Aspen Aerogels, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Aspen Aerogels Inc. Q2 2020 Earnings Conference Call. At this time, all participants are in the listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, John Fairbanks. Thank you. Please go ahead.

Good afternoon. Thank you for joining us for the Aspen Interagile's conference call. I'm John Fairbanks, Aspen's Chief Financial Officer. There are a few housekeeping items that I would like to address before turning the call over to Don Young, Aspen's President and CEO. The 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 investor section of Aspen's website, www.arajel.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 second quarter and six months ended June 30th, 2020. In addition, the investor section of Aspen's website will contain an archived version of this webcast for approximately one year.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 that is not an historical fact. These forward-looking statements are subject to risks and uncertainties. Aspen Aerogel's actual results may differ in material from those expressed in these 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 discussed in more detail in 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. The forward-looking statements made today represent the company's views as of today, July 30, 2020. Aspen Aerogels has claimed 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 to the most directly comparable GAAP measures and the 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 2020 earnings call. I will start by sharing our recent business results and our perspective on the current operating environment. I will also discuss our ongoing strategy related not only to our core energy infrastructure business, but also to our two electric vehicle initiatives. Next, John will review our Q2 and year-to-date financial performance, describe the progress we've made to ensure the long-term financial strength of the company and introduce new financial guidance for 2020. We will conclude the call with a Q&A session. Let's start with the obvious. The pandemic is having a negative impact on our business, particularly on our near-term revenue generation. Our products are installed by contractors working in refineries, petrochemical plants, and LNG terminals around the world. It is critical to us for contractors to have access to the energy infrastructure facilities that we serve. In response to COVID-19, facility owners have limited the number of contractors on site in order to reduce worker density. For this reason, our revenue has been negatively impacted during Q2, most notably in the U.S. maintenance market. Adding to the challenge in Q2, our distributors actively managed their own working capital, which resulted in a destocking of the distribution channel. Fortunately, a distributor can only destock once in a given period of time, so for this pandemic, we believe that the negative impact of destocking has largely played out. Looking forward, we expect revenue to rebound strongly when contractor access to facilities improves and the distribution channel restocks. It is clear that there is a significant pent-up demand, especially on the maintenance side of the business. When we examine EIA data for US refineries, we see the capacity utilization for this period last year was over 90%. In April 2020, as the pandemic intensified, capacity utilization for U.S. refiners dropped below 70%. Capacity utilization in U.S. refineries has now partially rebounded to approximately 80%. An active facility needs regular maintenance, so we view this trend as a positive sign. However, given that we have seen starts and stops in all regions, it is hard to predict with certainty when a consistent demand boost for our products will begin. To be cautious, our underlying assumption for our new financial guidance is that lower density work sites will be the reality for the remainder of the year. And therefore, we expect quarterly revenue levels to be relatively consistent with the first two quarters of 2020. In the face of the dual impact of COVID-19 and an uncertain energy environment, Our critical commercial task for both maintenance and project work is to sell our value propositions centered on simplified logistics and reduced workforce requirements to continue to gain market share in the energy infrastructure space, even in a down market. Also, we will continue to strengthen our sales organization, including a focus on converting our pipeline into additional project wins. We are confident that these investments will pay dividends. Our second quarter performance was largely consistent with our COVID-19 expectations with revenue down 17% for the quarter and down 8% year to date during which we had two positive pre-COVID months, January and February. Our revenue required for adjusted EBITDA breakeven has decreased from $140 million last year to a revenue level of approximately $110 million for 2020. This decrease in adjusted EBITDA breakeven is the result of the actions we took to lower compensation and discretionary expenses, to reduce our bill of material costs, and to improve our yields and productivity in our East Providence manufacturing plants. The impetus for this important work was both the pandemic and our ongoing drive to profitability. Interestingly, the lower break even level was achieved at a time when we increased our R&D spending to support our strategy to leverage our aerogel technology platform into new, diverse and valuable markets, including our two emerging opportunities in the EV space. Importantly, also during this time, we strengthened our company with an equity raise and credit line extension in February and a PPP loan in May. We believe we have positioned the company to emerge from the COVID-19 period with a strong operating platform and significant strategic momentum. On the subject of strategy, we continue to make substantial progress with our two initiatives addressing electric vehicles. We have accelerated optimization of our silica-based aerogel blankets to provide better solutions to EV manufacturers to manage thermal runaway. The development of our thermal runaway mitigation product, Pyrofen, benefited from our experience delivering critical fire protection solutions to our energy infrastructure customers and from active technical exchanges with key EV manufacturers. The thermal runaway product leverages our existing silica aerogel technology, can be produced using our current manufacturing assets, and is protected by our existing intellectual property. One of our performance indicators for 2020 is to gain adoption for or to generate initial revenue from the thermal runaway opportunity in the EV market in 2020. In fact, we have shipped an initial thermal barrier order to an Asian partner to be used by BYD in its new Blade battery platform. BYD, of course, is the largest Chinese producer of electric automobiles and buses. Blade is BYD's innovative battery system focused on safety, energy density, and cost. The Blade battery system will be used in BYD vehicles, and will also be available for sale to other EV manufacturers. In addition, we are in the midst of responding to a request for quote with a potential US-based customer with whom we have completed significant product development work. The RFQ contemplates orders spanning multiple years and potentially totaling multiple hundreds of millions of dollars of revenue. If successful in the near term, we will receive during Q3 2020 in order for a small prototype fleet of EVs. An RFQ does not guarantee success, but it does mean that we are in the hunt for significant business with our Pyrofin product. With respect to our carbon aerogel efforts, we continue our work to validate and accelerate the potential adoption of our technology within the battery materials market. Our effort centers on taking full advantage of the unique attributes of our carbon aerogels and leveraging our decades of experience manufacturing aerogels at scale. The ultimate goal is to improve the energy density of lithium ion batteries, a key enabler in expanding the drive range and reducing the cost of electric vehicles. continue to work closely with our evaluation partners, SKC and Evonik, and are actively engaged with other industry-leading companies, both battery and EV manufacturers. In the first six months of 2020, we accomplished several important items. We improved significantly both the performance and cost of our materials, we expanded our battery team, and we built an in-house battery fabrication and testing capability that will allow us to accelerate development even faster. During the remainder of 2020, we will provide larger sample quantities of our newest carbon aerogel materials to our partners to test in full cells and on more production level equipment. The goal is to test full battery systems with multiple cells stacked back to back to measure against a total energy output target. This feedback from our evaluation partners is critical as we continue to optimize our carbon aerogel materials. The advanced data also make our attractiveness to potential new partners yet more appealing. We continue to believe that we will expand our relationship with one or both of our existing partners and enter into additional agreements with other industry leaders during 2020. Our goal with these two opportunities that leverage the megatrend towards electric vehicles is to build proprietary and diverse aerogel-based businesses and to further demonstrate the value and breadth of our technology platform. We will continue to report out on our progress related to these important strategic initiatives. Finally, and to recap, we believe we are taking the correct actions in this unusual time fortify the company to regain our commercial momentum and to advance our strategy. Our goal is to keep everyone on the Aspen team safe and healthy and at the same time to keep the company strong. We are focused on our drive to profitability and on executing our strategy. These times demand a balancing act and we will continue to aggressively manage the company to ensure we maintain the correct balance. 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 2020 at a summary level. Second quarter's total revenue declined by 17% to $24.6 million from $29.5 million in the second quarter of 2019. Second quarter net loss was $5.7 million for 21 cents per share. versus $5.3 million or 22 cents per share last year. Second quarter adjusted EBITDA was negative $2.1 million compared to negative $1.7 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. For the first half of 2020, total revenue declined by $4.4 million or 8% to $53.1 million. Net loss improved to $8.9 million or 34 cents per share in 2020 versus a net loss of $11.3 million or 47 cents per share last year. And adjusted EBITDA for the first half improved to a loss of $1.6 million compared to a loss of $4.2 million a year ago. For the remainder of my comments, I'll focus on second quarter performance and our outlook for the remainder of the year. However, I first want to emphasize that in the first half of 2020, we improved adjusted EBITDA by $2.6 million, despite a revenue decline of $4.4 million during the period. This improvement was driven by Our initiatives to reduce compensation and discretionary expense in response to COVID-19 related uncertainty. Our multi-year initiatives to reduce bill of material costs. Continued improvement in yields and productivity in our East Providence plant. And our annual price increases. And importantly, we improved profitability despite an increase in research and development spending in support of our electric vehicle and next generation process technology programs. This performance indicates that we are operating well, despite the COVID-19 related market challenges, that the fundamental economics of our business are improving. And we believe that the actions we're taking to improve profitability in the energy market and the strategic investments we're making in the EV market will enable Aspen to thrive when business conditions improve. I'll now provide additional detail on the components of our second quarter results. First, I'll discuss revenue. Second quarter total revenue decreased by $4.9 million, or 17%, to $24.6 million versus $29.5 million last year. This decrease in second quarter total revenue was driven by a decrease in project-based revenue in the subsea market, a COVID-19-related decline in maintenance-related business, most notably in the U.S. petrochemical and refinery market, and our planned reduction in research services revenue. These are all set in part by growth in onshore project work globally led by strong demand in the LNG market. The COVID-19 related decline in our maintenance related business was largely impact of our energy customers limiting the number of internal and third party insulation installers in their facilities to reduce worker density. and temporarily shuttering operations from time to time in response to COVID-19 outbreaks. These access-related issues affected our business globally during the quarter, but were particularly prevalent in the U.S. Gulf Coast region. Total shipments during the quarter decreased by 13% to 7.3 million square feet of aerogel blankets, and our average selling price decreased by a slight, mix-related 2% to $3.35 per square foot. Next, I'll discuss gross profit. Gross profit was $2.9 million during the second quarter of 2020 versus $3.5 million during the second quarter last year. However, gross margin was 12% during both quarters. The decrease in gross profit was largely driven by the 13% decrease in volume, the 2% decrease in average selling price, and the decline in research services revenue are set in part by a decrease in manufacturing expense and a decrease in material costs. I want to highlight that our second quarter gross profit reflected $1.2 million of expense associated with our $4 million reduction in inventory during the quarter. If we had maintained inventories at first quarter levels, our gross margin would have improved to 16% in the second quarter of 2020, compared to 12% last year. However, we chose to decrease inventory balances in the second quarter to improve cash flow as we gained confidence that we could sustain manufacturing operations despite the COVID-19 pandemic. Next, I'll discuss operating expenses. Second quarter operating expenses decreased by $200,000, or 3%, versus last year to $8.5 million. despite a $300,000 increase in research and development in support of our electric vehicle initiatives. The decrease in operating expenses was principally the result of a decrease in travel related expenses and the tight discretionary cost controls we instituted in response to the COVID-19 pandemic. Next, I'll discuss our balance sheet and cash flow for the second quarter. Cash use and operations of $1.9 million. Reflected our adjusted EBITDA