News Column

ASPEN AEROGELS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

August 8, 2014

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 Prospectus that forms a part of our Registration Statement on Form S-1 (File No. 333-195523), which was filed with the Securities and Exchange Commission (the "SEC") pursuant to Rule 424(b) on June 16, 2014, which we refer to as the Prospectus. 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. 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, 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, including those risks identified under Part II, Item 1A, and the "Risk Factors" section of the Prospectus.

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 the SEC, 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 Information" and our financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. Overview We design, develop and manufacture innovative, high-performance aerogel insulation. 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, reduce energy use, preserve operating assets and protect workers.



Our insulation is used by oil producers and the owners and operators of refineries, petrochemical plants, LNG facilities, power generating assets and other energy infrastructure. Our Pyrogel and Cryogel product lines were introduced in 2008 and have undergone

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rigorous technical validation by industry leading end-users and achieved significant market adoption. We also derive product revenue from the building and construction and other end markets. Customers in these markets use our aerogels for applications as diverse as wall systems, military and commercial aircraft, trains, buses, appliances, apparel, footwear and outdoor gear.



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 North America, Europe and Asia. The efforts of our sales force are supported by a small number of sales consultants with extensive knowledge of a particular market or region. Our sales force is responsible for establishing and maintaining customer and partner relationships, delivering highly technical information and ensuring high-quality customer service.

Our salespeople work directly with end-use customers and engineering firms to promote 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 30 countries around the world that ensures 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 the U.S. government, including the Department of Defense and the Department of Energy, and other institutions. Research performed under contract with government agencies and other institutions enables us to develop and leverage technologies into broader commercial applications. We manufacture our products using our proprietary process and technology at our facility in East Providence, Rhode Island. We have operated the East Providence facility since 2008. We commenced operation of a second production line at this facility at the end of March 2011, which doubled our annual nameplate capacity to 40 million to 44 million square feet of aerogel blankets, depending on product mix. We commenced construction of a third production line in the East Providence facility during the three months ended June 30, 2014 with a total construction cost estimate of $30 million. We expect that this third production line will increase our annual nameplate capacity by 10 million to 11 million square feet of aerogel blankets when construction is concluded in the first half of 2015. Our revenue for the six months ended June 30, 2014 was $49.0 million, which represented an increase of 22% from the six months ended June 30, 2013. Net loss for the six months ended June 30, 2014 was $61.2 million and diluted loss per share attributable to common stockholders was $40.05. Net loss for the six months ended June 30, 2014 included a total of $38.8 million of expense or $25.42 per share attributable to common stockholders related to expenses recorded in connection with the closing of our initial public offering including (i) recognition of compensation cost of performance-based stock options of $5.6 million, and (ii) accretion of convertible notes to final conversion value of $33.2 million.



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 have produced in excess of 100 million square feet of aerogel blankets in the East Providence facility since 2008. We estimate our annual production capacity is currently 40 million to 44 million square feet of aerogel blankets, depending on product mix. We believe the square foot operating metric allows us and our investors to measure the growth in our manufacturing capacity and product shipments on a uniform and consistent basis. The following chart sets forth product shipments associated with recognized revenue in square feet for the periods presented: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (Square feet in thousands)



Product shipments in square feet 10,088 8,850 18,891 16,220

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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 that we do not believe are indicative of our core operating performance, which recently have included loss on disposal of assets, gain or loss on extinguishment or exchange of debt, write-off of costs of postponed financing activities and write-off of construction in progress. Adjusted EBITDA is a supplemental measure of our performance that is not presented in accordance with 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 with 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 GAAP, income from operations or an analysis of our results of operations as reported under 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; Adjusted EBITDA does not reflect stock-based compensation expense;



Adjusted EBITDA does not reflect our 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 the 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. 22



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The following table presents a reconciliation of net income (loss), the most directly comparable GAAP measure, to Adjusted EBITDA for the periods presented: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 ($ in thousands) Net income (loss) $ (42,148 )$ (18,984 )$ (61,196 )$ (17,957 ) Interest expense (1) 34,027 15,620 50,178 12,255 Depreciation and amortization 2,547 2,479 5,179 4,948 Loss on disposal of assets - - 15 - Stock-based compensation (2) 6,006 510 6,344 1,005 Gain on extinguishment of convertible notes - - - (8,898 ) Loss on exchange of convertible notes - 485 - 5,697 Write-off of costs associated with postponed public offering - 241 - 241 Adjusted EBITDA $ 432$ 351$ 520$ (2,709 )



(1) Interest expense consists primarily of fair market value adjustments related

to our subordinated notes, senior convertible notes, convertible notes and

Series C warrants, subordinated note and convertible note issuance costs, the

amortization of the subordinated note debt discount, and imputed interest on

our obligations under our cross license agreement with Cabot Corporation.

(2) Represents non-cash stock-based compensation related to vesting and

modifications of stock option grants.

Our Adjusted EBITDA is affected by a number of factors including the mix between product revenue and research services revenue, the mix of aerogel products sold, average selling prices, average material costs, our actual manufacturing costs, the costs associated with and timing of expansions and start-up of additional production capacity, and the amount and timing of operating expenses. As we continue to grow our base of product revenue and to build out manufacturing capacity, we expect increased manufacturing expenses will periodically have a negative impact on Adjusted EBITDA, but will set the framework for improved Adjusted EBITDA moving forward. Accordingly, we expect that our Adjusted EBITDA will vary from period to period as we expand our manufacturing capacity.



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 the U.S. government and other institutions. Product revenue is recognized upon transfer of title and risk of loss, which is generally upon shipment or delivery. Cost of Revenue Cost of revenue for our product revenue consists primarily of materials and manufacturing expense, including direct labor and manufacturing overhead, including depreciation. Cost of product revenue is recorded when the related product revenue is recognized. Cost of product revenue also includes stock-based compensation of manufacturing employees and costs of shipping. 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, blanket thickness and manufacturing yields. As a result, material costs as a percentage of revenue will vary from period to period due to changes in the mix of aerogel products sold. However, in general, we expect material costs in the aggregate to decline as a percentage of revenue as we seek to achieve higher selling prices, material sourcing improvements, new material sources and manufacturing yield enhancements for our aerogel products. 23



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Manufacturing expense is also a significant component of cost of revenue. As we continue to increase manufacturing capacity in our East Providence facility and a second plant, we expect manufacturing expense as a percentage of product revenue will increase in the near-term following each expansion but will decrease in the long-term with increased revenues supported by the effect of completed capacity expansions. Cost of revenue for our research services revenue consists primarily of direct labor costs of research personnel committed to funded research and development contracts, as well as third-party consulting, and associated direct material costs. This cost of revenue also includes overhead expenses associated with project resources, engineering tools and supplies. Cost of revenue for our research services revenue is recorded when the related research services revenue is recognized.



Gross Profit

Our gross profit as a percentage of revenue is affected by a number of factors, including the mix between product revenue and research services revenue, the mix of aerogel products sold, average selling prices, average material costs, our actual manufacturing costs and the costs associated with expansions and start-up of production capacity. As we continue to build out our manufacturing capacity, we expect increased manufacturing expenses will periodically have a negative impact on gross profit, but will set the framework for improved gross profit moving forward. Accordingly, we expect our gross profit in absolute dollars and as a percentage of revenue to vary from period to period as we expand our manufacturing capacity. However, in general, following the completion of our capacity expansions, we expect gross profit to improve as a percentage of revenue in the long-term due to increases in manufacturing productivity, increased production volumes, improved manufacturing yields and material purchasing efficiencies.



Operating Expenses

Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. The largest component of our operating expenses is personnel costs, consisting of salaries, benefits, incentive compensation and stock-based compensation. We expect to continue to hire a significant number of new employees in order to support our anticipated growth. In any particular period, the timing of additional hires could materially affect our operating expenses, both in absolute dollars and as a percentage of revenue.



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, 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 technology. We believe that these investments are necessary to maintain and improve our competitive position. We expect that our research and development expenses will increase as we continue to invest in additional research and engineering personnel and the infrastructure required in support of their efforts. Accordingly, we expect that our research and development expenses will continue to increase in absolute dollars but decrease as a percentage of revenue in the long-term.



Sales and Marketing Expenses

Sales and marketing expenses consist primarily of personnel costs, incentive compensation, marketing programs, travel and related costs and consulting expenses. We plan to expand our sales force and sales consultants globally to drive anticipated growth in customers and demand for our products. We expect that sales and marketing expenses will continue to increase in absolute dollars but decrease as a percentage of revenue in the long-term.



General and Administrative Expenses

General and administrative expenses consist primarily of personnel costs, legal expenses, consulting and professional services, tax and audit costs, and expenses for our executive, finance, human resources and information technology organizations. We expect general and administrative expenses to increase as we incur additional costs related to operating as a publicly-traded company, including costs of compliance with securities, corporate governance and related regulations, investor relations expenses, increased insurance premiums, including director and officer insurance, and increased audit and legal fees. In addition, we expect to add general and administrative personnel to support the anticipated growth of our business and continued expansion of our manufacturing operations. We expect that general and administrative expenses will continue to increase in absolute dollars but decrease as a percentage of revenue in the long-term. 24



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Other Income (Expense)

Other income (expense) consists of (i) interest expense consisting primarily of fair market value adjustments to our subordinated notes, convertible notes and the issuance of our Series C warrants, subordinated and convertible note issuance costs, the amortization of the subordinated note debt discount, and other interest, (ii) gains or losses on extinguishment or exchange of subordinated notes and convertible notes and (iii) costs associated with a postponed public offering.



Provision for Income Taxes

We have incurred net losses since inception and have not recorded benefit provisions for U.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.



Results of Operations

Three months ended June 30, 2014 compared to the three months ended June 30, 2013

The following tables set forth a comparison of the components of our results of operations for the periods presented:

Revenue Three Months Ended June 30, 2014 2013 Percentage Percentage of of Change Amount Revenue Amount Revenue Amount Percentage Revenue: Product $ 25,893 97% $ 21,801 95% $ 4,092 19% Research services 722 3% 1,177 5% (455 ) (39)%



Total Revenue $ 26,615 100% $ 22,978 100% $ 3,637 16%

The following chart sets forth product shipments in square feet for the periods presented: Three Months Ended June 30, Change 2014 2013 Amount Percentage Product shipments in square feet (in thousands) 10,088 8,850 1,238 14 % Total revenue increased $3.6 million, or 16%, to $26.6 million for the three months ended June 30, 2014 from $23.0 million in the comparable period in 2013, primarily as a result of an increase in product revenue. Product revenue increased $4.1 million, or 19%, to $25.9 million for the three months ended June 30, 2014 from $21.8 million in the comparable period in 2013. This increase was principally the result of an increase in sales of our aerogel products in the petrochemical sector in Asia and South America. The revenue increase reflects price increases enacted during the last half of 2013 and the first six months of 2014 and a shift in mix of aerogel products sold toward higher priced products. The average selling price per square foot of our products increased by an effective $0.11, or 4%, to $2.57 per square foot for the three months ended June 30, 2014 from $2.46 per square foot for the comparable period in 2013. In volume terms, product shipments increased 1.2 million square feet, or 14%, to 10.1 million square feet of aerogel products for the three months ended June 30, 2014, as compared to 8.9 million square feet in the comparable period in 2013. The increase in demand during the three months ended June 30, 2014 included increased sales of $3.6 million for use in a petrochemical facility expansion by a major Asian energy company, $1.2 million to a South American distributor primarily related to the construction of expanded capacity at a petrochemical plant in Brazil, and $0.9 million to a Korean distributor for general distribution into the petrochemical sector. 25



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Research services revenue decreased $0.5 million to $0.7 million for the three months ended June 30, 2014 from $1.2 million in the comparable period in 2013. The decrease was primarily due to a reduction in active research contracts with government agencies during 2014. During the three months ended June 30, 2014, we provided research services on six contracts compared to 13 contracts in the comparable period in 2013. This decrease in contracts is principally the result of certain limitations on our eligibility to receive contract awards under federal guidelines and programs due to a variety of factors including the size of our revenues, the number of our employees and the makeup of our ownership. Product revenue was 97% and 95% of total revenue for the three months ended June 30, 2014 and 2013, respectively. Research services revenue was 3% and 5% of total revenue for the three months ended June 30, 2014 and 2013, respectively. We expect that product revenue will increase as a percentage of our total revenue due to the anticipated growth in demand for our products in the energy infrastructure market. Cost of Revenue Three Months Ended June 30, 2014 2013 Change Percentage Percentage Percentage Percentage of Related of Total of Related of Total Amount Revenue Revenue Amount Revenue Revenue Amount Percentage ($ in thousands) Cost of revenue: Product $ 22,850 88% 86% $ 18,876 87% 82% $ 3,974 21% Research services 340 47% 1% 571 49% 2% (231 ) (40%) Total cost of revenue $ 23,190 87% 87% $ 19,447 85% 85% $ 3,743 19% Total cost of revenue increased $3.7 million, or 19%, to $23.2 million for the three months ended June 30, 2014 from $19.4 million in the comparable period in 2013. The increase in total cost of revenue was the result of an increase of $2.6 million in material costs and an increase of $1.4 million in manufacturing expense to support increased product revenue, offset, in part, by a decrease of $0.2 million in cost of research services. Product cost of revenue increased $4.0 million, or 21%, to $22.9 million for the three months ended June 30, 2014 from $18.9 million in the comparable period in 2013. Product cost of revenue as a percentage of product revenue increased to 88% during the three months ended June 30, 2014 versus 87% during the three months ended June 30, 2013. The favorable impact of improved manufacturing throughput and efficiency was more than offset by $0.7 million of stock based compensation charges related to the vesting of performance-based stock options upon the closing of our initial public offering and slightly higher material costs due to the mix of aerogel products sold. We expect that material costs and manufacturing expense will decrease slightly during the remainder of 2014 from the expense recognized in the three months ended June 30, 2014. This expected decrease is due to an expected decrease in stock based compensation expense and an expected favorable mix of aerogel products sold, offset, in part, by a small increase in manufacturing expense associated with initial start-up costs leading to operation of a third line in the East Providence facility. Research services cost of revenue decreased $0.2 million, or 40%, to $0.3 million for the three months ended June 30, 2014 from $0.6 million in the comparable period in 2013. The decrease in cost of research services revenue was due principally to the 39% reduction in research services revenue during the three months ended June 30, 2014. 26



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Table of Contents Gross Profit Three Months Ended June 30, 2014 2013 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Gross profit $ 3,425 13 % $ 3,531 15 % $ (106 ) (3 )% Gross profit decreased $0.1 million, or 3%, to $3.4 million for the three months ended June 30, 2014 from $3.5 million in the comparable period in 2013. The decrease is principally the result of $0.7 million of stock-based compensation charges related to the vesting of performance-based stock options upon the closing of our initial public offering and by slightly higher material costs due to the mix of aerogel products sold, offset, in part, by a 14% increase in product shipments and an effective 4% price increase. Gross profit as a percentage of total revenue decreased to 13% of total revenue for the three months ended June 30, 2014 from 15% in the comparable period in 2013 due principally to recognition of $0.7 million, equivalent to 3% of total revenue, of stock-based compensation related to the vesting of performance-based stock options upon the closing of our initial public offering. We expect gross profit as a percentage of total revenue during the remainder of 2014 to increase by several percentage points due to the continued impact of 2014 sales price increases, an expected decrease in stock based compensation expense and an expected favorable mix of aerogel products sold, offset, in part, by a small increase in manufacturing expense associated with initial start-up costs leading to operation of a third line in the East Providence facility.



Research and Development Expenses

Three Months Ended June 30, 2014 2013 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Research and development expenses $ 1,920 7 % $ 1,178 5 % $ 742 63 % Research and development expenses increased $0.7 million, or 63%, to $1.9 million for the three months ended June 30, 2014 from $1.2 million in the comparable period in 2013. This increase was primarily the result of stock-based compensation charges of $0.7 million related to the vesting of performance-based stock options upon the closing of our initial public offering. We expect that our research and development expenses will decrease in the short term due to a reduction in stock-based compensation expense, but increase in the long term as we invest in additional research and engineering personnel and the infrastructure required in support of their efforts. However, we expect that research and development expenses will decline as a percentage of total revenue in the long-term due to projected growth in product revenue. 27



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Sales and Marketing Expenses

Three Months Ended June 30, 2014 2013 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Sales and marketing expenses $ 3,420 13 % $ 2,439 11 % $ 981 40 % Sales and marketing expenses increased $1.0 million, or 40%, to $3.4 million for the three months ended June 30, 2014 from $2.4 million in the comparable period in 2013. The $1.0 million increase was primarily the result of stock based compensation charges of $0.9 million related to the vesting of performance-based stock options upon the closing of the initial public offering. We plan to continue to expand our sales force and sales consultants globally during 2014 to support anticipated growth in customers and demand for our products. We expect that sales and marketing expenses will decrease in the short term due to a reduction in stock compensation expense, but will increase in absolute dollars in the long term as we increase sales personnel and our marketing efforts. However, we expect that sales and marketing expenses will decrease as a percentage of total revenue in the long-term due to projected growth in product revenue.



General and Administrative Expenses

Three Months Ended June 30, 2014 2013 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) General and administrative expenses $ 6,206 23 % $ 2,552 11 % $ 3,654 143 % General and administrative expenses, or G&A expenses, increased $3.7 million, or 143%, during the three months ended June 30, 2014 compared to the same period in 2013. G&A expenses as a percentage of total revenue increased to 23% for the three months ended June 30, 2014 from 11% in the comparable period in 2013. The $3.7 million increase was primarily the result of stock-based compensation charges of $3.3 million related to the vesting of performance-based stock options upon the closing of our initial public offering. We expect that G&A expenses will decrease in the short term due to a reduction in stock compensation expense, but will increase in absolute dollars in the long term as we incur additional expenses to operate as a public company and in support of the anticipated growth of our business. The increased G&A expenses we expect to incur related to operating as a publicly traded company include costs of compliance with securities, corporate governance and related regulations, investor relations expenses, increased insurance premiums, including director and officer insurance, and increased legal and audit fees. In addition, we expect to add general and administrative personnel to support the anticipated growth of our business and continued expansion of our manufacturing operations. However, we expect general and administrative expenses will decline as a percentage of total revenue in the long-term as a result of projected growth in product revenue. 28



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Table of Contents Other Income (Expense) Three Months Ended June 30, 2014 2013 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Other income (expense): Interest expense $ (34,027 ) (128 )% $ (15,620 ) (68 )% $ (18,407 ) (118 )% Loss on exchange of convertible notes - - % (485 ) (2 )% 485 NA Costs associated with postponed public offering - - % (241 ) (1 )% 241 NA Total other expense, net $ (34,027 ) (128 )% $ (16,346 ) (71 )% $ (17,681 ) (108 )%



Total other expense was $34.0 million for the three months ended June 30, 2014 as compared to $16.3 million in the comparable period in 2013.

During the three months ended June 30, 2014, we incurred $34.0 million in interest expense comprised of changes in fair value of $0.8 million for subordinated notes, $7.8 million for senior convertible notes and $25.4 million for convertible notes. The changes in fair value of the respective notes were calculated based on the final repayment obligation for the subordinated notes and final conversion value of the convertible notes upon the closing of our initial public offering. The increase of $18.4 million in interest expense compared to the comparable period in 2013 was due principally to the accretion of the convertible notes to their final conversion value during the three months ended June 30, 2014.



During the three months ended June 30, 2013 we incurred a $0.5 million loss on exchange of convertible notes and $0.2 million of costs associated with a postponed public offering.

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Six months ended June 30, 2014 compared to six months ended June 30, 2013

The following tables set forth a comparison of the components of our results of operations for the periods presented:

Revenue Six Months Ended June 30, 2014 2013 Percentage of Percentage of Change Amount Revenue Amount Revenue Amount Percentage Revenue: Product $ 47,386 97 % $ 37,971 95 % $ 9,415 25 % Research services 1,592 3 % 2,012 5 % (420 ) (21 )% Total Revenue $ 48,978 100 % $ 39,983 100 % $ 8,995 22 % The following chart sets forth product shipments in square feet for the periods presented: Six Months Ended June 30, Change 2014 2013 Amount Percentage



Product shipments in square feet (in thousands) 18,891 16,220

2,671 16 %



Total revenue increased $9.0 million, or 22%, to $49.0 million for the six months ended June 30, 2014 from $40.0 million in the comparable period in 2013, primarily as a result of an increase in product revenue.

Product revenue increased $9.4 million, or 25%, to $47.4 million for the six months ended June 30, 2014 from $38.0 million in the comparable period in 2013. This increase was principally the result of an increase in sales of our aerogel products in the Asian and South American petrochemical markets and in the offshore oil markets. The revenue increase reflects price increases enacted during the last half of 2013 and the first six months of June 30, 2014 and a shift in mix of aerogel products sold toward higher priced products. The average selling price of our products increased by $0.17, or 7%, to $2.51 per square foot for the six months ended June 30, 2014 from $2.34 per square foot in the comparable period during 2013. In volume terms, product shipments increased 2.7 million square feet, or 16%, to 18.9 million square feet of aerogel products for the six months ended June 30, 2014, as compared to 16.2 million square feet in the comparable period in 2013. The increase in demand during the six months ended June 30, 2014 included increased sales of $5.4 million for use in a petrochemical facility expansion by a major Asian energy company, $3.0 million in increased sales to a South American distributor primarily related to construction of expanded capacity in a petrochemical plant in Brazil, and increased sales to a U.S. based contractor for an offshore oil project in the Gulf of Mexico. Research services revenue decreased $0.4 million, or 21%, to $1.6 million for the six months ended June 30, 2014 from $2.0 million in the comparable period in 2013. The decrease was primarily due to a reduction in active research contracts during the six months ended June 30, 2014. During the six months ended June 30, 2014, we provided research services on 7 contracts in contrast to 14 contracts in the comparable period in 2013. This decrease in contracts is principally the result of certain limitations on our eligibility to receive contract awards under federal guidelines and programs due to a variety of factors including the size of our revenues, the number of our employees and the makeup of our ownership. Product revenue was 97% and 95% of total revenue for the six months ended June 30, 2014 and 2013, respectively. Research services revenue was 3% and 5% of total revenue for the six months ended June 30, 2014 and 2013, respectively. We expect that product revenue will increase as a percentage of our total revenue due to the anticipated growth in demand for our products in the energy infrastructure market. 30



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Table of Contents Cost of Revenue Six Months Ended June 30, 2014 2013 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 $ 41,391 87 % 85 % $ 35,487 93 % 89 % $ 5,904 17 % Research services 816 51 % 2 % 926 46 % 2 % (110 ) (12 )% Total cost of revenue $ 42,207 86 % 86 % $ 36,413 91 % 91 % $ 5,794 16 % Total cost of revenue increased $5.8 million, or 16%, to $42.2 million for the six months ended June 30, 2014 from $36.4 million in the comparable period in 2013. The increase in total cost of revenue was the result of an increase of $3.5 million in material costs and an increase of $2.4 million in manufacturing expense to support increased product revenue, offset, in part, by a decrease of $0.1 million in cost of research services. Product cost of revenue increased $5.9 million, or 17%, to $41.4 million for the six months ended June 30, 2014 from $35.5 million in the comparable period in 2013. Product cost of revenue as a percentage of product revenue decreased to 87% during the six months ended June 30, 2014 from 93% for the comparable period in 2013 as a result of a reduction in material costs and manufacturing expense on a per square foot basis. The reduction in material costs as a percentage of product revenue was the result of improved manufacturing yields and a reduced raw material cost per square foot. The reduction in manufacturing expense as a percentage of product revenue was the result of increased manufacturing capacity utilization and improved manufacturing throughput and efficiency, offset, in part, by $0.7 million of stock based compensation charges related to the vesting of performance-based stock options upon the closing of our initial public offering. Research services cost of revenue decreased $0.1 million, or 12%, to $0.8 million for the six months ended June 30, 2014 from $0.9 million in the comparable period in 2013. The decrease in cost of research services revenue was due to a reduction in active research contracts during 2014, offset, in part, by an unfavorable mix of labor and expense required to perform the contracted research, each of which carries a different rate of reimbursement. 31



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Table of Contents Gross Profit Six Months Ended June 30, 2014 2013 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Gross profit $ 6,771 14 % $ 3,570 9 % $ 3,201 90 % Gross profit increased $3.2 million, or 90%, to $6.8 million for the six months ended June 30, 2014 from $3.6 million in the comparable period in 2013. The increase in gross profit of $3.2 million was principally the result of a reduction in material costs and manufacturing expenses as a percentage of product revenue due to improved manufacturing yields, purchasing efficiency and productivity at our East Providence facility, offset, in part, by the impact of stock based-compensation charges of $0.7 million related to the vesting of performance-based stock options upon the closing of our initial public offering. In addition, price increases enacted during 2013 and 2014 and the mix of aerogel products sold also contributed to the increase in gross profit during the six months ended June 30, 2014 as compared to the same period in the prior year. Gross profit as a percentage of total revenue increased to 14% of total revenue for the six months ended June 30, 2014 from 9% in the comparable period in 2013.



Research and Development Expenses

Six Months Ended June 30, 2014 2013 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Research and development expenses $ 3,203 7 % $ 2,413 6 % $ 790 33 % Research and development expenses increased $0.8 million, or 33%, to $3.2 million for the six months ended June 30, 2014 from $2.4 million in the comparable period in 2013. This increase was primarily the result of stock-based compensation charges of $0.7 million related to the vesting of performance-based stock options upon the closing of our initial public offering and $0.1 million related to professional services to support our existing patents. Sales and Marketing Expenses Six Months Ended June 30, 2014 2013 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Sales and marketing expenses $ 5,658 12 % $ 4,479 11 % $ 1,179 26 % Sales and marketing expenses increased $1.2 million, or 26%, to $5.7 million for the six months ended June 30, 2014 from $4.5 million in the comparable period in 2013. The $1.2 million increase is the result of stock based compensation charges of $0.9 million related to the vesting of performance-based stock options upon the closing of the initial public offering, and a $0.3 million increase in payroll and related costs associated with an increase in sales personnel and incentive compensation. Sales and marketing expenses as a percentage of total revenue increased to 12% during the six months ended June 30, 2014 as compared to 11% during the six months ended June 30, 2013 principally due to the increase in stock based compensation expense. 32



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General and Administrative Expenses

Six Months Ended June 30, 2014 2013 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) General and administrative expenses $ 8,928 18 % $ 5,340 13 % $ 3,588 67 % G&A expenses increased $3.6 million, or 67%, during the six months ended June 30, 2014 compared to the same period in the prior year. G&A expenses as a percentage of total revenue increased to 18% for the six months ended June 30, 2014 from 13% in the comparable period in 2013. The $3.6 million increase was primarily the result of stock based compensation charges of $3.3 million related to the vesting of performance-based stock options upon the closing of the initial public offering. Other Income (Expense) Six Months Ended June 30, 2014 2013 Change Percentage Percentage Amount of Revenue Amount of Revenue Amount Percentage ($ in thousands) Other income (expense): Interest expense $ (50,178 ) (102 )% $ (12,255 ) (31 )% $ (37,923 ) (309 )% Gain on extinguishment of convertible notes - - % 8,898 22 % (8,898 ) NA Loss on exchange of convertible notes - - % (5,697 ) (14 )% 5,697 NA Costs associated with postponed public offering - - % (241 ) (1 )% 241 NA Total other expense, net $ (50,178 ) (102 )% $ (9,295 ) (23 )% $ (40,883 ) (440 )%



Total other expense was $50.2 million for the six months ended June 30, 2014 as compared to $9.3 million in the comparable period in 2013.

During the six months ended June 30, 2014, we incurred $50.2 million in interest expense comprised of changes in fair value of $1.5 million for the subordinated notes, $11.4 million for the senior convertible notes and $37.1 million for the convertible notes, and $0.2 million in debt closing costs and other interest expense. The changes in fair value of the respective notes were calculated based on the final payment and conversion amounts of the notes at the closing of the initial public offering. The increase of $37.9 million period over period was due primarily to the accretion of the convertible notes to their final conversion value during the six months ended June 30, 2014. During the six months ended June 30, 2013, we incurred $12.3 million in interest expense comprised of changes in fair value of the subordinated notes of $2.3 million, senior convertible notes of $1.5 million, expense related to recognition of fair value upon issuance of Series C preferred stock warrants of $10.7 million and interest income of $3.3 million on the convertible notes. In addition, we recorded financing costs of $0.6 million and other interest charges of $0.5 million to interest expense during the period. During the six months ended June 30, 2013, we also incurred a $5.7 million loss on exchange of convertible notes, an $8.9 million gain on the extinguishment of convertible notes and $0.2 million of costs associated with a postponed public offering. No such transactions occurred during the six months ended June 30, 2014. 33



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Liquidity and Capital Resources

Overview

We have experienced significant losses and invested significant resources since inception to develop and commercialize 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.



We are currently experiencing rapid revenue growth as we gain share in our target markets. Our current financial forecast anticipates continued revenue growth, increased gross profit and improving cash flows from operations. However, we expect to incur significant capital expenditures through 2017 related to the expansion of our manufacturing capacity to keep pace with expected growth in demand.

We believe that our existing cash balance and available credit will be sufficient (i) to fund the design, development and construction of our third production line in East Providence, and (ii) to fund a portion of the design, development and construction of a second production plant in Europe or Asia. We expect to supplement our cash balance with anticipated cash flows from operations, local government grants, debt financings and potentially equity financings to provide the capital required to complete the first production line in our second facility. Primary Sources of Liquidity Our principal source of liquidity is currently our cash and cash equivalents. Cash and cash equivalents consist primarily of cash on deposit with banks. As of June 30, 2014, we had $56.9 million of cash. From our inception to June 2014, our primary sources of liquidity were funds raised through issuances of common stock, preferred stock, subordinated notes, senior convertible notes and convertible notes to venture capital funds and other private investors. In June 2014, we completed an initial public offering of our common stock and received net proceeds after underwriting discounts and offering expenses of $74.8 million. Upon the closing of the offering, all principal and accrued interest of our senior convertible notes and our convertible notes automatically converted into shares of our common stock. In addition, we utilized $19.8 million of the net proceeds of the offering to repay all amounts outstanding under our subordinated notes and revolving credit facility. At June 30, 2014, our total debt obligations were $0.2 million in capital lease obligations. At June 30, 2014, we also had $1.5 million of outstanding letters of credit. In March 2011, we entered into a $10.0 million revolving credit facility with Silicon Valley Bank. Due to a borrowing limitation under the terms of the credit facility, the effective amount available to us is $8.5 million as of June 30, 2014 after giving effect to the $1.5 million of outstanding letters of credit. As of June 30, 2014, we had no outstanding balance drawn on the line of credit. Interest on amounts outstanding under the revolving credit facility is equal to the greater of the prime rate or 4% per annum, plus 1.0% per annum. In addition, we are required to pay a quarterly unused revolving line facility fee of 0.5% per annum of the average unused portion of the revolving credit facility. The revolving credit facility has a maturity date of August 31, 2014. We are currently in discussions to renew the credit facility. 34



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Analysis of Cash Flow

Net Cash Provided by (Used in) Operating Activities

Our net cash generated by operating activities for the six months ended June 30, 2014 was $0.2 million and was comprised of our net loss of $61.2 million adjusted for non-cash items of $61.6 million (including depreciation and amortization of $5.2 million, accretion of debt to fair value of $50.0 million, stock compensation expense of $6.3 million and other non-cash of $0.1 million) and the net decrease in cash from changes in operating assets and liabilities of $0.2 million. This decrease in cash from changes in operating assets and liabilities was primarily due to an increase in prepaid expenses of $0.4 million and a decrease in accrued expenses of $1.7 million, partially offset by a decrease in accounts receivable of $0.2 million, a decrease in inventories of $1.4 million and an increase in deferred revenue of $0.4 million. The small decrease in accounts receivable of $0.2 million was primarily the result of strong and consistent receivables management in light of higher total revenue during the six month period ended June 30, 2014. The decrease in inventories is driven by the sales of finished goods inventory to support strong demand in the six months ending June 30, 2014. The decrease in accrued expenses is driven by the $2.0 million net decrease in non-equity incentive compensation offset. Our net cash used in operating activities for the six months ended June 30, 2013 was $12.6 million and was comprised of our net loss of $18.0 million reduced by non-cash items of $15.0 million (including depreciation and amortization of $4.9 million, amortization of debt issuance costs and non-cash interest expense of $1.0 million, change in the fair value of debt of $0.4 million, loss on exchange of convertible notes of $5.7 million, issuance of Series C preferred stock warrants in connection with senior convertible notes of $10.7 million and stock compensation expense of $1.0 million, which were offset by a gain on extinguishment of convertible notes of $8.9 million) and the net decrease in cash from changes in operating assets and liabilities of $9.7 million. This decrease in cash from changes in operating assets and liabilities was primarily due to decreases in other long-term liabilities of $6.0 million, decrease in deferred revenue of $0.8 million, decreases in accounts payable of $1.8 million and increases in accounts receivable of $1.1 million. The decrease in other liabilities was due to payments made pursuant to our cross license agreement with Cabot Corporation.



Net Cash Used in Investing Activities

Net cash used in investing activities is primarily related to capital expenditures to support our growth. Net cash used in investing activities for the six months ended June 30, 2014 and 2013 was $2.2 million and $0.8 million, respectively, and included capital expenditures primarily for machinery and equipment to improve the throughput and efficiency of our East Providence manufacturing operations.



Net Cash Provided by Financing Activities

Cash flows from financing activities primarily include (i) the net proceeds from the completion of our initial public offering, (ii) issuances of senior convertible notes and convertible notes, (iii) repayments of our subordinated notes, (iv) borrowings and repayments under our revolving credit facility, (v) repayments under capital leases, (vi) issuances of common stock, and (vii) related expenses. Net cash provided by financing activities for the six months ended June 30, 2014 totaled $57.3 million. Financing activities during the period included $77.3 million of net proceeds from the initial public offering (which does not reflect the payment of $2.5 million of unpaid initial public offering costs) and $4.5 million for borrowings under the line of credit, offset, in part, by $18.8 million of repayments on the subordinated debt, $5.5 million of repayments under the line of credit and other net payments of $0.1 million. Net cash provided by financing activities for the six months ended June 30, 2013 totaled $16.3 million. Financing activities during the period primarily consisted of $18.5 million of proceeds from the issuance of senior convertible notes offset by $0.9 million of related financing costs and $1.4 million of net repayments under the line of credit.



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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Recent Accounting Pronouncements

Information regarding new accounting pronouncements is included in note 3 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 with accounting principles generally accepted in the United States of America. 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 the accounting policies described below 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 Prospectus and note 3 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. 36



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Certain Factors That May Affect Future Results of Operations

The Securities and Exchange Commission, or SEC, 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, capital requirements, and the need for additional financing; the performance of our aerogel blankets; the estimated effects of our third production line on our annual nameplate capacity; our estimates of annual production capacity; 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 beliefs about the outcome, effects or estimated liabilities of current or potential litigation; our expectations about hiring additional personnel; our plans to devote substantial resources to the development of new aerogel technology; our expectations about product mix; our beliefs about the impact of sales price increases; 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 continued revenue growth, increased gross profit, and improving cash flows; 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 growth of 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 financial condition; and our beliefs about the expansion of our international operations. 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 Part II, Item 1A of this Quarterly Report on Form 10-Q and under the heading "Risk Factors" contained in the Prospectus. 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 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 to Aspen 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. 37



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