Plug Power Inc. (PLUG) Q3 2012 Earnings Report, Transcript and Summary

Greetings and welcome to the Plug Power 2012 Q3 Financial Results. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Cathy Yudzevich, Manager of Investor Relations for Plug Power. Thank you, Ms. Yudzevich. You may begin.

Good morning. Thank you for joining Plug Power to discuss our third quarter results for 2012. Andy Marsh, CEO; and Gerry Anderson, CFO, will be on this call today. This call will also be archived on our website at plugpower.com in the Investors section under Presentations. This conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including, but not limited to, expectations regarding revenues and product orders for 2012. These statements are based on current expectations that are subject to certain assumptions, risks and uncertainties, any of which are difficult to predict,are beyond our control and that may cause our actual results to differ materially from the expectations in our forward-looking statements. We encourage our listeners to refer to our SEC filings for a complete recital of our Safe Harbor statement, as well as other risks and uncertainties discussed under Item 1A Risk Factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, filed with the SEC on March 30, 2012. Plug Power does not intend to and undertakes no duty to update any forward-looking statements as a result of new information or future events. At this time, it is my pleasure to turn the call over to Andy Marsh.

Good morning. 2012 has been a very difficult and challenging year for Plug Power. It's now clear that we will fall short of both our revenue and profitability targets for the full year. The primary factor is related to quality issues. These issues, the result of both Plug Power's performance as well as the performance of some of our partners and suppliers, have in turn had a negative impact on our sales traction this year and I believe have delayed our progress by 9 to 12 months. Because of these issues, we are resetting our guidance for 2012. We expect revenue in the range of $26 million to $30 million. We expect EBITDAS lost to be in the range of $27 million to $29 million. Plug Power is, in many respects, still a startup business, and like many startups, predictability is challenging. What is difficult to discern from the role of financial performance is that the company has had significant successes that are fundamental to its long-term potential. I'd like to discuss some of these successes in greater detail. The material cost for new product platform is 60% of selling price of the product. This is a 2x improvement over the past 2 years. Material cost is the key indicator of the potential for long-term profitability of the company. Two, we believe we have solved the quality issues. Today, the operating performance of the new products are superior to the older products. These new platforms, with the lower costs and improved performance will be the basis of our offering for the coming 3 to 4 years. The majority of the development organization will be focused on cost reduction, continued quality improvement and customer-specific modifications. Having a stable, low-cost, high-quality platform will allow this business to become more predictable in the coming years. And most importantly, our customers remain supportive. To date, we have not had a canceled order. Over the past 2 months, I've spent considerable time with all of our major customers. And without exception, each is working closely with us to help us build a successful company. This is because they believe that Plug Power adds value to their operations. I would like now to discuss revenue, quarter and EBITDA in greater detail. The revenue shortfall from our previous projections is primarily due to 2 events. First, an order was received later than expected in 2012 and now will be shipped in the first quarter of 2013. This order is valued at approximately $4.4 million. Second, we shipped over $3.5 million in future product revenue in the third quarter that cannot be recognized this year because of a delay in the completion of the contract. The main reason for this delay is because the hydrogen system was under-designed by the vendor and could not support the fueling requirements of the entire fleet. The fleet will be financed by a third-party but must be fully deployed and operational before the third-party will close on the funding. This was an unusual event. For this customer's site, the supplier chose a mechanical compressor system. Although on paper, they believed this approach would be sufficient to support the site, in fact in application, it was not capable of keeping up with the fueling demand. We have fleets deployed at many sites that require significantly more hydrogen than needed this facility. Most suppliers use liquid pumps for systems of this size, and this site will most likely move to this newer technology in early 2013. This is an experience we're sharing with all of our customers in the industrial gas companies and is a critical learning for this nascent industry. I would expect very few sites with demand over 150 kilograms a day will use mechanical compressors in the future. With respect to orders, we received an order from P&G for 118 units for their site in Mehoopany, Pennsylvania. This would be the fourth site for PG deploying Plug Powered unit. P&G is one of our major customers. To date, Plug Power has received $14.5 million in orders, expects $30 million for the year. New customers in 2012 include Lowe’s, Mercedes and Stihl, with repeat orders being received from Sysco, Wal-mart, Kroeger, BMW and Coke. The sales funnel remains strong with the total value for the next 2 quarters for customers with a positive value proposition exceeding $100 million. Our JV with Air Liquide HyPulsion is making progress. The past year has been focused on modifying our products for European market and introducing the technology to potential customers via HyPulsion and Air Liquide sales force. In December, we expect we will release 2 products with CE approval and in the early half of 2013, there will be an acceleration of trials. This is on plan with the expectations for 2012, which set as a primary goal product and customer development. We expect revenue will be generated in 2013 in Europe. We have also received a $2.5 million grant from the Department of Energy with our partner Federal Express to develop fuel cells for tow tractors at airports. This product is a modification of our GenDrive unit and is a market expansion opportunity with our present customer base. Our partnership with government agencies has been beneficial to the company to cost effectively explore and develop new technologies and markets. We expect this relationship to continue. Now I'd like to talk about profitability. The lower-than-expected profitability for the business is primarily due to 3 reasons. First, is the timing that -- of the introduction of the new product platforms. In the first half of 2012, most units shipped by Plug Power were based off the older platform design. The material costs for these products was significantly higher than those of the newer design. As mentioned previously, one of the bright spots of the past quarter is that the material cost is now 60% of the product price, a significant achievement for the company. The impact to the business of shipping the older units was $1.5 million reduction in EBITDA in 2012. Second reason was quality issue. The company has taken a onetime charge of $3.3 million in the third quarter to address quality issues. These additional costs can be attributable to extra service staff required to support the product as well as upgraded and repaired units. We're now negotiating with suppliers and any recovery costs will be reflected in future financials. I'd like to note that the quality issues we have experienced, while frustrating, are issues of type that any emerging industry faces, and on a positive note, have demonstrated our ability to react quickly and effectively when faced with these problems. While no one welcomes such issues, I believe our customers have been understanding and are comfortable with how Plug Power has handled these situations. Finally, we generated lower-than-forecasted revenue. The lower-than-forecasted revenue reduced Plug Power's EBITDA by $4 million. To understand our long-term profitability, it is important to understand the impact of revenue and material cost to the business. Plug Power's profitability is dependent upon sales and material costs. The company carries approximately $1.5 million in labor and load per quarter. With the material costs 60% of the product price and expense run rate approximately $4.5 million per quarter, the company would be EBITDAS breakeven at approximately $18 million to $20 million per quarter. At $25 million in revenue per quarter, the company will achieve EBITDAS margin in the range of 8% to 10%. When one considers that the design cost and quality of our products are now stable, the key to success is accelerating sales. Our 4 major customers can purchase significant annual quantity that allow Plug Power to reach profitability. Additional customers in the European JV will add to the business' profitability. As we overcome the setbacks in the past year, we expect that orders and shipments will be accelerating over the next 12 months. As I mentioned previously, customers remain highly interested and engaged in buying our products since we add value to their operations. In summary, before handing off to Gerry, I would like to discuss a little more about the business and industry. The market for pen fuel cells for applications under 50 kilowatts has made progress. We will ship out of the facility 1,400 units versus 1,024 units last year. This is a 37% increase. Companies like Bauer are reporting success in additional markets such as backup power. The global auto end companies all have aggressive plans for the rollout of fuel cell automobiles. This is because the feedstock for hydrogen vehicles is natural gas and fuel cell cars are more efficient than natural gas cars. Though none of us has exceeded the pace we desire, we've all dramatically improved our businesses during the past year and that should be not lost in the sometimes disappointing news. Companies in the industry have many of the same challenges such as the need for scale, liquidity and the speed of customer acceptance. These are Plug Power challenges also. Our management team and the Board over the past were considering all options to meet these 3 challenges with an understanding that the primary focus remain expanding sales. Even after some obvious missteps, I remain optimistic about our future. As I've mentioned previously, we have a large market opportunity, a supportive customer base, have 95% of the hydrogen refuelings in North America and a solid, stable, cost-effective product platforms. These have always been the key ingredients for our business, and we are well-positioned to be successful in 2013 and beyond. I'd like now -- would now like to hand over the discussion to Gerry.

Thank you, Andy, and good morning, everyone. I would like to spend most of my time commenting on product and service revenues and cost of goods sold, as our R&D contract business and operating expenses are in line with our expectations. For the third quarter of 2012, our product and service revenue performance was $4.3 million, which was basically flat to the comparable prior year quarter. Our third quarter results were hampered by one particular deal, noted by Andy, where we shipped 245 units without any revenue recognition due to contractual obligations that have not yet been met. As such, these units remain in Plug's order backlog as well as our finished goods inventory, which was $3.5 million of the total $13 million in inventory on hand at September 30, 2012. Had we been able to meet all the contractual obligations and conclude the financing on this deal, we would've had almost $8 million in product and service revenue for the quarter and 431 units shipped. On a year-to-date basis, product and service revenue was $18.7 million on 873 units shipped, which represents increases of $6.8 million in revenue and 461 units shipped year-over-year. While our current backlog of business stands at $29.9 million, the majority of the backlog is now expected to ship in 2013. Hence, we have dropped our full year 2012 total revenue expectations to $26 million to $30 million. To follow up on a couple of Andy's earlier comments, while the challenges we have encountered have delayed sales tractions in terms of closing deals in our sales funnel, which is an excess of $100 million, we have not had any customers cancel signed deals. Admittedly, the most disappointing aspect of our performance in the quarter was our cost of goods sold for products and services, which was $10.8 million resulting in a $6.6 million gross margin loss on product and services. Half of this gross margin loss is attributable to the charges we took during the quarter for the component quality issues we encountered on the new platform products. Any settlements we finalized with our suppliers in these matters will be recognized as recoveries in future periods. Additionally, as we work through some of these issues in the field, rework and upgrade costs, expedited shipping of parts and service cost contributed an additional $2 million to the gross margin loss above what we planned for these activities. As we resolve these technical issues with our new platform products, we do expect these costs to moderate back down to planned levels. Year-to-date through September 30, cost of goods sold for product and services was $28.6 million, adversely impacted by the quarter's reissues just discussed, as well as underutilization of capacity which impacts our ability to absorb fixed overhead and labor. On the R&D contract side of our business, revenue for the quarter was $502,000 and cost of goods sold was $791,000, both in line with expectations and run rates for the full year. Our operating expenses for the quarter totaled $4.9 million and were comprised of research and development expenses at $1.3 million, selling, general and administrative expenses at $3.1 million and amortization expenses at $578,000. Operating expenses remain in line with our targets and we continue to scrutinize all operating expense categories and evaluate every opportunity to reduce these expenses without impacting our ability to take care of our customers and manage the business. Year-to-date, operating expenses totaled $16.4 million and remain in line with expectations for the full year. Noncash costs for depreciation, amortization and a noncash stock compensation included in our profit and loss statement were $1.5 million for the quarter and $4.7 million year-to-date. Our net loss for the quarter ended September 30, 2012, was $10.3 million, or $0.27 per share on a basic and diluted basis as reported. Weighted average shares outstanding for the quarter was $38 million, EBITDA'S loss for the quarter and year-to-date was $10.2 million and $22.4 million, respectively. Net cash used in operating activities for the quarter and year-to-date, respectively, were $7.1 million and $15.5 million. As of September 30, 2012, the company had $9.5 million in cash and cash equivalents and $15.6 million in working capital. Additionally, the company had a $1 million draw on its $15 million revolving line of credit with Silicon Valley Bank. We'd now like to open the call to any questions.

[Operator Instructions] Our first question comes from Philip Shen with Roth Capital partners.

So I'd like to talk about the product quality issues. On the last call, there was a hydrogen fueling system/O-ring issue and you guys talked about how it would be resolved by September, and maybe a few lingering units into October. So we're in November now and you also mentioned on the Q2 call that the financial impact would be relatively minor. So what happened? What -- did another issue crop up? I think the last time we talked about a quality issue, you said it was completely due to a -- another supplier who basically provided misrated equipment. So what's going on with the results in Q3?

So Phil, there were a number of quality issues with the introduction of the new products. Some of them related to Plug Power issues, some of them related to supplier issues. When -- if we take a look at them and that we have had some issues with the compressors selling prematurely in the field, we had issues with castings not coming from our suppliers with the appropriate dimensions, some of those issues caused by Plug Power, some of those issues caused by suppliers. And those issues on top of the issues with the TPRD have amounted to the $3.3 million in charges we took for the quarter. We do expect some recovery on those issues when I -- when we looked at it, we're in negotiations with many of those suppliers. And I don't want to go out and make estimates today, but there certainly will be some recovery in the fourth quarter for the write-off.

Okay. And you said TPRD, what does that stand for?

Temperature pressure relief device, and that's the O-ring device.

Okay. Good. And so, all of the products sold in Q3, what percent of them were based on the new design?

Virtually all of them.

100%, Phil.

Okay, 100%.

And let me emphasize that we are over the quality issues we have seen. As far as understanding how to resolve those issues and that by years end, we expect the majority of any issues in the field to be cleaned up and resolved.

Okay. And I can imagine when you bring new product to market and there's a -- at minimum of amount of testing, number of hours of operation that you need to kind of follow and test. Did you guys go through those -- the typical protocol? How is it that so many product quality issues occurred in the field? Did you guys push the product out too quickly?

I would say, Phil, that the testing algorithms probably didn't consider all the operation -- all the functions that the product will have to operate through. I'll give you an example. We spend most of our time testing units at worst case and that's the high-temperature, high-load. Actually, some of these product problems that we saw actually occurred at a very light loads, which wasn't the area that we were focused on during product qualification. So I think our product testing could have been broader, but where we test the product would be where I think is the natural areas of concern for power products. We just ended up running the issues that were beyond our expectations. Now I'll give you another example is with the issue we have with chassis. We had units that came in that passed first article inspection. And when we received the chassis from our supplier, we found all sorts of specification issues, and that led to massive rework and massive cost in the past quarter.

So were the specs that you gave the supplier not accurate? Or were...

They were accurate.

They were accurate. So the supplier delivered...

Parts out of specs.

Equipments out of spec, yes.

Right.

Equipment and parts out of spec.

And we were in a position where we -- we're not in position where we can delay customer deployment. Cost to us was probably over $800,000 modifying those chassis and bringing them up to specification so that they could be used by our customers.

Okay. So basically, you said, we need to meet our customer schedule needs, so we'll take the hit and make the changes and then push the product out on time?

We had no other choice.

Okay. So in terms of shipments, obviously the tune of 45 units would have been nice to have recognized. Have they been recognized to date? And if not, when do you expect that shipment to be recognized?

We feel, if you listened, I'd mentioned that I would have expected it to be recognized in the first quarter of 2013.

Okay. I missed that. I heard you say that they haven't. So it's not being recognized but -- so what -- so the delay here primarily due to the, I think there was some mechanical compressor system as opposed to -- so basically, it's some secondary situation where because the project is not a full go, you can't recognize the revenue?

Correct. So the hydrogen system could not provide full capability. The customer could not bring all of the fuel cells online. And that was not a completion of the product contract.

Okay. And is it your responsibility to spec out the compressor or the pump system?

We were not responsible, Phil, for spec-ing out that portion of the system, but we -- directly, but we were responsible for making sure that system was installed properly.

Okay. Because it feels like this -- this is obviously a key learning that you highlight but it's certainly something that could have been avoided.

Well, I would say this. Maybe. I'm not -- I think there's a little bit more complications associated with it. But I think it was not as easy as just picking a liquid pump.

Right. There's a...

There are other contractual obligations which led us to have to use this supplier and this supplier used this system.

Okay. Okay, so if -- did some of those units have product quality issues that you had to then have fixed as well just to get those shipments out, but then -- so you guys kind of got hit with that double whammy. On one hand, you try to take some charges to improve those units, and on the other hand you couldn't recognize the revenue?

I would let Gerry -- I believe that's the case. But I want Gerry to make sure I answer this one correct, Phil.

So Phil, several of these products that went to this particular site involved the chassis or the castings that we had to do the rework on, as well as some of the other design upgrades that we had to work through, we implemented in these products. And it's important point out, Phil, I mean, we delivered the products still. All of the units are at the site. But in accordance with the contract and all of the deliverables of the contract, we have not met all the contingencies. So technically, there's -- it's still our inventory at this time.

Okay, I am -- here's where I'm trying to go with this. Let's say -- all the units shipped in Q3 were -- on based on the new design. You got hit with, essentially, COGS and even charges with these 245 units, but then no revenue. Had you met these contractual contingencies and were able to generate revenue, what would the gross margins have been?

Well, I think what you have to look at on that, Phil, is you would have had roughly, I think Andy commented on it, about $3.5 million of additional revenue in the quarter, which would've put us closer to $8 million. Those products would've had probably around 60% standard rep[ph] material cost. But the $3.3 million charge that we took, would still impact of the quarter, some of those units were obviously impacted by the isolated quality issues that we had to address. So our margins still would've been challenged for the quarter.

Okay. I'm just trying to figure out what our normalized margin could be. Okay, so looking out to 2013, I know in the last call Andy talked about, if we are able to achieve, or if you guys are able to achieve $40 million in bookings in the back half of the year, revenues could be in the $70 million to $80 million range, which kind of gets us to kind of a breakeven. Talk to us about -- I know backlog is $28. -- I think, like, $28, $29 million or something?

It's almost $30 million, it's $29.9 million.

Okay, so $30 million. Tell us about where bookings stand and what you expect for the remainder of the year and where revenues could be -- well, you don't have to comment about revenues in 2013, but help us understand where bookings might end up for the back half of the year?

Phil, as I said in my presentation, Phil, that bookings are at $15 million. We expect to do $15 million more. So I expect bookings for the year to be approximately $30 million.

Okay. So and then in the remainder of the year, do you see additional bookings being realized?

Oh, yes. So Phil, I expect that we -- like last year, I expect about half our bookings will be here in the fourth quarter. So I expect that the bookings will be in the range of $30 million for the year, of that about $15 million in the back.

Okay. I see. Okay. And one last question here, about inventory. I think it kind of spiked up to $13 million from about $7 million. What happened and what do you expect going forward?

Well we do expect, Phil, to burn down some of that inventory as soon as we can recognize this one deal that we've talked about. That's $3.5 million of my inventory sitting in finished goods. As the installed base continues to grow as well, which we're over 3,000 units right now, we do have to carry parts for the aftermarkets. So that's probably about $1 million of our increase right there. And then we have staged raw materials for what we need to build and ship in quarter 4.

Our next question comes from Eric Wu with Fertilemind Capital.

A question on liquidity. Looks like you guys have about $9.4 million, $9.5 million of cash. And you're burning at about $7 million to $8 million a quarter. Can you talk a little bit about that?

Well I think that -- I think, Eric, that the burn rate will be lower this quarter. We did have some onetime cost this past quarter we didn't expect. And I think our Board is spending considerable amount of time looking at our liquidity position and thinking about what the right next steps are to make sure that our balance sheet becomes stronger.

Okay. And on the margins. So you say 60% are material cost. Can I use the $18 million to $20 million per quarter breakeven and use the 60% number to back out to figure out what the fixed cost of the gross margin component is?

Right. So if you look at it -- and I'll even make it easier for you -- that I talked about on the call. So that if you think about $18 million in revenue, 60% material cost, probably another 8% for warranty and shipping and then taking into consideration about $1.5 million in fixed cost and labor during the quarter, that model will give you a very good picture of how we reach profitability. I would expect next year at this time that, that 60% number will be lower.

Okay. And it still seems pretty high. Is there any opportunity to lower the fixed cost of the gross margin side? Or is there -- or you think that at this point is pretty optimal and is just a revenue question?

I think it's -- I think you could have reduced, slightly-er. But I think that primarily the issue is a revenue issue. We need revenue to drive this business forward.

[Operator Instructions] Our next question comes from Mike Cikos with Sidoti & Company. Michael Cikos - Sidoti & Company, LLC: So I had a question for you regarding the O-ring with a third-party supplier that we had spoken about on the second quarter earnings call. Have all those sites and, I guess, that installed base, has that all been fixed at this point? Or is there going to be some of that lapsing into the fourth quarter now?

It will -- all the costs, it will be billed some in the fourth quarter, Mike. Most of the costs,though, has been recognized. Michael Cikos - Sidoti & Company, LLC: Okay. And with the inventory that you currently have, I know that you launched this new platform. Do you still have the old platform in that inventory? Or have you worked through it all?

Well we do have some componentry in inventory for the older platforms, Mike. You have to keep in mind that in our installed base, we have over 2,000 units that are based on the older platforms. So we still are responsible for maintenance and servicing of those units, providing parts. Michael Cikos - Sidoti & Company, LLC: Right. But at this point, I mean, any new orders, let's say, are going to be based on this new platform that you've launched?

That's correct. Michael Cikos - Sidoti & Company, LLC: Okay. And can you talk about -- there was a 245 units, that $3.5 million in inventory and revenue that you expect to recognize now in the first quarter of 2013, as well as the $4.4 million order that got pushed back. I guess you were planning on that in 2012, but now you're looking to recognize that in the first quarter of '13 as well?

That's correct, Mike. Michael Cikos - Sidoti & Company, LLC: And can you comment on why that was pushed out?

I think, Mike, that -- I think that the speed of receiving the order was, quite frankly, as I've mentioned before, impacted by some of the quality issues that the customer wanted to see those issues resolved. And that after we resolved those issues, they were comfortable in providing us the next order. Michael Cikos - Sidoti & Company, LLC: Okay. And then my, I guess, my last question for you related to that $2.5 million. I believe you said it was a grant that you got from the DOE with your partner FedEx, was it?

That's correct, Mike. Michael Cikos - Sidoti & Company, LLC: I guess, can you comment on what it is the -- you and FedEx are looking to accomplish with that grant and the timeframe for which you would be recognizing?

So over the next few years, Plug Power and FedEx will be deploying parts -- will be deploying tow tractors at airport applications at 2 sites that will be demonstrating the technology and application in FedEx deployments at airports. So these are essentially tow tractors, Mike. If you think about -- you're at the airport and there's tow tractors which are pulling luggage or pulling mail in this case, these are fuel cells that are replacing internal combustion engines for these applications. And it's important at airports because there's a great deal of governmental policy issues which are driving reduction of pollution at airports. And companies like FedEx are giving consideration to moving away from LPG and diesel to pull the -- to pull luggage to move the fuel cells. So this is -- it's an exciting project and long-term, could be a large potential opportunity for Plug Power. Michael Cikos - Sidoti & Company, LLC: And then, apologies, last question here. And it's regarding the operating expenses. On a sequential basis, you guys went from $5.7 million down to $4.9 million. And I was wondering, what we're looking at right now. I know you're continually just reevaluating the business model, but is this a good run rate that we're looking at? Or would we expect some pickup in R&D or any other costs?

It will bump up a little bit and I think, as we commented in the script, we expect our cash basis OpEx of about $4.5 million or so a quarter. We did reverse some onetime accruals in the quarter 3, pertaining to bonuses and things like that, that helped moderate and bring that run rate down a little bit.

At this time, I would like to turn the call back over to Mr. Marsh for closing comments.

Appreciate everyone's time today. And as I say, the company remains optimistic about our future. We've had a difficult, challenging year. We've made significant progress with our material costs, the quality of the new product platforms are superior now when compared to the older platforms. And we expect success in the future. So thank you for your time today.

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.