AeroVironment Inc (AVAV) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen.

Welcome to the AeroVironment Incorporated Fourth Quarter and Full Fiscal 2017 Earnings Call.

(Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

With us today from the company is the President and Chief Executive Officer, Mr. Wahid Nawabi; Senior Vice President and Chief Financial Officer, Ms. Teresa Covington; and Vice President of Investor Relations, Mr. Steven Gitlin.

And now, at this time, I would like to turn the conference over to Mr. Gitlin.

Please go ahead, sir.

Thank you, Chelsea.

Welcome to AeroVironment's fourth quarter and full fiscal 2017 earnings call.

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.

Factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to, reliance on sales to the U.S. government; availability of U.S. government funding for defense procurement and R&D programs; changes in the timing and/or amount of government spending; risks related to our international business, including compliance with export control laws; potential need for changes in our long-term strategy in response to future developments; the extensive regulatory requirements governing our contracts with the United States government and international customers; the consequences to our financial position, business and reputation that could result from failing to comply with such regulatory requirements; unexpected technical and marketing difficulties inherent in major research and product development efforts; the impact of potential security and cyber threats; changes in the supply and/or demand and/or prices for our products and services; the activities and competitors and increased competition; failure of the markets in which we operate to grow; uncertainty in the customer adoption rate of commercial unmanned aircraft systems and electric vehicles; failure to remain a market innovator and create new market opportunities; changes in significant operating expenses, including components and raw materials; failure to develop new products, product liability, infringement and other claims; changes in the regulatory environment and general economic and business conditions in the United States and elsewhere in the world.

For a further list and description of such risks and uncertainties, see the reports we file with the Securities and Exchange Commission.

The content of this conference call contains time-sensitive information that is accurate only as of today, June 27, 2017.

The company undertakes no obligation to make any revision to the statements contained in our remarks or to update them to reflect the events or circumstances occurring after this conference call.

Let's begin with remarks from Wahid Nawabi.

Wahid?

Thank you, Steve.

Our 3 main messages today are as follows: first, our business remains strong and profitable and our team achieved or exceeded our financial objectives for fiscal 2017; second, we made good progress on our fiscal 2017 milestones that maintained the leading market positions in our core business and advanced our differentiated solutions for large new global opportunities in our growth portfolio; and third, we remain on track for long-term value creation.

On today's call, I will provide a summary of fourth quarter and full year financial performance, and we'll review our achievements in fiscal 2017.

Teresa Covington will provide a more detailed review of our financials before I share with you our goals for fiscal 2018.

Teresa, Steve, and I will then take your questions.

When I assumed the role as AeroVironment's Chief Executive Officer a little more than a year ago, I was confident we were well positioned to execute our strategy successfully, drive value for shareholders and provide our customers more actionable intelligence so they can proceed with certainty.

To troops on the frontline, that certainty can mean the difference between life and death.

To businesses, it can mean helping to ensure their financial prosperity.

Our core business is strong with leading market positions and the ability to generate attractive returns.

And our growth portfolio is compelling with the highly differentiated solutions we have been developing for launch into the large, new global market opportunities.

Achieving these opportunities requires planning.

When we developed our fiscal 2017 plan, customer order timing resulted in a heavily weighted fiscal fourth quarter.

Thanks to the support and dedication of our amazing team, we delivered record fourth quarter results as follows: revenue of $125 million, an increase of 48% year-over-year; operating income of $34 million, an increase of nearly 400% year-over-year; and fully diluted earnings per share of $1.30, an increase of more than 450% from the prior year.

Our outstanding fourth quarter performance combined with careful operating expense management throughout the year produced full year revenue of $264.9 million, a small increase over fiscal 2016 and fully diluted earnings per share of $0.54, well above our guidance and a 36% increase year-over-year.

Gross margin decreased, partly the result of a onetime reserve reversal in fiscal 2016 and partly due to higher sustaining expenses.

Our focus on operating expense management more than offset lower gross margin to produce operating income of $12.5 million, a 29% increase over last year.

Our expense management included reducing internal R&D investments from 16% of revenue in fiscal 2016 to 12% of revenue in fiscal 2017 as we consistently communicated to you throughout the year.

In addition to our financial performance, we achieved nearly all of the objectives for fiscal 2017 that we shared with you a year ago and we emerged even better positioned for long-term value creation than before.

At the beginning of fiscal 2017, I shared with you our 10 key milestones for the year, which I will now report on.

We continued the expansion of our domestic small UAS business through sustainment and upgrades, deliveries that support potential U.S. Army procurement programs and promising U.S. Navy adoption.

We began shipments of Mantis i45 sensors to DoD customers for Puma AE upgrades at the end of fiscal 2017.

The i45 sensor suite delivers unparalleled imaging capabilities for small UAS and has the potential to drive its own significant upgrade cycle among Puma AE customers.

We also improved our positioning for a U.S. Army soldier borne sensor competition with our next generation pocketable snipe unmanned aircraft system, including completing shipments of our first 30 systems for customer evaluation.

And we continued to demonstrate effective small UAS capabilities aboard naval vessels to drive further naval adoption of our solution.

We expanded our international small UAS install base with existing and new customers.

Small UAS constitutes the majority of AeroVironment's international revenue which grew from 28% to 36% of company revenue in fiscal 2017, or from about $70 million to nearly $90 million.

We offer a comprehensive solution that appeals to our international customers and they are procuring one or more products from our family of small UAS as well as multiyear services such as training and repairs.

Some of these customers are even using our systems 24/7, relying heavily on them to protect their forces and pushing the extreme capabilities of our unmanned solutions.

AeroVironment is, without question, helping these customers proceed with certainty with very high stakes on the line.

This integrated Family of Systems has helped to spur increased adoption across a broader geographic range from western to eastern Europe, from the Middle East to Asia and Oceania, expanding our list of allied customers to more than 40 countries.

New UAS customers in fiscal 2017 included Latvia, Lithuania and 3 other NATO and Middle East countries.

As an example of Family of Systems adoption, in October, we announced a $10.3 million contract with The Netherlands for digital upgrades to their existing Raven fleet and for new Wasp AE and Puma AE systems.

On June 1, we announced that the Australian Defence Force selected our Wasp AE for its small UAS program.

We anticipate more multiyear contracts from international customers ahead as our install base grows and we create more opportunities to build recurring revenue streams from sustainment services and upgrades.

We continue to progress towards the U.S. DoD's frequency relocation program for small UAS, winning an initial contract that we believe positions us well for follow-on work expected this fiscal year.

The strategic investments we've been making to build our TMS business continue to deliver results.

In fiscal 2011, our TMS revenue was about $6 million, growing to more than $40 million in fiscal 2016.

In fiscal 2017, TMS revenue grew to more than $75 million, an increase of more than 80% over the previous year.

From fiscal 2011, this represents a compound annual growth rate of 56%.

As you can see, the returns on our strategic incremental TMS investments of previous years are very positive.

TMS now accounts for 29% of total company revenue.

We continue to build our family of tactical missile systems to address the important needs of a growing number of customers and we continue to successfully deliver Switchblade systems to our U.S. government customers.

In October, we announced a $22.8 million contract from the U.S. Army for Switchblade systems, which strengthens our position as the leader in loitering munitions, one type of a tactical missile system.

In fiscal 2017, we deployed Blackwing systems for use on Navy submarines with very positive results, an encouraging milestone on the path towards long-term adoption into a Navy program of record.

Still within our TMS business, progress continued on our multiple Switchblade variants, including production and delivery of one variant

(technical difficulty)

Ladies and gentlemen, we apologize for the technical issues.

(Operator Instructions) You may resume.

Thank you very much, this is Steve Gitlin.

And again, we apologize for whatever technical issues cut our call off.

So Wahid's going to start a little bit earlier in the script.

Apologies if there's some repetition here, but we want to make sure that you're tracking with his prepared comments.

Thank you, Steve.

We continue to progress toward the U.S. DoD's frequency relocation program for small UAS, winning an initial contract that we believe positions us well for follow-on work expected this fiscal year.

The strategic investments we have been making to build our TMS business continue to deliver results.

In fiscal 2011, our TMS revenue was about $6 million, growing to more than $40 million in fiscal 2016.

In fiscal 2017, TMS revenue grew to more than $75 million, an increase of more than 80% over the previous year.

From fiscal 2011, this represents a compound annual growth rate of 56%.

As you can see, the returns on our strategic incremental TMS investments of previous years are very positive.

TMS now accounts for 29% of total company revenue.

We continue to build out our family of tactical missile systems to address the important needs of a growing number of customers, and we continue to successfully deliver Switchblade systems to our U.S. government customers.

In October, we announced a $22.8 million contract from the U.S. Army for Switchblade systems, which strengthens our position as the leader in loitering munitions, one type of tactical missile system.

In fiscal 2017, we deployed Blackwing systems for use on Navy submarines with very positive results, an encouraging milestone on the path toward long-term adoption into a Navy program of record.

Still within our TMS business, progress continued on our multiple Switchblade variants, including production and delivery of one variant and further development of others.

Nearly half of our fiscal 2017 TMS revenue comes in the form of customer funded research and development.

While customer funded R&D is usually lower-margin business, structured in cost plus contracts, it's also a strong indicator of customer engagement that generally leads to higher-margin product revenue in subsequent years.

Additionally, we are demonstrating effective counter UAS capabilities that have the potential to protect troops from the growing threat of lethal drones operated by our adversaries.

In our Commercial Information Solutions business, we unveiled our innovative Quantix drone, an AV decision support system analytics platform, shared news about important and relevant research with Fresno State University and made continued progress with early adopter customers in multiple industries.

In April, we performed an important demonstration with Ligado Networks, Dominion Virginia Power and Virginia Tech.

During this event, we flew our Puma AE system up to 14 miles away from its operator along power lines using Ligado's satellite and terrestrial capabilities to maintain communication and control.

This demonstration illustrated a safe and effective approach to controlling drones and beyond visual line of sight operations.

This type of capability will be critical towards maximizing the economic benefits of drones in commercial applications.

Additionally, we achieved further engagement with potential customers for atmospheric satellite systems.

In our EES business, we grew revenue by 18% year-over-year and accelerated our global EV charging strategy by winning a contract with Volvo to support their plug-in vehicle rollout in Europe and China, which we announced in March.

We continue to enjoy strong demand and growth for EV test systems from global OEMs and battery manufacturers, particularly in China, North America and South Korea.

Our passenger EV charging solutions enjoyed strong unit growth in 2017 and we surpassed 54,000 level 2 charging systems deployed.

Shipments of EVSEs increased sharply over last year as we supported the launch of the Chevrolet Bolt EV.

Outside of North America, our multiyear program with Volvo to develop a residential charger for the European, Chinese and North American markets is in progress, building on our next-generation EV charging systems architecture and is compatible with 2018 global standards and agency requirements.

Also in fiscal 2017, our EV CRS -- EVSE-RS system was integrated with eMotorWerks' JuiceNet for 2 utility programs.

This development added to our broad portfolio of network integrated charging solutions that demonstrate our adaptability to the evolving EV charging network ecosystem for demand response and vehicle-to-grid applications.

Finally, in EES, we began shipping turbo cord Level 2 chargers to a major global German automaker.

We made good progress on our continuous improvement initiatives, enhancing business processes, quality, our organization, planning and execution.

These initiatives have already delivered high customer and employee satisfaction, which ultimately contribute to shareholder value.

Across our business, we achieved our goals in fiscal 2017 and improved our positioning to achieve our long-term growth objectives.

Now I will turn the call over to Teresa to provide more detail on our financial performance in the fourth quarter and for the full fiscal year.

Teresa?

Thank you, Wahid, and good afternoon, everyone.

AeroVironment's fiscal 2017 fourth quarter results are as follows: revenue for Q4 was $125.4 million, an increase of $40.6 million or 48% from the fourth quarter of fiscal 2016 revenue of $84.8 million.

The increase in revenue resulted from an increase in product sales of $51.5 million, partially offset by a decrease in contract services revenue of $10.8 million.

Looking at revenue by segment, UAS revenue was $115.7 million, an increase of $39.8 million or 52% from the fourth quarter fiscal 2016 revenue of $75.9 million.

The increase was due to an increase in product deliveries of $50.4 million and an increase in service revenue of $2.1 million, partially offset by a decrease in customer-funded R&D work of $12.7 million.

EES revenue was $9.7 million, an increase of $0.8 million or 9% from the fourth quarter of fiscal 2016 revenue of $8.9 million.

This increase was primarily due to an increase in product deliveries of EV test systems.

Turning to gross margin.

Gross margin for the fourth quarter was $58.7 million or 47% as compared to $37.9 million or 45% for the fourth quarter of fiscal 2016.

The increase in gross margin was primarily due to an increase in product sales margin of $26.5 million, partially offset by a decrease in service margins of $5.8 million.

By segment, UAS gross margin increased to $56.3 million for the fourth quarter of fiscal 2017 from $35 million.

As a percentage of revenue, gross margin for UAS increased from 46% to 49%, primarily due to an increase in product sales volume and favorable product mix.

EES gross margin decreased $0.6 million to $2.3 million for the fourth quarter of fiscal 2017, primarily due to unfavorable product mix.

SG&A expense for the fourth quarter of fiscal 2017 was $16.7 million or 13% of revenue compared to SG&A expense of $16.8 million or 20% of revenue for the fourth quarter of fiscal 2016.

R&D expense for the fourth quarter of fiscal 2017 was $7.9 million or 6% of revenue compared to R&D expense of $14.3 million or 17% of revenue for the fourth quarter of fiscal 2016.

Operating income for the fourth quarter of fiscal 2017 was $34 million or 27% of revenue compared to operating income of $6.8 million or 8% of revenue for the fourth quarter of fiscal 2016.

The operating income increase was primarily due to higher gross margins of $20.7 million and a decrease in R&D expense of $6.4 million.

Net other income for the fourth quarter of fiscal 2017 was $1 million compared to the prior year net other income of $0.5 million.

During the fourth quarter of fiscal 2017, we acquired an additional equity ownership in our Turkish joint venture, ALTOY, for total proceeds of $625,000, providing us with a controlling interest.

As a result, ALTOY's financial results have been consolidated into AeroVironment's consolidated financial statements, which resulted in a gain on acquisition of $0.6 million or $0.02 earnings per diluted share.

Our effective income tax rate was 13% for the fourth quarter of fiscal 2017 as compared to an effective income tax rate of 26.4% for the fourth quarter of fiscal 2016.

Net income attributable to AeroVironment for the fourth quarter of fiscal 2017 was $30.5 million or a $1.30 earnings per diluted share compared to net income attributable to AeroVironment of $5.4 million or $0.23 earnings per diluted share for the fourth quarter of fiscal 2016.

Now moving through full fiscal year 2017 results as compared to fiscal year 2016.

Revenue for fiscal 2017 was $264.9 million, an increase of $0.8 million as compared to $264.1 million for fiscal 2016.

The increase in revenue was due to an increase in product deliveries of $3.9 million, partially offset by a decrease in contract service revenue of $3.1 million.

UAS revenue decreased $4.8 million to $228.9 million for fiscal 2017, primarily due to a decrease in customer-funded R&D work of $9.9 million and a decrease in product deliveries of $2.4 million, partially offset by an increase in service revenue of $7.5 million.

EES revenue increased $5.6 million to $35.9 million for fiscal 2017, primarily due to an increase in product deliveries of EV test systems and passenger EV charging solutions.

Gross margin for fiscal 2017 was $102.1 million or 39% as compared to $112.1 million or 42% for fiscal 2016.

The decrease was primarily due to a decrease in product margins of $5.7 million and a decrease in service margins of $4.3 million.

UAS gross margin decreased to $93 million for fiscal 2017 from $101.5 million in fiscal 2016.

As a percentage of revenue, gross margin for UAS decreased from 43% to 41%, primarily due to the reversal for the settlement of prior year government-incurred cost audits reported in the second quarter of fiscal 2016 and an increase in sustaining engineering costs in support of our existing products.

EES gross margin decreased $1.5 million to $9.1 million for fiscal 2017, primarily due to an increase in sustaining engineering costs in support of our existing products and the reserve reversal for the settlement of prior year government incurred cost audits recorded in the second quarter fiscal 2016, partially offset by the increased sales volume.

SG&A expense for fiscal 2017 was $56.5 million or 21% of revenue compared to SG&A expense of $60.1 million or 23% of revenue for fiscal 2016.

SG&A expense decreased $3.5 million, primarily due to a decrease in bid and proposal costs and a decrease in professional services.

R&D expense for fiscal 2017 was $33 million or 12% of revenue compared to R&D expense of $42.3 million or 16% of revenue for fiscal 2016.

The decrease in internal R&D expense was primarily due to a decrease in development activities for certain strategic initiatives.

Operating income for fiscal 2017 was $12.5 million or 5% of revenue compared to operating income of $9.7 million or 4% of revenue for fiscal 2016.

The increase in operating income was primarily due to decreases in R&D expense of $9.2 million and SG&A expense of $3.5 million, partially offset by lower gross margins of $10 million.

Net other income for fiscal year 2016 was $1.7 million compared to the prior year net other expense of $1.7 million.

Net other income increased primarily due to the recording of an other-than-temporary impairment loss of our CybAero equity securities during fiscal 2016 and the gain associated with our acquisition of a controlling interest in our Turkish joint venture.

The effective income tax rate for fiscal 2017 was 12.3% compared to the effective income tax rate of minus 11.1% for fiscal 2016.

The fiscal 2017 tax rate included a reversal of a reserve of $1 million for uncertain tax positions due to the settlement of prior fiscal year audits.

Net income attributable to AeroVironment for fiscal 2017 was $12.5 million or $0.54 earnings per diluted share compared to net income of $9 million or $0.39 earnings per diluted share for fiscal 2016.

Our funded backlog as of April 30, 2017, was $78 million, an increase of $12.2 million or 19% from the fourth quarter of fiscal year 2016 and a decrease of $56.1 million or 42% from the third quarter of fiscal 2017.

Turning to our balance sheet.

Cash, cash equivalents and investments at the end of fiscal year 2017 totaled $242 million, a decrease of $19.6 million from the end of fiscal 2016.

The decrease in cash, cash equivalents and investments was driven by higher working capital requirements of the business with our record fourth quarter revenue.

Accounts receivable, including unbilled and retentions receivables at the end of fiscal year 2017, totaled $88.5 million, an increase of $13.6 million from the end of fiscal year 2016.

Total days sales outstanding for fiscal 2017 was approximately 113 days compared to 87 days for fiscal 2016.

Net inventory at the end of fiscal year 2017 was $60.1 million compared to $68.8 million at the end of the prior quarter and $37.5 million at the end of fiscal year 2016.

Days in inventory for fiscal year 2017 were approximately 90 days compared to 92 days for fiscal 2016.

This increase in inventory dollars was primarily due to anticipated first half shipments.

Turning to capital expenditures.

In the fiscal year 2017, we invested approximately $9.9 million or 4% of revenue and property improvements and capital equipment and recognized $7.1 million of depreciation and amortization expense.

Now an update to our fiscal 2018 visibility.

As of today, we have Q4 ending backlog that we expect to execute in fiscal 2018 of $75 million.

Quarter-to-date bookings that we anticipate to execute in fiscal 2018 of $17 million, unfunded backlog from incrementally funded contracts that we anticipate to recognize revenue during the balance of the year of $3 million, revenues needed to hold EES revenues flat relative to last year of $24 million.

This adds up to $120 million, 41% at the midpoint of revenue guidance.

Now I'd like to turn things back to Wahid to discuss AeroVironment's expectations for fiscal year 2018.

Thanks, Teresa.

Now I would like to provide a macro view on our industry.

Industry trends are favorable for our -- in fiscal 2018.

First, the global threat environment remains very dynamic, requiring highly capable small military teams that can operate flexibly and effectively in a wide variety of theaters around the globe.

In this environment, organic intelligence, surveillance and reconnaissance and precision strike solutions, like our small UAS and TMS, offer game-changing capabilities that help troops obtain the actionable intelligence they need to act decisively and proceed with certainty.

Because U.S. forces are not operating alone in these theaters, demand from our allies for AeroVironment solutions remain strong as well.

Second, the federal government fiscal year 2018 budget request includes procurement line items associated with AeroVironment solutions.

The budget request includes approximately $40 million for the U.S. Army, Navy, Marine Corps, U.S. SOCOM and for the first time, Coast Guard and Customs and Border Patrol programs, seeking AeroVironment small UAS or Tactical Missile Systems.

Third, our international footprint continues to grow with an increasing number of new international customers.

We now count more than 40 countries outside of the U.S. as customers for our family of small UAS.

Similarly, our family of Tactical Missile Systems footprint among U.S. customers continues to advance with strong pull from the unique and game-changing capabilities these systems offer in the highly dynamic threat environment.

In our DoD small UAS market, we see incremental opportunities and upgrades, the Soldier Borne Sensor or SBS program and frequency relocation.

Combined with growing international demand for our family of small UAS, we see healthy opportunities for us in this core part of our business.

As for our growth portfolio, in TMS, Switchblade and its variants not only represent our second largest business but also continue to improve our positioning for an annual domestic market opportunity that we estimate exceeds $1 billion in value.

In CIS, we are poised to make the next step in our plan to enter that what could be a multibillion global market opportunity.

Looking ahead, we're focused on building on our 2017 success and accomplishing our fiscal 2018 objectives, which I will now outline.

First, increasing our small UAS footprint in domestic and international markets, continuing strong multiyear international revenue momentum, winning the U.S. Army SBS program should a competition and award take place this year, achieving further progress in our U.S. government's frequency relocation program and demonstrating progress with other U.S. government customers, such as the Coast Guard and DHS.

Second, continue to grow our TMS business while increasing its contribution to funded backlog and continuing adoption momentum of Switchblade variants.

Third, achieving the next major milestone in our CIS business plan this calendar year, which includes shipments of initial Quantix drone and Decision Support System subscriptions to customers in agriculture.

We are taking a gated approach that includes evaluating adoption to inform each subsequent phase of how we build this potentially large business.

Fourth, continuing to grow our EV charging business, domestically and globally, through relationships with automakers while maintaining our leadership in industrial EV charging and EV test systems.

And fifth, successfully deploying our key fiscal 2018 strategic internal initiatives, which include our people strategy and our business process improvement program to further position AeroVironment for long-term growth and value creation.

Now I will share our view of fiscal 2018.

As Teresa described moments ago, our total visibility for fiscal 2018 is now 41%, the same as this time last year.

Given our visibility, the strong performance of our team, our planning and forecasting based on customer demand signals, favorable macro factors and our strong position, we expect revenue to grow to between $280 million and $300 million this year.

We expect the mix of revenue, meaning the blend of higher-margin product revenue and fixed price contracts versus lower-margin services revenue in cost plus contracts to result in lower gross margin this year than last year.

We plan to spend between 9% and 10% of revenue on internal research and development investments in fiscal 2018 and we expect a significantly higher tax rate than last year.

We anticipate the net impact of revenue, mix, spending and taxes will produce fully diluted earnings per share between $0.45 and $0.65.

We expect lower seasonality in our results than last year with first half revenue representing about 40% of our full year.

We anticipate revenue in our first quarter, historically, the lowest of each fiscal year of between $40 million and $44 million, with fully diluted loss per share of between $0.32 and $0.40.

Before we move to Q&A, I would like to reemphasize the main points of today's call.

First, our business remains strong and profitable and our team achieved or exceeded our financial objectives for fiscal 2017.

Second, we achieved good progress on our fiscal 2017 milestones that maintained the leading market positions in our core business and advanced our differentiated solutions for large and new global opportunities in our growth portfolio.

And third, we remain on track for long-term value creation.

I would also like to remind you that AeroVironment continues to maintain a strong position in the most exciting categories of the defense market with profitable businesses and strong growth prospects.

Our strategic growth opportunities, such as our commercial businesses, offer the ability to capitalize on additional multibillion market opportunities.

And our strong balance sheet gives us the important ability to move quickly to seize new markets when opportunities emerge.

Thank you to the AeroVironment team for your outstanding efforts in fiscal 2017 and for your relentless dedication to supporting our customers.

Thank you to our customers who continue to make AeroVironment their preferred choice.

And thank you to our shareholders for your continued interest and confidence in us.

Now, Teresa, Steve and I will take your questions.

(Operator Instructions) And our first question comes from the line of Joseph DeNardi with Stifel.

Wahid, I think you mentioned seeing some renewed interest in Global Observer, I guess, in the quarter.

I wonder if you could just talk about that a little bit more in detail.

Sure, Joe.

As we've said before, AeroVironment remains to be a leader in that particular area of capability with a very strong demonstrated track record over 2 decades of successes in programs that we have executed on.

And as we said from approximately 3 years ago that we've been engaged, to my knowledge at least, engaged with various interested customers, both in the defense as well as the commercial markets for potential adoption and contracts for such capability.

And we -- although the investment level there is fairly low, but we are still engaged and we continue to be engaged with customer -- with interested customers for that capability.

The -- we've also said in the past, and I repeat, that, that represents a very large opportunity, which remains so far to be essentially a 0 for us in terms of capitalizing on that and making it into a real business.

And however, should that odds change or that situation change, it does represent a very large opportunity for AeroVironment, and AeroVironment offers a very compelling differentiated capability than anyone else in the world in that front.

And as we have more progress and engagements with the customers that are significant, we'll keep you abreast and informed.

Okay.

But should I understand the comment that you made to suggest that you did see that in the quarter?

You have seen some renewed interest there, or no?

All I've said is that we continue to be engaged with various customers who have an interest in that capability.

I have not said whether we have been engaged more or less than before.

It's been an ongoing activity and effort for us.

Very small, very small insignificant investment, but still a small investment to pursue those opportunities that have a serious, what I call, qualified potential customers that could turn into an adoption eventually.

But so far, there's nothing new to report.

And our next question comes from the line of Greg Konrad with Jefferies.

I just wanted to touch on LMAMS, kind of where that program stands.

And if you look at the [HASC] mark, they're obviously very supported, and you saw a nice markup there.

Maybe some of the milestones for that program or what type of feedback you're getting from the customer?

Greg, yes.

Sure.

So you're absolutely correct that the government budgeting process and the [HASC] or [HAPC], I think, it's referred to, has had a favorable indicator for the procurement of those solutions and budgeting for that through the congressional budget approval process.

Again, that remains to be just -- again it's going through the process by itself right now.

There is a specific line item on the Army's OCO or Overseas Contingency Operations line item for missile procurement of LMAMS and it's -- essentially, it's, I believe, it's line 14 on the actual budget line and it represents roughly $8.7 million worth of appropriation.

Now keep in mind that, that does not mean that actual dollars are completely approved or funded.

It's a request that has been made by the President's budget request or submittal, and it has to go through the approval process as it always does.

What I can tell you is that, as you saw from our results in fiscal 2017 in the fourth quarter, we remain fairly enthusiastic and excited about the prospects of our Tactical Missile Systems product portfolio, but we are positioned very well because we have delivered very successfully in the past on multiple such opportunities -- -and one of which that I mentioned early in the call in fiscal 2017.

The customer seem to really appreciate and prefer AeroVironment's capability and offering.

And as I mentioned on my earlier remarks, also the macro threat environment is such that, I believe, we're in an exciting category of the defense as well as in a very exciting subcategory of UAVs or drones, which is a loitering munition, which Switchblade offers.

One thing to add, Greg, this is Steve, is that LMAMS refers to a specific program for the Army that we're currently addressing with the product that we call Switchblade, which is the first -- the initial but only one of -- one element of our emerging family of Tactical Missile Systems that are now addressing a broad range of customers, opportunities and potential market value.

So progress on LMAMS, progress with our Switchblade product.

But also as you can see from the results in the year, significant progress across the breadth of our portfolio in Tactical Missile Systems contributing to that 56% CAGR from 2011 and revenue associated with that part of our business.

And then just I wanted to touch on working capital.

I think you mentioned in the script that there was buildup of inventory to need a first half shipment.

Should we expect to see working capital come down as we kind of move through 2018?

Or is this kind of the appropriate level?

So Greg, this is Teresa.

Yes, in my prepared remarks, I talked that inventory, although down from the third quarter, ending the year at $60 million was above the prior year.

I mentioned that, yes, some of that is related to shipments that we expect in the first half of fiscal 2018.

We do, from time to time, on a case-by-case basis, we will increase our inventory levels to respond quickly to a international small UAS customer or a key domestic customer that we believe gives us the ability to win business and has proven effective for us, but that's on a case-by-case basis.

Also, our accounts receivables, including our unbilled, was up $13 million at the end of '17 versus '16.

That is a result of just the high revenue in Q4.

No change in terms of our DSO or our collections.

And our next question comes from the line of Peter Arment with Baird.

Wahid, on the guidance for revenues, the $280 million to $300 million, wonder if you could just clarify why the kind of expectation you had a lower-margin mix.

It seems like TMS is really ramping; international is really ramping.

It would seem that, that would be -- that might potentially have some additional favorable margins.

Peter, great question.

As I mentioned on my remarks, so we do expect the gross margin percentage for the year, fiscal '18, to be slightly lower than fiscal '17.

And there's actually 2 factors related to -- 3 things or factors that make up the gross margin percentage in the product category.

First one is the different products such as one version of the Raven versus a different version of the Raven have different profitability profiles.

So a different product mix by itself has a different profile.

Number two is variations between product sales and services sales.

As you could see from our Tactical Missile Systems business, for example, that we generated a significant amount of revenue from customer funded R&D programs or serve -- engineering services type programs or projects, and those tend to be slightly lower-margin than just selling products as a product revenue.

And then third, the type of contracts that we actually engage with customers or we deliver products to, or services to customers, also have a different profile of profitability.

For example, products that we sell at firm fixed-price contracts tend to generally have slightly higher risk but higher profit for the company, primarily because we invest money to sell those -- to make those products and then we sell them as a fixed price contract.

On the other hand, cost plus contracts, relatively speaking, has a slightly lower gross margin and profitability profile due to the fact that it has lower risk, but also lower profit profile.

So based on those 3 main factors of types of mix of changes in the product, we expect the gross margins in fiscal '18 to be lower.

And that usually changes every year to some degree or another but that's what the profile looks like for fiscal '18 right now.

Got it.

And just one follow-up.

On TMS, the growth has been exponential, and $70 million, I guess, in revenue was, I think, the number you quoted for fiscal '17.

At what point does this business start to acquire significantly more CapEx going forward?

Another great question, Peter.

So we have been obviously very enthusiastic and bullish on our Tactical Missile Systems for a while.

If you recall, about 3 years ago, one of our strategic growth initiatives where we communicated to our shareholders that we were going to invest incrementally above and beyond our historical levels was the Tactical Missile Systems business.

And while we could not share the specific details of how much and to what products, we were fairly confident that the investments were going to pay off dividends, and they have done so as you can see from the results in the past few years.

And so fiscal '17 revenues were close to $75 million versus about $41 million or $40 million in fiscal '16.

So that family of products -- and so in addition to that, we now have multiple variants of the product, as I said, for different customer needs and different mission profiles and different applications.

And all that -- we're pursuing a few potential programs of record as well, as I mentioned.

So all of that means that when there's a program of record or there is more customer demand for -- or buying signals for those products, we will have to invest in ramping up manufacturing and building additional production capacities.

And part of the investment that we made in that fiscal year was actually to expand and upgrade that capability to build the world's best, what I call, tactical missile systems or loitering munitions manufacturing capability in the world.

And so we're on track with that and we will make the investments as we see them judiciously and prudently.

And our next question comes from the line of Troy Jensen with Piper Jaffray.

It's actually [Nick Johnson] on for Troy.

I wanted to ask on the news of your contract with the Australian Defence Force and your comments on future expansion with international customers.

Would you guys expect these future contracts with new countries to be substantial in size, similar to the one with Australia?

Additionally, do you further expect to expand your fleet with your current international customers?

Yes.

So [Nick], and as you also saw from our previous -- my previous -- earlier comments, the international small UAS category of our business has been very strong in the last few years.

And I've said this many times in the past, which is the adoption cycle and phase, which most of our international customers, on aggregate, are at, is about 5 to 10 years behind our domestic U.S. DoD customer adoption curve.

And the number of countries, I'm pleased to inform -- obviously announce that we achieved over 40 countries.

It's a very reputable list of countries around multiple continents and multiple geographies.

So that all bodes really well for the strength and the customer's desire and pull for our solutions and our differentiated capabilities.

Every country is somewhat different and unique in its profile of need as well as the adoption curve.

So specific to your question, we have a mix of all.

We have a mix of some customers that are fairly advanced in their adoption curve, such as the announcement with our Netherland customers, we see a contract that I mentioned on my call, for multimillions of dollars, and it was primarily an upgrade and expansion of our line versus other customers that are just initiating an initial buy.

Or the Australian case where they had evaluated our products and now, they're actually proceeding with a program of record for the Wasp AE Family of Systems.

So in general, we expect that to grow and continue to be strong throughout the -- this year and coming years.

And we're very delighted about our position, and pleased with the results that we've achieved so far.

(Operator Instructions) And we have a follow-up question from the line of Joseph DeNardi with Stifel.

Wahid, thanks for the additional color on TMS in terms of disclosing the revenue.

If you look at UAS, excluding the growth from TMS revenues, we're down there.

Does that -- does the remainder of the UAS business start to stabilize in FY '18?

Is that your expectation?

Great question, Joe.

You're welcome about the comment earlier.

So here's how I view this in general, Peter -- Joe.

First and foremost, since our product portfolio has grown over the last few years significantly, we now have different customers and different markets and geographies and different applications with various degrees or different phases of their adoption and life cycle.

I would characterize the domestic small UAS customer base, the most, what I call, advanced or ahead of the adoption curve, where they're in a sustainment and upgrade mode.

I refer to those terminologies internally, so I hope you can understand my rationale behind that.

And what I mean by that is that we have a very large install base, they are very comfortable with our products, they see the value in our products.

And primarily, they are buying upgrades and sustainment parts, spare parts and logistics services for the products.

And in those cases, for example, the i45, which we announced and shipped a significant number of them in fourth quarter was one example of that upgrade opportunity within our domestic U.S. customer base.

In addition to that, we're also launching new products and introducing new products, such as the example of the Snipe UAV that I mentioned that we delivered 30 systems in the fourth quarter and that's geared towards a new program or potential program of record called [SDS], or [sociable] sensor program.

And so that represents a new growth opportunity.

Additionally, we're pursuing new customers for existing and new products.

And I mentioned on the call earlier that we're pursuing adoption and we've made progress with the U.S. Navy and also their line items in the budget for Department of Homeland Security or Customs and Border Patrol as well as U.S. Coast Guard.

These are customers that we've been pursuing and engaged with for a while, and they're now starting to come online or -- and do procurements and budget for these capabilities, which I expect in the long run to pay fairly strong dividends for us in general.

So I don't view it as it's down.

I view it -- it's going through a different cycle of its phase and it has growth opportunities within itself, but also upgrade in new product sales to new and existing customers.

Okay.

And then I guess just on TMS.

Can you just talk about, to the extent you can, how big that business can get in terms of the way it's being deployed now?

Is it being used more broadly than you had expected?

I mean, just any color on what your expectations are for that family of products.

Sure.

So Joe, a long time ago, we decided to really provide specific guidance in terms of the exact size of these markets except to refer to third party data.

What we have shared in the Tactical Missile Systems category, for example, specifically the original Switchblade, that the addressable market which Switchblade, the original Switchblade, can and does provide a more compelling value proposition, that can replace or displace, represents roughly about $1 billion worth of annual spend in the U.S. DoD budget line items alone.

And so again, that's just a general rough estimate of the size of that potential market opportunity for the original Switchblade.

And as I mentioned, we have more than one variant of our original Switchblade, one variant of which we've been able to disclose with you in more detail, which was the Blackwing product.

And that is a submarine launched UAV nonlethal, that essentially gives a submarine a visual line of sight beyond the periscope.

And it allows it to communicate multi-domain platforms through a ship, airplane, satellite and submarines and UAVs.

And so that portfolio is growing.

The customer interest in that product line is strong and fairly healthy.

And also, our execution and our value proposition seems to be resonating with the customer base and very compelling and differentiate-able.

And our next question comes from the line of [Martin Miller], a private investor.

I apologize in advance if this subject has been covered because I was disconnected for a short time.

As follows, in the last reporting period, I recall that we were told that the company was essentially debt free.

I might not be using the phrase correctly, but I'm wondering if that has changed materially -- or?

Thank you, [Martin].

This is Wahid.

We have -- we're fairly in a good position in terms of our balance sheet.

You're fairly accurate on your conclusion that the company doesn't carry much debt.

So we had lines of credits, but we don't -- really don't carry much debt at all in our balance sheet.

And we do have a strong cash position on our balance sheet.

Primarily, the board looks at that on a very regular basis.

We, as management team, review that very regularly and there are many reasons as to why we have the position that we have based on our strategy and our business profile.

All right.

And may I have the second question?

Again, I apologize in advance if covered already.

And I'm wondering if our team is addressing with the government regulators the issues of altitude and distance from air traffic and the like and are we making progress?

Are we being joined by other interested manufacturers?

Sure, Martin.

This is Wahid again.

So we enjoy a very good and positive working relationship with various regulatory agencies in the national airspace, primarily the FAA.

We've had a relationship with FAA for a very long time and I characterize it as a very cooperative, productive and successful healthy relationship.

There are a number of different activities that we're involved with and engaged with, FAA and the industry partners and the commercial rules and regulatory requirements around the use of drones and UAVs in the national airspace for commercial applications.

There are multiple different projects, and we'll be glad to share that with you in more detail later at a separate time, if you like.

But we are involved in that and we are aware of the fact that, that would play a significant role in the long run in terms of the adoption of UAV for the commercial airspace.

One example that I shared on the previous -- on my comments earlier was the demonstration that we made with Dominion Virginia Power and Virginia Tech with a strategic industry partner called Ligado.

And what we did is we flew our U -- Puma UAVs approximately 14 miles away from the site where it was launched, along power lines, and we transferred communication and control of the UAV to a satellite and [threshold] system provided by the Ligado Networks, which essentially demonstrated the capability of operating beyond visual line of sight.

And that is a significant demonstration, in my opinion, in terms of demonstrating the ability that we can operate these UAVs safely and successfully, well beyond the visual line of sight in the national airspace for commercial applications.

And we did that earlier this summer -- this year, and I consider that as one example of such engagements that we have with the industry and various government agencies.

And one note to add to that, if I may.

Our products, unlike many others in the -- who are entering the market have been used for decades regularly around the world in some of the most inhospitable environments and beyond visual line of sight, missions and applications.

So we design our products to perform effectively, safely and reliably in a wide variety of applications, including beyond visual line of sight.

And as Wahid mentioned, we're actively engaged domestically and are eager to help lead the way into a future where safe, effective and reliable beyond visual line of sight drone operations take place.

And we have a follow-up question from the line of Peter Arment with Baird.

Just a quick housekeeping one.

You mentioned a higher tax rate for fiscal 2018.

Teresa, is there any sort of expected range that you're looking at?

Yes, Peter.

I did not include -- we didn't provide guidance on a range.

We are expecting it to be higher.

Historically, with higher pretax income, AeroVironment's tax range has been in the 25% to 35% range.

And I'm showing no further questions at this time.

I would now like to turn the call back to Mr. Steven Gitlin for any closing remarks.

Thank you, Chelsea.

We do apologize for the technical issues that arose during the course of today's call.

We're going to work diligently to determine what the cause of those are and ensure that those don't happen again.

We're also going to be working closely with the folks who develop the transcript for this call to ensure that it accurately reflects the comments that were delivered by both CEO, Wahid Nawabi; and CFO, Teresa Covington, today.

So we can -- so you can be sure that you're certain about the content we provided today.

Thank you for your attention and for your interest in AeroVironment.

An archived version of this call, all SEC filings, and relevant company and industry news can be found on our website at avinc.com.

And we look forward to speaking with you and being heard by you without interruption, again, following next quarter's results.

Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program, and you may all disconnect.

Everyone, have a great day.