Good day, ladies and gentlemen, and welcome to AeroVironment Incorporated’s fourth quarter fiscal 2014 earnings conference call. [Operator instructions.] With us today from the company is Chairman and Chief Executive Officer Mr. Tim Conver, Chief Financial Officer Mr. Jikun Kim, and Vice President of Investor Relations Mr. Steven Gitlin. At this time, I would like to turn the conference over to Mr. Gitlin. Please go ahead, sir.

Thank you, operator. Welcome to AeroVironment’s fourth quarter and full fiscal year 2014 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 of the 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, July 8, 2014. The company undertakes no obligation to make any revision to the statements contained in our remarks or to update them to reflect the events or circumstances occurring after this conference call. We will now begin with remarks from Tim Conver. Tim?

Thank you, Steve. I’ll begin today’s call with a short summary of our strong finish to fiscal 2014 and where we’re headed in a dynamic fiscal 2015 and beyond. In fiscal 2014, our team successfully executed our strategy, adapted to DOD budget changes, maintained market leadership, advanced key growth opportunities, and outperformed with respect to our guidance. We ended fiscal 2014 with our core business and a strong and considerably more profitable position than fiscal 2013, and three of our key growth opportunities have advanced demonstrably in the adoption process. Looking ahead to fiscal 2015, we see continued strength in our competitive position and our long term growth potential in each of our core business areas. That said, we see compelling opportunities to advance maximum future returns on key growth initiatives through timely, incremental investments this year. And now, let’s review our 2014 Q4 and full fiscal year performance. I’ll discuss our view of fiscal 2015 and then I’ll go into further detail on investments in our growth initiatives. And then we’ll take your questions. We are very pleased with our strong Q4 performance, which drove both revenue and fully diluted EPS, above the high end of our guidance. Fourth quarter revenue of $73 million rose 36% year over year, and fully diluted EPS on an adjusted basis, which excludes CybAero convertible notes, rose from a loss of $0.21 to a gain of $0.27. We’re equally pleased with our full year results. Compared to fiscal 2013, full year 2014 revenue grew 5% to $252 million. And fully diluted adjusted EPS grew 87% to $0.56, excluding the $0.04 increase from CybAero convertible notes. During the year, we achieved important financial and operating goals. From a financial perspective, we adjusted the organization to lower our breakeven level from $60 million to $65…

Thank you, Tim, and good afternoon everyone. AeroVironment FY14 Q4 results are as follows. Revenue for the fourth quarter was $73.5 million, an increase of 36% or $19.4 million over Q4 last year of $54.1 million. Looking at revenue by segment, UAS revenue was $60 million, an increase of 42% over the prior year. The increase in UAS revenue was largely due to higher product deliveries of $22.4 million, driven by higher Puma systems, related spares, and Switchblade systems. This increase was offset by lower customer funded R&D revenues of $2.8 million and reduced logistics services for small UAS of $1.9 million. EES revenue was $13.5 million, an increase of 15% from Q4 last year, primarily due to higher hardware deliveries of industrial electric vehicle charging systems, offset by lower deliveries of electric vehicle test systems and passenger electric vehicle charging systems. Turning to gross margin, gross margin in the fourth quarter was $30.1 million, up 70% from the fourth quarter last year of $17.7 million. Gross margin as a percentage of revenue was 41% versus 33% in the fourth quarter last year. By segment, UAS gross margin was $25.5 million, up 61% from the fourth quarter last year, primarily due to higher sales volumes. As a percentage of revenue, UAS gross margin was 42%, compared with 37% in the fourth quarter last year. The increase in gross margin percentage was primarily due to higher volumes generating higher overhead absorption as well as higher mix of fixed-price contracts. EES gross margin was $4.7 million, up 142% from last year, primarily due to higher sales volumes and favorable product mix. As a percentage of revenue, EES gross margin was 35% versus 16% in the fourth quarter last year. Keep in mind prior year results were impacted by higher inventory reserves on…

Thanks, Jikun. In 2014, we solidified and enhanced our position for continued market leadership and future growth. And now I’d like to discuss where we see the business moving this year and beyond. To frame this discussion for 2015, it may be helpful to think about AV as operating two business models that report one set of financials. The first model produces a market leading profitable core business with strong growth prospects. Historically, we’ve invested between 8% and 10% of revenue in internal R&D, in addition, up to 10% of revenue generated through customer funded research. For fiscal ’15, we will need to maintain that full level of investment to support our ongoing core business and be adequately positioned to sustain growth. The second model produces market focused innovations targeting value creation and large market opportunities over the mid to long term. The accelerating adoption trends that we are seeing in tactical missile systems, commercial UAS, and Global Observer make a compelling case for increased investments in fiscal 2015 to strengthen our position for these largely pre-revenue key growth opportunities. These investments will mostly consist of research and development in SG&A, and may largely offset operating profits from our core business in fiscal 2015. We’re confident that these additional investments that we are planning for fiscal 2015 will deliver outstanding future returns for stockholders. With that said, let me first address our approach to fiscal 2015 in our core business, and then I’ll discuss these growth opportunity investments. In our EES segment, we will focus on maintaining our market leadership in all three business areas and continue to position AV for long term growth in passenger electric vehicle charging infrastructure. Overall, we expect fiscal 2015 EES revenue to be about flat year over year. In our core UAS business, again…

[Operator instructions.] And our first question comes from Patrick McCarthy from FBR Capital.

My first question is on the R&D and business development that you spoke about. I guess as you walk through each of the three areas, it seems like it’s relatively balanced between business development and R&D. Is that actually how the math works as well? Or is it more geared toward R&D versus business development?

It’s much more geared to R&D than business development, but as you recognized in my comments, there’s a significant amount of business development, but the percentage we expect to be largely R&D.

And is there a way to give us a sense as to how much of it is in tactical versus commercial UAS versus geo?

Each one of these three areas is a very, very large opportunity, and each is independent of the other. So we expect them to move at different rates and we expect to adapt our investments midway based on how we see the market adoption signals evolving and how we see lead customers reacting. So I think there’s going to be too many moving parts to try to get specific about how much in each particular area at this point. We do expect to be able to update you on our progress and outcomes quarterly, as we move along, however.

Our next question comes from Andrea James from Dougherty & Company. Andrea James - Dougherty & Company : You had previously talked about Global Observer as maybe contributing in the back half of a three to five year timeframe. Am I just detecting that you’re thinking it could bear fruit a little bit sooner, or you’ve just gotten some really positive indicators in the market about that program?

I think it’s more the latter. I think the general timing that we’ve indicated in that notional chart that we’ve got in our investor deck is probably still largely intact. In the areas of Global Observer, tactical missile systems, and commercial UAS, we are clearly seeing a higher level of activity with lead customers recently, and I think that strongly suggests to us that we’re on track in all three of those areas, and that if anything, the timing that we had anticipated and previously indicated in those areas, is increasingly solid. We probably are seeing some slide in timing of what we had expected mission services adoption to be, that would somewhat offset the balance of those six. Andrea James - Dougherty & Company : And then with this BP contract in Alaska, it just sounds like you’re providing so much more than the aerial vehicle and the payload. And so I guess my question is, are you feeding data into some sort of BP software, or are you developing information systems that are proprietary to AeroVironment?

We are generating the data, we are processing and analyzing the data, and we’re providing actionable information as a service under our contract relationship with BP. So that’s the long answer, I guess. The short answer is, we’re doing that process within the service that we’re providing. That’s a combination of organic work and partnership relationships that we have and will continue to develop in this business area.

Our next question comes from Peter Arment from Sterne Agee.

Tim, in the past you’ve given us a little bit of color on the funding buckets that are still available to you. With $66 million in backlog, can you kind of give us what you still see on current visibility, just in case we have to go into another continuing resolution at the end of this year. What is currently, in terms of visibility of what’s funded, still left on some of the key programs?

A couple of things. At year-end, we had $65.9 million of funded backlog. At this point in time, we believe 95% of that will be calendarized into FY15 as revenue. So that’s about $63 million. As Tim alluded to, we also booked $76 million of orders, firm backlog orders, quarter-to-date. Various SUAS orders. And then if you want to hold EES revenue flat relative to last year, taking out all the bookings and backlog that they have, it would be an additional $28 million. And then finally, the last increment of the GFY14, which is about $7 million that we have not booked at this point in time. That adds up to $174 million or about 67% at midpoint of revenue visibility.

And then Tim, you did mention, also on the EES, that there was a kind of evolving subscription model. Could you give us a little more color on that? I’m just interested in hearing how that is rolling out.

That was in reference to the network of charging systems that we’ve installed along the I-5 freeway through Oregon and Washington in cooperation with the transportation departments of those states. And when we initially installed those, we made them openly available, or free of charge, to join than acquire subscriptions there, or a membership. , :

Your next question comes from Tyler Hojo from Sidoti & Company. Tyler Hojo - Sidoti & Company : I’d like to expand on EES a little bit. When you talk about a flat growth expectation or flat revenue expectation for fiscal 2015, what are the puts and takes? I’m assuming that industrial charging is up, it sounds like TurboCord should be somewhat of a driver. What’s the offset?

You’re correct, or at least you’re in agreement with us, in terms of your assessment that industrial PosiCharge solutions should grow. We also believe we’ll continue to see increasing adoption of TurboCord. In general, we think our consumer solutions for level one and level two charging will continue to grow as we expect adoption of electric vehicles to grow. We’re backing off on the level of focus we’ve had on our fast charging going forward into this year, so we expect that sales revenue of those new systems would be lower. And we also expect relatively low sales of our electric vehicle test equipment. A lot of the customers that buy that equipment basically built excess capacity during the stimulus funding period and I think we’re working that off now. That’s kind of the plus/minus contribution that ends up with an expectation of about flat revenue. Tyler Hojo - Sidoti & Company : And just on a different topic, I was wondering if you could perhaps provide an update in regards to CybAero. I guess you’ve been a seller, or a slow seller, of your investment there. Could you perhaps give us an update regarding your strategic relationship? Is that still ongoing?

Well, we have an ongoing relationship with CybAero. As you may have noticed, they’re having continued success in marketing their tier two helicopter on a global basis, and we’re delighted to see that success. We originally acquired two convertible notes when we established our relationship with them, and then last year we converted one of those notes to equity. So I don’t know that we want to go into any more detail on that relationship right now. I did mention that we have taken out Department of State revenue expectations from our fiscal 2015 plan and all things considered, that was expected to be the anchor tenant in that services business that would utilize tier two helicopters. And probably, as I also suggested earlier, that market adoption in our services business is probably a little pushed out.

Our next question comes from Michael Ciarmoli from KeyBanc Capital.

Just to kind of follow up on the R&D investments this year, I’m just trying to get a sense, if the timing toward some of the revenue growth in that five year window hasn’t changed, how should we be thinking about this period of zero earnings or operating income? Is this something that spills over into 2016? Does it gradually normalize? Just from a modeling perspective, how long should we think about this period of investment lasting before we see some revenue and earnings contribution?

The principal focus is this year, fiscal 2015. As I indicated, I think there’s a reasonable amount of variation in how much of that investment continues in each one of those areas that is a function of the ongoing adoption signals from each of those three large independent market opportunities. And so we’ll adapt as we see customer action in response. It’s possible that some of those investments could slide into ’16. Hard to predict at this point. I think if they did, it would be a good sign. It would indicate that that’s continuing to accelerate. But I think about it more in terms of this is localized. You may recall that back in fiscal ’11, after we began the year, we told you that we were going to increase our R&D investments by about 2% of revenue in the second probably three quarters of the year. That was a one-year investment that mostly was earmarked for Switchblade. And luckily enough, we’ve managed to increase Switchblade revenue by a factor of ten since then. And I think it was largely accelerated by that incremental investment we did in that one fiscal year.

What sort of probabilities are you guys putting around these investments? I mean, LMAMS, I would imagine, I know there’s a couple of well-capitalized competitors with good products. It sounds like some of these opportunities aren’t necessarily slam dunks. Internally, how are you guys handicapping win rates or the ROIs here on this investment?

I don’t think anything we take on is particularly easy. And by definition, when we get committed to bringing an innovative solution to a customer set, we’re targeting what we believe are very large market opportunities. So for sure, to the degree that is successful, we’re going to either displace large, entrenched incumbents, or we’re going to track the large competitors. And that’s been the case in every one of our historic efforts. You know that we’ve competed head up with some of the largest aerospace companies in the world for the last decade, in the small UAS area. Again, we’ve been lucky enough to win every one of those programs of record with the Department of Defense. In each of these large new markets that we’ve talked about, including the tactical missile systems area that you specifically addressed, we have a strong early position. And much like our initial work in small UAS, even though we have attracted, in both areas, lots of competition from very capable and in many cases very much larger competitors than ourselves, historically we’ve been able to maintain that first mover advantage and achieve the leading market share and maintain that market share. So our handicapping is based on our history and our current position. We’re optimistic and I think we operate with a reasonable and appropriate amount of paranoia in every one of these areas. So we run fast and we stay focused on customers.

Our next question comes from Brian Ruttenbur from CRT Capital.

In terms of funding for the DOD part of your business, for UAS, is this still primarily OCO? And if not, what is OCO as a percentage?

You know, we’ve been asked that question in the past and it’s really difficult to decipher that information from the budgetary documents. A lot of these contracts that we get, the [akron] numbers are not very clear, because these are long term IDIQs. And so it’s been difficult for us to decipher. However, having said that, in the Q1 quarter to date, bookings of $76 million, most of that did look like it came from the GFI14 funds in some fashion.

And trying to understand the breakdown of profitability, I assume in the first half of the year, in fiscal 2015, you’ll be somewhat unprofitable, and then second half of the year, you’ll go to more profitability and make you break even on an earnings per share basis? Is that the kind of guidance you’re giving on the year?

This is a question as to fiscal 2015, correct?

That’s correct. For fiscal 2015. So, first half of the year, kind of unprofitable, second half of the year, profitable? And a wash on the year?

No, I don’t think that’s the intent of our communication. I think we’ve got these three large emerging opportunities. We’re responding to the very clear and accelerating customer activity in each of those. We’re going to accelerate investments in each of those areas throughout the year. And while we can’t be sure of what that total investment will be, we know it could reach throughout the total year, about the amount of operating profit that we would otherwise produce in the ongoing, growing, profitable business. So I think at this point, we think it’s too uncertain for us to put a specific number on it and too uncertain for us to put a profit guidance number out.

Our next question comes from Howard Rubel from Jefferies.

Tim, in your outlook, you talked about gross margins at the low end, which is really at a level that we’ve really not seen. You alluded to mix as part of that. Can you elaborate a little bit on why is that the case? And then maybe talk about what you’re continuing to do to take costs out in advance of pricing pressure?

I can try to help you with the first portion, in terms of gross profit percentage range. So in FY15, we have two impacts. One is we will have a higher mix of cost plus business in FY15. Some of the growth areas that Tim identified had to do with the [crad] types of contracts that we’re looking for in the future, as well as we are going to have a mix change, meaning higher mix of newer products that are going into production, like Switchblade, which historically has had some margin pressure for us as we transition it into production.

And then maybe to follow up on that, and it sort of ties a couple of things together, you talked about [crad] and Tim talks about customer interest, and usually, in the world of aerospace, you usually get a little bit of customer money to help you along. So in fact, have you gotten some contracts from some of your customers? And is that sort of the underpinning for your optimism and confidence going forward with the higher levels of R&D?

Within the defense portion of our business, I agree with your assessment on the attractiveness and the expectation that as we move new technologies along, we would want to see customer adoption in the form of some contractual support. We’ve seen some of that to date. We expect more of that as we move along. And to some degree, those kinds of activities would be customer behaviors that would gate some of our ongoing investments in that defense area. As to the second part of your first question, yes, we are continuing to focus on our cost structure of our products. And we expect to continue to pay a lot of attention to product cost, both as a function of how we source and cost reduction design opportunities.

And our next question comes from Brian Gesuale from Raymond James.

It was helpful on the revenue breakdown throughout the year, Tim, but wondering if you could give us a sense on how these expenses that you’re going to put on the business filter through the year, given that we’re mostly through Q1. Are we going to see those in Q1? Are those going to be principally Q2, Q3, and Q4? Or really how should we look at the timing of that?

I think we’ll see them mostly through Q2, Q3, and Q4. So I think you’ve got that about right. I did mention that the revenue is, as usual, skewed to the second half, with about 60% in the second half. So maybe as we build up the investment in these areas, it will, to some degree, match that growing revenue stream.

And then with the revenue outlook and 60% in the back half of the year as troops are coming home in pretty significant batches, do you have concern with those orders? Or what visibility do you have in that remaining third of the business to get you there in the back half of the year?

I think we’re as confident as we ever can be in our forward looking expectations of orders and bookings. It may surprise you to see this level of bookings even quarter to date that already exceeds the identifiable small UAS funding in the budget language. So I don’t see a material difference in the quality of our confidence in our outlook right now than we had last year.

Our next question comes from Josephine Millward from Benchmark.

I was hoping you or Jikun could walk us through how you get to a flat U.S. DOD small UAS business in 2015, since the Army’s pretty much reached its acquisition objective. And I believe you’ve upgraded most of the Raven and Puma. And I believe the 2015 request for small UAS, the funding level, is about $13 million. So how do you maintain this business flat?

In probably a number of pieces of that. One is we’re looking at small UAS and other DOD contracts. So a lot of that is customer funded research. And that would be outside of the small UAS market per se.

So customer funded research, is it for the next generation small UAS, and that’s offsetting some of the procurement decreases we’re seeing?

No, as I noted earlier in the comments, we’ve been increasingly focused on other UAS applications that go beyond the hand-launched small UAS category. And we have been successful with a number of customers in initiating opportunities in that area, some of which are accompanied with customer funded development contracts.

Our next question comes from Patrick McCarthy from FBR Capital Markets.

I’m sure you’ve told us in the past, but I can’t find the note. Could you talk about how the CybAero investment is valued? Is that a market based valuation?

The convertible notes have the conversion feature, which would be an option, if you will. So we used the binomial distribution model for the valuation of that, but the fundamental value of the option is based on the stock price, which is clearly observable in the markets.

You might use some cash this year, it sounds like, but you’re cash rich. Any thoughts on capital allocation?

I think to the degree we’re using cash to deploy these incremental investments is we think, and management and the board believes, are the highest and best use of the capital right now. Long term, we still see the adoption of these large growth areas as driving significant investment at the time of adoption and when we need to scale the business to track what we expect to be very large and rapidly growing demand. So the return on those investments we continue to believe to be far greater than any other use of our capital, and that’s where our current focus is at this point in time.

Our next question comes from Andrea James from Dougherty & Company. Andrea James - Dougherty & Company : I just want to piggyback on Josephine’s question a little bit. If you do look at your quarter-to-date bookings, as well as your guidance on FY15, with the defense revenue, it does kind of feel like the Defense Department is pulling money out of nowhere to fund your programs. And so I guess my question is, are these programs in the classified budget? Or are they just too small individually to appear in the budget documents that are publicly available?

You probably recall that historically, our funding, the contracts we actually receive in any given year, from DOD, in our small UAS area, have only had about 30% of those actual amounts been identifiable in the budget before we started the year. And so that’s always been the case, and I don’t see that changing a lot right now. Andrea James - Dougherty & Company : Can you give me the customer funded R&D number in the quarter?

Actuals? Andrea James - Dougherty & Company : Yeah, the actuals. You gave the change, but I just want to make sure we have it.

Sure. $6.5 million. Andrea James - Dougherty & Company : So you’re expecting that to scale up quite a bit next year, you’re thinking?

Correct. Andrea James - Dougherty & Company : And then you didn’t mention the Airbus helicopter partnership. Should we just put that in the same bucket as sort of like the State Department contract of maybe being far out in the future?

I think about it differently than the State Department contract. I guess two things here. One is that even though we are a short cycle business, we think that we’re short cycle because we have a relatively short lead time between when we get orders and when we deliver hardware. But if we move to the development of business opportunities, especially business opportunities with international implications, those timelines for us are very often quite long cycle. So I wouldn’t expect short term results necessarily from these business development relationships, especially when we get beyond the borders. Having said that, the Eurocopter organization is going through some changes. They changed their name, they have new leadership. And that may affect decision making on timelines as we move forward on that particular deal.

Our next question comes from Michael Ciarmoli from KeyBanc Capital.

Just two quick ones. Can you elaborate, maybe Tim, what sort of role Lockheed is playing in Global Observer? Are they contributing investment as well? If you could walk us through that dynamic. And then you mentioned the $76 million of orders now here quarter-to-date a couple of times. Would you be willing to parse out, in terms of either product or what’s from the DOD, what’s from international customers? Just kind of help us out with that mix?

Sure, on the second part of the question, most of those orders this quarter are from DOD and they are small UAS associated. The Lockheed Martin collaboration on Global Observer, I mentioned we’re proceeding on schedule, with planned phases. A major piece of what Lockheed brings to this joint endeavor is their mission systems capabilities. Not only their payload capabilities, but very large national scale simulation capabilities and a broad, well-established global footprint. So all very complementary to our Global Observer platform capabilities and I think bringing a lot from two multiple customer opportunities.

I’m showing no further questions at this time. I would like to hand the conference back over to Steven Gitlin for closing remarks.

Thank you for your attention and your interest in AeroVironment. An archived version of this call, all SEC filings, and relevant company and industry news can be found on our website, www.avinc.com. We look forward to speaking with you soon, following next quarter’s results. Good day.