AeroVironment Inc (AVAV) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter Fiscal Year 2007 AeroVironment Inc.

Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the presentation over to your host for today's call, Director of Investor Relations, Mr. Steve Gitlin.

Please proceed, sir.

Thank you, Candice.

Welcome, everyone, to AV's third quarter earnings call.

With me today are the company's President and Chief Executive Officer Tim Conver and the company's Chief Financial Officer Steve Wright.

Before I hand the call over to them, please note that on this call certain information presented contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements and may contain words such as believe, anticipate, expect, estimate, intend, project, plan or words or phrases with similar meaning.

Forward-looking statements are based on current expectations, forecasts and assumptions that involve risks and uncertainties including, but not limited to, economic, competitive, governmental and technological factors outside of our control that may cause our business strategy or actual results to differ materially from the forward-looking statements.

Factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to, reliance on sales to the US government, changes in the supply and/or demand and/or prices for our products, the activities of competitors, failure of the markets in which we operate to grow, failure to expand into new markets, changes in significant operating expenses including components and raw materials, failure to develop new products, changes in the regulatory environment and general economic and business conditions in the United States and elsewhere in the world.

For a further list and description of such risks and uncertainties, see the reports we file with the Securities and Exchange Commission.

We do not intend and undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

The content of this conference call contains time sensitive information that is accurate only as of today, March 8, 2007.

The company undertakes no obligation to make any revision to the statements contained in our remarks or to update them to reflect the events or circumstances occurring after this conference call.

With that, it is my pleasure to turn the call over to Tim Conver.

Thank you, Steven.

Welcome to our first quarterly conference call, we're pleased to welcome our new public investors to AV, we look forward to establishing a long-term partnership with you.

Our initial public offering closed at the end of our third quarter.

By all measures it appears to have been a successful effort.

The road show provided us an opportunity to meet many interesting and interested people in the financial community, most of whom have become shareholders in AV.

The total institutional demand was heavily over subscribed and I'm pleased to report that over half of our employees participated in the IPO through a directed share program.

Results of our third quarter show significant improvement over the same period last year.

While revenue increased by over 30%, operating income increased by 111%.

Reductions in SG&A and R&D expense compared to FY 2006 favorably impacted our operating profit.

Our Unmanned Aircraft Systems or UAS segment revenue grew by 35% and PosiCharge revenue grew by 22%.

I'd like to review our segment performance in more detail, starting with the UAS segment, and that represented 84% of our third quarter revenue.

The $10.1 million increase in our UAS revenue over the same period in fiscal 2006 was primarily due to increased product sales, particularly of our Raven system.

For those of you new to our story, Raven, like our entire small UAS portfolio, is an unmanned aircraft system, it's designed to be man portable, launched by one person, operated through a handheld ground control unit.

It's electrically powered.

Configured to carry electro-optical or infrared sensors, fly quietly at speeds reaching 50 miles an hour using a replaceable battery pack.

These characteristics make our small UAS well suited for real time situational awareness, reconnaissance, surveillance, target acquisition and battle damage assessment operations.

These capabilities combined with our high level of service, logistical support and training and the overall value have created a strong demand among the military, and it's this demand that you're seeing in our numbers.

An important metric employed by the US Army to measure the performance of our Raven systems and our support capability is operational availability or Ao.

In forward locations our Ao remained well above our customers' target of 90%, ensuring that Raven systems are available and ready to perform their varied missions when and where they're needed.

The reliability of our products, which are used in the most demanding environments, remains a critical success factor for our small UAS business.

This high level of product reliability and capability contributed to a key contract win during our fiscal third quarter.

In December the US Air Force selected our Block III Wasp UAS to support its battlefield air operations kit.

This contract award, known as Battlefield Air Targeting Micro Air Vehicle, or BATMAV, represents the third time AV has won a full and open US DoD competition for small Unmanned Aircraft Systems for a program of record.

In fact, there have only been three such competitions to date.

The BATMAV win resulted in an IDIQ-type contract.

It has a $45 million ceiling over a five-year order period.

The basis of issue for this program is up to 1,000 systems with customers other than the Air Force able to add on contracts to this vehicle.

Other potential customers have already expressed significant interest in this product.

The three UAS development programs we identified in our prospectus, Digital Data-Link, SwitchBlade and Global Observer continue to receive customer funding, indicating continued customer interest.

In January the government distributed a notice indicating that the US Special Operations Command or SOCom intended to negotiate with us on a sole source basis for the development of our Global Observer system.

The SOCom announcement characterized this as a three-year up to $129 million program.

This is a joint capability technology demonstration program or a JCTD.

It's been approved by the office of the Secretary of Defense and Congress for a rolling start in government fiscal 2007.

Global Observer will be a unique, high altitude, long endurance unmanned aircraft system capable of providing 24 hour a day, 365 day a year persistence in the stratosphere.

GO builds on over 20 years of AV's development and flight experience aimed at affordable persistence in the stratosphere.

We continue to believe that Global Observer will offer a unique and a very valuable capability.

Other UAS systems of note from a research and development perspective include the successful military demonstration of our Digital Data-Link technology and the installation of our ground breaking Pathfinder-Plus solar powered UAV into the Smithsonian's Air and Space Museum.

Pathfinder-Plus is the fourth AV innovation to be acquired by the Smithsonian and it provided us with significant learning and technology that directly benefit our Global Observer development program now.

Funding for US DoD procurement for our UAS continues to come from various sources, including specific budget defense line items, embedded items, reprogramming and supplementals.

Steve will have more to say about backlog later when he talks to you.

Our continued pursuit of international business opportunities went on through the third quarter, the Italian Ministry of Defense ordered $4.9 million in Raven systems during the third quarter and this illustrates growing demand from allied military forces.

We also supported the Royal Australian Navy with the successful operation of our new Aqua Puma UAS from their new Armidale class patrol ship.

One benefit of Aqua Puma compared to other systems is that no modifications would be required to the ship enabling turnkey operations.

After the end of our fiscal third quarter we received an order from the US Army for over $53 million, this order represents over 350 Raven B systems and associated spares and support, it's for the Army, SOCom and the Marine Corps.

This is an order against the IDIQ-type contract that resulted from our winning the Army SUAV competition in the fall of 2005.

As we described in our prospectus, this contract vehicle provides for purchase of up to $331.9 million through the year 2010 and it also allows for contract additions from not only the US Army but SOCom, the Marine Corps or others.

The items in this particular order are planned for delivery through February 2008.

This order is a good example of the lumpy nature of our business that we've talked about.

Even though we're very close to our customers, in constant contact, orders under our IDIQ-type contracts can't be predicted with pinpoint accuracy.

The fact that this order came in later than we expected, makes production scheduling more of a challenge in the short term.

And revenue recognition between our fiscal '07 Q4 and our fiscal '08 Q1 will depend on how well we can schedule production and delivery.

Raven B now accounts for a majority of our UAS product sales.

It's important to note that our Raven system has now been adopted by the Army, SOCom, the Marines, the Air Force and foreign military services.

We provide our product support and training services to all these customers and this service business grows with the installed base.

With that said I'd like to move on to our PosiCharge segment.

Again for those of you new to our story, our PosiCharge systems are used in material handling applications where they fast charge electric utility vehicles like forklifts and other material handling vehicles to improve productivity as well as safety.

In multishift and heavy duty material handling operations, the batteries in these vehicles discharge during a shift.

Historically this requires operators to stop their productive work, drive across a large facility to a dedicated battery changing room where they have to replace a one to two ton discharged battery with a recharged battery for their truck.

PosiCharge technology eliminates that entire loss of productivity by fast charging those batteries during regularly scheduled breaks without ever removing the battery from the vehicle.

Our PosiCharge segment revenue represented 12% of the total company Q3 revenue and it grew by 20% compared to the same period last year.

Weakness in the US automotive sector continues to dampen overall PosiCharge growth, however our non-automotive PosiCharge revenue continued to grow, suggesting increased awareness and adoption of our solutions in newer industry segments.

In January PosiCharge introduced its Total Power Solution, this combines an expanded line of fast charging products along with a new integrated battery cooling module, our PosiNET Intelligent Fleet Management technology, new installation services and our unique applications engineering capabilities.

We believe this extended combination of products, engineering and installation services will provide our customers with even greater value and expand what was already the broadest range of products and services to satisfy the widest range of fast charge applications.

Our third segment is Energy Technology.

We experienced a slight revenue decline in the third quarter compared with the same quarter last year and gross margin also increased slightly.

In this segment of our business we provide contract development and engineering services, the sale of our power processing systems and we generate technology licensing fees.

The primary focus of this segment however is research, development and commercialization of innovative solutions based on efficient electric energy technology.

Energy Technology Center personnel are developing numerous innovative new solutions, although at this stage the rate and the amount of possible commercial demand can't be reliably assessed.

A primary example of our current development projects includes architectural wind, another development we identified in our prospectus, it's a renewable energy system utilizing a modular wind turbine design and that's fitted to individual buildings to generate and supply electricity for the building or for the grid.

We're just entering a beta test phase for this technology.

Our technology center is supporting other UAS and PosiCharge businesses with key efficient electric energy technology developments.

Now Steve Wright, our CFO, will provide you with further details of our third quarter financial results.

Thanks, Tim, good afternoon.

I'm going to discuss our third quarter and year-to-date results, beginning with fiscal 2007 third quarter.

Revenue for the third quarter was $46.3 million, an increase of 30% over third quarter prior year of $35.5 million.

Looking at revenue by segment, UAS revenue was $38.8 million, an increase of 35% over the prior year.

This increase resulted from higher manufacturing volume associated with completion of customer tests and evaluation of Raven B. PosiCharge revenue was $5.4 million, an increase of 22% over Q3 last year due to higher installations of fast charge systems for the reasons Tim discussed.

And lastly Energy Technology Center revenue was $2.1 million, a decrease of 12% from Q3 last year due to lower revenue from power processing test equipment.

Turning to gross margin, gross margin in the third quarter was $19.6 million compared to $15.5 million in Q3 of the prior year.

Gross margin as a percentage of revenue was 42% compared to 44% in Q3 last year.

By segment, UAS gross margin was $16.7 million, up 33% from Q3 of last year and as a percentage of revenue, UAS gross margin was 43% compared to 44% in Q3 last year.

PosiCharge gross margin was unchanged at $1.9 million.

However as a percentage of revenue, PosiCharge gross margin was 35% versus 42% in Q3 last year and this reduction was primarily due to higher manufacturing support costs.

Energy Technology Center gross margin was $1 million, a decrease from the Q3 prior amount of $1.1 million, due again to lower sales of power processing test equipment.

And as a percentage of revenue, Energy Technology Center gross margin grew from 47% to 49%.

SG&A expense for the quarter was $4.2 million.

This amount was net of the reversal of our Supplemental Executive Retirement Plan, or SERP, of $2.2 million.

Excluding the SERP reversal, SG&A expense was $6.4 million or 14% of revenue compared to Q3 of prior year of $5.8 million or 16% of revenue.

The increase in SG&A in absolute dollars was caused primarily by added admin and marketing infrastructure necessary as we grow our business.

R&D expense for the quarter was $2.2 million compared to $3.5 million for Q3 of last year.

The reduction in R&D expense was primarily due to a shift of engineering resources towards customer funded R&D projects.

And operating income for the quarter was $13.2 million or 28% of revenue.

Operating income is up 111% from the prior year Q3 and this improvement was due to higher gross margin, lower SG&A and lower R&D expense.

Net income for the quarter was $8.9 million or $0.57 per fully diluted share compared to 4.4 million or $0.29 per fully diluted share in the same period last year.

Moving next to year-to-date results.

Revenue for the first nine months of our fiscal 2007 was $123 million, up 13% from the prior year period of $108.8 million.

By segment, UAS revenue was $101.6 million, up 17% from the prior year period due to increases in UAS product revenue of $6.1 million, services revenue of $4.9 million and customer funded R&D of $4.1 million.

PosiCharge revenue for the first nine months was $14.9 million, a reduction of 8% from the prior year period.

This reduction was largely due to weakness in the automotive market.

Lastly, Energy Technology Center revenue was $6.5 million, up 6% from the prior year period.

Gross margin for the first nine months was $49.4 million compared to $44.3 million in the same period a year ago.

Gross margin as a percentage of revenue was 40%, a decrease of 1 percentage point from the prior year period.

By segment, UAS gross margin was $40.5 million, up 16% from the prior year and UAS gross margin as a percentage of revenue was unchanged at 40%.

PosiCharge gross margin was $5.7 million, a decline of 13% from the prior year primarily due to lower revenue and higher manufacturing support costs.

And as a percentage of revenue, PosiCharge gross margin was 38%, a decline of 3 percentage points from the prior year period.

Energy Technology Center gross margin was $3.2 million, up 12% from the prior year.

SG&A expense for the first nine months was $17.1 million and again this amount included reversal of expenses associated with the SERP of $2.2 million.

Excluding SERP reversal, SG&A expense was $19.3 million or 16% of revenue compared to prior year period of $17 million, also 16% of revenue.

R&D expense for the first nine months was $9.3 million versus $10.6 million in the prior year.

As a percent of revenue, R&D was 8% versus 10% last year and the reduction of R&D again was caused by shift of engineering resources away from independent R&D and towards customer funded R&D projects.

Operating income for the first nine months was $23 million or 19% of revenue.

Operating income up 38% from prior year primarily due to the margins and lower R&D expense.

The effective tax rate for the first nine months was 35.7%, up from the prior year of 30%, and this increase was largely due to lower Federal research and development tax credits.

Net income for the nine month period was $15.1 million or $0.98 per fully diluted share compared to $11.7 million or $0.79 per fully diluted share last year.

Turning next to backlog, funded backlog at the end of the third quarter was $43.2 million compared to $79.7 million at the end of our last fiscal year and compared to $48.2 million as of the end of Q3 a year ago.

Turning next to our balance sheet, cash and cash equivalent at the end of the third quarter grew to $108.2 million from $15.4 million as of our last fiscal year end.

The increase in cash was primarily due to proceeds received from the public offering of $80.5 million, net of expenses, and cash provided from operating activities of $12.6 million.

At the end of the quarter our accounts receivable, including unbilled receivables, were $28.8 million, up $2.4 million from our last fiscal year end.

Total days sales outstanding were approximately 56 days compared to 78 days of our last year end.

Taking a look at inventory, inventories were $10 million at the end of the third quarter compared to $11.5 million at the end of our last fiscal year, and days in inventory were approximately 34 days versus 57 days at the end of last fiscal year.

Turning to capital, capital expenditures for the first nine months of fiscal 2007, we invested approximately $1.7 million in property improvements and capital equipment compared to $2.6 million for the prior year.

Now I'd like to turn things back to Tim to discuss expectations for the remainder of the year.

Thanks, Steve.

In summary I think the team performed very well during the third quarter.

We continue to execute our plans, our customers are continuing to benefit from our solutions and reward us with their business.

Of course we don't think this is an accident, we have continuous interaction with our customers giving us feedback on what they're looking for in terms of upgrades, improvements and new capabilities.

Customer value delivered by our UAS products has further embedded them into the military as a standard part of their training, equipping, tactics and procedures.

Our PosiCharge products are becoming a recognized productivity solution in manufacturing, distribution and material handling applications.

The engine of AV's long-term future is our ability to innovate.

At the core we're a technology company.

I think that our people continue to be the best in the world at what they do, and in addition to being highly talented, motivated and innovative.

They're skilled at developing new solutions that deliver entirely new value propositions and ensuring that our customers are successful when they adopt our innovations.

Based on the demonstrated demand for our existing small Unmanned Aircraft Systems and PosiCharge product portfolios and the pipeline of innovative solutions in development, I think AV is well positioned for long-term growth.

As I said earlier, we sometimes experience lumpiness in order activity from quarter to quarter.

The timing of the Army Raven B contract I talked about earlier is a classic example.

However, looking forward to the end of our fiscal year in April 2007, I anticipate full year revenue growth of between 20 and 25% over our revenue for fiscal 2006 and an operating income margin for the full fiscal year of 15 to 16%.

We thank you for your interest, we look forward to reporting to you following the end of our fiscal year, probably sometime in July, at which time we expect to be able to provide an initial look for 2008.

At this point Steve and I would be pleased to answer any of your questions.

[OPERATOR INSTRUCTIONS] Our first question will come from the line of Troy Lahr of Stifel, Nicolaus.

Please proceed.

Thanks.

Can you talk a little bit about the contract for Raven that you got in the quarter?

I guess you said it was a little late and you thought you were going to have to work pretty hard to get that in the fourth quarter to get that through to revenues, can you kind of elaborate on that a little bit?

Well we did expect it earlier and it, for various reasons, just continued to slide and we have I think done a good job of anticipating the supply chain requirements.

In any event, the team is focused on playing catch up so that we can report our customer requirements, even though the order came in later than we thought.

But it did come in quite a bit later and it just means that it's going to be more of a challenge than normal in getting those first delivers out when we expected them.

Okay.

And on R&D you talked about how it's a little lower because the customers are picking up some of that now.

Is that going to be going forward also?

Is this kind of a new level we would look at, the 5% of sales?

No I don't think so, Troy.

I think it's just the natural ebb and flow of the combination of internally funded and customer funded R&D and I don't think it changes our long-term expectation of where those percentages shake out.

Okay.

And last question, can you just break out how have you charged, maybe how much is auto versus non-auto or maybe just help us understand the mix there?

I can do that.

Yes PosiCharge year-to-date is about 28% auto.

For the same period last year it was about 70% auto.

Great thanks.

Our next question will come from the line of Brian Gesuale of Raymond James.

Please proceed.

This is Matt for Brian, good quarter, guys.

First question, could you give a full backlog number please?

Including unfunded backlog?

Yes.

Yes. $531 million is the unfunded backlog piece that would be additive to the funded.

Okay.

And I guess my next question is about an update on SwitchBlade, if you could give us detail on the development and if and when you would see production, or just in general who is interested and a little color on that?

Well SwitchBlade, as you probably recall, the majority of the funding on SwitchBlade has converted from internally funded R&D to customer funding.

We're very pleased on the development progress.

We're moving ahead hitting all of our accelerated internal milestones.

We haven't announced who the customer is that's funding it and there's not any announced final delivery schedule, but we're very pleased and I think our customer is as well.

Okay the last one, going with the Aqua Puma with Australia with the release that you guys completed trials in Australia, I was wondering if any feedback that they gave that could key us in on what we could expect with that product in the future?

Well I'm trying to think, Matt, what the customer said publicly and I'm having trouble recalling that.

I know that all of our direct feedback was extremely positive and I believe that they have decided they need a small UAS capability on that class of ship, or at least it appears that they're reaching that conclusion as they do this evaluation process.

Okay.

Well thank you very much.

Thank you.

Our next question will come from the line of David Gremmels of Thomas, Weisel.

Please proceed.

Actually this is [inaudible] in for David.

The first question I had was, within UAS, do you have a mix of production versus support revenues for the quarter?

Within UAS the mix of product and support revenue is very similar to total company levels, which run approximately 70% product 20% support services and then approximately 10% for project R&D.

Okay great.

And just drilling down a little further on R&D, while you said your long-term goals aren't affected in the shift in resources this quarter, do you expect it to at least carry over to next quarter at the same levels?

Well we're not guiding in individual line items within the P&L, although I think the guidance that we did provide we would expect some additional investment in R&D in the balance of the year.

Okay great.

And on the longer-term picture, were there any surprises in the budget with all the supplemental detail that's come out with the submittal?

I know there was a line item for Global Observer in the fiscal '08 supplemental, is there anything else that's kind of caught you by surprise?

I think we're happily surprised that we're seeing our products in the budge line up.

In the past our products have been hidden within other line items or we get our funding through reprogramming and supplementals, and now we're starting to see our products as programs of record and line items in the budget so we're pleased by that.

Okay great.

And there was a call recently, I guess they were talking about increasing Army and Marine Corps strength by 92,000 soldiers over the next five years, does that create more of an opportunity for AeroVironment?

Well I think the small UAS are primarily used by ground forces, and the more feet or boots on the ground I think implies more demand for the small UAS tools that they use.

Okay great.

Thank you so much.

You bet, thank you.

Our next question will come from the line of Howard Rubel of Jefferies & Company.

Please proceed.

Thank you very much, just a couple things.

First Tim, could you bring us up to date where you are with respect to the negotiations of Global Observer?

Well Howard, you know we have that announcement from SOCom, there's a 40-day waiting period that they have by regulation once they've made a public announcement and so we expect they'll begin to do what they said they were going to do.

And we don't have anything to announce now other than that as soon as something newsworthy happens definitively, we'll be up letting you and others know exactly when that happens.

There's nothing that makes us believe that they intend to do anything other than what they said.

All right.

So I'm just going to go one step further until you tell me otherwise, the way this could play out is we could see some work start at some point late in this current quarter?

Or would it begin, if in fact you do get the award, would we have to wait until the first quarter of fiscal '08?

Well timing of when the customer would actually definitize a contract is, as you know, up to them and it's hard for us to predict.

We do have ongoing funding supporting the risk reduction and testing and some elements of development associated with that program.

So it's not like we go from a zero to a one with the new JCTD start.

But it also here is a case where you would be able to go possibly from some spending on your own money to all of a sudden have engineers be spending on what would be part of customer funded R&D going forward?

Well that's actually largely happened already, Howard, that was one of the major transitions over the last number of months in terms of switch from early when we first put out our S1 and identified Global Observers as a development program.

At that time it was predominantly funded by IR&D and for some period of time now it's been predominantly funded by customers.

Okay I appreciate that.

And then to go back to this issue, you're sort of telling us there's some risk with respect to we'll call it Raven being in production between Q3 and Q4.

And I wonder if you could just flush it out a little bit more in terms of it came in later and while it might have to do with stuff that we may not care about, why given the continual rate in which you're building the aircraft that there will be I will call it a disruption?

Well our normal lead time from order to initial delivery is X number of months.

So if we have X minus a couple of months, that just makes it more difficult to get the supply chain completely spooled up and everything on line in time for the initial deliveries that we would like to make for our customer needs.

Yes and I think we are just trying to recognize the factory throughput in terms of the range on the guidance, which is not a large range, but we're trying to get some recognition to that throughput issue.

Right.

And so the variability is you could be flat sequentially to up nicely, if we were to look at the UAS numbers?

Well quarter-to-quarter, but again that's why we've been saying that we're variable quarter-to-quarter and we feel better about giving annual guidance and achieving annual growth.

So 20 to 25% annual growth is where we feel comfortable.

I have just two final items very quickly, one is have you started to deliver BATMAV, is that correct?

Or did I not hear that right?

We have the BATMAV contract that started out with a cost plus contract, a smaller cost plus contract, and the production task orders against that IDIQ are yet to be let, much the same way that the Raven B contract started out.

So no production deliveries yet.

So it's be prototype development and testing on that initial order and then we'll move on after that is our expectation.

We'll get something in '08 then for first deliveries?

That's our expectation, yes.

And then the last thing is on taxes, if I'm not mistaken, if I did the math, it was a 33% number in the quarter?

Yes.

We had an adjustment for a Section 199 tax item, 35.7 year-to-date, and we're still thinking 36 to 37% for the year.

Okay thank you very much, gentlemen, very nice numbers.

Thank you.

Thanks, Howard.

Our next question will come from the line of [Richard Dufferin] of Goldman Sachs.

Please proceed.

Hi, good afternoon.

Hi, Richard.

Just generally speaking, I'm understanding where you're at right now with SwitchBlade, I just wanted to know if you could tell us notionally how does it take generally to ramp up on a program like that, assuming you got the contract et cetera?

Well, I guess in terms of development maybe a typical small UAS development program for us you might think in terms of a year.

And then ramping and production is, I don't know that there's any hard rule of thumb, but we have within a less than a year period have gone more than an order of magnitude in terms of volume development historically.

Okay.

I hear an ambulance in the background or something, I hope that's not --.

That's another risk factor.

Yes just hoped everything was okay.

The gross margin seemed quite a bit higher than I had thought and I was just wondering if there was anything going on in Unmanned Air Systems that was driving your costs our anything there?

No.

Well gross margins are good, down a little bit from last year but more or less sequentially flat.

I think the fixed price content is a little bit higher than we might have been expecting earlier on, and then we've had some good performance on some of our fixed price line item contracts.

Okay.

So it is a bit better contract.

Okay the last thing is could you give me an idea of what you think share count's going to be next quarter?

We have 18.2 million shares issued and outstanding and when you add the dilution of course you know we have 3.5 million options, but when you go through the calculation of dilution that equates to roughly 2 million, 2.1 million of options on top of that.

Okay thanks very much.

Thank you.

Thanks, Richard.

[OPERATOR INSTRUCTIONS] Our next question will come from the line of Randy Gwirtzman of Baron Capital.

Please proceed.

Hi good afternoon, guys.

Hi, Randy, good to hear from you.

Thanks, good to be on the call.

On Global Observer, I don't know if I can just probe a little bit more just based on what's out there, but obviously you guys are waiting, I guess you said there's a 40 day period from the January notice date on the Global Observer, is that correct?

Yes.

And I think that's either up or nearly up now.

Right, okay.

And then so if you guys are theoretically awarded the contracts, what's the timing of the revenues?

How does that tie into the $75 million request in the fiscal '08 budget that SOCom has made?

And where do the revenues flow through?

Is it R&D or is it product?

And what kind of margins would be expected on that kind of work?

I'll take the last part of that.

The revenues, this will start out as a development program, design development test and delivery of some initial number of systems and it would, as a result, start out as project R&D.

The contract type is TBD and so we're not in a position to really talk about the kind of margins that we would get.

But they would probably be at the gross margin level in the mid 30s somewhere.

Okay understood.

And in terms of the timing of revenues, obviously a three-year program for development and I think if I understood the tale behind the fiscal '08 request, within the next year or two there's going to be a prototype developed, at least one, as part of that program.

Do the revenues under the test and development contract accelerate kind of [nearby] to get the program rolling with that $75 million line up?

As Tim mentioned earlier, we're taking revenues now, because we do have some project R&D contracts in place for this.

Snd the timing of revenues, when we get started the revenues would happen almost immediately because this is not a product delivery, we don't take revenues at the end, we'd be taking revenues percent complete as we go.

Okay understood.

But they should accelerate materially I would think, given the size of the contract, in the fiscal year.

I've seen articles that talk about current funding, I don't know whether they're right or not, but it talks about 6 million-ish for this year.

I don't know if that's all or part correct.

Yes I think you generally have it right, Randy, the current level of funding is lower than the level of funding we would expect if this JCTD contract were awarded and funded.

And then I think we think there's some variability in how much gets funded when on that JCTD program, but we expect it to be about a three-year program, as the SOCom announcement indicated.

And in any event, if it is funded, it probably even at the lowest probable level would increase the current level of R&D funding that we've had supporting that program.

Got it.

Okay that's what I was kind of driving at, thanks very much for that help.

In terms of, I'm going to ask a question nobody's talked about too much, architectural wind?

Yes.

It seems like a neat project, could you just tell me a little bit about what the beta site testing that you've done entails and how close you are to maybe commercializing the product?

Well it's clearly still a development program, I wouldn't characterize it as being particularly close to commercialization.

We have had the first generation of that technology up and installed on a customer facility where we and they have been evaluating how it works.

We have the second generation up and installed on facilities where we're evaluating it, and I think we are well along the way of getting a third generation of the architectural wind product in a position to get installed and evaluated.

We have a couple of funded programs with customers where we will be installing either second or third generation architectural wind units on their facilities for what I'm referring to as beta testing.

The technology seems to be working well, customers seem to be very interested in it, but it's a completely new technology, there's still a lot to be evaluated from a business perspective.

But we continue to think a lot of it.

So the reliability has shown to be very good and the power generation is kind of up to spec?

Yes.

With the caveat that we're very early and we haven't got a lot of time under our belt in multiple installations, but having said that we don't see any major problems popping up in terms of reliability.

Well that's very neat.

I'm looking forward to hearing more about that product.

I just had a couple quick housekeeping questions, the tax rate going forward, I know there was kind of a strange R&D tax credit issue with Congress where the legislation was delayed.

But going forward your normalized tax rate would be what?

37 we think, 36 to 37.

Okay so that's normalized.

Yes that reflects the reinstatement of the Federal R&D credit.

Okay.

And the SG&A line, which is normalized at $6.2 million, did I understand the discussion correctly?

Well what you have in the press release is the accounting numbers.

During the period we reversed the Supplemental Executive Retirement Plan funding, since the terms of that agreement called for it to go away at the IPO.

And so to get more of a normalized number you would add $2.2 million to the SG&A.

Okay.

But go forward the actual dollar amount of SG&A is more in the $4 million range because that accounting item is no longer included?

SG&A in Q3 was 4.2, so $6.4 million would have been what we would have obtained in Q3 without the SERP.

And we're not really predicting what SG&A will be period-by-period, we are keeping guidance just at the operating income level.

Okay, understood.

But I guess you are ramping up, I know you're hiring because your website has a hiring line, so usually there's more personnel costs.

But --.

Yes that will hit cost of goods sold as well as R&D and SG&A.

You know we continue to build infrastructure coincident with the growth of the company, so we would expect growth in many of the areas including SG&A.

Got it.

But the baseline now, the $4.2 million plus hiring and presumably the $4.2 million also includes some FAS 123 expense?

Very little, $32,000 of FAS 123 expense year-to-date.

Only the option grant that we made last September is generating FAS 123 expense and it's maybe $10,000 a month.

It's de minimus.

And that's on a go-forward basis?

Yes.

And that is a little bit, probably the majority is in SG&A, but there is some in cost of goods sold as well.

Thank you very much, guys.

Thank you.

Thanks, Randy.

Our next question will come from the line of Brian Gesuale of Raymond James.

Please proceed.

Just a couple of quick questions, sorry about this, but the BATMAV contract that you guys won, was that a big surprise?

Or what kind of contract was that and what kind of margins, in the rough range, would you expect on that?

That's an IDIQ and we're typically not going to be talking about margins program by program.

Today we've only seen the starter or cost plus contract let against that.

We would expect that, go forward, when the production task orders get let that those would be fixed price.

Okay.

And could you, I'm sorry I missed this part, but talking about the share count again, so with the 2.1 you said like the 3.5 million in options and then that equals about 2.1 million in the shares.

So just help me do the math on this, you get like a year share count roughly?

Why don't we talk next year about share count, because share count this year is pervaded by the fact that the IPO happened on the last day of the last quarter and it pervades the averages.

You know you can look for something like 21.3 million shares fully diluted on average in fiscal year '08.

And if you want some guidance on how to calculate the average for fiscal '07, we can do that offline.

Okay.

All right, thanks very much, that's it for me.

Our next question will come from the line of Howard Rubel of Jefferies, please proceed.

Sorry to do this, just two quick ones.

One is you have $108 million in cash, sort of two things, one is what kind of rate are you getting on it as you invest it?

And then second, are there any plans to spend any of it for either acquisition or anything else strategic in the intermediate term?

I'll take the first part, since the IPO we established a new relationship with Credit Suisse to manage our funds long term.

We're continuing our relationship with California Bank & Trust to manage our disbursements and short-term funding needs.

Today we're getting about 3.6% after tax, it's all invested in short-term high grade municipals in fact today.

And Howard, as to what we might be using the cash for, we don't have any current acquisition plans.

As we've talked in the past, we think we'll have some working capital needs, we've got a number of organic growth opportunities out in front of us and we think this flexibility in financing, the ability to take advantage of those growth opportunities will be beneficial.

We haven't got a specific plan to give you any particular guidance on.

No I appreciate that, that's great because all of a sudden you don't want it to burn a hole in your pocket.

Right.

The last thing is, strategically you've got some very interesting energy technology, whether it be with solar cells on Global Observer or whether it be what you're doing with PosiCharge or architectural wind.

What other interests are you finding from customers out there that are saying, "Gee I can put this together for a system," or whether it's batteries or energy management or something else.

Yes, let me say first that the Global Observer currently has no solar energy capability.

We had two different recent programs where we were flying solar aircraft or aircraft at the end that was Pathfinder-Plus and then Helios.

And in the latter stages of the Helios program that we did with NASA we had incorporated fuel cell engine capability with hydrogen on board to augment the solar energy generation from the wing.

Global Observer is designed, at this point, to operate without any solar cells, so it's all hydrogen and oxygen fuel systems.

We're compressing the air and we're carrying hydrogen up.

But beyond that there are, as you suggest, a lot of areas where efficient electric energy technology is of interest both to us and a number of other potential customers or partners, and we're doing quite a bit work with funded programs as well as internally funded programs in different applications.

But we've only identified architectural wind out of all of the development work that's going on in that efficient technology sector, primarily because it's relatively early in the development or commercialization stage and we just think it's better to keep our powder dry in those areas.

All right .Thank you for the help on the first and I appreciate the effort on the second, Tim.

Great.

Ladies and gentlemen, this concludes the question-and-answer portion of today's conference.

I will turn it back to management for any closing remarks.

Well I think we've exhausted our remarks.

We really do appreciate the interest and the questions and the opportunity to develop what we look forward to as a long partnership with public shareholders.

So with that I think AV will exit the conference and thanks again.

Thank you for your participation, ladies and gentlemen.

You may now disconnect.

Have a wonderful day.