(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cautionary Note Regarding Forward-Looking Statements
This quarterly report on Form 10-Q includes "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, included in this quarterly report that address activities, events or developments that we expect or anticipate will or may occur in the future, including such matters as our projections of annual revenues, expenses and debt service coverage with respect to our debt securities, future capital expenditures, business strategy, competitive strengths, goals, development or operation of generation assets, market and industry developments and the growth of our business and operations, are forward-looking statements. When used in this quarterly report on Form 10-Q, the words "may", "will", "could", "should", "expects", "plans", "anticipates", "believes", "estimates", "predicts", "projects", "potential", or "contemplate" or the negative of these terms or other comparable terminology are intended to identify forward-looking statements, although not all forward-looking statements contain such words or expressions. The forward-looking statements in this quarterly report are primarily located in the material set forth under the headings "Management's Discussion and Analysis of Financial Condition and Results of Operations", "Risk Factors", and "Notes to Condensed Consolidated Financial Statements", but are found in other locations as well. These forward-looking statements generally relate to our plans, objectives and expectations for future operations and are based upon management's current estimates and projections of future results or trends. Although we believe that our plans and objectives reflected in or suggested by these forward-looking statements are reasonable, we may not achieve these plans or objectives. You should read this quarterly report on Form 10-Q completely and with the understanding that actual future results and developments may be materially different from what we expect attributable to a number of risks and uncertainties, many of which are beyond our control.
Specific factors that might cause actual results to differ from our expectations include, but are not limited to the following, many of which are, and will be, amplified by the COVID-19 pandemic:
the impact and potential impact of the COVID-19 outbreak on our growth plans, financial position and results of operations;
significant considerations, risks and uncertainties discussed in this quarterly report;
geothermal resource risk (such as the heat content, useful life and geological formation of the reservoir);
operating risks, including equipment failures and the amounts and timing of revenues and expenses;
financial market conditions and the results of financing efforts;
weather and other natural phenomena including earthquakes, volcanic eruption, drought and other natural disasters;
political, legal, regulatory, tax, governmental, administrative and economic conditions and developments in the United States and other countries in which we operate and, in particular, possible import tariffs, possible late payments, the impact of recent and future federal, state and local regulatory proceedings and changes, including legislative and regulatory initiatives regarding deregulation and restructuring of the electric utility industry, public policies and government incentives that support renewable energy and enhance the economic feasibility of our projects at the federal and state level in the United States, Kenya, Turkey and elsewhere, and carbon-related legislation;
risks and uncertainty with respect to our internal control over financial reporting, including the identification of a material weakness which, if not timely remediated, may adversely affect the accuracy and reliability of our financial statements;
the impact of fluctuations in oil and natural gas prices under certain of our power purchase agreements ("PPAs")
the competition with other renewable sources or a combination of renewable sources on the energy price component under future PPAs;
risks and uncertainties with respect to our ability to implement strategic goals or initiatives in segments of the clean energy industry or new or additional geographic focus areas;
risk and uncertainties associated with our operating storage facilities and with future development of storage and geothermal projects which operate as "merchant" facilities without long-term sales agreements, including the variability of revenues and profitability of such projects;
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environmental constraints on operations and environmental liabilities arising out of past or present operations, including the risk that we may not have, and in the future may be unable to procure, any necessary permits or other environmental authorizations;
construction or other project delays or cancellations;
the enforceability of long-term PPAs for our power plants;
contract counterparty risk, including late payments, or no payments;
changes in environmental and other laws and regulations to which our company is subject, as well as changes in the application of existing laws and regulations;
current and future litigation;
our ability to successfully identify, integrate and complete acquisitions;
our ability to access the public markets for debt or equity capital quickly;
competition from other geothermal energy projects and new geothermal energy projects developed in the future, and from alternative electricity producing technologies;
market or business conditions and fluctuations in demand for energy or capacity in the markets in which we operate, which may affects the market prices for energy or capacity including those in the market where we operate;
when, if and to what extent opportunities under our commercial cooperation agreement with ORIX Corporation may in fact materialize;
the direct or indirect impact on our Company's business of various forms of hostilities including the threat or occurrence of war, terrorist incidents or cyber-attacks or responses to such threatened or actual incidents or attacks, including the effect on the availability of and premiums on insurance;
our strategic plan to expand our geographic markets, customer base and product and service offerings may not be implemented as currently planned or may not achieve our goals as and when implemented;
development and construction of solar photovoltaic (Solar PV) and energy storage projects, if any, may not materialize as planned; and
the effect of and changes in current and future land use and zoning regulations, residential, commercial and industrial development and urbanization in the areas in which we operate.
Investors are cautioned that these forward-looking statements are inherently uncertain. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results or outcomes may vary materially from those described herein. Other than as required by law, we undertake no obligation to update forward-looking statements even though our situation may change in the future. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
The following discussion and analysis of our financial condition and results of operations should be read together with our condensed consolidated financial statements and related notes included elsewhere in this report and the "Risk Factors" section of our Annual Report on Form 10-K for the year ended December 31, 2019 (the "2019 Annual Report") and any updates contained herein as well as those set forth in our reports and other filings made with the Securities and Exchange Commission (the "SEC").
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We are a leading vertically integrated company that is primarily engaged in the geothermal, and recovered energy power businesses. We are also expanding into the solar Photovoltaic (PV) and energy storage and management services business.
We design, develop, build, sell, own, and operate clean, environmentally friendly geothermal and recovered energy-based power plants, usually using equipment that we design and manufacture. Our objective is to become a leading global provider of renewable energy and we have adopted a strategic plan to focus on several key initiatives to expand our business.
We currently conduct our business activities in three business segments:
Electricity Segment. In the Electricity segment, which contributed 74.4% of our total revenues in the three months ended March 31, 2020, we develop, build, own and operate geothermal, solar PV and recovered energy-based power plants in the United States and geothermal power plants in other countries around the world and sell the electricity they generate. In the three months ended March 31, 2020, we derived 64.2% of our Electricity segment revenues from our operations in the United States and 35.8% from the rest of the world.
Product Segment. In the Product segment, which contributed 24.7% of our total revenues in the three months ended March 31, 2020, we design, manufacture and sell equipment for geothermal and recovered energy-based electricity generation and remote power units and provide services relating to the engineering, procurement, construction, of geothermal, and recovered energy-based power plants. In the three months ended March 31, 2020, we derived 0.8% of our Product segment revenues from our operations in the United States and 99.2% from the rest of the world.
Energy Storage and Management Services Segment. In the Energy Storage and Management Services segment, which contributed 1.0% of our total revenues in the three months ended March 31, 2020, we provide energy storage, demand response and energy management related services as well as services relating to the engineering, procurement, construction, operation and maintenance of energy storage units through the business of our Viridity Energy Solutions Inc. ("Viridity"), which we acquired in 2017. In the three months ended March 31, 2020, we derived 100% of our Energy Storage and Management Services segment revenues from our operations in the United States.
Our operations are conducted in the U.S. and the rest of the world. Our current generating portfolio includes geothermal power plants in the U.S., Kenya, Guatemala, Honduras, Guadeloupe and Indonesia, as well as recovered energy generation and Solar PV power plants and storage activity in the U.S.
COVID 19 Update
In March 2020, the World Health Organization declared the outbreak of the novel coronavirus ("COVID-19") a pandemic. Governments around the world have ordered companies to limit or suspend non-essential operations and imposed operational and travel restrictions resulting in a decline in global economic activity and an increase in market volatility.
The Company has implemented significant measures both to comply with government requirements and to preserve the health and safety of its employees. These measures include working remotely where possible and operating separate shifts in its power plants, manufacturing facilities and other locations while trying to continue operations in close to full capacity in all locations. During the quarter and subsequently, the Company's power plants, manufacturing facility and storage facilities have been operating at close to full capacity and there has been no material impact on our operations as a result of these measures.
In addition, we did not experience any material impact on our results of operations during the first quarter of 2020 and the impact that we have started to experience in the second quarter of 2020 varies among business segments.
In our electricity segment almost all of our Electricity segment revenue in the three months ended March 31, 2020 was generated under long term contracts and the majority have a fixed energy rate. As a result, despite logistical and other challenges, we currently expect that the impact of COVID-19 on our electricity segment to be limited due to the long-term contracted nature and stability of the Company's revenue streams. Despite that expectation, on April 17, 2020, we received from Kenya Power & Lighting Co. Ltd. ("KPLC") a notice declaring a force majeure event in Kenya due to the impact of COVID-19 and purporting to reduce the Olkaria complex's contracted capacity from 150 MW to
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Our product segment revenues are generated from sales of products and services pursuant to contracts that are not terminable. However, recognition of revenue under these contracts is impacted by delays in the progress of the third-party projects into which our products and services are incorporated. We had a product backlog of $96.5 million as of May 3, 2020, which includes revenues for the period between April 1, 2020 and May 3, 2020 compared to $141.9 million as of February 25, 2020. We believe that the decline in backlog resulted in part from the impact of COVID-19 and the unwillingness of potential customers to enter into commitments at this time. We currently expect to recognize our backlog fully in the following 18 months. Nevertheless, we expect that product revenues will be adversely impacted for the reasons set out above, restrictions on travel and because our customers differing their decision to purchase have impacted our sales and marketing efforts.
Our energy storage and management services segment generate revenues mainly from the sale of the electricity ancillary services back to the energy markets based on the prevailing market price for the electricity or for the energy or ancillary services. There has been a decline in ancillary services prices that was driven primarily by mild winter weather and low natural gas prices but might also have impacted by COVID 19. This decline, in turn, impacted our energy storage facilities' revenues.
Given uncertainties regarding future global economic activity and the potential future impact of COVID-19, we have undertaken a number of steps optimizing our global supply chain as well as enhancing the Company's liquidity position. In the first quarter of 2020, we took prompt steps to manage our expenses including responsible cost cutting measures and significantly reduced hiring. Additional actions taken included delaying 2019 bonus payments to our management members and certain other managers from April 2019 to September 2020 and delaying 50% of bonus payments to all other eligible employees. In addition, in order to support our capital expenditure and growth plans, in April 2020, we raised an additional $64 million through the sale of bonds and borrowed $50 million pursuant to a loan agreement with an existing lender.
Despite our effort to provide insight into the performance of our business and the trends effective it, as of the date of this filing, significant uncertainty exists concerning the magnitude of the impact and duration of the COVID-19 pandemic. We may become subject to any of the following impacts:
limitations on the ability of our suppliers to obtain raw materials that are required for the manufacturing of the products we sell or to meet delivery requirements and commitments;
limitation on our ability to sign new contracts for our product segment due to operational and travel restrictions and availability of our customers;
limitations on the ability of our customers to pay us on a timely basis;
lack or limited availability of capital or postponement of capital allocation to future growth;
additional declarations of COVID-19 as force majeure by our customers and suppliers;
a reduction in the demand for electricity and for our products;
change in regulations, taxes and levies that may affects our operation and cost structure.
Other Recent Developments
The most significant developments in our company and business since January 1, 2020 are described below.
As of May 2020, reconstruction efforts at Puna continue. Permits that are required for the construction and operation of the substation were received. HELCO continues with its efforts to complete the upgrade of the transmission network and is waiting for PUC approval. On the field side, the Company completed drilling of two production wells, one of which was blocked immediately after its flow test while the other is ready to be connected to the power plant and is expected to enable partial production by the beginning of the fourth quarter. The Company continues its field recovery work, which includes redrilling and cleanouts of existing wells and drilling of new wells and expect gradual increase of production to 29 MW by the end of the year, assuming all permits are received, the transmission network upgrade is complete and field recovery is successfully achieved.
In April 2020, we announced the commercial operation of the Rabbit Hill Battery Energy Storage System ("BESS") facility, providing required ancillary services and energy optimization to the wholesale markets managed by the Electricity Reliability Council of Texas ("ERCOT"). The facility is located in the City of Georgetown, Texas, and it is sized to provide approximately 10 MW of fast responding capacity to the ERCOT market. Ormat's wholly owned subsidiary Viridity Energy Solutions Inc. designed, built, owns and operates the lithium-Ion-based BESS, using batteries from a tier 1 supplier.
In February 2020, we entered into definitive agreements to acquire a portfolio of energy storage assets in California from Alta Gas, which were amended in April and include purchase agreement to acquire the Pomona 20MW battery storage facility. The Pomona energy storage facility is contracted with South California Edison. Under the terms of the purchase agreements, we will pay Alta Gas $47 million in total consideration. The transaction is contingent upon specific conditions related to the project as well as other customary closing conditions. Closing is is expected during the third quarter of 2020. The Company is currently evaluating the accounting impact of this transaction on its 2020 consolidated financial statements.
In February 2020, we announced a transition of our senior management. Mr. Isaac Angel has decided to retire from his position as Chief Executive Officer, effective July 1, 2020, after six years of successful service to the Company, its employees and its shareholders. It is intended that Mr. Angel will become a member of Ormat's Board of Directors before his retirement as Chief Executive Officer and will continue to be employed by the Company through December 31, 2020 in order to assist with the management transition. If Mr. Angel is elected in the upcoming annual shareholders meeting, he will be appointed to serve as the chairman of the board. Ormat's Board of Directors has appointed Mr. Blachar, the Company's President and Chief Financial Officer, to succeed Mr. Angel. Mr. Blachar will assume the role of Chief Executive Officer on July 1, 2020 upon Mr. Angel's retirement.
Mr. Blachar will has been succeeded in his role as Chief Financial Officer by Assaf Ginzburg, effective May 10, 2020. Mr. Blachar is currently serving as President of the Company until assuming his role as Chief Executive Officer on July 1, 2020.
In January 2020, we signed two similar PPAs with Silicon Valley Clean Energy ("SVCE") and Monterey Bay Community Power (MBCP). Under the PPAs, SVCE and MBCP will each purchase 7 MW (for a total of 14 MW) of power generated by the expected 30 MW Casa Diablo-IV ("CD4") geothermal project located in Mammoth Lakes, California that is under construction. The PPAs are for a term of 10 years and have a fixed MWh price, which includes energy, capacity, environmental attributes, and all other ancillary benefits. The remaining 16 MW of generating capacity will be sold under an additional PPA with Southern California Public Power Authority, which was signed in early 2019. The CD4 power plant is expected to be on-line at the end of 2021, and will be the first geothermal power plant built within the California Independent System Operator ("CAISO") balancing authority in the last 30 years and will be the first in Ormat's portfolio that will sell its output to a Community Choice Aggregator.
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Trends and Uncertainties
Different trends, factors and uncertainties may impact our operations and financial condition, including many that we do not or cannot foresee. However, we believe that our results of operations and financial condition for the foreseeable future will be primarily affected by trends, factors and uncertainties discussed in our 2019 Annual Report under "Part II - Item 7 - Management Discussion and Analysis of Financial Condition and Results of Operation" in addition to the information set forth in this report. These trends, factors and uncertainties are from time to time also subject to market cycles.
As COVID-19 threatens demand, oil prices have declined below the $30 per barrel mark and could have consequences on the global transition to renewable energy and on governmental support for renewable . We believe that the direct impact of declining oil prices on us is not material.
For the three months ended March 31, 2020, 98.8% of our Electricity segment revenues were from PPAs with fixed energy rates, which are not affected by fluctuations in energy commodity prices. We have variable price PPAs in California and Hawaii, which provide for payments based on the local utilities' avoided cost, which is the incremental cost that the power purchaser avoids by not having to generate such electrical energy itself or purchase it from others, as follows:
the energy rates under the PPAs in California for each of Heber 2 power plant in the Heber Complex and the G2 power plant in the Mammoth Complex, a total of between 30 megawatts (MW) and 40 MW, change primarily based on fluctuations in natural gas prices; and
the prices paid for the electricity pursuant to the 25 MW PPA for the Puna Complex in Hawaii change primarily as a result of variations in the price of oil as well as other commodities. We recently signed a new PPA related to Puna with fixed prices that will govern a future plant.
To comply with obligations under their respective PPAs, certain of our project subsidiaries are structured as special purpose, bankruptcy remote entities and their assets and liabilities are ring-fenced. Such assets are not generally available to pay our debt, other than debt at the respective project subsidiary level. However, these project subsidiaries are allowed to pay dividends and make distributions of cash flows generated by their assets to us, subject in some cases to restrictions in debt instruments, as described below.
Electricity segment revenues are also subject to seasonal variations and are affected by higher-than-average ambient temperatures, as described below under "Seasonality".
Revenues attributable to our Product segment are based on the sale of equipment, engineering procurement and construction ("EPC") contracts and the provision of various services to our customers. Product segment revenues may vary from period to period because of the timing of our receipt of purchase orders and the progress of our equipment manufacturing and execution of the relevant project.
Revenues attributable to our Energy Storage and Management Services segment are derived primarily from Battery Storage as a Service ("BSAAS") systems, demand response and energy management services and may fluctuate from period to period. Pricing of such services and products are dependent on market supply and demand trends, market volatility, the need and price for ancillary services and other factors that may change over time.
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The following table sets forth a breakdown of our revenues for the periods indicated:
Revenue (Dollars in thousands) Increase (decrease) Three Months Ended Three Months Ended March 31, March 31, 2020 2019 2020 Revenues: Electricity $ 142,856 $ 142,908 $ (52 ) 0.0 % Product 47,411 52,128 (4,717 ) -9.0 Energy storage and management services 1,846 4,002 (2,156 ) -53.9 Total $ 192,113 $ 199,038 $ (6,925 ) -3.5 % % of Revenues for Period Indicated Three Months Ended March 31, 2020 2019 Revenues: Electricity 74.4 % 71.8 % Product 24.7 26.2 Energy storage and management services 1.0 2.0 Total 100.0 % 100.0 %
The following table sets forth the geographic breakdown of the revenues attributable to our Electricity, Product and Energy Storage and Management Services segments for the periods indicated:
Revenue (Dollars in thousands) Increase (decrease) Three Months Ended Three Months Ended March 31, March 31, 2020 2019 2020 Electricity Segment: United States $ 91,692 $ 91,528 $ 164 0.2 % Foreign 51,164 51,380 (216 ) -0.4 Total $ 142,856 $ 142,908 $ (52 ) 0.0 % . . .
May 11, 2020
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