AVAV

Business Context and Reporting Period

Company: AeroVironment, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: October 30, 2010 (Second Quarter of Fiscal Year 2011)
Business Overview: The Company designs, develops, produces, and supports unmanned aircraft systems (UAS) and efficient energy systems (EES) for various industries and governmental agencies. Operations are divided into two reportable segments: UAS and EES.

Key Financial Metrics

Note: The Company reported no long-term debt or material cash commitments other than trade payables and accrued expenses.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 24% year-over-year for the quarter ($63.8M vs. $51.4M) and 14% for the six-month period ($102.0M vs. $89.3M).
  • UAS Segment: Revenue rose due to increased product deliveries (Puma AE systems) and service revenue (Raven B retrofits), partially offset by a decrease in customer-funded R&D work on the Global Observer program.
  • EES Segment: Revenue increased 32% for the quarter, driven by higher deliveries of industrial electric vehicle charging systems.
• Profitability: While gross margin increased in absolute dollars, operating results deteriorated for the six-month period due to significant increases in operating expenses.
  • R&D Expenses: Increased 50% year-over-year for the quarter ($8.7M vs. $5.8M) and 45% for the six months ($16.7M vs. $11.4M) due to investments in UAS and EES technology.
  • SG&A Expenses: Increased 20% for the quarter and 15% for the six months, driven by marketing, business development, and administrative infrastructure costs.
• Cash Flow: Net cash used in operating activities improved significantly to $4.0M for the six months ended Oct 30, 2010, compared to $8.4M used in the prior year period. Investing activities provided $51.8M in cash, primarily from the net sale of investments ($60.0M).

Guidance, Outlook, and Risks

• Backlog: Funded backlog increased to approximately $103.8 million as of October 30, 2010, from $72.3 million at the end of the prior fiscal year. Unfunded backlog stood at $205.6 million. Management notes that unfunded backlog does not obligate the government to purchase goods and is not a reliable measure of future revenue.
• Liquidity: The Company maintains strong liquidity with $76.7M in cash and $80.7M in short-term investments. Management believes existing resources are sufficient to meet working capital and capital expenditure needs for the next 12 months without additional financing.
• Investment Risks: The Company holds $6.3M in auction rate securities (Level 3 assets) that have experienced failed auctions since 2008. These securities are in an unrealized loss position ($1.285M loss). Management does not consider them other-than-temporarily impaired but notes they may not be liquidated at fair value until a successful auction occurs.
• Tax Matters: The effective tax rate for the six-month period was 52.8%, higher than the prior year, primarily due to a $1.7M reduction in the liability for uncertain tax positions following the conclusion of a tax examination for fiscal years 2003 and 2004.

Key Facts for Investor Verification

• Operating Loss Trend: Verify the sustainability of the operating loss for the six-month period ($6.9M) given the 50% increase in R&D spending and whether this aligns with long-term strategic goals.
• Auction Rate Securities: Confirm the current status of the $6.3M in illiquid auction rate securities and the timeline for potential liquidity recovery.
• Customer Concentration: Assess reliance on government contracts, specifically the impact of the decrease in customer-funded R&D on the Global Observer program.
• Margin Compression: Monitor gross margin percentages, which declined for both UAS (36% to 33%) and EES (50% to 43%) segments year-over-year due to higher overhead and engineering costs.