The following information should be read in conjunction with the unaudited financial information and the notes thereto included in this Quarterly Report on Form 10-Q and the audited financial information and the notes thereto included in the Annual Report on Form 10-K for the year endedDecember 31, 2019 , filed with theU.S. Securities and Exchange Commission (SEC) onMarch 6, 2020 , which we refer to as the Annual Report. Certain matters discussed in this Quarterly Report on Form 10-Q may be deemed to be forward-looking statements that involve risks and uncertainties. We make such forward-looking statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and other federal securities laws. In this Quarterly Report on Form 10-Q, words such as "may," "will," "anticipate," "estimate," "expects," "projects," "intends," "plans," "believes" and similar expressions (as well as other words or expressions referencing future events, conditions or circumstances) are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ materially from the results discussed, projected, anticipated, or indicated in any forward-looking statements. We caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, and the development of the industry in which we operate may differ materially from the forward-looking statements contained in this Quarterly Report on Form 10-Q. In addition, even if our results of operations, financial condition and liquidity, and the development of the industry in which we operate are consistent with the forward-looking statements contained in this Quarterly Report on Form 10-Q, they may not be predictive of results or developments in future periods.
The following information and any forward-looking statements should be considered in light of factors discussed elsewhere in this Quarterly Report on Form 10-Q and under "Risk Factors" in Item 1A of the Annual Report.
We caution readers not to place undue reliance on any forward-looking statements made by us, which speak only as of the date they are made. We disclaim any obligation, except as specifically required by law and the rules of theSEC , to publicly update or revise any such statements to reflect any change in our expectations or in events, conditions or circumstances on which any such statements may be based, or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements. You should read the following discussion and analysis of financial condition and results of operations together with Part I Item 1 "Financial Statements," which includes our financial statements and related notes, elsewhere in this Quarterly Report on Form 10-Q. Investors and others should note that we routinely use the Investors section of our website to announce material information to investors and the marketplace. While not all of the information that we post on the Investors section of our website is of a material nature, some information could be deemed to be material. Accordingly, we encourage investors, the media, and others interested in us to review the information that we share on the Investors section of our website, https://www.aerogel.com/.
Overview
We design, develop and manufacture innovative, high-performance aerogel insulation used primarily in the energy infrastructure and building materials markets. We believe our aerogel blankets deliver the best thermal performance of any widely used insulation product available on the market today and provide a combination of performance attributes unmatched by traditional insulation materials. Our end-use customers select our products where thermal performance is critical and to save money, improve resource efficiency, enhance sustainability, preserve operating assets and protect workers. Our insulation is used by oil producers and the owners and operators of refineries, petrochemical plants, liquefied natural gas facilities, power generating assets and other energy infrastructure. Our Pyrogel and Cryogel product lines have undergone rigorous technical validation by industry leading end-users and achieved significant market adoption. We also derive product revenue from the building materials and other end markets. Customers in these markets use our products for applications as diverse as wall systems, military and commercial aircraft, trains, buses, appliances, apparel, footwear and outdoor gear. As we continue to enhance our aerogel technology platform, we believe we will have opportunities to address additional high value applications in the global insulation market and in a diverse set of new markets, including the electric vehicle market.
We generate product revenue through the sale of our line of aerogel blankets. We
market and sell our products primarily through a sales force based in
16 -------------------------------------------------------------------------------- Our salespeople work directly with end-use customers and engineering firms to promote the qualification, specification and acceptance of our products. We also rely on an existing and well-established channel of qualified insulation distributors and contractors in more than 50 countries around the world to ensure rapid delivery of our products and strong end-user support. Our salespeople also work to educate insulation contractors about the technical and operating cost advantages of our aerogel blankets. We also perform research services under contracts with various agencies of theU.S. government, including theDepartment of Defense and theDepartment of Energy , and other institutions. In late 2019, we decided to cease efforts to secure additional funded research contracts and to wind down our existing contract research activities during 2020. This decision reflected our desire to focus our research and development resources on initiatives to improve the profitability of our existing business and on efforts to develop new products and next generation technology with application in new, high value market segments. We manufacture our products using our proprietary technology at our facility inEast Providence, Rhode Island . We have operated theEast Providence facility since 2008 and had increased our annual capacity through 2017 to 50 million square feet of aerogel blankets. During 2018, we initiated a series of projects, which we refer to as EP20, designed to increase this capacity to 60 million square feet of aerogel blankets by the end of 2020. As ofMarch 31, 2020 , we had increased our annual capacity to 55 million square feet of aerogel blankets as a result of this initiative and believe we are on track to achieve our EP20 goals by the end of 2020. We are engaged in a strategic partnership with BASF to develop and commercialize products for the building materials and other markets. The strategic partnership includes a supply agreement governing the exclusive sale of specified products to BASF and a joint development agreement targeting innovative products and technologies. BASF has no obligation to purchase any products under the supply agreement. Pursuant to the supply agreement, BASF may, in its sole discretion, make prepayments to us in the aggregate amount of up to$22.0 million during the term of the agreement. We may repay the prepayments to BASF at any time in whole or in part for any reason. BASF made a prepayment to us of$5.0 million during 2018. As ofJanuary 1, 2019 , 25.3% of any amounts that we invoice for Spaceloft A2 sold to BASF will be credited against the outstanding balance of the 2018 prepayment. If any amount of the 2018 prepayment remains uncredited atDecember 31, 2021 , BASF may require that we repay the uncredited amount to BASF. InJanuary 2019 , BASF made an additional prepayment to us of$5.0 million . As ofJanuary 1, 2020 , 50% of any amounts that we invoice for a newly developed product sold to BASF will be credited against the outstanding balance of the 2019 prepayment. AfterDecember 31, 2022 , BASF may require that we credit 24.7% of any amounts we invoice for Spaceloft A2 sold to BASF against the outstanding balance of the 2019 prepayment or may require that we repay the uncredited amount to BASF. OnFebruary 18, 2020 , we completed an underwritten public offering of 1,955,000 shares of our common stock at an offering price of$8.25 per share. We received net proceeds of$14.8 million after deducting underwriting discounts and commissions of$1.1 million and offering expenses of approximately$0.3 million . OnMarch 3, 2020 , we amended our revolving credit facility withSilicon Valley Bank to extend the maturity date of the facility toApril 28, 2021 . Under our revolving credit facility, we are permitted to borrow a maximum of$20.0 million , subject to continued covenant compliance and borrowing base requirements. At our election, the interest rate applicable to borrowings under the revolving credit facility may be based on the prime rate or LIBOR. Prime rate-based rates vary from prime rate plus 0.75% per annum to prime rate plus 2.00% per annum, while LIBOR-based rates vary from LIBOR plus 3.75% per annum to LIBOR plus 4.25% per annum. In addition, we are required to pay a monthly unused revolving line of credit facility fee of 0.5% per annum of the average unused portion of the revolving credit facility. The credit facility has also been amended to establish certain minimum Adjusted EBITDA levels with respect to the minimum Adjusted EBITDA financial covenant for the extended term. We intend to extend or replace the facility prior to its maturity. Our revenue for the three months endedMarch 31, 2020 was$28.4 million , which represented an increase of$0.5 million , or 2%, from the three months endedMarch 31, 2019 . Net loss for the three months endedMarch 31, 2020 was$3.2 million and net loss per share was$0.13 . Net loss for the three months endedMarch 31, 2019 was$6.0 million and net loss per share was$0.25 . At present, we are not certain of the extent of the impact that the COVID-19 pandemic and the global oil market volatility may have on our business. Our manufacturing facility remains operational and we have not encountered any significant disruption to our supply chain or our ability to deliver to our customers. However, the demand for our products has been negatively impacted and we expect to experience a year-over-year decrease in total revenue. In response to this general uncertainty in the market for our products, we have taken a number of actions to reduce expenses, including wage reductions, temporary suspension of board fees and selected reductions to discretionary expenses. In addition, as permitted by the Coronavirus Aid, Relief and Economic Security Act (CARES Act), we have elected to defer certain payments of our employer share ofSocial Security tax that would otherwise be required to be paid during the period beginning onMarch 27, 2020 and 17 -------------------------------------------------------------------------------- endingDecember 31, 2020 . The CARES Act allows employers to deposit 50 percent of the deferred taxes on or beforeDecember 31, 2021 , and the remaining 50 percent byDecember 31, 2022 . We are also prepared to temporarily curtail operations in ourEast Providence, Rhode Island manufacturing facility if necessary to ensure the safety of our employees or to align capacity with the expected lower demand. However, these reductions and any subsequent actions we may take may not be sufficient to offset the impact of the expected decrease in revenue and we are likely to experience a year-over-year increase in net loss and decrease in Adjusted EBITDA in 2020.
Key Metrics and Non-GAAP Financial Measures
We regularly review a number of metrics, including the following key metrics, to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make strategic decisions.
Square Foot Operating Metric
We price our product and measure our product shipments in square feet. We estimate our annual capacity was 55 million square feet of aerogel blankets atMarch 31, 2020 . We believe the square foot operating metric allows us and our investors to measure our manufacturing capacity and product shipments on a uniform and consistent basis. The following chart sets forth product shipments in square feet associated with recognized revenue, including revenue recognized over time utilizing the input method, for the periods presented: Three Months Ended March 31, 2020 2019 (In thousands) Product shipments in square feet 8,165 8,685 Adjusted EBITDA We use Adjusted EBITDA, a non-GAAP financial measure, as a means to assess our operating performance. We define Adjusted EBITDA as net income (loss) before interest expense, taxes, depreciation, amortization, stock-based compensation expense and other items, from time to time, which we do not believe are indicative of our core operating performance. Adjusted EBITDA is a supplemental measure of our performance that is not presented in accordance withU.S. GAAP. Adjusted EBITDA should not be considered as an alternative to net income (loss) or any other measure of financial performance calculated and presented in accordance withU.S. GAAP. In addition, our definition and presentation of Adjusted EBITDA may not be comparable to similarly titled measures presented by other companies. We use Adjusted EBITDA:
• as a measure of operating performance because it does not include the
impact of items that we do not consider indicative of our core operating
performance;
• for planning purposes, including the preparation of our annual operating
budget; • to allocate resources to enhance the financial performance of our business; and • as a performance measure used under our bonus plan. We also believe that the presentation of Adjusted EBITDA provides useful information to investors with respect to our results of operations and in assessing the performance and value of our business. Various measures of EBITDA are widely used by investors to measure a company's operating performance without regard to items that can vary substantially from company to company depending upon financing and accounting methods, book values of assets, capital structures and the methods by which assets were acquired. Although measures similar to Adjusted EBITDA are frequently used by investors and securities analysts in their evaluation of companies, we understand that Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for net income (loss), income (loss) from operations, net cash provided by (used in) operating activities or an analysis of our results of operations as reported underU.S. GAAP. Some of these limitations are: • Adjusted EBITDA does not reflect our historical cash expenditures or future requirements for capital expenditures or other contractual commitments;
• Adjusted EBITDA does not reflect changes in, or cash requirements for, our
working capital needs; 18
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• Adjusted EBITDA does not reflect stock-based compensation expense; • Adjusted EBITDA does not reflect our income tax expense or cash requirements to pay our income taxes; • Adjusted EBITDA does not reflect our interest expense, or the cash requirements necessary to service interest or principal payments on our debt;
• although depreciation, amortization and impairment charges are non-cash
charges, the assets being depreciated, amortized or impaired will often
have to be replaced in the future, and Adjusted EBITDA does not reflect
any cash requirements for these replacements; and
• other companies in our industry may calculate EBITDA or Adjusted EBITDA
differently than we do, limiting their usefulness as a comparative
measure.
Because of these limitations, our Adjusted EBITDA should not be considered as a measure of discretionary cash available to us to reinvest in the growth of our business or as a measure of cash available for us to meet our obligations. To properly and prudently evaluate our business, we encourage you to review theU.S. GAAP financial statements included elsewhere in this Quarterly Report on Form 10-Q, and not to rely on any single financial measure to evaluate our business.
The following table presents a reconciliation of net loss, the most directly
comparable
Three Months Ended March 31, 2020 2019 (In thousands) Net loss$ (3,169 ) $ (6,002 ) Depreciation and amortization 2,563 2,532 Stock-based compensation(1) 992 878 Interest expense 83 41 Adjusted EBITDA$ 469 $ (2,551 ) (1) Represents non-cash stock-based compensation related to vesting and modifications of stock option grants, vesting of restricted stock units and vesting of restricted common stock. Our financial performance, including such measures as net income (loss), earnings per share and Adjusted EBITDA, are affected by a number of factors including volume and mix of aerogel products sold, average selling prices, our material and manufacturing costs, the costs associated with capacity expansions and start-up of additional production capacity, and the amount and timing of operating expenses, including patent enforcement costs. Accordingly, we expect that our net income (loss), earnings per share and Adjusted EBITDA will vary from period to period.
Components of Our Results of Operations
Revenue
We recognize product revenue from the sale of our line of aerogel products and research services revenue from the provision of services under contracts with various agencies of theU.S. government and other institutions. Product and research services revenue is recognized upon the satisfaction of contractual performance obligations. We record deferred revenue for product sales when (i) we have delivered products but other revenue recognition criteria have not been satisfied or (ii) payments have been received in advance of the completion of required performance obligations. At present, we are not certain of the extent of the impact that the COVID-19 pandemic and the global oil market volatility may have on our business. Our manufacturing facility remains operational and we have not yet encountered any significant disruption to our supply chain or our ability to deliver to our customers. However, the demand for our products has been negatively impacted and we expect to experience a year-over-year decrease in total revenue. 19 --------------------------------------------------------------------------------
Cost of Revenue
Cost of product revenue consists primarily of materials and manufacturing expense. Cost of product revenue is recorded when the related product revenue is recognized.
Material is our most significant component of cost of product revenue and includes fibrous batting, silica materials and additives. Material costs as a percentage of product revenue vary from product to product due to differences in average selling prices, material requirements, product thicknesses and manufacturing yields. In addition, we provide warranties for our products and record the estimated cost within cost of revenue in the period that the related revenue is recorded or when we become aware that a potential warranty claim is probable and can be reasonably estimated. As a result of these factors, material costs as a percentage of product revenue will vary from period to period due to changes in the mix of aerogel products sold, the costs of our raw materials or the estimated cost of warranties. We expect that material costs will decrease in absolute dollars during 2020 as we implement lower cost product formulations, seek enhanced yields and potentially as a result of any decrease in demand for our products associated with the COVID-19 pandemic and the global oil market volatility.
Manufacturing expense is also a significant component of cost of revenue. Manufacturing expense includes labor, utilities, maintenance expense, and depreciation on manufacturing assets. Manufacturing expense also includes stock-based compensation of manufacturing employees and shipping costs. We expect that manufacturing expense will decline in absolute dollars during 2020 principally due to our plan to reduce compensation costs and discretionary expenses in response to the general uncertainty in demand for our products associated with the COVID-19 pandemic and the global oil market volatility.
In total, we expect that cost of product revenue will decrease in absolute dollars during 2020, but may either increase or decrease as a percentage of product revenue versus 2019 due to uncertainty in our 2020 revenue levels associated with the COVID-19 pandemic and the global oil market volatility.
Cost of research services revenue consists of direct labor costs of research personnel engaged in contract research, third-party consulting and subcontractor expense, and associated direct material costs. This cost of revenue also includes overhead expenses associated with project resources, development tools and supplies. Cost of research services revenue is recorded when the related research services revenue is recognized. We expect cost of research services will decline as we wind down our existing contract research activities during 2020. Gross Profit Our gross profit as a percentage of revenue is affected by a number of factors, including the volume of aerogel products produced and sold, the mix of aerogel products sold, average selling prices, our material and manufacturing costs, realized capacity utilization and the costs associated with expansions and start-up of production capacity. Accordingly, we expect our gross profit in absolute dollars and as a percentage of revenue to vary significantly from period to period. During 2020, the demand for our products has been negatively impacted due to the COVID-19 pandemic and the global oil market volatility and we expect to experience a year-over-year decrease in total revenue. We also expect that material costs will decrease as a result of lower cost product formulations, enhanced yields and potentially due to any decrease in demand for our products. In addition, we expect that manufacturing expenses will decline principally due to our plan to reduce compensation costs and discretionary expenses. However, these material cost and manufacturing reductions may not be sufficient to offset the impact of the expected decrease in revenue and we are likely to experience a year-over-year decrease in gross profit both in absolute dollars and as a percentage of revenue during 2020.
Operating Expenses
Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. Operating expenses include personnel costs, legal fees, professional fees, service fees, insurance premiums, travel expense, facilities related costs and other costs and fees. The largest component of our operating expenses is personnel costs, consisting of salaries, benefits, incentive compensation and stock-based compensation. In any particular period, the timing and extent of personnel additions or reductions, legal activities, including patent enforcement actions, marketing programs, research efforts and a range of similar activities or actions could materially affect our operating expenses, both in absolute dollars and as a percentage of revenue.
We expect that operating expenses will decline in absolute dollars during 2020 principally due to our plan to reduce compensation costs and discretionary expenses in response to the general uncertainty in demand for our products associated with the COVID-19 pandemic and the global oil market volatility. However, operating expenses may either increase or decrease as a
20 --------------------------------------------------------------------------------
percentage of revenue versus 2019 due to the uncertain impact that the COVID-19 pandemic and the global oil market volatility may have on our 2020 revenue levels.
Research and Development Expenses
Research and development expenses consist primarily of expenses for personnel engaged in the development of next generation aerogel compositions, form factors and manufacturing technologies. These expenses also include testing services, prototype expenses, consulting services, trial formulations for new products, equipment depreciation, facilities costs and related overhead. We expense research and development costs as incurred. We expect to continue to devote substantial resources to the development of new aerogel technologies. We believe that these investments are necessary to maintain and improve our competitive position. We expect to continue to invest in research and engineering personnel and the infrastructure required in support of their efforts. We expect that research and development expenses will decline in absolute dollars during 2020 principally due to our plan to reduce compensation costs and discretionary expenses in response to the general uncertainty in demand for our products. However, research and development expenses may either increase or decrease as a percentage of revenue versus 2019 due to the uncertain impact that the COVID-19 pandemic and the global oil market volatility may have on our 2020 revenue levels.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of personnel costs, incentive compensation, marketing programs, travel and related costs, consulting expenses and facilities related costs. We expect that sales and marketing expenses will decline in absolute dollars during 2020 principally due to our plan to reduce compensation costs and discretionary expenses in response to the general uncertainty in demand for our products. However, sales and marketing expenses may either increase or decrease as a percentage of revenue versus 2019 due to the uncertain impact that the COVID-19 pandemic and the global oil market volatility may have on our 2020 revenue levels.
General and Administrative Expenses
General and administrative expenses consist primarily of personnel costs, legal expenses, consulting and professional services, audit and tax consulting costs, and expenses for our executive, finance, legal, human resources and information technology organizations. General and administrative expenses have increased as we have incurred additional costs related to operating as a publicly-traded company, which include costs of compliance with securities regulations, corporate governance and related laws and regulations, investor relations expenses, increased insurance premiums, including director and officer insurance, and increased audit and legal fees. In addition, we expect our general and administrative expenses to increase as we add general and administrative personnel to support the anticipated growth of our business. We also expect that the patent enforcement actions, described in more detail under "Legal Proceedings" in Part II, Item 1 of this Quarterly Report on Form 10-Q, if protracted, could result in significant legal expense over the medium to long-term. We expect that general and administrative expenses will decline in absolute dollars during 2020 principally due to our plan to reduce compensation costs and discretionary expenses in response to the general uncertainty in demand for our products. However, general and administrative expenses may either increase or decrease as a percentage of revenue versus 2019 due to the uncertain impact that the COVID-19 pandemic and the global oil market volatility may have on our 2020 revenue levels. Interest Expense, Net
Interest expense, net consists primarily of fees and interest expense related to our revolving credit facility.
Provision for Income Taxes
We have incurred net losses since inception and have not recorded benefit provisions forU.S. federal income taxes or state income taxes since the tax benefits of our net losses have been offset by valuation allowances due to the uncertainty associated with the utilization of net operating loss carryforwards. 21 --------------------------------------------------------------------------------
Results of Operations
Three months ended
The following tables set forth a comparison of the components of our results of operations for the periods presented:
Revenue Three Months Ended March 31, 2020 2019 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Revenue: Product$ 28,307 100 %$ 26,785 96 %$ 1,522 6 % Research services 112 0 % 1,127 4 % (1,015 ) (90 )% Total revenue$ 28,419 100 %$ 27,912 100 %$ 507 2 % The following chart sets forth product shipments in square feet associated with recognized revenue, including revenue recognized over time utilizing the input method, for the periods presented: Three Months Ended March 31, Change 2020 2019 Amount Percentage Product shipments in square feet (in thousands) 8,165 8,685 (520 ) (6 )% Total revenue increased$0.5 million , or 2%, to$28.4 million for the three months endedMarch 31, 2020 from$27.9 million in the comparable period in 2019 as a result of an increase in product revenue, offset, in part, by a decrease in research services revenue. Product revenue increased by$1.5 million , or 6%, to$28.3 million for the three months endedMarch 31, 2020 from$26.8 million in the comparable period in 2019. This increase was principally the result of growth in the US petrochemical and refinery markets, an increase in project-based demand in the LNG market, the impact of price increases enacted in 2019 and 2020, and a favorable mix of products sold, offset, in part, by decreases in project-based demand in the subsea market and the Canadian petrochemical and refinery market. Product revenue for the three months endedMarch 31, 2020 included$7.0 million to a North American distributor and$4.6 million to an Asian LNG project contractor. Product revenue for the three months endedMarch 31, 2019 included$5.6 million to a North American distributor and$4.5 million to a European subsea contractor. The average selling price per square foot of our products increased by$0.39 , or 13%, to$3.47 per square foot for the three months endedMarch 31, 2020 from$3.08 per square foot for the three months endedMarch 31, 2019 . The increase in average selling price principally reflected the impact of price increases enacted in 2019 and 2020. This increase in average selling price had the effect of increasing product revenue by$3.1 million for the three months endedMarch 31, 2020 from the comparable period in 2019. In volume terms, product shipments decreased by 0.5 million square feet, or 6%, to 8.2 million square feet of aerogel products for the three months endedMarch 31, 2020 , as compared to 8.7 million square feet for the three months endedMarch 31, 2019 . The decrease in product volume had the effect of decreasing product revenue by$1.6 million for the three months endedMarch 31, 2020 from the comparable period in 2019. Research services revenue decreased$1.0 million , or 90%, to$0.1 million for the three months endedMarch 31, 2020 from$1.1 million in the comparable period in 2019. The decrease was primarily due to our decision to wind down our contract research activities during 2020 to focus our research and development resources on improving our existing business profitability on developing new products and next generation technology with application in new, high value market segments. Product revenue was nearly 100% of total revenue for the three months endedMarch 31, 2020 and 96% of total revenue for the three months endedMarch 31, 2019 . Research services revenue was less than 1% of total revenue for the three months endedMarch 31, 2020 and 4% of total revenue for the three months endedMarch 31, 2019 . 22
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Cost of Revenue Three Months Ended March 31, 2020 2019 Change Percentage Percentage Percentage Percentage of Related of Total of Related of Total Amount Revenue Revenue Amount Revenue Revenue Amount Percentage ($ in thousands) Cost of revenue: Product$ 22,399 79 % 79 %$ 23,478 88 % 84 %$ (1,079 ) (5 )% Research services 40 36 % 0 % 716 64 % 3 % (676 ) (94 )% Total cost of revenue$ 22,439 79 % 79 %$ 24,194 87 % 87 %$ (1,755 ) (7 )% Total cost of revenue decreased$1.8 million , or 7%, to$22.4 million for the three months endedMarch 31, 2020 from$24.2 million in the comparable period in 2019. The decrease in total cost of revenue was the result of decreases in both product cost of revenue and research services cost of revenue. Product cost of revenue decreased by$1.1 million , or 5%, to$22.4 million for the three months endedMarch 31, 2020 from$23.5 million in the comparable period in 2019. The$1.1 million decrease was the result of a$1.5 million decrease in material costs, offset, in part, by a$0.4 million increase in manufacturing expense. The decrease in material costs was the result of the 0.5 million square feet, or 6%, decrease in total product shipments, the impact of lower cost product formulations and material purchasing efficiencies, and a favorable mix of products sold. The increase in manufacturing expense was the result of increases in compensation and related costs of$0.4 million , maintenance expense of$0.1 million , and other manufacturing expenses of$0.1 million , offset, in part, by a decrease in utilities expense of$0.2 million . Product cost of revenue as a percentage of product revenue decreased to 79% during the three months endedMarch 31, 2020 from 88% during the three months endedMarch 31, 2019 . This decrease was driven by both the decrease in product cost of revenue and the increase in product revenue during the three months endedMarch 31, 2020 . Research services cost of revenue decreased$0.7 million , or 94%, to less than$0.1 million for the three months endedMarch 31, 2020 from$0.7 million for the comparable period in 2019. Cost of research service revenue as a percentage of research services revenue decreased to 36% during the three months endedMarch 31, 2020 from 64% in the comparable period in 2019 due to a decrease in the proportion of third-party services utilized to support the contracted research. Gross Profit Three Months Ended March 31, 2020 2019 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Gross profit$ 5,980 21 %$ 3,718 13 %$ 2,262 61 % Gross profit increased by$2.3 million , or 61%, to$6.0 million for the three months endedMarch 31, 2020 from$3.7 million in the comparable period in 2019. The increase in gross profit was the result of the$0.5 million increase in total revenue and the$1.8 million decrease in total cost of revenue. The increase in revenue was principally associated with growth in the US petrochemical and refinery markets, an increase in project-based demand in the LNG market, the impact of price increases enacted in 2019 and 2020, and a favorable mix of products sold, offset, in part, by decreases in project-based demand in the subsea market and the Canadian petrochemical and refinery markets. The decrease in total cost of revenue was the result of the 0.5 million square feet, or 6%, decrease in total product shipments, the impact of lower cost product formulations and material purchasing efficiencies, and a favorable mix of products sold, offset, in part, by an increase in manufacturing expense. Gross profit as a percentage of total revenue increased to 21% of total revenue for the three months endedMarch 31, 2020 from 13% in the comparable period in 2019. 23
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Research and Development Expenses
Three Months Ended March 31, 2020 2019 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Research and development expenses$ 2,227 8 %$ 1,928 7 %$ 299 16 % Research and development expenses increased by$0.3 million , or 16%, to$2.2 million for the three months endedMarch 31, 2020 from$1.9 million in the comparable period in 2019. The$0.3 million increase was the result of increases in compensation and related costs of$0.2 million and other research and development costs of$0.1 million . Research and development expenses as a percentage of total revenue increased to 8% for the three months endedMarch 31, 2020 from 7% in the comparable period in 2019 due to the increase in research and development expenses, offset, in part, by the increase in revenue during the three months endedMarch 31, 2020 .
Sales and Marketing Expenses
Three Months Ended March 31, 2020 2019 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Sales and marketing expenses$ 3,324 12 %$ 3,511 13 %$ (187 ) (5 )% Sales and marketing expenses decreased by$0.2 million , or 5%, to$3.3 million from$3.5 million in the comparable period in 2019. The$0.2 million decrease was the result of decreases in compensation and related costs of$0.3 million and travel expense of$0.1 million , offset, in part, by an increase in sales consultant expense of$0.2 million . Sales and marketing expenses as a percentage of total revenue decreased to 12% for the three months endedMarch 31, 2020 from 13% in the comparable period in 2019 due to both the decrease in sales and marketing expenses and the increase in revenue.
General and Administrative Expenses
Three Months Ended March 31, 2020 2019 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) General and administrative expenses$ 3,515 12 %$ 4,240 15 %$ (725 ) (17 )% General and administrative expenses decreased by$0.7 million , or 17%, to$3.5 million during the three months endedMarch 31, 2020 from$4.2 million in the comparable period in 2019. The$0.7 million decrease was the result of decreases in compensation and related costs of$0.4 million , patent enforcement costs of$0.2 million and other general and administrative costs of$0.1 million
General and administrative expenses as a percentage of total revenue decreased
to 12% for the three months ended
Interest Expense, net Three Months Ended March 31, 2020 2019 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Interest expense, net$ (83 ) (0 )%$ (41 ) (0 )%$ (42 ) 102 % 24
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Interest expense, net, consists primarily of fees and interest expense
associated with outstanding balances under our revolving credit agreement and
was
Liquidity and Capital Resources
Overview
We have experienced significant losses and invested substantial resources since our inception to develop, commercialize and protect our aerogel technology and to build a manufacturing infrastructure capable of supplying aerogel products at the volumes and costs required by our customers. These investments have included research and development and other operating expenses, capital expenditures and investment in working capital balances. Through 2015, we experienced revenue growth and gained share in our target markets. Despite a decline in revenue in 2016, 2017 and 2018, we experienced strong growth in revenue, gross profit and cash flows from operations during 2019. Our financial projections anticipate long-term revenue growth, increasing levels of gross profit and improved cash flow from operations. To support this growth, we initiated a plan in 2018 to increase the capacity of ourEast Providence, Rhode Island manufacturing facility to approximately 60 million square feet of aerogel blankets by the end of 2020. We may incur additional capital expenditures to complete this plan during 2020. We have taken several actions to date in 2020 to increase the financial resources available to support current operating requirements, capacity expansions and strategic investments. InFebruary 2020 , we completed an underwritten public offering of our common stock and received net proceeds of$14.8 million . InMarch 2020 , we extended the maturity of our revolving credit facility withSilicon Valley Bank toApril 28, 2021 . OnMay 1, 2020 , our subsidiary,Aspen Aerogels Rhode Island, LLC , executed a promissory note to receive loan proceeds of approximately$3.7 million under the Paycheck Protection Program (PPP) of the CARES Act. We believe that our existing cash balance, expected PPP loan proceeds, and available credit will be sufficient to support operations, complete the planned capacity expansion of ourEast Providence manufacturing facility and to fund our planned strategic business initiatives.
However, we are not certain of the extent of the impact that the COVID-19 pandemic and the global oil market volatility may have on our business. The demand for our products has been negatively impacted and we expect to experience a year-over-year decrease in total revenue.
In response to the general uncertainty in demand for our products, we instituted a number of actions to reduce expenses and to improve liquidity during the first quarter andApril 2020 . However, these actions and any subsequent actions we may take may not be sufficient to offset the impact of the expected decrease in revenue and we are likely to experience a year-over-year increase in net loss, a decrease in Adjusted EBITDA and an increase in cash used in operating activities during 2020.
As a result, we may need to supplement our cash balance, expected PPP loan proceeds, and available credit with additional debt financings, customer prepayments, technology licensing fees or equity financings to provide the capital necessary to fund operating requirements, complete future capacity expansions or to support evolving strategic business initiatives.
Primary Sources of Liquidity
Our principal sources of liquidity are currently our cash and cash equivalents and our revolving credit facility withSilicon Valley Bank . Cash and cash equivalents consist primarily of cash and money market accounts on deposit with banks. As ofMarch 31, 2020 , we had$11.8 million of cash and cash equivalents. OnFebruary 18, 2020 , we completed an underwritten public offering of 1,955,000 shares of our common stock at an offering price of$8.25 per share. We received net proceeds of$14.8 million after deducting underwriting discounts and commissions of$1.1 million and offering expenses of approximately$0.3 million . OnMay 1, 2020 , our wholly-owned subsidiary,Aspen Aerogels Rhode Island, LLC , secured a PPP loan established as part of the CARES Act for the principal amount of approximately$3.7 million . The PPP loan and related accrued interest may be forgivable after eight weeks by application to the PPP lender provided that the subsidiary maintain the payroll level and use the loan proceeds for eligible purposes, including payroll, benefits, rent, and utilities of the subsidiary. The amount of loan forgiveness will be reduced if the subsidiary does not maintain the number of employees or reduce their salaries below certain levels during the eight-week period. The 25 -------------------------------------------------------------------------------- PPP loan is payable over two years at an interest rate of 1%, with a deferral of payments for the first six months. Our subsidiary intends to use the proceeds for purposes consistent with the PPP and we believe that our subsidiary's use of the loan proceeds will meet the conditions for forgiveness of at least a portion of the loan. AtMarch 31, 2020 , we had no outstanding borrowings under our revolving credit facility withSilicon Valley Bank ,$1.2 million of outstanding letters of credit secured by the revolving credit facility and an obligation of$9.9 million associated with prepayments received pursuant to our supply agreement with BASF. We have maintained the revolving credit facility, as amended from time to time, withSilicon Valley Bank sinceMarch 2011 . OnMarch 3, 2020 , our revolving credit facility was amended to extend the maturity date of the facility toApril 28, 2021 . The amendment to the credit facility also established certain minimum Adjusted EBITDA levels with respect to the minimum Adjusted EBITDA financial covenant for the extended term. Under our revolving credit facility, we are permitted to borrow a maximum of$20.0 million , subject to continued covenant compliance and borrowing base requirements. At our election, the interest rate applicable to borrowings under the revolving credit facility may be based on the prime rate or LIBOR. Prime rate-based rates vary from prime rate plus 0.75% per annum to prime rate plus 2.00% per annum, while LIBOR-based rates vary from LIBOR plus 3.75% per annum to LIBOR plus 4.25% per annum. In addition, we are required to pay a monthly unused revolving line of credit facility fee of 0.5% per annum of the average unused portion of the revolving credit facility. We intend to extend or replace the facility prior to its maturity.
Under the revolving credit facility, we are required to comply with both
non-financial and financial covenants, including the minimum Adjusted EBITDA
covenant, as defined in the loan agreement. At
The amount available to us under the facility at
Analysis of Cash Flow
During the three months endedMarch 31, 2020 , we used$1.4 million in net cash in operating activities, as compared to the use of$3.0 million in net cash during the comparable period in 2019, a decrease in the use of cash of$1.6 million . This decrease in use of cash was the result of a decrease in net loss adjusted for non-cash items of$3.0 million , offset, in part, by an increase in cash used by changes in operating assets and liabilities of$1.4 million .
Net cash used in investing activities is primarily related to capital expenditures to support our growth. Net cash used in investing activities for the three months endedMarch 31, 2020 and 2019 was$0.9 million and$0.6 million , respectively, in capital expenditures primarily for machinery and equipment to improve the capacity, throughput, efficiency and reliability of ourEast Providence facility.
Net Cash Provided by Financing Activities
Net cash provided by financing activities for the three months endedMarch 31, 2020 totaled$10.4 million and consisted of$19.4 million in borrowings under our line of credit and$14.8 million in net proceeds from an underwritten public offering of our common stock, offset, in part, by$22.6 million of repayments under our line of credit and$1.2 million in cash used for payments made for employee tax withholdings associated with the vesting of restricted stock units. Net cash provided by financing activities for the three months endedMarch 31, 2019 totaled$3.7 million and consisted of$36.9 million in borrowings under our line of credit and$5.0 million in prepayment proceeds under our supply agreement with BASF, offset, in part, by$37.8 million of repayments under our line of credit and$0.4 million in cash used for payments made for employee tax withholdings associated with the vesting of restricted stock units.
Off Balance Sheet Arrangements
Since inception, we have not engaged in any off balance sheet activities as defined in Item 303(a)(4) of Regulation S-K.
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Contractual Obligations and Commitments
There have been no material changes to our contractual obligations and commitments as reported in our Annual Report.
Recent Accounting Pronouncements
Information regarding new accounting pronouncements is included in note 2 to our unaudited consolidated financial statements contained in Item 1 of this Quarterly Report on Form 10-Q.
Critical Accounting Policies and Estimates
Our financial statements are prepared in accordance withU.S. GAAP. The preparation of our financial statements and related disclosures requires us to make estimates, assumptions and judgments that affect the reported amount of assets, liabilities, revenue, costs and expenses and related disclosures. We believe that the estimates, assumptions and judgments involved in these accounting policies have the greatest potential impact on our financial statements and, therefore, we consider these to be our critical accounting policies. Accordingly, we evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions and conditions. See our Annual Report and note 2 to our consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for information about these critical accounting policies, as well as a description of our other significant accounting policies.
Certain Factors That May Affect Future Results of Operations
TheSEC encourages companies to disclose forward-looking information so that investors can better understand a company's future prospects and make informed investment decisions. This Quarterly Report on Form 10-Q contains such "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other important factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Forward-looking statements include, but are not limited to, statements about: our beliefs in the appropriateness of our assumptions, the accuracy of our estimates regarding expenses, loss contingencies, future revenues, future profits, uses of cash, available credit, expected SBA Loan Proceeds, capital requirements, and the need for additional financing to operate our business, including to complete the planned capacity expansion of ourEast Providence manufacturing facility, and to fund our planned strategic business initiatives; the performance of our aerogel blankets; our expectation that we will be successful in obtaining, enforcing and defending our patents against competitors and that such patents are valid and enforceable; our belief that our products possess strong competitive advantages over traditional insulation materials, including the superior thermal performance and the thin, easy-to-use and durable blanket form of our products; our plans to expand capacity in ourEast Providence, Rhode Island manufacturing facility; our estimates of annual production capacity; our expectation to achieve our EP20 goals by the end of 2020; our strategic partnership with BASF and the potential benefits of such a relationship, including the potential for it to create new product and market opportunities; our supply agreement with BASF, our supply to BASF of its Spaceloft A2 product and newly developed product, the potential for future cash advances from BASF under our supply agreement with BASF (payment of which are subject to certain conditions) to provide a source of financing for some portion of the cost of the planned capacity expansion in ourEast Providence, Rhode Island manufacturing facility and the potential for BASF to become a significant customer for our products; our joint development agreement with BASF, and the potential for it to support the development of new aerogel products and technologies; our beliefs about the usefulness of the square foot operating metric; our beliefs about the financial metrics that are indicative of our core performance; our beliefs about the usefulness of our presentation of Adjusted EBITDA; our expectations about the effect of manufacturing capacity on financial metrics such as Adjusted EBITDA; our expectations about future revenues, expenses, gross profit, net loss, loss per share and Adjusted EBITDA, sources and uses of cash, capital requirements and the sufficiency of our existing cash balance and available credit; our beliefs about the outcome, effects or estimated costs of current or potential litigation or their respective timing, including expected legal expense in connection with our patent enforcement actions; our plans to devote substantial resources to the development of new aerogel technology; our expectations about product mix; our expectations about future material costs and manufacturing expenses as a percentage of revenue; our expectations of future gross profit and the effect of manufacturing expenses, manufacturing capacity and productivity on gross profit; our expectations about our resources and other investments in new technology and related research and development activities and associated expenses; our expectations about short and long term (a) research and development (b) general and administrative and (c) sales and marketing expenses; our expectations of revenue growth, increased gross profit, and improving cash flows over the long term; our intentions about managing capital expenditures and working capital balances; our expectations about incurring significant capital expenditures in the future; our expectations about the expansion of our workforce and resources and its effect on sales and marketing, general and administrative, and related expenses; our expectations about future product revenue and demand for our products; our expectations about the effect of stock based compensation on various costs and expenses; our expectations about potential sources of future financing; our beliefs about the impact of accounting policies on our financial statements; our beliefs about the effect of interest rates, inflation and foreign currency fluctuations on our results of operations and 27
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financial condition; our beliefs about the expansion of our international operations; our statements about the impact of major public health concerns, including the COVID-19 pandemic or other pandemics arising globally, and the future, and currently unknown, impact of the COVID-19 pandemic on our business and operations; our statements about the sufficiency of our current and future actions to address the impact of the COVID-19 pandemic on our business and operations, including our future revenue, Adjusted EBITDA and other financial metrics; our belief that we qualify for partial or complete forgiveness of the SBA Loan; and changes by governmental authorities regarding the CARES Act or related administrative matters and the Company's and its subsidiary's abilities to comply with the terms of the SBA Loans and the CARES Act, including to use the proceeds of the SBA Loans as described herein. Words such as "may," "will," "anticipate," "estimate," "expects," "projects," "intends," "plans," "believes" and words and terms of similar substance used in connection with any discussion of future operating or financial performance, identify forward-looking statements. All forward-looking statements are management's present expectations of future events and are subject to a number of risks and uncertainties that could cause actual results to differ materially and adversely from those described in the forward-looking statements. These risks include, but are not limited to, those set forth in this Quarterly Report on Form 10-Q and under the heading "Risk Factors" contained in Item 1A of our Annual Report. In light of these assumptions, risks and uncertainties, the results and events discussed in the forward-looking statements contained in this Quarterly Report on Form 10-Q might not occur. Stockholders and other readers are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We are not under any obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. All subsequent forward-looking statements attributable toAspen Aerogels, Inc. or to any person acting on its behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.
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