Earnings Call
Plug Power Inc (PLUG)
Earnings Call Transcript - PLUG Q3 2022
Teal Hoyos, Director Marketing Communications
Thank you. Welcome to the 2022 third quarter update call. This call will include forward-looking statements. These forward-looking statements contain projections of our future results of operations, or of our financial position or other forward-looking information. We intend these forward-looking statements to be covered by the Safe Harbor provision for forward-looking statements contained in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We believe it is important to communicate our future expectations to investors. However, investors are cautioned statements, and such statements should not be read or understood as a guarantee of future performance or results. Such statements are subject to risks and uncertainties that could cause actual results or performance to differ materially from those discussed as a result of various factors including, but not limited to risks and uncertainties discussed under Item 1A Risk Factors in our annual report on Form 10-K for the fiscal year ending December 31, 2021, as well as other reports we file from time to time with the SEC. These forward-looking statements speak only as of today in which the statements are made, and we do not undertake or intend to update any forward-looking statements after this call or as a result of new information. At this point, I would like to turn the call over to Plug's CEO, Andy Marsh.
Andrew Marsh, CEO
Well, thank you, Teal. So we have published an investor letter today that provides details about the quarter, status of our projects and a summary of our midterm ambitions. I noticed that the company is tough to financially understand in the near term. It really comes down to two areas, the cost of hydrogen and selling more equipment. The equation for success really comes down to building out our green hydrogen platform, which will transform a negative margin hydrogen business to a growing positive margin business just by turning on the plants. We've already demonstrated this in Tennessee. We can generate hydrogen at one-third of the cost we're paying from the industrial gas companies today. We won't be discussing this issue within a year. They'll be in the rear-view mirror and the issue will be how to accelerate the plans. Equipment sales, even for our new electrolyzer business gross margins are already over 15%. And we're just starting to scale. We've made fuel cells profitable and material handling and now doing this again in electrolyzers and stationaries. You put these two items together with the real improvements in service, the 2023 targets of $1.4 billion in revenue, and exiting the year at breakeven operating margins is achievable. The long-term business prospects are even more attractive and all starts with Plug doing real things. I know many of you were at the symposium and you saw a real gigafactory, real electrolyzer systems, real vehicles, real liquid hydrogen trailers, real fueling stations. You were able to touch and feel the hydrogen ecosystem, not in some distant future, but today. Now for the future. Plug is a leader and will continue to be a leader in the energy transition. We have first-mover advantage in the fuel cell and hydrogen industry that we do not intend to lose. We will have the first green hydrogen network across the United States by 2025. And when we look out to 2030, we'll have the most commercial vehicles on the road through our Renault joint venture, Hyvia. We'll have the largest deployments of PEM electrolyzers. We'll be selling fuel cell peaker plants at scale using our hydrogen and many, many more activities we’ll be engaged with. Finally, there are short-term challenges, but we have a clear, well-defined plan that is being demonstrated. And long term, we are building out our hydrogen ecosystem by ourselves and partners that, quite honestly, is unmatched in the industry. Paul and I are now ready to take your questions.
Operator, Operator
The first question is coming from Colin Rusch of Oppenheimer.
Kristen Owen, Analyst
This is Kristen on for Colin. So the first question, just with the substantial pipeline of opportunities, can you discuss how you are down selecting opportunities to pursue and to commit to, particularly for electrolyzer sales and potential hydrogen offtake agreements?
Andrew Marsh, CEO
Sure. I'm going to take the electrolyzer sales, and Sanjay is sitting here with me, and he works the hydrogen offtake agreements every day. So with electrolyzers, there are a few questions we ask right upfront. There are these huge opportunities. And does the customer really have access to renewable electricity or electricity at the scale that's required to generate hydrogen? It may seem like a simple question, but it actually is an important one. The second one is, do they have real projects? And do they have fundamentally land to be able to build an electrolyzer plant with? So we really make sure we understand what is the application, what are they doing with the hydrogen. And the third one is in an industry like this, you have to always be asking the question, how is the customer going to pay you? And how are they funded? That's kind of the first three items we look at when we think about doing a deal and working with the customer. On that note, Sanjay, how do you think about hydrogen itself, selling?
Sanjay Shrestha, CFO
Sure. We mentioned in our shareholder letter that the plan for our new facility in Europe has received six times the demand, and we are about to start construction. The interest in hydrogen offtake is quite significant. We have previously communicated that we aim to cap our commitments at 80% of our capacity, reserving 20% to accommodate peak demand and scheduled outages, ensuring we can support both our customers and the broader hydrogen economy. Moreover, we have numerous activities underway, including substantial offtake agreements spanning five to seven years, particularly focused on the mobility market. We look forward to providing updates on these developments soon. Additionally, we are collaborating with industrial gas companies for potential swap agreements or partnerships, especially with those less involved in hydrogen. Another priority for us, as Andy mentioned, is our stationary business, which is a major demand driver for our green hydrogen. We want to ensure the capacity we are building is available to serve these applications and our customers. Currently, out of the 500 tons of hydrogen, about 200 tons will support internal operations, while another 200 tons is expected to cater to third-party customers, mainly in mobility and industrial gas sectors.
Andrew Marsh, CEO
Kristen, did that answer your question?
Kristen Owen, Analyst
That's incredibly helpful and I appreciate that detail. So then if we think about just the incremental scale-up needed for the supply chain for fuel cells, are you seeing suppliers scaling to support the additional platforms beyond Plug? Or are they really focusing on just you? Just any color on the supply chain scale up.
Andrew Marsh, CEO
That's another good question. I believe many people on the call visited our gigafactory and can see how Plug is approaching the scaling of our manufacturing operations. If you look at our Vista plant, which is 400,000 square feet and was constructed in under a year to support our business activities, we feel quite confident in our internal capabilities. As you know, we have hired individuals who previously helped scale the Tesla business to oversee our operations, and they have team members who worked in Tesla’s supply chain reporting to them. We are very focused on several critical items necessary for the performance of our products. These include elements you might not typically consider, such as humidifiers and hydrogen tanks. We are committed to supporting our existing suppliers while also diversifying our supplier base. Like many in the industry, we are concentrating on securing the necessary semiconductors to meet our demands. There's a lot of excitement in this sector, and many companies are trying to figure out how to enter the market. Currently, we have volume, which makes us an attractive player.
Operator, Operator
The next question is coming from Bill Peterson of JPMorgan.
Bill Peterson, Analyst
Wanted to talk about the, I guess, the electrolyzer business merchant. It doesn't seem the backlog has grown. And I'm wondering if this is a function of maybe more your side or if customers are delaying FIDs, perhaps trying to get a better understanding of policy support benefits of the IRA, maybe renegotiating PPAs. Just I recognize it's probably transient, but I'm just kind of curious on what's happening with the backlog. And I guess maybe looking ahead to, where do you see more of the interest coming from as you discussed with your sales folks, ammonia, refining, smaller projects, large scale? Just kind of get a feel for how we should think about it into next year?
Andrew Marsh, CEO
So Bill, I think that the funnel has changed. We're modest in the investor letter. When you look at it, the key areas where we're seeing activity are in industrial applications, particularly with opportunities in fertilizer and e-methanol, which are seeing a lot of interest. As for scale, I'm separating it into what projects will be the significant ones to ship next year. You may have seen at the symposium the 5-megawatt platform. In many ways, it's almost a starter kit, but there's also considerable interest in areas like bottle manufacturing. Next year, we expect to ship about 400 megawatts of that platform. Additionally, there will be significant work on developing larger scale plants. The major numbers for backlogs will likely emerge more in the 2024-2025 timeframe, though there will be some upfront charges. Much of the activity right now is in the industrial markets, as highlighted in our investor letter, including ammonia, methanol, steel, and even natural gas pipeline work. There's a lot happening there at the moment. Is that helpful, Bill?
Bill Peterson, Analyst
Yes. Yes, I was just trying to see if this very near-term delays, but it feels like in any case, you're pretty feel good about '23.
Andrew Marsh, CEO
Yes.
Bill Peterson, Analyst
I have a question regarding stationary power. I appreciate the insights you shared about the expectations for '23 and '24. Could you provide an overview of how we should approach pricing per megawatt and what the margin structure might look like? I assume that at low scale, the margins won't align directly with the corporate average. How do you see this developing over the next few years?
Andrew Marsh, CEO
Yes. I’ll share some thoughts, and then I’ll let Paul, who is currently in London, chime in. I believe that our projects next year will primarily focus on two areas. The first is in regions where there is no grid available for charging electric vehicles, which I anticipate will account for about half of our shipments next year. The second area involves our traditional customers at their distribution centers, where we will be deploying stationary products. Jose, our VP of Sales in this sector, is estimating a demand of 20 to 30 megawatts. We have the capacity to support that and are driving our supply chain to ensure we can meet a demand of up to 60 megawatts. Overall, we believe this business, considering factors beyond just stationary products like the establishment of hydrogen infrastructure, will generate between $125 million to $150 million in revenue next year. Paul, would you like to add anything?
Paul Middleton, CFO
I would like to address the margin aspect. A significant advantage for Plug is the commonality of components across these products, which allows us to utilize our established supply chain and manufacturing base effectively. This foundation provides an excellent starting point. Additionally, the rapid growth of sales opportunities in our pipeline suggests that we will be able to scale more quickly than we have in other businesses right from the beginning. These elements will help to lessen some of the initial challenges associated with launching new products. We are indeed targeting over 30% margins for this product line, similar to our other equipment lines, and we believe it will efficiently scale in that direction. We anticipate it will contribute positively next year and continue to grow rapidly after that.
Andrew Marsh, CEO
Bill, I would have one other item. I think about our ProGen module, a lot like a solar panel. So that ProGen module, which we're selling to Hyvia, is essentially the same ProGen module from an architecture point of view, especially that we're going to be using in stationary. So there's a lot of economies that come from the fact that those product lines are complementary. And just like the solar industry, how solar panels dramatically reduced in cost because you were building the same thing over and over again. In reality, what we're doing in mobility and what we're doing in stationary for the fundamental platform is exactly the same, which should really help our cost position next year, but especially long term.
Operator, Operator
The next question is coming from P.J. Juvekar of Citi.
Eric Petrie, Analyst
This is Eric Petrie on for P.J. Could you just give us a little bit of essence as to Amazon's $2.1 billion portfolio deal going from forklifts and kind of what's next for them looking at either fuel cell trucks, fuel cell power generation, electrolyzers? What's the next thing that they're looking at?
Andrew Marsh, CEO
Yes, yes, yes. Why don't we start with green hydrogen, Sanjay?
Sanjay Shrestha, CFO
So as you saw in the shareholder letter, we did do a 30 tons per day green hydrogen offtake agreement with Amazon. So again, that's just the beginning of many portfolio sales opportunities we can have. That's the value of what we talked about, our vertically integrated model and all the efforts that we've put into positioning the company to where we are. So with that, why don't I turn it to you, Andy?
Andrew Marsh, CEO
Yes. At the symposium, Amazon emphasized the importance of hydrogen for a variety of applications, ranging from stationary products to on-road vehicles and electrolyzers. We are actively involved in all these areas with Amazon. While I can't share too much due to nondisclosure agreements, if you listen to what Dean, who oversees over 30,000 people in Amazon's logistics group, says, it’s clear that they are committed to green hydrogen and to partnering with Plug. We’ve had a long-standing partnership and they are eager to expand this business with us. The potential scale of our collaboration can be appreciated by considering the $2.1 billion figure.
Eric Petrie, Analyst
And then just turning to like commercial vehicles, Hyvia. When should we expect kind of going from pilot to commercial orders? And we've seen some delays on the truck side as well. So just any thoughts there.
Andrew Marsh, CEO
I want to start by mentioning that Renault held their Investor Day today, where they presented Hyvia as a vision for their future. We have established a facility with them that is set to support the deployment of 800 vans next year. We have already identified nine customers who are ready to start using these vehicles, along with others who are interested. I can share that we anticipate this facility to be fully booked next year, and we plan to grow from there.
Operator, Operator
The next question is coming from Joe Spak of RBC Capital Markets.
Joseph Spak, Analyst
I understand you mentioned some modeling challenges and short-term issues, but you believe these won't persist in the future. I appreciate that perspective. In your letter, you referred to a significant change in fuel margins, and during the Symposium, you projected a decrease of around 35% for the year, which would represent a substantial shift from current levels. However, I must express some concerns, as we've been discussing step changes for over a year, yet margins continue to be under pressure. I'd like to gauge your confidence in this matter. Additionally, earlier today, you touched on some charges related to industrial applications, and I'm unclear if that applies to you or your customers and if that was taken into account. Thus, I would like to give you the chance to provide more detail or perhaps some sensitivity analysis regarding your expectations for gross margins at the fuel level and for the overall company in the upcoming year.
Andrew Marsh, CEO
So Joe, I think you've misunderstood us on two levels here. I'll let Sanjay address the hydrogen margins because he's a little perplexed. Let him explain, and then after he is done, I'll ask you more about the industrial components.
Sanjay Shrestha, CFO
Yes. I appreciate the question. As Andy mentioned in his prepared remarks, there are two main factors driving this margin: hydrogen and equipment. Let’s focus on hydrogen first. Aside from our plant in Tennessee, we have been purchasing hydrogen from third parties, and the price of hydrogen has been influenced by the price of natural gas. Natural gas prices surged by nearly 61% in Q2 of this year, and there was a delay in how this affected our hydrogen fuel costs in Q3. Consequently, you are seeing a decline in margin from Q2 to Q3 due to these rising natural gas prices. However, moving forward, we are on track to commission our plant in Georgia by the end of the year, and we will also begin the commissioning of our plant in St. Gabe, Louisiana within the same timeframe. We're expanding in Tennessee and beginning work on multiple other plants. By the end of 2023, we expect to have about 200 tons of hydrogen production capacity online. Once these plants start operating, as Andy mentioned, the cost of the hydrogen we produce will be one-third of what we’re currently paying for third-party hydrogen. Moreover, all our legacy contracts taper off by 2025, and with the combination of our own production and third-party sales, we are confident that by the end of 2023, we will achieve breakeven operating performance in our fuel business. This will significantly improve our margin profile. Andy, I will hand it over to you to discuss how this intersects with the equipment margin and expansion.
Andrew Marsh, CEO
Yes. As I mentioned earlier, Joe, it's quite simple but challenging to achieve. Looking at Tennessee, which accounts for about one-fifth of our capacity, we are currently producing hydrogen at one-third of what we have to pay for it. Next year, we expect to generate around 60 tons of our own hydrogen solely for our customers. This will create a healthy and profitable business for us. Additionally, with the production tax credit, we plan to retain some benefits while passing some on to our customers. This combination will significantly boost equipment sales. When I consider the hydrogen aspect of our business, the benefits are clear to those engaged daily, but I understand your perspective, Joe. Regarding your other question, Joe, I don't think I communicated anything unclear; perhaps I misspoke or was misunderstood.
Joseph Spak, Analyst
Yes. I understand your concern about the decreasing cost of hydrogen. My main question revolves around the necessary ramp-up of production facilities needed to produce our own hydrogen. I need to grasp this better because if this ramp-up doesn't happen, our profit margins could continue to be impacted. I'm looking for a clearer understanding of the range of possible outcomes, rather than just a specific estimate. Additionally, I thought I heard you mention some initial costs related to hydrogen for industrial applications, and I'm unclear if those would affect your customers or your company.
Andrew Marsh, CEO
Joe, I'm not sure what I said, but if I indicated that there are upfront charges, that wasn't my intention. There are no upfront charges. Regarding Georgia, if you check our investor letter, you'll see our progress there. We expect to have the commission by the end of the year. The equipment is in place, and we are already producing hydrogen at low volumes with our first deployed electrolyzers. We will scale up production within three months. The plant we are developing with Olin is identical to our Tennessee facility, and we anticipate scaling up additional capacity there in the same timeframe. Therefore, I don't perceive the level of risk that you may be sensing. The challenges we face are less severe than you might assume.
Joseph Spak, Analyst
If I could ask one more question, it appears there has been another inventory increase. How much of this is related to the project delays you mentioned, and how much is possibly a buffer to meet demand due to supply chain issues? Also, what should we consider the appropriate level of inventory for the current state of the business?
Andrew Marsh, CEO
I'm going to let Paul take that one, Jeff. Paul?
Paul Middleton, CFO
Yes. One thing to keep in mind is that when considering the timing of the volume and the sales in relation to our guidance, the volume in Q4 could reach the higher end of double Q3, or perhaps even exceed that. We're consistently working to deliver on all of our programs, which is building up considerable momentum. Additionally, when analyzing the various initiatives we're undertaking, there's a wide range of new platforms including on-road ELX, electrolyzers, and new stationary programs in Europe. Each of the companies we've acquired has a different mix, supply chain, and scaling opportunities that we're rapidly addressing. We are fortunate to have a growing backlog and opportunities to scale accordingly. Our primary focus is on delivering and expanding that, and then we will optimize. We've recently initiated operations at our Rochester factory, and just last weekend, we commenced production at the new Vista facility, achieving a record time for scaling up there. In short, I strongly believe in minimizing inventory, and just-in-time production is the best approach. However, you will see inventory levels decrease and optimize in the near term as we work through scaling each of those specific businesses, and increased volume will significantly aid this effort. The third quarter should make a notable impact, and the fourth quarter will also contribute to this progress.
Operator, Operator
The next question is coming from Alex Kania of Wolfe Research.
Alex Kania, Analyst
I have a clarifying question about the shareholder letter, specifically regarding the average fuel molecule cost chart. Does it reflect your expected level of hydrogen sales or production for the upcoming year? Additionally, does it factor in something similar to the natural gas forward curve? We're anticipating peak margin tightness next quarter, but will that decrease based on gas prices alongside the swap to green?
Andrew Marsh, CEO
I'm going to let Sanjay answer that, Alex.
Sanjay Shrestha, CFO
Yes. Alex, short answer is yes. We have looked at the future of the natural gas prices to blend what we buy from the third party on that, right? So obviously, that's why you see the peak here. Hopefully, this is a peak here in Q3 from the third-party purchase perspective. And it takes into consideration what we expect our production cost to be from all of these different green hydrogen plants. And again, we do have the incremental benefit of the production tax credit as well. So that's why with the PTC, with our production despite these third-party existing contracts in place is what gives us the confidence why we believe that exiting next year, we'll be able to get to that operating breakeven performance in our business.
Alex Kania, Analyst
Okay. Great. You mentioned this briefly in your prepared remarks, but could you provide more details on the discussions with other industrial gas companies? Will this extend beyond Olin? Additionally, regarding Olin, can you elaborate on the exploration of other sites mentioned in the investor letter? Specifically, considering Olin's inherent hydrogen production from its chemical processes, how significant do you think this partnership could become and how quickly can we expect progress?
Sanjay Shrestha, CFO
So Alex, we're just getting the partnership started, right? But obviously, we've been working with Olin for a long time, right? Tennessee is the plan that is also a feed gas coming from. So it's been successful in Tennessee. We expect that success to continue also in Louisiana. And as you rightfully pointed out, they certainly do have a lot of feed gas available in the market. There's a lot of discussion going on. Give us some time, we'll be happy to share with you a lot more incremental updates. And we're in a discussion and dialogue with a partner right now, but I do want to have some time here before we can get into more specifics on that. But I think your thinking logic is the right one here because they certainly do have a lot of feed gas available, and we're in discussion with them in terms of how can we rapidly expand this partnership into something much bigger than just the Tennessee and Louisiana as well. That's on the Olin side, right? And when we were referring to some of the industrial gas opportunity. Look, I mean, over time, this hydrogen should enter into some sort of a swap agreement. If you're looking for green hydrogen, if you don't have it and if Plug has it, we're happy to provide that green hydrogen industrial gas company as well because it's a big market. We all have to work together, number one. Number two, there are some of the smaller industrial gas companies that actually don't have a lot of hydrogen capacity probably would like to have that as a part of your portfolio offering as well. And that's where we have some of those discussions going on at a pretty advanced stage as a matter of fact, and that's really what we're referring to.
Operator, Operator
The next question is coming from Eric Stine of Craig Hallum.
Eric Stine, Analyst
I have been jumping between calls, so I apologize if this has already been asked. I'm curious about the updated guidance you provided a few weeks before the Symposium. You mentioned a split between the third and fourth quarters that you expected to be significant. How did that split actually turn out? Was it in line with your expectations? Additionally, Paul referred to the possibility of the fourth quarter being twice that of the third quarter. What factors are influencing this? Are there large projects involved, and what could lead to either upside or potential delays into 2023?
Andrew Marsh, CEO
Paul, why don't you take that one?
Paul Middleton, CFO
Yes, we've been transparent about increasing the output of our electrolyzer plant in Rochester, and the volume is rising significantly each month. Much of this increase is happening in the fourth quarter due to the scaling activity. Additionally, many of the new products we're developing and launching come from substantial contracts that are finalizing as we anticipated. We're in the process of closing these deals and moving towards delivery. The timing can also vary each year, with Q3 sometimes being larger and other times Q4 taking the lead. Our major customers often have fluctuating schedules, but we have successfully launched and completed several new programs for them, which we expected to close in Q4. This includes projects like the ranger programs, marking the first time we've executed them at scale, and initiatives with new customers such as Lidl. Overall, our progress is in line with the updated guidance we provided.
Operator, Operator
The next question is coming from George Gianarikas of Canaccord.
George Gianarikas, Analyst
So just first, when you talk about back leveraging plans to recycle capital, to build your hydrogen network. Are you assuming you'll be doing that all on your own? Or are you looking for more partners? Or do you need more partners to help finance that build?
Andrew Marsh, CEO
Go ahead, Sanjay.
Sanjay Shrestha, CFO
George. So look, I mean, I think two things, right, on that. So obviously, we always explore and see what is the right structure a partnership can look like, right, whether it's a partnership with the likes of infrastructure fund or partnership with the likes is just strategic funds, that's always an option. But given where we are, there are two things that will happen, right? One is as these plants come online, we'll be able to demonstrate what is the cash flow from this plan is first thing, right? So there'll be a track record of a, let's say, for 12 months, number one. Number two, now with the production tax credit, you do have a view on a 10-year forward cash generation just without PTC as well, depending on what the split of that is between us versus the customer. That part is really getting refined here at this point in time. But can we do the back leveraging on these plans on our own? Answer is yes, we can. Is that the pathway go down? Frankly, we're having a lot of discussion at this point in time. It depends on what is the optimal solution for us. But this is no different, though, right, than what really happened in the solar and in the wind space when it first kind of got started, call it, about 10 years ago, right? So first, you have the DOE loan guarantee program for three mega solar project, which then led to the back leveraging those projects. You basically had ITC in the solar space that began 30% of the capital stack ITC. We have production tax ready in the wind industry, which then became 50% to 60% of capital stack in the wind industry. So there should be no change or no difference in terms of how the capital stack will unfold in the green hydrogen industry as well. But once we actually start to really generate cash from these plans and with the PTC now as a part of this Inflation Reduction Act, we absolutely believe that we will be able to back leverage there'll probably be some sort of a tax equity at some point, fast forward several years out. And we will be really able to not have to do this green hydrogen plant with 100% equity, balance sheet financing, but we should be able to do that out of the gate, probably it's 40% equity. There is a scenario where you can envision that eventually goes down to 20%. And that's what we mean when we say we should be able to get 4x to 5x multiple of available capital to really execute on the green hydrogen generation network that we're looking to build.
George Gianarikas, Analyst
And if I could just ask one follow-up. I'd love to get your thoughts on recent traditional energy activity in renewable natural gas. And I'm curious as to how you see that potentially extending more into hydrogen over time and how you see that potentially playing out?
Andrew Marsh, CEO
You want to give your view, Sanjay?
Sanjay Shrestha, CFO
No, you can start as well. Yes, it's an interesting question.
Andrew Marsh, CEO
I think ultimately as renewable electricity comes to scale, the local carbon footprint of using green energy coupled with electrolyzers, is the long-term solution. I think RNG is an interesting niche market, which supports the transition but it's not going to be ultimately the winner. I would put in an analogous to blue hydrogen. I was talking to one of the large funds in the Middle East on the sovereign funds. And I asked them, why are you talking to me when you could be generating blue hydrogen all day long? And their answer to me, once green hydrogen is shown to be competitive with blue hydrogen, no one's going to use blue hydrogen. I think the same holds for RNG versus hydrogen.
Sanjay Shrestha, CFO
Absolutely, Andy, right. Again, just to add to what Andrew has said, George, I think it's really a question of scale. We believe that the green hydrogen is scale much, much bigger going forward, leveraging off of the renewable asset.
Andrew Marsh, CEO
Yes, I'm supportive of anything that aids in accelerating the transition. I believe RNG plays a significant role in that process.
Operator, Operator
The next question is coming from Sam Burwell of Jefferies.
Sam Burwell, Analyst
Wanted to dig in on kind of the gross margin trajectory a little bit. So I guess, first off, for 4Q and Paul already touched on it a lot like the equipment sales should be up a lot, maybe almost a double in 4Q. So that should probably drag the company-wide gross margin up. But I'm curious how high should it or can it go in 4Q, assuming like roughly 20% equipment gross margins? Are there any other material uplift you should expect, whether it's fuel or service or PPA?
Andrew Marsh, CEO
I will let Mr. Middleton take that one, Sam.
Paul Middleton, CFO
Yes, you are absolutely right. There has been a notable increase in equipment sales this quarter. The recurring revenue acts as a gradual buildup over time, but in instances like this, we see a substantial immediate change in sales volume primarily driven by equipment. This will have a significant positive impact. Additionally, the scaling of our electrolyzer has led to a major increase in output from that facility compared to previous quarters, providing substantial leverage on those investments. We have seen positive developments, including improvements in our service offerings, which will influence our service revenues and PPA. We have launched several programs this year, and the benefits from our partnerships are beginning to show. In some locations where we implemented upgrades, we've observed reductions in part costs by 70% to 80%. We project that service costs per unit will decrease by approximately 10% to 15% in the fourth quarter compared to Q1. Furthermore, we expect a more significant decline over the next year as these programs continue to deliver benefits and new units are introduced with a better mix. All these factors are advantageous, and we anticipate seeing benefits starting in Q4, intensifying into next year. While there are challenges such as fuel and natural gas prices, the favorable aspects will provide a boost to our margin trend.
Sam Burwell, Analyst
Okay. That's certainly helpful. And then maybe shifting to look at 2023. And recall from the update that you guys gave on the guidance back in October, you said that some projects were pushed out to next year. So is it right to think that there might be less of a quarter-on-quarter decline in revenues in 1Q versus 4Q than like typically, you see because of seasonality? I'm just trying to get a sense of what we should expect for the trajectory of sales on the equipment side through 2023? And then also, how should we think about the margin trajectory for that segment in 2023? Is there any fixed cost absorption that should really improve through the year? Or should it be fairly consistent around that 20% mark in all four quarters?
Andrew Marsh, CEO
Paul, that sounds like a question for you.
Paul Middleton, CFO
I would expect our sales next year to follow a one-third, two-thirds distribution between the first half and the second half. The situation with material handling remains unchanged, as there is still a strong demand for new facilities and renewals starting around June and leading into the busy season. This aspect has not altered. While some programs may be delayed, benefiting Q1, overall volumes are increasing, which contributes positively. Therefore, we can anticipate year-over-year growth from Q1 next year compared to Q1 of 2022. I believe a similar split from this year's performance can serve as a guide for how the quarters might frame up percentage-wise for next year. Moreover, Q4 is projected to be a significant quarter for us due to the timing of the programs and the material handling situation this year, which positions Q4 as a strong performer. This does not come as a surprise to us. As we advance into next year, we aim to exceed our targets, which will likely enhance our second half’s activities considering the opportunities we are pursuing. For these reasons, I anticipate that Q1 will likely be lower than Q4 but a considerable improvement over last year's Q1, with steady growth afterward.
Andrew Marsh, CEO
Yes. Sam, I'm trying to ship everything I can this year.
Sam Burwell, Analyst
Sorry, just quickly, what about the margin trajectory in equipment? Should that be fairly consistent? Or are there a lot of fixed costs that get absorbed just as you ramp up electrolyzers and improve through the year?
Paul Middleton, CFO
Yes, we are projecting a 10% increase overall for next year. This aligns with expected volume increases, which will enhance our margin profile in the second half, driven by fuel activities and equipment sales. I anticipate that Q1 will show improved margins compared to Q1 of this year, and I expect each subsequent quarter next year to also perform better as we ramp up equipment activities. So, that's likely how things will unfold.
Operator, Operator
The next question is coming from Greg Lewis of BTIG.
Gregory Lewis, Analyst
Just one question for me. Sanjay, I guess, congrats on bringing on FreezPak, met those guys at the Symposium, super nice guys and they're super pumped about the use and Plug solutions. One of the questions I had, and I know you've talked to in the past is about the ability to kind of go in the mid-end of the market. I guess I'm wondering, any update there on the penetration on the mid and small ends of the market? And really, as you look ahead to 2023, how are you thinking about that opportunity?
Andrew Marsh, CEO
So Greg, this is Andy. I spent a lot of time with Jose, who runs that business. I think an interesting aspect in the fourth quarter is that smaller customers likely represent 35% of the shipments this quarter, which is a significant change. Some of that will continue to improve. I've mentioned before the idea of sharing some of the production tax credit to enhance the value proposition and help us sell more equipment, and you'll see more of that happening. We're performing much better in smaller applications. Additionally, we are exploring developments for much smaller hydrogen infrastructure. We've developed solutions for Europe that we are planning to introduce in the United States, which is one of the reasons Jose has been successful in attracting more pedestal customers in Europe.
Gregory Lewis, Analyst
And then I guess I'll just follow up on that, Andy, thanks. Is there any way to think about the margins on smaller versus larger? I mean, I would imagine they have to be at least a little better. Is that kind of a fair way to think about that?
Andrew Marsh, CEO
So they're listening, Greg.
Gregory Lewis, Analyst
They need to buy more than.
Andrew Marsh, CEO
Yes. I would have Paul comment if he has any changes. Obviously, if you buy more, the price is lower than if you buy less for other elements like hydrogen fuel and service. I believe we resemble other companies you follow that have had that experience.
Operator, Operator
The next question is coming from Ameet Thakkar of BMO Capital.
Ameet Thakkar, Analyst
Let's try this again. Sorry about that. I'll make it quick because I know it's been a long evening. I noticed in the investor letter that you reaffirmed your revenue and margin targets for 2026 and 2030, as well as for 2022 revenues. Should we still expect the 10% gross margins for 2023?
Andrew Marsh, CEO
Yes, Paul, I'll let you answer. But I think we're discussing the chart you presented on margins and performance for '23 and 2030.
Paul Middleton, CFO
Yes, I agree. It's a 10% still our target next year. And yes.
Ameet Thakkar, Analyst
And just real quick. And then thinking about like a lot of the electrolyzer contracts your equipment you're selling in Europe. Is there going to be like a service revenue part of that as well that's going to kind of grow as you deploy more capacity out there?
Andrew Marsh, CEO
Yes, that's a great question. The answer is yes. We haven't discussed much about the potential for service related to electrolyzers, which may turn out to be significantly more appealing than material handling. A lot of our efforts in Europe will focus on electrolyzers and the associated service business. We believe this could be very attractive. All right. Well, thanks, everyone. I appreciate everyone who is on the call today. Looking forward in January to provide will happen probably at the end of January, we'll schedule. And thank you again. Bye now.
Operator, Operator
Ladies and gentlemen, this concludes today's event. You may disconnect your lines or log off the webcast at this time, and enjoy the rest of your day.