Axsys Technologies Inc. Q4 2007 Earnings Call Transcript

Axsys Technologies Inc. (AXYS)

Q4 2007 Earnings Call

February 20 2008 10:00 am ET

Executives

Julie Oakes - Director of IR

Stephen Bershad - CEO

David Almeida - CFO

Scott Conner - President

Analysts

Steve Levenson - Stifel Nicolaus

Antonio Antezano - Bear Stearns

Michael French - Morgan Joseph

Michael Ciarmoli - Boenning & Scattergood

Scott Lewis - Lewis Capital Management

Presentation

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2007 Axsys Technologies Earnings Call. (Operator Instructions)

I will now turn your call over to Ms. Julie Oakes, the Director of Axsys Investor Relations. Please proceed.

Julie Oakes

Thank you. This call includes forward-looking information that Axsys does not undertake to update and may not reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking information. Although such statements reflect Axsys' current reasonable judgment regarding the direction of the business, the actual results might differ materially from those in the forward-looking statements. Assumptions and other information that could cause actual results to differ materially from those set forth in the forward-looking statements can be found in Axsys' filings with the Securities and Exchange Commission.

Any non-GAAP financial information presented will be reconciled to GAAP financial statement on the Investor Relations section of the company's website at www.axsys.com.

I will now turn the conference over to Mr. Stephen Bershad, Chief Executive Officer. Please go ahead.

Stephen Bershad

Thank you, Julie. Good morning, everyone, and thank you for joining Axsys Technologies fourth quarter 2007 conference call. As usual David Almeida, our Chief Financial Officer, and Scott Conner, our newly appointed President, are joining me on this call. As you can see from our quarterly earnings release, our fourth quarter performance was a strong finish to an exciting and transformative year for Axsys.

With quarterly revenues of $47.9 million in net income from continuing operations of $4.1 million, representing overall year-over-year growth of 42% and 71% respectively, the company is clearly on a roll. David will present the quarter's financial details shortly. So at this time, I'd like to take an opportunity to highlight the full year's success.

In fiscal 2007, sales grew 32% to a $171.6 million, even ignoring the impact of our April acquisition of Cineflex Camera Systems, Axsys' organic growth rate was an impressive 19%.

With that said, it's already clear that the addition of Cineflex, now Axsys' gimbal division, will provide significant strategic and financial advantages for our company. Not only did this organization grow at a fast clip during the year, but their margins, which are higher than Axsys' average margins, had a favorable impact on Axsys' annual results by accelerating our trend towards higher profitability.

Overall Axsys' 2007 gross margins grew to 32.5% from 31.5% in 2006 and operating margins from continuing operations grew to 13.6% from 11.2% last year. The effect of strong annual revenue growth and improved profitability resulted in a 49% year-over-year growth in fully diluted EPS from continuing operations.

My emphasis is on continuing operations, as a result really of the successful sale of our previously discontinued Distributed Products business. During the fourth quarter, we recorded a $1.7 million net after-tax gain from the sale. Although this is certainly a good result, the inclusion of this one-time event in any discussion of our performance tends to distort our results for comparative purposes.

Strategically, however, the sale of this non-core business allows us to focus all our management and financial resources on our rapidly growing Optics business. In further support of this objective, we also executed a corporate reorganization during the fourth quarter. The intent of this reorganization is to add management depth and reorient our company around markets rather than technologies.

Scott will discus the details of the restructuring later in the call, however it's important to note that the successful implementation of this reorganization, in addition to the sale of our Distributed Products business, plus the strong growth in our order backlog has enabled us to increase our 2008 guidance.

I will discus the details of the revised guidance at the end of the call, but clearly we have reason to be very enthusiastic about the company's outlook as we enter 2008.

At this point I will turn the call over to David, who will review the quarter results and then Scott will give you some background on our market development.

David Almeida

Thank you, Steve, and good morning, everyone. Today I will start with the review of our consolidated financial results for the quarter and year, followed by discussion of the financial performance of our business segments. I will then touch on some highlights of the balance sheet before turning the call over to Scott.

Starting with our fourth quarter results; sales were $47.9 million in 2007, up 42% from $33.8 million in 2006. While the gyro stabilized business, which was acquired in April 2007, was a significant contributor to our growth for the quarter, organic sales growth was 16%.

Gross margin for the quarter improved to 33.2% versus 30.4% in the fourth quarter of 2006. The improvement was largely due to favorable product mix, including the addition of the high margin gimbal business that we acquired.

Operating income increased from $3.5 million or 10.5% of sales in the fourth quarter of 2006 to $6.6 million or 13.7% of sales in the fourth quarter of 2007.

Our higher gross margins contributed combined with the overall controlled growth of our SG&A expenses, enabled us to increase our operating margin by 320 basis points in the fourth quarter, while increasing our investment in R&D to 4% of sales from 3.2% in 2006.

Income from continuing operations increased from $2.4 million or $0.22 per diluted share in fourth quarter of 2006 to $4.1 million or $0.36 per diluted share in the fourth quarter of 2007. Net income for the fourth quarter of 2007 was $5.8 million and included a $1.7 million after-tax gain on the sale of our previously discontinued Distributed Products business.

We are still finalizing networking capital adjustments from the sale, but we don't expect it to be that significant which may result in an adjustment to the gain in 2008.

Moving to our full year results; sales for fiscal 2007 were $171.6 million, a 32% increase over sales of a $129.9 million in the prior year. The year-over-year increase was driven by 19% organic growth, as well as the addition of the gimbal business.

Our full year gross margin for fiscal 2007 was 32.5%, up a 100 basis points from 31.5% in the prior year.

Operating income was $23.3 million in 2007, a 60% increase from $14.5 million in 2006.

We continue to leverage our overhead expenses as the business expands. Improvements in gross margin and management of our operating spending drove 240 basis points increase in our operating margins from 11.2% in fiscal 2006 to 13.6% in fiscal 2007.

Income from continuing operations was $14.1 million or $1.27 per diluted share in 2007, up from $9.3 million or $0.85 per diluted share in 2006. Full year net income including discontinued operations was $16.8 million or $1.51 per diluted share in 2007, compared to $10.3 million or $0.94 per diluted share in the previous year.

During fiscal 2007 backlog increased 21% to $140 million. 89% of our backlog is actually shippable in the next 12 months.

As Steve mentioned, we reorganized our business in the fourth quarter of 2007.

Results for the new segments are as follows. Surveillance Systems Group sales grew 149% from $6 million in the fourth quarter of 2006 to $15 million in the fourth quarter of 2007. Increase in sales for the quarter was mainly due to the addition of the gimbal business.

Gross margins increased from 32.7% in the fourth quarter of 2006 to 47.9% in the fourth quarter of 2007, due to favorable product mix, including the addition of the gimbal business as I mentioned and increased efficiency in our infrared camera production.

Operating income improved to $3.2 million or 21.2% of sales in Q4 of 2007 from $509,000 or 8.5% of sales in Q4 of 2006, due to gross margin expansion and the leverage of our selling, general, and administrative expenses. This is the first time we are presenting financial results for the new segment. I'd also like to give a brief overview of the full year segment results.

Full year sales for the Surveillance Systems Group of $47.5 million in 2007, up a 102% from $23.5 million in 2006, driven by strong growth in both our infrared cameras business and the recently acquired gimbal business. Gross margin increased from 37.4% in fiscal 2006 to 41.6% in fiscal 2007, while operating margin for the group also improved year-over-year from 13% to 18.6%.

Now for the Imaging Systems segment. In the fourth quarter of 2007, sales for the Imaging Systems Group were $32.9 million, a 19% increase from sale of $27.8 million in the fourth quarter of the prior year. The growth was mainly due to strong demand for infrared lenses and optics for space and high altitude surveillance.

Gross margins for the segment were 26.6% in the fourth quarter, down from 29.9% in the fourth quarter of 2006. The margin decline was due to unfavorable product mix within the segment and the impact of increased shipments on a couple of large government contracts that have high volume pricing.

Our operating income margin for the quarter was 15.6% in 2007, compared to 17.1% in 2006. The reduction in operating margin was due to lower gross margin in 2007 which was partially offset by increased leverage of our operating expenses.

Imaging Systems Group had full year sales of $124.1 million in 2007, up 17% compared to sales of $106.4 million in 2006. Gross margin decreased from 30.2% in '06 to 29% in '07, while operating income margins increased slightly from 16.8% in 2006 to 17.1% in 2007. Including with the balance sheet highlights, we ended 2007 with $15.3 million of cash, up $9.3 million from the prior year end.

We also used a portion of the proceeds from the sale of our Distributed Products business to repay all of the remaining debt and the acquisitions of the gimbal business.

With that, I will turn the call over to Scott. Scott?

Scott Conner

Thanks, Dave, and hello, every one. My comments today are going to be organized around the corporate reorganization that we implemented in the fourth quarter. I'd like to start by explaining why new organizational structure was necessary, after which I'll discuss the composition of the newly defined reporting segments, highlighting their different market and economic dynamics. And finally, I will note important Q4 events that took place in each segment.

The intent of the organizational structure was to address four fundamental goals. First, we needed to reorient the company around markets rather than technologies. To sustain our rapid growth it was important that we organize our business in such a way that our management is addressing customer needs in a broad sense rather than simply satisfying specific technical requirements.

Second, we needed to maximize the synergies of our inherently interrelated technologies. Customer oriented organization that enables cooperation and coordination of various technology areas was critical to achieve this goal.

Third, we needed to satisfy our requirements for increased management depth. The rapid growth of our business demanded the addition of a new management layer to ensure proper investment prioritization, business oversize and customer satisfaction.

Finally, with the sale of our Distributed Products business, we needed a new financial reporting structure that will provide investors with a clear and logical insight into our business.

With our new organizational structure we have achieved all four of these goals. Axsys is now defined by two new reporting segments, Surveillance Systems and Imaging Systems, each of which has its own customer types, business model, economics and growth trajectory.

Let me start by introducing the Surveillance Systems Group. The Surveillance Systems Group designs, manufactures and sells infrared camera systems for surveillance, reconnaissance and threat detection applications. These systems are deployed both in fixed configurations on poles and towers and on stabilized platforms aboard ground, marine and aerial vehicle.

Our primary competitors in this market group are FLIR Systems and L-3 Communications.

An important characteristic of the Surveillance Systems market segment is that its products do not typically need to be integrated into larger platforms. As a result, they are sold to end users, including homeland security, military, paramilitary and law enforcement agencies in the United States and around the world.

Our high-definition aerial camera systems are also the first choice of many electronic news gathering agencies and film production companies. While the Surveillance Systems Group is the smaller of our two business segments at present, it is also faster growing due to both the underlying market demand and the economics of the technologies involved.

Importantly, this segment's commercial business model support higher average gross margins and operating margins in the Imaging Systems segment, despite significant R&D and sales and marketing spending requirement. This segment also requires relatively limited fixed capital investment.

To satisfy our need for additional management depth in this market segment, we hired a new group President, Randy Moore in the fourth quarter. Randy joined Axsys from Kollsman, an Elbit subsidiary, where he served as Executive Vice President and General Manager. His market experienced with electro-optical system and infrared surveillance product, as well as his leadership experience in the United States Air Force, make Randy a valued addition to the Axsys management team.

The Surveillance Systems segment had several bookings of notes during the fourth quarter. As I mentioned earlier, this group produces solutions for land, sea and airborne application. So today, I will briefly discuss one notable booking in each of these areas.

In the land base area, perhaps the most high profile program is the U.S. Border Patrol SBInet initiative. As many of you know, SBInet is the Department of Homeland Security's program to build a virtual fence to protect to the US against illegal immigration and terrorism.

As I mentioned on the last call, Axsys has been approved as the land based camera vendor to Boeing, the program's prime contractor.

During the fourth quarter, Axsys received its first SBInet order to supply an array of different types of camera systems. While the rollout scheduled for this program remains unclear, Axsys continues to be well positioned on this major border protection initiative. I should also add that while this program certainly has the potential to be a large program for Axsys, it hardly stands alone.

Our sales pipeline among both international border agencies and military organizations worldwide continues to be quite strong. A somewhat recent addition to our product portfolio is a family of surveillance camera systems designed for sea-based deployment.

Some of these cameras are simply marinized versions of our land-based systems and others are integrated with gyro stabilized platform to compensate for the constant motion of the sea. These camera systems are used for applications, such as port security, where they are used by agencies, such as the Massachusetts State Police and they are also used by commercial shipping companies that are at risk of terrorist attack.

During the fourth quarter, for example, we sold cameras for deployment on liquefied natural gas tankers to assist in terrorist threat detection. While Axsys is relatively new to the marine-based market, we feel that our products are very competitive and that this market presents a great new opportunity.

In the air borne surveillance market, the most important event of the quarter was the formal introduction of our next generation multi-sensor platform called the MS2. This system leverages our newest long range 640 x 480 infrared camera and is designed specifically to satisfy military, paramilitary and law enforcement requirement.

During the fourth quarter, we sold and shipped several of these systems, but perhaps more importantly the MS2 is being evaluated by several U.S. government agencies and we are hopeful that at least some of these evaluations will turn into orders within the year.

I would be remiss if I didn't also mention the continued strength that we are experiencing in the electronic news gathering and movie production market. Our airborne gimbal products are increasingly viewed as the industry standard for high-definition image capture and a high demand for HD is leading to strong sale.

One interesting fourth quarter example of this trend was the BBC's purchase of a specially designed winterized stabilized camera platform for a new series called The Frozen Planet. This series, which will be filmed in the extreme climate of the North and South Poles, is a follow-up up to the BBC's critically acclaimed program Planet Earth.

BBC continues to rely on Axsys' state-of-the art stabilized camera systems to capture long-range, high-definition images.

Now I would like to move to our other newly defined reported segments, the Imaging Systems Group. This segment designs and manufactures products, such as infrared lenses, low-range telescopes, stabilized sensor positioners, and scanning and laser positioning system.

The primary distinction between these products and those sold by the Surveillance System Group is that Imaging Systems Group products do not usually operate on their own, but rather are customized and integrated into larger systems by our customers. The customers for the Imaging Systems Group are predominantly prime defense contractors, such as BAE and Raytheon, who depend on Axsys to provide enabling technology for next generation surveillance, reconnaissance and targeting systems for use on military platforms such as armored vehicles, satellite, military aircraft, and tactical and strategic missile system.

The economics of this business segment are quite different than those of the Surveillance Systems Group. Gross margins tend to be lower in this segment for a couple of reasons. First, R&D is often paid for as part of government contracts and therefore our engineering costs are normally included in cost of goods sold. Second, this business is more capital intensive than the Surveillance Systems group so it carries higher depreciation expense.

Conversely, our operating expense in this segment tends to be relatively low because we typically sell to large prime contractors with whom we have established long-term relationships and excellent reputation, our marketing costs are not high. In addition as previously mentioned much of the R&D expense in this segment is paid for and consequently accounted for above the gross margin line.

In the Surveillance Systems group, we felt a need the add management depth to this organization. In this instance, we decided to promote a key manager from within rather than hiring from the outside. Consequently Jim Howard, previously General Manager of the Infrared Lens Division will oversee the Optics business as Group President.

Since our last call, the most prominent booking in this segment is a recently announced order for infrared lenses Crows Remote Weapon Station program. I alluded to the potential for this order in the last call and we announced the order in Q1.

The initial award for this program amounts to $21.9 million that allows for additional quantities over five years, which could bring the total contract value to $87 million. I should note that since this contract was awarded in Q1 of 2008, it is not included the $140 million end of your backlog that Dave mentioned in his remarks.

This order is significant, but not only due to the size of the program. Weapon stations are just emerging as a key technology for situation of awareness and the protection of soldiers, because they allow combatants to detect threats and return fire from the protection of up-armored vehicles.

As we often point out, Axsys benefits when optics replace human in surveillance, reconnaissance and targeting applications of all kinds. Another large potential order which I mentioned in our last call is for the TWS' Thermal Weapons Sight program.

The TWS provides enhanced situational awareness for soldiers by allowing them to assess threat in dark environments. We're still actively negotiating this contract and expect to book it before the end of the quarter. From an engineering perspective, our most recent development in our Imaging Systems Group is a new gyro stabilized positioning system for marine application.

This product was initially developed to support the Surveillance Systems Group entry into the marine market but there are broad applications for integrating with and controlling sensor payloads, such as radar and lasers. The continued market demand in both of our segments, coupled with our strategic reorganization and strong market position, has set the stage for 2008.

As a result of these factors, the Axsys management team is feeling increasingly bullish about the year which allowed us to increase our annual guidance.

At this time I'd like to turn the call back over to Steve who will address the details of the revised guidance. Steve?

Stephen Bershad

Thanks, Scott. As Scott suggests our business has really never looked better. The sale of our Distributed Products business and the successful reorganization of the company, combined with a strong demand trends we're seeing, have enabled us to increase the guidance that Scott mentioned.

As we noted in our recent press release, we now expect 2008 revenues to range from $208 million to $212 million, an increase of 21% to 24% over 2007 revenues.

In addition, we expect 2008 earnings to be in a range of $1.70 to $1.75 per diluted share or EPS growth of 34% to 38%.

I am clearly pleased with these revised guidance results and we all feel strongly that we are very well positioned to execute on our 2008 plan.

This concludes our prepared remarks at this time.

So, I'd like to open the call for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question will come from the line of Steve Levenson of Stifel Nicolaus.

Steve Levenson - Stifel Nicolaus

Thank you. Good morning Steve, Scott and Dave.

Stephen Bershad

Good morning, Steve.

David Almeida

Good morning, Steve.

Scott Conner

Good morning, Steve.

Steve Levenson - Stifel Nicolaus

Sounds like the Cineflex acquisition is paying off a lot of better than a lot of us expected. Can you give us some additional details on where the revenue was and where it is because I know you haven't broken that out separately in the press release as a private company before?

David Almeida

Sure Steve. We originally anticipated that for the time that we owned Cineflex, which was from April 13, forward that we are planning on delivering about $11 million of revenue for that period of time. And we ended up, as you know we delivered $8.8 million in the fourth quarter, and from April 13th to December 31st we actually shipped $17.4 million, so well exceeded our expectations.

Steve Levenson - Stifel Nicolaus

Are you finding that this revenue is coming from new markets or are you taking share away from other providers?

Stephen Bershad

Well, the evolution of this market in fact many of the people with the players in this market started this production business and there is clear demand there, it is production electronic news gathering driven by the demand for HD for high definition visible images.

Increasingly, however, and if I can, in the fourth quarter we are getting a lot of interest and sales to, the best word of description is paramilitary type buyers and law enforcement and that's been driven by our new gimbal that I discussed earlier which really has a very advance infrared system in it.

Steve Levenson - Stifel Nicolaus

And that's using your own optics and somebody else's censor?

Stephen Bershad

Yes, it's our own camera system.

Steve Levenson - Stifel Nicolaus

Okay.

Stephen Bershad

A camera but someone else's chip right.

Steve Levenson - Stifel Nicolaus

At this pace you think you can keep up in 2008?

Stephen Bershad

So, we are feeling very good about that business, let me just say that.

Steve Levenson - Stifel Nicolaus

Okay. You discussed a new market, the liquefied natural gas carriers?

Stephen Bershad

Yeah, that was a pretty interesting, this whole marine area is new for us. That was our first win in that space, but in fact we are doing some more emphasis in that are. We are emphasizing that area because distinct there seems to be a lot of opportunity, both in commercial and law enforcement/military customers in that area. And it really is a not a huge enhancement to stuff that we are doing and most important one though is a stabilized marine based positioning system for our cameras which we released in Q4.

Steve Levenson - Stifel Nicolaus

Is that a single-ship or a multi-ship order that you talked about?

Stephen Bershad

It's a multi-ship but it's not a massive fleet but it was significant. And what important is that less the particular order and more our new position in that space, we've referenced customers and I think that the opportunities in that space could be pretty significant.

Steve Levenson - Stifel Nicolaus

Okay, thanks. Have you heard anything new from some of the foreign border contracts like [MICSA], I don't know what's going on there, it sounds like there is an award coming soon but nobody really knows the date yet.

Stephen Bershad

Right. And so let me just say there is not that much I can, I don't want to disclose too much on the call, but we're feeling very positive particularly about Middle East opportunities.

Steve Levenson - Stifel Nicolaus

Okay. And last acquisition pipeline, you've got a very clean balance sheet, are there things you clearly need to add? Or do you think you are well positioned right here, and don't need to add anything for 2008?

Stephen Bershad

No, I think you hit both. I think we feel we're well positioned, but as we discussed on previous calls we are constantly looking and this quarter is no different. We've been spending a lot of time looking at variety of acquisition candidates. But as we also say we're picky as you probably know and we are going to execute only when we feel the candidate is right not to fulfill any timeline requirement.

Steve Levenson - Stifel Nicolaus

Great, thanks very much.

Stephen Bershad

You are welcome.

Operator

Your next question will be from the line of Antonio Antezano of Bear Stearns.

Antonio Antezano - Bear Stearns

I was wondering in terms of acquisitions, just to follow up on the prior question. What are the priorities for acquisition?

Stephen Bershad

That's a little bit of a hard question for me to answer, because if I give something specific, you'll actually, I don't want to say publicly to be honest. And there are variety of areas that we're looking at and we are looking at specific companies in a variety of area.

Suffice it to say, we are looking for areas where we can leverage our optics capability, our precision military grade motion control capability and our distribution channel. I really would prefer not to go beyond that.

Antonio Antezano - Bear Stearns

Okay, thank you. Regarding I guess follow-up on Cineflex as well, given the success of Cineflex this year and I guess your expectations for 2008. At what point that's going to trigger earn-out payments related to this acquisition and what would those earn-out payments be I guess for the first year?

David Almeida

Yeah we've got actually it's a dual trigger, we've got two tiers, two thresholds that need to be met. The first threshold is $17 million threshold and the second threshold is a $26 million threshold full year revenue numbers. Does that answer your question?

Antonio Antezano - Bear Stearns

Okay, yeah.

Stephen Bershad

We are actually in fact, we are into the earn-out for, there's a stub period for the period between April 13th when we bought the company to the end of this calendar year and they actually went into the earn-out and we are making the payments in the next day or two we expect to be making payments this year and we also expect to make payments next year as well.

David Almeida

Right. The payment that we will be making shortly here is $3 million payment for the 2007 performance.

Antonio Antezano - Bear Stearns

2007.

Stephen Bershad

Of course that has no effect on earnings, actually the balance sheet effect is cash. This goes out for the payment and then we increased the goodwill related to the transaction.

Antonio Antezano - Bear Stearns

Right. And then just final question this new sensor, you mentioned the MS tool, is that based on Cineplex technology right, that's what you said?

Scott Conner

It's actually a combination, as I mentioned in the past the Cineplex team are real expert at precision motion control basically, so that you can hold the camera very stable looking at great distances. What we've done is the MS2 is an enhanced version leveraging that motion control capability, but also leveraging the infrared capability that we had announced before. And so we combined those two capabilities to provide a new gimbal that probably neither company could have created independently.

Antonio Antezano - Bear Stearns

Right. Okay, thank you.

Scott Conner

You are welcome.

Operator

Your next question will come from the line of Michael French of Morgan Joseph. Please proceed.

Michael French - Morgan Joseph

Good morning, gentlemen.

Stephen Bershad

Good morning, Michael.

David Almeida

Good morning, Michael.

Michael French - Morgan Joseph

Congratulations on a very strong performance.

Stephen Bershad

Thank you.

Michael French - Morgan Joseph

First question I have on the guidance, would you be interested in breaking out by segment at least the top line?

David Almeida

We are not actually prepared to breakout the guidance by segment. What I can tell you is that if you look at those two segments in 2007, Surveillance Systems grew, as you know, at a pretty healthy rate about 102%. We do expect that to slow somewhat down in 2008 and it is coming off a very small base. And for our Imaging Systems Group, we had grown at 17% and we feel that programs are going to continue at least around those levels as we move into 2008. So that gives you some sense anyway.

Michael French - Morgan Joseph

Yeah, that helps.

David Almeida

Because we have the starting point, okay.

Michael French - Morgan Joseph

And I think the follow-up on Scott's comments on SBInet, you mentioned that there's an order from Boeing. Could you indicate the size of the order, or also since Boeing has a couple different providers and is stable, do you know what market share that Axsys received?

David Almeida

No, I don't. Because I don't know what anyone else gets. I only know rumor and it's hard for me to comment on that. Yeah, the sense that we have is that everyone is getting equal amounts so far that basically there are three providers specifically [US], FLIR and L-3 and our sense is that everyone's got an equal amount which is a few million dollars. But the discussion, the topic, I mean the discussions that are going on right now among all these players is that the ramp is going to occur fairly soon.

But again as I've mentioned in my notes, it's really hard to judge and the predictions of the timing have not been particularly, you can't really count on them. And so I hesitate to provide any more specifics just because we really don't know.

Michael French - Morgan Joseph

Okay, that's fair. I appreciate that. And on the Thermal Weapons Sight, what's the magnitude of this deal you're negotiating?

David Almeida

I guess I can say that, I mean I suppose it's -- I hate to do this to provide, we're going to announce that when we get it, maybe I should just say that. And it should be relatively soon. Importantly, if you are asking from a modeling perspective, I don't think that the rate of these deployments will be any greater. So the magnitude of the order is not directly related to how much is gong to ship within a particular year. Our delivery rate is probably going to say how much constant and may be grow a bit but not dramatically so.

Michael French - Morgan Joseph

Okay. And since you are still far along in that and you said something you included in your guidance or would this be an addition to what you have outlined?

David Almeida

No, it's included in the guidance.

Michael French - Morgan Joseph

Okay, thank you, and good luck.

David Almeida

Sure. Thanks.

Operator

Your next question will be from the line of Michael Ciarmoli of Boenning & Scattergood. Please proceed.

Michael Ciarmoli - Boenning & Scattergood

Hey, guys, thanks for taking my call.

Stephen Bershad

Sure.

David Almeida

Sure.

Michael Ciarmoli - Boenning & Scattergood

On the Imaging System segment, what's the outlook for the gross margin, it trended down slightly year-over-year. Do you have sort of a range we should be looking for going forward there?

David Almeida

Sure. Yeah. It came down 100 basis points in 2007 from '06. Again a lot of that is just to the, as I mentioned large, to some of these large platforms that we are on and competitive pricing on those. But we expect those margins to stabilize as we move into '08. So we expect them to be around that range and hopefully we can even improve upon that.

Michael Ciarmoli - Boenning & Scattergood

In the 29% to 30% range?

David Almeida

Correct.

Michael Ciarmoli - Boenning & Scattergood

Okay. And if the organic growth was 19% in 2007, given the strong performance by Cineplex, is it possible that organic growth actually decelerate in 2008?

David Almeida

We don't anticipate that our organic growth is going to decelerate based upon the current guidance that we given.

Michael Ciarmoli - Boenning & Scattergood

Okay, great. And in terms of modeling for expenses, it sounds like trying to get into some new markets on the sales and marketing process and also product development efforts. Do you anticipate any additional unforeseen cost cropping up into the model over the course of 2008?

David Almeida

No, but we do have a higher level of investment spending in R&D built into our guidance for 2008 over 2007, that's up slightly. So that's probably the only anomaly at the top of my head that I can think of.

Michael Ciarmoli - Boenning & Scattergood

Okay. And then just looking more at the bigger picture on the defense spending landscape with the election coming up in November and the potential for party change, do you see any negative impact on some of the bigger programs like the TWS or the CROWS or any of the other sizable DoD related projects out there?

David Almeida

No, it's hard to say. I will tell you this is my opinion is that those programs are going to continue to move along. It's unclear if the rates of growth will be maintained, but I certainly don't think that there will be a decline.

And the reason that I think that is that these, what are called the electro-optical systems that improve surveillance and targeting are not a huge of defense spending. When the defense spending gets cut, they stop building new vehicles.

But what they end up doing is upgrading the older vehicles with new sensor platforms and the recognition during the war of the importance of infrared both for handheld programs like TWS or for these Remote Weapons Station programs is incredibly clear. Everyone is ecstatic about having this kind of capability, and I don't expect that that's going to change with a defense spending slowdown.

Michael Ciarmoli - Boenning & Scattergood

Okay, fair enough. And then just one final question, if you can, it sounds like the ultimate goal would be to attempt to sell some of those Surveillance Systems products into the military market. Have you guys effectively bridge that gap from driving sales from Imaging Segment through components to selling government entities complete systems?

David Almeida

Well, the Surveillance Systems already sells to government. And even most of our land-based cameras are sold to government entities today, in fact that's the predominant customer. There is a goal to accelerate the move from our airborne system into the military and in fact that was part of the acquisition concept for buying Cineflex.

Michael Ciarmoli - Boenning & Scattergood

Right.

David Almeida

And we don't expect that's going to be a problem. I mean it's just a matter of time, it's not that we have to just win. And as I alluded to, we are already having discussions with those military customers who are already our customers for our land-based systems and who in fact have requested our gimbal mounted capability. So again it's not really a question of, if it's just a question of time.

Michael Ciarmoli - Boenning & Scattergood

Okay, fair enough. Thanks guys.

David Almeida

You are welcome.

Operator

(Operator Instructions) Your next question will be from the line of Scott Lewis of Lewis Capital Management. Please proceed.

Scott Lewis - Lewis Capital Management

Hey, Steve, Scott, and Dave congratulations.

Stephen Bershad

Hi, Scott.

David Almeida

Hi, Scott.

Scott Conner

Hi, Scott.

Scott Lewis - Lewis Capital Management

Yeah. You guys have really done a great job repositioning the company in the last four or five years, not an easy task always. My question is on your new aerial gimbal that you are just talking today to the DoD about. Can you comment at all about on the total market size you might see available to you there over the next several years?

David Almeida

I will do that. These are going to be rough figures, I am going to give you, okay. You can break that airborne market in almost two ways. The market that we are serving which is the surveillance only market is roughly $1 billion market.

And then there is, when you use those gimbals for targeting, so basically if you have it on gun ship, and so what you are looking at, isn't just doing surveillance or reconnaissance, it's actually being used to target a weapon. That market is may be 3X, the surveillance business.

But it also tends to be more customized. When you get into targeting, you actually customize the gimbal system for a particular military platform. In the surveillance world, it tends to be more of a commercial product where the certain type of gimbal can be applied to many different helicopters or unmanned reconnaissance vehicles or those types of things.

Scott Lewis - Lewis Capital Management

Okay. So on the targeting type of gimbal, like you said, it would may be in conjunction with a new weapons platform or retrofit of the Apache fleet something like?

David Almeida

Exactly, and we are not at this time going after that market, we are going after reconnaissance surveillance market, not the targeting market at this time.

Scott Lewis - Lewis Capital Management

And that's $1 billion market, right?

David Almeida

I would say roughly, yes. So it's hard to actually gauge it. It depends on how you define yeah it. But yes, let's just for round numbers to $1 billion.

Scott Lewis - Lewis Capital Management

And FLIR and L3, how is that market currently?

David Almeida

Correct, FLIR is the dominant player, L3 is the number two and that's who we are going after.

Scott Lewis - Lewis Capital Management

Okay. Thank you very much.

David Almeida

Sure.

Operator

(Operator Instructions). And with no questions in queue, I would turn the call back over to Mr. Steve Bershad for closing remarks.

Stephen Bershad

Thank you, operator. Thank you everyone for joining us this morning, and obviously we are pleased with the 2007 results and excited about the opportunities that we are looking after 2008. I appreciate your continued support and look forward to updating you with our achievements in the coming months. Thanks again.

Operator

Thank you for your participation in today's conference. This concludes our presentation. And you may now disconnect. Have a good day.

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