Unassociated Document
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
(Mark
One)
x |
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the
fiscal year ended: October
31, 2007
OR
o |
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the
transition period from ___________ to ___________
Commission
File Number: 1-14204
FUELCELL
ENERGY, INC.
(Exact
name of registrant as specified in its charter)
Delaware
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|
06-0853042
|
(State
or other jurisdiction of
|
|
(I.R.S.
Employer
|
incorporation
or organization)
|
|
Identification
Number)
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3
Great Pasture Road
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|
|
Danbury,
Connecticut
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|
06813
|
(Address
of principal executive offices)
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|
(Zip
Code)
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Registrant’s
telephone number, including area code
(203) 825-6000
Securities
registered pursuant to Section 12(b) of the Act.
None.
Securities
registered pursuant to Section 12(g) of the Act:
Common
Stock, $0.0001 Par Value
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act.
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.
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this
Form 10-K o
Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check
one):
Large Accelerated Filer
o |
Accelerated Filer x |
Non-accelerated Filer
o |
Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Act).
The
aggregate market value of voting and non-voting common equity held by
non-affiliates of the registrant known to us as of April 30, 2007 was
approximately $478.1 million, which is based on the closing price of $7.04
on
April 30, 2007.
On
January 10, 2008 there were 68,398,582 shares
of
common stock of the registrant issued and outstanding.
DOCUMENTS
INCORPORATED BY REFERENCE Certain
information contained in the registrant’s definitive proxy statement relating to
its forthcoming 2008 Annual Meeting of Shareholders to be filed not later than
120 days after the end of registrant’s fiscal year ended October 31, 2007 is
incorporated by reference in Part III of this Annual Report on Form
10-K.
FUELCELL
ENERGY, INC.
INDEX
|
Description
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|
Page
Number
|
Part
I
|
|
|
|
Item
1
|
Business
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|
6
|
Item
1A
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Risk
Factors
|
|
23
|
Item
1B
|
Unresolved
Staff Comments
|
|
36
|
Item
2
|
Properties
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36
|
Item
3
|
Legal
Proceedings
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|
|
Item
4
|
Submission
of Matters to a Vote of Security Holders
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|
|
|
|
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Part
II
|
|
|
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Item
5
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Market
for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
|
|
37
|
Item
6
|
Selected
Financial Data
|
|
45
|
Item
7
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
|
47
|
Item
7A
|
Quantitative
and Qualitative Disclosures about Market Risk
|
|
63
|
Item
8
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Consolidated
Financial Statements and Supplementary Data
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|
64
|
Item
9
|
Changes
In and Disagreements with Accountants on Accounting and Financial
Disclosure
|
|
98
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Item
9A
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Controls
and Procedures
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|
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Item
9B
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Other
Information
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100
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|
|
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|
Part
III
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|
|
|
Item
10
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Directors,
Executive Officers and Corporate Governance
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100
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Item
11
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Executive
Compensation
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|
100
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Item
12
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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100
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Item
13
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Certain
Relationships and Related Transactions, and Director
Independence
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100
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Item
14
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Principal
Accountant Fees and Services
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100
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|
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Part
IV
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|
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Item
15
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Exhibits
and Financial Statement Schedules
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101
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|
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Signatures
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|
|
104
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Forward-looking
Statement Disclaimer
When
used
in this Report, the words “expects”, “anticipates”, “estimates”, “should”,
“will”, “could”, “would”, “may”, and similar expressions are intended to
identify forward-looking statements. Such statements relate to the development
and commercialization of our fuel cell technology and products, future funding
under government research and development contracts, the expected cost
competitiveness of our technology, and our
ability to achieve our sales plans and cost reduction targets.
These
and other 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, without
limitation, general risks associated with product development and introduction,
changes in the utility regulatory environment, potential volatility of energy
prices, government appropriations, the ability of the government to terminate
its development contracts at any time, rapid technological change, and
competition, as well as other risks contained under Item 7 “Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Factors That May Affect Future Results” of this Report. We cannot assure you
that we will be able to meet any of our development or commercialization
schedules, that the government will appropriate the funds anticipated by us
under our government contracts, that the government will not exercise its right
to terminate any or all of our government contracts, that any of our products
or
technology, once developed, will be commercially successful, or that we will
be
able to achieve any other result anticipated in any other forward-looking
statement contained herein. The forward-looking statements contained herein
speak only as of the date of this Report. Except for ongoing obligations to
disclose material information under the federal securities laws, we expressly
disclaim any obligation or undertaking to release publicly any updates or
revisions to any such statement to reflect any change in our expectations or
any
change in events, conditions or circumstances on which any such statement is
based.
Background
Information
contained in this Report concerning the electric power supply industry and
the
distributed generation market, our general expectations concerning this industry
and this market, and our position within this industry are based on market
research, industry publications, other publicly available information and on
assumptions made by us based on this information and our knowledge of this
industry and this market, which we believe to be reasonable. Although we believe
that the market research, industry publications and other publicly available
information are reliable, including the sources that we cite in this Report,
they have not been independently verified by us and, accordingly, we cannot
assure you that such information is accurate in all material respects. Our
estimates, particularly as they relate to our general expectations concerning
the electric power supply industry and the distributed generation market,
involve risks and uncertainties and are subject to change based on various
factors, including those discussed under “Factors That May Affect Future
Results” in Item 7 of this Report.
We
define
distributed generation as small (typically 50 megawatts or less) electric
generation plants (combustion-based such as engines and turbines as well as
non-combustion-based such as fuel cells) located at or near the end use
customer. This is contrasted with central generation that we define as large
power plants (typically hundreds of megawatts to 1,000 megawatts or larger)
that
deliver electricity to end users through a comprehensive transmission and
distribution system.
As
used
in this Report, all degrees refer to Fahrenheit (“F”) and kilowatt and megawatt
numbers designate nominal or rated capacity of the referenced power plant.
As
used in this Annual Report, “efficiency” or “electrical efficiency” means the
ratio of the electrical energy (“AC”) generated in the conversion of a fuel to
the total energy contained in the fuel. Lower heating value, the standard for
power plant generation assumes the water in the product is in vapor form; as
opposed to higher heating value, which assumes the water in the product is
in
the liquid form, net of parasitic load; “overall energy efficiency” refers to
efficiency based on the electrical output plus useful heat output of the power
plant; “kilowatt” (“kW”) means 1,000 watts; “megawatt” (“MW”) means 1,000,000
watts; “kilowatt hour” (“kWh”) is equal to 1kW of power supplied to or taken
from an electric circuit steadily for one hour, and “Btu” is equal to one
million British Thermal Unit (the amount of heat necessary to raise one pound
of
pure water from 59oF
to
60oF
at a
specified constant pressure).
All
dollar amounts are in U.S. dollars unless otherwise noted.
Additional
technical terms and definitions:
Alternating
Current (“AC”) — Electric
current where the magnitude and direction of the current varies cyclically,
as
opposed to Direct
Current (“DC”),
where
the direction of the current stays constant. The usual waveform in an AC power
circuit is a sine wave, as this results in the most efficient transmission
of
energy. AC refers to the form in which energy is delivered to businesses and
residences.
Anaerobic
Digester Gas - Fuel
gas
produced in biomass digesters employing bacterial and controlled oxygen
environment from municipal, industrial or commercial water treatment
facilities.
Anode
-An
active
fuel cell component functioning as a negative electrode, where oxidation of
fuel
occurs. Also referred to as “fuel electrode.”
Availability
- An
industry standard (IEEE (The Institute of Electrical and Electronics Engineers)
762, “Definitions for Use in Reporting Electric Generating Unit Reliability,
Availability and Productivity”) used to compute total operating period hours
less the amount of time a power plant is not producing electricity due to
planned or unplanned maintenance. “Availability percentage” is calculated as
total operating hours since commercial acceptance date (mutually agreed upon
time period when our DFC power plants have operated at a specific output level
for a specified period of time) less hours not producing electricity due to
planned and unplanned maintenance divided by total period hours. Grid
disturbances, force majeure events and site specific issues such as a lack
of
available fuel supply or customer infrastructure repair do not penalize the
calculation of availability according to this standard.
Balance
of Plant (“BOP”) - Balance
of plant consists of the remaining systems, components, and structures that
comprise a complete power plant or energy system that are not included in
the fuel cell stack module. The Company manufactures the fuel cell stack module
and procures the balance of plant (items such as fuel handling, processing
equipment and electrical interface equipment such as inverters to convert the
fuel cell stack module’s DC electricity output to AC) from third
parties.
Cathode
- An
active
fuel cell component functioning as
a
positive (electrically) electrode, where reduction of oxidant occurs. Also
referred to as “oxidant electrode.”
Co-generation
Configuration - A
power
plant configuration featuring simultaneous onsite
generation of electricity and recovery of waste heat to produce process steam
or
hot water, or to use heat for space heating.
Humid
Flue Gas - Exhaust
gas from fuel cell and other power plants or a furnace. The gas typically
contains humidity (moisture).
Metallic
Bipolar Plates - The
conductive plates used in a fuel cell stack to provide electrical continuity
from active components of one cell to those in an adjacent cell. The plates
also
provide isolation of fuel and air fed to the fuel cell.
Microturbine
- A
gas
turbine with typical power output ranges of 30 kW to 350 kW. Microturbines
are
characterized by low-pressure ratios (less than 5) and high-speed alternators.
Nitrogen
Oxides (“NOX”) — Generic
term for a group of highly reactive gases, all of which contain nitrogen and
oxygen in varying amounts. Many of the NOX are colorless and odorless. However,
one common pollutant, Nitrogen
Dioxide (“NO2”),
along
with particles in the air, can often be seen as a reddish-brown layer over
many
urban areas. NOX form when fuel is burned at high temperatures, as in a
combustion process. The primary manmade sources of NOX are motor vehicles,
electric utilities, and other industrial, commercial and residential sources
that burn fuels.
Reforming
- Catalytic
conversion of hydrocarbon fuel (such as pipeline natural gas or digester gas)
to
hydrogen-rich gas. The hydrogen-rich gas serves as a fuel for the
electrochemical reaction.
Renewable
Portfolio Standards (“RPS”) -
States
seeking to secure cleaner energy sources are setting standards that require
utilities provide a certain amount of their electricity from renewable sources
such as solar, wind or other biomass-fueled technologies, including fuel
cells. These standards are referred to as Renewable Portfolio Standards. There
are currently 23 states and the District of Columbia with RPS programs that
mandate a certain percentage of their electricity be generated from renewable
resources. Fuel cells using biomass fuels qualify as renewable power generation
technology in all of these states, and certain states (Connecticut,
Hawaii, Maine, New York and Pennsylvania) specify
that fuel cells operating on natural gas are eligible under these standards.
Sulfur
Oxide (“SOX”) - Sulfur
oxide refers to any one of the following: sulfur monoxide, sulfur dioxide
(“SO2”) and sulfur trioxide. SO2 is a byproduct of various industrial processes.
Coal and petroleum contain sulfur compounds, and generate SO2 when
burned.
Synthesis
Gas - A
gas
mixture of hydrogen and carbon monoxide generally derived from gasification
of
coal or other biomass. It can serve as a fuel for the fuel cell after any
required fuel clean up.
Item
1. BUSINESS
OVERVIEW
FuelCell
Energy is a world leader in the development and manufacture of fuel cell power
plants for ultra-clean, efficient and reliable electric power
generation. Our products are designed to meet the 24/7 baseload power needs
of commercial, industrial, government and utility customers. To date our
products have generated over 200 million kWh of electricity and are operating
at
over 40 locations around the world.
We
have
been developing fuel cell technology since our founding in 1969. Our core
carbonate fuel cell products (“Direct FuelCell®
or
DFC®
Power
Plants”) offer stationary power generation applications for customers. In
addition to our current commercial products, we continue to develop our next
generation of carbonate fuel cell, hybrid products and planar solid oxide fuel
cell (“SOFC”) technology with our own and government research and development
funds.
Our
proprietary carbonate DFC power plants electrochemically (without combustion)
produce electricity directly from readily available hydrocarbon fuels, such
as
natural gas and biogas fuels. Customers buy fuel cells to reduce cost, pollution
and improve reliability. Electric generation without combustion significantly
reduces harmful pollutants such as NOX and particulates. Higher fuel efficiency
results in lower emissions of carbon dioxide (“CO2”), a major component of
harmful greenhouse gases, and also results in less fuel needed per kWh of
electricity generated and Btu of heat produced, thereby reducing exposure to
volatile natural gas costs and minimizing operating costs. Our fuel cells
operate 24/7 providing reliable power to either on-site customers or in
grid-support applications.
We
believe that compared to other power generation technologies, our products
offer
significant advantages including:
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·
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Ultra-clean
(e.g. virtually zero emissions), quiet
operation
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·
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Reliable,
24/7 baseload power
|
|
·
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Ability
to site units locally
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|
·
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Potentially
lower cost power generation
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·
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Byproduct
high-temperature heat ideal for cogeneration (combined heat and power)
applications.
|
Typical
customers for our products include manufacturers, mission critical institutions
such as correction facilities and government installations, hotels, and
customers who can use renewable gas for fuel such as breweries, food processors
and wastewater treatment facilities. With increasing demand for renewable and
ultra-clean power options, and increased volatility and uncertainty in electric
markets, our customers gain control of power generation economics, reliability
and emissions. Our fuel cells also offer flexible siting and easy permitting.
DFC
power
plants are protected by 52 U.S. and 92 international patents and we have also
submitted 37 U.S. and 149 international patent applications.
2007
Update
We
made
significant progress executing our business plan to reduce costs and to increase
market share in our target markets. Our target markets are those that can
provide repeatable business and those where we can sell multi-MW products such
as California, Connecticut and Asia.
In
fiscal
2007, customers ordered 14.8 MW compared to 5.05 MW in the prior year. 12.1
MW
of our orders were for multi-unit or MW-sized products. We ended the fiscal
year
with 15.55 MW in backlog. Subsequent to yearend we closed an additional 9.45
MW
of orders to end calendar year 2007 with 25 MW in backlog.
Our
South
Korean partner, POSCO Power, ordered 12.6 MW of our DFC power plants during
the
calendar year, of which 12.0 MW are MW-class power plants including three
DFC3000 2.4 MW power plants. In early 2007, we signed a 10-year manufacturing
and distribution agreement with POSCO Power. Under the agreement, POSCO Power
is
building a 50 MW BOP manufacturing facility, expected to be operational in
late
2008. When its facility is completed, POSCO Power intends to order fuel cell
stack modules from us to be integrated with the BOP manufactured in Korea.
We
continue to demonstrate strong market leadership in California with 8.35 MW
of
DFC power plant orders in calendar year 2007. By comparison, we received 3.1
MW
of orders from California customers in calendar 2006. Order totals included
a
3.9 MW order from the The Linde Group. Linde’s model is to transport biogas
produced at a wastewater treatment plant to customer sites to operate the fuel
cells. Wastewater treatment customers continue to be among our best customers
having ordered 7 MW during calendar 2007.
Connecticut’s
Project 100 moved through the regulatory process throughout 2007 and in January
2008, 16.2 MW of projects that include our fuel cells are pending approval
by
the Department of Public Utility Control. The final decision is expected January
23, 2008, after which the project developers can finalize power purchase
agreements with utilities and complete their financing arrangements. In addition
to the Project 100 developments, Pepperidge Farm Inc. ordered, a 1.2 MW DFC1500
to add to its existing DFC300 for its bakery operations in Bloomfield,
Connecticut.
We
continue to engineer cost reductions to our products, institute production
process improvements to increase the efficiency of our manufacturing and
commissioning operations, and implement a global sourcing program. We
achieved cost reductions of 14 percent and 24 percent for the DFC300 and
DFC1500, respectively, through value engineering and manufacturing operations
in
2007.
In 2008,
we expect to produce our 2.4 MW DFC3000 for approximately $3,250 per kW, our
1.2
MW DFC1500 for approximately $3,400 per kW and our 300kW DFC300 for
approximately $4,200 per kW.
Markets
The
market for ultra-clean power generation is increasing as evidenced by the recent
growth of wind and solar applications. Driving this growth are concerns about
the limited supply and rising cost of fossil fuels and environmental concerns.
According to the International Energy Agency (IEA), fossil fuels such as coal,
oil and natural gas generated approximately 66 percent of the world’s
electricity in 2003. The Energy Information Administration (EIA) reported that
renewable sources including hydroelectric, biomass, geothermal, wind and solar
accounted for approximately 8.8 percent of electricity generated in the U.S.
With the primary source of electric generation still driven by fossil fuels,
markets need new power generation products that are more efficient,
environmentally superior, cost effective and operate with 24/7 reliability
such
as DFC fuel cells.
On-Site
Power. Stationary
fuel cell power plants can be an economical alternative to utility-provided
power and other distributed generation products. Customers can often produce
power with our products for less than the local utility price or other competing
distributed generation products. Wastewater treatment facilities and brewery
companies, for instance, can use a byproduct of their own processes, methane,
to
operate their fuel cells. This allows them to eliminate gas flaring or
combusting the gas in conventional power generation equipment, both of which
add
to pollution. Customers gain the added benefits of quiet operation,
improved reliability, reduced carbon dioxide output and lower
emissions.
As
we
reduce our product costs, we are able to price our products competitively in
the
markets in which we compete. In California, for instance, factoring in the
value
of the heat used for cogeneration, government incentives, and possible offsets
due to emissions credits, the net cost to the end user of our products is
approximately $0.10 to $0.12/kWh, depending on location and application. We
believe this is competitive with grid-delivered electricity and other
distributed generation products in our target markets. Tougher emission
standards increase the cost of competing distributed generation products and
as
our costs continue to come down, we will be increasingly more competitive in
more markets.
Utility
or RPS.
States
seeking to secure cleaner energy sources are setting standards that require
utilities to provide a certain amount of their electricity from renewable
sources such as solar, wind, biomass-fueled technologies and fuel cells. There
are currently 25 states and the District of Columbia that have instituted RPS
mandates. These markets represent a potential for an estimated 25,000 MW. DFC
fuel cells offer utilities and end-use customers in RPS states economical,
24/7,
reliable ultra-clean power that can be sited in grid-constrained areas, avoiding
substantial transmission and distribution equipment upgrades.
Fuel
cells using biogas fuels qualify as renewable power generation technology in
all
of the RPS states, with several states specifying that fuel cells operating
on
natural gas are eligible for these initiatives. As more renewables such as
wind
and solar are incorporated into the electric grid infrastructure, our fuel
cells
operating on natural and biogas can balance the intermittent nature of wind
and
solar with highly efficient, 24/7 electric power.
Business
Strategy
Our
business strategy is to expand our leadership position in key markets, build
multi-megawatt markets and continue to reduce the costs of our products. A
product mix weighted more heavily with MW-class products is our fastest path
to
achieve profitability. In 2008, our focus will be as follows:
Build
on our leadership position in vertical and geographic markets -
|
·
|
California
-
We are the fuel cell market leader in California where high electricity
costs and stringent environmental regulations make our products a
compelling value proposition for customers. California extended
its Self-Generation Incentive Program (SGIP) to 2012. The SGIP provides
annual incentives, at least $80 million in 2008, for which our fuel
cell
products are eligible.
|
|
·
|
Asia
--
Asia continues to be among our best markets due to high electricity
costs,
environmental regulations and incentives for fuel cells. In 2006,
South
Korea enacted substantial subsidies to promote renewable energy
technologies as part of a national carbon dioxide reduction effort.
Fuel
cells are eligible for up to 28 cents per kWh and 50 MW of generation
will
qualify for these funds. Because the electricity generated must first
be
exported to the grid, the incentives are expected to drive the
installation of MW-class power plants. To date, POSCO Power has ordered
12.6 MW of our power plants, of which 12.0 MW were
MW-class.
|
|
·
|
Europe
-
The European Union and member countries have various initiatives
underway
to promote clean energy. New and expanding incentives in the United
Kingdom, Germany, Spain and elsewhere could result in more sales
and we
are positioned to capitalize on this growth with our European distribution
partner, CFC Solutions GmbH.
|
Build
Multi-Megawatt Markets -
RPS
programs mandate a certain percentage of electricity be generated from renewable
and ultra-clean resources. Our multi-MW products in installations from 2 to
50
MW and our pipeline applications are well suited to address these markets.
Several near term opportunities that we are addressing are:
|
·
|
Connecticut
-
FuelCell Energy and its partners submitted multi-MW bids to the
Connecticut Clean Energy Fund (CCEF) in December 2006 and the CCEF
recommended six projects to go to the utilities for review. After
conducting their analysis, the utilities forwarded all of the projects
to
the utility regulator, Connecticut’s Department of Public Utility Control
(DPUC) for the final review which was completed in January 2008.
The DPUC
preliminarily selected projects totaling 16.2 MW using six DFC3000
power
plants. A final decision is expected on January 23, 2008 which will
allow
project developers to negotiate power purchase agreements with the
utilities and then finalize their financing.
|
|
·
|
Natural
Gas Pipeline Applications
-
FuelCell Energy sold a 1.2 MW fuel cell power plant to Enbridge,
Inc. for
inclusion in a Direct FuelCell-Energy Recovery Generation™ (DFC-ERG™)
system in Toronto, Canada, that combines our fuel cells with a turbine
to
achieve up to 65 percent efficiency in power generation. The system
generates ultra-clean electricity while recovering energy normally
lost
during natural gas pipeline operations. A second DFC-ERG system is
part of
the 16.2 MW of projects pending approval by the DPUC in Connecticut.
If
approved, this system will generate 9 MW (7.2 MW from our fuel cells
and
1.8 MW from a turbine) of ultra-clean energy in Milford, Connecticut
and
will be the largest fuel cell installation anywhere in the world
upon
completion.
|
|
·
|
South
Korea
-
Our manufacturing and distribution partner, POSCO Power, ordered
7.8 MW of
our power plants in fiscal 2007, and another 4.8 MW after the close
of the
fiscal year in November 2007. South Korea’s RPS requires the installation
of ultra-clean power systems that export power to the electric grid
thus
encouraging the installation of multi-MW power plants. We expect
POSCO
Power to continue to aggressively seed its market with our DFC products
to
prepare for a more extensive market penetration after its new BOP
plant
opens in late 2008.
|
Product
Cost Reduction -
|
·
|
FuelCell
Energy will continue its cost out initiatives in order to deliver
competitively priced and environmentally friendly distributed generation
products to the market. Our cost reduction efforts are now in their
fifth
year and we have reduced product costs by over 60 percent since the
program began. As a result, our largest product, the 2.4 MW DFC3000,
has a
product cost of $3,250 per kW, which is close to market clearing
prices in
our target markets and both of our MW-class products could benefit
from
volume production that would reduce the cost another 10 to 20 percent
without further design changes.
|
|
·
|
We
achieved cost reductions of 14 percent and 24 percent for the DFC300
and
DFC1500, respectively, through value engineering and improvement
to
manufacturing operations in 2007.
|
|
·
|
In
2008, we are targeting cost reductions of 20 percent for the MW-class
DFC1500 and DFC3000 through additional power output increases (uprate),
strategic sourcing and continued manufacturing improvements.
|
|
·
|
We
are also working to increase stack life which is expected to result
in
lower operating and maintenance costs across the entire product line.
|
At
a
sustained annual order and production volume of approximately 35 MW to 50 MW,
depending on product mix, geographic location and other variables such as fuel
prices, we believe we can reach gross margin breakeven. We believe that net
income breakeven can be achieved at a sustained annual order and volume
production of approximately 75-100 MW. Since the cost of our 2.4 MW product
is
close to market clearing prices in our target markets, profitability could
be
achieved on lower production volumes if product mix trends more toward MW and
multi-MW orders.
PRODUCTS
Direct
FuelCell® (DFC®) Power Plants
Our
core
products, the DFC300, DFC1500 and DFC3000, are currently rated in capacity
at
300 kW, 1.2 MW and 2.4 MW, respectively and are designed for applications up
to
50 MW. Our products are designed to meet the baseload power requirements of
a
wide range of customers including wastewater treatment plants (municipal, such
as sewage treatment facilities, and industrial, such as breweries and food
processors), hotels, manufacturing facilities, universities, hospitals,
telecommunications/data centers, government facilities, as well as grid support
applications for utility customers. Our DFC power plants can be part of a
total on-site power generation solution for customers, with our high efficiency
products providing the baseload power with grid-delivered electricity, and
intermittent power, such as solar, or less efficient combustion-based equipment,
providing peaking and load following energy needs. Our products are also ideal
to meet the needs of utilities and RPS mandates.
A
fuel
cell chemically converts a hydrocarbon fuel into electricity without combustion.
The primary byproducts of the fuel cell process are heat, water and carbon
dioxide. A fuel cell power plant can be thought of as having two basic segments:
the fuel cell stack module, the part that actually produces the electricity,
and
the balance of plant (BOP), which includes various fuel handling and processing
equipment, such as pipes and blowers, and electrical interface equipment such
as
inverters to convert the fuel cell stack module’s DC electricity output to AC.
There are virtually no SOX, NOX or particulate matter emissions.
Conventional
fossil fuel based power plants generate electricity by combustion of hydrocarbon
fuels, such as coal, oil or natural gas. With reciprocating engines, fuel
combustion takes place within the engine that drives a generator that produces
electricity. In a gas turbine combined cycle plant, fuels, such as natural
gas, are burned in the gas turbine, which drives a generator. The exhaust heat
from the gas turbine is used to boil water, which converts to high-pressure
steam, which is used to rotate a steam turbine generating additional
electricity. The combustion process typically creates emissions of SOX and
NOX,
CO2, carbon monoxide, soot and other air pollutants.
The
following table shows industry estimates of the electrical efficiency, operating
temperature, expected capacity range and certain other operating characteristics
of the principal types of fuel cells being developed for commercial
applications:
Fuel
Cell Type
|
|
Electrolyte
|
|
Electrical
Efficiency
Percentage
|
|
Operating
Temperature
oF
|
|
Expected
Capacity
Range
|
|
ByProduct
Heat Use
|
PEM
|
|
Polymer
Membrane
|
|
30-35
|
|
180
|
|
5
kW to
250
kW
|
|
Warm
Water
|
|
|
|
|
|
|
|
|
|
|
|
Phosphoric
Acid
|
|
Phosphoric
Acid
|
|
35-40
|
|
400
|
|
50
kW to
200
kW
|
|
Hot
Water
|
|
|
|
|
|
|
|
|
|
|
|
Carbonate
(Direct
FuelCell®)
|
|
Potassium/Lithium
Carbonate
|
|
45-57
|
|
1,200
|
|
300
kW to
2.4
MW and larger
|
|
Hot
water or High Pressure
Steam
|
|
|
|
|
|
|
|
|
|
|
|
Solid
Oxide (Tubular)
|
|
Stabilized
Zirconium dioxide Ceramic
|
|
45-50
|
|
1,800
|
|
100
kW to
3
MW
|
|
Hot
water or
High
Pressure
Steam
|
|
|
|
|
|
|
|
|
|
|
|
Solid
Oxide (Planar)
|
|
Stabilized
Zirconium dioxide Ceramic
|
|
40-60
|
|
1,200-1,600
|
|
3
kW to 1 MW and larger
|
|
Hot
water or High Pressure Steam
|
Our
carbonate fuel cell, known as the Direct FuelCell, operates at approximately
1200°F. This temperature avoids the use of precious metal electrodes required by
lower temperature fuel cells, such as proton exchange membrane (“PEM”) and
phosphoric acid, and the more expensive metals and ceramic materials required
by
higher temperature fuel cells, such as tubular solid oxide. As a result, we
are
able to use less expensive catalysts and readily available metals in our
designs. In addition, our fuel cell produces high quality by-product heat
energy (700°F) that can be harnessed for combined heat and power (“CHP”)
applications using hot water, steam or chiller water to heat or cool buildings.
Our
Direct FuelCell is so named because of its ability to generate electricity
directly from a hydrocarbon fuel, such as natural gas or wastewater treatment
gas, by reforming the fuel inside the fuel cell to produce hydrogen. We believe
that this “one-step” reforming process results in a simpler, more efficient and
cost-effective energy conversion system compared with external reforming fuel
cells. External reforming fuel cells, such as PEM and phosphoric acid, generally
use complex, external fuel processing equipment to convert the fuel into
hydrogen. This external equipment increases capital cost and reduces electrical
efficiency. Additionally, natural gas and wastewater treatment gas have
infrastructures that are already established. Consequently, our DFC products
do
not need to wait for the development of the hydrogen infrastructure for
continued commercialization.
Our
fuel
cells have been operated using a variety of hydrocarbon fuels, including natural
gas, methanol, diesel, biogas, coal gas, coal mine methane and propane.
Our commercial DFC power plants currently can achieve an electrical efficiency
of 47 percent. Depending on location, application and load size, a
co-generation configuration can reach an overall energy efficiency of between
65
percent and 85 percent.
MARKETS
AND APPLICATIONS
We
have
established a leading position in the sale of fuel cell power plants and
strengthened our position by continuing to improve our product performance
and
availability, reducing costs for our MW and sub-MW products, and expanding
repeatable markets for our DFC products. Our cumulative fleet availability
continues to exceed 90 percent and our newer units are achieving greater than
95
percent availability at customer sites.
Distributed
Generation Markets
We
compete in the distributed generation marketplace. We believe distributed
generation can be a more cost-effective solution than traditional grid-delivered
electricity because of the following features:
|
·
|
Provides
better economics.
Distributed generation avoids transmission and distribution system
investment; reduces line losses; can use the heat byproduct from
on-site
power generation; and offers the ability to control energy costs
through
fuel flexibility and efficiency.
|
|
·
|
Increases
reliability by locating power closer to the end
user.
On-site power generation bypasses the congested transmission and
distribution system, increasing electrical
reliability.
|
|
·
|
Eases
congestion in the transmission and distribution
system.
Each kW of on-site power generation removes the need for the same
amount
from the centralized transmission and distribution system, thereby
easing
congestion that can cause power outages and hastening the grid recovery
after electrical infrastructure problems have been
resolved.
|
|
·
|
Reduces
the need for transmission and distribution line investments and provides
greater capacity utilization in less time.
On-site, distributed generation can be added in increments that more
closely match expected demand in a shorter time frame (weeks to months)
compared with traditional central power generating plants and transmission
and distribution systems (often 36 months or longer) which require
more
extensive siting and right of way approvals. Siting distributed generation
can defer or avoid massive transmission and distribution investment
such
as unpopular above ground high voltage lines or very expensive underground
high voltage lines.
|
|
·
|
Enhances
security.
By locating smaller, incremental power plants in dispersed locations
closer to energy consumers, distributed generation can reduce dependence
on a vulnerable centralized electrical
infrastructure.
|
Our
fuel
cell products are competitive in this marketplace because of superior product
attributes including higher operational efficiency, lower emissions and the
ability to utilize multiple fuels.
Applications
Target
applications include those where customers can use renewable fuels such as
wastewater treatment facilities, breweries and food processors. Other on-site
applications include those facilities which require reliable 24/7 baseload
power
and ultra-clean distributed generation including manufacturers, mission critical
institutions such as correction facilities and government installations, hotels
and hospitals.
As
a
result of the high efficiency and flexible siting of our power plants, another
application well suited for our fuel cells is grid support where utilities
can
provide baseload power in grid-constrained areas to avoid substantial
transmission and distribution equipment upgrades. In this application,
distributed generation can be a superior choice to new central generation.
Strategic
Alliances and Market Development Agreements
Our
original equipment manufacturer (“OEM”) and energy service company (“ESCO”)
partners have extensive experience in designing, manufacturing, distributing
selling and servicing energy products worldwide. We believe our strength
in the development of fuel cell products coupled with their understanding of
sophisticated commercial and industrial customers, products and services will
enhance the sales, service and product development of our products.
POSCO
Power. In
November 2004, we and Marubeni Corp. signed an agreement with POSCO Power to
distribute and package DFC power plants in South Korea. POSCO Power has
extensive experience in power plant project development, building over 2,400
megawatts of power plants, equivalent to 3.7 percent of South Korea’s national
capacity, for its various facilities. POSCO Power is a subsidiary of POSCO,
a
world leader in the materials industry and is one of world’s largest producers
of steel.
In
February, 2007, we signed a 10-year manufacturing and distribution agreement
with POSCO. Under the agreement, we will supply POSCO Power with fuel cells
until it builds its own 50 MW BOP facility, expected by the end of 2008. After
the facility is running, we expect POSCO to procure from us fuel cell stack
modules which will be incorporated into power plants that they will sell,
install and service.
Since
the
signing of the agreement, POSCO
Power has ordered 12.6 MW of DFC power plants through December 31, 2007, of
which 12.0 MW are MW-class power plants. In addition, POSCO has formed a
partnership with KEPCO, South Korea’s largest power provider through which it
expects to develop the fuel cell market throughout the country.
Enbridge
Inc.
Enbridge, a leader in energy transportation and distribution in North America
and internationally, expanded our market development agreement to include
current DFC product distribution in the U.S. as well as Canada, and to include
the new DFC-ERG™ product that they co-developed with us in North America. The
first 1.2 MW unit is scheduled to ship to Enbridge’s headquarters in Toronto and
the second unit, that includes 7.2 MW of our fuel cells, is included as one
of
the Connecticut Project 100 projects pending approval.
In
2005,
we issued warrants to Enbridge to purchase up to 1,000,000 shares of our common
stock in conjunction with an amended distribution agreement. As of October
31,
2007, 212,500 warrants expired unvested and the remaining available unvested
warrants totaled 750,000 with exercise prices ranging from $10.88 to $11.87
per
share and expiration dates ranging from October 31, 2008 to October 31, 2011.
Marubeni
Corporation.
We
have
installed 4.75 MW and currently have in
backlog
from Marubeni an additional 1.5 MW of sales orders. Four DFC300 units, totaling
1 MW in output, were installed at Sharp Ltd.’s “super-green” factory in Kameyama
Prefecture, where Sharp manufactures LCD screens for its flat-panel television
displays. The 1 MW fuel cell installation provides baseload power to the
facility, while 5 MW of Sharp’s own photovoltaic modules provide peaking power.
Marubeni invested $10 million in our company in 2001 through the purchase of
approximately 268,000 shares of our common stock.
CFC
Solutions GmbH.
CFC
Solutions, a Tognum Group Company headquartered in Ottobrunn, Germany, was
a
co-developer of our DFC technology. Our first sub-MW power plant was a
collaborative effort using our DFC technology and the Hot Module®
BOP
designed by MTU Friedrichschafen GmbH now known as CFC Solutions. As an OEM
developer of stationary fuel cell power plants, CFC Solutions assembles and
stacks the DFC components that we sell to them and then adds their mechanical
and electrical BOP for ultimate sale to their customers. Nine units are
operating in Europe. CFC Solutions’ parent company, The Tognum Group, owns
approximately 2.7 million shares of our common stock and is represented on
our
Board of Directors.
Caterpillar,
Inc.
DFC units have been shipped to several commercial Caterpillar customers
including: a municipal wastewater treatment application for the Sanitation
Districts of Los Angeles County in Palmdale, California; and the State
University of New York College of Environmental Science and Forestry.
Energy
Service Company Distribution Partners. We
also
partner with energy service companies that have expertise in the markets in
which we are competing. These partners include: Alliance
Power, Inc., Chevron Energy Solutions, The Linde Group, LOGANEnergy Corp and
PPL
Energy Plus. Alliance Power is based in Colorado and specializes in small power
generation equipment. Alliance has completed 9.6 MW of projects incorporating
our products, including many of our wastewater treatment projects and 3.0 MW
of
power plants in California operating under power purchase agreements. The Linde
Group, a world leading gases and engineering company, ordered 3.9 MW of our
fuel
cells which it will locate at customer sites in California and will transport
biogas from Point Loma, California for use in our fuel cells.
COMPETITION
We
compete on the basis of our products’ reliability, fuel efficiency,
environmental considerations and cost. We believe that our DFC carbonate
fuel cell offers competitive and environmental advantages over other fuel cell
designs and other combustion-based technologies for stationary baseload power
generation.
Our
DFC
power plants specifically provide the following attributes that provide an
advantage over other distributed technologies of similar size:
|
·
|
Higher
operational efficiency.
Our DFC power plants currently achieve electrical efficiencies of
up 47
percent and an overall energy efficiency of 65 to 85 percent for
CHP
applications. This is significantly greater than the fuel efficiency
of
competing fuel cell and combustion-based technologies of similar
size and
results in a lower cost per kWh over the life of the power
plant.
|
|
·
|
Lower
emissions.
Our DFC power plant installations have lower emissions of carbon
dioxide,
and significantly lower emissions of other harmful pollutants, such
as
SOX, NOX and particulate matter, than conventional combustion-based
power
plants. They have been designated ultra-clean by the California Air
Resources Board (“CARB”), and our DFC products are certified to CARB 2007
emissions standards.
|
Emissions
of fuel cell power plants versus traditional combustion-based power plants
are
as follows:
|
|
Emissions
(Lbs. Per MWh)
|
|
|
|
NOX
|
|
SO2
|
|
PM10
|
|
CO2
|
|
CO2
with CHP
|
|
Average
U.S. Fossil Fuel Plant
|
|
|
5.06
|
|
|
11.6
|
|
|
0.27
|
|
|
2,031
|
|
|
NA
|
|
Microturbine
(60 kW)
|
|
|
0.44
|
|
|
.008
|
|
|
0.09
|
|
|
1,596
|
|
|
520
- 680
|
|
Small
Gas Turbine
|
|
|
1.15
|
|
|
.008
|
|
|
0.08
|
|
|
1,494
|
|
|
520
- 680
|
|
Direct
Fuel Cell
|
|
|
0.01
|
|
|
0.0001
|
|
|
0.00002
|
|
|
980
|
|
|
520
- 680
|
|
Source:
“Model Regulations for the Output of Specified Air Emissions from Smaller Scale
Electric Generation Resources Model Rule and Supporting Documentation”, October
15, 2002; The Regulatory Assistance Project report to National Renewable Energy
Laboratory. PM10
=
particulate matter.
|
·
|
Utilize
multiple fuels.
Our DFC power plants can use many fuel sources, such as natural gas,
bio-gas from wastewater treatment facilities, food processors and
breweries and coal gas (escaping gas from active and abandoned coal
mines
as well as synthesis gas processed from coal), thereby enhancing
independence from imported oil and allowing customers to have fuel
flexibility. Our DFC power plants can provide customers with an option
to
choose the least expensive
alternative.
|
|
·
|
Provide
end users with greater control of their energy costs.
Due
to the high efficiency of our DFC power plants, end users may select
to
have their firm, 24/7 baseload power needs provided by our ultra-clean
products. The cost of utility-provided power continues to rise and
is
subject to large, unpredictable increases. Generating on-site power
with
known generating costs resulting from the operation of a DFC power
plant
gives customers a predictable component of their operations that
can be
budgeted and controlled.
|
Several
companies in the U.S. are involved in fuel cell development, although we believe
we are the only domestic company engaged in significant manufacturing and
commercialization of carbonate fuel cells. Emerging fuel cell technologies
(and
companies developing them) include PEM fuel cells (Ballard Power Systems, Inc.;
UTC Fuel Cells; and Plug Power), phosphoric acid fuel cells (UTC Fuel Cells
and
HydroGen) and solid oxide fuel cells (Siemens Westinghouse Electric Company;
Cummins; SOFCo; General Electric; Delphi; Rolls Royce and Acumentrics).
Each of these competitors has the potential to capture market share in our
target markets.
There
are
other potential carbonate fuel cell competitors internationally. In Asia,
IHI Corporation offers a 40 kW carbonate fuel cell. In Europe, a company
in Italy, Ansaldo Fuel Cells, is actively engaged in the development of a 100
kW
carbonate fuel cell and is a potential competitor. CFC Solutions and its
partners have been the most active in Europe.
Other
than fuel cell developers, we must also compete with electricity provided by
the
electric grid and manufacturers of more mature combustion-based equipment,
including various engines and turbines which have more established
manufacturing, distribution, operating and cost features. These manufacturers
include: Caterpillar, General Electric, Cummins Inc. and Detroit Diesel
Corporation (a subsidiary of DaimlerChrysler AG).
Significant
competition may also come from gas turbine companies like General Electric,
Ingersoll-Rand Company Limited, Solar Turbines Incorporated and Kawasaki, which
have recently made progress in improving fuel efficiency and reducing pollution
in large-size combined cycle natural gas fueled generators. These companies
have
made efforts to extend these advantages to smaller sizes. We believe,
however, that these smaller gas turbines will not be able to match our fuel
efficiency or favorable environmental characteristics.
MANUFACTURING
AND COST REDUCTION
Manufacturing
Process
We
have
established a 65,000 square foot manufacturing facility in Torrington,
Connecticut where we produce our repeating fuel cell components: the anode
and
cathode electrodes, metallic bipolar plates and the electrolyte matrix. These
stack components are combined and assembled into modules that are currently
delivered to our test and conditioning facilities in Danbury, Connecticut and
then shipped to the customer site for final testing with an assembled BOP.
Capacity
and Production Ramp-up
Our
manufacturing, testing and conditioning facilities have equipment in place
for a
production capacity of 50 MW per year. We believe manufacturing capacity can
be
increased to 125 - 150 MW within our existing Torrington facility through the
addition of parallel production lines and additional machinery. We also have
additional land surrounding our Torrington facility, on which we could expand
to
400 MW of annual production of our repeating fuel cell components.
We
are
currently investing in the equipment required to expand our manufacturing
capacity to 60 MW. Expansion of our manufacturing facilities beyond 60 MW would
also require new facilities for the fuel cell stack and module assembly, test
and conditioning which could be deployed regionally. These regional assembly,
test and conditioning facilities are expected to provide additional cost savings
as they will reduce shipping costs, enhance delivery times and improve customer
service.
Our
fiscal 2007 production volume was 12 MW and we are currently ramping production
to a 25 MW run-rate based upon our growing sales backlog. This increase in
the
production rate is scheduled to be complete in January of 2008. Future
production volumes will be adjusted depending on customer demand.
Raw
Materials and Supplier Relationships
We
use
various raw materials and components to construct a fuel cell module, including
nickel and stainless steel which are critical to our manufacturing process.
In
addition to manufacturing the fuel cell module in our Torrington facility,
the
electrical BOP and mechanical BOP are assembled by and procured from several
key
suppliers. All of our suppliers must undergo a qualification process, which
may
take between four and twelve months. We continually evaluate new suppliers
and
currently are qualifying several new suppliers.
Cost
Reduction
Our
2 MW
Santa Clara ‘proof-of-concept’ project in 1996-1997 cost more than $20,000/kW to
produce. In 2003, we shipped our first commercial product, a DFC300 to the
Kirin
Brewery which cost approximately $10,000/kW. At that time, we implemented our
commercial cost-out program hiring additional engineers who focused
on
reducing the total life cycle costs of our power plants. Since 2003, they have
made significant progress primarily through value engineering our products
and
increasing the power output by 20 percent. Our current manufactured cost is
approximately $3,250 per kW for our multi-MW power plant, $3,400 per kW for
our
MW plant and $4,200 per kW for the sub-MW product. Reducing product cost is
essential for us to further penetrate the market for our high temperature fuel
cell products. Cost reductions will reduce and/or eliminate the need for
incentive funding programs that are currently available to allow our product
pricing to compete with grid-delivered power and other distributed generation
technologies, and are critical to attaining profitability.
In
2007,
we focused our cost reduction efforts on the DFC300 and DFC1500 product lines.
The cost reduction efforts included improvements in strategic sourcing,
increasing the efficiency of our manufacturing operations, and continued value
engineering. Our strategic sourcing program included the development of a more
global, high quality, low cost supplier network. We also developed the design
of
a new, lower cost version of the DFC1500 product. The new DFC1500 is 28 percent
more compact than the previous version and features a four-stack Direct FuelCell
module. The 2007 cost reduction efforts achieved 14 percent and 24 percent
cost
reductions for the DFC300 and DFC1500 products, respectively. These cost savings
will be realized as the new designs are produced and our supplier base is
transitioned to new, lower cost strategic suppliers.
We
will
continue to emphasize its cost out initiatives to deliver the most cost
efficient and environmentally friendly power generation solutions to meet the
needs of our target markets. In 2008, the DFC1500 and DFC3000 products are
targeted to achieve cost reductions of 20 percent through an additional power
output increase (uprate), strategic sourcing and manufacturing improvements.
Increased production volume could also reduce that cost another 10 to 20
percent.
SERVICE
AND CUSTOMER SATISFACTION
Our
service organization offers comprehensive service and maintenance programs
including total fleet management, refurbishment and recycling services, and
complete product support including spare parts inventory. We are offering
service agreements at various levels for one to 13 years, with flexible renewal
options. The service organization’s primary task is to maintain a
high level of service for our end user customers during the warranty period
of
the original DFC equipment. In providing a wide range of services to
support the fleet during the warranty period, we have developed infrastructure
that is designed to capture revenue as the units in the field enter the period
past the standard one year warranty period as our installed base
increases.
Our
services include a 24/7 Call Center and a web-based information system network
that allows fingertip access to plant performance data. We have also established
regional parts warehouses including a rotable pool of spare stacks, fully
equipped regional field service teams, a stack repair/refurbishment center,
and
testing and conditioning facilities. All personnel complete an operator and
maintenance technician training program and work very closely with the
engineering and technology support organizations to service our products in
the
field. This infrastructure has enabled us to diagnose issues quickly and
maintain high customer satisfaction.
POWER
PURCHASE AGREEMENTS
Power
purchase agreements (PPAs) are a common arrangement in the energy industry,
whereby a customer purchases energy from an owner and operator of the power
generation equipment. A number of our partners enter into PPAs with end use
customers, such as Marubeni in Japan and Alliance Power in the U.S. After
purchasing DFC power plants from us, they own and operate the units, and
recognize revenue as energy is sold to the end user.
We
have
seeded the market with a number of Company-funded PPAs to penetrate key target
markets and develop operational and transactional experience. To date, we have
funded the development and construction of certain fuel cell power plants sited
near customers in California, and own and operate 3 MW of assets through PPA
entities in which we have an 80 percent ownership interest. As we enter into
multi-MW projects in the RPS markets and with the benefit of the federal
investment tax credit and accelerated depreciation in the Energy Policy Act
of
2005 we believe future PPAs will attract third party financing or ownership.
RESEARCH
AND DEVELOPMENT CONTRACTS
The
goal
of our research and development efforts is to improve our core DFC products
and
expand our technology portfolio in complementary high temperature fuel cell
systems. In addition, we are also conducting development work on advanced
applications for other fuel cell technologies, such as SOFC and PEM. A
significant portion of our research and development has been funded by
government contracts and is classified as cost of research and development
contracts in our consolidated financial statements. For the fiscal years ended
2007, 2006 and 2005, total research and development expenses, including amounts
received from the Department of Energy (“DOE”), other government departments and
agencies and our customers, and amounts that have been self-funded, were $40.9
million, $35.0 million, and $35.0 million, respectively.
Government
Research & Development Contracts
Since
1975, we have worked on the development of our DFC technology with various
U.S.
government departments and agencies, including the DOE, the Navy, the Coast
Guard, the Department of Defense, the Environmental Protection Agency, the
Defense Advance Research Projects Agency and the National Aeronautics and Space
Administration. Government funding, principally from the DOE, provided
approximately 33 percent, 35 percent and 43 percent of our revenue for the
fiscal years ended 2007, 2006 and 2005, respectively. From the inception
of our carbonate fuel cell development program in the mid-1970s to date, more
than $536 million
has been invested relating to government programs in support of the development
of our DFC technology.
Significant
research and development programs we are currently working on
include:
Direct
FuelCell/Turbine.
The
DOE’s Office of Fossil Energy established its Vision 21 Program in 1999 with the
objective of developing a “21st
Century
Energy Plant” that can generate electricity, heat and hydrogen from a variety of
feedstocks such as fossil fuels and biomass with high efficiency and low
environmental impact. Under this program, we were awarded
a $19.4
million cost-shared contract to develop a fuel cell / turbine hybrid power
plant.
In
2005,
we completed the fabrication of an alpha sub-MW power plant by the intregration
of a 250 kW DFC stack module with a Capstone C60 microturbine. The
microturbine supplements the power produced by the fuel cell, increasing the
system electrical efficiency. The unit was installed and grid-connected at
the
Billings Clinic in Billings, Montana and started generating power in April
2006.
During approximately 8,000 hours of operation, the
unit
achieved a record-breaking electrical efficiency of 56 percent, surpassing
all
distributed generation technologies in this size range. Emissions testing of
the
DFC/T system demonstrated compliance with the stringent California Air Resources
Board’s CARB ‘07 standards.
Subsequent
to the success of the DFC/T field demonstration and following our shift to
MW-scale products, we have initiated the design of a MW-scale hybrid DFC/T.
Co-production
of Hydrogen and Electricity using DFC Power Plants. Our
high
temperature DFC power plants produce hydrogen internally from hydrocarbon fuels,
and then convert it to electricity. These DFC products are capable of
co-production of electricity and hydrogen at potentially attractive costs.
This
value-added proposition is attractive for industrial users of hydrogen. It
also
provides a technology bridge to the hydrogen infrastructure being developed
by
DOE in our nation’s bid for greater energy independence. A DOE-sponsored study
performed by Air Products and Chemicals, Inc. (APCI), showed that a sub-MW
DFC
power plant installed at a hydrogen refueling station for fuel cell vehicles
can
handle a fleet of approximately 200 cars while providing enough electricity
to
power a community of 200 homes.
During
2005, we were selected by APCI to develop and demonstrate the next generation
hydrogen energy station. The $10 million cost-shared project, co-sponsored
by
DOE, APCI and FuelCell Energy, integrates our ultra-clean DFC power plant and
Air Products’ advanced gas separation technology to co-produce hydrogen and
electricity at a vehicle refueling station from one single system, the
“DFC/H2”.
The
sub-MW system is designed to operate on pipeline natural gas and other renewable
fuels such as biogas. Air Products estimates that the DFC/H2
system
has the potential to be highly efficient and cost competitive with other
conventional technologies. The system will be tested in late 2008 in advance
of
a field demonstration.
We
are
also engaged are also developing an electrochemical hydrogen separator (EHS).
Under sponsorship from Connecticut Clean Energy Fund, a sub-scale (2 kW) EHS
stack was designed, built and delivered to University of Connecticut for
demonstration in February 2006 where it accumulated over six months of stable
operation under a variety of test conditions. Following this successful
demonstration, we were awarded a $1.2 million contract by U.S. Department of
Defense to scale-up the (EHS) stack to the appropriate size for co-production
of
high purity hydrogen from its DFC300 power plants. In 2007 an additional $1.2
million was awarded to continue this program through in-house system testing.
The EHS technology is highly modular, “truly green” and promises over 50 percent
reduction in the separation cost. EHS has no moving parts, which leads to
enhanced reliability and the higher levels of safety needed for the hydrogen
infrastructure.
SECA
and Large Scale Hybrid Programs
In
September 2006, we completed all the technical requirements for the DOE’s Solid
State Energy Conversion Alliance (“SECA”) Phase I, 3-10 kW solid oxide fuel cell
(“SOFC”) cost reduction program and entered into a new SECA Phase I program for
development of a multi-megawatt SOFC power plant operating on coal syngas (the
Large Scale Hybrid Program).
In
February 2006, we were selected by the DOE as a prime contractor for a Phase
I
award to develop a coal-based large scale solid oxide fuel
cell-based hybrid system . The contract was finalized in September 2006. The
program’s overall objective is to develop SOFC technology, fueled by coal
synthesis gas (coal gas) that will be used in highly-efficient central
generation power plant facilities. The advanced fuel cell-hybrid system will
have an overall efficiency of at least 50 percent in converting energy contained
in coal to ultra-clean grid electrical power. In contrast, today’s average U.S.
coal-based power plant has an electrical efficiency of approximately 35 percent.
In addition, the envisioned SOFC-hybrid system is expected to separate 90
percent
or more
of the system’s carbon dioxide emissions for capture and environmentally safe
disposal while being cost competitive with other baseload power generating
technologies.
The
first
phase of this three-phase program is focused on SOFC cell and stack technology
scale-up, as well as baseline and proof-of-concept system engineering design
and
analysis. In 2007, our subcontractor Versa Power Systems, achieved a four-fold
scale-up of its SOFC cell technology to meet the program requirements while
we
completed the preliminary design of the MW-class SOFC power module and BOP.
The
project will culminate in phase three with the fabrication and operation of
a
multi-MW proof-of-concept SOFC-hybrid power plant at FutureGen, a planned DOE
demonstration of advanced power systems that emit near-zero emissions, doubling
today's electric generating efficiency, co-produce hydrogen, and sequester
carbon dioxide, or
at
another suitable location using coal-derived synthesis gas as the fuel. Phase
I
of the program is a two-year, $36.2 million cost-shared program. If selected
for
subsequent phases, total project funding of approximately $180 million is
expected. The DOE anticipates commissioning multi-MW, proof-of-concept,
coal-based power plant systems in the 2012 time frame.
We
are
the prime contractor on this program. Other team members include: Versa Power
Systems, Inc., Gas Technology Institute (“GTI”), Nexant, Inc., WorleyParsons
Group Inc., and SatCon Technology Corporation.
GOVERNMENT
REGULATION
We
presently are, and our fuel cell power plants will be, subject to various
federal, state and local laws and regulations relating to, among other things,
land use, safe working conditions, handling and disposal of hazardous and
potentially hazardous substances and emissions of pollutants into the
atmosphere. Emissions of SOX and NOX from our fuel cell power plants are much
lower than conventional combustion-based generating stations, and are well
within existing and proposed regulatory limits. The primary emissions from
our
DFC power plants, assuming no cogeneration application, are humid flue gas
that
is discharged at a temperature of approximately 700-800° F, water that is
discharged at a temperature of approximately 10-20° F above ambient air
temperatures, and carbon dioxide in per kW amounts much less than conventional,
fossil fuel, central generation power plants. In light of the high temperature
of the gas emissions, we are required by regulatory authorities to site or
configure our power plants in a way that will allow the gas to be vented at
acceptable and safe distances. The discharge of water from our power plants
requires permits that depend on whether the water is permitted to be discharged
into a storm drain or into the local wastewater system. Lastly, as with any
use
of hydrocarbon fuel, the discharge of particulates must meet emissions
standards. While our products have very low carbon monoxide emissions, there
could be additional permitting requirements in smog non-attainment areas with
respect to carbon monoxide if a number of our units are aggregated
together.
We
are
also subject to federal, state, provincial or local regulation with respect
to,
among other things, emissions and siting. In addition, utility companies and
several states have created and adopted or are in the process of creating
interconnection regulations covering both technical and financial requirements
for interconnection of fuel cell power plants to utility grids.
PROPRIETARY
RIGHTS AND LICENSED TECHNOLOGY
To
compete in the marketplace, align effectively with business partners and protect
our proprietary rights, we rely primarily on a combination of trade secrets,
patents, confidentiality procedures and agreements and patent assignment
agreements. In this regard, we have 52 current U.S. patents and 92 international
patents covering our fuel cell technology (in certain cases covering the same
technology in multiple jurisdictions). All of the 52 U.S. patents relate to
our
Direct FuelCell technology. We also have submitted 37 U.S. and 149 international
patent applications.
The
patents we have obtained will expire between 2008 and 2025, and the current
average remaining life of our patents is approximately 11 years. In 2007, four
new U.S patents were issued or allowed (and two more patents have been allowed
in November and December of 2007). In fiscal 2007, two U.S. patents expired.
The
expiration of these patents has no material impact on our current or anticipated
operations. We also have approximately 28 invention disclosures in process
with
our patent counsel that may result in additional patent
applications.
Many
of
our U.S. patents are the result of government-funded research and development
programs, including the DOE cooperative agreement. Two of our patents, which
resulted from government-funded research before January 1988 (when we qualified
as a “small business”), are owned by the U.S. government and have been licensed
to us.
U.S.
patents that we own that resulted from government-funded research are subject
to
the government exercising “march-in” rights. We believe, however, that the
likelihood of the U.S. government exercising these rights is remote and would
only occur if we ceased our commercialization efforts and there was a compelling
national need to use the patents.
We
have
also entered into certain license agreements through which we have obtained
the
rights to use technology developed under joint projects. Through these
agreements we must make certain royalty payments on the sales of products that
contain the licensed technology, subject to certain milestones and
limitations.
We
have
two agreements with CFC Solutions; a Cell License Agreement and a BOP License
Agreement. Under our current Cell License Agreement, which has been
extended through December 2009, we license our DFC technology to CFC Solutions
for use exclusively in Europe and the Middle East and non-exclusively in Africa
and South America. We also sell our DFC components and stacks to CFC
Solutions under this agreement. Under the Cell License Agreement, CFC
Solutions also granted us an exclusive, royalty-free license to use any of
their
existing improvements to our Direct FuelCell that CFC Solutions developed as
of
December 1999 under a previous license agreement. In addition, CFC
Solutions has agreed to negotiate a license grant of any separate carbonate
fuel
cell know-how it develops during the term of the current Cell License once
it is
ready for commercialization. Under our BOP Cross Licensing and
Cross-Selling Agreement, we may sell to CFC Solutions our MW-class modules
and
CFC Solutions may sell their sub-MW class modules to us. The BOP License
continues through July 2008 and may be extended for up to three additional
5-year terms, at the option of either CFC Solutions or us.
REVENUE
AND BACKLOG
Our
consolidated revenues for the years ended October 31, 2007, 2006 and 2005 were
$48.2 million, $33.3 million and $30.4 million, respectively. These consolidated
revenues included product sales and revenues of $32.5 million,
$21.5
million and $17.4 million, respectively, and revenues from research and
development contracts of $15.7 million, $11.8 million and $13.0 million,
respectively. Consolidated revenues for the years ended October 31, 2007, 2006
and 2005 in the U.S. were $31.7 million, $26.6 million, and $22.2 million,
respectively, and consolidated revenues from foreign locations were $16.5
million, $6.7 million and $8.2 million, respectively, based on customer order
location.
Our
backlog as of October 31, 2007 was approximately $76.3 million compared with
backlog of approximately $58.0 million as of October 31, 2006. Backlog refers
to
the aggregate revenues remaining to be earned at a specified date under
contracts we have entered into.
|
·
|
Product
order backlog was approximately $42.5 million and $18.1 million as
of
October 31, 2007 and 2006, respectively, representing 15.55 MW as
of
October 31, 2007 and 8.05 MW as of October 31, 2006. Product orders
represent approximately 63 percent of our total funded backlog as
of
October 31, 2007. Backlog for long-term service agreements was
approximately $15.3 million and $9.8 million as of October 31, 2007
and
2006, respectively. Although backlog reflects business that is considered
firm, cancellations or scope adjustments may occur and will be reflected
in our backlog when known.
|
|
·
|
For
research and development contracts, we include the total contract
value
including any unfunded portion of the total contract value in backlog.
Research and development contract backlog was approximately $18.5
million
and $30.1 million as of October 31, 2007 and 2006, respectively.
The
unfunded portion of our research and development contracts amounted
to
approximately $9.1 million and $21.6 million as of October 31, 2007
and
2006, respectively. Due to the long-term nature of these contracts,
fluctuations from year to year are not an indication of any future
trend.
|
As
of
October 31, 2007, we had contracts for power plants totaling 3 MW under power
purchase agreements ranging from 5 - 10 years, this compares to 4 MW as of
October 31, 2006 (on plant was sold during the fiscal year) Revenue under these
agreements is recognized as electricity is produced. This revenue is not
included in backlog.
EMPLOYEES
As
of
October 31, 2007 we had 443 full-time employees, of whom 165 were located at
the
Torrington, Connecticut manufacturing plant, and 278 were located at the
Danbury, Connecticut facility or various field offices. None
of
our employees are represented by labor unions or covered by a collective
bargaining agreement.
AVAILABLE
INFORMATION
Our
annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
on
Form 8-K, and all amendments to those reports will be made available free of
charge through the Investor Relations section of the Company’s Internet website
(http://www.fuelcellenergy.com) as soon as practicable after such material
is
electronically filed with, or furnished to, the Securities and Exchange
Commission. Material contained on our website is not incorporated by reference
in this report. Our executive offices are located at 3 Great Pasture Road,
Danbury, CT 06813.
The
public may also read and copy any materials that we file with the SEC at the
SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549.
The public may obtain information on the operation of the Public Reference
Room
by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet website
that contains reports and other information regarding issuers that file
electronically with the SEC located at http://www.sec.gov.
EXECUTIVE
OFFICERS OF THE REGISTRANT
Our
executive officers and their ages and positions are as follows:
NAME
|
|
AGE
|
|
PRINCIPAL
OCCUPATION
|
|
|
|
|
|
R.
Daniel Brdar
President,
Chief Executive Officer and Chairman of the Board of
Directors
|
|
48
|
|
Mr.
Brdar has been Chairman of the Board of Directors since January 2007,
Chief Executive Officer since January 2006 and President since August
2005. Mr. Brdar, previously FuelCell Energy's Executive Vice President
and
Chief Operating Officer, joined the Company in 2000. Mr. Brdar held
management positions at General Electric Power Systems from 1997
to 2000
where he focused on new product introduction programs and was product
manager for its gas turbine technology. Mr. Brdar was Associate Director,
Office of Power Systems Product Management at the U.S. Department
of
Energy where he held a variety of positions from 1988 to 1997 including
directing the research, development and demonstration of advanced
power
systems including gas turbines, gasification systems and fuel
cells.
|
|
|
|
|
|
Christopher
R. Bentley Executive
Vice President, Government R&D Operations, Strategic Manufacturing
Development
|
|
65
|
|
Mr.
Bentley has been responsible for Government Research and Development
Operations and Strategic Manufacturing Development since January
of 2005.
He joined the Company in 1990 to develop manufacturing and operations
capability in support of the DFC commercialization initiative. He
served
on the Board of Directors from 1993 to 2004. Prior to joining the
Company,
he was Director of Manufacturing (1985), Vice-President and General
Manager (1985-1988) and President (1989) of the Turbine Airfoils
Division
of Chromalloy Gas Turbine Corporation, a major manufacturer of gas
turbine
hardware. From 1960 to 1985 he was with the General Electric Company
where
he served a four-year apprenticeship and completed the GE Manufacturing
Management Program prior to a series of increasingly responsible
manufacturing positions. Mr. Bentley received a B.S. in Mechanical
Engineering from Tufts University in 1966.
|
NAME
|
|
AGE |
|
PRINCIPAL
OCCUPATION
|
|
|
|
|
|
Bruce
A. Ludemann
Senior
Vice President of Sales & Marketing
|
|
48
|
|
Mr.
Ludemann joined the Company in April 2006. His responsibilities encompass
all the Company’s business development activities across global markets.
Prior to joining the Company, Mr. Ludemann had been a senior marketing
and
sales executive with Siemens, where he oversaw sales and marketing
efforts
for the firm’s Power Generation and Transmission & Distribution
business units. Earlier, he had been with ABB Power Transmission
&
Distribution Inc.; the industrial control firm Square D; and Swiss
electrical equipment manufacturer BBC Brown Boveri. He also served
four
years in the U.S. Navy specializing in electric power generation
and
distribution systems. Mr. Ludemann studied business at Barry University
in
Miami and holds an Executive MBA from the University of
Pittsburgh.
|
|
|
|
|
|
Joseph
G. Mahler
Senior
Vice President, Chief Financial Officer, Corporate Secretary, Treasurer,
Corporate Strategy
|
|
55
|
|
Mr.
Mahler joined the Company in October 1998 as Vice President, Chief
Financial Officer, Corporate Secretary, and Treasurer. Mr. Mahler’s
responsibilities include finance, accounting, corporate governance,
strategy, treasury, information systems and human resources. Mr.
Mahler
was Vice President-Chief Financial Officer at Earthgro, Inc. from
1993 to
1998 and worked at Ernst & Young in the New York and Hartford offices
from 1974 to 1992. He was a partner in the Hartford office’s
Entrepreneurial Services Group. Mr. Mahler received a B.S. in
Accounting from Boston College in
1974.
|
Item
1A. RISK FACTORS
You
should carefully consider the following risk factors before making an investment
decision. If any of the following risks actually occur, our business,
financial condition, or results of operations could be materially and adversely
affected. In such cases, the trading price of our common stock could
decline, and you may lose all or part of your investment.
We
have incurred losses and anticipate continued losses and negative cash
flow.
We
have
been transitioning from a contract research and development company to a
commercial products developer and manufacturer. As such, we have not been
profitable since our fiscal year ended October 31, 1997. We expect to continue
to incur net losses and generate negative cash flow until we can produce
sufficient revenues to cover our costs. We may never become profitable. Even
if
we do achieve profitability, we may be unable to sustain or increase our
profitability in the future. For the reasons discussed in more detail below,
there are substantial uncertainties associated with our achieving and sustaining
profitability. We have, from time to time, sought financing in the public
markets in order to fund operations. Our future ability to obtain such
financing, if required, could be impaired by a variety of factors including
the
price of our common stock and general market conditions.
Our
cost reduction strategy may not succeed or may be significantly delayed, which
may result in our inability to offer our products at competitive prices and
may
adversely affect our sales.
Our
cost
reduction strategy is based on the assumption that a significant increase in
production will result in economies of scale. In addition, our cost reduction
strategy relies on advancements in our manufacturing process, global competitive
sourcing, engineering design and technology (including projected power output).
Failure to achieve our cost reduction targets would have a material adverse
effect on our commercialization plans and, therefore, our business, prospects,
results of operations and financial condition.
Our
products will compete with products using other energy sources, and if the
prices of the alternative sources are lower than energy sources used by our
products, sales of our products will be adversely
affected.
Volatility of electricity prices may impact sales of our products in the
markets
in which we compete.
Our
Direct FuelCell®
has been
operated using a variety of hydrocarbon fuels, including natural gas, methanol,
diesel, biogas, coal gas, coal mine methane and propane. If these fuels are
not
readily available or if their prices increase such that electricity produced
by
our products costs more than electricity provided by other generation sources,
our products would be less economically attractive to potential customers.
In
addition, we have no control over the prices of several types of competitive
energy sources such as oil, gas or coal as well as local utility electricity
costs. Significant decreases (or short term increases) in the price of these
fuels or grid delivered prices for electricity could also have a material
adverse effect on our business because other generation sources could be
more
economically attractive to consumers than our products.
The
reduction or elimination of government subsidies and economic incentives for
alternative energy technologies, including our fuel cell power plants, could
reduce demand for our products, lead to a reduction in our revenues and
adversely impact our operating results.
We
believe that the near-term growth of alternative energy technologies, including
our fuel cells, relies on the availability and size of government and economic
incentives (including, but not limited to, the U.S. Investment Tax Credit and
the incentive programs in South Korea and the state of California and state
renewable portfolio standards programs). Many of these government incentives
expire, phase out over time, exhaust the allocated funding, or require renewal
by the applicable authority. In addition, these incentive programs could be
challenged by utility companies, or for other reasons found to be
unconstitutional, and/or could be reduced or discontinued for other reasons.
The
reduction, elimination, or expiration of government subsidies and economic
incentives may result in the diminished economic competitiveness of our power
plants to our customers and could materially and adversely affect the growth
of
alternative energy technologies, including our fuel cells, as well as our future
operating results.
We
have signed long-term power purchase and service agreements with customers
which
are subject to market conditions and operating risks that may affect our
operating results.
Under
the
terms of our power purchase agreements, customers agree to purchase power from
our fuel cell power plants at negotiated rates, generally for periods of five
to
ten years. Electricity rates are generally a function of the customer’s current
and future electricity pricing available from the grid. Revenues are earned
and
collected under these PPAs as power is produced. As owner of the power plants
in
these PPA entities, 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. Should electricity rates decrease or operating costs increase from
our
original estimates, our results of operations could be negatively impacted.
We
have qualified for incentive funding for these projects in California under
the
states’ Self Generation Incentive Funding Program and from other government
programs. Funds are payable upon commercial installation and demonstration
of
the plant and may require return of the funds for failure of certain performance
requirements. Revenue related to these incentive funds is recognized ratably
over the performance period. We are not required to produce minimum amounts
of
power under our PPA agreements and we have the right to terminate PPA agreements
by giving written notice to the customer, subject to certain exit
costs.
We
have
contracted with certain customers to provide service of fuel cell power plants
over terms ranging from one to thirteen years. Under the provisions of these
contracts, we provide services to maintain, monitor and repair customer power
plants. Pricing for service contracts is based upon estimates of future costs,
which given the early stage of development could be materially different from
actual expenses.
We
extend product warranties which could affect
our operating results.
We
warranty our products for a specific period of time against manufacturing or
performance defects. As we have limited operating experience, warranty costs
are
currently expensed as incurred. As a result operating results could be
negatively impacted should there be product manufacturing or performance
defects.
We
currently face and will continue to face significant
competition.
Our
Direct FuelCell®
currently faces, and will continue to face, significant competition. We compete
on the basis of our products’ reliability, fuel efficiency, environmental
considerations and cost. Technological advances in alternative energy products
or improvements in the electric grid or other sources of power generation,
or
other fuel cell technologies may negatively affect the development or sale
of
some or all of our products or make our products non-competitive or obsolete
prior to commercialization or afterwards. Other companies, some of which have
substantially greater resources than ours, are currently engaged in the
development of products and technologies that are similar to, or may be
competitive with, our products and technologies.
Several
companies in the U.S. are involved in fuel cell development, although we believe
we are the only domestic company engaged in significant manufacturing and
commercialization of carbonate fuel cells. Emerging fuel cell technologies
(and
companies developing them) include proton exchange membrane fuel cells (Ballard
Power Systems, Inc.; United Technologies Corp. or UTC Fuel Cells; and Plug
Power), phosphoric acid fuel cells (UTC Fuel Cells) and solid oxide fuel cells
(Siemens Westinghouse Electric Company, SOFCo, General Electric, Delphi, Rolls
Royce and Acumentrics). Each of these competitors has the potential to capture
market share in our target markets.
There
are
other potential carbonate fuel cell competitors internationally. In Europe,
a
company in Italy, Ansaldo Fuel Cells, is actively engaged in carbonate fuel
cell
development and is a potential competitor.
Other
than fuel cell developers, we must also compete with such companies as
Caterpillar, Cummins, and Detroit Diesel, which manufacture more mature
combustion-based equipment, including various engines and turbines, and have
well-established manufacturing, distribution, and operating and cost features.
Significant competition may also come from gas turbine companies like General
Electric, Ingersoll Rand, Solar Turbines and Kawasaki, which have recently
made
progress in improving fuel efficiency and reducing pollution in large-size
combined cycle natural gas fueled generators. These companies have also made
efforts to extend these advantages to smaller sizes.
We
have large and influential stockholders, which may make it difficult for a
third
party to acquire our common stock.
As
of
September 2007, our largest three shareholders each own more than 5%, but less
than 10%, of our outstanding common stock. POSCO Power owns approximately 6%
of
our outstanding common stock. MTU Friedrichshafen GmbH (“MTU”), a subsidiary of
Tognum GmbH, owns approximately 4% of our outstanding common stock James D.
Gerson beneficially owns approximately 2% of our outstanding common stock.
Loeb
Investors Co. LXXV beneficially owns approximately 1% of our outstanding common
stock. These ownership levels could make it difficult for a third party to
acquire our common stock or have input into the decisions made by our board
of
directors, which include Christof von Branconi, EVP
of
Tognum AG and CEO of its Onsite Energy Systems & Components Division,
James
D.
Gerson and Thomas L. Kempner (Chairman and Chief Executive Officer of an
affiliate of Loeb Investors Co. LXXV). Tognum GmbH, through its subsidiary
CFC
Soultions GmbH and POSCO Power are also licensees of our technology and
purchasers of Direct FuelCell®
products. Therefore, it may be in their interests to possess substantial
influence over matters concerning our overall strategy and technological and
commercial development.
CFC
may develop competing technologies.
CFC
Solutions GmbH is currently developing carbonate fuel cell technology. If this
technology does not use DFC know-how, CFC must use good faith efforts to license
the technology to us. If CFC is successful but does not grant us a license,
it
may be directly competing with us while having a significant ownership interest
in us, and a seat on our board of directors. We have agreed with CFC to continue
developing products with as much commonality as possible. However, the license
agreement between us and CFC provides that each of us retains the right to
independently pursue the development of carbonate fuel cell
technologies.
We
have limited experience manufacturing our Direct
FuelCell®
products on a commercial basis, which may adversely affect our planned increases
in production capacity and our ability to satisfy customer
requirements.
We
have
limited experience manufacturing our Direct FuelCell®
products
on a commercial basis. Our manufacturing, testing and conditioning facilities
have equipment in place for a production capacity of 50 MW per year. We expect
that we will then increase our manufacturing capacity based on market demand.
We
cannot be sure that we will be able to achieve any planned increases in
production capacity. Also, as we scale up our production capacity, we cannot
be
sure that unplanned failures or other technical problems relating to the
manufacturing process will not occur.
Even
if
we are successful in achieving our planned increases in production capacity,
we
cannot be sure that we will do so in time to meet our product commercialization
schedule or to satisfy the requirements of our customers. Additionally, we
cannot be sure that we will be able to develop efficient, low-cost manufacturing
capabilities and processes (including automation) that will enable us to meet
our cost goals and profitability projections. Our failure to develop advanced
manufacturing capabilities and processes, or meet our cost goals, could have
a
material adverse effect on our business, prospects, results of operations and
financial condition.
Unanticipated
increases or decreases in business growth may result in adverse financial
consequences for us.
If
our
business grows more quickly than we anticipate, our existing and planned
manufacturing facilities may become inadequate and we may need to seek out
new
or additional space, at considerable cost to us. If our business does not grow
as quickly as we expect, our existing and planned manufacturing facilities
would, in part, represent excess capacity for which we may not recover the
cost;
in that circumstance, our revenues may be inadequate to support our committed
costs and our planned growth and our gross margins and business strategy would
be adversely affected.
Our
plans are dependent on market acceptance of our Direct
FuelCell®
products.
Our
plans
are dependent upon market acceptance of, as well as enhancements to, those
products. Fuel cell systems represent an emerging market, and we cannot be
sure
that potential customers will accept fuel cells as a replacement for traditional
power sources. As is typical in a rapidly evolving industry, demand and market
acceptance for recently introduced products and services are subject to a high
level of uncertainty and risk. Since the distributed generation market is still
evolving, it is difficult to predict with certainty the size of the market
and
its growth rate. The development of a market for our Direct FuelCell®
products
may be affected by many factors that are out of our control,
including:
|
·
|
the
cost competitiveness of our fuel cell products;
|
|
·
|
the
future costs of natural gas and other fuels used by our fuel cell
products;
|
|
·
|
customer
reluctance to try a new product;
|
|
·
|
perceptions
of the safety of our fuel cell products;
|
|
·
|
the
market for distributed generation;
|
|
·
|
local
permitting and environmental requirements;
and
|
|
·
|
the
emergence of newer, more competitive technologies and
products.
|
If
a
sufficient market fails to develop or develops more slowly than we anticipate,
we may be unable to recover the losses we will have incurred in the development
of Direct FuelCell®
products
and may never achieve profitability.
As
we
continue to commercialize our Direct FuelCell®
products, we intend to continue to develop warranties, production guarantees
and
other terms and conditions relating to our products that will be acceptable
to
the marketplace, and continue to develop a service organization that will aid
in
servicing our products and obtain self-regulatory certifications, if available,
with respect to our products. Failure to achieve any of these objectives may
also slow the development of a sufficient market for our products and,
therefore, have a material adverse effect on our results of
operations.
Our
government research and development contracts are subject to the risk of
termination by the contracting party and we may not realize the full amounts
allocated under the contracts due to the lack of Congressional
appropriations.
A
portion
of our fuel cell revenues have been derived from long-term cooperative
agreements and other contracts with the U.S. Department of Energy, the U.S.
Department of Defense, the U.S. Navy and other U.S. government agencies. These
agreements are important to the continued development of our technology and
our
products.
Generally,
our U.S. government research and development contracts, are subject to the
risk
of termination at the convenience of the contracting agency. Furthermore, these
contracts, irrespective of the amounts allocated by the contracting agency,
are
subject to annual Congressional appropriations and the results of government
or
agency sponsored reviews and audits of our cost reduction projections and
efforts. We can only receive funds under these contracts ultimately made
available to us annually by Congress as a result of the appropriations process.
Accordingly, we cannot be sure whether we will receive the full amounts awarded
under our government research and development or other contracts. Failure to
receive the full amounts under any of our government research and development
contracts could materially and adversely affect our business prospects, results
of operations and financial condition.
A
negative government audit could result in an adverse adjustment of our revenue
and costs and could result in civil and criminal
penalties
Government
agencies, such as the Defense
Contract Audit Agency,
routinely audit and investigate government contractors. These agencies review
a
contractor’s performance under its contracts, cost structure and compliance with
applicable laws, regulations and standards. If the agencies determine through
these audits or reviews that we improperly allocated costs to specific
contracts, they will not reimburse us for these costs. Therefore, an audit
could
result in adjustments to our revenue and costs.
Further,
although we have internal controls in place to oversee our government contracts,
no assurance can be given that these controls are sufficient to prevent isolated
violations of applicable laws, regulations and standards. If the agencies
determine that we or one of our subcontractors engaged in improper conduct,
we
may be subject to civil or criminal penalties and administrative sanctions,
payments, fines and suspension or prohibition from doing business with the
government, any of which could materially affect our financial condition.
The
U.S. government has certain rights relating to our intellectual property,
including restricting or taking title to certain
patents.
Many
of
our U.S. patents relating to our fuel cell technology are the result of
government-funded research and development programs. Two of our patents that
were the result of DOE-funded research prior to January 1988 (the date that
we
qualified as a “small business”) are owned by the U.S. government and have been
licensed to us. This license is revocable only in the limited circumstances
where it has been demonstrated that we are not making an effort to commercialize
the invention. We own all patents resulting from research funded by our DOE
contracts awarded after January 1988 to date, based on our “small business”
status when each contract was awarded. Under current regulations, patents
resulting from research funded by government agencies other than the DOE are
owned by us, whether or not we are a “small business.”
Ten
U.S.
patents that we own have resulted from government-funded research and are
subject to the risk of exercise of “march-in” rights by the government. March-in
rights refer to the right of the U.S. government or a government agency to
exercise its non-exclusive, royalty-free, irrevocable worldwide license to
any
technology developed under contracts funded by the government if the contractor
fails to continue to develop the technology. These “march-in” rights permit the
U.S. government to take title to these patents and license the patented
technology to third parties if the contractor fails to utilize the patents.
In
addition, our DOE-funded research and development agreements also require us
to
agree that we will not provide to a foreign entity any fuel cell technology
subject to that agreement unless the fuel cell technology will be substantially
manufactured in the U.S. Accordingly, we could lose some or all of the value
of
these patents.
A
failure to qualify as a “small business” could adversely affect our rights to
own future patents under DOE-funded contracts.
Qualifying
as a “small business” under DOE contracts allows us to own the patents that we
develop under DOE contracts. A “small business” under applicable government
regulations generally consists of no more than 500 employees. If we continue
to
grow, we will no longer qualify as a “small business” and no longer own future
patents we develop under future contracts, grants or cooperative agreements
funded by the DOE based on such certification, unless we obtain a patent waiver
from the DOE. Should we not obtain a patent waiver and outright ownership,
we
would nevertheless retain exclusive rights to any such patents, so long as
we
continue to commercialize the technology covered by the patents. As a result
of
our acquisition of Global Thermoelectric Inc. in November 2003, the number
of
our employees increased and therefore, we temporarily did not qualify as a
“small business.” Following the sale of Global Thermoelectric Inc. and its TEG
product line on May 27, 2004, we again qualified as a “small business”; however,
we cannot assure you that we will continue to qualify as a “small business” in
the future.
Our
future success and growth is dependent on our distribution
strategy.
We
cannot
assure you that we will enter into distributor relationships that are consistent
with, or sufficient to support, our commercialization plans or our growth
strategy or that these relationships will be on terms favorable to us. Even
if
we enter into these types of relationships, we cannot assure you that the
distributors with which we form relationships will focus adequate resources
on
selling our products or will be successful in selling them. Some of these
distributor arrangements have or will require that we grant exclusive
distribution rights to companies in defined territories. These exclusive
arrangements could result in us being unable to enter into other arrangements
at
a time when the distributor with which we form a relationship is not successful
in selling our products or has reduced its commitment to marketing our products.
In addition, certain distributor arrangements include, and some future
distributor arrangements may also include, the issuance of equity and warrants
to purchase our equity, which may have an adverse effect on our stock price.
To
the extent we enter into distributor relationships, the failure of these
distributors in assisting us with the marketing and distribution of our products
may adversely affect our results of operations and financial
condition.
We
cannot
be sure that CFC Solutions GmbH will continue to, or original equipment
manufacturers (“OEMs”) will, manufacture or package products using our Direct
FuelCell®
components. In this area, our success will largely depend upon our ability
to
make our products compatible with the power plant products of OEMs and the
ability of these OEMs to sell their products containing our products. In
addition, some OEMs may need to redesign or modify their existing power plant
products to fully incorporate our products. Accordingly, any integration,
design, manufacturing or marketing problems encountered by CFC or other OEMs
could adversely affect the market for our Direct FuelCell®
products
and, therefore, our business, prospects, results of operations and financial
condition.
We
depend on third party suppliers for the development and supply of key components
for Direct FuelCell®
products.
We
use
various raw materials and components to construct a fuel cell module, including
nickel and stainless steel which are critical to our manufacturing process.
We
also
rely on third-party suppliers for the balance-of-plant components in our Direct
FuelCell®
products. Suppliers
must undergo a qualification process, which may take between four and twelve
months, and we continually evaluate new suppliers and currently are qualifying
several new suppliers. There
are
a limited number of suppliers for some of the key components of Direct
FuelCell®
products. A supplier’s failure to develop and supply components in a timely
manner or to supply components that meet our quality, quantity or cost
requirements or technical specifications or our inability to obtain alternative
sources of these components on a timely basis or on terms acceptable to us
could
harm our ability to manufacture our Direct FuelCell®
products. In addition, to the extent the processes that our suppliers use to
manufacture components are proprietary, we may be unable to obtain comparable
components from alternative suppliers.
We
do not
know when or whether we will secure long-term supply relationships with any
of
our suppliers or whether such relationships will be on terms that will allow
us
to achieve our objectives. Our business, prospects, results of operations and
financial condition could be harmed if we fail to secure long-term relationships
with entities that will supply the required components for our Direct
FuelCell®
products.
We
depend on our intellectual property, and our failure to protect that
intellectual property could adversely affect our future growth and success.
Failure
to protect our existing intellectual property rights may result in the loss
of
our exclusivity or the right to use our technologies. If we do not adequately
ensure our freedom to use certain technology, we may have to pay others for
rights to use their intellectual property, pay damages for infringement or
misappropriation or be enjoined from using such intellectual property. We rely
on patent, trade secret, trademark and copyright law to protect our intellectual
property. The patents that we have obtained will expire between 2008 and 2025
and the average remaining life of our U.S. patents is approximately 11 years.
Some
of
our intellectual property is not covered by any patent or patent application
and
includes trade secrets and other know-how that is not patentable, particularly
as it relates to our manufacturing processes and engineering design. In
addition, some of our intellectual property includes technologies and processes
that may be similar to the patented technologies and processes of third parties.
If we are found to be infringing third-party patents, we do not know whether
we
will be able to obtain licenses to use such patents on acceptable terms, if
at
all. Our patent position is subject to complex factual and legal issues that
may
give rise to uncertainty as to the validity, scope and enforceability of a
particular patent. Accordingly, we cannot assure you that:
·
any
of
the U.S., Canadian or other foreign patents owned by us or other patents
that
third parties license to us will not be invalidated, circumvented, challenged,
rendered unenforceable or licensed to others; or,
·
any
of
our pending or future patent applications will be issued with the breadth
of
claim coverage sought by us, if issued at all.
In
addition, effective patent, trademark, copyright and trade secret protection
may
be unavailable, limited or not applied for in certain foreign
countries.
We
also
seek to protect our proprietary intellectual property, including intellectual
property that may not be patented or patentable, in part by confidentiality
agreements and, if applicable, inventors’ rights agreements with our
subcontractors, vendors, suppliers, consultants, strategic partners and
employees. We cannot assure you that these agreements will not be breached,
that
we will have adequate remedies for any breach or that such persons or
institutions will not assert rights to intellectual property arising out of
these relationships. Certain of our intellectual property has been licensed
to
us on a non-exclusive basis from third parties that may also license such
intellectual property to others, including our competitors. If our licensors
are
found to be infringing third-party patents, we do not know whether we will
be
able to obtain licenses to use the intellectual property licensed to us on
acceptable terms, if at all.
If
necessary or desirable, we may seek extensions of existing licenses or further
licenses under the patents or other intellectual property rights of others.
However, we can give no assurances that we will obtain such extensions or
further licenses or that the terms of any offered licenses will be acceptable
to
us. The failure to obtain a license from a third party for intellectual property
that we use at present could cause us to incur substantial liabilities, and
to
suspend the manufacture or shipment of products or our use of processes
requiring the use of that intellectual property.
While
we
are not currently engaged in any intellectual property litigation, we could
become subject to lawsuits in which it is alleged that we have infringed the
intellectual property rights of others or commence lawsuits against others
who
we believe are infringing upon our rights. Our involvement in intellectual
property litigation could result in significant expense to us, adversely
affecting the development of sales of the challenged product or intellectual
property and diverting the efforts of our technical and management personnel,
whether or not that litigation is resolved in our favor.
Our
future success will depend on our ability to attract and retain qualified
management and technical personnel.
Our
future success is substantially dependent on the continued services and on
the
performance of our executive officers and other key management, engineering,
scientific, manufacturing and operating personnel, particularly R. Daniel Brdar,
our Chief Executive Officer and the Chairman of the Board of Directors. The
loss
of the services of any executive officer, including Mr. Brdar, or other key
management, engineering, scientific, manufacturing and operating personnel,
could materially adversely affect our business. Our ability to achieve our
development and commercialization plans will also depend on our ability to
attract and retain additional qualified management and technical personnel.
Recruiting personnel for the fuel cell industry is competitive. We do not know
whether we will be able to attract or retain additional qualified management
and
technical personnel. Our inability to attract and retain additional qualified
management and technical personnel, or the departure of key employees, could
materially and adversely affect our development and commercialization plans
and,
therefore, our business, prospects, results of operations and financial
condition.
Our
management may be unable to manage rapid growth
effectively.
We
may
rapidly expand our manufacturing capabilities, accelerate the commercialization
of our products and enter a period of rapid growth, which will place a
significant strain on our senior management team and our financial and other
resources. Any expansion may expose us to increased competition, greater
overhead, marketing and support costs and other risks associated with the
commercialization of a new product. Our ability to manage rapid growth
effectively will require us to continue to improve our operations, to improve
our financial and management information systems and to train, motivate and
manage our employees. Difficulties in effectively managing the budgeting,
forecasting and other process control issues presented by such a rapid expansion
could harm our business, prospects, results of operations and financial
condition.
We
may be affected by environmental and other governmental
regulation.
We
are
subject to federal, state, provincial or local regulation with respect to,
among
other things, emissions and siting. Assuming no co-generation applications
are
used in conjunction with our Direct FuelCell®
plants,
they will discharge humid flue gas at temperatures of up to 800o
F, water
at temperatures of approximately 10-20
o
F above
surrounding air temperatures and carbon dioxide.
In
addition, it is possible that industry-specific laws and regulations will be
adopted covering matters such as transmission scheduling, distribution and
the
characteristics and quality of our products, including installation and
servicing. These regulations could limit the growth in the use of carbonate
fuel
cell products, decrease the acceptance of fuel cells as a commercial product
and
increase our costs and, therefore, the price of our Direct FuelCell®
products. Accordingly, compliance with existing or future laws and regulations
could have a material adverse effect on our business, prospects, results of
operations and financial condition.
Utility
companies could impose customer fees or interconnection requirements on our
customers that could make our products less
desirable.
Utility
companies commonly charge fees to larger, industrial customers for disconnecting
from the electric grid or for having the capacity to use power from the electric
grid for back up purposes. These fees could increase the cost to our customers
of using our Direct FuelCell®
products
and could make our products less desirable, thereby harming our business,
prospects, results of operations and financial condition.
Several
states have created and adopted or are in the process of creating their own
interconnection regulations covering both technical and financial requirements
for interconnection to utility grids. Depending on the complexities of the
requirements, installation of our systems may become burdened with additional
costs that might have a negative impact on our ability to sell systems. The
Institute of Electrical and Electronics Engineers has been working to create
an
interconnection standard addressing the technical requirements for distributed
generation to interconnect to utility grids. Many parties are hopeful that
this
standard will be adopted nationally to help reduce the barriers to deployment
of
distributed generation such as fuel cells; however this standard may not be
adopted nationally thereby limiting the commercial prospects and profitability
of our fuel cell systems.
We
could be liable for environmental damages resulting from our research,
development or manufacturing operations.
Our
business exposes us to the risk of harmful substances escaping into the
environment, resulting in personal injury or loss of life, damage to or
destruction of property, and natural resource damage. Depending on the nature
of
the claim, our current insurance policies may not adequately reimburse us for
costs incurred in settling environmental damage claims, and in some instances,
we may not be reimbursed at all. Our business is subject to numerous federal,
state and local laws and regulations that govern environmental protection and
human health and safety. We believe that our businesses are operating in
compliance in all material respects with applicable environmental laws, however
these laws and regulations have changed frequently in the past and it is
reasonable to expect additional and more stringent changes in the
future.
Our
operations may not comply with future laws and regulations and we may be
required to make significant unanticipated capital and operating expenditures.
If we fail to comply with applicable environmental laws and regulations,
governmental authorities may seek to impose fines and penalties on us or to
revoke or deny the issuance or renewal of operating permits and private parties
may seek damages from us. Under those circumstances, we might be required to
curtail or cease operations, conduct site remediation or other corrective
action, or pay substantial damage claims.
We
may be required to conduct environmental remediation activities, which could
be
expensive.
We
are
subject to a number of environmental laws and regulations, including those
concerning the handling, treatment, storage and disposal of hazardous materials.
These environmental laws generally impose liability on present and former owners
and operators, transporters and generators for remediation of contaminated
properties. We believe that our businesses are operating in compliance in all
material respects with applicable environmental laws, many of which provide
for
substantial penalties for violations. We cannot assure you that future changes
in such laws, interpretations of existing regulations or the discovery of
currently unknown problems or conditions will not require substantial additional
expenditures. Any noncompliance with these laws and regulations could subject
us
to material administrative, civil or criminal penalties or other liabilities.
In
addition, we may be required to incur substantial costs to comply with current
or future environmental and safety laws and regulations.
Our
products use inherently dangerous, flammable fuels, operate at high temperatures
and use corrosive carbonate material, each of which could subject our business
to product liability claims.
Our
business exposes us to potential product liability claims that are inherent
in
products that use hydrogen. Our products utilize fuels such as natural gas
and
convert these fuels internally to hydrogen that is used by our products to
generate electricity. The fuels we use are combustible and may be toxic. In
addition, our Direct FuelCell®
products
operate at high temperatures and our Direct FuelCell®
products
use corrosive carbonate material, which could expose us to potential liability
claims. Although we have comprehensive safety, maintenance and training programs
in place, we cannot guarantee there will not be accidents. Any accidents
involving our products or other hydrogen-using products could materially impede
widespread market acceptance and demand for our Direct FuelCell®
products. In addition, we might be held responsible for damages beyond the
scope
of our insurance coverage. We also cannot predict whether we will be able to
maintain our insurance coverage on acceptable terms.
We
are subject to risks inherent in international
operations.
Since
we
market our Direct FuelCell®
products
both inside and outside the U.S. and Canada, our success depends, in part,
on
our ability to secure international customers and our ability to manufacture
products that meet foreign regulatory and commercial requirements in target
markets. We have limited experience developing and manufacturing our products
to
comply with the commercial and legal requirements of international markets.
In
addition, we are subject to tariff regulations and requirements for export
licenses, particularly with respect to the export of some of our technologies.
We face numerous challenges in our international expansion, including unexpected
changes in regulatory requirements, fluctuations in currency exchange rates,
longer accounts receivable requirements and collections, difficulties in
managing international operations, potentially adverse tax consequences,
restrictions on repatriation of earnings and the burdens of complying with
a
wide variety of international laws. Any of these factors could adversely affect
our operations and revenues.
Our
stock price has been and could remain volatile.
The
market price for our common stock has been and may continue to be volatile
and
subject to extreme price and volume fluctuations in response to market and
other
factors, including the following, some of which are beyond our
control:
· failure
to meet our product development and commercialization milestones;
· variations
in our quarterly operating results from the expectations of securities analysts
or investors;
· downward
revisions in securities analysts’ estimates or changes in general market
conditions;
· announcements
of technological innovations or new products or services by us or our
competitors;
· announcements
by us or our competitors of significant acquisitions, strategic partnerships,
joint ventures or capital commitments;
· additions
or departures of key personnel;
· investor
perception of our industry or our prospects;
· insider
selling or buying;
· demand
for our common stock; and
· general
technological or economic trends.
In
the
past, following periods of volatility in the market price of their stock, many
companies have been the subjects of securities class action litigation. If
we
became involved in securities class action litigation in the future, it could
result in substantial costs and diversion of management’s attention and
resources and could harm our stock price, business, prospects, results of
operations and financial condition.
Provisions
of Delaware and Connecticut law and of our charter and by-laws may make a
takeover more difficult.
Provisions
in our certificate of incorporation and by-laws and in Delaware and Connecticut
corporate law may make it difficult and expensive for a third party to pursue
a
tender offer, change in control or takeover attempt that is opposed by our
management and board of directors. Public stockholders who might desire to
participate in such a transaction may not have an opportunity to do so. These
anti-takeover provisions could substantially impede the ability of public
stockholders to benefit from a change in control or change in our management
and
board of directors.
We
depend on relationships with strategic partners, and the terms and
enforceability of many of these relationships are not
certain.
We
have
entered into relationships with strategic partners for design, product
development and distribution of our existing products, and products under
development, some of which may not have been documented by a definitive
agreement. The terms and conditions of many of these agreements allow for
termination by the partners. Termination of any of these agreements could
adversely affect our ability to design, develop and distribute these products
to
the marketplace. We cannot assure you that we will be able to successfully
negotiate and execute definitive agreements with any of these partners, and
failure to do so may effectively terminate the relevant
relationship.
Future
sales of substantial amounts of our common stock could affect the market price
of our common stock.
Future
sales of substantial amounts of our common stock, or securities convertible
or
exchangeable into shares of our common stock, into the public market, including
shares of our common stock issued upon exercise of options and warrants, or
perceptions that those sales could occur, could adversely affect the prevailing
market price of our common stock and our ability to raise capital in the
future.
The
rights of the Series 1 preferred shares and Series B preferred stock could
negatively impact FuelCell.
The
terms
of the Series 1 preferred shares issued by FuelCell Energy, Ltd., our
wholly-owned, indirect subsidiary, provide rights to the holder, Enbridge Inc.
(“Enbridge”), including dividend and conversion rights among others that could
negatively impact us. For example, the terms of the Series 1 preferred shares
provide that the holders are entitled to receive cumulative dividends for each
calendar quarter for so long as such shares are outstanding. Assuming the
exchange rate for Canadian dollars is Cdn.$1.006 to U.S.$1.00 (exchange rate
on
January 10, 2008) at the time of the applicable dividend payment date, we are
required to pay a preferred dividend of approximately $310,636 per calendar
quarter, subject to reduction in accordance with the terms of the Series 1
preferred shares. The terms of the Series 1 preferred shares also require that
the holder be paid any accrued and unpaid dividends on December 31, 2010. To
the
extent that there is a significant amount of accrued dividends that is unpaid
as
of December 31, 2010 and we do not have sufficient working capital at that
time
to pay the accrued dividends, our financial condition could be adversely
affected. As of October 31, 2007, cumulative unpaid dividends and accrued
interest totaled approximately $7.7 million on the Series 1 preferred shares.
We
have guaranteed these dividend obligations, including paying a minimum dividend
of Cdn.$500,000 in cash annually to Enbridge for so long as Enbridge holds
the
Series 1 preferred shares. We have also guaranteed the liquidation obligations
of FuelCell Energy, Ltd. under the Series 1 preferred shares.
We
are
also required to issue common stock to the holder of the Series 1 preferred
shares if and when the holder exercises its conversion rights. The number of
shares of common stock that we may issue upon conversion could be significant
and dilutive to our existing stockholders. For example, assuming the holder
of
the Series 1 preferred shares exercises its conversion rights after July 31,
2020 and assuming our common stock price is U.S. $9.61 (our common stock closing
price on January 10, 2008) and the exchange rate for Canadian dollars is Cdn.
$1.006 to U.S. $1.00 (exchange rate on January 10, 2008) at the time of
conversion, we would be required to issue approximately 2,722,043 shares of
our
common stock.
The
terms
of the Series B preferred stock also provide rights to their holders that could
negatively impact us. Holders of the Series B preferred stock are
entitled to receive cumulative dividends at the rate of $50 per share per year,
payable either in cash or in shares of our common stock. To the
extent the dividend is paid in shares, additional issuances could be dilutive
to
our existing stockholders and the sale of those shares could have a negative
impact on the price of our common stock. A share of our Series B preferred
stock may be converted at any time, at the option of the holder, into 85.1064
shares of our common stock (which is equivalent to an initial conversion price
of $11.75 per share), plus cash in lieu of fractional shares. Furthermore,
the conversion rate applicable to the Series B preferred stock is subject to
adjustment upon the occurrence of certain events.
If
we fail to maintain an effective system of internal controls, we may not be
able
to accurately report our financial results or prevent fraud, which could harm
our brand and operating results.
Effective
internal controls are necessary for us to provide reliable and accurate
financial reports and effectively prevent fraud. We have devoted significant
resources and time to comply with the internal control over financial reporting
requirements of the Sarbanes-Oxley Act of 2002. In addition, Section 404 under
the Sarbanes-Oxley Act of 2002 requires that we assess and our auditors attest
to the design and operating effectiveness of our controls over financial
reporting. Our compliance with the annual internal control report requirement
for each fiscal year will depend on the effectiveness of our financial reporting
and data systems and controls. Inferior internal controls could cause investors
to lose confidence in our reported financial information, which could have
a
negative effect on the trading price of our stock and our access to
capital.
Our
results of operations could vary as a result of methods, estimates and judgments
we use in applying our accounting policies.
The
methods, estimates and judgments we use in applying our accounting policies
have
a significant impact on our results of operations (see “Critical Accounting
Policies and Estimates” in Part II, Item 7 of this Form 10-K). Such methods,
estimates and judgments are, by their nature, subject to substantial risks,
uncertainties and assumptions, and factors may arise over time that lead us
to
change our methods, estimates and judgments. Changes in those methods, estimates
and judgments could significantly affect our results of operations. Examples
include the following:
The
calculation of share-based compensation under SFAS 123R, requires us to use
valuation methodologies that include a number of assumptions, estimates and
conclusions regarding matters such as expected forfeitures, expected volatility
of our share price, the expected dividend rate with respect to our common stock
and the exercise behavior of our employees. Furthermore, there are no means,
under applicable accounting principles, to compare and adjust our expense if
and
when we learn about additional information that may affect the estimates that
we
previously made with the exception of changes in expected forfeitures of
share-based awards. Factors may arise over time that lead us to change our
estimates and assumptions with respect to future share-based compensation
arrangements, resulting in variability in our share-based compensation over
time.
As
our
fuel cell products are in their initial stages of development and market
acceptance, actual costs incurred could differ materially from those previously
estimated. Once we have established that our fuel cell products have achieved
commercial market acceptance and order backlog is comparable to our production
capacity and future costs can be reasonably estimated, then estimated costs
to
complete an individual contract, in excess of revenue, will be accrued
immediately upon identification.
Item
1B. UNRESOLVED STAFF COMMENTS
None.
Item
2. PROPERTIES
Our
headquarters are located in Danbury, Connecticut. The following is a summary
of
our offices and locations:
Location
|
|
Business
Use
|
|
Square
Footage
|
|
Lease
Expiration Dates
|
|
|
|
|
|
|
|
Danbury,
Connecticut
|
|
Corporation
Headquarters, Research and Development, Sales, Marketing, Purchasing
and
Administration
|
|
72,000
|
|
Company
owned
|
|
|
|
|
|
|
|
Torrington,
Connecticut
|
|
Manufacturing
|
|
65,000
|
|
December
2015
|
|
|
|
|
|
|
|
Danbury,
Connecticut
|
|
Manufacturing
and Operations
|
|
38,000
|
|
October
2009
|
|
|
|
|
|
|
|
Item
3. LEGAL PROCEEDINGS
On
November 14, 2005, Zoot Properties, LLC and Zoot Enterprises, Inc. (“Zoot”)
commenced an action in the U.S. District Court for the District of Montana,
Butte Division against the Company and one of our distribution partners, PPL
Energy Services Holding, LLC (“PPL”). The lawsuit alleged that the plaintiffs
purchased fuel cells from PPL that were manufactured by the Company, and that
these fuel cells failed to perform as represented and warranted. Zoot sought
rescission of the contract with PPL, totaling approximately $2.5 million. We
reached a settlement agreement on this lawsuit resulting in payments by the
Company during the third quarter of 2007, net of insurance, of $0.8 million
in
exchange for the power plants which were recorded in inventory at this amount.
As a result, there was no impact on the Company’s Consolidated Statement of
Operations from this settlement.
Item
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART
II
Item
5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
FUELCELL
COMMON STOCK
Our
common stock has been publicly traded since June 25, 1992. From September 21,
1994 through February 25, 1997, it was quoted on the NASDAQ National Market,
and
from February 26, 1997 through June 6, 2000 it was traded on the American Stock
Exchange. Our common stock has traded under the symbol “FCEL” on the Nasdaq
Stock Market since June 7, 2000. The following table sets forth the high and
low
sale prices for our common stock for the fiscal periods indicated as reported
by
the Nasdaq Stock Market during the indicated quarters.
|
|
Common
Stock Price
|
|
|
|
High
|
|
Low
|
|
Year
Ended October 31, 2005
|
|
|
|
|
|
First
Quarter
|
|
$
|
13.45
|
|
$
|
7.98
|
|
Second
Quarter
|
|
$
|
12.06
|
|
$
|
7.71
|
|
Third
Quarter
|
|
$
|
10.94
|
|
$
|
7.05
|
|
Fourth
Quarter
|
|
$
|
12.25
|
|
$
|
8.25
|
|
|
|
|
|
|
|
|
|
Year
Ended October 31, 2006
|
|
|
|
|
|
|
|
First
Quarter
|
|
$
|
10.90
|
|
$
|
7.90
|
|
Second
Quarter
|
|
$
|
15.00
|
|
$
|
9.22
|
|
Third
Quarter
|
|
$
|
13.97
|
|
$
|
8.29
|
|
Fourth
Quarter
|
|
$
|
9.90
|
|
$
|
6.59
|
|
|
|
|
|
|
|
|
|
Year
Ended October 31, 2007
|
|
|
|
|
|
|
|
First
Quarter
|
|
$
|
7.37
|
|
$
|
5.84
|
|
Second
Quarter
|
|
$
|
9.30
|
|
$
|
6.15
|
|
Third
Quarter
|
|
$
|
8.40
|
|
$
|
6.30
|
|
Fourth
Quarter
|
|
$
|
10.57
|
|
$
|
7.22
|
|
On
January 10, 2008, the closing price of our common stock on the Nasdaq Stock
Market was $9.61 per share. As of January 10, 2008, there were 691 holders
of
record of our common stock.
We
have
never paid a cash dividend on our common stock and do not anticipate paying
any
cash dividends on common stock in the foreseeable future. In
addition, the terms of our Series B preferred shares prohibit the payment of
dividends on our common stock unless all dividends on the Series B preferred
stock have been paid in full.
PERFORMANCE
GRAPH
The
following graph compares the annual change in the Company’s cumulative total
shareholder return on its Common Stock for the five fiscal years ended October
31, 2007 with the cumulative total return on the Russell 2000 and a peer group
consisting of Standard Industry Classification (“SIC”) Group Code 369 companies
listed on The American Stock Exchange, Nasdaq Global Market and New York Stock
Exchange for that period. It assumes $100 invested on November 1, 2002 with
dividends reinvested.
SERIES
1 PREFERRED SHARES
On
August
4, 2003, we entered into a combination agreement with Global
Thermoelectric Inc. (“Global”) to combine Global with us in a share-for-share
exchange pursuant to a Plan of Arrangement subject to approval by the Court
of
Queen’s Bench of Alberta, Canada. On October 31, 2003, our shareholders and the
shareholders of Global approved the combination. On October 31, 2003, the Court
of Queen’s Bench of Alberta issued an order approving the combination. On
November 3, 2003, the combination transaction was consummated. In the aggregate,
we issued approximately 8.2 million shares of our common stock and exchangeable
shares in the acquisition. Following our acquisition of Global, Global’s Series
2 preferred shares remained outstanding in Global. At the time of the sale
of
our thermoelectric generator business, the holder of the Series 2 preferred
shares exchanged them for Series 1 Class A cumulative redeemable exchangeable
preferred shares (which were referred to as the Series 1 preferred shares)
issued by FuelCell Energy, Ltd., one of our wholly-owned subsidiaries. We have
guaranteed the obligations of FuelCell Energy, Ltd. under the Series 1 preferred
shares.
The
Series 1 preferred shares may be converted into shares of our common stock
at
the following conversion prices:
|
· |
Cdn.$120.22
per share of our common stock until July 31,
2010;
|
|
· |
Cdn.$129.46
per share of our common stock after July 31, 2010 until July 31,
2015;
|
|
· |
Cdn.$138.71
per share of our common stock after July 31, 2015 until July 31,
2020;
and
|
|
· |
at
any time after July 31, 2020, the price equal to 95% of the then
current
market price (converted to Cdn.$ at the time of such calculation)
of
shares of our common stock at the time of
conversion.
|
The
foregoing conversion prices are subject to adjustment for certain subsequent
events. As illustrated below, the number of shares of our common stock issuable
upon conversion of the Series 1 preferred shares after July 31, 2020 may be
significantly greater than the number of shares issuable prior to that
time.
The
following examples illustrate the number of shares of our common stock that
we
will be required to issue to the holder(s) of the Series 1 preferred shares
if
and when the holder(s) exercise their conversion rights pursuant to the terms
of
the Series 1 preferred shares. The following examples are based upon Cdn.$25.0
million of Series 1 preferred shares outstanding (which is the amount currently
outstanding) and assume that all accrued dividends on the Series 1 preferred
shares have been paid through the time of the conversion and, in the case of
conversions occurring after July 31, 2020, that the exchange rate for Canadian
dollars is Cdn.$1.006 to U.S.$1.00 (exchange rate on January 10, 2008) at the
time of the conversion:
|
·
|
if
the Series 1 preferred shares convert prior to July 31, 2010, we
would be
required to issue approximately 207,952 shares of our common
stock;
|
|
·
|
if
the Series 1 preferred shares convert after July 31, 2010, but prior
to
July 31, 2015, we would be required to issue approximately 193,110
shares
of our common stock;
|
|
·
|
if
the Series 1 preferred shares convert after July 31, 2015, but prior
to
July 31, 2020, we would be required to issue approximately 180,232
shares
of our common stock; and
|
|
·
|
if
the Series 1 preferred shares convert any time after July 31, 2020,
assuming
our common stock price is U.S. $9.61 (our common stock closing price
on
January 10, 2008) at the time of conversion, we would be required
to issue
approximately 2,722,043 shares of our common stock.
|
Subject
to the Business Corporations Act (Alberta), the holder of the Series 1 preferred
shares is not entitled to receive notice of or to attend or vote at any meeting
of the FuelCell Energy, Ltd. common shareholders. At present, we own all of
the
FuelCell Energy, Ltd. common stock.
Quarterly
dividends of Cdn.$312,500 accrue on the Series 1 preferred shares (subject
to
possible reduction pursuant to the terms of the Series 1 preferred shares on
account of increases in the price of our common stock). We have agreed to pay
a
minimum of Cdn.$500,000 in cash or common stock annually to Enbridge, the sole
current holder of the Series 1 preferred shares, as long as Enbridge holds
the
shares. Interest accrues on cumulative unpaid dividends at a 2.45% quarterly
rate, compounded quarterly, until payment thereof. All cumulative unpaid
dividends must be paid by December 31, 2010. Subsequent to 2010, FuelCell
Energy, Ltd. would be required to pay annual dividend amounts totaling Cdn.$1.25
million so long as the Series 1 Preferred shares remain outstanding. Using
an
exchange rate of Cdn.$1.0478 to U.S.$1.00 (exchange rate on October 31, 2007),
cumulative unpaid dividends and accrued interest of approximately $7.7 million
on the Series 1 preferred shares were outstanding as of October 31, 2007. We
have guaranteed the dividend obligations of FuelCell Energy, Ltd. to the Series
1 preferred shareholders.
Subject
to the Business Corporations Act (Alberta), we may redeem the Series 1 preferred
shares, in whole or part, at any time, if on the day that the notice of
redemption is first given, the volume-weighted average price at which our common
stock is traded on the applicable stock exchange during the 20 consecutive
trading days ending on a date not earlier than the fifth preceding day on which
the notice of redemption is given was not less than a 20% premium to the current
conversion price on payment of Cdn.$25.00 per Series 1 Preferred Share to be
redeemed, together with an amount equal to all accrued and unpaid dividends
to
the date fixed for redemption. On or after July 31, 2010, the Series 1 preferred
shares are redeemable by us at any time on payment of Cdn.$25.00 per Series
1
preferred share to be redeemed together with an amount equal to all accrued
and
unpaid dividends to the date fixed for redemption. Holders of the Series 1
preferred shares do not have any mandatory or conditional redemption rights.
There are currently 1,000,000 Series 1 preferred shares
outstanding.
In
the
event of the liquidation, dissolution or winding up of FuelCell Energy, Ltd.,
whether voluntary or involuntary, or any other distribution of its assets among
its shareholders for the purpose of winding up its affairs, the holder of the
Series 1 preferred shares will be entitled to receive the amount paid on such
Series 1 preferred shares (currently Cdn.$25.0 million) together with an amount
equal to all accrued and unpaid dividends thereon, before any amount will be
paid or any of FuelCell Energy, Ltd.’s property or assets will be distributed to
the holders of FuelCell Energy, Ltd.’s common stock. After payment to the holder
of the Series 1 preferred shares of the amounts payable to them, the holder
of
the Series 1 preferred shares will not be entitled to share in any other
distribution of FuelCell Energy, Ltd.’s property or assets. We have guaranteed
the liquidation obligations of FuelCell Energy, Ltd. under the Series 1
preferred shares.
SERIES
B PREFERRED SHARES
On
November 11, 2004, we entered into a purchase agreement with Citigroup Global
Markets Inc., RBC Capital Markets Corporation, Adams Harkness, Inc., and Lazard
Freres & Co., LLC (the “Initial Purchasers”) for the private placement under
Rule 144A of up to 135,000 shares of our 5% Series B Cumulative Convertible
Perpetual Preferred Stock (Liquidation Preference $1,000) (“Series B Preferred
Stock”). On November 17, 2004 and January 25, 2005, we closed on the sale of
100,000 shares and 5,875 shares, respectively, of Series B Preferred Stock
to
the Initial Purchasers.
At
October 31, 2007 and 2006, there were 250,000 authorized of which 64,120 were
outstanding. The carrying value of the Series B Preferred Stock as of October
31, 2007 and 2006 represents the net proceeds to us of approximately $60.0
million. During fiscal 2006, we converted 41,755 shares of Series B Preferred
Stock (the "Shares") into 3,553,615 shares of our common stock. The conversion
occurred pursuant to the terms of the Certificate of Designation for the Series
B Preferred Stock, whereby upon conversion, the holders received 85.1064 shares
of our common stock per share of Series B Preferred Stock. In addition, pursuant
to this conversion, we paid a conversion premium of $4.3 million.
The
following is a summary of certain provisions of our Series B Preferred Stock.
The resale of the shares of our Series B Preferred Stock and the resale of
the
shares of our common stock issuable upon conversion of the shares of our Series
B Preferred Stock are
covered
by a registration rights agreement.
Ranking
Shares
of
our Series B Preferred Stock rank with respect to dividend rights and rights
upon our liquidation, winding up or dissolution:
|
·
|
senior
to shares of our common stock;
|
|
·
|
junior
to our debt obligations; and
|
|
·
|
effectively
junior to our subsidiaries’ (i) existing and future liabilities and (ii)
capital stock held by others.
|
Dividends
The
Series B Preferred Stock pays cumulative annual dividends of $50 per share
which
are payable quarterly in arrears on February 15, May 15, August 15 and November
15, which commenced on February 15, 2005, when, as and if declared by the board
of directors. Dividends will be paid on the basis of a 360-day year consisting
of twelve 30-day months. Dividends on the shares of our Series B Preferred
Stock
will accumulate and be cumulative from the date of original issuance.
Accumulated dividends on the shares of our Series B preferred stock will not
bear any interest.
The
dividend rate on the Series B Preferred Stock is subject to upward adjustment
as
set forth in the certificate of designation of the Series B Preferred Stock
if
we fail to pay, or to set apart funds to pay, dividends on the shares of our
Series B Preferred Stock for any quarterly dividend period. The dividend rate
on
the Series B Preferred Stock is also subject to upward adjustment as set forth
in the registration rights agreement entered into with the Initial Purchasers
if
we fail to satisfy our registration obligations with respect to the Series
B
Preferred Shares (or the underlying common shares) set forth in the registration
rights agreement.
No
dividends or other distributions may be paid or set apart for payment upon
our
common shares (other than a dividend payable solely in shares of a like or
junior ranking) unless all accumulated and unpaid dividends have been paid
or
funds or shares of common stock therefore have been set apart on our Series
B
Preferred Stock.
We
may
pay dividends on the Series B Preferred Stock:
|
·
|
at
the option of the holder, in shares of our common stock, which will
be
registered pursuant to a registration statement to allow for the
immediate
sale of these common shares in the public
market.
|
Liquidation
The
Series B Preferred Stock has a liquidation preference of $1,000 per share.
Upon
any voluntary or involuntary liquidation, dissolution or winding up of our
company resulting in a distribution of assets to the holders of any class or
series of our capital stock, each holder of shares of our Series B preferred
stock will be entitled to payment out of our assets available for distribution
of an amount equal to the liquidation preference per share of Series B Preferred
Stock held by that holder, plus all accumulated and unpaid dividends on those
shares to the date of that liquidation, dissolution, or winding up, before
any
distribution is made on any junior shares, including shares of our common stock,
but after any distributions on any of our indebtedness or senior shares (if
any). After payment in full of the liquidation preference and all accumulated
and unpaid dividends to which holders of shares of our Series B preferred stock
are entitled, holders of shares of our Series B preferred stock will not be
entitled to any further participation in any distribution of our assets.
Conversion
A
share
of our Series B Preferred Stock may be converted at any time, at the option
of
the holder, into 85.1064 shares of our common stock (which is equivalent to
an
initial conversion price of $11.75 per share) plus cash in lieu of fractional
shares. The conversion rate is subject to adjustment upon the occurrence of
certain events, as described below, but will not be adjusted for accumulated
and
unpaid dividends. Upon conversion, holders of Series B preferred stock will
not
receive a cash payment for any accumulated dividends. Instead accumulated
dividends, if any, will be cancelled.
On
or
after November 20, 2009 we may, at our option, cause shares of our Series B
Preferred Stock to be automatically converted into that number of shares of
our
common stock that are issuable at the then prevailing conversion rate. We may
exercise our conversion right only if the closing price of our common stock
exceeds 150% of the then prevailing conversion price for 20 trading days during
any consecutive 30 trading day period, as described in the certificate of
designation for the Series B preferred stock.
If
holders of shares of our Series B Preferred Stock elect to convert their shares
in connection with certain fundamental changes (as described below and in the
certificate of designation), we will in certain circumstances discussed below
increase the conversion rate by a number of additional shares of common stock
upon conversion or, in lieu thereof, we may in certain circumstances elect
to
adjust the conversion rate and related conversion obligation so that shares
of
our Series B preferred stock are converted into shares of the acquiring or
surviving company, in each case as described in the certificate of
designation.
The
adjustment of the conversion price of the Series B Preferred Stock is to prevent
dilution of the interests of the holders of the Series B Preferred Shares,
including on account of the following:
|
·
|
Issuances
of common stock as a dividend or distribution to holders of our common
stock;
|
|
·
|
Common
stock share splits or share combinations;
|
|
·
|
Issuances
to holders of our common stock of any rights, warrants or options
to
purchase our common stock for a period of less than 60 days; and
|
|
·
|
Distributions
of assets, evidences of indebtedness or other property to holders
of our
common stock.
|
Shares
of
our Series B Preferred Stock will not be redeemable by us, except in the case
of
a fundamental change (as described below and in the certificate of designation)
whereby holders may require us to purchase all or part of their shares at a
redemption price equal to 100% of the liquidation preference of the shares
of
Series B Preferred Stock to be repurchased, plus accrued and unpaid dividends,
if any. We may, at our option, elect to pay the redemption price in cash or,
in
shares of our common stock valued at a discount of 5% from the market price
of
shares of our common stock, or any combination thereof. Notwithstanding the
foregoing, we may only pay such redemption price in shares of our common stock
that are registered under the Securities Act of 1933 and eligible for immediate
sale in the public market by non-affiliates of the Company.
Redemption
by holders of the Series B Preferred Stock can only occur upon a fundamental
change, which the Company does not consider to be probable at this time.
Accordingly, future adjustments of the redemption price will only be made if
and
when a fundamental change is considered probable.
A
“fundamental change” will be deemed to have occurred if any of the following
occurs:
(1)
any
"person" or "group" is or becomes the beneficial owner, directly or indirectly,
of 50% or more of the total voting power of all classes of our capital stock
then outstanding and normally entitled to vote in the election of
directors;
(2)
during any period of two consecutive years, individuals who at the beginning
of
such period constituted the Board of Directors (together with any new directors
whose election by our Board of Directors or whose nomination for election by
our
shareholders was approved by a vote of two-thirds of our directors then still
in
office who were either directors at the beginning of such period or whose
election of nomination for election was previously so approved) cease for any
reason to constitute a majority of our directors then in office;
(3)
the
termination of trading of our common stock on the Nasdaq Stock Market and such
shares are not approved for trading or quoted on any other U.S. securities
exchange; or
(4)
we
consolidate with or merge with or into another person or another person merges
with or into us or the sale, assignment, transfer, lease, conveyance or other
disposition of all or substantially all of our assets and certain of our
subsidiaries, taken as a whole, to another person and, in the case of any such
merger or consolidation, our securities that are outstanding immediately prior
to such transaction and which represent 100% of the aggregate voting power
of
our voting stock are changed into or exchanged for cash, securities or property,
unless pursuant to the transaction such securities are changed into securities
of the surviving person that represent, immediately after such transaction,
at
least a majority of the aggregate voting power of the voting stock of the
surviving person.
Notwithstanding
the foregoing, holders of shares of Series B Preferred Stock will not have
the
right to require us to repurchase their shares if either:
|
·
|
the
last reported sale price of shares of our common stock for any five
trading days within the 10 consecutive trading days ending immediately
before the later of the fundamental change or its announcement equaled
or
exceeded 105% of the conversion price of the shares of Series B Preferred
Stock immediately before the fundamental change or
announcement;
|
|
·
|
at
least 90% of the consideration, excluding cash payments for fractional
shares and in respect of dissenters' appraisal rights, in the transaction
constituting the fundamental change consists of shares of capital
stock
traded on a U.S. national securities exchange or which will be so
traded
or quoted when issued or exchanged in connection with a fundamental
change
and as a result of the transaction, shares of Series B Preferred
Stock
become convertible into such publicly traded securities;
or
|
|
·
|
in
the case of number 4 above of a fundamental change event, the transaction
is effected solely to change our jurisdiction of
incorporation.
|
Voting
Holders
of shares of our Series B Preferred Stock have no voting rights unless (1)
dividends on any shares of our Series B Preferred Stock or any other class
or
series of stock ranking on a parity with the shares of our Series B Preferred
Stock with respect to the payment of dividends shall be in arrears for dividend
periods, whether or not consecutive, containing in the aggregate a number of
days equivalent to six calendar quarters or (2) we fail to pay the repurchase
price, plus accrued and unpaid dividends, if any, on the fundamental change
repurchase date for shares of our Series B Preferred Stock following a
fundamental change (as described in the certificate of designation for the
Series B Preferred Stock). In each such case, the holders of shares of our
Series B Preferred Stock (voting separately as a class with all other series
of
other Preferred Stock on parity with our Series B Preferred Stock upon which
like voting rights have been conferred and are exercisable, if any) will be
entitled to vote for the election of two directors in addition to those
directors on the board of directors at such time at the next annual meeting
of
shareholders and each subsequent meeting until the repurchase price or all
dividends accumulated on the shares of our Series B Preferred Stock have been
fully paid or set aside for payment. The term of office of all directors elected
by the holders of shares of our Series B Preferred Stock will terminate
immediately upon the termination of the right of holders of shares of our Series
B Preferred Stock to vote for directors.
So
long
as any shares of our Series B Preferred Stock remain outstanding, we will not,
without the consent of the holders of at least two-thirds of the shares of
our
Series B Preferred Stock outstanding at the time (voting separately as a class
with all other series of Preferred Stock, if any, on parity with our Series
B
Preferred Stock upon which like voting rights have been conferred and are
exercisable) issue or increase the authorized amount of any class or series
of
shares ranking senior to the outstanding shares of our Series B Preferred Stock
as to dividends or upon liquidation. In addition, we will not, subject to
certain conditions, amend, alter or repeal provisions of our certificate of
incorporation, including the certificate of designation relating to our Series
B
Preferred Stock, whether by merger, consolidation or otherwise, so as to
adversely amend, alter or affect any power, preference or special right of
the
outstanding shares of our Series B Preferred Stock or the holders thereof
without the affirmative vote of not less than two-thirds of the issued and
outstanding shares of our Series B Preferred Stock.
UNREGISTERED
SECURITIES
The
following unregistered securities were issued during the twelve months ended
October 31, 2007:
Shares
Issued
On
February 7, 2007, we sold 3,822,630 shares of our common stock to POSCO Power
for $29.0 million. These securities were exempt from registration pursuant
to
section 4(2) of the Securities Act of 1933. We filed a registration statement
on
Form S-3 with the SEC on September 18, 2007 to register these shares for resale
by POSCO Power.
Warrants
Issued
On
July
7, 2005, we issued warrants to purchase up to an aggregate of 1,000,000 shares
of our common stock to Enbridge Inc. (Enbridge) in conjunction with an amended
distribution agreement. All previously issued warrants to Enbridge were
cancelled. The warrants vest on a graduated scale based on the total number
of
megawatts contained in product orders and the timing of when such orders are
generated by Enbridge. In October 2006 and July 2007, Enbridge placed qualifying
orders resulting in vesting of 30,000 and 7,500 warrants, respectively, both
with an exercise price of $9.89. The expiration dates are October 31, 2008
for
the 30,000 vested warrants and October 31, 2009 for the 7,500 vested warrants.
As of October 31, 2007, 212,500 warrants expired unvested and the remaining
available unvested warrants totaled 750,000 with exercise prices ranging from
$10.88 to $11.87 per share and expiration dates ranging from October 31, 2008
to
October 31, 2011.
Item
6. SELECTED FINANCIAL DATA
The
selected consolidated financial data presented below as of the end of each
of
the years in the five-year period ended October 31, 2007 have been derived
from
our audited consolidated financial statements together with the notes thereto
included elsewhere in this Report (the “Financial Statements”). The data set
forth below is qualified by reference to, and should be read in conjunction
with, the Financial Statements and “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” included elsewhere in this
Report.
(Amounts
presented in thousands, except for per share amounts)
Consolidated
Statement of Operations Data:
|
|
Year
Ended October 31,
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales and revenue
|
|
$
|
32,517
|
|
$
|
21,514
|
|
$
|
17,398
|
|
$
|
12,636
|
|
$
|
16,081
|
|
Research
and development contracts
|
|
|
15,717
|
|
|
11,774
|
|
|
12,972
|
|
|
18,750
|
|
|
17,709
|
|
Total
revenues
|
|
|
48,234
|
|
|
33,288
|
|
|
30,370
|
|
|
31,386
|
|
|
33,790
|
|
Costs
and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of product sales and revenues
|
|
|
61,827
|
|
|
61,526
|
|
|
52,067
|
|
|
39,961
|
|
|
50,391
|
|
Cost
of research and development contracts
|
|
|
13,438
|
|
|
10,330
|
|
|
13,183
|
|
|
27,290
|
|
|
35,827
|
|
Administrative
and selling expenses
|
|
|
18,625
|
|
|
17,759
|
|
|
14,154
|
|
|
14,901
|
|
|
12,631
|
|
Research
and development expenses
|
|
|
27,489
|
|
|
24,714
|
|
|
21,840
|
|
|
26,677
|
|
|
8,509
|
|
Purchased
in-process research and development
|
|
|
—
|
|
|
|
|
|
|
|
|
12,200
|
|
|
|
|
Total
costs and expenses
|
|
|
121,379
|
|
|
114,329
|
|
|
101,244
|
|
|
121,029
|
|
|
107,358
|
|
Loss
from operations
|
|
|
(73,145
|
)
|
|
(81,041
|
)
|
|
(70,874
|
)
|
|
(89,643
|
)
|
|
(73,568
|
)
|
License
fee income, net
|
|
|
34
|
|
|
42
|
|
|
70
|
|
|
19
|
|
|
270
|
|
Interest
expense
|
|
|
(84
|
)
|
|
(103
|
)
|
|
(103
|
)
|
|
(137
|
)
|
|
(128
|
)
|
Loss
from equity investments
|
|
|
(1,263
|
)
|
|
(828
|
)
|
|
(1,553
|
)
|
|
|
|
|
|
|
Interest
and other income, net
|
|
|
7,437
|
|
|
5,718
|
|
|
5,526
|
|
|
2,472
|
|
|
6,012
|
|
Redeemable
minority interest
|
|
|
(1,653
|
)
|
|
107
|
|
|
|
|
|
|
|
|
|
|
Provision
for taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
|
(68,674
|
)
|
|
(76,105
|
)
|
|
(66,934
|
)
|
|
(87,289
|
)
|
|
(67,414
|
)
|
Discontinued
operations, net of tax
|
|
|
|
|
|
|
|
|
(1,252
|
)
|
|
846
|
|
|
|
|
Net
loss
|
|
|
(68,674
|
)
|
|
(76,105
|
)
|
|
(68,186
|
)
|
|
(86,443
|
)
|
|
(67,414
|
)
|
Preferred
stock dividends
|
|
|
(3,208
|
)
|
|
(8,117
|
)
|
|
(6,077
|
)
|
|
(964
|
)
|
|
|
|
Net
loss to common shareholders
|
|
$
|
(71,882
|
)
|
$
|
(84,222
|
)
|
$
|
(74,263
|
)
|
$
|
(87,407
|
)
|
$
|
(67,414
|
)
|
Basic
and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing
operations
|
|
$
|
(1.16
|
)
|
$
|
(1.65
|
)
|
$
|
(1.51
|
)
|
$
|
(1.84
|
)
|
$
|
(1.71
|
)
|
Discontinued
operations
|
|
|
|
|
|
|
|
|
(.03
|
)
|
|
0.01
|
|
|
|
|
Net
loss to common shareholders
|
|
$
|
(1.16
|
)
|
$
|
(1.65
|
)
|
$
|
(1.54
|
)
|
$
|
(1.83
|
)
|
$
|
(1.71
|
)
|
Basic
and diluted weighted average shares Outstanding
|
|
|
61,991
|
|
|
51,047
|
|
|
48,261
|
|
|
47,875
|
|
|
39,342
|
|
Consolidated
Balance Sheet Data:
|
|
As
of October 31,
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
Cash,
cash equivalents and short term investments (U.S. treasury
securities)
|
|
$
|
153,631
|
|
$
|
107,533
|
|
$
|
136,032
|
|
$
|
152,395
|
|
$
|
134,750
|
|
Working
capital
|
|
|
158,687
|
|
|
104,307
|
|
|
140,736
|
|
|
156,798
|
|
|
143,998
|
|
Total
current assets
|
|
|
201,005
|
|
|
133,709
|
|
|
161,894
|
|
|
178,866
|
|
|
160,792
|
|
Long-term
investments (U.S. treasury securities)
|
|
|
|
|
|
13,054
|
|
|
43,928
|
|
|
|
|
|
18,690
|
|
Total
assets
|
|
|
253,188
|
|
|
206,652
|
|
|
265,520
|
|
|
236,510
|
|
|
223,363
|
|
Total
current liabilities
|
|
|
42,318
|
|
|
29,402
|
|
|
21,158
|
|
|
22,070
|
|
|
16,794
|
|
Total
non-current liabilities
|
|
|
5,014
|
|
|
5,840
|
|
|
2,892
|
|
|
1,476
|
|
|
1,484
|
|
Redeemable
minority interest
|
|
|
11,884
|
|
|
10,665
|
|
|
11,517
|
|
|
10,259
|
|
|
|
|
Redeemable
preferred stock
|
|
|
59,950
|
|
|
59,950
|
|
|
98,989
|
|
|
|
|
|
|
|
Total
shareholders’ equity
|
|
|
134,022
|
|
|
100,795
|
|
|
130,964
|
|
|
202,705
|
|
|
205,085
|
|
Book
value per share(1)
|
|
$
|
1.97
|
|
$
|
1.90
|
|
$
|
2.70
|
|
$
|
4.21
|
|
$
|
5.20
|
|
(1) Calculated
as total shareholders’ equity divided by common shares issued and outstanding as
of the balance sheet date.
Item
7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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
MD&A is organized as follows:
Caution
concerning forward-looking statements. This
section discusses how certain forward-looking statements made by us throughout
the MD&A are based on management’s present expectations about future events
and are inherently susceptible to uncertainty and changes in
circumstances.
Overview
and recent developments.
This
section provides a general description of our business. We also briefly
summarize any significant events occurring subsequent to the close of the
reporting period.
Critical
accounting policies and estimates.
This
section discusses those accounting policies and estimates that are both
considered important to our financial condition and operating results and
require significant judgment and estimates on the part of management in their
application.
Results
of operations.
This
section provides an analysis of our results of operations for the years ended
October 31, 2007, 2006 and 2005. In addition, a description is provided of
transactions and events that impact the comparability of the results being
analyzed.
Liquidity
and capital resources.
This
section provides an analysis of our cash position and cash flows.
Recent
accounting pronouncements.
This
section summarizes recent accounting pronouncements and their impact on the
Company.
Factors
that may affect future results. This
section details risk factors that affect our quarterly and annual results,
but
which are difficult to predict.
CAUTION
CONCERNING FORWARD-LOOKING STATEMENTS
The
following discussion should be read in conjunction with the accompanying
Consolidated Financial Statements and Notes thereto included within this report.
In addition to historical information, this Form 10-K and the following
discussion contain forward-looking statements. All forward-looking statements
are subject to risks and uncertainties that could cause actual results to differ
materially from those projected. Factors that could cause such a difference
include, without limitation, the risk that commercial field trials of the
Company’s products will not occur when anticipated, general risks associated
with product development, manufacturing, changes in the utility regulatory
environment, potential volatility of energy prices, rapid technological change,
competition, and the Company’s ability to achieve its sales plans and cost
reduction targets, as well as other risks set forth in our filings with the
Securities and Exchange Commission including those set forth under the caption
“Risk Factors” in this report.
OVERVIEW
AND RECENT DEVELOPMENTS
Overview
FuelCell
Energy is a world leader in the development and manufacture of fuel cell power
plants for ultra-clean, efficient and reliable electric power
generation. Our products are designed to meet the 24/7 baseload power needs
of commercial, industrial, government and utility customers. To date our
products have generated over 200 million kilowatt hours of electricity and
are
operating at over 40 locations around the world.
We
have
been developing fuel cell technology since our founding in 1969. Our core
carbonate fuel cell products (“Direct FuelCell®
or
DFC®
Power
Plants”) offer stationary power generation applications for customers. In
addition to our current commercial products, we continue to develop our next
generation of carbonate fuel cell and hybrid products as well as planar solid
oxide fuel cell (“SOFC”) technology with our own and government research and
development funds.
Our
proprietary carbonate DFC power plants electrochemically (without combustion)
produce electricity directly from readily available hydrocarbon fuels, such
as
natural gas and biogas fuels. Customers buy fuel cells to reduce cost, pollution
and improve reliability. Electric generation without combustion significantly
reduces harmful pollutants such as NOX and particulates. Higher fuel efficiency
results in lower emissions of carbon dioxide, a major component of harmful
greenhouse gases, and also results in less fuel needed per kWh of electricity
generated and Btu of heat produced, thereby reducing exposure to volatile
natural gas costs and minimizing operating costs.
We
believe that compared to other power generation technologies, our products
offer
significant advantages including:
|
·
|
Ultra-clean
(e.g. virtually zero emissions), quiet
operation
|
|
·
|
Reliable,
24/7 baseload power
|
|
·
|
Ability
to site units locally
|
|
·
|
Potentially
lower cost power generation
|
|
·
|
Byproduct
high-temperature heat ideal for cogeneration (combined heat and power)
applications.
|
Typical
customers for our products include manufacturers, mission critical institutions
such as correction facilities and government installations, hotels, and
customers who can use renewable gas for fuel such as breweries, food processors
and wastewater treatment facilities. With increasing demand for renewable and
ultra-clean power options, and increased volatility and uncertainty in electric
markets, our customers gain control of power generation economics, reliability
and emissions. Our fuel cells offer flexible siting and easy permitting.
DFC
power
plants are protected by 52 U.S. and 92 international patents and we have also
submitted 37 U.S. and 149 international patent applications.
Recent
Developments
Connecticut
Project 100
Connecticut’s
Project 100 moved through the regulatory process throughout 2007 and in January
2008, 16.2 MW of projects that include our fuel cells are pending approval
by
the Department of Public Utility Control. The final decision is due January
23,
2008, after which the project developers can finalize power purchase agreements
with the utilities, complete their project financing and submit purchase orders
for our fuel cells. If approved, these combined projects would represent
approximately $43 million of future sales, and would include a project in
Milford, Connecticut that will be the largest installation of stationary fuel
cells anywhere in the world at 7.2 MW.
The
DPUC’s draft ruling in December 2007 did not include a 13.7 MW fuel cell
generation facility in Bridgeport, Connecticut. During 2007, the Company
invested approximately $0.6 million of pre-development expenses funded, in
part,
from a loan totaling approximately $0.5 million from the Connecticut Clean
Energy Fund. The loan will be forgiven should the project not achieve commercial
operation. If the Bridgeport project is not included in the DPUC’s final ruling,
expected to be issued on January 23, 2008, then the Company would most likely
record an asset impairment charge totaling $0.6 million, offset by a $0.5
million gain on the forgiveness of the CCEF loan.
Expanded
distribution agreement with POSCO Power
On
February 20, 2007, we announced a ten-year manufacturing and distribution
agreement with POSCO Power, a subsidiary of our South Korean strategic
distribution partner, POSCO. For the first two years of the agreement, we will
sell complete DFC power plants to POSCO Power. Beginning in year three, POSCO
Power will buy fuel cell modules manufactured by us in Connecticut and build
its
own BOPs in South Korea using its design, procurement and manufacturing
expertise to achieve further cost savings. Under the terms of the agreement,
we
will receive a 4.1 percent royalty on sales made by POSCO Power payable in
a
combination of cash and common stock. POSCO Power also purchased approximately
3.8 million shares of our common stock for $29 million.
POSCO
broke ground on its 50 MW fuel cell BOP manufacturing facility, which is
scheduled for completion by the end of 2008, and formed a partnership with
the
largest electric utility in the country, KEPCO. Since February 2007, POSCO
Power
has ordered 12.6 MW of complete DFC power plants.
Increase
in Production Rate
In
response to increasing backlog and demand, the Company is ramping its annual
production rate from 12 MW to 25 MW. This increase in the production rate is
scheduled to be complete by January 2008. We expect to invest approximately
$10
- 15 million over the next fifteen months to increase the physical plant
capacity to approximately 60 MW of annual production volume.
Common
Stock Offerings
In
April
2007, we completed a public offering of 9.4 million shares of our common stock
for net proceeds of $65.4 million. We intend to use the net proceeds from this
offering for product development, project financing, expansion of manufacturing
capacity and general corporate purposes. Additionally, we sold 280,000 shares
of
our common stock on the open market during fiscal 2007. Total net proceeds
to us
from the sale of these securities was approximately $2.3 million and is intended
to be used for general corporate purposes and dividend payments on our preferred
stock.
Versa
Investment
In
June
2007, we invested $2.0 million in Versa Power Systems, Inc. (“Versa”) in the
form of a convertible note. This investment would bring the Company’s ownership
percentage in Versa to approximately 43% should this note be converted into
common stock. In conjunction with this investment we also received warrants
for
the right to purchase an additional 2,286 shares of Versa common stock with
an
exercise price of $175 per share. Versa is a leading planar solid-oxide
technology developer and is a subcontractor on the Company’s DOE large-scale
project to develop a coal-based, multi-megawatt solid oxide fuel cell-based
hybrid system.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
Revenue
Recognition
We
contract with our customers to perform research and development, manufacture
and
install fuel cell components and power plants under long-term contracts, and
provide services under contract. We recognize revenue on a method similar to
the
percentage-of-completion method.
Revenues
on fuel cell research and development contracts are recognized proportionally
as
costs are incurred and compared to the estimated total research and development
costs for each contract. In many cases, we are reimbursed only a portion of
the
costs incurred or to be incurred on the contract. Revenues from government
funded research, development and demonstration programs are generally
multi-year, 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.
While
government research and development contracts may extend for many years, funding
is often provided incrementally on a year-by-year basis if contract terms are
met and Congress has authorized the funds. As of October 31, 2007 research
and
development sales backlog totaled $18.5 million, of which 50 percent is funded.
Should funding be temporarily delayed or if business initiatives change, we
may
choose to devote resources to other activities, including internally funded
research and development.
Product
sales and revenues include revenues from power plant sales, service contracts,
electricity sales under power purchase agreements (“PPAs”), incentive funding
and power plant site engineering and construction related costs for certain
contracts. Revenues from power plant sales are recognized proportionally as
costs are incurred and assigned to a customer contract by comparing the
estimated total manufacture and installation costs for each contract to the
total contract value. Revenues from service contracts are generally recognized
ratably over the contract. For service contracts that include a fuel cell stack
replacement, a portion of the total contract value is recognized as revenue
at
the time of the stack replacement and the remainder of the contract value is
recognized ratably over the contract. Revenues from electricity sales under
power purchase agreements are recognized as power is produced. Revenues from
incentive funding are recognized ratably over the term of the incentive funding
agreement. Revenues related to site engineering and construction are recognized
as costs are incurred.
As
our
fuel cell products are in their initial stages of development and market
acceptance, actual costs incurred could differ materially from those previously
estimated. As of October 31, 2007, our order backlog was approximately 15.55
MW
and our current production capacity is approximately 50 MW. Once we have
established that our fuel cell products have achieved commercial market
acceptance and order backlog is comparable to our production capacity and future
costs can be reasonably estimated, then estimated costs to complete an
individual contract, in excess of revenue, will be accrued immediately upon
identification.
Warrant
Value Recognition
Warrants
have been issued as sales incentives to certain of our distribution partners.
These warrants vest as orders from our business partners exceed stipulated
levels. Should warrants vest, or when management estimates that it is probable
that warrants will vest, we record a proportional amount of the fair value
of
the warrants against related revenue as a sales discount.
Inventories
During
the procurement and manufacturing process of a fuel cell power plant, costs
for
material, labor and overhead are accumulated in raw materials and
work-in-process inventory until they are transferred to a customer contract,
at
which time they are recorded in cost of sales.
Our
inventories and advance payments to vendors are stated at the lower of cost
or
market price. As we currently sell products at or below cost, we provide for
a
lower of cost or market (“LCM”) adjustment to the cost basis of inventory and
advances to vendors. This adjustment is computed by comparing the current sales
prices of our power plants to estimated costs of completed power plants. In
certain circumstances, for long-lead time items, we will make advance payments
to vendors for future inventory deliveries, which are recorded as a component
of
other current assets on the consolidated balance sheet.
As
of
October 31, 2007 and October 31, 2006, the LCM adjustment to the cost basis
of
inventory and advance payments to vendors was approximately $16.8 million and
$11.3 million, respectively, which equates to a reduction of approximately
33
and 43 percent, respectively, of the gross inventory and advance payments to
vendors value. As of October 31, 2007, our gross inventory and advances to
vendors’ balances increased from the October 31, 2006 balances which resulted in
higher gross reserve balances. As inventory levels increase or decrease,
appropriate adjustments to the cost basis are made.
Internal
Research and Development Expenses
We
conduct internally funded research and development activities to improve current
or anticipated product performance and reduce product life-cycle costs. These
costs are classified as research and development expenses on our Consolidated
Statements of Operations.
Share-Based
Compensation
On
November 1, 2005, we adopted Statement of Financial Accounting Standard No.
123R, “Share-Based Payments” (SFAS 123R). Share-based payment transactions with
employees, which primarily consist of stock options, and third parties requires
the application of a fair value methodology that involves various assumptions.
The fair value of our options awarded to employees is estimated on the date
of
grant using the Black-Scholes option valuation model that uses the following
assumptions: expected life of the option, risk-free interest rate, expected
volatility of our common stock price and expected dividend yield. We estimate
the expected life of the options using historical data and the volatility of
our
common stock is estimated based on a combination of the historical volatility
and the implied volatility from traded options. Share-based compensation of
$5.2
million and $4.4 million were recognized in the Consolidated Statement of
Operations for the fiscal years ended October 31, 2007 and 2006, respectively.
Refer to Note 13 of the consolidated financial statements for additional
information.
RESULTS
OF OPERATIONS
Management
evaluates the results of operations and cash flows using a variety of key
performance indicators. Indicators that management uses include revenues
compared to prior periods, 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.
Comparison
of the Years Ended October 31, 2007 and October 31,
2006
Revenues
and costs of revenues
The
following tables summarize our revenue and cost of revenues for the years ended
October 31, 2007 and 2006 (dollar amounts in thousands), respectively:
|
|
Year
Ended
October
31, 2007
|
|
Year
Ended
October
31, 2006
|
|
Percentage
Increase /
|
|
Revenues:
|
|
Revenues
|
|
Percent of
Revenues
|
|
Revenues
|
|
Percent of
Revenues
|
|
(Decrease) in
Revenues
|
|
Product
sales and revenues
|
|
$
|
32,517
|
|
|
67
|
%
|
$ |
21,514 |
|
|
65
|
%
|
|
51
|
%
|
Research
and development contracts
|
|
|
15,717
|
|
|
33
|
%
|
|
11,774
|
|
|
35
|
%
|
|
33
|
%
|
Total
|
|
$
|
48,234
|
|
|
100
|
%
|
$ |
33,288 |
|
|
100
|
%
|
|
45
|
%
|
|
|
Year
Ended
October
31, 2007
|
|
Year
Ended
October
31, 2006
|
|
Percentage
Increase /(Decrease)
|
|
Cost
of revenues:
|
|
Costs
of
Revenues
|
|
Percent of
Costs of
Revenues
|
|
Cost
of
Revenues
|
|
Percent of
Costs of
Revenues
|
|
in
Cost of Revenues
|
|
Product
sales and revenues
|
|
$
|
61,827
|
|
|
82
|
%
|
$ |
61,526 |
|
|
86
|
%
|
|
1
|
%
|
Research
and development contracts
|
|
|
13,438
|
|
|
18
|
%
|
|
10,330 |
|
|
14
|
%
|
|
30
|
%
|
Total
|
|
$
|
75,265
|
|
|
100
|
%
|
$ |
71,856 |
|
|
100
|
%
|
|
6
|
%
|
Total
revenues for the year ended October 31, 2007 increased by $14.9 million, or
45%
percent, to $48.2 million
from $33.3 million during the same period last year. Components of revenues
and
costs of revenues are as follows:
Product
sales and revenues
Product
sales and revenue
increased
$11.0 million to $32.5 million for fiscal 2007, compared to $21.5 million for
fiscal 2006. Revenue
during fiscal 2007 included approximately $24.9 million of power plant and
component sales, $3.3 million related to service agreements and approximately
$4.3 million of revenue related to power purchase agreements. Higher product
sales and revenues were primarily due to an increase in power plant sales,
including production of MW-class units, as well as increases in service
agreement revenue, component sales and revenues from power purchase agreements,
and site engineering construction revenue.
Cost
of
product sales and revenues increased to $61.8 million for fiscal 2007, compared
to $61.5 million during fiscal 2006.
The
ratio of product cost to sales improved to 1.9 to 1 during 2007, compared to
2.9
to 1 during the same period a year ago. The improved margin is partially
attributable to a shift to sales of megawatt (MW) class power plants, which
have
a lower cost per kilowatt (kW) compared to the sub-MW units produced in prior
year. Product costs are lower on a per kW basis across all product lines as
result of the Company’s cost out program with continued reduction of product
costs through value engineering, manufacturing improvements and supply chain
enhancements. In addition, the Company introduced a 20 percent uprate in 2006,
which effectively lowered product costs on a per kW basis compared to the prior
year. The cost ratio was also favorably impacted in the period by higher revenue
and margins on component sales and service agreements related to the growing
installed fleet.
Research
and development contracts
Research
and development revenue increased
$3.9 million to $15.7 million for fiscal 2007, compared to $11.8 million for
2006.
Cost of
research and development contracts increased to $13.4 million during fiscal
2007, compared to $10.3 million for 2006. Margin for fiscal 2007 was $2.3
million compared to $1.4 million on higher revenues compared to the prior year.
Research and development contract revenue and costs were primarily related
to
the DOE’s large-scale SOFC hybrid program, the U.S. Navy contract for high
temperature ship service fuel cell development and the Electrochemical Hydrogen
Separation contract with the U.S. Army.
Administrative
and selling expenses
Administrative
and selling expenses increased $0.9 million to $18.6 million during fiscal
2007,
compared to $17.8 million in 2006. This increase is primarily due to higher
sales and marketing activities related to a growing order pipeline and higher
stock-based compensation.
Research
and development expenses
Research
and development expenses increased to $27.5 million during fiscal 2007, compared
to $24.7 million recorded in the prior year. The
increase is
due to
development costs for MW-class cost reduction and technology development to
extend stack life and increase power output of our power plants, and higher
stock-based compensation.
Loss
from operations
Loss
from
operations for fiscal 2007 totaled $73.1 million, compared to $81.0 million
recorded in 2006. The decrease in the loss from operations is primarily due
to a
favorable change in product margin resulting from the shift to production of
more MW-class power plants and lower-cost sub-MW units, and improved margins
on
power purchase agreements. This improvement in the loss from operations was
partially offset by higher administrative and selling and research and
development expenses as discussed above.
Loss
from equity investments
Our
equity investment in Versa totaled approximately $10.2 million and $11.5 million
as of October 31, 2007 and 2006, respectively. Our ownership interest at October
31, 2007 was 39 percent and we account for Versa under the equity method of
accounting. Our share of equity losses for fiscal 2007 and 2006 were $1.3
million and $0.8 million, respectively.
During
2007, the Company invested $2.0 million in Versa in the form of a convertible
note. Should this note be converted into common stock, this investment would
bring the Company’s ownership percentage in Versa to approximately 43 percent.
In conjunction with this investment the Company also received warrants for
the
right to purchase an additional 2,286 shares of common stock with an exercise
price of $175 per share. The fair value of the warrants was approximately $0.2
million as of October 31, 2007 and is included within Investment and loan to
affiliate on the consolidated balance sheet. Changes in the fair value of the
warrants are included in the Consolidated Statement of Operations each period.
Interest
and other income, net
Interest
and other income, net, was $7.4 million for fiscal 2007, compared
to $5.7 million for 2006.
Interest
and other income increased due to higher state research and development tax
credits which totaled $1.2 million in 2007, compared to $0.2 million for 2006,
as well as higher interest income on higher average invested balances. The
Company records Connecticut research and development tax credits in the period
in which the return is filed, which is when management believes the amount
of
the credits are probable of collection.
Provision
for income taxes
We
believe that due to our efforts to commercialize our DFC products, we will
continue to incur losses. Based on projections for future taxable income over
the period in which the deferred tax assets are realizable, management believes
that significant uncertainty exists surrounding the recoverability of the
deferred tax assets. Therefore, no tax benefit has been recognized related
to
current or prior year losses and other deferred tax assets.
Comparison
of the Years Ended October 31, 2006 and October 31,
2005
Revenues
and costs of revenues
The
following tables summarize our revenue mix for the years ended October 31,
2006
and 2005 (dollar amounts in thousands), respectively:
|
|
Year
Ended
October
31, 2006
|
|
Year
Ended
October
31, 2005
|
|
Percentage
Increase /
|
|
Revenues:
|
|
Revenues
|
|
Percent of
Revenues
|
|
Product
Revenues
|
|
Percent of
Revenues
|
|
(Decrease) in
Revenues
|
|
Product
sales and revenues
|
|
$
|
21,514
|
|
|
65
|
%
|
$ |
17,398 |
|
|
57
|
%
|
|
24
|
%
|
Research
and development contracts
|
|
|
11,774
|
|
|
35
|
%
|
|
12,972
|
|
|
43
|
%
|
|
(9
|
)%
|
Total
|
|
$
|
33,288
|
|
|
100
|
%
|
$ |
30,370 |
|
|
100
|
%
|
|
10
|
%
|
|
|
Year
Ended
October
31, 2006
|
|
Year
Ended
October
31, 2005
|
|
Percentage
Increase /(Decrease)
|
|
Cost
of revenues:
|
|
Costs
of
Revenues
|
|
Percent of
Costs of
Revenues
|
|
Costs
of
Revenues
|
|
Percent of
Costs of
Revenues
|
|
in
Costs of Revenues
|
|
Product
sales and revenues
|
|
$
|
61,526
|
|
|
86
|
%
|
$ |
52,067 |
|
|
80
|
%
|
|
18
|
%
|
Research
and development contracts
|
|
|
10,330
|
|
|
14
|
%
|
|
13,183 |
|
|
20
|
%
|
|
(22
|
%)
|
Total
|
|
$
|
71,856
|
|
|
100
|
%
|
$ |
65,250 |
|
|
100
|
%
|
|
10
|
%
|
Total
revenues for the year ended October 31, 2006 increased by $2.9 million, or
10
percent, to $33.3 million from $30.4 million during the same period last year.
Components of revenues and costs of revenues are as follows:
Product
sales and revenues
Product
sales and revenue increased
$4.1 million to $21.5 million for fiscal 2006, compared to $17.4 million for
fiscal 2005. Product sales and revenue
for 2006 included approximately $13.0 million of power plant sales, $5.0 million
related to service agreements and component sales and approximately $3.5 million
of revenue related to power purchase agreements. The increase in product sales
and revenues is primarily due to increased market share in the California market
as well as to the timing of customer delivery requirements on new and existing
backlog, an increase in both electricity and grant incentive revenues on power
purchase agreements as more units are operating in the field and higher revenues
on service agreements and stack components also due to a larger operating fleet
of units compared to the prior year.
Cost
of
product sales and revenues increased to $61.5 million during fiscal 2006,
compared to $52.1 million during fiscal 2005.
Included
in cost of sales during 2006 was a non-cash fixed asset impairment charge of
$0.6 million related to the pending sale as of October 31, 2006 of a power
plant
operating under a power purchase agreement. This sale was completed in December
2006. Included in cost of sales during 2005 was
a
non-cash fixed asset impairment charge totaling $1.0 million. This was related
to a planned change in manufacturing processes expected to increase electrical
output for improved product performance and reduced cost in future periods.
The
ratio
of product cost to sales improved to 2.9-to-1 during fiscal 2006 from 3.0-to-1
during fiscal 2005. The improvement in the cost ratio primarily reflects a
decrease in the average cost of our DFC power plants, offset by short-term
pressure on selling prices in California due to higher natural gas pricing,
delays in the Connecticut Renewable Portfolio Standards program and higher
after-market costs on a larger installed fleet.
Research
and development contracts
Research
and development revenue decreased
$1.2 million to $11.8 million for fiscal 2006, compared to $13.0 million for
fiscal 2005.
Cost of
research and development contracts decreased to $10.3 million during fiscal
2006, compared to $13.2 million for fiscal 2005.
Research
and development contract revenue and costs were primarily related to SOFC
development under the DOE’s Solid State Energy Conversion Alliance Program, the
Ship Service Fuel Cell contract with the U.S. Navy and the combined cycle Direct
FuelCell/Turbine® development under DOE’s Vision 21 program. The ratio of
research and development cost to revenue improved to 0.9-to-1 from 1.0-to-1
over
the same period a year ago due to the current mix of cost share contracts.
Administrative
and selling expenses
Administrative
and selling expenses increased by $3.6 million to $17.8 million during fiscal
2006, compared to $14.2 million in fiscal 2005. This increase is primarily
due
to share-based compensation of approximately $2.6 million resulting from the
adoption of SFAS 123R, higher salaries as a result of increased headcount and
higher professional costs resulting from commercial market development and
increased proposal activity for research and development and commercial
contracts.
Research
and development expenses
Research
and development expenses increased to $24.7 million during fiscal 2006, compared
to $21.8 million recorded in fiscal 2005. The
increase is
due to
development costs for sub-MW and MW cost reduction, including recent
achievements in advanced cell stack design that increases the power output
of
our power plants by 20 percent, costs related to our efforts to extend stack
life from the current three years to five years and longer and $0.8 million
of
share-based compensation resulting from the adoption
of SFAS 123R.
Loss
from operations
The
net
result of our revenues and costs was a loss from operations for fiscal 2006
totaling $81.0 million. This operating loss is approximately 14 percent higher
than the $70.9 million loss recorded in fiscal 2005. Operating loss was
higher primarily from increased product losses on higher revenue, an increase
in
administrative and selling expenses and research and development expenses as
discussed above.
Other
factors impacting the operating loss included development of our distribution
network, increases in depreciation on new production equipment, business
insurance premiums, information systems and infrastructure development. We
expect to incur operating losses in future reporting periods as we continue
to
participate in government cost share programs, sell products
at prices lower than our current production costs, and
invest in our “cost out” initiatives.
Loss
from equity investments
Our
investment in Versa totaled approximately $11.5 million and $12.3 million as
of
October 31, 2006 and 2005, respectively. Our current ownership interest is
39%
and we account for our investment in Versa under the equity method of
accounting. Our share of equity losses for fiscal 2006 and 2005 were $0.9
million and $1.6 million, respectively.
In
April
2006, we entered into an agreement to sell our equity investment in Everplore
Technology (Xiamen) Co. and recognized a gain of approximately $37 thousand,
which offset losses from equity investments.
Interest
and other income, net
Interest
and other income, net, was $6.0 million for fiscal 2006, compared
to $5.5 million for fiscal 2005.
Interest
and other income increased due to higher average yields on invested balances,
partially offset by lower state research and development tax credits, which
totaled $0.2 million and $0.5 million for 2006 and 2005,
respectively.
Discontinued
operations, net of tax
There
were no discontinued operations in fiscal 2006. During fiscal 2005, we exited
certain facilities in Canada and as a result recorded fixed asset impairment
charges totaling approximately $0.9 million and approximately $0.4 million
of
exit costs related to these facilities. This resulted in total loss from
discontinued operations of approximately $1.3 million.
Provision
for income taxes
We
believe that due to our efforts to commercialize our DFC technology, we will
continue to incur losses. Based on projections for future taxable income over
the period in which the deferred tax assets are realizable, management believes
that significant uncertainty exists surrounding the recoverability of the
deferred tax assets. Therefore, no tax benefit has been recognized related
to
current or prior year losses and other deferred tax assets.
LIQUIDITY
AND CAPITAL RESOURCES
We
had
approximately $153.6 million of cash, cash equivalents and investments as of
October 31, 2007, compared to $120.6 million as of October 31, 2006.
During
fiscal 2007, we sold shares of our common stock to POSCO for $29.0 million
and
completed a public offering with net proceeds of $65.4 million. Excluding these
stock sales, cash
and
investments used during the year totaled $61.4 million, which includes capital
expenditures of $4.4 million, dividend payments on our preferred stock of $3.6
million, and an investment of $2.0 million in the form of a convertible note
made to Versa Power, Inc. These uses of cash and investments were partially
offset by proceeds of $2.2 million from the sale of a power plant being used
to
service a power purchase agreement (includes $0.4 million from the sale of
a
long-term service agreement on this power plant), receipt of incentive funds
related to our power purchase agreements of $1.7 million and proceeds from
common stock issued for benefit plans of $2.2 million.
Cash
Inflows and Outflows
Cash
and
cash equivalents as of October 31, 2007 totaled $93.0 million, reflecting an
increase of $66.8 million from the balance reported as of October 31, 2006.
The
key components of our cash inflows and outflows from continuing operations
were
as follows:
Operating
Activities:
During
fiscal 2007, we used $56.0 million in cash for operating activities, compared
to
operating cash usage of $48.4 million during 2006. Cash used in operating
activities during 2007 consists of a net loss for the period of approximately
$68.7 million, offset by non-cash adjustments totaling $16.6 million, including
$5.2 million of share-based compensation and depreciation expense of $9.2
million.
In
addition, cash used in working capital totaled approximately $3.9 million.
Higher production levels in 2007 led to higher net inventories of approximately
$11.5 million, higher other assets of approximately $4.7 million primarily
relating to increases in advances to vendors on increasing production volumes
and higher accounts payable and accrued liabilities of approximately $3.1
million. These amounts were partially offset by higher deferred revenue and
customer deposits of $9.9 million. The deferred revenue increase is a result
of
higher commercial orders in the fiscal year. The Company receives milestone
payments from customers as products are being produced.
Investing
Activities: During
fiscal 2007, net cash provided by investing activities totaled $28.0 million,
compared with approximately $51.8 million in 2006. Capital expenditures totaled
$4.4 million for 2007 and approximately $312.1 million of investments in U.S.
Treasury Securities matured and new treasury purchases totaled $277.7 million
during the year. The Company also invested $2.0 million in the form of a
convertible note made to Versa.
Financing
Activities: During
fiscal 2007, net cash provided by financing activities was approximately $94.7
million, compared to $0.2 million in 2006. Fiscal 2007 included $96.3 million
from the
sale
of 3.8 million shares of our common stock to POSCO Power for $29.0 million
in
February 2007, 9.4 million shares sold in an underwritten public offering with
net proceeds of $65.4 million in April 2007 and sales of 0.3 million shares
on
the open market for $1.9 million during the fiscal year. The Company also
received $2.2 million from
the
sale of common stock issued for employee benefit plans. This was partially
offset by $3.6 million for the payment of dividends on preferred
stock.
Sources
and Uses of Cash and Investments
We
continue to invest in new product development and market development and, as
such, we are not currently generating positive cash flow from our
operations. Our operations are funded primarily through sales of equity
securities and cash generated from customer contracts, including cash from
government research and development contracts, product sales, power purchase
agreements, incentive funding and interest earned on investments. We anticipate
that our existing capital resources, together with anticipated revenues, will
be
adequate to satisfy our financial requirements and agreements through at least
the next twelve months.
Our
future cash requirements depend on numerous factors including future involvement
in research and development contracts, implementing our cost reduction efforts
and increasing annual order volume.
Future
involvement in research and development contracts
Our
research and development contracts are generally multi-year, cost reimbursement
type contracts. The majority of these are U.S. Government contracts that
are dependent upon the government’s continued allocation of funds and may be
terminated in whole or in part at the convenience of the government. We will
continue to seek research and development contracts. To obtain these contracts,
we must continue to prove the benefits of our technologies and be successful
in
our competitive bidding.
Implementing
cost reduction efforts on our fuel cell products
Reducing
product cost is essential for us to further penetrate the market for our high
temperature fuel cell products. Cost reductions will lessen and/or eliminate
the
need for incentive funding programs that are currently available to allow our
product pricing to compete with grid-delivered power and other distributed
generation technologies, and are critical to us attaining profitability.
Our
multi-disciplined cost reduction program focuses on value engineering,
manufacturing process improvements, and technology improvements to increase
power plant output and stack life.
Our
2MW
Santa Clara ‘proof-of-concept’ project in 1996-1997 cost more than $20,000/kW to
produce. In 2003, we shipped our first commercial product, a DFC300 to the
Kirin
Brewery which cost approximately $10,000/kW. At that time, we implemented our
commercial cost-out program hiring additional engineers who focused
on
reducing the total life cycle costs of our power plants. Since 2003, they have
made significant progress primarily through value engineering our products
and
increasing the power output by 20 percent. Our current manufactured cost is
approximately $3,250 per kW for our multi-MW power plant, $3,400 per kW for
our
MW plant and $4,200 per kW for the sub-MW product.
FuelCell
Energy will continue its cost out initiatives in order to deliver competitively
priced and environmentally friendly distributed generation products to the
market. In 2008, we are targeting cost reductions of 20 percent for the MW-class
DFC1500 and DFC3000 through an additional power output increase (uprate),
strategic sourcing and continued manufacturing improvements. We are also working
on increasing stack life that is expected to result in lower operating and
maintenance costs across the entire product line.
Increasing
annual order volume
In
addition to the cost reduction initiatives discussed above, we need to increase
annual order volume. Increased production volumes are necessary to lower costs
by leveraging supplier/purchasing opportunities, incorporating manufacturing
process improvements and spreading fixed costs over higher units of production.
Our manufacturing and conditioning facilities have the equipment in place to
accommodate 50 MW of annual production volume, but the higher production volume
will require increasing the manufacturing workforce. Based upon existing backlog
we are ramping our annual production volumes to 25 MW per year and adding
equipment necessary to achieve 60 MW of capacity.
We
ended
fiscal 2007 with 15.55 MW in backlog. Subsequent to fiscal year end we closed
an
additional 9.45 MW of orders to end calendar year 2007 with 25 MW in
backlog.
We see
continued opportunities for increased order volume in our key markets, including
Asia, California, Connecticut and other developing markets. Examples of these
opportunities include the following:
· |
In
Asia, the South Korean government has initiated a subsidy program
with
initial subsidies ranging from $0.23 to 0.28/kilowatt hour (kWh).
This
program was put in place to encourage utilities to buy highly efficient,
ultra-clean, low-emission, fuel cell-produced electricity, thus helping
the country to meet its carbon dioxide (CO2) reduction and clean
air
goals. In February, we signed a 10-year manufacturing and distribution
agreement with POSCO Power. We expect that this partnership will
allow us
to capture significant opportunities in the South Korean market.
During
calendar year 2007, POSCO ordered 12.6 MW of DFC power plants, of
which
12.3 MW are MW-class power plants. In addition, POSCO Power is building
a
fuel cell BOP manufacturing facility with 50 MW of capacity expected
to be
on-line in late 2008.
|
·
|
California
is a leading market for our ultra-clean products with approximately
40% of
our installed and backlog base at October 31, 2007. In California,
high
electricity costs and stringent environmental regulations make our
products a compelling value proposition for customers. California
extended
its Self-Generation Incentive Program (SGIP) to 2012. The SGIP provides
annual incentives, at least $80 million in 2008, for which our fuel
cell
products are eligible.
|
·
|
Connecticut
has a funded RPS program titled the “Project 100 Program”. In March 2007,
the Connecticut Clean Energy Fund recommended to the Connecticut
Department of Public Utility Control (“DPUC”) that projects containing
approximately 68 MW of the Company’s products be approved for contracts
with Connecticut utilities under the State’s Project 100 Program. In
December 2007, the DPUC issued a draft ruling recommending projects
containing 16.2 MW of the Company’s products be awarded contracts from the
utilities. A final decision by the DPUC is expected on January 23,
2008.
The Connecticut program is an example of both the significant opportunity
for our products in RPS markets and the risks associated with regulatory
agencies awarding projects under these programs.
|
Combined
with historical cost out achievements and successful completion of our new
targets, we believe we can reach gross margin breakeven on product sales at
a
sustained annual order and production volume of approximately 35 MW to 50 MW,
depending on product mix, geographic location and other variables such as fuel
prices. We believe that the Company net income breakeven can be achieved at
a
sustained annual order and volume production of approximately 75 to 100 MW
assuming a favorable mix of sub-MW and MW sales. If this mix trends more toward
MW and multi-MW orders, we believe that the gross margin and net income
breakeven volumes can be lower.
Commitments
and Significant Contractual Obligations
A
summary
of our significant future commitments and contractual obligations as of October
31, 2007 and the related payments by fiscal year is summarized as follows (in
thousands):
|
|
Payments
Due by Period
|
|
Contractual
Obligation:
|
|
Total
|
|
Less
than
1
Year
|
|
1
- 3
Years
|
|
3
- 5
Years
|
|
More
than
5
Years
|
|
Capital
and Operating lease commitments
(1)
|
|
|
|
|
$
|
930
|
|
$
|
1,487
|
|
$
|
85
|
|
$
|
|
|
Term
loans (principal and interest)
|
|
|
855
|
|
|
839
|
|
|
16
|
|
|
|
|
|
|
|
Purchase
commitments(2)
|
|
|
41,992
|
|
|
41,077
|
|
|
915
|
|
|
|
|
|
|
|
Series
I Preferred dividends payable
(3)
|
|
|
19,392
|
|
|
379
|
|
|
9,543
|
|
|
1,894
|
|
|
7,576
|
|
Series
B Preferred dividends payable
(4)
|
|
|
7,258
|
|
|
3,206
|
|
|
4,052
|
|
|
|
|
|
|
|
Totals
|
|
|
|
|
$
|
46,431
|
|
$
|
16,013
|
|
$
|
1,979
|
|
$
|
7,576
|
|
|
(1)
|
Future
minimum lease payments on capital and operating
leases.
|
|
(2)
|
Purchase
commitments with suppliers for materials supplies, and services incurred
in the normal course of business.
|
|
(3)
|
Quarterly
dividends of Cdn.$312,500 accrue on the Series 1 preferred shares
(subject
to possible reduction pursuant to the terms of the Series 1 preferred
shares on account of increases in the price of our common stock).
We have
agreed to pay a minimum of Cdn.$500,000 in cash or common stock annually
to Enbridge, Inc., the holder of the Series 1 preferred shares, so
long as
Enbridge holds the shares. Interest accrues on cumulative unpaid
dividends
at a 2.45 percent quarterly rate, compounded quarterly, until payment
thereof. Using an exchange rate of Cdn.$1.0478 to U.S.$1.00 (exchange
rate
on October 31, 2007), cumulative unpaid dividends and accrued interest
of
approximately $7.7 million on the Series 1 preferred shares were
outstanding as of October 31, 2007. For
the purposes of this disclosure, we have assumed that the minimum
dividend
payments would be made through 2010. In 2010, we would be required
to pay
any unpaid and accrued dividends. Subsequent to 2010, we would be
required
to pay annual dividend amounts totaling Cdn.$1.25 million. We have
the
option of paying these dividends in stock or cash.
|
|
(4)
|
Dividends
on Series B Preferred Stock accrue at an annual rate of 5% paid quarterly.
The obligations schedule assumes we will pay preferred dividends
on these
shares through November 20, 2009, at which time the preferred shares
may
be subject to mandatory conversion at the option of the Company.
|
In
April
2006, Bridgeport FuelCell Park, LLC (“BFCP”), one of our wholly-owned
subsidiaries, entered into a loan agreement for $0.5 million, secured by assets
of BFCP. Loan proceeds were designated for pre-development expenses associated
with the development, construction and operation of a fuel cell generation
facility in Bridgeport, Connecticut (the “Project”). Interest accrues monthly at
an annual rate of 8.75 percent. Repayment of the loan, together with any accrued
and unpaid interest, is required on the earliest occurrence of any of the
following events: (a) twelve months after the commencement date of the
commercial operation of the Project, (b) the date of consummation and closing
of
permanent institutional financing of the Project, (c) the date of consummation
and closing of any sale of the Project and (d) the date upon which certain
change in control events occur related to BFCP. We have not made any prepayments
as of October 31, 2007. The outstanding balance on this loan was $0.5 million,
including $0.05 million of accrued interest, as of October 31, 2007.
In
December 2006, we entered into a master equipment lease agreement for the lease
of equipment. The lease agreement allows for an aggregate cost of equipment
up
to $2.5 million. As of October 31, 2007, we had capital lease obligations under
this lease agreement of $0.3 million. Lease payment terms are thirty six months
from the date of acceptance for leased equipment.
In
June
2000, we entered into a loan agreement, secured by machinery and equipment,
and
have borrowed an aggregate of $2.2 million under the agreement. The loan is
payable over eight years, with payments of interest only for the first six
months and then repaid in monthly installments with interest computed annually
based on the ten-year U.S. Treasury note plus 2.5 percent. At October 31, 2007,
the outstanding balance on this loan was $0.3 million and the interest rate
was
7.4 percent.
Approximately
$3.4 million of our cash and cash equivalents have been pledged as collateral
and letters of credit for certain banking relationships and customer contracts.
Approximately $2.7 million of this supported letters of credit, which all
expired on December 31, 2007.
Research
and Development Cost-Share Contracts
We
have
contracted with various government agencies as either a prime contractor or
sub-contractor on cost-share contracts and agreements. Cost-share terms require
that participating contractors share the total cost of the project based on
an
agreed upon ratio with the government agency. As of October 31, 2007, our
research and development sales backlog totaled $18.5 million. As this backlog
is
funded in future periods, we will incur additional research and development
cost-share related to this backlog totaling approximately $14.7 million for
which we would not be reimbursed by the government.
Product
Sales Contracts
Our
fuel
cell power plant products are in the initial stages of development and market
acceptance. As such, costs to manufacture and install our products exceed
current market prices. As of October 31, 2007, we had product sales backlog of
approximately $42.5 million. We do not expect sales from this backlog to be
profitable.
Long-term
Service Agreements
We
have
contracted with certain customers to provide service for fuel cell power plants
ranging from one to thirteen years. Under the provisions of these contracts,
we
provide services to maintain, monitor and repair customer power plants. In
some
contracts we provide for replacement of fuel cell stacks. Pricing for service
contracts is based upon estimates of future costs, which given our products
early stage of development could be materially different from actual expenses.
As of October 31, 2007, we had a service agreement sales backlog of
approximately $15.3 million.
Power
Purchase Agreements
Power
purchase agreements (PPAs) are a common arrangement in the energy industry,
whereby a customer purchases energy from an owner and operator of the power
generation equipment. A number of our partners enter into PPAs with end use
customers, such as Marubeni in Japan and PPL in the U.S., where they purchase
DFC power plants from us, own and operate the units, and recognize revenue
as
energy is sold to the end user.
We
have
seeded the market with a number of Company funded PPAs to penetrate key target
markets and develop operational and transactional experience. With the added
benefit of the federal investment tax credit and accelerated depreciation in
the
Energy Policy Act of 2005, we believe this experience may enable us to attract
third party financing for existing and future projects, including multi-MW
projects. To date, we have funded the development and construction of certain
fuel cell power plants sited near customers in California, and own and operate
assets through PPA entities that we maintain an 80% ownership interest with
Alliance Power, Inc. owning the remaining 20%.
We
have
qualified for incentive funding for these projects in California under the
state’s Self Generation Incentive Funding Program and from other government
programs. Funds are payable upon commercial installation and demonstration
of
the plant and may require return of the funds for failure of certain performance
requirements. Revenue related to these incentive funds is recognized ratably
over the performance period. As of October 31, 2007 we had deferred revenue
totaling $6.2 million on the consolidated balance sheet related to incentive
funding received on PPAs.
Under
the
terms of our PPAs, customers agree to purchase power from our fuel cell power
plants at negotiated rates, generally for periods of five to ten years.
Electricity rates are generally a function of the customer’s current and future
electricity pricing available from the grid. Revenues are earned and collected
under these PPAs as power is produced. As owner of the power plants in these
PPA
entities, 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.
The assets, including fuel cell power plants in these PPA entities, are carried
at fair value on the Consolidated Balance Sheets based on our estimates of
future revenues and expenses. Should actual results differ from our estimates,
our results of operations could be negatively impacted. We are not required
to
produce minimum amounts of power under our PPAs and we have the right to
terminate PPAs by giving written notice to the customer, subject to certain
exit
costs.
As
of
October 31, 2007, we had 3 MW of power plants in operation under PPAs ranging
from 5 - 10 years.
RECENT
ACCOUNTING PRONOUNCEMENTS
In
June
2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertain
Income Taxes (“FIN 48”). FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an entity’s financial statements.
FIN 48 prescribes a comprehensive model for how a company should recognize,
measure, present, and disclose in its financial statements uncertain tax
positions that the company has taken or expects to take on a tax return.
FIN 48 is effective for fiscal years beginning after December 16, 2006
(beginning of our fiscal 2008 or November 1, 2007). Due to the Company’s current
income tax position, this new standard is not expected to have a material impact
on our financial statements in the first fiscal quarter of 2008.
In
September 2006, the FASB issued Statement No. 157, Fair Value Measurements.
This
Statement defines fair value and expands disclosures about fair value
measurements. These methods will apply to other accounting standards that use
fair value measurements and may change the application of certain measurements
used in current practice. This Statement is effective for the beginning of
fiscal year 2009. This new Statement is not expected to have a material effect
on our consolidated financial statements.
In
February 2007, the FASB issued Statement No. 159, the Fair Value Option for
Financial Assets and Financial Liabilities. This Statement permits entities
to
measure most financial instruments at fair value if desired. It may be applied
on a contract by contract basis and is irrevocable once applied to those
contracts. The standard may be applied at the time of adoption for existing
eligible items, or at initial recognition of eligible items. After election
of
this option, changes in fair value are reported in earnings. The items measured
at fair value must be shown separately on the balance sheet. This Statement
is
effective for the beginning of fiscal year 2009. The cumulative effect of
adoption, if any, would be reported as an adjustment to beginning retained
earnings. We have currently not determined the potential effect of this
Statement on the consolidated financial statements.
In
December 2007, the FASB issued Statement No. 141 (revised 2007), Business
Combinations, and Statement No. 160, Noncontrolling Interests in Consolidated
Financial Statements. Statement No. 141 (revised 2007) requires an acquirer
to
measure the identifiable assets acquired, the liabilities assumed and any
noncontrolling interest in the acquiree at their fair values on the acquisition
date, with goodwill being the excess value over the net identifiable assets
acquired. This standard also requires the fair value measurement of certain
other assets and liabilities related to the acquisition such as contingencies
and research and development. Statement No. 160 clarifies that a noncontrolling
interest in a subsidiary should be reported as equity in the consolidated
financial statements. Consolidated net income should include the net income
for
both the parent and the noncontrolling interest with disclosure of both amounts
on the consolidated statement income. The calculation of earnings per share
will
continue to be based on income amounts attributable to the parent. The effective
date for both Statements is the beginning of fiscal year 2010. The Company
has
currently not determined the potential effects on the consolidated financial
statements.
Item
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Interest
Rate Exposure
Our
exposures to market risk for changes in interest rates relate primarily to
our
investment portfolio and long term debt obligations. Our investment portfolio
as
of October 31, 2007 includes U.S. Treasury instruments with maturities averaging
three months or less, as well as U.S. Treasury notes with fixed interest rates
with maturities through June 30, 2008. Cash is invested overnight with high
credit quality financial institutions. Based on our overall interest exposure
at
October 31, 2007, including all interest rate sensitive instruments, a near-term
change in interest rate movements of 1 percent would affect our results of
operations by approximately $0.9 million annually.
Foreign
Currency Exchange Risk
With
our
Canadian business entity, FuelCell Energy, Ltd., we are subject to foreign
exchange risk, although we have taken steps to mitigate those risks where
possible. As of October 31, 2007, approximately $0.4 million (less than one
percent) of our total cash, cash equivalents and investments was in currencies
other than U.S. dollars. The functional currency of FuelCell Energy, Ltd. is
the
U.S. dollar. We also make purchases from certain vendors in currencies other
than U.S. dollars. Although we have not experienced significant foreign exchange
rate losses to date, we may in the future, especially to the extent that we
do
not engage in currency hedging activities. The economic impact of currency
exchange rate movements on our operating results is complex because such changes
are often linked to variability in real growth, inflation, interest rates,
governmental actions and other factors. These changes, if material, may cause
us
to adjust our financing and operating strategies. Consequently, isolating the
effect of changes in currency does not incorporate these other important
economic factors.
Derivative
Fair Value Exposure
As
discussed in more detail within Note 11 of Notes to Consolidated Financial
Statements, we have determined that our Series 1 Preferred shares include
embedded derivatives that require bifurcation from the host contract and
separate accounting in accordance with SFAS 133, Accounting
for Derivative Instruments and Hedging Activities.
Specifically, the embedded derivatives requiring bifurcation from the host
contract are the conversion feature of the security and the variable dividend
obligation. The aggregate fair value of these derivatives included within
Long-term debt and other liabilities on our Consolidated Balance Sheet as of
October 31, 2007 was $0.3 million. The fair value of these derivatives is based
on valuation models using various assumptions including historical stock price
volatility, risk-free interest rate and a credit spread based on the yield
indexes of technology high yield bonds, foreign exchange volatility as the
Series 1 Preferred security is denominated in Canadian dollars, and the closing
price of our common stock. Changes in any of these assumptions will result
in
fluctuations in the derivative value and will impact the Consolidated Statement
of Operations. For example, a 25% increase from the closing price of our common
stock at October 31, 2007 would result in an increase in the fair value of
these
derivatives and a charge to the Consolidated Statement of Operations of
approximately $0.1 million, assuming all other assumptions remain the
same.
As
discussed in more detail within Note 2 of Notes to Consolidated Financial
Statements, we have determined that the 2,286 warrants received in conjunction
with our investment in Versa during the third fiscal quarter of 2007 represent
derivatives. The fair value of the warrants is based on the Black-Scholes
valuation model using historical stock price, volatility (based on a peer
group
since Versa’s common stock is not publicly traded) and risk-free interest rate
assumptions. The fair value of this derivative included within Investment
and
loan to affiliate on our Consolidated Balance Sheet as of October 31, 2007
was
$0.2 million. Changes in any of these assumptions will result in fluctuations
in
the derivative value and will impact the Consolidated Statement of Operations.
For example, a 10 percent increase in the volatility assumption used at October
31, 2007 would result in an increase in the fair value of this derivative
and a
charge to the Consolidated Statement of Operations of approximately $14
thousand, assuming all other assumptions remain the same.
Item
8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA
Index
to the Consolidated Financial Statements
|
|
Page
|
|
|
|
Report
of Independent Registered Public Accounting Firm
|
|
65
|
|
|
|
Consolidated
Balance Sheets - October 31, 2007 and 2006
|
|
66
|
|
|
|
Consolidated
Statements of Operations for the Years ended October 31, 2007, 2006
and
2005
|
|
67
|
|
|
|
Consolidated
Statements of Changes in Shareholders’ Equity for the Years ended October
31, 2007, 2006 and 2005
|
|
68
|
|
|
|
Consolidated
Statements of Cash Flows for the Years ended October 31, 2007, 2006
and
2005
|
|
70
|
|
|
|
Notes
to Consolidated Financial Statements
|
|
71
|
Report
of Independent Registered Public Accounting Firm
The
Board
of Directors and Stockholders
FuelCell
Energy, Inc.:
We
have
audited the accompanying consolidated balance
sheets of FuelCell Energy, Inc. as of October 31, 2007 and 2006, and the related
consolidated statements of operations, changes in shareholders' equity, and
cash
flows for each of the years in the three-year period ended October 31, 2007.
We
also have audited FuelCell Energy, Inc.’s internal control over financial
reporting as of October 31, 2007, based on criteria established in Internal
Control - Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
FuelCell Energy, Inc.’s management is responsible for these consolidated
financial statements, for maintaining effective internal control over financial
reporting, and for its assessment of the effectiveness of internal control
over
financial reporting, included in the accompanying management report on internal
controls over financial reporting. Our responsibility is to express an opinion
on these consolidated financial statements and an opinion on the Company's
internal control over financial reporting based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the consolidated financial statements included
examining, on a test basis, evidence supporting the amounts and disclosures
in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. Our audit of internal control over financial reporting
included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing
and
evaluating the design and operating effectiveness of internal control based
on
the assessed risk. Our audits also included performing such other procedures
as
we considered necessary in the circumstances. We believe that our audits provide
a reasonable basis for our opinions.
A
company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control
over
financial reporting includes those policies and procedures that (1) pertain
to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors
of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In
our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of FuelCell Energy, Inc. as
of
October 31, 2007 and 2006, and the results of its operations and its cash flows
for each of the years in the three-year period ended October 31, 2007, in
conformity with accounting principles generally accepted in the United States
of
America. Also in our opinion, FuelCell Energy, Inc. maintained, in all material
respects, effective internal control over financial reporting as of October
31,
2007, based on criteria established in Internal
Control - Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway
Commission.
As
discussed in Note 13 to the consolidated financial statements, the Company
changed its method of accounting for share-based payments as of November 1,
2005.
Hartford,
Connecticut
January
14, 2008
FUELCELL
ENERGY, INC.
Consolidated
Balance Sheets
(Dollars
in thousands, except share and per share amounts)
|
|
October
31,
2007
|
|
October
31,
2006
|
|
ASSETS
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
92,997
|
|
$
|
26,247
|
|
Investments:
U.S. treasury securities
|
|
|
60,634
|
|
|
81,286
|
|
Accounts
receivable, net of allowance for doubtful accounts of $63 and $43,
respectively
|
|
|
10,063
|
|
|
9,402
|
|
Inventories,
net
|
|
|
29,581
|
|
|
14,121
|
|
Other
current assets
|
|
|
7,730
|
|
|
2,653
|
|
Total
current assets
|
|
|
201,005
|
|
|
133,709
|
|
|
|
|
|
|
|
|
|
Property,
plant and equipment, net
|
|
|
39,612
|
|
|
48,136
|
|
Investments:
U.S. treasury securities
|
|
|
-
|
|
|
13,054
|
|
Investment
and loan to affiliate
|
|
|
12,216
|
|
|
11,483
|
|
Other
assets, net
|
|
|
355
|
|
|
270
|
|
Total
assets
|
|
$
|
253,188
|
|
$
|
206,652
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Current
portion of long-term debt and other liabilities
|
|
$
|
924
|
|
$
|
653
|
|
Accounts
payable
|
|
|
12,397
|
|
|
12,508
|
|
Accrued
liabilities
|
|
|
8,511
|
|
|
6,418
|
|
Deferred
license fee income
|
|
|
-
|
|
|
38
|
|
Deferred
revenue and customer deposits
|
|
|
20,486
|
|
|
9,785
|
|
Total
current liabilities
|
|
|
42,318
|
|
|
29,402
|
|
|
|
|
|
|
|
|
|
Long-term
deferred revenue
|
|
|
4,401
|
|
|
5,162
|
|
Long-term
debt and other liabilities
|
|
|
613
|
|
|
678
|
|
Total
liabilities
|
|
|
47,332
|
|
|
35,242
|
|
Redeemable
minority interest
|
|
|
11,884
|
|
|
10,665
|
|
Redeemable
preferred stock ($0.01 par value, liquidation preference of $64,120
at
October 31, 2007 and 2006.)
|
|
|
59,950
|
|
|
59,950
|
|
Commitments
and Contingencies
|
|
|
|
|
|
|
|
Shareholders’
equity:
|
|
|
|
|
|
|
|
Common
stock ($.0001 par value); 150,000,000 shares authorized at October
31,
2007 and 2006; 68,085,059 and 53,130,901 shares issued and outstanding
at
October 31, 2007 and 2006, respectively.
|
|
|
7
|
|
|
5
|
|
Additional
paid-in capital
|
|
|
571,944
|
|
|
470,045
|
|
Accumulated
deficit
|
|
|
(437,929
|
)
|
|
(369,255
|
)
|
Treasury
stock, Common, at cost (12,282 and 15,583 shares in 2007 and 2006,
respectively.)
|
|
|
(126
|
)
|
|
(158
|
)
|
Deferred
compensation
|
|
|
126
|
|
|
158
|
|
Total
shareholders’ equity
|
|
|
134,022
|
|
|
100,795
|
|
Total
liabilities and shareholders’ equity
|
|
$
|
253,188
|
|
$
|
206,652
|
|
See
accompanying notes to consolidated financial statements.
FUELCELL
ENERGY, INC.
Consolidated
Statements of Operations
For
the years ended October 31, 2007, 2006, and 2005
(Dollars
in thousands, except share and per share amounts)
|
|
Years
Ended October 31,
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
Revenues:
|
|
|
|
|
|
|
|
Product
sales and revenues
|
|
$
|
32,517
|
|
$
|
21,514
|
|
$
|
17,398
|
|
Research
and development contracts
|
|
|
15,717
|
|
|
11,774
|
|
|
12,972
|
|
|