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

I have a few follow-up questions, if that's okay. Can you talk about Locus X3? What -- so as an Army platform, it sits on top of an armored vehicle. How could you expand it to potentially other services? And what differentiates it versus its competitors?

The -- so there's lots of differentiators in our solution versus everyone else. There's lots of people that are chasing this. We really -- a few things that's really important. Number one, we focused on the sweet spot of the market. A lot of players are going after higher kilowatt power. That's like giving somebody bigger and more powerful bullets, but they don't know how to aim at the target. So giving somebody more bullets or bigger bullets does not really solve the problem if somebody is spraying the shots everywhere, if I were to use that analogy. The secret sauce to our system is that we are able to perfect the ability for a moving vehicles such as Humvee or a Stryker vehicle armored vehicle to be able to go in an uneven payment at around 20, 30 kilometers per hour, detect 360 degrees around it, just real time, any type of drone from group 1 to 3 and then aim at it and then basically zap it down within 3 to 5 seconds, and do that every few minutes as you reload and recharge. That tracking, targeting and control hardware and software algorithm is something that we've been perfecting for a lot of lots of years. Now this base gives us the ability to expand the product line also at higher kilowatts and at like watts for a variety of other applications. In addition to that, the way X3 is designed, not only can you detect while you're on the move, you can also hit and defeat drones while they're on the move. That makes it incredibly compelling and powerful. It means you don't have to stop to do that action of actually hitting the drone. And lastly, we've done many tests with our customers, including the U.S. Navy, onboard aircraft carriers, ships where they have given us -- the latest 1 was we were given 17 real targets on a real mission with the U.S. Navy on a ship George W. Bush, I believe, and Norfolk, where they give us 17 different type of real targets, and our system hit 17 out of 17, 100% success rate. And so far, the success rate of this product in the field in terms of its availability also is very high. It's -- there are very few systems and operation and our customers just keep moving them around because it's in such high demand. Last piece of data. Department of Homeland Security and Customs and Border Patrol was developed -- deployed some of these systems in the southern border. They just published some stats on this that the success of Locus has been so phenomenal that the drug cartel drone traffic over the Southern border has de by 70% plus, 70% plus. And it just shows the power of this type of a solution set and the technology that it has. And so we really focused on this. It's not the only one. We're very fortunate because we have a half a dozen of these growth opportunities in our portfolio. But I think locus is going to be very unique because we are -- we've got a solution set that has a moat. It's very effective, and our customers have already pushed that, I believe, button. And we're scaling production and we can deliver them at scale today.

And as you think about the international expansion, you mentioned that these franchise programs tend to come in waves. And once you get 1 under the belt, more we'll go forward, how are you thinking about this international opportunity being tested in the time line potential other orders?

Yes. So I mean, historically, when we get adoption with the U.S. military and the U.S. government allows us to export and sell them to allies, the momentum picks up very quickly because Look, the world is not a safe place. Think of all the different theaters around the world, the Middle East Straits of Hormuz, Eastern Europe. Mediterranean Black Sea, Mediterranean Sea, Asia Pacific, lots of these places Gulf of America, Latin America, there's lots of places where systems like this could be dramatically effective and helpful to the needs of our customers. And so once the government gives them the nod that this is validated, and I believe buttons pushed, I mean, we're in multiple active shooting wars around the world. And it's not a safe place, right? And you see drone attacks in places like the Middle East where you run fires 1,000-plus of these drones in a week. And basically just drives habit into many countries, economies let alone the global markets. So it's not a small little deal that we're talking about. This is something that is going to be very seriously, I believe, observed and most likely adoption is going to take off after that. It doesn't happen overnight because the acquisition process still takes time. It is a military sale, it does have to go through the governments, and we still have to ramp up production because the lead times on some of the materials are still very long is it's a very new market. But we know how to do this. We've done it several times in our history, and we're executing on our plan.

That's super helpful color. Maybe I'll ask 2 more on international and focus on your other products from here. You mentioned it's still a process to sell internationally. How does the export agency approvals help you and how are you thinking about localized efforts as well?

Sure. So another thing that's very unique about AV is that our success and track record of being able to sell and successfully export products from the United States and our technologies in initially is phenomenal. We export to 55 different countries around the world. and pretty much every content accept and talk to go. And so we are very successful in knowing how to do that. We've been growing that before. And before the Blue Halo acquisition, international revenue represented various times between 40% to 50% of the total company revenue. I believe that the international markets adoption and revenue is going to grow even faster because there's tremendous need for our systems out there. We're actively engaged in several countries in those three markets. The key markets that we're focused on is Europe, Middle East and Asia Pacific. We have announced several joint ventures, subsidiaries, teaming agreements partnerships in multiple countries. And I think that that's going to continue to grow. In terms of local content versus not, some of these countries have such great needs, and there's so much demand for our systems that it's going to require some local content. We have a very sound strategy around that. We know exactly how to do that without compromising our IP without compromising our value proposition and the business model. And we know how to work with the U.S. government on how to set these things up. We've done it many times in our past, and that's a strength of AB in my view, in general.

That's super helpful. Can we talk about Titan as well, the $500 million IDIQ, just to touch upon that again. and the initial $80 million order under domestic Shield tied to Golden Dome. How do we think about that converting to revenues and further milestones?

Sure. So let me just touch on our overall strategy on counter-UAS. Counter-UAS, to us is not just a product. A counter-UAS is a problem and it's a category that is going to continue to grow over the next 5, 10 years. We never thought that you're going to have a one solution fits all strategy for this market. Our strategy, which is unique compared to almost all of our competitors is to have a layered defense solution set that addresses counter UAS and multiple different types of capabilities. The first layer of that defense against UAS is RF jamming. We've got one of the world's best RF jamming systems in the world. Titan series is proven. It's worked in Ukraine. It's worked in the U.S., it's internationally. We're doubling revenue every year in the last couple of years alone, and it's going to continue to grow. And the example you just described the order from the drone Shield program or the Shield and the Golden Dome initiative is roughly about $0.5 billion total contract awards sold sourced to AV, so we can actually build more of these and deliver them to the U.S. military. We're going to deliver those things -- or a portion of that $80 million, a significant portion of it this year. We're already actively ramping production. It's one of the product lines out of 7 different ones that were scaling production aggressively. The second layer of our defense, just to go back to the counter UAS is the direct energy solution. So if the RF jamming fails, which most likely in the future as drones become more autonomous and independent of GPS and RF communication, then RF jamming doesn't work. So then you have to go to the second layer of defense, which is direct energy. Direct energy is the technology that's going to become probably the lion's share of the use cases in the market for military applications. And you heard my story earlier as to what we're doing there and why we're the leader. If those 2 layers fail, the last resort is to use a kinetic missile. In the entire arsenal of the U.S. military's missiles, there is not a missile that is designed from the ground up that can address a group 1, 2, 3 drone cost effectively. Today, as I said, we used $1 million to $10 million missiles to shoot down $150,000 Shahed drone. That economically is not feasible. We have been awarded the contract. We competed with RTX on this. Called LRKI, Long Range Kinetic Intercept. It's a U.S. Army program to develop a next-generation counter UAS missile, specifically at cost targets that changes that equation make it at parity economically feasible to do that. We're ramping up our Huntsville facility, specifically to scale that site. The U.S. Congress actually put more money and awarded us more funding to accelerate the production and transition to full rate production. And we're aggressively building those units going through the safety confirmation and testing and maturity of that product to get it to a production level in the next 12 to 18 months. So as you could see, our strategy is not a one solution fits all or solve part of the problem. We believe that the counter UAS market is a multibillion dollar global market. We've got the leading solutions in all 3 categories. And I think over the next several years, we're going to continue to scale this and benefit from that growth as well.

As always, super helpful to provide the macro perspective, and I think we all appreciate it, especially myself. So on UAS, the revenues have been growing quite significantly. How do we think about the run rate going forward and sequential growth in that business. .

Yes. So the first quarter UAS revenue was up 71% year-over-year. So we'd love to continue that trend going forward to that level of rate. We've had some key wins. We won in the first quarter, a $117 million 550, our Group II solution for the long-range reconnaissance program with the U.S. Army. That award is beginning its deliveries now and headed in Q1. It's going to continue in Q2, and it will be included in our full year numbers. Overall, U.S. is continuing to grow. We're seeing tremendous adoption of our JUMP and our G2X, our Group 3 solutions in that space. both domestically and internationally. We've won multiple different programs internationally with our Jump 20. We've recently got a military designation for by the Italian government, putting it into their inventory as a defined inventory item -- that's a really key milestone to win and improve the airworthiness and the overall capability of that platform. So our UAS platforms continue with Puma as well and Puma has been around for a while, but we've enhanced it over the years. And we just announced a $30 million Germany award where the German military basically bought the full suite of our Puma capabilities. Our Puma AE, our Puma long range, our Puma Vitol, autonomous kits that get added to it. They bought the highest capable Puma system out there, and we're going to be delivering that this year as well. So UAS is doing very well. It's been part of our legacy for a while, and we're continuing to invest in it and expand the production capabilities and be able to deliver on all these key contract awards.

That's great to hear. And I guess, putting all that together, how do you think about margins across the business going forward as you've laid out your margin plans back in June?

Yes. So we did our Investor Day back early July, and we laid out our fiscal year 2030 targets. That took us from a revenue standpoint of growing roughly 15% to 20% over the next 4 years, getting us to essentially doubling our company between $3.5 billion and $4 billion. We also put some financial targets around our EBITDA expectations. We're currently running -- last year, it was at 14.5%. We're guiding 14.5% this year, and we expect that to grow between 18% and 20% to 18% to 20% by fiscal year -- the way that we're going to get that growth and that improvement is by -- obviously, the volume is going to help, but also the mix we're going to [indiscernible] into the production levels that we're expecting.

And maybe can we talk about despite the 400 basis point margin increase in your target R&D has been a double digits over the last decade. You're normalizing to more of a 7% to 9% range. How do we think about where you're spending the dollars?

Yes. I'll take it. So historically, before the acquisition of Blue halo, the AV old AV, I call it, R&D as a percentage of revenue was double digits between anywhere 10% to even sometimes we went to 13 15%, the highest was actually 18% 1 year. I'm not indicating that for the future. I just don't have to panic about that. And Blue halo had a lower rate. So the combined rate still, the dollars is much bigger, but it's around between the 7% to 9% as we discussed. We think that that's the normal range for us for the next several years, and it's going to fluctuate from year-to-year. We have a very ferocious appetite for opportunities to invest in. But we're very judicious on how do we risk adjust these opportunities and rank them, rank and stack and then we make decisions on the portfolio level as to where we should place our bets. Historically, AV has probably got one of the best track record of investing in a technology or an opportunity, and then over the next 3 to 5 years, demonstrating on how to take that and build it into a franchise capability and product line and business line for us. So if you look at the history of our company, it's literally made up of those layers of the cake. We've got several of those today. majority of the investments are going in these specific areas. It's going into our bread and butter, multi-mission ISR drones, lethal drones call it, precision strike systems, such as Switchblade, Red Dragon, F1, et cetera. Counter-UAS is getting a very heavy investments, primarily the locust and the direct energy systems. And then we have a whole bunch of other smaller, earlier-stage investments for what we call the breakthrough capabilities that essentially becomes a franchise later on. One of those that's actually you know about is RedDragon, RedDragon was not even known 3-plus years ago. We developed it during the Ukraine conflict and it's going to be a significant driver of revenue and profitability for the company this and next year. And so that's usually our strategy. That's what we're going to up doing. We're fortunate because the market for us to invest is actually pretty good. The returns on these things look really, really good. And you could argue that we should be higher in some cases. But we're trying to balance to two things, being judicious and methodical and very systematic in how we do this; and two, also, we don't want to get too aggressive and also make sure that we have a profitable business and sustainable value.

That's super helpful color. I guess as we think about some of those margin drivers, services and international, have you quantified the mix change or percentage change that you look to? .

Yes. So the overall mix is going to help drive that adjusted EBITDA from 14.5% up to the 18% to 20%. And as why he mentioned, our historical international portion of our portfolio was a lot larger a couple of years back. It has come to a smaller percentage as we've integrated a larger company with Blue Halo that was mostly domestic focus. So those percentages were sitting in roughly 20-ish percent right now, international exposure. We expect that to grow to 30% to 35%, probably not getting back to 50% if we don't need it to get back to that level in order to hit those adjusted EBITDA targets. From a product and services, we're around 68% product, 32% services. We expect that to also improve. So a higher mix of product sales going into the mid-70s, which will help drive fixed price contracts, which will help drive margins as well. So all those factors are in play. We're executing to that. These key awards that we're winning are all evidence that our strategy is paying out. Now we're just going to see that our execution of the programs effectively and ideally, the margins will improve in the back half of the year and continue into '28.

Two more questions and we'll wrap up. BluHale, where are you on the acquisition integration today? And where do you look to be in the next 6 months to a year?

When we did the acquisition, we had a very crisp and clear plan on a 3-phase approach on how do we integrate the business, how do we execute our strategy on this and how we go create value as the 2 businesses, 1 plus 1 equals way more than 4 or 5. We're right now at what I would call it, 2.5 phase, 2.5 roughly. Phase 1 was to basically get 2 organizations together, move the businesses and product lines in the right places, connect the plumbing and the wiring so we can function as a one AV company. Phase 2, which is the heaviest part of the lift was to actually connect our systems to be able to allow us to scale scale, both in terms of operations the cost synergies revenue synergies, customers, products, et cetera. We're about 60% to 70% or 50%, but been depending on which area you look at of that transition complete and successful. Remember, this is a very large thing to take on, and we're going very deep in terms of integrating these businesses very aggressively, very aggressively. There's no such thing as AV or Blue Halo anymore. We're one company, 1 year -- we're trying to go to 1 ERP system, 1 HR on Salesforce CRM system, massive, massive amount of efforts internally. Third phase of the integration is actually streamlining our investments in products and aligning our R&D and SG&A investments to make sure that we get 1 plus 1 equals 5 or 10, that takes a little longer because then you have to start -- it has to be in a lot of a new development on new products, new technologies that allows us to spend $1 and let 5 or 6 products benefit from that. That effort is already on the way, too, but I would say it's probably 20% to 30% done in terms of just rough order of magnitude. And so the last thing I would say is I'm very pleased with the progress we're making. Acquisitions, integrations of this size nature is never easy. We have had lots of experience and track record here. And if you look at what we've been able to achieve, both we've already achieved the cost synergies. We had a target for the first 2 years. We achieved that in the year in the first year. We're ahead of our revenue synergy expectations and goals, too. In the last 12 months alone, we've won 4, 5 different $0.5 billion sole-source programs and franchises. Titan, Feeding 1, laser communication terminals, laser weapon systems like locust, the list goes on. Helmsman is another program that we won. And so we continue to win in our record so far of being able to create the type of synergy that we wanted on the revenue side, I'd say it's quite, quite good. And so we're very pleased with that, and there's a lot more to come. But there's a lot more to come. We're going to continue to work on this. And I think the combination of the 2 is strategically exactly what our customers want us to do and generate value for our shareholders.

Thank you both. I think that's a great note to end on. So appreciate it. Thanks, everyone.