do expect it to be a great long-term tailwind to our business. We have already identified a number of ways this bill would directly benefit our customers and Ameresco. With our customized solutions, ranging from solar microgrids and battery energy storage to renewable natural gas and electric vehicle infrastructure, along with our innovative financing structures, Ameresco is well-positioned to be a long-term industry partner and key beneficiary of this legislation. Based on our experience with similar legislation, though, we anticipate these benefits will take some time to materialize. Now, I would like to provide an update on the Southern California Edison project. We made continued progress in the quarter with all battery cells and containers on site in early commissioning steps underway. Recently, however, Southern California Edison instructed us to adjust the project schedules into 2023. Under the terms of the contract, we are entitled to recover costs associated with a schedule adjustment. We are working with Southern California Edison to analyze and estimate these costs. We're also continuing discussions regarding the applicability and scope of any force majeure relief. Considering the scheduled adjustments requested by Southern California Edison and the delays disclosed earlier, we anticipate the projects to be in service and achieve substantial completion prior to the summer of 2023. Our relationship with Southern California Edison continues to be very cooperative. I would also like to highlight that in the third quarter, we were honored to become a Great Place to Work-certified company for the first time. This designation is based entirely on employee input, making it even more meaningful as it reflects the positive experience of our over 1,300 employees. Hiring and retention is critical to the company's growth and we will continue to strive to make Ameresco a great place for our employees to work, thus ensuring that we attract and retain the best and brightest in the industry. I will now turn over the call to Doran to provide some comments on our financial performance. Doran?

Thank you, George and good afternoon everyone. For additional financial information please refer to the press release and supplemental slides that were posted to our website after the market closed today. As George noted, the Ameresco team delivered another excellent quarter of financial results as all four of our business lines experienced solid growth led by our projects business. In addition, the combination of our project backlog and expected future revenues from our contracted energy asset and O&M businesses remains at close to $5 billion, giving us excellent long-term visibility and resilience during these uncertain economic times. Topline growth was led by our projects business as we continue to execute on the SoCalEd projects. Our O&M business line also experienced strong revenue growth as we attach O&M contracts to our projects, especially with the federal government. Separately, however, I'd like to take this opportunity to highlight our nationwide solar O&M business. This unit now manages over 564 megawatts, almost 400 megawatts of which are for third parties. When we acquired this business in early 2019, it had only 45 megawatts under management. We're very pleased with the growth of this business and will continue to focus on a disciplined approach to acquisitions, where we can acquire and grow companies, integrate their solutions, and create value for our stockholders. We also saw continued strong growth from our integrated PV revenue, which is part of the other revenue line. This unit's performance was driven by increased demand for off-grid solar systems from the oil and gas, rail, and other industries seeking energy solutions where no grid access exists. As we expected, our gross margin increased sequentially as the lower margin SoCalEd contract had a lower contribution to the overall revenue mix. We anticipate similar gross margins in the fourth quarter. We again achieved very strong double-digit year-over-year growth in adjusted EBITDA as a result of our operating leverage, demonstrating our ability to add gross profit dollars without adding direct incremental operating expenses. Even with the continued working capital needs from the execution of the SoCalEd projects, the company ended the quarter with $122 million in available cash, having generated $35 million in cash from operations on a GAAP basis. Our adjusted cash flow from operations was $87 million, which takes into account federal ESPC financing proceeds. We expected the SoCalEd projects will continue to impact our near-term working capital needs. This impact was anticipated from the onset and is one of the reasons why we amended our senior credit facility early in the year. We expect all components of working capital to return to more normalized levels for our business with the completion of the SoCalEd contract and the collection of the remaining amounts owed. Total project backlog was a healthy $2.6 billion at the end of the quarter. Off note, we're seeing increased activity from the C&I sector, as this market segment focuses on sustainability metrics. In addition, our projects and asset lines of business continue to grow in Europe amidst the ongoing energy crisis. Ameresco grew its portfolio of operating energy assets to 360 megawatts, while building its owned assets in development and construction pipeline to 452 megawatts. As a reminder, we are now reporting both the total assets in development as well as a pro forma net megawatt total after adjusting for our partners' equity interest. This should help investors better understand the positive impact these jointly owned assets are expected to have on our future financial performance. Even with increasing interest rates and equipment cost inflation, sustained high energy prices continue to create favorable long-term expected returns for a variety of energy asset types deployed by Ameresco. We're seeing an increase in proposals and awards for our energy assets. In particular, our newer nationwide greenfield solar and storage development group has been originating early-stage front-of-the-meter opportunities, which once de-risked, would grow our assets in development metric. For a bit of background, a couple of years ago, we began investing in a team of greenfield development experts and we're pleased to see the results of this organic strategy beginning to pay off. Furthermore, with the incentives in the IRA, we expect the pace of these opportunities will continue to accelerate. With debt being an important portion of our capital stack, I will spend some time discussing our interest rate exposure. About 90% of our non-recourse debt is protected from rate increases at this time as it is either fixed rate or was swapped at closing. The only material part of our debt structure that is variable is our senior secured credit facility. While the balance of the facility has increased due to the execution of the SCE contract, our funded debt under this facility is expected to decrease meaningfully following the completion of the projects and receipt of associated cash payments. This should limit any medium or long-term impact of higher interest rates on our financial results. Higher interest rates also have a potential impact on our projects business. The majority of our project customers fund their implementation under performance contracts with third-party bank financing. Higher interest rates have the potential to reduce project sizes, as a greater percentage of energy savings is consumed by interest expense. Similarly, when looking at new proposed energy assets, higher interest rates have the potential to affect the projected equity returns. However, both our customer projects and our renewable energy assets compete against traditional energy sources, in particular electricity and natural gas, which have seen dramatic price increases this year. These increases in energy costs have outpaced the year-on-year increase in Ameresco's overall project delivery costs, financial materials, and labor, which we believe on balance is preserving a positive economic outcome for our customers and ourselves in both the project and energy asset businesses. We monitor the pace of change in these macroeconomic factors closely and continue to remain very disciplined with our risk-adjusted returns-based approach. We're pleased to reaffirm our 2022 annual guidance; our ability to do so in today's challenging environment speaks to the diversity and resilience of our business model and the hard work of the Ameresco team. As in past years, we plan to provide guidance for 2023 when we report Q4. We remain very optimistic about the strength of our business model and end markets and we remain confident in our previously stated goal of achieving $300 million of adjusted EBITDA in 2024. Now, I'd like to turn the call back over to George for closing comments.

Thank you, Doran. Government and industry are now taking important steps to address the climate, geopolitical, and budgetary issues facing our customers around the globe. Ameresco, with our portfolio of comprehensive clean tech solutions, is at the nexus of this trend, positioning us for robust growth for years to come. I want to once again, take a moment to thank the entire Ameresco team for their dedication and outstanding execution. We also want to recognize the ongoing support of our customers and long-term stakeholders. Finally, following our successful Investor Day in March, we are once again welcoming analysts and institutional investors to learn more about Ameresco. We will be hosting a tour at our Phoenix, Arizona R&D Facility on November 15th. This plant is the largest wastewater treatment biogas to renewable natural gas facility in the U.S. We hope this tour will provide a deeper understanding not only of this impressive facility but also of the strength of Ameresco's RNG business. Operator, I would now like to open the call to questions.

Wonderful. Thank you. At this time, we will conduct a question-and-answer session. Our first question comes from the line of Noah Kaye from Oppenheimer and Co.

Thanks very much. Let's start that again. And thanks for taking the questions. I was wondering, since you touched on the prepared remarks, if you could go a little bit further on the impacts of the IRA, maybe take us through what the last couple of months have been like in terms of where the customer focus has really picked up, where the pipeline growth opportunities have picked up for you? Are there a couple of areas that you would really highlight? And where do you see that potentially impacting as we look out to the next year or two?

Yes. And it's a great bill, no question about it, it's going to help us tremendously. And that's going to take some time to gain traction. If you recall, back even when we had the recovery plan during the Obama administration, it took us like six months to 12 months to really take effect and get going. But where we see the most activity is on the asset base. The asset business has accelerated; I would say, at a faster pace than everything else. Some of the other items like, for example, the cogeneration ITC, some of the customers now are debating whether they should own the facility and monetize the rebate and cash, thereby owning the facilities themselves. So, it's only two months old and I think the customers are trying to figure out how to take the best advantage associated with the bill. And Doran, do you want to add anything?

No, I mean, George is right; the asset side of the business is where the focus is going to be. I would say that the last couple of months have involved a tremendous amount of analysis. We're working with several clients on that asset question, especially with the direct pay. Our customer base has a lot of government and not-for-profit organizations. So considering what asset ownership means to those customers and how it would alter the economics, certainly, we expect that to continue to be a topic of conversation. On our own assets, we've got sort of the immediate look forward on what to do between now and when the guidance comes out. And then also, we have the longer term on what to do with a lot of the assets that we've got in development with all sorts of different regulations to evaluate.

Very helpful color. And you talked a little bit about RNG development, adding a couple of new projects to the pipeline. And you mentioned the market activity. Yesterday, we saw Avista come out with their RFP for RNG procurements. And there have been a couple of high-profile deals recently. I guess, how do you assess, particularly post the IRA and the biogas incentives, the competitive landscape and the opportunity set now around RNG? I know we'll probably hear a little bit more about it at your investor event, but just wondering if you could give us the high-level view on how the landscape is shifting?

I believe this is a significant catalyst and a valuable asset for us, especially with our robust development pipeline that we are currently working on. We will provide updates on our development pipeline metrics, but it's important to note that our pipeline is considerably larger. However, we won't move them into the actual development pool and engage in deals until we finalize some gas agreements and secure additional rights with lenders. It's crucial to recognize that 40% of the energy in the United States comes from natural gas, and we need to find a way to decarbonize that pipeline. This is part of the reason NextEra took a major step into this sector. We were among the pioneers, establishing the first RNG facility in San Antonio back in 2012. We view this as a significant catalyst for our business, and the developments within the Inflation Reduction Act will further support our efforts. Our established track record in the market gives us a solid backlog.

Thank you everybody. Hello, everybody. Two things. Maybe Doran to start with, can you tell us a little bit about the SCE project? I mean the complete delivery is delayed to 2023. How does that impact how that project hits the income statement?

We reviewed the overall project and what we aim to achieve before the end of the year, along with what will be pushed to 2023 in terms of putting those assets into operation. We remain confident that a significant portion of the profits, or rather the revenues, will be generated in 2022. We estimate that approximately $30 million to $35 million in revenue will be deferred to 2023 from the total. This amount is not insignificant, but it doesn't constitute a major portion.

Okay, great. That's helpful. And I gathered that from some guidance, but I was just curious if there's anything else behind that within the guidance that changed. The other quick thing is on the RNG front. Can you just give us an update on facilities in operation and the timelines for the next few to come on stream in 2023 and 2024?

Yes, I believe one of the plants is likely to achieve mechanical completion by the end of the year, while the other two are expected to complete in the first quarter of 2023. However, it's important to note that after mechanical completion, it takes about three to four months to go through the commissioning process. Therefore, we won't start generating revenues and income until three to four months after mechanical completion. We have faced some delays, despite having the necessary environmental and building permits, as some equipment arrived later than anticipated. As previously mentioned, we aim to have five to six plants reach mechanical completion by the end of 2023, and we remain confident about meeting this timeline.

Wonderful. Our next question comes from Eric Stine from Craig-Hallum. All right, Eric, you're online.

Okay, can you hear me? So, I'm wondering if we can just talk about the Bristol project, maybe just an update on that. And I think in the last call, you talked about two potential similar projects in the U.S., one in Europe. So, just curious how the initial project is going, but then update on these new ones?

It's one of the most exciting projects we have, and we are also working on several other parallel initiatives. Some of these are moving forward, but the process typically takes a couple of years. The Bristol City project, for example, took over two years to reach its current stage. It's important to note that this project comes with a 20-year concession. While we have identified an investment of over £1 billion, that amount is spread over the 20 years. You will start seeing some projects emerge; some will be based on EPC and some asset-based. However, they won't begin to appear until the second quarter of 2023. Everything is progressing as planned, and we've transitioned some personnel from the city to our unit. While we are making strides, there won't be any updates until early next year.

Yes. Understood, okay, longer term.

This particular project, while significant at over £1 billion, is not set for a short-term timeline. Therefore, we won't be providing updates as frequently each quarter as we did for the Southern California project, which was over $800 million and implemented within a year.

Understood. Understood. Okay. And then just interested in your discussion; obviously, the wins in Europe, and that organic but also acquisition potential there. I mean, maybe just talk about kind of what you're seeing, just thinking through the energy landscape there, as well as the implications in terms of what's out there and potential valuations you might be looking at? I mean, I would assume these are going to be more strategic and bolt-on rather than large, but mainly just some thoughts on the acquisition side?

Our strategy remains consistent, especially in Europe. We're focused on acquisitions that won't lead us to overpay for assets. We monitor the market multiples closely and seek businesses that can be integrated effectively and enhance our earnings per share while aligning with our strategic goals. We value strong management teams in our potential acquisitions. At this time, we're considering various opportunities across all our business sectors in the region.

Perfect. All right. Thank you, guys. Our next question is going to be coming from George Gianarikas from Canaccord Genuity. Go ahead, George.

Hey, good afternoon, everyone, and thanks for taking my question. I had just a follow-up on the recent M&A activity in the space. I'm curious as to how you think about your portfolio of assets. Are you willing to trade mix and match, take capital from a sale and redeploy that in other directions? How should we think about your portfolio management strategy?

We always evaluate all options associated with the assets that we own, especially some of the RNG; the prices that people are paying out there and so on. But at this point in time, having the high-margin recurring revenue for us and very good EBITDA and that tremendous backlog associated with the asset, whether it's turbine power or solar or green gas, we feel they better stay where we are right now. But that doesn't mean that we won't evaluate all options that come to the table with an open mind. I think we refinanced some of the projects that we have. And maybe Doran wants to add a little more color to that.

Yes. I mean we did a refinancing of a few of the operating plants. I think one important point that I'll add to George's comments is the optionality of being the asset owner and controlling those assets going forward. As you see the developments of incentives as they go the year-ends are coming. We've had a variety of different strategies that we're looking at on the hydrogen front that relate to renewable natural gas; there's a lot of really exciting developments there and we like to own the assets so that we can pivot and deploy them in the most accretive way for our shareholders.

Thanks. And just for one follow-up, we get a lot of questions on the potential changing complexion of Congress, i.e., more Republicans than Democrats and the risk associated with renewable elements of the Inflation Reduction Act. Can you just share with us your thoughts on how any change in Congress could change certain elements of the Inflation Reduction Act in 2023?

I'll give you my gut feeling, and Doran can add to that. Look, we are not in politics, but I will say this much: we did very well under the previous administration. But with this Inflation Reduction Act, I mean, that's low right now. And if Congress, let's say, splits or whatever might happen, as long as the President is there, I don't think you're going to see any changes to that. So we have a pretty good runway from where we are. Look, whatever happens to the federal government, the states more and more are focused on decarbonization; the climate change is impacting everyone. The commercial and industrial sectors are starting to move. We're cautious about what we are doing, but we don't think there's going to be a material change.

Yes. I mean, I agree with George. We're not going to crystal ball the politics of the election and what's going to happen post-election. But the breadth of the provisions in that bill that apply to us has a significant range. If I crossed out two or three lines, I still have a dozen lines left of areas that we're going after. So I don't think we're thinking too hard about that right now. I think we're focusing on what's in there that's going to work for us.

Our next question comes from Christopher Souther. Christopher, please go ahead.

Thank you for taking my question. You mentioned that Greenfield solar is a new area you're pursuing. Could you provide a high-level overview of your strategy regarding whether you plan to own these assets on your balance sheet, the regions and geographies you're considering, any specific projects you can share, and what the working capital requirements might be if this became a larger part of your business?

Sure. I think because it's Greenfield, there's a lot of early-stage development. We are going direct to site control and interconnection queue positions. It's a variety of markets. We are focusing on the ones that we feel have really solid either community solar or some other tariff programs that we think create the right amount of value. The approach generally speaking as with anything is that ultimately, we'd like to bring those assets into our asset and development metric and grow the asset portfolio. We are not going after large utility scale projects; we're still sticking with sort of distributed generation. That's why I mentioned community solar. That being said, if those opportunities arise, we can create substantial value. If the assets ultimately aren't going to meet our return hurdles, then as we are all aware, there's a substantial market for those types of assets out there and we would, of course, consider monetization. Working capital on the development front isn’t so substantial in the early stages; it's reasonable and comes from permitting and establishing revenue contracts. The working capital really kicks in when you build the assets, like the assets we build now. We would expect to deploy construction facilities and bank facilities to help us finance that working capital on a non-recourse basis.

Got it. Okay. No, that all makes sense. So, looking at the 50 to 70 megawatts started for the year, would we need that first RNG facility to be completed to be included in there? And I just wanted to get a sense of whether there was any potential for some of the solar projects to slip into 2023 in order to get a little bit more juice on the ITC and the like or if there was any kind of momentum on that front? Thanks.

Yes. Nothing specific to talk about there; the RNG is not included in that figure. So we're just looking at the other assets there. But I couldn't pinpoint any that we specifically have identified as wanting to delay for any reason. Currently, with the sort of pre-guidance construct of the IRA, we feel like we're going to just plow right ahead and complete what's ready.

Perfect. Thank you. Our next question comes from Tim Mulrooney from William Blair. Go ahead, Tim.

Good afternoon. Can you guys hear me?

Yes. Hi, Tim.

Hey. So that was a really interesting data point that you gave last quarter when you said blended energy costs were up kind of 40% year-over-year, but blended project costs for your customers were up more like only 10% to 12%. So that gap is pretty compelling, enough so that I was wondering if you could provide an update for what you see for what a blended project cost would be for your customers right now, given some costs may have flattened out, while maybe others like interest rates continue to go up.

Yes, I mentioned in my comments that we are seeing strong performance. We have reviewed the numbers and will continue to monitor this internally, but we do not plan to publish regular updates. It's important for people to understand that the economic value we offer our customers regarding energy assets is still intact, and it remains true in light of recent movements. However, I don't have any statistical updates to share with you today.

Okay. No update to the 10% to 12%. Doran, you can't blame a guy for trying. I'll try a different question. Are you seeing higher interest rates have any material impact on project demand today, right now? I'm just curious if you're seeing any signs, whether I don't know, longer sales cycles or changes in customer behavior that would suggest maybe a tougher environment for the projects business until inflation is under control and interest rates can come back down somewhat?

We haven't. The only thing that we have seen lately is that once the bill passed, everyone is trying to figure out what way they're going to go, and how they're going to make maximum utilization of that. But I will tell you this much; some of the projects like a couple of co-gen projects, before they even penciled out, now with the ITC, although we're up to 30% and maybe a little bit more, they make sense. But now we're trying to figure out, we gave them six proposals the other day on a particular customer, which way they're going to go for the project. So we haven't seen an impact, but what we have seen in the C&I sector, because of the climate change, people wanted to decarbonize, we are getting more traction in that market.

Thank you for your question. All right. Our next question comes from Pavel Molchanov from Raymond James. Go ahead, Pavel.

Yes. Thanks for taking the question. As we look back at the SoCal Edison effort, it's pretty obvious there’ve been issues surrounding the project, through no fault of your own of course, is supply chain. Is this a lesson that taking kind of low-margin, very high-volume projects on such as this may not be the best idea for the future?

I'm going to firmly say no to that. When we undertake those types of projects without significantly increasing our operating expenses, we're demonstrating operational leverage. We are noticing proposal activity in similar projects, possibly not as large, but still substantial ones coming our way. We are pursuing these opportunities with confidence because we understand the supply chains. We know what is feasible and realistic. We are very confident in our ability to manage costs, mitigate risks, and successfully execute projects for various utility customers and developers across the country.

Yes, and one of my main points is that we learned a lot from that particular project. We established a great reputation in the industry. A few other utilities are now talking to us because of that project. With the ITC coming into play for standalone battery storage projects, you will see significant contributions to our balance sheet over the next few years because of that project.

With the rise of renewable and intermittent resources in the grid, particularly the offshore wind energy on the East Coast, storage is gaining momentum. This will be a vital component of our clean tech integration industry in the future. It would be unwise for us to overlook this opportunity.

Okay. A follow-up about Europe; Europe was 4% of your revenue in 2021, obviously, before the war and the energy crisis. What do you think that number will be by the time this year is over?

For 2022, I don't have any specifics to add. I don't think we will expect anything substantially different for 2022.

Give me one second. We'll see an increase, but it's not a substantial increase, and I think this is just timing. But we're seeing some growth year-over-year from 2021 to 2022.

Okay. So, a little bit of growth year-over-year from 2021 to 2022, modest increase in 2022. In 2023, we're going to start seeing our share of the revenue from the PV project that we announced come through, and that's a portion of that is for 2023. And then Bristol City will also see some of that start to kick in. And we have a pretty good backlog in the rest of the UK operations. So no, you will see it picking up next year.

Perfect. Our next question is going to come from Julien Dumoulin-Smith from Bank of America. Go ahead.

Hey, Good afternoon, team. Thanks for the time. Could you guys hear me?

Yes, Julien.

Thank you. I wanted to revisit the discussion regarding RNG. Could you provide more details? We've observed recent transactions involving the conversion of landfill to electric potential while utilizing the ITC. Considering your current portfolio, how do you plan to optimize efficiency to secure the ITC? Additionally, how do you intend to adapt existing projects to qualify for RNG given the new economic landscape?

Well, the short answer is we think about it a lot. As you mentioned, you basically laid out all of the various optionality elements that I was talking about before. There's certainly some programs that are going to be interesting for some of our preexisting assets. But as far as new developments are concerned, I think that we see the ITC, the potential for RNG, where the RINs are going to go. We see a lot of different paths for that portfolio of assets. Given that, we've got a funnel of assets behind the 20 that we've already mentioned that are in our asset and development metric, we're going to continue to work on the development front to increase the number of assets that we're actually focusing on moving through permitting. We're talking about evaluation of sites, negotiating gas contracts, and site control in areas we haven't covered in the 2020 announcements. We feel very good about all of that optionality, and we're looking at these sites one-by-one when we take a look at how to draw up a pro forma for where we think the economics will go. We consider all these different potential alternatives to make those projects profitable, applying both to some of the existing assets where the PPAs may be rolling off to the new ones that we're developing now.

Well, especially if the eRINs come to pass, if the eRINs come with the 30-plus existing plants that we have generating electricity. Some of them have excess gas. It would be an option for us to add a couple more engines on whatever the case might be or wait until we expand and then proceed with the RNG route. So it's a great time to own some of those assets. And if the eRINs come to pass, I think it would be great for value creation for us.

Got it. But could you please clarify a bit? I mean, when you had your Analyst Day earlier this year, it was before the IRA passed. When do you think you'll be able to provide an updated forecast, considering the various RNG projects already included, to reflect the results of these negotiations, including some of those credits? I understand that you may not fully benefit from the 30% or 40% ITC, and you might have to share some of that. However, it seems that this would represent a significant difference compared to the Analyst Day earlier this year, especially regarding the specific growth in RNG.

Julien, I think we will discuss that when we share our guidance for 2023 during the Q4 report. As we mentioned, we plan to do a tour and hold some Q&A sessions regarding the RNG plant. However, at that time, I don't expect we will have any particularly new information to share. We will continue our regular schedule for providing guidance with our Q4 report. Additionally, the guidance under the IRA is expected by the end of the year, which is something we are very interested in seeing.

Perfect. All right. The next question comes from Greg Wasikowski from Webber Research. Go ahead, Greg.

Hey, good afternoon guys. Can you hear me okay?

Yes, Greg. Hi.

Thanks for taking my question. I just want to clarify something regarding SoCal Edison. It seems that all the adjustments were made at their discretion. If no adjustments had been made to the schedule or strategy, do you think you would have had 200 to 300 megawatts of service now with completion expected by the end of the year, as mentioned in last quarter's update?

I don't think we're going to comment on what could have been. Discussing the nuances of that is really speculative across multiple projects. So I don't think we're going to address that.

Understood. That makes sense. Changing topics to a more technical question, could you share what you're observing regarding EV charging and potential solutions for addressing the strain on the grid? This could involve battery-integrated solutions, alternative fuels like renewable natural gas or hydrogen fuel cells, or perhaps more advanced software solutions. Is this a major concern for your customers, and what do you consider to be the most effective solutions available right now?

Well, right now, on the electric vehicle charging stations, we incorporate and test it both in every project we do with the federal government, every project in colleges and universities. We went back to what we did with this greenfield development when we hired a couple of specialists about 2.5 years ago. We now have a great group. We did hire somebody from Tesla to bring great experience with charging stations. We are going to be very active in that area. We have won a contract where we'll convert part of the RNG fuel to a fueling station for hydrogen. That's going to happen over the next 12 to 24 months.

I mean, I think on the RNG front, away from hydrogen, a lot of that connectivity to or the biogas or landfill gas to electric vehicle charging might be driven by the eRINs. Not surprisingly, we are looking at both federal projects and many in regions where we've got some fleet opportunities. Yes, the integration of batteries and renewables; we see ourselves at the forefront of our ability to put those projects together. However, the development of that overall business, at a scale beyond just deploying the technology that's part of our solar installations or carport installations is in its early stages.

Wonderful. Thank you for the question. Our next question comes from Joseph Osha from Guggenheim Partners. Go ahead, Joseph.

Hi, there. Thanks. Hello, everyone. A couple of questions. First, just a simple one. Doran, you alluded to your project hurdle rate. Obviously, your cost of financing is going up. I'm curious, do you all think about your business in terms of the spread of your incremental cost of capital? I'm just wondering if I can get some insight into how that hurdle rate is evolving. And then I've got a couple of follow-ups.

We've seen interest rate fluctuations over the years, and I think our hurdle is remaining relatively constant as kind of a mid-teens ROE target for assets that are on the balance sheet. As you might expect, with different types of assets in the battery, the solar, the RNG; those tend to vary quite substantially. When looking at levered returns in situations where you're getting very high advance rates on sale leaseback or tax equity, those hurdles tend to vary on an asset-class-by-asset basis. So on a portfolio basis is the kind of the way we're thinking about that.

Okay. The idea is that your debt rate remains constant while your funding costs fluctuate. However, over time, it stabilizes; you are not necessarily increasing your hurdle rate in response to changes in your funding costs.

No, not necessarily. No, Joe.

Okay, thanks. And then the second question, I think this is what Julien was getting at a little bit. One of the things you brought up in the past is that the pricing you get out of a kind of a 20-year utility grade off-taker for RNG just wasn't there, right? And one, were it there, one of the nice things you have is the ability to put a different and perhaps more favorable capital structure around an RNG project, right? So as things evolve here, is it possible that one outcome could be, say, a 20-year off-take with a utility grade off-taker and capital structure that's maybe a little more favorable relative to what we see now?

Hey, Joe, at the right price, yes. That's right. Everything has to be taken into account, though, of course, right? So as you can see, a lot of developments, a lot of different incentives floating around, a lot of different parties coming to the table. We're seeing the five-year and the ten-year contracts away from the transportation market. Those aren't the same as a 20-year. When you're looking at project financing and leverage, obviously, the higher interest rate environment, we have to consider that. It's a calculation, but we still watch that market very closely in the long-term market, so that if the right contract comes along, we would pursue it.

Yes, and we talked about this before. Ultimately, we think it will come because the utilities and gas companies have to decarbonize their pipelines. So it’s a matter of time. We feel that the prices will come up, and then we will be able to execute longer-term contracts. We constantly monitor that market, because we agree with you that it will provide us better financing.

Great questions. Our next question comes from Ben Kallo from Baird. Go ahead, Ben.

Hey, good afternoon everyone. Good evening.

Hey, Ben. Good afternoon.

Hey, everyone. A common question I receive is whether an increase in product complexity leads to higher margins or how we manage that, especially when considering complex projects that might make execution more challenging for the team.

Yes. So it depends on how that complexity translates into risk, Ben. We look at pricing on a risk-adjusted basis. There are a lot of different factors in addition to just the complexity of the technologies that are involved. It's not just a direct relationship. As the projects become more complex, they don't necessarily mean higher margins. You've got complexity risk associated with timelines, performance guarantees, whatever else it might be, that's part of the overall project. We take all of that into account. And then, of course, the customer and competitive nature of the business, so if we need to sharpen our pencils on pricing to win the deals that we want, sometimes we do it. But generally speaking, if you think about more complex projects, they might have a little bit more risk in the execution, and then yes.

The complex projects give us a competitive advantage because not too many people can provide that holistic approach on that particular project. As far as the margins, the gross profit margins, they don't change that much. What happens is that the project gets larger, and the contribution to the overall profit, the gross profit is very, very good.

How should we view your backlog? With the IRA influencing growth, is there currently a pause before we see significant increases in the backlog? Thank you.

Yes, I wouldn't call it a pause. I will tell people we are evaluating, which options to go for and there’s a lot of activity. Actually, we're making more proposals and talking to more customers than ever before, but it takes a little bit of time to get to the yes. Typically, it takes six to 12 months to move a customer from one stage to another. Then, once we get the award, it takes another 12 months to make it contracted. But as we said earlier, the asset part of the business is moving faster because it's a little clearer where they're going. Right now, we see more traction in that.

All right. Wonderful. Thank you everyone for your participation in today's conference. This does conclude our program. You may all disconnect now. Thank you for your time.

Thank you very much.