AeroVironment Inc (AVAV) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the AeroVironment first quarter fiscal year 2011 earnings conference call. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session after management's remarks. As a reminder this conference is being recorded for replay purposes. With us today from the Company is the Chairman and Chief Executive Officer, Mr. Tim Conver, Chief Financial Officer, Mr. Jikun Kim, and Vice President of Investor Relations, Mr. Steve Gitlin. Now at this time I would like to turn the conference over to Mr. Gitlin. Please go ahead, sir.

Thank you very much. Welcome to AV's first quarter fiscal 2011 earnings call. 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 statement 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, September 8, 2010. 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.

We will begin with remarks from Tim Conver and Jikun Kim, and then we'll move on to questions. Now it's my pleasure to turn the call over to Tim Conver.

Thank you, Steve. Welcome to our first quarter fiscal 2011 conference call. Today's comments are organized as follows. First I will review our performance in the quarter which unfolded as expected. Second, I will summarize advancements made in our production business and our key development programs including our digital small Unmanned Airplane Systems, Global Observer, Switchblade and electric vehicle solutions. Third, I will discuss my view of the balance of the year before turning over the call to Jikun Kim to review our financial performance. After Jikun's comments I will address full-year guidance. Now to Q1.

Our first quarter unfolded largely as we anticipated and as I described in our Q4 2010 conference call. Delays in the government's 2010 Raven orders resulted in quarterly revenues of $38.2 million as anticipated, while we continued a steady investment in SG&A and R&D, primarily supporting our key developments. This combination produced an operating loss of $7.3 million or 19% of revenue, about as projected.

It's important to note that the business potential of our combined developments is much larger than our current revenue. Because we're advancing these development initiatives toward market adoption and significant long-term growth opportunities, it would have been counter productive to dial down our investments in the short term since that would delay adoption or prevent us from maximizing market share when adoption takes place. The combination of steadily growing investments for the long term and uneven order flow in the short term contributes to the historic lumpy nature of our short-term results. Our 24% operating profit in Q4, contrasted with our Q1 loss, represents a clear example of this lumpiness.

The initial Digital Puma order that I expected in Q1 was delayed to the third week of Q2. This depressed our Q1 backlog, but will not affect or planned deliveries and revenue for the year. On August 19 and August 23 we received orders valued at $35.3 million and $4.4 million respectively for Digital Puma all environment Unmanned Aircraft Systems. As these orders were received subsequent to July 31, 2010, they are not included in our reported Q1 funded backlog. Adding this $40 million to our Q1 backlog would result in a total funded backlog of $103 million.

Now let's take a closer look at our UAS segment. We continue to believe that the value of our digital family of all of our small Unmanned Airplane Systems built around our common ground control system and Raven, the most prolific unmanned aircraft system in use today. The Army is in the process of a family of systems evaluation based on a brigade combat team's use of WASP and Puma systems to complement their existing Raven systems. Last month we received $40 million of orders for Digital Puma systems, initial spares provisioning and services, as I previously noted. We're planning on a second half delivery of most of this contract. We also expect significant additional orders for contract logistic support of these systems to follow, further contributing to second-half revenue.

These Puma system orders combined requirements from two customers for three different mission applications. The contract was released against the US Special Operations Command IDIQ contract which we won competitively two years ago. These orders also represent the adoption of Digital Puma beyond its initial customer base, an objective that we've been pursuing for some time. We see these new applications as positive indicators that Digital Puma is meeting significant needs with the potential to drive longer term adoption by both current and additional customers. Digital Puma is joining Digital Raven as a supported program of record in the active inventory of multiple services, reinforcing our small UAS family of systems strategy.

Beyond the ongoing opportunities with our US customers, we see continued interest in our small UAS among allied military forces. We expect growing sales to result from ongoing acquisition activity. However, we are cautious about the order timing, and we expect delays. Q1 for our efficient energy systems segment was also about as we expected. Plug-in Carolina selected AeroVironment for a -- from a sizable group of contenders, representing an important competitive win to supply public charging stations in seven South Carolina cities.

Before I address the status of specific developments, I would like to review the context in which these developments are playing out. On the last call I characterized our FY 2011 as a transition year for AV. And our key developments are at the center of that transition. AV has a successful track record of identifying important customer needs early, developing innovative practical solutions to satisfy them, and driving market leading growth once those innovations have been adopted. Whether helping the front line war fighter to operate more effectively with hand-launched UAS or providing safe and reliable charging solutions for electric vehicles that help achieve energy independence, we're committed to helping our customers and the world in important ways.

Our R&D investments are a critical part of this strategy, positioning us for a first mover advantage. We select and fund R&D programs to target both the development of innovative new solutions and the development designed to maintain leadership in existing solutions. These are all multi-year multi-million dollar developments requiring significant investment and market development in addition to technology and product development. We enter into these investments to drive high rates of long-term growth, knowing that it is impossible to predict the timing and the rate of innovation adoption. We also know that by staying close to customers we will get market signals when adoption probability is increasing.

When we're inside the 20-yard line, to use a football metaphor. In FY 2011 we think we're inside the 20-yard line on all four of our major developments, Global Observer, Switchblade, Digital small UAS, and electric vehicle solutions. We expect milestones critical to full-scale adoption in all of these developments this year, and we expect initial adoption of one or more. This is a fluid period requiring persistent development execution and agile response to the market to successfully close on the goal and the significant opportunities each of these developments represent. During Q1 alone, new opportunities in all four of our key development programs have been identified that have the potential to significantly increase our market leadership over the next year. I can't provide more specific details on these opportunities without getting into competitively sensitive information, but timing is critical to maximize our first mover advantage and our long-term success. It is in this context that I characterized FY 2011 as being a key transition year for AV.

Now let's catch up on the four development programs starting with the digital family of small Unmanned Airplane Systems. The scope of the production transition from Analog Puma to Digital Puma is on a par with that of the Digital Raven transition last fiscal year, but there are three main differences in the Puma production launch. First, the digital data link itself is now in production where before it was moving into production along with the Raven airplane system. Second, we pre loaded our supply chain and validated the new production tooling for Digital Puma. And third, we've received a contract for the production deliveries we plan to make in the second half of this year.

The digital WASP development program is similar in scope to both digital Raven and Puma. Development testing continues to progress well and digital WASP is expected to be ready in the late second half of our fiscal 2011.

Switchblade is a manned portable precision loitering munition with multiple wave off and reengagement capabilities. It was developed as a tool to help dismounted forces get out of trouble with other versatile deployment options in mind. It is designed to neutralize threats while resulting in minimal collateral damage. Switchblade prototype evaluations are continuing successfully with multiple US government customers and all customers continue to show broad interest. I believe adoption is likely and that once adopted the potential application for the single use, precise, affordable, and portable munition is very likely to broaden. Full scale Switchblade adoption could translate into significant revenue growth for AV.

Global Observer is another development program with significant potential. Developed under the Global Observer joint capability technology demonstration, or JCTD program, Global Observer is the first airplane system designed to offer five to seven day flight endurance and stratospheric operating altitudes. Global Observer is intended to provide 24/7 coverage affordably, anywhere, any time. The team has made great progress on this program.

During Q1, we completed ground testing of the first aircraft. In August, we announced the successful completion of wing load testing. In early Q2 we conducted the first flight test of Global Observer at Edward's Air Force Base. During this one hour flight the aircraft reached an altitude of about 4,000 feet above sea level and successfully validated aircraft handling, control, take-off, and landing capabilities. We have subsequently completed three additional flight tests of similar duration. Flight tests have been conducted about once a week with excellent results and we plan one more flight before converting the airplane to hydrogen flight for later in this calendar year. Customers have noticed and their response is positive.

Our key development program in the Efficient Energy Systems segment is our EV solutions initiative. We plan and we aim for market leadership in electric vehicle charging. Our agreement with Nissan North America to supply and install the overnight home charging systems for the Nissan Leaf puts us in a good starting position for achieving that goal. To our knowledge, the Nissan deal represents the largest and the most significant such agreement to date. Competition for this contract was intense with at least 10 competitors, including specialized EV charging suppliers, automotive tier one suppliers and global electrical equipment brands. Competitive evaluation and a process of successive reduction of remaining competitors extended for almost one year. We see this level of competition as an indication of the intense global interest in the electric vehicle charging market and the expectation that it is likely to become a very attractive business opportunity. Because the home will be the location of up to 80% of early EV charging, the win with Nissan was important.

As I previously noted, we have also won in the highly competitive public charging market as demonstrated by our success with Plug-In Carolina. The Nissan and the Carolina wins each represent separate, important agreements with the different segments of the EV infrastructure market that we're targeting. They are both important relationships and in and of themselves, and they position us for subsequent similar opportunities elsewhere. The integrated Charger installation and support solution that we are rolling out is an important part of the total solution for both residential and public charging infrastructure opportunities. This nationwide capability will be another significant competitive advantage to support our market leadership goal.

We believe we offer a truly differentiated value proposition based on numerous factors that include our core competency and electric vehicle technology and solutions built over decades of electric vehicle development, testing, and battery management experience. Our considerable experience, cultivating and supporting the successful adoption of innovative solutions, our leading market position in supplying test equipment used by auto manufacturers in R&D labs to develop electric vehicles and the batteries that power them, our installed base of more than 15,000 charging systems for industrial electric vehicles across North America, the breadth of our charging solutions, from level one to level two and through fast charging, and the integrated business infrastructure that we have put into place to support broad market coverage and our partner success.

We continue to participate in business discussions with customers and partners. We're addressing multiple residential and public infrastructure opportunities, as well as other areas of market interest beyond our successes to date. Some of these new opportunities have become increasingly attractive as customers have clarified their priorities over the last quarter. And we're responding to significant market opportunities. As you know, it's our practice to announce deals only when they become real. Until then, you can trust that we are working hard to realize our goal of market leadership in electric vehicle infrastructure. Beyond the progress we have made in our business segments, we strengthened our new management team when our new Corporate Vice President of Strategic Operations, Joel Hirsch, joined AV this month. We also introduced a new long term incentive compensation program designed to drive long-term compounded growth targets.

Now let's look at the balance of the year. The Raven orders funded in the government fiscal year 2010 Department of Defense appropriations bill now appear poised to arrive in November as opposed to our previous expectation of August. This implies a reduction in first-half revenue, shifting to a corresponding increase in second-half revenue. Ongoing dialogue with our customer on the pending Raven orders provides us with good insight into funding availability and drivers of order timing. The funding of this procurement appears to be secure and the issue seems to be related to our place in the contracting queue. Raven continues to be an integral element of the Army's planning, training, equipping and operations, as evidenced by the multi-year procurements planned through at least 2015.

On our third quarter 2010 earnings call I mentioned that the administrations fiscal 2011 budget request includes approximately $55 million for Raven procurement. We have not seen any reductions to this request as it has proceeded through the House and the Senate committees. Because of our recent experience with government contracting delays, our plans continue to assume that most of the revenue from the government fiscal year 2011 Army Raven systems contracts will be realized in our fiscal 2012. We are making good progress on our EV infrastructure roll out, supporting our view that revenue from this new business area will contribute to our current fiscal year as planned in the second half. This is the first such national rollout ever, so we expect to see and to address hiccups throughout the initial process. With that as an overview of the quarter and the balance of the year ahead, Jikun Kim, our Chief Financial Officer, will review our financial performance for Q1 FY 2011.

Thank you, Tim, and good afternoon, AeroVironment FY 2011 Q1 results are as follows. Revenue for the first quarter was $38.2 million, an increase of 1% over Q1 last year of $37.9 million. Looking at revenue by segment, UAS revenue was $33.4 million, flat compared to Q1 last year of $33.3 million. UAS recognized higher product revenues, primarily due to increased Raven D DDL systems deliveries, which was offset by lower service revenues. Largest reduction to service revenues was driven by the Global Observer program which was partially offset by higher Raven D DDL retrofit kit capabilities. EES revenue was $4.8 million, an increase of 3% from Q1 last year, primarily due to higher electric vehicle test system deliveries. Turning to gross margin.

Gross margin in the first quarter was $12 million, up 12% from the first quarter last year. Gross margin as a percent of revenue was 31% versus 28% in the first quarter last year. By segment, UAS gross margin was $10.4 million, up 15% from the first quarter last year. As a percent of revenue UAS gross margin was 31%, compared to 27% in the first quarter last year. The increase in gross margin percentage was largely due to a higher mix of fixed price contracts in the quarter. UAS -- EES gross margin was $1.6 million, down 4% from the first quarter last year, primarily due to higher manufacturing and engineering support costs. As a percent of revenue, EES gross margin was 35%, versus 37% in the first quarter last year.

SG&A expense for the quarter was $11.4 million, or 29% of revenue, compared to $10.5 million, or 28% of revenue in the prior year. SG&A expense was higher primarily due to higher selling, business development, and administrative infrastructure investments. R&D investments for the quarter was $8 million, or 20% of revenue, compared to the prior year amount of $5.7 million, or 15% of revenue. The growth in R&D was primarily driven by various UAS and EES technology development initiatives. Operating loss for the quarter was $7.3 million, or 19% of revenue. Operating loss was 34% higher than the first quarter last year, primarily due to higher SG&A and R&D investments. The effective tax rate for the first quarter was 52.1%, compared to prior year rate of 33.5%. This increased tax benefit was primarily due to a reduction in the liability for uncertain tax positions related to the examination of the Company's fiscal year 2003 and 2004 tax returns. This examination was concluded in the May of 2010 with no changes required to AV's tax returns. Net loss for the quarter was $3.4 million, or $0.16 per share loss, compared to a loss of $3.6 million, or $0.17 per share loss in the same quarter last year.

Looking at backlog, funded backlog at the end of the first quarter, July 31, 2010, was $63.6 million, down $8.7 million or 12% from April 30, 2010.

Turning to our balance sheet, cash equivalents and investments at the end of the first quarter totaled $164 million, down $6.9 million from the prior quarter. The negative cash flow was driven by net losses, increased working capital, and capital expenditures partially offset by depreciation.

Turning to receivables, at the end of the first quarter, our accounts receivables, including unbilled receivables, totaled $32.9 million, down $24.5 million from the prior quarter. Total day sales outstanding was approximately 77 days, compared to 52 days at the end of the prior quarter. Taking a look at inventory. Inventories were 27.6 million at the end of the quarter, compared to 20.9 million at the end of the prior quarter. Days in inventory were approximately 93 days, compared to 33 days at the end of the prior quarter.

Now turning to capital expenditures, in the first quarter we invested approximately $1.9 million, or 5% of revenue, in property improvements and capital equipment. Now I would like to turn things back to Tim to discuss AV's expectations for the balance of our FY 2011.

Thank you, Jikun. Based on what we see ahead of us, we reiterate our expectation for 10% to 15% revenue growth in FY 2011. The extraordinary amount of new business opportunities generated through our main development programs have convinced us to increase our current year R&D investments, which we expect will reduce our operating income to 10% to 12% of revenue for fiscal 2011. As a reminder, in our Q4 2010 call I said that we expected growth in fiscal 2011 to come mainly from our EV solutions business with an expected revenue ramp in Q4, and from Puma orders which we expect to deliver against in the second half. We said this Puma revenue could more than offset the expected 50% year-over-year decline in the Global Observer JCTD revenue which is under services as R&D. And with the recent announcement of these Puma orders there is now evidence to support this.

We expected limited FY 2011 revenue growth in Digital Raven, Switchblade, PosiCharge, and electric vehicle test systems, all of which we anticipated would hold about flat to FY 2010. This expectation remains unchanged. Because of the GFY 2010 Raven contract delay, we're now planning for $20 million in revenue moving from our second quarter, into our second half. This means we're now expecting the second half to account for about two-thirds of our FY 2011 revenue. As a result of moving this $20 million of revenue out of Q2, we now expect about a 4% operating loss in Q2.

As I stated earlier, this is a transition year for AV. We've been investing for years in key developments, and I believe they will accelerate our business growth on a long-term basis. During Q1, multiple new market opportunities have come into sharper focus. Each competing for additional R&D investment this year. We are limiting our investments and prioritizing only those we believe essential to the successful adoption and capture of leading market share in our key development opportunities. Even so, we now believe it's important to increase our R&D and business development spending for the balance of FY 2011 to optimize our market positioning in these specific high priority opportunities. We expect our gross profit to be unaffected by these incremental FY 2011 investments in R&D and business development.

We're pleased with the progress we've made in our production businesses and our key development initiatives year to date. Because the Digital Puma orders have been received, we now have greater visibility into revenue for the balance of the year. Our intent to increase development investments over the balance of the year is a response to the confluence of market opportunities that represent one-time entry points for very large, long-term growth opportunities. The expected return on these investments in organic growth is compelling. As much as we would like to hold off incremental spending in order to maintain previously planned operating profit this year, customers are moving now, and we must move with them.

We're confident in our operating plans for FY 2011 and we see significant growth potential in the development areas that I laid out earlier. I remain confident in our team's ability to execute successfully upon both our current production business and our development programs. Our first quarter proceeded as planned, and we're looking forward to updating you on our future progress. Thank you for your continued interest in AeroVironment. And Jikun and I will now take your questions.

Thank you, sir. (Operator Instructions) Our first question in queue comes from Brian Gesuale with Raymond James. Please go ahead.

Hi. Appreciate the color on the call here. Wanted to dive in with maybe a couple quick questions. Could you talk about the incremental R&D spend a little bit more, maybe put some borders around it in terms of what's going to efficient energy, what's going to the UAS business, and maybe what's changed over the last six or eight weeks? Because it seemed to me even back then you had an awful lot of opportunities in front of you.

Well, let me address the second part first, Brian. I think in terms of what's changed recently throughout the quarter, we've -- in all four development areas, we've seen customers getting much closer to identifying specific areas of initial adoption, both in terms of how they would see these innovations integrating into their enterprise and what their timing might look like. And so I think that's to be expected as we get closer and closer to real adoption customers refine their expectations, and we get a more clear view of exactly what they're looking for, and what their timing is. And that's been our experience in the past, so I think that's not necessarily a surprise. It's positive.

As to the split between the UAS and the EES segment, while we have continued to increase the rate of spending in R&D and development in our electric vehicle solutions enterprise over the last few years, by far the largest part of our investments continue to be focused on our Unmanned Airplane Systems business, and I think the incremental opportunities we see emerging are largely focused on a couple of the UAV developments and the electric vehicle solution development. That's, again, consistent I think with the imminent adoption in those two areas.

Okay, that's very helpful. Tim, wondering if you can also talk to us about Global Observer and Jikun, you could chime in a little bit in terms of -- as I look at it, I'm thinking you hit a couple of very good milestones that we continue to be excited about. Wondering if you could give us the revenue recognized in the quarter from that program, and then I'm guessing that there's a very little if any left in backlog, or maybe what some incremental orders on Global Observer might look like to carry you through the production phase if that would come around.

Well, let me take a first crack at it, Brian, then I'll let Jikun weigh in. I think the flight-test milestones were extraordinarily important. Obviously they were what we had been planning on, but this is such a revolutionary technology that actually demonstrating its flight performance I think was expected to be and in fact was especially important to our customer base. So, they've been watching for this closely. As I think I've mentioned in the past, more than one customer has said in the past, in some cases, literally if you build it, we will come. But that he had big if in that statement. So, I think it's been important for generating active customer evaluation of follow-on funding opportunities.

In general, we are, as we've said in the past, reaching the latter parts of the JCTD program. We've gone through the bulk of the funding elements of that program through what's now about a three-year program when the initial development in the production. So, we have existing funding remaining for some amount of continued flight test and utility demonstration through a significant part of the balance of this year.

A little more clarification on the numbers. We had roughly $11.9 million of project R&D work in the quarter, and that's roughly about 31% of the revenues for the quarter. Most of that is associated with the Global Observer program. Not all of it, but most of it.

Okay. Terrific. Thanks. The amount remaining in backlog is right about $10 million or a little less is that fair to say?

Yes.

Okay. Terrific. On the Global Observer, that's great, you got the cover story on Aviation Week without usurping the Secretary of Defense's big earth shattering comments in the DoD sector, so congratulations on that. I'll jump out of the queue on that one.

Thank you, sir. Our next question in queue comes from Michael Lewis with BB&T Capital Markets. Your question, please.

Thank you. Thanks for taking my questions. Tim, I was wondering if we could talk a little bit more about the $20 million slip from the second quarter. With those funds falling in, I think you said around the November time frame, would you expect us to more heavily weight the revenue in the third quarter versus the fourth? Can you help us a little bit with the timing of when you expect to recognize that revenue?

I think our current expectation of the customers scheduling at this point, Mike would about equally balance the deliveries on that contract between Q3 and Q4.

Okay, that's helpful. Let me shift gears here. Brian brought up the Aviation Week article and we saw something interesting in there, the first real commentary about your vertical take-off and landing system, I believe it is called the Shrike. I was wondering if you have looked at some of the lessons learned from the MAV program that was being run through the Army in Afghanistan and Iraq, and what some of the take-aways were for you to develop your system and where you think that you could surpass expectations when you do review that with the clients -- with the customers.

Did you mean the gMAV?

That is correct, the vertical take-off and landing system that they were use.

I think as you might expect from our history, as we approach this area, we're focused on small and quiet.

That was the biggest argument that the users in the field had about that previous system. One more question and I'll get out of the way here. Jikun, I was wondering if could you provide us with depreciation and amortization, and also what was the operating cash flow in the quarter?

Sure. Confirm that information. Operating cash in the quarter was $5.2 million negative. Depreciation was $2.7 million, and CapEx was $1.9 million.

Thank you very much.

Thank you, Mike.

Thank you, sir. Our next question in the queue comes from Peter Arment with Gleacher & Company. Please go ahead.

Hi, Tim and Jikun. Tim, just a question on international demand. You've mentioned it before, that you've had conversations with international customers for some of your UAS products, and I know you're trying. All your focus has been on getting the digital systems ramped up, but can you give us color on your thoughts on international versus where your systems are?

Yes, I'll give it an initial shot, and you can tell me if I got close enough to target. We have, for some time, felt that there are significant opportunities with international military procurements for small Unmanned Aircraft Systems. And we have had extended dialogues, and we've been involved in extended procurement activities in a number of areas. We have found, as I think we all expected, that the potential for contracting process delays in international procurements is considerably higher than domestic. And we had expected that, and we are finding that, that's the case.

Having said that, we previously announced, I think about five different international customers. At this point, we have about 13 international customers that we've already made deliveries to, and we're involved in discussions with a number beyond that. While the eight or so additional customers have not been announced, a little over half of those are relatively small dollar amounts to date, under a million dollars per country for, as I say, a little over half of them, but in almost all of those cases, I think that we're looking at initial evaluation, and with the potential of growing procurements there after. So, I think and continue to believe that there is significant global opportunity in this space, but it's -- the timing is something that we are not -- we're not counting on significant near-term bookings because we know that these things tend to drag out.

Okay, that's helpful. Then regarding big picture in terms of your cash balance, you've got -- while you've eaten into it a little bit here this quarter, it looks like, just given your volume for the year, you are still going to be generating positive cash. What is your approach on capital deployment here with $164 million in cash, how you're thinking about that going forward?

Pretty much the same as we have for some time, Peter. Our core strategy is focusing on organic growth, which we think we're going to drive by both continuing growth in our existing product lines and the introduction of new product lines leading to new businesses that are supported by the major development programs that we've been talking about. Each one of those major new developments we believe has the potential to create a very significant new business opportunity, and each one of those would basically pile on top of the prior businesses, creating a cumulative growth curve that we think will result in high rates of sustained compounded growth over the long term.

So, most of the investments to generate those growth opportunities are on the -- to date have been on the income statement in the form of R&D and SG&A. As we launch some of those large new businesses, then I believe we'll see an appetite for capital investment to support our volume growth and our market positioning. Also, as we begin to launch those new businesses based on those developments, those major new developments, and the specifics of the initial adoption and the highest initial rates of growth clarify, it's more likely that in that point we may find opportunities to buy assets that can accelerate our organic growth objectives in both the capital side and that lesser opportunity, lesser probability opportunity to buy assets would then be highly leveraged opportunities to use our cash.

Okay. Thank you for clarifying that. And, I'm sorry, Brian asked this earlier, but on the incremental R&D, you spent 10% of sales last year. Did you give us that percent which you think you are going to spend this year?

Yes, again, I would think of it this way. We do guide at the operating profit level, and so what Tim is suggesting is we take it down from 12% to 14% to 10% to 12%, so that's a two-point reduction. So, that's probably a good way to think about it.

Thank you.

Thank you, sir. Our next question in queue comes from Howard Rubel with Jefferies. Your line is now open.

Thank you. Couple questions. Jikun, you just sort of provided the segue. If I do the math on the second half of the year, for I think what Tim and you talked about, you have to do better than 20% EBIT margins. Am I thinking about that correctly?

Yes.

You haven't done anything quite like that in the past, and so I'm trying to understand the operating leverage that develops in order to get there.

I think we actually have. If you remember the fourth quarter, the operating profit margin was 24%.

23.6, I'm sorry.

Yes. So, the volumes that we're talking about for the second half, again, on the quarterly basis, is quite -- I think it's slightly higher, if I'm not mistaken, relative to Q4.

That's fine. The second thing is that if we do all the math on the Global Observer -- or maybe beret way to ask this Tim, are you going back to your customers and saying, look at all the progress I've done, could you give me some additional funding to continue the program? Otherwise, you are going to have to dig into -- that's going to be part of the reason for the higher R&D isn't it?

You are absolutely right in terms of our dialogue with our customers, Howard. We have been focused almost monomaniacally on the execution of the airplane development and its demonstration up until and through the flight testing and we have subsequently been heavily engaged with the broad base of customers that have funded the JCTD to make sure that they understand where we are and we understand where they are. And I think in all cases, we have happy customers, customers happy with the performance to date and we are engaged in those specific discussions about whether or not they have an appetite to continue to increase funding on the JCTD to get even more insight into the operational utility that this system will bring there. We're optimistic about that.

They all have a little bit of money in the kitty if they want to give it to you.

That's our hope, and I think our discussions have led to us be optimistic about outcomes, but we're still talking, and, of course, at the end of the day, customers make the decision.

You're walking a fine line between what you're providing us an outlook and what you are trying to do so that there's leeway on either side of that?

Yes, I think our -- as I characterized our plan for FY 2011 last quarter, we think we are taking a conservative approach in the revenue plans for Switchblade and Global Observer. In both cases, we think that there's the potential for up side, and, of course, we always have some downside risk, but I think we've been relatively conservative in planning our current revenue.

One simple one. On the tax rate, I understand the recoupment or the release of reserves. What would you -- Jikun what would you think would be an appropriate tax rate going forward? Would it be in the mid-30s?

Yes, I think we talked about this at the end of the year last quarter, and we were projecting 35% for the complete year, and we still hold that number. Again, that assumes no continuation of the R&D tax credits.

Well, the 35% for the remaining quarters, or including the benefit that we received here?

Including the benefit that we received here, so it would be 35% for the whole year.

I got that. And then last, Tim, in your discussions with customers, and sort of what we're sort of seeing evolve in the marketplace, it looks like longer duration vehicles seem to be a higher priority as the military experiences more -- gains more experience with small UAVs. Is there a possibility that you could see some switching from Raven to Puma?

Well, I think we see this concept of a family of systems increasingly attractive, and it might be a little misleading of a term, and there's probably two ways for that to be interpreted. From our internal perspective, we're moving to making all of our small unmanned airplane platforms digital, and that all -- then they will all be operated by a common digital ground control system, and they'll all be interoperable ultimately. So, in that concept -- context, we could be selling Pumas to one customer and Ravens to another, and WASPs to a third, and a fourth platform to be named later to a fourth customer. Or what we believe is likely to be the case, increasingly we would be selling two or more of those platforms with the common ground control system to a given customer, and they would get from that a significant increase in operational flexibility and utility of a system. So, from a product strategy, that's how we're approaching it.

Independent of that, largely, maybe separate is a better word than independent of that, the Army is considering modifying their small UAS requirement to go from what a current requirement for a small UAS that's been built by Raven to defining that small UAS requirement to be a family of systems that would be Raven and a larger platform, like Puma, and a smaller platform like WASP, and that with a common ground control system. And that, that family of systems would be issued at the brigade command level to be used for the same kind of broader applications that I previously described in our view. So, there's the Army's evaluation of changing their requirement and adopting those additional systems in a family, and there's our fundamental strategy of building an integrated family of platforms around a common digital ground control.

I see. That.

I hope that helped, but it might not have.

No, no, are you kidding. That's exactly what I see evolving. It's sort of like you've become the -- I'll call it one-stop shop for multiple mission applications.

I think it's that, Howard, and one of the things that we've seen evolving in the way many of our customers begin to think about small UAS is that especially with the experience they're now getting with the new digital systems, and each one of these platforms, as we convert it to the, we're obviously -- you get the advantages of the digital link over an analog link, but we have significantly enhanced the platform performance and in particular, the payload performance of each platform in the process of that conversion. The most dramatic enhancements probably seen in Puma with an entirely new pan, tilt, zoom payload platform with multiple sensors in it. That now begins to deliver quality of information and performance capabilities that starts to encroach on much higher level larger --

Shadow, you can say it, Shadow, right?

Yes, and I think that we're still doing that, the Raven, as to one where we've talked about price, and all of that incremental performance capability associated with the digital Raven comes at an incremental price of about 10%. So, the value proposition of small UAS is growing dramatically, and especially with the Puma platform, getting into a very high percentage of effective performance in some applications relative to much larger platforms. And those larger platforms you will recall cost somewhere between one and two orders of magnitude more. So, in general that becomes a very attractive value proposition, and in a period of constrained budgets, that's probably multiplied.

Sure. Thank you very much. Appreciate it.

Thanks, Howard.

Thank you, sir. Our next question in queue comes from Noah Poponak with Goldman Sachs. Your question please.

Hi, good afternoon.

Good afternoon, Noah.

Tim, from a higher level perspective, you mentioned your position in the Q being the issue, and we just -- we hear about order delays from every defense company out there. What's driving that? What's behind that, in your view, and when do you think we see some improvement?

Well, I don't know the answer to the second part of the question. I suspect that what's driving it is in general, I suspect there's a lot of consolidation going on within DoD. I think there are some circumstances where facilities have been on the BRAC list, and those facilities might have been responsible for significant procurement activity, and when they get shut down that procurement activity moves to another facility, and I'm guessing the resources, if the procurement load doubled, I'm doubting that the resource availability in the new facility doubled. So, I would guess that our customers are getting loaded up and that to some degree contributes to them having to prioritize the activities that they execute.

That makes sense. You express no answer to the second part of the question, which I think is a pretty common response. So, this isn't getting better any time soon, and we're potentially in a CR environment for the back half of the calendar year. What's the risk that you have some items like the Raven slip occur again in the back half of your fiscal 2011?

I think it's certainly a non-trivial risk that we would see -- we would see slides in the contract execution on the government FY 2011 Raven contracts. But we have been -- had that in mind from the beginning, going back to our call last quarter. I think I said at that time time we were not expecting to include a large part of the FY 2011 Raven opportunity in our FY 2011 revenue plan. And that continues to be the case. Our current plan has a small percentage of the government FY 2011 Raven revenues in our fiscal FY 2011.

Okay. On the R&D margin and margin topic, how do we think about the progression beyond fiscal 2011? Does R&D stay elevated into the first half of fiscal 2012, and what's the normalized kind of -- your 7% to 9% of R&D as a percentage of sales for a few years in a row there? Do we see that start to happen again in fiscal 2012, and do you stand by this 12% to 14% longer term operating margin target you've discussed before?

Yes, I think long term we don't see a change in our basic business model at this point. So, we would expect longer term that we can still operate the business with 12% to 14% operating profit and that would normally incorporate something like an 8% to 10% internally funded R&D plan. As to FY 2012, at this point, clearly we're not guiding on FY 2012 yet, and we're still focused on executing FY 2011. I think the -- it's more likely than not that we'd be back in a more normal operating mode in FY 2012, but I don't want to get too far ahead of myself, because the dynamics of the initial adoption of these major new developments are probably not going to dampen here until we get adoption and start executing on that.

That's fair enough.

I'll hedge it a little bit, but I think we're more likely than not to get back on that previous track.

Okay. And one question on the electric vehicle side. Is there any potential for AV to receive government grants to install stations? I believe there have been some other players out there that have received DOE grants for that.

Certainly there's the potential. We're well aware of the DOE program. We have an ongoing dialogue with DOE. So, we may very well be involved there, but I don't have any contract certainly to announce at this point.

Thanks a lot.

Thank you, Noah.

Our next question in queue comes from Troy Lahr with Stifel Nicolaus. Please go ahead.

I'm just wondering if you can drill down a little bit on the R&D. I hate to kind of keep working on this one, but I guess I'm not following exactly what was the catalyst that you have to spend more money and how that wasn't factored into your guidance in the band that you had out there before. Is it customers coming back and saying we have done enough testing here and we actually wanted to do a little more or it's not quite meeting our expectations? Can you maybe just talk a little bit about that and kind of why this wasn't factored into a broad range in your margin guidance?

I will give it my best shot, Troy. Starting out, but let me clarify most of the reason that I'm not beg as specific as I am sure you and others would like me to be is because this is in an area that's highly competitively sensitive. So, we're focused on specific customers and specific market opportunities that we think are very important in the initial adoption and our initial market positioning in these areas of new development. So, getting too specific there is probably not in the best interest of our competitive position or our investors. So, with that caveat, as we get -- take the electric vehicle infrastructure market as an example.

Nissan and -- is the -- is out in front in terms of production release of their all-battery electric car, and in relative to all of the other OEMs that have battery electric cars in their portfolio and scheduled for release later. And GM is out in front in the production release of their plug in electric hybrid relative to all other OEMs that are bringing similar products to market. So, that led us to -- that led Nissan to making the first major production decision on charging infrastructure to support their rollout, and as other OEMs get closer to the rollout timing, then they get more focused on addressing their charging infrastructure needs. And that increased level of focus associated with the timing of production, adoption, or in this case production release of innovative new solutions results in customers getting much more specific about exactly what they want and when they want it. And if we're doing -- and I use that particular market and automotive OEMs purely as an example, because all other customers in all other development areas are -- have the same kind of pattern of decision making.

So, as -- in this case as they get much closer to deciding exactly what they want and exactly when they want it, if we're doing our job, we're close to those customers. And if we've done our development job right, then the product lines and the technologies and the system solutions that we've been developing for years are either exactly on point, or they are generally what those customers are going to want. But as each customer gets -- refines their final real decision process, they each make their own calculation on exactly what they want and when they want it.

Again, if we're doing our jobs, and we understand what that is, we're able to specifically refine the developments that we've made and specifically adjust the timing assumptions we've made so that we match up with what they need. And those fine-tuning adjustments, in some cases, mean that we need to accelerate what we were planning to do later. In other cases, they mean we need to do something slightly different than we had planned in order to have an optimal solution.

So, it's not like Switchblade, the Army came back and said, look, it's just not doing what we want it to the do, go back and spend some more and tweak it. This is more just customers on the charging side?

No, I think in fact, some of our incremental investments will be targeted towards Switchblade. So, I don't mean to say it's -- I only picked the charging market as an example because I thought it would be an easy example. But that pattern exists in all of our four areas of development, and in particular, we will probably be accelerating some areas of R&D in both switch blade and in electric vehicle infrastructure to address specific significant real opportunities. That are clarified within the last three months relative to previously, because customers are very serious.

That's helpful. I appreciate that. If you look at your service sales they were down about 12%. Is that just some of the development work that you have tucked into service, kind of winding down, or is there any Iraq-related lower tempo, less spares and work associated with that? How should we understand that, the trends in service sales?

Yes, the reduction in service sales, I think I tried to elaborate a little on the call, but it was primarily driven by the project R&D work. Mostly the global server.

Okay. Do you expect to see any impact from lower operational tempos in Iraq and the service component? Should that continue to decline or you think as they come back they are going to be training with these things and there's still a pretty steady replacement and repair?

Troy, I think that's a reasonably complex question. So, at least the answer is reasonably complex. So, if we look at Iraq as an example with the, as we all know, the winding down the combat operations and what would that mean for our small UAS business. So, I think if we start off, our business is, in that product line is small UAS, it's not just Raven, and I think we have, as we've said for a number of years, and I think it's been born out, that our customers have now adopted small UAS. It's a part of how they plan, train, equip, and execute. It's increasingly like helmets, rifles, night vision goggles and a small UAS.

So, we don't expect to see a reduction in the basis of issue or the -- specifically, the Army acquisition objective based on moving out of Iraq. I think if the spares and the repairs portion of the business has two main drivers. One is the volume of systems that are in the inventory and the second is the ops tempo that drives -- that increases the incidence of broken parts and requires repairs and spares. So, to the degree that the ops tempo goes down, we would expect to see a decline in spares and repairs. To the extent that the volume goes up we would expect to see an increase. And I think the answer actually goes much farther than that, though.

In Iraq, we still have 50,000 DoD personnel, and presumably a growing number of non-DoD personnel. With the lack of combat operations, we go from simplistically an offensive operation to a defensive operation, and it's not clear that the force protection and force multiplication benefits of small UAS -- it's, rather than not clear, it's possible that those become even more important in an environment without the combat operations. So, it's not clear that demand would go down for systems with the -- as long as personnel are there. I think the fact that -- the point that I made earlier about the increasing value of small UAS with their increased performance capabilities and maybe to put at different way, if we can provide 70% to 80% of the benefit of larger systems in some applications for 1% to 10% of the cost, to the extent that the US budgets are constrained or to the extent that other countries don't have the size of budget that the US has, I think it's quite likely that small UAS become more attractive and potentially military demand could even increase.

Outside of the military, we have always believed that non-military applications like first responders and border patrol and industrial infrastructure and other government agencies offer significant long-term growth, all of that is conditioned on access to the national airspace.

Okay. That's helpful. I appreciate it. I'll jump out of queue. Thanks.

Thank you, sir. Our next question in queue comes from Josephine Millward with The Benchmark Company. Please go ahead.

Thank you. Good afternoon.

Hi, Josephine.

Hi Tim, nice Puma order.

Thank you very much.

Now, I understand --

I think you suspected that was coming.

Right. And you have interest from multiple customers with the Puma and it's very much driven by requirements from theater. Do you think we could see follow-on orders of the Puma in the coming year? Can you just talk about your outlook for the rest of the year on Puma?

Yes, I think there are two areas there. One is relative to the -- this $40 million of system orders that we just announced, I mentioned in my comments that we expect additional orders for contract logistical support to support those systems, and we would expect to begin to see those orders this quarter, and probably additional orders later in the year, and those are very significant volume levels that we expect. Some of that would translate into revenue yet this year. Most of it would be next year in our FY 2012. So, in and of its self, that is -- that's significant additional revenue that we would expect on Puma.

Beyond the existing orders and the associated logistical support for it, I do believe that Digital Puma is generating significant interest with not only the existing customers that have acquired it, but other customers beyond that. And I don't have a specific time or amount to predict, but I think that we will see continued growth in the adoption of Puma. But it sounds like in your outlook you have visibility for the Puma revenue that you have assumed in your guidance for the year. So, if you receive additional Puma procurement orders that would just be up side, is that right? To the extent that we ship them this year, it might be, but I wouldn't be -- I wouldn't, and we are not planning on any additional revenue upside based on new Puma system contracts in FY 2011.

Okay. And since the Puma is a program of record, do you think we could see a budget request in the fiscal year 2012 defense budget, or do you expect this to be continued -- continually funded through supplemental funding?

I don't think that's quite clear to me at this point, Josephine. I know what's -- what our existing -- the existing contract vehicle that -- where the initial Pumas were ordered against, and that these -- this most recent $40 million was released against was -- is an IDIQ from special operations command, and that resulted from a full and open competition a couple of years ago. That IDIQ I think had an upper limit of -- was it 200 million?

That sounds about right, yes.

And I know -- I'm familiar with what that customer has done to support the J&A for that contract and the funding, but what might happen beyond that in the budget or out I think is yet to be determined.

Okay, that's fair. Tim, can you clarify the installation fee for the AV Nissan Leaf charger? Because I read an article somewhere that you are charging people almost $2,000 to install the charger, in addition to people paying $2,000 for the charger. Can you just provide some clarification?

The Nissan North America announcement on the pricing of Leaf included the standard -- the pricing for standard, quote, standard installation of the home charging dock, and that charging dock and its installation are part of the business that we're supporting Nissan with. And in that announcement, I think they said the standard installation for the hardware and the installation service was about $2,200. So, that includes -- by standard that defines the nature of the utility interface, the breakers, and the wiring in the house and the distance of the wiring from the box to the utility interface. So, if there are major changes in that, if it's a much longer installation, if it requires an upgraded utility interface or something like that, then it becomes a non-standard installation, and it would cost more. The $2,200 includes the installation, our charging unit, and the permits and fees associated with all of that.

Okay, that sounds more reasonable. Can I forward you this article I read where a customer, Nissan Leaf customer is complaining that you're charging too much for installation, that's -- the $2,000 of installation is on top of the charger? Maybe it's a one-off case, but it certainly -- it's --

Well, that's not -- that's not impossible, because if it were a, quote, non-standard installation that required a higher price for the installation, then that could -- certainly I'm sure there are some that would have a $2,000 installation, in addition to the charging dock itself. But the charging dock is not $2,000.

Okay, so but you think that's an anomaly, it's not -- it's because of -- it's a one-off case?

Well, again, there's -- this standard installation is defined, it was originally defined by Nissan, and it's a standard price across the country. Now, we have had some circumstances where we've had unhappy customers that thought the price was too high in some of those cases as we went back and looked at that time data we had customers that had already had an EV-ready installation with a previously installed EV charger of a different type for a different interface, and the actual work to be done would be to take off the existing EV charger and replace with it ours. Now to the extent that, that turned out to have a utility interface and home wiring and everything that met the standard installation requirements that we have with Nissan, then the cost is actually considerably less than our standard installation, and we, based on that, we went back and revised or established a lower price for those relatively small number of customers that had that existing, pre existing installation. So, certainly we have not been error free in rolling this out, but I think we reacted quickly, and we're doing our best to meet customer needs.

That's helpful. Thank you. And based on Nissan's pre sale of the Leaf vehicle, can you talk about your outlook for -- on the charger in the coming year?

Everything I read from Nissan is, and from other public documents indicate that there's been a robust acceptance of that product. I think I read that they have sold out their initial capacity, and certainly our experience with customers that are requesting assessments and quotations for installation of charging systems in the home has been robust. We have some confidentiality and some proprietary issues on specific numbers, but we're well over 1,000, and we're working in multiple states, and we are -- I think that's all led us to conclude that our initial planning for the revenues we would expect in the second half still looks good.

Great. Thank you, Tim.

Thank you, Josephine.

Thank you. Our next question in queue comes from Jeff Evanson with Dougherty & Company. Please go ahead.

Just a couple of cleanup questions here. Jikun, how much GDL upgrade revenue was there in the quarter?

I don't think we're going to go down to that level of detail, but --

Was it up from Q4?

Oh, no, it was down from Q4, probably about -- let's see, I'm looking at maybe a third of Q4 levels.

Okay, that makes sense. Thanks. Boy, I hate to ask this, but one more question on R&D spend, last year it was 10% of revenues. Are you expecting it to be 11% to 12% in this fiscal year? Is that how we should think about it?

Yes, I think the reduction in the operating profit margin guidance would be a Delta up to the R&D budgets.

Got it. Okay. Thank you very much.

Thank you, Jeff.

Thank you, sir. Our next question in queue comes from Erik Olbeter with Pacific Crest. Please go ahead.

Thanks. And thanks for staying on so long to take our questions. Real quickly, looking at the energy efficiency business. So far we've seen good traction in the testing equipment. Are you starting to see, for testing at the end of the lines, or are they still largely for the R&D facilities of your customers?

Most of the revenues that we have seen to date on our test equipment is in the R&D section. There are -- there are opportunities developing, Erik, in end of line testing that we're aware of, and that we're paying attention to, but that's not been reflected in significant revenues to date.

Do you see that as a 2012 opportunity, or is it still a little too opaque to say?

I think I would opt for still a little too opaque.

Okay. Just a question on -- also on -- we've seen sort of GM and some of the other -- even Nissan, level three, choosing to go a different route. As you think about sort of the next iteration of the EV solutions initiative, how do you see the market evolving, and particularly given the heightened level of competition since the Nissan order, and how do you expect to respond?

Well, I think the Nissan order itself had an extreme level of competition associated with it, which I addressed in my early comments, but -- almost a 12-month competition in winnowing down from 10 to seven to five to three to one, with that level of global competition was clearly high. I would expect, and we have seen even additional entrants since then. I think that all reflects the relative -- or the anticipated size of this opportunity. I think we've been effective to date and we expect to continue to be effective based on the strategy and the competitive advantages that I ran through in the comments.

I don't think this is a lot different than than the pattern that we've seen in the other markets we've entered, where we have initiated the market opportunity through, in many of those cases, internally funded innovation, but small UAS was rapidly followed with large competitors that include some of the largest aerospace and defense contractors in the world that have competed consistently and continue to compete in that market, and so far we've been -- maintained an ability to compete successfully. We've seen a similar thing in similar characteristics in our other market. We see the same thing with Global Observer.

Great. Certainly no doubt you have been believably successful in small UAV. Just one last question. You talked about a CR through November, clearly the first step in the process. You have also shifted revenue and expect most of the Raven revenue to hit in 2012 now. If we go through a full year CR, which looks, according to some likely, does that change at all or put any risk into the back half expectations you've set today?

Well to clarify, the plan for the government FY 2011 Raven funding, we built our original plan assuming that we would have a very small amount of that revenue in our fiscal year 2011, and we continue to have that built into our plan.

Right.

If there were a continuing resolution that resulted in no contract release during FY 2011, for the government during our fiscal year 2011 for the government fiscal year 2011 budget for Raven, that could potentially have a very small double-digit effect on our current revenue plan, which most likely would be covered by -- our contingency.

Okay. Great. Thanks.

Thank you, sir. Our next question in queue comes from Tyler Hojo with Sidoti & Company. Your questions please.

Good evening. Just a couple of really quick clean up questions. What is the -- what was the unfunded backlog in the quarter, and also, I'm also looking -- under the Army's plan by where we currently stand? That's all I got.

Sure. Unfunded backlog at the end of the quarter was $255 million.

Okay.

And I'm assuming you're asking about the plan against the army BOIP. We are, -- let me confirm that number.

Under the 2182.

Right, right. Let me just -- I don't want to make a mistake here, because I know people ask this question all the time. We are 73%.

73%, great. Thanks a lot for all the color.

Thank you. Our next question in queue comes Cory Armand with Rice Voelker. Please go ahead.

Good afternoon. Tim, just real quick. At what point will you demonstrate the Global Observer's ability to fly at the target altitudes for long duration? Is it possible this could occur by calendar year end?

I think it's possible, Cory, but I would -- I think it would be more comfortable to talk about that being targeted in our second half.

Okay. And previously in the call you talked about the role of the family of systems. Has that proof of concept actually started? Has it test started in the field and is your optimism actually based on feedback from the theater?

Well, to the extent that we're talking about the Army's experiment with a family of systems to meet their requirement, yes that has started. We have delivered the Puma systems and the WASP systems that will -- are combined with Raven systems for a combat brigade team that has been equipped and trained and recently deployed.

Okay. Can you discuss at all whether you're gaining additional interest in the Switchblade and where that stands now?

We are -- by additional interest, I would characterize it as there are a significant number of customers that have a high level of interest in an all cases that level of interest has sustained or increased, and there is level of activity associated with that interest that is ongoing with a number of customers.

Okay. And the last one, sorry about that, is the development of your electrician installer network for the Nissan Leaf is that complete now?

It's ongoing, and it's being timed with the planned rollout of the Nissan Leaf on a national basis.

That's all I had. Thank you very much.

Thank you, Cory.

Thank you. And that is all the time we have for questions. We'd like to turn the time back over to Mr Gitlin for any additional or closing comments. Sir.

That is our final question. Thanks for all your attention and your interest in AeroVironment. We'd like to remind you that an archived version of this call, all SEC filings and relevant Company and industry news can be found on our website at www.avinc.com. And we look forward to speaking with you again following next quarter's results.

Thank you, sir. Again, ladies and gentlemen, this does conclude today's program. Thank you for your participation, and have a wonderful day. You may all now disconnect.