AeroVironment Inc (AVAV) 2019 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the AeroVironment, Inc.

Second Quarter 2019 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'd like to turn the conference over to Mr. Gitlin.

Please go ahead, sir.

Thank you, Adrienne, and it's good to be with you today.

Please note that on today's 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 they contain words such as believe, anticipate, expect, estimate, intend, project, plan or words or phrases with similar meaning.

Forward-looking statements are based on current expectations, forecasts and assumptions that involve risks and uncertainties, including, but not limited to, economic, competitive, governmental and technological factors outside of our control that may cause our business strategy or actual results to differ materially from the forward-looking statements.

For further information on these risks, we encourage you to review the risk factors discussed in AeroVironment's periodic reports on Form 10-K and Form 10-Q filed with the SEC and the Form 8-K filed today with the SEC, along with the associated earnings release and the safe harbor statement contained therein.

The content of this conference call contains time-sensitive information that is accurate only as of today, November 29, 2018.

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.

We will now begin with remarks from Wahid Nawabi.

Thank you, Steve, and welcome to our second quarter fiscal year 2019 earnings conference call.

On today's call, we will focus on 3 key messages.

First, our team is successfully executing our plan, as reflected in our strong second quarter and first half results.

Second, continued strong backlog and visibility keep us on track to achieve our fiscal year 2019 objectives.

And third, robust customer demand for our innovative solutions, coupled with our strategy, support our long-term value creation goals.

Today, I will review our second quarter fiscal year 2019 financial and operating performance and then provide an overview of some notable developments during the quarter.

Next, Teresa Covington will provide a detailed review of second quarter and year-to-date financials.

Then I will discuss our goals for fiscal year 2019, including our revised guidance, which reflects our strong momentum.

Teresa, Steve and I will then take your questions.

We are executing our fiscal year 2019 plan and continue to deliver strong results.

Second quarter revenue of $73 million increased by 11% year-over-year.

Earnings per diluted share from continuing operations was $0.29.

Funded backlog increased by 44% from $113 million to $164 million year-over-year.

It is important to note that over the last 4 quarters, we have consistently generated high funded backlog levels.

This strong funded backlog is helping us level load quarterly revenue and our operations.

Year-to-date, our performance reflects strong improvement over last year.

Revenue of $151 million increased by 51% over fiscal year 2018.

And earnings per diluted share from continuing operations of $1.14, including a $0.26 onetime litigation settlement, is up $1 over the same period last year.

This strong year-over-year improvement significantly enhances our visibility, as Teresa will detail shortly.

Now let's review some notable developments from the quarter.

Within the U.S. Department of Defense market, we remain the leader in small UAS, and our growing loitering missile systems business is disrupting the Tactical Missile Systems category.

The recently released 2018 U.S. National Defense Strategy defines a number of initiatives designed, in part, to enhance the lethality of U.S. military forces.

These initiatives include several supported by AeroVironment solutions namely: expanding surveillance, investing in infantry firepower and increasing the production of critical munitions.

AeroVironment unmanned solutions deliver greater situational awareness and lethality to front-line troops more affordably than many legacy ISR and weapon systems.

We believe our solutions will serve an important role in providing U.S. and allied forces winning capabilities in the future battle space through existing and next-generation offerings.

We also believe our solutions deliver exceptional capabilities and value in both conventional and nonconventional threat environments.

Examples of new U.S. DoD procurement opportunities include the Army's short-range reconnaissance and soldier-borne sensor programs.

Both of these programs represent initial adoption opportunities for our next-generation small UAS.

We are tracking them closely and look forward to updating you when we have news to share.

The fiscal year 2019 defense appropriations bill was enacted in our second quarter, and demand for our solutions remained robust.

Nearly $60 million was appropriated for our small UAS, made up of the Army's $46 million funding for Raven systems and the Air Force's $13.5 million for Puma systems.

And $110 million was appropriated for the Army and Marine Corps' LMAMS requirements, which specify AeroVironment as the supplier.

This totals $170 million of appropriated funding for AeroVironment solutions.

We look forward to negotiating and finalizing contract awards for these line items in the coming months.

Based on our winning track record, we continue to expand our leadership position in the small UAS category for defense requirement internationally with more than 45 allied customers.

Notable second quarter contract awards that reflect our strong international position are as follows: a $5.9 million NATO support and procurement agency contract for Raven systems for the Portuguese Army, our first contract with Portugal; a $13 million U.S. Air Force IDIQ contract to support Raven systems to multiple Caribbean nations; a $9 million Puma systems award for a Baltic nation; and a $3.2 million Puma systems award for an ally and the DoD's Indo-Pacific Command region.

We believe small UAS and TMS are in the early stages of market adoption.

We envision a future in which unmanned systems deliver increasingly valuable capabilities across defense and commercial markets and well beyond their contributions today.

Achieving these broader and deeper penetration of unmanned systems requires continued innovation across hardware and software domains.

It also involves the implementation of unmanned solutions in new integrated approaches, in which they work together to deliver more significant benefits to our customers.

In October, we announced a [teaming] agreement with General Dynamics Land Systems that serves as a powerful example of this new integration approach.

We are working with General Dynamics to integrate small UAS and Switchblade Tactical Missile Systems into armored combat vehicles for new upcoming U.S. Army and Marine Corps' acquisition programs and for potential retrofit of existing vehicles.

Essentially, we are establishing a new paradigm for airpower in which armored vehicle commanders would possess their own aerial capabilities for reconnaissance and precision strike while stationary or on the move.

Working together, our small UAS and Switchblade, for example, can deliver game-changing situational awareness and precision strike capabilities directly to the commander of an unarmed -- an armored vehicle.

This represents a new channel for us to enable and protect the war fighter.

It can also generate additional demand for our solutions through our other programs of record.

This also represents an important new way to integrate our unmanned systems into other platforms to enhance our customers' battlefield capabilities across multiple domains.

While development of this integrated solution is at a very early stage, we are confident in its superior ability to enable and protect the war fighter.

In our nascent commercial businesses, we remain focused on executing our design, development and demonstration program for HAPS.

We consider the ongoing announcements of new competing solutions emerging from multiple new players in this market as a recognition of the potential of this large global opportunity.

In Commercial Information Solutions, we continue to expand our reach into the large agriculture market.

We continue to believe in the compelling value proposition of our unique solution.

However, the overall market adoption rate is lower than most anticipated, as we have previously communicated.

We continue to seek strategic partners to help us capitalize on this potentially large long-term (technical difficulty) creation opportunity.

Now Teresa will review our second quarter financials.

Teresa?

Thank you, Wahid, and good afternoon, everyone.

AeroVironment's fiscal 2019 second quarter results are as follows.

Revenue from continuing operations for the second quarter fiscal 2019 was $73 million, an increase of $7.2 million or 11% from the second quarter of fiscal 2018 revenue of $65.8 million.

The increase was due to an increase in service revenue of $8.5 million, partially offset by a decrease in product deliveries of $1.3 million.

The second quarter fiscal 2019 revenue by major product line/program is as follows: small UAS was $42.2 million, TMS was $15 million, HAPS was $12.8 million, and other was $2.9 million.

Gross margin from continuing operations for the second quarter fiscal 2019 was $28.4 million or 39% of revenue compared to $30.1 million or 46% of revenue for the second quarter fiscal 2018.

The decrease in gross margin was primarily due to a decrease in product sales margin of $2.7 million, partially offset by an increase in service margins of $1 million.

Gross margin as a percentage of revenue decreased from 46% to 39% due to a higher percentage of service revenue in the second quarter as well as lower gross margins in both product sales and service revenue due to mix.

Looking at the rest of the income statement.

SG&A expense from continuing operations for the second quarter of fiscal 2019 was $13.6 million or 19% of revenue compared to SG&A expense of $12.8 million or 19% of revenue for the second quarter of fiscal 2018.

R&D expense from continuing operations for the second quarter of fiscal 2019 was $8.1 million or 11% of revenue compared to R&D expense of $6.8 million or 10% of revenue for the second quarter of fiscal 2018.

Income from continuing operations for the second quarter of fiscal 2019 was $6.6 million or 9% of revenue compared to a $10.5 million or 16% of revenue for the second quarter of fiscal 2018.

The decrease in income from operations was primarily due to a decrease in gross margin of $1.7 million, an increase in R&D expense of $1.3 million and an increase in SG&A expense of $0.9 million.

Net other income for the second quarter of fiscal 2019 was $2.4 million compared to net other income of $0.4 million for the second quarter of fiscal 2018.

The increase in net other income was due to income from the transition services agreement with Webasto Charging Systems and higher interest income on our investments.

The effective income tax rate from continuing operations was 13.5% for the second quarter of fiscal 2019 as compared to an effective income tax rate of 30.8% for the second quarter of fiscal 2018.

The effective tax rate for the second quarter fiscal 2019 included a discrete excess tax benefit of $0.4 million resulting from the vesting of restricted stock awards and exercises of stock options.

Equity method investment activity, net of tax, for the second quarter of fiscal 2019 was a loss of $0.8 million or $0.03 per diluted share compared to no equity method investment activity, net of tax, for the second quarter of fiscal 2018.

Net income from continuing operations attributable to AeroVironment for the second quarter of fiscal 2019 was $7 million or $0.29 per diluted share compared to net income from continuing operations attributable to AeroVironment of $7.8 million or $0.32 per diluted share for the second quarter of fiscal 2018.

The company completed the sale of the EES business to Webasto Charging Systems in the first quarter of fiscal 2019.

The company has not received the additional holdback cash consideration of $6.5 million, which the company is entitled to receive upon tendering consent to assignment of 2 remaining customer contracts to Webasto.

The company's satisfaction of the requirements for the payment of the holdback is currently under dispute.

Loss from discontinued operations, net of tax, for the second quarter of fiscal 2019 was $1 million or $0.04 loss per diluted share compared to a loss from discontinued operations, net of tax, of $33,000 for the second quarter of fiscal 2018.

Now moving through our first half fiscal 2019 results.

Revenue for the first half of fiscal 2019 was $151 million, an increase of $50.8 million as compared to $100.2 million for the 6 months ended October 27, 2018.

The increase in revenue was due to an increase in product deliveries of $35.1 million and an increase in contract service revenue of $15.7 million.

The first half of fiscal 2019 revenue by major product line/program is as follows: small UAS was $83.4 million, TMS was $37.8 million, HAPS was $24.4 million, and other was $5.4 million.

Gross margin for the first half of fiscal 2019 was $61 million or 40% as compared to $38.8 million or 39% for the first half of fiscal 2018.

The increase was due to an increase in product margins of $20 million and an increase in service margins of $2.2 million.

Gross margin as a percentage of revenue increased from 39% to 40% due primarily to higher gross margin and product sales, partially offset by lower gross margins and service revenue.

SG&A expense for the first half of fiscal 2019 was $25.6 million or 17% of revenue compared to SG&A expense of $24.1 million or 24% of revenue for the first half of fiscal 2018.

R&D expense for the first half of fiscal 2019 was $14.5 million or 10% of revenue compared to R&D expense of $12.4 million or 12% of revenue for the first half of fiscal 2018.

Income from continuing operations for the first half of fiscal 2019 was $20.8 million or 14% of revenue compared to a $2.4 million or 2% of revenue for the first half of fiscal 2018.

The increase in income from operations was primarily due to an increase in gross margins of $22.2 million, partially offset by an increase in R&D expense of $2.2 million and an increase in SG&A expense of $1.6 million.

Net other income for the first half of fiscal 2019 was $11.7 million compared to the prior year net other income of $0.9 million.

The net other income increase was primarily due to a litigation settlement income earned under a transition services agreement with Webasto Charging Systems and an increase in interest income resulting from higher short-term interest rates in fiscal 2019.

The effective income tax rate from continuing operations was 11.6% for the first half of fiscal 2019 as compared to an effective income tax rate of 4.2% for the first half of fiscal 2018.

The increase in effective income tax rate was due to higher income before taxes, partially offset by a reduced federal statutory rate from the Tax Cut and Jobs Act.

Equity method investment activity, net of tax, for the first half of fiscal 2019 was a loss of $1.4 million or $0.06 per diluted share compared to no equity method investment activity, net of tax, for the first half of fiscal 2018.

Net income from continuing operations attributable to AeroVironment for the first half of fiscal 2019 was $27.4 million or $1.14 per diluted share compared to $3.4 million or $0.14 per diluted share for the first half of fiscal 2018.

Our funded backlog as of October 27, 2018, was $163.9 million, an increase of $50.3 million or 44% from the second quarter of fiscal 2018 and an increase of $6.8 million or 4% from the first quarter of fiscal 2019.

Turning to our balance sheet.

Cash, cash equivalents and investments at the end of the second quarter fiscal 2019 totaled $320.3 million, an increase of $22.5 million from the end of fiscal 2018 cash, cash equivalents and investments of $297.8 million.

Net accounts receivable, including unbilled receivables and retention, at the end of the second quarter fiscal 2019 totaled $80.3 million.

The unbilled receivables and retention balance of $45.7 million, inclusive of $7.8 million related party amounts.

The unbilled receivables and retention balances arise due to timing differences between revenue recognition and billing.

All revenue from Tactical Missile Systems contracts is now recognized over time, which generally accelerates the timing of when revenue is recognized and results in an increase to unbilled receivables.

Total days sales outstanding from continuing operations for the second quarter fiscal year 2019 was approximately 95 days compared to 48 days for the fourth quarter fiscal year 2018.

Net inventory at the end of the second quarter fiscal year 2019 was $46.1 million compared to $37.4 million at the end of the fourth quarter fiscal year 2018.

Days in inventory outstanding for the second quarter fiscal year 2019 was approximately 89 days compared to 79 days for the fourth quarter fiscal year 2018.

Accounts payable at the end of the second quarter fiscal year 2019 was $14.1 million compared to $21.3 million at the end of the fourth quarter fiscal year 2018.

Total days payable outstanding for the second quarter fiscal year 2019 was approximately 27 days compared to 24 days for the fourth quarter fiscal year 2018.

Turning to capital expenditures.

In the second quarter fiscal year 2019, we invested approximately $2.7 million in property improvements and capital equipment and recognized $1.8 million of depreciation and amortization expense.

Now an update to our fiscal 2019 visibility.

As of today, we have year-to-date revenue in fiscal 2019 of $151 million; second quarter ending backlog that we expect to execute in fiscal 2019 of $127 million; Q3 quarter-to-date bookings that we anticipate to execute in fiscal 2019 of $0.3 million; unfunded backlog from incrementally funded contracts that we anticipate to recognize revenue during the balance of the year of $17 million.

This adds up to $296 million or 97% at the midpoint of revenue guidance.

We anticipate a full year effective tax rate for continuing operations in the range of 12% to 14%.

Now I'd like to turn things back to Wahid to discuss AV's expectations for fiscal year 2019.

Thanks, Teresa.

We're executing our plan effectively and enhancing our position for long-term value creation.

Customer demand for our solutions remain robust, supported by strong DoD appropriations for those solutions.

With strong and steady performance so far this year, we now have 97% visibility to the midpoint of our revised revenue guidance range, as Teresa described.

This represents historically high visibility for us at this point in the fiscal year.

The term visibility in this context refers to converting funded backlog and unfunded commitments into revenue in the current fiscal year.

So while visibility tells us much about the front end of the business, there remains timing and execution risks to fulfilling those orders on the back end and achieving our full year guidance.

With respect to our earnings, year-to-date, we have also generated earnings per share from continuing operations of $1.14, which places us within our EPS guidance range already.

While this as context -- with this as context, we are narrowing our revenue guidance within the upper portion of our range to between $300 million and $310 million, and we are raising and narrowing our earnings per diluted share from continuing operations guidance range to between $1.30 and $1.50.

As we indicated earlier this fiscal year, we expect first half revenue to be similar to second half revenue and fairly evenly distributed across all 4 quarters.

This represents a significant change from prior years, when historically, our fourth quarter produced the largest quarterly revenue.

We also expect lower profitability in the second half mainly due to higher planned operating expenses and a shift in our revenue mix, with higher services sales compared to product sales.

We continue to expect research and development investments to total 10% to 11% of full year revenue.

These factors drive the revised guidance, which I just outlined.

We are confident in our ability to extend our record of delivering on our objectives and achieving these revised targets.

In summary, to reiterate our main points for today's call.

First, our team is successfully executing our plan, as reflected in our strong first half results.

Second, continued strong backlog and visibility keep us on track to achieve our fiscal year 2019 objectives.

And third, robust customer demand for our innovative solutions, coupled with our strategy, support our long-term value creation goals.

Thank you to AeroVironment's team members for your relentless drive to serve our customers and stockholders.

Thank you to our customers who place their trust in AeroVironment to support their critical missions.

And thank you to our stockholders for recognizing the value-creation potential of our people and our company.

Teresa, Steve and I will now take your questions.

(Operator Instructions) And our first question comes from Ken Herbert from Canaccord.

Wahid, I first wanted to ask about the LMAMS and the $110 million in the fiscal '19 budget.

I'm curious, have you seen any of that?

I mean, is that -- any of that yet under contract?

I know you talked about timing.

And I know we're very early in the fiscal year, but can you just update us on where we are in the contract?

Have you seen any of that yet?

And then maybe how we should expect or how much of that potential in the budget do you see in your fiscal '19 just considering the timing?

Sure.

So Ken, the $110 million appropriated and authorized budget dollar amounts that are in the government fiscal year '19, which I mentioned earlier, is not under contract with us yet.

We are already working on that.

We're aware of it, as I mentioned.

And we continue to work towards the definitization and finalization of that contract with the customer.

And once we do that, we will obviously update you as we go forward.

At this time, we're in that position.

Okay.

So is it possible, Wahid, that you can just give an estimate of maybe how much of that is factored into the guidance this year versus how much maybe falls into your fiscal '20?

Yes.

So unfortunately, because we're still in contract negotiations and definitization process, I'm not in a position to be able to comment on that specifically.

Historically speaking, it always has taken us a certain amount of time for us to negotiate the contract, definitize it, finalize it.

And then we have to produce the product and then, obviously, test them and then get approval from the customer to be able to deliver them.

All of that activity is obviously planned and underway but still to be done.

And our next question comes from Jon Ladewig from Stifel.

I was hoping you guys could first start off with updating us on your capital allocation plans these days and kind of give us some color on what the latest thoughts are around HAPSMobile.

Yes.

So in terms of capital allocation, we currently, in our financial outlook that we provided, assume a 5% ownership in the joint venture with HAPS.

You mentioned specifically HAPS.

But per contract terms, we have the ability and the option to increase our joint venture ownership up to 19% during the step 2 contract with certain terms and conditions that are within the contract.

And we have not, to date, executed that or implemented that.

So as we progress through this process, we will keep you updated.

And so as I've said before, the initial joint venture was a $100 million joint venture, which we contributed up to 5% of that for the ownership piece.

That's one piece.

And then obviously, besides that, we have ordinary capital consumption and investments in various parts of our business, such as tooling and fixtures and operations that we do, and Teresa usually provides an update on that.

And that's the primary status of our capital expenditures year-to-date for this year.

All right.

The -- 2 other ones here just real quick.

Can you kind of update us on the impact the change on the export laws have had on your sales to date?

You talked about a bunch of the international sales, but has it fundamentally changed since the White House made that transition for allowing for additional exports?

And then can you kind of give us some color on the breakout for sales between TMS, international small and HAPS?

Sure.

So in terms of export licensing, Jon, we really haven't noticed a significant or meaningful change in the way that the export licenses are being processed or authorized.

Having said that, historically speaking, we have a very strong track record of obtaining and complying with all the requirements with the state department for obtaining those licenses.

And as you heard from my comments, we're up to over 45 allied countries now in terms of international customers for our small UAS products and solutions, and it's a growing list.

And I mentioned a number of new awards that we have achieved in the second quarter earlier in my remarks.

In terms of the breakdown of the revenue, Teresa can actually help you through with those numbers now.

Jon, as I had talked about in my prepared remarks, for the first 6 months of fiscal 2019, small UAS was $83.4 million, Tactical Missile Systems was $37.8 million, HAPS was $24.4 million, other was $5.4 million.

For the first half of fiscal 2018, small UAS was $67.1 million, TMS was $18.9 million, HAPS was $9.6 million, other was $4.5 million.

For the first 6 months of fiscal 2019, our domestic sales were $82.1 million, international sales were $68.9 million.

And for the 6 months in fiscal 2018, domestic sales were (technical difficulty), international sales were $39.4 million.

And our next question comes from Ken Herbert from Canaccord.

I just wanted to follow up.

You had mentioned part of the headwind in the second half of the year, at least from a margin or maybe gross margin standpoint, was going to be a step-up in some corporate expenses.

And I'm just wondering if you could maybe just provide the magnitude of that.

And is that something we should think about as sort of onetime as we think about sort of moving out of the second half of '19?

Sure, Ken.

So I can -- generally speaking, as I mentioned in my remarks, our second half profitability profile looks, obviously, slightly lower than our first half to achieve the results that I provided on my guidance, the revised guidance.

And there's 2 primary reasons for that.

First is our revenue mix.

And in the revenue mix, given any quarter, because our revenue is made up of large sums of projects and solution deliveries, the profile of those contracts and profitability (technical difficulty) could vary, such as services contracts versus product contracts and cost-plus contracts versus firm fixed-price contracts, et cetera, et cetera.

So that's one category of impact for the second half.

The second one is we also expect and plan higher operating expenditures, both on the R&D side as well as on the SG&A side.

And those 2 factors are the primary factors affecting the profitability for the second half.

And yes, to your second question, we -- this is really what I refer to based on the time frame that you look at this kind of a number.

In other words, I don't foresee this as a systemic issue.

I see this as a unique to the second half of the year as we are today, and it may change in different directions in the future, Ken.

Okay.

That's very helpful.

If I could, just one final follow-up.

You've also mentioned that the $6.5 million, I believe, expected payment in this quarter from the purchaser of the EES business was in dispute.

Is that -- do you think there's risk to that number?

Or is that just sort of timing?

I mean, how do we think about that potential cash payment for that final transaction?

Sure, Ken.

So yes, as Teresa mentioned, that is in dispute right now with us and the purchaser of the assets.

And as you know, in different transactions, there's always issues related to the contract terms and how we negotiate those things.

We are obviously working with them on that.

We are still currently providing transitional support services to them in multiple fashions.

However, there is a risk to that, and we're working through that.

And as we have more updates throughout the next several months and quarters, we will update you and let you know.

(Operator Instructions) And our next question comes from Peter Arment from Baird.

So the question, I guess, is around you have 45 countries.

I guess the international mix continues to grow.

Can you talk just a little bit about -- are you -- or all those countries come with service contracts?

Is that potentially a longer tail for the revenue stream as this grows with the international mix?

And then just as a follow-up, unrelated, but when do you expect to deliver the 2 prototype aircraft for HAPS?

Sure, Peter.

So in terms of our international market and customer adoption, we're now up to over 45 countries.

The types of contracts that we have with those customers all vary, but overwhelming majority, yes, they have both initial hardware sales.

In addition to that, we also have logistics support services and training services to help our customers train on using our products and then also maintaining and operating our products and solutions.

So that is definitely true.

And secondly, in general, the -- when we acquire a new international or domestic customer, there always, historically and in the future as well, continues to be a long tail in terms of sustainment and maintenance and upgrades.

And in general, the international markets, I have said this before that we still believe it is about 5-plus years behind the adoption curve of our U.S. domestic customers in terms of maturity and adoption.

So as I said before, we continue to believe that the international markets for our small UAS is strong and remains robust.

And we're working to not only grow the number of international customers but also our share of their spend, and our solution portfolio within those customers can grow as a family of solutions for those customers as we go forward.

And in terms of HAPS, we have not specified the specific timing of the deliveries of the 2 airplanes.

Well, we have said before and we continue to say that we're, right now, focused on executing our step 2 design development and demonstration program, which includes the delivery of 2 airplanes in that process.

And as we have updates, we will obviously keep you notified.

(Operator Instructions) And we have no questions in the queue.

This will conclude today's teleconference.

Thank you for participating, and you may now disconnect.

Thank you.

Thank you.