AeroVironment, Inc.

Good afternoon, ladies and gentlemen, and welcome to AeroVironment's third quarter fiscal year 2020 earnings call. This is Stephen Gidland, Vice President of Investor Relations for AeroVironment. At this time, all participants are in a 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 board-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 safe harbor statement contained therein. This afternoon, we also filed a slide presentation with our earnings release and posted the presentation to 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, March 3, 2020. 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 AirVironment are President and Chief Executive Officer, Mr. Wahid Nawabi, and Senior Vice President and Chief Financial Officer, Mr. Kevin McDonald. We will now begin with remarks from Wahid Nawabi. Wahid?

Thank you, Steve, and welcome to our third quarter fiscal year 2020 earnings conference call. Today, I will refer to the supplemental investor presentation we filed with our earnings release and post it to our website. On today's call, I will discuss three key topics. that are outlined on slide number three of our earnings presentation. First, we're on track to achieve our fiscal year 2020 objectives and deliver a third consecutive year of profitable double-digit growth, and today we increased our EPS guidance to reflect our strong momentum. Second, we are well positioned to maintain our growth trajectory beyond fiscal year 2020 based on our assessment of demand drivers. And third, we're executing effectively against our strategy for long-term value creation and delivering significant value to our stockholders. I will start by summarizing our third quarter fiscal year 2020 performance while highlighting our key financial and operational achievements during the quarter. Next, Kevin McDonnell, our new chief financial officer, will provide a more detailed summary of financial performance in the quarter. I will then discuss our goals and increased guidance for fiscal year 2020 before Kevin, Steve, and I take your questions. As I stated last quarter, we expected about one-third of our second half revenue in the third quarter, which is consistent with the $61.9 million we delivered and described on slide number four. Third quarter revenue produced loss per diluted share of four cents and non-gap loss per diluted share of one cent. which reflects expenses related to our pulse aerospace acquisition in June 2019 and amortization of intangible assets. Third quarter revenue also resulted in lower overhead absorption which impacted quarterly earnings. Higher revenue plan for the fourth quarter will result in improved absorption. For the fiscal year to date, revenue of $232 million increased 3% compared to the prior year. This was a modest improvement that does not reflect the higher top-line growth we continue to expect for the full fiscal year 2020. Funded backlog of $126 million declined from last quarter as a result of contract awards timing. We expect funded backlog to increase with the finalization of multiple contract negotiations which are currently underway. These contract negotiations include the multi-year Army LMAMS program estimated at $160 million. Now I will discuss the progress our team made in the third quarter. AeroVironment remains the go-to provider of fixed-wing Group 1 unmanned aircraft systems for the U.S. government and more than 45 allied nations. During the quarter, we announced international orders totaling $18 million for two allied customers. Our international business remains strong heading into our fourth quarter. The recently released U.S. government fiscal year 2021 budget request includes $85 million for LMAMS procurement and $14 million for Marine Corps and Air Force Puma procurement. This results in a total of about $100 million in requested line item funding for air environment solutions. In addition to requested line items for our solutions, there is more than $45 million for Marines and U.S. SOCOM unmanned requirements and $40 million in requested funding for U.S. Army Short-Range Reconnaissance, or SRR, and Soldier-Borne Sensor, or SBS, programs. We believe these requested funding items represent additional potential opportunities for new next-generation air environment solutions. In our family of tactical UAS, we're focused on developing this next generation family of systems. These new solutions will offer an enhanced user experience and will be capable of operating with greater autonomy through our focused development projects in AI, computer vision, and machine learning. Increased autonomy will reduce the cognitive load on system operators and will help enable operation in denied airspace. We're making significant progress in this area and remain focused on delivering this next generation family of systems. Now turning to our vapor small unmanned helicopter product line, we continue to execute our strategy and make good progress. We have relocated and set up vapor manufacturing in Simi Valley and are now producing units alongside our other UAS and TMS products. Our vapor systems are also generating interest from commercial customers who are pioneering the use of unmanned systems in their operations. Vapor is in the process of becoming evaluated for approval by the FAA for Beyond Visual Line of Sight operations in collaboration with a commercial customer. The specific timing is not known yet, but we look forward to achieving continued progress towards commercial certification. We're seeing continued momentum in our tactical missile systems product line, where we are the leading provider of loitering missile systems to the U.S. government with our switchblade and its patent wave-off technology. We are in negotiations with our customer for the multi-year $160 million LMAMS requirement. The timing of this contract award is currently uncertain, which means it could happen toward the end of this quarter or shortly thereafter. In addition to the US government demand for our unique switchblade capabilities, we are actively engaged in export discussions with multiple allied customers. We remain confident such exports will take place and create an opportunity for significant value creation, although timing is not certain. I would also like to point out that the $85 million in the government fiscal year 2021 budget request for Army LMAMS includes $5.5 million to promote competition for this program. Historically, every Air Environment U.S. defense contract has required some form of competitive evaluation before an award could be issued. We have been competing successfully for more than a decade for LMAMS contracts, and have had great success. These competitions typically involve a number of defense contractors and other companies ranging from some of the largest in the world to very small startups. Consistent with our track record of competitive success, we are confident in our ability to compete and win future competitions. As a technology company, we continually invest in research and development to enhance our capabilities and solutions. Switchblade is an example of a product we have continued to invest in to deliver the best capability to our customers and greatest value to our stockholders. Our investments to improve our operations continue to position us to deliver favorable bottom line results for our customers and our stockholders. As I have mentioned on prior earnings call, we continue to make progress in the development and maturation of a larger variant of our switchblade solution. We continue to invest strategically alongside our customer in order to deliver this capability to the warfighter. During this fiscal year, we conducted a series of flight tests which are moving us closer to introducing this product. This new variant is not only a game changer in this market, but it also significantly increases the size of the addressable market for our switchblade family of systems. We're excited about this opportunity to extend our leadership position. Speaking of large markets, we continue to make progress on our HAPS program, which is targeting the global connectivity opportunity. We're preparing for the next round of flight testing where we will expand flight duration and altitude while validating performance against our models. We now have two Hawk 30 aircraft to deploy for flight testing. Last month, the HAPS Alliance was unveiled to promote the growth of this emerging global industry utilizing the stratosphere. Leaders from technology, telecom, and aerospace industries joined the HAPS Mobile Alliance to accelerate commercial adoption, advocate for safety and sensible regulations, promote cross-industry collaboration, and provide thought leadership and education. In addition to AirVironment, SoftBank and HAPS Mobile, the other participating companies include Airbus, China Telecom, Deutsche Telekom, Ericsson, Entelsat, Alphabits Loon, Nokia and Telefonica. Broad and cross-industry support for the HAPS opportunity will help power its growth and create the framework for market adoption over time. This market and business opportunity are still in their infancy, but by working together with other industry leaders, we're confident we will advance the deployment of HAPS solutions for long-term value creation for Air Environment stockholders and customers. With that as a summary of our third quarter, I'm delighted to introduce Kevin McDonnell as Air Environment's Chief Financial Officer. Kevin brings extensive leadership and CFO experience across diverse industries, which give him unique insights and perspectives that will support Air Environment's continued growth and success. Kevin is a strategic thinker with a demonstrated track record of long-term value creation, and we look forward to his contributions to Air Environment's growth. Now Kevin will provide a detailed financial overview of our third quarter. Kevin?

Thank you, Wahid. Before sharing our third quarter financial results, I'd like to take a moment to thank AeroVironment's Board of Directors, Wahid, and the leadership team for the opportunity to serve our stakeholders as Chief Financial Officer. This is a unique and exciting company with tremendous growth potential. I look forward to working with our team to achieve our value creation objectives. I also look forward to meeting our stockholders and research analysts in the near future. Now let's turn to the Q3 results as highlighted on page four of the posted presentation. Revenue for the third quarter of fiscal 2020 was $61.9 million, a decrease of $13.4 million or 18% from the third quarter of fiscal 2019 revenue of $75.3 million. The decrease was due to a decrease in product deliveries of $13.6 million. Third quarter fiscal 2020 revenue by major product line and program is as follows. Small UAS was $37 million or 60% of total revenue. HAPS was $11.8 million or 19%. TMS was $7.9 million or 13%. And other was $5.3 million or 8%. Let me take a moment to outline the current status of the HAPS program. Inception to date revenue under contracts from the HAPS program is $115 million. The total value of all contracts with HAPS mobile is $148.6 million, which consists of $140.3 million for design and development and $8.3 million for preliminary design and other related efforts. There is $33.6 million remaining on these contracts, which includes a portion that is currently unfunded. Turning back to the financial performance for the quarter. Gross margin for the third quarter of fiscal 2020 was $23.5 million or 38% of revenue compared to $30.4 million or 40% of revenue for the third quarter of fiscal 2019. The decrease in gross margin was primarily due to a decrease in product margin of $7.8 million, partially offset by an increase in service margin of $1 million. Gross margin as a percentage of revenue decreased to 38% from 40%, primarily due to a decrease in the proportion of product revenue to total revenue. As highlighted on slide five, product sales were 59% of total sales in the third quarter of fiscal 2020, compared to 66% for the third quarter of fiscal 2019. In terms of bottom line results, the net loss The net loss from the third quarter of fiscal 2020 was $1 million, or $0.04 per diluted share, compared to net income of $8.4 million, or $0.35 per diluted share for the third quarter of fiscal 2019. The reduced third quarter net income was the result of lower gross margin of $6.9 million, higher operating expenses of $2.1 million, increased loss from House Mobile Equity Method investment activity of $0.5 million, and reduced other income of $1 million. It should be noted that fiscal 2019 net other income included transition services income for services performed for the buyer of our former efficient energy systems business. Non-GAAP diluted loss per share for the third quarter fiscal 2020 was $0.01 per diluted share and excludes $0.03 per diluted share for intangible amortization expense and integration costs associated with our acquisition of Pulse Aerospace. GAAP and non-GAAP diluted earnings per share for the third quarter of fiscal 2019 was 35 cents. Now moving through to our results for the first three quarters of fiscal 2020. Revenue for the first three quarters of fiscal 2020 was $232.1 million, an increase of $5.8 million from the $226.3 million recognized in the first three quarters of fiscal 2019. The increase in revenue was due to an increase in product deliveries of $7.3 million, partially offset by a decrease in contract service revenue of $1.5 million. The first three quarters of fiscal 2020 revenue by major product line and program is as follows. Small UAS was $162.9 million, or 70% of total revenue. HAPS was $37.5 million, or 16%. TMS was $21.4 million, and other was $10.3 million or 5%. Gross margin for the first three quarters of fiscal 2020 was $99.9 million or 43% of revenue as compared to $91.4 million or 40% of revenue for the first three quarters of fiscal 2019. The increase in dollars was due to an increase in product margin of $8.2 million and an increase in service margin of $0.4 million. Gross margin as a percentage of revenue increased from 40% to 43%, primarily due to favorable product mix and an increase in the proportion of product revenue to total revenue. In terms of the year-to-date third quarter bottom line, net income was $23.6 million, or 98 cents per diluted share, compared to $41.8 million, or $1.49 per diluted share, for the first three quarters of fiscal 2019. The fiscal 2019 year-to-date diluted earnings per share excludes income of $0.25 per diluted share from discontinued operations. In addition, the first three quarters of fiscal 2019 include a one-time gain from a litigation settlement equal to $0.26 per diluted share and net other income from transition services performed for the buyer of our former efficient energy systems business. In addition to the above, fiscal 2020 Net income decreased year-to-date as a result of increased operating expenses of $11.4 million, increased loss from HAP's mobile equity method investment activity of $1.3 million, partially offset by higher gross margin of $8.6 million. I should also note that the effective tax rate was 10.6% for the first three quarters of fiscal 2020 compared to an effective income tax rate of 11.1% for the first three quarters of fiscal 2019. Non-GAAP diluted earnings per share for the first three quarters of fiscal 2020 was $1.07 per share, and it includes $0.09 per share for intangible amortization expense, deal, and integration costs associated with our acquisition of Pulse Aerospace. Non-GAAP diluted earnings per share for the first three quarters of fiscal 2019 was $1.23 per share, and it includes $0.26 per share from a one-time litigation settlement gain of fiscal 2019. Our funded backlog as of January 25, 2020 was $126 million, a decrease of $6.5 million from the third quarter of fiscal 2019, and a decrease of $20.7 million from the second quarter of fiscal 2020 backlog of $146.7 million. Now I'd like to take a few moments to highlight some of the key balance sheet accounts. Cash, cash equivalents, restricted cash, and investments at the end of the third quarter of fiscal 2020 totaled $311.4 million, a decrease of $21.2 million from year-end fiscal 2019 balance of $332.6 million. The decrease in cash was primarily related to our acquisition of Pulse Aerospace as well as our increased investment in the HAPS Mobile joint venture. Net accounts receivable, including unbilled receivables and retention, at the end of the third quarter of fiscal 2020 totaled $105.3 million. Unbilled receivables and retentions was $77.4 million, and this includes $28.8 million of related party amounts, which we expect to be paid by the end of the current fiscal year. Total days outstanding for continuing operations for the third quarter of fiscal 2020 was approximately 151 days compared to 87 days for the fourth quarter of fiscal 2019. Net inventory at the end of the third quarter of fiscal 2020 was $65.2 million compared to $54.1 million at the end of fiscal 2019. The increase in inventory in Q3 reflects the buildup of inventory to fulfill a number of contracts, like the Raven contract from the U.S. Army Security Force Assistance Brigades and the LMAMS contract. Days in inventory outstanding for the third quarter of fiscal 2020 was approximately 138 days compared to 92 days for the fourth quarter of fiscal 2019. In terms of capital expenditure activity in the third quarter of 2020, we invested approximately $1.7 million in property improvements and capital equipment to support our growth and new product launches and recognized $2.6 million of depreciation and amortization expense. Lastly, I'd like to summarize our fiscal 2020 visibility as highlighted on page 8 of the supplemental charts. As of today, we have year-to-date revenue in fiscal 2020 of $232 million, third quarter ending backlog that we anticipate to execute in fiscal 2020 of $95 million, Q4 quarter-to-date bookings that we anticipate to execute in fiscal 2020 of $25 million. We currently have no unfunded backlog from incrementally funded contracts that we anticipate to recognize revenue during the balance of the year. This rounds to approximately $350 million, or 98% of our fiscal 2020 midpoint revenue guidance. We do 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 credits. Now I'd like to turn the call back to Wahid.