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Operator
Good morning, and welcome to the Armat Technologies Third Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. If you would like to ask a question, please press star 1 on your telephone keypad. Please note that this event is being recorded. I would now like to turn the conference over to your host, Sam Cohen with Alpha IR. Please go ahead.
Sam Cohen
Thank you, Operator. Hosting the call today are Duran Blashar, Chief Executive Officer, Ozzie Ginsberg, Chief Financial Officer, and Smadar Levy, Vice President of Investor Relations and ESG Planning and Reporting. Before beginning, we would like to remind you that information provided during this call may contain forward-looking statements relating to current expectations, estimates, forecasts, and projections about future events. that are forward-looking as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements generally relate to the company's plans, objectives, and expectations for future operations and are based on management's current estimates and projections, future results, or trends. Actual future results may differ materially from those projected as a result of certain risks and uncertainties. For a discussion of such risks and uncertainties, please see risk factors as described in ORMAT Technologies annual report on Form 10-K, and quarterly reports on Form 10-Q that are filed with the SEC. In addition, during the call, the company will present non-GAAP financial measures, such as adjusted EBITDA. Reconciliation is the most directly comparable GAAP measures, and management reasons for presenting such information is set forth in the press releases that was issued last night, as well as in the slides posted on the website. Because these measures are not calculated in accordance with GAAP, It should not be considered in isolation from the financial statements prepared in accordance with CAP. Before I turn the call over to management, I would like to remind everyone that a slide presentation accompanying or maybe access on the company's website at ORMAC.com under the presentation link that's found on the investor relations tab. With all that said, I would like to now turn the call over to Duran. Duran, the call is yours.
Duran Blashar
Thank you, Sam, and good morning, everyone. Thank you for joining us today. Omar's third quarter operating performance and financial results demonstrated strong growth to our consolidated top line, driven by continued momentum in our electricity and energy storage segment, along with a notable improvement in our product segment. This marked our fourth consecutive quarter of revenue growth, which continues to expand, both operating and net income, which grew significantly. by 8.1% and 21.5% respectively. We are seeing positive momentum and progress in line with our strategic initiative, which is evidenced by solid growth across our three business segments. The significant milestones we have reached since the beginning of this year with the addition of 73 megawatts of new capacity supported the continued growth in our electricity segment. Additionally, Newly signed contracts within the product segment have improved our margins while simultaneously strengthening our backlog by 150%. After the prolonged impact of the COVID-19 pandemic on our product segment, we are pleased to see this positive trend in development and the momentum that it is creating across the business. In the storage segment, we continue to capture the benefits from high energy prices in all of our markets as we advanced our strategy of building an energy storage portfolio balanced between contractual fixed revenue and merchant exposure. We recently signed a 15-year PPA, which I will elaborate on later in the call. We expect the positive momentum in our storage segment to continue in 2023 as we benefit from the regulatory tailwind created by the Inflation Reduction Act and the availability of ITC credit for storage projects. We continue to see strong global tailwinds from renewables, specifically in the US and Indonesia. The elevated global price environment for fossil fuels and increased focus on energy security supports our long-term plans, and we are confident in our ability to continue delivering on our healthy revenue and earning growth trajectory. We expect our combined geothermal energy storage and solar generating portfolio to reach approximately 1.5 gigawatts by the end of 2023 and to deliver an annual adjusted EBITDA of approximately $500 million on a run rate basis towards the end of 2022. Now, before I provide further updates on our operation and future plans, I will turn the call over to Asi to review the financial results. Afi?
Sam
Thank you, Daron. Let me start my review of our financial highlights on slide five. Total revenue for the third quarter was $175.9 million, up 10.7% year-over-year, reflecting strong growth across our electricity, product, and energy storage segments. Third quarter 2022, Total gross profit was $61.1 million. This resulted in a gross margin of 34.7%, up 475 basis points from an adjusted gross margin of 30% in the third quarter of 2021. When excluding the $15.5 million insurance settlement proceeds related to the Pula Power Plant that were recorded as a reduction to cost of goods sold in Q3 2021. net income attributed to the company stockholders was $18.1 million or 32 cents per diluted share in the quarter. This compares favorably to the results of $14.9 million or 26 cents per diluted share in the same quarter last year. On an adjusted basis, net income attributed to the company stockholders was $18.8 million or 33 cents per diluted shares with net income attributed to the stockholders up 5.3% and diluted adjusted EPS up 2.5% versus the same period last year. The increase in net income and adjusted net income was mainly as a result of a strong increase in operating income driven by all three operating segments. Adjusted EBITDA of $102.2 million increased 0.6% in the third quarter, compared to $101.6 million in the third quarter last year. The small increase was largely given by an 8.1% in operating income, given the good performance of our three segments, as well as the reduction in the GNX pattern caused by lower legal expenses versus last year. This increase was offset by the absence of insurance settlement proceeds received in the third quarter last year, Excluding the $15.8 million insurance settlement process, adjusted EBITDA was higher by 19.1%. Moving to slide six. Breaking the revenue down at the segment level. Electricity segment revenue equals 7.1% to $552.8 million. This increase was driven by higher revenue at Pune due to higher generation and electricity rate. The commercial operation in July 2022 of CD4 and the contributions from the Tungsten Enhancement Project, which began commercial operation in April of 2022. Revenues in this segment were partially offset by the ongoing shutdown at our Higa One plant. In the product segment, revenue increased 35.1% to $14.2 million and represented 8.1% of total consolidated revenue in the third quarter. The growth in our product segment revenues was primarily due to our project in New Zealand, which we started to record revenues in the third quarter of 2022. Energy storage segment revenues increased 56.2% to $8.8 million when compared to the third quarter of 2021. This meaningful increase was driven primarily by higher energy rates in most of our storage assets due to the higher overall merchant prices, coupled with added capacity in CAISO from the new 5 megawatt, 20 megawatt hour Tierra Buena facility. Moving to slide seven. The cost margin for the electricity segment was 36.5%. Excluding the one-time business interruption insurance process of $15.5 million related to our PUNA project that was recorded in the third quarter of 2021, The third quarter of 2022 electricity gross margin increased by 4.5%. In the product segment, gross margin was 18% in the quarter, compared to 12.8% in the same quarter last year. The increase in gross margin was driven by new agreements of which we were able to capture stronger margins. The energy storage segment reported a gross margin of 31.5%. compared to gross margin of 12.2% in the third quarter last year. This increase was positively impacted by the significantly higher rate and availability at most of our storages. Looking at slide eight, the electricity segment generation generated 95% of total consolidated and adjusted EBITDA in the third quarter. The product segment generated 1% and the energy storage segment generated about $4 million of EBITDA representing almost 4% of the total adjusted EBITDA. Reconciliation of EBITDA and adjusted EBITDA are provided in the appendix slide. Looking at slide 9, our net debt as of September 30 was $1.8 billion. Cash, cash equivalent and restricted cash and cash equivalent as of September 30, 2022 was approximately $253 million. compared to $387 million as of the year end 2021. The slide breaks down the use of cash for the nine months illustrated on what's the ability to reinvest in the business, service our debt, and return capital to our shareholders in form of cash dividend and shares buyback. We note that this use of cash has been funded from cash generated by operation and our store liquidity profile that we keep and maintain. Our total debt as of September 30, 2022 was approximately $2 billion net of deferred financing costs. And its payment schedule is presented on slide 30 in the appendix. Our average cost of debt is down to 3.9%. We think it is important to note that as we prepare to deploy capital to fund our multi-year goal, nearly all of our debt liabilities remain fixed rate in nature, which we believe will help continue position OMAD competitively in a rising global interest rate environment, particularly as we execute upon our strategic plan to deploy capital and progress toward a multi-year target. In addition, we expect to finance part of our future CapEx plan with the support of the ITC and PTC under the new IRA, the Inflation Reduction Act, which leads me to the next slide. Let's move to slide 10. On August 16 of this year, a new inflation reduction aid was signed, and we expect to benefit from it in many aspects. This act, combined with the recently signed PPA for our geothermal and our storage assets, is expected to improve economics in both segments, reduce capital needs in the US even further than anticipated. First, the IRA extended the tax credits for geothermal by three years, a potentially higher rate than before. which enable OMAD to get into tax equity transaction and find higher percentage of our investment. This should reduce our capital needs and increase project economics. We expect the geothermal project that will start operation in the next five to six years should be eligible for production tax credit. Second, for the first time, our investment in our storage segment going forward will be eligible for between 30 and up to 50% of ITC at commercial operation versus no incentive prior to the act. The expected ITC process will reduce significantly our capital needs and should improve the economics of the project. All projects under construction with COD of 2023 and beyond should be eligible to benefit from the inflation reduction act. The IRA significantly simplified our ability to sell the tax credit to third parties, enabling us to capture potential higher value of the tax benefit. Moving to slide 11. Due to date in 2022, we have invested nearly $408 million in CapEx to advance our goals. We have $750 million of cash and available line of credit. Our total expected capital for the last quarter of 2022 includes approximately $160 million for capital expenditures, as detailed in slide 31 in the appendix. Overall, Armat is very well positioned from a capital resource perspective, with excellent liquidity and ample access to additional capital and attractive rates to fund future growth initiatives. On November 2, 2022, our Board of Directors declared, approved, and authorized the payment of a quarterly dividend of $0.12 per share to all holders of the company's issued and outstanding shares of common stock as of November 16, 2022, payable on November 30, 2022. That concludes my financial overview. I would like now to turn the call over to Doron to discuss some of our recent developments.
Duran Blashar
Thank you, Asim. Turning to slide 14 for a look at our operating portfolio. Generation growth was positively supported by the inclusion of tungsten and CD4 and the generation of the Dixie Valley power plants and the increase in operation of Kona. This was partially offset by the EVO1 fire. As you can see on slide 15, we added 73 megawatts this year to the electricity segment portfolio, a 7.2% increase in total generating capacity. As noted on slide 16, in the third quarter, our Puna geothermal power plant operated at an approximate 23 megawatt level. Currently, BPA prices continue to be elevated as a result of higher global energy prices. We are still in discussions with HELCO to improve fixed-rate BPA pricing within our existing contract. Turning to slide 17, first, in our Olkaria power plant in Kenya, we're currently starting our drilling campaign, which should allow us to increase plant production during 2023. Second, with respect to Heber One, we are currently optimizing the complex through repowering work, which is expected to be fully completed in the second quarter of 2023. Finally, the Dixie Valley Power Plant is back in service and is performing at a higher capacity than before. Turning to slide 18 for an update on our backlog, we saw a 150% increase compared to last quarter. We were able to sign contracts totaling approximately $100 million during the quarter in Indonesia and New Zealand and expect improved margin on this quarter. Moving to slide 19, the energy storage segment delivered another strong quarter supported by the high energy prices at most of our energy storage assets in higher capacity in California. Despite short-term delays for some of our energy storage assets, we see improvement in the profitability as a result of the higher merchant market. As I mentioned earlier, we signed with the California utility our first-ever battery storage BPA, also called the Tolling Agreement. This 15-year agreement secures 100% of revenues of the 80 megawatt, 320 megawatt hour bottleneck facility, and the agreement is subject to the CPOC approval. The bottleneck project is our largest project currently under construction, and we expect revenues in EBITDA from this project to align with our growth plan outlined in our March investor day. We also expect this project to benefit from the inflation reduction act. The fixed nature of the bottleneck PPA supports our long-term growth objective of building a balanced energy storage portfolio, which will mitigate our risk exposure to merchant prices and will shift the portfolio more toward contracted fixed revenue arrangements. Moving to slide 21 and 22. As we have communicated all year, 2022 is a significant build-up year for Oman. The foundation laid this year will support our robust growth plan, which are expected to increase our total electricity generation to approximately 1.2 gigawatts by the end of 2023. Growth across all segments have been impacted by supply chain delays, availability of raw materials, including batteries, and low availability of local contractors, among other items. These have caused some delays in projected commercial operation days, and we may need to shift some of our goals and targets further in the year to account for those impacts. Even with these challenges, we are still on track to reach 273 megawatts, which is 640 megawatt-hours in our battery storage portfolio by the end of 2023, and expect continued positive growth in our other sectors. Slides 23 and 24 display the sixth geothermal and five hybrid solar PV projects currently underway. We're on track with COD of North Valley and HIBOR2, both of which we expect to bring online by the first quarter of 2023. HIBOR1 is expected to be completed in Q2 2023. In Guadeloupe, we received the required permits to start our construction. At EGEN in Indonesia, we have made meaningful progress and have already started the design of the power plant. And in our solar PV portfolio, we completed the tungsten solar project and released the steamboat till solar unit for construction. Moving to slides 25 and 26. The third layer of our growth plan comes from the energy storage system. Slide 25 demonstrates the energy storage facilities that have started construction. Upton is close to completion, with several other projects planned for completion in Q1 of 2023. As you can see, there are slight delays in commercial operation dates, but we are on track with our year-end 2023 growth targets. Please turn to slide 27 for a discussion of our 2022 guidance. In the first nine months of 2022, OMAD has delivered meaningful year-over-year growth across our revenue, operating income, and adjusted EBITDA. Heading into the close of the year, we are updating and narrowing our guidance ranges to reflect our performance through three quarters and expectation for the fourth quarter. We now expect full-year revenue to range between $720 million and $735 million. increasing our midpoint of the range. In turn, we are slightly narrowing adjusted EBITDA guidance within the previously articulated range, anticipating results to be between $430 million to $442 million. We remain confident in our ability to manage our business and assets to deliver on our guidance and to drive future growth in 2023 and beyond as we execute our integrated business model. I will end our prepared remarks on slide 28. This was a solid quarter demonstrated by continued financial and operating momentum with strong progress against our long-term goals. While the global markets are experiencing challenges related to supply chain disruption and raw material shortages, including batteries and solar panels, We continue to benefit from the acceleration in demand for renewable energy in the US and globally, and from our own improvements in operation. The broader migration towards renewable electricity sources supported by the recently approved Inflation Reduction Act should enable us to capture additional tax benefits in the US, which will further boost the economics and validate our decision to allocate the majority of our capital to be invested in the U.S. in both our electricity and storage sector. With growing pipeline and numerous projects under development, we remain confident in our long-term plan to increase our combined geothermal energy storage and solar generating portfolio to approximately 1.5 gigawatts by the end of 2023 and to deliver an annual adjusted EBITDA of approximately $500 million run rate. This concludes our prepared remarks. Now I would like to open the call for questions. Operator, please.
Operator
We will now begin the QA session. If you would like to ask a question, please press star followed by one on your touch-tone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, please press star one. As a reminder, if you are using a speakerphone, Please remember to pick up your handset before asking your question. We will pause here briefly to allow questions to generate in queue. The first question is from the line of Noah Kay with Oppenheimer. Please proceed.
Noah Kay
Good morning, Anne. Thanks for taking the questions. Could we start with just some clarification around the statement in slide 10? the new geothermal project receiving up to 33.75 cents per kilowatt hour based on the new law. Can you help folks walk through that a little bit? What requirements have to be met and how many of your projects under development do you think would actually qualify for that level of subsidy?
Sam
First, good morning and thank you for the question. This is Asif. When we look at the new PTC regulation, it looks like ORMAT on all of its broad projects will be eligible for $27.5 per megawatt over 10 years of production for PTCs. That's basically five times the minimum rate that was established by the regulator. And the reason why we are able to get the five times minimum rate is because we do plan and we really use contractors that meet all the regulation, including the rates that we'll have to pay them and the amount of basically observers that we have as part of our operation and the time that we build the project. So the 27 and a half is already a higher number versus where we are today. There are two other ways to get to a higher rate. One can take you to around $30 per megawatt and one can get to around $33 per megawatt. We assume that most of our projects will not be eligible for $30 and $33. In order to get to $30 per megawatt, what we will have to do is to utilize the local contractors and have local content as part of our construction. We all know that we are using... equipment that comes from overseas, but there are some exceptions that if you do not produce the equipment locally, you may be able to get a higher amount. So this is one option to get higher. The second option is to operate in an area that was in the past impacted by the energy community that is actually, in most cases, these are the energy communities that used to have coal in them or natural gas that didn't have any operation going forward. and then you can get a higher rate. I will say that in our plan, and as we see it now, most likely that we will get $27.50 for all the projects that we start in the next few years, and we will finish probably in the next five to six years. I will just tell you that if you take the 10 years of PTCs on a nominal base, they are equivalent to more than 50% of the cost to build a power plant.
Noah Kay
That's incredibly helpful, obviously. So, yeah, 33 per megawatt, that actually, I think, sounds like 3.3 cents per kilowatt hour, if I'm dividing it correctly. But that just may be a typo there. But certainly, I understand the higher benefit potential capture there and the impact. If we talk a little bit about project timing, I think the solar panel project Battery storage, those supply chain delays that are industry-wide are well-known. Can you talk to us a little bit about the geothermal side and what you're seeing in terms of timing for projects? It looks like maybe a little bit of shift on a few projects here and there, but at this point, do you see any significant either supply chain or permitting hurdles to meeting your year-end 23 goals, and what should we be watching for?
Duran Blashar
Hi, Noam. Thanks for the question. It's Daron. We don't see supply chain or material supply chain issues on the geothermal part. This is obviously something that we are leading and well aware with the different suppliers and making sure that we have the right inventory as needed. Permitting is always a challenge and interconnection is always a challenge in the U.S. So we do see some small delays maybe in North Valley, but in general on what we have on the plan, these are things that we expect that we'll meet and should not be impacted by supply chain issues.
Noah Kay
Okay, that's very helpful. And then last, congratulations on an income of $100 million in products. Can you talk to us a little about A, kind of the timeline for converting that backlog into revenues, that really more of a 23-story in terms of the inflection. It seems like that may be. And then just the potential depth of demand behind that, what the pipeline looks like in products for additional contracts.
Duran Blashar
So in general, you know, I would say EPC projects that we sign, and that's what the projects in New Zealand are. EPC projects usually are between 18 to 24 months, tended more beginning to the first 12 months compared to the second 12 months. Supply contracts are usually within one year, but the big project we have in New Zealand is an EPC, so it will spread over 18 months. up to 24 a month. In the pipeline, we have a few potential projects that we are discussing with customers. I think the largest or the most interesting place is New Zealand. There's a lot of growth potential. We have a very big player there. We have built actually quite a few pipelines there and we see some more opportunities there. I'd say the next large place that we see a lot of potential is in Indonesia. We see quite a lot of drilling and development done by various developers, including ourselves, but we're talking about the product side. We expect to see quite a few tenders coming out over there in the next few months and quarters. I'd say these are the two. And there are obviously also other places, but I think these are the two large ones.
Noah Kay
Okay. I mean, it's good to see that turning from really kind of a revenue headwind that had been for several years into a tailwind, it looks like, over the next couple of years. And we'll look for more. Thanks for taking the questions. Thank you.
Operator
Thank you. The next question comes from the line of Mark Strauss with JP Morgan. Please proceed.
Mark Strauss
Yes, thank you very much for taking our questions. Just a couple on energy storage, if I can. So it looks like some of the CODs that you were projecting for 4Q are now in early 2023. Not surprising, as Noah said, just given the industry headwinds, but curious about The year-end 23 target now seems to be at the lower end of the range that you were previously expecting. Is that really just because of kind of the slower start to 23, or are you kind of signaling that you're expecting the supply constraints to last this year?
Duran Blashar
I think the lower end is mainly because of what you and Noah said. You know, we see some issues with the supply chain. So we have the project that should come online, and we also discussed bottlenecks that we have secured through a contract, all the batteries, so it should be online by the end of 2023. Apart from that, we are continuing with our plans. As I said, the main issues here are supply of batteries, But also permitting is a major barrier in the U.S. that we are dealing across our segment.
Mark Strauss
Okay. And then more of a modeling question for my follow-up. Just going back to your comments around the profitability of your storage business benefiting from the higher merchant pricing, any commentary you can provide over the coming quarters, how we should think about margins for that business?
Sam
First, good morning. It's Asi. I will say that third quarter really enjoyed the higher prices due to natural gas prices increasing the East Coast. PGA market was our leading market, and month by month we see us. You know, when you look here over here, our revenue is up over 50% with almost no increase in assets. We only added the 5 megawatts of Tierra Bueno, Q4, you know, we already gave you guys guidance of $30 million for the year. So as you can see, it's not going to be as good as the Q3 because prices are not as high as of at least the first month of the fourth quarter. And so I would say we are expecting slightly lower margins in Q4. And we said that when we look forward as a company, we should see overall increase as we increase our capacity in our gross profits and EBITDA margin. And you can look, for example, on the bottleneck project, which we just signed. We gave an example in our investor day of an 80 megawatt, 320 megawatt hour project And the one in the analyst day is roughly $16 million of revenue and almost $13 million of EBITDA. So when we look forward, I will tell you that the EBITDA margins for this segment should continue and go high every year as we move forward. But Q4, I don't expect it to be as good as Q3. But things can change. Commodities are moving really fast. But at least October, we have seen better markets than last year, but not as good as Q3.
Q4
Makes sense. Thank you very much.
spk08
Thank you.
Operator
The next question comes from the line of Ron Levine with Citi. Please proceed.
Ron Levine
Good morning. Thanks for taking my question. In terms of the delays in the storage and solar segment, what are the implications in terms of your contractors and partners with the timing delays? Is there any recovery or penalties associated with any of these time shifts and how does that impact your financing plan and other capital plans?
Duran Blashar
Hi Ryan, thank you for joining us. What we see at least today are relatively small delays of a few weeks or maybe a month or two on the construction. However, we are able to manage it. We are not releasing today projects before we know that we have secured the batteries, which is the main component obviously for the energy storage. On the contracting side, it's many times a challenge. However, today when we have the ITC and you're required to pay the right wages, I hope it will make it a bit more easier to find the contractors because people will be more willing to work. Regarding LDs, This is something that is not a material impact. Sometimes we have some LDs with our suppliers. However, in most cases, we have a long-term relationship with our suppliers and it's a dialogue that we have, so this is not a major part. And on the financing part that you asked, we haven't yet financed a standard Only once we find a standalone storage project, so we don't see that as an issue yet.
Ron Levine
Okay. And then in terms of the product backlog, I think you highlighted 150% increase over last quarter. Can you delineate as to what region you're seeing the growth in or what types of customers you're seeing the biggest increase in your backlog?
Duran Blashar
I think the main two areas that we see the growth today is in New Zealand and in Indonesia. These are the two places that are pushing for geothermal projects. I think in the short term, it's more New Zealand. In the longer term or the medium term, it would be Indonesia. So these are the two large ones. On top of that, you know, I can tell you that we're responding, you know, to some issues in Taiwan, in Japan, and in Honduras, El Salvador, Mexico. So these are many projects. I think the main area is New Zealand and Indonesia. And we hope the Turkey, you know, economy will... come back to its feet, and that's a market that has a very high potential for growth.
Ron Levine
Is the growth of New Zealand and Indonesia predicated on certain macro developments, or what's really driving that expansion?
Duran Blashar
No, New Zealand, it's a question of negotiating contracts and winning tenders, and the same in Indonesia. It's not... They have the... the resource, the land, the willingness to develop, and the financing. It's just a question of either negotiating a one-on-one contract or responding to tenders. New Zealand projects have been well ready during the COVID and waited for COVID to go away, and now they are back into the market.
Ron Levine
Okay. Great. And then last question, in terms of the IRA impact to your core business, you highlighted more on the development side, but are there any expansions or repowering that may qualify for the ITC or PTC for geothermal?
Duran Blashar
In the geothermal part, if it's a new product, basically expanding an existing power plant like Biwawi, that we had one product and we're increasing it significantly, then the addition, the expansion should be eligible for the PTCs and IPCs. Okay, appreciate the talk. Thank you.
Q4
Thank you.
spk05
Thank you. Our next question is from the line of Jeff Osborne with Cowan & Company. Please go ahead.
Jeff Osborne
Yeah, great. Good afternoon. A couple questions on my end. Asi, I was wondering if you could just go over the current portfolio storage. Is that 100% merchant? Or could you give us a sense of the mix?
Sam
Sure. So when you look at the current portfolio, we do have only in California what we call a RA contract. They usually cover a up to 40% of the revenue. So on the current portfolio, the Pomona One Asset has a contract, Valestito has an RA contract, and Tierra Bueno has an RA contract. All of the remaining of format contracts are basically on a merchant bank. So when you look at the current operation of format, the majority of the revenue is coming from a merchant revenue. With that being said, when you look at what we expect to bring online between now and the end of 2023. And we're actually shifting to a more contractual revenue. And the leading part of it is the bottleneck contract, which is an 80 megawatt, 320 megawatt hour project. So the size per megawatt is bigger than anything that we operate, including everything that we're going to build next year. And that's why we'll have a full tolling, which means It's a fixed revenue for 15 years, which will benefit and allow us to balance between merchant and fixed revenue.
Jeff Osborne
That's great to hear. I see in the footnotes to the bottleneck slide, which is helpful, that it requires TPUC approval. Do you have a sense of when you would anticipate that, just given you're hoping to have it up and running by the end of next year?
Duran Blashar
We have started the construction. We expect the CPUC approval within 60 to 90 days. That's what we were told. We know that they've asked for an expedited approval. So we hope we'll get it within 60 to 90 days.
Jeff Osborne
Excellent. And my last question is just not as part of your 23 outlook, but more for your mid-decade. M&A was a part of that. I was just curious if you could opine on that. where M&A valuations are on both geothermal and storage. My sense is that storage had been a bit inflated a year or so ago. I didn't know if that's cooled off at all.
Duran Blashar
On geothermal, it's easier. We don't see today any assets in the market, but we are constantly discussing with the owners whether or not they would like to sell or to go into some kind of an M&A transaction. On the storage, you're right. The last year and before, pricing were inflated. I think the increased interest rates will bring them to reality. It didn't happen yet, but we do expect it to happen. Once they come to reality, we are there in the market and we are constantly looking to acquire energy storage assets.
Jeff Osborne
Excellent. That's all I have. Thank you so much.
Duran Blashar
Thank you. Thank you.
Operator
Thank you. The next question comes from the line of Justin Clair with Ross Capital Partners. Please proceed.
spk10
Yeah. Hi. Thanks for taking our questions here. So, first off, in Q3, we saw the gross margin for the product segment rebound meaningfully here. just wondering if you'd share a little bit more detail on what drove the improvement was it largely pricing related or did you also see improvement on the on the cost side and then just looking forward was wondering how we should think about the product segment margins you have a much larger backlog here you know could we see further improvement on the margin side thank you for the question in 2021 we have signed the two
Sam
contract in this product segment, that when we bought the raw material, including transportation, we encouraged additional costs, mostly related to supply issues and also, I would say, in general, commodity market uplift. And as a result, we saw the margins all year prior to this quarter at a lower level. The third quarter, we're actually seeing that these projects from 2021 are basically almost at the end of their cycle. They are basically almost over. And the new contract that we signed that will oversee mostly 2023, those are at a higher margin. I know that historically we would suggest that we think we can get anywhere from 24 to 27, 28, the product segment, I will say that I think that we're not there yet. Maybe in the low 20s at this point. But we are seeing now a phenomenon of a slight decrease in raw material costs. So the hope is as we sign new contracts, when we go and buy the raw material, we actually get a benefit similar to the fact that how we lost money when the cost of the raw material went up. So I think we will be in the low 20s, but not there where we need to be, but we're making progress.
spk10
Okay. The color's really helpful there. And then just wanted to understand your expectations for the level of the ITC you think you might be able to capture in the storage segment, given there's this range of 30% to 50%. I think part of that is a result of if you meet domestic content requirements, So can you meet those requirements, do you think, in either the 2023 or 2024 timeframe? So any context that would be helpful.
Duran Blashar
I think as you said, going up from 30 to 50 is a bit more challenging and requires some additional definitions. The detailed guidelines by the IRA have not been, you know, all of them issued. The question of domestic content, it's a question how it is going to be defined. As we all know, you know, most of the battery cells are manufactured outside of the U.S., but in other areas and in other countries, the definition how... you define something as manufactured locally and not just acquired differently. So that's one thing that is still open and we don't know. And the other 10% is location-specific. We have some locations that might qualify. We're not sure. We're looking at other locations that we know are not eligible for the additional 10%. So it's really a project-by-project analysis. But, you know, the inflation reduction that took us immediately from zero to 30% ITC, so it's a big upside.
spk10
Okay, great. And then just one last one. You reiterated the plan here for reaching a run rate for adjusted EBITDA of $500 million toward the end of this year. I was just wondering kind of what is factored into that? Are you including the potential upside from, you know, the tax credits for the PTC in that number? And then also, is there any, have you factored in the ITC for storage into that number or could those be upside as we look into 2023?
Sam
As we outlined in the investor discussion that we had in March, OMAT always anticipated PTC to be part of our life, and most of the projects that are going to end in 2022 and 2023, those will be eligible for PTC regardless of the new regulation, because start of construction was a few years ago. So the PTC was already included. The ITC, though, is still – there are four – big four accounting companies, and each one of them have a different thoughts of how we need to account for the ITC, especially when we are able to sell them in a transfer mode versus the ability to sell them as part of an ITC tax equity transaction. And we are not sure yet if it's going to go through the EBITDA line or potentially to the tax line item. And therefore, we did not include Any significant dollars related to ITC, you know, 500 million.
spk10
Okay. I appreciate it. Thank you.
Operator
Thank you. The next question comes from the line of Julian DeMolin Smith with Bank of America. Please go ahead.
spk12
Hi. Good morning, team. Thank you. I appreciate it. So if I can go back to this, and I don't mean to rehash too much, but I want to ask it more directly here. You have this $650 million EBITDA target by 2026, right? And you outlined that at the analyst's day prior to IRA. You've articulated numerous upsides on both development as well as seemingly upside on projects that are already in flight and contracted. How do you think about upside to the 650 or said differently, additional balance sheet latitude once you hit the 650 created as a function of this? And if you can clarify, for those projects that are already contracted here, specifically or more likely biased towards the geothermal side, to what extent is that additional value from IRA held on by you guys at this point?
Duran Blashar
Hi, Julian. I'll start with Dan. Regarding the IRA and who actually gets, at the end of the day, the full value of Obviously, suppliers, developers, utilities, everybody is aware of this upside. And as you might expect, it would be somehow split along all the parties in the transaction. It differs between projects that are already in development and are going to be in construction and obviously all contracts CAPEX has been signed already, so the IRA will move more toward the developer compared to future projects that we believe the market over time will get to a new, stabilize on a different number of merchant pricing, CAPEX pricing and development. Regarding the target that we've set in the in the analyst days five years from today it's not something you know that we constantly and look and update obviously in march when we did the the analyst day nobody knew about the inflation reduction act however everybody was expecting the ptc for the geothermal to continue and this is something obviously that was a all the time part of our modeling so The PTC is obviously in the geothermal power. ITC for storage is something new that came after that, so that was not included there.
Q4
Can you clarify just in terms of the 650 there?
spk12
I mean, how do you think about when you come back and provide a more comprehensive update? Again, I get that you don't have full line of sight as exists with the current projects necessarily to get out to there. You know, how do you think about just the accelerating nature of opportunities? Even more to the point, forget the 650, how do you think about the timeline for coming back and providing a medium-term update on opportunities arising from this? I get that a lot of the storage is merchant in nature and therefore is driven by you from a timing perspective, but a lot of the geothermal is driven by the pace of RFPs and procurement. Shouldn't we be seeing an accelerating effort on that front, both because California and the West are broadly short and need resources on a timely basis, as well as these elevated IRA opportunities for the time being?
Duran Blashar
Julian, we have been, you know, even before once the CPUC targets were set, we have been pushing exploration and pushing development of geothermal projects. and we are continuously doing it. We see extensive demand in California for geothermal assets. So whatever we can develop and move forward, and we've invested this year more in exploration than we've done in previous years, and next year we'll probably invest even more in exploration and development than in this year and previous years. So we are pushing it. The storage, the main barrier to develop storage projects in the U.S. is the interconnection queue. Cluster 14 in California came up. I think the queue had 90 gigawatts of potential projects. I think the entire usage in California is 50, but the queue for new projects was 90. gigawatts so this is something that is becoming the biggest barrier even more than supply chain issues but we have put on the table the ira didn't change you know our our plan to develop as many energy storage as we can um and if during next year or any other time in the future you know we would like to update specifically you know we will do a detailed analysis and give some updates
Sam
Julian, this is Asi. I think there are two parts of the plan that we're looking at as we speak. First, it looks like the capital needs that we had in mind of $2 billion to put all of this to work will be reduced because the ITC will provide on the storage anywhere from 30% to 50% in tax benefits to us. So the cost to rebuild the plant The five years plan that we put together will be lower and that will enable us to have a lower interest cost, lower leverage, which in our mind is very beneficial for the plan. Second, as I mentioned earlier in the prior question, if we will have a significant ITC that will impact EBITDA, we will have to look into it. We are not sure yet that the ITC will flow to the EBITDA level. It may go directly to the bottom line, to the earnings per share. which we are not guiding at this point. So once everybody agrees on how to better account for the ITC, we'll be able to look into our 650. But as I said, bottom line, we will see that the additional parts of the funding to grow Ormat will be covered by ITC benefits. And in the analyst day, we expected to spend roughly half a billion dollars on storage segments. over the next four years from now. And if that will be the case, then 30 to 40% of it will be financed by the IRA. It basically will reduce our cost of debt and our debt significantly.
Q4
Yep, I hear you on all points. Thank you. Good luck. We'll speak to you soon. Thank you.
spk08
Thank you. Again, to ask a question, please press star 1. There are no additional questions at this time. I will pass it back to the management team for closing remarks.
Duran Blashar
Thank you. Thank you all for joining us. This was another good quarter for OMAD, and we are now focusing on developing and pushing forward as we ended the call on our growth and exploration targets. Thank you all.
spk08
That concludes today's conference call. Thank you. You may now disconnect your line.
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