FUELCELL ENERGY INC - Quarter Report: 2017 July (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended July 31, 2017

OR

For the transition period from             to

Commission file number: 1-14204

FUELCELL ENERGY, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (203) 825-6000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   ☒    No   ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes  ☐    No  ☒

Number of shares of common stock, par value $.0001 per share, outstanding as of September 6, 2017:  61,485,741

FUELCELL ENERGY, INC.

FORM 10-Q

Table of Contents

2

FUELCELL ENERGY, INC.

Consolidated Balance Sheets

(Unaudited)

(Amounts in thousands, except share and per share amounts)

See accompanying notes to consolidated financial statements.

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FUELCELL ENERGY, INC.

Consolidated Statements of Operations and Comprehensive Loss

(Unaudited)

(Amounts in thousands, except share, per share and related party revenue amounts)

See accompanying notes to consolidated financial statements.

4

FUELCELL ENERGY, INC.

Consolidated Statements of Operations and Comprehensive Loss

(Unaudited)

(Amounts in thousands, except share, per share and related party revenue amounts)

See accompanying notes to consolidated financial statements.

5

FUELCELL ENERGY, INC.

Consolidated Statements of Cash Flows

(Unaudited)

(Amounts in thousands)

See accompanying notes to consolidated financial statements.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

Note 1.  Nature of Business and Basis of Presentation

FuelCell Energy, Inc. together with its subsidiaries (the “Company”, “FuelCell Energy”, “we”, “us”, or “our”) is a leading integrated fuel cell company with a growing global presence.  We design, manufacture, install, operate and service ultra-clean, efficient and reliable stationary fuel cell power plants.  Our SureSource power plants predictably generate electricity and usable high quality heat for commercial, industrial, government and utility customers.  We have commercialized our stationary carbonate fuel cells and are also pursuing the complementary development of planar solid oxide fuel cells and other fuel cell technologies.  Our operations are funded primarily through sales of equity instruments to strategic investors or in public markets, corporate and project level debt financing and local or state government loans or grants.  In order to produce positive cash flow from operations, we need to be successful at increasing annual order volume and production and in our cost reduction efforts.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial information.  Accordingly, they do not contain all of the information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements.  In the opinion of management, all normal and recurring adjustments necessary to fairly present our financial position and results of operations as of and for the three and nine months ended July 31, 2017  have been included.  All intercompany accounts and transactions have been eliminated.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted.  The balance sheet as of October 31, 2016 has been derived from the audited financial statements at that date, but it does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These financial statements should be read in conjunction with our financial statements and notes thereto for the year ended October 31, 2016, which are contained in our Annual Report on Form 10-K previously filed with the SEC.  The results of operations for the interim periods presented are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year.

Certain reclassifications have been made to conform to the current year presentation.  The Company has adopted Accounting Standards Update (“ASU”) 2015-03, Interest – Imputation of Interest effective January 31, 2017, and retrospective application is required which resulted in a reclassification in our Consolidated Balance Sheet as of October 31, 2016 of $0.3 million of debt issuance costs from Current assets to be a direct deduction from Current portion of long-term debt and a reclassification in our Consolidated Balance Sheet as of October 31, 2016 of $1.1 million of debt issuance costs from Other assets, net to be a direct deduction from Long-term debt and other liabilities. The Company has also early adopted ASU 2016-18, “Statement of Cash Flows (Topic 230) Restricted Cash” effective October 31, 2016 and has applied a retrospective transition method.  Accordingly, Restricted cash and cash equivalents has been reclassified as a component of “Cash, cash equivalents, and restricted cash” in the Consolidated Statement of Cash Flows for nine months ended July 31, 2016.  The Company has also included an additional line item, “Generation,” in the “Revenues” and “Cost of revenues” sections of the Statements of Operations to include revenues generated from the Company’s project assets (refer to the Revenue Recognition section below for more information).  The prior year amounts associated with power purchase agreements have been reclassified to the new “Generation” line item.

Revenue Recognition

We earn revenue from (i) the sale and installation of fuel cell power plants (ii) the sale of component part kits, modules and spare parts to customers, (iii) site engineering and construction services, (iv) performance under long-term service agreements, (v) the sale of electricity and other value streams under power purchase agreements (“PPAs”) and project assets retained by the Company under sales-leaseback transactions, (vi) license fees and royalty income from manufacturing and technology transfer agreements, and (vii) government and customer-sponsored advanced technology projects.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

Given the growing revenue related to PPAs and project assets retained by the Company, beginning in the first quarter of 2017, the Company began classifying such revenues in a separate line item called Generation, and prior period amounts have been reclassified.  As further clarification, revenue elements are classified as follows:

Product. Includes the sale and installation of fuel cell power plants, the sale of component part kits, modules and spare parts to customers, and site engineering and construction services.

Service and license. Includes performance under long-term service agreements for power plants owned by third parties and license fees and royalty income from manufacturing and technology transfer agreements.

Generation. Includes the sale of electricity under PPAs and project assets retained by the Company, and revenue received from the sale of other value streams from these assets including the sale of heat, steam and renewable energy credits.

Advanced technologies. Includes revenue from customer-sponsored and government-sponsored advanced technology projects that is recorded as “Advanced technologies” revenues in the Consolidated Statements of Operations.

Our revenue is primarily generated from customers located throughout the U.S., Europe and Asia and from agencies of the U.S. Government.

For customer contracts for complete SureSource power plants, with which the Company has adequate cost history and estimating experience, and with respect to which management believes it can reasonably estimate total contract costs, revenue is recognized under the percentage of completion method of accounting. The use of percentage of completion accounting requires significant judgment relative to estimating total contract costs, including assumptions relative to the length of time to complete the contract, the nature and complexity of the work to be performed, anticipated increases in wages and prices for subcontractor services and materials, and the availability of subcontractor services and materials. Our estimates are based upon the professional knowledge and experience of our engineers, project managers and other personnel, who review each long-term contract on a quarterly basis to assess the contract’s schedule, performance, technical matters and estimated cost at completion. When changes in estimated contract costs are identified, such revisions may result in current period adjustments to operations applicable to performance in prior periods. Revenues are recognized based on the percentage of the contract value that incurred costs to date bear to estimated total contract costs, after giving effect to estimates of costs to complete based on most recent information. For customer contracts for new or significantly customized products, where management does not believe it has the ability to reasonably estimate total contract costs, revenue is recognized using the completed contract method and therefore all revenue and costs for the contract are deferred and not recognized until installation and acceptance of the power plant is complete. We recognize anticipated contract losses as soon as they become known and estimable.  Actual results could vary from initial estimates and estimates will be updated as conditions change.  Site engineering and construction services revenue is recognized on a percentage of completion basis as costs are incurred.

Revenue from fuel cell kits, modules and spare parts sales is recognized upon shipment or title transfer under the terms of the customer contract. Terms for certain contracts provide for a transfer of title and risk of loss to our customers at our factory locations upon completion of our contractual requirement to produce products and prepare the products for shipment. A shipment in place may occur in the event that the customer is not ready to take delivery of the products on the contractually specified delivery dates.

Revenue from service agreements is generally recorded ratably over the term of the service agreement, as our performance of routine monitoring and maintenance under these service agreements is generally expected to be incurred on a straight-line basis.  For service agreements where we expect to have a module exchange at some point during the term (generally service agreements in excess of five years), the costs of performance are not expected to be incurred on a straight-line basis, and therefore, a portion of the initial contract value related to the module exchange is deferred and is recognized upon such module replacement event.

The Company receives license fees and royalty income from POSCO Energy (“POSCO”) as a result of manufacturing and technology transfer agreements entered into in 2007, 2009 and 2012.  The Cell Technology Transfer Agreement we entered into on October 31, 2012 provides POSCO with a technology license to manufacture SureSource power plants in South Korea.  On March 17, 2017, the Company entered into a Memorandum of Understanding (“2017 MOU”) with POSCO to engage in discussions to further amend the above referenced agreements and other agreements between the parties, as well as engaging in discussions relating to entering into new agreements to further the parties mutual interests. The 2017 MOU contemplates that POSCO will continue to service the existing installed base of fuel cell plants in South Korea.  In addition, the 2017 MOU contemplates entering into a module procurement agreement with POSCO that the Company anticipates will provide that POSCO will commit to a specified level of module purchases from the Company to supplement its own local manufacturing for servicing its existing fleet. Definitive agreements are expected to be finalized in 2017 subject to completion of due diligence, regulatory approvals, and customary closing conditions.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

Pursuant to the 2017 MOU, the Company commenced marketing the entire suite of SureSource solutions in South Korea as well as the broader Asian markets for the supply, recovery and storage of energy.

Under PPAs and project assets retained by the Company, revenue from the sale of electricity and other value streams is recognized as electricity is provided to the customer.  These revenues are classified as a component of generation revenues.

Advanced technologies contracts include both private industry and government entities.  Revenue from most government sponsored advanced technology projects is recognized as direct costs are incurred plus allowable overhead less cost share requirements, if any.  Revenue from fixed price advanced technology projects is recognized using percentage of completion accounting. Advanced technology programs are often multi-year projects or structured in phases with subsequent phases dependent on reaching certain milestones prior to additional funding being authorized.  Government contracts are typically structured with cost-reimbursement and/or cost-shared type contracts or cooperative agreements. We are reimbursed for reasonable and allocable costs up to the reimbursement limits set by the contract or cooperative agreement, and on certain contracts we are reimbursed only a portion of the costs incurred.

Use of Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Estimates are used in accounting for, among other things, revenue recognition, excess, slow-moving and obsolete inventories, product warranty costs, accruals for service agreements, allowance for uncollectible receivables, depreciation and amortization, impairment of goodwill, indefinite-lived intangible assets and long-lived assets, income taxes, and contingencies. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary.  Due to the inherent uncertainty involved in making estimates, actual results in future periods may differ from those estimates.

Related Parties

POSCO is a related party and owned approximately 4.0% of the outstanding common shares of the Company as of July 31, 2017.  Revenues from POSCO for the three months ended July 31, 2017 and 2016 represent 13% and 65%, respectively, of consolidated revenues and revenues from POSCO for the nine months ended July 31, 2017 and 2016 represent 9% and 52%, respectively, of consolidated revenues.

NRG Energy, Inc. (“NRG”) is a related party and owned approximately 2.0% of the outstanding common shares of the Company as of July 31, 2017.  NRG Yield is a dividend growth-oriented company formed by NRG that owns, operates and acquires a diversified portfolio of contracted renewable and conventional generation and thermal infrastructure assets in the United States.  Revenues from NRG and NRG Yield for the three months ended July 31, 2017 and 2016 represent 0.6% and 0.3%, respectively, of consolidated revenues and revenues form NRG and NRG Yield for the nine months ended July 31, 2017 and 2016 represent 0.4% and 0.2%, respectively, of consolidated revenues.

Recent Developments

Production Rate Adjustment:  In June 2017, the Company reduced its production to approximately fifteen megawatts on an annualized basis. This adjustment was made to manage inventory levels, prepare to transition to new product introductions and complete certain building expansion activities. From June through September 2017 approximately 110 manufacturing employees will work shortened work weeks. The Company is participating in the State of Connecticut’s “Shared Work Program” allowing affected employees to collect unemployment benefits for days they do not work.  This production level is anticipated to be temporary and will be reevaluated as order flow dictates.

Note 2.  Recent Accounting Pronouncements

Recently Adopted Accounting Guidance

In October 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-18, “Statement of Cash Flows (Topic 230) Restricted Cash.”  The amendments require that a statement of cash flows explain the change during the period in the total of cash, cash

9

FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows.  The Company early-adopted ASU 2016-18 as of October 31, 2016 using the retrospective transition method.  Accordingly, the Consolidated Statement of Cash Flows for the nine months ended July 31, 2016 has been revised to include “Restricted cash and cash equivalents” as a component of “cash, cash equivalents, and restricted cash.”

In April 2015, the FASB issued ASU 2015-03, “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” This ASU simplifies the presentation of debt issuance costs by requiring that such costs be presented in the balance sheet as a direct deduction from the carrying value of the associated debt instrument, consistent with debt discounts. The Company has adopted ASU 2015-03 effective January 31, 2017 and retrospective application is required which resulted in a reclassification in our Consolidated Balance Sheet as of October 31, 2016 of $0.3 million of debt issuance costs from Current assets to be a direct deduction from “Current portion of long-term debt” and a reclassification in our Consolidated Balance Sheet as of October 31, 2016 of $1.1 million of debt issuance costs from “Other assets” to be a direct deduction from Long-term debt and other liabilities.

In January 2017, the FASB issued ASU 2017-01, “Business Combinations.”  ASU 2017-01 was issued to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses.  The Company has elected to early adopt ASU 2017-01 effective November 1, 2016.

Recent Accounting Guidance Not Yet Effective

In February 2016, the FASB issued ASU 2016-02, “Leases” which, for operating leases, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. This ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (first quarter of fiscal year 2020 for the Company). Early adoption is permitted. The Company has both operating and capital leases (refer to Note 16. Commitments and contingences) as well as sale-leasebacks accounted for under the finance method and may have other arrangements that contain embedded leases as characterized in this ASU.  We expect this will result in the recognition of right-of-use assets and lease liabilities not currently recorded in our consolidated financial statements under existing accounting guidance, however we are still evaluating all of the Company’s contractual arrangements and the impact that adoption of ASU 2016-02 will have on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” This topic provides for five principles which should be followed to determine the appropriate amount and timing of revenue recognition for the transfer of goods and services to customers. The principles in this ASU should be applied to all contracts with customers regardless of industry. The amendments in this ASU are effective for fiscal years, and interim periods within those years beginning after December 15, 2016, with two transition methods of adoption allowed. Early adoption for reporting periods prior to December 15, 2016 is not permitted. In March 2015, the FASB voted to defer the effective date by one year to fiscal years, and interim periods within those fiscal years beginning after December 15, 2017 (first quarter of fiscal year 2019 for the Company), but allow adoption as of the original adoption date.  The Company has numerous different revenue sources including the sale and installation of fuel cell power plants, site engineering and construction services, sale of modules and spare parts, extended warranty service agreements, sale of electricity under power purchase agreements, license fees and royalty income from manufacturing and technology transfer agreements and customer-sponsored advanced technology projects.  This requires application of various revenue recognition methods under current accounting guidance.  Although we anticipate that, upon adoption of this new ASU the timing of revenue recognition for certain of our revenue sources might change, we are still evaluating the financial statement impacts of the guidance in this ASU and determining which transition method we will utilize. In May 2016, the FASB issued ASU 2016-12, “Revenue from Contracts with Customers (Topic 606).”  This topic provides narrow-scope improvements and practical expedients regarding collectability, presentation of sales tax collected from customers, non-cash consideration, contract modifications at transition, completed contracts at transition and other technical corrections.  We have initiated a review of the contracts for our significant revenue streams to understand the impact of the adoption of this ASU.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

Note 3.  Restructuring

On November 30, 2016, a business restructuring was announced to reduce costs and align production levels with current levels of demand in a manner that is consistent with the Company’s long-term strategic plan.

The Company reduced materials spend as well as implemented various cost control initiatives.  The workforce was reduced at both the North American production facility in Torrington, Connecticut, as well as at the corporate offices in Danbury, Connecticut and remote locations. A total of 96 positions, or approximately 17% of the Company’s global workforce, were eliminated.  The production rate was reduced to twenty-five megawatts annually, from the prior rate of fifty megawatts annually, in order to position for delays in anticipated order flow.  This production level is anticipated to be temporary and will be reevaluated as order flow dictates, with any future increases being undertaken from what is now a lower cost basis (refer to Note 1. Nature of Business and Basis of Presentation for further information on production rate reductions).  Restructuring expense relating to eliminated positions of $1.4 million has been recorded for the nine months ended July 31, 2017, which has been presented on a separate caption in the Consolidated Statement of Operations.

Note 4.  Accounts Receivable

Accounts receivable as of July 31, 2017 and October 31, 2016 consisted of the following:

We bill customers for power plant sales based on certain contractual milestones being reached.  We bill service agreements based on the contract price and billing terms of the contracts. Generally, our advanced technology contracts are billed based on actual recoverable costs incurred, typically in the month subsequent to incurring costs.  Some advanced technology contracts are billed based on contractual milestones or costs incurred.  Unbilled recoverable costs relate to revenue recognized on customer contracts that have not been billed.  Accounts receivable are presented net of an allowance for doubtful accounts of $0.1 million and $0.2 million as of July 31, 2017 and October 31, 2016, respectively.  Uncollectible accounts receivable are charged against the allowance for doubtful accounts when all collection efforts have failed and it is deemed unlikely that the amount will be recovered.

Accounts receivable from commercial customers (including unbilled recoverable costs) included amounts due from POSCO of $2.0 million and $5.0 million as of July 31, 2017 and October 31, 2016, respectively and amounts due from NRG and NRG Yield of $0.02 million and $0.1 million as of July 31, 2017 and October 31, 2016, respectively. 

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

Note 5.  Inventories

The components of inventories as of July 31, 2017 and October 31, 2016 consisted of the following:

Raw materials consist mainly of various nickel powders and steels, various other components used in producing cell stacks and purchased components for balance of plant.  Work-in-process inventory is comprised of material, labor, and overhead costs incurred to build balance of plant components, fuel cell stacks and modules, which are subcomponents of a power plant.

Raw materials and work in process are net of a valuation allowance of approximately $0.2 million as of July 31, 2017 and October 31, 2016.

Note 6.  Project Assets

Project assets as of July 31, 2017 and October 31, 2016 were $67.2 million and $47.1 million, respectively.  Project assets as of July 31, 2017 include $31.4 million which represents four completed, commissioned installations where we have a PPA with the end-user of power and site host.  These assets are the subject of sale-leaseback arrangements with PNC Energy Capital, LLC (“PNC”), which are recorded under the financing method of accounting for a sale-leaseback.  Under the finance method, the Company does not recognize the proceeds received from the lessor as a sale of such assets.  The Project assets balance also includes assets aggregating $32.4 million which are being constructed by the Company under PPAs which have been executed or are expected to be executed in fiscal year 2017.

In November 2016, the Company’s wholly-owned subsidiary, FuelCell Energy Finance, LLC (“FuelCell Finance”) entered into a membership interest purchase agreement with GW Power LLC (“Seller”) whereby FuelCell Finance purchased all of the outstanding membership interests in New Britain Renewable Energy, LLC (“NBRE”) from Seller.  Seller assigned the NBRE interest to FuelCell Finance free and clear of all liens other than a pledge in favor of Webster Bank, National Association.  The Company adopted ASU 2017-01 which resulted in the transaction being accounted for as an asset acquisition of a power plant with a fair value of $2.3 million ($2.0 million as of July 31, 2017) which has been classified as a long-term project asset in support of an Energy Purchase Agreement.

Project construction costs incurred for the long-term project assets are reported as investing activities in the Consolidated Statements of Cash Flows.  The proceeds received from the sale and subsequent leaseback of project assets are classified as “Cash flows from financing activities” within the Consolidated Statements of Cash Flows and are classified as a financing obligation within “Current portion of long-term debt” and “Long-term debt and other liabilities” on the Consolidated Balance Sheets (refer to Note 14 for more information).

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

Note 7.  Other Current Assets

Other current assets as of July 31, 2017 and October 31, 2016 consisted of the following:

Note 8.  Goodwill and Intangible Asset

As of July 31, 2017 and October 31, 2016, the Company had goodwill of $4.1 million and an intangible asset of $9.6 million associated with the December 2012 acquisition of Versa Power Systems.  The intangible asset represents indefinite lived in-process research and development for cumulative research and development efforts associated with the development of solid oxide fuel cells (SOFC) stationary power generation.    

The Company completed its annual impairment analysis of goodwill and in-process research and development assets as of July 31, 2017.   The Company performed a quantitative assessment in the prior year and determined that the estimated fair value of the reporting unit and in-process research and development intangible asset exceeded the respective carrying value and therefore no impairment was recognized as of July 31, 2016.  The Company performed a qualitative assessment for the current year and determined that it was more likely than not that there was no impairment of goodwill or the indefinite lived intangible asset.    

Note 9.  Other Assets

Other assets as of July 31, 2017 and October 31, 2016 consisted of the following:

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

Note 10.  Accrued Liabilities

Accrued liabilities as of July 31, 2017 and October 31, 2016 consisted of the following:

Note 11.  Shareholders’ Equity

Changes in shareholders’ equity

Changes in shareholders’ equity were as follows for the nine months ended July 31, 2017:

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

Common Stock Sales

The Company may sell common stock on the open market from time to time under an effective shelf registration statement.  The proceeds of these sales is used for general corporate purposes or to pay obligations related to the outstanding Series 1 preferred shares of our subsidiary, FCE FuelCell Energy, Ltd., and the Company’s outstanding Series B preferred shares. During the nine months ended July 31, 2017, the Company sold 7.2 million shares of the Company’s common stock at prevailing market prices through periodic trades on the open market and raised approximately $12.4 million, net of fees.

Public Offering and Outstanding Warrants

On May 3, 2017, the Company completed an underwritten public offering of (i) 12,000,000 shares of its common stock, (ii) Series C warrants to purchase 12,000,000 shares of its common stock and (iii) Series D warrants to purchase 12,000,000 shares of its common stock, for gross proceeds of approximately $15.4 million, at a public offering price of $1.28 per share and accompanying warrants. Total net proceeds to the Company were approximately $13.9 million.  The Series C warrants have an exercise price of $1.28 per share and a term of one year.  The Series D warrants have an exercise price of $1.60 per share and a term of five years.  A total of 1,377,540 shares of common stock were issued during the third quarter of fiscal year 2017 upon the exercise of Series D warrants and the Company received total proceeds of $1.8 million.

On July 12, 2016, the Company closed on a registered public offering of securities to a single institutional investor pursuant to a placement agent agreement with J.P. Morgan Securities LLC.  In conjunction with the offering the Company issued 7,680,000 Series A Warrants, all of which remained outstanding as of July 31, 2017, at an exercise price of $5.83 per share.  The Company also issued 4,926,000 prefunded Series B Warrants.  There were 3,826,000 prefunded Series B Warrants outstanding as of October 31, 2016, all of which were exercised during the nine months ended July 31, 2017.

On July 30, 2014, the Company issued a warrant to NRG in conjunction with the entry into a Securities Purchase Agreement for the sale of common stock.  Pursuant to the warrant agreement, NRG had the right to purchase up to 0.2 million shares of the Company’s common stock at an exercise price of $40.20 per share. The warrants expired on July 30, 2017.

Note 12.  Loss Per Share

The calculation of basic and diluted loss per share was as follows:

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

Refer to Note 12, Redeemable Preferred Stock, which is included in our Annual Report on Form 10-K for the year ended October 31, 2016, for information on the calculation of the common shares upon conversion.

Note 13.  Restricted Cash

As of July 31, 2017, there was $38.1 million of restricted cash and cash equivalents pledged as collateral for letters of credit for certain banking requirements and contractual commitments, compared to $34.1 million of restricted cash and cash equivalents pledged as of October 31, 2016. The restricted cash balance for both periods presented includes $15.0 million which has been placed in a Grantor’s Trust account to secure certain obligations under a 15-year service agreement and has been classified as long-term.  The restricted cash balance as of July 31, 2017 also includes $17.0 million to support obligations related to PNC sale-leaseback transactions.  As of July 31, 2017 and October 31, 2016, outstanding letters of credit totaled $2.9 million and $7.9 million, respectively.  These expire on various dates through April 2019.

Note 14.  Debt and Finance Obligation

Debt as of July 31, 2017 and October 31, 2016, consisted of the following:

The Company has a loan agreement with the Connecticut Development Authority to finance equipment purchases associated with manufacturing capacity expansion allowing for a maximum amount borrowed of $4.0 million. The interest rate is 5.0 percent and the

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

loan is collateralized by the assets procured under this loan as well as $4.0 million of additional machinery and equipment. Repayment terms require monthly interest and principal payments through May 2018.

The Company has a long-term loan agreement with the CT Green Bank totaling $5.9 million in support of the Bridgeport Fuel Cell Park project. The loan agreement carries an interest rate of 5.0 percent.  Interest only payments commenced in January 2014 and principal payments will commence on the eighth anniversary of the project’s provisional acceptance date, which is December 20, 2021, payable in forty-eight equal monthly installments.  Outstanding amounts are secured by future cash flows from the Bridgeport Fuel Cell Park service agreement.

In July 2014, the Company, through its wholly-owned subsidiary, FuelCell Finance, entered into a Loan Agreement (the “Loan Agreement”) with NRG.  Pursuant to the Loan Agreement, NRG has extended a $40.0 million revolving construction and term financing facility for the purpose of accelerating project development by the Company and its subsidiaries.  We may draw on the facility to finance the construction of projects through the commercial operating date of the power plants.  The interest rate is 8.5 percent per annum for construction-period financing and 8.0 percent thereafter.  Fees that were paid by FuelCell Finance to NRG for making the loan facility available and related legal fees incurred were capitalized and are being amortized straight-line over the life of the related loan agreement, which is five years. The term of the loans are up to five years but may be repaid early should the projects be sold or refinanced at the option of the Company.

In 2015, the Company entered into an agreement with PNC, whereby the Company’s project finance subsidiaries may enter into sale-leaseback agreements for commissioned projects where we have entered into a PPA with the site host/end-user of produced power.  Under the financing method of accounting for a sale-leaseback, the Company does not recognize as income any of the sale proceeds received from the lessor that contractually constitute payment to acquire the assets subject to these arrangements. Instead, the sale proceeds received are accounted for as financing obligations.  The outstanding finance obligation balance as of July 31, 2017 was $47.0 million and the increase from October 31, 2016 includes a sale-leaseback transaction which was completed in December 2016 and the recognition of interest expense offset by lease payments.

In November 2015, the Company closed on a definitive Assistance Agreement with the State of Connecticut and received a disbursement of $10.0 million for the first phase of the expansion project to expand the existing 65,000 square foot manufacturing facility in Torrington, Connecticut by approximately 102,000 square feet for a total size of 167,000 square feet. In conjunction with this financing, the Company entered into a $10.0 million Promissory Note and related security agreement securing the loan with equipment liens and a mortgage on its Danbury, Connecticut location.  Pursuant to the terms of the loan, payment of principal is deferred for the first four years. Interest at a fixed rate of 2.0 percent is payable beginning in December 2015.  The financing is payable over 15 years, and is predicated on certain terms and conditions, including the forgiveness of up to half of the loan principal if certain job retention and job creation targets are reached.  On April 17, 2017, the Company entered into an amendment to the Assistance Agreement extending certain of the job creation target dates.

In April 2016, the Company entered into a loan and security agreement with Hercules Capital, Inc. (“Hercules”) for an aggregate principal amount of up to $25.0 million, subject to certain terms and conditions.  The Company drew down $20.0 million during fiscal year 2016.  The loan is a 30 month secured facility and the term loan interest was previously 9.5 percent and increased to 9.75 percent resulting from the increase in the prime rate.  Interest is paid on a monthly basis.  Interest only payments were to be made for the first 18 months as a result of the Company achieving certain milestones.  In addition to interest, principal payments are to commence on November 1, 2017 in equal monthly installments.  The loan balance and all accrued and unpaid interest is due and payable by October 1, 2018.  Per the terms of the loan and security agreement, there is an end of term charge of $1.7 million which is being accreted over the 30 month term using the effective interest rate method.

As collateral for obligations under the loan and security agreement, the Company granted Hercules a security interest in FuelCell Energy, Inc.’s existing and hereafter-acquired assets except for intellectual property and certain other excluded assets. Collateral does not include assets held by FuelCell Finance or any project subsidiary thereof. The Company may continue to collateralize and finance its project subsidiaries through other lenders and partners. The loan contains a financial covenant whereby the Company is required to maintain an unrestricted cash balance of at least (a) 75% of the outstanding Loan balance plus (b) the amount of accounts payable (as defined under GAAP) not paid within 90 days of the date payment was issued.

In November 2016, in connection with the acquisition of NBRE, debt with Webster Bank was assumed as a part of the transaction in the amount of $2.3 million.  The term loan interest rate is 5.0 percent and payments are due on a quarterly basis commencing in January 2017.  The balance outstanding as of July 31, 2017 was $1.8 million.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

The Company leases computer equipment under master lease agreements. Lease payment terms are generally thirty-six months from the date of acceptance for leased equipment.

Direct deferred finance costs relate primarily to sale-leaseback transactions entered into with PNC which are being amortized over the ten-year term and direct deferred finance costs relating to the Hercules loan and security agreement entered into in April 2016 which is being amortized over the 30 month life of the loan.

Note 15.  Benefit Plans

The Company has 2006 and 2010 Equity Incentive Plans (collectively, the “Equity Plans”).  In April 2017, the number of shares of common stock reserved for issuance under the 2010 Equity Incentive Plan was increased to 4.5 million shares. As of July 31, 2017 there were 0.2 million shares available for grant under the 2010 Equity Incentive Plan.  As of July 31, 2017, equity awards outstanding consisted of incentive stock options, nonstatutory stock options, restricted stock awards (“RSAs”) and restricted stock units (“RSUs”).  

Restricted Stock Awards and Units

RSAs and RSUs granted during the nine months ended July 31, 2017 totaled 2.6 million. RSA and RSU expense is based on the fair value of the award at the date of grant and is amortized over the vesting period which is either over 3 or 4 years.  As of July 31, 2017, there were 3.1 million total RSAs and RSUs outstanding.

Stock Awards

During the nine months ended July 31, 2017, the Company awarded 86,000 shares of fully vested, unrestricted common stock to the independent members of its board of directors as a component of board of director compensation which resulted in recognition of $0.1 million of expense.

Note 16.  Commitments and Contingencies

Lease Agreements

As of July 31, 2017 and October 31, 2016, the Company had equipment financing and capital lease obligations of $0.7 million.  Payment terms are generally thirty-six months from the date of acceptance for leased equipment.

The Company also leases certain computer and office equipment and manufacturing facilities in Torrington and Danbury, Connecticut under operating leases expiring on various dates through 2030.

Non-cancelable minimum payments applicable to operating and capital leases as of July 31, 2017 were as follows (in thousands):

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

Service Agreements

Under the provisions of our service agreements, we provide services to maintain, monitor, and repair customer power plants to meet minimum operating levels. Under the terms of our service agreements, the power plant must meet a minimum operating output during the term. If minimum output falls below the contract requirement, we may be subject to performance penalties and/or may be required to repair or replace the customer’s fuel cell module. An estimate is not recorded for a potential performance guarantee liability until a performance issue has occurred at a particular power plant. At that point, the actual power plant’s output is compared against the minimum output guarantee and an accrual is recorded. The review of power plant performance is updated for each reporting period to incorporate the most recent performance of the power plant and minimum output guarantee payments made to customers, if any. The Company has provided for an accrual for performance guarantees, based on actual fleet performance, which totaled $2.1 million and $3.3 million as of July 31, 2017 and October 31, 2016, respectively, and is recorded in “Accrued liabilities.”

Our loss accrual on service agreements, excluding the accrual for performance guarantees, totaled $0.9 million and $2.7 million as of July 31, 2017 and October 31, 2016, respectively, and is recorded in “Accrued liabilities.” Our accrual estimates are performed on a contract by contract basis and include cost assumptions based on what we anticipate the service requirements will be to fulfill obligations under each contract.  The decrease primarily relates to module exchanges performed during the nine months ended July 31, 2017.

Power Purchase Agreements

Under the terms of our PPAs, customers agree to purchase power from our fuel cell power plants at negotiated rates. Electricity rates are generally a function of the customers’ current and future electricity pricing available from the grid. As lessee of the power plants, we are responsible for all operating costs necessary to maintain, monitor and repair the power plants. Under certain agreements, we are also responsible for procuring fuel, generally natural gas, to run the power plants.

Expansion of Torrington Facility and Related Financing

In December 2015, the Company commenced the first phase of its project to expand the existing 65,000 square foot manufacturing facility in Torrington, Connecticut by approximately 102,000 square feet for a total size of 167,000 square feet.  Initially, this additional space will be used to enhance and streamline logistics functions through consolidation of satellite warehouse locations and will provide the space needed to reconfigure the existing production process to improve manufacturing efficiencies.

On November 9, 2015, the Company closed on a definitive Assistance Agreement with the State of Connecticut and received a disbursement of $10.0 million to be used for the first phase of the expansion project. In conjunction with this financing, the Company entered into a $10.0 million Promissory Note and related security agreements.  The second phase of our manufacturing expansion, for which we will be eligible, subject to certain conditions to receive an additional $10.0 million in low-cost financing from the State of Connecticut, will commence as demand supports.

Other

As of July 31, 2017, the Company had unconditional purchase commitments aggregating $26.4 million, for materials, supplies and services in the normal course of business.

Under certain sales and financing agreements, the Company is contractually committed to provide compensation for any losses that its customers and finance partners may suffer in certain limited circumstances resulting from reductions in the U.S. Investment Tax Credit. Such obligations would arise as a result of reductions to the value of the underlying fuel cell projects as assessed by the U.S. Internal Revenue Service (IRS). The Company does not believe that any payments under these contracts are probable based on the facts known at the reporting date. The maximum potential future payments that the Company could have to make under these obligations would depend on the difference between the fair values of the fuel cell projects sold or financed and the values the IRS would determine as the fair value for the systems for purposes of claiming the Investment Tax Credit. The value of the Investment Tax Credit in the Company’s agreements is based on guidelines provided by the statutory regulations from the IRS. The Company and its customers use fair values determined with the assistance of independent third-party appraisals.

We are involved in legal proceedings, claims and litigation arising out of the ordinary conduct of our business. Although we cannot assure the outcome, management presently believes that the result of such legal proceedings, either individually, or in the aggregate,

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in thousands, except share and per share amounts)

will not have a material adverse effect on our consolidated financial statements, and no material amounts have been accrued in our consolidated financial statements with respect to these matters.

Note 17.  Subsequent Events

20 Megawatt Order in South Korea

On August 29, 2017, we entered into a contract to sell 20 megawatts of fuel cell power plants to Hanyang Industrial Development Company Ltd. (HYD), for installation at South Korean utility Korea Southern Power Company Ltd. (KOSPO). We expect that this project will represent in excess of $60 million of product revenue and any product not shipped by the end of the fourth fiscal quarter of 2017 will be added to backlog.  Revenue for the fourth quarter of 2017 is expected to increase compared to the third quarter of 2017, as revenue begins to be recognized on this contract. Product revenue recognition will carry into fiscal year 2018.

Convertible Preferred Offering

On September 5, 2017, the Company priced an underwritten offering of 33,500 shares of convertible preferred stock (the “Series C Preferred”).  The Series C Preferred carries a 0.0% dividend and a $1.84 conversion price. Each share of Series C Preferred is being sold at a price of $895.52 for gross proceeds of approximately $30 million. FuelCell Energy intends to use the net proceeds from this offering for working capital, project financing, and general corporate purposes.  The offering closed on September 8, 2017.

In connection with the convertible preferred offering, we have agreed with Hercules to amend the loan and security agreement (1) to permit us to make certain cash payments that may be required pursuant to the terms of the Series C Preferred Shares, (2) to require us to maintain an unrestricted blocked cash balance of at least the greater of (x) (a) $20.0 million plus (b) the amount of accounts payable not paid within 90 days of the date payment was issued and (y) (a) 100% of the outstanding loan balance plus (b) the amount of accounts payable not paid within 90 days of the date payment was issued and (3) to add an event of default in the event of the delivery of a notice by the holders to redeem the Series C Preferred Shares following a triggering event pursuant to the certificate of designations governing the Series C Preferred Shares.  

Proxy Ratification Vote

On September 5, 2017, we filed a definitive proxy statement with the SEC which provides notice to our shareholders of a special meeting of shareholders to be held on Friday, September 29, 2017 to ratify the filing and effectiveness of the certificate of amendment to our amended and restated certificate of incorporation filed with the Secretary of State of the State of Delaware on December 3, 2015 and the 1-for-12 reverse stock split of our common stock that was effected thereby and became effective on December 3, 2015.  

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FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q (including exhibits and any information incorporated by reference herein) contains both historical and forward-looking statements that involve risks, uncertainties and assumptions. The statements contained in this report that are not purely historical are forward-looking statements that are subject to the safe harbors created under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, beliefs, intentions and strategies for the future. When used in this report, the words “expects”, “anticipates”, “estimates”, “should”, “will”, “could”, “would”, “may”, “forecast”, and similar expressions are intended to identify forward-looking statements.  Such statements relate to, among other things, the following: (i) the development and commercialization by FuelCell Energy, Inc. and its subsidiaries (“FuelCell Energy”, “Company”, “we”, “us”, and “our”) of fuel cell technology and products and the market for such products; (ii) expected operating results such as revenue growth and earnings; (iii) our belief that we have sufficient liquidity to fund our business operations for the next 12 months; (iv) future funding under government research and development contracts; (v) future financing for projects including publicly issued bonds, equity and debt investments by investors and commercial bank financing; (vii) the expected cost competitiveness of our technology; and (viii) our ability to achieve our sales plans and cost reduction targets.

The forward-looking statements contained in this report are subject to risks and uncertainties, known and unknown, that could cause actual results to differ materially from those forward-looking statements, including the risks contained in our Annual Report on Form 10-K for the fiscal year ended October 31, 2016 in the section entitled “Item 1A. Risk Factors,” the risks described in Part II, Item 1A of this report, and the following:  general risks associated with product development and manufacturing; general economic conditions; changes in the utility regulatory environment; changes in the utility and the markets for distributed generation, distributed hydrogen, and carbon capture configured fuel cell power plants for coal and gas-fired central generation; potential volatility of energy prices; availability of government subsidies and economic incentives for alternative energy technologies; rapid technological change; competition; market acceptance of our products; changes in accounting policies or practices adopted voluntarily or as required by accounting principles generally accepted in the United States; factors affecting our liquidity position and financial condition; government appropriations; the ability of the government to terminate its development contracts at any time; the ability of the government to exercise “march-in” rights with respect to certain of our patents; our and POSCO Energy’s (“POSCO”) ability to develop the market in Asia, deploy SureSource power plants and successfully operate POSCO’s Asian manufacturing facility; our ability to implement our strategy; our ability to reduce our levelized cost of energy; the risk that commercial field trials of our products will not occur when anticipated; our ability to increase the output and longevity of our power plants; and our ability to expand our customer base and maintain relationships with our largest customers.

We cannot assure you that:  we will be able to meet any of our development or commercialization schedules; the government will appropriate the funds anticipated by us under our government contracts; the government will not exercise its right to terminate any or all of our government contracts; any of our new products or technology, once developed, will be commercially successful; our existing SureSource power plants will remain commercially successful; or we will be able to achieve any other result anticipated in any other forward-looking statement contained herein.

Investors are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, many of which are beyond our ability to control, and that actual results may differ materially from those projected in the forward-looking statements as a result of various factors discussed herein.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is provided as a supplement to the accompanying financial statements and footnotes to help provide an understanding of our financial condition, changes in our financial condition and results of operations. The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Estimates are used in accounting for, among other things, revenue recognition, excess, slow-moving and obsolete inventories, product warranty costs, loss accruals on service agreements, allowance for uncollectible receivables, depreciation and amortization, impairment of goodwill, indefinite-lived intangible assets and long-lived assets, income taxes, and contingencies. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Due to the inherent uncertainty involved in making estimates, actual results in future periods may differ from those estimates. The following discussion should be read in conjunction with information included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2016 filed with the SEC. Unless otherwise indicated, the terms “Company”, “FuelCell Energy”, “we”, “us”, and “our” refer to FuelCell Energy, Inc. and its subsidiaries. All tabular dollar amounts are in thousands.

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OVERVIEW AND RECENT DEVELOPMENTS

Overview

FuelCell Energy, Inc. delivers efficient, affordable and clean solutions for the supply, recovery and storage of energy.  We design, manufacture, undertake project development, install, operate and maintain megawatt-scale fuel cell systems, serving utilities, industrial and large municipal power users with solutions that include both utility-scale and on-site power generation, carbon capture, local hydrogen production for transportation and industry, and long duration energy storage.  Our plants are operating in more than 50 locations on three continents and have generated more than 6.6 million megawatt hours (MWh) of electricity, which is equivalent to powering more than 595,200 average sized U.S. homes for one year.

We provide comprehensive turn-key power generation solutions to our customers including installation of the power plants as well as operating and maintaining the plants under multi-year service agreements. We target large-scale power users with our megawatt-class installations.  As a reference, one megawatt is adequate to power approximately 1,000 average sized US homes.  Our customer base includes utility companies, municipalities, universities, government entities and businesses in a variety of industrial and commercial enterprises. Our leading geographic markets are South Korea and the United States and we are pursuing expanding opportunities in Asia and Europe.

Our value proposition provides highly efficient and environmentally friendly power generation with easy-to-site stationary fuel cell power plants.  The power plants are located in populated areas as they are virtually pollutant free, operate quietly and without vibrations, and have only modest space requirements.  Locating the power generation near the point of use provides many advantages, including less reliance on or even avoidance of the transmission grid, leading to enhanced energy security and power reliability.  Our power plants provide electricity priced competitively to grid-delivered electricity in certain high cost regions and our strategy is to continue to reduce costs, which is expected to lead to wider adoption.

We are developing Advanced Technologies which leverage our commercial platform and expertise. Our SureSource power plants utilize carbonate fuel cell technology, which is a very versatile type of fuel cell technology.  Utilizing our core SureSource plants, we have developed and are commercializing both a tri-generation distributed hydrogen configuration that generates electricity, heat and hydrogen for industrial or transportation uses, and a carbon capture application for coal or gas-fired power plants.  We also are developing and working to commercialize solid oxide fuel cells (SOFC) for adjacent sub-megawatt applications to the markets for our megawatt-class SureSource power plants as well as energy storage applications.  These applications are complementary to our core products, leverage our existing customer base, project development, sales and service expertise, and are large markets.

Recent Developments

Korea Market Developments. In June 2017, a bid in which the Company participated was awarded a 20 megawatt project by a Korean utility. On August 29, 2017, the Company entered into a contract with Hanyang Industrial Development Co., Ltd (“HYD”) pursuant to which the Company will provide equipment for a fuel cell project with Korea Southern Power Co., Ltd. (“KOSPO”).  The SureSource 3000^TM power plants will cleanly produce electricity and thermal energy to support a district heating system.  Construction is expected to begin in 2017 and the installation is expected to be operational in 2018, illustrating the relatively rapid deployment of fuel cell parks.  HYD is a leading global construction company and will provide the engineering, procurement and construction services for the project. The value of the equipment sale contract to the Company is in excess of $60 million USD. In addition, the Company expects to sign a 20 year services agreement with KOSPO with a value in excess of $130 million USD.

U.S. Market Developments. In July 2017 the Company was awarded fuel cell projects totaling 39.8 megawatts by LIPA under the Fuel Cell Resources Feed-in Tariff.  This 40 megawatt FIT IV program is structured to enhance energy resiliency with clean local power generation for western Long Island, New York.  Long Island Power Authority (LIPA) will purchase the power from the fuel cell projects under 20 year power purchase agreements.  The Company will install, operate and maintain the fuel cell power plants. Each fuel cell project, as described below, will supply a different LIPA electrical substation on Long Island:

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The next steps in project development include working with the utility on the interconnection agreements, executing power purchase agreements, and finalizing site engineering.  Upon execution of power purchase agreements (expected in late 2017), the projects will become contracted backlog. Contracted revenues over the twenty year operating period are expected to be greater than $800 million based on committed pricing and expected power generation over the term.  

Production Rate Adjustment. In June 2017, the Company reduced its production to approximately fifteen megawatts on an annualized basis. This adjustment was made to manage inventory levels, prepare to transition to new product introductions and complete certain building expansion activities. From June through September 2017 approximately 110 manufacturing employees will work shortened work weeks. The Company is participating in the State of Connecticut’s “Shared Work Program” allowing affected employees to collect unemployment benefits for days they do not work.  This production level is anticipated to be temporary and will be reevaluated as order flow dictates.

POSCO Energy MOU. On March 17, 2017, the Company entered into a Memorandum of Understanding (“2017 MOU”) with POSCO Energy to engage in discussions to further amend the manufacturing and technology transfer agreements entered into in 2007, 2009 and 2012 and other agreements between the parties, as well as engaging in discussions relating to entering into new agreements to further the parties’ mutual interests. The 2017 MOU contemplates that POSCO will continue to service the existing installed base of fuel cell plants in South Korea. In addition, the 2017 MOU contemplates entering into a module procurement agreement with POSCO that the Company anticipates will provide that POSCO will commit to a specified level of module purchases from the Company to supplement its own local manufacturing for servicing its existing fleet. Definitive agreements are expected to be finalized in 2017 subject to completion of due diligence, regulatory approvals, and customary closing conditions.

Pursuant to the 2017 MOU, the Company has commenced marketing the entire suite of SureSource solutions in South Korea as well as the broader Asian markets for the supply, recovery and storage of energy.

Convertible Preferred Offering

On September 5, 2017, the Company priced an underwritten offering of 33,500 shares of convertible preferred stock (the “Series C Preferred”).  The Series C Preferred carries a 0.0% dividend and a $1.84 conversion price. Each share of Series C Preferred is being sold at a price of $895.52 for gross proceeds of approximately $30 million. FuelCell Energy intends to use the net proceeds from this offering for working capital, project financing, and general corporate purposes.  The offering closed on September 8, 2017.

In connection with the convertible preferred offering, we have agreed with Hercules to amend the loan and security agreement (1) to permit us to make certain cash payments that may be required pursuant to the terms of the Series C Preferred Shares, (2) to require us to maintain an unrestricted blocked cash balance of at least the greater of (x) (a) $20.0 million plus (b) the amount of accounts payable not paid within 90 days of the date payment was issued and (y) (a) 100% of the outstanding loan balance plus (b) the amount of accounts payable not paid within 90 days of the date payment was issued and (3) to add an event of default in the event of the delivery of a notice by the holders to redeem the Series C Preferred Shares following a triggering event pursuant to the certificate of designations governing the Series C Preferred Shares.

RESULTS OF OPERATIONS

Management evaluates the results of operations and cash flows using a variety of key performance indicators, including revenues compared to prior periods and internal forecasts, costs of our products and results of our “cost-out” initiatives, and operating cash use. These are discussed throughout the “Results of Operations” and “Liquidity and Capital Resources” sections of this MD&A section.

Comparison of Three Months Ended July 31, 2017 and 2016

Revenues and Costs of revenues

Our revenues and cost of revenues for the three months ended July 31, 2017 and 2016 were as follows:

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Total revenues for the three months ended July 31, 2017 of $10.4 million reflects a decrease of $11.4 million from $21.7 million for the same period in the prior year.  Total cost of revenues for the three months ended July 31, 2017 decreased by $8.3 million to $13.0 million from $21.3 million during the same period in the prior year. A discussion of the changes in product sales and cost of sales, service and license revenues and cost of revenues, generation revenues and cost of revenues and advanced technologies contract revenues and cost of revenues follows.

Product sales

Our product sales, cost of sales and gross profit for three months ended July 31, 2017 and 2016 were as follows:

Product sales for the three months ended July 31, 2017 included $0.05 million of power plant revenue and $0.56 million of revenue related to engineering and construction services. This is compared to product sales for the three months ended July 31, 2016, which included $0.5 million of power plant revenue, $11.9 million of fuel cell module kits revenue and $1.3 million of revenue related to engineering and construction services.

The decline in revenue during the period is due primarily to lower revenue from POSCO due to no kit sales in the three months ended July 31, 2017 and the transition to a royalty-only based model.  POSCO is manufacturing cell components and modules in South Korea.  Also, the Company’s multi-year kit order with POSCO concluded at the end of fiscal year 2016 and, as a result, the Company does not expect to recognize product sales revenue during fiscal year 2017 at the levels previously recognized from POSCO Energy. The Company receives a 3.0% royalty on POSCO net product sales manufactured in South Korea as well as a royalty on each scheduled fuel cell module replacement under service agreements for modules that were built by POSCO Energy. Also contributing to the decline in revenue over the comparable period is that certain power plants are being recognized as “Project assets” on the Consolidated Balance Sheets and accordingly, product and engineering, procurement and construction revenue is not recognized. As the Company’s development business expands, it is installing power plants for customers that have executed power purchase agreements.  The power plants are recognized as “Project assets” on the Consolidated Balance Sheets and generation revenue will be recognized as earned over the life of the power purchase agreement or as a product sale in the event the Company sells the entire project (service agreement revenues would accompany a product sale).

Cost of product sales decreased $9.5 million for the three months ended July 31, 2017 to $4.3 million, compared to $13.7 million in the same period in the prior year.  Overall gross loss was $3.7 million for the three months ended July 31, 2017. Gross loss increased from the same period in the prior year as a result of under-absorption of fixed overhead costs due to lower than normal capacity.

Service and license revenues

Revenues for the three months ended July 31, 2017 from service agreements and license fee and royalty agreements totaled $4.8 million, compared to $4.3 million for the three months ended July 31, 2016.  Service agreement revenue increased slightly from the three months ended July 31, 2016 primarily due to a higher number of module replacements in the three months ended July 31, 2017. Revenue from license, royalty and material management fees decreased to $0.6 million for the three month period ended July 31, 2017 from $1.6 million for the comparable prior year period due to lower royalties recognized.  The Company’s license and royalty agreements with POSCO included a minimum royalty which expired in December 2016.

Cost of service and license revenues increased $0.4 million to $4.5 million for the three months ended July 31, 2017 from $4.1 million for the three months ended July 31, 2016.  Cost of service agreements includes maintenance and operating costs, module exchanges,

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and performance guarantees.  The increase over the comparable prior year period relates to higher expenses associated with module replacements in the three months ended July 31, 2017.

Overall gross profit was $0.4 million for the three months ended July 31, 2017. The overall gross margin percentage of 7.4 percent compares to 4.5 percent in the comparable prior year period.  Service margins were positively impacted by module exchanges during the three months ended July 31, 2017.

Service revenue from module exchanges is recognized at the time of the module exchange activity whereas the remaining portion of service revenue from service agreements is recognized ratably over the life of the service contract.  As a result, quarterly revenue and gross profit related to module exchanges can fluctuate quarter to quarter.  Additional power plant installations would lead to growth in service revenue.

Generation revenues

Revenues for the three months ended July 31, 2017 from generation totaled $1.7 million, compared to $0.2 million for the three months ended July 31, 2016.  Revenues for the three months ended July 31, 2017 reflects revenue from electricity generated from the Company’s PPAs. Cost of generation totaled $1.5 million in the three months ended July 31, 2017, compared to $0.2 million for the comparable prior year period.  The increases represent the growth in the Company’s operating portfolio. As of July 31, 2017, the Company had 11.2 megawatts of operating power plants in its portfolio.

Advanced technologies contract revenues

Advanced technologies contract revenues and related costs for the three months ended July 31, 2017 and 2016 were as follows:

Advanced technologies contracts revenue for the three months ended July 31, 2017 were $3.2 million, which reflects a decrease of $0.3 million when compared to $3.6 million of revenue for the three months ended July 31, 2016.  Cost of advanced technologies contracts decreased $0.5 million to $2.8 million for the three months ended July 31, 2017, compared to $3.3 million for the same period in the prior year.  Advanced technologies contracts for the three months ended July 31, 2017 generated a gross profit of $0.5 million compared to a gross profit of $0.3 million for the three months ended July 31, 2016.  The improvement in gross margin is related to the timing and mix of contracts being performed during the three months ended July 31, 2017, particularly a higher proportion related to private industry contracts.

Administrative and selling expenses

Administrative and selling expenses were $6.3 million and $5.5 million for the three months ended July 31, 2017 and 2016, respectively.

Research and development expenses

Research and development expenses increased to $5.4 million for the three months ended July 31, 2017 compared to $5.3 million during the three months ended July 31, 2016.

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Loss from operations

Loss from operations for the three months ended July 31, 2017 was $14.3 million compared to $10.3 million for the three months ended July 31, 2016.  The increase in the loss from operations relates to gross loss and higher operating expenses for the three months ended July 31, 2017.

Interest expense

Interest expense for the three months ended July 31, 2017 and 2016 was $2.3 million and $1.4 million, respectively.  Interest expense increased from the three months ended July 31, 2016 as a result of the interest on the loan and security agreement with Hercules Capital, Inc. (“Hercules”) and interest expense related to sale-leaseback transactions recorded under the finance method.  Interest expense for both periods also includes interest for the amortization of the redeemable preferred stock of subsidiary fair value discount of $0.5 million for the three months ended July 31, 2017 and 2016.

Other income (expense), net

Other income (expense), net, was expense of $0.4 million for the three month period ended July 31, 2017 compared to income of $0.7 million for the same period in 2016.  The income (expense) for both periods presented includes net foreign exchange gains (losses) related primarily to the remeasurement of the preferred stock obligation of our Canadian subsidiary which is payable in Canadian dollars and income from refundable research and development tax credits.

Benefit (provision) for income taxes

We have not paid federal or state income taxes in several years due to our history of net operating losses (NOL), although we have paid foreign income and withholding taxes in South Korea. For the three months ended July 31, 2017 and 2016, our benefit (provision) for income taxes was $0.001 million and $(0.1 million), respectively. We manufacture products that are gross margin profitable on a per unit basis; however, we cannot estimate when production volumes will be sufficient to generate taxable domestic income.  Accordingly, no tax benefit has been recognized for net operating losses or other deferred tax assets as significant uncertainty exists surrounding the recoverability of these deferred tax assets.

Net loss attributable to noncontrolling interest

The net loss attributable to noncontrolling interest was $0.01 million for the three months ended July 31, 2016.  There was no amount attributable to noncontrolling interest during the three months ended July 31, 2017 since the Company purchased the noncontrolling interest in FuelCell Energy Solutions, GmbH in October 2016.

Preferred stock dividends

Dividends recorded on the Series B Preferred Stock were $0.8 million for the three month periods ended July 31, 2017 and 2016.

Net loss attributable to common shareholders and loss per common share

Net loss attributable to common shareholders represents the net loss for the period less the net loss attributable to noncontrolling interest and the preferred stock dividends on the Series B Preferred Stock.  For the three month periods ended July 31, 2017 and 2016, net loss attributable to common shareholders was $17.8 million and $11.8 million, respectively, and loss per common share was $0.31 and $0.38, respectively.

Comparison of Nine Months Ended July 31, 2017 and 2016

Revenues and Costs of revenues

Our revenues and cost of revenues for the nine months ended July 31, 2017 and 2016 were as follows:

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Total revenues for the nine months ended July 31, 2017 of $47.8 million reflected a decrease of $36.0 million from $83.8 million for the same period in the prior year.  Total cost of revenues for the nine months ended July 31, 2017 decreased by $35.5 million to $48.2 million from $83.7 million during the same period last year. A discussion of the changes in product sales and cost of sales, service and license revenues and cost of revenues, generation revenues and cost of revenues and advanced technologies contract revenues and cost of revenues follows.

Product sales

Our product sales, cost of sales and gross profit for the nine months ended July 31, 2017 and 2016 were as follows:

Product sales for the nine months ended July 31, 2017 included $1.3 million of power plant revenue and $1.9 million of revenue related to engineering and construction services. This is compared to product sales for the nine months ended July 31, 2016, which included $10.5 million of power plant revenue, $35.8 million of fuel cell module kits revenue, $6.4 million of revenue related to engineering and construction services and $1.5 million of revenue primarily related to power plant component sales.

The decline in revenue during the period is due primarily to lower revenue from POSCO due to no kit sales in the nine months ended July 31, 2017 and the transition to a royalty-only based model.  POSCO is manufacturing cell components and modules in South Korea.  Also, the Company’s multi-year kit order with POSCO concluded at the end of fiscal year 2016 and as a result, the Company does not expect to recognize product sales revenue during fiscal year 2017 at the levels previously recognized from POSCO Energy. The Company receives a 3.0% royalty on POSCO net product sales manufactured in South Korea as well as a royalty on each scheduled fuel cell module replacement under service agreements for modules that were built by POSCO Energy. Also contributing to the decline in revenue over the comparable period is that certain power plants are being recognized as “Project assets” on the Consolidated Balance Sheets and accordingly, product and engineering, procurement and construction revenue is not recognized. As the Company’s development business expands, it is installing power plants for customers that have executed power purchase agreements.  The power plants are recognized as Project assets on the balance sheet and generation revenue will be recognized as earned over the life of the power purchase agreement or as a product sale in the event the Company sells the entire project (service agreement revenues would accompany a product sale).

Cost of product sales decreased $41.7 million for the nine months ended July 31, 2017 to $11.5 million, compared to $53.2 million in the same period in the prior year.  Overall gross loss was $8.4 million for the nine months ended July 31, 2017. Gross margin decreased from the same period in the prior year as a result of under-absorption of fixed overhead costs due to lower than normal capacity.

Service and license revenues

Revenues for the nine months ended July 31, 2017 from service agreements and license fee and royalty agreements totaled $24.3 million, compared to $20.8 million for the nine months ended July 31, 2016.  Service agreement revenue increased from the nine months ended July 31, 2016 primarily due to a higher number of module replacements in the nine months ended July 31, 2017. Revenue from license, royalty and material management fees decreased to $2.1 million for the nine month period ended July 31, 2017, compared to $4.6 million for the comparable prior year period due to lower royalties recognized.  The Company’s license and royalty agreements with POSCO Energy included a minimum royalty which expired in December 2016.

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Cost of service and license revenues increased to $22.9 million for the nine months ended July 31, 2017 from $21.5 million for nine months ended July 31, 2016.  The increase over the comparable prior year period relates to higher expenses associated with module replacements in the nine months ended July 31, 2017.

Overall gross profit was $1.5 million for the nine months ended July 31, 2017. The overall gross margin percentage of 6.0 percent compares to (3.3) percent in the comparable prior year period.  Service margins were positively impacted by module exchanges during the nine months ended July 31, 2017.

Generation revenues

Revenues for the nine months ended July 31, 2017 from generation totaled $5.4 million, compared to $0.5 million for the nine months ended July 31, 2016.  Revenues for the nine months ended July 31, 2017 reflects revenue from electricity generated from the Company’s PPAs. Cost of generation totaled $3.9 million in the nine months ended July 31, 2017, compared to $0.6 million for the comparable prior year period.  The increases represent the growth in the Company’s operating portfolio. As of July 31, 2017, the Company had 11.2 megawatts of operating power plants in its portfolio.

Advanced technologies contract revenues

Advanced technologies contracts revenue and related costs for the nine months ended July 31, 2017 and 2016 were as follows: