Earnings Call Transcript - AVAV Q2 2026

Operator, Operator

Good day and thank you for standing by. Welcome to the AeroVironment Second Quarter Fiscal Year 2026 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to the Head of Investor Relations, Denise Pacioni. Please proceed.

Denise Pacioni, Head of Investor Relations

Thank you, and good afternoon, ladies and gentlemen. Welcome to AeroVironment's Second Quarter Fiscal Year 2026 Earnings Call. My name is Denise Pacioni, Head of 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. These statements involve many risks and uncertainties that could cause actual results to differ materially from our expectations. Further information on these risks and uncertainties is contained in the company's 10-K and other filings with the SEC, in particular, in the risk factors and forward-looking statement portions of such filings. Copies are available from the SEC on the AeroVironment website, www.avinc.com or from our Investor Relations team. This afternoon, we also filed a slide presentation with our earnings release and posted the presentation to the Investors section of our website under Events and Presentations. The content of this conference call contains time-sensitive information that is accurate only as of today, December 9, 2025. The company undertakes no obligation to update any forward-looking statements whether as a result of new information, future events, or otherwise. Joining me today from AeroVironment are Chairman, President and Chief Executive Officer, Mr. Wahid Nawabi; and Executive Vice President and Chief Financial Officer, Mr. Kevin McDonnell. We will now begin with remarks from Wahid Nawabi. Wahid?

Wahid Nawabi, CEO

Thank you, Denise. Welcome, everyone, to our second quarter fiscal year 2026 earnings conference call. I'll begin by summarizing our quarterly performance followed by Kevin, who will review our financial results in greater detail and then discuss guidance for fiscal year 2026. After this, Kevin, Denise and I will take your questions. I'm pleased to report excellent quarterly financial results while setting new records in multiple areas of our business. Despite the challenges posed by the elongated U.S. government shutdown, we delivered excellent financial results and achieved several strategic milestones that we believe position AV for strong, sustained growth well into the future. During the quarter, we introduced several innovative products and secured multiple large long-term contracts, a testament to a recipe for innovation and proof that our strategy is winning. The total ceiling value of new contract awards during Q2 reached $3.5 billion, a historic record achievement by AV. This also resulted in record second quarter bookings of nearly $1.4 billion. These achievements underscore that our strategic investments are delivering results and progressing our business to new heights. We also made significant progress on multiple programs of record that we believe will solidify our leadership in all domains in which we participate: air, land, sea, space, and cyber. With strong top line growth expected on the horizon, we are executing on our expansion plans to further scale our manufacturing capacity and meet accelerating demand across several of our products and programs. Our proven execution capabilities, combined with the robust pipeline of orders and operational readiness, reinforce our confidence in achieving our industry-leading long-term growth objectives. At the same time, overall, the integration of BlueHalo is exceeding expectations, strengthening our capabilities and positioning AV as the premier next-generation defense tech company. Let me summarize our key messages for the second quarter of fiscal year 2026, which are... towards a total contract value of $3.5 billion bolstered bookings to reach an all-time high of nearly $1.4 billion, driven by key program wins that support AV's long-term growth. Second, we also achieved another record second quarter revenue of nearly $473 million. Third, we launched several new innovative products aligned to our customers' highest priorities and continued to execute on expanding our manufacturing capacity to meet accelerated demand. And fourth, we're raising the lower end of our fiscal year 2026 revenue guidance and now expect revenues between $1.95 billion and $2 billion. Beyond these strong results, the defense industry is at an inflection point, and NAV is not just prepared to lead. We are ahead of the curve, setting the pace for everyone else to follow. Let's not forget, the U.S. Department of War is firmly committed to shifting their procurement practices towards agile, commercially available products and capabilities, favoring companies that invest their own capital, develop disruptive solutions at speed while transitioning them to full-rate production and scaling capacity quickly. This validates the business model AV has embraced not just in the past few years, but over multiple decades. AV's business model and strategy have always been to invest in innovative and disruptive solutions ahead of customer requirements, scale their production rapidly, and deliver decisive advantages that enable customers to acquire capabilities quickly. Looking ahead, cost-efficient autonomous drones and counter-drone systems enabled by AI and machine learning will define the battlefield. Known for uncrewed aircraft systems and leading AI integration, we believe AV is uniquely positioned to capitalize on this transformation. AV Halo, our open architecture software platform, is designed to unify command and control, intelligence analysis, synthetic training, and autonomous targeting across all domains, creating advanced communications among critical assets during conflict. By integrating AV Halo into our portfolio and other platforms, we're delivering a powerful hardware-agnostic ecosystem that enhances the speed, autonomy, and interoperability of AV's platforms for our customers. Moreover, we expect that AV Halo's ability to enable competing products to operate on a common command and control software system will play an increasingly crucial role in U.S. defense procurement decisions. Our investment and development in AV Halo is just one example of how AV is ahead of this transformation and is well positioned within the industry. Our level of internal R&D investment and proactive CapEx strategy enable us to accelerate development and scale production ahead of demand. Using internal R&D to advance new products allows our technology to outpace our peers and leads to a faster time to market. We believe this core competency is a key differentiator that allows us to stay ahead of our customers' needs. Unlike traditional contractors that wait for contract vehicles before building prototypes, we innovate first and bring solutions to market faster. These forward-looking investments are not only fueling the launch of new products, but also translating into significant contract wins, reinforcing our ability to capture emerging opportunities. For example, in our Autonomous Systems segment, our P550 was recently down-selected by the U.S. Army's long-range reconnaissance program or LRR, estimated to be worth approximately $1 billion. Internal investments made on this group to uncrewed solution allowed us to quickly meet the needs and requirements included in the LRR program, and we're confident that our P550 is the best solution for the U.S. Army. We've also prudently invested in upgrades to our Group III uncrewed aircraft system, JUMP 20 and JUMP20-X, which was recently selected as one of four options on the U.S. Navy's basic ordering agreement. This significant achievement allows AV to compete for specific U.S. Navy intelligence, surveillance, and reconnaissance, or ISR, task orders over the next five years in a large and rapidly growing UAS maritime defense market. In addition to these domestic achievements, we're also expanding and experiencing an increase in international demand. Within our Autonomous Systems segment, we were recently awarded an $874 million sole-source IDIQ contract from the U.S. Army for international sales of our small UAS products to include Raven, Puma AE, and Puma LE. This IDIQ contract vehicle also allows for the sale of our JUMP 20 medium UAS and suite of counter UAS solutions. Our strategy is driving tangible results, which is evident in the successful product launches this quarter. We recently unveiled several new offerings, including our next generation of Switchblade loitering munitions with our Switchblade 600 Block 2, Switchblade 400, and Switchblade 300 Block 20. These products were mostly internally funded and developed quickly, helping to expand the Switchblade product line and create long-endurance multi-domain anti-armor solutions, ensuring warfighters maintain tactical overmatch in contested environments. We also debuted our next-generation vapor compact long-endurance helicopter, or VAPOR CLE. This group 2 VTOL UAV is fully autonomous and can deliver up to two hours of flight, which has doubled the endurance of typical group 2 quadrotor UAV platforms. Our newly integrated NVIDIA Orin onboard computer makes the VAPOR CLE fully autonomous and enables automatic target recognition through AV Halo Vision computer vision software and AV Halo Wizard artificial intelligence machine learning processing suite. On our last earnings call, we discussed the significance of our software solution, AV Halo. Since then, we have announced that AV was awarded the U.S. Army's contract for Human Machine Integrated Formation, or HMIF program. This award accelerates the fielding of multi-domain robotic formations using AV's unified interface of command and control, tactical awareness, and autonomy solutions at the tactical edge. As part of this win, AV is going to be the lead software and system integrator for robotic systems on the edge of the battlefield. This award also validates the strength of our approach to software solutions, common controllers, and user interfaces, and underscores the Army's confidence in AV's ability to deliver mission-critical solutions. We also just released two new products from the AV Halo suite, including AV Halo Cortex, a next-generation intelligence fusion and analysis environment, and AV Halo Mentor, a warfighter readiness suite that leans on virtual and augmented reality weapons training and mission rehearsal. AV Halo will continue to roll out more products and offerings that position AV as the core and leading developer in this space. Furthermore, we recently announced a collaboration with OpenJAUS, an open architecture software framework that allows robots, drones, missiles, and ground vehicles to communicate effectively. This integration extends AV Halo compatibility to seamlessly incorporate robotics, allowing original equipment manufacturers to integrate their platforms faster and more easily. This collaboration strengthens AV's role as a driver and leader of the industry's push towards interoperability. In addition, AV won several key awards in our Space, Cyber & Directed Energy segment with critical new contracts in laser communications, space-related satellite communications, and directed energy. For example, AV received a $240 million contract for our long-haul laser communication terminals, one of the largest ever awarded in this category. This disruptive innovation is moving from lab to orbit, a critical step for AV and the industry. Long-haul laser communications use precision optical links to move enormous amounts of data between satellites faster, more securely, and without the vulnerabilities of traditional radio frequency signals. This capability is critical as it creates a resilient high-bandwidth backbone for future space networks, ensuring warfighters and decision-makers get the right information instantly, even in contested environments. This win continues to push AV to the center of innovation in space. Additionally, AV secured a new firm-fixed-price option for two BADGER phased array systems under the SCAR program, or Satellite Communication Augmentation Resource program. This program represents a tremendous growth opportunity for AV as more BADGER systems move into production. Lastly, AV was awarded a contract valued at $499 million by the U.S. Air Force Research Laboratory to develop material technology and deploy protective solutions to the front lines to guard warfighters against exposure to harm from electromagnetic radiation. Work under this large program known as HELMSSMAN will help counter directed energy strikes in the future. We continue to set the standard in advanced protective technologies and directed energy defense, positioning AV as a clear leader in safeguarding warfighters against emerging threats. Our disruptive solutions continue to position AV as a leader in next-generation defense. From our family of Switchblade loitering munitions to advanced counter UAS solutions, we're redefining the battlespace. We have unseated incumbents with our locust laser weapon system and secured key wins like Freedom Eagle-1, delivering cost-effective kinetic counter UAS solutions for group 3 and 4 drones and beyond. With our AI and machine learning-driven platforms, we believe AV continues to set the industry standard, positioning us to fully capitalize on the generational opportunities ahead. During the quarter, we continued to form additional strategic alliances and collaborations that will help AV expand domestically and internationally. In September, we signed a memorandum of understanding with Taiwan's National Chung-Shan Institute of Science and Technology, or NCS IST, to collaborate on autonomous systems and technology to support Taiwan's defense and security needs. We also signed a memorandum of understanding with Korean Air to advance medium and large aircraft systems to the Republic of South Korea. Both of these agreements underscore our expanding international presence and steadfast commitment to providing flexible mission-ready solutions for our customers. Both agreements are centered around AV's JUMP 20 and JUMP20-X systems, which provide the kind of operational versatility that continues to grow in popularity in international markets. We also announced a collaboration with GrandSKY to establish the foundation for a Golden Dome for America Limited Area Defense architecture at Grand Forks Air Forces in North Dakota. This collaboration is significant as it marks the first deployment of AV's critical counter UAS solution set to secure a U.S. Air Force base, creating a model that can be replicated across other critical U.S. national security sites. As the demand for our innovative offerings accelerates, we recognize the critical importance of scaling quickly. Since last year, we have been focused on securing a new facility in Salt Lake City to expand our Switchblade manufacturing further. Plans are progressing on a 100,000 square foot facility that will allow for multiple Switchblade lines and provide additional capacity. This new factory has the potential capacity to produce over $2 billion worth of Switchblades or other AV products per year. We anticipate this factory to be operational about a year from now. Beyond expanding our own footprint, we're also actively strengthening our supply chain to support anticipated demand, continuing to stay ahead of the market. As part of our distributed approach to manufacturing for resiliency and risk diversification, we now have manufacturing sites operating across different states, reinforcing our ability to scale rapidly and reliably. In addition to scaling operations, we're transforming the defense technology landscape through our acquisition of BlueHalo. We are already realizing meaningful synergies from the BlueHalo acquisition, which Kevin will discuss in further detail. Together, we're building next-generation platforms that fuse counter UAS, space technologies, directed energy, electronic warfare, cyber, and integrated software solutions, creating a suite of capabilities unmatched in the industry. This combination accelerates innovation and continues to position AV as the disruptor driving rapid change in a market hungry for speed, agility, and advanced solutions. We are reshaping expectations and setting a new standard for what can be delivered to the U.S. and our allied forces. Before turning the call over to Kevin, who will provide more financial details on our second quarter results, let me conclude with the following comments. Despite a challenging environment, we delivered a strong quarter. Our continued investment in R&D and capacity expansion is translating into strong growth in key program wins and positioning AV for even more growth in the coming years. We recognize there is a generational shift in the U.S. Department of Defense's procurement strategy and product needs. Our offerings are designed to meet warfighter requirements, and our strategy is fully aligned with these new practices. We're executing on manufacturing expansion and are confident that we can meet increased demand. The integration of BlueHalo is progressing well, and this acquisition is helping to establish AV as a next-generation defense technology company with unmatched capabilities across multiple domains. With that, I would like to now turn the call over to Kevin McDonnell for a review of our second quarter financials. Kevin?

Kevin McDonnell, CFO

Thank you, Wahid. Today, I'll 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. I will start by commenting on our results for the quarter and then turn to guidance for the remainder of FY '26. While this quarter presented challenges in terms of the U.S. government shutdown and our transition to new operational systems, we are very pleased with the continued business momentum and more importantly, our revenue and adjusted EBITDA outlook for the year remains in the same range despite some of the challenges in Q2. Next, I'd like to draw your attention to Slide 17 of the earnings presentation, which sets forth the definitions for our customer contracting activity. Going forward, each quarter we will present a report on total contract awards, bookings, funded backlog, and underfunded backlog in the quarter. Now I'll highlight some of that customer contractual activity in the quarter. As Wahid mentioned, we earned awards with a total ceiling of $3.5 billion, and we achieved $1.4 billion of bookings and ended the quarter with $1.1 billion of funded backlog and $1.8 billion of unfunded backlog. We're very pleased that the U.S. Department of War contract activity continued progressing despite the shutdown, and we view this as a testament to the importance of the programs we're involved in. Some of the recent key awards are highlighted on Slide 10 of the earnings presentation. Both segments captured multiple large awards during the quarter. As Wahid mentioned in his remarks, total revenue totaled $472.5 million in the second quarter, which represented a 151% increase over the prior year as reported or a 9% increase on a pro forma basis. Legacy AV organic growth was 21% in the second quarter. Slide 6 and 7 of the earnings presentation show the second quarter and the year-to-date revenue by operating group for each of our two segments compared to pro forma FY '25 revenue. The AxS segment recognized $302 million in revenue in the quarter, which represented a 15.7% increase over the FY '25 pro forma revenues. Precision strike and counter UAS products led revenue growth for the segment with nearly a 38% increase compared to the pro forma FY '25 second quarter results. Strong Switchblade 600 and Titan sales led to the growth in this category. Uncrewed systems, including both our small UAS and medium UAS products improved more than 8% from the pro forma results from the same quarter last year. Uncrewed systems without Ukraine revenues grew more than 50% year-over-year, driven by strong JUMP 20 revenue increases. The Space, Cyber & Directed Energy segment recognized $171 million of revenue in the quarter, which was similar to the pro forma results from the same quarter last year. The space and directed energy products grew more than 20% in the quarter versus the prior year with the Locus directed energy counter UAS growth being one of the key drivers. As Wahid mentioned earlier, this segment also received several large contracts this past quarter, including a significant contract for our long-haul laser communications and two BADGERS for the U.S. Space Force's SCAR program. Cyber Mission Systems showed a decline in revenue largely as a result of discontinued programs and was negatively impacted by the government shutdown. As mentioned earlier, this segment had a strong quarter with new contracts, including the nearly $500 million HELMSSMAN award among others. Moving on to gross margins, Slide 13 shows the adjusted product and service gross margin, including reconciliations to GAAP gross margin. Second quarter overall adjusted gross margins were 27% versus 41% in the second quarter of FY '25. As noted, the business landscape of the combined new company has changed significantly with a higher service mix and several products in the early stages of maturation. The second quarter did present some additional challenges to adjusted gross margin. We went live with our Oracle Fusion ERP system upgrade in the quarter. As a result, we experienced some operational inefficiencies and one-time costs related to the go-live. With that said, we've made a major leap forward in our operational systems as we transition to the cloud to support a multibillion-dollar company. In addition, we saw an unfavorable service product mix partially as a result of the government shutdown caused by delays in FMS shipments. In addition, we lost revenues in our Space, Cyber & Directed Energy businesses during the shutdown. However, we believe the adjusted gross margin should improve in Q3 and be in the high 30s by Q4. We are maintaining our full year outlook for adjusted gross margins in the low 30s. Moving on to operating expenses, adjusted SG&A, which is net of intangible amortization and deal integration costs, was $66.1 million versus $33.2 million in the prior year. The increase is largely a result of a combination with BlueHalo. As a percentage of revenue, adjusted SG&A in the quarter was 14% of revenue versus 17.6% in FY '25. Again, these adjusted SG&A levels represent a shift in the business model and we expect to end the year in the 12% to 13% range as we begin to realize synergies and achieve higher revenue levels. R&D expense for the second quarter was $36 million or 7.6% of revenue compared to $28.7 million or 15.2% of revenue in the prior year. Again, this is due to a shift in the business model, and we expect R&D as a percentage of revenue to end the year between 6% and 7% of revenue, representing an increase in R&D dollars over the prior year for the combined company. In terms of adjusted EBITDA, Slide 14 of our earnings presentation shows a reconciliation of GAAP net income to adjusted EBITDA. Adjusted EBITDA for Q2 was $45 million, up from last year's Q2 of $25.9 million as reported, primarily due to the incremental BlueHalo results. EBITDA as a percentage of revenue was 9.5% in the quarter. Despite some of these one-time costs and impacts from the government shutdown, we continue to forecast the full year adjusted EBITDA between 15% and 16% of revenue. Now turning to non-GAAP earnings per share. Slide 12 shows the reconciliation of GAAP and adjusted or non-GAAP diluted EPS. The company posted adjusted earnings per diluted share of $0.44 for the second quarter of fiscal 2026 versus $0.47 per diluted share for the second quarter of fiscal 2025, slightly lower due to the same reasons stated previously. Moving to the balance sheet, at the close of the second quarter, our total cash and investments amounted to $669 million. As reported last quarter, we now have a completely new balance sheet as a result of the BlueHalo transaction and the convertible debt and equity financings completed in Q1. Consequently, many of our balances are not comparable to prior periods. For instance, our overtime revenue recognition has increased from 41% to 75% year-over-year, driving unbilled receivables. With that said, unbilled receivables continue to be at a higher level than we are targeting. Turning to backlog, as noted earlier, our funded backlog at the end of the second quarter was $1.1 billion, and unfunded backlog was $2.8 billion. Our visibility to the midpoint of the revenue guidance range is now 93%. I should note that this is consistent with past practice that we include within our visibility revenues from long-term contracts we expect to perform during the fiscal year, but which have not been funded as of this date. Finally, I'd like to provide you with our updated FY '26 guidance. On Slide 8 of the presentation, we provide fiscal 2026 guidance. Fiscal year revenue is expected to be between $1.95 billion and $2 billion. Adjusted EBITDA remains between $300 million and $320 million. And non-GAAP adjusted EPS is now projected to be between $3.40 and $3.55. The midpoint of our revenue guidance range represents nearly a 15% growth over the pro forma FY '25 results. The lower non-GAAP EPS range is a result of a higher full year projected tax rate, largely driven by the Q2 update of the purchase price allocation of the BlueHalo acquisition. With the government shutdown impacting both our fiscal Q2 and Q3, we have seen delays in some of the orders, shifting the projected revenues to the right. The second half revenue should be split approximately 45% in Q3 and 55% in Q4. The adjusted EBITDA shift will be more pronounced with 70% of the second half EBITDA coming in the fourth quarter. I'd like to close by echoing Wahid's remarks; we are very well aligned with the U.S. Department of Defense's priorities and those of our allies, and we are excited about our prospects. Despite some of the challenges in Q2, we are confident of meeting our guidance for the year. Now I'd like to turn things back to Wahid.

Wahid Nawabi, CEO

Thanks, Kevin. Before turning the call over for questions, I'd like to reiterate some of the positive momentum entering the third quarter of fiscal year 2026. First, record second quarter awards with a total contract value of $3.5 billion bolstered bookings to reach an all-time high of nearly $1.4 billion, driven by key program wins that support AV's long-term growth. Second, we also achieved another record second quarter revenue of nearly $473 million. Third, we launched several new innovative products aligned to our customers' highest priorities and continue to execute on expanding our manufacturing capacity to meet accelerated demand. And fourth, with 93% visibility to the midpoint of our guidance range, we are raising the lower end of our fiscal year 2026 revenue guidance and now expect revenues between $1.95 billion and $2 billion. Our strong second quarter results reinforce our confidence in AV's future and our role in shaping the next era of defense with integrated capabilities across multiple domains of modern warfare, advanced technologies, and the ability to scale rapidly. We believe we are well positioned to meet the Department of Defense's highest priorities and sustain significant growth in a demand-driven market. The Department of War has reiterated its sharpened focus on speed, scale, and commercially driven procurement strategies, all of which play directly to AV's strengths. This has been our strategy from the very beginning, investing in innovative solutions ahead of demand, scaling rapidly, and driving innovation to deliver decisive advantages for our customers. Our alignment with these priorities, combined with our successful track record and best-in-class production capacity, creates a powerful competitive advantage and positions AV as a trusted partner ready to deliver at the pace the mission demands. I want to thank our employees, shareholders, and customers for their continued commitment to AV and our mission. We're honored to support the most critical defense missions at this pivotal moment and we're ready to seize the tremendous opportunities ahead. And with that, Kevin, Denise and I will now take your questions.

Operator, Operator

Our first question comes from Greg Konrad with Jefferies.

Greg Konrad, Analyst

Maybe just one on programs. I think you announced that you got two more BADGER units in the quarter. Can you just remind us how you're thinking about the current scheduled SCAR and maybe how that contributes to the expected ramp for that program?

Wahid Nawabi, CEO

Sure. So Greg, as I mentioned in my remarks, we did secure an additional task order and award from the U.S. Space Force for two more additional BADGERS. The whole SCAR program, as we mentioned in our previous comments, has been so far in a customer-funded development process. We're shifting now from development activity to delivering products, most of which is going to end up eventually going into our firm fixed-price contracts. That transition not only ramps up the revenue for the second half of the year but also improves the margin profile of that business. So we're very much on track with our plans. We're pleased with the performance so far, and we expect the margins, as well as the revenue of that business, to improve in the third and fourth quarters of this year and continue to improve beyond this fiscal year.

Greg Konrad, Analyst

And then maybe just one follow-up to that. I think you've talked about a couple of the headwinds that you saw in the quarter around profitability, including Oracle and the shutdown. If you think about that ramp of profitability and margin, given the 70% in Q4, how are you thinking about that progression? How much is operating leverage versus maybe mix and just the biggest drivers that you see as you head into the second half?

Kevin McDonnell, CFO

Well, I think mix is going to be a big part of that. As Wahid just mentioned about the BADGER program and going into fixed price product revenues, some of our other programs and Locus being product revenues and a ramp-up in delivering across the other business units are increasing the proportion of product revenues versus service revenues. We don't see the service revenues growing significantly in the second half, whereas product revenue is going to drive most of that growth. So that's going to give us better mix, and that's why we're going to be able to achieve the high 30s adjusted gross margins by the fourth quarter.

Wahid Nawabi, CEO

And Greg, let's also keep in mind that we have secured nearly $3.5 billion worth of almost all sole-source IDIQ contracts that allows us now to receive task orders underneath those contracts. Once the funding from the big beautiful bill and the budgets for the Department of War come through as a result of the shutdown that has been delayed, those product revenues are going to turn into task orders that we expect to receive in the next one or two months. That's what we expect, and we want to convert those to revenues. So the volume goes up, mix improves, and also the survival of profitability of some of these products and businesses are going to improve, and that's precisely what we expect at the beginning of the fiscal year.

Operator, Operator

Our next question is from Ronald Epstein with Bank of America.

Louie Dipalma, Analyst

This is Ron's turn today. I was curious if you could provide an update on the product lines in your portfolio. Could you share some insights on the growth levels by product?

Kevin McDonnell, CFO

We have tried to provide more detailed information this quarter by breaking down the major product groupings for each segment. I aim to highlight which products are contributing to growth in those categories. While there are combinations of products, we are making an effort to give you more insights on that. Is there something specific you would like to know?

Unknown Analyst, Analyst

Just if you could talk about Switchblade growth. I think you mentioned Ukraine, if there's any color you could provide there.

Kevin McDonnell, CFO

Yes. I mean year-over-year, Switchblade by far is the fastest-growing product in the COES precision strike category. Overall, we saw significant growth, multiple times for the JUMP 20 in Q2 versus the prior year.

Operator, Operator

Our next question comes from Anthony Valentini with Goldman Sachs.

Anthony Valentini, Analyst

It seems pretty obvious you guys have massive growth opportunities here across the five to ten different products that you have been highlighting. Can you put a finer point on it? Is there a way to think through the catalyst path over the next few months as some of the reconciliation funding starts to hit backlog? Like what should people be looking for?

Wahid Nawabi, CEO

Yes, I’m happy to elaborate. We have substantial opportunities for growth and value creation not only in the coming quarters but also in the next few years, and our positioning is very strong. Key growth catalysts include loitering munition, particularly in the Switchblade and one-way attack drone category, as well as our risk counter UAS solutions, notably the Titan product family, which has shown significant year-over-year growth. Our medium UAS product line, including JUMP 20 and JUMP20-X, is also contributing strongly to our overall growth and profitability. We anticipate significant orders for our P550 in the third and fourth quarters, as the U.S. Army plans to allocate a considerable budget for it, and we expect to capture a significant portion of that funding. Additionally, we are securing several international customers for this product line. The SCAR and BADGER programs are transitioning to production as well, and we expect to increase revenue from those, which typically offers higher margins and volumes. Overall, there is growth across nearly all our key product lines, with some contributing more than others, but all are expanding rapidly. One area that might not experience as much growth is our cybersecurity business, as it focuses on customer-funded engineering services and software solutions, which do not scale aggressively. Overall, we are very pleased with our performance and anticipate continued growth over multiple quarters and years. Our positioning is strong with regard to the evolving strategies of the U.S. Department of Defense and administration. Our business model, products, and go-to-market strategy align perfectly with what the Department of War is seeking, and we are extremely well positioned. While it's challenging to predict the exact amount of spending, there is high demand approaching, and we are preparing for it.

Kevin McDonnell, CFO

Yes. I mean, we think we're on the precipice of significant growth across all those categories. But as with anything in defense, it's difficult to predict the exact timing of that. But we definitely think we're very close to some breakthroughs on some of these products Wahid mentioned.

Anthony Valentini, Analyst

Okay, that's helpful. I appreciate the information. I have another quick question. I'm curious about how to reconcile the slight decline in the backlog from Q1 to Q2. Can you help me understand the reason for that? Should we expect the backlog to increase significantly in the latter half of the year, or is it too unpredictable? It seems like you have a better sense of what might happen over the next 12 to 18 months compared to the next 6.

Kevin McDonnell, CFO

Well, I think it's pretty flat from Q1 in terms of the funded backlog. The underfunded backlog grew significantly. But remember, we were in the CR and the shutdown. So while we got many of these contracts through, which was great, many of them didn't come with significant funding. We expect that to come as they get back and funding improves for new contracts within the Department of War. So it's a little bit of an issue with the shutdown happening and delays in some of the actual funding on these contracts.

Anthony Valentini, Analyst

Okay. And Kevin, do you have a number for what you guys expect Switchblade to be in 2026? I know you gave the color on what the production capacity will be out of the Utah facility in the future. But is there a way for us to think about the 2026 forecast?

Kevin McDonnell, CFO

I don't believe we are providing specific guidance on the various products. However, we have mentioned previously that we expect to have around $500 million of capacity before we expand to the new facilities, so you can estimate around that figure.

Operator, Operator

Our next question comes from Louie Dipalma with William Blair.

Wahid Nawabi, CEO

I attended the Reagan National Defense Forum this past weekend, and the overall sentiment is that we are the model company that the U.S. Department of War and the current administration want to replicate. We are leading the way for others. The procurement strategies are shifting towards companies that develop products independently and ahead of program requirements. They are working at an incredibly fast pace and moving into production swiftly. We are focusing on all the right areas that align with the U.S. Department of War's needs and capability gaps. We believe we are positioned exceptionally well and anticipate continued demand because we can produce at scale today. We are among the very few companies that can deliver reliable, battle-tested products to our customers in large volumes. This is a significant competitive advantage over others in the market, and we are setting the pace for everyone. The overall sentiment for our company is very positive and strong.

Louie Dipalma, Analyst

And on this call, you've discussed many of your product lines, such as the P550, your BADGER with the SCAR program, your JUMP 20s. I was wondering, did your long-haul laser communications program from the undisclosed customer move from $240 million to $385 million? It shows the larger number in your slide presentation. And I was also wondering, have you started delivering terminals as part of that program?

Wahid Nawabi, CEO

So Louie, I can only speak to that program at a very high level due to its sensitivity. We are incredibly delighted and pleased with the success we are having in long-haul laser communication terminals. Essentially, we all know from the conflicts in Ukraine that RF communication is very susceptible to jamming. Every satellite that the U.S. has in space is susceptible to that jamming problem. If we cannot control and communicate with our satellites, especially in the geosynchronous satellites, we have a significant problem. Those assets are not useful. We are one of the only companies that has been awarded a contract of such magnitude, up to $240 million, to provide the laser communication terminals and upgrade the U.S. geosynchronous satellite constellation for national security. This is a massive step forward for our company. We beat many of the major prime contractors and the competition. There is a lot more upside on that contract because we're just beginning to deliver systems. We haven't delivered much yet. We continue to work with the customer. Our system is performing really well, which takes time. That's part of the program. We're very excited, and there are options for them to increase that significantly.

Kevin McDonnell, CFO

Yes, the $381 includes the options as we put forth our new definitions here, to make sure we're all on the same page. The $240 was the original committed contract and the $380 was associated with taking the options.

Louie Dipalma, Analyst

Great. So does that mean the original committed contract is already funded?

Wahid Nawabi, CEO

No. So Louie, a vast majority of that contract is not funded yet. As Kevin said earlier, one of the reasons why our funded backlog has nearly the same amount as last quarter, and it did not grow as much is because of two things: One, the government shutdown put employees of the government out of the office and prevented them from awarding contracts. But the bigger problem was that because of the continuing resolution in the budget that just passed with a big beautiful bill, those dollars have not made it into the accounts of our customers to be able to award task orders against those IDIQs. So we expect a significant number of additional funded orders in the third and fourth quarters, all of which will improve our backlog and allow us to deliver more products and increase revenues in the third and fourth quarters this year. Additionally, it will set us up well for fiscal year 2027. We're not ready to provide any guidance for that yet. But that is going to benefit from the anticipated demand coming our way in terms of task orders and more funding.

Operator, Operator

Our next question comes from Ken Herbert with RBC Capital Markets.

Unknown Analyst, Analyst

This is Peter for Ken Herbert. Could you maybe discuss the margin profile of the CD&E segment? Is there a time when you think that the adjusted EBITDA will be breakeven?

Kevin McDonnell, CFO

Yes. It will continue to grow throughout the year. They were probably the most impacted by the government shutdown of any of our businesses. They also had some delays in some of their receipts for their revenue recognition systems. So they'll definitely be on track as we move forward throughout the year.

Wahid Nawabi, CEO

And Peter, we strongly believe in that business; it is a very profitable, reliable, and consistent business model. Both of those two businesses in the long run are going to be profitable like they were in the past. There are likely to be fluctuations, but the business models are sound. They are very reliable, and we expect them to improve in Q3 and Q4 as we go.

Kevin McDonnell, CFO

Yes. And their product mix over service mix is going to drive their EBITDA margins up.

Unknown Analyst, Analyst

And I assume the next piece of my question kind of goes hand in hand. But can you talk about the free cash flow for the second half of the year? Or do you have a full-year outlook for it as well?

Kevin McDonnell, CFO

Well, we've always tried to say that we can get our EBITDA cash conversion over 50% as the goal for the year. And I still believe that's an achievable goal.

Operator, Operator

Our next question comes from Andrew Madrid with BTIG.

Andre Madrid, Analyst

I wanted to dive a little deeper into the almost $900 million Army contract, IDIQ that you guys got. I think the initial award had said that it was primarily for small UAS and then you guys announced earlier this week that it also included COAS, namely the Titan. Can you tell us more about what the international opportunity looks like for these COAS platforms? I think this is the first time we've really heard about it. Also, can Locus be sold internationally? And broadly, how should we think about the margin distinction between domestic and international COAS sales?

Wahid Nawabi, CEO

So Andre, yes, the nearly $900 million sole-source IDIQ contract, multiyear, includes our products. It now covers Raven, Puma AE, Puma LE, but we could also sell our Titan counter UAS solutions as well as potentially future low-cost direct energy solutions. This is significant because the U.S. Army could have purchased these products under existing contracts, but they chose to add an additional contract for nearly $900 million to allow us to deliver more products over the next couple to three years to our international customers. So that's very positive news. Secondly, the margins for international sales historically and in the future will continue to be slightly more favorable than the domestic markets. Those customers do not buy as much as the U.S. DoD, and generally, the margins are a little bit better. If we sell FMS, the margins are not significantly better, but the best margins are international DCS sales. However, FMS has less expenses because we do not have the responsibility for exporting it; the U.S. military does. So we deliver the product to the U.S. military, and they deliver that to the international customer. The market opportunity internationally is massive for us, and we're really just at the beginning phases of that for our counter UAS, for directed energy, for our Switchblade, for one-way attack, and for our core products. We are just scratching the surface on those items, and some of them are starting with no international sales. The area where we're really strong is our small UAS, but we have tremendous potential here. I expect the international market over the next several years to grow significantly and be a major contributor.

Andre Madrid, Analyst

Got it. That's super helpful. And then maybe to pivot to Switchblade, I think you said that by next year, you could support capacity of $2 billion in sales. I think previously, the number you disclosed was about $1 billion. I just wanted to see what might be driving that difference.

Wahid Nawabi, CEO

Sure. So Andre, as we keep building these new factories, we're also improving in terms of automation and the ability for us to produce and ramp up production. As you know, we have been ramping up production for Switchblade significantly already. We've already doubled and tripled output over the last couple of years, and we're going to continue to improve it even further. The new facility we have now in Salt Lake City is going to come online later next calendar year, towards the end of next calendar year, and has the potential to achieve production levels above $2 billion with multiple shifts. If we reach that level, we'll exceed a $2 billion factory. I expect that to even go higher than that because there is so much more potential room for growth in terms of our automation and efficiencies in the production processes. Lastly, this factory is also very flexible. We can produce any variant of Switchblade, and we could also produce other products such as our one-way attack product solutions and our non-lethal UAS platforms. So we're setting the factory to be flexible and agile for a lot of our products, and we can shift production in that factory as we go forward.

Operator, Operator

Our next question comes from Trevor Walsh with Citizens.

Trevor Walsh, Analyst

Great. Maybe just on AV Halo a little bit. Wahid, great to see the new products, or the new, I guess, module being added on to that. Can you take a step back, though, around that whole product opportunity? Given all the different systems from both AV and other providers in the ecosystem that you're partnering and OEMing with, how much of that needs to work its way through the system in terms of getting those systems out into the field so that the customer can actually determine the right overall software packages to go with those? I guess it's another way of asking if you have these wins around AV Halo now, but is there a much wider opportunity that is going to materialize later, especially once the actual hardware piece is a little more locked down?

Wahid Nawabi, CEO

Yes, of course, Trevor. So let me provide some color on that. First of all, I'm really excited about the AV Halo suite of software solutions. It's not just one particular product. Think of it as a very robust and broad portfolio of solution sets, a software stack and an ecosystem that provides numerous capabilities with different modules. Halo Command, AV Halo Cortex, AV Halo Pinpoint, etc. We launched two new modules, and we're going to continue to launch more new modules. The best way to think about it simply is like the Microsoft Office suite of products, Excel, Word, Outlook; all these different modules are underneath the Office suite. The same applies to AV Halo. AV Halo has several modules. Regarding deployment, we already have thousands, if not tens of thousands, of some of their modules already deployed in the field. That is the beauty of our system that is fully interoperable and integrated. We've tried to bring the ecosystem cohesively together into one umbrella solution. Secondly, it is very open architecture, allowing us to integrate with any other platform, including competitor platforms, and interface with other systems and battle management systems. We believe that our solution set is incredibly well-positioned yet not fully understood, and we have a long way to go in terms of growth over the next several years. One example of that success story is the U.S. Army selecting us for the Human Machine Integrated Formation program. This is a critical program. We competed with larger companies and smaller companies attempting to replicate our model, but we won. The U.S. Army selected us. This means that future battlefield systems and controllers will use our systems, whether on ground, air, land, or sea. We are open, interoperable, and we will integrate with numerous other systems as required. We have a lot more coming in this area, and I can't be more excited about the future.

Kevin McDonnell, CFO

And we already support multiple platforms with our AV command.

Wahid Nawabi, CEO

We support more competitor platforms today than our own, actually. That's a testament to how open we are with our architecture and platform for our customers, and this is an advantage that most other systems do not have.

Operator, Operator

Our next question comes from Jonathan Siegmann with Stifel.

Jonathan Siegmann, Analyst

I appreciate managing the shutdown. I thought that was great. It's a really interesting time with signals flashing green here with a lot of intent about where we want to spend money, but with the shutdown causing a real wrinkle. Historically, your January quarter hasn't been the strongest booking quarter for you guys. I'm just wondering if there's going to be some additional friction this year. Do you anticipate that we just can't catch up with all this pent-up demand and funded orders? Is that a worry for you guys?

Wahid Nawabi, CEO

Yes, Jonathan, that's a very insightful comment. The reason we do not want to raise our guidance any further is due to the timing risk regarding when we will receive some of these task orders. Although the government has emerged from the shutdown, the budget for the fiscal year is not completely approved yet. We have funding available until the end of January. While we anticipate positive results in the upcoming quarters, the exact timing remains uncertain. We are confident that we will meet the guidance we have provided, and we will update you if there are any improvements beyond that in the next quarter. Overall, we performed well and are on track with our plans for the first and second quarters, exactly where we intended to be, even with the industry facing a month of government shutdown. We are satisfied with our results and look forward to the second half of the year. We have ambitious goals but believe we can achieve them, supported by our capacity, team, and the backing of our customers.

Operator, Operator

Our next question comes from Austin Moeller with Canaccord Genuity.

Austin Moeller, Analyst

Kevin, can you discuss how much of the backlog today is related to Ukraine and when that might convert? Similarly, how much of the backlog comes from European allies excluding Ukraine?

Wahid Nawabi, CEO

Well, Austin, we do not break down specific backlog by customer regions or by specific products. What I can tell you is that we have derisked and pivoted from Ukraine demand nearly entirely. It represents less than 5% of our revenue for the full year. Number one. Number two, so far, we're on track with our plans and international demand is still back-end loaded a bit because of the government shutdown and contracting processes; some of those FMS sales have not yet made it to actual contracts with us. Do we continue to get contracts? Yes. But there's a lot more to come in the second half and into the next fiscal year. Overall, our backlog remains strong. We have a $1.1 billion funded backlog, $1.4 billion in funded bookings. Our orders and visibility numbers are very strong, given where we are at the quarter.

Kevin McDonnell, CFO

Yes, we've been saying consistently that Ukraine should be less than 10% of our revenue for the year, and there would be no additional orders in our guidance for Ukraine this year. Therefore, if we see any additional business from Ukraine, that would be positive for us. However, we are not counting on any new orders for Ukraine in our forecast.

Jonathan Siegmann, Analyst

Okay. Just a follow-up. I know the genesis of Red Dragon was to enable international sales by having an open payload bay that was payload agnostic and not containing any ammunition. But do you expect Red Dragon could replace or take additional share from the Switchblade 600 over time with the U.S. military in a long-range anti-armor, anti-FC installation role?

Wahid Nawabi, CEO

Austin, no, the short answer to that question is no. We do not expect that to take share away from Switchblade primarily because they're designed for very different mission sets. The missions that loitering munitions such as Switchblade 300, 600, and now 400, are very different than the missions of one-way attack drones, such as our Red Dragon. Our family of Red Dragon is expanding. We believe both of those product lines are going to grow significantly over the next few years. The demand for those systems is robust from more than one service and customer. Therefore, I anticipate significant growth for both categories, and they are complementary in how they engage with different targets and mission requirements for our customers.

Kevin McDonnell, CFO

Yes, our current volumes. We're only going to see growth in all those products. Red Dragon may potentially grow faster, but that doesn't mean it's taking away share from the other Switchblade products.

Operator, Operator

Our next question comes from Pete Skibitski with Alembic Global.

Peter Skibitski, Analyst

I just wondered if you could level set us. I'm still a little confused about where we stand with the Army long-range reconnaissance contract. I know that you and Edge both got contracts in August, and then you announced another award yesterday. Are you guys sole-source now on LRR with the P550? Or is there going to be ongoing competition over the next few years?

Wahid Nawabi, CEO

More the latter, Pete. What the Army has done, and this is consistent with many programs within the U.S. Army and other branches of the U.S. DoD, is that the traditional concept of a program of record single winner probably is not going to be that common. They will likely pick at least two players, and from those two, they want to field systems and analyze performance. The supplier or vendor with better performance is likely to get the bulk of that program or requirement. We believe our solution set is the best performing. We have received very strong feedback from our customers, and they are satisfied with our systems. We announced a couple of awards, but we expect more. We are ramping up production in anticipation of more P550 orders from the U.S. Army, as well as additional international customers. We consider the P550 product a $1 billion-plus franchise for the company over the next several years, and I am personally very high on that product. In terms of what to expect going forward, will it just be us? Most likely not. But do we expect to capture a large share of that spending? Yes.

Peter Skibitski, Analyst

Got it. Okay. Very helpful. I appreciate that. And just on the P550 specifically, are you clear to export that internationally already? How many countries can you export it to? And how do you expect that to grow?

Wahid Nawabi, CEO

Yes, Peter, that's a great question, and that product line was developed from the ground up to be MOSA, or Modular Open Systems Approach, interoperable and compliant. Additionally, it was developed primarily with our own R&D dollars. Therefore, it is a non-ITAR product in its base configuration. There are modules within it that can make it ITAR, but we believe we can sell the P550 to almost every customer that purchases our Pumas and Ravens and other products today. The market for P550 internationally is nearly as large, if not larger, than our domestic market. I expect several international customers to come online and place orders for that capability later this fiscal year and beyond.

Operator, Operator

Our next question comes from Colin Canfield with Cantor.

Colin Canfield, Analyst

Maybe just figure it out in terms of cash and profitability. If we can think about the building blocks of EBITDA, I think the Q4 guidance on adjusted EBITDA assumes roughly the same ballpark combined with whole company pro forma results as last year. Can you walk us through how you think of the progression on SG&A and essentially how we think about that EBITDA step up versus the supply chain dynamics you’re focusing on? Additionally, I think the Street expects free cash flow to be close to breakeven this year. Does that require investment? Or can we assume this shipping and booking business can enable you to hit something like that in terms of free cash flow?

Wahid Nawabi, CEO

Colin, let me add color to this. We do expect Q4 to be our largest quarter; as I provided some color, almost 55% of our second-half revenues will be in the fourth quarter. Therefore, the overall volume in Q4 will be higher. Additionally, the mix keeps improving in the fourth quarter, from Q1 to Q2, and Q3 to Q4. This trend is overall very positive for Q4's performance. We expect SG&A and R&D spending to maintain relatively stable levels. The mix shift in volume will greatly impact profitability and will be more pronounced in the fourth quarter in that regard. We’ve provided full-year profitability numbers, and we're confident in those outcomes.

Kevin McDonnell, CFO

Yes, I gave color in my script on SG&A and R&D and margins for the year, so that’s how you reach that. It comes from improved gross margins as well as leverage on things like SG&A, partly because we'll realize synergies established in the first half but won’t see until later in the year. In terms of capacity, those numbers really represent where we’re at in terms of capacity, and we are increasing incrementally in many places in the second half of the year.

Colin Canfield, Analyst

Got it. And just to clarify, is it fair to assume that your free cash flow will break even this year?

Kevin McDonnell, CFO

Well, we're aiming for cash flow conversion to be over 50%. It depends on how we define all that, but I still believe that's an achievable goal.

Operator, Operator

It comes from Peter Arment with Baird.

Peter Arment, Analyst

Wahid, could you maybe touch upon the cash comment you just discussed? Precision strike product revenues were up 68% for the first six months of this year, but unbilled continues to grow. I thought we were under a new contract or payment schedule. Could you give us more color on what's going on there?

Kevin McDonnell, CFO

Yes, as we have discussed in many quarters, there has been a transition period. Changes in personnel are positive, and we feel that we are clear to begin reducing backlog throughout the second half of this year. Additionally, a large portion of our overall revenue is also increasing due in part to the BlueHalo acquisition, which factors into the equation here. Our focus remains on top-line growth, capturing opportunities, and ensuring we can deliver capabilities to customers because we anticipate further demand.

Wahid Nawabi, CEO

We need to build products in advance; we can't wait until the last moment. We're taking some calculated risks to position ourselves to deliver because we know our customers need these systems desperately.

Operator, Operator

Our next question comes from Austin Bohlig with Needham.

Austin Bohlig, Analyst

Congratulations on the strong order follow-through despite the government shutdown. My question is regarding the full-year guidance, particularly in light of the expected funding from OBD. Can I assume that any anticipated funding you expect has not been included in your current full-year guidance?

Wahid Nawabi, CEO

No, Austin, we expect multiple task orders and awards in the second half to convert into revenue. We are confident in our full-year guidance. To overperform would be difficult depending on timing and how long it takes to build the products, test and accept them by the customer and then deliver them. We have confident guidance, and we believe we can achieve our goals.

Austin Bohlig, Analyst

Got you. And what product line do you hope to secure contracts for? Is this precision strike, UAS, counter UAS?

Wahid Nawabi, CEO

So Austin, we expect a variety of key contracts and awards in critical areas that the U.S. DoD needs immediately. These include P550, more Switchblade and one-way attack drones, additional counter UAS, directed energy, and further SCAR and BADGERS. Those five or six categories make up most of the expected contract awards and orders in the second half.

Operator, Operator

Our next question comes from the line of Clarke Jeffries with Piper Sandler.

Unknown Analyst, Analyst

I wanted to ask, Wahid, how do the recent changes to missile technology control and treatment affect the current AeroVironment portfolio? Did any of those changes impact the $870 million IDIQ? It sounds like there was some focus on counter UAS in that contract, but I'm curious to hear what other key policy changes you would flag as crucial for growing the international business?

Wahid Nawabi, CEO

Sure. We expect that the recent change in policy is favorable. The new definitions from the U.S. Department of War that categorize drones, munitions, and one-way attack systems will be beneficial for us. They are easing the definitions regarding how these products are handled compared to true long-range missiles. As a result, uncrewed weaponized drones or FPVs are not classified the same way. This will benefit us significantly over the next two to three years. Additionally, the sole-source $870 million IDIQ is related to this, as the U.S. Department of Defense anticipates that we will supply numerous products due to demand from various allies. The U.S. Department of Defense is communicating with international customers to confirm the increase in demand for our solutions. We foresee a rise in demand for our offerings in international markets, including directed energy, counter-UAS, one-way attack drones, P550, and JUMP 20.

Denise Pacioni, Head of Investor Relations

Thank you once again for joining today's conference call and for your interest in AeroVironment. As a reminder, an archived version of this call, SEC filings, and relevant news can be found under the Investors section of our website. We hope you enjoy the rest of your evening and we look forward to speaking with you again following next quarter's results.

Operator, Operator

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