As our calendar year moves speedily toward its close, so does AeroVironment's (NASDAQ:AVAV) first year as a public company. Upon reporting its fiscal Q2 2008 numbers Tuesday afternoon, will the unmanned aerial vehicle maker's stock soar, or crash and burn?

What analysts say:

  • Buy, sell, or waffle? Six analysts keep AeroVironment on their radar. Two rate it a buy, and four more a hold.
  • Revenues & earnings. On average, the analysts expect AeroVironment to report $0.21 per share in profit, on $50.7 million in sales.

What management says:
Recent 8-K filings out of AeroVironment (AV) take a "just the facts, ma'am" nature. Only two such filings have surfaced since the company reported a bumper crop of profits last quarter, and both promise further profits to come. The first, which appeared in September, announced a contract win that could be worth $108 million to AV over the next three years, as it works to help the United States Special Operations Command develop up to three unmanned "Global Observer" aircraft -- a new spy plane that will patrol the stratosphere (literally) for a week at a time before needing to land. (I'm not entirely sure of this, but the Global Observer project may have something to do with another story I discussed in late September, concerning the dogfight between Lockheed Martin (NYSE:LMT) and Northrop Grumman (NYSE:NOC) over which of their products does a better job of stratospheric spying.)

The second contract, smaller in size and more down-to-earth, was a $19 million deal to supply U.S. troops at the platoon level with an unmanned aircraft capability of their own -- AV's Wasp III "micro air vehicle." Small as it is, $19 million is still about 10% of what AV sells in a year. So this one makes the grade as "material" as well.

What management does:
Hey, remind me -- as a company sells more stuff, isn't that what we call "scale," and aren't companies supposed to earn better margins as they gain scale? I have to wonder, then, why AV's gross margins continue to erode, even as the contracts roll in. Operating and net margins are catching an updraft, granted, but the declining gross margins do have me a bit nervous. (Did I mention that I'm an AV shareholder myself?)

Margins

4/06

7/06

10/06

1/07

4/07

7/07

Gross

40.7%

41.0%

40.4%

40.2%

39.4%

38.3%

Operating

13.0%

12.8%

12.2%

15.9%

16.3%

16.2%

Net

8.0%

8.0%

7.1%

9.5%

11.9%

12.1%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
What distresses me most about AeroVironment, however, concerns neither of these GAAP accounting measures of profitability. Instead, it's the relationship between AV's "accounting profits" and its free cash flow. Over the last 12 months, AV has earned $5.7 million in free cash flow -- just a fraction of the $23.2 million the company has reported in net earnings.

For the most part, the shortfall in free cash flow seems tied to the increasingly stratospheric figures for accounts receivable; they've nearly doubled over the past year. Granted, sales are up even more, growing 119% in the most recent quarter -- a pace that also surpasses inventory growth of 49%.

But given my druthers, I'd much rather see this firm pulling in more free cash flow than it reports as "profit," instead of the other way around. After all, defense-contracting rivals like Boeing (NYSE:BA), L-3 (NYSE:LLL), and General Dynamics (NYSE:GD) accomplish that feat routinely. So come Tuesday, I'll be looking first and foremost for improvement in this regard.

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Fool contributor Rich Smith owns shares of AeroVironment. The Motley Fool's disclosure policy is cleared for takeoff.