Steven Gitlin - VP of IR Wahid Nawabi - CEO Teresa Covington - SVP & CFO.

Ken Herbert - Canaccord Howard Rubel - Jefferies.

Good day, ladies and gentlemen, and welcome to the AeroVironment Incorporated First Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session after the management's remarks. As a reminder, this conference is being recorded for replay purposes.

With us today and with the Company is 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 at this time, I would like to turn the conference call over to Mr. Gitlin. Please go ahead, sir..

Thank you, Gini, and welcome to our first quarter fiscal 2018 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 U.S.

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 of 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, August 29, 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. We will now begin with remarks from Wahid Nawabi.

Wahid?.

Thank you, Steve. On today's call, I will briefly review AeroVironment's first quarter financial results, then share with you the progress we made during the quarter on our fiscal year and long-term plans. Teresa Covington will review first quarter financials in detail, then I will discuss our outlook for the balance of the year.

Following this, Teresa, Steve and I will take your questions. Our three primary messages today are as follows; first, we achieve our revenue expectations and exceeded our profitability expectations for the quarter.

Second, we are on track to achieve our previously stated full-year guidance supported by our increased visibility during the first quarter; and third, we continue to execute on our growth initiatives successfully while positioning AeroVironment for long-term value creation. And now let's review first quarter financial results.

In our fourth quarter earnings release we communicated our revenue and profitability expectations for the first quarter. As a reminder, our first quarter's tend to produce the lowest revenue and profit each year and by providing our expectations, we have sought to help recalibrate first quarter expectations going forward through fiscal 2018.

First quarter revenue of $43.8 million was 21% higher than in first quarter fiscal 2017, and at the high-end of our expectations of $40 million to $44 million. Loss per fully diluted share of $0.19 was 63% smaller than in first quarter of fiscal 2017 and significantly more favorable than our expected loss of $0.32 to $0.40 per share.

The smaller than expected loss per share resulted primarily from three factors. First, more favorable revenue mix of products and services; second, lower than planned operating expenses; and third, on income tax benefit of $1 million relating to our equity incentive plan.

We experienced a healthy 9% sequential increase and funded backlog in the quarter. As a result, our visibility into the midpoint of our fiscal 2018 revenue guidance increased to 53% which Teresa will detail shortly in her comments.

We also increased our inventory position to approximately $72 million in order to support the execution of our fiscal 2018 plan. Now I will share some highlights of our first quarter progress. In our small UAS business, we remain on track for important long-term growth opportunities.

Specifically, we continue to pursue the Department of Defense frequency relocation program which involves modifying all small UAS and the DoD fleet to operate on new radio frequencies. Additionally, we delivered the first 30 Snipe systems to our U.S. DoD customer and we're focused on preparing for an upcoming competition for the U.S.

Army Soldier Borne Sensor program which we expect to begin this fiscal year. Also in the quarter we shipped our first Puma AE and Raven systems to the U.S. Customs and Border Patrol. We believe that our high-tech smart wall incorporating 21st-century technology such as our small UAS can better protect our homeland quickly and cost-effectively.

We look forward to demonstrating our unique value proposition to U.S. Customs and Border Patrol to help secure our borders intelligently. Beyond U.S. borders, we signed a multiyear contract with the Australian Defense Force for their acquisition of Wasp AE systems along with value added support services and content from our Australian partners.

As part of this contract, we're establishing an international certified logistics and repair facility with our Australian partner. In addition to Australia, we also added one new Middle East customer in our first quarter.

As we communicated during our previous earnings call, we continue to experience growing international demand for family of small UAS, and we expect this demand to contribute meaningfully to our fiscal 2018 results. While on the topic of the international market, recent news articles highlighted the U.S.

Army's decision to ban the use of consumer drones from a certain Chinese company citing serious security concerns. Our small UAS solutions are designed to be highly secure and reliable while delivering actionable intelligence to our customers so they can proceed with certainty and harsh and extreme environments.

Not only is the security of our small UAS a critical importance to our military customers, but enterprise customers also place high importance on information security. The trust of the U.S. military along with more than 40 allied nations, says a great deal about the security and reliability of our integrated family of systems.

Turning now to our Tactical Missile Systems business, our leading Switchblade Loitering missile solution continues to protect U.S. forces in dangerous environments. We continue to deliver value through market leading hardware and through support services.

Our multiple Switchblade variance include Blackwing which is generating more interest after successful deployment on U.S. Navy submarines. That interest is translating into procurement dollars to extend deployment and improve the overall performance of the solution set.

Other variance of our family Tactical Missile Systems are advancing through development or production. Tactical Missile Systems is another AeroVironment business offering compelling long-term growth opportunities.

In Commercial Information Solutions, we're readying our distribution strategy to support Quantix and AV DSS availability later this calendar year. We've demonstrated our integrated solutions value proposition to early adapt our customers by identifying issues they were not even aware of and then tracking this resolution.

This is a preliminary step toward providing prescriptive solutions that will increase the terms for farmers among other industries. The same security and reliability that are military customers value so much means a great deal to these and other customers who intend to pursue in this potentially large commercial market.

In our EES segment, our industrial EV charging business secured a new contract and initiated shipments for global carrier at one of the nation's largest international airports.

Indicative of this businesses growing international footprint, we also completed shipments of a major Asian airport with a fully network charging and ground support equipment battery management systems. In our passenger EV charging business, we surpassed 61,000 level 2 charging systems deployed in North America.

Internationally we delivered TurboCords to a new European customer and we began pilot shipments of products for China and Europe for Volvo. And in our third EES product line, we continue to shift EV test systems to multiple customers in China and in North America reflecting strength in our end markets.

I have described a number of AeroVironment solutions that are helping our customers proceed with certainty. Innovation has driven AeroVironment since our founding in 1971 by Dr. Paul MacCready with problem-solving and doing what has never been done before.

In the more than 45 years since our team has envisioned, invented and commercialized remarkable solutions that help our customers succeed while strengthening the core culture elements that make AeroVironment so special. Creativity manifests in the work our people perform across our entire organization.

Now we announce what I believe is the perfect name for the front-end of our innovation engine, MacCready Works.

In our new MacCready Works we assembled a small dedicated team of the industry's brightest and most experienced thinkers to focus on defining the future of our technology solutions alongside AeroVironment's other innovators embedded in each of our businesses.

We are partnering with customers to deploy customer funding along with our own research and development funds to start some of the most important problems and transition them to unique solutions. These solutions will address problems that extend from our farms to our skies and beyond.

We're exploring ideas that will help our customers cope with the challenges they face today, as well as the challenges that have yet to present themselves. We're excited to put a name on this team and look forward to its contributions to AeroVironment's future. Now Teresa will provide a detailed review of first quarter financials.

Teresa?.

Thank you, Wahid and good afternoon everyone. AeroVironment's fiscal 2018 first quarter results are as follows; revenue for Q1 was $43.8 million, an increase of $7.5 million or 21% from the first quarter of fiscal 2017 revenue of $36.2 million.

The increase in revenue resulted from an increase in product sales of $15.4 million partially offset by a decrease in contract services revenue of $7.8 million. Looking at revenue by segment, UAS revenue was $36.3 million, an increase of $5.8 million or 19% from the first quarter of fiscal 2017 revenue of $30.5 million.

The increase was due to an increase in product deliveries of $13.5 million and an increase in service revenue of $0.7 million partially offset by a decrease in customer funded R&D work of $8.5 million. EES revenue was $7.5 million, an increase of $1.8 million or 31% from the first quarter of fiscal 2017 revenue of $5.7 million.

This increase was primarily due to an increase in product deliveries of passenger electric vehicle charging equipment. Turning to gross margin, gross margin for the first quarter was $11.6 million or 27% as compared to $6.7 million or 18% for the first quarter of fiscal 2017.

The increase in gross margin was primarily due to an increase in product sales margins of $6.4 million partially offset by a decrease in service margins of $1.4 million. By segment, UAS gross margin increased to $9.8 million for the first quarter of fiscal 2018 from $5.4 million.

As a percentage of revenue, gross margin for UAS increase from 18% to 27% primarily due to a decrease in product, warranty related costs and an increase in the proportion of product sales to total revenue. EES gross margin increased $0.5 million to $1.8 million for the first quarter of fiscal 2018 primarily due to an increase in product sales volume.

As a percentage of revenue, gross margin for EES increased from 22% to 24%. SG&A expense for the first quarter of fiscal 2018 was $13.3 million or 31% of revenue compared to SG&A expense of $13.7 million or 38% of revenue for the first quarter of fiscal 2017.

R&D expense for the first quarter of fiscal 2018 was $6.5 million or 15% of revenue compared to R&D expense of $8.6 million or 24% of revenue for the first quarter of fiscal 2017.

The loss from operations for the first quarter of fiscal 2018 was $8.2 million or minus 19% of revenue compared to a loss from operations of $15.6 million or minus 43% of revenue for the first quarter of fiscal 2017. The operating loss decrease was primarily due to higher gross margins of $4.9 million and a decrease in R&D expense of $2.1 million.

Net other income for the first quarter of fiscal 2018 was $0.5 million compared to the prior year net other income of $0.1 million. The net other income increase was primarily due to an increase in interest income and a foreign exchange loss in the prior year.

Benefit from income taxes for the first quarter of fiscal 2018 was $3.2 million compared to a benefit for income taxes of $3.9 million for the first quarter of fiscal 2017. The effective income tax rate was 41.6% for the first quarter of fiscal 2018 as compared to an effective income tax rate of 24.9% for the first quarter of fiscal 2017.

The effective income tax rate for the first quarter of fiscal 2018 included a discrete excess tax benefit of $1 million resulting from the vesting of restricted stock awards and exercises of stock option.

Net loss attributable to AeroVironment for the first quarter of fiscal 2018 was $4.4 million or a $0.19 loss per share compared to a net loss attributable to AeroVironment of $11.6 million or a $0.51 loss per share for the first quarter of fiscal 2017.

Turning to our balance sheet, cash, cash equivalents and investments at the end of the first quarter of fiscal 2018 totaled $261.1 million, an increase of $19.2 million from the end of fiscal 2017.

The increase in cash, cash equivalents and investments was driven by the collection of accounts receivable from our record fourth quarter of fiscal 2017 revenue.

Accounts receivable including unbilled and retention receivables at the end of the first quarter of fiscal 2018 totaled $41.4 million, a decrease of $47.1 million from the end of fiscal year 2017.

Total days sales outstanding for the first quarter of fiscal 2018 was approximately 134 days compared to 45 days for the prior quarter and 152 days for the first quarter of fiscal 2017. Net inventory at the end of the first quarter of fiscal year 2018 was $72 million compared to $60.1 million at the end of the prior quarter.

Days in inventory for the first quarter of fiscal 2018 were approximately 185 days compared to 87 days for the prior quarter and 124 days for the first quarter of fiscal 2017. This increase in inventory days was primarily due to anticipated fiscal 2018 shipments from orders and backlog and anticipated orders.

Turning to capital expenditures in the first quarter of fiscal year 2018, we invested approximately $3 million in property improvement and capital equipment and recognized $1.9 million of depreciation and amortization expense. Now an update to our fiscal 2018 visibility, as of today we have year-to-date revenue in fiscal 2018 of $44 million.

First quarter ending backlog that we expect to execute in fiscal 2018 of $56 million, Q2 quarter-to-date bookings that we anticipate to execute in fiscal 2018 of $32 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 $19 million. This adds up to $154 million or 53% 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..

Thank you, Teresa. Before addressing our outlook for the year, I'll comment briefly on the Federal budget request as it relates to our solutions. As we've been communicating budget line items typically account for a small portion of AeroVironment UAS revenue. Much of the funding for U.S.

military procurement of our solutions comes in the form of urgent need statements, and a growing percentage is from international customers. The current government fiscal 2018 President's budget request includes approximately $50 million for relevant small UAS and Tactical Missile Solutions.

These requested funds address small UAS for the Marine Corp and Army and Lethal Miniature Aerial Missile Systems or LMAMS for the Army. Recent news regarding increased U.S. troop deployment to Afghanistan has the potential to provide further opportunities for our solutions.

In the short time since we spoke with you at the end of June, we have delivered on our expectation and advanced our business towards the long-term value creation was so focused on realizing. We are the leading publicly traded unmanned aircraft systems or drone company serving a roster of highly discriminative customers around the world.

Our market positions remain strong across our tactical UAS, Tactical Missile Systems and Efficient Energy Systems businesses.

Soon we will launch our commercial information solutions offering into a promising new commercial market and multiple Switchblade variants are progressing through development to production expanding the size of this market opportunity.

We're also making good progress on internal initiatives relating to attracting and retaining the best people and making continuous improvement a cultural standard of how we do business.

Given our effective performance to-date along with our increased visibility, we reiterate our state of fiscal 2018 guidance as follows; revenue between $280 million and $300 million with diluted earnings per share between $0.45 and $0.65, similar to previous years, we expect revenue in the first half of year to represent about 40% of full year revenue and we're on track to invest 9% to 10% of revenue on internal research and development.

Better than anticipated profitability in the first quarter does not imply an increase in annual earnings per share above our guidance since Q1 benefited from the tax benefit we discussed earlier.

While we will continue to manage expenses carefully, we expect operating expenses to increase in the balance of the year and revenue mix will continue to move around within quarters. Once again our three main messages today are first, we achieved our revenue expectations and exceeded our profitability expectations for the quarter.

Second, we’re on track to achieve our previously stated full year guidance supported by our increased visibility during the first quarter. And third, we continue to execute on our growth initiatives successfully while positioning AeroVironment for long-term value creation.

We remain confident in our ability to transform our innovation into continued market leadership through the creation of superior customer value.

On behalf of our entire team, thank you for your attention today and thanks to all our customers who continue to make AeroVironment their preferred choice to our outstanding employees, for their relentless dedication, and to our stockholders for their continued confidence and support.

We’re excited about the future and look forward to continued success. Teresa, Steve and I will now take your questions..

[Operator Instructions] And the first question comes from Ken Herbert from Canaccord. Please go ahead..

Wahid I just wanted to first ask about the guidance, I can appreciate the tax benefit maybe it looks like about a nickel in the quarter if my math is correct. Obviously maintaining the full year EPS guidance implies significantly down EPS in the next three quarters relative to last year even with better revenues.

Can you just talk maybe about where we should see some of the pressure there obviously you're taking R&D down as well relative to last year, is it mix, is it maybe just a little bit more investment on any programs or just help reconcile some of that relative to maybe just what's some conservatism that you've built into the estimates?.

As I said earlier in my comments, we are very pleased with the results on our first quarter. We achieved our revenue expectations and we overachieved in our EPS expectations. And we also feel comfortable with the full year guidance and that's why we reiterated and reconfirmed our guidance for the full year in terms of revenue and EPS.

The reason I caution about the full year is primarily because this is only the first quarter and we got three more quarters to go number one. And number two, historically and consistent with historical this first quarter is the smallest of our four quarters.

So we still have a longer way to go for the year in order for us to achieve our full year expectation. We’re committed to that, we feel confident about our ability to succeed in that.

And last but not least also we benefited in terms of EPS on the first quarter because of those three primary reasons that I described earlier, one of which was the one-time tax benefit as a result of our incentive plan..

And can you provide any more specifics on the visibility you’ve highlighted a few times, is that what you're seeing internationally, is that maybe what you're seeing domestically on some of the programs you’re pursuing say around frequency relocation and other areas or maybe just a little bit more detail on specifics around the better visibility that would be helpful.?.

As you heard from Teresa's comments, she broke down the visibility into specific pieces that we historically have been in the past. Our visibility has improved since the last time we spoke on the last earnings call for the fourth quarter which represents essentially now $154 million which is 53% of the midpoint of our guidance.

In terms of the color of our business as I mentioned in my remarks and domestic small UAS, we continue to pursue specific opportunities one of which is the frequency relocation which we believe are positioned quite well.

But it really depends on the customer's execution timing as to when they expect to execute that and how fast can they actually execute the plans that they have put in place, but we’re positioned well for that.

And then in addition to that, we also have our Snipe solution that we delivered and there is a stated customer requirement for a potential program of record in long run which is referred to as a Soldier Borne Sensors or SBS program.

We believe that our Snipe positions us quite well for that and then we have continued to say this before and I re-estate that the demand for our small UAS products and solutions internationally is strong and continues to be strong. We added one new Middle East customer. We also delivered - we signed a contract with the Australian Army on forces.

And so these are what I referred to consistent strong signals from international markets and similar to the small UAS our Tactical Missile Systems business enjoys a very strong position in the market and we look forward to competing on various opportunities that are hopefully as part of our plan and is coming our way in the coming year..

[Operator Instructions] And we have Howard Rubel from Jefferies. Please go ahead..

Wahid couple of questions, first - if your R&D is down or flat a little bit is your headcount down or are you just reallocating resources?.

Yes, so in the first quarter our operating expenses in general were slightly lower than we expected and that was one of the contributors to our better than expected performance on the EPS on first quarter. R&D is made up of generally both in-house R&D work that we do and also some work that we outsource to sub - third-party subcontractors.

In general, our headcount is somewhat of a flat. We have not decreased or increased it significantly one way or the other. However, we do intend to achieve our full year R&D expectations which we provided which is between 9% to 10%.

And so I would say that we had a slower start with the beginning of the year not necessarily because of our headcount changes but primarily because of customer funded R&D projects that take usually a priority over our internal funded R&D and when that happens our headcount gets more allocated to this customer funded R&D projects, as well as some subcontract that we could phase in later throughout the year..

It’s a high-class problem if customers want more work from you, so I mean that could very well continue and it would be – it's a high-class problem if you miss it because your customer R&D is better, I guess it’s fair?.

Yes, I would agree with you Howard and that's why I said we’re pleased with our results and obviously it’s above our expectations but it's favorable so we’re pleased with the results..

The second thing is, could you talk for a moment about your commercial market progress. I know - there's a lot of moving parts and some of it's a function of what the FAA does and I mean every day it seems as if that market changes a bit - and I know that elements of this are still speculative.

But maybe if you could keep us grounded a little bit on sort of the parameters that you're thinking about and the progress you've made in I guess launching some of the new information solutions that might be helpful please?.

So that’s a great question and very obviously a hot topic these days in the market in general. We believe that Commercial Information Solutions as we refer to at CIS represents a long-term very large opportunity for AeroVironment for our customers and shareholders. So for the long run, I would say that our position hasn’t changed much at all.

And we still believe that there is a large opportunity and growth potential for AeroVironment there. In terms of the short-term we’re really focused from now until the end of this calendar year sort of very focused on the sales and marketing and channel distribution strategy related to our solutions.

As we have discussed before, we unveiled the product line the Quantix and DSS solution set. We believe that the hardware and software and service solutions that we offer is highly differentiated and compelling to the market and to the competitors that are playing in the market.

And we believe that we offer a compelling value proposition to this market and our customers in that space. But right now we got to make sure that we get the right product, the right solution to the market and ship it successfully to initial early-adopter customers.

And then once we do that, I will refer to that to gated approach when we get to that phase in that gate, we can then assess our position, the response in the market, the macro-level climate that's going on in this whole space, and then inform you of our plans and our findings.

In terms of the FAA, we've always known and we continue to believe that FAA will play and is going to play a critical role as an enabling factor for the adoption of this market. There are certain applications that the FAA role is less significant than in some other application.

So for example, you could argue that a small farmer has visual line of sight on flying a drone over their farm.

However, if you consider for example the electric utilities which has hundreds if not thousands of miles of transmission and distribution lines, would require solution that can go much further linearly which will be beyond visual line of sight. And so in that case, the FAA ruling would have a significant influence or a factor in it.

So in general we’re excited about the long run, we are focused on the short-term which is get the product to the market and then test the market and inform our decision for the next gate..

And then finally the last thing to go back to the Navy and Blackwing, and it seems as if there are - if I'm not mistaken there's incremental applications that are being developed and tested, can you provide any further color on that?.

So as we said before, Blackwing is one of the variants of our Switchblade family of systems which we have been able to publicly talk about based on our customer's permission. And we believe that Blackwing offers a tremendously differentiated and compelling value proposition for submarines.

And about a year ago, if you recall we demonstrated this capability to the Navy and U.S. DoD. The feedback was very favorable. And they decided to proceed with a pilot program of deployment of our initial pilot systems into a submarine.

And the results of that were favorable and now as I mentioned in my remarks today, we've been - we look forward to further funding to progress the development and maturation of the product with further field testing and deployments and that will hopefully we believe that eventually will lead to a larger adoption in the long run.

But it is a process that we have to follow and work with our customer to able to essentially transform this capability into a solution set that delivers value for all our stakeholders..

[Operator Instructions] And I will turn the call back over to Mr. Gitlin for final remarks..

Thank you very much Gini and thank you all for your attention today and your ongoing interest in AeroVironment. An archived version of this call, along with all SEC filings and relevant company and industry news can be found on our website, avinc.com. We look forward to speaking with you again following next quarter's results. Good day..

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating and we now disconnect..