Good evening, and thank you for standing by, and welcome to the AeroVironment Fiscal Year '23 Second Quarter Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to turn the conference over to your speaker for today, Jonah Teeter-Balin. Please go ahead.

Thanks, and good afternoon, ladies and gentlemen. Welcome to AeroVironment's fiscal year 2023 second quarter earnings call. This is Jonah Teeter-Balin, Senior Director of Corporate Development and Investor Relations for AeroVironment. Before we begin, please note that certain information presented on this call 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, which involve risks and uncertainties, including, but not limited to, economic, competitive, governmental and technological factors outside of our control that may cause our business strategy or actual results to differ materially from the forward-looking statements. For further information on these risks, we encourage you to review the risk factors discussed in AeroVironment's periodic reports on Form 10-K and other filings with the SEC, along with the associated earnings release and safe harbor statement contained therein. This afternoon, we also filed a slide presentations with our earnings release and posted the presentations to the Investors section of our website at avinc.com in the Events and Presentations section. The content of this conference call contains time-sensitive information that is accurate only as of today, December 6, 2022. The company undertakes no obligation to make any revision to any forward-looking statements contained in our remarks today or to update them to reflect this events or circumstances occurring after this conference call. Joining me today from AeroVironment are Chairman, President and Chief Executive Officer, Mr. Wahid Nawabi; and Senior Vice President and Chief Financial Officer, Mr. Kevin McDonnell. We will now begin with remarks from Wahid Nawabi. Wahid?

Thank you, Jonah. Welcome to our fiscal year 2023 second quarter earnings conference call. I'll start by summarizing our performance and recent achievements, after which Kevin will review our financial results in greater detail. I will then provide a summary of our expectations for the remainder of fiscal year 2023 before Kevin, Jonah and I take your questions. Let me first emphasize a few key messages, which are included on Slide number three of our earnings presentation. First, second quarter and first half results were largely in line or slightly better than our expectations, while we continue to experience solid demand across nearly all our product lines. Second, solid first half performance, coupled with growing order volume gives us confidence to increase our revenue guidance for fiscal year 2023. We're also slightly reducing our profitability outlook for fiscal year 2023 due to increased R&D investments to capture additional growth opportunities and accelerated Medium UAS or MUAS asset depreciation related to a shift in U.S. DOD funding priorities. And third, we experienced funded backlog of $293 million at the end of the second quarter and record funded backlog of $388 million through November. With this record backlog, revenue visibility and increasing order flow, we are well positioned for profitable double-digit top line growth in fiscal year '23 and beyond. Now let me summarize our financial results for the second quarter. We delivered second quarter revenue of $111.6 million compared to $122.0 million last year, a decline of approximately 9% year-over-year. This decrease was primarily due to lower SUAS sales, although, we posted higher revenue within our Tactical Missile Systems or TMS product line related to increasing international demand for our Switchblade loitering munitions. Gross profit for the quarter was $25.9 million compared to $42.5 million in the prior year period. Our…

Thank you, Wahid. Today, I will be reviewing the highlights of our second quarter performance. During which I will occasionally refer to both our press release and earnings presentation available on our website. Let me start by saying that the second quarter results were in line with expectations and with the strength of our order bookings, backlog and subsequent large FMS order, we are positioned for a very strong second half of the year. As a result, I will try to provide increased visibility to the second half during my remarks. Revenue for the second quarter of fiscal 2023 was $111.6 million, a decrease of 9% compared to the second quarter of fiscal 2022 revenue of $122 million. Slide 5 of the earnings presentation provides a breakdown of revenue by segment for the quarter. Our largest segment during the quarter was Tactical Missile Systems or TMS, which contributed $31.1 million of revenue compared to $18.4 million during Q2 of last year. This increase was driven by a higher level of TMS manufacturing activity in the quarter, which was recognized based upon revenue overtime accounting. Our small UAS business finished the quarter with $26.7 million revenue, down from last year's $54.7 million. The lower revenue in the quarter result of order timing and we expect a very strong second half of the year for SUAS, given the large FMS order received after the end of the quarter. We also continue to see growing demand for upgrades and add-on products for both U.S. and international customers. The Medium UAS segment finished the quarter with revenue of $27.3 million, a 3% increase compared to the second quarter FY '22. We expect increased product sales of the MUAS JUMP 20 in the second half of the year, however, we do anticipate a reduction in…

Thanks, Kevin. As I noted earlier, we now have greater line of sight on our fiscal year 2023 financial performance, given the overall robust demand environment and recent contract awards, especially our record FMS order for Puma systems. As such, we are now raising our revenue guidance for this fiscal year. Our new outlook for fiscal year 2023 is shown on Slide number 7 and is as follows: we anticipate revenue of between $505 million and $525 million, which is higher than our prior guidance; net income of $8 million to $17 million, or $0.33 to $0.65 per diluted share; non-GAAP adjusted EBITDA of between $84 million and $92 million; and non-GAAP earnings per diluted share, excluding acquisition-related costs, amortization of intangible assets and other one-time expenses of between $1.26 and $1.58. While we are raising revenue guidance and narrow guidance for adjusted EBITDA, we have reduced some earnings metrics given greater than expected depreciation of MUAS assets and higher R&D investments necessary to capture future business opportunities. However, we believe adjusted gross margins will increase sequentially going forward, driven by favorable product mix and higher volumes. We expect to deliver adjusted EBITDA between 17% and 18% of revenue and R&D investments between 11% to 12% of revenue for the full fiscal year. We continue to anticipate roughly 60% of full year revenue will be recognized in the second half of this fiscal year. Of that second half total, approximately 60% of it will occur in Q4 as we deliver on orders now in the production stage. In summary, with 92% visibility to the midpoint of our revised revenue guidance range, we are confident in our ability to achieve not only these objectives in fiscal year 2023, but also position AeroVironment for another year of strong profitable growth in fiscal…

Thank you. [Operator Instructions] Our first question comes from the line of Peter Arment of Baird. Your line is open.

Hi, guys. Good afternoon, Wahid and Kevin.

Yes, Peter. Hi, there Peter.

Yeah. Wahid, I guess, just to comment on the backlog, maybe you could just give us an expectation of kind of how you see things progressing here from here with TMS? Obviously, it sounds like a lot of the Small UAS is really ramping up based on the order. But maybe if you could just walk us through kind of some of the demand signals that you're seeing on TMS just given the growing list of countries there?

Sure. So, Peter, we're very excited about the prospects of growth this year as well as next year. Yes, for this quarter, at this time, our Small UAS have booked some very significant international FMS orders and domestic orders that have really propelled it. But we expect similar demand and growth in our Tactical Missile Systems business, if not greater. It's purely based on the timing of the quarter and our customers' ability to execute the contracts. The U.S. DOD is really, really backed up in terms of resources to be able to execute on these contracts. The Ukraine conflict is obviously priority number one for a lot of the customers of ours and folks that we deal with, but we expect strong order growth in the next second -- two quarters for not only our Small UAS but absolutely also for our TMS business. Similarly, we expect some strong growth in our other product lines such as our MacCready Works, which really is constrained primarily not by contracts but by resources, the top talent that we need to execute to work. So overall, I see very, very positive signs in terms of our prospects for growth in the future. And I expect the order activity to continue to be in this momentum that we are today, and it will even pick up towards the latter part of this second half of this fiscal year.

Okay. Great. And just as a follow-up, just thinking about like the bottom line, adjusted EPS, so you're still expecting quite a big range to come in, in the second half of the remaining two quarters of the year. That range still with only two quarters is still pretty wide. Is that just the mix driven or are there any other puts and takes we should be thinking about within that EPS range? Thanks.

Great, Peter. Glad you asked that question because really, the range has to do with the timing of these orders, the mix obviously is the number one driver there. Given the different product lines that we have, the profitability profile of each and every single one of these contracts vary. And depending on which contract is able to come in first and what takes priority versus the other, it really makes a big difference on the profitability. Overall, though, we expect profitability significantly increase in the second half, especially in the fourth quarter. And we also expect our gross margin to pick up and since volume is going to be up, all of that ends up being a better profitable outcome for the second half of the year for us as we have forecasted.

[Operator Instructions] Our next question comes from the line of Austin Moeller of CFG (ph). Your line is open.

Hello, Austin. Hi, there.

So a nice outlook in the quarter here. Your Puma delivery outlook over the next couple of quarters would seem to imply that CPU and GPU supply chain is improving. Is this because of softer consumer demand, you're able to get your hands on some of these CPUs and GPUs now?

So Austin, the supply chain picture is really a mixed bag. If you look at the entire spectrum of parts, CPUs, GPUs, composites, et cetera. I believe that our team has done a fantastic job navigating through those challenges last couple of years as well as this year. For this year, we have very strong visibility on our booking in backlog as you saw from the numbers. And we have pretty much addressed vast, vast majority of the supply chain risks related to the execution and delivery of products within the second half of the year. By no means is the supply chain constraints overall completely done and gone, it's actually improving, but it's improving slowly. And we don't see risk on our fiscal year '23 forecast as much, although there's always some uncertainty. But beyond that, it's still a day-to-day, week-to-week challenge of addressing them. The other thing that has really helped us is, we really plan our supply chain many quarters out in upfront. And since we actually have been building up inventory and buying material at risk and building product, it allows us to execute on these orders and respond to the U.S. government in Ukraine conflict very, very quickly. These orders that we received, we were expecting these orders before the timing of which was not really very firm. We have built ahead of that, many of the modules, and we were able to ship some of that -- majority of that this fiscal year. So it is a great testament to our team's ability to execute and also plan for the growth that we expected this year and the years after this.

Okay. That's super encouraging. DOD, I don't know if you've seen the news that they're running out of HIMARS rockets and now they're trying to stick small diameter bombs onto artillery rockets to send to Ukraine. Can you do the same with Switchblade 600's warhead just given the Javelin production delays and supply chain issues? Could you put a different explosive on there and still make to work?

So the short answer is yes, but there's a big but on that response. We are definitely the number one supply chain constraint for Switchblade remains the warhead for Switchblade, both 300 and 600. We have tackled all the other supply chain issues, and we're getting those two from two major primes, primarily General Dynamics and Northrop Grumman. And both of them have constraints in terms of the capacity of producing that warhead. We are actively not only working how we can secure more warheads for Switchblade 300 and 600 but also to put in new warheads as you indicated on your comment. Now the challenge with substituting the warhead is that it has to go through a safety confirmation test and approval by the U.S. Army. And that process is not only nontrivial but it also takes time because they're backed up in a lot of other requests and activities related to this. Nonetheless, we're focused on multiple fronts. We feel very confident about our forecast for this fiscal year. We're really working on issues beyond this fiscal year because we believe that the demand for our Switchblade is going to continue to grow. We're going to have one of the best years for our Small UAS and TMS this fiscal year, and I am confident that we're going to be positioned extremely well for the next year as well. The order activity and demand is pretty robust both domestically and internationally, and I expect that to continue and those to transition into orders and leave us this fiscal year with a pretty healthy strong backlog going into next year.

Thank you.

Thank you. One moment please. Our next question comes from the line of Pete Skibitski of Alembic. Your line is open.

Hey, good evening, guys.

Good evening, Pete.

Yeah. So sorry, if you addressed this already, I got on the call a little bit late guys. But on the $86 million Small UAS contract with the, I guess, $176 million ceiling, the FMS contract. What's the time frame for both of those portions, the $86 million portion and the larger portion? And then also, is that the one country or multiple countries?

So Pete, that order is the -- historically, the largest FMS order we've ever recorded in the history of our company. It's an exciting big order for our Pumas. It includes Puma LEs and Puma AE systems and spares and logistics. $86 million of that contract is funded today. The total ceiling value of that contract is approximately $176 million. Because it's a contract that involves delivering hardware and logistics support and training, the tail of that will continue for another six months to 12 months even. But majority of the hardware will be delivered between the second half of this fiscal year starting this quarter and the beginning of next fiscal year. The -- in response to how many countries, that is specific to one country, one country, and it just shows the power of our systems and the value that our customers place on our systems as part of their battle rhythms in their conflicts. As you know, Switchblade has received a lot of notoriety and success in Ukraine and also have sort of attention, but Pumas are equally as effective and vital to the Ukrainian forces and their conflict against Russia. And we believe that it's going to continue to be the case for not only Ukraine, but many of our other allies around the region and around the world.

Okay. That's an extraordinary contract. Congrats on that.

Thank you.

And then just last one for me. On the Medium -- on the MUAS segment, the steep loss there this quarter on gross margin and operating margin. I was just wondering, was there some strategic reason there for that loss? Was there a surge in R&D or some unusual mix or -- I'm just wondering -- because revenue was good this quarter in MUAS, but the loss was the largest since you acquired the firm. So I was just wondering what's going on there?

Sure, Pete. So let me shed some light onto that. This is a one-time really accounting thing that took place and the math is pretty straightforward. We operate all these sites as a COCO, contractor-owned, contractor-operated sites for the U.S. SOCOM. Because of the attention to Ukraine and the conflict with Russia, many of the other activities around the world is getting less attention and less focus. So if the sites in the other parts of the world are reduced or the OPTEMPO is shrunk, then by accounting GAAP rule -- accounting rules, by definition, it means the inventories that we carry as the assets -- I'm sorry, the capital assets that we carry to operate those sites get accelerated in terms of its depreciation on our books. That charge is directly a result of that. We still feel very solid and confident about our MUAS business in the long run. As I said in my remarks, we won Increment 0 and Increment 1 contract for FTUAS. We're performing well against that contract. We've already started training the U.S. Army forces on those. We have shipped the product to them, and we're looking forward to Increment 2 awards, which there is close to $100 million in the U.S. DOD budget for government fiscal year '24. So long term, we feel very strong about our MUAS business and its process for growth, both domestic and internationally. That was a onetime depreciation -- accelerated depreciation that resulted as a result of the slight reduction in...

Right. It was $4.5 million in case you missed it in our comments of accelerated depreciation in the quarter. And even with that, we still believe we're going to hit our gross margin targets for the year.

Yeah.

Okay. That's great. Appreciate the color, guys. Thank you.

You're welcome.

One moment please. Our next question comes from the line of Brian Ruttenbur of Imperial Capital. Your line is open.

Yeah. Thank you very much. Just a couple of follow-ups real quick. In terms of operating expenses, can you give us a little bit of guidance for third quarter and fourth quarter, how they look versus second quarter in terms of R&D and SG&A, maybe give us directionally flat, up, down from the second quarter levels?

We don't normally give that level of guidance, but as Wahid indicated, I think we're at 11% to 12% R&D for the year.

And generally, we usually try to level load our -- in R&D throughout the year because of capacity of headcount and resources. So you don't usually see a major increase or decrease on a quarterly basis in our R&D spend, Brian, in general.

Great. You talked about 11% to 12% R&D. SG&A as a percentage, it should drop from second quarter levels to...

Yes.

Okay. Great. Thank you very much.

I mean it's the same situation. Your SG&A expenses aren't going to bump way up with revenue in the next couple of quarters. We're going to get a lot of leverage with that increase in revenue. They will continue to increase primarily because there are some commissions and things like that, and we are expanding our sales force activities.

And the BNP (ph) business proposal activity has been high and will continue to be high, but those are very positive signs, Brian, because it means that there's a demand for our solutions, and we're competing for projects and our win rate generally is quite high.

Right. Thank you.

You’re welcome.

Thank you. I'm showing no further questions at this time. And let's turn the call back over to Jonah Teeter-Balin for any closing remarks.

Thank you once again for joining today's conference call and for your interest in AeroVironment. An archived version of this call, all SEC filings and relevant news can be found on our website at avinc.com. We wish you a good evening and look forward to speaking with you again following next quarter's results.

This concludes today's conference call. Thank you for participating. You may now disconnect.