Good day, and thank you for standing by. Welcome to the AeroVironment Fiscal Year 2023 Third 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 third 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, March 6, 2023. 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 third quarter earnings conference call. I will 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 updated expectations for the remainder of fiscal year 2023 before Kevin, Jonah and I take your questions. Before I jump into the quarter, let me be clear about one thing. The fundamentals and underlying demand drivers of our business remain very strong and robust across all our product lines. Our businesses core operating metrics are clearly trending in a positive direction, including record backlog, significantly better gross margins and over 50% improvement on our adjusted EBITDA. Our industry trends should continue to drive long-term sustainable and profitable growth for our business. In short, I believe the prospects for AeroVironment have never been better. Now, I will highlight a few key messages on the quarter, which are included on slide number three of our earnings presentation. First, third quarter results were in line with or slightly ahead of our expectations as we continue to successfully execute against our plan with solid enduring demand across our portfolio, as evidenced by our record funded backlog at the end of Q3 of more than $400 million. Second, given our strong backlog, we are narrowing our revenue guidance range and increasing our adjusted EBITDA guidance with the midpoint of our adjusted EBITDA range, representing more than a 50% improvement over last year. And finally, we expect fiscal year 2024 to be another year of double-digit top line profitable growth for AeroVironment supported by our solid backlog and robust global demand for our innovative and best-in-class portfolio of intelligent unmanned robotic solutions. Now, let me summarize our financial results for the quarter. We…

Thank you, Wahid. Today I'll be reviewing the highlights of our third quarter performance during which I will occasionally refer to both our press release and earnings presentation available on our website. Revenue for the third quarter of fiscal 2023 was $134.4 million, an increase of 49% compared to the third quarter of fiscal 2022 revenue of $90.1 million. Slide five of the earnings presentation provides a breakdown of revenue by segment for the quarter. Our latest -- our largest segment during the quarter was our small UAS business, which finished a quarter with $69.4 million of revenue up from last year's $24.4 million. As Wahid mentioned the increase in revenue in the quarter was primarily a result of the large FMS Ukraine order received at the end of the second quarter. Tactical Missile Systems or TMS contributed $24 million of revenue compared to $18.6 million last year during Q3. This increase was driven by a higher level of TMS manufacturing activity in the quarter, which was recognized based upon revenue over time accounting. The medium UAS segment finished the quarter with revenue of $15.4 million, a 27% decrease compared to the third quarter of fiscal 2022. The reduction of revenue was a result of lower COCO service revenue, which in turn was caused by a decrease in the number of MEUAS sites operated. Our HAPS segment contributed $8.9 million in Q3, a decrease from $9.5 million in the prior year third quarter. Revenue from the other segment increased year-over-year to $16.7 million versus $16.4 million in last year's third quarter. Turning to gross margins. Slide five of the earnings presentation shows the mix of product versus service revenue. During the third quarter, product revenues represented 68% of total revenues versus 47% in the same quarter last year. This is…

Thanks Kevin. As we approach the end of fiscal year 2023, we have enhanced visibility into our financial performance this year and next. With a record funded backlog and increasing demand across the board, and given the recent MUAS site closure, we have adjusted our current year guidance. Our updated outlook for fiscal year 2023 is shown on slide number seven and is as follows. We anticipate revenue of between $510 million and $525 million. We're now expecting net income between $0.3 million to $5 million, or gain of $0.01 to $0.21 per diluted share. Non-GAAP adjusted EBITDA of between $89 million and $95 million, and non-GAAP earnings per diluted share, excluding acquisition related costs, amortization of intangible assets, and other one-time expenses, of between $1.13 and $1.33. While we are raising revenue and adjusted EBITDA guidance, we have reduced our GAAP and non-GAAP EPS outlook as a result of the closure of our remaining MUAS COCO site. I want to emphasize that the primary impact from the closure is from the acceleration of the depreciation on certain of our MUAS assets and is a non-cash impact. As I mentioned earlier, this resulted from shifting U.S. DoD priorities and we expect these events to occur in the fourth quarter with no impact in fiscal year 2024 on our consolidated results. In addition, we have reduced net income guidance due to greater than expected unrealized losses tied to equity investments. This occurred as a result of mark-to-market accounting related to our investments in strategic partnerships and venture activities. However, we believe adjusted gross margins will strengthen going forward, driven by favorable product mix and higher volumes. We expect to deliver adjusted EBITDA of between 16% and 18% of revenue for the full fiscal year. R&D investments for this fiscal year is…

Thank you. [Operator Instructions] Our first question comes from the line of Peter Arment with R.B. Baird. Your line is open. Please go ahead.

Yeah. Thanks. Good afternoon, Wahid, Kevin, Jonah. Wahid, can you give us an update on just the supply chain, how things are evolving there? I know there had been some discussions in the past that things were starting to get a little better with chips, but there are obviously a lot of other components and just related to how that's affecting both when we think of small UAS and then TMS.

Sure, Peter. In general, the supply chain constraints have overall improved slightly. Although, it is still a challenge on a day-to-day basis. For a fourth quarter, we have pretty much our supply chain well addressed and taken care of. But beyond fourth quarter for next fiscal year, there's still some areas where supply chain remains to be a constraint. The most important area for us remains the warhead for our Tactical Missile Systems, the Switchblade 300, 600, which we do not make that we receive those from General Dynamics and Northrop Grumman. Both of those two warhead are highly in demand and supply is still a challenge on a quarterly and annual basis. Besides the warhead for small UAS, medium UAS, UGV and other products, there are still some semiconductors supply chain constraints. But overall, since last quarter has as improved to some extent, although it's still an ongoing challenge. We expect that to continue throughout next fiscal year. Although, the improvements that we've seen in the last couple of quarters gives me some hope and optimism that things are going to get to get better and better.

Yeah. And just as a follow up, is your -- you mentioned the warhead. Is there alternative sources, because it seems like you're being held back by the demand for Javelin and some of the other products that use similar type warheads? Could you discuss that a little bit if there -- if that's an opportunity for your long-term? Thanks.

Sure. Peter, great, great question. Certainly there is alternatives, but that takes a little bit of time. We have already started even before the conflict in Ukraine, alternative patch to be able to source other war hits for Switchblade 300 and 600. The challenge with 600 is, is that it shares the same warhead that the government furnishes for both the Javelin Missile as well as our Switchblade 600, the anti-tank Javelin Missile. And so, the production capacity on that takes a while for it to ramp up an increase. While that's going on, we are already working on multiple, not just one, multiple other options on how to source other warheads that are equivalent and even warheads that have different mission capabilities for both Switchblade 300 and 600. This is top of mind for us. We've been focused on that for a while. Although, the certification process and selection and qualification does take time, and it's a longer term goal that we are making progress towards as we speak.

Appreciate the color. Thanks.

Thank you, Peter.

Thank you. And one moment for our next question. Our next question comes on the line of Austin Moeller with Canaccord Genuity. Your line is open. Please go ahead.

Hi. Good afternoon, Wahid.

Good afternoon.

My first question here, are the Switchblade 600s that are being sent to Ukraine as part of the aid package, are those coming out of the DoD inventory, or have you been able to produce more in the fall?

So, Austin, we continue to produce Switchblade 600s as we speak. There are some limited quantities in the U.S. DoD 's inventory. Some of those have been supplied to Ukraine. And then -- but there's significant more numbers that we're producing that we have been delivering to the customer in the last couple of quarters. U.S. DoD 's inventory of Switchblade 600 remains very low in general. It started out to be quite low, because it's fairly new inventory for them. But we have plenty of capacity to produce more other than the warhead. The warhead is the main gating factor there. And of course, the U.S. DoD contracts has been another one. So, in general, the latest package that was announced by the President Biden's administration on February 24th included some Switchblade 600 and/or JUMP 20. Those we would be delivering to the U.S. DoD and then they will be deploying them to the Ukraine forces.

Okay. That's helpful. And then, just since the announcement from Lithuania, what progress have you made on switchblade FMS sales to other European countries, and do you expect some of those to show up in the fourth quarter and in the first quarter of 2024?

So, Austin, all switchblade sales so far has been through the U.S. DoD's FMS office, foreign military sales so far. As I mentioned on my remarks, Ukraine has received them already, and then Lithuania publicly announced that they're going to be purchasing Switchblade 300 and 600. We expect that to be about $45 million worth of orders, FMS orders, that is, and that's not reflected in our backlog. All those -- those sales plus many other countries, we have several other countries that we're engaged with. And over the next several quarters, not just several weeks or months, we will continue to convert those into contracts. Most likely majority, if not all of them, will be FMS contracts so far it seems like, and that is going to be a pretty large demand for switchblade into the fiscal year 2024 and beyond. I consider the Ukraine conflict and event a mind shift, a real seismic mind shift in the minds of political leaders and military leaders on what loitering munitions could do and specifically on switchblade. And as you know, we've gotten U.S. DoD's approval to be able to sell to 20 plus countries, and I see that more and more of those countries are requesting Switchblade 300 and 600 and more of them will convert into contracts in the coming quarters and years to come.

Awesome. Great quarter and thanks for all the details.

Thank you, Austin.

Thank you. And one moment for our next question. Our next question comes on the line of Louie DiPalma with William Blair. Your line is open. Please go ahead.

Wahid, Kevin and Jonah, good afternoon.

Good afternoon.

Good afternoon.

Hi Louie.

Hi. Slide eight provided several backlog metrics and in the 10-Q you disclosed how the unfunded backlog includes a $235 million contract with a third-party that's pending an export license approval. That's obviously a very large, total contract value. Are you able to shed any light in terms of the probability of receiving that export license and the potential timing of that?

Sure, Louie. You are absolutely right that on our unfunded backlog, there is a -- about a $235 million roughly contract for switchblades. It's a DCS contract for a foreign country and military. And the reason for that is because that military needs them and is asked for them and requested them. The reason why it's unfunded is because we were not sure in about the U.S. DoD's willingness to allow for such a large contract value for switchblade to be initially DCS. That's why you see more announcements from the U.S. Department of Defense on switchblade FMS sales. So, while that contract still exists in our unfunded backlog, I don't really count on it as much because I am less confident about U.S. DoD giving approval for DCS sales for such a large contract for switchblade. Now, whether or not that contract gets authorized for a DCS sale and approved through the State Department, I still believe that the demand is still there. The customer has already requested the same amount, if not more of them through FMS avenue and channels. And I expect that to actually convert to FMS sales or contract in the coming quarter. So, either way, I think it's going to work itself out, but I'm less optimistic on DCS sales and far more optimistic on FMS sales, which we're gaining more and more traction with the announcement that have occurred in the last couple quarters.

Great. That detail was fantastic. And on another topic, has there been an increase in interest for your Sunglider aircraft in the wake of the Chinese balloon incident?

Louie, thank you again for a great question. The answer is absolutely yes. Even before the Chinese balloons on the U.S. airspace, there's been significant discussions that we've had over the last year plus with the U.S. DoD on Sunglider for defense applications. The recent events of the Chinese balloon really elevated that to a whole different level. And it -- what it's done, it has increased its urgency. And I am -- as I said on my remarks, I am more optimistic about the potential for securing a some small contract amount to get us going on Sunglider for U.S. DoD needs and applications. Obviously, it'll be a longer term development and engagement and contract, but the initial one, I expect that to happen within the next quarter or so. There's a lot of interest in that capability. Sunglider has incredibly unique and powerful value proposition for stratospheric, ISR and other types of mission for defense. And the events with China as well as the conflict in Ukraine and Russia and what's going on around the globe has really elevated the importance of this and the urgency of it has also elevated quite dramatically.

Great. Thanks Wahid. Thanks Kevin and Jonah.

Thank you.

Thank you, Louie.

Thank you. And one moment for our next question. Our next question comes from the line of Ken Herbert with RBC Capital Markets. Your line is open. Please go ahead.

Yeah. Hi. Good afternoon everybody.

Good afternoon.

Good afternoon.

Hey, Wahid, maybe or Kevin, just to start off, I wanted to see if you could provide a little more detail on the MUAS segment and specifically, gross profit. I know you're investing significantly in this business. How do we think about maybe profitability in this business through the remainder of this fiscal year and in the next year? And maybe at what point, or maybe at what revenue point should we start to see gross margins really inflect positively in this segment?

I'll start and then Wahid you can fill in. Well, basically, they're getting a large order from Ukraine. As we've been talking about over the last several quarters, they're shifting more to a product business that was anticipated with -- also with FUAS potential coming online here. So, we see their gross margins improving as they become more of a product business over time. So, you should see gradual improvement in the contribution.

Okay.

Yeah. And again, Ken, that business, as you know, it's primarily a COCO service today. Our strategy when we acquired that business was to transition it more to product sales. There are several sort of pathways that we're pursuing to achieve that. One was that we're relying less and less on the COCO operations. Two is to increase international sales and the potential Ukraine order that was announced by the presidential latest aid package is a significant potential for JUMP 20. And then this will be a -- the first of its kind that the U.S. has given to Ukraine other than our Puma 3s and Puma LE systems. And by far our UAVs are the workhorse of the Ukraine conflict today. And then lastly, we have several additional international customers that are interested in JUMP 20 systems for product sales. What I forgot to also mention is that the Army FTUAS selection that we just received, a small incremental contract, is a potentially $1 billion program. After that there's several other programs within the U.S. Marine Corps and the U.S. Navy that we're considering, although those are a little longer term than this next year. The U.S. Army announcement was now, and the selection should probably take place sometimes by the end of our next fiscal year. And so, all of those events, Ken, will help improve the margins and the profile of that business, which was exactly the plan that we had when we purchased the company to begin with.

Yeah. Thanks Wahid. And as we -- and apologize if you went through this, but as we look at the aircraft you delivered as part of Increment 1 on the FTUAS contract, can you comment on how those are performing and any maybe lessons learned, and how you think specifically the results of Increment 1 are positioning or helping you is obviously you moved into Increment 2 opportunities?

Sure. So, that's a really important point that you bring up is just that we are the only one who has been selected sole source for Increment 0 and Increment 1. And we're the only one that has been selected for three phases. Increment 1 is still early. The reason I'm saying early is because we've delivered the hardware. We're in the process of training the U.S. Army personnel both in Germany and in United States and Huntsville, Alabama. The Army is taken as slower -- it's not going as fast as we expected it to go, meaning that they now have to deploy it out there and goes to an extensive set of testing. From our perspective, and based on our experience and based on our engagement with the customer, so far their experience with us has been extremely good. We believe that we have the advantage in that competition so far based on our track record of performance and our quite considerably more compelling and differentiated solution. The requirements that the U.S. Army has for FTUAS on Increment 2 and the final selection are things that we can deliver now. Most other vendors are not even close to that yet, and we're at least a few steps ahead of those folks in terms of delivering the capabilities and the reliability that the U.S. Army's looking for on Army FTUAS. So, overall, we feel good about it, but we also remind ourselves every day that we're competing with multiple serious players and we take nothing for granted and we're going to keep, continue to work and execute as we have done in the past.

That's great. And just finally, is it fair to assume that the inventory level on the balance sheet, significant portion of that is in the MUAS or with the JUMP 20 considering the amount of aircraft you got in process as you prepare obviously for this ramp?

We have some inventory, but no, the overall level of inventory increasing is intentional for two reasons, because of the supply chain issues. Number one, we've been buying ahead because we are expecting these customers to take deliveries quickly as soon as the contracts come in. And number two has been, we've been experiencing significant growth this year and we expect even more growth next year. And so for those in order to secure our inventory on our products for our customers, and most of these situations are very urgent and high priority for the U.S. DoD and for allies. That's why the inventory is up. So, a mixture of both small UAS, TMS, and UAS and even some UGV business as well, all those businesses are growing and we're going to require inventories to support those businesses for fourth quarter and fiscal 2024.

Yeah. Remember the Ukraine contract was over $170 million, so they only delivered a portion of that here in the third quarter.

Excellent. All right. Nice quarter. Thanks Kevin. Thanks Wahid.

Thank you Ken.

One moment for our next question. Our next question comes from the line of Brian Ruttenbur with Imperial Capital. Your line is open. Please go ahead.

Yes. Thank you very much. Very good quarter. First of all, in terms of cash, where do you anticipate ending the year in terms of cash? You had a big drop from quarter to quarter, obviously, but I wanted to get your perspective on that.

Well, I mean, we don't necessarily predict the cash balance at the end of the year, but I would expect inventories to continue to rise, but at the same time, we're going to be moving the cycle on some of these Ukraine billings, so we should be bringing some of the receivables down, but we're again going to end the year with a large quarter. So, you could see some working capital usage still into the fourth quarter.

Okay.

And generally speaking, Brian, our cash position or balance sheet very strong and healthy. We watch that and we keep an eye on it. Our ability to be able to fund the business operations is not going to be an issue in our mind.

Absolutely. It should normalize, the cash positions should normalize. I know they're -- when you're growing fast like that, a lot of moving parts, but should normalize within the next two or three quarters. Is that what you anticipate?

Yeah. Normalize the certain extent, but we do continue to grow that. We're going to -- expecting to grow as I think Wahid had said, least double-digit next year. So that would imply a significant growth year-over-year. And so you'll continue to have some working capital usage. But there is some potential efficiencies over time as some of these supply chain issues ease, and we don't have to do as much pre-buying as we're doing right now.

Great. And then just last question, since you mentioned the double-digit growth in fiscal 2024, can you talk a little bit about what you expect to see going to the bottom line in terms of the growth? Obviously much -- well, I'm making the statement obviously, but greater growth on earnings and EBITDA. Can you give us any kind of parameters around that?

So, Brian, we obviously have a very large fourth quarter in front of us right now. We're executing against that. We will be updating you with all of our financial guidance for next fiscal year on our next call. Overall, what I could say is that we expect another year of improvements in pretty much almost all of our metrics, I think our top line will grow. I think our gross margin will sustain or even grow slightly more as we gain scale, our mixed between hardware versus hardware and product sales versus services will improve and all of that would also mean that we'll get some scale and leverage, which means the bottom line will improve significantly as well. So, I think that we have executed extremely well this year against very, very difficult challenges and tough sort of headwinds and position the company for multiple years of growth and prosperity. I think that it's going to be a shift in way people realize and look at small UAS and Tactical Missile Systems and loitering munitions in general. Pretty much the future conflicts is going to be about unmanned systems on the air, on the ground, and with all, with lethal precision capabilities such as switchblade. I think we're getting ourselves positioned for that. We work really hard for that. We're going to have a great year, and I think we're going to continue to have even a better year of 2024 and beyond.

Great. Thank you.

You're welcome, Brian.

Thank you. [Operator Instructions] Our next question comes from the line of Pete Skibitski with Alembic Global. Your line is open. Please go ahead.

Hey, good afternoon guys.

Good afternoon.

Guys, one thing that's difficult to track is, this Ukraine funding as it grows, I think, more than $100 billion, it's just kind of the total amount that you're expecting. So, I'm sure you've kind track it with a fine tooth comb, but could you give us any kind of an estimate in terms of the Ukraine funding initiatives that have been announced so far, how much of that is as yet to make it into your backlog, even just as a rough order of magnitude?

Sure. So, Pete, it is a very fluid situation, number one, because the war is an ongoing thing. And on a regular basis, the U.S. DoD keeps giving our systems to Ukraine and the efficacy of those systems are phenomenally good and the demand for it continues to increase. While that's happening, U.S. DoD also is starting to realize we have to have more of these systems for their own backlog and for their own stockpiles of weapon systems and unmanned systems. And in addition to that, there are other international allies. We look at this on the neighborhood and even outside the neighborhoods of Ukraine that are requesting and demanding the same systems -- similar capabilities. So, so far, I would say, we're probably getting maybe half to a third of what's been announced into our bookings and our backlog. I think that that's going to continue to grow and show more and more of it in our backlog. The biggest beneficiary so far has been our small UAS with Puma AE and Puma LE systems, which is, by the way, the workhorse of the U.S. DoD's assets that they have given to Ukraine. We are told that every weapon system the U.S. DoD has given to Ukraine has one of our Pumas or Puma LEs lying in front of them. So, it is the workhorse of Ukraine conflict against Russia and their defenses. It scouts targets, it sweetens targets for HIMARS and other weapon systems. It then actually helps them to shoot it. And then once it's done and it does with battle assessments. So, variety of different missions have been achieved by Pumas and Puma LEs very effectively and very cost effectively for Ukraine and for U.S. I think that trend is going to continue. I think we've only seen a small portions of that reflecting on our backlog so far and more of that to come in the fiscal year 2024 and beyond.

And the recent announcement is not in our backlog.

None of the recent announcements, Pete, that you heard from the 24th of February is reflected in our backlog, neither is the Pumas, the Switchblade 300 and 600s or the JUMP 20 systems. All of those we expect to convert into backlog in the next one or two quarters.

Okay. Yeah. I mean one-third to one-half implies a lot more to go it seems like. And just let me follow up on your comments on fiscal 2024 growth. A lot of people, I think, believe we could have a full year CR for DoD in the government fiscal 2024 or at least an extended CR. Is that factored into your thinking -- your double-digit growth thinking for fiscal 2024 and does that matter -- does that potential long-term CR matter less given you're ending backlog here, funded backlog?

So, Pete, CRs always do matter to some extent. But given our backlog, our backlog at the end of Q3 was over $400 million. Same time last year was much lower than that, significantly lower than that. Even last quarter was about $293 million at the end of Q2. So, we're talking about almost the two times increase in our backlog compared to third quarter of last fiscal year. Going into fiscal 2024, that gives us a lot of confidence in our ability to be able to achieve that year. Obviously, the big factor is going to be supply chain and availability of products and lead time of components. But overall, I think that the CR should -- always has some impact, but not as much to our business as other businesses. There is -- like I said, one is the backlog reason. Another reason is the fact that the system is a high priority and high urgency for both U.S. and Ukraine, and I don't see that actually decreasing over time, whether there is or there isn't a CR in general. I think that the macro level demand drivers for our business is very, very healthy. And let's not also forget, vast majority of our sales now -- shouldn't say vast majority, a significant portion of our sales come from international demand, both for small UAS as well as for now Tactical Missile Systems as many countries that are interested in them. So, I think all of those combined, net-net, we're going to -- we're looking forward to a really strong year in 2024 and even beyond.

Okay. Great. Thanks guys.

You are welcome, Pete.

Thank you, Pete.

Thank you. And I would now like to turn the conference back over to Jonah Teeter-Balin for any further remarks. End of Q&A:

Thank you all once again for joining today's conference call and for your interest in AeroVironment. An archive version of this call, all SEC filings and relevant news can be found on our website at www.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.