普拉格能源 (PLUG) 2003 Q3 法說會逐字稿

Good morning, my name is Mandy and I will be your conference facilitator. At this time I would like to welcome everyone to Plug Powers quarterly earnings conference call. All lines have been placed on mute to prevent any background noise

After the speakers remarks there will be a question-and-answer period. If you would like to ask a question during this time, simply press star and the number one on your telephone keypad. If you would like to withdraw your question, press star, then the number two on your telephone keypad. Thank you.

Ms. Mahoney-White you may begin your conference.

Good morning, and welcome to Plug Power’s third quarter 2003 financial review. Participants on the call include Roger Saillant, President and Chief Executive Officer, Dave Neumann, Chief Financial Officer, Greg Silvestri, Chief Operating Officer and Mark Sperry, Chief Marketing Officer.

Today Roger Saillant will begin with an update on our activities throughout the third quarter ended September 30th, 2003, followed by Dave Neumann providing a review of our financial results. We will conclude the call with a question-and-answer session.

During the course of the call, management may make projections or other forward-looking statements regarding the events or future financial performance of the company within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward looking statements are subject to numerous assumptions, risks, and uncertainties that may cause Plug Power’s actual results to be materially different from the future results expressed or implied in such statements. Plug Power undertakes no obligation to release any revision to any forward-looking statements. For a detailed discussion of the forward looking statements, please refer to our press release issued today. Now I would like to introduce Roger Saillant, President and Chief Executive Officer of Plug Power.

Thank you, Cynthia. Good morning and thank you for taking the time to be with us today. We've continued to make good progress since our second quarter call in July. External factors, especially the recent blackouts around the world, have heightened awareness that changes will be needed in the way we generate, distribute and consume energy.

The electrical grid in the U.S., Europe and Malaysia has faltered and failed. These failures have served notice about the vulnerability of the numerous components within the grid system. Distributed generation, which includes fuel cells, can help increase reliability of the overall system by delivering power at the point of need.

Plug Power's backup product the GenCore5T, introduced this past June, can assist in increasing the reliability of critical infrastructure within the electrical grid. Backup power sources such as GenCore will ensure that critical systems continue to operate smoothly during power outages or provide soft landings for other critical systems like water and sewer pumping stations so that startups are easier and costly system crashes are avoided.

We've achieved many objectives during the third quarter. We installed and commissioned the company's first prototype backup product for the telecommunications industry. This system has been actively providing power to Verizon's telecommunications equipment since its installation in July. This one-year program is sponsored by the New York State Energy Research and Development Authority. Plug Power and Verizon are learning together about the application of fuel cells in the telecom industry in this project. The installed system will be replaced with our most recent GenCore product when final certification is obtained, which is anticipated in January 2004.

We delivered 41 Genesis grid parallel 5-kilowatt stationary systems in the third quarter. Plug Power and our partner Bailon (ph) shipped 16 systems destined for the European Union's virtual power plant program. Additionally, we shipped 20 systems to the Long Island Power Authority for installation in residential locations beginning in the fourth quarter of this year.

Our customers operated 129 systems during the quarter. These systems included 10 newly installed systems at 64 -- these systems included 10 newly installed systems, at 64 locations which generated more than 400,000 kilowatts of electricity. Plug Power systems have eclipsed 1 million hours of operation at customer locations and have generated more than 2.8 million kilowatt hours of electricity since 2001.

We demonstrated a prototype home-energy station at Honda R&D America’s facility in Torrance California. The home-energy station is a fully integrated system co-developed by Plug Power of Honda using proprietary technologies from both companies.

We were awarded more than $14 million in federal and state funding from from the U.S. Department of Energy, the New York State Energy Research and Development Authority and the National Institute of Standards and Technology. These programs provide funding for the advancement of specific tactical areas necessary for continued stationary fuel cell development, consistent with our product market adoption strategy.

We added four new patents to Plug Power's portfolio in the third quarter for a total of 105 patents issued with 144 pending to date.

We will continue to ship GenSys systems that are fueled by liquefied petroleum gas during the fourth quarter. This product entry will lead to applications in the off grid markets that are not served by grid power or natural gas service.

We're working on projects with Agway Energy Products, the New York State Energy Research and Development Authority, the New York State Department of Agriculture and Markets and the U.S. Army Corps of Engineers for the installation and operation of propane fuel systems in remote areas.

We will also begin to ship GenCore backup systems in the fourth quarter. These shipments will go to early adopters in the telecommunications, electric utility and uninterruptible power supply markets.

Our order book remains strong. Currently we have a product backlog of 61 fuel cell systems which include 32 Genesis systems and 29 GenCore systems.

These are significant accomplishments. They have been achieved through the hard work and collaboration of our employees, our extended supply base, our customers and our partners. We are excited about our future.

Now I will turn the call over to Dave Neumann, our Chief Financial Officer, to review our third quarter financials. Dave?

Thank you, Roger. I will be providing a summary of our financial results for the quarter and year to date periods ended September 30th, 2003.

To begin with, we should note that on October 16th we filed a shelf registration statement with the Securities and Exchange Commission, registering up to an aggregate of $60 million worth of our common and preferred stock. Once declared effective by the SEC, this registration statement should provide us the flexibility to react timely to favorable market conditions.

I would now like to report our third quarter financial results which includes the full effect of our acquisition of H Power completed in the first quarter of this year. Upon consummation of that acquisition on March 25th, we recorded the fair value of H Power’s net assets on our consolidated financial statements. The purchase price in excess of fair value was recorded as in process research and development expense, capitalized technology and good will.

Accordingly, in the first quarter of 2003 we expensed $3 million related to the amount allocated in process research and development, a noncash charge to our statement of operations.

We also recorded intangible assets in the amount of $5.5 million which are being expensed ratably (ph) over 24 months resulting in a quarterly charge to our statement of operations at 700,000 or a penny per share.

And we recorded good will of approximately 10.3 million. We will periodically evaluate the good will for impairment as we continue to evaluate the technology, product design and intellectual property and continue to explore the opportunities to carry forward customer relationships.

We have quickly integrated the businesses and have consolidated the facilities and operations at or headquarters in Latham, New York. The result has been net cash used in operating activities for the third quarter ended September 30th of $8.3 million, including 300,000 for integration costs related to the acquisition. Net of the acquisition-related expenses or net cash used in operating activities, was $8 million, which compares to 9.2 million used in operating activities for the third quarter of last year.

Year to date net cash used in operating activities has been 27.6 million, including 3.2 million related to the acquisition, compared to 26 million during the same period of 2002. We do not expect to incur significant additional integration costs in the fourth quarter of 2003 and excluding the impact of the H Power acquisition, net cash to use in operating activities is expected to be at the lower end of our previous guidance of 35 to 40 million for the full year of 2003.

Lower revenue for the third quarter in September 30th was 3.5 million, compared to 3 million for the third quarter of 2002. Year to date total revenue has been 9.5 million compared to 8.4 million last year. Product and service revenue, a component of total revenue, was 2 million for the quarter, which compares to 2.6 million last year. Year to date product and service revenue was 6.2 million, compared to 7.4 million in 2002.

It should be noted that we continue to defer 100% of our product and service revenue at the time of sale and recognize this revenue over the period of the underlying service and other contractual obligations. The impact on our statement of operations is conservative, since the cost associated with the production of these systems are fully expensed as they are incurred.

Contract revenue under research and development contract for the quarter ended December 30th was 1.5 million as compared to 375,000 in the third quarter of 2002. Year to date contract revenue was 3.4 million compared to 1.1 in 2002. Cost of revenues was 3.6 million in the third quarter, which compares to 3.1 million last year. Our cost of revenues represent the direct material costs of the fuel cells systems delivered during the quarter combined with the labor and materials associated with servicing all of the systems under contract. It does not include factory overhead or factory overhead expenses. Cost of revenues does also include the fully burdened cost of R&D contract activity.

Year to date cost of revenues was 8.7 million compared to 7.7 million last year. Recurring research and development costs were 10.2 million during the quarter ended September 30th compared to 8.7 million in the same quarter of 2002. Year to date research and development costs were 30.8 million, compared to 29.9 million last year.

Recurring general administrative expenses were 1.7 million in both the quarter ended September 30th 2003 and the quarter ended September 30th, 2002. Year to date general administrative expenses were 5.1 million in '03, compared to 5.1 million in the same period last year.

Equity and losses of affiliates represents our minority interests in GE fuel cells systems, which we account for under the equity method of accounting, for the quarter ended September 30th, we reported a loss of 477,000, including 448,000 representing amortization of our original investment.

Our net loss for the quarter was 12.4 million or 20 cents per share, compared to 10.6 million or 21 cents per share in the same period of 2002. Year to date, the net loss was 39 million or 68 cents per share, compared to 34.5 million and 68 cents per share in the same period last year. The current year to date loss includes the previously mentioned noncash charge of $3 million or 5 cents per share, for the writeoff of in process R&D related to the acquisition of H Power.

Weighted (ph) average shares out standing for the third quarter were 61 million compared to 50.8 million in 2002. Increased the weighted (ph) average shares as result of issuing 9 million shares in connection with the acquisition. As of September 30th, there were approximately 61 million shares of our common stock issued and outstanding.

Our balance sheet continues to be strong with 62.6 million of cash, cash equivalents and marketable securities, including 5 million of restricted cash securing the bank debt on our facilities. We anticipate that these cash balances are sufficient to fund operations into 2005.

That concludes our prepared remarks. We would now like to open the meeting for questions. Operator, will you please proceed.

At this time, if you would like to ask a question, please press star then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q & A roster.

Your first question comes from David Smith with Smith Barney.

Can you hear me?

Good morning, David.

Good morning, David.

Can you give us more color into the backlog for the GenCore unit. Last quarter was 12 units this quarter it looks like it’s jumped to 29. Just a sense of who’s putting those orders in and what you’re seeing in terms of bid activity for that first commercial product.

David, Mark Sperry here. I guess the complexion of the people that are coming in are, I would characterize it as the targeted end-users for the product, that would be in telecommunications organizations, people that are in the roughly in the broadband industry. We do have interests as well that's being generated by some of our more traditional customers in terms of utilities to put the GenCore out in a backup application at substations.

Those are the types of customers that are included in the backlog and you are correct it's sitting at just under 30 units at this point in time. So I would characterize it as we're very pleased with the type of customers that are coming after it. They are the markets that we are targeting. Clearly there will be a period where they install these and evaluate the technology before they look at broader more larger work lines.

How are you guys finding these customers? Are you going and actively pursuing them like a Verizon or are they coming to you or is it a bit of both?

It's a bit of both. We're actively working to develop a distribution channel around the product, around the folks that currently have face to the existing customer sets so the folks at Verizon or Singular, for example, would be buying from -- I think you are aware that we've been having ongoing conversations with Tyco. It's a combination of the customers coming directly into us and some of the potential distribution partners that we're in conversations with bringing our customer set in to the conversations as well.

Okay. As far as bed (ph) activity -- I know you haven't -- what do you see in terms of more business in this area?

What I would do, David is characterize it and say the interest and inquiry level is definitely up as Roger indicated at front end of his comments, the recent blackouts, I think, have really generated some concerns and some interests around how can the infrastructure be bolstered, if you will, with respect to outages potentially are inevitable, and given that, is there a way that the cell infrastructure can stay up, the land line infrastructure can stay up, the grids, for example, the substation equipment where you have control systems that need to be activated to bring those things back on line, you know, pumping stations, those types of infrastructure elements that by and large had some issues in terms of operation during the blackouts, have generated increased interest and definitely the phone is ringing more often.

Is there any hesitation to be the first one to try this technology? Is there any hesitation as well in terms of cost?

I think more the former. The existing technology sets have been around for quite a long time in terms of variable lead acid batteries and some of the diesel or DC Gen sets that are out there. So clearly there is and incumbent technology that people have been purchasing and for all of the warts and pimples it may have, it is a known technology and there absolutely is going to be some adoption rate which is one of the things that we're trying to get more visibility into is how readily and how quickly will the technology be adopted given that we are selling into a fairly established marketplace.

Just one other thing on the equity financing, $60 million to me, I'm not sure, but maybe you can clarify whether it's enough to get you where you have to get. Is it the final amount of financing that you guys are going to have to do or at some point do you think you're going to have to go back to the market after that?

David, this is Dave Neumann. We're absolutely following the path of profitability here. If we sell all of the securities out of the shelf, I mean, that may have the potential to fund the business to profitability, but Mark mentioned the rate of market adoption of the GenCore product which is the big unknown right now. If the product takes off like we think it can, this should get us pretty close.

Okay. So the units that you are shipping, the GenCore units, are going to be profitable?

Absolutely. I think that you asked the question about is price determining the market, and one of the things that we're hearing, David, is that from all of the data from our joint marketing studies and so forth, talking to potential customers, customers coming to us, that is of no concern. We are at the right price point, which is good for us, because we've been focused on delivering a cost of energy value proposition and driving our costs down so that both our customers would benefit from it and we would be able to do this all profitably for our company.

I would add, David, that the risk of trying to predict whether the $60 million shelf is enough, it all gets back to the rate of market adoption that Mark had talked about earlier, and that does remain the biggest risk in the business plan.

And what kind of follow-on products can we expect after this? I'm assuming this wouldn't be the only thing, you know, if we assume that the $60 million would take to you 2007, 2008 at the current burn rate. I'm assuming the burn rate would go down but, can you give us any sense of timing as to follow-on products and what we would expect there?

Yeah, Dave, Mark, I think the notion of an architected platform approach that we have been pursuing here with our -- with respect to our development activities enables us to put what we call internally here “point products” against particular market opportunities fairly rapidly.

So the GenCore product that we're going out with is a 5 kilowatt product today targeted at telecommunications and broadband and industrial UPS. You take that same technology and repurpose it for other activities such as material handling equipment is certainly something that you can expect us to be working on. The architecture, when you look at our current GenSys platform, the fact that it has an integrated reformer gives us a leg up on some technology that could be applied against the industrial hydrogen market, for example.

And then clearly we continue to work on the continuous run applications evolving our thinking with respect to what are the early market adopters with respect to our low continuous run or prime power application. We are pushing products and development efforts across that entire waterfront.

So for the time being broadband and telecom give you enough work to do?

I'm sorry, Dave?

For the time being telecom, broadband wire line, I guess, would give you enough new market to go after?

The opportunity there is certainly large enough to keep us busy.

As far as alternative technologies that go into that market, you know, how does that $3,000 compare? We've heard about fly-wheels, we’ve heard about other companies with fuel cells as well going after this market.

Well, we think 3,000 is comparable to what people are paying today on a price per kilowatt fully installed compared to the existing solution. So they tend to be a combination of battery technology, battery technology along with generator set technology. And you know, in some cases fly-wheels for ride-through sorts of application. But by and large, price has not been the major -- a major objection in our early conversations. It's more a conversation about what is a fuel cell and how can this technology work and how does it work and comparing it to, you know, what do I need to do from an infrastructure standpoint to modify my site in order to accept a fuel cell. It's not about price, it's around the technology and how does it operate.

The other messages that are tending to resonate are around the advantages for extended outages. So we have clearly the ability to go through very extended outages simply by adding more fuel. So our run time is a function of how much hydrogen you want to put on site. So the way we're coming at some of those early objections are to look at what are the standards that are typically embraced in those industries so things like UL, things like conforming to the NEB standards are activities that we are focused on and will help with respect to making people more comfortable with the new technology set.

Thanks a lot, guys.

Your next question comes from David Snow with Energy Equity.

Good morning. You mentioned your integrated reformer. Was that developed in conjunction with one of the alliances with Honda or somebody else? Or did you do that yourself? What's the origin of that?

David, this is Greg Silvestri. The integrated reformer that we used in our systems is plug power proprietary technology and I think Honda called out in their press release about our home energy station that there is a multitude of technologies in that system and fuel processing technology is a direct contribution from plug power.

We collaborate with Honda in terms of how that fuel processor is integrated into the overall system requirements for the home energy station, but the core technology and design is a work that was done here at Plug Power.

How would you use that for addressing the industrial hydrogen market?

Well, I think that's what Mark is alluding to that we're going to provide some insight into that at the upcoming Power-Gen show in December. So other than that statement, we've put out there, any additional commentary would have to come from Mark.

I would say stay tuned. There'll be more to come on that, but the basic premise is that we generate hydrogen for consumption internal to our systems today. And it's a fairly easy process to disconnect that and make it available for other applications.

Would you be able to do that on a profitable basis, same as you've done with the GenCore?

Everything we do has to be on a profitable basis given our commitment to the shortest path to profitability.

At the present time you are not there on the GenSys, how far do you have to come down the curve to bring us up to date on your cost cutting program and scheduling on --

I think what we've described on our GenSys program is that today we sell those on a favorable basis and overall cash but they are not full-length gross margin profits profitable and I think that given the design of that system and the resources that we put against that product versus future generations of products, we won't make the current SU1 system gross margin profitable.

We'll continue to use it selectively at important accounts to have relationships and provide the early learning and immediately available learning tool to the customers. It's a futures generation of GenSys products which I think Mark talked about a little while ago that we're going to go after the market segments where they want a remote fuel and continuous run. Those are the products that we would anticipate being gross margin profitable to our company.

Those will be introduced when?

At a future period.

You can't say next --

We're not giving guidance around those product configurations and dates at this point. We gave some specific guidance on GenCore when we introduced that. You know, Mark has already talked about a new round of product insight that will provide then, product insight into the remote continuous run products would be at some subsequent future date to that.

Can you bring us up to date on the progress, if any, in the Celanese high temperature program and the Engelhard catalyst program?

Well, first of all, just to to touch to the Engelhard catalyst program, we have a very good relationship with Engelhard. -- this is Roger -- working on the precious metal content, configuration, stabilization that's required in order to get the highest rate of conversion at the lowest cost. And so that is an ongoing and tight relationship which we're very pleased with. And it's fundamental to our success and our future reformer developments working with our people, particularly in the Netherlands and obviously in Latham.

With regard to Celanese we are enjoining a closer and tighter relationship with Celanese such that I can see the technology phase gates, the technology delivery process phase gates which we have as an internal discipline to decide what the march is -- what the pathway is, the path forward is, to a true value proposition in the market in the form of a new product which we think will be a break through product.

We're enjoying good progress. We're reporting some of our data in public forums, technical forums, and it's looked upon, for example, NIST is helping to fund that, DOE is helping to fund that and they view that not only is it disruptive next step in the pen technology, but as a key place among the other market fuel cell providers, that they want to finance. So people are placing their bets with us, because they see our leadership position. I'm not at liberty to say when we see that coming to the market, but I'm quite excited about the progress we're making.

Okay. Thank you very much.

Thank you.

Your next question comes from Jarrett Carson with RBC Capital Market.

Yes, good morning. Dave, real quick on the R&D contract revenue numbers for this quarter, did we see anything related to some of the earlier big contracts and if so, particularly around the DOE contract were we expecting that to start to ramp in the fourth quarter?

We actually finalized some of those DOE contracts that were ordered earlier this quarter, late during the quarter and we were able to realize some activity against those contracts, and we did collect -- record revenue and collect some cash against them. So yes they did begin this quarter.

So we did see a little of that in the roughly 1.5 million?

Yeah. And we'll expect to see continuing efforts in those contracts for the next 30 months.

Okay. But likely ramping up more since you'll have a full quarter starting fourth quarter?

That's a fair statement, yes.

Okay. Mark, with regard to the GenCore product, can you talk a little bit around -- because there is obviously a number of players and I regard this as very positive that we have a lot of, I guess, competitiveness now targeted in the particularly around the telecom backup, I think it's very good for the industry, and helpful. Can you talk a little bit about product size and roughly, you know, your 5 kilowatt increment, what you see in terms of requirements from the Verizons and Singulars and how they are looking for redundancy and reliability and how that fits into the equation?

Sure, in terms of output size, there is a pretty substantial market in terms of where I would put it in sort of the 2 to 12 to 15 kilowatt output range. You're looking at, for example, the substation backup application, typically what's going on there is in a couple of kilowatt, depending on where you are in the telecommunications infrastructure, there is a large requirement in the 3 to, say, 6 or 7 kilowatt, and then it tends to jump up into maybe a 25 to 35 sort of kilowatt range.

So clearly most our technical experience base is around an anomaly of 5 kilowatt output. That's where we've been focused and fortunately, it is a power output range that there is substantial opportunity in the infrastructure of both the telecommunications, the broadband infrastructure, the utility grid infrastructure, all of those have a nice fit to the power output range that we are.

As I mentioned, we do have a platform approach to our development and the decisioning that we're going through now and working back and forth with our potential distributors and the end users is what is the right next output range in product manifestations. So those conversations are very rich right now and we haven't made a decision with respect to where that's going to go, but the good news is we're having direct dialogue with the end users as to what is the right next step.

And so cell towers, that size range is predominantly, is that 5 -- I know anywhere it could be anywhere from 2 to 20 or so, but maybe 5 to 10, is that a --

That's a good range. It's going to depend on where the tower is and how many tenants are actually operating off of it. They have separate backup systems versus one common for the site, but that output range is what we're seeing by and large.

Do you feel issues in terms of positioning relative to some of the other players because you have a larger unit, so to speak, and so in terms of redundancy and multiple redundancies of units, do you feel that you would have a better positioning statement or attractiveness in the higher power ranges because you would have potential for more redundancy relative to say if it was a 5 kilowatt unit you would have only say one unit?

I guess we haven't really run into a scenario where we've had that line of questioning or conversation. If the redundancy -- basically we're trying to provide an output size that satisfies the requirements. We have had conversations with customers who intentionally want redundancy so they want multiple backup sources in case one should not come on line. That can be multiple fuel cells or fuel cells in addition to batteries and generator sets and some other technologies. So by and large, people are looking at getting the availability and reliability numbers via redundancies within the technology bracket or across the technology bracket.

Jarrett, this is Greg. If part of your question was can we gain these initial units to provide more than 5 kilowatts of power at the site, the answer to that is yes. So as, we've worked with marketing organization and the engineering staffs of the people that we're selling the product to, we can demonstrate that. So the system is clearly capable of doing that. I think what Mark is pointing out is that longer term answers will come at higher power ranges.

Okay.

That was part of your question, then, that's why I just added in.

So you can obviously you can make it up to the 20 kilowatt size and just back 4, 5s?

We can demonstrate the viability of the technology and show our ability in that application with the current -- it’s not the optimum long-term answer, but we can definitely demonstrate the capability.

To substantiate that in our backlog, there are some systems that are ganged, if you will, type applications.

And finally, I mean, what is your thought on maybe what are the backup -- the run time requirements that, maybe, where have they been and now certainly post blackout and we've seen Singular talking about thousands of towers are down and stuff. Where do you think they are going or what kind of extended run time requirements do you think are coming through for a number of these wireless operators?

I think the conversation we've had, the indications are that it's definitely increasing. By and large it's on the order of between 4 and 8 hours, 4 hours at the low end. It's moving more towards an 8 to 16 hour conversation and, again, it depends on where you are. I was in Chile last week talking to the major tel-co folks down there and their expectation is 16 hours as the standard. So I would say here domestically it's moving towards 8 and -- 8 and north of that and other places in the world it's actually already beyond the 8 hours moving more towards 16 or 20.

And certainly just to clarify, as the run times extend, my data kind of indicates that the fuel cell option becomes more competitive relative to the battery option.

Absolutely correct. The more run time you need, the more the economic model is going to drive you towards a fuel cell.

All right, okay, thanks.

Thank you.

Your next question comes from Allen Matrani (ph) with Copper Beach.

I may have missed this earlier. It seems like from your guidance that cash burn will go up to $10 million next quarter; is that correct? Using the low end of the $35 million?

Allen, this Dave Neumann. We're saying we'll be on the low end of that $35 to $40 million excluding any H Power related expenses, that's right.

That equates to about $10 million roughly; correct?

If you take it as it's stated literally, yes.

You expect to beat that, though? What's the -- I'm wondering is it because you are shipping more units this coming quarter? What's the reason why it would go up from $8 million roughly to 9, 10, something like that?

A lot of it has to do with the fact that we're going to introduce this product this quarter and workinging capital requirements could fluctuate. Some of the receivables may carry over into the first quarter. There is a lot of reasons that you could be slightly higher in this quarter, but all in all, it seems pretty comparable.

Can you give us a sense as to what cash burn will be next year?

We generally give that kind of guidance at the fourth quarter conference call. Early next year we'll talk about those -- that guidance.

Lastly, do you have a sense of timing of the equity deal?

We don't. We put the shelf up to give us the flexibility to be able to react quickly if market conditions are favorable. -- so stay tuned there.

Allen, this is Roger, I just want to be very clear that our drive is to get the profitability as quick as we possibly can, so, anything that we do takes cash conservation into mind and any kind of trade that we make is only to shorten the path to profitability. I just want to emphasize that, because we run intentionally a very focused tight-fisted operation relative to the way we manage our cash.

I would say relative to almost every other fuel cell company as well, so -- Thank you very much. Roger.

Your next question comes from Chris Kwan with KD Securities.

A couple of questions on this GenCore system that you are selling at a profit today, does that assume that the buyers are able to get some type of government or state incentives or they are paying that $3,000?

Chris, Mark. No, the assumptions that we have embedded in our business model, we don't -- we don't put government subsidies into our pricing or business models. There are some things that are going on out there that, you know, I don't have the latest state of play on their energy bill, but there are some credit type programs that are embedded in that and by and large, the GenCore technology would be available to the generic fuel cell credits that are out there, but we don't take that into account, so the assumption is that the price point in the market is one that's competitive without any sorts of subsidies.

Okay. Next question on -- maybe you can give me a status update on this Honda home-energy station. Is this a one off thing or what is the next stage that you guys are working on?

First I'm going to say this and turn it over to Mark is that there is a lot of richness and evolving complexity in our relationship with Honda. It is truly based on their stature of the way they enter the market. They have the kind of focus on quality and reliability that we like. Their systems we like. Their intention to provide clean energy solutions for society, we like. So our philosophies are aligned and the technology growth that will come in that relationship while achieving very good price points through good disciplines and practices we expect. So let Mark bring you up to speed on, but I want to make that umbrella statement about that Honda relationship.

Chris, I would just echo some of what Roger said and finish directly your question. As was referenced in the press release Honda considers us a strategic development partner. I think it's taken quite some amount of time to develop our relationship to that point and a lot of that has been based on our ability to work with them to honor their request for confidentiality around certain elements. So I just want to tell you right up front, I can't go too deep with respect to what's going on there. But the intent absolutely, as was indicated in our release around that, is to move into a next development stage primarily focused around size reduction and reliability improvements on the initial prototype that we put in place. So we are currently having conversations with Honda with respect to what exactly does that mean in terms of statements of work for the next couple of years but right now we're very happy with the way that relationship is going, and we are -- that we are currently going down the path specific to the home refueling is one of many things we're in conversation about to make it smaller and to make it more reliable.

Just a follow up on that particular program was that the arrangements with Honda, is it on a R&D cost shared basis or did you generate revenues or are the revenues being generated from government funding? How is this appearing for the financial statements?

It shows up in the financial statements as in the contract revenue line. And you know essentially this development activity is being funded by Honda. There is no government involvement with it at this point.

Great, thanks a lot.

Your next question comes from John Quealy with Adams, Harkness and Hill.

Could you give an update on the Vaillant (ph) relationship. It looks like you shipped about 16 units in terms of what your expectations are for units moving forward and secondly, how that program is going in terms of operating efficiencies for the units, et cetera.

Yes, John, this is Greg. I can answer most of those points. The relationship with Vaillant remains intact southbound and is very strong. What we referenced in this quarterly release is that a new generation product which internally we call the “Euro 2 design” began to ship to Vaillant for direct placement at sites throughout Europe and we're going to be in many countries. I think the number is at least 8 with this generation of product. So the European Union virtual power plant expected this design iteration, expected to place the units this year and early next year, and all of us are on track to accomplish that objective. Vaillant in public forums has characterized the performance of the units as meeting their expectations with good, strong availability and reliability that is within everybody's expectations.

We've had characterizations of EU commissioners that this is the single fuel cell program in Europe that had delivered what it promised to deliver. So if you go back and comb the last 24 months, you'll see a lot of expectations and proclamations about a number of fuel cell companies about how they were going to bring their product into Europe. And I think the actual results that Plug and Vaillant have achieved collectively have pretty much surpassed what other people had represented as they would be able to do. So our feeling is the customer satisfaction is demonstrated by checkbooks and Vaillant's feet and our feet remain in this program and checks keep coming in relation to people in Europe that want these systems.

Great. And this is the last question. It looks like the patent portfolio backlog, if you will, is pretty sizable with 144 patent proposals pending. Competitive issues aside, can you give us a generalized indication of where those patents are split whether it's balance of plants or the stack itself or some other technology?

Yeah, we've represented that it's absolutely spread throughout the system which I think people expect from us because we're an integrated systems provider. So it's well distributed across the balance plan for stat, the fuel processor, power electronics, application patents. We did an analysis of where we saw the existing issues, issued patents and what the pipeline looks like and there were two categories that are increasing between the exiting patents and the pipeline. One is in software and integration control and the other is in fuel processor technology. So when you look at those two categories, each one was relatively large category to start with, and they are growing as a share, if you will, if you dissect our pipeline of 140-some that you mentioned.

Great, thanks very much.

Your next question is a follow-up question from David Smith with Smith Barney.

Hi. Just a follow-up on the cost question, first of all, can you pen some numbers, I'm not looking for dollars, necessary, on cost reduction, but just give us a sense of where costs have gone. I don't know if you want to index it and say we started at -- when Roger first came on in 2001, you know, if we say 100, where would costs be today. Where are they going to be, say, at the end of 2003 or where they'll be at the end of 2005, roughly and secondly give us an update on any happenings with General Electric.

Okay. David, this is Roger. I would say that the way to do it is if you look at it as a direct material cost problem -- by the way, other costs come down at the same time, once you start focusing on price drives costs. Your whole system -- you flow cost oust your entire system, so your manufacturing time, your test time and all of that comes down as well. But the direct material costs if we were to say it was roughly indexed at 100%, almost three years ago, clearly we're working in a domain now of about a 60% reduction, working in the 40% domain range.

We know with line of sight how to take another easy 50% out in terms of the next design round. We have that verified with supply building material kind of information so we understand what we're doing there. We still feel that that's insufficient to deliver a value proposition at this time to the marketplace, and so we're working very hard to come out with another generation of designs, a later generation of design that's further down the cost curve.

We have no reason not to believe that we can continue that slope of learning that we've already encountered in the last two to three years working with our extended supply base. So I'm very optimistic that two parts of our strategy, one is to nourish our self coming down the adoption curve, such that we can generate the revenues and profits with each sequence product on the adoption curve, and also that we can keep pushing toward bigger and bigger markets further down the curve, ultimately obviously it's linked to where automotive is. We look at that as the ultimate cost and reliability value proposition, okay?

Okay.

Mark?

David on the GE question, I would answer that a couple of ways. With respect to the GenCore product line, I think we've said GE doesn't necessary view themselves as the most appropriate channel for that product, but they are very active in introducing us to customers with which they have relationships for that backup application, so obviously with utilities, you have some direct relationships with some of the telecommunications companies, working with their staffs around the world and Asia. I mentioned I was in Chile last week, facilitated by some of the GE relationships down there.

So their approach has been to introduce us to their local feet on the street, if you will, and customers as potential end users for the product as it relates to GenCore. They are also very active with us in voice of the customer requirements sets around some of the future product activities that we have going that I alluded to earlier, both in the continuous prime power application, as well as the hydrogen generation application, if you will.

Okay, great. Thanks, guys.

We have one call remaining, there is a follow-up from David Snow with Energy Equity.

Let's see, can you give me any idea what the energy efficiency of your reformer stage is. I'm thinking, if I can recall, you had a real bogie of a large central steam reformer, it would be something like 65 or 70%. What do you get in the smaller application? Obviously it would be much less than that.

David, this is difficult ground to try and cover in a teleconference because as we saw earlier, when we were trying to answer questions about overall system efficiencies, how people measure the efficiencies of, you know, fuel processing operation are -- it varies a lot. I would say that we know where we need to be for an effective cost of hydrogen and the efficiencies of our system are very well suited to hit those bogies.

When you look at a cost of hydrogen, you are going to think about the capital costs for the equipment and the operating costs and the ongoing maintenance and the big part of the operating cost is obviously going to be your incoming fuel and the cost of that fuel and then how much hydrogen you get per unit of incoming fuel. So our efficiencies are very well suited to make us very competitive and the cost of hydrogen equation that the customers are telling us that they'll use to evaluate the technology.

You would compete with the delivered canisters?

Yes.

And would you do that for just the remote application, the remote delivered applications where you get a pretty high price to compete against? Or would you go into the broader market, too?

I think we've got to ask you to stay tuned.

Okay. Thank you very much.

That concludes the Q & A portion. I will now turn the call over to Ms. Mahoney-White.

Thank you very much, this will conclude our call today. We hope you found the session informative and we look forward to having you join us next quarter for another update.

Thank you for participating in today's conference call. You may now disconnect.