AeroVironment, Inc.
Q2 2019 Earnings Call Transcript

Published: 30 Nov 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the AeroVironment, Incorporated Second Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. We will conduct a question answer session after the management’s remarks. 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. Steve Gitlin. And now at this time, I would like to turn the conference over to Mr. Gitlin. Please go ahead, sir.

[Steve Gitlin:]

Thank you, Adrian, 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 may contain words such as believe, anticipate, expect, estimate, intend, project, plan or words or phrases with similar meaning. Forward-looking statements are based on current expectations, forecasts and assumptions that involve risks and uncertainties, including but not limited to, economic, competitive, governmental and technological factors outside of our control that may cause our business strategy or actual results to differ materially from the forward-looking statements. For further information on these risks, we encourage you to review the risk factors discussed in AeroVironment’s periodic reports on Form 10-K and Form 10-Q filed with the SEC and the Form 8-K filed today with the SEC along with the associated earnings release and the Safe Harbor statement contained therein. 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.

[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 three 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 four 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 one-time 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’s 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 the frontline 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 non-conventional 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 remains 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 Corp’s 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 requirements internationally with more than 45 allied customers. Notable second quarter contract awards that reflects our strong international position are as follows

[Teresa Covington:]

Thank you, Wahid, and good afternoon everyone. AeroVironment’s fiscal 2019 second quarter results are as follows. Revenues 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 of fiscal 2019 revenue by major product lines/programs is as follows

[Wahid Nawabi:]

Thanks, Teresa. We are executing our plan effectively and enhancing our position for long-term value creation. Customer demand for our solutions remains 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 and 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 in 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 four 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 placed 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:]

[Operator Instructions] And our first question comes from Ken Herbert of Canaccord. Please go ahead. Your line is open.

[Ken Herbert:]

Hi, good afternoon.

[Wahid Nawabi:]

Good afternoon, Ken.

[Ken Herbert:]

Hey, Wahid, I first wanted to ask about the LMAMS, the $110 million in the fiscal 2019 budget, I am 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 are 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 2019 just considering the timing?

[Wahid Nawabi:]

Sure, so, Ken, the $110 million appropriated and authorized budget dollar amounts that are in the government fiscal year 2019 which I mentioned earlier is not under contract with us yet. We are already working on that. We are 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 are in that position.

[Ken Herbert:]

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 2020?

[Wahid Nawabi:]

So, unfortunately, because we are still in contract negotiations and definitization process, I am not in a position to be able to comment on that specifically. Historically speaking, it always have 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.

[Operator:]

And our next question comes from Jon Ladewig from Stifel. Please go ahead. Your line is open.

[Jon Ladewig:]

Hey guys. Thanks for taking my call. 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’s the latest thoughts are around HAPSMobile?

[Wahid Nawabi:]

Yes, hi there, Jon. 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 this step two 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 contributed up to 5% of that for the ownership piece. That’s one piece and then obviously besides that we have our 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.

[Jon Ladewig:]

All right. Thank you. The two other ones here, just real quick. Can you kind of update us on the impact to change in 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?

[Wahid Nawabi:]

Sure. So, in terms of export licensing Jon, we really haven’t noticed a significant or meaningful change in the way that export license 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 are 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 the 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.

[Teresa Covington:]

Hi, Jon. As I had talked about in my prepared remarks, for the first six 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 six months of fiscal 2019, our domestic sales were $82.1 million, international sales were $68.9 million and for the six months in fiscal 2018, domestic sales were $60.7 million, international sales were $39.4 million.

[Operator:]

And your next question comes from Ken Herbert of Canaccord. Your line is open.

[Ken Herbert:]

Yes, hi, good afternoon. I just wanted to follow-up.

[Wahid Nawabi:]

Hi, Ken.

[Ken Herbert:]

Yes, hi, Wahid. 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 am just wondering if you could maybe just provide the magnitude of that and is that something we should think about a sort of one-time as we think about sort of moving out of the second half of 2019?

[Wahid Nawabi:]

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 in my guidance, the revised guidance. And there is two 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 solutions deliveries, the profile of those contracts and profitability [Inaudible] could vary, such as services contracts versus product contracts and cost plus contracts, 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 two factors are the primary factors that’s affecting the profitability for the second half and yes, to your second question, we – this is really, what I refer to based on the timeframe that you look at this kind of a number. In other words, I don’t foresee it 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.

[Ken Herbert:]

Okay, that’s very helpful. And if I could just one final follow-up. You had also mentioned that the $6.5 million I believe was expected payment in this quarter from the purchaser of the EES business was in dispute. Is that – do you think there is 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?

[Wahid Nawabi:]

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 is always issues related to deep contract terms and how new 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 are 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:]

[Operator Instructions] And our next question comes from Peter Arment from Baird. Please go ahead. Your line is open.

[Peter Arment:]

Yes, good afternoon, Wahid.

[Wahid Nawabi:]

Hi, Peter. Good afternoon.

[Peter Arment:]

Hey, so, the question I guess is around, you’ve got 45 countries I guess, the international mix continues to grow. Can you talk us a little bit about how – are all those countries come with service contracts? Is that potentially a longer tail or 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 two prototype aircraft for HAPS? Thanks.

[Wahid Nawabi:]

Sure. Peter, so, in terms of our international market and customer adoption, we are 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 and 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 is 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 five 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 are 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. In terms of HAPS, we have not specified the specific timing of the deliveries of the two airplanes. What we said before, we continue to say that, we are right now focused on executing our step two design, development and demonstration program which includes the delivery of two airplanes in that process. And as we have updates, we will obviously keep you notified.

[Operator:]

[Operator Instructions] And we have no questions in the queue. This will conclude today's teleconference. Thanks for participating and you may now disconnect.

[Wahid Nawabi:]

Thank you.

[Teresa Covington:]

Thank you.

[Steve Gitlin:]

Thank you.