Steve Gitlin - IR Wahid Nawabi - President and CEO Teresa Covington - SVP and CFO.

Joseph DeNardi - Stifel Nicolaus Peter Arment - Robert W. Baird Nick Johnson - Piper Jaffray Brian Ruttenbur - Drexel Hamilton.

Welcome to the AeroVironment, Incorporated Fourth Quarter and Full Fiscal 2018 Earnings Call. My name is Adrianne, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session.

[Operator Instructions] Please note this conference is being recorded, and I will turn the call over to Steve Gitlin. Steve Gitlin, you may begin..

Thank you very much, Adrianne, and welcome to our fourth quarter and full 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 research and development programs; changes in the timing and/or amount of government spending; our ability to perform under existing contracts including the asset purchase agreement for the proposed sale of our EES business and obtain new contracts; 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; 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 26, 2018.

The company undertakes no obligation to make any revision to the statements contained in our remarks or to update them to reflect events or circumstances occurring after this conference call. We will now begin with remarks from Wahid Nawabi.

Wahid?.

First, the army awarded a $2.6 million initial small order from the SBS program to a competitor last month. This is an initial small order, and we see promising upcoming opportunities to secure this program. Second, among our Switchblade variants, while we achieved positive progress for one, we did not achieve our targeted progress for others.

We remain focused on developing these variants effectively to address large, new opportunities for our TMS business. In addition to our publicly-stated goals for the year, we achieved several very important strategic milestones that we had been working towards for some time, which position us for continued growth.

First and foremost, we began deploying our balance sheet to establish a joint venture with SoftBank Corporation called HAPSMobile. We are developing the next-generation solar HAPS solution for the JV to provide global broadband telecommunications services.

As of today, AeroVironment owns 5% of the JV and has the option to increase our equity stake in the joint venture up to 19% in the near future. This represents another strategic use of capital, which our strong balance sheet enables.

This is a great example of how our position at the intersection of robotics, sensors, software analytics, and connectivity is creating exciting opportunities for long-term value creation. This strategic opportunity creates value for AV in two ways.

First, by manufacturing and selling HAPS systems to HAPSMobile subject to our conformance to contract terms; and second, by participating in the HAPSMobile Inc's business as it seeks to deliver broadband and 5G telecommunications services around the globe.

The financial impact of the current investment phase of the HAPS program appears in our financial statements in four forms. (A) Using cash from our balance sheet to maintain and potentially to increase our equity stake in the JV. (B) Absorbing a portion of the JV's near-term losses and anticipated long-term gains as we progress through the program.

(C) Capital spending to build our facility and capability. And (D) Gross margin impact as our overall revenue mix is influenced by the HAPSMobile funded cost plus program.

Once again, this is one of our key long-term value creation opportunities that we will continue to invest in, in order to generate the two forms of value creation I described earlier.

Our second strategic milestone in 2018 was securing the next significant tranche of Switchblade orders for the army's LMAMS program through DoD Joint Urgent Operational Need Statement generating $111 million in hardware and services orders that I mentioned earlier. Additionally, we saw the largest procurement line item yet for Switchblade in the U.S.

government fiscal year 2019 budget request, totaling nearly $130 million to fund future Switchblade orders. As a reminder, the budget is not finalized until approved by Congress and signed by the U.S. President. A testament to the operational improvements we have been implementing was our designation by the U.S. Army as a Tier 1 supplier.

This recognizes us as one of the highest ranking supplier to the U.S. DoD.

Additionally, we are part of the first group of nearly 10,000 companies to achieve this stringent requirement for ISO 9001, 2015, and AS 9100D certifications, which give our customers even greater confidence that we deliver the quality they expect to serve as their part of choice for UAS and TMS.

These important supply and quality certification achievements are quite significant, given our selection in April as one of seven companies to compete for upcoming army small UAS task orders under a new five-year IGIQ contract valued at up to $248 million. In summary, our UAS and TMS core business and growth portfolio are strong and robust.

Our team is aligned with our growth strategy, and demand for solutions also remains strong. Thanks to our proven strategy, investments, and execution. Now, Teresa will summarize our financial performance in fiscal 2018.

Teresa?.

Revenue from continuing operations for the fourth quarter was $117.4 million, an increase of $1.7 million or 1% from the fourth quarter of fiscal 2017 revenue of $115.7 million. The increase was due to an increase in service revenue of $15.6 million, partially offset by a decrease in product deliveries of $13.9 million.

Gross margin from continuing operations for the fourth quarter was $52.2 million or 44% of revenue, compared to $57.4 million or 50% of revenue for the fourth quarter of fiscal 2017. The decrease in gross margin was primarily due to a decrease in product sales margin of $9.9 million, partially offset by an increase in service margins of $4.7 million.

Gross margin as a percentage of revenue decreased from 50% to 44%, primarily due to a lower percentage of product sales in the fourth quarter.

Looking at the rest of the income statement, SG&A expense from continuing operations for the fourth quarter of fiscal 2018 was $15.3 million or 13% of revenue, compared to SG&A expense of $14.4 million or 12% of revenue for the fourth quarter of fiscal 2017.

R&D expense from continuing operations for the fourth quarter of fiscal 2018 was $7.4 million or 6% of revenue, compared to R&D expense of $6.7 million or 6% of revenue for the fourth quarter of fiscal 2017.

Income from continuing operations for the fourth quarter of fiscal 2018 was $29.5 million or 25% of revenue, compared to $36.3 million or 31% of revenue for the fourth quarter of fiscal 2017.

The decrease in income from operations was primarily due to lower gross margins of $5.2 million, and increase in SG&A of $0.9 million, and an increase in R&D expense of $0.7 million. Net other income for the fourth quarter of fiscal 2018 was $0.9 million, compared to net other income of $1 million for the fourth quarter of fiscal 2017.

The effective income tax rate from continuing operations was 30.4% for the fourth quarter of fiscal 2018 as compared to an effective income tax rate of 23.7% for the fourth quarter of fiscal 2017.

Equity method investment activity net of tax for the fourth quarter of fiscal 2018 was a loss of $0.9 million or $0.04 per diluted share compared to equity method investment activity net loss of $8,000 for the fourth quarter of fiscal 2017.

Net income from continuing operations attributable to AeroVironment for the fourth quarter of fiscal 2018 was $20.2 million or $0.85 per diluted share, compared to net income from continuing operations attributable to AeroVironment of $28.4 million or $1.21 per diluted share for the fourth quarter of fiscal 2017.

Loss from discontinued operations net of tax for the fourth quarter of fiscal 2018 was $1.9 million or $0.08 loss per diluted share, compared to income from discontinued operations net of tax of $2 million for the fourth quarter fiscal 2017 or $0.09 income per diluted share.

Now, moving through our full-year fiscal 2018 results; revenue from continuing operations for fiscal 2018 was $271.1 million, an increase of $42.2 million or 18% from 2017 revenue of $228.9 million.

The increase was due to an increase in product deliveries of $35.7 million, and an increase in customer-funded R&D work of $8.2 million, partially offset by a decrease in service revenue of $1.7 million.

Gross margin from continuing operations for fiscal 2018 was $108.9 million or 40% of revenue, compared to $95.2 million or 42% of revenue for fiscal 2017. The increase in gross margin was primarily due to an increase in product sales margin of $12.7 million, and an increase in service margins of $1 million.

Gross margin as a percentage of revenue decreased from 42% to 40%, primarily due to unfavorable product mix. Looking at the rest of the income statement, SG&A expense from continuing operations for fiscal 2018 was $50.8 million or 19% of revenue, compared to SG&A expense of $47.6 million or 21% of revenue for fiscal 2017.

R&D expense from continuing operations for fiscal 2018 was $26.4 million or 10% of revenue, compared to R&D expense of $28.5 million or 12% of revenue for fiscal 2017. Income from continuing operations for fiscal 2018 was $31.6 million or 12% of revenue, compared to $19.1 million or 8% of revenue for fiscal 2017.

The increase in income from operations was primarily due to higher gross margins of $13.7 million, and a decrease in R&D expense of $2 million, partially offset by an increase in SG&A of $3.2 million. Net other income for fiscal 2018 was $2.2 million, compared to $1.8 million for fiscal 2017.

The effective income tax rate from continuing operations was 30.1% for fiscal 2018 as compared to an effective income tax rate of 19.8% for fiscal 2017.

The provision for income taxes for fiscal year 2018 included the impact of the Tax Cut and Jobs Act of 2017, inclusive of a reduction in the blended fiscal year 2018 Federal Statutory Tax Rate from 35% to 30.4%, and an estimated $3.4 million one-time expense resulting from the re-measurement of our deferred tax assets and liabilities.

Equity method investment activity net of tax for fiscal 2018 was a loss of $1.3 million or $0.05 per diluted share, compared to equity method investment activity net of loss of $0.1 million for fiscal 2017 or $0.01 per diluted share.

Net income from continuing operations attributable to AeroVironment for fiscal 2018 was $22.4 million or $0.95 per diluted share, compared to net income from continuing operations attributable to AeroVironment of $16.6 million or $0.72 per diluted share for fiscal 2017.

Loss from discontinued operations net of tax for fiscal 2018 was $2.5 million or $0.11 diluted loss per share, compared to a loss from discontinued operations tax of $4.2 million for fiscal 2017 or $0.18 loss per diluted share.

Our funded backlog from continuing operations as of April 30, 2018 was $174.3 million, an increase of $53.4 million or 44% from the third order of fiscal 2018, and an increase of $103.4 million or 146% from the fourth quarter of fiscal 2017.

Turning to our balance sheet; cash, cash equivalents and investments at the end of the fourth quarter of fiscal 2018 totaled $297.8 million, an increase of $55.9 million from the end of fiscal 2017 cash, cash equivalents and investments of $242 million.

Net accounts receivable including unbilled receivables and retention from continuing operations at the end of the fourth quarter fiscal 2018 totaled $69.9 million, a decrease of $30 million from the end of the fourth quarter fiscal 2017. Total day sales outstanding from continuing operations for the fiscal year 2018 were approximately 103.

Net inventory from continuing operations at the end of the fourth quarter fiscal year 2018 was $38.6 million, compared to $40.9 million at the end of the fourth quarter fiscal year 2017. Days and inventory outstanding from continuing operations for the fiscal year 2018 was approximately 90 days.

Accounts payable from continuing operations at the end of the fourth quarter fiscal year 2018 was $21.3 million compared to $15.9 million at the end of the fourth quarter fiscal year 2017. Total days payable outstanding from continuing operations for the fiscal year 2018 was approximately 42 days.

Current assets from discontinued operations at the end of the fourth quarter fiscal year 2018 were $28.3 million. Current liabilities from discontinued operations at the end of the fourth quarter fiscal year 2018 were $9.2 million.

Turning to capital expenditures; in fiscal year 2018, we invested approximately $9.6 million in property improvements and capital equipment for continuing operations, and recognized $6 million of depreciation and amortization expense.

We adopted the new ASC 606 Revenue Recognition Standard as required for all public companies on May 1, 2018 under the full retrospective transition method. For fiscal year 2016, the cumulative increase to retain earnings from continuing operations was approximately $0.7 million.

For fiscal year 2017, the revenue increase from continuing operations was approximately $4.2 million, and a cumulative increase to retained earnings from continuing operations was approximately $1.8 million. We will have the impact for fiscal year 2018 with our first quarter fiscal 2019 results.

The impact to our revenue in prior years is primarily driven by contracts in our Tactical Missile Systems business. We continue to assess the potential impact of this guidance for fiscal 2019, but do not currently expect it to be material.

Now, an update to our fiscal 2019 visibility; as of today, we have fourth quarter ending backlog from continuing operations that we expect to execute in fiscal 2019 of $147 million.

Q1 quarter-to-date bookings from continuing operations that we anticipate to execute in fiscal 2019 of $6 million, unfunded backlog from incrementally-funded contracts and continuing operations that we anticipate to recognize revenue during the balance of the year of $15 million; this adds up to $168 million or 56% at the midpoint of revenue guidance.

With the Tax Cut and Jobs Act, we anticipate a lower full-year effective tax rate for continuing operations in the range of 15% to 18%. Now, I'd like to turn things back to Wahid to discuss AV's expectations for fiscal year 2019..

First, our team continue to deliver outstanding financial and operational results in fiscal 2018. Second, we have developed a multi-year track record of meeting or exceeding our annual guidance and progressing toward long-term value creation objectives.

Third, we are reshaping our portfolio to put all our focus on solutions based on robotics, sensors, software analytics and connectivity to serve promising large global markets consisting of defense, telecommunications and control information solution. And fourth, we are making strategic investments to realize these large and exciting opportunities.

Thank you to all members of the AeroVironment team for your outstanding efforts in support of our stakeholders in 2018. Thank you to all of our customers for choosing AeroVironment to help you proceed with certainty and thank you to our stock holders for supporting the value creation potential of our people and our business.

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

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Joseph DeNardi from Stifel. Please go ahead..

Yes, hi, good afternoon everybody..

Hi, Joseph..

Wahid, last year you mentioned that TMS was also $75 million, maybe half of it was R&D, half of it was product-related; could you just give us an update on what that looked like last fiscal year?.

Sure, Joe.

As I said in my remarks that we have achieved significant progress on our Tactical Missiles Systems business in general, given the record backlog that we booked in the fiscal year, primarily due to government fiscal year budgeting delays and appropriations that we saw in fiscal -- government fiscal year 2018, the timing of those bookings were such that our ability to deliver those products by the request of our customers within fiscal 2019, fiscal 2018 -- I am sorry, did not really take place.

So, essentially that revenue showed up -- those order showed up as backlog, which we intend to execute in the fiscal year 2019. We feel very strong about the prospects of the long-term value creation and robust business in our TMS business long-term.

As you know, the Switchblade product is the product of choice or the solution of choice within our U.S. DoD customers, and we have successfully won several of the competitions that are out there, and we also intend to expand that portfolio of the Tactical Missile Systems variants in fiscal '19 as you heard in my remarks.

So we achieved a lot of milestones that I mentioned, but however, the government fiscal year budget timing delayed the recognition of that revenue in fiscal 2018..

Yes, I guess what I am trying to get at it is, when you think about the potential from the variants of Switchblade, what was the customer-funded R&D for TMS last year if you can talk about it?.

So, unfortunately, due to the nature of those programs, I am not able to comment specifically on those particulars, but as I said in my remarks, we continue to see demand and desire from our customers for our Switchblade and its variants.

We see -- we have booked revenue both in terms of product delivery revenue as well as services revenue for development of variants, which to me is both positive indicators for the TMS business, and we will share more details on this tomorrow during our Analyst and Investor Day..

And our next question from Peter Arment from Baird. Please go ahead..

Yes, good afternoon, Wahid, Teresa, and Steve..

Hi, Peter..

Wahid, question regarding -- hi, thanks for the revenue kind of the moving parts on the revenue side, you mentioned that I think on the earnings per share for the year for fiscal 2019, normally you’ve kind of provided a little bit of cadence how you think the bottom line, it sounds like it’s fairly balanced through the year just given the way the shipments are falling through, just maybe a little more color on that?.

Yes. Peter, so as I said on my remarks at the end that our revenue distribution throughout the year remains fluctuating primarily because of the nature of our business, right.

We see – historically, we have seen higher fourth quarters and lower first quarters and first-halves, however, in fiscal 2019 as I said on my comments, we expect that half of our fiscal year's revenue to occur on the first-half of the year, and approximately half of the first-half revenue to occur within our first quarter of this fiscal year, so generally speaking the main contributor to that of course is these large historical levels of backlog, and the bookings that we have in our backlog that enables us to execute on that earlier within the year.

And that would be the overall distribution of revenue throughout the year. In terms of EPS, we have only provided guidance for the full-year, and that is the range of EPS from continued operations -- $1.10 to $1.40, but that does include a one-time gain from a previously disclosed litigation of $0.25 to $0.26 per share..

Yes, just regarding the latter, do you know when that officially will be flowing through in terms of is it in the first-half or is it -- how do we expect to see that…?.

Yes, we expect that to occur, the one-time gain to occur during the first quarter of this fiscal year, and we also expect the EES divestiture to occur during the close, during the first quarter of this fiscal year..

And our next question comes from Nick Johnson from Piper Jaffray. Please go ahead..

Hey guys, congrats on a great fiscal 2018..

Thank you, Nick..

So I just -- it sounds like your domestic business is doing well, which is great, I just want to maybe touch more on your international opportunities, maybe give some update there, and any potential from the tariff or trade restrictions that have been going on internationally by our government, is that -- would that potentially impact you guys as well?.

Sure. So, most of the news that we see in the public domain related to foreign trade and foreign military sales are related to programmatic sort of products and capabilities within the U.S. DoD. However, given -- having said that, we expect our international business to remain strong.

It's been very strong throughout the last several years as you have seen in our results. We are up to 45 countries now internationally in terms of new customers or existing customers for AeroVironment, and the amount of our revenue for Tactical, UAS internationally is also very healthy.

We also booked the largest ever order from a Middle East nation as you saw on my remarks for $44.5 million.

So, going forward in fiscal 2019, as I said for the past few years, we believe that our international business is strong and diverse, and we continue to see desire and interest and demand from our customers, and we expect to continue that momentum in fiscal 2019.

The governments around the world, allied nations also see tremendous value in our capabilities given the type of conflicts that are going on around the world, essentially almost every continent and every region of the world. So we feel quite positive about our products.

We do have to obtain export licenses for every single one of our UAS shipments for international customers. We have been very successful of that historically, and there is always a timing risk on that as before, but we don't expect that to be any issues in fiscal 2019..

Okay, thank you. And then just as a follow-up, you mentioned in your commentary that there is some opportunity also in Homeland Security which we haven't seen before. So what kind of -- what's the size of that opportunity and maybe in comparison to the -- what you have seen in U.S.

Army?.

Sure. So, similar to the other businesses that I mentioned earlier, the government's fiscal year '18 budget procurement and appropriation process delays caused some delay in the acquisition process and the obligation of those funded dollar that are already approved in the budget -- of the government's budget that's already approved in fiscal '18.

So however, in fiscal -- government fiscal 2017 budget, there was about $4 million worth of appropriations, specifically for small UAS and our solutions for the Department of Homeland Security.

There was approximately $10 million worth of funding approved in government fiscal year '18, which you can these figures publicly in the release documents from the government. So we have delivered the initial systems, which we shared with you guys publicly several quarters ago.

However, the $10 million funding line item has not been obligated yet, and we are working with our customer through the process of fulfilling that demand, and we continue to see the demand and the request from DHS, specifically the customs and border patrol for our solutions. They see great value in our solutions.

We believe that it delivers a very unique compelling value proposition for border patrol and border security. However, the timing delays due to the appropriation process could vary..

[Operator Instructions] And our next question comes from Brian Ruttenbur from Drexel Hamilton..

Yes. Thank you very much.

So first of all, if I could get a breakdown of depreciation and amortization going forward when you exclude the EES, I am just trying to figure out your cash flows and EBIDTA going forward, if you could talk a little bit about that and your guidance for cash generation in fiscal 2019?.

Hi, Brian. We have not provided guidance on the cash in the past. On the capital side, in 2018, we invested $9.6 million in depreciation and amortization. Historically, over the last couple of years from continuous operations, we have invested 4% of revenue in capital. And so -- and historically it's been in the 3% to 5% range.

We would expect it to be in that range in fiscal 2019. Regarding cash, we haven't forecasted cash; we had very strong cash from operations in fiscal 2018..

Okay.

So what is your depreciation, amortization on a going forward basis excluding the EES?.

Well, we had $6 million in fiscal '18. We haven't provided a forecast of what that looks like in 2019, but we do expect the amount of capital that we are spending to be in the 3% to 5% range of revenue..

Okay.

And then plans for cash, you have roughly $300 million in cash, I think that you are talking about ramping up certain operations getting ready to perform on this opportunities in front of you on demand side, what kind of capital is that going to require outside of your traditional CapEx? Do you see that there is going to be increased use of your capital outside of that?.

So Brian, this is Wahid. That's a really good question. As I said in my remarks, first and foremost, the board and our leadership team, we review our capital allocation and the return on that capital regularly, and quite rigorously.

Inherent to our business strategy is the timing of certain market adoptions that we are pursuing within our business strategy. And when and if those adoptions take place, the demand for cash to scale our various businesses still remains quite strong and healthy.

So for example, we have utilized some of our cash in fiscal '18 as you saw and the formation of our joint venture for HAPSMobile with SoftBank Corporation, and there is primarily two methods or means of utilization of capital for that business.

One, as we ramp up that business and demonstrate the capability we will be building facilities and manufacturing capacity to manufacture airplanes to sell to the joint venture, AeroVironment will. And then secondly, we still have an option to increase our ownership in the joint venture from 5% today up to 19% at a certain time.

And so, if we were to increase that, that will consume additional capital for that. And obviously, this is considered to be a very large global business.

The rollout of 5G connectivity and mobile telephony and telecommunication is a multibillion dollar opportunity based on several, several reports publicly, and HAPSMobile is right at the center of that opportunity in terms of the enablement capabilities to achieve that globally.

So that's just one example of uses of our cash amongst many other such as our Tactical Missile Systems business, International business et cetera..

And the next question comes from Nick Johnson from Piper Jaffray. Please go ahead..

Sorry, I just had one more follow-up here.

I know in the past you split out revenue between UAS and EES, I know obviously EES is going forward, maybe we could get the figures for this quarter, help give an idea of kind of core business growth projected in 2019?.

Nick, are you referring to EES revenue as discontinued operations for this fiscal year's first quarter?.

No, for fiscal fourth quarter, this previous quarter here; I know in the past you guys have given out revenue between the two segments..

So Nick, in the fourth quarter, UAS revenue was $117.4 million. In the first quarter of '17, UAS revenue was $115.7..

So, it was - okay, I see.

So, the total not there - kind of not from EES, is that correct?.

That is correct. That's just the continuing operations..

Yes, the balance of it would be the EES….

Got it..

-- discontinued operations..

Understood, thank you..

You are welcome..

This concludes our question-and-answer session, and I will turn the call back over to Steve Gitlin for final remarks..

Thank you, Adrianne, and thank you all for your attention today, and your interest in AeroVironment. An archive version of this call, all SEC filings and relevant company and industry news can be found at our Web site, www.avinc.com.

A live audio webcast of tomorrow's Investor and Analyst event will begin at 8:30 AM Eastern Time, and it can be found on the Events and Presentation section of the Investor portion of our corporate Web site. The presentation filed for tomorrow's event will be posted shortly before the event begins.

We look forward to speaking with you tomorrow, and again following next quarter's results. And we wish you a good day..

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