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FLIR Systems, Inc. (NASDAQ:FLIR)

Q1 2014 Earnings Conference Call

April 25, 2014 11:00 ET

Executives

Wit Davis - Senior Vice President, General Counsel and Secretary

Andy Teich - President and Chief Executive Officer

Tony Trunzo - Chief Financial Officer

Tom Surran - Chief Operating Officer

Jeff Frank - Vice President, Global Product Strategy

Travis Merrill - Chief Marketing Officer

Analysts

Noah Poponak - Goldman Sachs

Pete Skibitski - Drexel Hamilton

Tim Quillin - Stephens

Peter Arment - Sterne Agee

Jim Ricchiuti - Needham & Company

Michael Ciarmoli - KeyBanc Capital Markets

Jonathan Ho - William Blair

Saliq Khan - Imperial Capital

Operator

Greetings, and welcome to the FLIR Systems’ First Quarter 2014 Earnings Call. At this time, all participants are in a listen-only mode. (Operator Instructions)

It is now my pleasure to introduce your host, Wit Davis, Senior Vice President, General Counsel and Secretary for FLIR Systems. Thank you. You may now begin.

Wit Davis - Senior Vice President, General Counsel and Secretary

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?

Andy Teich - President and Chief Executive Officer

Thank you, Wit and thank you for joining us this morning for FLIR’s first quarter 2014 earnings call. With me on the call today is our CFO, Tony Trunzo; our COO, Tom Surran; our Chief of Product Strategy, Jeff Frank; and our new Chief Marketing Officer, Travis Merrill.

This morning we reported first quarter revenue of $352 million and earnings per share of $0.21. Excluding one-time charges, Q1 earnings were $0.25 per share. Revenue increased 1% versus the first quarter of 2013. We saw nearly double-digit growth in our commercial end markets. Margins were in line with our expectations for the quarter. Operating cash flow of $60 million during the quarter was again well ahead of our net income. The success of new products including our EX series thermography camera, the K-series firefighter camera, and the NV-3 automotive camera help drive over 50% growth in the number of thermal imaging products shipped versus Q1 of 2013.

The launch of our Lepton microthermal camera core, the introduction of several new products that will incorporate the significantly lower cost core and other new products we have announced recently are anticipated to drive our unit volumes higher in the near-term. As you know, unit volume is a very important factor in our strategy to lower cost and is integral to our mission to become the world’s sixth sense. These first of these Lepton based products is the FLIR ONE thermal imager accessory for iPhone 5 and iPhone 5S. We are targeting making FLIR ONE available later this quarter and we have seen a notable increase in the awareness of both thermal imaging and of the FLIR brand since our introduction of the products at CES in January.

We have strategy to broaden our market reach by entering more consumer oriented spaces as we bring the prices of thermal technology to levels that are affordable to everyone. A part of that strategy involves investing in our marketing and this month we hired a Chief Marketing Officer, Travis Merrill who will head up our global marketing and branding initiatives. Travis was previously Head of Marketing for the U.S. Samsung tablet business and we welcome his insight and leadership as we navigate the many new opportunities that are arising. Additionally, we added two new members to our Board of Directors during the quarter. Kathy Halligan brings broad experience in e-commerce marketing and Kathy Stauffer adds significant consumer electronics retail product marketing knowledge to our brand, to our board.

Our realignment activity continued in the first quarter, as we closed a facility in France, relocated several assets to existing locations and reduced staff in certain locations. As a result of this work, we have removed our divisional structure and re-segmented the company. As mentioned last quarter, there are now six segments that are better aligned to our growth, go to market and product development strategies. Based on our Q1 results and our current view of the business, we are maintaining our outlook for the full year 2014. We continued to expect 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 excluding expenses related to restructuring actions. We continued to expect the second half of the year will drive much of our growth in 2014 as improved product mix and the realization of our realignment initiatives help to drive better margins.

I will now hand the call over to Tony to review the first quarter financial results. Tony?

Tony Trunzo - Chief Financial Officer

Thank you, Andy. The following discussion of Q1 results excludes restructuring and other one-time costs totaling $8.4 million. Of this amount $7.8 million is reflected in a line item titled restructuring and an additional $600,000 is contained in the cost of goods sold line. First quarter consolidated revenue was $351.5 million, an increase of 1% compared to the first quarter of 2013, primarily due to strength in our Instruments, OEM & Emerging and Maritime segments. Consolidated gross margin of 48.1% was below last year, but in line with our expectations for the quarter. As we indicated in the February call revenue mix in Q1 was skewed towards lower margin product lines resulting in the margin contraction.

Segment operating expenses were well controlled during the quarter falling just over 1% compared to last year, while corporate expenses were up by $4.4 million due to higher costs associated with several litigation matters. During the quarter we resolved two of these matters, which should reduce our legal costs going forward. Surveillance segment revenue of $117.2 million was essentially flat compared to last year and above our expectations for the quarter. As anticipated gross margins were affected by deliveries under two large lower margin programs, we expect margins in this segment to trend upward throughout the remainder of the year. The Instruments segment performed well during the quarter as good unit growth and strong reception to new products led to a 7% increase in revenue. Gross margin remained strong but when combined with essentially flat segment operating expenses resulted in a very good 20% increase in segment operating income to $24 million.

OEM & Emerging saw a good sales growth during the quarter as well. The gross margins were negatively impacted by the inclusion of our Optical Components Group which was acquired in August of last year. Operating expenses increased due to higher R&D spending related to the development of FLIT ONE and Lepton which combined to create a 19% drop in segment operating profit to $11.9 million. Securities segment revenue was down 1% compared to Q1 of last year. Lower volumes of high end thermal cameras negatively affected gross margin, which combined with increased marketing and engineering investments led to a $2.7 million decline in operating income to $1.7 million. We anticipate improved thermal camera volumes and better margins from this segment going forward.

Our Maritime segment which now includes FLIR branded maritime thermal imaging line as well as the traditional Raymarine business posted a 4% increase in revenue and a 7% increase in operating income. Both the FLIR and Raymarine brands businesses formed well. The Detection segment swung to an operating loss of $1.2 million in Q1 as sales dropped due to the conclusion of the DRC program which contributed substantial revenue in Q1 of last year.

Bookings, however, were very strong and backlog stands at a record level. On a consolidated basis bookings were strong during the quarter as we saw a 5% increase in 12-month backlog to $514 million. Also on a consolidated basis international revenue growth with 7% for the quarter will U.S. government revenue declined by 8%. As a result international revenue accounted for 54% of the consolidated total in Q1, up from 50.9% of revenue last year.

Total sales to U.S. government were 20.4% of the total in Q1, down from 22.3% revenue in the first quarter of 2013. Cash flow from operations including the impact of restructuring was $59.8 million for the quarter representing 200% of net income. During the quarter we have returned $14.1 million to shareholders through dividends and an additional $1.8 million through share repurchase. We ended the quarter with cash on hand of $584 million providing ample liquidity to capitalize on strategic opportunities as we more throughout the year. Also of note, we have reduced net inventory and accounts receivables by a total of $87 million or 13% over the past 12 months. This is a good progress, but there is more to do and we expect continued improvements in working capital going forward.

As Andy indicated, we are reaffirming our full year guidance for revenue and earnings per share excluding certain restructuring and one-time items. For the full year 2014, we currently expect revenue to be in the range of $1.45 billion to $1.55 billion and earnings per share excluding restructuring and one-time items to be in the range of $1.40 to $1.50. Restructuring costs in Q1 of $8.4 million were in line with our expectation. We will continue to see restructuring costs in the next few periods associated with decisions made in 2013 that could not be reserved for at that time. We anticipate additional restructuring costs to be approximately $3 million in Q2 and then decline rapidly in the second half of the year. Today, we also announced our regular quarterly dividend of $0.10 per common share, which will be payable on June 6 to shareholders of record as of May 20.

That concludes the summary of our first quarter financial results. I will now pass the call over to Tom Surran to cover the segment operating highlights.

Tom Surran - Chief Operating Officer

Thanks, Tony. Total bookings in the quarter increased 13% over the prior year. However, the associated delivery of the significant portion of the products, were outside the quarter resulting in Q1 revenue being flat with the prior year. While there was improved revenue growth in many of our commercial end markets, it was offset by continued weakness in the government-funded markets.

Geographically, we saw the EMEA region grow revenues 21% versus Q1 of 2013 primarily due to growth in the surveillance segment. We also saw meaningful growth in the EMEA region in our instrument and maritime segment. Americas and APAC were down 5% and 15% respectively with the Americas being impacted by reduced revenue to government funded customers.

Sales of lower margin product in the surveillance segment and companywide restructuring charges were key drivers to a 6.5 percentage point decline in total segment operating margin. The restructuring charges amounted to $8.4 million as we continued to execute our previously announced realignment plan during the first quarter. Investments that we believe will show significant long-term efficiency and cost improvements.

Revenue in the surveillance segment which now includes the non-severity products of integrated segment declined 1% for the pro forma first quarter for 2013. Growth in the surveillance land product line was offset by reduced shipments of surveillance maritime products as well as less service revenue. There was a significant drop in the gross margin percentage for this segment as a result of two large low margin programs being shipped during the quarter, which in turn negatively affected segment operating profit. Also impacting operating profitability was $4.1 million of restructuring charges in the segment.

Notable bookings in Q1 included a major order for our Middle East for various security and border protection products including $30 million to the surveillance segment versus Star SAFIRE III HDC airborne gimbals and MVSS integrated vehicles, which is the international variant of the MSC truck we have sold to the U.S. Customs and Border Protection Southern Border program. U.S. Navy ordered $18 million worth of our BRITE Star systems for their Fire Scout unmanned helicopter program. Additionally, we booked two orders totaling $16 million for III HD gimbals to two international customers.

Revenue in the instrument segment which represents our thermography and test and measurement product lines was up 7% versus the first quarter of 2013. All regions had healthy growth led by APAC of 13%. Our EX series performed very well and set a thermography product record for units shipped in the quarter. K-series firefighting cameras continued to gain traction in the first responder market contributed meaningfully to the top line growth in the quarter.

Our automation line of business grew nearly 30% due to our continued improvement of this product line. Combined, these successes drove 37% year-over-year increase in instruments total unit volumes and a 3 percentage point increase in segment operating margins, excluding the restructuring charges recorded this year.

The OEM and Emerging segment grew revenues 7% over the first quarter of last year, with the APAC region nearly tripling revenue from the prior year. Our automotive product line continued to perform well with year-over-year revenue growth of 40%. Uncool thermal camera cores grew nearly 40% while the PVS line of business grew 12%. This growth was partially offset by declines in our high end cooled camera cores as military OEM markets remain challenging.

Volume growth in the OEM products were strong, up nearly 80% over the prior year. Operating margin declined 22% from 29% in the prior year due to the inclusion of relatively low margin micro-optics components business that we acquired last summer as well as increased product development costs associated with new products, including the Lepton camera core and the FLIR ONE product Andy spoke about earlier. The Security segment which includes our commercial thermal security systems, our visible security systems and our Lorex consumer security systems recorded a 1% decline in revenue versus the prior year.

All three of the regions were relatively stable in comparison to last year. Lorex revenue was up 25% versus Q1 of 2013 and our FLIR branded visible systems grew over 20%. Adding FLIR branded visible camera system to our security products suite has proven to be significant with integrators and distributors embracing the quality and innovation FLIR has introduced into the market segment. Security operating margins declined due to the introduction of NVR bundles to the professional market. At the ISC West Security Show in Las Vegas earlier in this month, we introduced 30 new security products in our thermal and visible camera lens, significantly broadening our offering.

We showed a mini bullet thermal camera which utilizes our new thermal Lepton thermal core and will break a new price barrier in the industry with its $499 price point. We expect this product to open up the benefits of thermal imaging to a whole new base of commercial customers. Also shown at ISC was our new Pro series full-size thermal (bullet) cameras. Later this year we will be bringing integrated analytics to the market as well as megapixel product offering. The Maritime business saw revenue growth 4% compared to the first quarter 2013. Sales of multifunction displays were the primary driver of the growth and Dragonfly was a key contributor.

Maritime’s EMEA region continues to perform well with 10% year-over-year growth it will be economic concern from the area appeared to be easing. Maritime operating margins increased slightly compared to Q1 of 2013 as unit volume improvements positively impacted gross margins. Detection segment first quarter revenue decline 33% versus the prior year, which has been adjusted to include (indiscernible) related products that used to accounted for under the integrated systems segment. The year-over-year decrease was primarily the result of wind down of the domestic response capability or DRC program which had significant deliveries in Q1 2013. The lack of DRC deliveries and $600,000 of restructuring charges contributed to Detection having a negative operating margin in the quarter.

From a bookings perspective Detection had a very strong first quarter with orders of over 70% versus the prior year. The driver of this growth was an $18 million reduction in development order for our Dismounted Recovery Sets Kits and Outfits known as DR SKO and formally known as J2. This direct response system provide an integrated (indiscernible) detection, identification, sample collection, testing and personal safety kits for all branches of the U.S. military, National Guard, and civilian support teams. Perhaps more importantly we also received full rate production decision from the Department of Defense for the DR SKO program that has a significant five year procurement plan in the President’s 2015 budget proposal.

In addition, we received the first $2.8 million booking associated with the blade program for the development of institute chemical threat neutralization using foams. That concludes my summary of the segments first quarter.

I will now pass to call back to Andy.

Andy Teich - President and Chief Executive Officer

Thanks Tom. Our first quarter results were in line with our expectations and while we see positive signs in many of our market we remain cautious about the government markets. Overall, however, we continued to anticipate sequential improvements throughout the year. It’s now been nearly a year since I became CEO. During that time we reduced costs, re-segmented and realigned the business for better operating efficiency added necessary new talent to the management team and created several new product categories which will drive revenue growth.

The product portfolio we are able to offer is unique and powerful as demonstrated by the recent major order from the Middle East customer that Tom mentioned earlier. This order totaled $50 million and contained content from five of our six segments. This order would not have been possible without this broad product suite and the seamless coordination of our various businesses. Our ability to identify, innovate, execute and invest in value-creating opportunities has led us to an unprecedented point in our history. Our CDMQ model is unique in the worldwide government markets and we intend to leverage that differentiator further with new products that will give our customers mission-ready capability at a fraction of the costs they are accustomed to.

We have introduced and continued to develop new products across our existing lines of business that will enable in existing customers to benefit from our technology and solutions in more ways than they have in the past. And with the launch of Lepton and the products it will enable, the opportunity to offer infrared everywhere and become the world’s sixth sense is closer than it has ever been.

Last, I would like to thank our employees who have not only fully supported me and the rest of the management team through the transition period, but also for facilitating the seamless transition that has taken place as we have realigned the business. They too see the tremendous opportunity ahead of us and have strongly embraced our vision for growth.

That concludes our comments on the first quarter. We will now open up the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is coming from the line of Noah Poponak with Goldman Sachs. Please proceed with your question.

Noah Poponak - Goldman Sachs

Hi, good morning everyone.

Andy Teich

Good morning.

Noah Poponak - Goldman Sachs

At the Investor Day, you guys had some good hard data on FLIR ONE demand and interest metrics thus far and I think specifically from CES, any ability to update us on how those numbers have progressed? I don’t know if you have the specific numbers or if you can talk about pace of acceleration or deceleration there?

Andy Teich

Sure, Noah. So it’s actually quite encouraging, the inquiry level on the product and the sort of related demand that it’s been generating has continued to grow which is actually a little bit surprising given that we have the PR coverage of it obviously dropped off after CES and then we will pickup again after we launch the product. I am going to pass it over to Jeff who can talk about some of the numbers that we have been seeing in both pre-registrations and product developer requests.

Jeff Frank

Hi, Noah. I think when we were at the last conference we were talking about numbers that have come in from the sales side of this thing. For the pre-registration, I should say that we are on the order of 6 I think what was the number again?

Andy Teich

I knew it was in the high-teens.

Jeff Frank

Yes, 16.

Andy Teich

16K, 17K.

Jeff Frank

I think we are over 2,000 on those numbers now.

Andy Teich

No, those are….

Jeff Frank

Well, I am sorry, yes, it’s not going the developer stuff. So we had like 1,600 developers that were signed up in 1,600 level, I think that’s over 2,000 now. And at pre-registration, I think we are over 30,000. So those numbers continue to grow dramatically. We are really – the response from the developer side has been really most interesting to us. We would be releasing our software developer kits and in our screening those interest of developers for a few that will be act as beta testers before we have a broad release of the SDK. We are really excited we are opening up this third-party, because we are quite sure we are going to see tremendous innovation there.

Noah Poponak - Goldman Sachs

Okay, that’s very helpful. I appreciate that color. And then just as a follow-up, on the surveillance margin, if I add back the restructuring that fell there, I guess it was in the low 20% and it looks like – or I know you are citing the two low-margin programs you had there. So, just wondering if you can help us with the pace at which you expect that to pick up and before the resegmentation you guys had discussed kind of a medium to long run right margin there. I just wondered if you could maybe update us on your thoughts on that?

Tony Trunzo

Yes. So, Noah, it’s Tony. You are right your calculation is right, I think it was without pulling out, it was 20.4%.

Andy Teich

20.9%

Tony Trunzo

20.9%, yes for the quarter excluding the charges. We will see improvement in that business going forward. We spent a fair bit of time this week looking at the gross margin profile, because that’s really where we have seen some fairly meaningful shift. Our BRITE Star product has lower margins than our Star HD line and we have seen a pretty significant delivery bolus if you will in Q1 of BRITE Stars that mix shift should begin to normalize a little bit. And then as Tom mentioned we have some shipments on an international order that were materially lower margins that we typically see in that case the products that we are shipping is a relatively old product and the replacement product that will be coming into the market later this year not only it is a better product but it should have meaningfully better margins as well. I think from a spending standpoint that business is well controlled as it typically has been. This is all really at the gross margin line.

And when you really break it down and you look at the product level gross margins and the mix shift dynamics you can pretty clearly see given the context of our backlog but we should see a reasonably good recovery in the second part of the year. I wouldn’t tell you that we see visibility to that business getting back into the 30 point margin range in the next few quarter. I still think over the longer term that’s a reasonable objective, but when we look at the content of the backlog and the current outlook I don’t think that’s likely nor was it expected to get back to that level in our outlook for the year.

Operator

Thank you. Our next question is coming from the line of Pete Skibitski with Drexel Hamilton. Please proceed with your question.

Pete Skibitski - Drexel Hamilton

Hi, good morning guys. I want to I guess focus on a couple of question on FLIR ONE, the first is I am just interested in the progress you have made and your thoughts on distribution channels for FLIR ONE as you get closer to the rollout day?

Andy Teich

Yes, Pete, so this is Andy. We are working distribution partners on two fronts, one on the master distributor side and two on the retail side. And both of those are progressing very nicely. We are at a phase right now we can’t talk about who they are but safe to say that when the product is complete from a production testing and certification place. We are confident that we are going to have meaningful retail channels in place. We are also going to be opening up an ecommerce portal for the product on the flir.com website so people can buy it direct from the company as well.

Pete Skibitski - Drexel Hamilton

Okay so when rollout actually happens like on that day there will be multiple channels?

Andy Teich

It will actually be – there won’t be day one. On day one it will be ecommerce only direct through the FLIR channel and then shortly thereafter retail channels will come online.

Pete Skibitski - Drexel Hamilton

Okay, okay, got it. I guess just a follow-up, I have heard some questions from people about the prospects for inventory obsolescence on the FLIR ONE and so far as Apple tends to turnover it’s iPhone models fairly frequently have you guys kind of thought about the financial risk to you if you have the FLIR ONE come out there and that Apple changes models and maybe that the model that FLIR ONE is available for isn’t the hot smartphone anymore?

Andy Teich

Sure, well certainly something that’s on our radar screen and it’s an issue that we will have to deal with in terms of our production planning. I mean the reality is that that anybody who is making an accessory for Apple products deals with this problem. And the switchover doesn’t happen as fast as you might think because people they do continues to sell the previous model and will act quickly to respond to what the new hardware is that’s come out in the market.

Tony Trunzo

Pete, it’s Tony, a couple of things I think I heard embedded in your question a concern about inventory build and some obsolescence there that’s not going to be an issue. I mean the obviously the Lepton cores going into that product we are building up some Lepton cores but they are at a pretty generic level and we don’t have an obsolescence issue there. In respect to the other components given the volumes that we are expecting and the cost of those components I don’t think you are going to see anything significant. The other – the under the worst of circumstance I don’t think you will see anything significant. The other thing to bear in mind is we have had conversations with other folks who sell similar products to this. And you have to keep in mind the installed base of these products in addition to where they are in their own product cycle. And the unit volumes that we are anticipating for FLIR ONE relative to the installed base of the iPhone 5 and 5S is so trivial that I think we can expect that we will see even if you do see an accelerated introduction of new products that installed base continues to live pretty long time. People tend to keep those products for a fairly long period of time.

Operator

Thank you. Our next question is coming from the line of Tim Quillin with Stephens. Please proceed with your question.

Tim Quillin - Stephens

Hey, good morning. So excluding the restructuring charges, I think operating expenses were about $118 million in the first quarter, does it stay at that level or does it go notably down after you fully implement the restructuring charge or just maybe how – maybe help us understand how we should think about timing and magnitude of benefits from the restructuring charge?

Andy Teich

You should – I am not sure how to define notably, Tim. If you look at Q1, if you break it into the corporate piece and the segment piece, segment OpEx was actually down a little bit from Q1 of last year. So in that respect we are in pretty good shape. We will certainly see benefits associated with Q – with the restructuring for the second half of the year. Not sure I want to tell you that, that’s going to ultimately for that second hall of the year drive segment OpEx down, but it will certainly mitigate any increase. With respect to corporate, the increase in corporate spending is really what drove the delta in total OpEx for the quarter. And that was almost entirely driven by legal. I mentioned that we have settled a couple of cases in Q1 that should help fairly meaningfully going forward. We have also entered into some agreements that I think will mitigate the ongoing cost of some other litigation that we have, but you will see corporate expenses be meaningfully higher than that they were last year. And you can see the data on that when we file our Qs. You can see our corporate expenses broken out separately in the other line. So you will get a little bit of visibility to what’s happening at the segment level on OpEx versus at the corporate level.

Tim Quillin - Stephens

Okay. And then with FLIR ONE what – and you alluded to them, but what are the exact steps that need to happen before that can be available for sale? And then how should we think about the timing of the next new products that utilize the new Lepton core and what is kind of generally the tempo of new product introductions that you are hoping for over the next couple of years? Thank you.

Jeff Frank

Hi, Tim. This is Jeff. I will take that one. We are still working within our original plan to have FLIR ONE in customers’ hands in the second quarter as Andy mentioned in his opening statement. Right now, design is looking solid. Our contract manufacturing partner is gearing up quite nicely in Asia. We are working to complete compliance testing under Apples made for iPhone program requirements. Other than that, the hardware – other than the hardware or the MX app that goes along with this thing will be available for free on Apple Store is now feature-complete. That’s in the hands where beta testers are also working hard to get a few other useful apps done before release. Probably the long pole in that tent is relates to the MFI testing process that we have to go through with Apple.

Andy Teich

Tim, you also asked about, what’s the follow-on product cadence look like for Lepton-enabled products and we have launched the first of a series of products that will be Lepton-based products that will come out in 2014. Tom talked about that in his prepared remarks and that’s product called the mini bullet, which is a $499 thermal camera in a weatherized enclosure designed for security applications that’s both analog and IP connectivity. And we have several other products that will get launched later in the year in the various segments of the business. So we are pretty excited about the prospect that those products bring to the market because they will create new categories of product and I don’t think present cannibalization risks to the existing business.

Operator

Thank you. The next question is coming from the line of Peter Arment with Sterne Agee. Please proceed with your question.

Peter Arment - Sterne Agee

Yes, good morning everyone. My question, Andy, I guess is maybe on the security market, down 1%. It sounds like all three regions were stable. Just curious to see why we aren’t seeing maybe a broader uptake, given I think their general view is that the infrared adoption within the security market continues to be very attractive. And just you have launched 30 new products, I am just curious to get a little more color on that?

Andy Teich

Sure, Peter. If you look inside the data actually both Lorex and FLIR brand that professional grade visible cameras did very well during the quarter. So the mission that we have set out to accomplish of Lorex and the conversion of Lorex’s program under the FLIR brand is executing well and a acuminating with the launch of thee 30 products that we launched at ISC West to round out the line. So we are in good shape on that side of it. The other side of the business is the thermal side of the business and there is two dynamics going on there. Number one is that business is just lumpy, it’s just a reality of that business and I think we will see that as the data comes in throughout the year that we are going to see ups and downs in that business related to some major infrastructure programs that we are working on.

The second thing is that we have augmented the thermal side of the business with lower cost products both on the Lepton base side, which I spoke about a moment ago and then also for our higher resolution QVGA and VGA thermal products. And we expect the new price points and IP connectivity feature set that comes from those new products will drive higher adoption rates. In general I am feeling very good about the security business going forward.

Peter Arment - Sterne Agee

Okay. And if I would sneak one in on Lepton just related to that, Andy you talked a lot about the Investor Day that long-term on the OEM channels is really going to be an attractive area for Lepton, it’s been four months since you launched it how are those discussions going and any color you could provide would be great ?

Andy Teich

It’s going well as I mentioned during the Investor Day that we expect that the adoption cycle is going to have a fairly long time related to it that it takes 9 to 12 months for somebody to integrate a product into end solution. With that said, the number of requests that are coming in to our OEM team for lepton are really high and we are in a mode of really filtering those to go after what we feel are the highest value add and long-term potential once. We have already received our first major order during the quarter for a Lepton customer it’s going into a UAV and we will be shipping units into that – into Q2. So we think that the promise there is good but I think the really high volume applications there we are going to have longer gestation period because we are dealing with people that have not historically dealt with normal cameras and need to do product integration and some market evaluation.

Peter Arment - Sterne Agee

Got it. Thank you, Andy

Operator

Thank you. And the next question is coming from the line of Jim Ricchiuti with Needham & Company. Please proceed with your question.

Jim Ricchiuti - Needham & Company

Thanks. Good morning. Question just with respect to the government business in Q2, last year I believe it was a reasonably good quarter as it related to the rest of the year, how much of the headwind do you have with that comparison just in the context of your bookings and your backlog right now for Q2, how should we think about your government business in Q2?

Andy Teich

Well, the comps for the government business get easier quarter-on-quarter as we move through each year obviously Jim. We are going to – we have got – we are doing okay on the backlog front bookings held up reasonably well in Q1. I think we feel pretty good about where it’s going to play out over the next couple of quarters. The – it’s more in the second half of the year where the comps get meaningfully easier Q2 of last year was a reasonably good quarter as well. So from this I don’t want to necessarily get into how that specific business is going to perform in Q2 versus last year, but it’s more towards the second half of the year where you will start to see things improve meaningfully both in terms – primarily really there in terms of margins but also in terms of revenue.

Jim Ricchiuti - Needham & Company

Okay. And then just I will switch gears a little bit on the Maritime business it looks like you are seeing some signs of strength there the amount of strength that looks like the end markets are improving, can you talk a little bit about that business and perhaps how we should think about it in the current quarter only because I think seasonally this is normally a good quarter for that businesses?

Andy Teich

Yes, the Q1 and Q2 are the strong quarter that it tappers off Q3 is the low and Q4 is starting to be the bounce back. As you can imagine it’s outdoor activity and therefore that’s where that seasonality is. Q2 will be a strong quarter and in terms of the business overall we are happy with the progress we are seeing and you will look across the product lines we have seen strength in the MFDs, but it’s in other associated or attached product. We are seeing strength in the auto pilots with the new evolution. We’re seeing strength in our sonar or fish lining and sonar products with the introduction of DownVision and our CHIRP technologies. So it’s pretty broad that we’re seeing a nice uptake. Now that market doesn’t move in rapid swings, there is a slower adoption cycle but I would say the trend is a deposit for us, we’re happy with it.

Jeff Frank

The other thing I would mention Jim is that thermal continues to do very well in the maritime space. FLIR-branded thermal product had very strong bookings in Q1 and it was against a relatively easier comp from last year, the comp was up in Q2. But the business continues to do well and we still like the adoption curve that we’re seeing on the thermal side of the house.

Tony Trunzo

Jim, its Tony. I think our operator maybe in the process of moving on to the next caller. But I wanted to put a little finer point, I went back and look well Andy and Tom was speaking. Last year Q2 was the strongest revenue quarter of the four in the surveillance business. And that’s an unusual level of – that’s an unusual seasonal trend typically Q4 is the strongest quarter and I think what’s included in our outlook for the year is that we returned to that more normal season is the strongest quarter and you don’t see the highest revenue in Q2. So I just wanted to make sure that we’re – I was a little clear on that point.

Jim Ricchiuti - Needham & Company

Got it. Thanks, Tony.

Operator

Thank you. The next question is coming from the line of Michael Ciarmoli with KeyBanc Capital Markets. Please proceed with your question.

Michael Ciarmoli - KeyBanc Capital Markets

Hey, good morning, guys, thanks for taking my questions. Maybe Andy or Tony kind of a big picture question. It seems like you guys are getting substantial unit growth in a lot of your product lines. You’re getting the adoption. But the financials are still being dictated by your high-end products and I’m just trying to understand is as you guys morph more into a lower end consumer-oriented more price competitive marketplace, how are you thinking about this financial model as it evolves? What sort of things are you planning on for pricing pressure; we mentioned the obsolescence issues that came up already on this call. I don’t know if it happens or not but you get this FLIR ONE into the Chinese market; I’m sure knockoffs are going to happen. So I mean can you talk to me about how you guys are planning strategically for changes to your sort of just kind of financials as this transition evolves?

Andy Teich

Sure, Michael. Well one issue is that the volume products that we’ve launched to-date and that we have in the product pipeline support very good gross margin. So at this point this really isn’t an issue for us. I think that the thing that we go to navigate through is how we support the higher level of spending on the marketing front. The – I think it will be quite sometime before someone is capable of knocking off of FLIR ONE type product as the technology is fairly unique there and the Lepton core took quite a long time to develop and has a very significant amount of intellectual property in it. So I think that we’re going to have quite some runway ahead of us with those products.

The other thing that I’ll mention is one of the key pillars of our strategy that we outlined during the Investor Call is that Control the Corners concept. And that means that we’re going to continue to be active in the very high-end market, that’s not a space that we’re walking away from by any stretch of the imagination, in fact we continue to make significant investments there right from the read-out integrated circuit and detector level right up through the system level. And we’ll have product launches in the coming months in that upper corner as well. So I think that blended model of having both the high-end product and low-end product is a good platform for which we can maintain the kind of finance model that we’ve had.

Michael Ciarmoli - KeyBanc Capital Markets

What do you have to do to educate your customers not to make that trade down to lower end products, I mean as they see more compelling, richer features, what do you do I mean inevitably customers are probably especially corporate customers looking to cut costs and if they can do the same or more with less, how do you attack that strategy?

Andy Teich

There is two issues. First is the segmentation is to appropriately segment our products both from product feature positioning and application point solution capability with our products. And that’s something that I think that we’ve been pretty good at and it’s something that we’re focusing on more so going forward. So you’ll see more products that are specifically targeted at specific markets. And within those have a value ladder that we’re capable of up-selling too. We’ve seen in this market a very good ability to up-sell the products that particularly in the industrial markets when people buy a low-end product to become a thermographer, it’s fairly common that they over time budget for higher end capabilities, they find this technology works well and they want more capability is the one that they’re using.

Michael Ciarmoli - KeyBanc Capital Markets

Okay, okay, fair enough. Last one, I think you mentioned APAC down 15%. I didn’t know if that was units or revenues and if you could just give us some color as to what’s happening there?

Andy Teich

APAC down 15%.

Tony Trunzo

In total.

Andy Teich

Yes, that was revenue, yes.

Tony Trunzo

That was consolidated.

Andy Teich

Yes.

Tony Trunzo

Yes, yes. Mike we can give you a little bit of follow-up on that. There were some puts and takes in APAC in terms of each segment and what happened there. I don’t have that right in my fingertips, but.

Michael Ciarmoli - KeyBanc Capital Markets

Okay.

Tony Trunzo

The consolidated minus 15 masks some shifts and some in – at the segment level that there were ups and downs.

Michael Ciarmoli - KeyBanc Capital Markets

Okay, okay. We follow-up. Thanks. Thanks guys.

Andy Teich

It’s a pleasure.

Operator

Thank you. The next question is coming from the line of Jonathan Ho with William Blair. Please proceed with your question.

Jonathan Ho - William Blair

Hey guys. This one is for Travis. I just wanted to understand what you see as some of the opportunities and challenges relative to extending FLIR’s brand into the consumer markets?

Travis Merrill

Sure. Good morning. Take what I’d say with the caveat that I’ve only been here for about three weeks. But it’s very apparent that there are opportunities in a few key areas. The first one is really extending that strength that exist today in some of FLIR’s more traditional markets to the consumer market by bringing the brand to life in a new way, right by leveraging some of those core elements. And I think those two distinct groups of markets are becoming more blurred anyway and having a more robust brand strategy in general of raising the awareness, focusing on the preference of the brand can really help them feed off the strengths of one another.

Secondly I think it’s really around continuing to develop and horn new channel capabilities particularly those that are more consumer-centric and really understanding that new customer’s needs through both research as well as robust CRM activities. And then finally I think you’re really connecting with those new customers directly and potential customer’s enthusiast to the technology via social media, via a friendlier FLIR.com to ultimately try to create new FLIR customers and create customers for the life.

Jonathan Ho - William Blair

Got it. And just in terms of the high-end cores market and some of the high-end ThermoVision business. I know this has been an area that’s slowed for a little while at this point. Can you maybe give us a sense of what’s happening there and what could maybe cause stabilization or improvement in terms of maybe the higher end products over the next couple of quarters?

Andy Teich

Jonathan, are we talking specifically about cores or more broadly than that?

Jonathan Ho - William Blair

So, I think with the change in the segment, it’s going to be both the cores as well as the high-end ThermoVision products?

Andy Teich

The cores and instruments.

Jonathan Ho - William Blair

That’s right.

Andy Teich

So Jonathan there are a couple of things there. On the high-end cores businesses is sort of largely driven by a couple of our major military OEM customers and that business also tends to be a bit lumpy, but we’ve got a pretty good outlook on that for the rest of the year and it looks pretty solid. And I think the bigger question there probably in the some of the higher end cores are what happens with some of the export markets. That’s an area where it could tend to be a little bit more volatile giving current political than some terms, things are going on in Russia and so forth if we see any restriction in terms of exportability in the markets like that.

Relative to the instruments business, high-end product manifestation there is what we call the science segment. That segment was slow in Q1. It’s – I think it’s largely driven by capital spending, it’s a business that also tends to be a bit lumpy. So that’s one that we’re going to watch closely here in the second quarter and as we move into the second half. The product, the prospect pipeline there looks good. It’s just getting our customers to release funding to authorize procurements there. And then the last piece you mentioned is this ThermoVision I think there you’re talking about products like our HRC product that are used in long-range surveillance programs or patrol kind of activity.

That product continues to do well. We’ve launched a high-definition version of it also recently. Again a business that can be lumpy at times, but we find that we have a very strong competitive advantage in that market and we’ve got a good business development team that are pursuing a pipeline that looks pretty good right now. So again it’s just going to be conversion of that pipeline and some orders.

Jonathan Ho - William Blair

Great. Thank you.

Operator

Thank you. The next question is coming from the line of Saliq Khan with Imperial Capital. Please proceed with your question.

Saliq Khan - Imperial Capital

Hi, good afternoon. I’ll be speaking on behalf of Jeff Kessler. I believe that you guys may have already answered this question, but I’ll ask anyways. Could you give us the update on Lorex from a perspective of DIY along with the commercial business particularly as we’re looking at the Digimerge subsidiary?

Andy Teich

So, two things there, Saliq. The business did well in Q1. Tom talked about the increases in revenues there, I think was low 20s.

Tom Surran

20%.

Andy Teich

Yes, low 20s for Lorex and high-teens for the professional brand under the FLIR brand, so both of those segments did well during the quarter. I think that’s going to be further bolstered by the product introductions that we’ve mentioned, we introduced 30 new products at ISC West. Many of those were focused at the FLIR professional brand both on the visible and thermal side. So having a broader product offering having megapixel cameras, having cameras with IP connectivity or all going to enable growth in that market.

We also launched under both the Lorex and FLIR Pro brand, a new technology that we call MPX which is – gives you the ability to have high-definition cameras connected via conventional coax cables and it also allows you to transmit to a audio and pan-tilt-zoom control signals over single coax wire. That opens up a nice upgrade market for us as many of the home and small business markets already have wiring installed in the walls and to analog coax wire and this gives you fundamentally the ability to move to the capabilities of the digital system using existing analog cable.

Saliq Khan - Imperial Capital

Great, thank you for that. Actually what you answered my follow-up question as well so thank you.

Operator

Thank you. Our next question is a follow-up question coming from the line of Tim Quillin with Stephens. Please proceed with your question.

Tim Quillin - Stephens

Hi, thank you for taking my follow-up. Just a couple, three quick hitters. But one, what is the – Jeff could you share the government fiscal year 2015 funding for DR SKO? And what’s your general expectations are for revenue? And then if you – maybe you did, but if you can talk about surveillance book to bill? And then lastly in terms of guidance and I know you don’t like to give quarterly guidance, but should we think about EPS comparisons being positive in 2Q or not? Thank you.

Andy Teich

I’ll answer the last question. Well actually let me come back to the last question. I just want to do a couple of things with some numbers here before I answer that piece.

Jeff Frank

Yes, I don’t have a firm number on DR SKO funding for FY ‘15 at this point. I know that we think it can be in the $20 million to $30 million range, but we’ve got some gap between what we understand is going to be in the President’s budget more to customer expectation is, so we’ll have to.

Andy Teich

Grabbed the transition. They’ve ordered as many as they could under the low rate initial production and therefore as we migrate to full rate production that order has been released is a fairly large volume and it’s over about an eight year timeframe. So the amount of orders that will be placed in the timing of those over that is still the open issue.

Jeff Frank

Right.

Tony Trunzo

Tim, without giving quarterly guidance we’re plus or minus – we’re going to be a lot closer in Q2 to last year than we were in Q1, hey that we’re going to get over the hurdle to growth in Q2 but we’re going to be a lot closer than we were in Q1.

Tim Quillin - Stephens

Okay. That’s fair. And then the surveillance book to bill?

Tony Trunzo

I don’t have that right in my fingertips.

Andy Teich

Last question.

Tony Trunzo

No, it’s Q1.

Andy Teich

Book to bill, the number was, right.

Tony Trunzo

Well it was 1.01.

Tim Quillin - Stephens

Okay, over one.

Tony Trunzo

It was over one.

Andy Teich

Yes, yes.

Tim Quillin - Stephens

Alright. Thank you very much.

Tony Trunzo

Well operator while you’re queuing up the next question I have an answer for Mike Ciarmoli for the – your inquiry about APAC by segment. That 15% decline that Tom mentioned from a dollar standpoint it was more than all made up from surveillance. Instrumental is up a little bit, OEM and maritime were up a good bit, they were very strong, security and detection were down a little bit, but they are small dollars because of the squeezing of those markets to the U.S. and to the Americas and EMEA. Hardly enough there is a good chance that you’ll use a flip in surveillance in Q2 from where they were in Q1, so it’s really just lumpiness in the surveillance business in terms of deliveries into Asia that accounted for that profit. Systemically the commercial businesses are staying perfectly good, if not better than good performance in Asia.

Operator

Thank you. The next question is coming from the line of Pete Skibitski with Drexel Hamilton. Please proceed with your question.

Pete Skibitski - Drexel Hamilton

Hey guys, I just wanted to ask on sort of the preorders for the FLIR ONE continuing to rise pretty nicely in advance of the introduction. I mean are you guys starting to think that maybe actual orders for this year are going to be maybe well above what your initial expectations were and if they are, can you actually deliver in the timeframe that you’d like?

Andy Teich

I’ll answer the second question first. I think that we’re not going to be production constrained on this unless we have a much higher response than we’re thinking about and I think we’ll have a production constraint issue. We’re producing Lepton’s that reasonable volume at this point and the assembly line for FLIR ONE is coming up to schedule. Going back to the first question that you asked Pete it’s really a function of two things. Number one is what kind of conversion rate do we get out of these pre-registrations. We have some anecdotal data on that because we did the same thing with the ThermoSight RS which is the – it’s a thermal weapon sight for recreational non-game hunters that we launched.

And so we have some data in terms of an understanding of the kind of conversion rate that we saw in that because we did a preregistration situation there as well. But we are not sure how that’s going to convert to more of a consumer curiosity oriented product like the FLIR ONE. So at this point I wish I could give you a better answer than that, but we’ll really have to see how things play out and what kind of interest we get from the second wave of PR that will come once we start shipping the units.

Jeff Frank

It’s probably we’re saying that based on the pre-registration we have, we haven’t changed our business model internally based on that.

Andy Teich

That’s correct.

Pete Skibitski - Drexel Hamilton

Thanks guys.

Andy Teich

We’ll take one more question, operator?

Operator

Thank you. Our final question is a follow-up question coming from the line of Peter Arment with Sterne Agee. Please proceed with your question.

Peter Arment - Sterne Agee

Yes. Thank you. Tony, I couldn’t let you get away without talking about capital deployment activities given that your cash flow continues to be very impressive in reducing inventories. How are you thinking about just in general the plan for this year as cash continues to build?

Tony Trunzo

Well the M&A market is interesting right now. Obviously pricing is a bit of a challenge, you’re seeing valuations be pretty strong. But I would say that we’re also seeing a few interesting targets out there, so I think that absent a compelling opportunity to deploy cash back to shareholders, I think we want to keep some powder dry because we do see some opportunities moving forward over the next couple of quarters. Having said that we’re going to continue to approach capital deployment as a mix of returning capital to shareholders doing M&A and CapEx. And you will see an uptake in CapEx as we move through this year as we build out our facility in Santa Barbara. We acquired the facility there a couple of years ago and the tenants are finally moving out and we’re in a position to consolidate our operations there. So you’ll see an uptake in CapEx. All that said, I would ask maybe to have a little bit of patience with respect to cash building as we hopefully are successful in continuing to improve the working capital and generating strong cash flow, because we do think that there maybe some opportunities over the next few quarters to effectively deploy it. Love to see an opportunity to put that to work from an M&A perspective, while also making sure that we are attentive to shareholder needs, but at this point, we are just going to have to see what – where the market breaks. In Q1, we looked reasonably hard at one particular transaction and we did pass at least partly, because it didn’t strategically pan out, but also partly because the price that the seller was looking for was higher than we thought was reasonable. So we are going to be disciplined in terms of pricing, but we do see some opportunities to potentially do M&A. And under that circumstance, we are going to probably be a little more cautious in terms of share repurchase.

Peter Arment - Sterne Agee

Okay, very helpful. Thank you.

Andy Teich

You bet.

Operator

Thank you. We have reached the end of our question-and-answer session. I would now like to turn the floor back over to Mr. Teich for any additional concluding comments.

Andy Teich - President and Chief Executive Officer

Well, thank you everyone for joining us this morning. As I had mentioned earlier, the quarter executed very much in line with what we planned. We saw nice strong bookings in the quarter, particularly in our commercial sectors and we probably get a little bit more work to do on the expense side and we will see that improve as the efforts of our restructuring manifest themselves later in the year. We are very focused on executing on the new product development plans that we have in place to FLIR ONE and new Lepton enabled products and we very much look forward to getting those products launched and seeing how they perform in the market. And last I would like to welcome Travis to the management team and Kathy Stauffer and Kathy Halligan to our Board of Directors and all three of these individuals really bolster us from a management capability in terms of building knowledge in area that we are headed into which will require more marketing intelligence and brand building capability. So with that, I will thank you all and say goodbye.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation and you may disconnect your lines at this time.

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