AeroVironment Inc (AVAV) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the AeroVironment First Quarter Fiscal 2012 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. Steven Gitlin. At this time, I would like to turn the conference over to Mr. Gitlin. Sir, you may begin.

Thank you very much, Said, and welcome to AeroVironment's First Quarter Fiscal 2012 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 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 as of only today, September 7, 2011. 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'll begin with remarks from our CEO and Chairman Tim Conver, and then hear from Jikun Kim, and then we'll move on to questions. It is now my pleasure to turn the call over to Tim.

Thank you, Steve, and welcome to our First Quarter Fiscal 2012 Conference Call. I will begin by emphasizing three main points.

First, we executed effectively and achieved key results in Q1 and significantly improved year-over-year first-quarter performance; second, demand and order flow remained strong for our solutions at our UAS and our EES business segments; and we are well-positioned for long-term growth in both segments of our business. I will expand on each of these three points and then Jikun will review our financial performance before turning it back to me to provide our view on the remainder of fiscal year 2012.

Now, more on our first quarter. Historically, our first-quarters have produced the lowest revenue, mainly due to UAS customer order timing. The last two years demonstrated this trend clearly, with low first-quarter revenue that also produced net losses. We expect Q1 to again be the low revenue quarter for our fiscal year 2012, however this year Q1 revenues of $62 million and earnings per share of $0.01 were significantly higher than the last two years, and represent a much higher percentage of the full-year guidance.

Revenue and earnings per share, respectively, met and slightly exceeded our guidance. Our reported Q1 funded backlog was about $73 million. With the $65 million Puma order announced in early August, we now have visibility into approximately 60% of our full-year revenue guidance, much earlier than previous years, which supports our confidence in executing fiscal year 2012 as planned. During the quarter, we also booked other key contracts for our Switchblade and Efficient Energy Systems products that reinforces our planned fiscal year 2012 revenue growth.

In the quarter, AV's gross profit margin percentage increased from 31% to 35% year-over-year. UAS gross margin improved significantly, driven by a higher mix of fixed-price contracts, and EES gross margin declined sharply as we recognized higher-than-anticipated costs on a DOD development contract and on the electric vehicle solution product transition to production. Both showed up as production charges to Efficient Energy Systems' cost of goods sold. We believe that Q1 marks the trough for the EES gross margin from these effects and expect to see improvements as we progress through the year.

But that is an overview of Q1, let's now move on to a more detailed review of unmanned airplane systems, or UAS operations, and development programs, starting with small UAS. We believe that AV's C4ISR architecture embedded in our small UAS product solutions makes the family of small UAS concept operational today.

Our common ground control system and widely adopted digital data network, multiple air vehicles, and payloads to further enable the squad as a strategic force. This month the Army will showcase manned and unmanned interoperability to include ground troops using expanded capabilities of our small unmanned airplane systems ground control and Digital Data Link to directly control the sensors of a Group 4 unmanned airplane system for their own ISR use.

The AV family of small UAS is a unique common joint interoperable solution that meets the ongoing demand for cost-effective ISR capability that acts as a first multiplier. Raven is the most prolific small unmanned plane system, and we will have retrofitted most of the install base of analog systems with the digital upgrade by year-end.

User response to this new capability enabled by our Digital Data Link is positive, and Raven remains in demand. In fact, the Army has boosted its basis of issue plan for troops in Afghanistan from 15 Raven systems to 35 per combat brigade. They are satisfying this increased demand through the redeployment of existing Army Raven systems from the continental United States.

Puma AE systems are performing very well in the field, as evidenced by the recent contracts, and are generating more user demand. Users have told us that Puma has changed the way they operate and makes their operations much safer.

In anticipation of the recent Puma contract, we previously ramped up our supply chain and staged inventory to execute rapidly on our customer's need for expedited delivery this fiscal year. We see Puma increasingly delivering the benefits of a larger platform in the Army's small UAS inventory.

Beyond Raven and Puma, we've been demonstrating new prototypes of the smaller digital Wasp customers, which incorporates key capabilities improvements desired by users. The new Wasp will complete the digital transition of all AV small unmanned airplane system programs of record. Customer response has been positive, and initial adoption is possible within a year.

Our DARPA program to develop a stealthy, persistent perch and stare small, unmanned airplane system produced the Shrike VTOL. This new capability may soon be in a position to address the Army's long-term desire for a practical, man-portable, quiet, vertical takeoff and landing, small UAS, with hover, perch, and stare capability.

We view continuous upgrades to our systems as a key part of our commitment to help our customers succeed, and as an important element of our growth strategy. We are well along in planning the next new capabilities to improve the value of small unmanned airplane systems for the men and women who serve our country.

In addition to our traditional business of selling and supporting unmanned airplane systems, we are expanding our capability to provide operating services, which involves AeroVironment personnel operating unmanned airplane systems and providing and actionable intelligence to our customers. We believe operating services will be a preferred solution for some customers, and may enable some to sustain valuable UAS benefits during and after a combat troop draw-down.

We have also seen evidence that the draw-down of troops in war zones has actually created some new opportunities for the use of our small UAS, to enhance the situational awareness for those who are still deployed in those locations. In some cases, draw-downs have removed more expensive scarcer options, thus driving the increased use and benefit from small UAS.

In addition, some of our customers have chosen to use our operating service model to reduce customer manpower costs while gaining proven and flexible ISR capability in draw-down environments.

Beyond the US, other countries a following the DOD's successful example of small UAS adoption. Small UAS often deliver solutions for less than 10% of the cost of alternatives, a value proposition not lost on defense ministries that operate with much smaller budgets than the United States.

To fully consider our future UAS demand drivers, we also have to go beyond military applications. When national airspace opens up for small UAS use by first responders, for infrastructure monitoring, and for other public safety applications, we think AV's family of small UAS solutions will be well-positioned to address this largely untapped potential. This market is likely to develop in the next few years, and be both global and large once it emerges.

I'll now move on to consider UAS developments beyond our historic base in small, unmanned airplane systems. In general, adoption of any of these incremental developments could significantly accelerate our growth.

Global Observer is our hybrid electric unmanned airplane system designed to provide seamless persistent communications and surveillance at a fraction of the cost of existing solutions.

After undergoing eight successful flight tests, Global Observer 1 experienced a mishap on April 1. It's important to highlight that the success of the first eight flights included the major technologies we developed to enable Global Observer that all performed extremely well. We are awaiting the release of the Air Force incident investigation report before we say more publicly, but we are confident we understand the cause of this mishap. We have completed weeks of successful testing in our systems integration laboratory, validating the corrective action.

While the timeline for Global Observer has been extended by the mishap, we believe the underlying need has not changed. Global Observer airplane number two is 90% complete, and low rate initial capacity for production is in place to deliver operating systems. Multiple customers are interested in Global Observer capabilities, and discussions are ongoing.

Early adoption of Switchblade appears to be taking hold for this unique new capability of loitering munition. We recently announced a $5 million contract from the US Army close combat weapon system that includes requirements for rapid fielding of operational systems deployed to combat forces. Other customers are also showing active interest in deploying advanced prototypes. Demonstrated performance, safety, and ease-of-use reduce barriers to Switchblade adoption. AV is well-positioned to support the adoption of this innovation with successful safety testing completed, an established supply chain and low rate initial production capability, and demonstrated performance matching customer requirements.

Our business and much of our long-term growth is tied to US government contracts, which can in turn be strongly affected by DOD budget decisions. Congressional committee language still supports the President's request for government fiscal year 2012 Raven funding at about $70 million.

Anticipating possible delays in the DOD fiscal year 2012 budget, our plan includes only a portion of that funding in our fiscal year 2012 revenue. The most DOD budget uncertainty appears to begin in government fiscal year 2013, but there is still little visibility into how that uncertainty will affect our specific programs. Today, what we know is small UAS are broadly supported and have a high priority, because they save lives and increase mission effectiveness for all services with ground forces, and they are a fraction of the cost of alternative solutions.

We don't expect the priority of small UAS to change in the foreseeable future. We do expect the future DOD procurement decisions will be most likely becoming increasingly constrained by lower budgets affecting spending choices. At a time when our solutions remain in demand, our maintaining high levels of operational effectiveness and cost less than 10% of alternatives. We think these factors position our base is small UAS business well for future DOD budget trade-offs.

In other UAS developments that represent multiple incremental growth opportunities, all of which are relatively low cost, and anyone of which could drive significant growth in the long term. We believe Switchblade has broad joint support and is a cost-effective solution to a high-priority requirement.

Further, we believe that the cost savings promised by Global Observer will be even more attractive in a DOD budget-constrained environment.

International customers and non-defense market opportunities represent incremental long-term growth potential for unmanned planes systems beyond the base DOD market.

Few businesses are easy or certain, but as we move our UAS business ahead into the uncertainty and fiscal constraints of future defense budgets, I don't see another set of cards at the table that I would want to trade for.

Now to move on to our EES, or Efficient Energy Systems Segment, demand for electric industrial vehicles such as fork lifts has returned, and with it, positively charged systems remain in demand throughout the quarter and our market share remained high. We think overall market demand affecting the positive charge product line is likely to follow the industrial economy in general, and forklift sales in particular.

Our electric vehicle test equipment product line is growing, with broader EV and battery pack development, both in the United States and abroad. Future market demand for this product line will remain associated with electric vehicle development for now. Positive charge EV test equipment and the emerging electric vehicle solution products are increasingly synergistic, with integrated technology road maps, modular design, and leverage supply chain volumes benefiting all three. The startup of our electrical vehicle solutions business, while absorbing resources, continues to create new products, attract important new customers, and win key competitions. We believe this is a very large opportunity.

Production and installation of a Level 2 electric vehicle supply equipment continues to ramp up. We have now deployed more than 3,000 Level 2 charge ports in homes, at businesses, and in the public in 27 states and five Canadian provinces. We plan to increase our installation network to all 50 states by the end of our fiscal year. We have received UL certification for products spanning all electric vehicle charging needs at home, at work, and in the public. Our EV fast chargers and our 110-volt cord set are the first US products in their category to be UL certified.

Most of our electric vehicle solutions revenue to date has come from our previously launched residential and business Level 2 charge ports, but we expect our newly certified products to contribute an increasing share of revenue in the future.

We announced more important new competitive wins in Q1. Oregon and Washington chose us to install a network of fast-charging systems along Interstate 5. This creates a fast-charging corridor between population centers that is ultimately planned to stretch from San Diego to the Canadian border. Auto maker BMW chose us to supply and install Level 2 home charging systems for its Active E all-electric vehicle. Nissan Canada contracted with us to support their Leaf rollout, thus expanding our Nissan relationship internationally. TXU Energy selected us to build a Level 2 charging network in McKinney, Texas. These wins augment our previous awards, including those with Nissan North America with NRG energy and with the state of Hawaii.

During Q1, we recognized two significant charges to our EES cost of goods sold, contributing to the low Q1 EES gross margin. The larger of these two charges recognizes additional development costs now anticipated on a fixed-price US Department of Defense contract that we will be working on throughout the year. The other charge recognized production startup costs on new electric vehicle solution products.

We will continue to invest throughout the year to move these new electric vehicle solution products through low-rate initial production, and into high-rate production with lean processes that support our long-term competitive strategy. The cost to move these products into production and to scale will be accounted for in segment cost of goods sold. This plan is anticipated in our fiscal year earnings per share guidance.

EV charging infrastructure is seen by many as a huge new market opportunity, and it has attracted global competition. We believe we offer the broadest set of high-value solutions, with integrated hardware, software, and customer requirement management solutions that are providing compelling decision-making opportunities to multiple sets of customers, from automotive OEMs, to utilities, to states.

Our competitive strategy includes innovation, agility, and a focus on integrated and practical customer solutions. We intend to continue to execute on this successful strategy while focusing on lean operations and customer satisfaction as we scale production to support expanding customer requirements. We believe this approach will extend our strong current market position into the future and drive growth in the emerging markets for EV infrastructure.

Many third-party forecasts project sustained demand for electric vehicles and associated charging infrastructure, even with the current cost and limited range of batteries. On the supply side of the market, the recently passed federal corporate average fuel economy, or CAFE standards, increased the mileage requirements for cars from around 30 miles per gallon today to almost 55 miles per gallon by 2025. We believe this will further incentivize plug-in electric vehicle supply, as EVs can play a significant and growing role in helping auto makers comply with this efficiency challenge.

As with all emerging markets, uncertainty in market adoption rates, timing, and structure exists. Our considered conclusion is that the EV market is more likely than not to grow significantly long-term, and that our strategy and agility are more likely than not to continue to succeed competitively. We believe this creates a very large opportunity for AeroVironment.

To sum up, we're well on our way to executing the plan for the year. And across the business we believe the combination of multiple growth opportunities and competitive success will produce sustained long-term growth for AV. To continue my analogy, we dealt our own cards in this game and we still like our hand.

With that I'll now turn it over to Jikun.

Thank you, Tim, and good afternoon everyone. AeroVironment fiscal year 2012 Q1 results are as follows -- Revenue for the first quarter was $62 million, an increase of 62% over Q1 last year of $38.2 million. Looking at revenue by segment, UAS revenue was $52.2 million, an increase of 56% over the prior year. The growth in UAS revenue was largely due to higher product deliveries of $12.8 million, driven by digital Puma AE systems, and the higher services revenue of $12.3 million driven by services and retro fits. However, this growth was offset by lower customer-funded R&D work of $6.3 million, largely due to the Global Observer program.

EES revenue was $9.8 million, an increase of 105% from Q1 last year, primarily due to higher hardware deliveries of our electric vehicle charging systems, industrial fast charge, or positive charge systems, and electric vehicle test systems.

Turning to gross margin, gross margin in the first quarter was $21.7 million, up 80% from the first quarter last year. Gross margin as a percent of revenue was 35%, versus 31% in the first quarter last year. By segment, UAS gross margin was $20.2 million, up 95% from the first quarter last year. As a percent of revenue, UAS gross margin was 39%, compared to 31% in the first quarter last year. The growth was largely driven by a higher mix of firm fixed-price contracts, compared to cost-reimbursable contracts.

EES gross margin was $1.5 million, down 9% from the first quarter last year. The decrease in gross margin was driven primarily by higher program costs on a firm fixed-price DOD development contract, and the investments required to transition the suite of electric vehicle charging systems into low-rate initial production. As a percent of revenue, EES gross margin was 15%, versus 35% in the first quarter last year.

SG&A investment for the quarter was $13.7 million, or 22% of revenue, compared to $11.4 million, or 30% of revenue, in the prior year. SG&A investment was higher, primarily due to higher marketing and business development investments. R&D investments for the quarter was $7.6 million, or 12% of revenue, Compared to a prior year amount of $8 million, or 21% of revenue. The decrease in R&D was primarily driven by the transition of new products into production.

Operating income for the quarter was $0.4 million, or 1% of revenue, compared to a loss of $7.3 million, or negative 19% of revenue in the prior year. Operating income was higher than first quarter last year, primarily due to higher gross margins and lower R&D investments, partially offset by higher SG&A.

The effective tax rate for the quarter was 35.7%. Net income for the quarter was $0.3 million, or $0.01 per fully diluted share, compared to a loss of $3.4 million, or a loss of $0.16 per share in the same quarter last year.

Looking at backlog, funded backlog at the end of the quarter was $72.7 million, down $10.2 million, or 12%, from April 30, 2011. Not included in the funded backlog was a subsequent $65 million Puma AV order.

Turning to the balance sheet, cash equivalents and investments at the end of the first quarter totaled $194.3 million, down $0.9 million from the prior quarter. The negative cash flow was driven by higher working capital needs.

Turning to receivables, at the end of the first quarter, our account receivables including un-billed receivables totaled $35.4 million, down $30.9 million from the prior quarter. Total day sales outstanding were approximately 51 days, compared to 56 days at the end of the prior quarter.

Taking a look at inventory, inventories were $38.3 million at the end of the quarter, up $0.2 million from the end of the prior quarter. Days in inventory were approximately 86 days, compared to 60 days at the end of the prior quarter.

Turning to capital expenditures, in the first quarter, we invested approximately $2.6 million, or 4% of revenue, in property improvements and capital equipment. We recognized $2 million of depreciation.

Now, I'd like to turn things back to Tim to discuss AV's expectations for the balance of our fiscal year 2012.

Thank you, Jikun. To restate the main points I made at the onset of this call, we delivered the performance we expected in Q1, improving year-over-year results, and booking important contracts that support our annual plan. Demand and order flow remained strong, and we are well-positioned for long-term growth opportunities in both the unmanned airplane systems and efficient energy system segment.

We expect EES gross profit to improve significantly from Q1, but remain lower than last year, because of the Q1 charges to cost of goods sold, and the transition of multiple new electric vehicle solution products into production throughout fiscal year 2012.

We have more visibility than usual supporting our annual plan, and with that we reiterate our guidance for fiscal year 2012 performance at $321 million to $336 million in revenue, and $1.28 to $1.35 earnings per share fully diluted.

With the benefit of early backlog now on order, we are working to smooth out our quarters somewhat from last year. We expect Q2 to be around $72 million-$78 million in revenue, with about $0.15 to $0.25 EPS fully diluted.

The high-priority of ISR and communications enabled by unmanned airplane systems, the broadly acknowledged lifesaving performance of small unmanned airplane systems, and the relative cost advantage of all of our solutions should benefit our position in an environment of future DOD budget constraints.

Growing international demand for small UAS, emerging opportunities for Switchblade, the potential for small UAS in public safety, and Global Observer adoption can each significantly augment our long-term UAS growth potential.

Industrial charging and electric vehicle test equipment markets continue to grow, and plug-in electric vehicle charging infrastructure is expected to grow significantly.

We have a leadership position in all of these markets in both of our segments, and believe we can sustain long-term compounded growth, creating value for customers, our employees, and our stockholders. Thank you, and we'll open the question line now.

(Operator Instructions)

Tim Quillin, Stephens Inc.

I'm not sure how much more you can say about the charges, but if you can just talk about in the EV business, what exactly you were doing on the DOD fixed-price contract? And then on the EV solutions charge, where are we in the ramp-up of that business? And which precisely what units are you moving from LRIP into full production, that they are having a little bit of a hiccup here?

Let me give it a shot, Tim. As to the first question on the DOD contract, that's -- as you probably remember, we have an IR&D function going on in each of the segments that supports our technology developments and our product developments, and augments in many cases our customer-funded developments. And the Efficient Energy Systems business has been working on multiple contracts with the Defense Department for years in related efficient energy products. This happens to be a subcontract that we have on a DOD program that relates to some of our motor technology, and it turns out that as happens from time to time, we underestimated the cost of executing the contract and we realized that during the quarter, and accounted for that.

As to the other charge that was applied to the electric vehicle solutions products, that's primarily associated with the half a dozen new products that we have developed over the last few quarters, five of which completed UL certification last quarter, and are transitioning into production. So, that's electric vehicle charging products over and above the Level 2 electric vehicle supply equipment that we've been rolling out since last year.

And just one follow-up, and I'll jump back in for other questions, but in terms of the ramp-up of the EV solutions business in aggregate, where do you feel you are right now? I'm kind of especially interested in what you're seeing in terms of take rate from Nissan LEAF owners? I know they are just starting to deliver LEAFs at high rates, and I'm kind of interested what kind of take rate you are getting on the preferred home charger? Thank you.

Okay, I think you're correct, everything I see in public release shows increasing volumes of Nissan LEAFs being delivered. I think the vast majority of the charging infrastructure being acquired to support those LEAFs is either coming from us or from the federal government-funded programs that in some parts of the country are providing free chargers for a period of time. So, I think we're about where we expected to be in the percentage of up-take there relative to other opportunities consumers have.

Jeremy Devaney, BB&T Capital Markets

First, I wanted to go back to the brigade combat teams and the new numbers that are being put out there, 35 Ravens per brigade combat team. I was wondering if you could talk about where we are in terms of penetration against the 2,385-system mandate -- the historical mandate that we've always talked about. Then also, if you could talk about penetration rate against the BCT requirement expansion. Lastly, maybe frame it all within the greater discussion that Army's having now about reductions of the BCTs going from 45 down to 30 under this new budgetary environment.

Okay, let me take a start at that and then I'll pass it off to Jikun. The requirement to move from the original basis of issue of 15 Raven systems per combat brigade team to 35 to support the surge in Afghanistan, I believe was driven by the recognition that these systems are providing much more value and are generating much more demand than the Army originally anticipated about six years ago when they set that basis of issue at 15 per brigade combat team. That is consistent with the discussion that have been -- the Army has been making public for some period of time now around their consideration of expanding their requirement for small UAS and/or moving to a family of small UAS, to wrap larger and smaller systems around to complement the Raven.

As to the specific performance against the current requirement, Jikun what's that look like?

73% relative to the 2,358 systems -- Army systems.

All right. Going separately from that, looking at the backlog -- was down sequentially, but you saw a pretty strong improvement in DSOs, sequentially as well. I was wondering if you could talk a little bit about what's going on at your customer. We've been hearing that the contracting environment is pretty well shut down. You saw some contracts during the quarter. Just some puts and takes here -- you're obviously seeing some payments come in from the customer, but backlog's dropping.

Yes, I believe again, the timing of the orders drives a lot of our backlog. We have commitments when we get the orders for delivery over a certain period of time. The $65 million Puma order was not included in the $72 million backlog order. In terms of accounts receivable and day sales outstanding, again, we have normal terms with the US customer, DOD customer, and we have not seen any delays in payment.

All right, excellent. I'll hop back in queue. Thank you.

Michael Ciarmoli, KeyBanc Capital

Maybe just to stay on the backlog. Do you guys have a bookings target in mind for the year? I mean, do you expect a booked-to-bill of over one time this year, or even a kind of a projected first-half bookings number that you're shooting for?

Not, I'm not going to attack our bookings by quarter or by month, but in general we do expect our backlog to grow year-over-year, if that helps.

Okay, so by the close of your 2012 you're expecting year-over-year growth?

Yes.

Okay, that's helpful. Maybe if you can, Tim, elaborate on the operating service model, maybe? I don't know how specific you want to get, maybe the number of customers there, what your levels of revenue are, and even the potential profit levels there, if they differ meaningfully from your other traditional product sales business models.

Michael, that's an emerging option to -- that we're providing to meet different customer needs. We think it's going to resonate with some customers. We have some early adoption, and we think there is a good chance that might get more and take-up. Primarily, we're trying to just be responsive to different customer needs as their situation changes. The revenue from that is growing. We think it's hard to predict, again, the timing and the rate of adoption, but it could grow significantly over time. The profit is -- I don't think it's affected our margins yet. It's not yet been, probably, even if it did have different margins, it hasn't been large enough to move the dial at this point, but I think we'll have to wait to see how this model rolls out.

There is obviously a different scenario than selling hardware and then logistics support thereafter. In this case, to the extent that we own the hardware, we would capitalize it and amortize it over a period, and then we're supplying more labor in the services that operate that system. So, I can't get much more specific right now. I think in general it's a positive turn of events, and I think if anything, it will help drive more revenue as we are more responsive to specific customer needs.

Okay, perfect. Just a housekeeping item -- the charges in the EES, were they included in your guidance that you issued in June?

Well, I think they have not affected our guidance, and they're -- everything we see about what happened in Q1 and what we anticipate for the balance of the year is baked into our current guidance, which is the same that we provided at that point.

Okay, fair enough. Thanks guys, I'll jump back into the queue.

Troy Lahr, Stifel Nicolaus

Just wondering if you could start off by telling us how much the charge was at EES?

Yes, we're not going to get into that level of detail, but I could point you, as an example of a normal quarter, would be something like Q2 last year for EES.

So kind of backed into that 40-plus percent margin range is where you would have been?

Correct.

Okay. Then you still have some of these production issues. Do you think that you snap back to that 40% margin level in the second quarter, or are you just kind of hoping to get to that by the back half of the year?

Well, I think we've -- for the balance of the year, we're expecting that we're A, the gross margin in the EES segment will rebound; B, we expect that we'll finish the year at a gross margin percentage that's lower than we had last year, primarily because of the impact we've already taken in Q1, and the somewhat lower gross margin we would expect for the balance of the year because we're moving a lot of new products at one time from development into low rate production and then towards high-rate production.

Okay, so as we get to later on the year, margins should be lower year-over-year, getting second, third, and fourth quarter, is how we should think about it?

Yes.

Okay, and then just lastly, can you talk about R&D a little bit in the quarter? It was probably a little lower than I thought. Should we still think about that in the $7 million range, or do you think that trends higher, or how should we think about just R&D?

Yes, I think if you go back to last year, we actually had what I would call an anomaly, in that we saw some opportunities to invest heavily to accelerate growth, and so we increased the R&D budget, but I think this year we are heading back to our historical norms, which would be the 8% to 10% of revenues.

For the full year?

Correct.

Tyler Hojo, Sidoti & Co.

Good evening. I was hoping that you could talk a little bit more about Global Observer. In your prepared remarks, I think you said that the time line had stretched out a little bit. Just wondering if you could elaborate on that, and specifically comment on, I think your previous guidance, which excluded Global Observer entirely from this fiscal year.

Well, to begin with, we still are not anticipating Global Observer revenue in our guidance for the year. And that's primarily because of the uncertainty of timing of adoption. As to how far out the schedule for that uncertain schedule for adoption is pushed out, certainly the time from April 1 until we get back into finishing flight tests would be a minimum extension, and that clock is still ticking as we have ongoing discussions with customers. So we're pretty much back to the uncertainty of the timing of adoption of innovations. Although, we believe the demand opportunity remains, and the compelling advantage of lower cost and significantly lower operations remain to support the ultimate adoption of Global Observer.

Okay, and maybe just a follow-up to that. I mean, would you be surprised if you were not generating revenue from Global Observer in your fiscal 2013?

We have this, as you know, this strategy based on developing entirely new solutions and then supporting their adoption into large market opportunities. And that strategy has lots of strengths, and it has a few anomalies, like the complete inability to predict when those innovations get adopted. So we build a lot of flexibility into our planning process, and how we try to prepare for those adoptions, and support the acceleration when it happens, and also prepare for delayed periods when the unpredictability shows up in delays in adoption.

I think it's -- that's a long roundabout way to answer the question would I be surprised if it's not there? I guess we plan for and push for early adoption of innovations. At the same time, we're prepared for extended periods of time before that adoption happens.

Great, thanks for all that color.

Michael Lewis, Lazard Capital Markets

Hi, Tim. I just wanted to circle back on Tim's question earlier with regard to the federal grants. If I'm not correct, I thought that they ended at the end of this government's fiscal year. Is that the right time line to think about that?

Help me a little bit on which particular grants you're talking about?

Oh, I'm sorry. I'm talking about the energy systems for the EV chargers -- the grants, the federal grants that the government's been providing for the charging systems.

Okay. I believe those grants were scheduled to run through maybe the fall of 2012 -- or no, the fall of 2011 -- and I think they were extended to something around December of this year, the last I saw of those contracts.

So regardless, we're going to see that fall off, and that could serve as an opportunity for you to increase the traction in that side of the business. Would you agree with that?

Yes, I would hope that at some point everybody competing in the market is actually selling products.

Yes, okay. Then just me just switch gears here and talk about Switchblade. The recent orders that we've seen over the last few months, does that position you to be fully funded for all your planned fiscal year 2012 deliveries right now?

Again, my brain must not be fully wired up, could you restate the question for me?

Yes, so if you look at the Switchblade orders that you have received so far this year, are you fully funded on your expected delivery load for your fiscal year 2012? In other words do have all of the contracts that you need to fully deliver your plans?

For Switchblade, no I don't think so. I think we have expectations of additional Switchblade contracts throughout the year.

Got you. Okay, thank you.

Good, thanks. Sorry about my slow up-take, there.

Noah Poponak, Goldman Sachs

Tim, you mentioned anticipating possible delays in the fiscal 2012 budget process, and specifically only including a portion of the Raven funding from 2012 as a result of that line of thinking, so can you elaborate on both of those? On the first part, is there anything you're hearing out of Washington and from the customer specifically to make you think that, or is it just the general malaise we're all seeing? Then secondly, can you quantify how much Raven you do have in the number?

To the first question, nothing specific, either from our customer or regarding our programs. Just our sensitivity to the budgeting process for the last couple of years and anticipating that we may see a recurring nature to those non-recurring events. As to how much we have, is certainly less than half.

Less than half, okay. As a follow-up question, are there any -- when you talk about the international opportunities, is there anything meaningful in the campaigning there that we could see near-term?

Well, there are multiple opportunities internationally, and some of them certainly would qualify as meaningful. I'm hesitant to put a timeline on that, mainly because our experience has been that the international contracting process tends to be slower than the DOD process, and so given the fact that we have that experience, I'd be hesitant to put a timeline on it. I think opportunities of significance will emerge, and we'll be successful with them. Some of those opportunities are likely to happen this year, and some of them are likely to slide out.

Okay. One other really quick one. How much of the Puma orders should we expect to hit funded backlog in the next fiscal quarter?

Are you asking how much revenue am I going to recognize next quarter?

No. The Puma order that was after the end of the fiscal first quarter that you're saying goes in to backlog, I'm just wondering how much will be in funded.

All of it, 100% funded.

Brian Ruttenbur, Morgan Keegan & Co., Inc.

Just a couple of follow-up questions on the fiscal DOD delays. Can you talk in terms of timeline if this delayed, if there is a continuing resolution for 30 days, versus 90 days, versus 180 days. How much have you got built in their as a cushion? I'm just trying to understand if things get delayed, how long do you think that you can maintain these numbers, or is everything that you need already in there?

Well, let's see -- most of our, because we've tried to look at this conservatively, and build our plan around the assumption that there could be a delay in the budget, and there could be a continuing resolution, the revenue that we do have in the plan that is based on government fiscal 2012 anticipated funding, would all fall in our fourth quarter. So, I guess if we would start to -- if a delay would extend to the point where we couldn't be under contract and begin to deliver some of that in our fourth quarter, then we are in the zone of having a potential impact on our year.

Okay, and then can you talk -- I don't think you've broken this out before -- but can you break out revenue between EES in your protections versus unmanned systems, approximately?

I think we're going to stay with our historic basis of providing guidance at enterprise revenue and enterprise EPS. We do expect that the growth we anticipate this year will be primarily driven by small unmanned airplane systems and EES systems product lines in addition to growth in Switchblade.

Josephine Millward, The Benchmark Company

Tim, the Puma received rave reviews from the Army's network integration exercise over the summer, can you talk about how the Puma was utilized in this exercise, and what this could mean for future requirements?

I guess I don't -- I would prefer not to get into that beyond what our customer has already said publicly, Josephine, just in respect of their information and their approach. In general, the Puma systems that we have -- the digital Puma systems we've recently deployed with customers have been used to great effect, as I said earlier. Users that we have talked with have universally been -- said not only are they pleased with this system, but it in fact is changing the way they operate, and it has provided very significant force protection benefit. So, they're clearly saving a lot of lives.

In many cases, the Army has been using these systems recently deployed for route clearance patrol. I think there's some data starting to accrue there that shows very significant effects from the addition of this capability. It's really -- it's very rewarding to everybody that's been involved in that program to see the benefits for the people on the ground.

Okay. It sounds like the Digital Data Link capability is enabling the Army to use the Puma as a networking asset? Is that the right way to think about it, in addition to ISR?

Well, it is a good way to think about it, and it applies not just to Puma, but to all of our -- each of our programs of record that, as they transition to having a Digital Data Link capability, then -- since that's an Internet protocol system, every time an operator throws one of those airplanes up in the air, it becomes a node and creates a network that then can communicate with other airplanes and other ground control systems, and in an ad hoc network that enables moving not only video information around, but text and voice over IP. Increasingly, as we can make Digital Data Links available to other platforms, then those other platforms can become part of that network.

One of the comments I'd made earlier today referred to an upcoming Army demonstration where small teams on the ground will be able to use their small UAS ground control system to take over control of the ISR assets on other independent -- other previously independent larger unmanned airplane systems, and steer the ball and acquire that information for their own ISR use. So, that's now enabling a much broader extension of that network than just the original small UAS.

That is very helpful, Tim. Do you expect additional Puma orders for this fiscal year?

I think we do have an expectation that we are likely to get more orders as we go through the year.

Great. Can you give us an update on the timing of the Raven order from the Army, based on the fiscal year 2011 defense budget?

One more time, Josephine? I'm sorry.

I'm just trying to get an update on timing, when you might get the rest of the fiscal year 2011 funding, the Raven order based on the 2011 budget. Because I think there is still another $45 million or $50 million outstanding?

Yes, I'm not sure about the exact number, but again the timing of these orders are -- don't disclose that until we actually get the award. So we should be seeing those hit sometime in the near future, but the exact timing we're not disclosing at this time.

Jikun, I think on your last earnings call, I believe you guys thought you could be getting the rest of your Raven order from the Army, I think before your fiscal year and. Has that changed or--?

I need to refer back to my notes. I don't have those with me at this point in time, but yes, I'll look into that.

How about this, do you think we could see these orders before the end of the government's fiscal year?

I'm sorry, you broke up.

Do you think we could see the Raven orders from the Army before the end of the government fiscal year at the end of September?

Yes, again I'd have to go and verify my notes, but I think in general as a policy we don't disclose when we expect to see orders, until they've actually happened.

Andrea James, Dougherty & Company

First question on the Switchblade, congratulations on the Army order. Could you just give us an update on the LMAMS program, which I believe is separate from the order you announced. Then also, I guess I was wondering, are you ramping up production capability on that program, and should we figure in some margin compression in the near-term in anticipation of a larger order?

Well, let me see, the LMAMS question, to the degree that program was being managed by Special Operations Command, they held a couple of evaluations and fly-offs, and I guess I would leave it to them to make any announcements on any future plans they have. The Army program that we recently announced is -- addresses a similar requirement. What we've seen in the past is ultimately, similar requirements tend to often collapse down into a common requirement. I guess we'll wait to see how this evolves. There was a second part of your question that --?

Production.

Yes. So in anticipation of this Army requirement and others that we believe are possible, we have built out a supply chain and a low rate -- something that I would be close to a low rate initial production capability. So we're somewhere in between advanced prototypes and LRIP in at this point, and capable of delivering and supporting initial quantities.

Thank you.

To the degree that might affect margins, I think we would just refer back to our guidance that our revenue and our EPS guidance would anticipate everything we think is likely to happen this year.

Awesome, thank you. Just two quick ones, one is housekeeping. The funded R&D -- down $6.3 million, or is it $6.3 million for the quarter?

Let me take a look and confirm that. You're talking about revenue in the quarter, right?

That's right.

Yes, the R&D was $5.2 million in the quarter.

Okay, thank you. That was the funded, okay. Just finally on the hover and stare, I'm wondering, did that play into the Army's decision to increase the BCT requirement? What does it open up 40 does it open up for you? Does it open up international opportunities, or can you talk a little bit about it?

Yes, I don't think it, to my knowledge, did not affect any Army decisions that have been announced to date. There has been a long-standing desire enunciated by the Army for this kind of a capability, that at one time was the primary driver of the Class 1 UAS in future combat systems a number of years ago. While that solution developed there didn't quite meet all expectations, I think the underlying requirement for the initial desired capability has not gone away.

To that extent, if the Army decides they still have that kind of a requirement, we think we'll be well-positioned to address it. We think this capability goes beyond that, and addresses similar desires by other customers, and in particular, could be a very appropriate solution for non-defense applications for first responders, for example, when the national airspace is ultimately opened up for the use of unmanned airplane systems.

Tim Quillin, Stephens Inc.

I just wanted to follow real quick on the government fiscal 2011 Raven order, and I've got the benefit of looking at the transcript from the last conference call, but at that time you'd said there's $55 million of planned funding for Raven procurement, and you expected contracts in Q1. So, I just didn't know -- not to put you on the spot -- I just didn't know if that kind of jogged your memory in terms of anticipation of the timing of that order or orders?

Yes, I just don't have the notes in front of me at this point in time, so I'll have to get back to you with a follow-up phone call.

Okay, fair enough. Then a couple other detail questions, Jikun, is that you provide R& D target of 8% to 10% of revenue. Do you have a similar SG&A target in mind? Then also, what's the anticipated tax rate for the year? Thanks a lot.

Yes. Again, our primary motivation for moving to EPS was to provide a more comprehensive guidance, but in general, I believe SG&A runs historically at, I'm sorry, I'm having a moment here today, but I can get that information for you. In terms of the tax rate, we're expecting 30%.

And Tim, regarding the government fiscal year 2011 for Raven, although I don't think we are prepared to talk about specific timing, we have no information that would suggest that funding won't flow through as contracts as originally anticipated. While we don't want to project for the government when they're going to issue contracts, we don't expect any change in the total amount of those contracts.

Jeremy Devaney, BB&T Capital Markets

Thanks for taking the follow-up. I just wanted to circle back to the GO for a second. Last quarter you said the airframe number two was in late stages of completion. This quarter we're talking 90% completion. Have you been utilizing any IR&D to complete the airframe. Is there any intention to complete the airframe and pursue some of the flight requirements to bridge the vehicle to full contract?

Well, the difference between substantially complete and 90% complete is just semantics at different points in time. So, there's no intent to imply anything different between those two sets of descriptions. We have continued to support Global Observer with IR&D funding, but I think our primary focus remains working with customers on their adoption of this capability.

All right. Excellent, thanks for the follow-up.

Michael Ciarmoli, KeyBanc Capital Markets

Thanks for taking the follow up. I may have missed this, but the quarter -- the EES revenues of $9.8 million, they were at the lowest level in about a year. Was there any reason for that sharp sequential down-tick. Was that expected? If you could characterize that?

No. I mean, yes, from Q1 last year to Q1 this year you saw that sharp increase, but no, we continue to move along our business.

Was there anything, I mean it went from $15 million in 4Q down to just below $10 million. Any -- was that level of decline expected on a sequential basis?

Well Jeremy, this is Tim. I think we've seen historically that there's a annual change in revenue from high second quarter to low -- or high second half to low first half, year-over-year, in both segments. So I don't see that we have any anomalies here that were unexpected.

Michael Lewis, Lazard Capital Markets.

My question has been answered, thank you.

This is all the time we have for questions. I'd like to take the time to return the call to Mr. Gitlin for any additional or closing comments.

Thank you very much for all your attention today and your interest in AeroVironment. 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.

This concludes today's conference call. Thank you for your participation. Have a wonderful day.