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Flir Systems, Inc. (NASDAQ:FLIR)

Q1 FY08 Earnings Call

April 24, 2008, 11:00 AM ET

Executives

William W. Davis - Sr. VP, General Counselor and Secretary

Earl R. Lewis - Chairman, President and CEO

Arne Almerfors - EVP and President, Thermography Division

Andrew C. Teich - President, Commercial Vision Systems Division

William A. Sundermeier - President, Government Systems Division

Stephen M. Bailey - Sr. VP, Finance and CFO

Analysts

Brian Gesuale - Raymond James

Antonio Antezano - Bear Stearns

Paul Coster - JP Morgan

Chris Donaghey - SunTrust Robinson Humphrey

Jim Ricchiuti - Needham & Co

Jonathan Ho - William Blair

Tim Quillin - Stephens, Inc

Peter Arment - JSA Research

Michael Smith - BB& T Capital Markets

Operator

Good morning, my name is Polly and I will be your conference operator today. At this time, I would like to welcome everyone to the Flir System's First Quarter 2008 Financial Results Conference Call.

I will now turn the conference over to Mr. Wit Davis, Senior Vice President, General Counselor and Secretary of Flir System. Sir, you may begin.

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

Good morning, everyone. Before we begin this conference call, I need to remind you that other than statements as to historical fact; the 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 expect, anticipate, intend, believe, estimate 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 forecasted. 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 R. Lewis - Chairman, President and Chief Executive Officer

Well, thank you Wit, and thank you all for joining us this morning. We are, as you... I am sure know, quite pleased with our Q1 results. Our financial performance was very good and our long-term strategies continue to deliver excellent results. First quarter revenue of nearly 237 million, increased by 47% from the first quarter of 2007 and was the second highest quarterly revenue in the company's history.

Organic revenue growth for the quarter was 35%, still the second highest ever. First quarter operating margin was 23.3%, up a full percentage point from the first quarter of '07. Operating margins were particularly strong in our Government Systems and our Commercial Vision Systems division as both achieved record performance. Thermography margins were down from historical levels as anticipated, due primarily to the impact of our acquisitions of Cedip and Extech. We expect these margins to improve over time as planned efficiencies are realized.

Earnings per share increased 33% over last year to $0.24 per share. Cash flow from operations for the quarter was a record $55 million, just slightly higher than our fourth quarter. We spent $18 million during there quarter to buy 700,000 shares of our stock during the brief decline in the stock price in early March, $68 million to acquire Cedip.

We also repaid the remaining $90 million balance on our credit facilities during this quarter and then ended up the quarter with a $159 million in cash. Orders were strong in all three divisions resulting in backlog at the end of the quarter for a new record of $471 million, up $78 million compared to the end of the 2007, excluding backlog acquired from Cedip, backlog growth was $61 million in total. On April 8th, we announced and closed the acquisition of Ifara Technology, a leading provider of middleware and client application software used to create sensor networks. We paid €7 million in cash or about $11 million. Ifara will operate a separate business unit within our Commercial Vision Systems division and will also support our Government Systems division.

Ifara will initially have little direct financial impact but we are very excited about bringing these institutionally critical technologies in-house. Andy will talk more about this later in our call. Also M&A related, we successfully completed the standing market order in France and purchased the remaining shares in Cedip Infrared Systems. We now own 99.8% of Cedip's outstanding shares and the company has lifted from the Alternext market in France. With that each of the three presidents would comment in greater detail on the result of their businesses. We will start with Arne, President, Thermography division. Arne?

Arne Almerfors - Executive Vice President and President, Thermography Division

Thank you, Earl. Thermography revenue increased 47% in the first quarter of 2007. Excluding the Extech and Cedip acquisitions, traditional thermography revenue grew by 17%. Growth in the Americas and Asia-Pacific was healthy during the quarter, Europe was relatively slow but we expect improvement in Q2. Demand for high-end R&D products and GasFindIR was excellent during the quarter as shipments increased over 100%. GasFindIR strength was the result of good demand internationally and we are making good progress in developing the R&D markets.

Operating income for the quarter was 15.5 million and operating margin was 20%, down from 27% last year. Gross margins in our traditional thermography business were essentially flat with the prior year. But the overall margins were affected by the impact of exchange rates, acquisitions and somewhat higher R&D expenses. Extech's instrumentation business has a lower intrinsic margin structure then the rest of the rest of the thermography division, which will impact margins by a few points moving forward. Overall, however we expect to see better margins for the reminder of the year. Integration of the Extech and Cedip acquisitions is proceeding well. Extech's significant value to FLIR will be realized through the sale of new lower priced thermography products through their high volume distribution center.

In the meantime, we are expanding Extech's distribution capacity internationally and have introduced an Extech branded version or a low price InfraCAM product to sell through their channels. Our expectations for the Extech branded InfraCAM are modest, but it should lay the foundation for the high volume less market products of the future.

At Cedip, we are beginning to integrate sales and distribution infrastructure to eliminate redundant expenses and provide increased distribution for both FLIR and Cedip products. We expect to have Cedip fully integrated by the end of this year 2008. As the thermography industry evolves the need for new and improved products at effective price points will only accelerate. As we have seen with the exceptional demand for our new T-Series cameras, customers expect state-of-the-art features and attractive form factors every price point. With that end we are aggressively investing in new product development across our entire product line.

For example, at the high-end of the thermography market we recently introduced the GPS enabled high-definition T60 camera. The T60 provides optimum temperature judgment accuracy, outstanding facial resolution, special image enhancement software, GPS and other productivity boosting features. Looking to the reminder of 2008, we expect solid growth. To-date, we have not seen any impact of slower U.S. economy and overall market positions are strong. We will continue our long standing strategies of expanding our markets and introducing new low-priced products in Q2 and beyond. With our new manufacturing capability in Estonia and new distribution channels, these products will drive strong growth for the rest of 2008 and beyond. That concludes my comments. So let me now turn the call over to Andy Teich, President of our Commercial Vision Systems division. Andy?

Andrew C. Teich - President, Commercial Vision Systems Division

Thanks, Arne. Commercial Vision Systems revenue increased 67% in Q1 to a record $43.7 million. Orders were strong as well and we added over $12 million of backlog, $9 million as a result of the Cedip acquisition. Orders were very good in each of our served markets during the quarter and our strategy to increase demand through lower cost infrared technologies continues to produce results. Operating income doubled from Q1 of last year to a record $9.8 million and our operating margin for the first quarter was 22%, up from 18% in the first quarter of last year.

In the security and surveillance market, we received several orders for both long-range cooled cameras and short-range uncooled cameras for a variety of projects worldwide. In the U.S, we received orders from integrators supplying both the U.S Custom and Border Patrol mobile surveillance system program and the SBInet program. For these applications our long-range censors have performed very well on the field, both in test against the spec and against the competition. We feel we are well positioned to participate in these potentially large border protection projects going forward. In the security business, it's strong overseas as well. Of interest we sold a large quantity of uncooled cameras to two major golf resorts in Europe. To be installed, where lighting and fence installation are not possible.

In Maritime, orders doubled from last year despite softness in the overall maritime market. In addition to our aftermarket business, we've had success in pursuing maritime OEM as several of them are now offering a navigator system as an option on their product. Navigator has been so well received that the Motor Boating magazine named it product of the year for navigational aids. Success we've experienced in the security and maritime markets is due in part to the distribution network we built over the past few years. Our overall number of dealers continues to increase as we recently added 59 new dealers in security and 24 in maritime for a combined total of over 500 today. Ultimately, we plan to have nearly 1000 dealers in these markets.

In the automotive market with our partner Autoliv we've captured yet another major auto OEM account. This one is for a second German manufacturer with systems to be introduced in late 2009 with the 2010 model year. These systems will be based on our second generation design which includes automated pedestrian detection from Autoliv. We have now won a total of four automotive manufacturers and are very excited about the opportunity in the market going forward. In a slightly different transportation night vision market a major RV manufacturer Country Coach is now offering our path finder product as an option on their high-end motor boat.

Other markets that are growing nicely include the fire fighting market, where funding from FEMA's Fire Act was driving orders and the airborne law enforcement market where Q1 orders rebounded from a weak 2007. Our venture with AMI Semiconductor remains ahead of schedule and we are currently producing images from the first parts. This relationship should help us drive additional costs from our uncooled infrared censors allowing us to introduce lower-priced products to drive demand. As Earl mentioned earlier the Ifara Tecnologias acquisition is very important for FLIR and for CVS. Their networking middleware will allow our cameras to communicate with each other through multiple protocol. The system also allows easy integration with many other security censors such as radar, ground censors, access control devices and electronic maps.

Ifara also has the strong video analytics capability bringing real-time rule based intrusion alert, object classification and tracking into our products in a low cost manner. In the coming months we will be imbedding Ifara's Nexus technology into most of our new products in many of our existing platforms. We expect continued solid growth in CVS for the rest of 2008. We have yet to see any adverse effects from the U.S. economy and feel our markets are as strong as ever, giving us confidence in our forecasts for the year.

And with that I will now pass the call on to Bill Sundermeier, for his comments on the Government Systems results.

William A. Sundermeier - President, Government Systems Division

Thanks, Andy. Q1 was another excellent quarter for the Government Systems division. Through our unique product strategy, customer focused sales model and global operations infrastructure we have created a business model that delivers both high growth and strong profitability. Q1 revenue was $113.7 million up 40% compared with last year's Q1 revenue of $81.2 million. Orders were outstanding as well as backlog increased by $66 million to an all time high of $371 million. Excluding backlog acquired from Cedip, backlog increased by $61 million. In addition to the large orders we publicly announced order activity was widely dispersed and particularly strong overseas. Q1 operating profit was a record $42.6 million and operating margin was 37%. With excellent visibility entering the quarter due to the substantial backlog and long-term contract vehicle our factories worldwide were able to operate at high levels of efficiency, improving overall profitability level.

During the quarter we received orders totaling approximately $75 million for the Marine Corp G-BOSS program through the U.S. Army Space and Missiles Defense Command. We are pleased that the U.S. Army continues to value our systems for these critical force protection applications and we expect to see additional significant orders for similar missions over the next few quarters, although the specific timing and amounts are not yet certain. During the quarter we were informed that we were not selected for the Army's Bos program. Even though this program was upside to our plan, we are disappointed in the Army's choice as we know we provide the best technologies and value for the war fighter.

Internationally we received a large order during the quarter out of Sweden for a custom designed thermal imaging systems for use in surface-to-air missile site and a large order from an ally in the Middle East for Star SAFIRE III system used for homeland security and high value asset protection mission. We also received several smaller orders from government customers in Japan, Austria, Spain and U.K. for a variety of missions. Business was strong across the board and airborne maritime and land based applications each grew at least 30% during the quarter. The airborne market was driven primarily by large gimbaled systems out of our proven operation.

We expect deliveries of our small ball systems to increase as our new Talon system, a program proven lightweight a program-proven, lightweight, gyro-stabilized 9 turret contains up to five payloads becomes established in the market. We remain optimistic for the reminder of 2008 and beyond and are expanding customer base is the value provided by our products and our commercially developed military qualified model. With record backlog, a significant base of long-term contract vehicle and a large pipeline of opportunities on the horizon the future continues to look bright. That concludes my comment. I will turn it back over to Earl.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Well thank you all. As you can see from the comments from our Presidents the success that FLIR experienced during 2007 has been continuing into '08. Even with our rapid growth in unit volumes over the past few years untapped market opportunities remain enormous. And we believe FLIR is still in the very early stages of exploiting these markets. Our strategy of reducing cost of infrared technology and expanding market making infrared technology available to more and more people. However, many people are either unaware of how infrared technology can make them safer, more aware and more productive or they aren't able to afford it. Our goal is to bridge that gap. And we are well on our way.

Thus we reaffirm our outlook for '08 of revenue between $1 billion, $1.05 billion up 35% from last year and a full year earnings per share between $1.13 and $1.20 up 27% to 35%. I would also like to comment on just everyone... remind everyone rather there are a number of other executives and I have entered into MD5 stock trading plans over the past year. We have also established an insider trading policy designed to minimize the impact of insider activity on our investments. This policy requires all sales by section 15 officers to be transacted through MD5 plan. Such plans must be established during an open window and no sales are allowed to occur until at least one earnings announcement and a closed window of the past.

Once established these plans will not be altered and if canceled these plan cannot be established for six months. Six of our offices have options that will expire in February '09 and you could expect to see sales from us due to this in the upcoming period. Personally you will see sales by me as I exercise inspiring actions diversify my personal holdings. At the conclusion of these sales, I will continue to have a significant portion of my personal wealth investment in FLIR. With that Steve call is yours to provide some details on the Q1 financials and then we will take a few questions. Steve?

Stephen M. Bailey - Senior Vice President, Finance and Chief Financial Officer

Thanks, Earl. The financial information that will be discussed today includes the operating results of Cedip Infrared Systems, which was acquired in early Q1 and Extech Instruments which was acquired in Q4 of 2007. Extech will be combined with our Thermography division and accordingly the results would be included in the Thermography division financial results. Cedip financial results will be reflected primarily in Thermography but a portion of their operations will report through CVS and the Government Systems as well. For 2008, we'll provide appropriate disclosure of material impacts on Cedip and Extech to assist and understanding the comparison to FLIR 2007 pre-acquisition results.

References to future periods beyond 2008 will be on a fully consolidated and integrated basis with the FLIR operations. Revenue for the first quarter of 2008 totaled $236.9 million, an increase of 47% from the same quarter last year. Revenue from our Thermography division increased 47% over the first quarter of 2007, a 17% organic increase excluding Cedip and Extech revenue. Revenue from our Government Systems and Commercial Vision Systems divisions increased 40% and 67% respectively, as compared with first quarter 2007.

For the quarter, revenue was distributed 48%; from Government Systems, 34%; from Thermography and 18% from Commercial Vision Systems. Our international revenues for the quarter were 37% of the total revenue, while revenues from the U.S. government sales also accounted for 37% consolidated revenue during the period. As previously disclosed we closed the quarter with a backlog and that is orders in hand for delivery within 12 months of $471 million, an increase of approximately 20% or $78 million over a backlog at the end of 2007. Excluding backlog acquired in the Cedip transaction backlog rose by $61 million for the quarter.

By divisions, backlog amounted to Government Systems 371 million, an increase of 22% over the year-end, Thermography $20 million flat with year-end 2007 and Commercial Vision Systems $80 million, an increase of 18%. The gross margin for the current quarter is 55.2%, as compared to 55.7% in the first quarter of last year. The research and development expenses of $23.1 million were 9.8% of revenue for the quarter as compared to $18 million or 11.2% of revenue for the first quarter 2007. Selling, general, administrative expenses for the first quarter 2008 were $52.6 million which were 22.2% of sales as compared to $35.8 million or 22.2% for the same period 2007.

Earnings from operations for the quarter totaled $55.1 million or 23.3% of revenue as compared to $36 million or 22.3% of revenue in the first quarter 2007. The 53% or $19.1 million improvement of operating profit as compared to the first quarter of 2007 is a result of a 47% increase in revenues while incurring a 41% operating cost increase for the same period. Interest expense for the quarter totaled $2.5 million as compared to $2.7 million in the same period last year. Interest expense of $1.8 million relates to the interest cost and amortization of transaction cost of the $210 million convertible notes. The remaining interest expense in both years primarily relates to credit line borrowings in those respective periods.

During the quarter, the company earned $1.4 million of interest income while incurring a $1.3 million of currency losses. For the prior year, first quarter interest income was $1.1 million and currency gains amounted to $1 million. Based on the anticipated mix of foreign and domestic income for the full year, the effective tax rate for the quarter was approximately 29% and we expect the annual rate to approximate 29% to 31% for the full year.

For the first quarter, net earnings were $37.3 million or $0.24 per diluted share, the 42% increase in net earnings compares with net earnings of $26.3 million or $0.18 per diluted share in the same quarter of 2007. We finished the quarter with cash of approximately $159 million as compared to year end 2007 cash balance of $204 million. Our cash provided from operating activities during the quarter totaled $55.2 million. Cash used in investing activities of $80.5 million was primarily applied as $68.2 million for the acquisition of Cedip and capital expenditures of $10 million with $2.3 million applied to other investments.

Cash used by financing activities during the quarter included the net repayment of $19.3 million of credit agreements, $17.7 million applied to the repurchase of 700,000 common shares at average price of $25.42, while receiving $5.6 million of proceeds from the exercise of stock options.

Other long-term assets on the balance sheet increased during the quarter to $83.4 million, an increase of $66.7 million. The increase is primarily due to the purchase price of Cedip that is in excess of the net tangible assets acquired. The purchase price allocation study has not been completed for the acquisition and the excess purchase price of approximately $63 million has been reported in this other asset category until such time that it can be appropriately valued for reporting as intangible assets and goodwill.

This concludes the financial summary. I will turn the call back to Earl.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Okay, thanks Steven. Polly, we are ready for questions.

Question And Answer

Operator

Yes sir. [Operator Instructions]. Your first question comes from the line of Brian Gesuale.

Brian Gesuale - Raymond James

Good [ph] quarter.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Thank you.

Brian Gesuale - Raymond James

I am wondering that, if you guys will care, maybe have Arne share a little bit more detail on the product strategy and thermography, talk about maybe some of the new products that you expect to really hit and how the synergies with the distribution are really going to drive that business going forward?

Earl R. Lewis - Chairman, President and Chief Executive Officer

Yes, that's about a half an hour answer, Brian.

Arne Almerfors - Executive Vice President and President, Thermography Division

Let me just say that we have our roadmap for the total spectrum of products and the high volume product development that goes on and has been going on for certain period of time has been complimented by the acquisition of factory in Astomia and the Extech distribution company and that's just to support the growth going forward and we have continued to develop products in both ends of our total product setup which means higher and the lower. And we expect to see more of higher volume come through moving forward to the low-end side. And it's going to come as we said in our comments here already in Q2.

Brian Gesuale - Raymond James

Okay, terrific, maybe just one other question on the financial side. Can you talk about legal expenses, how they were incurred in the quarter and maybe how expect those to go out through on the year?

Earl R. Lewis - Chairman, President and Chief Executive Officer

I guess we are not going to say what they were but they are too much.

Brian Gesuale - Raymond James

They always are.

Earl R. Lewis - Chairman, President and Chief Executive Officer

And unfortunately they'll probably remain fairly high for us throughout this year, due to couple of issues that we hope will be solved by the end of the year. But there are running higher than we'd like them, that's for sure.

Brian Gesuale - Raymond James

Okay. Great, thanks a lot guys.

Operator

And your next question comes from the line of Antonio Antezano.

Antonio Antezano - Bear Stearns

Good morning.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Hi.

Antonio Antezano - Bear Stearns

I was wondering, given the very strong backlog that you reported, what is preventing you from raising your guidance for the full year.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Conservativeness, we'll look at that.

Stephen M. Bailey - Senior Vice President, Finance and Chief Financial Officer

Well I think conservativeness. We'll look at it the end of Q2 and that's what we've done every year basically. We don't like to do quarterly guidance particularly and I think that we will give it a good strong review at the end of second quarter and if we think it should be adjusted we will adjust it then.

I think from memory the only time we've really ever missed that forecast is when I decided half way through to increase it because everything looks so good and we therefore missed it. I think its conservative thinking on my part, I just... that's what we've said about month ago, two months ago and the whole world hasn't changed that fast. We don't know what are the results of a lot of the things that are happening in our general economy are going to be either. Although historically they haven't had a big impact on us, but I am not sure where that's going. We would give you a good head's up at the end of second quarter as to where we think the year will end.

Antonio Antezano - Bear Stearns

And quick follow-up on the AMI facility you mentioned that you are ahead of the schedule and what should we expect... before you mentioned the addition of any significant impact on gross margins, but as you are now ramping up what would be the impact on your operations now?

Earl R. Lewis - Chairman, President and Chief Executive Officer

Andy, you want to?

Andrew C. Teich - President, Commercial Vision Systems Division

Well I don't expect there will be any financial impact in 2008. Our plan although this program is running ahead of schedule with regard to technology side as I mentioned our imaging parts are ready, we still don't expect to switch AMI on in terms of producing parts that we'll release in market before the end of the year.

Operator

Your next question comes from the line of Paul Coster.

Paul Coster - JP Morgan

Andy if I may on first on the border protection side of your business, is any of it in backlog at the moment and do you expect given the nature of the program that it will start to appear in backlog moving forward?

Andrew C. Teich - President, Commercial Vision Systems Division

No. There is very little of it in backlog because we basically treat that business as booking ship business. So the model for CDS is to have very rapid shipment capability from placement of order and that's the way we treat the orders coming from primes, such as Boeing on the SBInet program.

Paul Coster - JP Morgan

Even if it scales up you think it will remain a turn's business?

Andrew C. Teich - President, Commercial Vision Systems Division

I believe so. Boeing has been releasing orders on a basis such that we can ship the product right away and they like the fact that we can do that.

Paul Coster - JP Morgan

Okay got it. On the... I mean we've got enough scale now for the differences between North America and Europe, don't have the explanations so why was Europe a little bit weak relative to North America, is there any lessons you learned there?

Arne Almerfors - Executive Vice President and President, Thermography Division

I would say that the setup in distribution has taken somewhat longer time in EMEA, as we call it and we have seen the success in Americas and in Asia Pacific. And I expect the improvement coming through in Q2. And there were no general economic conditions that actually would support the fact that they were somewhat slower.

Operator

Your next question comes from the line of Chris Donaghey.

Chris Donaghey - SunTrust Robinson Humphrey

Good morning guys. A great quarter overall. I wonder if you can talk a little bit about orders in the quarter and just can I get this back to the backlog question, very strong sequential increase in backlog from Q4 to Q1, is the company's policy still to not announce orders unless they hit some $5 million threshold, and if that's still the case then implication must be that the number of orders in that $1 million to $5 million range must be going out pretty significantly?

Earl R. Lewis - Chairman, President and Chief Executive Officer

Yes, with one small exception, there are some orders we cannot announce, as you might imagine, but given that, and that's not a big deal, I don't believe in the last quarter. But yes, we've had lots of smaller orders as well.

Chris Donaghey - SunTrust Robinson Humphrey

And, can you kind of help us out with the geography... geographical representation on those orders?

Earl R. Lewis - Chairman, President and Chief Executive Officer

I'll ask Bill, but I don't think there has been, majority of backlog build of course was in those business and we've seen good strength out of Europe, and I think that that is running at least as well as it has historically on our outlook side. So around 40% to 45% range.

William A. Sundermeier - President, Government Systems Division

Yes, I would agree with that, we had a lot of orders internationally and quite a few in the two to three unit categories in our threshold to announce. We are still very strong hopefully in U.S. and international, lots of small orders in addition to large orders we did have clearly all three of the components land and air and sea so to speak were quite strong. Many of those are smaller orders as well.

Chris Donaghey - SunTrust Robinson Humphrey

Okay great and Bill just

William A. Sundermeier - President, Government Systems Division

Hey, Chris sorry about that.

Operator

Your next question comes from the line of Jim Ricchiuti.

Jim Ricchiuti - Needham & Co

Bill, quick question for you, I just wondering as we look out at the DoD supplemental budget which I guess Congress is looking at sometime next month. Can you give us any sense of the opportunity that you guys see there?

William A. Sundermeier - President, Government Systems Division

Jim, I have little trouble hearing you, I think you asked about supplemental?

Jim Ricchiuti - Needham & Co

Yes, I did... sorry I am... question was just with respect to that supplemental, how do you guys see the opportunities?

William A. Sundermeier - President, Government Systems Division

Primarily we're tracking the funding that been going through quite a few of the IDIQ base that we already have to keep the unfunded portions of those IDIQ, some more of the rate type opportunities should be funded through that and some other programs in the lead times phase. So we're watching it closer and hope we would get the IDIQ will provide good backlog for us.

Earl R. Lewis - Chairman, President and Chief Executive Officer

It's always been tough for us to pick out our name in those budgets in general.

Jim Ricchiuti - Needham & Co

Yes.

Earl R. Lewis - Chairman, President and Chief Executive Officer

It's never been... the big companies they can do it, they can they can go in. They can say oh, that's my program or that's for Bill's program, but we're kind of down in the ladder, so when they say security for example they may not include us. But I think that clearly in the about funding for our potential orders relative to as far as that to the innovation like with the GBOS program. We do know where some of the major funding will or will not come from, but I don't think we have a clear indication to tell you that supplemental will add significant amount of volumes to our company.

Jim Ricchiuti - Needham & Co

Okay and if I could lob one into to Arne. Arne, are you gaining share or is this market just expanding at a faster rate then we've expected?

Arne Almerfors - Executive Vice President and President, Thermography Division

I would say the market is definitely expanding and we are expanding the market you could say since we have been in the market leader over years and to that effect we have been able to open new market segments in markets and expand the markets and we are tracking our market side and we are definitely keeping our market share going forward. So it's a combination of keeping our market share but growing the market and the market is expanding especially when you go into the high volume area.

Jim Ricchiuti - Needham & Co

Congratulations on the quarter.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Or likein the Far East transaction.

Arne Almerfors - Executive Vice President and President, Thermography Division

Oh yes, we see very positive growth in Far East for example right?

Earl R. Lewis - Chairman, President and Chief Executive Officer

Arne has been judged, as having 60%, 70%, 80% market share depending on which part of the market share you are breaking it down to so, with the advent of Danaher [ph] clearly they have helped the market grow by lots of advertising and that's what happens many times and that's very healthy for everybody. Well I don't see them gaining market share on at this point.

Jim Ricchiuti - Needham & Co

Thank you.

Operator

And your next question comes from the line of Jonathan Ho.

Jonathan Ho - William Blair

Good morning, great quarter guys. You guys have mentioned some of these new GBOS opportunities as coming up then just wanted to get a little bit more color from you in terms of the BetSEA program and maybe the potential magnitude that you are seeing for I guess the programs that are shipping up that are tied to GBOS?

Stephen M. Bailey - Senior Vice President, Finance and Chief Financial Officer

Hey,you know we made the mistake last quarter, I think it was... who was that who trapped me there from... no, anyway. I just hate to comment on future orders, but BetSEA is basically the army use of the equipment that the Marine Corp using today, it that a better way of saying it.

Earl R. Lewis - Chairman, President and Chief Executive Officer

The army originally started the program and the Marine Corp. came on as a requirement or assistant. And we have to be careful. The program office is the [indiscernible] program office and we have received orders for all but totally nine systems of the marine corps requirement and that will fulfill the Marine Corp. requirement and we will be moving into additional army requirements that are proposed but not yet coming. I hope that answers the question. Great, additional opportunity there.

Jonathan Ho - William Blair

Fantastic. In terms of just the SG&A, we saw significant growth in revenue and we just wanted to kind of understand why we are not seeing a little bit more leverage on the SG&A side?

Stephen M. Bailey - Senior Vice President, Finance and Chief Financial Officer

It's a question I ask too. Jonathan, one is that as you look at the quarter comparison on the SG&A, its pretty much in line if you will as a percent of revenue with Q1 of last year, so they do kind of grow together, but there are certainly certain areas that has been, I think some additional fund expanded particularly in some of the marketing and sales development areas in anticipation of some of the products and products introductions going forward.

With that said, clearly, I think I have made this comment before, I think make it again, we have a track to keeping the lowest cost possible or cost it was sold and I think we are proving that, we backward integrated, we know we can do that well, we know we can hold as possible.. With that said, we're now in a different phase to a certain extent, we're trying to have the three-year brand become the brand for infrared applications and many, many different applications and that is expensive doesn't come cheap, and we're stepping up to that and we are spending the money to make that happen.

I think that's an investment in the future that will payoff for this company for many, many years and we're not too worried about generating additional operating margins, frankly. Our operating margins are excellent, so what we want to do is make darn sure that our name is so well established in these markets and we'll spend the money to do that. It's a worthwhile investment, although sometimes I do ask the same question.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Jonathan one other thing to remember is, a big chunk of Arne's cost structure is in Europe and exchange rates have fairly negative impact on his cost structure, Andy too, Andy's got some costs in Europe and frankly Bill's does as well. So we're not fully, when you look at the expenses, we're not fully U.S. dollars denominated and weakening of the dollar definitely impacts expense trajectory in Q1.So we did see some leverage there.

Stephen M. Bailey - Senior Vice President, Finance and Chief Financial Officer

Yes, we did.

Earl R. Lewis - Chairman, President and Chief Executive Officer

So I think we are in the right track. It's a balance and it's a balance I think we're about right on.

Operator

And your next question comes from the line of Tim Quillin.

Stephen M. Bailey - Senior Vice President, Finance and Chief Financial Officer

Tim was the guy last year.

Tim Quillin - Stephens, Inc

Good morning.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Good morning, Tim.

Tim Quillin - Stephens, Inc

Well it's nice to know I am so memorable, Earl. I just want to follow up on the GBOS program, a year ago for the fiscal '08 budget year Marine Corp. had requested funding and had discussed a quantity of 440 sensors for that program, has that changed?

Earl R. Lewis - Chairman, President and Chief Executive Officer

Well, again I want to separate. The GBOS program was for the Marine Corps and the Marine Corps actually had a much smaller subset of that number and they will be through their requirements for both Star IIIs and--well, they for their further requirement now in Q3. So they have purchased all of those and they have another 29 on their requirements for Star IIIs yet purchased and we are watching the funding for that. They will be done. There is a total requirement in that came through at that time which we have included Marine Corp. as well as Army, and the Army is still working on their requirements. And as far as we know some of that requirement is staying with the G stock [ph] and finally determining what their final number is going to be then the funding process continues from there. So the Marine Corp. will be done here with their requirement shortly and then we would be moving on to army requirements, a's a number yet to be determined.

Stephen M. Bailey - Senior Vice President, Finance and Chief Financial Officer

There is potentially a larger order out there though.

Tim Quillin - Stephens, Inc

And is the army requirement larger than the Marine Corp?

Earl R. Lewis - Chairman, President and Chief Executive Officer

Yes.

Tim Quillin - Stephens, Inc

Okay and just one detail for Steve, what was D&A in the quarter?

Stephen M. Bailey - Senior Vice President, Finance and Chief Financial Officer

So now you are going to come with the question for me, Tim. I can't find the right schedule for, D&A for the quarter was $8 million.

Operator

And your next question comes from the line of Peter Arment.

Peter Arment - JSA Research

Good morning, nice quarter. Could you give us a little more color on your margin, I guess some of the commercial vision, it seems it was very strong this quarter compared to the previous run rate and is it sustainable throughout the year?

Stephen M. Bailey - Senior Vice President, Finance and Chief Financial Officer

Well, I'll address the second question first, which is with regards to sustainability, this is the rate at which we intend to be running going forward and I expect it will be north of 20% going forward. In terms of the change versus prior quarters, we continue to get some efficiencies out of the volumes that we are running through our fab, our detector foundry and those result higher in margins through the cores and components business in commercial vision system which is still about half of our total business, that trickles down to the bottom line.

Peter Arment - JSA Research

Okay, so it's really volume driven so we could see these expand beyond this level then?

Earl R. Lewis - Chairman, President and Chief Executive Officer

Well, I don't expect it to expand significantly beyond this level at this point because we have stated before that as we get additional efficiencies on our cost side, we intend to utilize that to leverage the price elasticity of the market.

Peter Arment - JSA Research

Okay. Fair enough.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Thank you.

Operator

And your next question comes from the line of Michael Lewis.

Michael Smith - BB& T Capital Markets

Good morning, actually this is Mike Smith here for Mike Lewis. Just a couple of quick questions. First was CapEx it was at least 15 million in Q4, 10 million this quarter, how do you expect that trend throughout the reminder of the year?

Stephen M. Bailey - Senior Vice President, Finance and Chief Financial Officer

Probably not a bad number. That's, yes, I would worry that 10 million is pretty that we have around... there is only one real large expense, $4 million type number, on the horizon, the balance of the three presidents are all planning on spending around $10 million each for the year.

Michael Smith - BB& T Capital Markets

Great, and, lastly is that very recently Secretary Gates said that drone capacity in theater is still not good enough. Does that have any implications on your business?

Earl R. Lewis - Chairman, President and Chief Executive Officer

I can't get what you said.

Unidentified Analyst

Very recently Defense Secretary Gate said that drone capacity in theatre?

Earl R. Lewis - Chairman, President and Chief Executive Officer

You mean UA--

Michael Smith - BB& T Capital Markets

UAB capacity.

Earl R. Lewis - Chairman, President and Chief Executive Officer

I will take it, yes, okay.

Michael Smith - BB& T Capital Markets

Okay, it's still not good enough. Does that have implication, if you were to increase the number of UABs overseas?

Earl R. Lewis - Chairman, President and Chief Executive Officer

I think we are by far the largest infrared suppliers for UAB market. So as, now there is some platforms around, some we aren't but in total, I almost positive that we supply more UAB systems with infrared equipment then anyone else in the world. So, yes, might depend on which one goes but I think that's very favorable to clear we state that out as a market we want to be very active in.

Michael Smith - BB& T Capital Markets

Okay.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Operator.

Operator

And at this time sir, there are no further questions in queue.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Great.

Unidentified Company Representative

Operator.

Operator

Sir, okay, I am showing there is a follow up question from the line of Paul Coster.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Okay sure, yes Paul.

Operator

And he has withdrawn his question.

Earl R. Lewis - Chairman, President and Chief Executive Officer

Okay, fine. Well then thank you all for listening into us today. We appreciate very much. We enjoy this kind of conferences to be honest, we look forward to many more of them. Thank you, very much.

Operator

Thank you sir. This concludes today's conference, you may now disconnect.

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Source: Flir Systems, Inc. Q1 2008 Earnings Call Transcript
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