AeroVironment, Inc.

Yeah, we'll go ahead and kick it off, because I know standing between us or this, you guys in happy hour is probably not a good thing to keep going. No, thanks for the spot. No, it's a good spot, though, because everyone's going to be in a good mood. Thanks all for joining us today. Hope you've had a good first day of the Citizens Technology Conference. I'm excited to kind of move this maybe from the digital to more of the physical realm with the Executive Vice President and Chief Financial Officer for Aero Environment, Kevin McDonald. I'm Trevor Walsh, the Senior Equity Research Analyst for Aerospace and Defense, and we're going to run through a good little fireside chat here, and then we'll kick it over to you all for questions from the audience. So thanks, Kevin, for being here. Really appreciate it.

Well, I appreciate it, Trevor. Thank you. Thanks to Citizens.

Let's just maybe, with the most recent news from last week, your retirement. from the company. Congratulations first, but maybe just give us a sense of how you're thinking about, or the company's thinking about when they take, you know, replacement. You know, obviously, you know, you've been there for a while. What is the kind of next person taking the reins of CFO kind of, you know, experiences, qualities in that leader? Do you think that Waheed...

Well, I mean, it's definitely got to be somebody who's experienced in growth. I mean, we feel like this is only the beginning. Like, you know, there's really strong growth prospects for the next five years, and going from a couple billion to five billion is a challenge. You know, I feel pretty proud of where we got it so far, and the next person's got to be able to take it from that two billion to five billion in growth in a very dynamic defense market where things are changing. It has to be adaptable to the situations and being able to take, I just look at the capabilities of the company and they're immense. I don't even think we've even really begun to fully tap into everything that we have, but that'll come. And so this person has to be adapted, understanding that, identifying that, shaping a culture that's innovative, continues to be innovative, but at a scale, at scale.

Perfect. You took my kind of next question about kind of first order priorities, but maybe anything that you expect to kind of remain consistent or unchanged, kind of that you either already implemented, et cetera, that they can just, you know, expect it to sort of run with, I guess.

Well, it It's still a work in progress. I mean, with the combination of Blue Halo, we went from under a billion-dollar company to a two-billion-dollar company. And the types of infrastructure and processes you need at two billion versus a billion are actually pretty different. So, you know, I think there's still work to do there. I'm not going to sit here and say everything's hunky-dory. You know, just... Just basic stuff. How you prepare for a conference call when now you have 15 business units versus three. These types of things are things we're all still trying to work on improving. Then we just throw some new systems in the mix for this year. That's the one thing I think that is going to be a positive for my successor is we've done it. We've had a lot of progress on the system front. We're on platforms that are world-class platforms of Workday, Oracle Fusion in the government cloud, Salesforce, and I think ServiceNow soon. So we have a world-class infrastructure, which great, but I think the big part of that is we're going to be able to take advantage of some of the AI tools and things that all those vendors now offer to automate things, better analysis and things like that. I would say that's the one thing I'm most proud of is that I was there to start the effort to lay that foundation for it to be a big company.

Great. Perfect. Yeah, I got to hear Mr. McDermott speak from ServiceNow earlier. So it sounds like you've picked a good kind of solid partner there for sure. Exciting. Great. I'll switch gears a little bit if I can. You mentioned Blue Halo. Can you, there's obviously a lot to talk about there and whether it's capabilities, how the company and the models change, which you've alluded to, but could you maybe just walk us through the history of, from a margin perspective specifically, kind of where, just remind us kind of where you saw Well, where you saw legacy AV before kind of acquisition and merger and then kind of, you know, bringing in the Blue Halo piece, what that sort of, you know, how that changed margins and then what should we kind of expect or kind of look for from that standpoint kind of on the go forward.

Yeah, I mean, today the Defense Department talks about companies having a commercial model where they would invest in products and bring them to the government, and they would select them and not do these massive RDT&E projects to get. That's been, commercial products has been the AV model for a long time. I think we invented that model for defense somewhat. And so we had great EBITDA margins, 18%, always double-digit growth. And Blue Halo, I would characterize as more of a traditional defense contractor in much of their business. The pieces that were more commercial like Titan or their underwater vehicle, these types of things were more commercial and those end up being in the AXS segment. But the space segment, the cyber intel, our mission solutions business in Dayton are all more traditional time and material type businesses. So those come with the traditional defense contractor type of margins. I'll have to say that the Blue Halo team is extraordinary at government contracting and subcontracting, which is important even in a commercial model. So the real value creation here comes as we move some of their core products like the ground station known as Badger today to a commercial model, the locus laser counter UAS system to a commercial model. a product called WASP, which is a derivative of Badger for upgrading existing ground stations, and a product called GunSights, which is a pointing and tracking technology on traditional ground-based weapon systems or vehicle-based weapon systems. All those are ripe for commercialization and taking more to a product margins. And I feel like as I stand here today, that it's about going to be a one to two year. I mean, you'll see obviously pieces of it, but a one to two year process to get those more commercialized global markets and increase the EBITDA margins. I mean, fundamentally. It's not a good business model to have one customer who's telling you what to do and you're beholden to them, because if they fall out of favor or they don't get funding, then you're stuck there. So a commercial model is a better model to say, we have this technology, here's the specifications, and sell it to multiple customers than try to have one or two customers. And the US government probably has to look at that and say, we have to be better at allowing those companies to sell their technology globally. Because, again, that helps scale and helps improve the capital for these companies to even do better and sell more products to the U.S. government. So I think that's the part of the model that needs to work from the U.S. government standpoint.

Got it. And so over that kind of one- to two-year time frame then, do you see kind of company margins returning to that legacy kind of where it was, you know, 18%?

Yeah, I think so.

Is that sort of a reasonable target?

I think so. That's what I think. Okay. Great. Another great segue. We're right on the cusp of these products moving from basically the experimental, we're trying to see if this works phase to the full adoption phase. And by that nature itself will help your margins, but even more accelerate those margins if you get them to a commercial model. Perfect.

Since we were kind of on that topic, or at least touched on it, why don't we move to SCAR and to Badger. Obviously some news came out today, so I just wanted to give you a chance to just generally, not that it was necessarily new news per se, but any initial thoughts just broadly on kind of what's happening around Badger and maybe all just setting the record straight.

Yeah, I mean, from my perspective, we had the satellite ground station, the phased array ground station that was going to capture multiple signals at a time from multiple satellites out there and communicate back and forth. And just over time, the spec got such that when we quoted and won two new systems back in the fall, the price tag was a lot higher than the government expected. And so they asked us to look at ways we could reduce the cost, which we did, and we came up with a version that's less expensive because basically they looked at it and go, we don't have enough money. It's a pretty simple thing. We didn't have enough money to get all the ground stations that we need with our mission set. They said, can you make something less expensive, maybe not as exquisite and do as much capability? We said, yeah, here's an idea and we gave them that idea. We tested it and we proved that that worked on a test situation. That's when we said, well, that's the version they want to go to because we can get the units we need to cover the mission set. At the same time, they want to go to a more commercial model, which we're totally fine with. and have a fixed price and a set delivery schedule and all the things that comes with that, and that's the process we're in now of negotiating that go-forward contract. We didn't cancel the contract. We're still on the program. We still have the contract. They've indicated, I think there was our news article today, that maybe they'll have some other people take a bid at it, but I would say we're multiple years ahead of any particular competitors in the market, so it's a little bit of a game of them trying to make us go faster, I think,

do you think they've already felt like they've gotten the sort of the the win or they've gotten what they needed from you from a price point perspective so it's now more just the like well we're negotiating that so we're still still going okay um well if it's a good negotiation they're unhappy and we're unhappy so sure um On that note of competition and you being ahead, do you think that you're ahead with respect to Badger and SCAR specifically technologically or capacity and manufacturing, both of those things?

Both of those things. One of the competitors is a startup that's getting a lot of news. They're a software model, recurring subscription model. But from what I've been told, they don't have the hardware yet, and they haven't been able to prove upward communication. So those are big hurdles to overcome. But nonetheless, I think that the new product will have wider, more ubiquitous use cases. So I think that it can become more of a commercial product. And so, you know, because if it is too exquisite and too overpriced, then the commercial market shrinks. So for us, we look at it as a long-term good thing to have a product that is more useful to many customers versus one.

Great. Let's dig in there maybe a little bit more because I think you've talked about it in the past and recently with us. as far as more commercial kind of non-defense or non-primary customer type customers, international, et cetera, can you just give us a sense, maybe not actual specific customers, but just a flavor of what those customers might look like and what the use cases might be for them?

I could just say generically, anybody who's communicating with multiple satellites would want the capability of, it isn't going to be called Badgers, it'll be called something else, for that new product over time, whether they're defense or non-defense.

Got it. So that could be anyone from someone just operating a constellation of communication satellites. It could be electro-optical and more imagery. It could be any of those things, really. Got it. Great. Any changes to give, I mean, does the facility that you have in New Mexico to kind of churn the badgers out, does that need to have any kind of major overhaul or changes to it given the new specs on the thing, or is that essentially kind of business as usual?

No, we see that as a positive that we don't really have to make any major capital investments, potentially some more R&D investments given the nature of the contract. But at this point, we don't believe that that's significant. But we're very proud, if those have been to our Albuquerque facility, very proud of the facility, the testing bed we have, the state-of-the-art equipment and the capabilities we have there. So like I said, that all gives us kind of a... I mean, the government needs these systems. They want them as fast as they can. So somebody that can provide them sooner is going to have a tremendous advantage over a newer company.

Got it.

Great. I'll switch gears a little bit.

Can we talk about Red Dragon? Love to. Okay, cool. What do you think is just the art of the possible in terms of pricing and quantity for, again, not specifics, but just a hypothetical customer that would want to have Red Dragon? What does that look like from just kind of a deal perspective?

Well, I mean, you know, how these technologies go, in the beginning, it's all very mission-focused. You know, they want this capability for this mission, this type of stuff. We're kind of in, you know, we need to try it here and there, that type of thing. We're kind of in, we're still in that phase a little bit. But, you know, as I look forward, you know, I just kind of put it this way, make it simple for myself. You know, that, you know, if I was a country... You know, I was Korea, you know, South Korea. You know, and I wanted to buy 500,000-something, that's what they've said. I'd buy hundreds of thousands of Red Dragons and tens of thousands of Switchblades because you have the, you know, en masse, swarming-type capability, fairly low cost. but could do some massive damage as a group of, say, 50 or 100 shot at a target. So we're very bullish on the future of Red Dragon. And the one-way attack got a lot of publicity with the Iran invasion. We're familiar with that one-way attack drone. Our view is it's not as capable at hitting the target as a Red Dragon would be.

Got it. And I think, correct me if I'm wrong, but the Red Dragon price point as of now that you're thinking is actually less than I think all the Switchblade models.

Right, correct, correct. It was, I remember the beginning two or three years ago. This is how long things take. You know, two or three years ago, there was this notion like Taiwan, they need something that's low cost, easy to assemble, that people could make in their garage and they could make hundreds of them and shoot them up. That was kind of the notion and then eventually this idea of Red Dragon. Something that's easy to assemble, easy to store, it has a zipper pouch for the kinetic effect so you don't have to store it with the kinetic effects was born out of that idea. And here we are, you know, three, more plus years later at least, but we feel like we're right on the cusp of full-scale adoption.

Great, maybe just, so great, thank you for level setting around kind of an initial purchase of what that might look like for a country. How much, and I think we've seen this a little bit with LMS and Switchblade where there's almost like a recurring type of spend because they either get used or even training or otherwise, these are not necessarily meant to be an explicit system that just comes back, right? They're like munitions, they're effectively munitions. How does that look for Red Dragon? Does this have a similar type of feel where they're not just, customer doesn't just buy the 100,000, but there's kind of more orders as they come because they're just going to get depleted over time?

Yeah, any time you have a weapon like this, you're going to have a recurring business because they're going to be firing them off for training. There's probably a notion that these things improve over time, that maybe you just want to deplete 20 percent a year or something like that for that reason. But in switchblade type products, we're just so early on this. These countries have not got to a point where they're going to buy thousands yet, but that'll happen the next two or three years. So we're early days.

Okay. That was one of my last questions. So two or three, so should we think FY27 is a possible contributor, do you think, or more for Red Dragon specifically? Oh, absolutely. Okay. Absolutely. Okay, and then final question, too, then, on Red Dragon, and then we can switch to a new topic. Do you, and you mentioned what's kind of happening in Iran now, you know, in real time around, you know, these one-way attack type munitions. Do you think, in terms of just broadly that as a category, what factors do you think customers are evaluating kind of most between, you know, the cost, autonomy capabilities, manufacturing at a scale that can get it done, something else? Like, how do you think they're balancing all those things as far as making a decision around a final?

Hit the target. Hit the target. I mean, they got to work. They got to hit the target. They got to find the target. You know, this is where we, you know, have strong capabilities. Completing the mission, getting the mission done. Cost is, you know, everybody always says they want, I mean, I haven't met somebody buying a product and want it cheaper. I mean, you know, but, you know, so the cost is always element. And this was designed to be a high value product. weapon system. But everything has its day. There's a myriad of weapons the U.S. have that have different ranges, different payloads, different use cases. There's no end-all, be-all. There'll be many different products in the lethal drone category. We think between this and Switchblade, we've covered a nice part of the market.

Great, perfect. Okay, well, let's go from the stuff that goes boom to maybe the stuff that prevents the boom from happening and talk a little bit about Counter UAS if we can. Yeah. When we had you out for investor meetings a few weeks back, you talked about two different Counter UAS site implementations by FY27. Can you maybe just give us a sense of what that, I mean, are those essentially the type of installation that that's most likely going to be in terms of?

Well, as we said, we're pitching kind of part of the Golden Dome initiative, which is to protect the critical infrastructure, that we actually have the capabilities that you need to protect critical sites. So it's just like any type of sales process. We're trying to make that pitch. We have our LOCUS laser weapon systems. We have our RF defeat systems. We've got... the software. We've got the detect systems and the Titan SV product. We can put that together on a site. So the goal is in the next 12 months or so to get the government to agree to have us put on a couple sites and see how it works. I think no matter what, laser counter UAS, we're definitely the most important player. You would think that an analyst would pick up on that as more important than a little contract issue with SCAR, that we basically, I mean, look at all the, just the little publicity we've gotten lately in the border. Not that it's massive, but, I mean, that's, people don't understand, that's like amazing, you know? The U.S. government is using counter-U.S. lasers on U.S. soil that are made by us. They wouldn't use it, they wouldn't use it if they didn't really fully believe this was capable. So we believe this as... Big opportunity in the short run for us. Again, there's multiple products that came over from the Blue Halo portfolio that are in this kind of coming out of the let's test it, let's see if this works phase. After many years starting way back here at this is going to be the awesome most thing to reality to now to full adoption. And there's multiple sitting at this. Counter UASRF for public safety purposes. Counter drone laser technologies. On the AV side, it's a one-way attack drones, long-haul laser communications from the AV side. Again, we just got a $500 million contract for nobody else. If you believe that laser communications is important for military purposes and long-haul, then you got to believe in what we're doing. Multiple products are just hitting this adoption phase. That's what's super excited about the story.

Yeah. Do you think that whether it's for the one to two sites that you think you'll have online in the near term versus just broadly with the opportunity, is selling the full package of layer defenses that you guys have just internally within your portfolio is a... As a key differentiator or are you OK to just you know just sell locusts to a you know to the laser weapons and then someone else can do the RF or how how do you from a you know BD kind of go to market how are you thinking about that type of we traditionally have not taken on the system integrator.

model and we are doing this here. I personally would love to see it successful from this purpose because I do think we do have a variety of capabilities that as proposing solutions might be the best way for us to grow those products. You know, it has not been our traditional route. I mean, we've done some stuff here and there, but more and more we're seeing, you know, improving our capabilities and expanding our capabilities in that kind of system integrator model with mostly our product and some other people's products.

as you have success on more what you'd probably call, you know, kind of classic, you know, critical infrastructure, military bases, DOD-type installations, and that's probably going to be, I think, probably the most likely first candidates, just given Golden Dome. That naturally leads you to more public critical infrastructure, utilities, other things. Is that something that you guys will also pursue eventually? And will that create a new kind of BD type motion for you guys that you haven't necessarily exercised before?

Well, it definitely would be new. And so, yes, those are things that are under consideration. How do we go to market if every power plant in the United States needs some type of protection, that type of thing? The Titan product, we do mostly today sell through resellers. And that would be a question. How should we be more of the reseller ourselves than other people? Got it. Great.

Oh, man, time flies. And I've been chatting the whole time. I'll make sure there's not questions from the audience before I can continue on. Are there any questions from the audience? No? I can keep going. I have a list. Okay, Ethan, go ahead.

Well, it's already the best margin product of the company. So, you know, I don't know. In some way, it could be close to the same or maybe a little bit better, but you're probably going to be taking on a little bit lower kind of integration work as part of that. So maybe overall, you know, if you said that business goes from $100 to $200 million, the margin might be the same or a little down because now you're incorporating more services in it. So I don't know. What that looks like but it's it's a great margin product as it is.

I'll do one more international business you guys had a great kind of I think motion around that even before blue halo and put a lot of work in there now with blue you've got like we talked about a whole host of new products that you can now take to those international. strongholds you've already established. What do you think you could be doing better, though, as well as you've done there, especially with all the new dynamics, let's say, around other countries really taking more of their own destiny into their own hands? What do you guys think you should be doing just better on the international front? What might we see in FY27 coming up?

Yeah, we're definitely adopting a strategy that gets us more in-country resources. You know, either, you know, BD or business development or technical resources. You know, some of these countries want some type of, you know, I wouldn't say manufacturing, at least assembly equipment. type of operation in country. So we're exploring all those alternatives. It wasn't as imperative for us before, because we really had one main product we were selling internationally, Puma. Then over the last couple of years, we've been able to sell Switchblades. But now we have a host of products we can sell into these countries. And so it makes sense for us to have a more localized, at least sales and support, operation versus a reseller network in the in-country so you'll see more of that in the next 12 months great all right and we're in the kind of the red zone time so again if there's any other questions otherwise we'll let everybody thank you trevor thank you so much sir appreciate it thanks