AeroVironment, Inc. (AVAV) Q4 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the AeroVironment Incorporated Fourth Quarter and Full Fiscal 2017 Earnings Call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session after 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. Steven Gitlin. And now at this time, I would like to turn the conference over to Mr. Gitlin. Please go ahead, sir.

Thank you, Chelsey, welcome to AeroVironment's fourth quarter and full fiscal 2017 earnings call. Please note that on this call, certain information presented contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain words such as believe, anticipate, expect, estimate, intend, project, plan, or words or phrases with similar meaning. Forward-looking statements are based on current expectations, forecasts and assumptions that involve risks and uncertainties, including, but not limited to, economic, competitive, governmental and technological factors outside of our control, that may cause our business, strategy or actual results to differ materially from the forward-looking statements. Factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to, reliance on sales to the U.S. government; availability of U.S. government funding for defense procurement and R&D programs; changes in the timing and/or amount of government spending; risks related to our international business including compliance with export control laws, potential need for changes in our long-term strategy in response to future developments; the extensive regulatory requirements governing our contracts with the United States Government and international customers, the consequences to our financial position, business and reputation that could result from failing to comply with such regulatory requirements, unexpected technical and marketing difficulties inherent in major research and product development efforts; the impact of potential security and cyber threats; changes in the supply and/or demand and/or prices for our products and services; the activities 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, June 27, 2017. The Company undertakes no obligation to make any revision to the statements contained in our remarks or to update them to reflect the events or circumstances occurring after this conference call. Let's begin with remarks from Wahid Nawabi. Wahid?

Thank you, Steve. Our three main messages today are as follows; First, our business remains strong and profitable and our team achieved our exceeded our financial objectives for fiscal 2017, second we made good progress on our fiscal 2017 milestones that maintained the leading market positions in our core business and advance our differentiated solutions for large new global opportunities and our growth portfolio, and third we remain on track for long term value creation. On today's call, I will provide a summary of fourth quarter and full year financial performance and will review our achievements in fiscal 2017. Teresa Covington will provide a more detailed review of our financials before I share with you our goals for fiscal 2018. Teresa, Steve and I will then take your questions. When I assumed the role as AeroVironment's Chief Executive Officer a little more than a year ago I was confident we were well positioned to execute our strategy successfully, drive value for shareholders and provide our customers more actionable intelligence so they can proceed with certainty. To troops on the front line, that certainty can mean the difference between life and death. To businesses it can mean helping to ensure their financial prosperity. Our core business is strong with leading market positions and the ability to generate attractive returns and our growth portfolio is compelling with the highly differentiated solutions we've been developing for launch into large new global market opportunities. Achieving these opportunities requires planning, when we developed our fiscal 2017 plan customer order timing resulted in a heavily weighted fiscal fourth quarter, thanks to the support and dedication of our amazing team we delivered record fourth quarter results as follows. Revenue of $125 million, an increase of 48% year-over-year. Operating income of $34 million, an increase of nearly 400% year-over-year and fully diluted earnings per share of $1.30, an increase of more than 450% from the prior year. Our outstanding fourth quarter performance combined with careful operating expense management throughout the year produced full year revenue of $264.9 million, a small increase over fiscal 2016 and fully diluted earnings per share of 40 -- $0.54, well above our guidance and a 36% increase year-over-year. Gross margin decrease partly the result of our one-time reserve reversal in fiscal 2016 and partly due to higher sustaining expenses. Our focus on operating expense management more than offset low gross margin to produce operating income of $12.5 million, a 29% increase over last year. Our expense management included reducing internal R&D investments from 16% of revenue in fiscal 2016 to 12% of revenue in fiscal 2017, as we consistently communicated to you throughout the year. In addition to our financial performance we achieved nearly all of the objectives for fiscal 2017 that we shared with you a year ago and we emerged even better positioned for long term value creation than before. At the beginning of fiscal 2017 I shared with you our 10 key milestones for the year which I will now report on. We continued the expansion of our domestic small UAS business through sustainment and upgrades, deliveries that support potential U.S. Army procurement programs and promising U.S. Navy adoption. We began shipments of Mantis i45 sensors to DoD customers for Puma AE upgrades at the end of fiscal 2017. The i45 sensors suite delivers unparalleled imaging capabilities for small UAS and has the potential to drive its own significant upgrade cycle among Puma AE customers. We also improved our positioning for U.S. army soldier born sensor competition with our next generation pocketable Snipe unmanned aircraft system including completing shipment of our first 30 systems for customer evaluation. And we continue to demonstrate effective small UAS capabilities aboard naval vessels to drive further navel adoption of our solutions. We extended out international small UAS installed base with existing and new customers. Small UAS constitutes the majority of air environments international revenue which grew from 28% to 36% of company revenue in fiscal 2017, or from about $70 million to nearly $90 million. We offered a comprehensive solution that appeals to our international customers and they are procuring one or more products from our family of small UAS as well as multiyear services such as training and repairs. Some of these customers are even using our systems 24/7 relying heavily on them to protect their forces and pushing the extreme capabilities of our unmanned solutions. AeroVironment is without question helping these customers proceed with certainty with very high stakes on the line. This integrated family of systems has helped to score increased adoption across a broader geographic range from western to eastern Europe from the middle east to Asia and Oceana expanding our list of allied customers to more than 40 countries. New UAS customers in fiscal 2017 included [indiscernible] and three other NATO and Middle East countries. As an example of family of systems adoption in October we announced a $10.3 million contract with the Netherlands for digital upgrades to their existing Raven fleet and for new Wasp AE and Puma AE systems. On June 1st, we announced that the Australian defense force selected our Wasp AE for small UAS program. We anticipate more multiyear contracts from international customers ahead as our installed base grows and we create more opportunities to build recurring revenue streams from sustainment services and upgrades. We continued to progress toward the U.S. DoD frequency relocation program for small UAS winning an initial contract that we believe positions us well for follow on work expected this fiscal year. The strategic investments we have been making to build our TMS business continue to deliver results. In fiscal 2011, our TMS revenue was about $6 million, growing to more than $40 million in fiscal 2016. In fiscal 2017, TMS revenue grew to more than $75 million an increase of more than 80% over the previous year. From fiscal 2011 this represents a compound annual growth rate of 56%. As you can see the returns on our strategic incremental TMS investments of previous years are very positive. TMS now accounts for 29% of total company revenue. We continue to build our family of tactical missile systems to address the important needs of a growing number of customers and we continue to successfully deliver Switchblade systems to our U.S. government customers. In October, we announced a $22.8 million contract from the U.S. army for Switchblade systems, which strengthens our position as the leader in Loitering Munitions, one type of the tactical missile systems. In fiscal 2017, we deployed Blackwing systems for use on navy submarines, with very positive results, an encouraging milestone on the path towards long-term adoption into a navy program of record. Still within our TMS business progress continued on our multiple Switchblade variance including production and delivery of one variant --. [Technical Difficulty]

[Operator Instructions] You may resume.

Thank you very much. This is Steve Gitlin, and we again we apologize for whatever technical issues cut our call off. So Wahid is going to start a little bit earlier in the script, apologies if there is some repetition here, but we want to make sure that you're tracking with his prepared comments.

Thank you, Steve. We continue to progress towards the U.S. view of this frequency relocation program for small UAS winning an initial contract that we believe positions us well for follow on work expected this fiscal year. The strategic investments we've been making to build our TMS business continue to deliver results. In fiscal 2011 our TMS revenue was about $6 million growing to more than $40 million in fiscal 2016. In fiscal 2017 TMS revenue grew to more than $75 million an increase of more than 80% over the previous year. From fiscal 2011 this represents a compound annual growth rate of 56%. As you can see the returns on our strategic incremental TMS investments of previous years are very positive. TMS now accounts for 29% of total company revenue. We continue to build out our family of tactical missile systems to address the important needs of a growing number of customers and we continue to successfully deliver Switchblade systems to our U.S. government customers. In October we announced a $22.8 million contract from the U.S. Army for Switchblade systems, which strengthens our position as the leader in Loitering Munitions, one type of tactical missile system. In fiscal 2017, we deployed Blackwing systems for use on Navy submarines with very positive results an encouraging milestone on the path toward long term adoption into a Navy program of record. Still within our TMS business progress continued on our multiple Switchblade variants including production and delivery of one variant and further development of others. Nearly half of our fiscal 2017 TMS revenue comes in the form of customer funded research and development. While customer funded R&D is usually lower margin business structured and costs plus contracts it’s also a strong indicator of customer engagement that generally leads to higher margin product revenue in subsequent years. Additionally, we are demonstrating effective counter UAF capabilities that have the potential to protect troops from the growing threat of lethal drones operated by our adversaries. In our commercial information solutions business, we unveiled our innovative Quantix drone, an AV decision support system analytics platform, shared news about important and relevant research with Fresno State University and made continued progress with early adopter customers and multiple industries. In April we performed an important demonstration with Legado Networks, Dominion Virginia Power and Virginia Tech. During this event we flew our Puma AE system up to 14 miles away from its operator along power lines using Legado's satellite and terrestrial capabilities to maintain communication and control. This demonstration illustrated a safe and effective approach to controlling drones and beyond visual line of sight operation. This type of capability will be critical towards maximizing the economic benefits of drones in commercial applications. Additionally, we achieved further engagement with potential customers for atmospheric satellite systems. In our EES business we grew revenue by 18% year over year and accelerated our global EV charging strategy by winning a contract with Volvo to support their plug-in vehicle rollout in Europe and China which we announced in March. We continue to enjoy strong demand and growth for EV test systems from global OEMs and battery manufacturers particularly in China, North America and South Korea. Our passenger EV charging solutions enjoyed strong unit growth in 2017 and we surpassed 54,000 level two charging systems deployed. Shipments of EVSEs increased sharply over last year as we supported the launch of the Chevrolet Bolt EV. Outside of North America our multi-year program with Volvo to develop a residential charger for the European, Chinese and North America markets is in progress, building on our next generation EV charging systems architecture and is compatible with 2018 global standards and agency requirements. Also in fiscal 2017, our EVSE-RS system was integrated with eMotorWerks JuiceNet for two utility programs. This development added to our broad portfolio of network integrated charging solutions that demonstrate our adaptability to the evolving EV charging network ecosystem for demand response and vehicle-to-grid applications. Finally, in EES we began shipping TurboCord level two chargers to a major global German automaker. We made good progress on our continued improvement initiatives, enhancing business processes, quality, our organization, planning and execution. These initiatives have already delivered high customer and employee satisfaction which ultimately contribute to shareholder value. Across our business we achieved our goals in fiscal 2017 and improved our positioning to achieve our long-term growth objectives. Now I will turn the call over to Teresa to provide more detail on our financial performance in the fourth quarter and for the full fiscal year. Teresa?

Thank you, Wahid and good afternoon everyone. AeroVironment's fiscal 2017 fourth quarter results are as follows; Revenue for Q4 was $125.4 million, an increase of $40.6 million or 48% from the fourth quarter of fiscal 2016 revenue of $84.8 million. The increase in revenue resulted from an increase in product sales of $51.5 million, partially offset by a decrease in contract services revenue of $10.8 million. Looking at revenue by segment, UAS revenue was $115.7 million, an increase of $39.8 million or 52% from the fourth quarter of fiscal 2016 revenue of $75.9 million. The increase was due to an increase in product deliveries of $50.4 million and an increase in service revenue of $2.1 million partially offset by a decrease in customer funded R&D work of $12.7 million. EES revenue was $9.7 million, an increase of $0.8 million or 9% from the fourth quarter of fiscal 2016 revenue of $8.9 million. This increase was primarily due to an increase in product delivery of EV test systems. Turning to gross margin, gross margin for the fourth quarter was $58.7 million or 47% as compared to $37.9 million or 45% for the fourth quarter of fiscal 2016. The increase in gross margin was primarily due to an increase in product sales margin of $26.5 million partially offset by a decrease in service margins of $5.8 million. By segment, UAS gross margin increased to $56.3 million for the fourth quarter of fiscal 2017 from $35 million. As a percentage of revenue gross margin for UAS increased from 46% to 49% primarily due to an increase in product sales volume and favorable product mix. EES gross margin decreased $0.6 million to $2.3 million for the fourth quarter of fiscal 2017, primarily due to unfavorable product mix. SG&A expense for the fourth quarter of fiscal 2017 was $16.7 million or 13% of revenue, compared to SG&A expense of $16.8 million or 20% of revenue for the fourth quarter of fiscal 2016. R&D expense for the fourth quarter of fiscal 2017 was $7.9 million or 6% of revenue, compared to R&D expense of $14.3 million or 17% of revenue for the fourth quarter of fiscal 2016. Operating income for the fourth quarter of fiscal 2017 was $34 million or 27% of revenue compared to operating income of $6.8 million or 8% of revenue for the fourth quarter of fiscal 2016. The operating income increase was primarily due to higher gross margins of $20.7 million, and a decrease in R&D expense of $6.4 million. Net other income for the fourth quarter of fiscal 2017 was $1 million, compared to the prior year net other income of $0.5 million. During the fourth quarter of fiscal 2017 we acquired an additional equity ownership in our Turkish joint venture Altoy for total proceeds of $625,000 providing us with a controlling interest. As a result, Altoy's financial results have been consolidated into AeroVironment's consolidated financial statements, which resulted in a gain on acquisition of $0.6 million or $0.02 earnings per diluted share. Our effective income tax rate was 13% for the fourth quarter of fiscal 2017, as compared to an effective income tax rate of 26.4% for the fourth quarter of fiscal 2016. Net income attributable to AeroVironment, for the fourth quarter of fiscal 2017 was $30.5 million or $1.30 earnings per diluted share compared the net income attributable to AeroVironment of $5.4 million or $0.23 earnings per diluted share for the fourth quarter of fiscal 2016. Now moving through full fiscal year 2017 results, as compared to fiscal year 2016. Revenue for fiscal 2017 was $264.9 million, an increase of $0.8 million as compared to $264.1 million for fiscal 2016. The increase in revenue was due to an increase in product deliveries of $3.9 million, partially offset by a decrease in contract service revenue of $3.1 million. UAS revenue decreased $4.8 million to $228.9 million for fiscal 2017, primarily due to a decrease in customer funded R&D work of $9.9 million and a decrease in product deliveries of $2.4 million partially offset by an increase in service revenue of $7.5 million. EES revenue increased $5.6 million to $35.9 million for fiscal 2017, primarily due to an increase in product delivery of EV test systems, and passenger EV charging solutions. Gross margin for fiscal 2017 was $102.2 million or 39% as compared to $112.1 million or 42% for fiscal 2016. The decrease was primarily due to a decrease in product margins of $5.7 million, and a decrease in service margins of $4.3 million. UAS gross margin decreased to $93 million for fiscal 2017 from $101.5 million in fiscal 2016. As a percentage of revenue gross margin for UAS decreased from 43% to 41%, primarily due to the reversal for the settlement of prior year government incurred cost audits recorded in the second quarter of fiscal 2016 and an increase in sustaining engineering cost and support of our existing products. The EES gross margin increased $1.5 million to $9.1 million for fiscal 2017 primarily due to an increase in sustaining engineering cost and support of our existing products and the reverse reversal for the settlement of prior year government incurred cost audits recorded in the second quarter of fiscal 2016, partially offset by the increased sales volumes. SG&A expense for the fiscal 2017 was $56.5 million or 21% of revenue, compared to SG&A expense of $60.1 million or 23% of revenue for the fiscal 2016. SG&A decreased $3.5 million primarily due to a decrease in bid and proposal cost and a decrease in professional services. R&D expense for the fiscal 2017 was $33 million or 12% of revenue, compared to R&D expense of $42.3 million or 16% of revenue for the fiscal 2016. The decrease in internal R&D expense was primarily due to a decrease in development activities for certain strategic initiatives. Operating income for fiscal 2017 was $12.5 million or 5% of revenue compared to compared to operating income of $9.7 million or 4% of revenue for the fiscal 2016. The increase in operating income was primarily due to decreases in R&D expense of $9.2 million and SG&A expense of $3.5 million, partially offset by lower gross margins of $10 million. Net other income for fiscal year 2016 was 1.7 million compared to the prior year net other expense of $1.7 million. Net other income increased primarily due to the recording of an other than temporary impairment loss of our CybAero equity securities during fiscal 2016 and the gain associated with our acquisition of a controlling interest in our Turkish joint venture. The effected income tax rate for fiscal 2017 was 12.3% compared to the effective income tax rate of minus 11.1% for fiscal 2016. The fiscal 2017 tax rate included a reversal of a reverse of $1 million for uncertain tax positions due to the settlement of prior fiscal year audits. Net income attributable to AeroVironment for fiscal 2017 was $12.5 million or $0.54 earnings per diluted share compared to net income of $9 million or $0.39 earnings per diluted share for fiscal 2016. Our funded backlog as of April 30, 2017 was $78 million an increase of $12.2 million or 19% from the fourth quarter of fiscal year of 2016, and the decrease of $56.1 million or 42% from the third quarter of fiscal 2017. Turning to our balance sheet cash, cash equivalents and investments at the end of fiscal year 2017 totaled $242 million, a decrease of $19.6 million from the end of fiscal 2016. The decrease in cash, cash equivalents and investments was driven by higher working capital requirements of the business with our record fourth quarter revenue. Accounts receivable including unbilled and retention receivables at the end of fiscal year 2017 totaled $88.5 million, an increase of $13.6 million from the end of fiscal year 2016. Total days sales outstanding for fiscal 2017 was approximately 113 days compared to 87 days for fiscal 2016. Net inventory at the end of fiscal year 2017 was $60.1 million compared to $68.8 million at the end of the prior quarter and $37.5 million at the end of fiscal year 2016. Days in inventory for fiscal year 2017 were approximately 90 days compared to 92 days for fiscal 2016. This increase in inventory dollars was primarily due to an anticipated first half shipment. Turning to capital expenditures, in the fiscal year 2017 we invested approximately $9.9 million or 4% of revenue in property improvements and capital equipment and recognized $7.1 million of depreciation and amortization expense. Now an update to our fiscal 2018 visibility. As of today we have Q4 ending backlog that we expect to execute in fiscal 2018 of $75 million. Quarter to date bookings that we anticipate to execute in fiscal 2018 of $17 million, unfunded backlog from incrementally funded contracts that we anticipate to recognize revenue during the balance of the year are $3 million. Revenues needed to hold EES revenues flat relative to last year, up $24 million. This adds up to $120 million, 41% at the midpoint of revenue guidance. Now I'd like to turn things back to Wahid to discuss AreoVironment's expectations for fiscal year 2018.

Thanks Teresa. Now I would like to provide a macro view on our industry. Industry trends are favorable for our -- in fiscal 2018. First, the global threat environment remains very dynamic requiring highly capable small military teams that can operate flexibly and effectively in a wide variety of theaters around the globe. In this environment, organic intelligence surveillance and reconnaissance and precision strike solutions like our small UAS and TMS offer game changing capabilities that help troops obtain the actionable intelligence they need to act decisively and proceed with certainty. Because U.S. forces are not operating alone in these theaters demand from our allies for AeroVironment solutions remained strong as well. Second, the Federal Government fiscal year 2018 budget request includes procurement line items associated with AeroVironment solutions. The budget request includes approximately $40 million for the U.S. Army, Navy, Marine Corp, US SOCOMM and for the first time Coast Guard and customs and border patrol programs seeking AeroVironment's small UAS or tactical missile systems. Third, our international footprint continues to grow with an increasing number of new international customers. We now count more than 40 countries outside of the U.S. as customers for a family of small UAS. Similarly, our family of tactical missile systems footprint among U.S. customers continues to advance with strong pulls from the unique and game changing capabilities these systems offer and the highly dynamic threat environment. In our DoD small UAS market we see incremental opportunities and upgrades, the Soldier Borne Sensor or SBS program in frequency relocation, combined with growing international demand for our family of small UAS we see healthy opportunities for us in this core part of our business. As for our growth portfolio in TMS Switchblade and its variants not only represent our second largest business but also continue to improve our positioning for an annual domestic opportunity that we estimate exceeds $1 billion in value. In CIS, we're poised to make the next step in our plan to enter that what could be a multibillion dollar global market opportunity. Looking ahead we're focused on building on our 2017 success and accomplishing 2018 objectives which I will now outline. First, increasing our small UAS footprint in domestic and international markets, continuing strong multi-year international revenue momentum, winning the U.S. Army SBS program should a competition and award take place this year, achieving further progress in our U.S. government's frequency relocation program and demonstrating progress with other U.S. government customers such as the Coast Guard and DHS. Second, continuing to grow our TMS business while increasing its contribution to funded backlog and continuing adoption momentum of Switchblade variants. Third, achieving the next major milestone in our CIS business plan this calendar year which includes shipment of initial Quantix drone and decision support system subscriptions to customers in agriculture. We're taking a gated approach that includes evaluating adoption to inform each subsequent phase of how we build this potentially large business. Fourth, continuing to grow our EV charging business domestically and globally through relationships with automakers while maintaining our leadership in industrial EV charging and EV test systems. And fifth, successfully deploying our key fiscal 2018 strategic internal initiatives which include our people strategy and our business process improvement program to further position AeroVironment for long term growth and value creation. Now I will share our view of fiscal 2018. As Teresa described moments ago, our total visibility for fiscal 2018 is now 41%, the same as this time last year. Given our visibility, the strong performance our team, our planning and forecasting based on customer demand signals, favorable macro factors and our strong position we expect revenue to grow to between $280 million and $300 million this year. We expect the mix of revenue, meaning the blend of higher margin product revenue and fixed priced contract versus lower margin services revenue in cost plus contracts to result in lower gross margin this year than last year. We plan to spend between 9% and 10% of revenue on internal research and development investments in fiscal 2018 and we expect a significantly higher tax rate than last year. We anticipate the net impact of revenue, mix, spending and taxes will produce fully diluted earnings per share between $0.45 and $0.65. We expect lower seasonality in our results than last year with first half revenue representing about 40% of our full year. We anticipate revenue in our first quarter historically the lowest of each fiscal year of between $40 million and $44 million which fully diluted loss per share of between $0.32 and $0.40. Before we move to Q&A, I would like to reemphasize the main point of today's call. First, our business remains strong and profitable and our team achieved or exceeded our financial objectives for fiscal 2017. Second, we achieved good progress on our fiscal 2017 milestones that maintained the leading market position in our core business and advanced our differentiated solutions for large and new global opportunities and our growth portfolio. And third, we remain on track for long term value creation. I would also like to remind you that AeroVironment continues to maintain a strong position in the most exciting categories of the defense market, with profitable businesses and strong growth prospects. Our strategic growth opportunities such as our commercial businesses offered the ability to capitalize on additional multibillion dollar market opportunities. And our strong balance sheet gives us the important ability to move quickly to seize new markets when opportunities emerge. Thank you to the AeroVironment team for your outstanding efforts in fiscal 2017 and for your relentless dedication to supporting our customers. Thank you to our customers who continue to make AeroVironment their preferred choice and thank you to our shareholders for your continued interest and confidence in us. Now Teresa, Steve and I will take your questions.

[Operator Instructions] Your first question comes from the line of Joseph De Nardi with Stifel. Your line is now open.

Wahid, I think you mentioned seeing some renewed interest in global Observer, I guess in the quarter, I'm wondering if you could just talk about that a little bit more in detail?

As we have said before AeroVironment remains to be a leader in that particular area of capability with a very strong demonstrated track record over two decades of successes and programs that we have executed on. And as we said from approximately three years ago that we have been engaged -- to my knowledge at least, engaged with various interested of customers both in the defense as well as the commercial markets for potential adoption and contracts for such capability. And we -- although the investment level is there fairly low, but we are still engaging and we continue to be engaged with customer -- of interested customers for that capability. We've also said in the past and I repeat that, that represents a very large opportunity which remain so far to be essentially a zero for us in terms of capitalizing on that and making it to a real business. And however, should that odds change or that situation change, it does represent a very large opportunity for AeroVironment and AeroVironment offers a very compelling differentiated capability than anyone else in the world in that front. And as we have more progress and engagements with the customers that are significant we will keep you abreast and informed.

Okay. But should I understand the comment that you made to suggest that you did see that in the quarter, you have seen some renewed interest there or no?

All I've said is that we continue to be enraged with various customers who have an interest in that capability. I have not said whether we have been engaged more or less than before, it's been an ongoing activity and effort for us a very small, very small insignificant investment, but still a small investment to pursue those opportunities that have a serious, what I call, qualify potential customers that could turn into an adoption eventually. But so far there is nothing new to report.

Thank you. Our next question comes from the line of Greg Konrad with Jefferies. Your line is now open.

I just wanted to touch on LMAMS, kind of where that program stands? If you look at the half mark [ph], they are obviously very supportive and you saw a nice mark-up there and maybe some of the milestones for that program or what type of feedback you are getting from the customer?

Yes, sure. So you are absolutely correct that the government budgeting process and the HAPC or HAP-C [ph] I think its referred to as had a favorable indicator for the procurement of those solutions and budgeting for that through the congressional budget approval process. Again, that remains to be just -- again it goes -- going through the process by itself right now, there is a specific line item on the Army's OCO or Overseas Contingency Operations line item for missile procurement of LMAMS and it's essentially, it's -- I believe it's line 14 on the actual budget line and it represents roughly $8.7 million worked up appropriation. Now keep in mind that that does not mean that actual dollars are completely approved or funded, it's a request that has been made by the President's budget request or submittal and it has to go through the approval process as it always does. What I can tell you is that as you saw from our results in fiscal 2017 in the fourth quarter, we remain fairly enthusiastic and excited about the prospects of our tactical missile systems product portfolio. We are positioned very well because we have delivered very successfully in the past on multiple such opportunities, one of which that I mentioned earlier in the call in fiscal 2017. The customer seems to really appreciate and prefer AeroVironment's capability and offering, and as I mentioned on my earlier remarks also the macro threat environment is such that I believe we are an exciting category of the defense as well as in a very exciting sub-category of UAVs or drones which is a Loitering Munitions, which Switchblade offers.

And one thing to add Greg, this is Steve, is that LMAMS refers to a specific program for the Army that we're currently addressing with the product that we call Switchblade, which is the first, the initial, but only one of -- one element of our emerging family of tactical missile systems that are now addressing a broad range of customers opportunities and potential market value. So progress on LMAMS, progress with our Switchblade product, but also as you can see from the results in the year on significant progress across the breath of our portfolio and tactical missile systems contributing to that 56% CAGR from 2011 and revenue associated with that part of our business.

Thank you and then just I wanted to touch on working capital. I think you mentioned in the script that there was some buildup of inventory to meet first half shipment, should we expect to see working capital come down as we kind of move through 2018 or is this kind of the appropriate level?

So Greg, this is Teresa, in my prepared remarks I talked that inventory, although down from the third quarter, ending the year at 60 million, was above the prior year. I mentioned that, yes, some of that is related to shipments that we expect in the first half of fiscal 2018. We do from time-to-time on a case-by-case basis, we will increase our inventory level to respond quickly to an international small UAS customer or a key domestic customer that we believe gives us ability to win business and has proven effective for us, but that's on a case-by-case basis. Also, our accounts receivable, including our unbilled, it was up 13 million at the end of '17 versus '16, that is a result of just the high revenue in Q4, no change in terms of our DSO or collections.

Thank you, and our next question comes from the line of Peter Armand with Baird, your line is now open.

Wahid, on the guidance for revenues the 280 million to 300 million, wondering if you could just clarify why the kind of expectation you have a lower margin mix? It seems like TMS is really ramping, international is really ramping, would seem that would be, that might potential have some additional favorable margins.

Peter, great question. As I mentioned on my remarks, so we do expect the gross margin percentage for the year fiscal '18 to be slightly lower than fiscal '17, and there's actually two factors related to -- three things or factors that make up the gross margin percentage and the product category. First one is, the different products, such as one version of the Raven versus a different version of the Raven have different profitability profiles. So different product mix by itself, has a different profile. Number two is, variations between product sales and services sale. As you could see from our tactical missile systems business for example that we generated a significant amount of revenue from customer funded RMV programs or engineering services type programs or projects, and those tend to be slightly lower margin than just selling products as a product revenue. And then third, the type of contracts that we actually engage with customers or we deliver products to or services to customers also have a different profile of probability for example, products that we sell at firm fixed price contracts tend to generally have slightly higher risk, but also a higher profit for the company primarily because we invest money to sell those -- to make those products and then we sell them as a fixed price contract. On the other hand, cost plus contracts relatively speaking has a slightly lower gross margin and profitability profile due to the fact that has lower risk but also you know lower profiting profile. So based on those three main factors of types of mix that changes in the product we expect the gross margins in fiscal '18 to be lower and that usually changes every year to some degree or another, but that's what the profile looks like for fiscal '18 right now.

Got it and just one follow-up, on TMS the growth has been exponential and 70 million I guess in revenue was I think the number you quoted for fiscal '17 at what point does this business start to acquire significantly more CapEx going forward?

Another great question Peter. So we have been obviously very enthusiastic and bullish on our tactical missile systems for a while, if you recall about three years ago one of our strategic growth initiatives where we communicated to our shareholders that we're going to invest incrementally above and beyond our historical levels was a tactical missile systems business. And while we could not share the specific details of how much and to what product, we were fairly confident that the investments were going to payoff dividend and they've done so as you could see from the results from the past few years. And fiscal '17 revenues were close to $75 million versus about $41 million or $40 million in fiscal '16. So, that family of products -- and so in addition to that we now have multiple variants of the products as I said, for different customer needs and different mission profiles and different applications. And all that means we're pursuing a few potential programs of records as well, as I mentioned. So all of that means that when there is a program of record, or there's more customer demand for or buying signals for those products we will have to invest in ramping up manufacturing and building additional production capacity. And part of the investments that we made in last fiscal year was actually to expand and upgrade that capability to build the world's best, what I call Tactical Missile Systems or Loitering Munitions manufacturing capability in the world. And so, we're on track with that and we'll make the investments as we see them judiciously and prudently.

Thank you. And our next question comes from the line of Troy Jensen with Piper Jaffray. Your line is now open.

Thanks for taking my call, it's actually Nick Johnson on for Troy. Congrats first of all on the strong quarter. I wanted to ask on the news of your contract with the Australian Defense Force and your comments on future expansion with international customers, would you guys expect these future contracts with the new countries be substantial in size similar to one with Australia. Additionally, do you further expect to expand your fleet with your current international customers?

So, Nick good afternoon and as you also saw from our previous -- my previous or earlier comments, the international small UAS category of our business has been very strong in the last few years and I've said this many times in the past which is the adoption cycle and phase which most of our international customers on aggregate are at is about five to 10 years behind our domestic U.S. DoD customer adoption curve. And the number of countries I'm pleased to inform -- obviously announce that we've achieved over 40 countries, it's a very reputable list of countries around multiple continents and multiple geographies. So, that all bodes really well for the strength and the customers desire and pull for our solutions and our differentiated capabilities. Every country is somewhat different and unique in its profile of need as well as the adoption curve. So specific to your question we have a mix of all. We have a mix of some customers that are fairly advanced in their adoption curve, such as the announcement with the Netherlands customers, we see the contracts that I mentioned in my call for multimillions of dollars and it was primarily an upgrade and extension of our line versus other customers that are just initiating initial buy or the Australian case where they had evaluated our products and now they are actually proceeding with a program of record for the Wasp AE family of systems. So in general, we expect that to grow and continue to be strong throughout this year and in coming year and we are very delighted about our position and pleased with the results that we've achieved so far.

[Operator Instructions] And we have a follow up question from the line of Joseph De Nardi with Stifel. Your line is now open.

Wahid thanks for the additional color on TMS in terms of disclosing the revenue. If you look at UAS excluding the growth from TMS revenues were down there does that -- the remainder of the UAS business starts to stabilize in FY '18, is that your expectation?

Great question Joe and you welcome about the comment earlier. So here is how I view this in general Peter -- Joe. First and foremost, since our product portfolio has grown over the last few years significantly, we now have different customers and different markets and geographies and different applications with various degrees or different stages of their adoption in life cycle. I would characterize the domestic small UAS customer base, the most what I call advanced or ahead of the adoption curve, where they are in a sustainment and upgrade mode, I referred to those terminologies internally, so I hope you can understand my rational behind that. And what I mean by that is that, we have a very large installed base, they are very comfortable with our products, they see the value in our products and primarily they are buying upgrades and sustainment spare parts and logistic services for the products. In those cases, for example, the i45 which we announced and shift a significant number of them in fourth quarter was one example of that upgrade opportunity within our domestic U.S. customer base. In addition to that we are also launching new products and introducing products such as the example of the Snipe UAV that I mentioned that we delivered 30 systems in the fourth quarter and that’s geared towards the new program of potential program of record calls SBS of soldier board sensor program. And so that represents a new growth opportunity. Additionally, we are pursuing new customers for existing and new products, and I mentioned in my -- on the call earlier that we are pursuing adoption and we made progress with the U.S. Navy and also their line items in the budget for department of homeland security or customs and border petrol as well as U.S. coast guards. These are customers that we have been pursuing and engaged with for a while and they are now starting to come online or do procurements and budget for these capabilities which I expect in the long run to pay fairly strong dividend for us in general. So I don’t feel as it's down, I view that its going through a different cycle of its phase and it has growth opportunities within itself, but also upgraded new products sales to new and existing customers.

Okay, and then I guess just on TMS. Can you just talk about, to the extent you can, how big that business can get in terms of the way it seems deployed now, is it being used more broadly than you had expected, I mean, just any color on what you are expectations are for that family of products?

Sure. So Joe, a long time ago we decided to really provide specific guidance in terms of the exact size of these market except to refer to third party data. What we have shared in the tactical missile systems category, for example, specifically the original Switchblade, that the addressable market which Switchblades -- the original Switchblade can and does provide a more compelling value preposition that can replace or displace represents roughly about $1 billion worth of annual spend in the U.S. DoD budgets for line items alone. And so again that's just a general rough estimate of the size of that potential market opportunity for the original Switchblade. And as I mentioned, we have more than one variant of our original Switchblade, one variant of which we've been able to disclose with you in more detail which was the Blackwing product. And that is a submarine launched UAV, non-lethal, that essentially gives the submarine visual line-of-sight beyond the periscope and it allows it to communicate multidomain platforms through to a ship, airplane, satellite and submarines and UUVs. So that portfolio is growing, the customer interest in that product line is strong and fairly healthy and also our execution and our value preposition seems to be resonating with the customer base and very compelling and differentiatable.

Thank you. And our next question comes from the line of Martin Miller [ph], a private investor. Your line is now open.

I apologize in advance if this subject has been covered because I was disconnected for a short-time, as follows. In the last reporting period, I recall that we were told that the company was essentially debt free, I might not be using the phrase correctly, but I'm wondering if that has changed materially or? Thank you.

Thank you, Martin. This is Wahid. We have -- we're fairly in a good position in terms of our balance sheet. You are fairly accurate on your conclusion that the company doesn’t carry much debt. So we have lines of credits, but we don’t really don’t really carry much debt at all in our balance sheet. And we do have a strong cash position on the balance sheet, primarily the board looks at that on a very regular basis, we as a management team review that very regularly and there are many reasons as to why we have that position that we have based on our strategy and our business profile.

Alright, thank you. And may I have the second question, again I apologize in advance if covered already. And I'm wondering if our team is addressing with the government regulators, the issues of altitude and distance on air traffic and the like, and are we making progress, are we being joined by other interested manufacturers? Thank you.

Sure Martin. This is Wahid again, so we enjoy a very good and positive working relationship with various regulatory agencies in the national airspace, primarily the FAA. We've had a relationship with FAA for a very long time and I characterize it as a very cooperative, productive and successful healthy relationship. There are number of different activities that we're involved with and engage with FAA and the industry partners and the commercial rules and regulatory requirements around the use of drones and UAVs in the national airspace for commercial applications. There are multiple different projects and we'll be glad to share that with you in more detail later at a separate time if you like, but we are involved in that and we are aware of the fact that would play a significant role in the long run in terms of the adoption of UAVs for the commercial airspace. One example that I shared on the -- on my comments earlier was, the demonstration that we made with Dominion Virginia Power and Virginia Tech with a strategic industry partner called Ligado, and what we did is we flew our Puma UAVs approximately 14 miles away from the site where it was launched, along power lines and we transferred communication and control of the UAV to a satellite and terrestrial system provided by the Legado Networks which essentially demonstrated the capability of operating beyond visual line of sight. And that is a significant demonstration in my opinion in terms of demonstrating the ability that we can operate these UAVs safely and successfully well beyond the visual line of sight in the national airspace for commercial applications. And we did that earlier this summer, this year and I consider it as one example of such engagements that we have with the industry and various government agencies.

And one note to add to that if I may, our products unlike many others in the -- who are entering the market, have been used for decades regularly around the world in some of the most inhospitable environments and beyond visual line of sight missions and application. So, we design our products to perform effectively, safely and reliably in a wide variety of applications including beyond visual line of sight and as Wahid mentioned we're actively engaged domestically and are eager to help lead the way into a future where safe effective and reliable beyond visual line of sight drone operations take place.

Thank you, and we have a follow up question from the line of Peter Armand with Baird. Your line is now open.

Just a quick housekeeping one. You mentioned the higher tax rate for fiscal '18, Teresa is there any sort of expected range that you're looking at?

Yes Peter, I did not include and we didn't provide guidance on the range, we are expecting it to be higher. Historically, with higher pre-tax income AeroVironment's tax range has been in the 25% to 35% range.

Thank you, and I'm showing no further questions at this time, I would now like to turn the call back to Mr. Steven Gitlin for any closing remarks.

Thank you, Chelsey, we do apologize for the technical issues that arose during the course of today's call, we're going to work diligently to determine what the cause of those are and ensure that those don’t happen again. We're also going to be working closely with the folks who developed the transcript for this call to ensure that it accurately reflects the comments that were delivered by both CEO, Wahid Nawabi and CFO, Teresa Covington today. So you can be sure that you're certain about the content we provided today. Thank you for your attention and for your interest in AeroVironment. An archived version of this call, all SEC filings and relevant company and industry news can be found on our website at avinc.com, and we look forward to speaking with you and being heard by you without interruption again following next quarter’s results. Thank you very much.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program, and you may all disconnect. Everyone have a great day.