FuelCell Energy (FCEL) 10-Q 2005 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended July 31, 2005

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	06-0853042
(State of Incorporation)	(I.R.S. Employer Identification Number)

3 Great Pasture Road

Danbury, Connecticut 06813

(Address of Principal Executive Offices)

Telephone (203) 825-6000

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No o

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.0001 per share, outstanding at August 29, 2005: 48,372,216.

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FUELCELL ENERGY, INC.

FORM 10-Q

As of and For the Three and Nine Month Period Ended July 31, 2005

Table of Contents

		Page
PART I.    FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements (unaudited)
	Consolidated Balance Sheets as of July 31, 2005 and October 31, 2004	3
	Consolidated Statements of Operations for the three months ended July 31, 2005 and 2004	4
	Consolidated Statements of Operations for the nine months ended July 31, 2005 and 2004	5
	Consolidated Statements of Cash Flows for the nine months ended July 31, 2005 and 2004	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	31
Item 4.	Controls and Procedures	32
PART II.    OTHER INFORMATION
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	33
Item 6.	Exhibits and Reports on Form 8-K	33
	Signatures	34

2

FUELCELL ENERGY, INC.

Consolidated Balance Sheets

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

		July 31, 2005 (Unaudited)			October 31, 2004
ASSETS
Current assets:
Cash and cash equivalents	$	16,814		$	45,759
Investments: U.S. treasury securities		162,336			106,636
Accounts receivable, net		12,799			7,599
Inventories, net		13,267			14,619
Other current assets, net		5,467			4,253
Total current assets		210,683			178,866
Property, plant and equipment, net		45,224			42,254
Investments: long-term U.S. treasury securities		12,312			--
Assets held for sale		--			12,344
Equity investments		12,840			2,125
Other assets, net		571			921
Total assets	$	281,630		$	236,510
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt and other liabilities	$	565		$	539
Accounts payable		7,181			9,526
Accrued liabilities		6,106			5,255
Deferred license fee income		113			37
Deferred revenue		8,227			6,713
Total current liabilities		22,192			22,070
Long-term debt and other liabilities		971			1,476
Total liabilities		23,163			23,546
Shareholders’ equity:
Preferred stock ($0.01 par value); 200,000 shares authorized at July 31, 2005 and October 31, 2004: Series B Convertible Preferred Stock; 105,875 shares issued and outstanding at July 31, 2005 and -0- at October 31, 2004		1			--
Common stock ($.0001 par value); 150,000,000 shares authorized and 48,294,216 and 48,132,694 shares issued and outstanding at July 31, 2005 and October 31,  2004, respectively		5			5
Preferred shares of subsidiary		10,441			10,259
Additional paid-in capital		520,430			424,621
Accumulated deficit		(272,410	)		(221,921	)
Total shareholders’ equity		258,467			212,964
Total liabilities and shareholders’ equity	$	281,630		$	236,510

See accompanying notes to consolidated financial statements.

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FUELCELL ENERGY, INC.
Consolidated Statements of Operations

(UNAUDITED)

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

	Three Months Ended July 31,
		2005			2004
Revenues:
Product sales and revenues	$	4,877		$	3,646
Research and development contracts		3,865			4,422
Total revenues		8,742			8,068
Costs and expenses:
Cost of product sales and revenues		13,827			9,740
Cost of research and development contracts		3,665			7,436
Administrative and selling expenses		4,049			3,448
Research and development expenses		5,732			6,670
Total costs and expenses		27,273			27,294
Loss from operations		(18,531	)		(19,226	)
License fee income, net		69			68
Interest expense		(6	)		(32	)
Loss from equity investments		(510	)		--
Interest and other income, net		1,976			357
Net loss from continuing operations before provision for income tax		(17,002	)		(18,833	)
Provision for income taxes		--			--
Net loss from continuing operations		(17,002	)		(18,833	)
Discontinued operations, net of tax		--			(95	)
Net loss		(17,002	)		(18,928	)
Preferred stock dividends		(1,576	)		(231	)
Net loss to common shareholders	$	(18,578	)	$	(19,159	)
Loss per share basic and diluted:
Continuing operations	$	(0.38	)	$	(0.40	)
Discontinued operations		--			--
Net loss to common shareholders	$	(0.38	)	$	(0.40	)
Basic and diluted weighted average shares outstanding		48,275,315			48,097,321

See accompanying notes to consolidated financial statements.

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FUELCELL ENERGY, INC.

Consolidated Statements of Operations

(UNAUDITED)

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

	Nine Months Ended July 31,
		2005			2004
Revenues:
Product sales and revenues	$	13,257		$	7,598
Research and development contracts		9,153			14,913
Total revenues		22,410			22,511
Costs and expenses:
Cost of product sales and revenues		38,138			26,930
Cost of research and development contracts		9,095			21,882
Administrative and selling expenses		10,793			10,872
Research and development expenses		16,244			18,982
Purchased in-process research and development		--			12,200
Total costs and expenses		74,270			90,866
Loss from operations		(51,860	)		(68,355	)
License fee income, net		172			204
Interest expense		(79	)		(92	)
Loss from equity investments		(1,185	)		--
Interest and other income, net		3,947			1,738
Net loss from continuing operations before provision for income tax		(49,005	)		(66,505	)
Provision for income taxes		--			--
Net loss from continuing operations		(49,005	)		(66,505	)
Discontinued operations, net of tax		(1,252	)		846
Net loss		(50,257	)		(65,659	)
Preferred stock dividends		(4,491	)		(702	)
Net loss to common shareholders	$	(54,748	)	$	(66,361	)
Income (loss) per share basic and diluted:
Continuing operations	$	(1.11	)	$	(1.41	)
Discontinued operations		(.03	)		.02
Net loss to common shareholders	$	(1.14	)	$	(1.39	)
Basic and diluted weighted average shares outstanding		48,205,160			47,874,599

See accompanying notes to consolidated financial statements.

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FUELCELL ENERGY, INC.

Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

	Nine Months Ended July 31,
		2005			2004
Cash flows from operating activities:
Net loss	$	(50,257	)	$	(65,659	)
Adjustments to reconcile net loss to net cash used in
operating activities, net of effects of acquisition:
Income (loss) from discontinued operations		1,252			(846	)
Asset impairment		994			--
Loss in equity investments		1,185			--
Purchased in process research and development		--			12,200
Depreciation and amortization		5,164			7,436
Loss on disposal of assets		--			8
Provision for doubtful accounts		256			32
(Increase) decrease in operating assets:
Accounts receivable		(5,456	)		(967	)
Inventories		1,352			1,013
Other assets		(923	)		352
Increase (decrease) in operating liabilities:
Accounts payable		(2,345	)		(6,042	)
Accrued liabilities		(128	)		(153	)
Deferred revenue		1,514			2,088
Deferred license fee income and other		76			76
Net cash used in operating activities		(47,316	)		(50,462	)
Cash flows from investing activities:
Capital expenditures		(10,463	)		(5,360	)
Treasury notes matured		274,858			85,941
Treasury notes purchased		(342,262	)		(76,502	)
Proceeds from sale of Global Thermoelectric, Inc., net of transaction costs		--			16,008
Cash acquired from acquisition of Global Thermoelectric, Inc., net of transaction costs		--			53,004
Net cash (used in) provided by investing activities		(77,867	)		73,091
Cash flows from financing activities:
Repayment on long-term debt		(327	)		(240	)
Net proceeds from issuance of preferred stock		99,007			--
Payment of preferred dividends		(2,997	)		(379	)
Common stock issued for Option and Stock Purchase Plans		555			3,225
Net cash provided by financing activities		96,238			2,606
Net cash provided by discontinued operations		--			559
Net increase (decrease) in cash and cash equivalents		(28,945	)		25,794
Cash and cash equivalents-beginning of period		45,759			41,000
Cash and cash equivalents-end of period	$	16,814		$	66,794

 

See accompanying notes to consolidated financial statements.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

Note 1. Summary of Significant Accounting Policies

Nature of Business

FuelCell Energy, Inc. is engaged in the development and manufacture of high temperature fuel cells for clean electric power generation. Our Direct FuelCell ("DFC") power plants produce reliable, secure and environmentally friendly base load electricity for commercial and industrial, government and other customers. We are currently in the process of commercializing our DFC carbonate technology and are beginning the development of planar solid oxide fuel cell technology. We expect to incur losses 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” and commercialization  initiatives.

Basis of Presentation - Interim Consolidated financial statements

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), for interim financial information, and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly our financial position as of July 31, 2005 have been included. The balance sheet as of October 31, 2004 has been derived from the audited financial statements at that date.

The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the period reported. Actual results could differ from those estimates.

The results of operations for the three and nine months ended July 31, 2005 and cash flows for the nine months ended July 31, 2005 are not necessarily indicative of the results to be expected for the full year. The reader should supplement the information in this document with prior disclosures in our 2004 Annual Report on Form 10-K.

Consolidation

The consolidated financial statements include our accounts and those of our subsidiaries, including FuelCell Energy, Ltd. Intercompany accounts and transactions have been eliminated. Alliance Monterrey, LLC, Alliance Chico, LLC and Alliance Star Energy, LLC are joint ventures with Alliance Power, Inc. to construct fuel cell power plants and sell power under power purchase agreements with the City of Santa Barbara, the Sierra Nevada Brewery Co. and Sheraton San Diego Hotel and Marina. The financial results of the joint ventures are consolidated with those of FuelCell, which owns 80 percent of each entity. Cumulative minority interest in these Alliance entities is not material to the consolidated financial statements.

Certain reclassifications have been made to our prior year amounts to conform to the 2005 presentation.

Foreign Currency Translation

Our Canadian subsidiary, FuelCell Energy, Ltd., is financially and operationally integrated and therefore the temporal method of translation of foreign currencies is followed. Under the temporal method, foreign currency gains or losses are recorded on the statement of operations. The functional currency is U.S. dollars. As of November 1, 2004, all Canadian business operations were transferred to Versa Power Systems, Inc. (refer to Note 2 - Discontinued Operations and Sale of Solid Oxide Fuel Cell Assets) but we do retain the legal entity in Canada with certain monetary balances (primarily cash). We recognized a foreign currency gain of approximately $.01 million and a foreign currency loss of approximately $.05 million during the three and nine months ended July 31, 2005, respectively. A foreign currency loss of approximately $0.03 million and a foreign currency gain of approximately $0.2 million were recognized in the three and nine months ended July 31, 2004, respectively. These amounts have been classified in interest and other income on our consolidated statement of operations.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

Stock-Based Compensation

Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," encourages entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows entities to continue to apply the provisions of Accounting Principles Board (“APB”) Opinion No. 25 “Accounting for Stock Issued to Employees” and provide pro forma net income and pro forma earnings per share disclosures for employees’ stock option grants as if the fair-value-based method defined in SFAS No. 123 had been applied. We apply the intrinsic value method of recognition under APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. Accordingly, no compensation expense was recorded in the statement of operations. The following table illustrates the effect on net loss and net loss per basic and diluted share as if we had applied the fair value method to our stock-based compensation, as required under the disclosure provisions of SFAS No. 123:

	Three Months Ended July 31,						Nine Months Ended July 31,
		2005			2004			2005			2004
Net loss to common shareholders, as reported	$	(18,578	)	$	(19,159	)	$	(54,748	)	$	(66,361	)
Less: Total stock-based employee compensation expense determined under the fair value method for all awards		(2,074	)		(2,339	)		(5,463	)		(6,866	)
Pro forma net loss to common shareholders	$	(20,652	)	$	(21,498	)	$	(60,211	)	$	(73,227	)
Loss per basic and diluted common share to common shareholders, as reported	$	(0.38	)	$	(0.40	)	$	(1.14	)	$	(1.39	)
Pro forma loss per basic and diluted common share to common shareholders	$	(.043	)	$	(0.45	)	$	(1.25	)	$	(1.53	)

 

These pro forma amounts may not be representative of future disclosures since the estimated fair value of stock options is amortized to expense over the vesting period, and additional options may be granted in future years. The pro forma amounts assume that the corporation had been following the fair value approach since the beginning. There was no stock based compensation expense from discontinued operations during the periods being reported.

Comprehensive Loss

Comprehensive loss was $17.0 million and $18.9 million for the three months ended July 31, 2005 and 2004, respectively.

Comprehensive loss was $50.5 million and $65.7 million for the nine months ended July 31, 2005 and 2004, respectively. Comprehensive loss for the nine months ended July 31, 2005 included an adjustment to retained earnings totaling approximately $0.2 million as a result from switching from the cost to equity method of accounting for our investment in Versa Power, Ltd. Refer also to Note 3 - Equity Investments.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004) (“SFAS No. 123R”), “Share-Based Payment” which revised SFAS No. 123, “Accounting for Stock-Based Compensation”. This statement supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation costs relating to such transactions be recognized in the consolidated statement of operations. The revised statement is effective as of the first fiscal year beginning after June 15, 2005 (our fiscal year begins on November 1, 2005). We currently use the Black-Scholes option pricing model to measure the fair value of stock-based compensation to employees for pro forma disclosures under SFAS No. 123. SFAS No. 123R requires that compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is rendered on or after the required effective date and the compensation cost shall be based on the grant-date fair value of those awards as calculated for pro forma disclosures under SFAS No. 123. We expect 2006 compensation cost to be material for the portion of awards made prior to November 1, 2005 for which the requisite service has not been rendered. We are currently evaluating SFAS No. 123R and have not determined whether we will use the Black-Scholes option pricing model or a “lattice” model for stock-based instruments granted subsequent to November 1, 2005.

In November 2004, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations”. The Issue provides a model to assist in evaluating (a) which cash flows should be considered in the determination of whether cash flows of the disposal component have been or will be eliminated from the ongoing operations of the entity and (b) the types of continuing involvement that constitute significant continuing involvement in the operations of the disposal component. Should significant continuing ongoing involvement exist, then the disposal component shall be reported in the results of continuing operations on the consolidated statements of operations and cash flows. We applied the provisions of this accounting standard to our financial statements.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs,” which amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. We are currently evaluating the provisions of SFAS No. 151 and will adopt it on November 1, 2005, as required.

Note 2.    Discontinued Operations and Sale of Solid Oxide Fuel Cell Assets

During fiscal 2004, we acquired, Global Thermoelectric Inc. (Global) and subsequently divested its generator business unit through the sale of Global on May 28, 2004. The following table represents the results of discontinued operations, net of related income taxes:

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

	Three months ended July 31,					Nine months ended July 31,
		2005(1)		2004(2)			2005(1)			2004(2)
Product sales and revenues	$	--	$	1,419		$	--		$	13,079
Cost of product sales		--		1,157			--			9,853
Asset impairments and facility exit costs		--		--			1,252			--
Operating expenses		--		360			--			2,217
Operating income (loss)	$	--	$	(98	)	$	(1,252	)	$	1,009
Provision (benefit) for income taxes		--		(3	)		--			163
Discontinued operations, net of tax	$	--	$	(95	)	$	(1,252	)	$	846

(1)   During the nine months ended July 31, 2005, we exited certain facilities in Canada and recorded fixed asset impairment charges totaling approximately $0.9 million. In addition, we incurred approximately $0.4 million of exit costs related to these facilities, which resulted in total loss from discontinued operations of approximately $1.3 million. There were no charges related to discontinued operations during the three months ended July 31, 2005.

(2)   During fiscal 2004, we acquired Global and subsequently divested its generator business unit through the sale of Global on May 28, 2004. As a result, historical results were reclassified as discontinued operations.

Sale of Solid Oxide Fuel Cell Assets

On October 19, 2004, we signed a definitive agreement to transfer substantially all of our Canadian solid oxide fuel cell (SOFC) assets and operations (including manufacturing and test equipment, intellectual property and personnel) to Versa Power Systems, Ltd. This transaction closed on November 1, 2004. In exchange, we received 5,714 shares of Versa Power Systems, Inc. (“Versa”) common stock, increasing our ownership position in Versa to 7,714 shares, or 42 percent. No cash was exchanged in the transaction. On May 1, 2005, Versa had a 10-for-1 stock split resulting in an increase in the number of shares we own to 77,140, which remains a 42 percent ownership interest. The consideration received by us in the transaction was determined based upon arms-length negotiations of the parties.

The following assets and liabilities of the SOFC operation were divested:

Assets
Property, plant and equipment, net	$7,429
Goodwill		4,816
Other assets		39
Total assets sold	$	12,284
Long term debt sold	$	152

As defined by EITF Issue 03-13, we will have an ongoing significant involvement in the Canadian operations transferred to Versa given our 42 percent ownership interest. Therefore, the fiscal 2004 results of the Canadian operation have been reported as continuing operations in the consolidated statements of operations and cash flows.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

Note 3. Equity investments

Our investment in Versa totaled approximately $12.7 million and $2.0 million as of July 31, 2005 and as of October 31, 2004, respectively. We began accounting for this investment under the equity method as of November 1, 2004, at which time our ownership increased from 16 percent to 42 percent.

With the change from the cost to the equity method of accounting, we recorded an adjustment of $0.2 million to accumulated deficit to account for our share of the historical losses in this entity assuming we had always been under the equity method. Our share of equity losses for the three and nine months ended July 31, 2005, totaled approximately $.5 and $1.2 million, respectively.

We also have a 25 percent ownership interest in Xiamen Technology Co. Ltd., valued at approximately $0.1 million, which is accounted for under the equity method.

Note 4. Investments in U.S. treasury securities

Our short and long-term investments are in U.S. treasury securities, which are held to maturity. The following table summarizes the amortized cost basis and fair value at July 31, 2005 and October 31, 2004:

	AmortizedCost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
At July 31, 2005
U.S. government obligations	$	174,648	$	1	$	(286	)	$	174,363
At October 31, 2004
U.S. government obligations	$	106,636	$	--	$	(190	)	$	(106,446	)

Reported as:

	July 31,		October 31,
	2005		2004
Short-term investments	$	162,336	$	106,636
Long-term investments		12,312		--
Total	$	174,648	$	106,636

As of July 31, 2005, short-term investment securities have maturity dates ranging from August 11, 2005 to May 31, 2006, and estimated yields ranging from 1.91 percent to 3.55 percent. Long-term investment securities have maturity dates ranging from August 15, 2006 to December 31, 2006, and estimated yields ranging from 3.32 percent to 3.92 percent. Our weighted average yield on our short and long-term investments was 3.00 percent as of July 31, 2005.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

Note 5. Inventories

The components of inventory at July 31, 2005 and October 31, 2004 consisted of the following:

	July 31,		October 31,
		2005		2004
Raw materials	$	3,739	$	1,663
Work-in-process		9,528		12,956
Total	$	13,267	$	14,619

Our inventories are stated at the lower of recoverable cost or market price. Our lower of cost or market and obsolescence adjustment, reducing gross inventory values to the reported amounts, was approximately $9.4 million and $11.4 million at July 31, 2005 and October 31, 2004, respectively.

Note 6. Property, Plant and Equipment

Property, plant and equipment at July 31, 2005 and October 31, 2004 consisted of the following:

	July 31, 2005			October 31, 2004			Estimated Useful Life
Land	$ 524			$ 524			—
Building and improvements	5,985			6,824			10-30 years
Machinery, equipment and software(2)		59,830			48,576			3-8 years
Furniture and fixtures		2,320			2,217			6-10 years
Assets available for lease(1)		2,063			2,063			3 years
Construction in progress(2)		4,609			6,645
	$	75,331		$	66,849
Less, accumulated depreciation and amortization		(30,107	)		(24,595	)
Total	$	45,224		$	42,254

____

(1)   Assets available for lease are two DFC 300 power plants. One of these assets is currently under lease to a customer and another is on loan to a government test facility.

(2)   Includes costs of power plants for power purchase agreement contracts.

Depreciation expense was approximately $5.6 million and $6.6 million for the nine months ended July 31, 2005 and 2004, respectively.

During the three months ended January 31, 2005, we recorded a fixed asset impairment charge related to an obsolete catalyst extruding system totaling $1.0 million, against cost of product sales. This was related to a planned change in manufacturing processes that is expected to improve product performance and reduce costs in future periods. In addition, during the three months ended January 31, 2005, we recorded a fixed asset impairment charge to discontinued operations totaling $0.9 million related to excess facilities in Calgary, Alberta, Canada. There were no asset impairment charges during the three months ended July 31, 2005 or the three and nine months ended July 31, 2004.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

Note 7. Shareholders' Equity

Changes in shareholders’ equity were as follows for the nine months ended July 31, 2005:

Balance at October 31, 2004	$                               212,964
Issuance of Series B Preferred shares		99,007
Accretion of fair value discount of preferred stock		940
Reduction of additional paid in capital for accretion of discount		(940	)
Series B preferred dividends accrued		(3,680	)
Series I preferred dividends paid		(379	)
Registration statement fees		(17	)
Proceeds from sales of shares through employee stock plans		555
Issuance of common shares for employee stock incentive plan		506
Equity method losses in Versa Power Systems, Inc.(1)		(232	)
Net loss		(50,257	)
Balance at July 31, 2005	$	258,467

____

(1) With an increase of ownership in Versa to 42 percent, we now account for our investment under the equity method of accounting. As a result, we recorded a $0.2 million adjustment against retained earnings to record historical losses as if the investment had been accounted for under the equity method since our original investment in fiscal 2002.

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). On November 17, 2004, we closed on the sale of 100,000 shares of Series B preferred stock to the Initial Purchasers. Net proceeds to us were approximately $93.5 million.

Under the terms of the purchase agreement, the Initial Purchasers had an option through January 25, 2005 to purchase the remaining 35,000 shares. On January 14, 2005, we closed on the sale of 5,875 shares of Series B preferred stock to the Initial Purchasers. Net proceeds to us were approximately $5.5 million.

The following is a summary of certain provisions of our Series B preferred stock. The shares of our Series B preferred stock and 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 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.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

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, commencing 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.

We may pay dividends on the Series B preferred stock:

·   in cash; or

·   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, as amended, for the Series B preferred stock.

If there is a fundamental change in the ownership or control of FuelCell (as described in the certificate of designation, as amended), holders of our Series B preferred stock 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 our Series B preferred stock to be repurchased, plus accrued and unpaid dividends, if any, in the manner set forth in the certificate of designation, as amended.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

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, as amended, for the Series B preferred stock).

Preferred shares of subsidiary

In conjunction with our acquisition of Global, we assumed the preferred share obligation comprised of 1,000,000 Series 2 non-voting Preferred Shares. With the sale of the Global entity in May of 2004, the Global Series 2 Preferred Shares were cancelled, and replaced with substantially equivalent Series 1 Preferred Shares (Preferred Shares) issued by FuelCell Energy, Ltd. The Preferred Shares are convertible at the option of the holder into a number of our common shares based on the fraction by which their face value of Cdn.$25.00 is of the conversion prices (in Canadian dollars) identified below:

Period of conversion	Conversion price per share of FuelCell common stock in Canadian Dollars(1)	Conversion price per share of FuelCell common stock in U.S. Dollars (1) (2)
To July 31, 2010	Cdn.$120.22	$ 91.31
August 1, 2010 to July 31, 2015	Cdn.$129.46	$ 98.39
August 1, 2015 to July 31, 2020	Cdn.$138.71	$ 105.42
After July 31, 2020	95% of the market trading price of FuelCell’s common stock at the time of conversion (expressed in Canadian dollars)	95% of the market trading price of FuelCell’s common stock at the time of conversion

____

(1)   The foregoing “conversion prices” are subject to adjustment for certain subsequent events.

(2)   While the conversion of preferred shares is based on the prices of our common stock expressed in Canadian dollars, we have provided this example of conversion prices in U.S. dollars assuming a constant exchange rate of 0.76 U.S. dollars to 1.00 Canadian dollar (which was the exchange rate at the date of acquisition). The conversion price in U.S. dollars will increase or decrease over time as currency rates fluctuate.

Quarterly dividends of Cdn.$312,500 accrue on the Preferred Shares (subject to possible reduction pursuant to the terms of the 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 Preferred Shares, so long as Enbridge holds the shares. Interest accrues on cumulative unpaid dividends at a 2.45 percent quarterly rate, compounded quarterly (9.8% annually), until payment thereof. All cumulative unpaid dividends must be paid by December 31, 2010. From 2010 through 2020, we would be required to pay annual dividend amounts totaling Cdn.$1.25 million. During the year ended October 31, 2004, we paid cash dividends totaling Cdn. $500,000 to Enbridge.

The Preferred Shares may be redeemed by us, in whole or part, if on the day that the notice of redemption is first given, the volume-weighted average price at which our common shares are traded is at least a 20 percent premium to the current conversion price on payment of Cdn.$25.00 per 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 Preferred Shares are redeemable at any time on payment of Cdn.$25.00 per Preferred Share to be redeemed together with an amount equal to all accrued and unpaid dividends to the date fixed for redemption.

As of the November 3, 2003 acquisition date of Global, the fair value of the Preferred Shares was determined to be $9.1 million. The fair value of the Preferred Shares is adjusted quarterly to reflect dividend payments and accretion of the fair value discount. As of July 31, 2005, this was valued at $10.4 million.

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

Warrants

On April 6, 2004, we issued warrants to purchase 1,000,000 shares of our common stock to Marubeni Corporation (Marubeni) in conjunction with a revised distribution agreement. Pursuant to the terms of this agreement, Marubeni placed orders for 4 megawatts of DFC power plants, and committed to creating a sub-distributor network and to provide additional support for our products. All previously issued warrants to Marubeni were cancelled. As part of these warrant agreements, the warrants vest in separate tranches once Marubeni has ordered totals of between 5 MW and 45 MW of our products. As of July 31, 2005, 200,000 of these warrants with an exercise price of $13.38 had expired. The exercise prices of the remaining warrants range from $13.38 to $18.73 per share and the warrants will expire between October 2005 and April 2007, if not exercised sooner.

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. The exercise prices of the warrants range from $9.89 to $11.87 per share and the expiration dates range from June 30, 2007 to June 30, 2010. As of July 31, 2005, all of the warrants issued to Enbridge remained unvested.

Note 8. Segment Information and Major Customers

Under SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” we use the “management” approach to reporting segments. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of reportable segments. SFAS No. 131 also requires disclosures about products and services, geographic areas, and major customers. Under SFAS No. 131, we have identified one business segment: fuel cell power plant production and research.

Enterprise-wide Information

Enterprise-wide information provided on geographic revenues is based on the customer’s ordering location. The following table presents revenues (greater than ten percent of our total revenues) for geographic areas:

	Three months ended July 31,				Nine months ended July 31,
		2005		2004		2005		2004
Revenues:
United States	$	6,291	$	5,737	$	15,625	$	18,469
Japan		1,912		2,329		4,796		3,219

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FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

Information about Major Customers

We contract with a small number of customers for the sales of our products or research and development contracts. Those customers that accounted for greater than ten percent of our total revenues during the three and nine months ended July 31, 2005 and 2004 are as follows:

	Three months ended July 31,					Nine months ended July 31,
		2005		2004			2005		2004
U.S. Government (1)		43	%	55	%		39	%	66	%
Marubeni Corporation		22	%	29	%		21	%	14	%

____

(1) - Includes government agencies such as the U.S. Department of Energy and the U.S. Navy either directly or through prime contractors.

Note 9. Earnings Per Share

Basic and diluted earnings per share are calculated using the following data:

	Three months ended July 31,			Nine months ended July 31,
		2005	2004		2005	2004
Weighted average basic common shares		48,275,315	48,097,321		48,205,160	47,874,599
Effect of dilutive securities(1)		--	--		--	--
Weighted average basic common shares adjusted for diluted calculations		48,275,315	48,097,321		48,205,160	47,874,599

____

(1)   We computed earnings per share without consideration to potentially dilutive instruments due to the fact that the losses incurred would make them antidilutive. Future potentially dilutive stock options that were in-the-money at July 31, 2005 and 2004 totaled 3.2 million and 2.6 million, respectively, and future potentially dilutive stock options that were not in-the-money totaled 2.6 million and 2.8, respectively. We also have issued warrants as previously discussed, which vest and expire over time. These warrants, if dilutive, would be excluded from the calculation of earnings per share since their vesting is contingent upon certain future performance requirements that are not yet probable. We also have convertible preferred stock outstanding as previously discussed that has been excluded from this calculation as the effect would be antidilutive.

17

FUELCELL ENERGY, INC.

Notes to Consolidated Financial Statements

For the three and nine months ended July 31, 2005 and 2004

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

Note 10. Supplemental Cash Flow Information

The following represents supplemental cash flow information:

	Nine Months Ended July 31,
Cash paid during the period for:	2005		2004
Interest	$	78	$	92
Taxes	$	276	$	597
Supplemental disclosure of non-cash investing and financing activities:
Common stock issued in acquisitions	$	--	$	81,825
Common stock issued for employee incentive plan	$	506	$	--
Capital lease obligations in connection with property and equipment	$	--	$	390
Assets and liabilities, net, invested in Versa Power Systems, Inc.	$	12,132	$	--

 

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ITEM 2. 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 consolidated 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. This section provides a general description of our business and where investors can find additional information.

Recent developments. This section provides a brief overview of any significant events occurring subsequent to the close of the reporting period.

Critical accounting policies and estimates. This section discusses those accounting policies that are 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 three and nine months ended July 31, 2005 and 2004, respectively. In addition, a brief description is provided for 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.

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

The following discussion should be read in conjunction with the accompanying Unaudited Consolidated Financial Statements and Notes thereto included within this report, and our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2004. In addition to historical information, this Form 10-Q 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 product deliveries 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, ability to reach product cost objectives, and competition, 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 our Annual Report on Form 10-K filed for the fiscal year ended October 31, 2004.

OVERVIEW

FuelCell Energy, Inc., based in Danbury, Conn., is a world leader in the development and manufacture of high temperature fuel cells for clean electric power generation. Our Direct FuelCell ("DFC") power plants produce reliable, secure and environmentally friendly base load electricity for commercial and industrial, government and other customers. We are currently in the process of commercializing our DFC carbonate technology. We have developed commercial distribution alliances for its carbonate Direct FuelCell products with world class companies such as PPL Energy Plus, Caterpillar, Alliance Power, Chevron Energy Solutions and LOGANEnergy in the U.S.; Marubeni Corporation in Asia; MTU CFC Solutions in Europe; and Enbridge Inc. in Canada. FuelCell Energy developed its patented DFC technology for stationary power plants with support from the U.S. Department of Energy (DOE) through its Office of Fossil Energy’s National Energy Technology Laboratory. In addition, we are beginning the development of another high temperature fuel cell system, planar solid oxide fuel cell (SOFC) technology, as a prime contractor in the DOE Solid State Energy Conversion Alliance (SECA) Program and through our 42 percent ownership interest in Versa Power Systems, Inc. (“Versa”).

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Direct FuelCell Power Plants

Increasing demand for reliable power worldwide, supplemented by air pollution concerns caused by older, combustion power generation, and electrical grid delivery systems that are constrained or unreliable present significant market opportunities for our core distributed generation products. Our proprietary carbonate DFC power plants electrochemically produce electricity directly from readily available hydrocarbon fuels, such as natural gas and wastewater treatment gas.  We believe our products offer significant advantages compared to other power generation technologies, including:

·    High fuel efficiency;

·    Ultra-clean emissions;

·    Improved reliability;

·    Quiet operation;

·    Flexible siting and permitting requirements;

·    Scalability;

·    Ability to provide electricity and heat for cogeneration applications, such as district heating, process steam, hot water and absorption chilling for air conditioning;

 ·   Potentially lower operating, maintenance and generation costs than alternative distributed power generation technologies; and,

·   Because our DFC power plants produce hydrogen from readily available fuels such as natural gas and wastewater treatment gas, they can be used to cost-effectively cogenerate hydrogen as well as electricity and heat.

Our current products, the DFC300MA ^TM, DFC1500 and DFC3000, are rated in capacity at 250 kW, 1 MW and 2 MW, respectively, and are scalable for distributed applications up to 10 MW or larger.  Our products are designed to meet the base load power requirements of a wide range of commercial and industrial customers including wastewater treatment plants (municipal, such as sewage treatment facilities, and industrial, such as breweries and food processors), data centers, manufacturing facilities, office buildings, hospitals, universities, prisons, mail processing facilities and hotels, as well as in grid support applications for utility customers.

Through July 2005, more than 78 million kilowatt hours of electricity have been generated by fuel cell power plants worldwide incorporating our DFC technology. This increase in operating hours at customer sites has provided additional experience for improvement of the performance and availability of DFC power plants. From January 2003 through July 2005, the fleet availability for our DFC power plants was approximately 90 percent.

RECENT DEVELOPMENTS

We closed on a $100 million private offering of shares of our 5% Series B cumulative convertible perpetual preferred stock on November 18, 2004, with net proceeds to us of approximately $93.5 million. On January 14, 2005, we closed on the sale of an over-allotment of this same offering providing an additional $5.5 million of net proceeds. Total net proceeds to us from the sale of these securities was approximately $99.0 million and is intended to be used for product development, product commercialization and general corporate purposes.

On November 1, 2004, we closed on our agreement to combine the Canadian SOFC operations into Versa in exchange for Versa stock. Under the terms of the agreement, all SOFC intellectual property and the majority of the fixed assets of Fuel Cell Energy, Ltd., our Canadian subsidiary, was combined with Versa in exchange for 5,714 shares. We now own 7,714 shares or 42 percent of the common shares of Versa. No cash was exchanged in this transaction and employees of FuelCell Energy, Ltd. became Versa employees. On May 1, 2005, Versa had a 10-for-1 stock split resulting in an increase in the number of shares we own to 77,140, which remains a 42 percent ownership interest.

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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 our 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.

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 July 31, 2005, research and development sales backlog totaled $19.2 million, of which 79 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.

Fuel cell product sales and revenues include revenues from product sales and service contracts. Revenues are also derived, to a lesser extent, from electricity sales under power purchase agreements and from California and Department of Defense incentive funding. Revenues from fuel cell product 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 recognized ratably over the contract term. Electricity revenues are recognized as power is produced and incentive funding revenues are recognized ratably over the term of the incentive funding agreement.

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 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 business 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 will record a proportional amount of the fair value of the warrants against related revenue as a sales discount.

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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 (WIP) inventory until they are transferred to a customer contract.

Our inventories and advance payments to vendors are stated at the lower of cost or market price. As we 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 estimated 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 July 31, 2005 and October 31, 2004, the LCM and obsolescence adjustment to the cost basis of inventory and advance payments to vendors was approximately $9.8 million and $12.5 million, respectively, which equates to a reduction of approximately 41 and 43 percent, respectively, of the gross inventory value. As of July 31, 2005, our gross inventory and advances to vendors’ balances declined from the October 31, 2004 balances due to plants being completed for customer orders. 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 statements of operations.

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 and internal forecasts, costs of our products and results of our “cost-out” initiatives, and operating cash use. These are discussed throughout the ‘Results of Operations’ and ‘Liquidity and Capital Resources’ sections.

Comparison of Three Months ended July 31, 2005 and July 31, 2004

Revenues and costs of revenues

The following tables summarize the components of our revenues and cost of revenues for the three months ended July 31, 2005 and 2004 (dollar amounts in thousands), respectively:

	Three Months Ended July 31, 2005			Three Months Ended July 31, 2004				Percentage Increase/
Revenues:	Revenues		Percent of Revenues	Revenues		Percent of Revenues		(Decrease) in Revenues
Fuel cell product sales and revenues	$	4,877	56%	$	3,646		45%		34%
Research and development contracts		3,865	44%		4,422		55%		(13%)
Total	$	8,742	100%	$	8,068		100%		8%

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	Three Months Ended July 31, 2005			Three Months Ended July 31, 2004
Cost of revenues:	Costs of Revenues		Percent of Costs of Revenues	Costs of Revenues		Percent of Costs of Revenues		Percentage Increase/ (Decrease) in Costs of Revenues
Fuel cell product sales and revenues	$	13,827	79%	$	9,740		57%		42%
Research and development contracts		3,665	21%		7,436		43%		(51%)
Total	$	17,492	100%	$	17,176		100%		2%

Total revenues for the three months ended July 31, 2005 increased by $0.7 million, or 8 percent, to $8.7 million from $8.1 million during the same period last year.

Fuel cell product sales and revenues

Fuel cell product sales and revenue increased $1.2 million to $4.9 million for the three months ended July 31, 2005, compared to $3.6 million for the same period in 2004. The increase in product sales and revenues was primarily due to the manufacturing of power plants for LOGANEnergy Corp., Chevron Energy Solutions and MTU as well as the recognition of electricity and grant revenue related to power purchase agreements. As of July 31, 2005, our fuel cell product backlog totaled approximately $23.3 million, compared to $25.4 million on the same date a year ago. Included in these figures are $5.7 million and $1.7 million, respectively, related to long-term service agreements. Product backlog does not include power purchase or incentive funding agreements.

Cost of product sales and revenues increased to $13.8 million during the three months ended July 31, 2005, compared to $9.7 million during the same period of the prior year. The ratio of product cost to sales was 2.8-to-1 during the three months ended July 31, 2005, compared to 2.7-to-1 during the three months ended July 31, 2004. This increase in the ratio was impacted by higher costs related to the manufacture of power plants for power purchase agreements.

Cost of product sales, and the related ratio of product cost to sales are impacted by changes in inventory levels as cost of sales includes lower of cost or market adjustments. We expect to continue to sell our DFC products at prices lower than our production costs until such time as we are able to reduce product costs through our “cost out program” and production volumes increase. Refer to the “Liquidity and Capital Resources” section of this document, which further describes our “cost out program”.

Research and development contracts

Research and development revenue decreased $0.5 million to $3.9 million for the three months ended July 31, 2005, compared to $4.4 million for the same period in 2004. Research and development contract revenue and costs for the three months ended July 31, 2005 were primarily related to SOFC development under the DOE’s Solid State Energy Conversion Alliance Program and the combined cycle Direct FuelCell/Turbine® development under DOE’s Vision 21 program. Research and development contract revenues and costs declined with the completion of the DOE’s Product Design Improvement program and the U.S. Navy Bath Iron Works subcontract, and lower revenues on the Clean Coal and U.S. Navy contracts. As of July 31, 2005, our research and development sales backlog totaled approximately $19.2 million of which Congress has authorized funding of $15.1 million. This compares to research and development sales backlog totaling $19.5 million ($13.5 million funded) as of July 31, 2004.

Cost of research and development contracts decreased $3.7 million to $3.7 million during the three months ended July 31, 2005, compared to $7.4 million for the same period in 2004. The ratio of research and development cost to revenue improved to .95-to-1 from 1.7-to-1 over the same quarter a year ago due to completion of the majority of tasks on the Clean Coal and King County contracts, which had significant cost share commitments. The Clean Coal DFC3000 power plant was not operated at the Indiana site due to inoperability of the coal gassifier to provide fuel. The power plant is currently being relocated.

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Administrative and selling expenses

Administrative and selling expenses increased by 17 percent to $4.0 million during the three months ended July 31, 2005, compared to $3.4 million in the same period of the prior year. The Company recognized an increase in costs due to increased proposal work on recent project bids and higher administrative costs, which relate in part to Sarbanes-Oxley Act compliance. These increases were partially offset by a decrease in administrative and selling expenses resulting from the disposition of the Canadian operation.

Research and development expenses

Research and development expenses decreased to $5.7 million during the three months ended July 31, 2005, compared to $6.7 million recorded in the same period of the prior year. The Company recognized lower costs as a result of the disposition of the Canadian operation totaling approximately $1.7 million. This decrease was partially offset by higher DFC product development costs.

Loss from operations

Loss from operations for the three months ended July 31, 2005 totaling $18.5 million is approximately 4 percent lower than the $19.2 million loss recorded in the comparable period last year. This was due primarily to lower costs on research and development contracts and the disposition of our Canadian operation. 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” and commercialization initiatives. 

Loss from equity investments

Our investment in Versa totaled approximately $12.7 million and $2.0 million as of July 31, 2005 and as of October 31, 2004, respectively. We began accounting for this investment under the equity method as of November 1, 2004, at which time our ownership had increased from 16 percent to 42 percent. Our share of equity losses for the three months ended July 31, 2005, totaled approximately $0.5 million.

Interest and other income, net

Interest and other income, net, was $2.0 million for the three months ended July 31, 2005, compared to $0.4 million for the same period in 2004. Interest income increased due to higher yields on higher cash and investment balances and state research and development tax credits totaling $0.5 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.

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Comparison of Nine Months ended July 31, 2005 and July 31, 2004

Revenues and costs of revenues

The following tables summarize the components of our revenues and cost of revenues for the nine months ended July 31, 2005 and 2004 (dollar amounts in thousands), respectively:

	Nine Months Ended July 31, 2005				Nine Months Ended July 31, 2004
Revenues:	Revenues		Percent of Revenues		Revenues		Percent of Revenues		Percentage Increase/(Decrease) in Revenues
Fuel cell product sales and revenues	$	13,257		59%	$	7,598		34%		74%
Research and development contracts		9,153		41%		14,913		66%		(39%)
Total	$	22,410		100%	$	22,511		100%		(0.4)%

	Nine Months Ended July 30, 2005				Nine Months Ended July 30, 2004
Cost of Revenues:	Costs of Revenues		Percent of Costs of Revenues		Costs of Revenues		Percent of Costs of Revenues		Percentage Increase/ (Decrease) in Costs of Revenues
Fuel cell product sales and revenues	$	38,138		81%	$	26,930		55%		42%
Research and development contracts		9,095		19%		21,882		45%		(58%)
Total	$	47,233		100%	$	48,812		100%		(3%)

Total revenues for the nine months ended July 31, 2005 decreased by $0.1 million, or 0.4 percent, to $22.4 million from $22.5 million during the same period last year.

Fuel cell product sales and revenues

Fuel cell product sales and revenue increased $5.7 million to $13.3 million for the nine months ended July 31, 2005, compared to $7.6 million for the same period in 2004. Cost of product sales and revenues increased to $38.1 million during the nine months ended July 31, 2005, compared to $26.9 million during the same period of the prior year. Included in cost of sales during the nine months ended July 31, 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 (“uprate”) for improved product performance and reduced cost in future periods.

The increase in product sales and revenues and costs of product sales and revenues was due primarily to the progress on power plants for Chevron Energy Solutions, Marubeni, MTU and LOGANEnergy as well as the recognition of electricity and grant revenue related to power purchase agreements. The ratio of product cost to sales improved to 2.8-to-1 during the nine months ended July 31, 2005, as compared to 3.5-to-1 during the nine months ended July 31, 2004 when adjusted for the one-time asset impairment charge described above. This ratio is inclusive of costs related to power purchase agreements that had no corresponding revenues as if they were costs associated with equipment sales. The ratio of costs to product sales improved from the same period of a year ago as we recognized savings from our cost out program.

We expect to continue to sell our DFC products at prices lower than our production costs until such time as we are able to reduce product costs through our engineering and manufacturing efforts and production volumes increase.

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Research and development contracts

Research and development revenue decreased $5.8 million to $9.2 million for the nine months ended July 31, 2005, compared to $14.9 million for the same period in 2004. Cost of research and development contracts decreased to $9.1 million during the nine months ended July 31, 2005, compared to $21.9 million for the same period in 2004.

Research and development contract revenues and costs declined with the completion of the U.S. Department of Energy’s (DOE’s) Product Design Improvement program and the U.S. Navy Bath Iron Works subcontract, and lower revenues on the Clean Coal and U.S. Navy contracts. Research and development contract revenue and costs for the nine months ended July 31, 2005 were primarily related to SOFC development under the DOE’s Solid State Energy Conversion Alliance Program, the combined cycle Direct FuelCell/Turbine® development under DOE’s Vision 21 program, and the Ship Service Fuel Cell contract with the U.S. Navy. The ratio of research and development cost to revenue improved to .99-to-1 from 1.5-to-1 over the same period a year ago due to the current mix of cost share contracts. The Clean Coal DFC3000 power plant was not operated at the Indiana site due to inoperability of the coal gassifier to provide fuel. The power plant is currently being relocated.

Administrative and selling expenses

Administrative and selling expenses decreased $0.1 million, to $10.8 million during the nine months ended July 31, 2005, compared to $10.9 million in the same period of the prior year. The Company recognized lower costs as a result of the disposition of the Canadian operation, which was almost entirely offset by an increase in consulting fees related in part to Sarbanes-Oxley Act compliance, an increase in bad debt allowance related to increased receivables and an increase in costs resulting from increased proposal work on project bids.

Research and development expenses

Research and development expenses decreased to $16.2 million during the nine months ended July 31, 2005, compared to $19.0 million recorded in the same period of the prior year. The Company recognized lower costs as a result of the disposition of the Canadian operation, partially offset by increased internal research and development related to support of the DFC products and our cost out programs.

Purchased in-process research and development

We recorded a charge totaling $12.2 million during the nine months ended July 31, 2004 for in-process research and development (IPR&D) acquired in the Global transaction. The amount allocated to IPR&D was determined using established valuation techniques through a qualified third party valuation. As the SOFC technology is in the early stages of development, the valuation was based, in part, on the cost approach and a second method, the market approach. The amounts estimated in this valuation were calculated using a risk-adjusted discount rate of 30 percent. As the acquired technology had not yet reached technological feasibility and no alternative future uses exist, it was expensed upon acquisition in accordance with Statement of Financial Accounting Standards (SFAS) No. 2, “Accounting for Research and Development Costs.”

Loss from operations

The net result of our revenues and costs was a loss from operations for the nine months ended July 31, 2005 totaling $51.9 million. This operating loss is approximately 24 percent lower than the $68.4 million loss recorded in the comparable period last year due primarily to the acquisition related charge of purchased in-process research and development in the prior year totaling $12.2 million, lower costs on research and development contracts and disposition of our Canadian operations. 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” and commercialization initiatives.

Loss from equity investments

Our investment in Versa totaled approximately $12.7 million and $2.0 million as of July 31, 2005 and as of October 31, 2004, respectively. We began accounting for this investment under the equity method of accounting as of November 1, 2004, at which time our ownership had increased from 16 percent to 42 percent. Our share of equity losses for the nine months ended July 31, 2005, totaled approximately $1.2 million.

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Interest and other income, net

Interest and other income, net, was $3.9 million for the nine months ended July 31, 2005, compared to $1.7 million for the same period in 2004. Interest income increased due to higher yields on higher cash and investment balances and state research and development tax credits totaling $0.5 million. This increase was offset by foreign currency losses of approximately $0.1 million during the nine months ended July 31, 2005, compared to foreign currency gains of $0.2 million during the nine months ended July 31, 2004.

Discontinued operations, net of tax

During the nine months ended July 31, 2005, we exited certain facilities in Canada and as a result recorded fixed asset impairment charges totaling approximately $0.9 million and exit costs of approximately $0.4 million.

During fiscal 2004, we acquired Global Thermoelectric Inc. (Global) and subsequently divested its generator business unit through the sale of Global on May 28, 2004. As a result, historical results were reclassified as discontinued operations. Income, net of taxes, related to the generator business totaled approximately $0.9 million for the nine months ended July 31, 2004.

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 $191.5 million of cash, cash equivalents and investments as of July 31, 2005, compared to $152.4 million as of October 31, 2004. Net cash and investments provided during the nine months ended July 31, 2005 was $39.1 million, consisting of approximately $99.0 million from the sale of preferred stock, offset by approximately $58.9 million used for continuing operations, and approximately $1.0 million used in our discontinued Canadian operations.

Sources and Uses of Cash and Investments

We continue to invest in the development and commercialization of new products 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 operations. Cash from operations includes revenue from government research and development contracts, product sales, license fees and interest income. Our future cash requirements depend on numerous factors including future involvement in research and development contracts, sales of power purchase agreements, implementing our cost reduction efforts on our fuel cell products and increasing annual order volume.

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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

We believe that reducing product cost is essential to penetrate the market for fuel cell products and is critical to achieving profitability. We believe this 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. In 2003, we began a “cost-out” program that focuses on three key areas:

·   increased performance output;

·   increased stack life; and

·   design simplification and materials replacement and/or elimination to reduce product cost.

The cost-out program began focusing initially on the sub-megawatt (sub-MW) DFC product with a cost, at that time, of approximately $10,000 per kilowatt (kW). Since 2003, we have introduced two blocks of cost reductions that have brought product costs down to approximately $6,000 per kW for the newly introduced DFC300MA™.

The DFC300MA incorporates design changes to the 250 kW Direct FuelCell power plant that is expected to result in lower routine maintenance expenses due to its modular three-piece design. This modular architecture, with separate skids for the mechanical balance of plant, electronic balance of plant and the DFC module, is expected to enhance serviceability due to greater accessibility for each component. Additional improvements in the DFC300MA power plant include modifying certain subsystems, so parts and materials may be sourced from multiple vendors, and automating the fuel cell conditioning process resulting in higher product quality. Balance of plant testing and verification on the DFC300MA has been completed with successful results and this new sub-MW design has been released for production.

We are on target to meet our cost objective of $4,800/kW for our sub-MW product by the end of calendar year 2005. After cost-out initiatives are verified on the sub-MW product, then similar initiatives will extend to the MW product. Our MW-class products have an inherent 20 to 25 percent cost advantage over the sub-MW product due to economies of scale of the balance of plant and other components.

Increasing annual order volume

We believe that increased production volumes will spread fixed costs over more units of production, resulting in a lower per unit cost. Our manufacturing, testing and conditioning facilities have equipment in place to accommodate 50 MW of annual production. We currently believe that we can achieve operating break-even at annual production volumes of approximately 100 MW. Our fiscal 2004 production volume was approximately 6 MW.

We anticipate that our existing capital resources, together with anticipated revenues, will be adequate to satisfy our planned financial requirements and agreements through at least the next twelve months.

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Cash Inflows and Outflows

The key components of our cash inflows and outflows from continuing operations were as follows:

Operating Activities: During the nine months ended July 31, 2005, we used $47.3 million in cash in our operating activities, compared to an operating cash usage of $50.5 million during the nine months ended July 31, 2004. Fiscal year to date cash used in operating activities consists of a net loss for the period of approximately $50.3 million, offset by non-cash adjustments totaling $7.6 million, cash used in working capital of approximately $5.9 million and loss from discontinued operations of approximately $1.3 million.  Depreciation and amortization include depreciation expense totaling $5.6 million and other amortization totaling $0.1 million, partially offset by net amortization of discounts on investments totaling $0.6 million.

Investing Activities:  During the nine months ended July 31, 2005, net cash used by investing activities totaled $77.9 million, compared with approximately $73.1 million generated in the nine months ended July 31, 2004. During the nine months ended July 31, 2004, we acquired Global Thermoelectric, Inc., which resulted in a net increase to cash in that period of $53.0 million. Capital expenditures totaled $10.5 million for the nine months ended July 31, 2005. This included approximately $9.0 million for equipment being built for power purchase agreements in our Alliance entities. During the nine months ended July 31, 2005, approximately $274.9 million of investments in U.S. Treasury Securities matured and new treasury purchases were made totaling $342.3 million.

Financing Activities:  During the nine months ended July 31, 2005 we closed on a Series B cumulative convertible preferred perpetual preferred stock offering which resulted in net proceeds to us totaling $99.0 million. We generated $0.5 million from financing activities through the issuance of stock for option and stock purchase plans, partially offset by dividend payments on preferred dividends of $3.0 million and repayments of debt totaling approximately $0.3 million.  This compares with approximately $2.6 million generated in the nine months ended July 31, 2004.

Commitments and Significant Contractual Obligations

A summary of our significant future commitments and contractual obligations as of July 31, 2005 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)	$	4,081	$	978	$	1,541	$	1,349	$	213
Term loans (principal and interest)		1,251		413		819		19		--
Purchase commitments(2)		19,946		18,370		1,576		--		--
Series I Preferred dividends payable (3)		20,072		379		758		1,326		17,609
Series B Preferred dividends payable (4)		23,823		5,294		10,588		7,941		--
Totals	$	69,173	$	25,434	$	15,282	$	10,635	$	17,822

(1)   Future minimum lease payments on capital and operating leases.

(2)   Short-term 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. Cumulative unpaid dividends and interest at October 31, 2004 were approximately $2.8 million. 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. From 2010 through 2020, we would be required to pay annual dividend amounts totaling Cdn.$1.25 million.

(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. We have the option of paying the dividends in stock or cash.

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On June 29, 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 seven years, with payments of interest only for the first six months and then repaid in monthly installments over the remaining six and one-half years with interest computed annually based on the ten-year U.S. Treasury note plus 2.5 percent. Our current interest rate at July 31, 2005 is 7.2 percent and the outstanding principal balance on this loan is approximately $1.1 million.

Approximately $0.7 million of our cash and cash equivalents have been pledged as collateral for certain banking relationships in which we participate.

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 July 31, 2005, our research and development sales backlog totaled $19.2 million. As this backlog is funded in future periods, we will incur additional research and development cost-share totaling approximately $11.6 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 July 31, 2005, we had product sales backlog of approximately $23.3 million. We do not expect sales from this backlog to be profitable.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004) (“SFAS No. 123R”), “Share-Based Payment” which revised SFAS No. 123, “Accounting for Stock-Based Compensation”. This statement supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation costs relating to such transactions be recognized in the consolidated statement of operations. The revised statement is effective as of the first fiscal year beginning after June 15, 2005 (our fiscal year begins on November 1, 2005). We currently use the Black-Scholes option-pricing model to measure the fair value of stock-based compensation to employees for pro forma disclosures under SFAS No. 123. SFAS No. 123R requires that compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is rendered on or after the required effective date and the compensation cost shall be based on the grant-date fair value of those awards as calculated for pro forma disclosures under SFAS No. 123. We expect 2006 compensation cost to be material for the portion of awards made prior to November 1, 2005 for which the requisite service has not been rendered. We are currently evaluating SFAS No. 123R and have not determined whether we will use the Black-Scholes option-pricing model or a “lattice” model for stock-based instruments granted subsequent to November 1, 2005.

In November 2004, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations”. The Issue provides a model to assist in evaluating (a) which cash flows should be considered in the determination of whether cash flows of the disposal component have been or will be eliminated from the ongoing operations of the entity and (b) the types of continuing involvement that constitute significant continuing involvement in the operations of the disposal component. Should significant continuing ongoing involvement exist, then the disposal component shall be reported in the results of continuing operations on the consolidated statements of operations and cash flows. We applied the provisions of this accounting standard to our financial statements.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs,” which amends the guidance in Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal”. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. We are currently evaluating the provisions of SFAS No. 151 and will adopt it on November 1, 2005, as required.

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Item 3. 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 includes both short-term United States Treasury instruments with maturities averaging three months or less, as well as U.S. Treasury notes with fixed interest rates with maturities of up to twenty months. Cash is invested overnight with high credit quality financial institutions. Based on our overall interest exposure at July 31, 2005, 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 $0.2 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 July 31, 2005, approximately $1.1 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 recognized approximately $0.1 million in foreign currency losses and $0.2 million in foreign currency gains during the nine months ended July 31, 2005 and 2004, respectively. This has been recorded as a component of ‘Interest and other income’ on our consolidated statement of operations. 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 hedging activities. We do not enter into derivative financial instruments. 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.

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Item 4. CONTROLS AND PROCEDURES

We carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

During the most recent fiscal quarter, there has been no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

On July 7, 2005, we entered into an amendment (“Amendment”) to a distribution agreement with Enbridge Inc. dated as of November 4, 2003, and discussed below, whereby we will jointly develop a new multi-megawatt product, the Direct FuelCell-Energy Recovery Generation ^TM, specifically designed for natural gas pipeline applications. Enbridge will act as the exclusive distributor of the product in Canada and the United States. Pursuant to the Amendment, the original warrants were cancelled and we granted to Enbridge new warrants to purchase up to an aggregate of 1,000,000 shares (the “New Warrants”) of common stock of FuelCell, as discussed in further detail below.

On November 4, 2003, FuelCell entered into a distribution Agreement with Enbridge whereby Enbridge was appointed as a non-exclusive distributor of certain carbonate-based fuel cell based power plants in Canada utilizing FuelCell’s Direct FuelCell technology. In connection with this distribution agreement, FuelCell granted Enbridge warrants to purchase up to an aggregate of 500,000 shares (the “Original Warrants”) of common stock of FuelCell. These warrants have been cancelled pursuant to the Amendment.

The New Warrants vest on a graduated scale based on the total number of megawatts contained in product orders generated by Enbridge. The exercise prices of the New Warrants range from $9.89 to $11.87 per share and the expiration of the New Warrants range from June 30, 2007 to June 30, 2010.  The New Warrants were issued pursuant to the exemption provided by Section 4(2) of the Securities Act of 1933, as amended.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

Exhibit No.	Description
31.1	CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b)Reports on Form 8-K

We filed a Form 8-K dated July 12, 2005 under Item 3.02, regarding a distribution agreement amendment whereby we cancelled certain warrants granted to a distributor under a previous distribution agreement and granted new warrants to purchase up to an aggregate of 1,000,000 shares of our common stock.

We filed a Form 8-K dated June 6, 2005 under Items 2.02 and 9.01, in connection with a press release announcing our financial results and accomplishments for the three months ended April 30, 2005.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	FUELCELL ENERGY, INC. (Registrant)
September 9, 2005	/s/ Joseph G. Mahler
Date	Joseph G. Mahler Senior Vice President, Chief Financial Officer, Treasurer and Corporate Secretary (Principal Financial Officer and Principal Accounting Officer)

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INDEX OF EXHIBITS

Exhibit No.	Description
31.1	CEO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	CFO Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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