AeroVironment Inc (AVAV) 2010 Q1 法說會逐字稿

Welcome to the first quarter fiscal year 2010 AeroVironment Inc. earnings conference call. I will be your coordinator for today. All participants are in a listen-only mode. We will conduct a question-and-answer session after management's remarks. As reminder, this conference call is being recorded for replay purposes. With us 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. I would like to turn the presentation over to Mr. Gitlin. Please go ahead, sir.

Welcome to AV's first quarter fiscal 2010 earnings call. Before I hand the call over to Tim, 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 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.

For a list and description of such risks and uncertainties, see the reports we filed with the Securities and Exchange Commission. Investors are cautioned not to place undue reliance on forward-looking statements, which speak as of the date on which they are made. We do not intend and undertake no obligation up to date 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 September 8th 2009.

The Company under takes no obligation to make revision to the statements contained in our remarks or 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 quarter fiscal 2010 conference call. I would like to begin by emphasizing three points. First, we are seeing about the performance we expected and that we outlined in the Q4 earnings call. Second we are confident in our FY 2010 guidance of 18% to 22% revenue growth weighted to the second half. And third, the long-term growth drivers of our business look very good. Thousands of our Raven and aircraft continue to help US and ground forces operate affectively and safely and thousands of our POSI charge systems help materially handling vehicles operate safely every day. The underlying demand for solutions remains strong and the potential market opportunities for solutions and development remain attractive.

Now, I would like to expand on those three initial points. We are seeing about the performance that we expected and outlined in our call. Our predicted low Q1 and Q2 and high Q3 and Q4 performance is driven by the planned conversion from analog to digital Raven Systems by US Army and Marine Corps. The conversion and retro fit to digital systems is a high priority for both customers. Product and services revenue in first quarter was down, mainly as a result of customers waiting to place Raven orders until new digital systems become available if the second half of the year.

As we said in our last call, digital Raven Systems and retro fit kits for the hundreds of deployed Raven Systems are planned for transition to production at the end of Q2 with volume ramping significantly through Q3 and Q4. The digital Raven change is extensive affects most of the system and requires over six months to cut in to production. While the production system price increase will be modest, the retro fit of analog system to digital will be extensive and cost about $50,000. The compelling advantages of digital systems, the expectation of broad retro fit of installed base and that price difference let our customers to defer additional Raven System orders until digital deliveries began in the second half.

While our first quarter unfolded generally as we anticipated, and as we discussed in our last conference call, revenue in first quarter was a bit lower than we planned. Sales were $3 million to $4 million less than we expected primarily at EES, and largely attributable to timing of orders. To prepare for a second half surge, we have been building production readiness, spooling up supply chain and making investments to enable that growth. Also we noted in the last call our SG&A and our R&D spending remains sized for full year and continued growth expectations. The low revenue in first quarter combined with the steady spending to support full year growth adversely impacted our profitability and produced a first quarter loss, although I'm not pleased with our first loss as a public Company, this general pattern did not come as a surprise given the imperatives of the digital Raven transition, low revenue if the resulting negative profitability in first quarter was a necessary price for the transition to a compelling new digital capability. One that is important to our customers and to AV.

My second point referred to confidence in full year guidance, several factors support our view. We are moving from digital towards Raven production, on schedule, with performance tests customer valuations, design finalizations and production readiness going well. The second 2009 supplemental spending bill and the 2010 DOD budget request include $163 million for digital Raven Systems and retro fits. Combined with the $17 million Army order, we previously announced, this totals almost $180 million. This is a positive indication of demand, and provides good visibility in to the expected orders supporting our second half revenue plan. Beyond Raven, we have good visibility in to global observer fiscal year revenue with existing backlog and customers positive about evaluation of WASP and Puma Systems for broader procurement. In summary, despite quarterly operating results that fell short of our expectations, our fiscal year is developing as planned with good progress important achievements and focus on execution.

Point number three was that long-term growth drivers continued to look good. I will go in to more program detail when I discuss the segments, but our long-term growth opportunities are exciting and have never looked better. Our new Digital Data Link significantly increases the value proposition for our family of small unmanned aircraft systems and further strengthens our competitive position in this growing market. Switchblade has the potential to open a new and large market opportunity for us. Global Observer development is progressing well and the customer demand for affordable persistence will create a large new market for which we are well positioned. We are also well positioned for the charging infrastructure demand that we anticipate will be created as new planned battery and plug in hybrid cars come to market over the next few years.

Let's discuss our unmanned aircraft systems business segment. The Digital Data Link I've been talking about a communications architecture we developed in-house, because there were no Digital Data Links that could meet the requirement force integration in to our Raven small unmanned aircraft system. Remember Raven is a 4.2 pound airplane that flies for 90 minutes using electric battery pack. The reason the digital conversion represent such a key component for our current years activity, is that it provides new capabilities that make small unmanned aircraft systems much more useful to our customers. The benefits of digital Raven Systems include expanding the number of channels Raven can utilize with the existing frequency allocation from the original four to as many as 40, which enables customers to fly many many airplanes in a geographical area without radio channel conflict, enhancing digital signal encryption which provides enhanced security for the critical information generated by these systems. Enabling beyond line of sight operation through airborne digital relay, which will enable users to expand the range in which these systems can be operated as well as neutralize the effects of many topographical obstacles that would otherwise interfere with line of sight communications and flow of data or facilitating it through our system of IP formatting making it easier to share video, voice and data across the battlefield. Each Raven airplane and ground station will soon be a known for a self forming pop up IP network any place any time. Our Digital Data Link will find its way in to production integration in to new Raven Systems in the production process and retro fits that will convert existing analog systems to digital systems, which will be processed in the factory and parallel with the new system production. We are in the process of finalizing the system details and production level drawings and test procedures as we complete the move from development to high rate production. Our experience a year ago cutting in frequency change production of WASP and Raven prepared us well for the production system to Digital Raven.

Our WASP system is evaluated by customers beyond the US Air Force and the Marine Corps., and new puma systems generating positive feedback from initial and potential new customers. We recently demonstrated Puma publicly for the first time at the AUVSI conference in Washington DC, generating a great deal of interest in this unique platform. The announcer at the AUVSI air show repeatedly commented on how quiet the Puma was, characterizing its that quietist UAV at the show. Whereas WASP is a one pound air vehicle that is extremely small, Puma is larger hand launched air vehicle that flies for two hours and highest quality imaging payload that we have yet developed. Puma is also the only production small unmanned aircraft system able to land repeatedly on the ground or in the water. Raven, WASP and Puma all operate off common and inner operable ground control system, which includes a hand-held controller with embedded color monitor. We are now developing plans for the transition in the future of both WASP and Puma to digital systems working towards a small unmanned aircraft system family of interoperable systems built around a common digital ground control system.

On the development front, Global Observer is about two years in to its customer funded three plus year Joint Capability Technology Demonstration Program. The objective of the JCTD is to develop a unmanned aircraft system that will deliver affordable persistence for multiple high value remote sensing and communication relay payloads. With flight duration of up to seven days per aircraft, a two aircraft Global Observer system will provide satellite like persistence over any area on the earth by alternating the aircraft sequentially to maintain seemless persistence over the designated orbit. With over $120 million funding, Global Observer moved successfully from the development phase to assembly with aircraft number one nearing completion and aircraft two beginning to take shape in the low production line. I'm pleased to report that an important milestone in the Global Observer development program is in sight. Current plans call for the first Global Observer airplane to move to Edwards Air Force Base this quarter, where it will undergo final system level ground testing, flight readiness and then flight testing at this historic flight test center. After the flight testing phase is completed, payloads will be integrated into the aircraft and tested and military assessment of the entire Global Observer system will begin. We remain on track for system integration and flight testing in the second half of fiscal 2010.

The challenges facing US and NATO troops in Afghanistan reemphasize the game changing potential of stratospheric systems with affordable persistence that can provide critically important ISR and communication in areas that otherwise are under served, or where it is unavailable most of the time. Switchblade is another of our important UAS development programs. Switchblade is a loitering precision munition offering an entirely new solution for finding and verifying specific targets addressing the proximity of noncombatants to avoid collateral damage, producing high precision force protection and standoff strike affects. Switchblade demonstrations in first quarter continue to perform well in new applications, impress potential customers and generate significant customer activity. Just this quarter we completed a very successful three day demonstration at a government site with over 50 people representing many potential customers. Switchblade is a very high potential development because its unique characteristics and proven prototype performance appear to be very well matched to current needs and policy. Adoption timing remains uncertain but I continue to expect initial orders for preproduction systems yet this fiscal year.

Our development systems continue to make progress on with SP2S, the stealthy persistent perch and stare, a small UAS funded by DARPA. Further back in the development pipeline is the DARPA funded Nano Air Vehicle Program, another program that in true AV fashion is expanding the envelope of small unmanned aircraft capabilities. During first quarter we released a video showing several stations of the Nano Air Vehicle s development. The video shows the flapping wing test aircraft flying up, down, sideways and front to back, using only its two wings for control lift and thrust. To our knowledge this tri-access control has never before been achieved. Significant technology challenges remain on the NAV R&D program, but it's a useful example of the kind of cutting edge work that takes place regularly at AV. Beyond the market for UAS in the United States, international companies are re-engaging in the pre-procurement small UAS acquisition activities and we may be seeing a thaw or the beginning of thaw in the nonUS segments of the market. In summary, the outlook for UAS products and development programs remain strong.

Our Efficient Energy Systems or EES segment levers decades of experience in high efficiency, electric energy systems to deliver clean transportation and clean energy solutions. In addition to spawning new market leading products such as POSI charge, fast charge systems and electric vehicle test systems EES develops key subsystems that support the unmanned aircraft segment. Efficient electric generator propulsion motors and energy storage systems in Global Observer developed by EES team and state of the art. Additionally EES is actively involved in exploring fuel cell technology integration to expand significantly the flight duration of our small unmanned aircraft. Revenue in EES declined in first quarter, we saw continuing economic pressure in the industrial markets in which we sell POSI charge systems and delays in orders for electric vehicle test systems, some of which we believe were affected by pending decisions in federal funding for clean transportation initiatives.

During the quarter we announced the introduction of AV800. At 800-kilowatts, the AV800 is now the highest power EV test system we offer and know of in the market. The first AV800 was purchased by the US Army Tank Automotive and Armaments Command in Warren, Michigan. It will provide new capabilities that will enable the development and testing of high duty electric and hybrid electric vehicles and serves as an example of the breadth of our involvement in and understanding of the electric vehicle technologies. We also announced we received a patent for a method of enabling the collection of data from electric vehicles. This supports one of the important opportunities in the emerging electric vehicle and hybrid electric transportation market, which relates to managing energy and information between the utility and the battery charging system.

From a broader perspective, we offer a range of charging, data management, energy management, testing and consulting solutions designed to enable broad electric vehicle and plug in hybrid adoption and their practical use. Our EV solutions group has made great progress with vehicle OEM's around the world, which are developing electric and hybrid electric vehicles for market introduction over the next three years. Recent government funding for clean transportation has been directed towards EV infrastructure projects and represents a start in the direction of supporting battery and plug in hybrid electrical vehicle adoption. I believe that EV's will be adopted in to the mainstream. Although, it's difficult to know when. For now there are over two dozen electric vehicles in development for introduction over the next few years, we intend to be ready to support passenger and flight EV adoption. We will offer comprehensive development support in charging solutions including true fast charge capable systems, systems capable of fully recharging certain battery packs in less than 10 minutes. I continue to believe that AV is strategically well positioned with our UAS team focused on enabling the growing demand for actionable intelligence and communications and EES team focus on enabling the adoption of material handling and transportation vehicles. That is a broad overview of our business.

Steve will now take you through our financial performance in the next quarter.

Thanks Tim. Good afternoon everyone. Revenue for the first quarter was $37.9 million, a decrease of 29% from first quarter prior year of $53.6 million.

Looking at revenue by segment, UAS revenue was $33.3 million. This is a decrease of 28% from the prior year. The decrease in the UAS revenue was primarily due to lower product deliveries of $14.2 million, and lower service revenue of $9.8 million, partially offset by increase in customer funded R&D of $11.2 million. The decrease in UAS product deliveries and service revenue was primarily due to a cessation of Raven deliveries as we prepare for the introduction of DDL. This increase is customer funded R&D was primarily due to increased activity on the Global Observer contract. EES revenue was $4.6 million, a decrease of 39% from first quarter last year. The decrease in EES was primarily due to lower deliveries of EV test and fast charge systems.

Turning to gross margin, gross margin in the first quarter was $10.7 million. Down 48%, from first quarter of last year. Gross margin as a percent of revenue was 28%, versus 38% in first quarter last year. By segment, UAS gross margin was $9 million, down 46% from first quarter of last year. As a percent of revenue, UAS gross margin was 27%, compared to 36% in first quarter last year. This decrease in gross margin rate was primarily due to lower production and service revenue resulting in higher unabsorbed overhead cost. EES gross margin was $1.7 million, down 56% from first quarter of last year. As a percent of revenue, EES gross margin was 37%, compared to 52% last year. This decrease in gross margin rate was primarily due to overall lower product deliveries, again resulting in higher unabsorbed overhead cost. SG&A for the quarter totaled $10.5 million or 28% of revenue, compared to $8.1 million, or 15% of revenue in the prior year. SG&A growth is primarily due to higher selling and business development expense, increased hidden proposal activity and higher administrative costs.

R&D for the quarter totaled $5.7 million or 15% of revenue, compared to the prior year amount of $5.3 million or 10% of revenue. The majority of R&D investments were for various UAS development initiatives. Operating loss for the quarter was $5.5 million or negative 14% of revenue compared to an operating income of $7.2 million, or 13% in the prior year. The operating loss was attributable to lower sales volume resulting in a lower gross margin in the prior year and higher SG&A and R&D expense. Net loss for the quarter was $3.6 million, or $0.17 loss per share compared to net income of $4.8 million or $0.22 for fully diluted share in the same quarter last year. Looking at backlog, funded backlog at the end of the first quarter totaled $108.7 million, down $6.1 million or 5% from April 30th, 2009.

Turning to balance sheet, cash equivalence and investments at the ends of the first quarter totaled $147.7 million. This is up $2.5 million from our prior quarter amount, of $145.2 million. Positive cash flow was largely due to lower working capital, partially offset by operating loss and capital expenditures. Long-term investments at the end of the first quarter totaled $7 million. Down from the previous quarter amount of $7.2 million. The decrease in investments was largely due to redemptions and municipal option rate securities.

Turning to receivables, at the end of the first quarter, our accounts receivable including unbilled receivables totaled $31.9 million. Down $30.7 million from the prior quarter. Total day sales outstanding were approximately 76 days, compared to 74 days of the prior quarter end. Looking at inventory, inventories totaled $19.2 million at the end of the quarter compared to $11.6 million at the end of the prior quarter. Days in inventory were approximately 64 days, versus 43 days at the prior quarter end. Turning to capital expenditures, in the first quarter we invested approximately $2.3 million, or 6% of revenue in property improvements and capital equipment.

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

Thanks Steve. The business is tracking to our view of 2010 and remains well positioned for long-term growth. We lead the market in small unmanned aircraft systems supporting all existing programs of record in the US Department of Defense. Ground forces rely on these systems to operate affectively and safely and become embedded capabilities that move with them where they deploy and where they train. Dod and administration remain committed to supporting ground forces to enhance intelligence -- protection. Our solutions are consistent with that goal and uniquely affordable. Out development programs address critical domestic and international priorities and proceeding on the right path towards market entry. Customer relationships are strong and they we increased the size of our team of outstanding high performing associates. Our view of the full fiscal year is unchanged. We expect revenue growth of 18 to 22%, over FY 2009. Which would be $292 million to $302 million with an operating margin between 12 and 14%. Visibility in to customer intent and government budgeting plans along with our own production capabilities support our ability to achieve these goals. Given the importance of to the Army and the Marine Corps. of early acquisition and retro fit of digital Raven Systems as a catalyst for new rach system and retro fit order anticipate our second half to account for 70% of our fiscal year revenue. With the quality and relevance of our products and of our solutions in development, and the quality and the passionate focus of our team, I believe that we are in a position to continue to help our customers win help our people develop, and help our stockholders benefit. Thank you once again for your attention and the interest in our Company and Steve and I will take your questions.

(Operator Instructions). First to Mike Lewis with BB&T.

Thank you, very much, for taking my questions. Tim, dod a few weeks ago released an award to you for some option, an option award, it was actually if many hundreds of ddl retro fit, now I don't believe that you have released this in a press release. I guess my question with regard to the ddl option is this what you are expecting to see the ramp in in the second half off of this most recent option award?

Yes. Mike, thanks. I think what you are referring to was a release that the army made of the it was the synopsis of their intent to pro cure sole source digital ravens from ad and I think that's probably there were doctor there have been a few that come out of the program office. Most recent one was the intent in funding in the overseas contingency operations line that is planned in fy10.

Okay. So, okay, but all we know is it's out there and coming.

Yes. Mike, -- we haven't actually negotiated that, that's still ahead of us. I would say Mike, that what we've seen publicly released from the army for army and marine Corp. procurements in both the supplemental, the OCO funding and fy ten budget, is what totals to the 163 million that I referenced in my comments.

Okay. Just a quick follow up. In the press release you actually discussed that there is a quote unquote thousands of UAS in the field. Could you perhaps quantify the number of Raven a. s that you think the army is going to look at to convert with the ddl package?

Let me preface that with a couple of comments, we are visibility in to the near term intent with these announcements they've made on their plans to track with us for both new systems and retro fits and Steve probably has some specific quantities associated with those. Beyond that, we certainly don't -- but it's my expectation that they will intend to end up with a common digital fleet of their entire installed base but will have to wait to see until that rolls out in future years to be sure of that.

For Army, Marines and everyone else we delivered over 7000 new vehicles today.

Steve, one more question for you. Interest income $59,000 at the quarter. You haven't got$ 50 million in cash and investments, why is a s that number much higher?

We are really invested primarily in T bills and earning almost nothing on those investments. We have (inaudible) for nine months to a year been focused primarily on safety.

Thanks very much.

Thank you. We will go next to Chris Donaghey with SunTrust Robinson Humphrey. Chris your line is open, please check your mute function.

Sorry about that. Tim?

Yes.

Just wanted to clarify something real quick you mentioned the 163 million S that for Digital Data Link upgrades and new production or was that upgrades only?

That was included both, Chris, both new systems and upgrades retro fit upgrades that have been publicly announced.

Okay. Just -- is there anyway you can help us breakdown what percentage of that you believe is going to have a 2010 fiscal 2010 impact? Just based on what you know of the time.

I will jump in here, we haven't negotiated a lot of these contract vehicles so it's hard to say but our best information today is that we will perform on about a thousand new and refurbished Raven systems with ddl this fiscal year. That's what our guidance in our current fiscal year plans assume.

Okay. Can you tell was the percentage of that is would be predicated on the government's fiscal 2010 budget being approved on time, or is there enough funding available with what is left in the fiscal 09 budget to get us there?

Well, I think I have to be hedge a little bit here op timing, but let me try to answer your question Chris. I think clearly the sooner the fy10 budget is approved and flows through in to contracts the better. I mean that's maybe a foregone conclusion. We anticipate some delay as we have often seen in the budget approval cycle when we are considering our expectations for the year. But the farther that pushes out, the less room we have at the end of the year. So I'm not sure that I can get it down to a specific percentage. Maybe Steve has a better cut at that answer than I had.

I don't but I do want to go back to my earlier answer to your question, Chris. Of the thousand systems that's both retro fits and new systems and we don't know the exact mix there. So probably the right way to think about it is maybe 50/50. 500 retro fit systems and 500 new systems.

Okay, great. Any insight whatsoever yet in to how Raven demand is going to look going forward, before we started getting the -- before we got the disruption from the frequency, new frequency cutover and the cutover from analog Raven to Digital Data Link I think you were running at 200 to 250 or so airframes per month. Do you see that as a normalized production rate going forward or what are your expectations? Once you get beyond this surge in DDL equipment.

The DDL surge to the extent that we continue with retro fit programs we'll probably go along beyond this year. Again it's my guess that most customers are going to want a homogenous digital fleet -- significant retro fit over time. As of this quarter we are 57% in to the existing army acquisition objective for ravens. The capabilities that the digital system brings to the customer and to the users on the ground are likely to be even greater than they anticipated when they made their production decisions in the beginning. And if that turns out to be true, then I would expect that to have a positive affect on overall Raven demand.

Just as a related question to that then, ddl was developed specifically for the Raven but has applications to -- puma AV, do you see the potential for ddl beyond Raven as a future opportunity and have those discussions or negotiations been underway?

Yes. We expect that we will -- we are already in the process of planning the conversion of both WASP and puma to digital systems. That's in the future, but its definitely our intent on ultimately we would see a offering, a family of unmanned aircraft systems all of which have interoperable digital ground control systems and user interface. The one of the elements that made -- has made the digital conversion of rach Raven so extensive we designed it to be back ward compatible so we can upgrade Raven -- analog systems as well as forward compatible to what we would envision as the next generation ground condition troll system. So our view is that those other two existing production programs would have digital options in the future and that all of this -- we produce would be inner operable with common user interface.

Okay, great. Just one last question, Tim on the Global Observer, as you start to enter the operational evaluation, say I know you got two more aircrafts to build but can you help us with what where you see from a milestone perspective there, do you see a revenue bathtub for Global observer or does it depend really on how the initial aircraft tests go, maybe there are things that can happen to fill in that bathtub once you get in to the formal testing phase, thanks.

Great question Chris and significant area of focus that we have had for sometime as have had our customers. Or as our customers have had. This bathtub affect that you referred to is almost This bathtub affect that you referred to is almost in JC td programs that capability that the secretary of defense office has developed to push or pull forward promising new technology capabilities more rapidly than the conventional Procurement system. It's been really successful at that and we I think Global Observer is a good demonstration as was Raven and the Digital Data Link that we are now incorporating in Raven. However the potential for this GAAP between the end of the JC td and the beginning of a program of record has always been there as we have discussed this follow on funding issue with the half a dozen customers that currently fund the development of Global Observer, almost a universal response has been if you fly it, we will come. So I think the because its such a revolutionary capability, it is going to be very important for our customers to see it in transitioning from development to flight test. Of opportunities, being discussed with a number of customers to bridge that GAAP from the end of the JC td program, to the beginning of a production program, and we're aggressively working with them to that end.

Great, thank you.

Thank you, Troy Lahr with Stifel Nicolaus.

Thanks I'm wondering if you could walk me through the risk of digital rach and it might not ramp up as you are thinking about the third quarter.

Thanks Troy another good question. It clearly is a big ramp and it is a significant change integration in to the Raven system. We are confident in where we are in the plans we put in place and where we are on executing those plans. We are moving ahead on schedule and as we expected, we have the recent experience from a year ago, when we introduced the new frequencies and channel changes to the communication links for both rach and WASP if you recall we developed those tested them, we did field tests on prototypes we shutdown each of those production lines see sequentially we cut in the change, we ramped back up and executed that well and to our customers satisfaction. I think another example of this kind of complex production ramp was when we transitioned from the early small volume production of Raven and our other small UAS to rate production, a few years ago, in a six month period we went from two airplanes a week to ten airplanes a day, per day. And we missed no deliveries and delivered high quality products. So I think making this kind of complex production ramp implementation is difficult, but it's what we do, it's what we got an extraordinary team of highly motivated smart people that have done this before have planned this well and I think we are confident in its execution.

Is it getting your production line up and running or technology lines that -- is it production or technology that kind of gauges us on where we are on track for the Q3.

It's probably a bit of both. This process involves the development of the digital link itself which we had been doing for a number of years. Leading up to this transition, so the transition however is much more than the data link it's is integration of those links throughout the system and the system modifications in order to enable that. So that process led us to build preproduction systems, a number of those systems that we use for our development and then our testing and verification. We've done training of our initial customer users with those systems. And then our customers have taken those systems in to the field and given them to operators to use so that they can evaluate the affects and the actual interface in their real live operations. And that's typical of both new system introduction and major change introduction. It's a combination of our process as well as our customers rigorous formal process.

In that process of evaluation, we expect that new things will be found either something shows up in operation, that department show up on bench tests or something shows up in operation that the customers department anticipate and they want something different than they thought they wanted. Those lead to despite finalization and revisions, we are just finishing up that latest version of those. At the same time in a ideal world I think we would wait until we would have waited until all of that is done until we do final documentation and tooling and supply chain commitments. In order to be adequately responsive to our market and our customers we historically do all that in parallel. So we are in the midst of that now and that involves supply chain involves new test equipment on the floor and validating that as well as the assembly process.

Is the customer field testing is that complete or is that still on going and when will that come to a conclusion?

I believe the customer has the systems in the field and but I think we have a good grasp of what their perception is. I think we are moving ahead with confidence.

Okay. Then the timing on the negotiation. You still don't have orders for this ramp up. When do you expect to have the orders in hands.

Some of those, there is some backlog as I mentioned. $17 million that we announced in January. We -- there is a segment of orders in incorporated in the second supplemental for 2009. And that's in the process of being converted to contracts. And there is a budget request in the fy2010 both the base dod budget and the oco budget. Those have been announced publicly. And we would be expect that as soon as the -- as that budget is approved and signed by the President, it would flow through to the army and we would be in contract negotiation. We know that both the army and the marine Corp. are anxious to execute both the acquisition of new digital systems through those fy ten budgets and the large number of retro fits, we think it is likely to move rapidly once it's approved.

Last question, sorry to keep going on here, but UAS revenues first quarter, did that represent a low point from the year, we should ramp up from this point on or second quarter similar to the point.

It's a low point. Tim said earlier, 70% of the year in the second half and I think then you can do the math on what that Q2 would tend to look like.

Okay, thanks, guys.

We will go next to Jeff Evanson with Dougherty and Company.

Thanks for taking my questions.

Hi, Jeff.

Well, I guess in first question is, is there a third aircraft go aircraft in our backlog figure?

Yes, the -- there was the third aircraft funding for the third aircraft was included in change orders that were released, did we announce that in Q3? I think it was Q3 last year.

It was it is now in backlog?

Yes, since that announcement, -- Q3 I think -- I wanted to make sure it was funded in and in the backlog order.. It was funded and announced and we continue to work with our customers on the Global Observer program. Continues to be change orders that priorities move around for what customers want when they want it, what's -- how much funding is one in plan or another. So at any given time the content within a specific contract line item can and does move around.

Okay. Obviously learning that spares and repairs can be lumpy. US service revenue calculation of lay at 5.5 million in the quarter. Could you verify that and give us some color commentary around how that's tied to overall UAS activity level? Where you see that going?

Yes. $5.3 million for the quarter.

Okay. Yes, that's sort of where it was in Q3 of last year and it's moved all over the place sense then. I think we would look at this level as being somewhat low. Expect that to grow as we go through the year. We think it's been somewhat impacted along with product deliveries with customers waiting to buy spares for Digital Data Link.

I think there is no question that our largest customers for Raven that are if the process of converting from analog to digital have been trying to minimize expenditures for analog spares. As they anticipate the conversion to digital and there's some obvious difficulty in guessing how many spares will be required to support the analog installed base before its converted to digital. But there is no question that they are trying to husband their funds so that they have more capability to support the conversion to digital going forward.

So frankly given the delay here, it would make sense we might see another tough quarter on service revenue.

I guess we are not guiding on those individual elements. Probably where we got to leave it is the overall guidance that Tim gave and then the 70% in the second half and that's probably as close as we want to get to Q2.

Okay.

Specificity.

All right. Now obviously we've had some testing on the puma and positive feed back there, I thought you had gone in to production in May. When do you think we might see production orders for the puma?

I saw some line items in the House version of the defense appropriation bill. I know that there are multiple customers with an appetite for either new pumas or more pumas and I can't really comment on where they are in the process of lining up the funding for their earlier acquisition. But I think in general everything I can see with customers that have used or seen the product is positive and I think that bodes well for acquisition. I don't have enough insight in to the funding line items there to put a pin point on timing.

I would add in first quarter, the product revenue that you do see accepting the EES product revenue is not for Raven. We a had no Raven product revenue in first quarter it would all be puma and WASP.

As you look at 70% of revenue in the back half of the year, what do you see as a max production level per month of Ravens and DDL upgrade kits to achieve that. I'm going to attempt to back in to number but I'm sure you guys thought it through thoroughly. Well we clearly have a production plan.

I'm trying to see how I can answer your question without getting in to more detail there than we --

I can try a couple of data points. Inventory grew we might expect inventory to grow somewhat more as we build and pro cure what component subsystems we can ahead of time to help make those deliveries. Beyond that I think we mentioned earlier our internal plans call for production of about 1000 systems worth. Either retro fits or new Raven systems in the balance of the year. Mostly if the second half.

Given you got finished good and work in progress in inventory you are planning it's going to be tough but you are planning to meet that challenge right?

We are not saying it's a slam dunk but we think we've got the capacity to do it.

All right. Last question, sorry for all these, my last question, just curious, Tim, what federal decision points are you waiting for in the timing around ramping of EV test systems you said that was weak in the quarter due to timing of federal decisions.

And I what I meant this, Jeff, was that a number of our customers for electric vehicle test systems, either OEMs or battery manufacturers had proposals in for government funding as some of what would likely be applicable to the test equipment for their development programs. And so I think we had some indication that waiting for those decisions and that potential cash affected their procurement . Beyond that, there are opportunities for charging systems that we would sell other than the test equipment, to support the implementation of infrastructure for electric vehicles which potentially could show up in the future.

Okay, thank you very much.

Thank you next we will go to Peter Armond with Broad Point AmTech.

A lot of questions have been answered you mentioned new customers on the WASP and potentially puma. Maybe you could just provide more insight on that if you could.

I'm reluctant to get in to what customers might be considering what procurements in the future and we made a habit of not commenting on our proposal activity. But there are US government customers, DOD customers, beyond the Air Force and the Marines that currently have acquired WASP that have been evaluating it, appear to be positively disposed to acquiring WASP in the future. And there are also international customers that are in that same, in that same stance.

I think as to puma, our initial customer was and continues to be special operations command. All of the feedback has been very positive there. I think that's a matter of funding approval and timing for that. We just began showing puma to potential new customers within the last couple of months. And as I mentioned in my comments, the response has been very positive. I think that's going to be a popular product, again both domestically and potentially internationally. We're still very early in the marketing stage with puma.

I appreciate that. Have you seen any change at least qualitatively in terms of requirements concerning the ramp in Afghanistan and potentially further additional troops there.

Well, general McCrystal's made a number of comments including something to the affect that he expects never to have enough ISR. And this issue of collateral damage has entered in to his public comments on how he is conducting and implementing policy there. I think those overarching large scale issues come right in to providing more ISR and more situational awareness, more persistence and more precision at the ground level and I think that's what our systems provide to our users. So I think it's -- I think we can continue to bring more to the party.

Thank you very much.

Next we'll go to [Randy Cuiersen] with Barren Capital.

In term of looking out in terms of the quarterly calculations, I know you are not giving a lot beyond the 70% in the second half. On the revenue line, are you assuming that EES is relatively flat through the first quarter throughout the rest of the year or counting on pick up there as well?

This is Steve. I think we don't expect ees to continue at the level that we saw in first quarter. That was a disappointment to us.

Okay. And we can make our assumptions as to revenue but obviously its a huge jump from Q2 to Q3, are there any scenario, on the operating expense line, you guys mentioned in the prepared comments that SG&A is basically fully loaded because you have proposal activity and full teaming to sell existing future systems at -- so is it fair to assume that that run rate will be stable throughout the rest of the year?

I think if we fit our top -- I will let Tim say more, -- but if we hit our top line the way to think of it is SG&A and R&D think of it as a percent of revenue, not unlike what we saw last year, so that would indicate in the balance of the year we would see some continued investment in the expense area. Maybe not right off the bat. But by the end of the year.

So for example in the Q4 you guys were running 13.5% on the SG&A line and 9% on R&D, and Q4 was the most revenue, are those reasonable percentages or how do I think about that?

Randy, would be looking at it on an annual basis and we have in the past and we are currently looking at the year to come in at 13% or 12% to 14% operating margin on the total annual revenue.

Right.

So we're as a percentage we are much higher in the front half where we've got lower revenue and I think as a percentage we would be lower in the back half with higher revenue but overall I would expect our expense spending to be higher in Q4 than it was in first quarter as we typically have continued to grow and those investments over time. Does that helpful?

That's helpful. I will have to back in to the individual quarters as to how to get the 12% to 14%. But it makes sense. Then switching gear as little on switchblade you guys have been consistent in looking for orders by the ends of the fiscal year, what is kinds of holding things back, is it production, funding, contract negotiations or something else?

I think it is at a high level, the issue is that this is an entirely new capability. This is really out of the box. Few if any -- few customers even anticipated this capability being possible even a year ago. While our initial customer was funding the early development and evaluation, most others were, this wasn't on their radar screen. So its like most innovative new solutions. It requires customers to think about how they would implement this in to their system, how they would fund it. Who owns it, how they operate it. And how this fits in to their enterprise and I think that's whether it's Global Observer, whether it is switchblade or the original introduction of hand launched unmanned aircraft, it just appears to require a considerable amount of time for customers to sort through those issues. And whether it's DOD or whether it's retailers operating distribution center with electric forklifts the introduction of a fundamentally new technology solution just seems to take a lot of time and that's why we've never been great at predicting the timing of adoption.

So having said that, the -- I think what is going on right now is I think there is a lot of activity in a lot of customers that is -- that began when we did our end to end solution at the end of last calendar year and I think that's continuing to move ahead and gain steam. It's certainly not abating and as I mentioned in the comments, this three day demonstration just a couple of weeks ago had over 50 people there for three days in a what was the determinant undisclosed -- federal facility watching extraordinary challenges to the demonstration of switchblade and it was very very successful.

My next question was going to be was the facility state side or overseas.

It was domestic but it department necessarily look that way.

Okay. Good enough. Just a quick question, cash flow from operations in the quarter?

$4.5 million positive.

And what was DA Steve?

1950.

Okay. Thank you guys very much.

Thank you. Thanks Randy.

Thank you next we will go to Josephine Millward with Dougherty and Company. Josephine your line is open. Please check your mute function.

Hello?

Hello, Josephine.

How are you?

Doing well, how are you?

I'm doing very well, thank you. Just -- you may have talked about this. I want to confirm that you're reiterating your is 12% to 14% operating margin including the loss in first quarter.

That's correct.

Okay. All my other questions have been answered. Actually let me confirm something, did you say that the puma funding was in the House appropriations bill?

Yes. The last time I saw the or was aware of where we stood, I had the -- there was approved funding or for puma in the House appropriations bill.

That's good news. I know it was approved by the House and Senate defense authorization. So it got it was in your probes as well. Can you confirm if it was $14 million or $15 million, the same amount in the authorization bill?

That was my sense. I'm trying to pull it out of memory Josephine. But I think that's what it was. I think it was not did not end up in the Senate version and so I think we find out what really happens after conference.

Sure. I think you still have time to work on that. I think the Senate is still has a lot of work to do. Great that's good news, thank you very much.

Thanks Josephine.

Thank you, next we will go to Brian Rutenberg with Morgan Keegan.

How long does a ramp of DDL go, I know you talked about third and Q4 that's when its kicking in. I want to know is it a three quarter ramp, four quarter rach, five quarter rach, what is the state after that ramp? A big rush for the DDL and then what is it going to come back down to. Look likes you are going to take it up in Q3 and Q4 to $100 million run rate in total. I'm trying to figure out what the run rate is, where it falls off to.

I think our view will probably change over time as we see what customers actually do beyond the what we can see now in the FY10 budget request. But given what we know now we will peak capacity in Q4 probably as we continue to move forward with digital systems and retro fit kits after that. But -- I don't have great visibility deep in to the next year at this point.

Would a trail off number be more like $80 million from the $100 million run rate. What do you see the trail, where do you see a steady stake after the big buildup?

Well, I don't think, again, I want to lock down on what happens after fiscal ten. But so but what I'm talking about capacity, I'm referring to the capacity we are building in to our production capability. And we are sizing that to be a little over what I think the peak demand will be. If that changes, and goes up, we will just increase capacity and that's not going to be a huge problem for us.

Then last question on the Global Observer, do you expect the revenue from the three systems to come in in fiscal 11 or a big chunk of it, is that right?

Mainly it's we are sort of -- we are in the middle or on the other side of the middle on that program. So we are really running at pace on Global Observer this year.

Okay. Very good. Thank you very much. That's was all my questions.

Thank you.

We will take our next question from Tyler Hojo with Sidoti and Company.

Good evening everybody. A couple of housekeeping things first. What was the number of Raven systems purchased by the army in the quarter?

Zero.

Talking about the army acquisition ?

Right. It was 57% delivered in Q4, we remain at 57% in first quarter. I think in the quarter we delivered on the order of two Raven air vehicle out of the factory and to nonDOD customers in first quarter. We are -- that part of the Company was really just working to get ready for DDL

And I know you guys don't look at this, but what was the unfunded backlog in the quarter?

$513 million approximately and again, you're correct we don't view this as a real backlog number.

Just to plug it in the model. And just lastly, you've got this question asked a lot of different ways but in terms of digital Raven at what point in the fiscal year do you actually need to have funded orders in hand to make the guidance that you gave or -- backed here today.

Let me take another shot at answering that a little differently and see if it helps. There is different places that publicly available funding is coming from. And the I believe that the amount that's in the second '09 supplemental is already appropriated and in the contracting process. So what's left is in the base defense budget and in the 2010 OCO request. Typically, that could get approved as soon as the end of this month. But we have often seen those orders slide out in to our third quarter. So I think we can certainly handle a couple of months slide there without affecting our existing plan. Is it -- if it gets extraordinarily late then we are going to be up against it and we will do what we normally do which is build ahead, fill -- smooth our production flow, and be in a position to put the maximum amount of hardware out to our customers in the shortest amount of time when contracts finally do flow in. But it's very difficult to pin that down to a date certain at which point we are just too far.

But it sounds like even if you get these orders by the end of your calendar year or before January, that you could still meet the goals that you've set out here tonight?

That timing has happened in the past and when it has we have been able to meet our annual plans anyway. It gets a little more difficult when we got this heavy back end load but its the kind of planning flexibility that we built in to our system.

Fantastic, thanks a lot.

Let me interject before we move on. Josephine asked me about the puma numbers in the budget and I -- I said that I last time I saw the expectation on the House appropriations bill that those that puma funding was there still even though it wasn't in the Senate. Steve points out he thinks it was not in the House appropriations so I would like to get back with you, Josephine, on what we really think the answer is on that status after we check it tomorrow.

Next is Erik Olbeter with Pacific Crest.

Thank you for taking my question. Going back to a little bit to a Global Observer, had a strong ramp, how should we expect that through the remainder of this year, is this a high water mark in terms of revenue you are going to book? It's going to continue as you get the products out the door?

Generally, its going to continue through our fiscal year at something close the rate we saw in first quarter. As reminder global doesn't make up all of the project R&D that we break out by program but the largest component of that.

Right, maybe just going back to the EES business, there's been a fair amount of loan guarantees going through the pipeline, right now, at the federal level, projects waiting for that financing to see if it materializes, is that sort of a specifically something we should look for to see when those loan guarantees are actually pilot funds are released as indicated of the business coming back on line.

I don't think I would tie our business directly to the timing on those federal loan guarantees Eric. I think there has been an affect on our sales of our electric vehicle test equipment, that's been driven by those anticipation of those loans and other grants, moving through the federal process and I would expect as that moves through that those customers that then intend to use that funding to build up their test capability would we would see that in our test equipment revenue.

That's helpful. Last question for me, Tim, I know you guys don't guide on gross margin, but as you think about the ramp in Q3 and Q4 for the UA business, is that should we expect sort of gross margins come down a little bit. I assume a lot of people busting the hump to get this out, is that something you guys have forecasted in our model?

I think in general Eric, certainly there is the probability that we are going to be busting our hump as you put it, to make this heavy back end production happen. But -- the my expectation would be that the larger affect would be that the higher revenue of more of our overhead just like the lower revenue absorbed less of our overhead in first quarter.

And I will add first quarter I mean we certainly expect gross margins to move up from first quarter levels when we get in to the second half of the year. first quarter was about 70% cost plus. And we will be -- we will have a normal mix as we go in to the balance of the year.

Great, thank you, gentlemen.

Thank you Eric.

Thank you, time for one final question. We will move to Michael [Chimole] with (inaudible).

Thanks for taking my question. Tim, on the -- I will ask one quick one here on the Digital Data Link. I was told that the Army actually owns the wave form for the DDL, and a push was going to be made to deploy DDL to all of the Army's unmanned systems not only the aeroenvironment, but fire scouts, hunters, an additional revenue opportunity for you guys to sell ddl to perhaps some of your competitors or other army customers out there?

Eric, when we -- the DDL development started internally, we built prototypes we took those to customers and to gauge their ultimate interest and that led to incorporating the further development of DDL within a advanced ACTD program. That was partially sponsored by the Army and partially by the office of Secretary of Defense and potentially others. As we developed that, we wanted to make sure that the wave form was approved within the government system and it is. One of the either the few or only -- I guess I should characterize that as its one of the few at least of the wave forms that have a jitter exemption within the larger department of defense so.

As we have now moved this to production, it has a unique position in the overall wave form approval process, and I certainly have heard a number of indications from our existing customers that they would like to use this dimming digital data fling other applications. Long answer to your question that probably could have been yes. But hope it provides a little more color.

That does, thanks a lot. Most of my questions have been answered. Thanks, guys.

Thank you, Mike.

With that, I would like to turn your program back over to Mr. Gitlin for closing comments.

Thank you for your continued interest in AeroVironment archived version of this call, all filings and with found at avinc.com. We look forward to speaking with you again following next quarter's results, have a good day.

That does conclude today's conference. Thank you for your participation.