5E Advanced Materials, Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis of financial condition, results of operations, liquidity and capital resources should be read in conjunction with, and is qualified in its entirety by, the unaudited Condensed Consolidated Financial Statements and the notes thereto included in this Quarterly Report on Form 10-Q, and the Consolidated Financial Statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Annual Report on Form 10-K filed on August 30, 2023. This discussion and analysis contains forward looking statements that involve risks, uncertainties and assumptions and other important factors, which include, but are not limited to, the risks described in our annual report on Form 10-K filed with the SEC, any of which could cause the Company’s actual results, performance or achievements, or industry results, to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. The actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth elsewhere in this Form 10-Q and under “Item 1A. Risk Factors” and elsewhere in our Form 10-K. In addition, see “Cautionary Note Regarding Forward-Looking Statements.” References to the “Company,” “we,” “our,” and “us,” refer to 5E Advanced Materials, Inc. and its subsidiaries.

Overview

5E Advanced Materials, Inc. is focused on becoming a vertically integrated global leader and supplier of boron specialty and advanced materials whose mission is to enable decarbonization, increase food security, and ensure domestic supply of critical materials. We hold 100% of the rights through ownership in the 5E Boron Americas (Fort Cady) Complex (the “Project”) located in southern California, through our wholly owned subsidiary 5E Boron Americas, LLC. Our Project is underpinned by a mineral resource that includes boron and lithium, with the boron being contained in a conventional boron mineral known as colemanite. In 2022, our facility was designated as Critical Infrastructure by the Department of Homeland Security’s Cybersecurity and Infrastructure Security Agency. Our vision is to safely process boric acid and lithium carbonate through sustainable best practices to enable decarbonization, food security and domestic supply surety.

2024 Outlook and Goals

Step-Rate Testing

Initial production of boric acid can commence upon final clearance from the U.S. Environmental Protection Agency (EPA) under our Underground Injection Control Permit as well as successful completion of commissioning activities, including step-rate testing which establishes the porosity of the ore body and forms a base-line parameter. During the quarter, the EPA approved step-rate testing, and we believe that this approval to commence testing under the terms of the Company's existing permit marks a meaningful step closer towards conducting boric acid and lithium carbonate extraction operations.

Small-Scale Facility

During the quarter ended September 30, 2023, we have substantially completed construction of our Small-Scale Facility. Currently, the only open item to complete is the final electrical work for the back-end of the facility where boric acid, gypsum, and lithium carbonate production will occur. In October 2023, Step-Rate Testing was completed, results were submitted to the EPA, and the well-field was reassembled post-Step-Rate Testing. Upon final clearance from the EPA, the Small-Scale Facility will be ready to commence production and historical data suggests the well-field will take less than a month to condition before producing boric acid, gypsum, and lithium carbonate. During well-field conditioning, we expect to focus on completing final electrical work and commissioning.

Standstill Agreement with Senior Secured Lender

During the quarter ended September 30, 2023, Bluescape Special Situations IV (the "Lender"), the holder of our senior secured convertible note (the "Convertible Note"), communicated an alleged breach of the Convertible Note agreement regarding a nonfinancial covenant. However, the Lender elected not to pursue any remedies related thereto. We disagreed with the Lender's contention. As discussed in Note 7 of the unaudited condensed consolidated financial statements, the Convertible Note agreement contains a financial covenant requiring us to maintain a cash balance of at least $10 million. On November 9, 2023, we entered into a Standstill Agreement (the "Agreement") with the Lender. The Agreement enables 5E, the Lender, and other strategic investors to advance discussions towards a resolution for a recapitalization plan for the Company. Under the Agreement, the parties have agreed to a period of standstill, temporarily allowing the Company to go below its current cash covenant of $10 million until December 1, 2023. We are committed to protecting the interests of our stakeholders and are working diligently to enhance our financial health.

Liquidity

Our latest liquidity forecast indicates that available cash resources are expected to be exhausted in the next six months. We are actively exploring various financing options. However, if additional financing is not secured and our cash balance falls below $10 million, an event of default under the Convertible Note indenture would occur. An event of default would cause our Convertible Note balance outstanding to become immediately due and payable, which we would not have the resources to repay without additional financing. On November 9, 2023, we entered into an Agreement with our Lender and other strategic investors. The Agreement enables 5E, the Lender and other strategic investors to advance discussions towards a recapitalization plan for the Company. Under the Agreement, the parties have agreed to a period of standstill, temporarily allowing the Company to go below its current cash covenant of $10 million until December 1, 2023. If we are not able to obtain additional financing and agree to a successful recapitalization plan by December 1, 2023, our cash balance is expected to fall below $10 million, and an event of default would occur. However, it is expected that any recapitalization plan will waive any default under the Convertible Note agreement. While we believe that the standstill period will result in a successful recapitalization, it is not entirely within our control and accordingly there is substantial doubt regarding our ability to continue as a going concern for a period of one year after the date that these unaudited condensed consolidated financial statements are issued. Further, even if the anticipated recapitalization plan is successfully consummated in the fourth quarter 2023, available liquidity may still not be sufficient to eliminate the aforementioned substantial doubt regarding the Company's ability to continue as a going concern. Refer to the "Going Concern" discussion within Note 1 of the unaudited condensed consolidated financial statements and “Liquidity and Capital Resources” below for more information.

Inflation

The U.S. inflation rate rose steadily beginning in 2021 and continued a steep climb into 2022. Although the inflation rate has somewhat moderated in 2023 it continues to be higher than historic averages. These inflationary pressures have resulted in and may result in additional increases to the cost of our goods, services, and personnel, which in turn causes our capital expenditures and labor costs to rise, including the estimated costs for our reclamation activities. Sustained levels of high inflation have caused the U.S. Federal Reserve and other central banks to increase interest rates, which could have the effects of raising the cost of capital and depressing economic growth, either of which or the combination thereof, could adversely affect our business.

COVID-19 Response

We have implemented policies at our offices in Hesperia, CA and Houston, TX and at our project site in Newberry Springs, CA designed to ensure the safety and well-being of all employees and the people associated with them. In that regard, to reduce risk, our employees have been encouraged to get fully vaccinated against COVID-19, have been asked to work remotely at times, avoid non-essential business travel, when possible, adhere to good hygiene practices, and engage in social distancing. Continuation of COVID-19 or other widespread outbreak of contagious disease in 2024 and beyond could impact employee health, workforce productivity, insurance premiums, ability to travel, the availability of industry experts, personnel and equipment, restrictions or delays to field work, construction, procurement, studies, lab results, and other factors that will depend on future developments that may be beyond our control.

At the onset of the COVID-19 pandemic and through 2022, we experienced, at times, significant shipping delays due to congestion and slowdowns at U.S. and international ports caused by shortages in vessels, containers, and truckers, also disrupting the global supply chain. This contributed to certain cost and schedule pressures related to the construction of the Small-Scale Facility. We continue to monitor the global situation, including the impacts of new and potential future variants of COVID-19, or other factors that may affect international shipping, logistics, and supply chain, or involve responses to government actions such as strikes or other disruptions.

The forward-looking information contained in this section is subject to the risk factors and assumptions contained in the “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factor” sections.

Results of Operations

The following table summarizes our results of operations for the periods presented.

(in thousands)

Comparison of the three months ended September 30, 2023 and 2022

Project expenses

Project expenses include drilling, plug and abandonment, site-preparation, engineering, consumables, testing and sampling, hydrology, permits, surveys, and other expenses associated with further progressing our Project. For the three months ended September 30, 2023, project expenses decreased $2.0 million or 56% versus the comparable period in 2022 as there was decreased activity related to the Project. Specifically, the decrease was primarily due to a reduction in expenses incurred relating to our plug and abandonment program ($2.5 million), reduced expenses incurred for engineering and technical reports that were not eligible for capitalization as construction in progress ($0.2 million), and a reduction in general site-related operating costs ($0.2 million). These decreases were partially offset by increased Environmental Protection Agency compliance costs ($0.6 million), testing and analysis ($0.2 million) and construction related insurance costs ($0.1 million).

General and administrative expenses

General and administrative expenses include professional fees, costs associated with marketing, on-going SEC and public company costs, public relations, rent, salaries, sponsorships, share based compensation and other expenses. For the three months ended September 30, 2023 general and administrative expenses increased $1.2 million or 24% versus the comparable period in 2022. The increase was primarily due to an increase in professional fees ($1.0 million), an increase in non-incentive employee compensation and benefits ($0.6 million) and an increase in compliance and filing fees ($0.2 million). The increase in professional fees was primarily due to an increase in legal fees, and the increase in salaries and benefits resulted from the hiring of additional personnel for the construction and operation of the Small-Scale Facility. Currently, all salaries and benefits are reported in general and administrative expenses. These increases were partially offset by a decrease in share based compensation costs ($0.7 million), and specifically a reduction in option awards.

Depreciation and amortization expense

Depreciation and amortization expense increased $16 thousand or 43% versus the comparable period in 2022. The increase was primarily due to additional assets placed in service during the second and third fiscal quarters of 2023.

Interest income

The increase in interest income during the three months ended September 30, 2023 versus the comparable period in 2022 was attributable to short-term investments (original maturities of three months or less) in highly liquid treasury bills and a certificate of deposit starting at the end of the quarter ending September 30, 2022. The weighted average interest rate earned on these investments was approximately 5.3% and 2.8 % for the three months ended September 30, 2023 and 2022, respectively.

Derivative gain

The derivative gain (loss) during the three months ended September 30, 2022 related to changes in fair value of the embedded conversion feature of our convertible notes that was required to be bifurcated and accounted for separately as a stand-alone derivative instrument during the quarter ended September 30, 2022. The unrealized gain during the three months ended September 30, 2022, was primarily due to the decrease in our stock price to $10.16 as of September 30, 2022 from $15.83 on August 26, 2022 (inception date).

Interest expense

The increase in interest expense of $1.0 million, or 118%, during the three months ended September 30, 2023 versus the comparable period in 2022 was primarily due to the issuance of the convertible note on August 26, 2022. We recognized $2.4 million of interest on the principal balance, debt issuance cost and discount amortization during the three months ended September 30, 2023 compared to $0.8 million for the comparable period in 2022. Additionally, during the three months ended September 30, 2023 we capitalized $0.6 million of interest to construction in progress compared to none in the comparable period of 2022.

Income Tax

We did not have any income tax expense or benefit for the three months ended September 30, 2023 and 2022, as we have recorded a full valuation allowance against our net deferred tax asset.

Cash flows

($ in thousands)

During the three months ended September 30, 2023, we used $6.9 million of cash for operating activities, a decrease of $0.9 million or 12% compared to the comparable period in 2022. Cash used by operating activities decreased between periods primarily due to a decrease in project related expenses that was offset by a lesser extent to an increase in general and administrative expenses net of non-cash share based compensation expense. Refer to the preceding discussion for more information on increases and decreases in certain expenses between periods. During the three months ended September 30, 2023, we used $1.6 million of cash for investing activities, a decrease of $3.5 million or 68% compared to the comparable period in 2022. The reduction in investing cash flows was due to reduced spending on construction in progress related to the Small-Scale Facility between periods. Cash flows provided by financing activities during the three months ended September 30, 2022 were the result of the issuance of the Convertible Notes net of debt issuance costs with no comparable activity during the same period in 2023.

Liquidity and Capital Resources

As of September 30, 2023, we had cash and cash equivalents of $11.8 million and working capital of $3.8 million compared to $20.3 million and $13.3 million as of June 30, 2023, respectively. Our predominant source of cash has been generated through equity financing from issuances of our common stock and hybrid equity and debt securities. Since inception, we have not generated revenues, and as such, have relied on equity financing and hybrid equity and debt instruments to fund our operating and investing activities.

In August 2022, we executed a $60 million private placement of senior secured convertible notes to complete construction and commissioning of our Small-Scale Facility, fund operation of our Small-Scale Facility, and general corporate purposes.

With our current capital resources and constructing nearly complete, we believe that we have sufficient funds to construct and commission our Small-Scale Facility; however, delay of final authorization to commence mining could push out operation of the facility until we raise additional capital. Over the next 12 months we have plans to achieve the following milestones that will require additional capital:

• Operate the Small-Scale Facility;
• Progress FEL2, FEL3, and detailed engineering and procure long lead item equipment, specifically our crystallization units;
• Optimize well-field design in an effort to reduce future mining capital and operational expenditures through various drilling techniques such as directional, horizontal and radial drilling;
• Pursue and optimize infrastructure capital expenditures for our larger-scale facility which could include expansion of non-potable water resources, upgrading shore power, connection to a natural gas network, and constructing new access roads into and out of the location for our larger-scale facility;
• Further define our advanced materials strategy with consideration to engineering and repurposing our Small-Scale Facility to produce boron advanced materials once sufficient data has been obtained for flow sheet optimization and the production of product for customer qualification; and
• Continue hiring team members necessary to support our operation efforts of becoming a global producer of boric acid, lithium carbonate and gypsum.

We are currently operating under a modified business plan until we secure additional financing. Absent additional financing as outlined above, we may no longer be able to meet our ongoing obligations, progress operations or achieve the milestones outlined above. If we are not able to procure other financing cash flows and our cash balance falls below $10 million, an event of default under the Convertible Note agreement would occur. An event of default would cause our Convertible Note balance outstanding to become immediately due and payable, which we would not have the resources to repay without additional financing. On November 9, 2023, we entered into an Agreement with our Lender and other strategic investors. The Agreement enables 5E, the Lender, and other strategic investors to advance discussions towards a recapitalization plan for the Company. Under the Agreement, the parties have agreed to a period of standstill, temporarily allowing the Company to go below its current cash covenant of $10 million until December 1, 2023. Given that raising additional capital and a successful recapitalization are not entirely within our control combined with our expectation of incurring significant operating and development costs for the foreseeable future, there exists substantial doubt regarding our ability to continue as a going concern for a period of one year after the date that these financial statements are issued. Further, if the anticipated recapitalization plan is successfully consummated in the fourth quarter 2023, available liquidity may still not be sufficient to eliminate the aforementioned substantial doubt regarding the Company's ability to continue as a going concern. Refer to the “Going Concern” discussion within Note 1 of the unaudited condensed consolidated financial statements for more information.

Material Cash Requirements

Our material short-term cash requirements include general and administrative expenses including recurring payroll and benefit obligations for our employees, construction related costs necessary to complete the Small-Scale Facility, project related costs, payments under certain lease agreements and working capital needs. Our long-term material cash requirements from currently known obligations include repayment of outstanding borrowings and interest payment obligations under our Convertible Notes (which may be avoided to the extent the notes are converted to shares of our common stock and/or interest is paid-in-kind) and future obligations to reclaim, remediate, or otherwise restore properties to a condition that existed prior to our operations. Refer to the “Construction in Progress,” “Asset Retirement Obligations,” “Accounts Payable and Accrued Liabilities,” “Long-term Debt” and “Commitments and Contingencies” footnotes in the unaudited condensed consolidated financial statements for more information on certain of these expenditures and obligations.

Critical Accounting Policies

A complete discussion of our critical accounting policies is included in our Form 10-K for the year ended June 30, 2023. There have been no significant changes in our critical accounting policies during the three months ended September 30, 2023.

Contractual Commitments and Contingencies

Purchase Obligations

We had purchase order commitments of $6.8 million for the construction works in progress, equipment, software, drilling and technical reports.

In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), our management evaluated, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act) as of September 30, 2023. Based on the evaluation of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of September 30, 2023 to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

Changes in Internal Control over Financial Reporting

There were no changes in internal control over financial reporting identified in the evaluation for the quarter ended September 30, 2023, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In addition to the risk factor set out below and other information set forth in this Form 10-Q, you should carefully consider the factors discussed in Part 1, Item 1A. “Risk Factors” in our annual report on Form 10-K, which could materially affect our business, financial condition, and future results. The risks described in our Form 10-K are not the only risks that we face. Additional risk and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our financial condition, operating results and cash flows.

If we are not able to successfully negotiate and or structure a recapitalization plan during the standstill period provided for in the Standstill Agreement, it is highly probable that we will by then be in default under our Convertible Notes, which could result in our Lender exercising any or all of its remedies under the Convertible Notes, including the immediate acceleration of all obligations due thereunder.

In connection with the issuance of our Convertible Notes to Lender, we entered into a Convertible Note Purchase Agreement, dated August 11, 2022, with Bluescape (the “Convertible Note Purchase Agreement”), which contains customary affirmative and restrictive covenants, including a covenant against permitting the Company’s unrestricted cash to be less than ten million dollars ($10,000,000) (the “Financial Covenant”). The Convertible Note Purchase Agreement also includes customary events of default, including an event of default tied to any breach of the Financial Covenant. Upon the occurrence of an event of default, Bluescape may declare all outstanding obligations immediately due and payable and take such other actions as set forth in the Convertible Note Purchase Agreement. Such accelerated repayment or other actions may have a negative impact on our business, financial condition, and results of operations.

On November 9, 2023, the Company entered into a standstill agreement with Lender, which will enable the Company, Lender, and other strategic investors to continue to advance discussions toward a resolution for a recapitalization plan for the Company, and the parties have agreed to a period of standstill under the Convertible Notes Purchase Agreement to December 1, 2023, to allow the Company to go below the Financial Covenant. However, if the parties to the standstill agreement are unable to come to a timely resolution of the Company’s capital needs, Bluescape may accelerate the outstanding obligations under the Convertible Note Purchase Agreement, which may have a negative impact on the Company’s business, financial condition, and results of operations or force us into bankruptcy or liquidation. And note that even if we successfully execute on the recapitalization plan, we will still need to raise additional funds over the next year to implement our strategic plan and there can be no assurance that we can raise such funds when required.

Pursuing the recapitalization plan is also time consuming and may distract management from critical operational initiatives, including finalizing the Company’s EPA approval to inject, which could also have a negative impact on the Company’s business, financial condition and results of operations, even if the recapitalization plan is ultimately successful.