Aspen Aerogels, Inc. (ASPN) Q1 2017 Earnings Report, Transcript and Summary

Good afternoon. My name is Megan and I will be your conference operator today. At this time, I would like to welcome everyone to the Aspen Aerogel's Q1, 2017 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a Question-and-Answer Session. [Operator Instructions]. Thank you, John Fairbanks, you may begin your conference.

Good afternoon. Thank you for joining us for the Aspen Aerogel's conference call. I'm John Fairbanks, Aspen's Chief Financial Officer. There are a couple of housekeeping items that I would like to address before turning the call over to Don Young, Aspen 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 as compared to the most applicable GAAP measures is available on the investor section of Aspen’s website, www.aerogel.com. Included in the press release is a summary statement of operations, a summary balance sheet, a summary of key financial and operating statistics for the quarter and year ended March 31st, 2016. In addition, the investor section of Aspen’s website will contain an archived version of this webcast for approximately one year.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 statements regarding outlook, expectations, beliefs, projections, estimates, targets, prospects, business plans and any other statement that is not 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 on the Investor section of Aspen’s website. The forward-looking statements made today represent the company's views as of today May 4, 2017. 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 of and reconciliations of these non-GAAP financial measures to most directly comparable GAAP financial measures and a discussion of why we present these non-GAAP financial measures is also available in today's press release. I will now turn the call over to Don Young, President and CEO of Aspen Aerogels.

Good afternoon. Thank you for joining us for our Q1, 2017 earnings call. I will provide comments about the business and our performance and John will present financial details for the first quarter and comment on our guidance for 2017. We will conclude the with the Q&A session. I plan to cover 3 topics in my prepared remarks. First, I'll provide a recap of Q1, second, I'll discuss the current commercial environment and our market outlook for the remainder of 2017, and third, I'll describe our key success factors for the year. The first quarter of 2017 played out largely as we expected. Revenue when compared to Q1, 2016 was down in all regions except for the United States which was positively impacted by the successful delivery of the Cryogel Z to the co-point LNG project. On a customer and market segment basis, the conclusion of the South Asia Petrochemical project and continued lower activity levels in the Subsea market accounted for over 70% of our nearly $10 million revenue decrease versus last year's first quarter. To provide context, it is important to remember that the South Asia Petrochemical Project and Subsea together accounted for approximately 30% of our revenue in both 2015 and 2016. However, in 2017, we anticipate that they will account for less than 10% of our revenue. Later in my comments, we will discuss the historical and anticipated levels of our base revenue. That is revenue not derived from the South Asia Petrochemical project or the Subsea market. We will also discuss the importance of continuing to build that foundation as we return to our growth trajectory. During the first quarter, we continue to make progress in our adjacent markets, while we still have substantial room to grow in our core markets, refinery, petrochemical and Subsea, we also have important opportunities to diversify our sources of revenue. Our first efforts have focused on LNG and district energy. With respect to LNG as engineering firms and asset owners have gained experience with and confidence in our Cryogel products. We have progressed from doing maintenance work to small projects and now we are competing for projects with larger scope. We have earned the credibility to participate in these larger projects with a proven solution that provide a strong ROI for our end-users. During Q1, we delivered $2.3 million of the approximately $4 million copoint order, the third such LNG project we have delivered in the past 12 months. We are currently targeting LNG projects with various scopes, some with $5 million, $10 million and up to $20 million in revenue potential. We believe this adoption pattern for maintenance to small scope projects to larger scope projects applies to many of our end markets and as our products becomes more universally recognized, we believe the adoption pattern will be accelerated and become truncated in time. District energy, where steam is generated centrally and distributed through a tunnel system to a complex building is another adjacent market with a thin profile and hydrophobic nature of our Pyrogel, our winning characteristics. After introducing our products to the district energy market in 2015, we've more than doubled our revenue in 2016 as we continued to build a portfolio of successful projects. Our products have been installed now by over 50 customers and we're recently qualified within and added to the Con Edison corporate specification, an important milestone in our penetration of this market. In addition, we remain on track to launching the second half of 2017 product specifically designed to the large and attractive power industry, an end market that consumes more than $1 billion of installations per year. The LNG, district energy and power markets are examples of our progress thus far in targeting and developing diverse and high value adjacent markets to supplement our core refinery petrochemical and Subsea work. The second topic today pretrains the current commercial environment and market outlook for 2017, where we remain cautious. As we highlighted at the time of our last earnings call, we are assuming for planning purposes that conditions in the upstream and downstream energy end markets in 2017 will be about on par with 2016. That is to say no meaningful upstream activity and frugal downstream spending by our refining and petrochemical end users. We saw nothing in the first quarter that causes us to want to revise that outlook. While there is recent industry sentiment suggesting the potential for increased activity in the energy markets in 2017, we believe planning for a slower, more conservative recovery is prudent, especially given the late-cycle nature of our products. Our 2017 revenue guidance assumes no significant project work and is comprised nearly entirely of singles and doubles, just day in and day out maintenance and small project work. Excluding revenue from our Subsea and South Asia petrochemical projects are base revenue in millions of dollars has grown from the low 70s in 2013 and 2014 to the low 80s in 2015 and 2016. We project continued growth in the base revenue during 2017 to between $90 million and $100 million. This projected growth in base revenue in 2017 is driven by anticipated gains in market penetration in our core markets, growth in our adjacent markets and by our price increases. Our third topic today is a description of the three important performance indicators that we believe will mark 2017 as a successful year. First, our goal for 2017 is to build momentum each quarter by gaining market share in our core refinery and petrochemical end markets, by demonstrating value and growth in our LNG, district energy and power adjacent markets, and by taking a partnered approach in the development of new markets, including building materials. Our first indicator of success will be characterized by the building of commercial momentum through the year with Q2 stronger than Q1, Q3 stronger than Q2 and Q4 stronger than Q3. This momentum will position us to resume our revenue and adjusted EBITDA growth trajectory in 2018. The second performance indicator goes back to our definition of base revenue that is all revenue not comprised of Subsea and the South Asia petrochemical projects. While the annualized base revenue in millions of dollars for Q1, 2017 was in the low 80s, we expect that the annualized number for the first half of 2017 will reach the mid to upper 80s. If we are successful in building momentum during 2017, we expect base revenue to grow into the 90s for the full year. In combination with our expected 2017 revenue from Subsea and the final shipments to the South Asia petrochemical project, this level of base business will support our 2017 revenue guidance and position us for renewed revenue growth in 2018. Also, the nature of our 2017 revenue with no big-ticket items helps us to avoid negative revenue comparisons in 2018 resulting from the completion of significant project work. The third indicator of success in 2017 relates to the strategic importance of diversifying into adjacent markets. We remain on track to launch in the second half of 2017 a new product Pyrogel HPS dedicated to the power industry, in the industry that consumes over $1 billion of installations per year. Success will be defined by our ability to generate $1 million to $3 million of Pyrogel HPS revenue during late 2017, to build a portfolio of case studies and to begin the adoption progression for maintenance work, the small scope project work and then on to larger scale project work. A bonus would be attract a lead customer as we have done in the past with Technique [ph] and Subsea, Exxon Mobil in the refinery market and BSF in building materials as examples. The successful rollout of Pyrogel HPS is also an important demonstration of Aspen Core competency that is our ability to develop and commercialize new Aerogel products into adjacent and new markets. This key value driver for Aspen bodes well for future efforts as we leverage our Aerogel technology platform into new and exciting markets. We will track and report out on these three indicators of success as we progress through 2017. Again the three indicators are building momentum each quarter, expanding our base revenue, and launching Pyrogel HPS. During this downturn in the energy market, we have continued invest in research and development, sales and marketing and operational excellence and believe these investments are creating strong technical and commercial positions in our core adjacent markets and in several promising opportunities in potential new markets. We will continue our strategy of leveraging our Aerogel Technology platform with the support of a strong balance sheet, and we believe we are well positioned to return to a solid growth trajectory as the energy market strengthens and as we have continued success developing our adjacent and new markets. Overall, we are confident that the strength of our technology and the ROI that we bring to our end users across multiple markets will enable solid performance for our company. We will maintain our commitments to grow profitably to prudently scale up our operations and to remain financial strong. We have an experienced team of people and we are confident in our ability to execute our strategy and to realize our vision for the quarter. Now I'll turn the call over to John for a review of our financial results.

I like to start by running through our reported results for the first quarter of 2017 at a summary level. First quarter total revenue declined 30% to $23 million versus $32. 8 million in 2016. First quarter net loss was $9.1 million to $0.39 per share versus a net loss of $1.8 million or $0.08 per share last year. First quarter adjusted EBITDA was negative $5.1 million compared to positive $2 million a year ago. We define adjusted EBITDA as net income or loss before interest, taxes, depreciation, amortization, stock based compensation expense another item that we do not believe are indicative of our core operating performance. Patent enforcement costs had a significant impact on both our net loss and adjusted EBITDA during the first quarter this year. We incurred $2.7 million of patent enforcement costs during the quarter versus $200,000 in the first quarter of last year. At a summary level, the decline is $7.1 million in first quarter adjusted EBITDA versus the first quarter of 2016 was driven by two principle factors. First, a decline is gross profit associated with the year-over-year decline in product revenue. And second, the $2.5 million increase in patent enforcement cost versus last year's first quarter. As we highlighted in February's conference call, our gross profit and gross margin are highly dependent on product revenue and capacity utilization levels. Due to the high proportion of fixed cost in our manufacturing operations our variable contribution margins on product revenue is approximately 45%. At this 45% variable margin, a $10 million decline in product revenue versus the first quarter of 2016 would be expected to lead to a $4.5 million in gross profit. Our actual first quarter gross profit declined by $4.4 million. In combination with the $2.5 million increase in patent enforcement cost, this $4.4 million decline in gross profit explains principally all of the decline in adjusted EBITDA during the period. I’d like to emphasize that we have not seen any significant change to the economics of our business. Our value proposition remains strong and our product pricing, material cost and manufacturing expenses are relatively stable. The future revenue and volume growth we'd expect growth and gross profit and adjusted EBITDA equal to approximately 45% of the associated growth and product revenue. And moving forward, we would expect to see a meaningful reduction in patent enforcement cost. I'll now provide additional detail on the components of our results. First, I'll discuss revenue. First quarter total revenue was comprised of product revenue of $22.3 million and research services revenue of $676,000. During the first quarter product revenue decreased by $10 million or 31% versus last year's $32.3 million. As expected this decline was led by the conclusion of the shipment to the multiyear South Asia petrochemical project and a continued decline in Subsea revenue, in combination with the ongoing weakness in the global downstream markets. In our view, the root cause of the decline in product revenue continues to be constrained capital investment and lower activity levels in our core energy markets. During the quarter, shipments decreased 30%, 8.2 million square feet of Aerogel blankets, while our average selling price decreased by 1% to $2.70 per square foot, in line with our guidance. A slight decrease in average selling prices reflected a year-over-year decline in the mix of our higher priced Subsea products offset by the decrease in revenue from the lower price South Asia petrochemical projects. For the full year we continue to expect products revenue in the range of $100 million to $110 million, this is unchanged from prior guidance. We also expect our average selling price for the 2017 to increase to remain in the range of $2.75 per square foot plus or minus $0.10. I'll now turn to our research services revenue. Our research services revenue is related to contract research performed principally for government agencies. Research services revenue increased 26% through the first quarter to approximately $700,000. This growth was due to relative value and timing of research contracts versus last year. For the full year, we expect research services revenue to be approximately $2 million. This expectation is included in our 2017 total revenue guidance. Next, I’ll discuss gross profit. Our gross profit $2.2 million and our gross margin of 10% during the first quarter represented a significant decrease from first quarter of 2016. This decline in gross profit and gross margin was driven principally by the 30% decline in shipment volume versus last year and to a lesser extent warranty cost of $885,000, offset in part by a favorable shift in mix due to the decrease in volume from the lower margin South Asia petrochemical project. Looking forward, we anticipate improvements in gross margin, principally associated with our expectation of increasing revenue levels and associated capacity utilization. For the full year, we continue to expect gross margins in the mid-teens, this gross margin expectation is unchanged from our prior 2017 guidance. Next, I’ll discuss operating expenses. First quarter operating expenses grew by $3 million or 36% to $11.3million. This growth in operating expense was driven by the $2.5 million increase in patent enforcement cost, the $300,000 increase in research and development expenses, the $200,000 year-over-year increase in all other operating expenses during the quarter. Moving forward, we expected operating expense growth will moderate due to reduction in quarterly pattern enforcement cost from the $2.7 million during Q1 into the range of $400,000 to $600,000 per quarter for the remainder of the year. Our 2017 full year operating expense guidance has not changed. We expect the full year operating expenses will increase by approximately 8% versus 2016, driven principally by the increase in pattern enforcement cost. Next, I'll discuss our balance sheet and cash flow. Overall, or cash flow was in line with our expectations for the first quarter. Cash used in operations of $4.4 million reflected our negative adjusted EBITDA of $5.1 million offset impart by $700,000 of cash generated by changes in working capital during the period. Capital expenditures during the first quarter totaled $2.1 million down from $3.1 million last year. We ended the first quarter with $11.2 million of cash in minimal debt, current assets of $44.8 million and stakeholder's equity of a $107.4 million. In addition, our $20 million revolving credit facility remains untapped. During the first quarter, we extended the term of the facility through January 2018. Our guidance for 2017 is unchanged. Total revenue expected to range between $102 million and $112 million. Net loss is expected to range between $18.2 million and $21.2 million. Adjusted EBITDA is expected to range between the loss of $2 million and a loss of $5.4 million. EPS is expected to range between a loss of $0.78 and a loss of $0.91 per share. This EPS guidance assumes a weighted average of 23.4 million shares outstanding for the year. This 2017 outlook also assumes depreciation and amortization of between $10.6 million and $10.8 million, stock-based compensation of between $5 million and $5.2 million and interest expense of $200,000. In addition, this financial outlook includes between $3.9 million and $4.4 million of cost and expenses associated with our patent enforcement actions for the year. As a reminder, our 2017 capital expenditures guidance of $7.3 million was comprised of $2 million in new projects to be initiated during 2017 and $5.3 million in final expenditures for the pilot line, equipment and support of the new power market product and other projects approved and initiated during 2016. We continue to expect capital expenditures will be front loaded during the year to approximately $6 million of spending projected for the first half of 2017. For the second half of the year, we planned to constraint capital expenditures to a level slightly greater than a $0.5 million per quarter. Turning to cash at an aggregate level, we continue to expect the use cash during the first half of 2017 to fund front loaded operating losses patent enforcement expenses and capital expenditures. During the second half of the year, we expect to generate cash due to projected improvements in operating performance, dissipated declines in patent enforcements costs and reductions in capital spending during the year. In the context of the range of our 2017 guidance, we expect to exit the year to between $10 million and $14 million of cash on hand. As always, project work and product mix can create quarterly variability and we will update our annual guidance at the time of each earnings release during 2017 or as otherwise necessary. I'll now turn the call back to Megan for Q&A.

[Operator Instructions]. Our first question comes from Eric Stine with Craig Hallum. Eric, your line is open.

So I just wanted to start with LNG and kind a what you're seeing here with the increased scope. Are you being asked to do this by the project owner or is the ETC firm or is it both? I mean just how we should think about that playing out?

It's a combination of the two. We have to be in the good grades both of those out players. And again, as we've continue to do some of these projects as we've done in the last 12 months, in the $3 million $4 million $5 million scope where I think demonstrating the value that we articulated entering this market. So it's getting a little easier for us with every good case study that we are behind this.

And I mean thinking about kind of as we're sitting today and what you see, I mean would you characterize that being asked to compete for that scope, is that -- what you’ve done to date is that tie to one of those projects or has it become more of a broad request from your customers?

There are -- we cover all projects that are in all phases from concept right on through the execution. And so we’re working all the projects. I do think we tend to have a leg up when we’re working with the engineering companies or end users, asset owners that -- with whom we’ve had successful installations in the past, there is no doubt about that. But, our team is broad going after all the opportunities in that arena.

Okay. Are you thinking about that, I think in the past you’ve said that that’s not a 2017 event? I mean I guess that would be -- is that more of a potential order in 2017, would maybe impact 2018?

I think the impact will be on 2018 and 2019 in that timeframe.

Okay.

As I mentioned it and I'll just repeat it, but I think it's important. We’re really comprised largely in 2017 of maintenance work and small project type activities. And if you go back to these calls in 2014 and 2015 when we were asked about the mix between the maintenance and project work, our answer has been that its roughly 50-50 and sometimes it can wait in one side or the other. And I think specially with the South Asia petrochemical project mostly in our rearview mirror, we were waited during that timeframe a little over to the projects. But we’re pretty dramatically waited in 2017 over onto that maintenance and smaller very smaller scale type project work. So, I think over any period of time, longer period of time that balance should be closer to 50-50. So when I think about the type of projects that can get as back to 50-50 in that 2018, 2019, 2020 certainly LNG project are candidates to bring life back into the project side.

Yeah. Great to hear that's that how 2017 guidance is set. Maybe just turning to district energy, I mean, just characteristics of that market. I mean do you think it is kind of the same thing or is it increased scope or is that a market where its more about just getting in with more customers, more opportunities, [indiscernible] that sort of thing?

Yeah. It is largely made up of smaller opportunities, a lot of maintenance work and expansions of existing systems. We still believe that that’s an opportunity that over a longer period of time can be a $50 million segment for our company. But -- and it would be made up of a wide range of opportunities without anyone big project design, is the way we look at that market.

Okay. Got it. Maybe last one for me. Just on power gen, you’ve talked about that you'd love to be able to secure a lead customer there maybe, I mean if you're able describe kind of what that lead customer might look like?

Well, our value proposition for our product is particularly robust in the vicinity of the Turbines and so if you can imagine that -- you know that there are a small handful of major Turbine players and so it would be that type of partner that we think would be really an idea partner in that market. Maybe as opposed to a large power company, I think instead we would like that target -- that partner to be on the equipment side -- kind of over on our side of the fence if you want.

[Operator Instruction] Your next question comes from Chip Moore of Canaccord. Your line is open.

Maybe you guys could talk a little bit -- I don’t think we heard too much about BASF in the broader sort of building materials opportunity, just gives us an update there if you could?

Our work with BASF, when we signed those agreements in the summer of 2016 we really had a few different angles to them. One of course -- one angle of course was the support of plants two as you all know is on pause for the momentum, but that part of the agreement, it is a standing steady and ready to commence when we restart that project, so that’s one part of it. And then a second part of it was work dedicated towards helping Aspen improve the manufacturing performance in our existing manufacturing plants, and so we have been able to leverage some of the experience and some of the engineering resources at BASF in our plants two to look at elements of our operation that are common to all chemical plants and we've worked hand in glove with BASF in that process and we really believe that that will pay dividends in terms of yield and throughput and overall operational excellence in that facility. And then third and very importantly is the activities around the building material market itself and we together have developed a product by the name of Spaceloft A2 and that product is in the final stages of manufacturing specifications and we have been sampling it into the market via BASF. So we are in that early stage of market introduction, getting the certifications across primarily the European market, that’s our first focus for that market. So that BASF relationship I just -- I can't tell you how happy I am with our team and the work that we have done with BASF team in getting value from those agreements with that company.

And if we get back to sort of the looking at annualized base revenues, that 80 million's range right now, can you just -- I guess talk about trends you are seeing there, it's sounds like you are looking more for share gains and any move in the market? And then on that other piece of Subsea and closing out that project visibility on that end? Thanks guys.

The $80 million, it is largely comprised of our continued penetration in those core markets that we talk about in particular refinery and petrochemical. We have a tremendous amount of rooms still to grow and with these companies all around the world. We have a terrific focus on that. The second component of that of course is our adjacent markets where we've done some nice work in developing in these markets we've got some pace going with the District Energy and with LNG and we're all hands on deck right now working towards the successful launch of Pyrogel XT for that power market. And third, and I think it's interesting for 2017 the third area where we've being helped of course is we put price increases in place in 2017 which has held in the vicinity of 2% of 3% for this year after several years of price increases closer to 4% and even 5%. So those have been the key drivers for us as we've tried to expand that $80 million base up into 90s as we intend to do here in 2017. The Subsea market, I think we've all been reading the earnings reports of some of the big companies that are Deepwater and Subsea type entities. And there is no doubt that there is a lot more activity going on today and there was even 3 and 6 months ago. Having said that that activity has not really turned in to a terrific number of purchase orders for anyone in the chain quite yet. But it's at least nice to see some activity going on in that market. We are not counting significantly on that market in 2017 as we've said in the past and so what we -- so anything we get on that will be upside from our point of view. What we really want is for that market as we've improved quarter-after-quarter going into 2018. It will be at it will really nice as we have that momentum from our base to be able to add on some these kinds of projects into 2018 and really get some acceleration back after 7 years of growing nearly 30% compounded during that period of time. So we're eager for that to come about. You also mentioned the South Asia petrochemical project, we are delivering final deliveries to that project here in 2017 that is a large important company and we're a very good partner with that company. And we know that we'll have opportunities in the future with that company and so again I think we've delivered a nearly $60 million of product to that project successfully and we're happy about that.

Okay, thanks for that. And I guess just one last one on the legal side obviously with some significant investment in the past couple of quarters. Just latest on the patent enforcement and do you expect to see some near-term benefit out of that or how should we think about that.

Yeah go ahead John.

Yeah so the German -- we've initiated the German proceedings in the fourth quarter of 2016 and those remain ongoing. The ITC in the U.S. the evidentiary hearing was which was one of the trial was wrapped up in February 2017, but the judge has yet to rule. The timing on the results of these trials and hearings is uncertain, but we'd expect to get some initial determination in both venues in the second half of 2017. And we still, we don’t want to really comment about the litigation itself, but we can say that nothing has transpired in either Germany or here in the U.S. at the ITC, that’s diminished our confidence in the strength of our case. So, we’re in a wait and see mode, but we remain confident.

Yeah. That’s fair. Thanks a lot.

This concludes our question-and-answer session. I would now like to turn the call back to Don Young for closing remarks.

Thank you, Began. We appreciate your interest in Aspen Aerogels, we look forward to reporting our second quarter 2017 results to you in early August. Thank you. Have a good evening. Thank you.

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