AeroVironment, Inc.

Good afternoon, ladies and gentlemen, and welcome to AeroVironment's second quarter fiscal year 2020 earnings call. This is Stephen Gitlin, Vice President of Investor Relations for AeroVironment. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session after management's remarks. As a reminder, this conference is being recorded for replay purposes. Before we begin, please note that on this call, certain information presented contains forward-looking statements within the meaning of the private securities Litigation Reform Act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements, and may contain words such as believe, anticipate, expect, estimate, intend, project, plan, or words or phrases with similar meaning. Forward-looking statements are based on current expectations, forecasts, and assumptions that involve risks and uncertainties including but not limited to economic, competitive, governmental, and technological factors outside of our control that may cause our business strategy or actual results to differ materially from the forward-looking statements. For further information on these risks, we encourage you to review the risk factors discussed in AeroVironment's periodic reports on Form 10-K and Form 10-Q filed with the SEC and the Form 8-K filed today with the SEC. along with the associated earnings release and the safe harbor statement contained therein. This afternoon, we also filed a slide presentation with our earnings release and posted the presentation on our website at avinc.com in the events and presentations section. The content of this conference call contains time-sensitive information that is accurate only as of today, December 3, 2019. The company undertakes no obligation to make any revision to any forward-looking statements contained in our remarks today or to update them to reflect the events or circumstances occurring after this conference call. Joining me today from AeroVironment are President and Chief Executive Officer Mr. Wahid Nawabi and Vice President and Interim Chief Financial Officer Mr. Brian Shackley. We will now begin with remarks from Wahid Nawabi.

Wahid? Thank you, Steve, and welcome to our second quarter fiscal year 2020 earnings conference call. Today I will refer to the supplemental charts we filed with our earnings release and post it to our website to highlight important messages. On today's call, I will discuss three key topics that are outlined on slide number three of our earnings presentation. First, our team's track record of delivering excellent quarterly results continues. Second, we're successfully executing our plan and remain on track to achieve our fiscal year 2020 objectives. And third, we continue to make great progress on our strategic growth initiatives. I will start by summarizing our strong second quarter fiscal year 2020 performance while highlighting our key achievements during the quarter. Next, Brian Shackley, our Interim Chief Financial Officer, will provide a more detailed summary of financial performance in the quarter. I will then discuss our goals for fiscal year 2020 before Brian, Steve, and I take your questions. Once again, our financial results reflect the sustained strong demand for our solutions and continued successful execution by our team. Key highlights of our second quarter results, summarized on page number four of our supplemental presentation, include the following. Revenue of $83.3 million increased 14% over last year. Gross profit of $35.2 million increased 24% over last year. Gross margin of 42% was three points higher than last year, primarily due to more favorable mix in revenue and higher volumes. Slide number five illustrates the product versus service revenue trend for the past five quarters. Gap earnings per diluted share of $0.31 increased $0.02 from second quarter fiscal year 2019 diluted gap EPS of $0.29. Non-gap earnings per diluted share of $0.35 increased $0.05 from second quarter fiscal year 2019 diluted EPS of $0.29. Funded backlog of $146.7 million was 10% lower than last year, but remained high compared to historical averages. With respect to operations, our team continued to make important achievements in several areas of our business, as highlighted on slide number six. Our small UAS business continues to lead the market for fixed-wing defense solutions with the largest share of U.S. Thank you for joining us. The Army requires this frequency modification because the U.S. government auctioned the frequency spectrum for the DoD's small UAS to commercial interests several years ago. Air Environment was awarded this contract by the U.S. Army under a full and open competition. The FCS contract was originally awarded in June 2019, but a protest delayed its commencement until the recent resolution of the protest. This contract award for FCS is one of six domains awarded as part of the Army's $248.5 million small UAS program announced in April 2018. In total, AeroVironment has won four of the six domains associated with this program and is the only supplier to the Army for FCS, Raven spare parts, Puma spare parts, and other major components. We compete for individual delivery orders on the new Raven and PUMA systems domain. Since 2013, we have won more than 90% of the dollar value of all delivery orders for the Army Small UAS IDIQ program. As a pioneer and serial innovator in Small UAS, were continuously working with customers to identify valuable new capabilities that can help them achieve their mission objectives. Having identified a need to expand the endurance of small UAS, we introduced our newest small UAS product in October, the Puma LE, its name reflecting its long endurance. Offering five and a half hours of flight time with the ability to carry two separate payloads Puma Elite delivers Group 2 capabilities and a Group 1 footprint and for a fraction of the upfront as well as total cost. This means significantly more mission capabilities to troops on the front line to help them proceed with certainty. Puma Elite has generated strong interest from multiple U.S. government customers as well as a number of allied nations. And as the market continues to evolve, we believe there are several emerging opportunities to expand on our growth and success in the near term, including through the U.S. Army's SBS and SRR programs. Our expansion from fixed-wing small UAS into unmanned helicopters is also showing progress. We have generated interest in our vapor products from multiple customers. We have successfully integrated all core business processes between our Kansas and Simi Valley operations. We are on track to move the vapor product line manufacturing from Kansas to our Simi Valley operations by the end of our third fiscal quarter. This manufacturing consolidation is driving incremental capital expenditures for tooling and fixtures. Our team is making great progress with this new addition to our family of small UAS. In the international market, we continue to generate significant demand for our family of small UAS. In the quarter, we received multiple awards from existing customers in Southeast Asia and the Middle East, totaling more than $20 million. Beyond the defense market, we received a $5 million Puma contract award for the U.S. Border Patrol. This represents another procurement of our fixed-wing systems by the U.S. Border Patrol. We believe additional Border Patrol procurement opportunities will be forthcoming. In our Tactical Missile Systems product line, we submitted our proposal for the three-year sole source LMAMS award we have been addressing in recent quarterly earnings call. This hardware production contract to AeroVironment would cover government fiscal years 2020 through 2022. The performance period includes one 12-month base period and two additional 12-month options. We anticipate receiving this contract award by our fourth fiscal quarter and therefore is not included in our current funded backlog calculation. We anticipate this award would be worth up to $160 million over that time period. Once awarded, this will be the single largest sole source multiyear award ever for our innovative switchblade solution. We've made significant progress with U.S. government export authorities on the possibilities of exporting switchblade to our allies. Multiple allies have expressed strong interest in Switchblade, and we stand ready to help them protect their forces with its unique and disruptive capabilities once we receive the appropriate approvals and complete the associated negotiations. We also continue to advance the development of our larger version of Switchblade, which is capable of significantly longer flight endurance and far greater mission effects. This larger variant of Switchblade will address a much larger potential market opportunity. In another application of our groundbreaking technology, we are partnering with General Dynamics Land Systems to integrate Air Environment's small UAS and Switchblade systems into GDLS's next-generation armored combat vehicle for upcoming U.S. Army and Marine Corps programs. GDLS is the only qualified bidder for the Army's potentially large next-generation armored combat vehicle program, and we are the sole provider of switchblade and small UAS to GDLS for this specific opportunity. Turning to our HAPS business, HAPS Mobile, Inc., which is our joint venture with SoftBank Corporation, is positioning itself as a leader and catalyst for the global HAPS opportunity. AeroVironment and SoftBank established our HAPS mobile joint venture to bridge the global digital divide, and we welcome all other participants in this exciting emerging market to join with us. We completed the first and second test flights of our Hawk 30 solar HAPS during the second quarter with flying colors. Noted on slide number eight, we continue to make progress Positioning Air Environment to Manufacture, Supply, and Support Solar HAPS UAS for HAPS Mobile, Inc. As we have previously stated, our contract with HAPS Mobile offers significant flexibility to grow with the program. Early in 2018, when we initially signed the Design and Development Agreement, the contract value was $65 million. Today, we announced a new $14 million increase in the value of this contract. This brings the total value of the HAPS project to $149 million since its inception. We anticipate our HAPS program bookings and revenue beyond fiscal year 2020 will be similar to this year as the program transitions from the design and development to the testing and certification phase. We look forward to updating you as we continue to make progress in this exciting and large growth opportunity. Now Brian will provide a detailed financial overview of our second quarter.

Brian? Thank you, Wahid, and good afternoon, everyone. Our team delivered a strong financial performance in the second quarter of fiscal 2020. Revenue from continuing operations for the second quarter of fiscal 2020 was $83.3 million, an increase of $10.3 million, or 14%, from the second quarter of fiscal 2019 revenue of $73 million. The increase was due to an increase in product deliveries of $10.3 million. Second quarter fiscal 2020 revenue by major product line or program is as follows. Small UAS was $59.2 million, or 71% of total revenue. HAPS was $13.4 million, or 16%. TMS was $7.9 million, or 10%. And other was $2.8 million, or 3%. Inception to date revenue under contract for the HAPS program is $103.2 million. The total value of all contracts with HAPS Mobile is $148.9 million, which consists of $140.3 million for the design and development agreement and $8.7 million for preliminary design and other related efforts. There is $45.7 million remaining on these contracts, which includes a portion that is currently unfunded. Gross margin from continuing operations for the second quarter of fiscal 2020 was $35.2 million, or 42% of revenue compared to $28.4 million or 39% of revenue for the second quarter of fiscal 2019. The increase in gross margin was primarily due to an increase in product margin of $6.1 million and an increase in service margin of $0.7 million. Gross margin as a percentage of revenue increased from 42% from 39% primarily due to a favorable product mix and an increase in the proportion of product revenue to total revenue, partially offset by an increase in inventory reserves. Product sales were 69% of total sales in the second quarter of fiscal 2020 compared to 64% for the second quarter of fiscal 2019. Looking at the rest of the income statement, SG&A expense from continuing operations for the second quarter of fiscal 2020 was $16.3 million, or 20% of revenue, and a number of other members of the SGA. The SGA was the largest company in the U.S. in terms of revenue compared to SGA expense of $13.6 million or 19% of revenue for the second quarter of fiscal 2019. The increase in SGA expense was primarily due to increases in commission expenses, legal expenses and employee-related expenses. R&D expense from continuing operations for the second quarter of fiscal 2020 was $10.9 million or 13% of revenue compared to R&D expense of $8.1 million or 11% of revenue for the second quarter of fiscal 2019. Income from continuing operations for the second quarter of fiscal 2020 was $8.1 million compared to $6.6 million for the second quarter of fiscal 2019. The increase in income from operations was primarily due to an increase in gross margin of $6.8 million, partially upset by an increase in R&D expense of $2.7 million and an increase in SG&A expense of $2.6 million. Net other income for the second quarter of fiscal 2020 was $1.4 million compared to $2.4 million for the second quarter of 2019. The decrease in net other income was primarily due to a decrease in transition services performed for the buyer of our former efficient energy systems business. The effective income tax rate from continuing operations was 11.7% for the second quarter of fiscal 2020. compared to an effective income tax rate of 13.5% for the second quarter of fiscal 2019. Equity method investment activity net of tax for the second quarter of fiscal 2020 was a loss of $0.9 million or 4 cents per diluted share compared to a loss of $0.8 million or 3 cents per diluted share for the second quarter of fiscal 2019. Net income from continuing operations of the Tribal to AeroVironment for the second quarter of fiscal 2020 with $7.5 million or $0.31 per diluted share compared to $7 million or $0.29 per diluted share for the second quarter of fiscal 2019. Non-GAAP diluted earnings per share for the second quarter of fiscal 2020 was $0.34 per diluted share and excludes $0.03 per diluted share for intangible amortization expense and integration costs associated with the acquisition of Pulse Aerospace. GAAP and non-GAAP diluting earnings per share for the second quarter of fiscal 2020 was 29 cents. Now moving through our first half fiscal 2020 results. Revenue for the first half of fiscal 2020 was $170.2 million, an increase of $19.2 million compared to $151 million for the first half of fiscal 2019. The increase in revenue was due to an increase in product deliveries of $20.9 million Partially upset by a decrease in contract service revenue of $1.7 million. The first half of fiscal 2020 revenue by major products line of program is as follows. Small UAS was $125.9 million, or 74% of total revenue. HAPS was $25.7 million, or 15%. TMS was $13.5 million, or 8%. And other was $5 million, or 3%. Gross margin for the first half of fiscal 2020 was $76.4 million, or 45%, compared to $61 million, or 40% for the first half of fiscal 2019. The increase was due to an increase in product margin of $16 million, partially upset by a decrease in service margin of $0.6 million. Gross margin as a percentage of revenue increased from 40% to 45%, primarily due to a favorable product mix and an increase in the proportion of product revenue to total revenue partially upset by an increase in inventory reserves. Looking at the rest of the income statement, SG&A expense for the first half of fiscal 2020 was $29.9 million or 18% of revenue compared to SG&A expense of $25.6 million or 17% of revenue for the first half of fiscal 2019. The increase in SG&A is due to increases in commission expenses Legal expenses and employee related expenses. R&D expense for the first half of fiscal 2020 was $19.6 million or 11% of revenue compared to R&D expense of $14.5 million or 10% of revenue for the first half of fiscal 2019. Income from continuing operations for the first half of fiscal 2020 was $26.9 million or 16% of revenue The increase in income from tuning operations was primarily due to an increase in gross margin of $15.5 million, partially offset by an increase in R&D expense of $5 million and an increase in SG&A expense of $4.3 million. Net other income for the first half of fiscal 2020 was $3.1 million, and a number of other members of the Board of Directors. The first half of fiscal 2019 was 10.8% for the first half of fiscal 2020 compared to an effective income tax rate of 11.6% for the first half of fiscal 2019. Equity method investment activity net of tax for the first half of fiscal 2020 was a loss of $2.2 million, or $0.09 per diluted share, compared to a loss of $1.4 million, or $0.06 per diluted share, for the first half of fiscal 2019. Net income from continuing operations attributable to AeroVironment for the first half of fiscal 2020 was $24.6 million, or $1.02 per diluted share, compared to $27.4 million, for $1.14 per diluted share for the first half of fiscal 2019. The first half of fiscal 2019 included a one-time gain from a litigation settlement of $0.26 per diluted share. Non-GAAP diluted earnings per share for the first half of fiscal 2020 was $1.08 per diluted share and excludes $0.06 per diluted share for intangible amortization expense and deal and integration costs associated with our acquisition of Pulse Aerospace. Non-GAAP diluted earnings per share for the first half of fiscal 2019 was $0.88 per diluted share and excludes $0.26 per diluted share from a one-time litigation settlement gain in fiscal 2019. Our funded backlog as of October 26, 2019 was $146.7 million, a decrease of $17.2 million from the second quarter of fiscal 2019, and a decrease of $18.6 million from the first quarter of fiscal 2020 backlog of $165.2 million. Our funded backlog as of October 26, 2019 remained high compared to historical averages. Turning to our balance sheet, cash, cash equivalents, restricted cash, and investments at the end of the second quarter of fiscal 2020 totaled $310.9 million, a decrease of $21.7 million from the end of fiscal 2019 The decrease in cash was primarily related to our acquisition of Pulse Aerospace, as well as our increased investment in the House Mobile joint venture. Net accounts receivable, including unbilled receivables and retention, at the end of the second quarter of fiscal 2020, totaled $103 million. Unbilled receivables and retentions was $62.4 million, inclusive of $21.7 million of related party amounts. Total day sales outstanding from continuing operations for the second quarter fiscal 2020 was approximately 105 days compared to 87 days for the fourth quarter of fiscal year 2019. Net inventory at the end of the second quarter of fiscal year 2020 was $52.8 million compared to $54.1 million at the end of fiscal year 2019. Days in inventory outstanding for the second quarter of fiscal year 2020 was approximately 102 days for the fourth quarter of fiscal year 2019. Accounts payable at the end of the second quarter of fiscal year 2020 was $11 million compared to $16 million at the end of the fourth quarter of fiscal year 2019. Total days payable outstanding for the second quarter of fiscal year 2020 was approximately 21 days compared to 24 days for the fourth quarter of fiscal year 2019. Turning to capital expenditures. In the second quarter of fiscal year 2020, we invested approximately $4.9 million in property improvements and capital equipment to support our growth strategy and new product launches, and recognized $2.4 million of depreciation and amortization expense. Now, an update to our fiscal 2020 visibility, as highlighted on page 9 of the supplemental charts. As of today, we have year-to-date revenue in fiscal 2020 of $170 million. Second quarter ending backlog that we anticipate to execute in fiscal 2020 of $125 million Q3 quarter to date bookings that we anticipate to execute in fiscal 2020 of $22 million And unfunded backlog from incrementally funded contracts that we anticipate to recognize revenue during the balance of the year of $2 million This adds up to $319 million or 89% of our fiscal year 2020 midpoint revenue guidance range. We anticipate a full year effective tax rate of approximately 11%. This is higher than the fiscal 2019 full year tax rate of 9%, primarily due to anticipated lower excess tax benefits from equity awards and other tax credit estimates. Now, I'd like to turn the call back to Wahid.