Aspen Aerogels, Inc.
Q2 2016 Earnings Call Transcript

Published: 7 Aug 2016

[Operator:]

Good afternoon. My name is Blair and I am the conference operator today. At this time, I would like to welcome everyone to Aspen Aerogel’s Second Quarter 2016 Earnings Conference Call. [Operator Instructions] Thank you. John Fairbanks, you may begin.

[John Fairbanks:]

Good afternoon. Thank you for joining us for the Aspen Aerogels conference call. I am John Fairbanks, Aspen’s CFO. There are couple of housekeeping items that I would like to address before turning the call over to Don Young, Aspen’s CEO. Press release announcing Aspen’s second quarter 2016 results and business developments as well as a reconciliation of management’s use of non-GAAP financial measures as compared to the most applicable GAAP measures is available on the Investors section of Aspen’s website, www.aerogel.com. Included in the press release is a summary statement of operations, a summary balance sheet and a summary of key financial and operating statistics for the quarter and 6 months ended June 30, 2016. In addition, the Investors section of Aspen’s website will contain an archived version of this webcast for approximately 1 year. Please also note that our discussion today will include forward-looking statements, including any statements regarding outlook, expectations, beliefs, projections, estimates, targets, prospects, business plans and any other statement that is not a historical fact, and such statements are subject to risks and uncertainties. Aspen Aerogels’ actual results may differ materially from those expressed in the forward-looking statements. A list of factors that could affect the company’s actual results can be found in Aspen’s press release issued today and are discussed in more detail in the reports Aspen files with the SEC, particularly in the company’s most recent annual report on Form 10-K. The company’s press release issued today and filings with the SEC can also be found in the Investors section of Aspen’s website. Forward-looking statements made today represent the company’s views as of today, August 4, 2016. Aspen Aerogels disclaims any obligation to update these forward-looking statements to reflect future events or circumstances. During this call, we will refer to non-GAAP financial measures, including adjusted EBITDA. These financial measures are not prepared in accordance with U.S. generally accepted accounting principles, or GAAP. These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for the results prepared in accordance with GAAP. Definitions of and reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures and a discussion of why we present these non-GAAP financial measures is available in today’s press release. I will now turn the call over to Don Young, President and CEO of Aspen Aerogels.

[Don Young:]

Thank you, John. Good afternoon. Thank you for joining us for our Q2 2016 earnings call. I will provide comments about the business and our performance and John Fairbanks, our CFO, will present financial details for the second quarter and our guidance for 2016. We will conclude the call with a Q&A session. I plan to cover three topics in my prepared remarks. First, I will provide a second quarter and first half 2016 overview, a sense for the current commercial environment and an update on our 2016 catalysts, namely Plant 2, market expansion and technology development. Second, I will comment on our IP enforcement initiative. And third, I will take a moment to review both our strategy, which is based on leveraging our Aerogel technology platform and our vision, which sees Aspen as a $500 million revenue company with 40% gross margins. Despite revenue declining by 8% compared to Q2 2015, the second quarter was marked by strong improvement in gross profit, net loss and adjusted EBITDA. Revenue increased 13% to $60.5 million for the first half of 2016 and was within our guidance. Our current outlook for total revenue in the second half is between $56.5 million and $64.5 million, up from our prior outlook. As we have said in the past, we will experience quarterly variability in revenue and gross margins due to projects, product mix or short-term trends in a given market segment and Q2 revenue is an example of that phenomenon. As we continue to diversify our end markets, we expect the quarterly variability will become increasingly muted. The market shift we predicted in late 2015 is materializing largely as expected, with a significant increase in our subsidy and oil sands activities. It will be hard to feel confident about these upstream areas until oil prices stabilize at or above the $50 to $60 per barrel level. However, we continue to see growth in our downstream energy infrastructure business, with particular strength in Asia. Latin America is also an area where we think we will see a strong finish to 2016, in part because Petrobras has recently announced the green light to restart work in two refineries where we are well positioned. We are also benefiting from our focus on adjacent and new markets, most notably from the building materials, LNG, district heating and OEM markets. These developments are good examples of our efforts to broaden and diversify our end markets to create additional growth engines and to offset areas of weakness such as the current upstream environment. As discussed in early 2016, we are focused on important catalysts for the long-term success of the company. These catalysts fall into three categories

[John Fairbanks:]

Thanks Don. As Don highlighted during his comments, we delivered strong growth and profitability during the second quarter and made solid progress in our goal to expand and diversify our business. We grew gross profit 30% to $6.7 million and achieved a 24% gross margin. Net loss improved to $1.4 million and adjusted EBITDA nearly doubled to $2.5 million, despite almost $400,000 in expense associated with our patent enforcement actions. And we effectively secured $22 million in financing for the Statesboro, Georgia facility through the scheduled prepayments under our supply agreement with BASF. I would like to start by running through our reported financial results for the second quarter and the first half of 2016 at a summary level. Second quarter total revenue declined 8% year-over-year to $27.7 million. Second quarter GAAP net loss improved to $1.4 million or $0.06 per share versus a net loss of $2.7 million or $0.12 per share last year. Second quarter adjusted EBITDA improved to $2.5 million compared to $1.3 million a year ago. Our net loss and adjusted EBITDA for the second quarter included nearly $400,000 or $0.02 per share of legal and related costs associated with our patent enforcement actions during the period. Just to be clear, if we had not incurred these patent enforcement costs during the second quarter, our net loss would have been reduced to approximately $1 million and our adjusted EBITDA would have been approximately $2.9 million. We define adjusted EBITDA as net income or loss before interest, taxes, depreciation, amortization, stock-based compensation expense and other items that we do not believe are indicative of our core operating performance. For the first half of 2016, total revenue increased 13% to $60.5 million, within our first half guidance range. GAAP net loss improved to $3.2 million or $0.14 per share in 2016 versus a net loss of $5.5 million or $0.24 per share last year. And our adjusted EBITDA for the first half of 2016 was $4.5 million, up from $2 million a year ago. Our net loss and adjusted EBITDA for the first half of 2016 included approximately $600,000 or $0.03 per share of legal and related costs associated with our patent enforcement actions during the six-month period. I’ll now provide additional detail on the components of our results. First, I will discuss revenue. Second quarter total revenue was comprised of product revenue of $27.1 million and research services revenue of approximately $600,000. For the first half of 2016, product revenue was $59.4 million and research services revenue was $1.1 million. During the second quarter, products revenue declined 9% versus last year. This decrease reflected the previously anticipated weakness in the subsea market and our reduced rate of shipments to the South Asian petrochemical project, offset in large part by strong growth in the Asian and North American markets and resurgent demand in the building materials market. During the quarter, we shipped 9.9 million square feet of Aerogel blankets at an average selling price of $2.73 per square foot. Manufacturing productivity was strong. Total production during the quarter exceeded 12.6 million square feet of Aerogel blankets, including a build of 2.7 million square feet in finished goods inventory. For the first half of the year, products revenue increased 12% versus last year. This growth was due principally to renewed demand in the building materials market and the strong growth within the Asian market. For the first half of the year, shipments increased by 9% to 21.8 million square feet. And our average selling price for the first six months of 2016 increased 3% versus a year ago to $2.73 per square foot and reflected the impact of price increases over the past year offset in part by the year-over-year decline in the mix of our high-priced subsea products. I will now turn to the research services revenue. Our research services revenue is related to contract research performed principally for government agencies. Research services revenue increased 74% during the second quarter of 2016 or approximately $600,000, and 79% during the first half of 2016 to $1.1 million. This growth was due to the relative value and timing of contracts versus last year. For the full year, we expect research services revenue to be approximately $2 million, essentially flat with 2015 revenue levels. This expectation is reflected in our 2016 full year financial outlook. Next, I will discuss gross profit. During the second quarter, gross profit grew 30% to $6.7 million. Our gross margin of 24% represented an increase of 7 points from the second quarter of 2015. Gross profit was $13.2 million for the first half of the year and our gross margin of 22% represented an increase of 4 points over last year. The significant improvement in gross margin during both the second quarter and the first half of 2016 was due to improved manufacturing yields and productivity, favorable mix of products sold and the impact of our 2016 price increases. Next, I will discuss operating expenses. Second quarter operating expenses grew $200,000 or 2% to $8 million. The increase in G&A expense associated with patent enforcement costs of nearly $400,000 was offset in part by a $200,000 year-over-year reduction in all other operating expenses during the quarter. For the first half of 2016, operating expenses increased by $1.2 million or 8% to $16.3 million. The increase in first half operating expenses included $800,000 for increased investment in sales personnel and marketing program and approximately $600,000 in patent enforcement costs offset in part by a $200,000 reduction in all other operating expenses during the period. Next, I will discuss our balance sheet and cash flow. We generated $2.5 million in adjusted EBITDA during the second quarter, but we used $5 million in cash to fund our operating activities due to a $7.5 million investment in working capital. This working capital increase was driven by a $5.6 million increase in finished goods inventory and a $1.9 million increase in all other working capital items. Capital expenditures during the quarter totaled $4.6 million and included expenditures related to Plant 2 engineering designs, equipment to support production of new products for the power market, and betterments and additions in our East Providence manufacturing facility. We ended the quarter with $19.7 million of cash and minimal debt, net current assets of $41 million and shareholders’ equity of $122 million. In addition, our $20 million revolving credit facility remains untapped. We are updating our full year financial outlook for 2016. Total revenue is expected to range between $117 million and $125 million unchanged from prior guidance. Net loss is expected to range between $6.8 million to $8.6 million. This is our initial net loss guidance. Adjusted EBITDA is expected to range between $7 million and $8.5 million, down from prior guidance of between $11.5 million and $13 million. This adjusted EBITDA guidance reflects the expected legal and related costs associated with our patent enforcement actions for the year of between $3.4 million and $3.9 million. GAAP EPS is expected to range between a loss of $0.30 and a loss of $0.37 per share, down from prior guidance of a loss of between $0.09 and $0.16 per share. Again, this GAAP EPS guidance reflects the legal and related cost of the patent enforcement actions for the year. In addition, this GAAP EPS guidance assumes weighted average shares outstanding of 23.2 million shares for the year. This outlook also assumes depreciation and amortization of between $9.8 million and $10 million, stock-based compensation of between $5.3 million and $5.4 million, and interest expense of $200,000. As always, product mix and the timing of project work may create quarterly and annual variability. In addition, we may incur charges, realized gains or losses, incur additional financing and interest expense or experience other events in 2016 that could cause our results to vary materially from this outlook. I will now turn the call back to Blair for Q&A.

[Operator:]

[Operator Instructions] The first question comes from the line of Robin Shoemaker from KeyBanc Capital Markets. Your line is open.

[Robin Shoemaker:]

Thank you. So, Don and John, what is causing the litigation or the patent enforcement expense to be $3 million in the second half of the year roughly versus $600,000 in the first half? Is there something – some significant incremental actions, I guess taken there?

[John Fairbanks:]

Yes. So Robin, the Chinese defendants have secured attorneys and are defending themselves and we are now fully engaged in the litigation. And so, the second half of the year is really the expense leading up to a hearing, ultimately, on the patent infringement case in early 2017. So, the bulk of the litigation, the bulk of the legal effort is going to occur in the second half of 2016.

[Robin Shoemaker:]

Okay. So, hearing and then I guess potentially a trial or how does that work?

[John Fairbanks:]

The hearing is essentially the trial before an administrative judge that works for the ITC.

[Robin Shoemaker:]

Okay. And my other question on the volume in the quarter, the square footage 9.9, so, it sounds like based on your guidance that you expect the volume to accelerate in the second half of the year, third and fourth quarter. And are you still expecting the price per square foot to be around $2.70 plus or minus $0.05?

[John Fairbanks:]

Yes. So, based – I think the better way to think about it Robin is just to think about volume. So, we did $60.5 million of revenue in the first half of the year. If you look at our financial guidance, for the second half of the year, it would have us between $56.5 million and $64.5 million. And so within that range, the volume would be slightly lower, on par or higher than clearly at the upper end of the range than the volume that we had in the first half of the year. In terms of the price per square foot, some project work in various different product mix can have our price per square foot actually vary probably between about $2.50 per square foot and $2.80 per square foot, but we do expect that the average selling price for the full year will still come in line with that $2.65 to $2.75 range.

[Robin Shoemaker:]

Okay.

[Don Young:]

And Robin, you will remember also, Robin, when we gave our outlook at the beginning of the year, we suggested that revenue would be a little heavier in the first half and a little lighter in the second half. But as you can see, we have adjusted that a little bit. While we fell within guidance in the first half, we have raised that outlook here for the second half, as John just described.

[John Fairbanks:]

And Robin, that’s principally due to just timing of project work during the year.

[Don Young:]

Exactly.

[Robin Shoemaker:]

Right, right. Okay, thank you.

[Don Young:]

Thank you, Robin.

[John Fairbanks:]

Thanks, Robin.

[Operator:]

The next question comes from the line of Tyler Frank from Robert Baird. Your line is open.

[Tyler Frank:]

Hi, guys. Thanks for taking the question.

[Don Young:]

Hi Tyler.

[Tyler Frank:]

Can you discuss what your current lead times are like and given the visibility that you have into the back half of the year, how should we expect the cadence of revenue and earnings to come in on Q3 versus Q4?

[Don Young:]

I will start with the first part of that in terms of backlog or lead times, I should say. As we have said for a long time, we have been trying to work those down so we could be more responsive to the market and run our plant more efficiently. And we have been – we are in the process of achieving that goal. I wouldn’t say we are all the way there yet, but our ability to respond to – in a more industry standard of say eight weeks, I think we are very much in there. And what’s important also Tyler, we have had two examples recently, where we have had relatively sizable orders come on an emergency basis and we have been able to fulfill those very rapidly. And in the past, that would be a struggle for us. As you remember, when we had lead times of 20 weeks and 24 weeks, we would have to change meaningfully our manufacturing cadence and a variety of different things to try to fill those orders. And we were able to do that more – very effectively here recently. John also talked a bit about the successful productivity in the manufacturing plant and we attribute part of that to the facility’s ability to take longer runs and run, let me just say more normally. And so that ability to have some level of inventory is beginning to pay dividends.

[John Fairbanks:]

Yes. And then I think the other part of your question was about how – what the expectations were by quarter for the second half of the year, we haven’t provided any guidance for the quarter. But I think just some rule of thumb, it should be fairly level third and fourth quarter of the year. And we could see variability based upon timing of projects, whether a project – a shipment falls in the last week of September or the first week of October could swing that quarterly performance slightly. So I think its best right now, the best thing to do is to simply project the second half in the aggregate.

[Tyler Frank:]

Right. Okay, that makes sense. And then just a quick follow-up and shifting gears to the second plant, I guess what should we expect in terms of the timing of the financing and are you going to try and secure financing for both phases or should we expect sort of Phase 1 financing closer to $85 million prior to Phase 2 and what sort of milestones should we be looking construction wise to make sure that you guys are on track?

[John Fairbanks:]

Yes. So we are on track. So the first milestone that we will achieve this year is the completion of our – of the engineering work. And we expect to have that done shortly, get approval for the project and the aggregate from our Board of Directors and to close the financing. And I think as we have alluded to, we see that we should be able to close that financing, announce the financing within the next several months, so we remain highly confident in our ability to get that financing accomplished. We are focusing our financing on the first phase of that first line. And then we will focus on financing the second phase of that line in a couple of years really. But we would expect that it would be generating significant cash flow at that point in time and we would hope to be able to finance a good portion of the second phase of the first line through our cash from operations – our ability just to generate cash.

[Don Young:]

And Tyler, obviously the $22 million prepayment from BASF primes the pump, I just – you could say with respect to the financing of – the financing that John talked about. And as we complete that here, we will – the next milestone for this calendar year will be the beginning of the ordering the long lead time items, which will take place later in 2016. But as John said, we feel very much on track to hit all of those milestones.

[Tyler Frank:]

Got it. Great. Thank you, guys.

[Operator:]

Your next question comes from the line of Sean Hannan from Needham & Company. Your line is open.

[Sean Hannan:]

Yes. Good afternoon folks and thanks for taking my question here. First, I want to see if I can get some perspective or update on the BASF relationship in terms of outlook or orders, obviously it’s going to be something that will take some time as there is a little bit of education and I suppose a process in that sale, but I wanted to get a better understanding of around that, where you stand today, the reception with your customers really so far in this joint product relationship?

[Don Young:]

Yes. Well, so we – obviously, we decided a few weeks ago. But I think we certainly had a running start. We have a long-standing relationship with BASF, as you know Sean and really dating back to an earlier small equity investment that they made in our company when we were in our private days and then a joint – our first joint development agreement in 2011. And that yielded – that work yielded a product that we refer to as Spaceloft A2. And that will be the primary focus of our commercial activities in the early days, 2017 and for those years. I think the joint development agreement is work that we have done – that we have discussed and are beginning to put in action as exactly that, a joint development effort. And we are very confident – very interested in this joint work. We have some really excellent ideas, I think to reach – to create a second generation product for that market. So the punch line or the answer to your question, expect revenue coming from the first generation products, again primarily in 2017 and building over time, especially as we bring up that new asset in Statesboro, Georgia and then a little further down the road from there a second generation product that might have yet broader applications in that large building materials market that I talked about.

[Sean Hannan:]

That’s great. And then are there other products that you can partner with them on in terms of your interest or entry into other markets or is there anything being actively explored in that regard?

[Don Young:]

BASF is a big, capable company and with a far reach both in terms of distribution, but also their technical capability. You have heard us talk more and more about the leveraging of our Aerogel technology platform and beginning to exploit some of the unique properties of an Aerogel. And BASF – and a lot of great companies actually understand the uniqueness and the value of those properties. So I think you will see us with BASF and other companies begin to develop products and markets that are beyond kind of our core energy infrastructure in those adjacent markets I talked about. Building materials is certainly a first market – a first new market, if you will. I mentioned in my comments the strength of our so called OEM market here in the first half of 2016. For us, OEM is – internally, we call it planes, trains and automobiles. It’s mostly transportation. And it’s a business that has moved from the low single-digit millions last year to something very much in the 5 to 10 and growing rapidly a part of our business. This is mostly high speed trains, subway systems and automobiles. And obviously, companies like BASF have very extensive – have a very extensive reach into the – certainly into the auto industry. And so I think you can count on us building that relationship in time with BASF and other great companies.

[John Fairbanks:]

And I think importantly Sean, the joint development agreement does not have any constraints in terms of what markets we can attack jointly with our combined technology.

[Sean Hannan:]

Sure, sure, I follow-up. Okay. And that’s helpful. Thank you. Last question here, I am sorry if I had missed this, did you state when that hearing would be?

[John Fairbanks:]

Yes. So, it’s anticipated it would be in early 2017 and that’s what we are ultimately driving to.

[Sean Hannan:]

Okay, right. But we don’t have a set date yet, okay.

[John Fairbanks:]

No. And we are trying to keep our calm. We are involved in litigation trying to keep our comments at a very high level here. And we obviously will disclose information when it’s in the best interest of the company and our shareholders.

[Sean Hannan:]

Thank you very much.

[John Fairbanks:]

Thanks, John.

[Don Young:]

Thanks, John.

[Operator:]

Your next question comes from the line of Ryan Cassil from Seaport Global. Your line is open.

[Ryan Cassil:]

Good afternoon, guys. Just to piggyback on the litigation questions, do you get a sense that there is more copycat brands, if you will, out there or is this – do you get the sense this is going to be an ongoing issue?

[Don Young:]

We are very focused on these two. We are not aware of others who are infringing our intellectual property. We think this will be a – we are developing a market that is ultimately going to be a $1 billion market, a $3 billion market, a $5 billion market. This is an enormous opportunity. And as we build out our business, we will come into the sights of other companies. So, we think it’s important for us to be aggressive now and that’s exactly what we are doing to lay claim to the technical work that we have done and we will do that, but we are focused on these two and are not aware of others at this point.

[Ryan Cassil:]

Okay. And I think just with the cross-licensing agreement, is Cabot involved or would they come to the table here in terms of litigation or is that a sort of a non-issue?

[Don Young:]

Non-issue, I would say. Again, that agreement dates back a number of years at this point. And we are not, let me just say, partnering with Cabot on this activity.

[Ryan Cassil:]

Got it. And then just, I know it’s a little early, but any visibility that you have on ‘17 and whether we should see growth there on an overall basis? And then maybe also on the power generation side when should we think that, that vertical picks up steam, if you will?

[Don Young:]

Let me start with the second part of it and I will have John do the first part of it. On the power side, we are very much on track in the development of – in the final development really of this product aimed very specifically at that market. And we have made an investment – a capital investment to make that product a reality and we are scheduled to introduce that product into the market during 2017, so again very much on the track that we have talked about in the past. We have come to know more and more about that market and what makes – what we think will make our product special within that area. And so again, we are very much on track.

[John Fairbanks:]

And Ryan, we haven’t provided any financial guidance on 2017 at present. We are not prepared to do that today.

[Ryan Cassil:]

Okay. Alright, thanks guys. Appreciate it.

[John Fairbanks:]

Thanks, Ryan.

[Don Young:]

Thanks, Ryan.

[Operator:]

Your next question comes from the line of Sean Meakim from JPMorgan. Your line is open.

[Sean Meakim:]

Gentlemen, hi, good afternoon.

[Don Young:]

Hey, how are you, Sean?

[Sean Meakim:]

Good. So, a lot of my questions have been asked, but I just wanted to maybe touch base a little more on the pilot line that you talked about today. Could you give us maybe a little more detail on what the impact could be across production capacity? Are there any implications in terms of R&D run-rate going forward? Just trying to think a little bit more about where the impact could be across the financial statements.

[Don Young:]

Yes. Well, we are excited about it. It will be operational here in this current quarter. It has been – in past years, Sean, for us to experiment at scale we had to break into one of our existing lines. And as we became sold out towards the end of 2013 breaking into a line to do an experiment became a relatively expensive endeavor from an opportunity point of view. And so this pilot line was built really in concert – or at least designed in concert with our Line 3 build out in 2014 and 2015 in the East Providence facility, meaning that we can – for the pilot facility, we can segregate chemicals and run it independently, but while still using some of the assets associated with Line 3. So, it’s very efficient. Again, it allows us to experiment without upsetting the steady productivity of our other lines. So, we are focused really on two different aspects of it. One is in fact yield and productivity and our ability to experiment and drive more products through our existing asset is very lucrative for us as you can well imagine. And so that is certainly a focus of that effort. As we take on partners such as BASF, we have ideas for second generation products. And to be able to do those at full scale will certainly be an advantage for us in accelerating. And it’s attractive for those partner companies to be able to team up with us to utilize those assets. In terms of operating expense, relative to the cost of that facility overall and operating that in the cost – I want to say it’s close to negligible. I wouldn’t call it super meaningful.

[John Fairbanks:]

The line actually leverages our existing manufacturing infrastructure and so there is a minor increment in the number of people in the plant and in the operating expenses. But we would expect that to have it pay for itself fairly rapidly in expansion of gross profit due to improved manufacturing productivity and that sort of full effect of those expenses is already baked into our guidance for the year.

[Sean Meakim:]

Got it. Okay, great. That’s very helpful. Thanks.

[John Fairbanks:]

Thanks, Sean.

[Don Young:]

Thanks, Sean.

[Operator:]

And I will now turn the call over to Mr. Young for closing remarks.

[Don Young:]

Thank you, Blair. We appreciate your interest in Aspen Aerogels. We look forward to reporting our third quarter results to you in early November. Have a good evening. Thanks again.

[John Fairbanks:]

Thank you.

[Operator:]

This concludes today’s conference call. You may now disconnect.