AeroVironment Inc (AVAV) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the AeroVironment Incorporated third-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 remainder, this conference is being recorded for replay purposes. With us today from the Company is Chairman and Chief Executive Officer, Mr. Tim Conver; Chief Financial Officer, Jikun Kim; and Vice President of Investor Relations, Mr. Steven Gitlin. And now at this time, I'd like to turn the conference over to Mr. Gitlin. Please go ahead sir.

Thanks very much Huey. Welcome to AeroVironment's third-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 only as of today, March 6, 2012. The Company undertakes no obligation to make any revision to the statements contained in our remarks or to update them to reflect events or circumstances occurring after this conference call. We will now begin with remarks from Tim Conver. Tim?

Thank you, Steve. Before I review the quarter and the year to date, I would like to explain why our Q3 revenue came in lower than anticipated. And why it does not impact our current fiscal year. As we communicate regularly, the timing of order receipt and delivery can have an impact on our quarterly revenue and this was the case in Q3. $20 million of small unmanned airplane systems planned for shipment in our third quarter, completed assembly and test in January but those shipments were pushed out into the first week of our fourth quarter due to an administrative delay in customer acceptance.

As a result, customer acceptance was not processed until Tuesday, January 31, three days after our third-quarter end. $20 million of revenue will be recorded in Q4 rather than our third quarter as planned. However, this timing will not affect our annual revenue. We do not expect similar administrative delays in the future.

On today's call I will provide a brief overview of our Q3 performance, then I will review progress in our business segments, reinforcing three points. Our team is executing effectively against our Q '12 plans. Our core businesses continue to prosper in our position for sustained growth and we see tangible evidence of adoption of multiple long-term growth initiatives. Jikun Kim will address financial performance. I will follow up after his comments with our view of the balance of fiscal year '12, our long-term growth drivers, and some initial color on how we view our fiscal 2013.

Now on to Q3. Delivery timing aside, our team performed well and executed to plan in Q3. We produced quarterly revenues of $72 million and fully diluted earnings per share of $0.26. Comparing the first nine months of fiscal 2012 with fiscal 2011, our revenue was up 15% and diluted earnings per share increased by 50%. The $20 million of small UAS delivered early in our fourth quarter gives us a strong start to what we anticipate will be a record Q4 revenue. Additionally, gross margin and Efficient Energy Systems continues to recover from its Q1 low point, increasing to 29% from quarter two's 25%.

Now focusing on small UAS within our Unmanned Airplane System's segment. While Raven remains the most widely used UAS in the world, Puma is continuing to gain broader exposure and adoption with multiple customers. We have also been demonstrating two smaller platforms, digital WASP and Shrike VTOL, and customers are providing positive reinforcement that these platforms will eventually see meaningful adoption. We expect that they will expand the value and the capabilities of our family of small UAS. We have also successfully expanded our UAS support services beyond training and field support to include operating AV-owned systems to deliver information to customers as a service. These services have been well received and have driven significant growth. We expect support services revenue to double this year over last year.

This calendar year we will introduce the latest upgrade to the Raven system. Hand-tilt zoom payload for both electro-optical and infrared imagery. This capability dramatically improves the imagery and the operational flexibility of Raven and is easily retrofittable. We expect this upgrade to be adopted by the Army this year, and we believe it will be attractive to other customers, both in new acquisitions and as an upgrade for the installed base.

Small UAS are integrated into the way our military plans, equips, trains, and operates. These systems uniquely empower the squad level unit to know more about what's going on around them, better enabling them to avoid and defeat threats, move faster and save lives. The Marines reported that during a six-month period there were 90 incidents in which the ability to immediately engage targets with the same unmanned aircraft that identified them would have enabled effective engagement of enemy forces in placing IEDs, and that was before the broad adoption of Puma in route clearance patrols.

When you consider the addition of the backpackable Switchblade Loitering Munition capability, you can imagine a squad with real-time situational awareness and a beyond-line-of-sight precision strike capability. This turns the squad into an ever more effective fighting force that can acquire and quickly act on intelligence, empowering them with what the military calls over-match capabilities. Integrating ISR and precision strike at the squad level will translate into an important advantage, increasing effectiveness, while decreasing US casualties, collateral damage, and cost. We think that's a powerful value proposition at any time, but even more so in a budget-constrained environment.

Staying on the topic of budgets, the President's recently announced fiscal year 2013 budget request contains about $45 million of line items for our small UAS and for a small organic precision munition. The majority of this funding, $25.8 million is for Army Raven systems. While this may look like, to some, a demand decline for Raven, this amount is consistent with our expectations and it is consist with last year's Army future-year defense program report as well. We have seen the size of these Raven procurement amounts increase and decrease from year to year based on the Army's long-term acquisition plans. Demand for small UAS remains strong and we do not believe this lower budget amount is driven by force-reduction initiatives or ops tempo. In fact, budget documents show planning Army Raven procurement now extends out through 2017, reinforcing the continued demand for small UAS.

From a business perspective, budget line items accounted for only about a third of our total UAS revenue in previous years. Furthermore, Raven system procurement by the Army in our current fiscal year 2012 is a smaller percentage of our total UAS revenue than in the past. Continued product and service diversification have positioned us well for future, small UAS demand, both within and beyond the US Department of Defense, and we expect this part of our business will continue to prosper.

International demand is following a pattern similar to DoD's adoption of small UAS. That is, trial, initial adoption, formal requirements, acquisition upgrade, and support. Broader international military market is trailing DoD by 5 to 10 years, but it is continuing to develop and we believe it will represent significant demand for our solutions. The US Congress and the FAA seem to be moving to action on permitting UAS to operate in the national air space, and the topic has generated a flurry of news coverage reflecting broad interest. The FAA's recently signed budget calls for the agency to integrate UAS into the national airspace, and the FAA itself is preparing to publish its recommended rules for small unmanned airplane systems later this spring.

In anticipation, we introduced the Qube system in October as our first solution tailored for the needs of non-military markets. Public safety is one early non-military market segment that we believe will adopt small UAS in a meaningful way. We are encouraged by the significant level of interest in our solutions within and beyond the public safety community, and we fully expect that our small UAS will serve public and commercial interests in the future, saving lives and property and enabling new capabilities and services in the process. Predicting the timing and the rate of adoption of innovative solutions is always difficult, but we believe that we are recognized by many as a leader in this new category and we fully intend to maintain that position to grow with this significant emerging market.

Moving from small UAS to Loitering Munitions, Switchblade continues to gain funding and active interest from customers. The $4.2 million Air Force contract we announced in February represents the second such order involving production Switchblade units. The prior order coming from the Army. Demand is continuing to build and broaden. As a single-use round, the potentially high-production volume of Switchblade could enable ever more cost effective manufacturing, creating even more compelling customer values. We're fortunate to have ATK supporting us as a partner on Switchblade and our system solution benefits greatly from their munitions expertise. We anticipate more Switchblade orders in the future and believe that broad adoption will drive significant long-term growth.

Global Observer is our large UAS designed to operate as a stratospheric satellite, providing affordable, persistent communications and remote sensing. Although we have not provided news on Global Observer, we have not stood still since last April. We are talking with customers about moving the Global Observer program forward, and we have continued investing our own funds to further our manufacturing transition capabilities to ensure that we are prepared once we have secured customers support to move forward. We believe the need for Global Observer is as strong as ever and remain committed to deploying this unique innovation.

Now shifting to our Efficient Energy Systems business segment, Wahid Nawabi recently joined AV as Senior Vice President and he's been working closely with his team as he takes over leadership of this segment of our business. Our EV test systems and industrial electric vehicle charging product lines are continuing to grow and we see significant growth potential for our on-road electric vehicle solution offering. As I mentioned earlier, we saw the gross margin again improve at EES as we had expected after Q1. We're also building on our strong position in the EV charging market, now providing and installing the home and dealer charging systems across North America for Mitsubishi, BMW, and Nissan. 2012 is shaping up to be an important year for electric vehicles with the introduction planned for new plug-in models for Mitsubishi, Ford, Chrysler, Fiat, and others. We have now deployed around 7,000 level 2 charger docks in North America and have installed 27 DC fast-charging systems.

Most public charging will require a network to manage access, availability and electric usage, and our network solution is a key element of our public charging offering. The network solution we built to support NRG's Ecosystems in Houston and Dallas/Fort Worth is operational and provides drivers the ability to charge at their homes or in public locations when and where they need to. Given the emerging nature of this market, we think that providing the most comprehensive solution of private and public hardware, installation and service, customer relationship management, and network software positions us as the provider of choice for many auto makers, utilities, and stakeholders. We believe this market will continue to evolve and our broad solutions and relationships will position us well for the winning moves that will drive long-term growth and profitability. We like our position, and we believe that our approach continues to be validated by contracts with important participants in multiple segments of this market. With that as a broad overview of the business, I'll turn the call over to Jikun to provide a detailed financial overview.

Thank you Tim and good afternoon, everyone. AeroVironment FY '12 Q3 results are as follows. Revenue for the third quarter was $72 million, a decrease of 15% over the third quarter last year of $84.4 million. Looking at revenue by segment, UAS revenue was $57.2 million, a decrease of 20% over the prior year. The decrease in UAS revenue was largely due to lower SUAS product deliveries of $10.8 million, lower customer funded R&D work of $2.3 million driven by the Global Observer contract, and lower logistics in repair revenues of $1.4 million. EES revenue was $14.7 million, an increase of 16% from Q3 last year, primarily due to higher product deliveries and installation services of our on-road electric vehicle and industrial electric vehicle charging systems.

Turning to gross margins, gross profit dollars in the third quarter was $27.4 million, down 20% from the third quarter last year. Gross margin as a percent of revenue was 38% versus 40% in the third quarter last year. By segment, UAS gross profit dollars was $23.2 million, down 20% from the third quarter last year, primarily due to lower sales volumes. As a percent of revenue, UAS growth margin percentage was unchanged at 40%. EES gross profit dollars was $4.3 million, down 16% from the third quarter last year. The decline in gross profit dollars was driven by lower gross margin percentages, offset by higher sales volumes. As a percent of revenue, EES gross margin decreased to 29% from 40%, primarily driven by increase in sales of new products and low rates initial production, and higher manufacturing and engineering overhead support costs, driven by increased production capability and capacity.

SG&A investments for the quarter was $12.9 million, or 18% of revenue, compared to $10.6 million, or 13% of revenue in the prior year. The increase was primarily due to higher bids and proposal activity, and administrative infrastructure investments. R&D investments for the quarter were $7.2 million, or 10% of revenue, compared to the prior-year amount of $7.9 million, or 9% of revenue. Operating income for the quarter was $7.3 million, or 10% of revenue, compared to the prior-year amount of $15.7 million, or 19% of revenue. Operating income was lower due to lower sales volumes and higher SG&A investments, partially offset by slightly lower R&D investments. The effective tax rate for the quarter was 23%, a decline from the prior-year period of 27.2%.The decline was driven by R&D tax credits. Net income for the quarter was $5.7 million, or $0.26 per fully diluted share, compared to $11.5 million, or $0.52 per fully diluted share in the same quarter last year.

Now moving quickly through our year-to-date Q3 FY '12 results, revenue for the first nine months was $214.3 million, up 15% from the prior-year period of $186.4 million. By segment, UAS revenue was $176.4 million, up 11% from the prior year. The increase in revenue was largely due to increased service revenues of $17.7 million, driven by logistics, retro fits, and turnkey support services, increased product deliveries of $14.2 million driven by Puma AV systems, but offset by lower customer funded R&D work of $14.3 million driven by the Global Observer contract. EES revenue was $38 million, up 37% from the prior-year period, primarily due to increased product deliveries and installation services of our on-road electric vehicle charging systems and electric vehicle test systems.

Gross profit dollars for the first nine months were $79.8 million, compared to $67.9 million a year ago. Gross margin as a percent of revenue was 37%, approximately 80 basis points higher than the prior year. By segment, UAS gross profit dollars was $70.6 million, up 24% primarily due to higher sales volumes and higher portion of revenues that were tied to fixed price contracts compared to cost reimbursable contracts. EES gross profit dollars was $9.2 million, down 17% primarily due to lower gross margin percentages offset by higher volumes. As a percent of revenue, EES gross margin percentage decreased from 40% to 24%, primarily due to higher program costs on 6-byte DoD development sub contracts, higher sales mix of new products and low rate initial production, and higher overhead support costs driven increased production capability and capacity.

SG&A investments for the first nine months was $38.8 million, or 18% of revenue, compared to the prior-year period of $34.6 million, or 19% of revenue. R&D investments for the full year was $23.6 million, or 11% of revenue, compared to $24.5 million, or 13% of revenue in the prior year. Operating income for the first nine months was $17.3 million, an increase of 98% from last year of $8.8 million. As a percent of revenue, operating income percentage for the first nine months was 8% of revenue, compared to 5% of revenue last year. The effective tax rate for the first nine months was 28.3%, up from the prior-year period of 8%, primarily due to lower R&D tax credits. Net income for the first nine months was $12.7 million, or $0.57 per fully diluted share, compared to a net income of $8.3 million, or $0.38 per fully diluted share last year. This reflects a 50% year-over-year growth in fully diluted EPS. Now looking at backlog, funded backlog at the end of the third quarter was $85.5 million, up $2.6 million, or 3% from April 30, 2011.

Turning to our balance sheet, cash equivalents and investments at the end of the third quarter totaled $190.9 million, down $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 third quarter, our accounts receivable, including unbilled receivables, totaled $48.7 million, up $1.5 million from the prior quarter. Total day sales outstanding were approximately 61 days, compared to 53 days at the end of the prior quarter. Taking a look at inventory, inventories were $48.4 million at the end of the quarter, compared to $41.4 million at the end of the prior quarter. Days in inventory were approximately 98 days, compared to 75 days at the end of the prior quarter. Finally, turning to capital expenditures, in the third quarter we invested approximately $4.4 million, or 6% of revenue in property improvements and capital equipment. Depreciation for the quarter was $2.3 million. Now, I would like to turn things back to Tim to discuss AV's expectations for the balance of FY '12.

Thanks, Jikun. In our first quarter I outlined the three areas we expected to drive growth for our business in fiscal year '12. Small UAS, Switchblade, and the EV product line. Each of these areas has delivered on expectations, a testament to the effectiveness of our team and the demand for our innovative solutions. Each area also presents a pathway towards growth opportunities for our fiscal '13 and beyond.

At the start of the year we said we'd plan to deliver a minority of the government fiscal year '12 budget request for Army Raven systems in our AV fiscal year '12. Our customers now have funding for the government fiscal year '12 Raven budget line items and for multiple other small UAS requirements. We are confident that they intend to process initial contracts for these requirements and our fiscal year '12 fourth quarter. This plan contracting schedule will support our original guidance for fiscal 2012 revenue of $321 million to $336 million, and fully diluted EPS of $1.28 to $1.35. We will carry some timing risk until these contracts are received, but we do expect to receive and to make initial deliveries on these GFY 2012 contracts from the government in our Q4 and to achieve the guided revenue and EPS for the year.

We remain optimistic about our long-term outlook and the five growth drivers of our business all remain viable. These growth drivers are more current products to current customers, services to support our installed base, upgrades and retro fits to current products, expanded markets and applications for current products, and new product developments. Our three- to five-year compounded growth strategy is based on three key assumptions. First, unmanned airplane systems and the electric vehicle markets will grow globally. Second, we will maintain strong market share in these growth markets. Third, we will continue our innovation and agile execution.

We assume defense budgets will be pressured over this period and at the same time, ISR and UAS will remain high priorities for defense acquisition. We expect to see continued demand for our current products in small UAS, as well as for upgrades and retro fits. We also expect adoption of our smaller UAS platforms and continued growth in our UAS services. We anticipate accelerated international small UAS adoption and the emergence of non-military markets in the United States and globally. We believe there will be broad adoption of Switchblade. We remain committed to putting Global Observer into service and believe that its adoption will drive incremental revenue.

We assume the economy will not relapse and that electric vehicle development will continue, sustaining the capital spending we have seen over the past year. We expect this capital spending will support our EES segment with continued demand for our industrial EV Solutions. We also anticipate related technology applications to emerge from our development process. We believe the adoption of plug-in EVs in North America and globally will increase significantly over this period and that we will be effective in growing with that market. The first year of this long-term outlook will be our fiscal year 2013, and we plan to solidify next year's guidance on our Q4 call as we have consistently done in the past. However, it is clear already that many of the conditions for the long-term growth drivers I just mentioned are manifesting now and I expect they will be positive contributers to growth in the coming year, supporting our optimism about fiscal year 2013. Thank you for your continued interest in AV, and Jikun and I will now take your questions.

(Operator Instructions). Jeremy Devaney, BB&T.

Wanted to first take a look at this revenue split from Q3 to Q4, looks like you would of put up a strong UAS number if it had been in the quarter. Can you comment at all on the impacts that had on gross margin and do you expect the -- do you have cost matching in the quarter, or did you have costs that ran through to Q4 with that revenue?

In terms of the cost matching, basically the products were built in inventory and had been in inventory at the end of the quarter, so the cost would have been in our inventory and then as we recognized revenues in the fourth quarter, that will be released out of our cost of goods sold.

No impact on the Q3 margin then because of the slip, just to clarify.

Right.

As you hypothesized early on, Jeremy, had that shipment taken place three days earlier, that not only the revenue but the profitability would have been significantly higher in Q3 and, in fact, at the high range of our planning.

Earlier in your comments, Tim, you mentioned the power by the hour field support services plans that you're starting to put in place with some customers. Could you give us more color and perhaps quantify? You said you are expecting it to double in the calendar year. What base is that off of and what kind of customer implementation plans are you using there?

First, my intent was to say that we expect that to double this fiscal year, 2012, over last fiscal year, 2011. We actually are on track three-quarters in now to that objective. We think that is a long-term growth opportunity that adds to the small UAS business complementing the historic basis of selling hardware and then supporting that hardware with customers. We certainly expect that we will continue to sell hardware, but we think adding services will support sustained growth in that area where it's advantageous for multiple different customers.

Michael Lewis, Lazard Capital Markets.

Wanted to ask you a question about whether you're seeing some trends with some of your government customers of moving to leasing some of the UAS owned by AeroVironment rather than buying all out. We're seeing that in the tactical UAS market right now. Have we seen any trends there at your firm?

Mike, good question. The answer is no. We haven't seen an appetite from our existing customers to switch to lease. I would only be guessing at why we do not see that when two or maybe three do, but we, as I mentioned in response to Jeremy's question, we do see a lot of advantage perceived by some customers to the services business, which may be somewhat analogous to leasing.

It's just interesting that the dynamic has -- that the tier 2 shadow has been moving to that lease model, and they continue to buy the smaller UAS. What would you perceive as more positive for AeroVironment? Would it be a lease dynamic or continue to see the purchases across the organization?

Well, I think from our perspective, we would certainly be willing and able to address a lease option if customers were desirous of that. We just haven't seen that appetite. It's possible that it's a price point. As you know, our systems are in order of magnitude lower cost than the next level up of unmanned airplane systems and that may change the dynamics, I don't know.

Noah Poponak, Goldman Sachs.

I wondered, Tim, you sounded pretty confident with regard to next year, fiscal '13. I wondered if you would say if you expect each segment's rate of revenue growth to accelerate in '13 versus '12 or not.

Well, I think I mentioned that we have historically provided definitive guidance on our Q4 call, and that's what we plan to do this year. We're still in the process of refining our operating plan for Q3. I think as a result, I don't want to get too finite in statements at this point, but as you observed, we're quite optimistic about our potential growth on both sides of the business next year.

If I keep it in fiscal '12, you have the $20 million for sure booked in the fourth quarter. I wonder, a month into the quarter, if you could describe how confident you are in the other 90 to 100 that you need to book to get into the revenue range.

The answer is we're confident. There's a significant number of contracts in the contracting queue, requirements that have funding behind them and are in the process. In almost all of those cases our close contact with our customers at this point indicates their schedule planning will support the release of those contracts in our Q4, and our ability to address initial shipments against those contracts in Q4.

Now, there is a significant number, and each one is in a different contracting queue and has some different schedule around it with some different probability around achieving those schedules. We really look at that as a portfolio with a bell distribution, and we're confident that the means supports our requirements for contract placement and shipment in Q4 to meet the government. I don't know if that helps any more or not. I will wait to see what you think about that answer.

Tyler Hojo, Sidoti & Company.

Out of the fiscal '12 budget, how much funding are you expecting from Raven to hit before April?

We know that our customer is anxious to take early delivery of Raven against that customer to support their deployment needs, and that both the contracting office in our customer and we are leaning forward to support that objective. I think the key thing is the timing of the contract and not so much the amount that we would ship this quarter as we had originally planned, and we have not changed our plans that in this fiscal year we would ship a minority of that requirement and the majority of it would be shipped in our fiscal 2013.

When we look at what your expectation is for fiscal '12, could you quantify what the dollar amount is that is coming from the budget that you need to receive to make the guide for Q4?

Well, I want to avoid getting into any one of the specific contracts that I referred to that are in process now. You know the gross amount that was funded in the defense appropriation bill. That number gets reduced before it gets to us. There's some administrative taxes along the way, and there are some government procurements of some of the components, but that still is a very large number, and we don't anticipate shipping a large portion of that total number in Q4.

Andrea James, Dougherty and Company.

My first question is about the support services that's doubling this year. You haven't noted who the customers are and what the exact nature of the services are. I was wondering, should we assume that it's classified, or is there some more detail you can give about the nature of the service, which vehicles are operating and also how those contracts flow through the government budget's process?

Well, you're correct, Andrea, we have not talked about customers, and that's because our customers haven't announced those contracts, and we don't want to get out ahead of them. We're just leaving it to our customers to decide if they want to announce how they're using these services. As to the services themselves, they would be probably classified as contractor owned, contractor operated assets and services. We are providing a turnkey service that includes all of the hardware and support and the operation to collect and disseminate information to our customer, which gives them what they really want without having to acquire the hardware, train and maintain it, train and maintain operators. It appears to be an attractive option for customers that we're currently working with, and we believe that is likely to extend and expand in the future.

Also, just the next one, there's been some talk about foreign governments, particularly South Korea taking a look at the Global Observer. Can you give us a sense of where you stand with international sales and maybe pursuing those international markets, both for this year and for your long term outlook?

We are clearly focused on a number of international opportunities for UAS, ranging from our small UAS to and including Global Observer. That's not limited to the specific application that you mentioned in South Korea that's been mentioned in the press a few times over the last few months. I think it is, as I mentioned in my statements earlier, I think it is a real and a significant opportunity for AV to acquire and grow substantially our business with international military customers across the board as they begin to adopt UAS in a more robust way. I don't know that there's any specifics that I can get into beyond that general statement, though.

Josephine Millward, Benchmark.

Tim, how much of the Raven fleet do you think the Army will upgrade in the coming year? Going forward, do you think all the Raven systems will have the new payload? The reason I'm asking this is in the past, if you recall, the DDL upgrade created some delays to new Raven procurement, can you talk about that?

I think our expectations for this new payload upgrade with Raven are similar to what we expected with Digital Data Link, that it is likely that, as I mentioned previously, I think it's likely the Army will adopt that upgrade this year, and I think it is likely that all customers will find that to be attractive in the future, and it is designed to be easily retrofittable into all installed bases of Raven B platform. I think it's probably going to be attractive. It's going to catch on quickly. We will see not only upgraded capabilities in new acquisition, but some considerable retrofit of the installed base.

On the Switchblade, I understand you've delivered combat prototypes and have had some success. Can you walk us through the next steps? What needs to happen for this to go into full production?

Again, going back to my previous comments today, we now have announced two contracts, one from the Air Force and one from the Army, that include production hardware in the contract, and so we will be producing and delivering those systems. I would characterize the stage we're in right now as early adoption, which is consistent with our prior history of introducing innovative new solutions to defense applications.

What we have seen in the past is that as customers use the new systems and find them to be as valuable as they expected, that they increase their acquisition and ultimately they develop formal requirements and move them into long-term programs of record. Predicting where we are on that process is probably not what I want to do, since it's really up to the customers and they're not prohibited or locked into a fixed schedule. I do see strong interest, and it's very broad, and it continues to grow so we're very optimistic about the experience that our customers will have as we go forward and the probability that they will accelerate their adoption.

Brian Ruttenbur, Morgan Keegan.

What proportion of Q4 '12 revenue is dependent on the next Raven order?

I want to avoid getting into specifically defining the different contracts that we're currently working on. Let me pause here, because I'm getting a lot of feedback, so I don't know how I'm coming across on the call here.

Maybe the next question, you talked about UAV growth worldwide. Your growth is obviously dependent on UAV growth worldwide. In that assumption, what percentage of the UAV market is the US? When you're talking about growth, what are you looking for the US market to grow right now?

Well, I think we expect to see our UAS business continue to grow, and right now, the largest user of unmanned airplane systems in the world, by far, is the US and the Department of Defense. I think the rate of growth will be higher from the sum of all non-US customers over the next three to five years, but that's starting from a much lower base than the US. For us, as a supplier of the largest quantity of UAS, probably in the world, but a very small percentage of the total dollar volume, the primary effect is programmatic and which programs are adopted at what rates. Within an overall strong market demand for UAS, we think we can continue to thrive.

Michael Ciarmoli, KeyBanc Capital.

The $20 million order that slipped, is that presently in the backlog that you guys reported?

Yes.

Then would you expect to be able to grow backlog at the end of fiscal '12?

I think that will be a function of the number of contracts and the volume of those contracts that are booked during the quarter. As I mentioned before, there are a large number in process, and in total, considerably more than we would intend to ship in Q4. Even though we are focused on the probability of the contracts necessary to meet our Q4 revenue objectives, it's contracts above and beyond that are likely and it will be a timing issue of how many, and that will drive backlog at the end of the quarter. In general, quarter end backlog may have some relevance to our next quarter revenue, but it's relatively uncorrelated historically with our annual revenue.

Can you give us an update on the trajectory of service-related revenues as we've seen basically off tempo wind down in the Middle East and where you're expecting your service revenues to trend to?

I think we would expect to see a portion of that service revenue to be driven by that kind of wind-down. As the bulk of military forces leave an area, the people that are left have arguably an increased interest in situational awareness with the decrease of force protection, and so I think that offers the potential to continue to grow our small UAS business, whether it's in hardware sales or in services.

(Operator Instructions). Jeremy Devaney.

I just want to circle up on the EES segment. I know we haven't talked about it a lot on the call, but I was interested to hear your thoughts on the trajectory of adoption of electric vehicles in the US, especially given GM's announcement about the Volt yesterday. What are you seeing in terms of utility and power companies moving forward UTX, NRG type activities?

We haven't seen any abatement in activity, Jeremy, from the various vertical groups of customers that we address. I'm not sure what to make of the GM announcement. One thing, of course, the Volt is a plug-in hybrid. My sense is that as to the Nissan LEAF, for example, which is a battery electric vehicle, that the deliveries there have been constrained by supply and not by demand. All indications are that, that supply should increase in the coming year, and a new factory is planned to come on-line in Tennessee for Nissan the end of this year, with a dramatic increase in capacity. Overall, our view at this point is that it's continuing to move ahead, and the admonition that it's difficult to predict the timing and the rate of adoption of an innovation seems to be holding true.

Could we get unfunded backlog for the quarter and also customer funded R&D for Q2 and Q3?

Unfunded backlog at the end of the third quarter was $121.5 million, and the other question had to do with customer funded R&D in the quarter. It was $5.9 million in the quarter.

Noah Poponak, Goldman Sachs.

The EES margin has reset here this year versus where it was last year. Is the third quarter margin the new margin for EES, or do you expect that to continue to revert further back to where it used to be?

I don't think that's the new margin, Noah. I think we saw what we expected to be a low point of margin in Q1 that was related with the introduction of half a dozen new products, and a fixed price R&D contract. We expect it to incrementally improve that margin throughout the year. We've seen that in the second and third quarter. We expect to see that again in the fourth quarter. Having said that, we also expected and continue to expect that the gross margin for the year will be lower in 2012 than it was in 2011 for those very reasons.

As we go forward, I think we will continue to see improvement. Where that settles out is yet to be determined. We've got a different mix of hardware and service in the new on-road electric vehicle solutions product line with a higher percentage of service component in that revenue stream than in our historic industrial product line. We also expect that on-road infrastructure business to grow at a faster rate than our industrial business. The mix will change over time, and it's not quite clear at this point where we settle out. I think we continue to see improvement along the way.

Then on R&D, what's your latest thinking on where R&D shakes out over the next year or so?

I think our model is probably going to stay about the same. Historically we've looked at 8% to 10% of revenue at R&D. While we are prepared to modify that model if there are compelling market drivers, right now I think it is still a good model going forward.

Andrea James, Dougherty and Company.

Do you expect Raven and Puma revenues to grow in 2013?

We try to avoid getting into discussing particular revenue or profitability by product line or by product group. I think what we've done as we began this year is talk about that business in the context of our small UAS product line, which we expected to be contributing to our growth in 2012 and, in fact, it is. My guess is that, that product line will continue to contribute to growth going forward.

Thinking about the non-military applications and what's going on with the FAA, and then there was this video at one of the TED conferences of a UAS made by university students that looked a lot like the Shrike. They were playing instruments and stuff like that. My question is what is that opportunity, in terms of timing, and do you think there's going to be a lot of competition? Does the Shrike face competition from these ones that look like it? What's your differentiation?

I think it's all on point, Andrea. In general, I think the market opportunity in non-military applications of small UAS is very large. I think it's global. I think, I sound like a broken record, but the prediction of the timing and the rate of adoption of innovation is difficult, and I would expect to see that difficulty in predicting timing and rate in this adoption of all UAS in the national airspace. I think sooner or later it becomes a very large market opportunity. I do think that we will see plenty of competition. We still see competitors entering the military market because it continues to look like an attractive market opportunity. We have the same characteristics around the non-military market potential and, arguably, a new open field to compete in. I would expect plenty of incumbent and new market entrants.

Having said that, I think the competitive advantage that we have found in our military applications in many cases rolls over to non-military users. Deep understanding of the technology far down the learning curve on volume production experience, a system integration that focuses on user interface and reliability and in addition to high performance, and a training and support business that enables customers to be assured that they will have operating hardware when they need it in a cost effective way. I think we're well positioned to compete, and I expect lots of competition.

Tyler Hojo, Sidoti and Company.

Where are we in terms of the planned buy for the Army with Raven?

We are at 1,727 systems, which is 73% against the Army acquisition objective of 2,358 systems. In the quarter we did not have a lot of activity, although we shipped a lot of Ravens for different customers.

What's the tax rate expectation for Q4?

Again, for the full year, it would be 30%.

At this time I'm showing that's enough time for our questions. We'd like to turn the call back over to Mr. Gitlin for any additional or closing remarks.

Thank you for your attention and 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.

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