The chemical warfare destruction unit, that PyroGenesis developed for a consortium involving various groups within the US military, and was in the process of being tested, continues to have its schedule delayed accommodating other unrelated testing needs by the group. This testing timeline is out of the Company’s control.

Revenues from military contracts in 2017 were over $4,300,000, mainly related to providing technical support, training services and sale of spare parts.  Over the past three years, revenues from military contracts have typically represented more than $2,000,000 per year of PyroGenesis’ revenues.  As the PAWDS technology becomes fully operational on US Navy ships, management expects the level of recurring revenues from the sale of parts and services to increase over the next 2 to 5 years.

The Company is looking at ways to establish a presence in the USA to, amongst other things, better serve the US Military’s needs arising from having multiple systems in operation.

D) HPQ:

On August 2, 2016, PyroGenesis announced that it had signed contracts totaling $8,260,000 with HPQ Silicon Resources Inc., formally Uragold Bay Resources Inc. (“HPQ”) for the sale of IP and to provide a pilot system to produce high purity silicon metal directly from quartz. Of particular note, if successful, PyroGenesis benefits from a 10% royalty on all revenues derived from the use of this system by HPQ, subject to annual minimums.

E) Torch/Equipment Sales:

Consistent with the Company’s overall strategy to (i) remain focused on reducing PyroGenesis’ dependency on long-cycle projects by developing a strategic portfolio of volume driven, high margin/low risk products that resolve specific problems within niche markets and doing so by introducing these plasma-based technologies to industries that have yet to consider such solutions, and (ii) to actively target recurring revenue opportunities that will generate a growing, and profitable, regular cash flow to the Company, the Company continues to market its torch/equipment capabilities and expects this to start becoming a revenue contributor, with its recurring revenue stream, in the very near future.

PyroGenesis has one of the largest concentrations of plasma expertise in the world, with over 250 years of accumulated technical experience and supporting patents, combined with unique relationships with major Universities performing cutting edge plasma research and development, positions the Company well to execute its strategies.

Management’s focus will continue to be to generate an improved mix of short and long-term projects that will, in turn, facilitate operational and financial planning. Repeat orders for the same, or similar, products will further result in the standardization of manufacturing processes which will lead to improved gross margins.

All indications are that 2018 should be a profitable year for the Company given that business lines, other than non-additive manufacturing, continue to contribute significantly to PyroGenesis’ revenues.  Management expects that the Corporation’s non-additive manufacturing business lines will generate enough revenues, on their own in 2018, to make PyroGenesis profitable overall going forward.

Financial Summary

Revenue

PyroGenesis recorded revenue of $1,421,352 in the second quarter of 2018 (“Q2, 2018”), representing a decrease of 35% compared with $2,173,397 recorded in the second quarter of 2017 (“Q2, 2017”).

Revenues recorded in Q2, 2018 were generated primarily from:

Cost of Sales and Services and Gross Margins

Cost of sales and services was $924,954 in Q2, 2018, representing a decrease of 18% compared with $1,130,295 in Q2, 2017.

In Q2, 2018 cost of direct materials, manufacturing overhead and subcontracting decreased to $460,542 (Q2, 2017: $490,996), $141,779 (Q2, 2017: $221,573) and $30,851 (Q2, 2017 - $43,241) respectively.

The type of contracts being executed and the nature of the project activity during any given quarter has a significant impact on both the overall level of cost of sales and services reported in a period, as well as the composition of the cost of sales and services, as the mix between labor, materials and subcontracts may be significantly different.

The gross margin for Q2, 2018, was $496,398, or 34.9% of revenue. This compares with a gross margin of $1,043,102 (48% of revenue) for Q2, 2017.

Selling, General and Administrative Expenses

Included within Selling, General and Administrative expenses (“SG&A”) are costs associated with corporate administration, business development, project proposals, operations administration, investor relations and employee training.

SG&A expenses for Q2, 2018 excluding the costs associated with share-based payments (a non-cash item in which options vest over a four-year period), were $1,177,552, representing an increase of 18% compared with $998,012 reported for Q2, 2017.

The increase in SG&A expenses in Q2, 2018 over the same period in 2017 is mainly attributable to the net effect of:

• an increase of 21% in employee compensation;
• an increase of 25% for professional fees, primarily due to an increase in patent expenses;
• a decrease of 24% in office and general expenses, due to a decrease in courses, seminar, computers and internet expenses;
• travel costs decreased by 4%, due to less travels abroad;
• depreciation on property and equipment increased by 39%, primarily due to an increase in plant and equipment assets. The asset under development in Q2, 2018 will begin to be depreciated when the asset is available or ready for use;
• government grants increased by 100% due to higher level of activities supported by such grants and;
• other expenses increased by 107%, primarily due to higher cost of freight and shipping.

Separately, share based payments increased by 118% in Q2, 2018 over the same period in 2017 as a result of the vesting structure of the stock option plan including the stock options offered on April 3, 2018 and May 10, 2018.

Research and Development (“R&D”) Costs

The Company incurred $404,017 of R&D costs in Q2, 2018, compared with $62,143 in Q2, 2017, representing an increase of 550%.

In addition to internally funded R&D projects, the Company also incurred R&D expenditures during the execution of client funded projects. These expenses are eligible for Scientific Research and Experimental Development (“SR&ED”) tax credits. SR&ED tax credits on client funded projects are applied against cost of sales and services (see “Cost of Sales” above). Investment tax credits recorded against cost of sales are primarily related to client funded projects that qualify for tax credits from the provincial government of Quebec. Qualifying tax credits decreased to $39,064 in Q2, 2018, compared with $136,994 in Q2, 2017. This represents a decrease of 71%. The Company continues to make investments in research and development projects involving strategic partners and government bodies.

Inventory       

As a result of the Company’s strategy to increase powder inventory to meet increased market demand, powder inventory increased to $611,359 in Q2, 2018, compared with Nil in the same period in 2017.

Net Comprehensive Loss

The loss from operations and comprehensive loss for Q2, 2018 was $1,534,890 compared to $608,584 in Q2, 2017 representing an increase in loss of 152% primarily attributable to a decrease in revenue of $752,045 and by the factors described above, which have been summarized as follows: