A123 Systems' CEO Discusses Q2 Results - Earnings Call Transcript

 |  About: A123 Systems, Inc. (AONEQ)
by: SA Transcripts

A123 Systems, Inc. (AONE) Q2 2012 Earnings Call August 8, 2012 8:00 AM ET


Good day, ladies and gentlemen and welcome to the A123 Systems Second Quarter 2012 Conference Call. At this time, all participants are in a listen-only mode. Later, we will hold a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to turn the conference over to your Garo Toomajanian. Please go ahead.

Garo Toomajanian

Thank you. Good morning and welcome to A123 Systems' earnings call for the second quarter of 2012. With me on the call today are Dave Vieau, A123's President and CEO, and David Prystash, Chief Financial Officer. In addition to prepared remarks, we have posted supplementary slides related to this call on our IR website at ir.a123systems.com under events and presentations.

Before we begin the call, please allow me to read the following statement to inform you of certain Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. During the course of this conference call, we will discuss our business outlook and make other forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Such statements are only predictions based on management's current expectations. Actual events or results could differ materially from those predictions due to a number of risks and uncertainties, including those discussed in our Annual Report on Form 10-K for the year ended December 31, 2011 and Form 10-Q for the quarter ended March 31, 2012.

In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. While we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our views change. Therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

We will also be referring to non-GAAP measures on this call. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of GAAP to non-GAAP measures is available in our press release issued today, which is available on our website at www.a123systems.com.

Now, let me turn the call over to Dave Vieau for his remarks.

Dave Vieau

Thanks, Garo and thanks for those of you joining us on our call today. On today's call, we will discuss our financial performance for the second quarter of 2012, operational stability we have achieved since our last call and new technology and customers that we expect to help drive our future growth.

Before we do that, I would like to discuss an announcement we made this morning that we consider to be an important step toward removing the uncertainty regarding A123's financial situation.

Last quarter, we indicated that we were actively pursuing strategic partnership options to strengthen our liquidity and stabilize our financial situation. This morning, we announced a non-binding memorandum of understanding with Wanxiang Group Corporation that establishes the framework for strategic agreement through which Wanxiang would invest up to $450 million in A123.

According to the proposed terms of the strategic agreement Wanxiang would provide A123 with initial bridge financing of up to $75 million and subsequently we purchased $200 million aggregate principle amount of A123's senior secured convertible notes subject to necessary conditions and approvals.

Agreement would also include potential for Wanxiang to invest up to an additional $175 million if it exercises the warrants that would be issued in connection with the Bridge Facility and the convertible notes for cash. We believe this proposed strategic agreement would provide financial stability to A123 as we continue to grow our business and as we progress towards profitability targets, including achieving positive adjusted EBITDA on a quarterly basis during 2013.

Wanxiang Group Corporation is China's largest automotive components manufacturer and one of China's largest non-government owned companies. Wanxiang has more than $13 billion in revenue and more than 45,000 employees including more than 3,000 in the U.S. Wanxiang's global businesses include equipment and automotive parts manufacturing, clean energy, financial services, natural resources and other industries.

We believe the proposed agreement with Wanxiang makes financial and strategic sense for A123, and we see a number of synergies between the two companies. For example, we expect this partnership to provide A123 with even greater access to China's growing vehicle electrification and grid energy storage markets which we think would drive demand in the near-term.

We believe, we could leverage Wanxiang's global supply chain and automotive manufacturing efficiencies to reduce our cost. We believe that Wanxiang's capital investment will remove the uncertainty regarding A123's financial situation and enable us to resolve our liquidity constraints that have impacted business growth.

Wanxiang has stated its intention to build on the strong manufacturing and systems' engineering capabilities that A123 has established in Michigan and Massachusetts.

Dave will provide you with more details on the framework of the agreement, but the bottom line is that we expect this proposed strategic agreement to provide A123 with sufficient capital to fund their operating requirements and grow our business.

Now let me turn to our results for the second quarter. Revenue for the second quarter was $17 million. Not included in this total is approximately $3 million of revenue from prismatic cell shipments that was not recognized in the quarter. We anticipate that we will recognize the revenue later this year once these cells have achieved sufficient field experience.

While the production ramp-up at our Livonia, Michigan facility is proceeding well, demand for our prismatic cells continues to outpace our ability to produce them. We expect this trend to continue for the next several months. At the same time, improving our cash flow remains a high priority and we believe we can reduce manufacturing cost as a percentage of revenue as our production volume increases and we are identifying additional potential cost reductions that we will maybe able to implement in the months and quarters ahead.

Turning to business events that have taken place since our last call, our prismatic cell field campaign continues to progress. The failure rate of products in the field has been lower than expected, so we are reducing the replacement rate accordingly. As a result, we now expect the campaign to be completed in mid-2013. Our customers continue to be generally supportive and we have not lost any customer as a result of public campaign.

Turning to our grid business, we recently announced an agreement with Ray Power Systems, a company focused on bringing frequency regulation technology to grid operators in the Chinese market. Ray Power expects to demonstrate the technical capabilities and benefits of A123's energy storage solution as a fast-ramping accurate and clean resource for providing frequency regulations services in China.

Overall demand for our grid products remained strong and we are actively bidding on more than 185 megawatt hours of new projects for 2013. We also remain excited about our large and growing portfolio of customers in the commercial and government markets. These customers are leveraging advantage of A123 technology and a range of diverse applications for which we believe our solutions deliver lower total cost of ownership as compared to lead acid batteries.

We are engaged in 37 development and production programs. In total, the customer programs we have in production and in development represent more than $100 million in customer stated demand in 2013.

Turning to our Transportation business, we are executing on several major customer production programs. In addition to ongoing programs with BMW, SAIC, Smith Electric and others. General Motors has reaffirmed its commitment to working with A123 as supplier to its Chevy Spark EV, which is expected to enter production in 2013.

In addition, we have signed a new contract with BAE Systems that expands our longstanding relationship and strengthens our position as the number one provider of lithium batteries to the commercial vehicle market.

BAE's HybriDrive system using A123 cylindrical cells is already being deployed on nearly 3,000 city transit buses globally that we have collectively logged more than 300 million miles. Under this new agreement, A123 will supply battery packs built on our prismatic cells to satisfy BAE's requirements for a more compact and economical solution. This new design is initially expected to be deployed on city transit buses, and as part of the new agreement, A123 will also supply lithium ion battery packs for additional versions of BAE's HybriDrive system for other commercial vehicle applications.

We're also excited about the introduction of Nanophosphate EXT, our new lithium ion battery technology, capable of operating at extreme temperatures to minimize our all together eliminate thermal management systems. Nanophosphate EXT is designed to significantly reduce or eliminate the need for heating or cooling systems, which is expected to create sizable new opportunities within the transportation and telecommunication markets among others. We believe this new technology is particularly well suited for micro hybrid vehicles, EVs and telecom backup. We have signed our first production customer for EXT and expect to start shipping products from the first half of 2013.

In summary, our quality-driven gradual ramp in production has been successful. At the same time, we have balanced demand from customers for revenue generating products with demand for replacement products for our field campaign while also continuing to build a pipeline of new customers. We continue to make technology advances that we expect will provide distinct competitive advantages in the marketplace.

Finally, we believe we our proposed strategic agreement with Wanxiang will improve our financial stability and provide us with access to new business opportunities helping to strengthen our position as a global manufacturer of lithium ion batteries and systems.

Now let me turn the call over to Dave for more details on our financial results and outlook.

David Prystash

Thanks, Dave. Starting with our results for the second quarter. Revenue was $17.0 million, down from $36.4 million a year ago. Not included in this total is approximately $3 million of revenue from prismatic cell shipment that was not recognized in the quarter. We anticipate that we will recognize the revenue later this year once these cells achieve sufficient field experience.

Demand for prismatic cells in the second quarter was greater than our ability to produce them, which created revenue generation. Product revenue was $11.5 million in the second quarter, down from $29.6 million a year ago and services revenue was $5.5 million, down from $6.8 million a year ago.

Within product revenue, revenue from the transportation market was $7 million, compared to $24.4 million in the second quarter of 2011, which reflected the significant ramp-up for Fisker. Revenue from the commercial market was $4.5 million, compared to $5.2 million in the second quarter of 2011. Electric grid revenue was not meaningful in the second quarter of 2012 as well as in the year ago quarter.

During the second quarter, we shipped the equivalent of 16.3 megawatt hours of batteries and battery system, which include some prismatic product shipments, compared to 42.6 megawatt hours in the second quarter.

Turning to profitability, gross margin was negative 172% in the second quarter, compared to negative 8% a year ago. The lower second quarter 2012 gross margin was driven primarily by our production ramp up at all the production levels as well as the classification of certain production start-up expenses to operating expense in 2011. Included in the second quarter 2012 growth is a $3.3 million asset impairment charge related to the shutdown of our facilities in Korea.

Adjusted EBITDA loss was $52.4 million in the second quarter, compared to an adjusted EBITDA loss of $41.1 million a year ago. The deterioration is driven primarily by our higher growth loss in Q2 2012.

Net loss in the second quarter 2012 was $82.9 million, or $0.56 per common share, based on an average share count of $147 million weighted average common shares outstanding in the second quarter for 2012. This compares to a net loss of $55.4 million or $0.44 per common share a year ago, based on an average count of 124.5 million weighted average common shares outstanding.

Turning to our balance sheet, we ended the quarter with $47.7 million in cash and cash equivalent, compared to $113 million at the end of the first quarter. For the quarter, cash from operating activities was now four $54.8 million, roughly flat compared to an operating cash outflow of $64.9 million a year ago.

Capital expenditures during the quarter were $5.1 million net of government grant proceeds, compared with $29 million, $26 million a year ago. While we completed private offering 50 million senior unsecured convertible notes and warrants during the quarter, 30 million of the proceeds from this transaction was restricted at the end of the quarter. Consequent to the end of the quarter, we fulfilled the conditions for the release of the remaining 30 million of proceeds, which are now unrestricted and available for general corporate purposes. Additionally, since the end of the second quarter, we completed a private direct offering, which provided approximately $6.8 million in net proceeds.

As we mentioned earlier, we also announced a non-binding memorandum of understanding with Wanxiang Group Corporation outlined the proposed terms of the potential investment in A123. Under the proposed terms of the strategic investment outlined in the MOU, Wanxiang would provide A123 with up to $75 million in initial debt financing under a senior secured bridge facility with an initial credit extension of $25 million and $50 million to be funded after the satisfaction of certain closing conditions.

Subsequently, upon satisfaction of certain closing conditions, Wanxiang would purchase $200 million aggregate principle amount of A123's senior secured convertible notes. The agreement would also include the potential for Wanxiang to invest up to an additional $175 million if it exercise the warrants that would be issued in connection with the Bridge Facility and the convertible notes for cash.

Incurrence of the remaining $50 million of loan under the senior secured Bridge Facility would be subject to the satisfaction of certain approvals and conditions including receipt of favorable determination from CFIUS, and receipt of Chinese government approval.

Issuance of the convertible notes and the related warrants would also be subject to additional conditions, including approval from A123 shareholders, termination of the Hart-Scott-Rodino waiting period, the conversion or redemption of all the outstanding six percent convertible notes and relevant warrants and the repurchase or retirement of at least 90% of A123's 3.75% convertible subordinated notes due 2016.

According to the proposed terms of the strategic agreement, if the entire amount of the initial debt financing is provided to A123 and the full amount of the warrants and convertible notes are issued and exercised for cash, Wanxiang's total capital investment in A123 from these agreements would total approximately $450 million.

The total amount of shares of A123's common stock issuable upon exercise and conversion of the warrants and convertible notes would represent approximately 80% of the then outstanding common stock of A123.

While the MOU is non-binding and the execution of definitive documentation is subject to negotiation and among other things, the amendment of agreements with certain of A123's existing lenders, A123 and Wanxiang are currently negotiating definitive documentation and intend to close the full transaction by the end of 2012. More details on the framework of the proposed strategic investment are available on our 8-K filing from this morning.

Operator, we are now ready to open the call for questions.

Question-and-Answer Session


(Operator Instructions). Our first question is from Dan Galves of Deutsche Bank. Your line is open. Please go ahead.

Dan Galves - Deutsche Bank

Can you give us the share count of A1 at the end of the quarter? Also, I don't know if you can provide what you are basing beyond 80% Wanxiang ownership pro forma. What share count you are basing that on , if can give that to us.

David Prystash

Yes. The existing share count at the end of August was roughly 172 million shares. 170.

Dan Galves - Deutsche Bank


David Prystash


Dan Galves - Deutsche Bank

Okay. Got you. How will this MOU, this tie up with Wanxiang. How do you expect that to impact your existing business in China? I believe they have an existing battery business in China as well.

David Prystash

As soon as we get through the first two steps and they invest $200 million, there would be really no impact as A123 is still a standalone entity, so we wouldn't anticipate any implications up until that point, which say exercise the warrants and take a greater controller. I think that could potentially have impact, but first part of the transaction we are not anticipating having any impact.

Dave Vieau

Yes. I would add to that. I think that a part of the incentive on their part. This is the technological capability that we do bring from both, core chemistry, cell technology and also certainly from a system's standpoint and their stated activities in the area of transportation. Iron grid are meaningful, so there is an ambition on their part that what we would bring is significant assistance to their overall market ambition in China.

Dan Galves - Deutsche Bank

Got you. Is there anything that they can do for you maybe on the cost side, on the supply chain side in terms of their scale as well as anything you do see any potential for Wanxiang to purchase batteries from A123.

David Prystash

We do have both accounts. We think that their access to better clouds to their present supply chain, plus their size we'll beneficial as we do started cost, but that's just batteries but system component.

In addition, it would allow us to have opportunity to sell cells into their businesses, particularly in China. They do have our business in the commercial investor for electric battery packs and hybrid systems.

Dan Galves - Deutsche Bank

Okay. Great. Then last question, can you just give us a little more color on what's going on Livonia right now? In terms how large of a percentage of the filed action has been completed or where you stand in terms of ramping production towards potential capacity in that facility and just the timing when you will get full capacity.

David Prystash

Yes. I think there are couple of questions there. On the warranty of vehicle program, we are actually seeing less issues in the field than what we were originally anticipating, and now this was the latest problem, so it could just be either beneficial or occur later, but up until this point, we've seen far fewer issues of the (Inaudible).

We continue to ramp-up with our customers and replacing the packs, but given the lower amount of issues that we're seeing. It will allow us to take more gradual approach in replacing them unless something changes significantly from what we are seeing.

The ramp-up in Livonia is going well. It's a challenge to revamp the factory at the pace we think that will be at the target for the end of the fourth quarter, which is around 75% capacity utilization, but getting there may be a little bit, the ramp may not be as steep as what we were originally anticipating given some of the complexities and ramping up in terms of putting in new processes and equipment and (Inaudible) workforce.

Dave Vieau

I can add to it. The quality problem that are initiated this campaign has been very thoroughly addressed and we are very comfortable with the changes that we put in place. I think we've also done a very good job. Operationally, we are improving overall quality mindset with a substantial campaign associated with that, so our gradual ramp up is respectful to the quality ambition as opposed to the volume ambition. I think that's an important change.

Dan Galves - Deutsche Bank

Appreciate that. Just one more follow-up. Are you saying that you expect to have revenue or you expect to have demand for their facility that would represent 75% of its total capacity by the end of the year? Is that the way we should think about that. In megawatts, what do you expect of that facility to be by the end of the year?

David Prystash

Well, there's a couple of different concepts. Right now, we have more demand than we have ability to fulfill. We think that the capacity will be at the name plate capacity of 20 CPM by the end of the fourth quarter, we'll be operating at around 16 cells per minutes, and at that level we still have more demand than we have the ability to make cells.

Dan Galves - Deutsche Bank

Okay. Thanks very much.


(Operator Instructions). Our next question is from Amir Rozwadowski of Barclays. Your line is open. Please go ahead.

Amir Rozwadowski - Barclays

Just to follow-up on the that last line of question in terms of overall capacity. I mean, certainly there's a lot of moving parts here, but in the past you had provided some level of expectations of where we should see the cross over to the positive gross margin territory than further down the line on EBITDA basis. Any chance you could give us a little bit of color here in terms of that trajectory from a cost perspective that would be helpful.

David Prystash

I think, Amir that our view hasn't really changed. We think that based up on the plan we have today and the volumes that we are seeing, if that will occur some\time next year for both. I think as we get the stability of the company from a financial standpoint, but the highness will give us more bandwidth on executing, and I think the relationship with Wanxiang would help us even further in terms of cost opportunities. Likely not to be immediate, but we can see some benefit as we enter into second part of next year.

Amir Rozwadowski - Barclays

That's helpful. Then given the capital raising initiatives that you folks have gone through in recent and over the last couple of quarters, it seems like give memorandum of understanding you feel fairly comfortable that that step for putting the company back on stabler grounds is now behind the company. What I mean to say is, we shouldn't expect additional investors or capital raising initiatives from this point going forward.

David Prystash

Yes. We think that that once we consummate this transaction, it will give us sufficient capital to get us through the next several months as we go from this ramp-up period to where we think that we are a commercially viable valuable company without the cash burn and getting the EBITDA breakeven.

Amir Rozwadowski - Barclays

That's helpful. Then I guess lastly, you had mentioned number of recent wins and congratulations on that front from a customer perspective. Has there been any change in terms of the trajectory for some of your other customers over the last period of somewhat instability that you folks have faced, so any sort of change in terms of production plans or anything along those lines?

David Prystash

I think in general, our customers have been very supportive and have been very patient with us. We've been working through this problem. I think once we get this behind us that will provide them with the comfort that will be there and we will be able to satisfy their demand, so we haven't really seen any changes up until this point from a customer standpoint.

Dave Vieau

There is a heightened awareness of the situation on the part of the existing customers. There has been concern, obviously exceeded about the financial situation of company has been monitored on a very frequent high level basis, but the plans have not changed.

On new customers, we have closed a number of new accounts, but certainly a number of customers' prospects have put a caution or a slowdown in many areas. Ending the completion of this we think is announcement of first step to remedy in some of that and we think that we should pick momentum as this deal comes to a firm conclusion.

Amir Rozwadowski - Barclays

Thank you very much for the incremental color, gentlemen.


Thank you. Our next question in queue is from the line of Tom Daniels of Stifel Nicolaus. Your line is open.

Tom Daniels - Stifel Nicolaus

Good morning. Thanks for taking my question. In terms of your guys' capacity, could you give us a little update? It should like the Korea capacity was shutdown this quarter. I think that was about 50 megawatt hours. Are you still expecting to add another 125 megawatt hours at Livonia this year?

Dave Vieau

We were 60 megawatt hours in the Korean plant and that the question is that we're going add 125?

David Prystash

Korean plant was roughly 48 megawatt hours of capacity that will be going away. There is really no plans right now to we'll create that immediately, but as demand grows, we have a plan that would expand capacity over the next several years.

Tom Daniels - Stifel Nicolaus

Okay. I believe a couple of quarters ago, you said you are going to add about 125, and then the DOE grant. You guys got an extension there, so should we kind of think about your capacity exiting 2012 at around 600 megawatt hours? I am just trying to think of your comments around 75% capacity utilization by fourth year.

David Prystash

Yes. The part we'll be running at effectively 75% of nameplate utilization. We did say in the past that our stated demand would have us adding another five cells per minute for next year, so I believe that's where you are coming up with another 125 megawatt hours. That would likely be put in place in the second half of the year as we ramp.

As we get the effective utilization of nameplate utilization then our present sales forecast would require us to increased by another five cells per minute. I think that's where your 125 is coming from. That continues to be our vehicle.

Tom Daniels - Stifel Nicolaus

Okay. In the past you guys weren't a cell per minute, now take as much as a megawatt hour shipped to $16.3 this quarter. You know capacity utilization is very low. I mean, where do you guys see business picking up within transportation grid and commercial that will push you to 75% capacity utilization from fellow teams today?

David Prystash

Yes. Just to clear, we said on the call that right now we are allocating cell for our customers. We have greater demand than our ability to do. What's limiting our capacity is not cells. Demand. It's our ability to ramp it up with the new tighter discipline around quality and some of the actions we are taking, so when we get to the 75 CPM at the end of this year, it's not related to lack of demand it's related to ramp-up the facility back to a level that we feel comfortable producing high volume of high quality. We could sell significantly more cells today, than what we did it's the same gated buyer ability to restart the factory.

Tom Daniels - Stifel Nicolaus

Where you guys said we're seeing demand? Is it across your three segments bridge, transportation and commercial or?

David Prystash

Well, for the prismatic cell, it's all of our automotive applications. We are launching a new grid application that you are using the prismatic cell and we have a commercial application in the telecom are that would use that cell, so the combination of all those three areas would indicate that we need more cells. Next June we're presently making to satisfy a customer demand.

Tom Daniels - Stifel Nicolaus

Okay. Are you guys going to update your revenue guidance for the year at all?

David Prystash

No. I think our guidance, the range that we provided with in the last quarter was still same.

Tom Daniels - Stifel Nicolaus

Okay. Great. Thank you.


Thank you. With that, I am showing now further questions in queue. I would like to turn it back to Dave Vieau for any further comments.

Dave Vieau

Okay. Well, I'd like to thank you all for joining on the call today. We believe take an important step towards stabilizing the financial position and that the pipeline of our customer demand business remains healthy. We believe that the proposed strategic investment with Wanxiang combined with our blue-chip customer base and the increase in the competitive products with these recent technology announcements.

We're just in a very strong position to achieve our ultimate goal of profitable growth for the longer term, so thank you very much. Thanks again. Good bye.


Again, thank you ladies and gentlemen for joining today's conference. You may now disconnect. Have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!