Cautionary Statement The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto contained elsewhere in this report. The information contained in this quarterly report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other filings with theSecurities and Exchange Commission , orSEC , including our Annual Report on Form 10-K for the year endedDecember 31, 2019 filed with theSEC onMarch 11, 2020 , or our Annual Report. In this report we make, and from time to time we otherwise make written and oral statements regarding our business and prospects, such as projections of future performance, statements of management's plans and objectives, forecasts of market trends, and other matters that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Statements containing the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimates," "projects," "believes," "expects," "anticipates," "intends," "target," "goal," "plans," "objective," "should" or similar expressions identify forward-looking statements, which may appear in our documents, reports, filings with theSEC , and news releases, and in written or oral presentations made by officers or other representatives to analysts, stockholders, investors, news organizations and others, and in discussions with management and other of our representatives. Our future results, including results related to forward-looking statements, involve a number of risks and uncertainties, including those risks included below in Part II, Item 1 "Risk Factors". No assurance can be given that the results reflected in any forward-looking statements will be achieved. Any forward-looking statement speaks only as of the date on which such statement is made. Our forward-looking statements are based upon assumptions that are sometimes based upon estimates, data, communications and other information from suppliers, government agencies and other sources that may be subject to revision. Except as required by law, we do not undertake any obligation to update or keep current either (i) any forward-looking statement to reflect events or circumstances arising after the date of such statement or (ii) the important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or which are reflected from time to time in any forward-looking statement.
General
Aqua Metals (NASDAQ: AQMS) is engaged in the business of equipment supply, technology licensing and related services for recycling lead through a novel, proprietary and patented process we developed and named AquaRefining™. AquaRefining is a room temperature, water and organic acid-based process that greatly reduces environmental emissions. Lead is a globally traded commodity with a worldwide market value in excess of$20 billion . We believe our suite of patented and patent pending AquaRefining technologies will allow the lead-acid battery industry to simultaneously improve the environmental impact of lead recycling and scale recycling production to meet demand. Furthermore, our AquaRefining technologies result in high purity lead. We were formed as aDelaware corporation onJune 20, 2014 and since our formation, we have focused our efforts on the development and testing of our AquaRefining process, the construction of our initial lead acid battery, or LAB, recycling facility at the Tahoe Reno Industrial Center, or TRIC, located inMcCarran, Nevada and commercializing the AquaRefining process. We completed the development of our first LAB recycling facility atNevada's Tahoe Reno Industrial Center, or TRIC, inMcCarran, Nevada and commenced production of battery breaking and limited operations during the first quarter of 2017. InApril 2017 , we commenced the shipment of products for sale, consisting of lead compounds as well as plastics. InApril 2018 , we commenced the limited production of lead bullion, including AquaRefined lead. InJuly 2018 , we commenced the sale of pure AquaRefined lead in the form of two tonne blocks and inOctober 2018 , we commenced the sale of AquaRefined lead in the form of battery manufacturing ready ingots. InNovember 2018 , we received official vendor certification from Clarios for our AquaRefined lead and inDecember 2018 , we commenced shipments directly to Clarios owned and partner battery manufacturing facilities. In 2019, we operated our demonstration AquaRefinery at commercial quantity production levels and produced over 35,000 AquaRefined ingots by operating the AquaRefinery 24 hours a day and 7 days a week for sustained periods of time. The AquaRefining electrolyzers produced at or above the target 100 Kg/Hr of production throughput per module of six electrolyzers or ~ 16-17 Kg/Hr per electrolyzer and ran sustained endurance runs for over one month several times. 15 -------------------------------------------------------------------------------- In order to expand the demonstration AquaRefinery to its full capacity, we chose to idle the AquaRefinery beginning inSeptember 2019 to facilitate contracting work required to step the plant up to the next level of capacity planned for late 2019 or early 2020. On the evening ofNovember 29, 2019 , a fire occurred in the AquaRefining area of the recycling facility at TRIC. The cause of the fire was not due to the technology or process of AquaRefining but rather to contracting activities. The fire and related intense heat and smoke caused significant damage to a material amount of equipment in the AquaRefinery area, including all 16 AquaRefining modules, electrical and tank infrastructure, steel superstructure, control wiring and other supporting infrastructure. The floor to ceiling firewall between the AquaRefining area and the rest of the plant isolated the worst of the damage to the AquaRefining area. The firewall also appears to have spared material damage to much of the key front-end process equipment, such as the battery breaker/separation system, concentrate production area, kettles and ingot casting, water treatment and recovery and other important areas of the plant. The administrative office area also remained intact. Based on preliminary estimates, as of the date of this report, we believe that the replacement value of the equipment and plant lost or damaged in the fire could be over$30 million excluding any business interruption cost recovery. Assets on our balance sheet as ofJune 30, 2020 that were not affected by the fire total approximately$38 million in book value, including the battery breaker, melting kettles, kiln, filter presses, mixing and storage tanks, water recovery system and the building infrastructure plus the land. We have$50 million dollars in combined property, equipment and business interruption insurance. Initial estimates for property, plant and business interruption claims may reach total limits. However, this number could change pending detailed analysis and review. Pursuant to the loan agreement withVeritex Community Bank , or Veritex, the successor in interest toGreen Bank, N.A. , for approximately$9.1 million ($8.6 million net of issuance costs), Veritex is the loss payee on our insured claims and all funds are paid directly to Veritex, which in turn disburses the proceeds to us subject to their approval. InMarch 2020 , we entered into a memorandum of agreement with Veritex pursuant to which the parties agreed on the allocation of funds from collected insurance payments. Pursuant to the memorandum of agreement, 90% of the initial$5 million and 55% of the next$7.5 million of insurance proceeds were allocated to us and the balance was allocated towards the retirement of the Veritex loan. Thereafter, 60% of the next$12.5 million of insurance proceeds will be allocated to us, and the balance towards the repayment of the Veritex loan, until such time as the Veritex loan has been paid in full, after which 100% of all future insurance payouts will be disbursed directly to us. As of the date of this report, of the$15.0 million of insurance proceeds received from our insurance carriers, Veritex has put into escrow$4.875 million and we have received$10.125 million . We expect the insurance carriers to pay an additional$10.0 to$15.0 million in insurance proceeds over the next three to six months, of which we should receive$6.0 to$11.0 million . This estimate is based upon the cadence of receipts to date. We intend to vigorously pursue receipt of insurance proceeds to satisfy in full all of our property, casualty and business interruption losses, subject to the coverage limits.
We have engaged a public adjuster to support our legal and finance team and provide forensic accounting, construction expertise and direct interface with the insurers to assist us in quickly and properly documenting the loss and maximizing our insurance recovery amounts on the best possible timeline.
As a result of the fire we have suspended all commercial operations and the date on which we can resume revenue producing operations is currently undetermined. Following the fire, an investigation of the fire was commenced by theStorey County Fire Marshal and we were denied access to the fire damaged portion of the facility until lateDecember 2019 , at which time we were given access to the fire damaged area. Since then, we have been engaged in the process of analyzing the fire damage and the clean-up and disposal of the damaged equipment, and the development of our capital light strategy.
Plan of Operations
Following theNovember 2019 fire, we have been engaged in the pursuit of a capital light strategy that is based on the pursuit of licensing opportunities within the lead battery recycling marketplace without maintaining and operating a capital-intensive lead recycling facility. We plan to continue securing our cash position by working on the successful collection of additional insurance proceeds with the assistance of our retained public adjuster and special counsel to facilitate the collection for property and business interruption losses. We intend to dispose certain assets that are not essential to the capital light licensing strategy. We believe our capital light business strategy will require less space and less equipment and focus on the needs of our future licensees. As of the date of this report, we have accelerated our capital light business strategy, designed to optimize shareholder value by focusing on equipment supply and licensing opportunities, which have always been a core part of our business plans. We believe this path has the potential to maximize shareholder value in that it could be far less capital intensive than a rebuild and could be funded solely or primarily from a combination of cash on hand, insurance proceeds and asset dispositions. 16 -------------------------------------------------------------------------------- Our capital light strategy is consistent with our long-held business strategy and objectives. When we designed and developed TRIC in 2016, we did so at a time when our business model assumed that TRIC would be the first of many LAB recycling facilities owned and operated by us. Commencing in 2017, we began to shift our focus away from the development of additional Company-owned LAB recycling facilities and towards the licensing of our AquaRefining technology to partners engaged in LAB recycling. We continued to develop TRIC as a LAB recycling facility for purposes of further demonstrating AquaRefining on a commercial scale. However, as a result of the fire and our high costs of capital we believe that the cost of restoring TRIC to its pre-fire state would not be the best use of our available and projected cash and that we may be able to achieve the benefits of operating our facility at TRIC in its pre-fire state, namely the development and demonstration of the licensing ready iteration of our AquaRefining technologies, which we call Version 1.25L, through a less costly commercialization program. Further, we believe that our results of operations to date can demonstrate to potential licensees the value proposition of our AquaRefining technologies. We believe that our AquaRefining technology would be a commercially attractive valuable proposition in the hands of battery recyclers, who typically have access to lower cost feedstock and ability to process all materials on site through a furnace. Results of Operations Our lead recycling facility was not in production during the second quarter due to the fire and the acceleration of our licensing strategy. Product sales during the second quarter of 2019 consisted of high purity lead from our AquaRefining process as well as lead bullion, lead compounds, and plastics. The following table summarizes our results of operations with respect to the items set forth below for the three and six months endedJune 30, 2020 and 2019 together with the percentage change in those items (in thousands). Three months endedJune 30 , Six months endedJune 30 , Favorable % Favorable % 2020 2019 (Unfavorable) Change 2020 2019 (Unfavorable) Change Product sales $ -$ 1,483 $ (1,483) (100.0) %$ 18 $ 1,920 $ (1,902) (99.1) % Cost of product sales 1,306 7,185 5,879 (81.8) % 2,760 11,866 9,106 (76.7) % Research and development cost 217 338 121 (35.8) % 459 958 499 (52.1) % General and administrative expense 2,245 4,335 2,090 (48.2) % 4,630 8,351 3,721 (44.6) % Total operating expense$ 3,768 $ 11,858 $ 8,090 (68.2) %$ 7,849 $ 21,175 $ 13,326 (62.9) % As mentioned previously, product sales consist of high-purity lead from our AquaRefining process as well as lead bullion, lead compounds and plastics. Except for nominal sales of inventory in the first quarter of 2020, we did not generate revenue for the three and six months endedJune 30, 2020 as there has been no production subsequent to the fire that occurred during the fourth quarter of 2019. The plant will not be in production during 2020 except for the operation and testing of our improved electrolyzers as part of the V1.25 program. Cost of product sales includes raw materials, supplies and related costs, salaries and benefits, consulting and outside services costs, depreciation and amortization costs and insurance, travel and overhead costs. Cost of product sales decreased approximately 82% and 77% for the three and six months endedJune 30, 2020 , respectively, as compared to the three and six months endedJune 30, 2019 . Cost of product sales decreased during 2020 due to the suspension of production, resulting from the fire. Research and development cost included expenditures related to the improvement of the AquaRefining technology. During the three and six months endedJune 30, 2020 , research and development costs decreased 36% and 52%, respectively, over the comparable periods in 2019. The decline in research and development cost is primarily the result of management's focus on transitioning to a capital light business strategy. General and administrative expense decreased approximately 48% and 45% for the three and six months endedJune 30, 2020 , respectively, compared to the three and six months endedJune 30, 2019 . The suspension of activities under our Operations, Maintenance and Management Agreement with Veolia, reduced Company payroll and improvements in nearly all other expense categories drove the decrease. We expect to further decrease general and administrative expenses during the year as a result of our move to a more capital light strategy. For the six months endedJune 30, 2019 we had$3.7 million of non-cash expense related to the Veolia agreement. We also incurred costs of approximately$0.2 million for professional serves fees associated with the sublease of theAlameda facility. 17 -------------------------------------------------------------------------------- The following table summarizes our other income and interest expense for the three and six months endedJune 30, 2020 and 2019 together with the percentage change in those items (in thousands). Three months ended June 30, Six months ended June 30, Favorable % Favorable % 2020 2019 (Unfavorable) Change 2020 2019 (Unfavorable) Change
Other income and (expense)
Interest expense$ (164) $ (203) $ 39 19.2 %$ (347) $ (3,092) $ 2,745 88.8 % Interest and other income$ 3 $ 77 $ (74) (96.1) %$ 25 $ 140 $ (115) (82.1) % Interest expense has related primarily to the$5.0 million Interstate Battery convertible note (until January of 2019) and the$10.0 million note payable to Veritex, the successor in interest toGreen Bank , amortization of debt issuance costs incurred in connection with both of these notes, as well as an accrual for theUSDA guarantee fee on the$10.0 million note to Veritex. OnJanuary 24, 2019 , we repaid Interstate Battery the outstanding principal and interest on the convertible debt in the amount of$6.7 million . As a result of this debt repayment, we amortized the remaining discount on the note of$2.6 million and remaining deferred financing expenses of$20,000 to interest expense. Interest expense decreased for the three months endedJune 30, 2020 as compared to the same period in 2019 as the result of the principle debt reduction through scheduled payments on the Veritex loan, along with decreases in the variable interest rate for that note. Interest income decreased for the three months endedJune 30, 2020 compared to the same period in 2019 due to lower cash balances during the period. Liquidity and Capital Resources As ofJune 30, 2020 , we had total assets of$57.6 million and working capital of$6.1 million . The following table summarizes our cash provided by (used in) operating, investing and financing activities (in thousands): Six months ended June 30, 2020 2019 Net cash used in operating activities$ (8,323) $ (11,831) Net cash provided by (used in) investing activities$ 5,350 $ (4,299) Net cash provided by financing activities$ 174 $ 22,550 Net cash used in operating activities Net cash used in operating activities for the six months endedJune 30, 2020 and 2019 was$8.3 million and$11.8 million , respectively. Net cash used in operating activities during each of these periods consisted primarily of our net loss adjusted for noncash items such as depreciation, amortization, stock-based compensation charges, and impairment charge as well as net changes in working capital. Net cash provided by and used in investing activities Net cash provided by investing activities for the six months endedJune 30, 2020 was$5.4 million and consisted mainly of$7.6 million of insurance proceeds offset by$2.2 million related to purchases of property and equipment. Net cash used by investing activities for the six months endedJune 30, 2019 was$4.3 million and consisted primarily of purchases of fixed assets related to the build-out of our TRIC recycling facility inNevada . In March of 2019, we disposed of the capital shares of ourUK subsidiary,Ebonex IPR, Ltd. The sale price was a nominal cash amount and did not contribute to net cash used in investing activities. Net cash provided by financing activities Net cash provided by financing activities for the six months endedJune 30, 2020 was approximately$0.2 million and consisted of Payroll Protection Program loan proceeds of$0.3 million , partially offset by payments on debt. Net cash provided by financing activities for the six months endedJune 30, 2019 consisted of$9.1 million net proceeds from ourJanuary 2019 18 -------------------------------------------------------------------------------- public offering and$20.3 million net proceeds from ourMay 2019 public offering. This increase was offset by a$6.7 million payoff of the Interstate Battery convertible note. As ofJune 30, 2020 , we had total cash of$4.8 million and working capital of$6.1 million which includes a$4.9 million insurance proceeds receivable. As of the date of this report, we believe that we will require additional capital in order to fund our current level of ongoing costs and our proposed business plan over the next 12 months as we move forward with our capital light licensing strategy. We intend to acquire the necessary capital though the recovery of insurance proceeds on our fire related claims and the possible sale of certain equipment and assets at TRIC. However, there can be no assurance that we will be able to collect insurance proceeds or acquire proceeds from the sale of TRIC in amounts sufficient to fund the capital requirements or, if we are successful, that we will not require additional capital. If needed, we may seek funding through the sale of equity or debt securities. Funding that includes the sale of our equity may be dilutive. If such financing is not available on satisfactory terms, we may be unable to further pursue our business plan and we may be unable to continue operations. Additionally, we were not in compliance with the minimum debt service coverage ratio covenant on our loan from Veritex as of the fiscal quarter ends betweenMarch 31, 2017 andJune 30, 2020 . We received a waiver for the minimum debt service coverage ratio covenant for those periods. While we expect to continue to receive waivers from Veritex for non-compliance with such covenant, there is no guarantee that we will receive such waivers. If Veritex determines not to grant us a waiver for non-compliance in the future, we would be in default of the loan and Veritex would be able to accelerate the payment of all amounts under the loan.
On
Pursuant to the MOA, we have agreed to the allocation of proceeds from insurance policies and sales of collateral secured by the loan. We have agreed on the allocation of all insurance proceeds, with the proceeds allocated to Veritex to be used to pay off all amounts outstanding under the loan, approximately$8.6 million as of the date of this report (inclusive of an approximate$500,000 prepayment penalty, netted against a$1,000,000 CD collateral). Off-Balance Sheet Arrangements We do not have any off-balance sheet financing arrangements. Item 3. Quantitative and Qualitative Disclosures about Market Risk We do not enter into financial instruments for trading or speculative purpose. Our primary exposure to market risk is interest expense related to our debt withVeritex Bank . The interest rate on this loan adjusts on the first day of each calendar quarter equal to the greater of six percent (6%) or two percent (2%) per annum above the minimum prime lending rate charged by largeU.S. money center commercial banks as published by theWall Street Journal . Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based on that evaluation, management, including our chief executive officer and chief financial officer, concluded that our disclosure controls and procedures were effective as ofJune 30, 2020 . Changes in Internal Control Over Financial Reporting There were no changes in our internal control over financial reporting that occurred during the six month period endedJune 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 19
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