FLIR Systems' CEO Discusses Q2 2011 Results - Earnings Call Transcript

| About: FLIR Systems, (FLIR)

FLIR Systems (NASDAQ:FLIR)

Q2 2011 Earnings Call

July 22, 2011 8:00 am ET

Executives

Tom Surran -

William Davis - Senior Vice President, Secretary and General Counsel

Andrew Teich - President of Commercial Systems

Earl Lewis - Chairman, Chief Executive Officer and President

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

William Sundermeier - President of Government Systems Division

Analysts

Michael Lewis - Lazard Capital Markets LLC

Jonathan Ho - William Blair & Company L.L.C.

Michael Ciarmoli - KeyBanc Capital Markets Inc.

James Ricchiuti - Needham & Company, LLC

Josephine Millward - The Benchmark Company, LLC

Brian Ruttenbur - Morgan Keegan & Company, Inc.

Timothy Quillin - Stephens Inc.

Noah Poponak - Goldman Sachs Group Inc.

Michael French - Morgan Joseph TriArtisan LLC

Jeremy Devaney - BB&T Capital Markets

Peter Arment - Gleacher & Company, Inc.

Peter Skibitski - SunTrust Robinson Humphrey, Inc.

Operator

Good Morning. My name is Tracy, and I will be your conference operator today. At this time, I would like to welcome everyone to the FLIR Systems Second Quarter 2011 Results Conference Call. [Operator Instructions] Thank you. Mr. Wit Davis, Senior Vice President General Counsel and Secretary, you may begin your conference.

William Davis

Good morning, everyone. Before we begin this conference call, I need to remind you that other than statements as to 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 Earl Lewis, Chairman and CEO of FLIR Systems. Earl?

Earl Lewis

Yes, thank you, Wit, and we appreciate everyone joining us this morning. As we advised last week, FLIR second quarter 2011 was not up to our expectations. With that said, our Commercial Systems division had one of the best 12 quarters in its history, with improving operating margins of almost 2.5 percentage points compared to last year. Our Government Systems division had a difficult quarter due to U.S. Government procurement not recovering to the level that we had anticipated, as well as the delay of some significant international orders. As promised in our pre-announcement, we reevaluated our outlook for the revenue and earnings per share for 2011. We now expect full year revenue between $1.6 billion and $1.65 billion, and full year earnings to be between $1.33 and $1.38 per diluted share or $1.50 to $1.55 per share, excluding the impact of the recent legal settlement and its related expenses, and some restructuring charges that we expect in Q3. This compares to our prior range of $1.7 billion to $1.75 billion in revenue, and EPS of between $1.70 and $1.75. This change in outlook is entirely a result of lower expected order activity from our government customers. Our commercial business outlook is unchanged, and we continue to expect continued strong growth in Commercial Systems in the second half of '11.

We announced today the acquisition of Aerius Photonics LLC, a leading provider of shortwave infrared detectors and advanced laser technologies. The addition of Aerius, which was acquired for approximately $27 million in cash is expected to strengthen our presence in SWIR sensors development and in advanced laser rangefinders and illuminators. The acquisition will have no meaningful impact on our earnings in the near term, but Aerius will immediately strengthen our position in the fast-growing market for multi-spectral imaging systems.

I'll now pass the call on to Andy to discuss the performance of our Commercial Systems division. Andy?

Andrew Teich

Thanks, Earl. On a consolidated basis, revenue for the Commercial Systems division increased by 32% compared to the combined second quarter 2010 revenue of Thermography, CVS and Raymarine. During the quarter, we shipped the highest number of thermography cameras in our history and our order growth in both units and dollars was very strong, especially considering the comparison to the then record-breaking second quarter of 2010. Revenue in TVM's largest business line, Cores and Components, increased by 55%, and orders grew by 11% compared to Q2 2010, which was one of the best quarters for bookings in our cores’ business history. Revenue in our Automotive business grew by 29% over the second quarter of 2010. Our FLIR-branded maritime products grew revenue of more than 40%, and orders more than 35% over the second quarter of 2010, where, like last quarter, demand for our high-end Voyager products was significant.

Personal Vision Systems posted bookings growth in the mid-teens during the quarter, and we expect this business to expand rapidly in the second half with the release of the new Scout PS. This product, which is priced at $1,999, and is roughly half the size and weight of its predecessor is the latest and lowest cost product in what we believe is a large untapped market for personal handheld thermal imaging products.

Our Thermography products continue to penetrate new and existing markets. The release of our E-Series cameras, the extension of our T-Series line of cameras and the introduction of a sub $1,200 point-and-shoot i-Series camera have proven to be successes, with orders for our Thermography cameras growing more than 30% over the prior year. iX series product revenues grew approximately 85% year-over-year, with volumes through April of this year exceeding our total for all of 2010. Our new E-Series line has become our third largest product line after less than 2 quarters. Customers are drawn to the performance, look and feel and WiFi-enabled functionality of these cameras, as well as the usefulness of our iPhone and iPad apps, which have had nearly 12,000 downloads since we introduced the image management and reporting tool a few months ago.

Our EMEA region posted 56% bookings growth in Thermography over Q2 2010, representing our third straight quarter of double-digit order growth in the region. Raymarine finished the quarter with $50.2 million in revenue and $7.2 million in operating income despite an overall soft marine electronics market. The second quarter showed us that thermal imaging technology is continuing to penetrate the recreational boating market. That's including both Raymarine and FLIR-branded products, maritime thermal imaging bookings grew by nearly 70% over the second quarter of last year. We're also excited to have just introduced the first round of redesigned Raymarine GPS multi-function displays since our acquisition. This completely new platform features several innovative capabilities, including wireless communication to Apple iOS devices, Bluetooth steering-wheel mounted remote control, superfast graphics processing, hybrid touch control, and an attractive new industrial design. We anticipate a strong market response to this innovative new Raymarine platform, and look forward to positively impact results in late 2011 and 2012.

We continued our string of new product introductions during the quarter, launching the QUARK, the smallest and widest 640 x 480 resolution thermal camera core. QUARK was developed with the needs of both government and commercial customers in mind, and incorporates several technological advances including wafer scale detector packaging, camera-on-a-chip ASIC, and refined calibration techniques. It is expected to be a truly valuable product for many different markets ranging from UAVs to a variety of handheld products.

As I touched on earlier, we also released the latest in our Personal Vision line of products, the Scout PS series for outdoor enthusiasts, which offers roughly 50% reduction in size and weight, and features an MSRP, which is 30% lower than our previous H-Series Scout product. As we mentioned last quarter, our E-Series and T-Series introductions generated higher demand than we anticipated. We made significant progress satisfying demand for these products in Q2. In the second half, we expect to be reducing backlog in TVM as the impact of our initiatives with our component suppliers, as well in addition of a second shift in our Estonia manufacturing facility.

The TVM segment posted revenue growth in all regions worldwide. Notable results were seen from both EMEA and Asia-Pacific markets, driven partially by strength in our FLIR-branded Maritime business, and the successful reorganization of our Thermography product sales platform in Europe. On a bookings basis, TVM EMEA showed particular strength this quarter, with nearly 30% growth year-over-year and the Americas and the APAC TVM regions each posted solid double-digit order growth.

Commercial Systems was active on the acquisitions front. In June, we purchased Tactic Limited, a U.K.-based sailing instruments company for under $3 million in cash. While not material to our overall operations, Tactic is a key addition to Raymarine's instruments product lines as they're a pioneer in wireless solar-powered instrumentation, and an established brand in the performance sailing market. Additionally, as Earl mentioned, this week, we acquired Aerius Photonics, a leader in the next-generation spectral imaging and laser technologies. Adding Aerius to our Cores and Components business will position us well in the developing SWIR market, and enhance our laser capabilities by adding next-generation VCSELs technology, and strengthen our presence with OEMs across numerous sectors. VCSELs, by the way, our vertical-cavity surface-emitting lasers.

That concludes my summary of the Commercial Systems division, so I'll now turn it over to Bill to discuss Government Systems. Bill?

William Sundermeier

Thank you, Andy. As mentioned in our earnings pre-announcement, continued weakness in procurement from the U.S. Government negatively affected Q2 Government Systems results. The anticipated strong government [ph] order activity post continuing resolution has not materialized, and even our most dependable U.S. customers are experiencing drawn-out contracting. U.S. Government continues to delay the procurement of even mission-critical products, which has caused a considerable amount of anticipated order activity to shift to the right. None of our significant identified opportunities fell out entirely, and we did not experience significant unexpected losses to competition. Our position in the U.S. Government market remains strong, but order activity simply isn't at the levels we expected.

International activity was hampered somewhat by regional unrests and by several specific orders destined for Pakistan that are held up in licensing reevaluations by the U.S. Government. Demand remains robust in the Middle East, as well as in all of our international markets. Despite the difficult macro environment, we saw some promising activity in the second quarter, we continued our strong positioning on the Persistent Ground Surveillance System or PGSS program, with significant orders for aerostat and tower-based [ph] systems. Increasing interest in our game-changing Star 380 high-definition systems was seen after successful exhibitions for the DoD and UAV makers during the last few months.

Internationally, we are seeing increasing interest in our coupled radar and EO/IR security solutions. Our operations were able to successfully manage the transition to greater book and ship business during the quarter, and we are increasingly able to fill these requests. We finished the quarter with an overall divisional backlog of $319 million compared with $360 million at the end of Q1. Surveillance backlog ended the quarter at $254 million compared to $294 million at the end of last quarter.

Detection products from the former ICx are increasingly being integrated into our distribution channel, and orders continued to flow in for some of its larger projects. Ending backlog for the Detection segment increased from $20 million at the end of the first quarter of 2010 to $22 million. We received a sole-source $15 million 3-year award to supply mass spectrometry detection equipment to an Asian military agency. Our Radiation business recorded 2 orders for equipment and development from the U.S. DoD, totaling nearly $4 million. The second quarter was also important from a product-testing standpoint. With a well-received bio aerosol tracer test completed in an international country, and a robot-based Raman chemical detection system successfully deployed for the DoD, 2 milestones that are integral to our expansion into new countries and new pockets within the U.S. Government. But also like to note that we are building out our business development capabilities in the Detection segment, with the goal of bringing these life-saving products to the world in a commercially oriented manner.

Integrated Systems backlog ended the quarter at $43 million, decreasing $3 million from the first quarter. Our $102 million mobile surveillance platforms award was upheld in April, and we anticipate shipments to begin in the second half of this year. We saw continued activity from the J2 program, suggesting that the integrated threat detection unit is back on track, and our priority for the program office after some delays in 2010. A successful test and exhibition of our integrated force protection system for the U.S. Army was a key milestone for both FLIR and our customer, an award-modified contract for 2 additional systems for $6 million for the initial result. And as a part of this project, the U.S. Army decided to use our cohesion surveillance software solution as its backbone for its force protection software suite. These are promising steps as we continue to build the Integrated Systems segment into a full-service multi-sensor systems development provider.

As we look into the second half, we do not expect to see our usual spike in orders in Q3. At the end of the U.S. Government's fiscal year, contracting will most likely remain slow, and procurement delays will push orders to the right. A new continuing resolution is likely for at least the beginning of the fiscal year 2012. In light of our results for the quarter and to better match operating expenses with our new view for revenue, we're evaluating and taking steps to rationalize our cost structure, and anticipate some non-recurring expenses will result during Q3.

This adjusted outlook will not change how we approach the government market, however, we know our products continue to define the state-of-the-art for infrared imaging, and our new products releasing in Q3 such as the Star 380, high-definition laser designation system and the 1280 x 720 variant of our HD tower sensor will continue that trend, and allow our outstanding business development team to provide our customers with the optimal solutions for protecting people and assets. Over the long term, we believe FLIR is ideally positioned to provide low-cost conscious customers the solutions they need, given our commercially development and distribution model that yields the best value and the widest customer base in the industry.

Then I'll turn it over to Tom.

Tom Surran

Thanks, Bill. Second quarter consolidated revenue was $390 million, an increase of 18% from the second quarter of 2010. Excluding ICx technologies, which we acquired early in the fourth quarter of 2010, second quarter revenue was $351 million, an increase of 6% from the second quarter of 2010.

Second quarter Government Systems revenue increased 4% to $175 million. Excluding ICx, second quarter Government Systems revenue declined by 19% compared with the second quarter of last year. Surveillance segment revenue in Q2 was $141.5 million. Detection segment revenue was $17.2 million, and Integrated Systems segment revenue was $16.2 million.

Commercial Systems revenue increased by 32% in Q2 to $215 million. The Thermal Vision and Measurement segment comprised of our former Thermography and Commercial Vision system segments posted revenue of $164.8 million, an increase of 21% over the last year, while Raymarine revenue of $50.2 million was up 85% compared with the partial period of our ownership in the second quarter of last year. International revenue was 50% of the second quarter total, the same proportion as last year, while sales to the U.S. Government represented 23% of total revenue in Q2, down from 32% of revenue in the second quarter of last year, and the lowest percentage in 8 years.

Consolidated gross margin was 52.5% for the quarter compared with 55.4% last Q2. Excluding ICx, consolidated gross margin was 54.9%, effectively unchanged from the prior year. Of note, gross margin in the legacy Government Systems business was very similar to the prior year despite 19% lower revenue. Commercial Systems' operating income in the second quarter of 2011 was $54.5 million, up 38% compared with the prior second quarter, and representing 56% of consolidated divisional operating income. TVM operating income was $47.2 million, up 31% last year, and represented an operating margin of 29%, 3 percentage points better than the combination of Thermography and TVM last Q2. Raymarine operating income was $7.2 million, more than double the second quarter operating income for the period of FLIR ownership in 2010.

Q2 Government Systems' operating income was $43.4 million, a decrease of 34% compared with the second quarter of 2010. The Surveillance segment reported operating income of $46.5 million, 29% lower than last year when operating income benefited from the last significant shipments under the RAID program. Detection reported an operating loss of $3 million, and Integrated Systems was effectively breakeven for the quarter. Included in the results of the Detection and Integrated Systems segments was $1 million in the amortization of intangibles, and $2.3 million associated with the write-up of acquired inventory. The effect of the inventory write-up was completed in Q2. And beginning in the third quarter, intangible amortization will be approximately $1 million per quarter for these 2 segments combined. Thus, we expect each of these 2 segments to report improved profitability in the second half.

Earnings before interest, taxes, depreciation and amortization in the quarter were $66.6 million. Excluding the one-time litigation settlement and associated cost, EBITDA for the quarter was $107 million compared with $103.3 million in the second quarter of last year. Cash flow from operations for the quarter was $19.4 million, and was $47 million, excluding the impact of the litigation settlement compared with $42.7 million last year. Payment of estimated taxes during the quarter reduced cash flow by approximately $23 million. Significant uses of cash during the quarter included $9.6 million for dividend, $17 million for the repurchase of stocks and $14.4 million in capital expenditures. Approximately $10 million in the capital expenditures related to the purchase of a building to house our Raymarine operations in Portsmouth, England that will significantly lower our overall costs going forward. Accounts receivable days and inventory turnover are essentially unchanged for the quarter.

During the second quarter, we repurchased 500,000 shares at an average price of $34 per share, bringing our total repurchases for the year to 713,000 shares. We anticipate continued share repurchase activity in the second half of the year. As Earl stated earlier, we've modified our outlook for revenue and earnings per share for 2011. We now expect revenue for the year to be in the range of $1.6 billion to $1.65 billion, and net earnings to be in the range of $1.33 to $1.38 per fully diluted share or $1.50 to $1.55 per fully diluted share, excluding the net after-tax impact of the litigation settlement and related expenses. The change in outlook is entirely based on lower-than-previously anticipated revenue in our Government Systems division. We continue to expect very good growth in our Commercial Systems business in 2011 and our outlook for that division is unchanged.

Not included in the earnings per share outlook are expenses we anticipate during Q3 associated with lowering our overall cost base in Government Systems, and streamlining acquired operations. These expenses may total several cents per share and we'll, of course, call these items out on our Q3 call.

That concludes my comments on the financials, I'll turn the call back over to Earl for some final comments.

Earl Lewis

Thank you, Tony. Although I'm not happy with the quarter's performance, we remain encouraged by the core strength of our commercial operating model and the growth potential of our businesses. Our positioning as a value-focused service-oriented and fastest to market provider of force-multiplying and life-saving technologies will deliver significant benefits to our shareholders over the long term. Our commercial markets continue to exhibit tremendous opportunities, and we intend to continue to open up these markets. We are releasing new products that are expanding access to infrared technology, with increasingly affordable price points, while revolutionizing the industry with advanced imaging products that are changing the standards for price, performance and size.

We remain committed to our balanced capital deployment strategy, purchasing 500,000 shares during the quarter, paying a 6% dividend, and making 2 small but very interesting acquisitions. Our past acquisitions have exhibited our success of adding new products and technologies to our company. ICx has now showed top line growth year-over-year for the first time since 2009. Raymarine is successfully turning around its operations, and set to release a revamped product line, AIS and MCS, each posting order growth rates in the quarter over 40% compared to last year, and our ATS acquisition reported over 40% year-over-year growth in the second quarter revenue.

Given these results, we are excited to add areas to our operations, and look forward to working with our innovative management team. As a final note, I would like to let everyone know that I plan to exercise approximately 180,000 options during the remainder of the year because these options expire in February of next year. I intend to exercise and sell a significant number of shares related to these options to cover the excise price -- the exercise price and tax obligations and hold the remainder.

With that, Tracy, we're ready for our first question.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Michael Lewis with Lazard Capital Management.

Michael Lewis - Lazard Capital Markets LLC

Earl, if we could just parse out the $100 million revenue reduction in GS, were there any actual cancellations of product, or is this revenue just simply moving to the right?

Earl Lewis

No cancellations.

Michael Lewis - Lazard Capital Markets LLC

Okay. And is there any specific area that you're seeing more weakness relative to other areas within GS?

Earl Lewis

No.

Michael Lewis - Lazard Capital Markets LLC

Okay. I am going to ask one more question. I'll get out of the way. Okay, so we see the revision to revenue of about 6% versus the midpoint. EPS is down 12%, so there's margin implications in there. Is this your new view and your most conservative outlook at this time? And should we expect to see the new norm in EBIT margin at around 25% below at FLIR?

Earl Lewis

Well, we have to go through some adjustments right now and those adjustments, as we said, will cost us a little bit. And we have a momentum issue of course, that you run into when these things happen. No, I think that we'll get back on our feet.

Operator

And your next question comes from Jeremy Devaney with BB&T Capital Market.

Jeremy Devaney - BB&T Capital Markets

First, I wanted to explore the slowness you saw in Government Systems this quarter. Can you help us understand whether you think this is going to be short term or long term in nature, and whether you're seeing any end-customer demand move-off or is it strictly procurement related? And also, is there a specific resolution to these slowdowns?

Earl Lewis

I'll let Bill answer it, and then I'll comment --

William Sundermeier

Our outlook is certainly based on procurement activities slowing down. Not only is it slowing down because the 2011 budget's been passed, and that they're just overwhelmed. But we're seeing contracting officers having to get approvals many more levels up in the organization. It's just slowing that contracting activity down. And we've looked out in the remainder of the year and anticipate continuing resolutions. So when does this turnaround? I think it has to turnaround when we finally get a budget and things start flowing normally, and that could be second half of 2012, depending on how continuing resolutions for the U.S. get resolved. And Middle East, we mentioned in the call that we had some significant opportunities for the Middle East, especially Pakistan, and those issues need to get resolved as well to continue that flow of our orders.

Earl Lewis

We're going to organize the company for a slower growth rate.

Jeremy Devaney - BB&T Capital Markets

All right. That's helpful. And then also, Bill, building on Michael's question regarding EBIT margin. We see R&D up about 160 bps year-over-year. Is this going to be the level we're going to see going forward? Should we continue to see this trend build?

Earl Lewis

No.

Jeremy Devaney - BB&T Capital Markets

No? All right. Simple answer. And then lastly, and I'll get out of the way. Noted in the litigation press release, the original litigation expense was $39 million. But kind of parsing through the numbers here, it looks like it is more like $27.5 million taken in the quarter. Is there additional expense expected to come on that?

Earl Lewis

No additional expense, and it is $39 million plus some legal fees. So it brought it to about $41 million, and that was all in the quarter or $0.17 a share.

Operator

And your next question comes from Pete Skibitski with SunTrust.

Peter Skibitski - SunTrust Robinson Humphrey, Inc.

Yes, I apologize, I missed a part of your opening remarks. So I want to ask you again, what's your go-forward kind of annual expectations now for government top-line growth?

Earl Lewis

Yes, right now, of course, we're looking at a slowdown compared to what we thought was going to happen. I'm not sure we've adjusted our thinking for what's going to happen next year right now. We're looking at the second half of this year pretty hard, and that's kind of the way we're going to gauge it in the last 2 weeks. Most of this kind of hit us at the end of the quarter. We usually have orders that come in at the end of the quarter. And this quarter, they just -- a slew of them just did not happen.

Anthony Trunzo

Pete, I think the -- it's Tony, I think, obviously, given the guidance that we've just laid out for the second half of the year, we're going to see less revenue from the Surveillance business than we originally anticipated, and that business is going to get effectively sized differently than we had anticipated it to be. Looking out beyond this year and this slowdown, at some point, we continue to expect that to be a growth business for us. We look at the dynamics of the market. We see the needs embedded in not only our international customers but frankly, in the U.S. as well. We see the reactions we get to the products that we're offering the market, and the price points that we're offering them at, and the value proposition we offer our customers. And there's still -- there's an undiminished amount of enthusiasm for FLIR and FLIR products and what it is that we can bring to the marketplace. But clearly, in the short term, there's going to be a resizing downward of the scale of the Surveillance business. Looking out longer term, we still think it's a growth business for us.

Earl Lewis

Okay. Our long-range plans clearly call for the growth rate to come back. It's just that right now, we're not going to see that this year and maybe part of next year.

Peter Skibitski - SunTrust Robinson Humphrey, Inc.

Okay. So I mean you guys don't think that kind of the war spend headwinds that we'll likely have over the next few years, you don't think that's going to present a meaningful headwind to FLIR, I guess, because of your international exposure, maybe Homeland Security and whatnot, is that accurate?

Earl Lewis

That is accurate and -- but more importantly, it's the products that we offer as Tony was referring. Those products have a very justifiable purchase, if you will, by the government. And I think we've expanded our government product line very, very nicely with ICx. And now, we offer a suite of sensors that we can integrate completely. That business starting to grow fairly quickly, I think, and has some very good opportunities in the future. This change is completely related to surveillance, and it really kind of hit us at the end of the quarter and we're just going to make sure we don't wish it away. We're not going to wish it away.

Operator

And your next question comes from Tim Quillin with Stephens.

Timothy Quillin - Stephens Inc.

But -- so as you alluded to, the Surveillance business in the back half of the quarter started getting weaker. You don't expect a kind of a normal spike up in orders in 3Q, and trailing bookings in the Surveillance business and Government business have been meaningfully below revenue, so your size in the business for slow growth, but should you be thinking about sizing it for a lower revenue level?

Anthony Trunzo

That's what we just said a minute ago. I mean, we're going to have a lower revenue level in the second half of the year than we expected.

Timothy Quillin - Stephens Inc.

Yes, so I guess, the question is why wouldn't that business decline in 2012?

Earl Lewis

You ask about next year, I got you. Yes, and we just don't have that crystal ball yet. We know we're going to size the business for what we think the next half -- this coming half of the year is, and then we'll look. But when we're done, we will be in a position so that we can be profitable next year at a significant lower rate if that's what happens.

Timothy Quillin - Stephens Inc.

That's fair. And then in terms of Raymarine, what do you expect long term there in terms of revenue rebound? We didn't quite maybe see the revenues we would've hoped this quarter. And do you still think you can get the margins there, the operating margins, up to 20% plus within the next couple of years?

Earl Lewis

The last question is an easy answer. Yes, we can. We're now starting to sell our own products, in other words, ones that we've designed, and the issue there has always been gross margin. And gross margin is affected by design more than anything else in the world. And so as we start to sell our new designs, we'll see improvements in the gross margin and therefore, improvements in the bottom line. The boating industry, Tim, is on its back. It's just not healthy. Whether that will come back or not, I think, we all know it's apparently directly correlated to housing prices. So if the housing market ever gets out of its doldrums, we'll see a revert. It's also, to answer your other question, the front end of it, it's a cyclical business. Q3 is not a good quarter for that business. So revenue, sequentially, will be actually down in Q3 and Q4 from Q2. With all I've said, I think Andy might have given you a statistic relative to the increase in our thermal products, which I think is somewhere in the neighborhood of 70% year-over-year. And now becoming a substantial base, not $1 million, it's going up by 70%, but significantly more. So the acquisition is a good a acquisition, and it produced, I think, $7 million of operating income in Q2. So we're very happy with it, and delighted about the new products that are going to be coming out there. I just wish that the boating industry was more healthy. Sorry for the long answer.

Operator

Your next question comes from Noah Poponak with Goldman Sachs.

Noah Poponak - Goldman Sachs Group Inc.

This is maybe more of a philosophical question, but I'd love to ask it. I'm wondering if there is a disconnect between defense company views of sort of their own product and positioning versus just where the actual defense budget is. Because we've been in meetings with you guys in recent months where you've been asked the question by investors how your outlook factored the continuing resolution that was going on and the response was, we all look at it that way, we look at our individual products and opportunities, and we think we're very well positioned, which is sort of what we hear from every defense company. And then in your -- in the press release this morning, we're specifically citing the continuing resolution and attributing all this to procurement delays and procurement timing. And so I wonder if there's just a concern we should all have in the investment community in the defense world, that you all are looking at your very good product and the opportunities that you have versus sort of coming to grips with the reality of that the pool of money is just lower and is going to keep going lower?

Earl Lewis

I hate philosophical questions because everybody has different opinions there. I'm going to answer you with what we're going to do. We're going to structure our business towards what we can really get our hands around relative to Q3 and Q4 right now, whether continuing resolution or whether it's stalling by people in the procurement side of the business or whether it's problems in Pakistan, I'm not so sure I'm qualified to tell you the answer to that. We'll see how the other companies that compete in this industry do in the next quarter or so. All I know is that when we saw the orders push out at the end of this last month, we decided that we really don't want to see our backlog continue down another couple of quarters. And that we want to now size the business to what we really think the order intake is going to be during the next 2 quarters. Then we took a very hard, I believe, conservative look at that and that's the way we're going to go forward right now. No, I wish I could give you a forecast but clearly it's...

Noah Poponak - Goldman Sachs Group Inc.

Well, if I could just interrupt, Earl. It's less -- I'm not even really asking for a forecast. I'm asking for an explanation as to why we as defense company management teams don't just look at the budget and funding and say -- I mean, investment accounts are down and including the supplemental, are down significantly, yet all defense companies keep sort of saying, we're in the sweet spot. We have good product. We're well positioned. Why not just admit that funding is lower, and it is what it is?

Earl Lewis

Well, first of all, our U.S. DoD government shipments this quarter, I think, were 20% of our total or less. I think it was actually less. It is more like 10% to 12%, I think, of our total. And as you know, the size of our products and their total revenue in the "Defense business" in the United States is very, very small and technically, we very rarely get called out. You go through those budgets, and you look line by line by line, and you're not going to find FLIR. We're down underneath it. So the change of multimillions of dollars does not, I don't think necessarily relate to our business. So yes, you could maybe -- we're naive in that, I don't know. But it's very difficult for us to say a 5% or a 10% reduction in the defense budget is going to be a 10% reduction on our business. It just is. It doesn't necessarily compute at all. Maybe this is a discussion we could take up for an hour or so. Operator?

Operator

And your next question comes from Jonathan Ho with William Blair & Company.

Jonathan Ho - William Blair & Company L.L.C.

Just a quick one in terms of the contracting activity and just the lack of a third quarter budget flush. Do we expect 2011 funds then to go unspent or will there be some type of extension into 2012? I mean, how do we think about sort of this timing catch up? I mean, obviously, you guys don't have great visibility, but it doesn't make sense to me that if you have program demand there that the government just doesn't get it done, and I'm just trying to understand the dynamics around that and how you guys are thinking about that.

Anthony Trunzo

Sure, Jonathan, and this happens all the time. And why it's typically the surge happens in Q3. If they don't spend the money, they lose it. And what we're seeing is money being swept up by more aggressive contracting officers that are in the range [ph] spent in other areas. Will there be a surge in Q3? There could be, but what we're seeing so far is that the contracting officers are overwhelmed, and there's a lot more levels of scrutiny being put on it. And so we're just not anticipating a big bubble like that. And if the money doesn't get spent, it really does move on until the 2012 fiscal year cycle. And if that goes under continuing resolution, then it will be those programs that get awarded with 2012's money that we'll start looking at. So it's going to be a struggle at Q3 and Q4 to see what happens with the budget process.

Jonathan Ho - William Blair & Company L.L.C.

Got it. And just in terms of the international business, I mean how should we think about that on a go-forward basis? I mean, it seem like there are a lot of issues tied with just the activity in the Middle East, but is this temporary? Is it kind of a similar situation to the U.S. Defense spending budget? I mean are you guys being impacted by cuts and worldwide budgets? What are some of the issues that you guys are evaluating on the international side?

William Sundermeier

Sure. On international side, we see a lot of good activity out there, first, Raman, that is going to happen here in the second half, and that tends to put a pause on order activity during that period. But we have several good programs that we did see shift to the right for us in Q2, and still anticipate some good orders in the second half that are -- really, our situation with Pakistan, we'll have to see how that unfolds. We do have not only revenue and backlog that is held up on that, but other orders that we anticipate that are being held up by the U.S. policy with Pakistan right now. So we'll have to see how that shapes out in the second half.

Earl Lewis

We still have a long list of potential orders, don't get me wrong. It's that -- you see the backlog decline 2, 3, 4 quarters in a row, and then eventually, and then a fairly large hit this quarter. Eventually, just say, "Well, okay, let's make this business profitable if it continues along that line." And that's the decision we've made. We expect we'll continue to have good -- great operating margins in our Government business. And we have a little less clarity when it comes to what the order intake is going to be for the next 2 or 3 quarters.

Operator

And your next question comes from Jim Ricchiuti with Needham & Company.

James Ricchiuti - Needham & Company, LLC

Just a question on ICx, you mentioned that it did showed revenue growth in the quarter year-over-year for the first time, I believe, since '09. How would characterize the profitability of the business in the quarter?

Earl Lewis

It's getting there, but it's got a long ways to go, Jim. It's getting there. But we're making improvements and this quarter, we're going to take a few more actions in regard to improving the profitability of ICx, and we'll get there.

James Ricchiuti - Needham & Company, LLC

Okay, and then a follow-up, and maybe on a happier topic. Andy, I believe you said in the TVM business, you gave quite a bit of the detail, but I think you said the revenues were up in EMEA, 56%, is that right?

Earl Lewis

It was up significantly. Was it 56%?

Andrew Teich

That number was actually referring to bookings for Thermography for the EMEA region, which as you recall, we had a pretty significant problem there in the first 3 quarters of 2010 that we're correcting, so that's what I was talking about there.

Operator

And your next question comes from Brian Ruttenbur with Morgan Keegan.

Brian Ruttenbur - Morgan Keegan & Company, Inc.

Okay. I'm trying to understand the third quarter non-recurring expense. How big of charges are we talking, millions, tens of millions, 10% layoffs, can you give us some kind of scale we're talking about?

Earl Lewis

We're certainly not going to talk about layoffs. What we have thought is it's between $0.02 and $0.04 a share.

Brian Ruttenbur - Morgan Keegan & Company, Inc.

As a charge that's built into your guidance?

Earl Lewis

No, it's not built-in.

Brian Ruttenbur - Morgan Keegan & Company, Inc.

Okay. So in your $1.33 to $1.38 in addition, there's going to be a $0.02 to $0.04 charge. In the third quarter, will there be also something in the fourth quarter?

Earl Lewis

No, we don't believe so.

Anthony Trunzo

Brian, I want to be careful about being overly precise about exactly what's going to happen in Q3. There are a few things going on. We're doing some reorganization of some of the acquired businesses that will ultimately result in some pretty significant cost savings that are related to facilities more than reductions in force and those kinds of things. We're looking at those business. And as we said, we're going to try to get the overall cost structure in line with what we think the revenue base is going to be. A point that I hope that captured in the comments that we made is our Surveillance business was substantially down in revenue, but the gross margin was the same as last year. We've done a very good job at the gross margin line in that business of ensuring continued -- of keeping profitability despite dropping revenue, which is a pretty tough thing to do. The operating expense piece needs to get reduced, and we're not yet done evaluating exactly what scale of reduction that's going to be. That's why we said a few cents, and that's why we said we're going to call it out separately, and that's why it's not in our guidance. It's because we don't exactly know what they're going to be. Tens of millions, I think that's a reach, I don't know, be it getting over $10 million, but it will be in the millions for sure.

Operator

Your next question comes from Peter Arment with Gleacher.

Peter Arment - Gleacher & Company, Inc.

A question, Bill, I guess if you could just quantify, I mean, rough size of what's being held up in the Pakistan order?

William Sundermeier

Well, I'm not going to go into the revenue and the order size, but we have some significant opportunity there for handheld equipment in the Recon flavor, and we certainly have revenue here in Boston that we're anticipating shipping if we get a license for that. And then there are some order opportunities in that same vein for the second half of the year. As we were able launch those and get orders, we'll try to announced them if they're of a significant size.

Peter Arment - Gleacher & Company, Inc.

Yes, I'm just trying to understand. Is this more -- I mean, is this an opportunity for -- is this a new opportunity, or have you sold in the Pakistan before, and it's now being reviewed? I just want to understand where the sensitivity comes from?

William Sundermeier

For several years, we've been selling to Pakistan both direct and through SMS. So it's a familiar customer for us.

Operator

And your next question comes from Josephine Millward with the Benchmark Company.

Josephine Millward - The Benchmark Company, LLC

The U.S. Military has 2 potentially large infrared requirements. I was wondering if you can comment on whether these 2 opportunities are in your guidance. The first one, the Navy has a pre-solicitation to [indiscernible] up to 65 Star Sapphire images to FLIR. And #2, the army now has a requirement for additional service mobile surveillance systems, I believe the number is 78. And finally, if you can talk about where you think your government backlog could end up at the end of this calendar year?

Earl Lewis

Go ahead, Bill.

William Sundermeier

Sure, well, Josephine, there's several things that are happening in the reprogram. There was a $6 billion reprogramming request on the 30th of June, a $34 million increase for Army National Guard for the utility helicopter that is up to 45 potential systems there, $39 million increase for 81 RAID towers and server systems, and there's a $4.3 million decrease for ship protection systems, and also another in reprogramming that went for $84.9 million for PGSS, which were also on -- so those are all the things that we're watching, and seeing if that funding does shift and become available to the program officers that we're working with, as well as the Navy. And we certainly have those opportunities in our factored forecast, and are looking at those hopefully being funded. And as soon as they are and we have orders of a significant size, then we'll certainly start talking about them. We like to run our Government Systems business at least a 50% book-and-build, and we'll see how the back end of this year comes to be able to see where our backlog ends up. As Earl mentioned, we're trying to size the business properly such that we stop seeing the diminishing backlog in Government Systems. That's probably the best guidance I can give you, thus far, is that we're trying to not diminish backlog any further for the rest of the year.

Earl Lewis

But just one last comment on that. Those of you that remember the company 6 or 7 years ago when we are running on very, very thin vapor in terms of backlog, we were running it very inefficiently. And we've now been able for the last 3 or 4 years to generate tremendous margins, and run these businesses much more efficiently with a decent backlog. And I just think that our decision has been we're not going to push for every last dollar out of our backlog this year to meet the original numbers we said we were going to meet. We'd rather have this business run efficiently, and so we're going to slow down on the output, so to speak, and not squeeze every nickel out of it. I think that positions ourselves much better for 2012. As Noah pointed out, the budgets are very squishy right now, and it's very difficult to get a good handle on what the future is going to be. The only thing I really know how to control is cost, and we're going to match it to our lower revenue number now.

Operator

Your next question comes from Michael Ciarmoli with KeyBanc Capital Markets.

Michael Ciarmoli - KeyBanc Capital Markets Inc.

I don't know if this is an Earl or Tony question, but I guess you guys recently -- the Analyst Day last year, you recommitted to the 15% top line, 20% bottom line growth. Looking at this new growth rate that you're planning for in defense, how should we think about your long-term model? Has anything changed there? Do you have enough sort of earnings leverage in that commercial model to achieve those growth rates? Or is that something you're looking at as well?

Earl Lewis

We are absolutely ecstatic about the commercial side of our business. I wish you guys were. It's growth rate. The last quarter we just had was a fantastic one. Our Thermography business still has too high a backlog. I mean, we're scrambling like crazy to make shipments out of that business. The new products we've introduced have had tremendous success. Some of the new Raymarine products, I think, will have tremendous success. The cores business, I think, had the largest order intake they have ever had. Our Commercial businesses are in all 8 cylinders and then some. It's very strong, and I think, perhaps, it will do better than our budget in our current plans frankly.

Michael Ciarmoli - KeyBanc Capital Markets Inc.

Is it reasonable to think though at the corporate level you can achieve this 20% bottom line growth rate over the long run?

Earl Lewis

Yes, absolutely, yes. Over the long run, we can. In every quarter, even a year-to-year, no. We did face a -- this is the first quarter that the Government System business has not shipped any of the RAID-type products. And everyone was scared that our gross margins were going to -- were going to get bad, and the business was going to not do well when that went away. It's gone away, and we're still producing terrific margins, and that's our job. We'll have to find a way to get the growth rate up, and that's our next job. Tony, you were going to comment?

Anthony Trunzo

I was just going to say, Mike, we just went through, over the last several months, a long-term look at the business. And with our even reduced expectations for the Government Systems business, there are lots of opportunities in the business to produce earnings per share growth over a 3-to-5 year period, north of 20%. So that's a very long answer to the question: "Are we changing that expectation long term for 20% earnings per share guidance?" No, we're not. I think that model supports it.

Operator

Your next question comes from Michael French with Morgan Joseph.

Michael French - Morgan Joseph TriArtisan LLC

Quick housekeeping one. What was the depreciation and amortization for the quarter?

Earl Lewis

Tony or Dave, can you?

Anthony Trunzo

Yes, hang on a second, Michael.

Earl Lewis

We'll announce it soon as they've looked it up, Michael.

Michael French - Morgan Joseph TriArtisan LLC

Okay. Sure. And on the international business, were there any delays beside Pakistan? And if so, is there any common theme for them, or is it all different situations?

Earl Lewis

There were, definitely. There was both in the Saudi Arabia and UAE. We had delays in orders that we expected to get.

Michael French - Morgan Joseph TriArtisan LLC

And was it for, like I said, is there a theme -- funding or...

Earl Lewis

No. The Pakistan issue, everybody understands, right, that -- Bill, you want to...

William Sundermeier

There's been effectively a hold there and a reevaluation of all the licenses that are going on. So we're just held up until the U.S. reaffirms its policy, and allows those licenses to move forward. And in the UAE and Saudi, the existing customers just -- we were surprised to find them and not being able to get those orders. Normally, we get the orders and it's just difficult to get the payment. But this time around, we didn't even get the orders from them.

Michael French - Morgan Joseph TriArtisan LLC

Okay. Did you get the depreciation, amortization...

William Sundermeier

Yes, Michael, depreciation and amortization in the quarter was $23.7 million.

Michael French - Morgan Joseph TriArtisan LLC

And the last one. Earl, you had mentioned RAID, and I guess the question's for Bill. Is there any update on a follow-on program or record?

William Sundermeier

Not right now. There are certainly, with the activity that's going on with all these reprogramming -- moving systems still from Iraq to Afghanistan and determining what the coverage is for Afghanistan. And right now, they're kind of being put on pause for Afghanistan to see how long we're going to be there. So Marine Corps got theirs in, but the Army missed the window for 2012. So we should see something for the Marine Corps, for G-BOSS in 2012 or less, but the Army missed the opportunity to get in for 2012. So I think it'll be 1 more year before you'd see anything coming from the Army.

Operator

Your next question comes from Jeremy Devaney with BB&T Capital Markets.

Jeremy Devaney - BB&T Capital Markets

I just wanted to follow-up on those line of questions. You know we've seen the DoD operate under a CR year-in and year-out over the past decade. What is specifically different this time that's causing such operating difficulties? And what is causing program offices in your words to "suck up funds"?

Earl Lewis

Those are Bill's words. I don't see it quite that way. Go ahead, Bill.

William Sundermeier

To clarify on sucking up funds. What typically happens is if there's money out there and you have an aggressive contracting office, where they want to spend something they have an urgent need, they'll go find a contract vehicle in the funds and get them reprograms, so that they can spend them. So there's a lot of shifting and a lot of fighting over those funds. In a CR environment, really, you end up with a lot of contracting delays where things, for example, that are in the budget don't get approved during the continuing resolution. Certain things get approved, which are basically for theater operations, but you don't get R&D programs approved. You don't get standard things that are in the budget approved. So it just causes the normal process of procurement to get delayed, and what happens is people will end up having to move money around and fight for that money to be able to associate it with their programs to get their orders done. So it just causes a general slowdown in the procurement activity. Not that it all goes away, it just causes a delay in being able to obtain those funds.

Jeremy Devaney - BB&T Capital Markets

Bill, just to jump in here though. I mean, the CR environment is kind of self-explanatory. But is there something that's different about this time versus prior years that's causing, really, a more impactful situation, specifically, to you guys? And I mean we're hearing it across the defense space, but it sounds like, more or less, people aren't taking the impacts as seriously in their guidance there. What's not -- what's different this time than in the past?

William Sundermeier

I can tell you what's different this time for FLIR, and that is over the last 5 years. We've had a wonderful RAID program that we can continue to work off of, and if we ever had contracting delays, we sort of can fill in those gaps with that program. We don't have that program moving forward, and so we're a little bit hand-to-mouth, and we're setting ourselves up to be more conservative about how fast we can get those opportunities in the door. I can't comment about how other businesses are operating, but's that's our particular situation.

Earl Lewis

I think he was more concerned with the buyers in this case. And I guess the only observation I could make from what I've heard anyway is that they seem to be a little more reluctant to make a decision. I don't know how to quantify that to you, but there does seem to be some reluctance to get the paper out.

William Sundermeier

Well, in that specific point, you have Dave talking about no more [ph] sole sources, you had the whole Halliburton situation, the contracting officers are paranoid about giving out sole sources, and making sure all their SBAs and their minority-owned divisions are all done. So what we see that's happening differently is the contracting officers aren't allowed to release those funds. It's actually getting approved by colonels 2 or 3 levels up before these vehicles actually get appropriated. So they're -- not only do we have a lot of things coming into the system, but they're requiring maybe 1 and 2 more levels of sign-off before you can actually get it appropriated, so double problem right now. That it's much different than we've seen in the past.

Earl Lewis

I don't know how to quantify that. But clearly, there is more bureaucracy, let's put it that way, in the procurement side than I think we've seen in the past.

Operator

And your last question comes from Jonathan Ho with William Blair & Company.

Jonathan Ho - William Blair & Company L.L.C.

Just want to end the call then with a couple of questions on the commercial side. This 55% growth in the cores, can you maybe give us a little bit more detail on where you saw that strength, and maybe give us some additional detail on what you think are some of the drivers behind some of the new products in the new cores that you have in particular?

Andrew Teich

Sure, Jonathan. I think that the fundamental driver for this is that we got a very good product development engine running in CS. And in the cores piece, specifically the Tau, is doing very well. You recall we launched the Tau, if it was 2 years ago. And then last year, we had the 640 17-micron Tau that we launched. And then this April, we launched QUARK, which isn't yet showing up in the Cores and Components revenues. But Tau is a very competitive product in the market. Those products get measured by government customers looking at a thing they call swap C, size, weight and power and cost. And we do very well on those points. We usually don't talk about the level of fidelity customer-by-customer basis there. But I can talk about customer segments. We sell into thermal weapon site manufacturers. We sell them to UAV manufacturers. We sell into ground-based UAV manufacturers, fire business picked up a little bit, that's another one that's on the Commercial side. The Security business, we sell through a couple of other security camera manufacturers that integrate those cores. And then also on the cool side, our business is doing fairly well. Specifically, we called out in the conference call script the performance of what we call ATS, advanced thermal solutions, which is a former CDEP business that we acquired in France. And they have had an extraordinary run the last couple of quarters, and they're selling cooled, mostly cooled cores into primarily foreign locations, and these products end up in products that are being used for security infrastructure, some border surveillance kinds of products.

Jonathan Ho - William Blair & Company L.L.C.

Great. And in terms of the Aerius acquisition, I mean, you guys mentioned sort of multi-spectral capabilities and other sort of type of capabilities. How much of a market does that open up for you guys? And I guess how should we think about this in terms of revenue contribution, if any. I think you guys said there are no contribution to earnings. But I just want to understand a little bit more about that acquisition and what you see as an opportunity there.

Andrew Teich

Yes, sure. Yes, we'll talk about the technology side first, which is I'm quite excited about. This is a very innovative company, a company who we've been working with for a fair amount of time through our AIS group in Colorado Springs, a former Salvador Imaging. And so this company is quite active in SWIR technology that shortwave infrared technology, and one of the things that we've been leaning on is developing multi-spectral solutions for the Tau product line. So we show, for example, at this year's SPIE Conference several versions of the Tau to include long wave, short wave, low light and HD color imaging versions of the Tau platform such that a manufacturer of a UAV, for example, can bring a UAV in and unplug a long wave core and plug in a SWIR core or a plug in a invisible light core, or a low light core. So we think there's a lot of opportunity. I think SWIR has got a tremendous amount of opportunity, and we've been working on SWIR technology both at the read-out integrated circuit level in Santa Barbara, at the camera level at AIS in Colorado and now, with Aerius coming into play, they'll -- they're going to bring another level of capability in SWIR. And then the second piece on that is the active illumination side, and that's where these VCSEL arrays come in. It's sort of leading technology for low-power lightweight laser illumination technology, and they're quite advanced in that area. We'll roll that into our Cores and Components group. It's going to take some time for you to see that, and feel that in the income statement of the business, because we've got to do some additional development. But as we do that, we'll push it through our existing sales channel, I think, pretty effectively.

Well, operator, thank you very much, and thank you all for calling in, and I'm sure we'll hear some more from you in the next couple of days, and be glad to talk to some more about where we're headed. Thanks again for calling.

Operator

This concludes today's conference call. You may now disconnect.

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