Ameresco, Inc. (AMRC) Q2 2024 Earnings Call Transcript

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; Nicole Bulgarino, Executive Vice President and General Manager, Federal and Utility Solutions; Mike Bakas, Executive Vice President, Renewable Natural Gas; 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 2 of our supplemental information, 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 information. I will now turn the call over to George. George?

Thank you, Leila, and good afternoon, everyone. Before I get started on the Q2 results, I would like to address the statement captured in our earnings release. Doran Hole has resigned as Chief Financial Officer to pursue other opportunities. We greatly appreciate Doran's contributions over the last five years and wish him the best in his future endeavors. Doran will continue to serve as Chief Financial Officer until August 30, at which time Mark Chiplock could be promoted to the Chief Financial Officer. Mark has been with Ameresco for over 10 years and has served in multiple roles with increasing responsibility. I am thrilled to have Mark step into this role as a seasoned Ameresco leader. In addition, Josh Baribeau will assume an expanded role as a Senior Vice President of Finance. I believe our deep bench of seasoned executives will skillfully navigate this transition. And now, on to the results. Our momentum continues into the second quarter, as the Ameresco team again delivered strong revenue growth across all four of our business lines, led by an impressive 45% growth in Projects revenue. At the same time, we continue to build on our excellent long-term visibility, increasing total backlog by 36% year-over-year to a record $4.4 billion, while also bringing a record 155 megawatts of Energy Assets into operation. And we still have 635 megawatts of assets in development. Demand for our renewable energy efficiency and resiliency offerings continues to be very strong as our customers seek clean technology solutions that yield both cost savings and increased reliability. Ameresco's technology-agnostic platform and depth of engineering expertise allow us to stay at the forefront of the energy transition. While our market environment continues to be very strong, we do understand that there is a lot of uncertainty around the upcoming elections. Ameresco was established almost 25 years ago that has not only grown but thrived under a variety of administrations. The foundation of our business is helping customers, including the government, achieve core savings and improve their energy infrastructure in a capital-efficient manner. I have asked two key members of our executive team, Nicole Bulgarino and Mike Bakas, to join us to discuss their business. Nicole?

Thank you, George, and good afternoon, everyone. As George just mentioned, we are excited for the outlook of both our federal and utility businesses as we expect continued demand for resilient clean energy projects for many years to come. Over the last two decades, while we have seen policy and messaging shift from one administration to another, the key drivers for our business have remained consistent. Our government agency and military customers continue to be focused on mission-critical projects that deliver secure and resilient power to support their bases, ports, facilities, office buildings, and military housing communities. We are uniquely positioned to help our customers achieve these objectives by reducing load through the latest energy efficiency upgrades and by deploying distributed generation solutions. Across multiple administrations, we have delivered large, highly successful comprehensive energy solutions for the Department of Defense and other government agencies. We have a very strong pipeline of additional projects and assets, integrating domestically-sourced solutions using third-party financing. For our utility business, our customers are focused on providing cost-effective, reliable electricity while also transitioning to clean energy. In addition, they need to increase capacity to address the load growth driven by electrification and data center development. More recently, utility customers have been utilizing battery energy storage solutions for resiliency and grid stability, providing critical power during peak demand periods and allowing the grid to better handle an increased amount of intermittent renewable energy. We are already experiencing rapid growth in our utility business, as seen by the meaningful increase in the number of significant announcements made in just the last few years. The battery storage systems we recently celebrated with the United Power team in Colorado last week are a perfect example of this work, as is the large Kupono solar and battery storage system we brought online in June, which is a great example of an integrated solution serving both our federal and utility customers at the same time. As you can hear, our strong reputation for technology expertise and execution places us in a prime position to capitalize on the expanding opportunities in both the federal and utility markets. Our projects save money, enhance efficiency, provide clean, resilient, reliable power while creating jobs and supporting local and national policies. This great value proposition is in high demand regardless of changes in Washington. I will now turn the call over to Mike. Mike?

Thank you, Nicole. Ameresco has been developing biofuel projects since our founding, and I can honestly say that I have never been as excited as I am now about its prospects. For a number of years, RNG's primary market has been the transportation sector, leveraging the RFS program. But as global markets have continued to focus on sustainability, primarily in the electric side of the carbon footprint equation, we are seeing many industries turning their attention to the thermal side. This is a market with huge potential with natural gas utility consumption over 440 times the volumes used in the transportation sector. And for Ameresco, it is a perfect opportunity as it involves longer-term profitable offtake contracts while reducing our exposure to RINs. Gas utility RFPs for RNG supply agreements have picked up noticeably, as these parties seek to meet their carbon reduction goals. In the end, RNG is the only immediately available, drop-in green substitute for natural gas, requiring no changes to the utilities' existing infrastructure. This demand is not only driven by the utilities themselves but also by the states and their regulatory bodies as part of programs to reduce overall carbon impact. In light of this, we are very excited to announce that Ameresco has been chosen by a large California-based natural gas utility to supply RNG to help meet its state-mandated locally-sourced renewable content. If final approval is granted by the California Public Utility Commission, this would represent a meaningful portion of our RNG volume. In doing so, this fixed-price contract would also help to balance our portfolio to reduce long-term exposure to RIN volatility while benefiting from a five-year profitable revenue stream. And this potential contract represents only one of many opportunities across the country to sell our RNG via longer-term offtake agreements to non-transportation customers. In summary, Ameresco's biofuels business is uniquely positioned to capitalize on this expansion of the addressable market with the entrance of very large industries, such as natural gas utilities. Importantly, this asset class also continues to meet our return hurdles without reliance on any IRA-related investment tax credits. We believe our RNG assets will continue to provide significant, stable, profitable growth for years to come. I will now turn the call over to Doran to comment on our financial performance and outlook. Doran?

Thanks, Mike, and good afternoon, everyone. Before I start, I just want to say a huge thanks to George and the entire Ameresco team for what's been an amazing experience I've had here over the past five years. It is impossible to put into words how much I've learned from this management team and this Board. I want to congratulate Mark and Josh on their new roles. It's been a real pleasure working with both of them. I feel very, very confident in their successful futures here at Ameresco. And I have to say the company is in excellent hands. So with that, now let's jump into the numbers. For additional financial information, please refer to the press release and supplemental slides that were posted to our website after the market closed today. Total revenues in the quarter grew 34% to $438 million, with each of our four business lines experiencing revenue growth. Our Projects business revenue grew 45%, reflecting our focus on execution and conversion of our backlog. Energy Asset revenue grew 6.8%, largely due to the greater number of operating assets compared to last year, improved production, as well as higher RIN prices. We brought a record 155 megawatts of assets into operation in the second quarter and are well on our way to meeting our anticipated 200 megawatt target for the year. Our large and growing base of operating energy assets now stands at 661 megawatts, which should provide decades of profitable revenue to the company. Our O&M business had a very strong quarter with revenue growing 13.9%, and revenue for our other line of business grew 9.5% with strong performance from our consulting businesses. Gross margin of approximately 15% dipped as we incurred additional costs of approximately $6.6 million related to our SCE projects, plus a mix of some other lower-margin projects. That said, our underlying gross margins, as well as the expected margins in our backlog, continued to match our historic ranges. In the second quarter, our revenue growth as well as cost savings and operating leverage drove adjusted EBITDA growth of 21% to $45.1 million. As George noted, our business development activity on both the project and asset side was very healthy during the quarter. The company's total project backlog was approximately $4.4 billion, growing 36% year-on-year and 9% sequentially. This growth was led by our contracted backlog which reached $1.6 billion and grew 50% year-on-year and 12% sequentially. Turning to our balance sheet and cash flows. We ended the quarter with approximately $150 million in cash and corporate debt of approximately $273 million. Our debt-to-EBITDA leverage ratio under our senior secured credit facility declined to 2.9 times and remains below the covenant level of 3.5 times. Our energy asset debt advance rate remained at a conservative 73%. Importantly, we believe our access to Energy Asset capital is excellent with many financing options available as demonstrated by us having secured approximately $170 million in new project financing commitments in the quarter. We also believe our Energy Assets remain highly attractive to many financing parties interested in teaming with Ameresco, given our proven capabilities. And on the corporate side, at the end of the quarter, we were pleased to have successfully raised $100 million in subordinated debt from Nuveen Energy Infrastructure Credit. Our cash flow continued to be strong with positive adjusted cash flow from operations of approximately $154 million during the quarter. Our eight-quarter rolling average, which best represents our implementation cycle, reached almost $45.6 million. In our supplemental slides, we highlight the increased momentum we have seen in the rolling cash flows, and we expect both cash flow metrics to continue to improve, especially as we bill and collect on the SoCal Ed battery projects. Speaking of SoCal Ed, our performance testing has been approved and we are working together on the final checklist for substantial completion for two of the three projects. The third project, which was more significantly impacted by the 2023 rainfall, is expected to reach substantial completion in September of this year. Now let me spend a few minutes on our new 2024 guidance. We're increasing our revenue range based on the solid financial performance for the first half of the year and our strong visibility for the remainder of the year. Our new gross margin range reflects the expected full-year impact of the cost budget revisions on the SCE projects of approximately $10 million. Our new guidance range would yield revenue and adjusted EBITDA growth of 27% and 35%, respectively, at the midpoints. You can find more details on the revised 2024 guidance in our press release. Now, I'd like to turn the call back over to George for closing comments.

Thank you, Doran. Ameresco thrives in an environment where customers seek clean energy solutions that result in cost savings and greater resiliency. We believe this environment and the demand for these solutions will continue regardless of the political environment in Washington. We are extremely well positioned with over $8.3 billion in future revenue visibility, and we are laser-focused on executing our tremendous backlog and cash flow generation. In closing, I would like to once again thank our employees, customers, and stockholders for their continued support. Operator, we would like to open the call to questions now.

Thank you. Our first question is from Noah Kaye with Oppenheimer & Co. Your line is open. Please go ahead.

Good afternoon. Thanks for taking the questions. First one is around cash generation. The trend line here, especially in the last few quarters around the improving cash generation, is really encouraging. Obviously, in the past, there were some conversion headwinds related to specific projects, but I was hoping you could maybe take us a little bit deeper into what you seem to drive some of the improvement in cash generation and your visibility into that continuing potentially additional levers. You not necessarily just have to talk on SoCal Edison, but in the business more broadly.

Yeah, I will let Mark get into this, but go ahead, Mark.

Yeah. So, I think what we're seeing, so if you look in the quarter, a lot of it's timing in Q2, but some of the things that I found encouraging, that I think will help us to continue to show improved cash flow is that a lot of billing milestones were front-end loaded now in some of our contracts. So, we're seeing those come in. You see it on the Federal ESPC when you net liability and receivable, and you also see it on our deferred revenue line. We also saw the proceeds from the conversion or the transfer of ITC in the quarter as well. So, I think those are some of the positives that are helping that trend. I think, Noah, keep in mind the quarterly stuff is always going to be lumpy, which is why we started to roll out this new metric. But yeah, we're encouraged by some of the things that we're seeing and the changes we're making on the contractual side that are keeping those billing milestones a little bit more front-end loaded to keep the projects cash flow positive throughout.

Yes, I would like to add that when we concentrate on specific issues, we achieve good results, such as sending out bills on time and following up on collections. This attention has been beneficial, especially since accounts receivable was quite significant. Previously, when interest rates were lower, we may not have paid as much attention as necessary. However, for the past nine to ten months, our focus has led to improvements in our metrics, with cash generation increasing, and we will maintain this focus. I believe there is still room for further enhancement in this area.

Thanks. Second question on the RNG business. Mike called out the contract with a large California natural gas utility supply RNG. And I think, Mike, you did a good job of talking on these points of why that kind of predictability and visibility is helpful. So, I would just like to understand, what is the opportunity and the appetite of the company to continue to increase sort of these fixed contracts as a portion of the RNG exposure? Is there any kind of target we should think about that would be optimal for a portfolio? And then, how does this potentially contribute to more favorable financing on the development of the assets?

Very, very good question. I will ask Mike to address it, and then I will come back at the end to talk about what percentage we might get into long-term contracts. Go ahead, Mike.

I think generally we've said to the Street in the past that we try to fix our pricing, 50% of volume on our new projects. This is a unique contract vehicle and that it's leaving the transportation sector and going to a voluntary market. Obviously, great credit with the utility and the terms will, I think, without a doubt, help on the financing of these projects. And I think we're going to start seeing more and more of our gas going to the non-transportation sector as that market continues to expand.

And the financing, Doran, do you want to add something?

No, not surprisingly, when you get fixed-price contracts, the banks like the stability of those cash flows. And the fact that we're actually now striking these projects, even though this first one might be five years, as more and more of those cash flows get fixed, we would expect that we'll get better advance rates and obviously we'll be pushing for tighter spreads in the future, but it's definitely one of those characteristics.

Thank you. And one moment as we move on to our next question. And our next question is going to come from the line of Stephen Gengaro with Stifel. Your line is open. Please go ahead.

Thanks. Good afternoon, everybody.

Hi, Steve.

George, I thought you might have been about to add something on the last question before I asked mine.

Nope.

Okay. Sorry. So, I think two things for me. And one, I'll start with, and I'm not sure how much you want to get into this, but when you look at your Energy Assets backlog and you look at your Projects backlog and SCE rolling off, at a high level, what should we think about as the big positives and negatives as we go into 2025?

I don't know if I can pinpoint the major positives and negatives. The key takeaway is that we have an impressive backlog and are actively executing on it. Additionally, I've noticed that our actual gross profit margin has been increasing every quarter since we began focusing on the types of projects we pursue and working to improve those margins. This is definitely a strong positive. The backlog related to our assets, including battery storage, solar plants, and renewable gas plants, also reflects good prospects. The only concern is the elections, which could have an impact. However, I wanted Nicole and Mike to join us today to highlight that our federal business has performed well under any administration. Moreover, as utilities are increasingly mandated to provide more renewable natural gas, this trend is favorable. With Southern California transitioning off, I believe the risks are significantly reduced while the opportunities are much greater.

Great. Thanks, George. And maybe just as a follow on to that, when you look at the Projects portfolio, you mentioned this a little bit, but the embedded margins, assuming strong execution of the backlog, you should have margin improvement in projects over the next year one to two years. Is that a fair assessment?

Yes, that is a fair statement. That's why it can become a focus. I have noticed, especially with the company's growth over the last five years and the challenges posed by COVID, that the team took on some projects which had lower margins and did not adequately mitigate risks. However, by refocusing the organization on margins and minimizing the associated risks, we are starting to see positive results. There is a lot of optimism for the upcoming year.

Thanks for the question. Is there anything we should consider regarding seasonality as we look at the second half of the year? You provided guidance for 2024, so how should we think about how that develops in the third and fourth quarters? Any additional insights on that?

Yes. Good question. And I will let Mark follow-up, because he's been dreaming about all the numbers.

I think, briefly, that unlike last year, we expect Q3 and Q4 to be fairly similar. There may be a slight increase in Q3 due to normal seasonal trends, but overall, Q3 and Q4 should be more aligned compared to last year.

Great. Thank you, Mark.

Thank you. And one moment as we move on to our next question. And our next question is going to come from the line of George Gianarikas with Canaccord Genuity. Your line is open. Please go ahead.

Hi, good afternoon, everyone. Thank you for taking my questions.

Hi.

I would like to clarify the updated revenue and EBITDA guidance to ensure we understand it correctly. There is a $5 million decrease at the midpoint due to increased costs from SCE. To clarify, if those costs were not a factor, would you have increased by $5 million? Is there anything else impacting the EBITDA guidance for 2024, or is it solely the SCE costs you mentioned?

Yes. Essentially, we aim to demonstrate the impact of the Southern California projects. While there were some other minor projects that negatively affected us, that was the main effect because we had anticipated the projects we completed after the last quarter.

I believe the modifications we focused on, particularly regarding EBITDA, were related to the assumed costs for SCE. While our revenue performance has improved, we've noticed a slightly lower margin profile, which we considered. Based on our performance in the first half of the year and the visibility we currently have, we made those adjustments and feel positive about the outcome.

Okay. And then maybe just a question on the backlog, the big growth in backlog. I'm curious as to whether you can give us a little bit more detail as to what's going on there. Where do you see significant growth? And is anything related to data center opportunities? Thank you.

Yeah. And actually, it's across the board. We see growth across the board. But since Nicole is here and she is the project queen, I will let her talk a little bit.

Sure. I think a large percentage of our growth in backlog is coming from the market drivers that we just described earlier a few minutes ago, really related to the battery energy storage. So, we're seeing those in our Projects business, on a lot of our federal and utility markets. So that's probably the largest portion of that. And then certainly not captured in the pipeline right now, but there is a lot of work that we're doing to capitalize on batteries for the data centers and energy. It's a little too early right now for that to be in the awarded pipeline.

Great. Thank you.

Thank you. And one moment as we move on to our next question. And our next question is going to come from the line of Kashy Harrison with Piper Sandler. Your line is open. Please go ahead.

Good afternoon. Thanks for taking the questions, and Doran, best of luck with the future endeavors.

Thanks, Kashy.

So, the first question is for Mike. Sorry if I missed this, but did you quantify the size of this RNG project you're working on with the California utilities? A megawatt or EBITDA number would be great. I'm just trying to think of the scale of this project relative to the portfolio.

Yeah, there's two projects, and so it's about 22 megawatts, 23 megawatts between the two. One comes online, actually, this quarter coming up, and the other one will come online in early 2026. The agreement with the utility doesn't begin actually effective until January 1, 2026. It's a material portion of our portfolio. If those two projects were online today, it would represent probably close to 40% of our supply, and in 2026, we're forecasting it to be around 12%, 13% of our supply.

That's helpful. I appreciate the added color. And then, my next question is just a follow-up on the budget revisions to SoCal Ed. I think you flagged $10 million of total revisions in EBITDA. Can you just help us think through the risk of potential further budget revisions? For example, if the project is delayed another quarter, what does that do to that forecast? And then, are these overruns separate from the liquidated damages, or are these tied to the liquidated damages? Any color on that would be appreciated. Thank you.

Go ahead, Doran.

I'll start and let others contribute. The expectation for the entire year is $10 million. We have mentioned some adjustments in Q1 and noted $6.6 million for Q2, mainly due to insurance premiums as projects continue to face delays. I don't anticipate a significant risk of that number increasing. We've taken a conservative approach in estimating what we may encounter as we work towards substantial completion. This is entirely distinct from any issues regarding liquidated damages.

Thank you. And one moment as we move on to our next question. And our next question comes from the line of Eric Stine with Craig-Hallum Capital Group. Your line is open. Please go ahead.

Hey, everyone. So, just curious, on the Project business. You mentioned that you had some larger projects in this quarter, and that's why the margin came in where it was. But George, you also talked about some projects that were priced maybe in the past that were rolling through and if that that impacted margin. Just curious, I mean, is this trend to larger projects, is that something that you expect to sustain, or is this more about, hey, you just had a mix of that in the quarter, plus some of those older contracts, and that's what impacted the margin in the quarter?

Primarily, we have some large portion of the project executed for the quarter coming from some of the European EPC contracts that we just signed over there. And then, when you book the revenue, because we consult on the top line, and then the margin will account only half of the actual margin, and it impacted more than normally. But the overall, though, what we have on the backlog, the projects, that's what makes me feel very good is going up, but any given quarter, the mixture might change, and that adversely impacts your margin. Do you want to add anything to that, Mike?

Yeah, I think it's just a mix.

Okay. No, that's great. And then maybe second one for me, just more high level. Yeah, I know the SCE, the contracts there, a lot of that is out of your control. It's weather-related, etc., but as you sign more of these energy storage awards, I'm just curious, some of the lessons learned, how you're structuring contracts differently, anything that you might be changing based on what's happened here for SoCal Edison?

We have become leaders in the industry and have gained significant insights. Every contract we are currently signing provides us with strong protections. We have a substantial backlog and have successfully executed projects beyond Southern California. For instance, we recently completed the United Power project, setting a record by getting six out of eight projects operational within a year of signing the contract. The remaining two projects are also contracted and have been commissioned. In Hawaii, despite facing labor challenges, the Kupono projects are operational, including solar energy generation and 44 megawatts of battery storage. Additionally, our recent project in the UK is excellent, and we have addressed nearly all associated risks.

I would like to mention that the UK project is a prime example of our efforts to enhance contracts by prioritizing the fulfillment of more milestones upfront. This was evident in our deferred revenue figures reflected in our cash flow for Q2. We are implementing these adjustments to enhance cash flow and liquidity.

Got it. Okay. Thank you.

Thank you. And one moment as we move on to our next question. And our next question is going to come from the line of Joseph Osha with Guggenheim. Your line is open. Please go ahead.

Sir, your line may be muted. We'll move on to our next question from Craig Irwin with Roth KM or MKM. Your line is open. Please go ahead.

Good evening. Thanks for taking my questions. So, George, I wanted to ask if there's some metrics maybe you can share with us around organic growth, either in revenue or contracted backlog away from the energy storage business, the legacy projects business of the company before you started moving into energy storage. Maybe if you have a storage contribution to your contracted backlog that could help with visibility, or if you could help us with what the storage contribution to revenue growth is year-over-year in the quarter?

I will provide a high-level overview. Currently, battery storage projects account for nearly 10% of our $4.4 billion, specifically between $350 million and $400 million. The growth in other areas is driven by the federal government and spans multiple sectors. This is why you are observing a gradual increase in margins. I wanted to clarify this point because even though our revenues from the federal government typically make up one-third, around one-third of our current backlog consists of federal government projects. At any moment, especially with some EPC projects, which come in quickly after the RFP process, we start executing. If we front load them, the execution related to materials can affect the margin for that specific quarter, but they significantly enhance our profitability and gross profit line.

Excellent. That's strong progress. So, my second question I wanted to ask is about the assets business, right? So, you seem to be outperforming there some nice growth year-over-year in EBITDA. Many of the other companies in the sector, both private and public, are having issues, let's just say politely, even a couple of the very large portfolios of projects that were slated to get built, the customers are apparently taking them away from the partners that they'd identified. Can you maybe talk to us a little bit about your philosophy about how you structure these projects that allows you to generate positive returns in difficult periods? And can you maybe talk about whether or not you'd be interested in these portfolios?

We focus on developing assets from the ground up and aim to reduce risks associated with them. For the projects we decide to retain, we seek higher returns compared to other investors. Our strong development team plays a key role in this process, as we operate nationwide, which allows us to acquire many projects. For the ones we choose to keep, we not only mitigate risks but also aim for returns that surpass our cost of capital. Although the capital we raised from Nuveen comes with a higher interest cost, we are confident that we can generate returns significantly greater than our interest payments. Additionally, we consider Nuveen a solid partner for future projects, enhancing our overall strategy. In my extensive experience in this field, we place a strong emphasis on risk management, and with the support of Doran and Josh, we effectively reduce risk across our projects. Our investment committee conducts rigorous due diligence, exploring various scenarios to determine which projects to retain or potentially sell. Consequently, we can identify assets in our portfolio that will be sold for a substantial profit before they even appear on our balance sheet, especially given the liquidity in the current market.

Hey, Craig, I'll just add. That market for our developed and sold assets is exactly the reason why we're probably not going after any portfolios that are out there as buyers because we're taking advantage of the market that's out there at a cost of capital return hurdles that are lower than ours to sell the assets that we're developing. And the development team George mentioned is so strong, it's bringing so many solid quality megawatts into that asset development metric that we've got the liberty to kind of choose the ones we want to keep on our balance sheet. And other folks in the market also don't have as diversified of a pool of asset types. We've got one of the best, or arguably the best development group for RNG on the street, and that's not going to fall into the competition that you might see for some of the others that are more into the solar and battery side.

Understood. Thank you for that color. And I should say, Doran, I hope you're going somewhere where we continue to work together going forward, and Mark, congratulations on the promotion.

Thanks, Craig.

Thank you, Craig.

Thank you. And one moment as we move on to our next question. Our next question is going to come from the line of Tim Mulrooney with William Blair. Your line is open. Please go ahead.

Thank you for taking my questions. I wanted to ask about your gross margin guidance, which I believe was around 18% at the midpoint before, and has now adjusted to the low 16% range. Can you explain the factors that contributed to this change? I understand there was a $10 million impact from Southern California, which I think accounts for about 50 to 60 basis points if my calculations are correct. I'm just interested in what other factors were involved.

Go ahead, Mark.

Remember in Q1, we also took a handful of hits to the gross margin just with some legacy projects and some things that were a little bit unexpected, I think we were able to kind of offset that overall by the performance on the revenue side. But, yeah, I think Q1 and Q2 combined, I think is really what's driving the margins down. I think that we talked about the SoCal Ed impact. I think it's important to come back and really refocus on what we're seeing in operating leverage, which is actually up. So, even though we're seeing gross margins down, we're still continuing to grow gross profit faster than OpEx. So, we're seeing improvement in our operating leverage. But, yeah, I think, Tim, that's really the bridge on what you're seeing in margins is there were also some hits that we took on certain projects in Q1 as well.

Okay, that's helpful and well-understood. Thank you. Secondly, backlog on your Projects business is up a lot year-over-year, I think maybe 36% or something like that, but I'm not sure if you have this number handy. I'm curious how much of that's from switching assets in development over the project side versus completely new wins, like how much is each of those buckets is driving that increase?

It's all new wins.

Yes.

It's all new wins. Nicole, do you want to add something?

Sure. I think a large percentage of our growth in backlog is coming from the market drivers that we just described earlier a few minutes ago, really related to the battery energy storage. So, we're seeing those in our Projects business, on a lot of our federal and utility markets. So that's probably the largest portion of that. And then certainly not captured in the pipeline right now, but there is a lot of work that we're doing to capitalize on batteries for the data centers and energy. It's a little too early right now for that to be in the awarded pipeline.

Great. Thank you.

Thank you. And one moment as we move on to our next question. And our next question is going to come from the line of Kashy Harrison with Piper Sandler. Your line is open. Please go ahead.

Good afternoon. Thanks for taking the questions, and Doran, best of luck with the future endeavors.

Thanks, Kashy.

So, the first question is for Mike. Sorry if I missed this, but did you quantify the size of this RNG project you're working on with the California utilities? A megawatt or EBITDA number would be great. I'm just trying to think about the scale of this project relative to the portfolio.

Yeah, there's two projects, and so it's about 22 megawatts, 23 megawatts between the two. One comes online, actually, this quarter coming up, and the other one will come online in early 2026. The agreement with the utility doesn't begin actually effective until January 1, 2026. It's a material portion of our portfolio. If those two projects were online today, it would represent probably close to 40% of our supply, and in 2026, we're forecasting it to be around 12%, 13% of our supply.

That's helpful. I appreciate the added color. And then, my next question is just a follow-up on the budget revisions to SoCal Ed. I think you flagged $10 million of total revisions in EBITDA. Can you just help us think through the risk of potential further budget revisions? For example, if the project is delayed another quarter, what does that do to that forecast? And then, are these overruns separate from the liquidated damages, or are these tied to the liquidated damages? Any color on that would be appreciated. Thank you.

Go ahead, Doran.

I’ll begin, and then the others can add their input. We expect the total to be $10 million for the entire year. As you may have noted, we have already accounted for some adjustments in Q1, and we've mentioned $6.6 million in Q2, mainly due to insurance premiums as the projects continue to face delays. I don't anticipate a significant increase in that figure. Our estimate seems quite conservative regarding what we might encounter as we approach substantial completion. This is entirely distinct from any considerations regarding liquidated damages.

Thank you. And one moment as we move on to our next question. And our next question comes from the line of Eric Stine with Craig-Hallum Capital Group. Your line is open. Please go ahead.

Hey, everyone. So, just curious, on the Project business. You mentioned that you had some larger projects in this quarter, and that's why the margin came in where it was. But George, you also talked about some projects that were priced maybe in the past that were rolling through and if that that impacted margin. Just curious, I mean, is this trend to larger projects, is that something that you expect to sustain, or is this more about, hey, you just had a mix of that in the quarter, plus some of those older contracts, and that's what impacted the margin in the quarter?

Primarily, we have some large portion of the project executed for the quarter coming from some of the European EPC contracts that we just signed over there. And then, when you book the revenue, because we consult on the top line, and then the margin will account only half of the actual margin, and it impacted more than normally. But the overall, though, what we have on the backlog, the projects, that's what makes me feel very good is going up, but any given quarter, the mixture might change, and that adversely impacts your margin. Do you want to add anything to that, Mike?

Yeah, I think it's just a mix.

Okay. No, that's great. And then maybe second one for me, just more high level. Yeah, I know the SCE, the contracts there, a lot of that is out of your control. It's weather-related, etc., but as you sign more of these energy storage awards, I'm just curious, some of the lessons learned, how you're structuring contracts differently, anything that you might be changing based on what's happened here for SoCal Edison?

We have become experts in the industry and gained valuable insights. Every contract we sign now includes significant protections for us. You can see our backlog and the execution success we've had, particularly following our projects in Southern California. For instance, we recently completed the United Power project and achieved a record by getting six out of eight projects operational within a year of signing the contract. The remaining two projects are fully contracted and have also been commissioned. In Hawaii, despite labor challenges, our Kupono projects are operational, producing solar energy and 44 megawatts of battery storage. Additionally, our recently announced project in the UK is remarkable, with minimized risks involved.

Yes, I want to emphasize that in the UK we are actively working on improving our contracts by front-loading more milestones. As a result, you will notice a significant contribution from this improvement reflected in our deferred revenue line within the cash flow for Q2. We are implementing these changes to enhance our cash flow and liquidity.

Got it. Okay. Thank you.

Thank you. And one moment as we move on to our next question. And our next question is going to come from the line of Joseph Osha with Guggenheim. Your line is open. Please go ahead.

Sir, your line may be muted. We'll move on to our next question from Craig Irwin with Roth KM or MKM. Your line is open. Please go ahead.

Good evening. Thanks for taking my questions. So, George, I wanted to ask if there's some metrics maybe you can share with us around organic growth, either in revenue or contracted backlog away from the energy storage business, the legacy projects business of the company before you started moving into energy storage. Maybe if you have a storage contribution to your contracted backlog that could help with visibility, or if you could help us with what the storage contribution to revenue growth is year-over-year in the quarter?

I will provide a high-level overview. Currently, battery storage projects account for nearly 10% of our $4.4 billion total, which translates to between $350 million and $400 million. The growth from other areas is coming from the federal government and is reflected across our traditional core business, which is why we've seen a gradual improvement in margins. I wanted to clarify this because, generally, about one-third of our revenues come from federal sources, and around one-third of our current backlog consists of federal government projects. At times, certain EPC projects can ramp up quickly after the RFP process, leading to immediate execution, especially when we front-load them. This approach can affect margins for specific quarters, but it significantly contributes to the overall profitability and gross profit.

Hey, Craig, I'll just add. That market for our developed and sold assets is exactly the reason why we're probably not going after any portfolios that are out there as buyers because we're taking advantage of the market that's out there at a cost of capital return hurdles that are lower than ours to sell the assets that we're developing. And the development team George mentioned is so strong, it's bringing so many solid quality megawatts into that asset development metric that we've got the liberty to kind of choose the ones we want to keep on our balance sheet. And other folks in the market also don't have as diversified of a pool of asset types. We've got one of the best, or arguably the best development group for RNG on the street, and that's not going to fall into the competition that you might see for some of the others that are more into the solar and battery side.

Understood. Thank you for that color. And I should say, Doran, I hope you're going somewhere where we continue to work together going forward, and Mark, congratulations on the promotion.

Thanks, Craig.

Thank you, Craig.

Thank you. And one moment as we move on to our next question. Our next question is going to come from the line of Tim Mulrooney with William Blair. Your line is open. Please go ahead.

Thanks for taking my questions. I wanted to start with your gross margin guidance, which was around 18% at the midpoint before and is now in the low 16% range. Can you help me understand the factors that led to this adjustment? I know there was a $10 million impact from SoCal, which seems to account for about 50 to 60 basis points based on my calculations. I'm curious about what other factors are influencing this change.

Go ahead, Mark.

Remember in Q1, we also took a handful of hits to the gross margin just with some legacy projects and some things that were a little bit unexpected, I think we were able to kind of offset that overall by the performance on the revenue side. But, yeah, I think Q1 and Q2 combined, I think is really what's driving the margins down. I think that we talked about the SoCal Ed impact. I think it's important to come back and really refocus on what we're seeing in operating leverage, which is actually up. So, even though we're seeing gross margins down, we're still continuing to grow gross profit faster than OpEx. So, we're seeing improvement in our operating leverage. But, yeah, I think, Tim, that's really the bridge on what you're seeing in margins is there were also some hits that we took on certain projects in Q1 as well.