Plug Power Poised For Potential Failure In 2016

| About: Plug Power, (PLUG)


Revenue target of $150 mln will require substantial additional business with customers other than Wal-Mart in 2016 as Wal-Mart related product revenues will be up by only roughly 10%.

Company is partially shifting its sales approach to expansion projects with existing large customers.

Ongoing stack failure issues might require the company to take a charge in its year end 2015 results.

Ongoing leasing issues will remain unresolved at least through Q1 with the majority of the company's remaining cash balance going to become restricted in order to serve as collateral.

On January, 28, Plug Power (NASDAQ:PLUG) hosted its 2016 business update conference call. In addition to laying out the company's goals for FY16 management also shared some key Q4/FY15 and FY15 performance metrics and provided some more detailed insights into the company's planned revenue and margin allocation for FY16.

As expected the company delivered on the guidance set out on their Q3/FY15 conference call with revenues, bookings and GenDrive gross margins seemingly all slightly exceeding management's previous forecast. Investors should keep in mind that the company had to substantially reset gross margin expectations for both the product and service business after a much weaker than expected Q3 performance.

In additions management revealed the following FY16 performance goals:

  • revenues of more than $150 mln
  • contract bookings of more than $275 mln
  • overall gross margins above 10%
  • operating cash burn of less than $20 mln
  • new GenKey installations at more than 25 infrastructure sites
  • reaching EBITDAS and cash break even levels in Q4/FY16
  • GenDrive gross margins of 35%
  • reversing current slightly negative gross margins on the company's infrastructure and GenFuel offerings
  • improving service gross margins to roughly -10%

In addition the company noted that the FY16 gross margin forecast excludes $10 mln of deferred profits related to sale and leaseback transactions in connection with power purchase agreements (PPA) that will be recognized ratably over 6 years. Adding back the number would bring the company's gross margin forecast to roughly 16.7%.

From the company's slide presentation (slide 8) we can also approximate the expected quarterly revenue allocation for FY16:

  • Q1: $26 mln
  • Q2: $33 mln
  • Q3: $43 mln
  • Q4: $48 mln

While the Q1 revenue forecast is substantially below current analysts' estimates the full year guidance essentially matches the views of the analyst community. But the company's bookings guidance actually does not match management's projected 50% revenue growth thereby already pointing to deceleration in the company's growth rate going forward.

The company also provided some color on the past and expected future evolution of its contract backlog (slide 9). FY15 year end contract backlog is expected to be above $235 mln with that number projected to increase to more than $360 mln at the end of FY16. From the current contract backlog roughly 42% is projected to be realized in FY2016.

On the bottom of the slide management is stating that just above 50% of the FY15 revenues were already in contract backlog at the end of FY14 while the projected number for FY16 has increased to more than 70% at the end of FY15.

Unfortunately the number is somewhat misleading as management indicated on the call that another 11 Wal-Mart (NYSE:WMT) distribution centers will be converted next year (compared to 10 in 2015) so the vast majority of PLUG's already contracted revenues for FY16 is again associated with this somewhat problematic key customer.

In contrast the company had not an exact forecast from Wal-Mart at the start of FY15 causing the Wal-Mart related backlog to be lower at that time.

In FY15 growth at Wal-Mart more than compensated for the decline in the remaining business but in FY16 PLUG won't have the benefit of a large increase in Wal-Mart related product revenues which will be up by only roughly 10%. So the company will have to ignite a BIG turnaround in its business with other customers than Wal-Mart in order to live up to its guidance.

I continue to view this as highly unlikely given PLUG's limited success so far to materially expand existing customer relationships or to acquire new customers for multi-site deployments. In fact management on the call only named two existing "anchor customers" - Wal-Mart and Kroger (NYSE:KR).

By the way PLUG offers a selection of many of its current GenDrive customers on its website.

In addition investors should take a look at the company's 2016 sales plan by product line (slide 10). The slide allows for an approximation of the company's planned numbers and their respective backlog coverage as of the date of the presentation:

  • GenDrive $67 mln (coverage 46%)
  • GenKey Infrastructure $29 mln (coverage 48%)
  • GenCare $21 mln (coverage 86%)
  • Power Purchase Agreements $14 mln (coverage 100%)
  • GenFuel $11 mln (coverage 91%)
  • Stationary Backup Power $8 mln (coverage 100%)

So management's celebrated more than 70% backlog coverage number for FY16 is largely a function of the company's growing service business. In fact the all important higher margin GenDrive product line has the lowest backlog coverage at just 46% which is seemingly almost solely related to upcoming Wal-Mart deployments. Once again this issue does not bode well for the company's 2016 revenue and bookings guidance given that almost 65% of 2015 sales are projected to come from the two product lines with the lowest backlog coverage.

On the call management further elaborated on its 2016 sales approach as the company is looking to establish additional anchor accounts and is shifting its focus to better penetration of existing large customers in order to generate large multi-site deployment orders with increased revenue visibility into the future.

The new approach somewhat de-emphasizes the acquisition of new and smaller customers which often hold little promise in terms of scalability.

While somewhat understandable this sales strategy shift is not a guaranteed recipe for success as PLUG has so far largely failed to materially expand long-standing customer relationships with the exception of Wal-Mart and to a much lesser extent Kroger. The vast majority of the company's deployments have been limited to one-site projects so far with only four customers having deployed more than two sites (Wal-Mart, Kroger, Sysco, Procter & Gamble). In many cases larger customers only order PLUG's products when it comes to greenfield projects or they only commit to converting a single site. On the conference call CEO Marsh indirectly admitted to this issue by referring to some of the company's latest deployments with e.g. Home Depot as "showcases". The new business relationship recently established with Nike might finally bring another multi-site deployment in the future but this remains to be seen.

At this point it seems difficult to envision that even a more focused sales effort would change their customers' approach towards deploying the company's products. So far only Wal-Mart and to a lesser extent Kroger have committed to a major conversion of existing facilities with all other larger customers deploying mainly greenfield projects or converting only a single site. There's no reason to expect this pattern to change anytime soon so PLUG would be well served to continue to acquire new, preferably large customers at an increased pace.

PLUG's GenDrive products have been subject to material reliability issues and even after recent improvements are still lagging far behind conventional lead-acid-based technology when it comes to unit uptime which remains at 98% compared to virtually 100% for lead-acid-battery powered units used in three-shift operations. The lower uptime number currently results in each unit being an entire week out of service due to maintenance and repair requirements on average each year thereby entirely eliminating the fuel cell technology's theoretically time savings advantage. So PLUG still needs to substantially improve the reliability of their GenDrive products in order to really deliver on the economic advantages the company has promised to their customers for many years now. Management on the call stated their intent to increase the uptime to 99.5% over time.

So with the technology's potential economic advantages still being largely negated by ongoing product issues PLUG will have to continue to rely on customers which are looking to deploy fuel cell technology mainly for image reasons rather than for direct economic benefits. Virtually all of PLUG's larger customers have publicly committed to becoming "greener" companies with the deployment of fuel cell-based material handling technology being just one small module in a series of comprehensive environmental initiatives.

In addition many of PLUG's GenDrive products sold in the past do not live up to the useful life initially promised by the company to its customers due to premature failures of stacks sourced from Ballard Power (NASDAQ:BLDP). The problem actually escalated over time forcing management to take a major step backwards with regard to its future service margin expectations during its Q3 conference call.

On the call management even revealed the probability of the company taking an earnings charge with regard to this issue. While certainly an unpleasant surprise investors should not overreact to this new disclosure. Technically PLUG would most likely increase its warranty liability on the balance sheet by a substantial amount and realize an associated loss on the income statement. The effect of this one-time charge would in fact be highly beneficial to future service margins.

For example:

Eliminating $1 mln in quarterly service costs related to premature stack failures would have brought the Q3 service gross margin up from -20.5% to roughly -13%. Given the positive effect on future margins I would actually urge management to take this potential charge.

PLUG has recently started to roll out GenDrive products equipped with internally sourced Reli-On stacks using an improved membrane design that have lower input costs and hopefully a higher reliability and useful life. In addition also stacks sourced from Ballard Power have seemingly been redesigned and are expected to finally live up to expectations now. The true performance of the new internally sourced and redesigned Ballard Power stacks remains yet to be seen over time.

In addition to the company's issues with generating sustained business with other customers than Wal-Mart and product performance far below the company's initially stated specifications Plug Power still did not come up with a solution for the company's most urgent problem: Ever increasing collateral requirements on sale and lease back transactions caused by the company's business relationship with Wal-Mart.

I have covered the issue extensively in the past, so I won't go into detail here again but on the conference call CFO Middleton disclosed that the company's unrestricted cash balance was down another $20 mln to $65 mln with the restricted cash balance moving up to $48 mln from $29.2 mln in the previous quarter. At this pace the company would run out of unrestricted funds during the second half of FY16 at the latest date.

Management indicated on the call that they are continuing to work on developing "more robust capital solutions" and pointed to the company's upcoming Q4 conference call in March to share some more information on this topic. Unfortunately some of the CFO's comments on the call gave reason to the assumption that there most likely won't be a retroactive solution enabling the company to re-access its restricted cash. I already pointed to this potential outcome in the past while fellow contributor Matt Margolis was pretty confident that the company would be able to free up the restricted cash balance entirely.

Q1/FY16 will see more cash getting restricted, perhaps in the $10-15 mln ballpark. Given the weak first quarter revenue guidance Plug Power will again burn through a sizeable amount of cash most likely in the $10 mln range. Unrestricted cash at the end of Q1 will finish substantially below $50 mln with the majority of the company's cash balance then being restricted.

Management WILL have to come up with a comprehensive solution for the issue no later than at the end of Q2/FY16 as otherwise a substantial capital raise would be the only remaining option then.

On a different note I was somewhat disappointed to learn about current negative gross margins in the GenKey infrastructure and even the GenFuel business and to see the stationary power business' gross margins being at only around 2%. At least management promised to cross the break-even line on the GenKey and GenFuel product lines during FY16. Given the company's history when it comes to forecasting break-even goals investors should take these projections with a huge grain of salt particularly when looking at management's target for reaching EBITDAS and cash flow breakeven in Q4/FY16. This mantra-like projection seems to have made its way into almost every forecast management has offered over the last couple of years and actually never held true so far.

Lastly, competition is finally going to enter the market in 2016. The largest US-based material handling equipment manufacturer Hyster-Yale (NYSE:HY) will start to deploy its PowerTap and PowerEdge solutions into the US market. The PowerTap product actually is an on-site hydrogen generation unit, an offering PLUG is lacking so far. Management on the call actually welcomed the arrival of a new competitor as they expect them to further raise awareness of the fuel cell technology among potential customers. When asked about potentially competing technologies like lithium-based batteries CEO Marsh did not view them as a current threat to Plug Power's business because of ongoing issues like battery charging and exchange requirements as well as counterbalance problems in larger units. Nevertheless he acknowledged that the technology might very well evolve over the next few years.

So overall management is again facing several difficult challenges in FY16. In order to deliver upon its ambitious targets Plug Power needs to:

  • engineer a huge turnaround in its business with other customers than Wal-Mart
  • finally present a comprehensive solution for the company's ongoing leasing issues and avoid a potential capital raise
  • further improve product reliability and useful life
  • increase GenDrive product gross margins by another 40% from Q4/FY15 levels
  • achieve another large reduction in losses related to the company's GenCare service business

As stated above I am particularly skeptical about the company's ability to secure the required large orders from other customers than Wal-Mart and remain concerned that Plug Power will still have to raise a substantial amount of new capital in order to adequately address its ongoing leasing issues.

But should management this time deliver upon each and every one of its outlined ambitious targets some of the company's most patient investors might be finally rewarded very nicely as a year of flawless execution would clearly shift investor sentiment back in favor of the company.

Bottom line:

Plug Power's management has again set highly ambitious targets for its new fiscal year and will again face severe challenges to deliver upon all of them. The company seems particularly at risk to miss its GenDrive product and GenKey infrastructure revenue forecast due to the lapse of another large increase in Wal-Mart related revenues. With the leasing issues still being unresolved and unrestricted cash melting fast investors might still face the possibility of a substantial capital raise going forward.

Only flawless execution against all of the goals laid out by management would finally bring a change in investor sentiment going forward.

Investors should wait for the company's Q4/FY15 in March to learn more about management's ideas to address the company's ongoing leasing issues.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I trade PLUG.