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AeroVironment, Inc. (NASDAQ:AVAV)

F4Q08 (Qtr End 08/02/08) Earnings Call Transcript

September 9, 2008 4:30 pm ET

Executives

Steven Gitlin – Director, IR

Tim Conver – Chairman, President and CEO

Stephen Wright – VP of Finance and CFO

Analysts

Michael Lewis – BB&T Capital Markets

Chris Donaghey – SunTrust

Tyler Hojo – Sidoti & Company

Brian Gesuale – Raymond James

Richard Safran – Goldman Sachs

Troy Lahr – Stifel Nicolaus

Michael Ciarmoli – Boenning & Scatter

Howard Rubel – Jefferies

Josephine Millward – Stanford Group

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2009 AeroVironment earnings conference call. My name is Teresa and I will be your coordinator today. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. 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, Mr. Steve Wright and Director of Investor Relations, Mr. Steven Gitlin. I would now like to turn the presentation over to Mr. Gitlin; please go ahead sir.

Steven Gitlin

Thank you, Teresa. Welcome to AV’s first quarter fiscal year 2009 earnings call. Joining me today our AeroVironment Chairman and Chief Executive Officer and President, Tim Conver and the company’s Chief Financial Officer, Steve Wright. Before I hand the call over to them 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 include without limitation any statement that may predict, forecast, indicate or imply future results, performance or achievements and may contain words such as believe, anticipate, expect, estimate, intend, project, plan or words or phrases with similar meaning.

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.

Factors that could cause actual results to differ materially from the forward-looking statements include but are not limited to reliance on sales to the U.S. government, changes in the supply and/or demand and/or prices for our products, the activities of competitors, failure of the markets in which we operate to grow, failure to expand into new markets, changes in significant operating expenses including components and raw materials, failure to develop new products, changes in the regulatory environment and general economic and business conditions in the Unites States and elsewhere in the world.

For a further list and description of such risks and uncertainties, see the reports we file with the Securities and Exchange Commission. We do not intend and undertake no obligation to update any forward-looking statements whether as a result of new information, future events or otherwise. The content of this conference call contains time sensitive information that is accurate only as of today, September 9, 2008. The company undertakes no obligation to make any revision to the statements contained in our remarks or to update them to reflect the events or circumstances occurring after this conference call.

With that said. It is my pleasure to turn the call over to Tim Conver.

Tim Conver

Thank you, Steven. Welcome to our first quarter fiscal 2009 conference call. Before I discuss the details of Q1, I’d like to take a few minutes to review what I believe to be an important and distinguishing aspect of our story. When we began speaking with potential investors in preparation for our IPO we thought it was important to discuss both our solutions in production and in development.

We highlighted four development programs that represented innovative new capabilities that were further along in our process than others in our pipeline. These four developments were global observer, switch blade, digital data length and architectural wind. Since our January 2007 IPO we’ve been discussing these programs as they’ve progressed from internally funded R&D to customer funded development and as they have achieved key milestones that move them closer to becoming production solutions.

I will discuss some of these milestones later in the call. Well recently we’ve been providing information on other UAS developments that are in various stages in the research and development process. The PUMA AE is the third generation of our PUMA small unmanned aircraft system that we began as an internally funded development just a few years ago and that won the latest DoD competition for a program of record.

The Nano Air Vehicle contract with DARPA is a very early stage R&D program that could lead us to the smallest class of unmanned aircraft system, an aircraft that weights 10 grams, for the stealthy perch and persistent system stare program also funded DARPA we are developing and have now demonstrated a new aircraft based on our one-pound Wasp that can perform vertical take-off and landing, hobbler, perch and steer machines in a very stealthy manner.

Innovation is the lifeblood of this company and these are several examples of innovations that contribute to our future growth potential. I think this is a great track record that demonstrates an effective research development and commercialization process and that position us well for the future.

Now, let’s move on to review last quarter’s results. Q1 was a solid beginning to fiscal 2009 in several respects. We successfully cut in the frequency change for our DoD customers and we restarted both Wasp in Raven production lines. We saw a continued demand for our unmanned aircraft systems, electric vehicle fast charge systems and electric vehicle test systems. We also made great progress on our development programs.

There were a number of specific highlights in the quarters. We grew revenue by 9% over Q1 fiscal 08 and we delivered an operating margin of 13%. We won the fourth consecutive DoD competition for a small unmanned aircraft system program of record with PUMA AE.

We ended the quarter with funded backlog of over a $108 million, the highest in our history. We achieve important milestones in our Global Observer development program, we achieved operational improvement in our new efficient energy systems segment and we continue to build our team to position ourselves for growing market opportunities. Now let’s take a closer look at the UAS segment first.

Customer funded R&D primarily from our Global Observer development program increase during the quarter. This increased more than offset our planned production slowdown in small UAS relative to the same period last year. The Global Observer program is just about one year into its three year timeline. We have made great progress in this development program.

GO system will be breakthrough stratospheric unmanned aircraft system that will provide satellite like persistence with valuable pay loads over any point on earth at a fraction of the cost of available alternatives. We received an important purchase order for the second GO airplane when our customer exercised a contract option in Q1. I believe it’s a very significant indication of customers confidence in the program and customer intend for this capability.

Unlike most new airplane programs we are simultaneously developing the propulsion systems with the aircraft system for GO. In that regard we completed a major milestone with the successful multi-day simulated flight test, the production configuration propulsion system. As the GO program has ramped up, it’s become a more significant contributor to company revenue and to backlog. There are many challenges ahead on this program, but I’m encourage by the great progress our team is made and by the confidence that our customers have in this very difficult but high pay off endeavor.

If you recall from our Q1 earnings call in June, I mentioned that we expected a reduction in UAS product revenue during Q1 due to a customer funded engineering change. To recap our DoD customers asked us to change the frequencies that Wasp and Raven systems transmit receive on. This change necessitated development of new components and software for our aircraft and our ground control systems.

We agreed with our customers on a plan to pause new production, focus initially on retrofits and then proceed with both new production and retrofits in parallel. We successfully executed that plan during Q1 and we anticipate catching up with our plan production before the end of fiscal ‘09 while continuing to process retrofits. One month into our Q1 we received the good news that we had won the fourth DoD competition for small UAS.

The U.S. special operations command selected our PUMA AE for their all environment capable variant program. The PUMA AE will be operated with the same handheld ground control system used for Wasp and Raven. It will feature long endurance, quite operation, continuous stare cameras and amphibious landing capability. We believe PUMA AE will provide an important capability to so-com and that’s unique features and capabilities maybe attractive to many other customers.

By adding a third production airplane at the upper end of our family of small UAS, all using our common joint and inner operable ground control unit I believe we have significantly improved our competitive position. Development programs for Digital Data Link and Switchblade continued to make good progress demonstrating there valuable new capabilities. Both programs are attracting growing customer interest. On the other side of our business this is the first quarter that we reported Efficient Energy Systems as one segment after combining our PosiCharge and our Energy Technology Center segment at the end of FY ’08.

We made this structural change to enable the people of this group to be more effective and efficient in addressing the large market opportunities that we’ve targeted in clean transportation and clean energy. Concerns about environmental footprint, energy security and high fuel prices have increased interest around the world in these important areas. Consolidating our electric vehicle product lines and our development programs will leverage common technologies, resources and business relationships.

It will also strengthen management focus in our initiatives in both areas. Quarterly revenue for the combined EES segment is up slightly year-over-year with good margin improvement. In clean transportation we market our PosiCharge electric vehicle fast charge systems as a productive enhancer or industrial EV fleet operators. We also market our EV test systems to developers of the next generation of EV systems around the world.

In the clean energy space we are continuing to develop our architectural wind energy generation system for installation on buildings. We continued to move forward carefully and deliberately working closely with early adapted customers and maintaining our focus on insuring that all customers will be successful when we determine that this innovative system and its target markets are ready for broad adoption.

We are continuing to secure new customers for PosiCharge and believe that we maintain the largest share in the industrial EV fast charge at market. However, we have not yet broken through the adoption barriers that have prevented a rapid increase in growth in this area. We are exploring a number of initiatives from new system solutions to innovative channel strategies design to increase the penetration of PosiCharge Systems into the hundreds of thousands of industrial EVs operated in North America and beyond.

Outside of the industrial EV market, we are seeing increased interest in our EV Test Systems from OEMs that are working to develop new Battery Electric and Plug-In Hybrid Vehicles. As a result we believe that opportunities exist for increased volume for our EV Test Systems. That is an overview of our business. I’ll turn the call over to Stephen Wright for a more detail discussion of our financial performance.

Stephen Wright

Thank you, Tim. Good afternoon. Revenue for the first quarter was $53.6 million an increase of 9% over first quarter or prior year of 49.2%. Looking at revenue by segment, UAS revenue was $46.1 million, an increase of 10% over prior year. The growth in UAS revenue was due to higher projects R&D partially offset by lower product deliveries. EES revenue was $7.5 million an increase of 3% from Q1 of last year.

Turning to gross margin, gross margin in the first quarter was $20.6 million up 22% from Q1 of last year. Gross margin as a percentage of revenue was 38% versus 34% in Q1 last year. By segment UAS gross margin was $16.6 million, up 18% from Q1 of last year. As a percentage of revenue UAS gross margin was 36% compared to 34% in Q1 of last year. This increase in gross margin rate was primarily due to lower program costs. EES gross margin was $3.9 million, up 43% from Q1 of last year and as a percent of revenue EES gross margin was 52% compared to 37% in Q1 last year. This increase in gross margin rate is primarily due to operating efficiencies in sales mix.

SG&A for the quarter was $8.1 million or 15% of revenue compared to $7.7 million or 16% of revenue in the prior year. SG&A growth is primarily due to higher selling and marketing expense. R&D expense for the quarter was $5.3 million or 10% of revenue compared to the prior year amount of $4.3 million or 9% of revenue. Customer funded R&D during the quarter was $13 million or 24% of revenue compared to $4.3 million or 9% of revenue in Q1 of the prior year and total R&D, internal and external was $18.3 million or 34% of revenue versus $8.6 million or 17% of revenue in the prior year.

Operating income for the quarter was $7.2 million or 13% of revenue. Operating income was 50% higher than Q1 of the prior year primarily due to the higher gross margin partially offset by R&D and SG&A expense. Net income for Q1 was $4.8 million or $0.22 per fully diluted share compared to $3.8 million or $0.18 per fully diluted share in the same period a year ago.

Looking at backlog, funded backlog at the end of first quarter was $108.9 million up $26.9 million or 33% from April 30, 2008.

Turning to our balance sheet, cash equivalents and short-term investments at the end of the first quarter totaled $113.4 million, down $5 million from our prior quarter amount of $118.4 million. The negative cash flow was partially due to working capital and capital expenditures partially offset by income.

Investments at the end of the first quarter were $8.5 million, down from the previous quarter amount $13.4 million. The decrease in investments was due to net redemptions of municipal auction rate securities.

Turning to receivables, at the end of the first quarter, our accounts receivable including on bill receivables totaled $50.9 million up $500,000 from the prior quarter. Total daily sales outstanding were approximately 85-days compared to 71-days at the prior quarter end.

Taking a look at our inventory, inventories were $20.7 million at the end of the first quarter compared to $15.9 million at the end of the prior quarter. Days in inventory were approximately 56-days versus 35-days at the end of the prior quarter.

Turning to capital expenditures, in the first quarter, we invested approximately $2.3 million or 4% of revenue in property improvements in capital equipment. Of the CapEx, approximately 90% was related to growth. I now like to turn things back to Tim to discuss expectations for the full-year.

Tim Conver

Thanks, Stephen. As I said earlier, Q1 was a good start to our fiscal 2009 and positioned us well for achieving our full-year targets. In summary, the frequency change was executed successfully. Our production in development programs are on track. The Puma AE win was an important success and fortifies our position in small UAS.

Our receipt of an order for a second Global Observer was a key milestone in that program. We believe that we may receive commitments for proceeding with the introduction of Digital Data Link this year. Based on our solid performance in Q1 I’m comfortable reiterating the annual guidance we’ve provided during our last call, which is fiscal 2009 revenue growth of 20% to 25% and 12% to 14% operating income margin.

Of course none of this would be possible without the skill, commitment and effective efforts of our team members, the commitment to success of our customers, the support of our suppliers and the trust of our stockholders.

Thank you all for your attention and your interest, and with that Stephen and I will open the call to questions.

Question-and-Answer Session

Operator

(Operator instructions) We’ll go first to Michael Lewis with BB&T Capital Markets.

Michael Lewis – BB&T Capital Markets

Hi Tim, Hi Stephen, how are you?

Tim Conver

Hi, Michael how are you?

Michael Lewis – BB&T Capital Markets

I’m fine. Okay, so it was a really nice quarter, strong margin and very much a surprise on my side, but my question is you talked a little bit about the GO customer funded R&D in the quarter. What exactly was that number and did any of that revenue come in earlier than you had anticipated on your internal plan?

Stephen Wright

Mike we don’t break down individual programs, but for the quarter of project R&D in total was 24% of total company revenue Global Observer would be the lion share of that. In terms of the timing, I think the timing is consistent with our expectations. Its Global Observers have large project and is building up overtime and I think its proceeding more or less according the plan.

Michael Lewis – BB&T Capital Markets

Okay. Also just one more question and I’ll get out of the way here. If you look at your total UAS revenue, what proportion is PBO at performance based logistics and can you tell us what level of year-over-year growth that you’re seeing in that area of your line item at this time?

Tim Conver

Well, Mike this is Tim. It’s not performance based logistics. The logistic aspect of that service line is spare parts, repairs, training and I guess upgrades, yes, Stephen pointing out upgrades as well. So the spare parts and repairs or the maintenance is typically on a cost plus basis and its not associated with the performance based the contract.

Michael Lewis – BB&T Capital Markets

May be what I’m trying to gather here is this part of the UAS revenue stream growing at a higher clip versus the production side of revenue stream.

Tim Conver

Well, I think the only way that I can answer that is to point out where its been and where it is in Q1, because we are not guiding on that element going forward in fiscal ’08 services company wide and its primarily UAS. Services were 30% of total company sales and in Q1 continues to be around that at 28% of revenue.

Michael Lewis – BB&T Capital Markets

Okay, that’s very helpful. Thank you, Tim.

Operator

We’ll go next to Chris Donaghey, SunTrust.

Chris Donaghey – SunTrust

Hi, good evening and congratulations on the quarter. Tim on the Global Observer, with the option exercise for the second aircraft, does that mean that the $35 million that was included in the fiscal 2008 supplemental has been released.

Tim Conver

Well, I don’t think it means that its all been released, but I believe that the portions that have been exercised, the options that have been exercise under the contract to date were funded through that line item. We actually expect there will be some more later on.

Chris Donaghey – SunTrust

Well, that’s where I was going next, in the house appropriations committee, expect committee on defense their markup of the fiscal ’09 defense bill, they included a plus up of $40 million for Global Observer development so, if you took the first contract that you received, the $57 million plus the $35 million is in 2008 supplemental plus what’s coming now more than likely in the fiscal ’09 bill. So that puts you at a $133 million versus the original contract value of a 108 bill.

Can you just talk a little bit about what’s going on, what the customer is saying? Are they trying to significantly accelerate development, are they allowing you to add scope to the work and what would be causing the size of that program to be going up this early in the development cycle.

Stephen Wright

Chris, let me say first that as far as the ’09 defense budget is concerned to my knowledge that’s still in process and (inaudible) so I don’t really got any comments there, but in general I think as we’ve been saying the program is going I think very well, I think the customers are very satisfy with the progress we’ve had completed the first half of our critical design review last month. I think that went very well, I mentioned some very significant test results that we’ve had in the program. So, I think there is generally a good appreciation of program performance and a very high level of interest in the kinds of capability that this breakthrough technology will provide.

So, having said that it’s not surprising to me that there is some opportunity to fund more of the initial development than was anticipated in the base contract, but until we get to that point I’ll just keep myself focused on the exciting contract and working with our customers to exercise options up to that level.

Chris Donaghey – SunTrust

Fair enough, thanks again, Tim, and good job in the quarter.

Tim Conver

Thanks, Chris.

Operator

And we’ll go next to Tyler Hojo with Sidoti & Company.

Tyler Hojo – Sidoti & Company

Hey, good evening guys. One question from me, just on the EES gross margin, that looked incredibly strong and I know you mentioned a little bit, but I was hoping you could talk a little bit more about kind of what drove that strengthen the quarter and if that’s sustainable going forward?

Tim Conver

I’ll start off, I think we combined those previously the Energy and PosiCharge segment, so that we would see some efficiencies and improvement going forward. However, we continue to look at that business as an entry into a number of very, very favorable markets and we are really, mostly focused on top-line growth. We did achieve efficiencies during the quarter to some extent we’ll see that in the future, but we don’t want you to think it’s kind of come rolling in at that level of gross margin going forward.

Tyler Hojo – Sidoti & Company

Okay, that’s helpful and then I guess just a clarification on the production and the restart for Raven and Wasp. I mean it look like it pretty much when according to your plan as of Q4, was that the case or was it maybe a little bit faster or little slower than you had previously expected?

Tim Conver

No Tyler, I think it was pretty much on plan. From the outside, I think a good metaphor is a duck swimming in the water, looks calm but there is a lot of activity going on under the water. So, it took a significant concentration and collaboration with our customers to get that done, but in fact it was executed well and pretty much on schedule as planned.

Tyler Hojo – Sidoti & Company

Okay, great and just one more maintenance question, you provided a firm backlog number for us, but would you mind providing the IDIQ backlog?

Stephen Wright

Yes. The unfunded backlog at the end of the quarter was $598 million.

Tyler Hojo – Sidoti & Company

Thanks very much.

Operator

And we’ll next to Brian Gesuale, Raymond James.

Brian Gesuale – Raymond James

Hi, guys great job on the quarter.

Tim Conver

Thanks, Brain.

Brian Gesuale – Raymond James

Wanted to kind of dig in the backlog a little bit more on the funded side, there was a really nice goody increase sequentially. Wondered, if you can give us a little bit of color in terms of you won obviously the big IDIQ contract, maybe how much of that sits in backlog in the funded portion and then obviously Global Observer coming online, but just maybe help us connect the dots on the massive increase.

Stephen Wright

Brain did you mean unfunded backlog or funded backlog?

Brian Gesuale – Raymond James

The funded backlog, Stephen.

Stephen Wright

Well the funded backlog, the Puma AE contract or AECV contract come in with a if I recall a $6 million order and that went into funded backlog and we’re currently working on that contract. The total contract or IDIQ value was $200 million, so the difference between that $200 million and the $6 million exercised would be in unfunded and would be the major driver for the growth in the unfunded backlog that I just refer to.

Brian Gesuale – Raymond James

Okay and then maybe Global Observer, how that build into the funded backlog?

Stephen Wright

I’m sorry can you repeat?

Brian Gesuale – Raymond James

Yes, I’m sorry the funded backlog portion may be contribution from Global Observer since the activity was so heavy there?

Stephen Wright

Yes, we cannot disclose that amount it was in one airplane plus some additional items that were funded during the quarter, but we are precluded by – we don’t have permission from our customer to disclose amounts. Clearly it was a good chunk added to the funded backlog, even without that the funded backlog would have been very healthy. I guess I can say that.

Brian Gesuale – Raymond James

Okay perfect and then the one final Tim maybe can you give us an update on timing and expectations for Switchblade?

Tim Conver

Yes, Brain. We are in a Phase II funded program on the development and demonstration of Switchblade. We have been successfully flying the new airplane under that program and we expect to complete the full scale demonstration expectations with our customer yet this calendar year, let me say within Q3. So, I think at that point we will have completed the expectations for the Phase II program. I think our customer will have the performance information that they need to make decisions on what they want to do going to forward.

Brian Gesuale – Raymond James

Okay, terrific. That's helpful and you guys make this quarterly reporting stuff look pretty easy. Congratulations.

Tim Conver

Thanks, Brian.

Operator

We’ll go next Richard Safran, Goldman Sachs.

Richard Safran – Goldman Sachs

Hi, good afternoon.

Tim Conver

Hi, Rich.

Richard Safran – Goldman Sachs

Just first a quick housekeeping question. Just on your tax rate just seems a bit high. I just want to know if you can comment on that and is there any change in what you’re thinking about for the full year for that?

Tim Conver

Not really, if you recall on the last call I talked about tax rate being in the high 30s at 38 is probably a little higher than I thought it would close at. The main difference between where we are now and we were last year and we were at 34% last year is we don’t have a lot of tax free municipal interest income and we don’t have the federal R&D tax credit. If the federal R&D tax credit is renewed that will probably bring down this tax rate 2 to 3 points and at the time it happens it’s will be a cumulative catch up in that...

Richard Safran – Goldman Sachs

Okay, and then I want to just follow up a little bit more on Switchblade. I heard your comments on status, so when should we start to expect to look for our production decision. What are you guys getting from the government as far as if all things going well when they would start notifying you about anything that they would want to with production?

Tim Conver

Well, I don’t have any data to give you on that Rich, I can tell you that our initial customer continuous to be extremely interested in this capability in the form that we initially envisioned it and that we are currently demonstrating it, which is a backpackable system that’s been launched vertically off the ground out of its self contained package launching capability.

There are other customers that have now become increasingly interested in variance of this capability and I think all of them are waiting to see the results of the current Phase II program and as you know with the new capability like this, it requires not only the development, but then customers are presumably in the process of anticipating there own requirements and their own funding needs and then there own funding lines to support those needs and I really don’t have good insight into the timing of those decisions.

Having settle that, I think in the next few months we are going to include this demonstration contract with full scale demonstration and after that we’ll see how to have they decide they can move with the funding and the programmatic issues.

Richard Safran – Goldman Sachs

I guess just the last thing on that is as a result of the demos and the program that you’ve been right now. Do you foresee, has the government foreseen any need for any sources of change to this system or have these demos just pretty much proved proofs of concept as..?

Tim Conver

I think it’s the more the later. In terms of changes I would anticipate as different customers to the degree that they get serious about their interest. They will probably all tend to have slightly different concepts of operations and those might lead to slight modifications of the implementation, but for the most part we are moving along as planned.

Richard Safran – Goldman Sachs

Okay. Appreciate it. Thank you.

Tim Conver

Thank you, Rick.

Operator

We’ll go next to Troy Lahr of Stifel Nicolaus.

Troy Lahr – Stifel Nicolaus

Just wanted to drill down a little bit on the – did you say in the beginning that Global Observer was most of the external R&D.

Tim Conver

Well, I think it’s clearly our largest externally funded R&D program and so I think it’s probably the largest sources, probably a good summary of it.

Troy Lahr – Stifel Nicolaus

Okay, and then if I use that to kind of back in to UAS segment is it safe to say that Global Observer is maybe 20% of the business at UAS now and then maybe Raven is 60%, 70%. I mean, how should I think about this business mix now at UAS with some of these other programs starting to ramp up?

Tim Conver

Well, I guess we don’t want to start breaking it down that way. I would look at the project R&D and say that the lion’s share of that is Global Observer. If you look at the product line, again we’re not going to break it down by product, but Raven is still the largest product followed by Wasp and BATMAV and that then followed by the products on the EES side.

Troy Lahr – Stifel Nicolaus

Okay, so I mean is Global Observer bigger than kind of Wasp and BATMAV?

Tim Conver

I probably don’t want to add anything more to that. If you look at the product R&D line, Global Observer is the major contributor there and then if you look at the product line, the major contributor continues to be Raven. Raven is probably, on a rough order of magnitude 50% of our product sales, the total company product sales going to a growing number of different customers.

Troy Lahr – Stifel Nicolaus

Right, okay and then on the service side, the majority of that is Raven and how should I think about the service work that you are doing relative to the Raven versus to the other systems?

Tim Conver

It follows the product, so it’s into the services would be related. Well, I don’t know if I could even say that, I don’t know if that is true, Troy. I think services, it’s sort of lagging, but it probably we have the most Raven Systems fielded, so the services are probably related mostly to Raven and then overtime we’ll start to see more and more of services related to other new products as a cut in.

Troy Lahr – Stifel Nicolaus

Okay, yes that frames a little bit. That’s helpful and you said you still have some retrofit to go on the Raven System regarding these frequency changes; could you maybe ballpark how far you are along in that; is this kind of like a seventh inning or I mean you still have a lot more room to go just on the retrofit work?

Tim Conver

Yes, I think that retrofit work will continue out beyond next year Troy and that’s just primarily it’s not really a capacity constraint; I think it’s mostly what’s convenient for our customers to address.

Troy Lahr – Stifel Nicolaus

Okay and then how quickly should Puma AE start to ramp up; I mean is that relatively quickly or I mean certain millstones are going to drive that again also?

Tim Conver

Yes, I think we had a look at that. It’s very early, so this first $6 million-ish installment on that buy we will get the LRIP done, we’ll move I think to full rate production review and approval and then after that we would expect to see greater volumes move in, so.

Stephen Wright

It’s an IDIQ and it's going to resemble our first SUAV Raven contract, its going to come in a matter of steps overtime.

Troy Lahr – Stifel Nicolaus

Okay, and then lastly can you kind of walk us through the cash flow; what was cash flow from operations in the quarter? I though you said it was negative, but I didn’t get the actual number.

Tim Conver

Yes, lets see; cash from operating activities was approximately $3 million negative than property capital.

Troy Lahr – Stifel Nicolaus

CapEx?

Tim Conver

$2.3 million, so we had a negative free cash flow calculation of $5.3 million.

Troy Lahr – Stifel Nicolaus

Okay, but you expect that to recover or how do you expect that to progress throughout the year?

Tim Conver

Well, probably recovers to some extent. The CapEx is obviously going to continue. In fact that it will probably creep up as we go through the year. CapEx was 4% of revenue for the quarter and I expect 5% to 6% for the year. The day sales were a little bit worse than normal probated by this cut in of volume or cut in of the RF frequency change of Raven that caused a lot of the volume to bunch up in the second half of the quarter, which increased receivables and similar reasons increased inventory. Working capital could get a little bit better as we go through the balance of the year.

Troy Lahr – Stifel Nicolaus

Okay, thanks guys.

Tim Conver

Thanks, Troy.

Operator

We’ll go next to Michael Ciarmoli, Boenning & Scatter.

Michael Ciarmoli – Boenning & Scatter

Hey guys, thanks for taking my call, most of my questions have been answered. Just a follow-up I guess on the last callers question and on the CapEx where is the lot of the funding going and what specific resources do you guys find yourselves needing as you’re starting to get into the ramp phase with some other programs here?

Tim Conver

It’s growth capital, it’s primarily UAS and further it really relates mostly to our new engineering facility in Simi Valley, build out of that facility in tooling test equipment and I think there is also in the cap issued to-date and probably as we go forward a significant amount going into the Global Observer capability.

Michael Ciarmoli – Boenning & Scatter

Okay that’s helpful and then if you can on the Raven penetration here, 1400 order. Can you tell us how far along you are into that order right now?

Tim Conver

I think you’re talking about the army acquisition objective that we’ve talked about before, which is a 1900 acquisition objective. We’re 48% delivered against that acquisition objective as of Q1.

Michael Ciarmoli – Boenning & Scatter

Great and then just I know you guys don’t like to give sort of the guidance quarter-over-quarter, but with the production halt that happen in Q1, do you have any sort of expectation as to how product revenues ramp in the next quarter or how should we be looking at the product related revenues? Is it pretty back to those maybe $13 million levels; if you can give us any guidance there that would be helpful?

Tim Conver

Well, I think that we’d like to stay with the annual guidance. On the last call, we did talk a little bit about Q1 because that was a pretty significant change and that we talked about how we would ketchup over the balance of our fiscal year and that that ketchup would be spread pro rata or like peanut butter throughout the balance of the year and I think we would probably just stick with that and that continues to be our view. I think, by far the best way to look at the balance of the year is back to our guidance for the year of 20% to 25% top line growth.

Michael Ciarmoli – Boenning & Scatter

Okay, fair enough. All right, that’s all I have got. Thanks.

Tim Conver

Thank you.

Operator

We’ll go next to Howard Rubel, Jefferies.

Howard Rubel – Jefferies

Thank you very much. Just a follow-up on some things that you said Tim. First you talked about on the gross margins in ES kind of being a little bit larger than normal; could you help us a little bit to understand what normal might be or what was it that caused you to get to these good numbers and why can’t you keep them?

Tim Conver

Good question, Howard. So, I think primarily those operating numbers were driven by higher gross margins and the higher gross margin was a combination of operating effectiveness improvements and some product mix that shifted around in the quarter relative to history.

As to why wouldn’t we keep those going forward, I think some of the issues regarding mix probably balance out going forward and then we get back to Steve’s point that the real opportunity in that efficient energy systems business is the figuring out how we accelerate adoption of PosiCharge into what we think is a much larger potential market and figuring out how we develop and launch new products into clean energy and clean technology potential markets. All of which require significant investment both in R&D and in business development in the commercialization process.

So, we think the upside in the long-term is very large and we’ll be focused on maintaining share in PosiCharge and accelerating adoption and commercializing other new products, all of which will lead us to focus on the top line and the market entry as opposed to trying to maximize quarterly earrings.

Howard Rubel – Jefferies

No, I understand that, that’s the right strategic approach and I appreciate that, but I’m still a little bit of – you said this was unusually large, I mean can you give me a range or a bound of what kind of variability I might be able to expect?

Tim Conver

Maybe I’ll just say that we’re one quarter into this reorganization and we’re happy with these results, but we feel that it would be premature to start planning on these margin levels. I mean we’re obviously pleased with them and we’re going to be trying to manage the business to sustain much of this improvement, but it’s a little early for us to start talking about what this business is going to do from a long-term perspective.

Howard Rubel – Jefferies

I think that’s fair. I mean if anything I think you did extraordinarily well given the volume was what appeared to me to be a little bit light given the opportunity, so I’m just sort of impressed to say at least on this but was hopeful for some sense down, but to follow further on this you talked about some new customers, Tim in this market. Can you talk in either industry terms of who they were and why they showed up and took the product or bought the product?

Tim Conver

Well, I think in the area of our ongoing PosiCharge business Howard, we are continuing to find new customers primarily in terms of new customers outside the automotive segment, food and beverage and retail distribution. In the EV Fast Charging product line the customer base there have been vehicle OEMs and battery manufacturers and fuel cell systems manufacturers primarily and some R&D facilities in other industry secondarily. In that area I think its some new entrance into those markets that are building up their needs for development testing as well as prior customers that are accelerating their efforts in this area.

Howard Rubel – Jefferies

You’re still down playing architectural wind. You now have what, about 13 sites, is that correct?

Tim Conver

I think its a little closer to 10, but pretty close double digit numbers.

Howard Rubel – Jefferies

Okay and just two other things; one on Digital Data Link, again you have said very close to receiving and order, could you add a little more color to that please?

Tim Conver

Well, I wouldn’t necessarily characterize it as very close, but in our discussions with our customers I believe that they’re serious about rounding up the funding and launching the first production or pre-production orders for that. Probably I would expect to see that be a limited initial program design to field a limited set for evaluation and with the expectation that they would then move onto a much broader adoption. So, I believe that their intent is to do that yet this year. So, I get that was the point I was trying to make.

Howard Rubel – Jefferies

That’s fair and then the final thing is that some of these projects you have, the perch and stare and some of the other developments, does that give you some indication that you have some opportunity to break into FCS or we still on the outside looking in there?

Tim Conver

Well, this program is a DARPA funded program, Howard; it’s not an FCS.

Howard Rubel – Jefferies

I understand the difference, its DARPA hard.

Tim Conver

Yes, but now that we are in a Phase II of this and we have actually demonstrated many of the objective performance characteristics, we are pretty excited about the potential for all of our exciting customers and I think our DARPA customer’s pleased with the performance here. I think you’re referring to the Class 1 FCS program that does have, I think a hover and stare initial requirement and a perch and start objective requirement, but we’re not involved with this program in FCS at this point.

Howard Rubel – Jefferies

Thank you very much, Tim.

Tim Conver

Howard, also as you were poking around that in the original question, the development programs and particularly the kind of conservative approach we’re taking with rolling out architectural wind. To just answer, where I think you might have been going, our concern there is with very innovative new technology, it’s been our experience that going slower, working closely with early adopter customers and understanding how they use it, how their expectation adapt, what happens in various installations overtime in various environments is really essential to ultimately getting it right and if we go back to one of our mantras, we’re committed to the success of any customer that adopts our innovations and just our experience is it takes longer than one might expect to sort all that out to make sure that we don’t disappoint when we actually move to full rate production.

Howard Rubel – Jefferies

Another way of saying this is zero warranty costs.

Tim Conver

Well, it’s surprising how many unexpected things come along with really innovative technology. I think pool players have a metaphor for long shots, even though it looks like it straight, there is a lot of green in between.

Howard Rubel – Jefferies

Thank you, I appreciate your point on this, Tim, a lot.

Tim Conver

Thanks, Howard.

Operator

We’ll go next to Josephine Millward, Stanford Group.

Josephine Millward – Stanford Group

Good afternoon.

Tim Conver

Hello Josephine, how are you?

Josephine Millward – Stanford Group

Doing well, thank you. Congratulations on winning the special operations contract. Can you talk a little bit about your outlook for the Puma; since this is a program of record, have you had any indication from the military in terms of the requirement going forward?

Tim Conver

Well, as you know the customer that has this initial requirement and placed this initial order is U.S. Special Operations Command. The contract has an IDIQ value of about $200 million or I think it is $200 million, so that’s some vague in quotation of long-term intend. The initial contract was about $6 million and that will take us through the evaluation leading to a full rate production decision. After that we would expect that our first customer will then begin to increase their production requirements. If we look back at our last program of record win which was the BATMAV program and our Wasp III System, that was I believe about 11 months from the initial contract win to the full rate production approval. So, about a year is maybe a reasonable expectation in that first phase of the program.

Josephine Millward – Stanford Group

You’re not really expecting a lot of revenue contribution until next year?

Tim Conver

Correct.

Josephine Millward – Stanford Group

Okay and you had a very strong quarter for new bookings; it looks like it was over a $70 million; other than the Global Observer, can you talk about what areas your bookings came from and if you expect this trend to continue?

Tim Conver

Well, I’ll try. It’s really all of the above. I mean clearly the Puma was a press release and we talked about Global Observer on the call, but in addition there is just more Raven, more services, etc.

Josephine Millward – Stanford Group

Okay, so other than the Global Observer, the Raven was really the key driver behind your strong bookings?

Tim Conver

Yes, it typically is and I think to answer your question on expectations, I would go back to our guidance at the 20% to 25% top line growth for the year.

Josephine Millward – Stanford Group

Okay, thank you very much.

Tim Conver

Thanks, Josephine.

Operator

(Operator instructions) We have a follow-up question from Michael Lewis, BB&T Capital Markets.

Michael Lewis – BB&T Capital Markets

Steve or Tim, can you help me with some math here. You had stated around 48% with the Army’s expectation of 1,900 systems. I know that last quarter you came in around 43% completed, this quarter you came at 48%, such as five percentage point shift that we were working with one less month in production. So, are you saying that we should anticipate to see 300 to 400 units being produced per quarter going forward or is this just an extremely strong production quarter for AeroVironment in Q1. I’m just a little bit confused as to how this is working through, since there is a step up in production deliveries it looks like in the quarter?

Stephen Wright

I’m not completely following. We had a 5% increase in Raven deliveries during the quarter and that should be consistent with the product deliveries that we’re reporting on. In fact if anything the product deliveries were a little bit lower than usual. When we talk about the Army acquisition objective, we’re really talking about the deliveries that we’re making to the Army customer in any particular period and we’re not talking about all of the production deliveries that we’re doing. So, in any particular quarter we may make more or less deliveries to the Army itself?

Tim Conver

Mike, this is Tim. I see the point you’re making there, but I suspect that this is more just and anomaly; I don’t think this implies any material increase in our base rate, if that’s what you were thinking the implication might be?

Michael Lewis – BB&T Capital Markets

Okay I’ll take that off-line with you, but just two more quick questions and I’ll get out of your way here. Did you imbed the entire unfunded portion of ACV into your unfunded backlogs in that IDIQ?

Tim Conver

Yes, expect for the $6 million that have been ordered.

Michael Lewis – BB&T Capital Markets

So your expectation is that will be fully procured over the next few years?

Tim Conver

No, we never say unfunded, but we expect it to be converted into orders. We just know that this is the total value of the IDIQ.

Michael Lewis – BB&T Capital Markets

Okay, but you don’t put any discount factor into unfunded portions?

Tim Conver

No, we never have. That’s why we really report and focus on funded backlog.

Michael Lewis – BB&T Capital Markets

Okay, that’s fair and then just one more question. I know you won’t give us the level of revenue from loss from the quarter, but what is your expectation with regard to the Army stepping up and answering its intent to field more Wasp or procure the contract from the Army in that area?

Tim Conver

Army expectations to field and procure more Wasp?

Michael Lewis – BB&T Capital Markets

I have asked the question as what’s your expectation on whether the Army will purchase additional Wasp for the –?

Tim Conver

Okay, Mike let me take that. Let me just start by going back; the initial production contract on Wasp III was a Air Force program of record and subsequent to that win the Marine Corp bought the Wasp III for their own use and that was significant not only because it was about a $19 million order, but the Marine Corp then issued those at the company level, which we believe validated a trend towards lower issue. The Army has not procured production Wasp aero planes to-date.

I think that there is some interest in multiple customers looking at Wasp going forward and how that might fit into their small unmanned aircraft system requirements, but there is no current contract relationship with the Army on that product.

Michael Lewis – BB&T Capital Markets

Is the Army working with DARPA on that initiative though?

Tim Conver

Well, I think DARPA’s crew was our initial customer that funded much of the development of the original loss through configurations one, two and three. It has worked with a number of different services and I guess now that you bring it up probably enabled multiple services to get demonstration units for infield valuation, and it is possible in that context that some Wasp units did go to the army, but they didn’t go there through a contract directly with us.

Howard Rubel – Jefferies & Company

Got you, thank you very much.

Operator

It appears there are no further questions at this time. Mr. Conver, I would like to turn the conference back to you for closing remarks.

Tim Conver

Well, thank you all very much for your interest. We continue to be excited about our future growth prospectus and we look forward to talking with you on our next call.

Operator

That does conclude today’s conference. Thank you for your participation. You may now disconnect.

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Source: AeroVironment, Inc. F1Q09 (Qtr End 08/02/08) Earnings Call Transcript
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