AeroVironment, Inc. (AVAV) Earnings Call Transcript & Summary

We'll go ahead and kick it off. I know standing between us or this -- you guys in happy hour is probably not a good thing to keep.

Thanks for the spot.

No, it's a good spot though because everyone is going to be a good mood. Thanks all for joining us today. I hope you've had a good first day of the Citizens Technology Conference. I'm excited to kind of move this maybe to -- from the digital to more of the physical realm with the Executive Vice President and Chief Financial Officer for AeroVironment, Kevin McDonnell. I'm Trevor Walsh, the Senior Equity Research Analyst for Aerospace and Defense, and we're going to run through a good little fireside chat here, and then we'll kick it over to you all for questions from the audience. So thanks, Kevin, for being here. Really appreciate it.

Well, I appreciate it, Trevor. Thank you and thanks to Citizens.

Let's just maybe with the more -- the most recent news from last week, your retirement from the company. Congratulations first, but maybe just give us a sense of how you're thinking about or the company is thinking about when they think replacement, obviously, you've been there for a while. What is the kind of next person taking the reins of CFO kind of experiences, qualities in that leader? Do you think that will heat...

Well, I mean, it's definitely got to be somebody who is experienced in growth. I mean we feel like this is only the beginning, like there's really strong growth prospects for the next 5 years. And going from a couple of billion to $5 billion is a challenge. It's -- I feel pretty proud of where we got it so far. And the next person has got to be able to build -- take it from that $2 billion to $5 billion in a very dynamic defense market where things are changing and has to be adaptable to the situations and being able to take -- I just look at the capabilities of the company and they are immense. I don't even think we've even really begun to fully tap into everything that we have, but that will come. And so this person has to be adept at understanding that, identifying that, shaping a culture that's innovate -- continues to be innovative, but at a scale -- at scale.

Perfect. You took my kind of next question about kind of first order priorities, but maybe anything that you expect to kind of remain consistent or unchanged kind of that you either already implemented, et cetera, that they can just expect it to sort of run with, I guess?

Well, it's still a work in progress. I mean with this -- the combination of BlueHalo, we went from under $1 billion company to a $2 billion company. And the types of infrastructure and processes you need at $2 billion versus $1 billion are actually pretty different. So I think there's still work to do there. I'm not going to sit here and say everything is hunky dory, just basic stuff, how you prepare for a conference call when now you have 15 business units versus 3, these types of things are things we're all still trying to work on improving. And then we just throw some new systems in the mix for this year. That's the one thing that I think that is going to be a positive for my successor is we've done -- we've made a lot of progress on the system front. We're on platforms that are world-class platforms of Workday, Oracle Fusion and the government cloud, Salesforce and I think ServiceNow soon. So we have a world-class infrastructure, which is great. But I think the big part of that is that we're going to be able to take advantage of some of the AI tools and things that all those vendors now offer to automate things, better analysis and things. So I would say that's the one thing I'm most proud of is that I was there to start the effort to lay that foundation for it to be a big company.

Perfect. Yes, I got to hear Mr. McDermott' speech from ServiceNow earlier. So it sounds like you picked a good kind of solid partner there for sure. Exciting. Great. I'll switch gears a little bit, if I can. You mentioned BlueHalo. Can you -- there's obviously a lot to talk about there and whether it's capabilities, kind of how the company and the models change, which you've alluded to. But could you maybe just walk us through the history of -- from a margin perspective, specifically, kind of where -- just remind us kind of where you saw -- well, where you saw a legacy AV before kind of acquisition merger and then kind of bringing in the BlueHalo piece, what that sort of -- how that changed margins? And then what should we kind of expect or kind of look for from that standpoint kind of on the go forward.

Yes. I mean today, the Defense Department talks about companies having a commercial model where they would invest in products and bring them to the government, and they would select them and not do these massive RDT&E projects to get, that's been -- the commercial products has been the AV model for a long time. I think we embedded that model for defense somewhat. And so we had a great EBITDA margins, 18% always double-digit growth. And BlueHalo, I would characterize as more of a traditional defense contractor in much of their business. The pieces that were more commercial like Titan, or their underwater vehicle, these types of things were commercial. And those end up being in the AXS segment. But the space segment, the cyber intel, our Mission Solutions business in Dayton are all more traditional time and material type businesses. So those come with a traditional defense contractor type of margins. I'll have to say that the BlueHalo team is extraordinary at government contracting and subcontracting, which is important even in a commercial model. So the real value creation here comes as we move some of their core products like the ground station known as BADGER today to a commercial model, the LOCUST laser counter-UAS system to a commercial model, a product called Wasp, which is a derivative of BADGER for existing -- upgrading existing ground stations and a product called [ Gun Sight ], which is appointing and tracking technology on traditional ground-based weapon systems or vehicle-based weapon systems. All those are ripe for commercialization and taking more to product margins. And I feel like, as I stand here today, it's about going to be a 1- to 2-year -- I mean you'll see obviously pieces of it, but a 1- to 2-year process to get those more commercialized global markets and increase the EBITDA margins. I mean, fundamentally, it's not a good business model to have 1 customer who's telling you what to do and you're beholden to them because if they don't -- they fall in a favor or they don't get funding, then you're stuck there. So a commercial model is a much better model to say we have this technology, here's the specifications and sell it to multiple customers than try to have 1 or 2 customers. And the U.S. government probably has to look at that and say, we have to be better at allowing those companies to sell their technology globally because again, that helps scale and helps improve the capital for these companies to even do better and sell more products to the U.S. government. So I think that's a part of the model that needs to work from the U.S. government standpoint.

Got it. And so over that kind of 1- to 2-year time frame, then do you see kind of company margins returning to that legacy kind of where it was 18%, is that sort of a reasonable like target.

Yes. I think so. That's what I think.

Okay. Great. Another great...

We're right on the cusp of these products becoming -- moving from basically the experimental. We're trying to see if this works phase to the full adoption phase. And by that nature itself, will help your margins, but even more accelerate those margins if you get them to a commercial model.

Perfect. Since we were kind of on that topic or at least touched on it, we'll -- why don't we talk -- move to SCAR and to BADGER. Obviously, some news came out today. So I just want to give you a chance to just generally -- not that it was necessarily new news per se, but any initial thoughts just broadly on kind of where that -- what's happening around BADGER and maybe all -- just setting the record straight.

Yes. I mean from my perspective, we had the satellite ground station, the phased array ground station that was going to capture multiple signals at a time for multiple satellites out there and communicate back and forth. And just over time, the spec got such that when we quoted it one, 2 new systems back in the fall, the price tag was a lot higher than the government expected. And so they asked us to look at ways we could reduce the cost which we did, and we came up with a version that's less expensive because basically, they looked at it and go, "we don't have enough money" -- it's a pretty simple thing. "we didn't have enough money to get all the ground stations that we need with our mission set." And so they said, "Can you make something less expensive, maybe not as exquisite and do as much capability." And we said, yes, here's an idea, and we gave them that idea. We tested it and we proved that, that works and -- on a test situation. And that's when we said, well, that's the version they want to go to because we can get the units we need to cover the mission set. At the same time, they want to go to a more commercial model, which we're totally fine with and have a fixed price and a set delivery schedule and all the things that comes with that. And that's the process we're in now of negotiating that go-forward contract. We didn't cancel the contract. We're still on the program. We still have a contract. They've indicated, I think there was a news article today that maybe they'll have some other people take a bid at it. But I would say we're multiple years ahead of any particular competitors in the market. So that's -- it's a little bit of a game of them trying to make us go faster, I think.

Do you think they've already felt like they've gotten sort of the win or they've gotten what they needed from you from a price point perspective. So it's now more just like...

Well, we're negotiating that. So we're still going.

Still going, okay.

Well, if it's a good negotiation, they're unhappy and we're unhappy.

Sure. On that note of competition and you being ahead, do you think that you're ahead in -- with respect to BADGER and SCAR specifically technologically or capacity and manufacturing, both of those things?

Both of those things. I mean, one of the competitors is a start-up that's getting a lot of news. They're a software model, recurring subscription model. But from what I've been told they don't have the hardware yet, and they haven't been able to prove upward communication. So those are big hurdles to overcome. But nonetheless, I think that this -- the new product will have wider, more ubiquitous use cases. So I think that it could become more of a commercial product. And so -- because if it is too exquisite and too overpriced, then the commercial market shrinks. So for us, we look at it as a long-term good thing to have a product that is more useful to many customers versus one.

Great. Can we maybe -- let's dig in there maybe a little bit more because I think you've talked about it in the past and recently with us. As far as more commercial kind of nondefense or non-space non-primary customer type customers, international, et cetera. What -- can you just give us a sense, maybe not actual specific customers, but just a flavor of what those customers might look like and what the use cases might be for them?

I could just say generically, anybody who's communicating with multiple satellites would want the capability of -- it isn't going to be called BADGER so we call it something else for that new product over time, whether they're defense or nondefense.

Got it. And so that could be anyone from someone just operating a constellation of communication satellites, it could be optical and more imagery. It could be any of those things really.

Right.

Okay. Got it. Great. Any changes to give -- I mean does the facility that you have in New Mexico to kind of to turn the BADGERs out. Does that need to have any kind of major overhaul or changes to it given the new specs on thing? Or is that essentially kind of business as usual?

No, we see that as a positive that we don't really have to make any major capital investments, potentially some more R&D investments given the nature of the contract. But at this point, we don't believe that, that certificate. But we're very proud if those have been in our Albuquerque facility, very proud of the facility, the testing bed we have, the state-of-the-art equipment and the capabilities we have there. So like I said, that all gives us kind of -- I mean the government needs these systems. They want them as fast as they can. So somebody that can provide them sooner is going to be -- have a tremendous advantage over a newer company.

Got it. Great. I'll switch gears a little bit. Can we talk about Red Dragon?

Love to.

Okay, cool. What do you think is just the art of the possible in terms of pricing and quantity for -- again, not specifics, but just a hypothetical customer that would want to have Red Dragon. What does that look like from just kind of a deal perspective?

Well, I mean, how these technologies go. In the beginning, it's all very mission-focused. They want this capability for this mission, this type of stuff. We're kind of in -- and we need to try it here and there, that type of thing. We're kind of in -- we're still in that phase a little bit. But as I look forward, I just kind of put it this way, make it simple for myself, that if I was a country, I was Korea -- South Korea. And I wanted to buy 500,000 of something, that's what they've said. I'd buy hundreds of thousands of Red Dragons and tens of thousands of Switchblades because you have the on-mass swarming type capability, fairly low cost, but could do some massive damage as a group of, say, 50 or 100 shot at a target. So we're very bullish on the future of Red Dragon. And the real -- the one way attack at a lot of publicity with the Iran invasion, we're familiar with that one-way attack drone. Our view is it's not as capable at hitting the target as the Red Dragon would be.

Got it. And I think, correct me if I'm wrong, but the Red Dragon price point as of now that you're thinking is actually less than, I think, all the Switchblade models.

Right, correct, correct. It was -- I remember in the beginning 2 or 3 years ago, this is how long things take. Two or 3 years ago, there was this notion like Taiwan, they need something that's low cost, easy to assemble that people can make in their garage and they could make hundreds of them and shoot them on. That was kind of the notion and then eventually this idea of Red Dragons, something that's easy to assemble, easy to store. It has a zipper pouch for the kinetic effect, so you don't have to store it with the kinetic effects was born out of that idea. And here we are, 3 more plus years later at least, but we feel like we're right on the cusp of full-scale adoption.

Great. Maybe just -- so great. Thank you for level-setting around like kind of an initial purchase of what that might like for, you know, for a country. How much -- and I think we've seen this a little bit with LMS and Switchblade where there's almost like a recurring type of spend because they either get used or even training or otherwise, these are not necessarily meant to be an exquisite system that just comes back, right? They're like munitions -- they're effectively munitions. How does that look for Red Dragon. Does this have a similar type of feel where they're not just customer doesn't just buy the 100,000, but there's kind of more orders kind of as they come because they're just going to get depleted over time.

Yes. Any time you have a weapon like this, you're going to have a recurring business because they're going to be firing them off for training. There's probably a notion that these things improve over time that maybe you just want to deplete 20% a year or something like that for that reason. But in Switchblade type products, Red Dragon, we're just so early on this. These countries have not got to a point where they're going to buy thousands yet, but that will happen in the next 2 or 3 years. So we're early days.

Okay. Now that was one of my last questions is so should we think FY '27 as a possible contributor do you think or beyond for...

Red Dragon?

For Red Dragon.

Absolutely. Absolutely.

Okay. And then final question to then on Red Dragon then we can switch to a new topic. Do you -- and you mentioned what's kind of happening in Iran now as real time around these one-way attack type munitions. Do you think in terms of just broadly that as a category, what factors do you think customers are evaluating kind of most between the cost autonomy capabilities, manufacturing at a scale that can get it done, something else? Like how do you think they're balancing all those things as far as making a decision around a final hit the target.

Hit the target. I mean, they got to work. They got to hit the target, they got to find the target. This is where we have strong capabilities, completing the mission getting the mission done, cost is -- everybody always says they want -- I mean, I haven't met somebody buying a product, didn't want it cheaper. I mean -- but -- so the cost is always element. This was designed to be a high-value weapon system. But everything has its day. There's a myriad of weapons that U.S. have that have different ranges, different payloads, different use cases. There's no end-all-be-all. There'll be many different products in the kind of the lethal drone category. We think between this and Switchblade, we've covered a nice part of the market.

Great. Perfect. Okay. Well, let's go from the stuff that goes boom to maybe the stuff that prevents the boom from happening and talk a little bit about counter-UAS if we can. When we had you out for investor meetings a few weeks back, you talked about 2 different counter-UAS site implementations by FY '27. Can you maybe just give us a sense of like what that -- I mean, are those essentially -- the type of installation that that's most likely going to be ...

Well, as we said, we're pitching -- we're pitching kind of part of the Golden Dome initiative, which is a protected critical infrastructure that we actually have the capabilities that you need to protect critical sites. So it's just like any type of sales process. We're trying to make that pitch. We have our LOCUST laser weapon systems. We have our RF defeat systems. We've got the software, we've got the tech systems and the Titan SV product. We can put that together on a site. So the goal is in the next 12 months or so to get the government to agree to have us put on a couple of sites. I think no matter what, laser counter-UAS, we're definitely the most important player. You would think that an analyst would pick up on that is more important than a little contract issue with SCAR, that we basically -- I mean, look at all the -- just a little publicity we've gotten lately in the border, not that it's massive, but I mean that's -- people don't understand, that's like amazing. The U.S. government is using counter-UAS lasers on U.S. soil that are made by us. They wouldn't use it -- they wouldn't use it if they didn't really fully believe this is capable. So we believe this has big opportunity in the short run for us. This is -- again, this is just -- there's multiple products that came over from the BlueHalo portfolio that are in this kind of coming out of, let's test it, let's see at this workspace after many years starting way back here at this is going to be the awesome most thing to reality to now to full adoption. And there's multiple settings of this, counter-UAS RF or public safety purposes, counter-drone laser technologies on the AV side, it's a one-way attack drones, it's long-haul laser communications from the AV side. Again, we just got a $500 million contract for -- I mean nobody else -- if you think -- if you believe that laser communications is important for military purposes in long haul, then you've got to believe in what we're doing. So we have multiple products that are kind of just hitting this adoption phase. That's what's super excited about the story.

Yes. Do you think that the -- whether it's for the -- the one to 2 sites that you think you'll have online kind of in the near term versus just broadly what the opportunity is the full package of kind of layer defenses that you guys have just internally within your portfolio as a key differentiator? Or are you okay to just sell LOCUSTs to a -- to the laser weapons and then someone else can do the RF like how do you -- from a BD kind of go to market, how are you thinking about that type of...

We traditionally have not taken on the system integrator model. And we are doing this here. I personally would love to see it successful for this purpose because I do think we do have a variety of capabilities that as proposing solutions might be the best way for us to grow those products. It has not been our traditional route. I mean, we've done some stuff here and there. But more and more, we're seeing improving our capabilities and expand our capabilities in that kind of system integrator model with mostly our product and some other people's products.

As you have success on more, what you'd probably call, kind of classic critical infrastructure of military bases, DoD-type installations, and probably going to be -- I think, probably the most likely first candidates just given Golden Dome naturally leads you to more public critical infrastructure like utilities, other things. Is that something that you guys will also pursue eventually? And will that create like a new kind of BD-type motion for you guys, you haven't necessarily exercised before or how would that...

It definitely would be new. And so yes, those are things that are under consideration. How do we go to market? If every power plant in the United States needs some type of protection, that type of thing. We do -- the Titan product we do mostly today sell through resellers, and that would be a question of how should we do more of -- the more the reseller ourselves than other people.

Got it. Great. Time flies. And I've been chatting all the time. I'll make sure there's no questions from the audience before I continue on?

Are there any questions from the audience?

No? I can keep going. I have a list. Okay. Yes, go ahead.

So with [indiscernible] you mentioned like you're selling through resellers, like how much of the margin in the end that behavior [indiscernible].

Well, it's already the best margin product in the company. So I don't know, in some way, it could be closer to the same or maybe a little bit better, but you're probably going to be taking on a little bit lower kind of integration work as part of that. So maybe overall, if you said that business was -- goes from $100 million to $200 million. The margin might be the same or a little down because now you're incorporating more services in it. So I don't know what that looks like. But it's a great margin product as it is.

All right, I'll do one more. International business, you guys had a great kind of, I think, motion around that even before BlueHalo and put a lot of work in there. Now with BlueHalo, you've got, like we've talked about a whole host of new products that you can now take to those international kind of strongholds you've already established. What do you think you could be doing better, though as well as you've done there? What -- especially with all the -- just the new dynamics, let's say, around just other countries really taking more of their own destiny into their own hands. What do you guys think you should be doing just better on the international front, what might we see in FY '27 kind of...?

Yes, we're definitely adopting a strategy that gets us more in-country resources, either BD -- or business development or technical resources, some of these countries want some type of, I would say, manufacturing, at least assembly type of operation in country. So we're exploring all those alternatives. It wasn't as imperative for us before because we really had one main product we're selling internationally Puma. Then over the last couple of years, we've been able to sell Switchblades, but now we have a host of products we can sell into these countries. And so it makes sense for us to have a more localized at least sales and support operation versus a reseller network in country. So you'll see more of that in the next 12 months.

Great. All right. And we're in the kind of the red zone time. So again, if there's any other questions, otherwise, we'll let everybody [indiscernible].

Thank you, Trevor.

Thank you so much, sir. Appreciate it.

Thanks.