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FLIR Systems (NASDAQ:FLIR)

Q4 2013 Earnings Call

February 07, 2014 11:00 am ET

Executives

William W. Davis - Senior Vice President, General Counsel and Secretary

Andrew C. Teich - Chief Executive Officer, President and Director

Anthony L. Trunzo - Chief Financial Officer and Senior Vice President of Finance

Thomas A. Surran - Chief Operating Officer

Jeffrey D. Frank - Vice President of Global Product Strategy

Analysts

Noah Poponak - Goldman Sachs Group Inc., Research Division

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Timothy J. Quillin - Stephens Inc., Research Division

Peter J. Arment - Sterne Agee & Leach Inc., Research Division

James Ricchiuti - Needham & Company, LLC, Research Division

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Jonathan Ho - William Blair & Company L.L.C., Research Division

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

Operator

Greetings, and welcome to the FLIR Systems, Inc. Fourth Quarter 2013 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Wit Davis, Senior Vice President, General Counsel and Secretary for FLIR Systems. Thank you. You may begin.

William W. Davis

Good morning, everyone. Before we begin this conference call, I need to remind you that other than statements of historical facts, statements made on this conference call are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are based on our current expectations.

Words such as expects, anticipates, intends, believes, estimates and variations of such words and similar expressions are intended to identify such forward-looking statements. All of these statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the press release we issued earlier today for a description of factors that could cause actual results to differ materially from those forecast. The forward-looking statements we make today speak as of today, and we do not undertake any obligation to update any such statements to reflect events or circumstances occurring after today.

Let me now turn the call over to Andy Teich, President and CEO of FLIR Systems. Andy?

Andrew C. Teich

Thank you, Wit, and thank you, everyone, for joining us this morning for FLIR's fourth quarter 2013 earnings call. With me on the call today is our CFO, Tony Trunzo; Tom Surran, the former President of our Commercial Systems division and new COO of FLIR; and Jeff Frank, our Senior Vice President of Product Strategy.

This morning we reported fourth quarter revenue of $400 million and earnings per share of $0.20. This EPS result included after-tax charges of $21 million for restructuring expenses and retirement benefit expenses for our former CEO. Excluding these charges, Q4 earnings were $0.35 per share. We saw good revenue growth in our commercial businesses, but lower revenue from U.S. government kept overall revenue growth to 4% for the quarter, and margins declined due to less favorable mix and higher spending related to marketing and product launches.

We expect the recent restructuring actions we've implemented will manifest themselves in improve margins in the second half of 2014, but first half 2014 operating margins will be lower than prior year.

Operating cash flow during the quarter was very strong. And for the year, we generated a record $355 million in cash from operations, an increase of 24% over 2012, as we saw progress in our efforts to reduce working capital.

The Commercial Systems division increased revenue 15% versus the fourth quarter of 2012, with all 3 geographic regions growing, led by a nice recovery in the EMEA region. The number of thermal imaging products shipped by our commercial businesses grew over 40% versus Q4 of 2012.

Government Systems division revenue declined 10% year-over-year, driven largely by weak domestic DoD demand, partly offset by double-digit growth from international markets.

We have begun this year with some exciting product launches that we believe will change the game and finally bring thermal technology to the mass market.

At the Consumer Electronics Show, we introduced FLIR ONE, a thermal imaging smartphone case at a remarkable price of $349, representing our first true entry into the consumer electronics market. The market reaction to this product has been quite positive, and we've already seen the knock-on effects of overall awareness building that it is bringing to our other markets.

FLIR ONE is enabled by our new Lepton thermal imaging micro core, which was also introduced at CES.

Lepton is a result of a 3-year ground-up camera development that truly maximizes our size, weight, power and cost reduction mantra.

Lepton delivers thermal imaging technology in a package similar in size, weight, power and electrical interface to a conventional CMOS smartphone camera module.

Lepton's been developed with a strong focus on core intellectual property innovation, specifically in the areas of high-volume wafer-scale detector packaging, low-cost wafer-scale optics production and low-power camera-on-chip electronics.

We anticipate that Lepton's power consumption, calibration process and onboard image signal processing will enable multiple high-volume potential markets and platforms. Needless to say, we're very excited about the potential for both FLIR ONE and Lepton.

As we announced 2 weeks ago, Bill Sundermeier, President of the Government Systems division, will be leaving the company at the end of this month. I'd like to thank Bill for his contribution and dedication over the past 19 years. We wish him the best in his next endeavor.

Concurrently, Tom Surran has become FLIR's Senior Vice President and Chief Operating Officer, overseeing all of our current business segments. This change will effectively eliminate the commercial and government divisional structure we have had for the past 8 years.

By streamlining our organization, we can further strengthen company-wide communication, collaboration and cooperation, while creating a logical structure that further leverages our vertical integration and focuses on our core markets.

Also as a result of this change, we are modifying our segment reporting to reflect the changing dynamics of our market and to better align our strategy with our customer base. Beginning in Q1 of 2014, we will report our results in 6 segments: Surveillance, which will include the current Surveillance business, plus much of our Integrated System segment; Detection, which will include the current Detection business, plus the detection-oriented programs of the Integrated Systems business; Instruments, which will house our thermography and test and measurement business, which is targeted primarily at commercial and industrial markets; Security, which will include our Lorex consumer security cameras, as well as FLIR-branded professional thermal and visible security products; Maritime, which will encompass Raymarine, plus FLIR-branded maritime thermal imaging products previously held inside of TVM; and OEM and Emerging, which will include our OEM Personal Vision Systems, mobile accessories and intelligent traffic solutions lines of business.

Today, we announced our outlook for 2014. We're expecting revenues of between $1.45 billion and $1.55 billion for the full year, and earnings per diluted share in the range of $1.40 to $1.50, which excludes expenses related to restructuring actions. This outlook assumes meaningful growth in many of our commercial businesses, but is tempered by U.S. DoD softness and product mix challenges, particularly in the first half.

With that, I'll now pass the call over to Tony to review the fourth quarter and full year financials. Tony?

Anthony L. Trunzo

Thanks, Andy. The following discussion of pretax operating results for the fourth quarter and full year 2013 excludes restructuring and other onetime costs totaling $31 million.

Of the $31 million amount, $25.8 million is reflected in a line item titled Restructuring within operating expenses.

In addition, there is $1.7 million of cost in cost of goods sold related to inventory write-downs for terminated product lines as a result of our restructuring actions, and $3.5 million in SG&A related to the settlement of retirement benefits paid during the quarter.

Fourth quarter consolidated revenue was $400 million, an increase of 4% compared to the fourth quarter of 2012.

International revenue was 55% of the Q4 total, and was 50% for the year, the highest proportion in at least 12 years.

Sales to U.S. government represented 18% of total revenue in Q4 compared to 28% of revenue in the fourth quarter of 2013 -- 2012, excuse me.

Consolidated Q4 gross margin before unusual items was 47.9% compared to 53.2% last year. Consolidated operating margin before unusual items was 17.2% compared with 26% in the fourth quarter of 2012.

Research and development expenses increased by 13%, partially due to the costs associated with the development of several new products, primarily in the TVM segment.

Selling, general and administrative expenses were up by 19% due to higher compensation expense, as well as the inclusion of $6.2 million in SG&A related to the acquisitions of Lorex and Traficon.

Net earnings, excluding restructuring and onetime items, was $49.7 million and earnings per fully diluted share were $0.35 in the quarter.

Moving to segment results. Surveillance segment Q4 revenue of $124.7 million was 9% below Q4 2012, and segment operating income of $28.8 million was 36% lower than last year.

Lower revenue was attributed primarily to a significant decline in deliveries of large gimbal systems out of our Portland factory. Lower Portland revenue also had a significant negative impact on gross margin.

Integrated Systems segment revenue of $17.9 million represented a drop of 27% from Q4 of 2012, which resulted in a $300,000 operating loss for the quarter compared to operating income of $3.9 million last Q4.

Detection revenue increased by 3% to $13.2 million and operating income was essentially unchanged at $800,000.

TVM segment revenue increased by 16% to $208.5 million due to higher systems revenue and the inclusion of Lorex and Traficon, partially offset by a 55% decline in delivery to U.S. military OEM customers.

TVM segment operating income was $53.2 million, down 14% versus Q4 of 2012 due to the significant margin impact of the revenue shift described above, as well as higher engineering costs related to new product development and SG&A costs associated with the acquired businesses.

Raymarine revenue of $36.1 million represented a 10% increase from Q4 of 2012, and the segment posted an operating profit of $200,000 compared to an operating profit of $1.2 million in Q4 of 2012, with the decline primarily due to higher warranty costs and unfavorable inventory absorption.

For the full year 2013, international revenue represented a record 50% of the total, continuing a 5-year upward trend, while sales to the U.S. government were 24% of the annual total, representing the lowest percentage since at least 2001.

Full year gross margin, excluding restructuring expenses, was 49.4% compared to 52.3% last year, due to unfavorable product mix in Surveillance, higher Integrated Systems delivery at lower margin and the inclusion of Lorex revenue also of lower margin.

TVM reported 2013 operating income of $178.7 million, up 2% over 2012 and Raymarine segment operating income improved by 30% to $14.5 million for the quarter. Surveillance segment operating income was $129.6 million compared with $160 million in 2012. Detection posted operating income of $4 million compared to $4.4 million in 2012, while Integrated Systems operating loss of $100,000 compared to operating income of $5.2 million in 2012.

Full year selling, general and administrative expenses were $319.2 million, an increase of 11% due to Lorex, Traficon and other acquisitions, as well as higher compensation costs.

Our reported tax expense in Q4 was $6.4 million or 18.2% of GAAP pretax quarterly net income. And for the full year, our tax rate came in at 22.7%. The fourth quarter expense reflects downward adjustments to the full year based on reconciliation of estimated tax expense booked in the first 3 quarters of the year, as well as benefits recognized in connection with the business realignment.

Cash provided by operations for the fourth quarter was $105.2 million. And for the full year, we posted record cash from operations of $355 million, an increase of 24% from 2012.

During Q4, we purchased 1 million shares of our stock at an average price of $28.95 per share. For all of 2013, we repurchased 6 million shares of stock at an average price of $27.07, and have 19 million shares remaining under our current authorization which expires in February 2015.

Looking toward 2014, we currently expect revenue for the year to be in the range of $1.45 billion to $1.55 billion, and earnings per fully diluted share to be in the range of $1.40 to $1.50, excluding remaining charges related to our restructuring initiative and potential further realignment activity.

We also anticipate continued product mix challenges in our government businesses, particularly in the first half of the year, but expect to see accelerating growth in the second half arising from new product introduction. As a result, we expect first quarter earnings to be significantly below Q1 of last year and see sequential improvement each quarter throughout the year.

As Andy mentioned, we have decided to realign the business into 6 new segments to better reflect how we're aligned with our customers in the market and to provide greater clarity to the investment community. We'll begin reporting these new segments with our Q1 financials, and we'll recast [ph] the comparable financials from 2012 and 2013 for comparative purposes.

We also announced an 11% increase in our quarterly dividend today to $0.10 per share, reflecting our -- per share per quarter, reflecting our continued commitment to appropriate capital deployment that includes a combination of direct and indirect return of capital via dividends and shares repurchase, along with continued capital investment and M&A activity.

For 2014, we're expecting to continue our long-standing approach to share repurchase, whereby repurchase activity is governed by our view of relative value and expected capital needs. This concludes the summary of our fourth quarter and annual financial results. Let me now turn the call over to Tom Surran to cover our operational highlights for Q4.

Thomas A. Surran

Thank you, Tony. The Commercial Systems division finished the fourth quarter with a 15% increase in revenue compared to the prior year. The inclusion of Lorex and Traficon, as well as growth in the Raymarine, FLIR-branded maritime and PVS businesses, was partially offset by a decline in the OEM businesses, due mainly to reduced shipments to government-funded customers. Excluding the OEM business, the division grew nearly 30% over the prior year.

The commercial division recorded $17.7 million of pretax restructuring charges related to our previously announced plans to close 3 sites and transfer those operations to Santa Barbara and Täby, Sweden. We expect these changes to result in meaningful, long-term productivity and cost benefits and improve our product development and production capabilities.

On a regional basis, Commercial Systems grew revenue in all regions, with growth in the Americas of 14%, EMEA of 21%, and APAC of 6%, as compared to the fourth quarter of 2012.

Revenue from TVM's thermography line of business was roughly flat from a year ago, with growth from our new Ex-Series, firefighting and automation products being offset by weakness in predictive maintenance, building products and high-end R&D instruments.

Thermography bookings improved throughout the year in comparison to the prior year, with Q4 achieving an all-time high level of bookings for a quarter. Our systems business within TVM had revenue growth of over 30%, which was partially offset by a 24% drop in OEM revenue compared to last Q4. The decline in OEM revenue was largely the result of a more than 50% drop in shipments of cooled cores to military customers.

However, the unit volume shipped in the OEM business increased over 80% in the fourth quarter, as units shipped for the automotive market have nearly tripled with the launch of our product in selected Mercedes-Benz vehicles.

The Security line of business revenue, excluding Lorex, declined 9% versus the prior year. On a units shipped basis, however, fourth quarter growth was over 17% in Security, driven by our uncooled security cameras.

Lorex revenue was up nearly 30% versus their pre-acquisition performance in Q4 of 2012. These 2 businesses will come together to form our new Security segment and they are already working together on product development as demonstrated by the development of the consumer-oriented FLIR FX wireless IP camera system that was debuted at the CES in January.

The FLIR FX is a unique modular visible light camera that can be integrated with several optional enclosures and mounts, such as a surveillance camera, baby monitor dashboard camera and an action sports camera. So it will be priced at $249 and available early summer this year.

The Personal Vision Systems line of business had revenue growth of 22% versus the fourth quarter of 2012. In addition to the FLIR ONE launch, our PVS business also introduced the ThermoSight R-Series in January. This is FLIR's entry product to the recreational rifle scope market. Its introduction has created a new class of thermal imaging scope due to its pricing, which starts at $3,499. We are seeing a positive market reaction to the product as it makes thermal imaging affordable to a larger number of hunters. With these introductions and future product plans, we are optimistic about the continued growth prospects of the PVS business.

TVM's maritime business saw revenue grow 45% compared to Q4 of 2012. Strong results from our M-Series pan-tilt systems and our new MD-Series fixed cameras helped drive growth this quarter, as did the shipment of several of our high-end MU-Series stabilized multi-sensor imaging systems.

Raymarine exhibited double-digit growth year-over-year for the second consecutive quarter, with revenue up 10% over the fourth quarter of 2012.

Both the Americas and EMEA regions grew in the teens, offset by a weaker-than-normal APAC region.

Moving over to the Government Systems, divisional revenue declined 10% versus the fourth quarter of 2012. As we indicated on the Q3 call, the flow-through of soft Q3 bookings had a significant negative effect on Q4 performance.

For the full year, orders from the DoD were down 51% from 2012, which was partially offset by non-DoD order growth of 35%.

Revenue from our foreign end-users eclipsed 50% of total division revenue for the quarter, a first in our history.

Profitability was negatively impacted by $9.6 million restructuring charges, as well as unfavorable product mix.

Surveillance segment Q4 revenue was down 9% year-over-year, driven by a weak U.S. DoD activity, partially offset by a 7% growth in international revenue. Impacting surveillance operating profit in the fourth quarter was nearly $3.6 million in charges related to the consolidation of Swedish manufacturing and engineering operations, elimination of certain product lines and consolidation of 2 optics businesses. We are optimistic about, not only the positive cost implications of the changes, but also the enhanced productivity and innovation we can expect from the realignment of these operations.

Detection segment fourth quarter revenue grew 3% versus the prior year, with product revenue growing 19%, and government-funded R&D revenue decreasing 23%. While funded R&D is declining as we rationalize the projects we choose to contract, it remains an important element of Detection's product and customer relationship development and we expect to maintain a certain level of funded R&D as we evolve our SeaFLIR marine technology with broader adoption.

In the fourth quarter, Detection recognized a $4.2 million restructuring charge related to the continued consolidation of the radiation business by moving many assets that were located in Germany to our facility in Oak Ridge, Tennessee, which we will -- envision will create a more agile product development operation.

Integrated Systems revenue and margins were down in comparison to a strong fourth quarter of 2012, where there were significant shipments of COSFPS from DRC units. Segment profitability was also negatively impacted by $1.8 million in charges related to the closure of one manufacturing facility. Segment backlog increased by $7 million during the fourth quarter, due primarily to the receipt of a second order under the $102 million IDIQ contract for MSC units from the Department of Homeland Security CBP. We expect further orders in 2014 based on feedback from our customers regarding initial shipment. We also received an additional $7 million of LRIP funding for our DR-SKO multi-threat identification system. We believe this program will generate significant value for us in the coming years.

That concludes my summary of the divisions' fourth quarter. I'd now pass the call back to Andy.

Andrew C. Teich

Thank you, Tom. While our results for 2013 did not meet our expectations, the steps we've taken to reduce cost, streamline operations and improve our organizational structure position us well for the future.

The introduction of Lepton, FLIR ONE and FLIR FX at CES in January are examples of what you'll see from FLIR in the coming years: great product development, entry into exciting new markets and continued focus on bringing high-value, low-cost sensing technologies to an array of global markets.

We also see opportunities in our government business, driven by continued technological innovation under our CDMQ model and growth opportunities outside the U.S., where we feel we have a significant competitive position. We remain committed to being a leader in CDMQ products for demanding high-value applications.

2014 will have several transition elements as we continue to navigate through weaker demand and government markets. We will have additional restructuring charges early in the year associated with our organizational changes and ongoing cost from last year's realignment. Our margins will be challenged early in the year due to weaker mix in our traditional government business compared to a strong mix early in 2013. The benefits from the restructuring and stronger margin performance will manifest themselves in a much stronger second half.

That concludes our comments on the fourth quarter. We'll now open the call up for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Noah Poponak with Goldman Sachs.

Noah Poponak - Goldman Sachs Group Inc., Research Division

Now that you've launched Lepton and the FLIR ONE piece, specifically -- I guess, I wanted to kind of ask you, high level, if you were us, if you were an investor, how would you attempt to estimate the potential revenue and earnings contribution from Lepton or even just from the FLIR ONE piece? Specifically, how can we all get our arms around exactly what this could be over the next 1, 2, 3 years? It seems like the range of potential outcomes is extremely wide.

Andrew C. Teich

Noah, you hit the nail on the head there. The range of potential outcomes is wide. And honestly, we don't know that yet. It's a new category. Both products represent new technology into a new category that doesn't exist. So it's very difficult to understand what the market reaction is going to be to either of those products. For us, we've conservatively budgeted FLIR ONE for 2014, and Lepton very conservatively because, fundamentally, it's an OEM core that is going to require a design cycle to be designed into the kinds of products that we envision it going into and to end markets from an OEM standpoint. So it will not have any meaningful impact in revenue in 2014. It will be a 2015 play. The issue for us -- and really back to that point, we'll have more clarity on that as the year goes forward. I think as we come towards the latter part of 2014, we'll have a much better understanding of what the OEM adoption is going to be. We'll have a much better understanding of what the FLIR ONE adoption looks like from the retail channel perspective and we'll be able to provide a stronger guidance there. I think the one thing that we can talk about is what we've seen so far on FLIR ONE. And I'll actually -- I'll turn the call over to Jeff. Maybe he can comment. He was on the forefront of the line at CES to talk about what happened with FLIR ONE there.

Jeffrey D. Frank

This is Jeff Frank. Yes, we had a -- we launched it, as Andy said, at the CES, both FLIR and -- I'm sorry, the Lepton and the FLIR ONE. We're very encouraged by the results we got there. Over the 4-day period, we had literally thousands of visitors in our booth. We had a very good reception from the consumers, the press, the distribution partners and potential OEM partners as well. Probably, from a metric standpoint, immediately before the show opened up, we launched the FLIR ONE website, where we allowed consumers the ability to register and pre-order for the product. And during the 4 days of the show, we registered or received 9,800 pre-orders. And as of today, we stand just shy of 20,000 pre-orders for the product itself. The website also provided the potential developers to sign up to gain access to software development tools that we have under development right now. And this is probably an area that surprises more than any other. During this 4-day show, we signed up 700 developers. And as of today, we stand at almost 1,400 developers. This really kind of blew us away, frankly. The developer interest is most -- is probably the most compelling area. We've started to reach out to this group and are seeing a very high level of both interest and innovation. I think this is a very good indication that we've hit the right price point and the right form factor to reach these consumer markets.

Andrew C. Teich

Yes. I just want to clarify one point on the pre-registrations, just about the terminology there. So what we were doing is collecting information from people that have expressed a strong interest in either procuring or receiving more information about FLIR ONE. And that's the number that Jeff referred to. We're not taking orders as of yet. But our intention, obviously, we're keeping very tight track of the data coming in from those requests. And as soon as we're ready to have the products start shipping, we'll go back to those people and offer them the opportunity to buy via either direct e-commerce channels or retail channels.

Noah Poponak - Goldman Sachs Group Inc., Research Division

Has there been -- well, first of all, that's very helpful color. I appreciate it. Just specifically, has there been any -- have there been any orders or serious interest from retail distributors that are kind of bigger mainstream players?

Andrew C. Teich

Yes. And it's been the logical players that you might imagine in retail consumer electronics product movement. And we're very pleased with the results there. I would add that our connection with these partners through the Lorex acquisition was very favorable. So fundamentally, in all of the meetings that took place at CES with our big-box CE retailer, both online and brick-and-mortar retailers that went on, that we do in the normal course of business during CES through the Lorex channel, they were all exposed to FLIR ONE. And I would say, universally expressed interest in the product.

Operator

Our next question comes from the line of Pete Skibitski with Drexel Hamilton.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Let me -- I want to focus on free cash flow for a minute because that was, obviously, a great year free cash flow-wise. You took out a lot of working capital. Is that momentum -- do think that will continue in 2014? Will working capital expand? Or have you reached the pinnacle there? Can you talk about that?

Anthony L. Trunzo

Yes, Pete, it's Tony. So one minor point that I'll observe. We did have, in Q4, the benefit of the restructuring charges on cash flow. So the cash flow from operations for the year, excluding the effect of those restructuring charges, it's a little hard to nail down, but it was 181%, rather than the 201% for the year that you'd calculate. But still, exceptionally strong. Prior to this year -- prior to 2013, the highest ratio of cash flow to net income we'd have was 128%, so dramatically better. I don't think we're anywhere close to the pinnacle in terms of driving working capital out of the business. It's clearly an objective that we have for 2014 and beyond. One of the conversations we had yesterday at our board meeting centered on getting our return on equity back up to that 20%-plus level. And there's 5 or 6 different things we need to do operationally to make that happen. But one of them is to get our inventory turns up to -- first, up to the peak that we had in the mid-2000s. And then ultimately, up to the -- at least the median of our peer group. And there's a lot of cash to be released there still that we'll start to get at in 2014. And I think the realignment of the business and elimination of the divisional structure is going to have some positive impacts there. Having said all of that, I would not expect cash flow to net income to be as high in 2014 as it was in 2013. I think it will certainly be better than any other year in our history, but I would not anticipate it to reach quite the levels that we had last year because we will have kind of the reverse impact of the restructuring charges from last year, where they'll become cash in 2014. So there's a couple of things there. But overall, I think the trend is going to continue to be substantial improvements in working capital. It's a critical piece of getting our returns on equity and returns on net assets back up to where they need to be.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Okay. And then just one follow-up, Tony. Directionally, on SG&A and R&D, with Lepton completed, should R&D come down meaningfully next year? And will SG&A be up meaningfully because you're kind of moving to more of a consumer-type of footprint? Can you talk about that?

Anthony L. Trunzo

Yes. So R&D is not -- probably not going to be down relative to revenue next year. We've got a pretty robust pipeline of new product introductions centered around Lepton that is going to continue to drive that. I'll talk about SG&A, and then some of my colleagues here might have more comments on the R&D side. We will probably have higher marketing spending in 2014. Unfortunately, we're also going to have higher legal expenses in 2014 compared to 2013 as well. The patent litigation situation for FLIR is, I guess, it's probably normalized. We've gotten to a scale and gotten involved in enough markets, where we're seeing a fairly steady flow of relatively low-level patent and other IP litigation activity. It's not in any way worrisome from a strategic standpoint. But I'm looking at our General Counsel, he's got a few million dollars extra dollars in the plan for 2014 related to cost in that particular area.

Andrew C. Teich

I'm going to ask Tom just to add a little more color commentary on the R&D spending for '14 relative to the Lepton development.

Thomas A. Surran

Sure. Before I go to the specific things on the product side, I do want to say, we do have a business model and R&D level of spending, and we go through a rigorous process to determine what we're going to be working on with those R&D dollars. Now what happened with the Lepton being brought in, we see the opportunity to create especially in new vertical markets and even in our existing markets. And the combination of those, we've got several products that take advantages of what Lepton brings to us and brings to the marketplace. And we're very excited. I just don't want to preannounce what those products specifically are at this time, but it creates some very interesting opportunities for us.

Operator

Our next question comes from the line of Tim Quillin with Stephens Inc.

Timothy J. Quillin - Stephens Inc., Research Division

So what's the right way to think about gross margins, both in the near term and long term? I think especially thinking about those mix issues that you're having in the Surveillance business. And then also, Tony, just a follow-up on the SG&A. I wasn't clear whether that aggregates out to SG&A going up year-over-year or SG&A going flat or down?

Anthony L. Trunzo

Sure. So on the gross margin side, we -- the pieces of the business that were hit hardest in 2013 relative to declines in revenue, yes, we talked about the U.S. DoD pieces, it's interesting. There's -- we've talked about this before. The margins in our Portland facility are meaningfully higher than the margins in our Boston facility. And there's a number of dynamics about that, that we probably don't need to get into right now. But that shift caused a mid-teens-million-dollar negative impact on gross profit dollars in Q4. And compared to what the mix was, particularly in Q1 of 2013, we're looking at a real headwind there in 2014. When you look at the standard margins of our products, there's really been no meaningful change. I'm looking at Tom as well. I'm trying to think of a product line where there's been any meaningful change in our standard margin. So it's all mix. And I think once we wash through some of the things I talked about that are going to happen in Q1 and in Q2, you'll see margin stabilize. They probably aren't going to stabilize in the mid-50s where we were before, but I think you'll see them come back up over the 50% level. In terms of SG&A, let me just take a look here. I mean, clearly, there's going to be an increase in -- well, for the year, Tim, SG&A probably isn't going to go up a lot in absolute dollar terms. There's -- in the first half, you'll see more OpEx than you will in the second half because we'll see the -- we'll start to get some traction on the savings from the restructuring activities that we undertook this year, getting the transition -- getting through the transition on those things, particularly with some of the changes of bigger magnitude, where we're closing factories in Europe and doing things like that, is going to take a little while. But in the second half of the year, I expect the you probably will see -- you will see an improvement in operating expenses relative to the -- relative to what you saw last year.

Andrew C. Teich

And one other thing I'll add to that. As Tony mentioned, there's a marked difference in the total gross margin that comes from the products out of Portland versus out of Boston. And fundamentally, that's one of the issues that Tom will be focused on in his new role in terms of injecting that high level margin generation capability that we have in Portland into the Boston product line. And that work is already ongoing. If you look at Boston's latest product, for example, the 280-HDc is a product that has a very high level of commonality with Portland products. It has a common optical bench that's used in both Boston and Oregon's [ph] product -- Boston and Portland products. We'll be pulling much harder on the vertical integration lever. With regard to optics, lasers and coolers, there's a big opportunity there in terms of Boston products. And then the last issue was something that Tom executed quite well at Raymarine, which is the use of common displays, electronics and interfaces in all the products. Today, Raymarine's multifunction display platforms, for example, all use common components across the entire line. And there's a significant efficiency that comes from that. That said, this is, again, one of the types of things, though, that isn't going to manifest itself until late in '14 or perhaps even early '15.

Timothy J. Quillin - Stephens Inc., Research Division

Great. And then Tony, just on buyback, you mentioned that you will continue buybacks. Do you factor in additional buybacks in the guidance? And does it make sense in the context of improving return on invested capital to recap -- recapitalize the balance sheet with a more major buyback?

Anthony L. Trunzo

We have what I'd consider to be a normal amount of share buybacks in the budget for 2014. We assume that there'll be a little bit each quarter. It's not going to be a huge driver at the levels we're looking at to be -- to the results for the year, maybe a couple of pennies. As to a major buyback, we talk about it every now and then. It's certainly not something that I'd tell you we have in the plan right now, but we do talk about it. It's -- we're -- we have a lot on our plate, obviously. But there's also some interesting M&A opportunities out there that if we were to act on them can have a real strategic impact on the business. And I think we continue to see the opportunity there as one that we don't want to necessarily miss because we get overly aggressive in the buyback.

Operator

Our next question comes from the line of Peter Arment with Sterne Agee Group.

Peter J. Arment - Sterne Agee & Leach Inc., Research Division

Tony, just a clarification on the restructuring savings. I think, previously, you mentioned that the bulk of it was going to flow through on the SG&A side. Is that correct?

Anthony L. Trunzo

Pete, I don't have that in front of me. There's a fair bit of it that's going to come through -- there's a fair bit of it that's going to come through COGS. I guess there's probably -- more than half of it is going to be SG&A, but I'd have to go back and look at the detail on that. What we talked about, I think, in Q4 was the benefit this year was going to be kind of low-8 figure benefit, and then meaningfully more than that in 2015. And that's proving out. The numbers that we talked about in October -- on the October call, they're very consistent with the numbers that we're looking at today.

Peter J. Arment - Sterne Agee & Leach Inc., Research Division

Okay. And then just -- if I could just follow up on the guidance. And I know, obviously, we've got the new segments that are going to be classified in Q1, but you talk about the government business. There's obviously -- and you guys are a little bit more on the book-and-ship side, but your backlog has held in there quite well. Could you maybe just kind of connect the dots there of what we're seeing, because it seems like the fiscal '15 budget that will be introduced in early March is also going to be relatively flat year-over-year. So the government profile and the base budget looks relatively flat. I'm just trying to understand the overall weakness that we're seeing.

Andrew C. Teich

So fundamentally, Peter, what you're seeing there is our budgeting for the business is also flat as well. And driven by uncertainty in the U.S. DoD procurement market is primarily the area there. And we've budgeted the international growth fairly conservatively as well. This is just an area where I want to find the bottom in this business. I don't want to be constantly responding to lower-than-anticipated demand. So we've taken a very hard look, bottom-up look at this business and built a revenue plan around that, trying to reduce our dependence on book-and-ship within a quarter, such that we can get the business just to operate more efficiently. And that obviously has a knock-on effect to our gross margin.

Anthony L. Trunzo

Yes. The challenge in government for this year, Peter, is -- it's more on the margin side. It's more on the mix of business that we're seeing than it is in terms of seeing significant downward pressure from a revenue point of view, significant declines in revenue.

Operator

Our next question comes from the line of Jim Ricchiuti with Needham & Company.

James Ricchiuti - Needham & Company, LLC, Research Division

I think you gave in a metric, an interesting metric in the commercial business. And I think you were excluding the government-related OEM business. If I heard you correctly, you said that it was up 30%. That was Q4?

Anthony L. Trunzo

Yes.

James Ricchiuti - Needham & Company, LLC, Research Division

And I'm wondering, you've obviously got Lorex and Traficon. How should -- what was the contribution x that? Or either organic for commercial in general or just if you could just kind of maybe pull that out and give us an indication of how the business grew?

Thomas A. Surran

Sure. The comment was the division, excluding the OEM business grew 30%. I think that's the one you're referring to, if I may. Okay. If you kind of, I guess, want to go down that one layer and, I guess, the way we look at it is the thermography business was relatively flat. The systems business that has the commercial had strong growth in multiple segments. Our maritime did very well. Our PVS did very well. We saw growth in some of our non-cores business, even on the OEM side. Then Raymarine, we talked about that, having the 11%. So excluding that OEM core section, in particular, we saw a fairly good quarter on those.

James Ricchiuti - Needham & Company, LLC, Research Division

Okay. But did you give a contribution for Lorex and Traficon?

Anthony L. Trunzo

We didn't. We'd have to -- you start to peel the onion, Jim, and it gets -- you get into pieces that are pretty thin. The -- as Tom said, the security business -- and talking [ph] about the security business, the security business declined because in Q4 of 2012, we had some pretty large shipments of pretty high dollar volume things through that business. But every other metric in the systems business on an organic basis ranged from flat -- as we said, a small increase in thermography, up to meaningful double-digit growth in places like PVS.

James Ricchiuti - Needham & Company, LLC, Research Division

Okay. One final question, if I may. Just if I go back over the last 4 years. Your sequential decline in -- from Q4 to Q1 has been high-single digits to 14% or so. How should we think about the current environment, just given all the things that are going on in the business in terms of the kind of sequential decline?

Anthony L. Trunzo

Well, we're not giving quarterly guidance. But I will tell you, it's going to be meaningful. I mean, it's going to be a meaningful double-digit percentage decline. It could be more than 20% Q1-to-Q1 on an EPS basis.

Operator

Our next question comes from the line of Michael Ciarmoli with KeyBanc Capital Markets.

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Tony, I'm not sure if you're going to be willing to do this or not, but would you help to size these new segments? Maybe the expected growth and kind of profitability we should be expecting, even if it's just kind of general ballpark thinking here?

Anthony L. Trunzo

Well, I think that we'll be in a much better position to have that conversation on the call after Q1, Mike. But the objective here is to try to get more clarity and better alignment against our markets. All of them should be -- should have very healthy profitability. I don't think there's any of them that are not going to have good profitability. But there's a lot of stuff that's moving around. For example, we have the vast majority of the security business that's going into the Security segment, but we've pushed a lot of the border security stuff over into Surveillance, where it probably logically belongs. The maritime business is combining Raymarine, which we do expect to have good growth in 2014 with our -- the FLIR-branded maritime business, which, frankly, should do better than that. We've got more ambitious growth expectations for it. So until we really -- I mean, we built our budgets on our old segments, and until we get our budgets re-segmented as well, I think it's going to be tough for us to give a lot of direction on that.

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Okay. Now that's fair. And then just one other item. What sort of tax rate are you guys building in for 2014?

Anthony L. Trunzo

And I neglected to mention that in the script. I apologize. We're looking at somewhere between 23% and 25%.

Operator

Our next question comes from the line of Jonathan Ho with William Blair & Company.

Jonathan Ho - William Blair & Company L.L.C., Research Division

Just wanted to build on that last set of comments around the reorganization of business units. Can you talk a little bit about sort of the rationale and what some of the primary advantages that you see coming out of the new business combinations?

Andrew C. Teich

Sure. Well, I'll start with that, and I'll have Tom add some commentary, Jonathan. The first issue is that this change that we've made focuses each of these segments around their customers and what their customer needs are. And I think that's always the best approach in terms of a go-to-market strategy. We had a strategy a long time ago when we very first started the Commercial Vision Systems business to create a bunch of new categories and vertical market access points. And we did that in maritime, security, PVS, transportation. And the strategy has been successful. And in each one of those product lines, we have created a new product that have created new categories within those market verticals. And by creating that segmentation, it allows us to very cleanly focus those businesses on those segments, get the research and development activities, the product development activities that will go on in that segment very focused and the channels that we will utilize to go-to-market, very focused on each of those channels. So I think it's just that the timing is right to do this now, Jonathan, particularly with Tom's new role. The addition of Lepton as a core technology into each of these vertical markets, it will play a role in every one of those vertical markets. But each of them will have to take a unique product development and technology insertion strategy as to how they use that technology in each market. And again, it allows us to really focus those solutions most properly against the customer needs that exist there. Tom, you want to add anything to that?

Thomas A. Surran

Probably not to the strategy or theme of why we did it, but I can just tell you, operationally, removing any hindrance to being able to improve the integration between the operations and the communication, collaboration, coordination, needed to be removed. And so that -- by removing that divisional structure, we're in a much better place to be able to achieve what we want to do in terms of the integration and the collaboration between the businesses. It allows us, especially looking from an operational side, it makes it much easier to be successful in executing that.

Jonathan Ho - William Blair & Company L.L.C., Research Division

Great. And then just as a follow-up. Can you talk a little bit about marketing initiatives for 2014, and maybe some of the movements that you guys are making in order to raise awareness of the value proposition around infrared? I mean, clearly, with CES and the attraction and interest in FLIR ONE, this seems like the time is right, but just wanted to hear your thoughts on how that might evolve or shift this year.

Andrew C. Teich

Sure. Well, FLIR ONE is all about building awareness. It is a new category for us and offers a significant dynamic shift in terms of the volume potentials that are associated with that market. But one of the key reasons that we did FLIR ONE is that we want to drive awareness in the business. We've mentioned many times in the past that the 2 biggest barriers that we see to growth in this business are price and awareness. And FLIR ONE pulls harder on those 2 levers than any product in the history of this industry. We've already seen, as I mentioned in the prepared comments, we've already seen a knock-on effect from that. And it's been very broad-based to include our military business that we've had incoming contacts at levels within our military business, for example, that were generated by FLIR ONE that wouldn't have happened else -- otherwise. So in terms of the marketing plan there, that's also a dynamic shift for us. And one of the previous questions was focused around that in terms of SG&A spending that, that over the long term, we will need to move some spending from engineering into marketing. As you get into more consumer markets, the marketing spend is going to need to go up somewhat. And to that end, we're in the process right now of recruiting a senior vice president and CMO for the business, and expect to get that slot filled fairly soon with an individual that has fundamentally been where we are headed in the consumer electronics market. So we'll bring that expertise on board. We did bring on a new ad agency to assist us with the FLIR ONE launch. And I would say, I'm quite happy with the results that they delivered. The amount of PR that we generated from FLIR ONE, its launch at CES, was completely unprecedented. And the number of points of exposure, the number of on-camera interviews and the social media buzz that was created by it was quite extraordinary. And that's a brand-building exercise for FLIR, which is necessary for us as a leader in the business.

Operator

Our next question comes from the line of Brian Ruttenbur with CRT Capital Group.

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

Just a couple of quick ones to wrap up. So it sounds like the first quarter's going to be down 20%-plus. Second quarter is going to be, I assume, flattish with last year, and then the second half of the year will be where you make up the majority of the earnings? Is that how you look at things?

Anthony L. Trunzo

That's a pretty good way to look at it, Brian, yes.

Operator

Our next question is a follow-up question from the line of Pete Skibitski with Drexel Hamilton.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Just a couple of follow-ups, guys. On the cooled government cores within commercial that had the rough quarter, has visibility improved there at all?

Thomas A. Surran

Visibility there -- so we're working through customers who do communicate their views on the marketplace. And so we've had those debriefings or those meetings and planning exercises so we know what their expectation is. Of course, now they're basing theirs on their own view of what actually is going to happen in DoD spending, but we have specific plans for revenue for this year and bookings for this year based on the interaction with those customers.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Can you share those with us just directionally?

Anthony L. Trunzo

Probably not, Peter. It gets into a level of granularity that when you look back, it -- with a 12-month forward look and a 12-month back look, it tends to bounce around. You get stuff that -- some stuff comes in, some stuff doesn't come in. Overall, it's about even, but looking at the individual pieces of it, that's pretty tough to do.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Okay. Okay. And then I just want to get some more color also on the high-end thermography systems, the high-end R&D-type systems that sort of -- it seemed like struggled through 2013 kind of because of the economy. What's -- any change in the outlook there?

Thomas A. Surran

Well, what we saw in the fourth quarter was a change. So we had been seeing negative. And we actually finally saw that break positive. So that was very -- a good sign. So the resolution or/the situation on the funding in the government, I think some of that high-end R&D actually is driven from that. The part that's the high-end thermography business, we haven't seen the improvement yet. There's some products that we'll be announcing to that marketplace and some feature sets to the cameras that we hope will have an impact on that business. And the reality is, we spent a fair amount of our mind share on the introduction of the Ex in the fourth quarter, which really was a fantastic product and it's doing extremely well. And so we didn't emphasize and speak as much about the high-end premium offerings that we have, but we'll be changing that through this year.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Are you guys seeing, in general, just a pickup in Europe at all, like we're seeing in the ISM numbers for the thermo segment and security as well?

Thomas A. Surran

Sorry, could you just ask that question again?

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Oh, sure. I said, just in general, are you seeing a pickup out of Europe for the thermography segment?

Thomas A. Surran

It actually did fine. Did [ph] positive on that. It was not that different than what we were seeing in the other regions right now.

Anthony L. Trunzo

The thermography business, I guess, I would say globally, we're seeing some green shoots, right? I mean, we started -- if you look sequentially at each quarter, it got better in Q3. And through Q4, it improved. Our outlook for that business at the beginning of the quarter in terms of revenue, it ended up -- for the first time in a while, we ended up doing better than what we thought we were going to do coming into the quarter. So I think, globally, I think the trends are positive from a regional and product slice perspective. You get a little bit of noise in the numbers, but overall, I think that business -- it looks like it's getting a little bit of air under its wings.

Andrew C. Teich

Yes. And I would add a couple of other points to that, Pete. That business, as Tom mentioned, is a business -- when we launch a new product in the segment, we, obviously, have a lot of promotion around that and you end up getting a response focused on that product. And Ex was the big news in that business last fall. And we saw strong response to that in Q4. That product is doing very well in the market. We like the mix that we're seeing from it and the margins are good coming from it as well. The premium segment, as a result, underperformed in 2013. And we have plans in that area to bolster that product line with some new product introductions that, I think, will really inject some enthusiasm into that market in terms of demand. The other thing about the thermography business is that, I do expect that, that's a business that will see some effect from the FLIR ONE, because FLIR ONE is going to not only build awareness, but also build brand recognition. And there -- a lot of the customers that we've seen express an interest in FLIR ONE are sort of looking at low-end thermography applications. And I think that as they explore the product further, there's a good upsell opportunity into the premium features that are associated with the thermography lines of products for professional and tradesman operators.

Operator, we'll take one more question, if they're out there. If not, we'll go ahead and bring the call to conclusion.

Operator

We have no further questions at this time. I'll turn the floor back to Mr. Andy Teich, FLIR's Chief Executive Officer, for closing comments.

Andrew C. Teich

Great. Well, thank you, and thank you, everybody, for joining us today. While this was a difficult quarter for us, it was also a quarter that we made significant progress in terms of new product launches, new core platform launches and good progress on our restructuring activities in terms of positioning the business for growth and profitability going forward.

With that said, we'll continue to focus of 3 main things, going forward, in the business: Stabilizing our government business and reaping the benefits of the new product launches with our 380-HDc and 280-HDc products there in the airborne and maritime segment. Of course, we'll continue to be focused on our restructure initiatives. And that's an ongoing activity. And we've still got a fair amount of work to do there in Q1. And then, of course, we're very focused on rationalizing and realizing the opportunities that will be derived from both FLIR ONE and Lepton. I want to underscore the fact that in the last couple of years, a good portion of FLIR's growth has come from the new categories that we've created from a product standpoint. And with the recent introductions, even in Q4, of the launch of FLIR ONE, Lepton and the ThermoSight R-Series, they all represent new categories for our business. And particularly, Lepton itself has many tentacles off of that product platform in terms of where it will go. And that's something that's got the team here very excited. And we're looking forward to sharing with you the ultimate product plans and financial performance that we'll see from those factors going forward. Thank you, again, everyone.

Operator

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.

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