Axsys Technologies Q4 2008 Earnings Call Transcript

Axsys Technologies, Inc. (AXYS)

Q4 2008 Earnings Call

February 18, 2009 10:00 AM ET

Executives

Stephen W. Bershad - Chairman and Chief Executive Officer

David A. Almeida - Executive Vice President and Chief Financial Officer

Scott B. Conner - President and Chief Operating Officer

Analysts

Steve Levenson - Stifel Nicolaus

Michael French - Morgan Joseph

Tim Quillin - Stephens, Inc.

Paul Coster - JP Morgan

Brian Ruttenbur - Morgan Keegan & Company Inc.

Kevin Putney - Boenning and Scattergood

Presentation

Operator

Good day, everyone and welcome to Axsys Technologies Fourth Quarter and Year-End 2008 Financial Results Conference Call. At this time, I would like to inform you that this conference is being recorded and that all participants are currently in listen-only mode.

This conference call includes forward-looking information that Axsys does not undertake to update or that may not reflect actual results, changes and assumptions or changes in other factors affecting such forward-looking information. Although, such statements reflect Axsys's current reasonable judgment regarding the direction of the business, the actual results may differ materially from those in the forward-looking statements.

Assumptions and other information that could cause actual results to differ materially from those set forth in the forward-looking statements can be found in Axsys's filings with the Securities and Exchange Commission. Any non-GAAP financial information presented will be reconciled to GAAP financial statements on the Investor Relations section of the company's website at www.axsys.com.

I will now like to turn the presentation over to your host for today, Mr. Stephen Bershad, Chief Executive Officer. Please go ahead, sir.

Stephen W. Bershad

Thank you, operator. Good morning everyone, and thank you for joining us this morning on Axsys Technologies fourth quarter 2008 conference call. Joining me today as usual are David Almeida, our Chief Financial Officer and Scott Conner, our President.

As you can see from our earnings release, our fourth quarter results were a great finish to an outstanding year, where we increased our guidance several times and still met and exceeded the high-end of our latest guidance.

This is clearly a gratifying result. David and Scott will cover our fourth quarter results later in the call. I will focus my comments on our full year accomplishments. Fiscal 2008 was a year of unprecedented financial growth and important operational achievements.

Our sales grew 43% to a record $245.5 million, and our operating income margin increased 300 basis points to 16.6%. As a result, our fully diluted earnings per share from continuing operations grew 81% to $2.30. These results provide strong evidence that our strategies are sound.

Equally important, we positioned the company for future growth with the introduction of several new products as well as opening a new manufacturing facility.

First, we introduced the new gyro-stabilized camera systems, the MS2 to address the airborne law enforcement and paramilitary markets.

Second, we developed a new line of un-core infrared cameras for short range military and commercial perimeter security.

And finally, we launched a whole line of two access gyro-stabilized sensor positioning systems that are ideally suited for a number of threat detection applications.

We're already beginning to penetrate new markets with all these products and we expect that they will help to drive our sales growth in coming years.

In order to accommodate our growth, we leased and outfitted a second manufacturing facility in Nashua, New Hampshire. This capacity expansion will provide additional manufacturing stage for both camera systems and our infrared lens business.

The relocation of our surveillance business -- Surveillance Systems business to the new facility which was accomplished with minimal disruption for our customers was an unqualified success.

As we entered 2009, Axsys is financially and organizationally strong. As a result of the organizational restructuring that we did in the fourth quarter of 2007, our various businesses are formed a cohesive and effective team that is well suited to the task before us.

Before I turn the call over to David, I'd like to take an opportunity to express my appreciation to the entire Axsys team, pound for pound I put this group of professionals up against any organization in the country. Their achievements last year were truly outstanding and I am truly thankful for their... for all their extra efforts.

At this point, I'll turn the call over to David for a review of our financial results. David?

David A. Almeida

Thank you Steve, and good morning everyone. Today I'll start with the review of our consolidated financial results for the quarter and the full year, and then follow that up with some balance sheet highlights.

Consolidated sales for the first quarter of 2008, was 63.9 million, up 34% from 47.9 million in 2007 due to strong growth in both reporting segments.

Gross margin for the quarter decreased slightly from 33.2% in the fourth quarter of 2007, 32.5% in 2008. The gross margin decline was mainly due to an unfavorable product mix and the Surveillance System Segment in the fourth quarter of 2007, and the favorable product mix in 2007.

Operating income increased 6.6 million or 13.7% of sales in the fourth quarter of 2007 to 11.1 million or 17.3% of sales in the fourth quarter of 2008.

The favorable impact of higher gross margins in the Imaging System Segment combined with improved leverage and our SG&A expenses across both business segments, drove the year-over-year operating margin improvement.

We maintained our level of R&D spending at 4% of sales, as we continue to invest in future growth opportunities.

Income from continuing operations were 6.8 million or $0.59 per diluted share in the fourth quarter of 2008, up from 4.1 million or $0.36 per diluted share in the fourth quarter of 2007.

Net income was 6.7 million or $0.58 per diluted share in 2008, up from 5.8 or $0.51 per diluted share in the comparable quarter last year.

The prior year results included $0.15 of income per share from the sale and operations of our discontinued AST Bearings business as compared to a discontinued operations loss of $0.01 in 2008.

Looking at the details within the segment, the Surveillance Group grew 30% from 15 million in the fourth quarter of 2007 and 19.5 million in the fourth quarter of 2008.

Increase in sales for the quarter was primarily due to continued strong demand of thermal camera systems for land based primer security and border protection applications.

Gross margin decreased from 47.9% in the fourth quarter of 2007 to 43.7% in the fourth quarter of 2008. The decrease in gross margin was due to product mix and increased overhead associated with the new national facility.

Operating income improved to 5.4 million or 27.5% of sales in 2008 from 3.2 million or 21.2% of sales in the comparable quarter of 2007 while controlling spending within the business.

Sales in the Imaging Systems Segment were 44.5 million for the fourth quarter of 2008, a 35% increase from sales of 32.9 million in the fourth quarter of the prior year. The growth was mainly due to strong demand for infrared lenses and precession motion control products.

Gross margin in this segment was 27.6% for the fourth quarter of 2008, up from 26.6% last year. The increase in gross margin was mainly due to a favorable product mix within the segment.

Operating margins improves from 15.6% in the prior year to 17.2% this year, both due to favorable gross margin and increased leverage of our operating expenses.

Moving to our consolidated full year results, sales in fiscal 2008 were 245.5 million, a 43% increase over sales of $171.6 million in the prior year. The year-over-year growth was primarily driven by strong demand for infrared and precession motion control technology for surveillance, reconnaissance and targeting applications.

Our full year gross margin for fiscal 2008 was 33.9%, up 140 basis points from 32.5% in the prior year.

Operating income was 40.7 million or 16% of sales, up from 23.3 million or 13.6% of sales in fiscal 2007.

Improvements in our gross margin combined with careful management of our operating expenses drove a 300 basis point improvement in our operating margin.

Income from continuing operations was 26.3 million or $2.30 per diluted share in 2008, up from 14.1 million or $1.27 per diluted share in the prior year.

Full year net income including discontinued operations was 25.9 million or $2.26 per diluted share compared to 16.8 million or $1.51 per diluted share in fiscal 2007.

Net income for 2007 included $1.7 million after-tax gain from the sale of our AST Bearings business, as well as $1 million from the 11 months we've owned it.

During fiscal 2008, our backlog increased 18% to 165.1 million, with approximately 92% of our year-end backlog being scheduled to ship in fiscal 2009.

As usual, I'd like to end my comments this morning by providing some brief balance sheet highlights. We ended the fourth quarter this year with 24.7 million of cash, up from 15.3 million at the end of last year.

As we expected, we generated strong cash flow from operations during the fourth quarter, although our rapid growth both significant increases in the accounts receivable and inventory first half of the year, we're able to generate 14.4 million of operating cash flow from continuing operations in 2008.

We have no debt on our balance sheet. In 2009, we expect to convert approximately 60% of our net income to free cash flow which will enable us to continue funding our existing operations with internally generated cash flows.

With that, I'll turn the call over to Scott.

Scott B. Conner

Thanks, Dave and hello everyone. As both Steve and Dave have mentioned 2008 was a very good year for Axsys.

In fact it's not simply a statement about our financial results however, but instead reflects our success in a whole array of functional areas, including operations efficiency, product line breadth and reliability, service orientation, international market penetration, organizational discipline, interdivisional cooperation and increased depth and breadth of leadership.

Critically from my perspective, we've managed dramatically mature the company without loosing the essential entrepreneurial spirit that has made us and will continue to make us successful. Of the one area where Axsys has not been particularly successful is brand awareness.

Even our long standing customers often do not fully appreciate the breadth of products and capabilities, we now posses. This is perhaps understandable given the rate of growth we have experienced which is also obviously unacceptable as it leads to loss in business. Consequently, we have been implementing a new marketing effort and I'd like to discuss this briefly before turning to the quarter's bookings and other strategic developments.

The foundation of our new brand development initiative is our corporate vision to be the premier supplier of optical solutions for surveillance, reconnaissance and targeting applications in markets ranging from ground to space.

We aspire to offer the premier product both cost and custom design for applications as diverse, a terrestrial force protection, Maritime threat deterrence, airborne security and space-borne surveillance. We're currently involved in all of these markets and as I will discuss, our bookings from Q4 are fairly illustrative of this fact.

However, the breadth of our offering is sometimes not fully understood in industry in an order to increase our value-added content across these markets we need our customers to have a better appreciation of our capabilities and heritage.

The most visible media that we plan on rolling out in support of this marketing initiative is the new website which will go by early next week. This new website will more accurately represent our business and our vision, and simultaneously showcase the breadth of our product offering.

The theme on the website will be reinforced by our soon to be release annual report and new marketing collateral. Finally, we're unifying our advertising and trade show collateral, our new tradeshow will in fact will be first displayed at the HELI-EXPO Show in Anaheim, California, next week.

The HELI-EXPO trade show will also be form for one of our important strategic developments for the first quarter. Introduction of our new 9-inch law enforcement gimbal, this four active gyro-stabilized camera system is called the V9, is designed for lower altitude aerial surveillance. And we believe it will have the highest performance cameras and greater stabilization capability in its class.

Not surprisingly, we're enthusiastic about this product introduction and the new market potential for the V9 in the airborne law enforcement and paramilitary markets.

Well our product line for airborne camera systems is still somewhat narrow, compared to that of our nearest competitor. We've spent and continue to implement significant R&D resources to building up our product offerings in that space, and it will only be a matter of time, until we have a portfolio that competes effectively in all airborne market areas.

Let me move now to a discussion of some of the strategic bookings from the fourth quarter. And I am going to group these orders by the categories I mentioned earlier. Ground-based applications, Maritime, airborne and space-based programs. As it's typical of most quarters, we booked business for applications across this spectrum.

Let me start with ground-based applications. Force protection in general and forward operating base security specifically continues to be a fast growing market for our surveillance cameras, and this quarter was no exception.

During the quarter, we have received additional orders for both the IBDSS Space Security Program and CRAM the Rocket Interdiction Program.

Another long running force protection program for which we booked a follow-on order, with a Thermal Weapon Sight Program or TWS. As many of you know, we have manufactured large quantities of infrared lenses for this program and expect to continue do so, going forward.

We also booked orders for a number of vehicle integrated optical targeting acquisition program, for example we received orders for the delivery of optics and our motion control for HTI, DIV and IBAS programs. Each of these programs provides advanced target acquisition capabilities for vehicles such as the Bradley Fighting Vehicle and the Abrams Tank.

Finally, in the border protection area, we booked orders for cameras that will be deployed on the U.S. border and for cameras that will be deployed on the border of the United Arab Emirates.

Interestingly, we received contracts from two separate U.S. Border Patrol programs during the quarter, one for FBI net and the other for the Mobile Surveillance System or MSF program.

Well on discussing ground-based applications, I do want to comment briefly on the Driver's Vision Enhancement or DVE program that many analysts have been writing about as an up-sight to our 2009 financial guidance.

First, it's been noted on several occasions that we're teaming with particular prime vendors for this program. While we certainly provide a course to some of these bidders for this program, there is no guarantee that they will choose access to provide their lenses should they win.

Also while it's true that DVE is a multi-billion dollar program, our participation would amount to at most $10 million per year, because the lenses we would be supplying are quite smaller in expenses.

In addition to 2009 affect, would be even slower because the program ramp will only begin in the second half of the year. We're still quite hopeful that we'll be involved in this program but I wanted to use this opportunity to clarify the situation, so that there aren't any misunderstandings.

Let me move now from ground to Maritime application. As I've mentioned in previous calls the Maritime market is our least penetrated market and one for which we are not well known. However, we believe that this market has great potential for our business.

Our longest running Maritime program for which we received a follow-on order during the fourth quarter is the failing missile defense program for which we supply precession motion control for the optical targeting mechanism.

However, our goal is to pursue this market on a much broader basis. This typically with both our cost gyro-stabilized and non-gyro-stabilized camera system. Consequently it was exciting to receive multi-camera orders during the fourth quarter from three different foreign Navies, one in Europe, one in Central Asia and one in South America.

These orders suggest that the industry is starting to learn about Axsys and is beginning to recognize the applicability of our solution to their operation.

For example, the European customer is purchasing gyro-stabilized systems specifically to be used for coastal surveillance and terrorist interdiction. A mission that is perfectly suited for capability.

In the airborne area, strong demand continued in Q4. Some of the programs that we booked included the aerohead infrared targeting system for the Apache attack helicopter, the LN 120 Dower inertial navigation system for the air forces RC 135, Aclear the targeting system for the Navies F-18 and Mass Mounted Site the surveillance system on the Kiowa helicopter.

Most important strategic bookings in the quarter, during the fourth quarter however refer our MS2 gyro-stabilized camera system. As many of you know, we develop the MS2 following our acquisition of Cineflex in 2007 to satisfy immediate long range law enforcement and paramilitary requirement. And an evolutionary step toward an even more advanced system that can support a broad array of military mission.

Simultaneously, we've been introducing our existing products to a broad array of military and paramilitary customers.

These efforts started to bear fruit in the fourth quarter when we were awarded two multi-million dollar contracts, one from the South East Asian military customer, and another from a paramilitary organization in the Middle East.

These are clearly exciting and strategic wins for Axsys, most importantly for what they represent, hard proof that our tactics are paying off, and that we're making headway toward our strategic goal.

Finally, in the area of space-based applications, we booked orders totaling several million dollars to supply a variety of satellite and space-based missile defense programs.

The specifics of the satellite programs, I cannot discuss, but in the missile defense areas, we booked orders in support of both the standard missile and surveillance high program.

Before I turn the call back over to Steve, I would like to echo Steve's introductory comments regarding the terrifically successful move that was executed during the fourth quarter. We had no serious disruptions to the business as a result of the move, and the transition was carried out on-time and within budget. This was truly a great accomplishment by our team.

With that summary of the state of the company, I'll now turn the call back over to Steve who'll address guidance for 2009.

Stephen W. Bershad

Thank you, Scott, and David. As we begin in 2009, we believe we are well positioned for continued growth. The markets that we serve, most of which are not been directly impacted by the downturn in the general economy remains strong.

Our backlog grew 18% to $165.1 million in 2008 due to continued strong demand for our products and our new product pipeline has never been stronger. Based on these factors we expect sales to grow approximately 14% from 245.5 million in 2008 to between 278 million and 282 million in 2009. And in addition, we expect our 2009 fully diluted earnings per share from continuing operations to grow approximately 17% to between $2.66 and $2.72 per share.

This concludes our comments this morning, and at this we'd like to open the call for questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Steve Levenson of Stifel. Please proceed.

Steve Levenson - Stifel Nicolaus

Thank you. Good morning.

Stephen Bershad

Good morning, Steve.

David Almeida

Good morning, Steve.

Steve Levenson - Stifel Nicolaus

I had some questions about Cineflex. What's it going to take to get to the next stage, is it a camera and is it something that you'll make or something that you'll buy? And I'm curious about the sales pipeline, are they big programs or the smaller and medium size programs that you're going after?

Scott Conner

Steve, it's a good question, there is an increasing number. I'm going to address the second part of your question first. There is an increasing number of multi-gimbal orders that we're going after, were traditionally in 2007, we were kind of selling ones and twos, and the perfect examples of what I am explaining here is the two that I mentioned in my comments almost, the -- this order -- these two orders one in the Middle East and one in South East Asia which was a quite a few and these are really great strategic steps forward for us.

And so there is an increasing number of multi-gimbal orders that we're continuing to look at in the pipeline now. Now back to your initial question what take -- does it take to get to the next step. What we're executing is our development program right now, internal organic development, and the V9 which I also discussed is our first incarnation, the first result of that development. And the reason this is so important that we do it organically is that you do these gimbals really well you need to leverage both this high precession motion control which we have in-house. And this very high-end optics capabilities and integrate them in the design of poor product. And we can do that very effectively with the capabilities we have in house. It's just a matter of time to roll out a broad array of these product to serve a lot of the markets that we currently of don't serve today.

Steve Levenson - Stifel Nicolaus

Okay. Thanks.

Scott Conner

Sure.

Operator

Our next question comes from the line of Michael French of Morgan Joseph. Please proceed.

Michael French - Morgan Joseph

Good morning, gentlemen.

Scott Conner

Good morning.

Michael French - Morgan Joseph

Scott my question is to follow-up on one point you just made there in terms you're taking time to roll out these new products. You -- specifically how many new ones are in the pipeline and when do you think that they would hit those new products like the V9?

Scott Conner

Right. So, I wouldn't expect given our current level investment to see more of an new one year, that's a rough rule of thumb. I mean I give it a rough rule of thumb because that is some or more complex than others, then it depends on how we're going to -- in what ones we're going to invest our most time in. But I would as a rough rule of thumb think about one year, given our current levels of investments.

I'd love too, honestly I'd love to invest even more, but we of course have to deliver the expected profits to the shareholders.

Michael French - Morgan Joseph

Okay. And you mentioned that the V9 is highly capable. I saw at a trade show it seem impressive and if you understand the pricing is it pretty much the same price about 250,000?

Scott Conner

I' rather not discuss pricing on the call, if I could avoid it just because I -- that's not something I like to disclose on this call. But I will tell you that in terms of capability, its going to have other gimbals in this class have two access of stability ours is going to have four. So its going to be a very stable platform and the range the ability which you see great distances will be in excess of other products on the market.

Michael French - Morgan Joseph

And would you think the addressable market is for us to various?

Scott Conner

As I mentioned, the law enforcement and paramilitary customers.

Michael French - Morgan Joseph

I mean in size, dollars per year?

Scott Conner

I don't think I want to answer that question either not because I -- because I think I'll say something incorrectly that I have to correct that later day. I don't have a number in my head that I can give you right now.

Michael French - Morgan Joseph

Okay, let met please ask one more and I'll turn back...

Scott Conner

Sure, no problem.

Michael French - Morgan Joseph

On the gross margin side, you had mentioned the product mix and the national overhead. Just wonder I think you break that down a little or did a better sense of what's going on at Aclear and if it's expected to have a turnaround?

David Almeida

Sure, sure. Margins year-over-year, I think you're looking at the margins year-over-year, year-over-year they went down 70 basis points. About half of that was due to the actual physical move within the quarter of the incremental facility as well as the additional overhead that we're assuming with the new building. And then half of that was due to product mix.

And now traditionally, our margins in the fourth quarter are affected by the holidays and the shutdown. So our utilization in fourth quarter only as low as -- if you look from a sequential standpoint, we had lower margins in the fourth quarter. Mix issues nothing that's necessarily permanent, it's just -- it was really across several product lines we had. We're dealing with some fiscal inventories at year-end. We had a small fiscal inventory write-off. It wasn't anything anyone significant thing.

We delivered margins of almost 34% within the year. We expect that going forward that we're going be at least to those margins as we move into the future. So and hope can improve them. And again some of that's going to be lumpy from quarter-to-quarter based upon things that happened in the fourth quarter mixed related items et cetera. That answers your question?

Michael French - Morgan Joseph

Yes. Thank you.

David Almeida

You are welcome.

Operator

Our next question comes from the line of Steve Quillin of Steven Incorporated.

Tim Quillin - Stephens, Inc.

Tim Quillin. Thanks.

Stephen Bershad

Good morning. How are you?

Tim Quillin - Stephens, Inc.

Nice quarter, I think despite the stock price today I think you beat your guidance especially if you conclude out the higher tax rate. In terms of bookings, if you look at the backlog decline, it suggests kind of computed bookings number for around 45 million and book-to-bill of about 0.7, is there anything timing wise we should think about there?

Stephen Bershad

And that makes some surprise, it took the third analyst to ask this question, to be honest. There is nothing, people read into and it seems we've try to reiterate in every quarter that book-to-bill in our business, it's very hard to make any -- come to any fundamental conclusion based on a single quarter's book-to-bill. I think, that's why we emphasize the year-end backlog. Where we had an 18% growth over the previous year, which situates us exactly where we want to be, going into the year given our guidance for 2009, we had some strong bookings earlier in the year, just again from timing that they happen to come in from earlier quarters, you really shouldn't read into that fourth quarter affect, it doesn't have any great significance.

Tim Quillin - Stephens, Inc.

That's fair. In the 10-K, you talked about BAE's remote weapons station, which I presume is bulk CROWS and Stryker CROWS was about 13% of revenue in 2008, about $32 million, I mean what was that in 07, how does that compared to year-to-year?

Scott Conner

Hold on one second. While she's looking up, I will tell you that '07 had a greater percentage of -- that's combining two different military programs.

Tim Quillin - Stephens, Inc.

Right.

Scott Conner

The reason its combined is that the products that we deliver is largely the same, but it's providing (ph) funding sources for those different programs, and 2007 had a greater percentage of Stryker, 2008 had a greater percentage of CROWS, I just gave you that background because it won't really -- when we give you the total combination, you're not going to be seeing that shift come into place.

Tim Quillin - Stephens, Inc.

And maybe while you're looking that up, I can sneak in a question here in terms of the imaging gross margins, which were -- came in about 30% for the full year. Is that kind of the way we should look at it going into '09?

David Almeida

Yeah, that's about what we expect those margins to be, 30% imaging, and the low to mid 40s for surveillance.

Tim Quillin - Stephens, Inc.

Perfect.

Scott Conner

And now I have your answer. I think in '07 that combines -- those two combined products were 9.4 million roughly in 2007, and I guess in 2008 I guess 13 or something like that. Again just as you understand, there is a mix shift it's going on in there as well from the ultimate funding source from Stryker to CROWS also that's going on.

Tim Quillin - Stephens, Inc.

In '07 was that 9.4 million or 9.4%?

David Almeida

Million.

Tim Quillin - Stephens, Inc.

Million. Okay, versus 32 million in '08. Okay, thank you.

Operator

Our next question comes from the line of Paul Coster of JP Morgan. Please proceed.

Paul Coster - JP Morgan

Thank you. Good morning. Your growth rate domestically was stronger than international in '08. But in the prepared remarks there, I just got a sense that international business on the imaging side is about to lift off or at least has very strong momentum. Do you think the percentage of revenues coming from international will change in '09 over '08?

Scott Conner

That's an excellent question. And it largely as a result of the fact is the surveillance business has an increasing percentage of international business, and it is growing as the percentage of the business, always we expected to increase this as a total size of the business. The Imaging System business has left potential impact for international business because it's primarily serving U.S. military vehicles. But the international -- on the surveillance side, the international percentage will grow and the surveillance because the bigger percentage of the total buy by definition international should grow in 2009 and in fact probably beyond.

Stephen Bershad

The absolute number will grow year-over-year.

Paul Coster - JP Morgan

I am new to stock, so if you give this question, but in issuing this guidance how did you review this conservative and what are the potentially the biggest sort of external factors that could change the numbers either to the upside or downside?

Scott Conner

Are you still there?

Paul Coster - JP Morgan

Yup.

Scott Conner

Yeah. We heard a click, I wasn't sure if something had happened. So the imaging side of the business is a much more predictable business, and that is roughly two-thirds of our company right now. And in fact represents a large chunk of the backlog because the book-to-bill is quite long in that business. And so that gives us a lot of visibility in that side of the business.

The surveillance business which is -- you can think of it land Maritime and airborne gimbal camera systems, full camera systems is a cost product, is a shorter book-to-bill say four months between the time that you maybe three to four months, between the time that you book contract and the time that you ship it. So, there is a lot more variability in that business both on the up and downside. So, you can have the possibility to get big win and you have the more opportunities. So, of the one-third of our business has that greater variability in revenue.

Paul Coster - JP Morgan

Okay. The last question are there any big contracts outside of DVE that could positively impact the Imaging business for the potentially in the next 12 months?

Scott Conner

We don't consider DVE, a particularly large program, particularly in '09 as I mentioned because even if we were involved, the ramp it doesn't start late in the year, so I do not think that I have particularly upside in 2009.

And the possibility to have a big uptick in 2009 in imaging is limited because we already have three quarters roughly of the year already in contract that we're going to be shipping. So now there is not a dramatic upside in imaging side in the current year.

Paul Coster - JP Morgan

Okay. Thank you.

Operator

Our next question comes from the line of Brian Ruttenbur of Morgan Keegan. Please proceed.

Brian Ruttenbur - Morgan Keegan & Company Inc.

Okay. Thanks very much. First of all, just some housekeeping questions, tax rate going forward, can you give us that, and then cash flow anticipated in '09?

David Almeida

Sure. Tax rate going forward in '09 again, these things move around but right now we're expecting just about a 37% tax rate for '09.

Brian Ruttenbur - Morgan Keegan & Company Inc.

Okay. And then cash flow from operations, how much cash do you expect to generate to the balance sheet?

David Almeida

Yeah. Cash I think I have mentioned earlier in my script. We expect to convert about 60% of our net income which equates $18 to $20 million somewhere in that range of free cash flow.

Brian Ruttenbur - Morgan Keegan & Company Inc.

Okay. And maybe I should ask the question differently on the cash flow side. How is that going to be weighted throughout the year, is it going to be even or is it going to all be back end like '08?

Stephen Bershad

It's never even. And actually normally first quarter is normally a low quarter and we're going to see if we're going and try to manage that through the year. So it's not is back end loaded but again some of that depends on our built schedules and the timing of building inventories and what not for orders so.

Brian Ruttenbur - Morgan Keegan & Company Inc.

Okay.

David Almeida

To answer that because we haven't given quarterly guidance as you know we've just given the annual guidance so.

Brian Ruttenbur - Morgan Keegan & Company Inc.

Okay. And then as I calculate gross margins just from what you'd said earlier in answering questions. I'm getting about 34.5% on the year, is that what you're thinking gross margin is going to shake out?

David Almeida

That's not in realistic. We have been provided guidance specifically for gross margin but as I say we ended '08 at around 34%. And we expect to achieve 2008 levels and hopefully improve them, so that's none other range.

Brian Ruttenbur - Morgan Keegan & Company Inc.

Okay and then just couple more questions along these lines. SG&A should trend upward or flat from '08?

David Almeida

As a percent -- it's going to go up in relative dollars. But again hopefully we'll continue to get some leverage as we grow to top-line by about 60%.

Brian Ruttenbur - Morgan Keegan & Company Inc.

Okay. And R&D is the same thing?

David Almeida

R&D, we expect our R&D will be around the level that has been in the fourth quarter, we've been about a 4% rate of R&D per share (ph). And that's the level we expect in '09. For the full year of '08 with 3.6 so that is actually up from '08.

Brian Ruttenbur - Morgan Keegan & Company Inc.

Okay. As a total amount it'd be around $10 million is that where you are shooting for?

David Almeida

We have designed 4% of our guidance.

Brian Ruttenbur - Morgan Keegan & Company Inc.

Okay.

David Almeida

Is that right?

Brian Ruttenbur - Morgan Keegan & Company Inc.

That's it around that. Great thank you very much.

David Almeida

You're welcome.

Operator

The next question comes from the line of Kevin Putney of Boenning and Scattergood. Please proceed.

Kevin Putney - Boenning and Scattergood

Good morning guys. Thanks for taking my question.

Stephen Bershad

Good morning.

Kevin Putney - Boenning and Scattergood

Can you give us a ballpark idea where utilization stands in international plan. And whether there is any further issues or CapEx spend that looks like it may have to take place related to that. They would have an effect on margins in '09?

Stephen Bershad

No, in fact we're in a good -- we're not at full utilization that in fact that wasn't intentional. We actually see great growth potential in this business and we think we can do a lot with this second facility in national. So there should not need -- although we said the last time there should be clear that we threw lot of our previous building lot faster than we expected. In fact that will all be great for all of us if that actually occurs. But we currently believe we have sufficient space in the new facility to grow quite a bit with our cameras and gimbals in that new line. And we have additional space in our infrared lens business as well. So I think we're very well positioned from a capacity utilization standpoint.

Kevin Putney - Boenning and Scattergood

Okay. And then looking at bookings, can you give us an idea of how many were, how much of that was follow on versus new customers in the quarter?

Stephen Bershad

We don't have that, reasonable question but I'm afraid I just don't have that with us.

Kevin Putney - Boenning and Scattergood

Okay. And then in terms of the troop ramping in Afghanistan, are you guys getting any feel for what's going to be necessary there in terms of equipment, I guess specifically looking MRAP and CROWS et cetera.

Scott Conner

It's hard for me to answer with specific program. There a discussion in the press focuses on most generally, surveillance reconnaissance and targeting, in fact, the Commander General -- they're supposed to get, and in fact the Commander In-Charge of Afghanistan specifically said their number one priority is greater surveillance capability. They want to have persistent surveillance, and it's the number one priority for Afghanistan, so that's of course very good in general. We've also heard that there is greater need for ground vehicles and UAVs as well, those seem to be the high priorities. All of these bode well for both our Imaging Systems business and our Surveillance business. So -- well I can't point to specific things; the trends seem to be in our favor.

Kevin Putney - Boenning and Scattergood

Okay. And last question. Can you give an update on kind of what kind of attraction you're seeing with the few other agencies here domestically?

Scott Conner

Increased, just let me say that, I can't disclose very much to be honest. But we're doing more work with few other agencies than we have in the past.

Kevin Putney - Boenning and Scattergood

Okay. Fair enough. Thanks.

Operator

Our next question comes from the line of Rick Pat (ph) of Columbia Management. Please proceed.

Unidentified Analyst

Good morning.

Stephen Bershad

Good morning.

David Almeida

Morning, Rick.

Unidentified Analyst

The acquisition had an earn out component, I'm sorry if you address this, I had to get off for a minute, but what I assume that's they're going to earn the whole should match, (ph) what's the timing and the expected dollar amount on that?

David Almeida

No, right now, it would be timeframe is -- the acquisitions made under 13th of April, 2007 and that was a three year earn out and was a significant earn out in fact that they would be happy to pay the earn out if we had it because it was very substantial but previously curve. That's for we paid earn out for this sub-year of 2007 about $3 million, and then this year the earn out that we recently paid -- are going to pay in 2009, for 2008 is around $800,000. And we'll have basically the earned out remaining will be for the remainder of 2009 and for the January to April 13, 2010.

Unidentified Analyst

And, but you're saying it substantial so, could it still be substantial from here or numbers like we saw in the prior two years?

David Almeida

Yes, I think it made up a blow than the door is off. I think it could potentially be in the range of $8 to $9 million in that might few range, yes $8 to $9 million.

Unidentified Analyst

Okay

David Almeida

If that would have to be a pretty dramatic result.

Stephen Bershad

That's not in any of the anticipated numbers that we've been discussing in terms of our guidance. So those kinds of results are considerably in excess with any thing we anticipate.

Unidentified Analyst

Okay. My recollection was and I don't recall the specifics. But I thought that the entire opportunity was much more than something like $10 or $11 million at the time you announced the deal. Was you assuming at much higher levels or....

David Almeida

Yeah I mean the reason they could ever earned, I think the total was something like 42 million.

Unidentified Analyst

Yes. Okay.

David Almeida

But to have achieved that the results were would have been remarkable. I mean would have been very, very high to actually get but you haven't get to disclose what they could potentially earn of course that would had a potential effect on investors. But it has a very, very high number.

Stephen Bershad

And that's was part just part of the arrangement in deal.

Unidentified Analyst

Okay. All right, I appreciate the insights. Thanks.

Stephen Bershad

You're welcome.

Operator: (Operator Instructions). Our next question comes from the line of Tim Quillin of Stephens Incorporated. Please proceed.

Tim Quillin - Stephens, Inc.

Hey I apologize I just didn't want to confuse anybody. I just want to read out of the 10-K it says our infrared lens products which are used in BAE systems remote, weapon station program represent 13% of OE revenue. Is that the entire infrared lens products business or just CROWS and Stryker which was, 13% would be 32 million in revenue in '08.

Stephen Bershad

CROWS and Stryker not the whole infrared business, that's just CROWS and Stryker.

Tim Quillin - Stephens, Inc.

Okay. And that's versus 9.4 million in '07?

Stephen Bershad

Yes.

Tim Quillin - Stephens, Inc.

Okay, I'm sorry. And then other question is...

Stephen Bershad

Under little low at the end of '07 but I need to I think and seems low to me and I'm unfortunately we didn't get the document. If it's incorrect I'll ask to correct it but it sounds lower...

Tim Quillin - Stephens, Inc.

We can talk about offline...

(Multiple Speaker)

Tim Quillin - Stephens, Inc.

And then in terms of the Surveillance business, we came into this year with a lot of momentum behind it, still nice growth rates but sequentially from first quarter to fourth quarter, we haven't seen a huge amount of growth in first quarter of '08 to fourth quarter of '08. There is some kind of -- would you expect any kind of inflection of this for instance from MS2 or what should we look for in terms of growth catalyst and in acceleration and sequential growth in '09? Thank you.

Stephen Bershad

Sure, no problem. I think that there is a number of things that are going to kind of affect the ongoing growth. The easiest one to point to as you're asking for our new products development as I mentioned the V9 that's part of why there is an excitement because that can create incremental markets that we can pursue. However, we're also pursuing new market by expansion of channels, geographic expansion which we really haven't done dramatic amounts in the past. And so that is harder for you to say okay, well this is going to lead to something, it's going to be incremental increases. But the easiest thing to point to you again was that you could see with the new product introductions.

Tim Quillin - Stephens, Inc.

Okay. And still looking for high-teens to 20% type top-line growth in that segment in '09?

Stephen Bershad

Yes.

Tim Quillin - Stephens, Inc.

Thank you.

Operator

Our next question comes from the line of Steve Levenson of Stifel Nicolaus. Please proceed.

Steve Levenson - Stifel Nicolaus

Thanks. Just had two follow-ups, one was for Dave. Can you tell us about the tax rate in the fourth quarter and what you expect it to be in 2009? And the other question is what's going on in the sensor detector market? Are prices still coming down or do new innovations make them stabilize or go up, and how does that affect your camera pricing?

David Almeida

Okay. On the taxes -- yes the tax rate for the fourth quarter was 38.7%, little higher than we expected, I think in our last call I had -- I thought that rate would come in around 36%. Based upon our final balance sheet and the composition of the final balance sheet, we actually had some things that affected our manufacturing deductions and we get too much technical detail but that actually caused our tax rate to go up higher than I expected along with some other things that we had estimated in our rate when I reported the 36% rate.

For 2009, now we're expecting our rates to be around 37%. That can change and will change with any reserve adjustment based upon the new FIN 48 rules. But right row we're expecting normalized rate of around 37% for 2009.

Steve Levenson - Stifel Nicolaus

Thanks.

Scott Conner

Regarding the second question with sensors, there's not a simple answer, well let me just give you a simple answer. There is a constant increase in price performance of detectors out there and innovation that's going on. And to get back to my first statement, the reason it's not a simple answer is that it affects the different -- different markets differently. In the high-end long range surveillance area, of course the -- what the customers won't be able to do is take that higher performance product and there is less price sensitive. So they just want to leverage the new capabilities of the new detectors.

In the lower end commercial surveillance, what's happening is that price -- at the price reduction for a similar performance is driving price points down, which in fact is what drove us into the -- or why we're reemerging in the un-core camera area. And as Steve had mentioned in his comments we -- during the year we reintroduced our un-core product line to attack the commercial and lower range military market which is perfect for us because the lens is becoming a larger and larger percentage of that solution.

So again, different parts of the market is taking the new price performance capabilities to detectors and using them differently. But we certainly expect that that trend for increased price performance of detectors is going to continue and that of course leads the ongoing growth and opportunity for us.

Steve Levenson - Stifel Nicolaus

Okay. Thank you.

David Almeida

Sure.

Operator

Our next question comes from the line of Michael French of Morgan Joseph. Please proceed.

Michael French - Morgan Joseph

Hello again. Just a quick follow-up question here on cash, it's a nice balance for you guys, and there is two questions. Are you still interested in pursuing acquisitions, and I mean I'm sure you are but if you could discuss what the landscape looks like now. And also if you would consider buying stock at this levels with the cash that are up?

Stephen Bershad

Let me just address the stock issue and then I'll let Scott talk about the acquisition opportunities. The short answer to the stock repurchase issue is probably not. We still think there are enough opportunities out there that we're pursuing that we think it has bidding our cash is probably the best strategy for us going forward especially in the environment that we're currently facing where debt is more difficult to obtain. Although we think is certainly obtainable, but we can't rely on that exclusively in this requirement. So, in the near-term I don't anticipate any stock repurchase.

Scott Conner

In terms of acquisitions, as I think you know, we view despite the fact we haven't done lot of that, we use acquisitions as a very important strategic tool for us and we're constantly evaluating company. I think the biggest change that has occurred as a result of the downturn in the market is that I -- with number of opportunities that we have lost making businesses because people are trying to rush to get out of their as the positions that they're in. That will be very effective for us of course. But certainly the activity continues to remain high, but there is nothing in the immediate offerings that we're pursuing that will have an affect in the short-term.

Michael French - Morgan Joseph

Okay. Thank you and good luck.

Stephen Bershad

Thank you.

Operator

That concludes the Q&A portion of the presentation. I would now like to turn the call over to Mr. Stephen Bershad.

Stephen Bershad

Well, thank you, operator. And thank you everyone for joining us this morning. We're obviously pleased to have delivered another quarter of strong growth for our shareholders and we appreciate your continued support. We look forward to updating you on our achievements in the coming months. Thank you.

Operator

Ladies and gentlemen, that concludes our presentation today. You may now disconnect. Have a good day.

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