AeroVironment (NASDAQ:AVAV) missed Q1 EPS expectations (-$0.18 reported vs. the Street at -$0.09) as its gross margin declined 110bps year-on-year to 27.2% due to higher cost and service related contracts. Fortunately, this margin pressure does not look secular as AeroVironment reiterated its 34.5-37.5% FY15 gross margin guidance. Hence, we would focus our attention on the quarter's positives, i.e. revenue growth which came in slightly above expectations at +18% and bookings which were up both sequentially and year-on-year (+25% and +6% respectively). AeroVironment CEO gave additional color on the backlog during the conference call as he commented that strong bookings were continuing ("$52m booked in the second quarter to date") and that there was a good pipeline of future orders.
In our view, this Q1 miss is a small bump on the road and is unlikely to derail the equity story. In our previous articles, we explained that the expected development of the commercial market was a major growth avenue for drone makers, with many high-profile initiatives currently under way (such as Amazon (NASDAQ:AMZN) and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) testing drones for delivery purposes). Interestingly, AeroVironment CEO cited opportunities in oil and gas, agriculture, mining, public safety, border patrol during the conference call. For the time being, the Federal Aviation Administration bans the commercial use of drones but said recently that it would soon revisit the commercial use of drones and potentially put new rules in place by 2015. In our view, commercial contracts are likely to become big as soon as FY16 and to feed the earnings beat momentum in a few quarters.
In all, we remain confident in the stock's EPS upside potential in view of emerging commercial applications for drones. And we reiterate that AeroVironment could attract M&A attention soon, specifically from tech giants seeking to offer new services to their customers and to catch up with Google which is moving fast on drone-based services.
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