Aspen Aerogels, Inc.

Good afternoon. My name is Jesse, and I'll be your conference operator today. At this time, I'd like to welcome everyone to Aspen Aerogels Inc. Q2 2019 earnings call. All lines, please unmute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. To ask a question, please press star 1 on your telephone keypad. Thank you. John Fairbanks, you may begin your conference.

Good afternoon. Thank you for joining us for the Aspen Aerogels conference call. I'm John Fairbanks, ASPEN's Chief Financial Officer. There are a few housekeeping items that I'd like to address before turning the call over to Don Young, ASPEN's President and CEO. Press release announcing ASPEN's financial results and business developments, as well as a reconciliation of management's use of non-GAAP financial measures compared to the most applicable GAAP measures, is available on the Investors section of ASPEN's website, www.arajil.com. Included in the press release is a summary statement of operations, summary balance sheet, and a summary of key financial and operating statistics for the quarter, and six months ended June 30, 2019. In addition, the investor section of Aspen's website will contain an archived version of this webcast for approximately one year. Please note that our discussion today will include forward-looking statements, including any statement regarding outlook, expectations, beliefs, projections, estimates, targets, prospects, business plans, and any other statement is not a historical fact. These forward-looking statements are subject to risks and uncertainties. Aspen Aerogel's actual results may differ materially from those expressed in these forward-looking statements. A list of factors that could affect that company's actual results can be found in Aspen's press release issued today and 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 investor section of Aspen's website. Forward-looking statements made today represent the company's views as of today, August 1, 2019. 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 results prepared in accordance with GAAP. The definitions and reconciliations of these non-GAAP financial measures are the most directly comparable GAAP financial measures and a discussion of why we present these non-GAAP financial measures are included in today's press release. I'll now turn the call over to Don Young, President and CEO of Aspen Aerogels.

Thank you, John. Good afternoon. Thank you for joining us for our Q2 2019 earnings call. I will start by providing comments about our performance and outlook. Next, John will review our Q2 2019 and first half 2019 financials and update our 2019 guidance. We will conclude the call with a Q&A session. The second quarter was important for us because revenue growth continued to accelerate and because we completed important gross margin improvement initiatives that will provide significant EBITDA benefits over the remainder of 2019 and into 2020. Two of our three performance indicators for 2019 are focused on revenue, specifically to grow total revenue by more than 20% for the year, and to have an increasing percentage of total revenue, at least 33%, derived from project work. We are on pace to meet these objectives. We grew total revenue by 36% in Q2, and we expect this strong growth trend to continue into the third quarter. With respect to project revenue as percentage of total revenue, we have defined project revenue consistent with industry practice to be revenue stemming from a customer's specific scope of work, which exceeds $1 million in size. This project revenue is distinguishable from our day-in and day-out maintenance work, which tends to come in smaller, steadier increments and has grown consistently since 2008 through when we first introduced our Pyrogel and CrowdGel products. Our regional sales teams are tapping into their deep local relationships in order to position us for project work, and in addition, we built a team dedicated to reestablishing project work to play a more substantial and balanced role in our overall revenue. We set our 2019 performance indicator target for project revenue as a percentage of total revenue, to 33%, a significant increase from our performance in 2018. Project revenue was 38% for the first half of 2019 and exceeded our target. At the very end of June, project revenue included an initial set of shipments to PTT LNG as part of the $35 to $40 million purchase order for the non-FAB terminal project. We anticipate shipments for the project will run until the end of 2020. Our focus on projects is contributing to our revenue growth in 2019, and we expect a continued significant return on our investment in project work in 2020, 2021, and beyond. Overall, activity levels are high in both maintenance and project work, and we are confident that we will meet our full year commitments for 2019. Again, to grow revenue by more than 20% and to have a growing percentage of revenue, at least 33%, derived from project work. As a reminder, we made significant progress in 2018 on our EP20 goal to implement low capital cost process technology improvements to increase our manufacturing capacity by 20% by the end of 2020, an initiative we will complete next year. Our focus in 2019 is our drive to profitability. And during the second quarter, we completed two major initiatives that focused on optimizing our bill of materials in order to improve our gross margins. We anticipate completing a third initiative by the end of the third quarter and expect to have all three initiatives contributing for Q4 and beyond. In the short term, the implementation of these initiatives was modestly disruptive to our manufacturing operations because of various trials and interruptions and did negatively impact gross margins in Q2. However, we expect to experience a notably positive impact from these initiatives for the remainder of the year. In addition, product mix in Q2 had a significant component of lower margin subsea project work and resulted in below target overall gross margins for the period. Moving to the second half of 2019, we expect to benefit from our gross margin improvement initiatives and a considerably more favorable product mix. As a result, we expect gross margins for the second half of 2019 to reach the low to mid 20s, and our goal remains for the full year 2019 gross margin of 20%. This drive to profitability is central to our 2019 commitment to improve year-over-year adjusted EBITDA by more than $11 million and to reach positive adjusted EBITDA for the year. We are confident that we will meet these objectives in 2019. And while these are important milestones, our broader goal is to set the stage for another significant increase in adjusted EBITDA in 2020. The key elements of our drive to profitability are these gross margin improvement initiatives and continued revenue growth. We have an intense focus on making our existing assets more efficient, more fully utilized, and thus significantly more profitable. Our Drive to Profitability program is designed to enable the company to generate as much as $35 million of adjusted EBITDA from our existing manufacturing assets. There are two additional topics that I would like to cover in these prepared remarks. First, our new business creation initiative, and second, a quick final comment on our three performance indicators for 2019. Our new business creation work is an important element of the strategy to leverage our aerogel technology platform. Since our founding in 2001, Aspen Aerogels has engaged in a variety of partnerships to commercialize successfully silica aerogel materials which have been utilized in many of the most demanding thermal insulation applications. To date, We have installed over $850 million of these products. We are now positioning ourselves to leverage more than a decade of proprietary and patented research and development on carbon aerogels. Over a year ago, we dedicated a team to explore the use of our carbon aerogels in the battery materials market, but not as thermal insulation. Our exploration centers on how we take full advantage of three key attributes of our carbon aerogels. You need poor morphology, high electrical conductivity, and high mechanical strength, with the goal to improve the energy density of lithium ion and next generation batteries, a key enabler in expanding drive range in electric vehicles. Our team is actively characterizing our carbon aerogels and establishing our IP portfolio as we determine our potential value in the battery market. While we are global leaders in the development, mass production, and commercialization of aerogels, we are considerably less expert in the technology of battery systems. Therefore, we anticipate attracting one or more partners who have expertise in battery materials, battery production, and battery applications, and who can bring technical, commercial, and financial support to our battery materials endeavor, much as BASF has done in the area of building materials. Our goal is to build another attractive aerogel-based business stemming from our aerogel technology platform. And finally, to recap, our three performance indicators for 2019 are first, 20% revenue growth and positive adjusted EBITDA. Second, project revenue comprising 33% of total revenue. And third, the formation of an additional partnership with a leading company aimed at leveraging our aerogel technology platform into a new market. Based on our revenue outlook, our gross margin improvement initiatives, and our initial progress on battery materials, we are confident that we will meet our three performance indicators for 2019. We think a fourth indicator worth monitoring and one that will make 2019 an important and successful year is the delivery of gross margins solidly in the 20s for the second half of 2019. The drive to profitability is our imperative for 2019. With strong revenue and improving profitability in 2019, we will position ourselves to generate in 2020 additional significant growth in adjusted EBITDA. We believe the key to maximizing long-term shareholder returns is to build a strong energy infrastructure business that generates cash to invest in realizing the full potential of opportunities in our core and adjacent markets and to invest in business opportunities in new markets which can lead to significant breakout value, markets such as building materials and battery materials. The goal is to unlock our potential and to reset meaningfully the valuation of the company. Now I'll turn the call over to John for a review of our financial results. John?

Thanks, Don. I'd like to start by running through our reported financial results for the second quarter of 2019 at a summary level. Second quarter total revenue grew 36% to $29.5 million from $21.7 million in the second quarter of 2018. Second quarter net loss improved to $5.3 million or 22 cents per share from $7 million or 29 cents per share last year. Second quarter adjusted EBITDA was negative $1.7 million compared to negative $3.2 million a year ago. 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. I'll now provide additional detail on the components of our results. First, I'll discuss revenue. Second quarter total revenue of $29.5 million was comprised of product revenue of $28.9 million and research services of $.6 million and represented growth of $7.9 million, or 36%, from last year's $21.7 million. This increase in second quarter total revenue was driven by strong growth in the subsea market during the quarter, initial shipments to the PTT LNG Nong Fab terminal project, and solid growth in our core energy markets in the U.S. Total shipments during the quarter increased by 18% to 8.4 million square feet of aerogel blankets, and our average selling price increased by 16% to $3.43 per square foot. We're increasing our average selling price outlook for the full year to $3.35 per square foot, plus or minus 5 cents from our prior estimate of $3.25 per square foot. At the time of our first quarter investor call in May of this year, we reiterated our projected revenue growth of between 20% and 28% in 2019, resulting principally from an increase in project revenue in the subsea and LNG markets. Our second quarter revenue performance was in line with our May guidance. In addition, the PTT LNG non-FAB terminal project serves as a strong foundation for our 2019 revenue growth projections. As a result, we're reaffirming our 2019 revenue guidance again today. Next, I'll discuss gross profit. Gross profit was $3.5 million, or 12% of revenue during the second quarter of 2019. versus $2.7 million, or 13% of revenue, during the second quarter last year. The improvement in gross profit was largely driven by the 16% increase in average selling price, the 18% increase in volume, and was offset in part by an increase in material costs and an increase in manufacturing expense. During the second quarter, the rate of growth in material costs exceeded our revenue growth rate, This outsized growth in material cost during the quarter is principally due to a significant increase in the proportion of revenue derived from our higher costs of seed products combined with a decrease in the proportion of revenue derived from our lower cost pyrogel products. This unfavorable change in the mix of products sold led to the year-over-year decrease in our gross profit margin during the quarter. In line with our 2019 full-year outlook, we continue to project a significant increase in revenue, capacity utilization, and gross profit during the remainder of 2019. As we discussed in past earning calls, our variable contribution margin is approximately 40%. Accordingly, we expect the increase in revenue and capacity utilization during the remainder of the year will lead to a disproportionate increase in both gross profit and gross margins. We also expect to see an increasing benefit during the second half of the year from our initiatives to offset the raw material cost increases we've experienced over the past 18 months. And importantly, our 2019 revenue forecast projects a significant increase in the mix of our higher margin pyrogel products over the remainder of the year. As a result, we expect our gross margin will exceed 20% during the final two quarters of 2019 I'll approach 20% plus or minus one percentage point for the full year. Next, I'll discuss operating expenses. Second quarter operating expenses decreased by $900,000, or 9%, versus last year to $8.7 million. The decrease in operating expenses was principally the result of a decrease in incentive compensation and a reduction in discretionary expense. offset in part by increased sales and marketing expenses to drive revenue growth and increased investment in research and development in support of our battery materials initiatives. We're revising our 2019 full-year operating expense guidance from a flat $40 million to a range of between $37.5 million at the low end of our revenue guidance range to $40 million at the high end of our revenue guidance range. Next, I'll discuss our balance sheet and cash flow for the second quarter. Cash generated from operations of $1.1 million reflected a $2.8 million decrease in working capital investment during the quarter, offset in part by our adjusted EBITDA of negative $1.7 million. Capital expenditures during the second quarter were principally for improvements in our East Providence facility, totaled $665,000. During the quarter, we also reduced the amount owed under our revolving credit facility with Silicon Valley Bank by $440,000. We ended the second quarter with $3.3 million of cash, net current assets of $15 million, $2.9 million outstanding on a revolving credit facility, shareholders' equity of $60.3 million. And importantly, we had access to an additional $6.4 million available under our revolving credit facility at quarter end. We're fine tuning our full year financial outlook for 2019. Total revenue is expected to range between $126 and $134 million, unchanged from prior guidance. Net loss is expected to range between $12.8 and $14.4 million. revised from prior guidance of between $12.7 and $14.7 million. Adjusted EBITDA is expected to range between break-even and positive $1.6 million, revised from prior guidance of between break-even and $2 million even. EPS is expected to range between a loss of 53 cents and a loss of 60 cents per share revised from between a loss of 53 cents and a loss of 61 cents per share. The CPS guidance assumes a weighted average of 24.1 million shares outstanding for the year. In addition, this revised 2019 outlook assumes depreciation amortization of $10.2 million, stock-based compensation expense of $3.9 million, interest expense of $300,000, and patent enforcement costs of $900,000. This full year outlook also assumes our gross margin will approach 20% plus or minus one percentage point and an average selling price of $3.35 per square foot plus or minus five cents. Turning to cash, we continue to expect the capital expenditures will total approximately $2.5 million for the full year. And within the context of the adjusted EBITDA range set out in our 2019 full year outlook, We expect to fully repay the outstanding balance on our credit line with Silicon Valley Bank and to exit 2019 with between $5 and $9 million of net cash on hand. I'll now turn the call back to Jesse for Q&A.

Thank you. At this time, I would like to remind everyone, in order to ask a question, please press star, then the number 1 on your telephone keypad. Again, that's star 1 to ask a question. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Eric Stein with Craig Hallam. Your line is open. Hi, Don. Hi, John.

Hey, Eric. How are you?

I'm fine. You? So maybe just starting with the potential partnership in the battery material space, I might be misreading your commentary, but it seems like maybe you've sharpened that a little bit, and as you've gotten into it over the last number of months, maybe, I guess, put your focus into a specific area over another. So I guess curious if that is the case, but maybe also kind of what you've learned as this process has played out, and is this still something that you are hoping that you have at least one partnership by the end of this year?

Yes, I did reiterate that that remains a goal of ours and an expectation of ours to in fact have a partnership this year in 2019. What we've learned, I think at the time of our last earnings call, I would say that we were in what I think I referred to as sort of pre-NDA discussions for the most part with with some of the major battery players and now we have moved into post-NDA discussions with a few of them. That's just a much deeper exchange of information and technical data. That has focused us in certain areas. They have encouraged us to work in one area or another as we've talked to different, uh, different major players in the area. And I guess we have become more focused and I would say a little smarter in it. As I said in my commentary, we know a heck of a lot about our aerogel. Uh, and, and we are, the reason that we want to have one or more partnerships in this area is because the, the, the expertise in battery systems is, is really critical to us as we, as we aim our, carbon aerogels in hopefully the right direction and create a value out of that effort.

Got it. Okay, that's helpful. Maybe switching gears, just thinking about some of your strong relationships like Technip, ExxonMobil, that sort of thing. I mean, now is your capabilities across your platform, your project team, does that kind of unfold? I mean, should we start thinking about that you potentially have some crossover within applications? I guess the reason I ask, and I know that this is something that, you know, might be a ways away from asking, is this a potential award? But I see Technip just awarded a big award for the Arctic LNG project. I know you're strong with them. And Subsea, is that something that down the road you think we could see crossover to LNG?

So I think we have... begun to demonstrate a very valuable value proposition on the LNG side. We're now in 36 LNG facilities around the world, mostly in maintenance work, of course. We have been used in 16 of the last 22 large-scale LNG export terminals built, including Cove Point, which we delivered on in 2018. end of 2017, Wheatstone in the same timeframe, and now the receiving terminal in Thailand. I think we are demonstrating both in terms of maintenance and project work our value in that area. We have a very strong LNG project pipeline right now. You're right to think that we have a very good relationship with Techniv. Yes, that's C, but broadly across their company as well. And so we've got work to do to participate mightily in that Arctic LNG project, and our project team and our, from myself right down through our organization, are working on that project. So we're targeting it, and we think we've got a... you know, a strong chance to compete for that project in a very effective way.

Okay, good. I'll stay tuned on that. Maybe last one for me, just in your core, the refinery petrochem business. I know that, you know, getting qualified with Saudi Aramco, that's something that, you know, took a while and was heavy lifting and you're finally there. You know, just curious when we should start to expect that to impact the business.

I think what you will see and getting the the qualification, if you will, with Saudi Aramco was, I think, important but also symbolic of the work that we've done more broadly in the Middle East and the focus that we have brought to that region over the course of the past year or so, or actually over the course of the past two or three years. And so I would anticipate that you will see the Middle East playing a more and more important role in our let's call it our geographic mix later this year and in the years to come. And Saudi Aramco will certainly be a part of that. So, again, I would anticipate you're noticing some good revenue wins coming out of the Middle East here in the coming quarter and year.

Okay, thanks a lot.

Thank you, Eric.

Your next question comes from . Your line is open.

Thank you, . You referred to efforts continuing on the raw material front, lowering costs. Is this specifically focused on the subsea products, or is it across all product lines?

That's a very good question. It's across all product lines, but it would have an outsized impact on our cold products, our cryogel Z product, and on our more ambient temperature products like the sub-C product. And the initiatives really are broadly in three areas. We're qualifying secondary low-cost sources of supply for our highest value raw materials. We are optimizing product formulations to reduce our reliance on some of the more volatile, higher cost materials where we've seen increases over the past year. And we're really working hard with our existing vendor base to negotiate lower prices and volume discounts sort of across the board on all our materials. As Don mentioned, there were three products very significant initiatives that we had targeted in this year. We've got a host of others as well. We've concluded and have implemented two of them, and they'll principally be operative in the third quarter, and then the third we expect to have in place for the fourth quarter. In addition to increased volume and a more favorable mix in the second half, we expect those initiatives to really put a floor under our gross profit margin. As Don mentioned, we expect to have 20-plus percent gross margins in each of the third and fourth quarters this year.

Understood. And you mentioned also seeing some ASP increases coming into play. Is this going to be limited to 2019, or do you expect the average selling price is room for these to continue expanding in 2020 and beyond?

I would say that if you just, two things. One is we have put price increases in place each year since 2013, and that's both what our practice, but it's also industry practice. So we would anticipate that selectively doing price increases in the future as well. The price increase we put in place for 2019 was outsized to match some of the raw material increases that we saw entering into, well, really late in 2018 and here in 2019. And so that's why we put an outsized price price increase in place of approximately 10% this past year. But it is typical of our industry to increase prices in the range of 1, 2, 3%. If you look back to 2013, our increases have been more in the 2, 3, 4% kind of level. And again, we will be smart about that as we look into 2020. But if history is is any indication we will, again, we'll take a good hard look at it.

Thank you. And just one final one. In terms of your project pipeline, it looks like the LNG space is looking more sort of attractive, I guess, in terms of how this is building up from a project's point of view. You had a big win earlier in the year. Is there anything in the pipeline of a similar size that you may be working on, or are these smaller project opportunities?

A receiving terminal, again, just really broad strokes. They use roughly $50 million of insulation in a project like that. The PTT project in Thailand is an example of that. As we said, of that $50 million in that project, rough numbers. we had between 35 and 40 million dollars. There are certain parts of a LNG receiving terminal that our aerogels are not perfectly suited for, but that kind of scope is available to us. Look, 35 to 40 million dollars, that's a pretty big project for any company and certainly for ours. There are lots of opportunities in other projects that are doing expansions, maybe not pure big greenfield-type projects that enable us to have wins in the 3, 5, 8, 10 range. And if you'll remember, at the end of 2017, beginning of 2018, we had three project wins then, and they were, in fact, 3, 5, and 8, if I remember correctly, John. And so I think you have the full spectrum available to us, which is to say maintenance work, And we really earn our credentials being problem solvers on the maintenance side. The small scope project work, which we consider to be sort of single digit millions, terrific business for us. And then you get these big projects from time to time. There are a host of them in the project pipeline right now that are in that small project to large projects scale. So we're excited about those and You know, look, every project that we deliver on successfully makes the next one just a little bit easier to win. Understood.

Thank you so much. That's all I have. Thank you.

Again, if you'd like to ask a question, please press star 1. Your next question comes from Chip Moore with Canaccord. Your line is open.

Hey, guys. How's it going? Hey, Chip. How are you? Good. Good. Hey, so it looked like you were able to build a little bit of inventory. Is that in support of PTT or anything specifically, or what's going on there?

Yeah, precisely, Chip. At month end, we had increased inventory of our Cryogel Z product in anticipation of additional shipments in the third quarter, so it was specifically for that. And our finished goods inventory went up by approximately $3 million in the second quarter. But we felt confident in building that inventory because we've got that strong backlog of project work.

Absolutely. So maybe switching gears, maybe you can touch a bit on some of the initiatives you've made more on the outbound sales side over the years, how some of those efforts are progressing?

Well, you know, look, we made a pretty significant investment in our sales and marketing team end of 2017 and throughout 2018. So that included a bit more geographic reach and including a focus on the Middle East, which I talked about earlier. And again, I would anticipate some wins in that region to make that investment a good one, in fact. We've also added to our technical sales team out in the field, and we still make technical sales with our high-performance insulation materials, and those investments we believe are paying off substantially as well we interestingly we've seen you know work in some some areas that you know the US has been very very strong I would say North America has the potential as well there's there's some activity in Canada that that were that we have high expectations for for the remainder of this the remainder of this year so so those investments look we We monitor them and be sure that we make good decisions and we make adjustments as needed. We're very pleased with the work that the project team is doing. Again, working very closely with our regional teams. It's the regional teams who have the tight, close relationships, and it is the project teams that are really working hard with the EPCs and being sure that they know how to bid our materials appropriately. Sales and marketing is critical to us. The fact that we're going to meet and exceed our revenue targets for the year from a performance indicators point of view, the 20% plus growth and then the 33% project revenue of total, we have those numbers, we believe, well in hand. So we're excited about the work that they're doing in sales and marketing.

Absolutely, that's helpful. And maybe one last one, guys, from me, an update on BASF, you know, building materials, traction, and then sort of where we stand on partnering on potentially some new stuff.

Yeah, BASF's really been interesting for us here. We've continued to work hard both on our first-generation product in the building materials area, the so-called SpaceLoft A2, We're working closely. We had a team of people here recently from BASF helping us with our second-generation product as well. Again, high-performance, noncombustible material, principally or at least initially targeting the building materials area, but we also believe it has broader applicability as well. So BSF continues to be an important partner. Of course, they made their second $5 million prepayment earlier this year, which was helpful. It's interesting, too. I mean, BSF has gone through one CEO retired, another one has come on. He is very, very focused on innovation, on speed. He was the former CTO of the of the company, especially coming out of the performance materials area. We want to be a poster child for them in terms of innovation and speed, and so we had close relationships with the earlier team, and we're developing, I think, equally and really exciting relationships with with some of the new senior leaders at BASF as well. So it is a company that we remain very, very close to and have a multidimensional relationship with.

Great. I'll hop back in queue. Thanks a lot, guys. Thank you, Chip.

There are no further questions. With that, I'll turn the call back to Don Young for closing comments.

Thank you, Jesse. We appreciate your interest in Aspen Aerogels, and we look forward to reporting our Third quarter results to you on October 31st. Have a good evening. Thank you.

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