AeroVironment Inc (AVAV) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2010 AeroVironment, Inc. earnings conference call. I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session after managements' remarks. As a reminder, this conference is re -- 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.

I would now like to turn the call over to Mr. Gitlin. Please proceed, sir.

Thank you, Melanie. Welcome to AV's second-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 file with the Securities and Exchange Commission.

Investors are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date on which they are made. 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, December 8, 2009. The Company undertakes no obligation to make any revision to the statements contained in our remarks, or to update them to reflect the events or circumstances occurring after this conference call.

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

Thank you, Steven, and welcome to our second quarter fiscal 2010 conference call. The second quarter unfolded about as we had expected,, and it was consistent with what we outlined for the balance of the fiscal tear in our Q1 call. We initiated production of our digital Raven systems at the tail end of the quarter, we made good progress on our development programs including Global Observer and Switchblade and we delivered sequential improvements in our EEF segment's performance. As we vindicated in our Q1 call, we expect the second half of our current fiscal year to account for about 70% of our full-year revenue, driven primarily by deliveries of digital Raven systems and upgrades to convert existing analog systems to digital. Our team worked hard in Q1 and Q2 to position us to deliver on this important product upgrade, and although the back-end weighted delivery plan inherently brings with it an increased execution risk, we expect to execute that plan and we maintain our guidance of 18% to 22% year-over-year revenue growth for fiscal 2010, with an operating income margin of 12% to 14%.

Beyond this year's guidance my continued belief that the long-term growth drivers of our business remain very compelling is supported by sustained demand for our current products and active customer interest in the innovative solutions represented by our advanced developments. As a result of the digital Raven transition, including associated system upgrades, Raven systems will be even more useful to US forces, including those operating in the high altitudes in the mountainous terrain of Afghanistan.

I'd like to spend a moment to address the production transition of digital Raven. With the start of digital Raven deliveries we've taken an important step forward with one of our most significant product upgrades today. As you will recall, customers have been waiting for the new digital Raven systems to become available. The development and transition to production of digital Raven systems was the focus of much of our teams attention during the first half of the year. The scope of this transition is significant, as is the nature of the benefits it provides to our customers. In every product transitioned to production that I'm familiar with start-up issues emerge and are addressed. The transition to digital Raven has been no exception. The engineering changes from analog to digital Ravens requires changes to most of the subsystems and it was accompanied by several other important modifications to the Raven system that resulted in an even more robust and capable solution.

These additional improvements include an improved motor, a reduced acoustic signature and z higher-resolution color video camera, all in addition to the frequency efficiency, the communication encryption enhancement and the beyond line-of-sight capabilities specifically associated with the Digital Data Link. Throughout the development and transition we have identified issues as they emerged, identified and determined their root causes, developed and implemented solutions, tested the integrated system to confirm its effectiveness. This spiral process is typical of our developments and was anticipated in our plan for the production ramp up. We have received strong customer support for our approach to this production start-up phase.

After initial deliveries in late October we assessed our product performance and our production yield and we decided in concert with our customer to further optimize the system. Since October we have continued to improve the performance characteristics of the system and resolve issues affecting initial yield. We continued to refine our supply C\chain, continued customer training, staged production hardware, and added production technicians to support and enable the plans. The net result is that we have a more robust high-yield production system as we ramp up production in December and January. We delivered small quantities of digital systems through November, as we continued to optimize our systems and stage hardware for the production ramp we are starting this week.

Our production plan for the year is now only slightly more back-end loaded, but the improved yield and the staged hardware support our production and revenue plan for fiscal '10. We expect our production rate to build rapidly through the balance of Q3 and to peak in Q4, delivering about 1,000 digital Raven systems and upgrade kits in total this year. Considering that we have surged our small UAS production in the past to over 600 air vehicles and equivalents in a single month, this surge in production anticipated in Q4 is not unprecedented and is within our production capacity. From a customer perspective the upgraded digital Raven system will now be even better suited that operational requirements of Afghanistan, supporting the increase in troops there at a critical time.

We are still awaiting passage of the fiscal 2010 defense appropriation bill, which includes approximately $121 million of funding for Army and Marine Corps Raven systems and digital upgrades, as well as the arrival of orders funded from a previously-approved $27.5 million supplemental line item. In the meantime we are working closely with our customers to negotiate the multiple proposals related to this anticipated funding. We would obviously like the appropriations bill to be signed sooner rather than later, but we believe that we can still achieve our fiscal '10 performance objectives with the expected signing of the bill by the end of this month or in early January. In summary our second quarter performance was in line with what we expected and we expect to deliver the growth reflected in our guidance.

Now let's discuss our Unmanned Aircraft Systems business beyond the digital Raven transition. AB remains the leader in small UAS. We are the prime contractor for each of the four US DoD programs of record for small UAS and have delivered over 13,000 new and replacement air vehicles to customers in the United States and elsewhere. All US ground forces have adopted small UAS and are now using them regularly to enable front-line war fighters to identify threats and perform post-action recognizant, protect bases, scout ahead of convoys and provide aerial observation for elections, peacekeeping operations, recovery operations, and myriad other missions. In much the same way that PCs eliminated the bottlenecks associated with mainframe computing by putting computing power into the hands of individuals, small unmanned aircraft systems are delivering realtime information to the hands of soldiers, sailors, airmen and marines who need it when they need it. This disintermediation from larger, more costly and scarcer reconnaissance assets has given small teams the ability to make better decisions, move quickly, resulting in more effective operations and lives saved in the current threat environment.

Within our UAS segment we have developed a full suite of small unmanned aircraft systems for intelligence, surveillance and reconnaissance, all designed around a hand-held common ground controller. We are now under contract to develop digital Puma systems and we are developing plans for the future transition of WASP, working towards a small UAS family of interoperable systems built around a common digital ground control system. We support all of our UAS customers with training, spare parts and repair services that are tailored to their needs and designed to make them more successful when they use our systems. Our outstanding small UAS team is very focused on this set of technologies and customer needs, a strategy that I believe makes it easy for our customers and hard for competitors. We also have an active research and development function within Unmanned Aircraft Systems that is creating entirely new solutions that build on decades of experience in two domains; small unmanned aircraft platforms and high-altitude, long-endurance unmanned aircraft systems.

Switchblade is the development initiative that adds a lethal strike component to small unmanned aircraft, creating an entirely new capability of a loitering precision munition that is moving closer to early adoption. We are seeing small quantity purchases of Switchblade and apparent growing interest in this new capability. We received nearly a dozen small orders in small -- in Switchblade systems to date, primarily for test and evaluation of this new system capability in multiple applications. In Q2 we received orders for Switchblade that I would characterize as combat prototypes, which we believe represents the next step in customer evaluation and consideration of adoption. We expect additional similar orders over the balance of the fiscal year, as multiple customers continue to express interest in this unique new capability. Volume production timing continues to be difficult to predict, but I believe the current level of interest is a positive indicator.

Global Observer is a development initiative focused on creating and exploiting the ability to fly in the stratosphere for up to a week at a time in order to provide affordable satellite-like persistence for remote sensing and communications relay. We believe this will be a highly-desirable and a high-value capability that does not exist today. Now over two years into a three-and-a-half year development program the Global Observer joint capability technology demonstration is making great progress towards our goal of initiating flight testing during the second half of the current fiscal year. This is a revolutionary aircraft that employs technologies never before used in such a manner. In our last call I said we were planning to ship the first Global Observer air force -- aircraft to Edwards Air Force Base during Q2 for ground testing prior to flight testing during our second half of this fiscal year.

We kept airplane number one in our development facility two months longer than planned to continue integrated system testing in a location optimally equipped to resolve problems and to validate the airplane and ground control station system hardware and software. The team has now completed a continuous 12-hour fully-powered run on airplane number one and has systematically stressed the software and simulated multiple faults to provide additional confidence in the aircraft's new control and power systems. We have successfully completed all of these tests and airplane number one is currently being disassembled for shipments to Edwards where it will undergo integrated system tests, mission simulation and flight crew training prior to the initial flight test series. The move to Edwards should be completed this month and will support our plans to be in flight testing in the second half of fiscal 2010. Airplane number two is moving to the second of three assembly stations within our development facility as airplane number one moves to Edwards.

In the international small UAS market, we have seen signs of reengagement in a number of countries, suggesting that that market is improving. We remain well situated to generate growth through each of the five growth drivers of our business; that is selling more of our existing products to existing customers, supporting the growing installed base of products, developing and introducing product upgrades, entering new markets for existing products, and successfully introducing entirely new solutions that are currently in development. At this point I'd like to turn to our other operating segment.

Revenue in Efficient Energy Systems, or EES, increased sequentially despite continued pressure in the industrial markets for capital equipment served by our industrial electric vehicle charging systems. As a business segment, EES develops and supplies test systems, production systems and charging infrastructure to support the development, the production and the safe and reliable use of electric vehicles. Our EV test systems remain industry leaders in North America and we see opportunities for growth, both domestically and abroad. A growing global interest in electric vehicles has helped to drive sales of this test equipment, with all major automotive manufacturers now planning to introduce plug-in vehicles over the next three years. Additionally there is an increased awareness regarding the importance of the infrastructure that will be required to support electric vehicle adoption and broad use. We have been very active working with a large number of automakers, battery manufacturers, utilities and government agencies to generate awareness of the critical role charging infrastructure will play in the adoption and the practical use of electric vehicles. Our EV infrastructure solutions position us as a potential supplier of these solutions as EVs appear in the market.

We have also helped to create public organizations focused on promoting a rational, practical approach to transportation electrification. The Battery Electric Vehicle Coalition and the Electrification Coalition consist of industry leaders committed to the successful introduction and adoption of electric vehicles in the United States. We look forward to working with our partners in these groups to move toward a cleaner environment, energy independence, and clean technology job creation. As I look at what our team at AV is accomplishing, I believe that we remain in a uniquely good position to generate long-term growth through the practical application of our innovative technology solutions and capabilities to critical market needs.

At this point, Steve Wright will discuss our financial performance in the second quarter. Steve?

Thanks, Tim. Good afternoon, everyone. Revenue for the second quarter was $51.4 million, a decrease of 22% from second-quarter prior year of $65.8 million. By segment, UAS revenue was $43.7 million, a decline of 23% from the prior year. The decrease in UAS revenue was primarily due to lower product deliveries of $16.1 million and lower service revenue of $3.4 million, partially offset by an increase in customer-funded R&D of $6.7 million. The decrease in UAS product deliveries, and service revenue was primarily due to the reduction of our analog Raven B production and services, as we began production in retrofit of Raven B systems with our DDL technology. The increase in customer-funded R&D was primarily due to increased activity on the Global Observer contract. EES revenue totaled $7.7 million, a decrease of 18% from Q2 of last year. The decrease in EES was primarily due to lower deliveries of our EV test and industrial charging systems.

Turning to gross margin, gross margin in the second quarter was $19.6 million, down 21% from Q2 of last year. Gross margin as a percent of revenue was 38%, unchanged from last year. By segment, UAS gross margin was $15.8 million, down 21% from last year, and as a percentage of revenue, UAS gross margin was 36% compared to 35% last year. EES gross margin was $3.8 million down 24% from Q2 of last year. As a percentage of revenue, EES gross margin was 50% compared to 54% last year. This decrease in gross margin rate was primarily due to product mix.

SG&A expense for the quarter totaled $10.5 million, or 20% of revenue, compared to $7.9 million, or 12% of revenue in the prior year. SG&A growth is primarily due to higher selling and business development expense, increased bid and proposal activity and higher admin costs. R&D for the quarter totaled $5.8 million, or 11% of revenue, compared to the prior year of $4.9 million, or 7% of revenue. The majority of our R&D investments were for various UAS development initiatives. Operating income for the quarter was $3.4 million, or 7% of revenue. Operating income was 72% lower than the prior year, primarily due to lower sales volume resulting in lower gross margins, and higher SG&A and R&D expenses. Net income for the quarter was $2.2 million, or $0.10 per fully-diluted share, compared to a net income of $9.1 million, or $0.41 per fully0diluted share in the same quarter last year.

Now moving quickly through our year-to-date results, revenue for the first six months was $89.3 million, down 25% from the prior-year period of $119.4 million. UAS revenue was $77 million ,down 25% from the prior year, and EES revenue was $12.3 million, down 27% from the prior year. Gross margin for the first half was $30.4 million versus $45.6 million in the same period a year ago. Gross margin as a percent of revenue was 34%, a decline of four percentage points from the prior year. UAS gross margin was $24.8 million, down 32%, and EES gross margin was $5.6, million down 38%.

SG&A for the first half totaled $21 million, or 24% of revenue, versus the prior year of $16 million, or 13% of revenue. R&D for the first six months was $11.4 million, or 13% of revenue, versus $10.2 million, or 9% of revenue in the prior year. The operating loss for the first half was $2.1 million, or 2% of revenue versus, an operating income of $19.5 million, or 16% of revenue in the prior year. The effective tax rate for the first half was 30.4% versus 31.9% in the prior year, and the net loss for the first half was $1.4 million, or a loss of $0.06 per share, compared to a net income of $13.9 million, or $0.64 per fully-diluted share last year.

Looking at backlog, funded backlog at the end of the second quarter was $107.1 million down $7.7 million, or 7% from April 30, 2009. Unfunded backlog at the end of the second quarter was $303.5 million versus $510.6 million at April 30, 2009. This decline was primarily due to the expiration of a five-year IEIQ contract with the NATEC Army Center. The IEIQ was established prior to the Raven program-of-record competition and was used slightly after we awarded the Army SUAV contract.

Turning to our balance sheet, cash equivalents and investments at the end of the second quarter totaled $131.5 million, down $16.2 million from our prior-quarter amount of $147.7 million. Free cash flow for the quarter was -$16.3 million and was comprised of cash from operations of -$12.9 million and capital expenditures of $3.4 million. The negative operating cash flow was primarily caused by growth in inventories and receivables, partially offset by income, depreciation and payables.

Turning to receivables, at the end of the second quarter our accounts receivable, including unbilled receivables, totaled $52.2 million, up $20.3 million from the prior quarter. Total day sales outstanding were 91 days compared to 76 days at the prior-quarter end. Receivable growth for the quarter was caused by higher sales volume generated towards the end of the quarter. Taking a look at our inventory, inventories were $25.1 million at the end of the quarter compared to $19.2 million at the end of the prior quarter. Days in inventory were approximately 71 days compared to 64 days at the end of the prior quarter. Inventory growth for the quarter was largely to build for the anticipated high volumes of deliveries we expect in the balance of the year. Turning to capital Expenditures, in the second quarter we invested approximately $3.4 million, or 7% of revenue in property improvements and capital equipment.

And now I'd like to turn things back to Tim to discuss expectations for the full year.

Thanks, Steve. Looking forward, our digital Raven system will reinforce our leading position in the small UAS market and along with WASP and Puma will support the administrations planned force increase in Afghanistan and wherever else US ground troops train and operate. Our development programs continue to generate positive progress and move towards addressing important high-value market needs. We remain in a great position to produce long-term growth. As I stated earlier, our fiscal 2010 is unfolding within the schedule window that we anticipated. With approximately 65% of our second-half revenue expected to be generated in Q4, we clearly have our work cut out for us to execute the second half ramp up in digital Raven production and the government fiscal year '10 defense bill needs to be signed in a timely manner.

Nevertheless, we still expect revenue growth of 18% to 22% over fiscal 2009, which would be $292 million to $302 million in revenue with an operating margin between 12% and 14%. This view is supported by funding in our backlog, in the previously approved supplemental bill and in the current defense appropriations bill, along with our view of the demand for our solutions and feedback we receive on a regular basis from our customers. And I believe that we are doing important work, helping our customers succeed and serving the long-term interest of our associates and our stockholders.

Thank you once again for your attention and your interest in our Company. Steve Wright and I will now take questions.

(Operator Instructions). We'll take our first question from Howard Rubel from Jefferies.

Thank you very much. I want to try to just do two, Tim. First, the Global Observer was a couple of months late but sometimes you make that up by keeping it in place. How do you stand on your estimate to complete for the program?

Well, we still expect to complete the JCTD objectives of ultimately demonstrating military utility effectiveness with an integrated airplane and payload system later next calendar year, Howard, and within the existing funding.

So the difference -- so this incremental cost, because time is always money, is really irrelevant to how we should think about your bottom line over the next 12 months or so?

Well, I think we believe that the additional costs associated with the additional time -- and that is a reality -- are being accommodated within the existing contract structure by our customer, without additional funding. Steve, have you got any comments on the --?

Well, other than it shouldn't affect the financials over the next 12 months because it's a cost-plus program, Howard.

Yes, but you do get -- your revenues would be a little higher, right, and either the fee might be a little lower,or the fee is unchanged here? Isn't there a performance element to the fee?

It's a CPFF, and right now I don't think we have a forecast of any change in the total funding or how that funding rolls out. Notwithstanding the two months of testing here at our plant I think a lot of that testing would have gone on at Edwards anyways.

It's one bucket or another bucket is a way of saying it, is that fair?

Yes.

And then just staying on R&D for a moment, it was flat sequentially, so are you -- I know you have some other ideas for doing some additional things, Tim, but is this a fair run rate for a while, or can you do some other things to help on the cost side?

I'll just start. I think the run rate really just reflects the programs that we're working on at the current time. Going forward even in the balance of the year we might see some growth in the R&D line.

Thank you, gentlemen.

Thanks, Howard.

Our next question comes from Michael Lewis with BB&T Capital Markets.

Thanks very much for taking my call. Tim, with regard to the [MOT] that was released in the 8-K this afternoon there's some cautionary language, it addresses that there's no assurance that any of these options will be exercised, the standard language, it just stood out to me, but with regard to that, how confident are you that timely tasks will progress on this program over the next three to five months?

Well, that announcement, Mike, was on the increase in the IDIQ level of the Army contract. I believe that's associated with the negotiation around the digital Raven funding tied to line items in the '09 supplemental. I think our customer wanted to negotiate values in excess of the actual amount of the line items that were included in the supplemental and we expect some of that tied to the line items that you saw in the '09 supplemental to flow through in a timely manner.

Okay, and also re -- okay, that's very helpful, but also if we look at the ramifications of the appropriations bill still being in conference, and we talked about this that there could cause some pressure if it's not passed by the end of the fis -- of the calendar year, so where do you stand? Let's say it passes by mid to late January, what does that mean to this current guidance that we have in front of us now?

Well, let me start by pointing out, I think, another comment that I made in my previous statements that we have been working diligently with our customers negotiating the terms of the contracts that would be anticipated to execute the funding that's identified in the current 2010 appropriations bill. We're -- my comments assumed a signing of that bill by the end of this month or early January. Of course, we don't control that and we're just guessing but we have historically often seen the budget get approved in that timeframe, which tends to translate into contracts hitting our Company maybe the end of Q1 and the early part of Q -- or excuse me, the end of Q3 and the early part of Q4, and in those cases in the past, we have always been able to anticipate those and flow that work through the -- into our Q4 revenues. Steve, you may be able to (inaudible) on that?

Well, I guess I would just add that it's not sequential. We are working on the contract and going through that process in parallel while we wait for the formal budget to get approved and I would just reiterate, in the past, these large bookings happen the very tail end of Q3, very beginning of Q4, and if that's when it happens this year our production plans should be able to accommodate the guidance that Tim gave.

Okay, that's very helpful, and just one final question here. With regard to the DDL integration, has there been any issues -- let's just say, for example, software glitches in the integration, that would cause any pressure to the current weighting of the guidance now for the third and fourth quarter?

Well, we -- I pointed out there is really -- in my other remarks, Mike, there were really -- I can think of the digital data link ECP in three chunks. One is the digital data link itself, all of the changes in the hardware and software that were required for other parts of the airplane system to accommodate that transition from analog to digital. For example, the camera output and many other changes like that. And then a third category of changes where we either upgraded or improved other parts of the system like the motor and cameras. The data link itself has been really robust from an early stage and to the degree that we have seen challenges in the performance in the corners of the envelope and in the production yield when we put it all together, they were mostly associated with the integrated effect of these myriad other changes throughout the system, so that affects both hardware and software. We've continued to optimize that and we are confident that we've got a solid robust system at this point.

Yes, okay. Well that's very helpful, thank you very much.

Thanks, Mike.

We'll take our next question from Brian Ruttenbur with Morgan Keegan.

Thank you very much. Just going to talk about weighting of revenue. This year you said it's going to be weighted more heavily towards the fourth quarter; is that correct?

Yes. Yes, I think we said approximately 65% of the remaining revenue in Q4?

Okay. And then just going forward beyond Q4, how long do you expect revenue acceleration to be in the 18% to 22% range when we're looking at fiscal '11 and beyond. Do you expect it to settle down more at 15% longer term, or do you think the 18% to 22% is sustainable for a period of time?

I'll just start and I would say we would have to punt there. We would plan to give our guidance for the next year on our Q4 call.

Yes, Brian, we have historically provided annual revenue guidance, although I continue to be very optimistic about our long term-growth potential, as I said earlier, driven both by the continued demand for our existing products and the sustained level of interest in the kinds of solutions that we currently have in development and the size of the market opportunities that are addressed by both of those categories.

Okay, thank you. Gross margin was 38.3%. Is that sustainable, or does it go higher with the ramp up in the fourth quarter, or what do you think about gross?

I think we -- what we want to focus on is operating income 12% to 14% so we don't want to guide on gross margins. What I would point back to is last two years on average we've closed the year on a consolidated basis at 36%, so somewhere between there and where we were in Q2 is probably not a bad way to think about it, but really focusing on the operating income is where we would point to it at 12T to 14%.

Last question, cash burn. Do you expect to have a lot of cash generation? You've had a cash burn, obviously, in the first half of the year, do you expect a cash generation the second half of the year?

No, I would expect continued cash burn in the second half based on the kind of profile for revenues in the balance of the year. We have the prospect of continued inventory growth as we look to tee up the operations throughput to achieve our top line and also because the revenue will be heavily back-end loaded you will -- I would expect to see some revenue receivable growth, as well.

Okay, thank you very much.

Thank you.

We'll take our next question from Tim Quillin with Stephens, Inc.

Good afternoon.

Hi, Tim, how are you?

Good, congratulations on getting started with digital Ravens. I'm trying to -- maybe if you could summarize your -- the anticipated orders, but it sounds like you expect a $27.5 million or so order with supplemental monies sooner rather than later and then expect maybe a series of orders, or a couple different orders totaling as much as $120 million in January or February some time to support your guidance. Is that about right?

Yes, Tim, the 8-K announcement that came out today is a regulatory matter, but it really represents the GFY '09 supplemental out of that would come the $27.5 million and typically we wouldn't see the whole $27.5 million, it would be taxed before it got here. In addition to that you have the GFY '10 base and OCO for both Marines and Army and I think you have the right number there at about $120+ million.

Right. So -- but an order in December and then one later in -- or a couple later in January or February?

Yes, the GFY '10, as we said earlier, we typically see the government fiscal year funding coming in either at the tail end of our Q3 or the very beginning of our Q4 and if it behaves the same way our plans will accommodate that. If it slips much beyond that then we have to regroup and look at our production plans and what we can do.

Right. And I know you don't want to comment too much about future gross margins, but gross margins in UAS were strong, I guess over 36% in your Q2 and relatively low production levels and I was just wondering what the key to that margin was and should we expect margins to improve as you ramp up production of digital Raven?

Well, 36%, yes, way high compared to last quarter,but last quarter was way low. as you know. Looking in the past, UAS is in the 34% to 3% range so I don't think the 36% is off the chart high, really reflects a mix of the programs that we're working on. Another thing to keep in mind is, included in our services revenue is the DDL retrofit kits, which are product like in nature but the accounting puts them in the services line.

Okay, and just one more question, if I may. The EES business, do you expect that to grow overall in fiscal '10?

I don't think we can comment. We try to restrict our guidance to the total Company. We continue to feel very, very positive about the business, but probably need to restrict ourselves to total Company guidance.

Yes, I think if you dissect what I said earlier, Tim, if you look at the three pieces, the industrial electric vehicle charging business remains sub par and that's really reflected by the economy and the capital equipment market -- or the spending in capital equipment. The test equipment that we sell primarily for electric vehicle development work is still a growing part of the business and it seems to be tied with this global demand for electric vehicle development and the emerging opportunity for on-road electric vehicles I think is still out there. It's billions of dollars being invested by governments around the world over the next few years and all automotive companies investing there, so I think that continues to present an opportunity for us to participate potentially in the future.

Great, thank you.

Thank you.

We'll take our next question from Troy Lahr with Stifel Nicolaus.

Thanks. I just want to circle back to, I think it was Brian's question, a little bit. The ramp up that you're really going to see in the fourth quarter, is that sustainable, or are you guys planning for that to be a one-quarter phenomenon and then it returns -- gradually returns back to normal levels?

I think this is a -- at least for the time being a one-quarter high point and then we get back to more traditional levels of throughput.

Troy, I think this is a function of the pent-up demand for Ravens while as customers waited for the digital systems to be available and they and we are now playing catch up and I think we will have largely caught up through fourth quarter. There clearly is an ongoing demand, not only for digital Raven systems but it appears that our customers will want to continue to retrofit their installed base, but I would expect, as Steve said, that we will peak in Q4.

And I would just add that this is really -- this is largely the way the year was planned and we probably don't set out to plan the year with -- while we typically are back -- have more at the back end than the front end, it's accentuated this year and we wouldn't expect to plan it this way when we start doing our plans for subsequent years.

Okay. And you said you were going to be more back-end weighted -- I think you were saying more back-end weighted than you previously expected, is that just again the timing on budgets, or is that actually your production ramp up, kind of getting your supply chain in line?

Yes, I think it's more the latter, Troy. In an ideal world we would have -- when we started production deliveries at the very end of October we would have continued to ramp from that point. In fact what we did was assess the production yields we had in that first tranch of deliveries and the system performance at the corners of the envelope and we decided to do some more optimization before we really ramped up production (inaudible) so we slid that out maybe a month. In the meantime, though, I think the fact that we have continued to build the supply chain, we've staged hardware, we've trained customers and we have significantly improved the factors that will affect yield. I think the net result is a slight increase in the back-end load but a significant increase in the ability to execute it.

And so I'm clear, you finished the optimization and you're now building digital systems and these have the effective yields, or you're hoping to get the effective yields?

Yes, we are just beginning to launch the production ramp this week, so I guess I would say we're confident that we've addressed those issues and we'll know, in fact, after a few weeks of being in production.

Okay, and then lastly, Puma AE, when should we start seeing a meaningful ramp up in that, or is that just going to be a slow gradual build up?

I'm not quite sure how that's going to roll out. It's -- we have -- we've just for the last couple of months been in a position to be able to begin demonstrating Puma AE to new customers and we've done quite a bit of that. Some customers have taken delivery of small quantities that they're evaluating in their own applications. All of the feedback that I've gotten to date is positive. It looks like multiple customers see advantages in the characteristics of that system and I expect it to be a significant growth opportunity for us in the future, but as usual, it's very difficult for us to guess the timing and the rate of that adoption.

Okay, thanks guys.

You bet.

We'll take our next question from Peter Arment with Broadpoint.

Good afternoon, thanks for taking my questions. Could you give us where you are now on the existing Army acquisition objective for Ravens? I think you ended last quarter at 57%. has there been much change there?

Well, as of the Q2 point we were 58% delivered. As Tim mentioned, we started deliveries of the digital Ravens and that is what contributed to the growth from 57% to 58%.

Okay, so not much change. And then also just on the Switchblade, you mentioned there's some small quantities of orders and multiple customers and actually some orders for combat prototypes. Tim, I'd be curious with just your thoughts on how this has -- the customer base has matured, given from when they first got their hands, or at least their eyes on Switchblade 2, now where they're actually ordering some combat prototypes. How should we think about Switchblade going forward?

Well, if we go back almost a year now to when we first demonstrated the full Switchblade system to our initial customer and that was pretty much an end-to-end demonstration in its initial configuration, which is a packaged unmanned aircraft in a -- launched from a tube and the tube is both a carrying package container that could be carried around, for example, in a rucsack and it's the launch tube for the vehicle. In that configuration it allows it to be rapidly pulled out, set on the ground, launched, and put into service almost immediately. Since that time that customer has continued to first evaluate the systems and then -- and in greater and greater detail and in more rigorous and more rigorous testing evaluations.

Other customers have come to look at this. They have now -- they subsequently acquired systems, did their own evaluation and testing. In many of those cases their applications are somewhat different than the original customer's and in all of those various scenarios the testing and evaluation has gone very well. So I believe what's happened in Q2 is a transition from buying small quantities solely for the purpose of testing and evaluation and moving towards what I was referring to as combat prototypes, which I see as a significant next step in this process of evaluation towards adoption.

Okay, and you don't have, though, any Switchblade in their guidance, correct?

Well, other than what we would normally expect in these small quantities of procurement that have been taking place and that we expect will continue to take place throughout the fiscal year.

Okay, thank you very much, guys.

You bet.

We'll take our next question from Randy Gwirtzman with Baron Capital.

Hey, good afternoon guys.

Hi, Randy.

I had a question about Global Observer. You mentioned that in the end point of the program was, I guess, to get military qualification with payload by the end of calendar year '10. Is that -- did I hear that correctly?

Yes, that's pretty much our expectation.

So what does that mean in terms of delivery schedule? I would assume that you're going to -- the first three GO's are part of the JCTD, and that would be the first deliverable system? Is that correct?

Yes. The way this one program is structured, Randy, is that we will move -- we will complete the system flight testing, then we will integrate payloads and we will then demonstrate the system effectiveness for military applications with the combination of the ground system, the airplane and the payload and its communication system. At that point the joint -- the JCTD is technically completed and the customer takes delivery of the residual hardware and then they decide at that point what they want to do with the assets that they have taken delivery on and they and other customers would decide what they want to do in terms of future acquisition, or utilization of this potential capability.

When would acquisition decisions be made? It would be -- it be made post, obviously, the flight.

Yes, I think that the broad consensus I get as I talk with potential customers for Global Observer is it's a -- it addresses this apparent gap in capability to provide affordable persistence, and as a result it's very, very interesting to a number of potential customers and to a customer, they want to see it fly. It's such a revolutionary concept that I think fly before buy is in the front of the minds of all potential customers. Once that capability has been demonstrated, then we'll be -- I'm back to my mantra of it's very difficult to predict the timing and the rate of adoption of innovative technologies, but I've had more than one customer tell me that if you build it, we will come.

Okay. And how does that fit into your ability to produce? I know you mentioned you're going to start building the next GO for the JCTD when the first one is packed up and shipped to Edwards and I think there's three aircraft in the program., do you start -- is that right?

Yes, we will continue to execute on the existing JCTD and, in fact, the second airplane has been in the development facility in the first of three fabrication stations behind the first airplane and as the first one moves out, the second one will move into station number two. We will -- we'll deliver those sequentially and we will -- they will be ultimately flight testing both the first and the second airplane simultaneously in our plan. There was a second part of your question. I think. that I -- that escaped me that I didn't address?

No, the last part of the question was the third aircraft and then future -- how do you scale in future production? You obviously have to balance competing interests of waiting for orders until the flight comes (inaudible)?

Yes, I think our plan would be that we would not be building airplanes in anticipation of future orders, so we'll be -- we've got this situation where our customers are waiting to see the air -- the flight test results before they make decisions on future orders and we'll be waiting for future orders before we make decisions on production, so that's --

Okay. And last question is, just the flight test itself, that's on schedule basically and that's supposed to occur by April, I think it was?

Yes, we -- my comments last call, Randy, were that we expected to be in flight test in the second half of our fiscal year and we still expect to be there.

Okay, thank you, guys.

You bet. Thanks, Randy.

And we'll take our next questions from Michael Ciarmoli with Boenning & Scattergood.

Hey, good afternoon, gentlemen, thanks for taking my questions.

Hi, Mike.

How are you? Just, Tim, if you can, obviously with the announcement to surge troops into Afghanistan, can you give me a sense as to what you guys might be expecting from you services revenues? If I look back towards the Iraq troop surge you guys were seemingly doing a run rate north of $60 million. Do you have -- are you planning for elevated levels of service, or is it still too early to tell?

I think it's probably too early anticipate the affect. We -- certainly there are many reasons to think there might be an affect of one sort or another. Our position at this point is to rely on our vaunted agility. We are working with our customers to plan how we're going to support the increased troop level and, therefore, the increased use of our systems in Afghanistan and we have the advantage of years of optimizing that forward support capability in Iraq to be able to plan with them. But in terms of anticipating the effect on production rates or service revenues we'll just wait to see. I think we're in a position to respond in a timely manner when we see the whites of the eyes of demand.

Okay, fair enough. And then, Steve, just so I have it correct, was that service revenue number this quarter about $9.4 million? Did I do the math correct there?

Total service revenue this quarter $8.9 million, --

$8.9 million.

-- project R&D $23.3 million and products $19.1 million.

Perfect. And then last question and I'll jump off here. Tim, just on penetration, I know it's something we've talked about in the past, how many troops will be -- or Raven systems per soldiers, do you see that penetration rate increasing at all given the more -- the unique challenges related to Afghanistan, the complete lack of infrastructure? I think you guys might be at one system per every 180 soldiers now. Do you see that rate changing?

Well, I'll maybe address that in two segments, Mike. As to Afghanistan, I don't know and I think that's an issue that a number of our customers are evaluating to -- in that area and we'll wait to see what they decide. One could certainly anticipate some possibility of change given the obvious differences in the nature of troop deployment and operations in Afghanistan. Secondly, and in a broader area, a number of our customers continue to evaluate the potential value of pushing these systems farther down into their [pork] structure and I have -- if anything I've seen more thinking in that line rather than less over the last year, so that's certainly a consideration that's on the table and in the minds of some of our existing customers that have been using these systems for a long time and developing a high level of experience and appreciation for what they bring to the party.

Okay, that's fair enough, that's helpful. Thanks a lot, guys.

Thank you.

That completes the question-and-answer session today. At this time I will turn the conference back over to Mr. Gitlin for any additional or closing remarks.

Thank you, Melanie. With that as our final question we thank you all for your continued attention and interest in AeroVironment and remind you that an archived version of this call, all SEC filings and relevant Company and industry news can be found on our website, www.avinc.com. We look forward to speaking with you again following next-quarter's results.

That concludes today's conference call. We thank you for your participation.