This section and other parts of this Quarterly Report on Form 10-Q contain forward-looking statements that involve risks and uncertainties. In some cases, forward-looking statements can be identified by words such as "anticipates," "believes," "could," "estimates," "expects," "intends," "may," "plans," "potential," "predicts," "projects," "should," "will," "would" or similar expressions. Such forward-looking statements are based on current expectations, estimates and projections about our industry, our management's beliefs and assumptions made by our management. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in

Unless required by law, we expressly disclaim any obligation to update publicly any forward-looking statements, whether as result of new information, future events or otherwise.

Critical Accounting Policies and Estimates

Management's Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. When we prepare these consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Some of our accounting policies require that we make subjective judgments, including estimates that involve matters that are inherently uncertain. Our most critical estimates include those related to revenue recognition, inventories and reserves for excess and obsolescence, long-term investments, self-insured liabilities, accounting for stock-based awards, and income taxes. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different assumptions or conditions.

There have been no material changes made to the critical accounting estimates during the periods presented in the consolidated financial statements from those disclosed in the Form 10-K for the fiscal year ended April 30, 2009.

Fiscal Periods

Due to our fixed year end date of April 30, our first and fourth quarters each consist of approximately 13 weeks. The second and third quarters each consist of exactly 13 weeks. Our first three quarters end on a Saturday. Our 2010 fiscal year ends on April 30, 2010 and our fiscal quarters end on August 1, 2009, October 31, 2009 and January 30, 2010.

Results of Operations

Our operating segments are Unmanned Aircraft Systems, or UAS, and Efficient Energy Systems, or EES. The accounting policies for each of these segments are the same. In addition, a significant portion of our research and development, or R&D, selling, general and administrative, or SG&A, and general overhead resources are shared across our segments.

The following table sets forth our revenue and gross margin generated by each operating segment for the periods indicated (in thousands):

Three Months Ended August 1, 2009 Compared to Three Months Ended August 2, 2008



                                        Three Months Ended
                                      August 1,    August 2,
                                         2009         2008
Revenue:
UAS                                   $   33,310   $   46,076
EES                                        4,630        7,537
Total                                     37,940       53,613
Gross margin:
UAS                                        8,979       16,643
EES                                        1,736        3,940
Total                                     10,715       20,583
Selling, general and administrative       10,495        8,095
Research and development                   5,673        5,260
(Loss) income from operations             (5,453 )      7,228
Interest income                               59          541
(Loss) income before income taxes     $   (5,394 ) $    7,769

Revenue. Revenue for the three months ended August 1, 2009 was $37.9 million, as compared to $53.6 million for the three months ended August 2, 2008, representing a decrease of $15.7 million, or 29%. UAS revenue decreased $12.8 million, or 28%, to $33.3 million for the three months ended August 1, 2009, primarily due to decreased UAS product deliveries of $14.2 million and lower service revenue of $9.8 million, partially offset by an increase in customer-funded R&D work of $11.2 million. The decrease in UAS product deliveries and service revenue was primarily due to a reduction in our analog Raven B production and services as we prepare for the production and retrofit of Raven B systems integrating our Digital Data Link technology. The increase in customer-funded R&D work was primarily due to increased activity on the Global Observer contract. EES revenue decreased by $2.9 million, or 39%, to $4.6 million for the three months ended August 1, 2009. The decrease in EES revenue was primarily due to decreased product deliveries of Electric Vehicle test systems and fast charge systems.

Cost of Sales. Cost of sales for the three months ended August 1, 2009 was $27.2 million, as compared to $33.0 million for the three months ended August 2, 2008, representing a decrease of $5.8 million, or 18%. The decrease in cost of sales was caused primarily by lower UAS cost of sales of $5.1 million and lower EES cost of sales of $0.7 million.

Gross Margin. Gross margin for the three months ended August 1, 2009 was $10.7 million, as compared to $20.6 million for the three months ended August 2, 2008, representing a decrease of $9.9 million, or 48%. UAS gross margin decreased $7.7 million, or 46%, to $9.0 million for the three months ended August 1, 2009. As a percentage of revenue, gross margin for UAS decreased from 36% to 27% primarily due to lower production and service volume resulting in higher unabsorbed manufacturing and engineering overhead support costs. EES gross margin decreased $2.2 million, or 56%, to $1.7 million for the three months ended August 1, 2009. As a percentage of revenue, EES gross margin decreased from 52% to 37% primarily due to overall lower product deliveries resulting in higher unabsorbed manufacturing and engineering overhead support costs.

Selling, General and Administrative. SG&A expense for the three months ended August 1, 2009 was $10.5 million, or 28% of revenue, compared to SG&A expense of $8.1 million, or 15% of revenue, for the three months ended August 2, 2008. SG&A expense increased $2.4 million primarily due to higher selling and business development costs, increased bid and proposal activity and higher administrative infrastructure costs.

Research and Development. R&D expense for the three months ended August 1, 2009 was $5.7 million, or 15% of revenue, which was higher than R&D expense of $5.3 million, or 10% of revenue, for the three months ended August 2, 2008. R&D expense increased $0.4 million largely due to increased investment in various development initiatives.

Interest Income. Interest income for the three months ended August 1, 2009 was $0.1 million, as compared to interest income of $0.5 million for the three months ended August 2, 2008, representing a decrease of $0.4 million, or 89%. Interest income decreased primarily due to lower yields on investment grade securities.

Income Tax Expense. Our effective income tax rate was 33.5% for the three months ended August 1, 2009, as compared to 38.1% for the three months ended August 2, 2008. The decrease in the effective tax rate is due to higher R&D tax credits in the current period.

Backlog. We define funded backlog as unfilled firm orders for products and services for which funding currently is appropriated to us under the contract by the customer. As of August 1, 2009 and April 30, 2009, our funded backlog was approximately $108.7 million and $114.8 million, respectively.

In addition to our funded backlog, we also had unfunded backlog of $512.9 million and $510.6 million as of August 1, 2009 and April 30, 2009, respectively. We define unfunded backlog as the total remaining potential order amounts under cost reimbursable and fixed price contracts with multiple one-year options, and indefinite delivery indefinite quantity, or IDIQ, contracts. Unfunded backlog does not obligate the U.S. government to purchase goods or services. There can be no assurance that unfunded backlog will result in any orders in any particular period, if at all. Management believes that unfunded backlog does not provide a reliable measure of future estimated revenue under our contracts.

Because of possible future changes in delivery schedules and/or cancellations of orders, backlog at any particular date is not necessarily representative of actual sales to be expected for any succeeding period, and actual sales for the year may not meet or exceed the backlog represented. Our backlog is typically subject to large variations from quarter to quarter as existing contracts expire or are renewed, or new contracts are awarded. A majority of our contracts, specifically our IDIQ contracts, do not currently obligate the U.S. government to purchase any goods or services. Additionally, all U.S. government contracts included in backlog, whether or not funded, may be terminated at the convenience of the U.S. government.

Liquidity and Capital Resources

We currently have no material cash commitments, except for normal recurring trade payables, accrued expenses and ongoing research and development costs, all of which we anticipate funding through our existing working capital and funds provided by operating activities. The majority of our purchase obligations are pursuant to funded contractual arrangements with our customers. In addition, we do not currently anticipate significant investment in property, plant and equipment, and we believe that our existing cash, cash equivalents, cash provided by operating activities and other financing sources will be sufficient to meet our anticipated working capital, capital expenditure and debt service requirements, if any, during the next twelve months. There can be no assurance, however, that our business will continue to generate cash flow at current levels. If we are unable to generate sufficient cash flow from operations, then we may be required to sell assets, reduce capital expenditures or obtain additional financing. The global credit crisis has imposed exceptional levels of volatility and disruption in the capital markets, severely diminished liquidity and credit availability, and increased counterparty risk. Nevertheless, we anticipate that existing sources of liquidity and cash flows from operations will be sufficient to satisfy our cash needs for the foreseeable future.

Our primary liquidity needs are for financing working capital, investing in capital expenditures, supporting product development efforts, introducing new products and enhancing existing products, and marketing acceptance and adoption of our products and services. Our future capital requirements, to a certain extent, are also subject to general conditions in or affecting the defense industry and are subject to general economic, political, financial, competitive, legislative and regulatory factors that are beyond our control. Moreover, to the extent that existing cash, cash equivalents, cash from operations, and cash from short-term borrowing are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. To the extent we require additional funding, we cannot be certain that such funding will be available to us on acceptable terms, or at all. Although we are currently not a party to any agreement or letter of intent with respect to potential investment in, or acquisitions of, businesses, services or technologies, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing.

Recent global market and economic conditions have been unprecedented and challenging with tighter credit conditions and recession in most major economies. As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide credit to businesses and consumers. These factors have led to a decrease in spending by businesses and consumers alike, and a corresponding decrease in global infrastructure spending. Continued turbulence in the U.S. and international markets and economies and prolonged declines in business and consumer spending may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers, including our ability to access the capital markets to meet liquidity needs. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits. Given the current instability of financial institutions, we cannot be assured that we will not experience losses on these deposits.

Our working capital requirements vary by contract type. On cost-plus-fee programs, we typically bill our incurred costs and fees monthly as work progresses, and therefore working capital investment is minimal. On fixed-price contracts, we typically are paid as we deliver products, and working capital is needed to fund labor and expenses incurred during the lead time from contract award until contract deliveries begin.

Cash Flows



The following table provides our cash flow data for the three months ended
August 1, 2009 and August 2, 2008 (in thousands):



                                                         Three Months Ended
                                                       August 1,     August 2,
                                                          2009          2008
                                                             (Unaudited)
Net cash provided by (used in) operating activities   $     4,491   $    (3,002 )
Net cash (used in) provided by investing activities   $    (8,101 ) $     2,509
Net cash provided by financing activities             $       393   $       260

Cash Provided by Operating Activities. Net cash provided by operating activities for the three months ended August 1, 2009 increased by $7.5 million to $4.5 million, compared to net cash used by operating activities of $3.0 million for the three months ended August 2, 2008. This increase in net cash provided by operating activities was primarily due to lower working capital needs of $21.1 million partially offset by lower income of $8.4 million and lower tax benefits from stock option exercises of $6.4 million.

Cash Used in Investing Activities. Net cash used in investing activities increased by $10.6 million to $8.1 million for the three months ended August 1, 2009, compared to net cash provided by investing activities of $2.5 million for the three months ended August 2, 2008. The increase in net cash used in investing activities was primarily due to an increase in net purchases of investments of $10.7 million offset by lower capital expenditures of $0.1 million.

Cash Provided by Financing Activities. Net cash provided by financing activities increased by $0.1 million to $0.4 million for the three months ended August 1, 2009, compared to $0.3 million for the three months ended August 2, 2008. During the three months ended August 1, 2009, we received proceeds from stock option exercises of $0.4 million.

Off-Balance Sheet Arrangements

During the first quarter, there were no material changes in our off balance sheet arrangements or contractual obligations and commercial commitments from those disclosed in the Form 10-K for the fiscal year ended April 30, 2009.

Inflation

Our operations have not been, and we do not expect them to be, materially affected by inflation. Historically, we have been successful in adjusting prices to our customers to reflect changes in our material and labor costs.

New Accounting Standards

Please refer to Note 1 "Organization and Significant Accounting Policies" to our unaudited consolidated financial statements in Part I, Item 1 of this quarterly report for a discussion of new accounting pronouncements.