AeroVironment Inc (AVAV) 2008 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter and full fiscal year 2008 AeroVironment earnings conference call. At this time, all participants are in a listen-only mode. We will conduct a question and answer session towards the end of this conference. As a reminder this, conference is being recorded for replay purposes.

With us today from the company is Chairman and Chief Executive Officer, Mr. Tim Conver; Chief Financial Officer, Mr. Steve Wright; and Director of Investor Relations, Mr. Steven Gitlin. Now at this time, I would like to turn the presentation over to Mr. Gitlin. Please go ahead, sir.

Thank you, Dustin. Welcome to AV's fourth quarter and full fiscal year 2008 earnings call. Before I hand the call over to management, please note that on this call, certain in formation 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 U.S. 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, June 24, 2008. 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's my pleasure to turn the call over to Tim Conver.

Thank you, Steven. Welcome to our fourth quarter and full fiscal 2008 conference call. On April 30, we completed our second fiscal year end as a public company and our solid organic growth is once again in line with our targets.

At the beginning of FY '08 we said we expected 20 to 25% revenue growth with 12 to 14% operating margin. Continued strong demand for our products and services made for a record fourth quarter revenue of 64.3 million and a total FY '08 revenue of 215.7 million. This represents a year-over-year revenue growth of 24%, with an operating margin of 13%.

Doing what we say continues to be a core value of the company in all of our relationships. In addition to delivering the financial results and supporting our customer needs, we made significant progress positioning the company for future growth across our businesses. Here are eight examples of that progress.

We successfully transitioned WASP three into a full rate production in support of the BATMAV program with both the U.S. Air Force and the U.S. Marine Corps, placing orders for these systems. We won a competitive award to develop our Global Observer, Stratospheric persistent UAS, under a $57 million joint capabilities technology demonstration program.

We grew our UAS spares and repairs business in support of the growing number of our Raven and Wasp systems used by our customers. We added to the number of international Allied military customers for our small UAS. We achieved important milestones in several technology development programs, including Global Observer, Switchblade, and Digital DataLink.

We managed to increase and expand the number of architectural wind early adopter systems purchased by our customers and installed on their buildings. We successfully demonstrated our PosiCharge technology, as fast charge infrastructure for on-road electric vehicle demonstrations in both the United States and Europe. And we grew our human resource strength, which is the source of the high value we deliver to customers, while maintaining a culture of innovation, agility and customer responsiveness.

These developments position us well to address what we believe are two important long-term global trends. One, the increased security and economic value of ISR, communications and force protection that is driving the adoption of UAS. And two, the increased economic and environmental value of energy efficiency, which we believe will drive the adoption of clean energy and clean transportation.

With these accomplishments as a backdrop, I would like to take a little more time than usual on this call to address two broader issues that may be on the minds of our investors, especially in the short-term. By far the most frequently asked question we receive when we speak with investors relates to, what will happen as a result of a drawdown of U.S. troops in Iraq as it relates to our small UAS business? Here's my view.

First, it's clear that UAS are here to stay. Newsweek's recent headline quote "the hundreds of drones cruising over Iraq and Afghanistan have changed war forever," end quote, is a good summary. The effectiveness of our small UAS is not limited to the mountains of Afghanistan or the cities of Iraq. These systems provide unique value wherever our ground forces operate.

Our customers have each determined that they require this capability throughout their force structures. We believe they will continue to buy these systems whether we are fighting a war or training, similar to the adoption of other breakthrough technologies, like night vision. We have found a congressional support for affordable force protection is widespread and bipartisan and we believe that any administration will provide similar support.

If a drawdown in U.S. forces from Iraq does take place, we believe it will take sometime to complete and that it will require tools such as our systems that protect our troops during the process. The main driver for our spares and repairs revenue is total flight hours of our aircraft. We believe the number of aircraft in use will continue to increase, even if the ops tempo decreases due to drawdown, reduces flight hours on each airplane.

In that scenario, we believe the net effect on our spares and repairs business is unclear, but I think the net result will be determined primarily by the total use of the system. Finally, we believe that the new UAS capabilities that we're developing and the new markets and applications that are emerging, will continue to drive UAS market growth and our revenue growth.

The second question we're often asked is what will happen when we face significant competition, which I believe refers to competition from large prime contractors. It's important to remember that each and every full and open competition we've entered has included a significant number of competitors, including large aerospace prime contractors.

We've managed to win each of the three competitions for DOD programs of record to date, as well as the one and a half-year competition for the Global Observer JCTD award. There are a number of reasons for our success in the market.

First, we're competing in market segments that we created and we've been focused on for years. Second, we've built a competitive strategy from the ground-up to be uniquely good at anticipating and delivering on our customers' most important needs. And third, our capabilities are focused on a limited set of markets, where we're committed to winning every competition we enter and expanding every customer relationship we have.

I think the voice of the customer speaks most clearly through market share and market share favors us in small UAS and Stratospheric persistent UAS. Precisely because of the strategic advantage afforded by our small size relative to others, our focus and our ability -- our agility, excuse me. Let's now review our three business segments, beginning with UAS.

With a $56 million fourth quarter, UAS produced record revenues of 186.6 million for FY '08, an increase of 27% over FY '07. There are five aspects of our UAS business that we believe will continue to drive future growth.

First, sale of existing products to existing customers. Raven continues to dominate the UAS -- small UAS market, but our Wasp line is ramped up and it is now contributing to revenue as well. The Marine Corps is issuing their Ravens to the battalion level, while they are issuing their Wasp to the platoon level.

We have already received inquiries from other customers regarding Wasp and we are pursuing them actively. Second, services that sustain our deployed system, as the total number of aircraft in use increases, we benefit from increased spares, repairs and training revenue. Our logistics group has also added turnkey flight services to its portfolio.

Third, product upgrades will continue to drive revenue. Our customers have already been upgrading their previously purchased Ravens to Raven B configurations and we are actively working with them to define the next Raven product improvement program.

We anticipate that our digital DataLink will be broadly adopted after it becomes available during FY '09 for initial military assessment. Fourth, new products, the Global Observer program is ramping up and will contribute meaningfully to our FY '09 revenue. Global Observer intends to provide affordable persistence in the stratosphere and that's a game-changer.

We believe the six government customers who are funding the Global Observer three-year development program, are a strong indication of broad interest in this capability. Switchblade, another customer-funded initiative is bringing to reality yet another unique capability.

Switchblade combines the visual information provided by our small UAS with a precision munition delivery ability. This will deliver an entirely new level of precision and response time, while significantly minimizing collateral damage. Each of these programs represents a significant market opportunity that has never before been addressed successfully.

And fifth, new markets and applications. We benefited this year from growing international adoption of Raven during FY '08, receiving orders from Denmark and Spain. Shortly after the end of FY '08, we also received our first Raven order from the Netherlands, and we are pursuing actively a number of additional international opportunities.

We believe that our international customers are following the earlier adoption pattern of our U.S. DOD customers and represent potential long-term future growth order flow, as they gain the same experience and confidence in our solutions that all of our earlier customers have.

We also remain convinced of the broader potential of our small UAS in applications such as border patrol, law enforcement, infrastructure monitoring and emergency response, when regular use of UAS and national air space is approved.

In addition to the growing interest in UAS, there's also an increased interest in efficient energy solutions, which leads us to a review of our other operating segments, PosiCharge and Energy Technology. This will be the last time we report PosiCharge and Energy Technology Center's individual segments.

In May, we announced that we would combine these two groups into a single operating segment called Efficient Energy Systems, or EES. Starting with our Q1 FY '09 cycle, we will report these as a single segment.

This is essentially the organizational combination that worked very well for us two years ago, when we combined the group that was performing UAS R&D with our small UAS production business. EES is designed to address the increasing economic and environmental value of efficient electric energy solutions.

It will use the critical mass of its combined resources to focus on two major areas, clean transportation and clean energy systems. PosiCharge for industrial vehicles, PosiCharge for on-road vehicles, electric vehicle test equipment and architectural wind, are representative of the innovative solutions we intend to offer from this integrated group.

We increased PosiCharge revenues slightly over FY '07 and believe that we maintained approximately 50% of the fast charge market. There's no doubt that PosiCharge has increased productivity, enhanced safety, and improved energy efficiency for our customers. They continue to adopt and deploy our systems across their enterprises, although we have not seen the broader market adoption that we anticipated.

Based on our data, PosiCharge is the most widely used electric vehicle fast charge system in the world, supporting thousands of electric lift trucks used heavily every day. I think we have the best technology in the market and we will continue to work creatively to expand awareness and adoption of the PosiCharge solution.

PosiCharge was developed by our Energy Technology Center, which I'll now discuss in more detail. The purpose of our ETC has been twofold, to develop advanced electric technologies that support our existing businesses and to develop entirely new solutions targeting new opportunities for significant market adoption.

Our electric vehicle test equipment has seen an uptick in sales, as more and more organizations work on electric and hybrid electric vehicle development programs. Our ETC team has delivered state of the art subsystems for energy generation, energy storage and propulsion, that are critical to achieving the performance targets of our revolutionary Global Observer system.

We are also seeing more interest in clean energy solutions, such as architectural wind, which has increased the number of customer-funded earlier adoption systems installed and operating. We're working with electric vehicle companies and potential customers to present our fast charge technology as an infrastructure solution.

With that as an overview for our business, Steve Wright, our CFO, will review our financial results. Steve?

Good afternoon. Revenue for the fourth quarter was 64.3 million, an increase of 27% over fourth quarter prior year of 50.7 million. Looking at revenue by segment, UAS revenue was 56 million, an increase of 25% over the prior year. The growth in UAS revenue was due to higher product sales and project R&D, partially offset by slightly lower services.

PosiCharge revenue was 3.9 million, an increase of 45% from Q4 last year, primarily due to higher revenue from sales to the automotive market. And Energy Technology Center revenue was 4.4 million, an increase of 43% from Q4 last year due to higher power processing equipment deliveries.

Turning to gross margin, gross margin in the fourth quarter was 23 million, up 20% from Q4 of last year. Gross margin as a percentage of revenue was 36% versus 38% in Q4 last year. By segment, UAS gross margin was 20.1 million, up 18% from Q4 of last year, and as a percent of revenue, UAS gross margin was 36% versus 38% last year. This decrease in gross margin rate was primarily due to higher program costs.

PosiCharge gross margin was 0.7 million, up 0.3 million from Q4 last year, primarily due to higher sales volume. As a percentage of revenue, PosiCharge gross margin was 19%, versus 16% in Q4 last year. Energy Technology Center gross margin was 2.1 million, up 0.5 million from Q4 last year due to higher sales volume.

SG&A for the quarter was 9.1 million, or 14% of revenue, compared to 7 million, also 14% of revenue in the prior year. SG&A growth is primarily due to higher selling and marketing expense. R&D for the quarter totaled 4.7 million, or 7% of revenue, compared to the prior year amount of 4.7 million, or 9% of revenue.

Customer-funded R&D during the quarter was 11.3 million, or 18% of revenue compared to 7.1 million, or 14% of revenue in the prior year. And total R&D, both internal and customer funded, totaled 16 million, or 25% of revenue versus 11.8 million, or 23% of revenue in the prior year.

Operating income for the quarter totaled 9.1 million, or 14% of revenue. Operating income was 22% higher than Q4 prior year, primarily due to higher gross margin, partially offset by higher SG&A. And net income for the quarter was 6.4 million, or $0.30 per fully diluted share, compared to 5.6 million, or $0.27 per fully diluted share last year.

Now moving quickly to our full year results. Revenue for the full year totaled 215.7 million, up 24% from the prior year and by segment, UAS revenue was 186.6 million, up 27% from the prior year. PosiCharge revenue was 18.6 million, up 6% from the prior year, and Energy Technology Center revenue was 10.5 million, up 9% from the prior year.

Gross margin for the full year totaled 78.5 million, compared to 68.5 million in the prior year. Gross margin as a percentage of revenue was 36% versus 39% in the prior year. By segment, UAS gross margin was 68.6 million, up 19% from prior year. PosiCharge gross margin was 5.5 million, down 10%, and Energy Technology Center gross margin was 4.5 million, down 6%.

SG&A for the full year totaled 33.7 million, or 16% of revenue compared to the prior year of 24 million, or 14% of revenue. The prior year SG&A included the SERP reversal of 2.2 million, or 1% of revenue. R&D for the full year totaled 16.4 million, or 8% of revenue, compared to 13.9 million, also 8% of revenue in the prior year.

And total R&D, internal plus customer-funded, was 44.7 million, or 21% of revenue compared to 33 million, or 19% of revenue in the prior year. Full year operating income was 28.4 million, or 13% of revenue. Operating income was 7% below the prior year amount.

The effective tax rate for the full year was 34%, down from the prior year rate of 36%. The federal R&D tax credit expired in December 2007 and thus we expect a higher effective tax rate in fiscal year '09 unless the tax credit is renewed. Net income for the full year was 21.4 million, or $1 per fully diluted share compared to 20.7 million, or 1.22 per fully diluted share last year.

Looking at backlog, funded backlog ended fiscal year '08 at 82 million, up 21.1 million or 35% from prior year end. Turning to our balance sheet, cash equivalents and investments at the end of fiscal year totaled 118.4 million, up 7.6 million from our prior quarter amount of 110.8 million. This positive cash flow was largely due to income and working capital, partially offset by capital expenditures.

Investments at the end of the fiscal year were 13.4 million, down from the previous quarter amount of 30.8 million. The decrease in investments was due to net redemptions of a municipal option rate securities. We funnel redemptions largely to U.S. treasury bills, which will limit our ability to earn higher interest income go forward. We currently hold about 80% of our cash and treasuries earning an average taxable interest rate of less than 2%.

Subsequent to our fiscal year end, we were able to redeem four million of option rate securities at par and as of today, the company holds approximately 9.4 million of these securities. The option rate securities are backed by municipal bonds, rated A minus of higher and rated AA or higher with their insurance.

At the end of the year, our accounts receivable including unbilled, totaled 50.4 million, up 6.5 million from the prior quarter. Total day sales outstanding were approximately 71 days, compared to 81 days at the prior quarter end. Taking a look at our inventory, inventories were 15.9 million at the end of the fiscal year compared to 17 million at the end of the third quarter.

Days in inventory were approximately 35 days compared to 53 days at the end of the third quarter. Turning to capital expenditures, in the fourth quarter, we invested approximately 1.3 million, or 2% of revenue in property improvements and capital equipment. Of this CapEx, approximately 90% was related to growth.

Now I would like to turn things back to Tim to discuss expectations for the new year.

Thanks, Steve. We look forward to continued growth and opportunities across the entire business. We believe we will grow revenue in fiscal 2009 by 20 to 25%, with 12 to 14% operating profit. As we've discussed on multiple occasions, history demonstrates that our quarterly results can be bumpy.

Last year, timing of orders and operational issues contributed to this bumpiness. During the first half of our fiscal 2009, we will be implementing a customer funded change in the radio frequencies that our small DOD unmanned aircraft system customers use, to transmit and receive information. We have fully tested these changes, that will implement the frequency upgrade and we're well prepared for this changeover. We are cutting in this change during our Q1 '09.

We will temporarily halt shipments of new Raven and Wasp systems while we reconfigure the hardware to the new configuration, then upgrade systems currently in the field and resume production shipments. Later in FY '09 we expect to introduce our new digital DataLink as a product improvement and that will also incorporate this frequency capability along with other important enhancements to our small UAS.

This frequency change is anticipated in the guidance for FY '09 that I just shared a moment ago. I would like to thank you all for our continued interest in AV and at this point, Steve and I would be pleased to answer any questions.

Thank you, sir. (OPERATOR INSTRUCTIONS) We'll go first to Michael Lewis, BB&T Capital Markets.

Thank you. Very nice quarter. And, Tim, I was wondering, would you be able to provide us with a breakout of the logistics component of the UAS sales in both FY '08 and the fourth quarter?

Hi, Mike. Thank you. Let me pass that to Steve because I think that's a function of how we break out the income statement between product and services in general.

Yes, Mike, we, we provide that breakout at the total company level. In Q4, products were 61%. Services, 21%, and project R&D.

Okay. Do you have it for the full year?

Full year. 57% for products, 30% for services, and 13% for project R&D.

Okay, and then just wanted to talk to you just for a second about the Raven B conversion. How many Raven A systems have you completed thus far? And also, what's the total number of Raven A systems left for conversion at this time?

I don't have the specific numbers off the top of my head, Mike. However, I think the majority of the army's Raven As have now been converted to the Raven B configuration.

I'll just jump in here. We don't know exactly how many Raven A's are left to be converted, but our understanding is contractually, there's about 170 Raven A systems that have yet to be converted. We -- those, those may be converted at the discretion of the army or not. We just -- we don't have any orders putting into conversion mode.

Okay. Then just one final question, you put out the release on the seven million Netherlands order. Have you delivered any of this product to date?

No.

Okay. Thank you very much.

Thanks, Mike.

Thank you. Our next question from Tim Quillin with Stephens.

Good afternoon.

Hi, Tim. How are you?

Good. In terms of the production halt that you're talking about on Raven and Wasp, how should we think about that in terms of the potential revenue impact in 1Q?

Well, I think overall, it's positive. It's a, it's a directed change funded by the customer and that has an overall positive effect on revenue. In Q1, we expect it will have other things equal, a negative effect because we'll be deferring some production shipments while we cut in that change.

I can just jump in here a little bit. As Tim mentioned, cutting in that change will defer revenue and for the balance of the year.

We probably don't want to get into giving specific guidance by quarters and just stick with our annual guidance for all the reasons that we've discussed in the past. But since we are talking about this, probably the way to think about it is this cut-in will -- in Q1, will reduce our product revenues on the order that they would be running -- on the order of about two-thirds of the level that we were at in Q4.

Okay. That's helpful. Thank you. Can you give us some sense of just in general what the Raven backlog and pipeline looks like right now?

I know you still have some remaining backlog from your $46 million order from the army. Is -- are you anticipating additional orders this quarter, or should we expect the backlog, the funded backlog to decline by the end of July?

Well, our funded backlog currently at 82 million is higher than it was last year, but if you look at the trend, we've never had multiyear backlog. We've never had huge levels of backlog, so we're continuously getting orders and filling them.

Probably the metric we have talked about in the past with respect to Raven is the army acquisition objective, 1900 systems. Through Q4, we are about 43% delivered against that army acquisition objective.

Okay, thank you. That's helpful. And the Energy Technology Center revenue bumped up quite a bit.

Is that solely the power processing equipment and is that sustainable? And also, is there some Global Observer revenue that's booked there and some that's booked in UAS, or how do you record the Global Observer project?

The Global Observer -- excuse me -- energy first. Energy Technology for the full year is up about 900,000. Probably the surprisingly the single largest contributor to that variance was architectural wind.

Power processing would be the other main component of that, again, on a full year basis. Global Observer revenues are all in UAS. Even a number of the engineers in the Energy Technology Center support Global Observer, but the revenue is all recorded under UAS.

Okay. The Energy Technology Center, it was up two million quarter to quarter, 4.4 million versus 2.3 million in 3Q '08?

Yes, that growth would be power processing system.

And is that sustainable?

Well, that -- what Steve's referring to is power processing systems is the fast charge test equipment, Tim. And I don't know that sustainable's the right term, but clearly more and more organizations on a global basis, whether they are automotive companies, start-ups, or battery or FuelCell firms, are devoting an increasing amount of their energies to developing both electric and hybrid electric vehicles, and that is the primary driver for revenue in that product line for us.

Okay. That's great. And then just one last question for Steve. What do we expect the tax rate to be in fiscal '09? Thank you.

Assuming the R&D credit does not, does not get renewed, I would think something in the high 30s, approximately 37%. And if the R&D credit gets renewed, as it has, a number of times in the past, I knocked a couple of points off of that to 35%.

Thank you.

We'll go next to Chris Donaghey with SunTrust Robinson.

Hi, good evening, and congratulations on the quarter, guys.

Thanks, Chris.

Tim, I was wondering if you could update us on kind of the congressional outlook for the wind tax credit, given the focus on the energy these days by congress.

Well, I can tell you what I know. I don't know if that will count as a meaningful update or not. There, there is, there is language in both the energy bill and the agriculture bill that address small wind.

Although the language in each of those bills is less than what we are looking for, and what we're looking for is parody in terms of investment tax credit with small solar. So we, we expect that it's likely that we'll get some help in that existing language, but that we'll be continuing to look for a bill that provides parody across the board.

There seems to be bipartisan support for renewable energy and for the concept of parody in the investment tax credit, but you know as well as I do how difficult it is to predict legislation.

Okay, great. And just from the development of that product, or the -- from a deployment perspective. What are you looking for from a milestone perspective before you really open the throttles on business development activities and trying to put that out in the market aggressively?

Well, there's -- I think that investment tax treatment is a significant objective of ours. We're also being careful to move reasonably slowly as early adopters get real world experience with the system. I think I've mentioned before we're currently on the third generation of this technology and we're in the midst of developing generation four.

So far, we're very pleased with how it's behaving and how it's being received. But it's an entirely new concept and I think it's prudent for us and our customers to know what the real world experience is. So I would think a number of months of additional real evaluation in sight is appropriate.

Okay, great. And then on the Raven program, you mentioned that you're going to offer DDL as a product improvement later this year.

Are there other improvements that, you know, will work this way -- work this towards a Raven C type of upgrade, or how would you expect DDL to be deployed? Does it involve a complete replacement of the, of the system to upgrade to DDL?

Well, let me take that in two pieces. One is DDL itself. I think our current expectation is that will be introduced and rolled out independent of other product improvements and before other product improvements.

It will require both hardware and software upgrades to -- on the air frame and in the ground control system. The list of other product improvements that we're working on with a broad set of Raven customers, range from payloads and imagery to other characteristics of the system.

There's a lot of energy in the customer community about that opportunity and we're optimistic about that. But we think that will follow the introduction of DDL. Did I get both of your questions there?

I think so. Is there any way to estimate at this point what that would -- what a DDL conversion would run per system? Is it 50% of the original system cost, is it 25, is it 75, is there any way to quantify that at this point?

We haven't -- we haven't put a specific price point on that in the public and in general, we haven't talked about specific prices. It's certainly not a 50% kind of price of the original system.

I think we would probably have to punt that one down the road, we haven't priced it, we can't talk about it here.

Okay, that's fine. And then just one last housekeeping question, I apologize if I missed it, do you have an IDIQ backlog number?

Yes. And again, firm backlog is what we really look at. IDIQ, unfunded backlog as of Q4, 384 million.

Okay, great. Thanks again, and congratulations on the quarter.

Thank you.

Thanks, Chris.

We'll take our next question from Brian Gesuale with Raymond James.

Yes, hi, guys. Wanted to kind of chat a little bit more about this frequency conversion just to make sure that I understand it. I guess kind of two or three questions rolled up into one here.

Will you still be delivering Wasp product, and is is that why you'll still have that kind of one third of the product run rate? And then maybe, how many of the Ravens are you under contract now to swap out the frequencies when you do that upgrade phase and when should we expect that to start?

And then maybe if you look at this in the complex, or in the context of your contract mix, what is this going to do to your cost plus mix and maybe your overall contract mix as you shut the line down before ramping it back up in the second quarter?

Well, this, this change, Brian, affects both Wasp and Raven and it affects all systems that DOD uses. So and there's a slight-as we implement it, we'll be implementing Raven first, then Wasp second. It will affect -- once we cut the change over, then all future production under contract will be delivered with the new frequency capabilities.

Okay, and--

In terms of mix on that, Steve, do you want to take a shot at that?

Yes, well -- I mean let me answer that two ways. For Q1, as I said earlier, we don't want to get into a lot of detail on that -- that could be construed as guidance.

I would just say the product revenues in Q1 will be about a third lower than the levels we had in Q4, based on what we see today. Two, the broader issue of mix, let me talk about the full year. In fiscal year '08, we had 57% products, 30% services and 13% project R&D, as I indicated earlier.

As we go into fiscal year '09, we will see -- we'll see growth in all areas, but there will be more growth in project R&D, primarily due to Global Observer relative to the other areas. So in terms of overall mix as we look out into '09, we would expect the project R&D to grow from the 13% up, somewhere into the low 20s.

And then the other areas too, both the products and logistics as a share of the total to go down a little bit.

Okay. That's very helpful. Thanks. On the -- as far as the backlog goes, as you mentioned record funded backlog here.

Given the conversion and kind of the disruption on the product line, how -- is it correct to think that most of these -- or a good portion of the recent orders you've had are really tied to this frequency conversion and of a cost plus nature, or how actually do we look at that?

Some of it has been cost plus. I think the -- most of the conversion work will be done under CLS contract.

Okay.

Again, these conversions are for our DOD customers. It doesn't go beyond there.

Right, and I guess in terms of, targeting -- just I mean give us a magnitude or a time line in terms of, from -- I think, Tim, you mentioned Phase I is shut the down down and halt shipments, Phase II is upgrade the existing inventory and then third is production units getting shipped out with the new features. When, when is that Phase III kind of kick in, as you notionally see it today?

That will all kick in in Q1, so it will be wham, bam, wham.

Okay. You guys are going to be busy.

Yes.

Okay, terrific.

And that, that's sort of hiatus really is, was in the middle of Q1.

Okay.

Or in production before Q1 concludes.

Okay, and I guess the last part, if we look at the UAS mix, it looks like that maintenance line has been very bumpy on a quarter to quarter basis, as you would expect. And so is the product side. I think product, your UAS product revenue is up more than twofold from the third quarter.

As we kind of move out and you talk about that growth in product, how much of that was Raven versus Wasp, and are we starting to see some of these new products that you've worked for several years to get to production rates, are we really start to see that contribution come out in that balance here? Is that really the strength of the business that we're seeing?

Yeah, well, I think the -- in Q4, the part of that significant increase in products was picking up some -- what you saw as a relatively low shipment of products in Q3, and that's -- that was driven by, as I think I had mentioned in my comments, order flow and some operational issues. And secondly, it's the ramp-up of Wasp.

So we got full rate of production approval earlier in the year, as we began to roll that out, we had the -- what we don't find surprising as early startup challenges, but we're, we're on track and shipping those out at an increasing rate now. So I think the -- it's a long answer to your question to say yes. We're starting to see significant contribution now from Wasp as a new product.

Great. Nice job on the quarter. Thanks a lot.

Thank you, Brian.

(OPERATOR INSTRUCTIONS) we'll go next to Howard Rubel is Jefferies & Company.

Thank you very much. I have a couple of things. I got disconnected for a moment, Steve, so I apologize. I think you said that the production rate for the first quarter would be down by a third, is that correct?

Yes, from the Q4 level.

Yes, that's correct. Okay. Thank you for that. Just a couple of other items, could you give us a sense of the number of customers in NATO that are now interested in either Raven or Wasp?

Well, Howard, we're -- we are working with over a dozen customers, potential customers right now, international customers primarily interested in Raven and, and a number of those now with the production introduction of Wasp, there's a growing interest there. So I, I don't think I can get into a specific number in NATO, but, but hopefully the more than 12, bakers dozen is helpful.

Yes, I mean there's only 20-odd in NATO, so I figure that's still a good stab at that by any stretch of the imagination. Couple things, where are you with getting Switchblade into the field? I know that there's been a number of issues that you need to overcome.

Well, the issues are, are more a matter of demonstration of this new capability. We are -- we're doing very well on the second generation demonstration contract that we are working on now with our -- from our original customer.

We're expecting to do full scale demonstrations late summer, early fall on that program and we now have a second -- a contract from a second customer for a Switchblade derivative and we have very significant interest from other customers that we expect to show up as we go forward.

Our current view is that we should see increasing revenues from Switchblade throughout this fiscal year. We think most of those will probably continue to fall in our R&D category and we think it's not likely that it would transition to production orders yet this fiscal year. But that's my best guess at the time.

Tim you might call them like LRIP at this point, would that be a fairway to think about it?

I'm not sure that I would -- certainly not at this point, we are not in what I would call an LRIP phase at this point. I think we're still demonstrating specific capabilities to customers and as we move farther down that line, we're going to go, I think, through more demonstration units and then into LRIP and then into production. And whether we, we're in the latter part of this year or beginning next year when we get to that point, it's a little hard to pin down.

Just one last thing on that, and then I have just two other questions. So what you're finding is that the demonstration of the vehicle is creating more interest by other customers?

Yes, I think that's been a very clear outcome and, and further, I think there's a very broad level of interest looking at the results of the demonstrations of the second stage contract that we're currently in. And those demonstrations, as I mentioned, would happen late summer, early fall.

There were a couple of other high flying UAS contracts, I think, awarded to either Boeing or Lockheed, one of them was called Vulture or something like that, ultra high UASs, I believe. Is this just an alternate solution and you weren't competing, or how do you sort of look at that market, either opportunity or challenge or how would you define it?

Well, Global Observer is a JCTD program that's funded out of the office of secretary of defense and is -- or originated out of the office of the secretary of defense and it's funded by six different customers and managed by SOCOM. It's intent is to produce in a complete system and do a full demonstration of military utility.

For a handful of specific applications. Vulture, that you mentioned, is a program sponsored by DARPA. Its objective, as published, is to develop an airplane that flies up to 100,000 feet for five years at a time and it's a very long-term R&D-focused program to develop a capability that is well beyond any current technology.

We did put a proposal in for Vulture with DARPA and we did not get an award. They awarded three different contracts. We -- I guess I should point out that prior to developing the Global Observer system, the core technology that led to that was our solar unmanned aircraft program that we conducted for over a decade with over 50 flights on that, throughout that program we set and currently hold the world altitude record for any kind of airplane in level flight.

So I think we have a huge percentage of the world's experience in that flight regime.

My sense would probably be a huge percentage of the patents in that regime as well.

Well, we've been, we've been plowing early -- previously unplowed ground in that area for a long time.

And then the last thing, I just want to talk about energy for a moment and architectural wind. Could you -- I mean there's two parts to this. One is how many customer installation do you have now and then second, how do your customers think about carbon credits, and is this sort of something that really would play in Europe?

I think we have less than ten current installed customers on architectural wind, Howard. Right now, carbon credits aren't playing a significant role in the early evaluation adoption of these systems from my perspective, but I do think that as a production business, it becomes a significant factor.

Thank you, Tim.

Thanks, Howard. Thanks, Howard Rubel.

We'll take our next question from Michael Ciarmoli with Boenning & Scattergood.

Hi, guys, thanks for taking my call. Most of my questions have been answered. Just two quick ones. Relating to the frequency conversion in Q1, what impact do you think that has on gross margins, if any?

I don't think we have anything to comment on there. We just -- we really don't want to get into guidance by quarter.

Okay.

We've baked it into our full year guidance.

Okay, fair enough. And then the last one, just this most recent quarter, product revenues of 39 million and product gross margin, 36%. So you had a high on the revenues there and a low in the gross margin. Is there anything to read into that? Was that a function of the programs or customer mix? Can you just elaborate on what was going on there?

I think it's really just the programs that we're working on in the quarter. There's nothing, no significant messages there.

Okay. Fair enough. Thanks, guys.

Thanks, Mike.

And we have a follow-up from Tim Quillin, Stephens.

Yeah, just two quick questions. One is regards to PosiCharge gross margins. I think 29% or so for the year.

Is that how we should be thinking about those going into fiscal '09? And my second question is regarding Wasp and where you think the army is at as far as evaluating the Wasp for lower unit level deployment? Thanks.

Let me take the gross margin question and Tim can take Wasp. I think the, 29% -- first, we won't be breaking it out go-forward. But just as, as it stands, 29%, we wouldn't normally -- we wouldn't guide on gross margin levels period, much less within the segment. But I guess my editorial is the 29% is lower than we would like to see it generally, as it is a commercial business. We would like to eventually see higher gross margins in PosiCharge.

Okay.

Tim, regarding the army and Wasp, the army has not bought Wasp. Right now our only two Wasp customers in production are, are the Air Force and Marine Corps.

The army and other services and other customers are looking at Wasp and the relative benefits and trade-offs that it provides relative -- compared to, compared to Raven. And as I think I've indicated in the past, it's my view that the ultimate opportunity for small UAS gets down to the squad level because that's where the systems are actually used.

In the case of the army, they are issued at the brigade level, but then used by squads. So I, I know that there is, there's a level of interest, but it's hard for me at this point to quantify it or to put it in any kind of a timeframe.

Okay, thank you.

We'll go back to Michael Lewis with BB&T Capital Markets.

I'm going to beat a dead horse here with regard to the one third of product revenue coming out of UAS in the first quarter. Now, the question is, how do you expect that we'll pick that back up? Will that be evenly flowing through the rest of the year, or would there be a proportional ramp through the remaining three quarters?

I -- let me jump first. I would say the latter. Proportionally ramp it through the balance of the year.

And just two, or actually three housekeeping. Cash flow from operations for the year?

It -- yes, it was -- we were positive in fiscal '08. Are you talking fiscal year '08?

Yes, that's correct, cash flow from operations.

Yes, we were positive.

Do you have that actual number?

Yes, 15.5 million for the year.

15.5 million, okay. And your depreciation and amortization?

For the year, 3.8 million, with 1.2 million of that in Q4.

Okay, and then just finally, you had offered the customer-funded R&D in the fourth quarter. I missed that number. What was that again?

Okay, one second. Customer-funded R&D in Q4 was 11.3 million.

Okay, thank you very much.

Thank you.

And at this time, there appear to be no further questions. I would like to turn the conference back over to management for any additional or closing comments.

Well, thank you, all, for your continued interest and support of the company. We look forward to reporting our progress for the first quarter of fiscal 2009.

And that does conclude today's conference call. Thank you for your participation. You may disconnect at this time.