AQUABOUNTY TECHNOLOGIES INC 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes that appear elsewhere in this Annual Report on Form 10‑K. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10‑K, particularly in “Risk Factors.” Overview We believe that we are a distinctive brand in the field of land-based aquaculture, leveraging decades of technology expertise to deliver innovative solutions that address food insecurity and climate change issues, while improving efficiency and sustainability. We provide fresh Atlantic salmon to nearby markets by raising our fish in carefully monitored land-based fish farms through a safe, secure and sustainable process. Our land-based Recirculating Aquaculture System farms, including our grow-out farm located in Indiana in the United States and our broodstock and egg production farm located on Prince Edward Island in Canada, are close to key consumption markets and are designed to prevent disease and to include multiple levels of fish containment to protect wild fish populations. We are raising nutritious salmon that is free of antibiotics and other contaminants and provides a solution with a reduced carbon footprint without the risk of pollution to marine ecosystems as compared to traditional sea-cage farming. Our primary product is our GE Atlantic salmon, which received FDA approval in 2015 as the first genetically engineered animal available for sale for human consumption. We commenced commercial activities in 2021 with operations in the United States and Canada. We are actively engaged in genetic, genomic, fish health and fish nutrition research, which drive continuous improvement in our operations and may lead to new, disruptive technologies and products that could further expand our competitive offerings. Company Update We have been pursuing a growth strategy that includes the construction of large-scale recirculating aquaculture system farms for producing our GE Atlantic salmon. Our farm in Pioneer, Ohio is under construction and roughly 30% complete, but construction activities have been paused. To fund the construction cost, we were using cash on hand, which would be supplemented by a municipal bond financing. However, during the initial two years of construction, the cost estimate for the farm increased substantially and eventually exceeded our ability to complete the proposed financing. Consequently, we require new financing to provide liquidity for working capital and to fund the construction of our farm in Pioneer, Ohio. To meet this need, we have engaged an investment bank to pursue a range of funding and strategic alternatives, including the recently announced sale process for our Indiana farm, potential debt financing secured by our unencumbered assets, and potential joint venture partnerships or other strategic transactions. Inflation Recently elevated global inflation rates continue to impact all areas of our business. We are experiencing higher costs for farming supplies, transportation costs, wage rates, and other direct operating expenses, as well as for capital expenditures related to the construction of our farm in Ohio. We expect inflation to continue to negatively impact our results of operations for the near-term. Financial Overview We expect our future capital requirements will be substantial, particularly as we continue to develop our business and expand our commercial activities, as discussed in “Liquidity and Capital Resources”. Product Revenue We have generated product revenue primarily through the sales of our GE Atlantic salmon, supplemented by sales of conventional Atlantic salmon, salmon eggs, fry, and byproducts. With the expected sale of our Indiana farm, our product revenues will consist of conventional Atlantic salmon eggs and fry for the near term. Product Costs Product costs include the labor and related costs to grow out our fish, including feed, oxygen, and other direct costs; overhead; and the cost to process and ship our products to customers. A portion of production costs is absorbed into inventory as fish in process to the extent that these costs do not exceed the net realizable value of the fish biomass. The costs that are not absorbed into inventory, as well as any net realizable value inventory adjustments, are classified as product costs . Our product costs also include the labor and related costs to maintain our salmon broodstock. As of December 31, 2023 and 2022, we had 82 and 70 employees, respectively, engaged in production activities. Sales and Marketing Expenses Our sales and marketing expenses currently include salaries and related costs for our sales personnel and agency fees for market-related activities. As of December 31, 2023 and 2022, we had one and two employees, respectively, dedicated to sales and marketing. We expect our sales and marketing expenses to increase as our production output and revenues grow. 32 Table of Contents Research and Development Expenses We recognize research and development expenses as they are incurred. Our research and development expenses consist primarily of salaries and related overhead expenses for personnel in research and development functions; fees paid to contract research organizations and consultants who perform research for us; and costs related to laboratory supplies used in our research and development efforts. As of December 31, 2023 and 2022, we employed six and 12 scientists and technicians, respectively, at our farms to oversee the lines of fish we maintain for research and development purposes. General and Administrative Expenses General and administrative expenses consist primarily of salaries and related costs for employees in executive, corporate, and finance functions. Other significant general and administrative expenses include corporate governance and public company costs, regulatory affairs, rent and utilities, insurance, and legal services. We had 15 and 16 employees in our general and administrative group at December 31, 2023 and 2022, respectively. Other Income (Expense), Net Interest expense includes the interest on our outstanding loans and the amortization of debt issuance costs. Other income (expense) includes bank charges, fees, interest income, miscellaneous gains or losses on asset disposals and realized gains or losses on investments. Critical Accounting Policies and Estimates This Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our consolidated financial statements, which we have prepared in accordance with GAAP. The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. We evaluate these estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are more fully described in Note 2 to our audited consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K, we believe that the following accounting policies and estimates are the most critical for fully understanding and evaluating our financial condition and results of operations. Inventories Inventories are mainly comprised of feed, eggs, fry, fish in process and fish for sale. Fish in process inventory is a biological asset that is measured based on the estimated biomass of fish on hand. The estimate of fish biomass contains uncertainty, as we cannot weigh each individual fish until harvest. We have therefore established a standard procedure to estimate the biomass of fish on hand using counting and sampling techniques. Historically, our estimate of fish biomass has had a variability of approximately 4%. We measure inventory at the lower of cost or net realizable value (“NRV”), where NRV is defined as the estimated market price, less the estimated costs of processing, packaging and transportation. We consider fish that have been harvested and transported from its farm to be fish for sale. Revenue Recognition We generate revenue from the sale of our products. Revenue is recognized when the customer takes physical control of the goods, in an amount that reflects the transaction price consideration that we expect to receive in exchange for the goods. Revenue excludes any sales tax collected and includes any estimate of future credits. Recent Accounting Pronouncements We do not expect any recently issued, but not yet effective, accounting standards to have a material effect on our results of operations or financial condition. 33 Table of Contents Results of Operations Comparison of the year ended December 31, 2023 to the year ended December 31, 2022. The following table summarizes our results of operations for the years ended December 31, 2023 and 2022, together with the changes in those items in dollars (in thousands) and as a percentage: Years Ended ‎ December 31, Dollar % 2023 2022 Change Change Product revenue $ 2,473 $ 3,137 (664) (21)% Operating expenses: Product costs 15,282 13,631 1,651 12% Sales and marketing 796 1,139 (343) (30)% Research and development 704 904 (200) (22)% General and administrative 13,008 9,787 3,221 33% Operating loss 27,317 22,324 4,993 22% Total other (expense) income (241) 167 (408) (244)% Net loss $ 27,558 $ 22,157 5,401 24% Product Revenue Product revenue for the year ended December 31, 2023 consisted of sales of our GE Atlantic salmon and conventional Atlantic salmon eggs, fry and byproducts. During the current year, we increased the volume of harvests of GE Atlantic salmon from our Indiana farm and completed the transition of our Rollo Bay farm to a broodstock and egg production facility. Our Indiana farm required extensive repairs to one of its buildings during the fourth quarter of 2022, which impacted the number of fish that could be harvested and sold during the final two months of 2022 and the first two months of 2023. The decrease in revenue during the year ended December 31, 2023 was primarily due to changes in product mix during the first half of 2023 and decreases in market prices for Atlantic salmon in the second half of 2023. Years Ended ‎ December 31, % 2023 2022 Change Change Harvest of GE Atlantic salmon (mt) 492 430 62 14% Product revenue GE Atlantic salmon revenue $ 2,332 $ 2,913 $ (581) (20)% Non-GE Atlantic salmon revenue 124 187 (63) (34)% Other revenue 17 37 (20) (54)% Total product revenue $ 2,473 $ 3,137 $ (664) (21)% Product Costs Product costs for the year ended December 31, 2023 were up from the year ended December 31, 2022, due to production cost increases for labor and other direct costs related to increased production output and inflation. Increases included headcount additions, feed costs and other direct supplies, maintenance and repairs, as well as the costs for processing and transportation to bring our product to market. Sales and Marketing Expenses Sales and marketing expenses for the year ended December 31, 2023 were down from the year ended December 31, 2022, primarily due to a decrease in marketing program costs. Research and Development Expenses Research and development expenses for the year ended December 31, 2023 were down from the year ended December 31, 2022, due to the receipt of provincial government grant funds in support of local hiring and a reduction in outside research costs. Gross research and development expenses for the year ended December 31, 2023, excluding the grant funds, were $816 thousand versus $935 thousand in 2022. During the current period, research activities continued in key strategic areas of genomics and breeding, gene editing, fish health and operational optimization. 34 Table of Contents General and Administrative Expenses General and administrative expenses for the year ended December 31, 2023 were up from the year ended December 31, 2022, due to increases in legal fees, state excise taxes, personnel, audit fees, consulting fees and share-based compensation charges. Total Other (Expense) Income Total other (expense) income for 2023 and 2022 is comprised of interest income, interest on debt, bank charges, and miscellaneous gains and losses on the disposal of assets. The change in total other (expense) income in the year ended December 31, 2023, compared to the year ended December 31, 2022, was primarily due to interest income, which was down considerably in 2023 compared to 2022, due to a reduction in marketable securities. Liquidity and Capital Resources Sources of Liquidity We have incurred losses from operations since our inception in 1991, and, as of December 31, 2023, we had an accumulated deficit of $221 million. We expect to continue to experience losses from operations for the foreseeable future and we will require substantial additional cash to fund our business plans. Liquidity has primarily come from equity financings, supplemented by debt transactions. During 2023 and 2022, we received $418 thousand and $476 thousand, respectively, in debt proceeds on an existing loan facility. In the future, we expect to use both debt and equity issuances to fund our continued operations and growth opportunities. As of December 31, 2023, we had $9.2 million in cash, cash equivalents, and restricted cash. Our principal contractual commitments include capital expenditure obligations, repayments of debt and related interest, and payments under operating leases. Refer to the notes in our consolidated financial statements for further information about our capital expenditure commitments (Note 6), debt (Note 7), and lease payment obligations (Note 10). Cash Flows The following table sets forth the significant sources and uses of cash for the periods set forth below (in thousands): Years Ended ‎ December 31, Dollar % 2023 2022 Change Change Net cash (used in) provided by: Operating activities $ (24,236) $ (21,007) (3,229) 15% Investing activities (68,893) 34,350 (103,243) (301)% Financing activities (309) (162) (147) 91% Effect of exchange rate changes on cash 3 3 - —% Net change in cash $ (93,435) $ 13,184 (106,619) (809)% Cash Flows from Operating Activities Net cash used in operating activities during the year ended December 31, 2023, was primarily due to our $27.6 million net loss, partially offset by non-cash depreciation and share-based compensation charges of $2.7 million and decreased by working capital sources of $0.6 million. Spending on operations increased in 2023 due to increases in production activities at our Rollo Bay and Indiana farm sites, increases in headcount and increases in costs for excise taxes, legal fees and professional fees. The decrease in cash provided by working capital was due primarily to a decrease in inventory and prepaid expenses, partially offset by an increase in accrued expenses. We expect cash flows from operating activities to remain negative and roughly flat in the near term. Net cash used in operating activities during the year ended December 31, 2022, was primarily comprised of our $22.2 million net loss, partially offset by non-cash depreciation and share-based compensation charges of $2.6 million and increased by working capital uses of $1.4 million. Spending on operations increased in 2022 due to increases in production activities at our Rollo Bay and Indiana farm sites, increases in headcount and increases in costs for insurance, taxes, and professional fees. The increase in cash used for working capital was due primarily to increases in inventory and prepaid expenses, partially offset by an increase in accrued expenses. Cash Flows from Investing Activities During 2023, we used $65.1 million for construction charges and equipment deposits for our Ohio farm, and $2.2 million and $1.6 million for equipment purchases and deposits for our Indiana and Rollo Bay farms, respectively. During 2022, we used $65.1 million for construction charges and equipment deposits for our Ohio farm, and $1.4 million and $1.0 million for equipment purchases and deposits for our Indiana and Rollo Bay farms, respectively, and we received $101.8 million on the net sales of marketable securities. 35 Table of Contents We have paused construction at our Ohio farm, but we expect expenditures on capital projects to increase in future periods once we secure additional funding and resume construction at the site. For more information, see “ Our current business plans include the need for substantial additional capital, and without it, we may not be able to implement our strategy as planned or at all .” Cash Flows from Financing Activities During 2023, we received approximately $418 thousand in proceeds from new debt, and we repaid $726 thousand of outstanding debt. During 2022, we received approximately $476 thousand in proceeds from new debt, and we repaid $640 thousand of outstanding debt. Future Capital Requirements Since inception, we have incurred cumulative net losses and negative cash flows from operating activities and we expect this to continue for the foreseeable future. As of December 31, 2023, we had $9.2 million of cash, cash equivalents, and restricted cash, a significant portion of which is required to fund our current liabilities and other contractual obligations. Our ability to continue as a going concern is dependent upon our ability to raise additional capital, and there can be no assurance that such capital will be available in sufficient amounts, on a timely basis, on terms acceptable to us, or at all. This raises substantial doubt about our ability to continue as a going concern within one year after the date that the accompanying consolidated financial statements are issued. Until such time, if ever, as we can generate positive cash flows from operating activities, we may finance our cash needs through a combination of equity offerings, debt financings, government or other third-party funding, strategic alliances, and licensing arrangements, as well as our announced plan to sell our Indiana farm. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interests of holders of our common stock will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of holders of our common stock. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures, or declaring dividends. If we raise additional funds through government or other third-party funding, marketing and distribution arrangements, or other collaborations, strategic alliances, or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs, or product candidates or to grant licenses on terms that may not be favorable to us. If we are unable to generate additional funds in a timely manner, we will exhaust our resources and will be unable to maintain our currently planned operations. If we cannot continue as a going concern, our stockholders would likely lose most or all of their investment in us.