Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

FLIR Systems (NASDAQ:FLIR)

Q2 2012 Earnings Call

July 26, 2012 8:00 am ET

Executives

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

Earl R. Lewis - Chairman, Chief Executive Officer, President and Chairman of Strategy & Technology Committee

Andrew C. Teich - President of Commercial Systems

William A. Sundermeier - President of Government Systems Division

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

Analysts

Jeremy W. Devaney - BB&T Capital Markets, Research Division

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

Timothy J. Quillin - Stephens Inc., Research Division

Michael S. Lewis - Lazard Capital Markets LLC, Research Division

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

Noah Poponak - Goldman Sachs Group Inc., Research Division

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

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

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

Operator

Greetings, and welcome to the FLIR Systems, Inc. Second Quarter 2012 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Wit Davis, Senior Vice President, General Counsel, and Secretary for FLIR Systems Inc. Thank you, Mr. Davis, you may begin.

William W. 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 R. Lewis

Yes, thank you, Wit. And welcome, everyone, and thank you for joining us this morning. As we indicated last week, our second quarter 2012 performance was below our expectations. Global fiscal uncertainty caused by weakness in our Maritime, Predictive Maintenance and Building markets and our cores business within Commercial Systems was negatively impacted by order delays from several key customers.

The Government Systems division saw better order flow but revenue and earnings were down compared with last year. In response to lower earnings, we made operational changes during the quarter that resulted in a pretax restructuring charge of approximately $7 million. The restructuring should reduce costs by approximately $17 million per year beginning in the fourth quarter of this year.

We generated $77 million of cash from operations in the second quarter and utilized some of that cash to repurchase 3 million shares of our stock. We also increased our backlog by over $40 million from the end of Q1. Our Commercial business generated about half of this increase and Government, the other half. Our unit volumes continue to grow and many of our systems markets did well, reflecting continuing progress on our strategy to continually lower the cost of ownership of infrared technology.

Given the results for the first half of the year and our re-forecast of the remainder of the year, we've adjusted our outlook for 2012 revenue to between $1 -- or between $1.4 billion and $1.5 billion, and earnings per diluted share between $1.40 and $1.50.

Our current order pipeline backlog and our efforts to streamline our operations indicate a return to growth in our fourth quarter. While there remain some significant unknowns in our markets, such as sequestration, softness in Europe and the building markets, we believe this represents an attainable result.

Andy Teich will now discuss the detail performance of Commercial Systems division. Andy?

Andrew C. Teich

Thanks, Earl. The Commercial Systems division finished the second quarter with a decline in revenue of 12% from the second quarter of 2011. The 2 primary drivers of this decline were delayed order flow for our camera cores and reduced sales of our premium thermography products. While these areas of our business did disappoint, we saw continued growth in our cameras and systems unit volumes which grew 18% over the volume shipped in the second quarter of last year.

Raymarine saw a good revenue growth in the Americas due to shipments of our new E-Series line of multifunction displays, but weakness in the EMEA and APAC regions overshadowed that performance. The recreational marine maritime market remained sluggish, but we've made significant progress in reducing costs, improving margins and introducing exciting new products. In fact, this quarter, Raymarine achieved its highest operating margin percentage since being acquired by FLIR and is very well positioned for higher margins when the market recovers.

Looking now at our bookings activity for the quarter, TVM bookings dollars declined 10% versus the prior year. The APAC region had low-teens growth in bookings dollars, while the Americas and EMEA regions were down compared to Q2 2011. The 12-month backlog and orders for the TVM segment increased $21 million from the end of the first quarter of this year due primarily to stronger bookings activity during the last few weeks of the quarter. TVM's Thermography business saw bookings dollars declined 5% from a year ago driven primarily by the fact that the premium predictive maintenance product lines were negatively impacted by the global economic environment.

Partially offsetting these declines was growth in our volume cameras. The I-Series and E-Series, and the introduction of our T400-Series cameras. This product replaces the one product in our Thermography lineup that has not been updated since 2011. This new midrange professional product supports all of our wireless connectivity apps, touchscreen interface functionality and has our new MSX image fusion capability. The product has been very well received by our distribution channel partners.

Additionally, our factory automation cameras grew bookings dollars over 30% in the quarter as we introduce the new A35 product that features a small footprint, low power consumption and industry-standard connectivity. Overall, Thermography unit volumes booked during the second quarter grew at nearly 20% over the prior year, consistent with our strategy to build volumes at the lower end that will ultimately develop the awareness of the thermal value proposition to mass markets and provide a platform for future upselling opportunities. For example, during Q2, we booked an order for 2,000 iX series cameras from a distribution partner in Japan. These cameras are intended to be sold into the spot pyrometer market which has been a long-starting target market for FLIR.

TVM's cores and components bookings were down significantly in the second quarter due to order delays. Over $30 million of orders to various OEMs that were expected to come during the second quarter were pushed out. However, we expect a large percentage of these orders to be received in the second half of this year.

The security line of business grew bookings dollars 5%, while security unit volumes booked increased nearly 70% in the second quarter as our uncooled products gained further traction in various security markets. End user prices continued to come down and stride with our cost of manufacturing these cameras.

The FLIR-branded maritime business within TVM was strong despite the difficult boating market, posting bookings dollars growth of over 26% and unit volumes growth of over 50%. All regions showed growth over the prior year, illustrating the value proposition of having thermal imaging on the water. Including the Raymarine brand of thermal cameras, growth in bookings for maritime infrared was 50% ahead of last year, with the unit volumes up over 80%. While the recreational maritime market remains weak, we are seeing increased interest for our technology from commercial shippers, maritime law enforcement and cruise lines.

We continue to grow our Personal Vision Systems business at a strong rate as well. Compared to the second quarter of 2011, PVS bookings dollars were up over 150% with unit volumes more than quadrupling. Next month, we will release a new line of handheld thermal cameras for the law enforcement market called the LS-Series that we expect to contribute to the continued success of the PVS business.

Our Raymarine segment saw second-quarter bookings dollars decline 5% versus the second quarter of 2011 with weakness in the Americas and EMEA regions. The OEM channel was particularly weak in EMEA as boat builders continue to struggle in the current environment. Hardest hit were boat builders in France and Italy. The APAC region slightly offset these declines with over 20% growth in bookings dollars this quarter compared to the second quarter of last year, driven by very strong bookings of Raymarine-branded infrared cameras.

Commercial Systems results for the second quarter were below our expectations. And during the quarter, we took steps to right side the operations of both TVM and Raymarine in order to reduce our cost structure. The opportunities for growth in Commercial Systems remain tremendous and we fully expect to see a return to substantial growth in coming quarters. We have and will continue to introduce cutting-edge imaging and diagnostic products that satisfy the very needs of our existing and eventual markets, while also providing a value-to-price ratio that far exceeds any other participant in the industry.

That concludes my review of the second quarter. I will now pass the call to Bill Sundermeier who will discuss the results of our Government Systems division. Bill?

William A. Sundermeier

Thanks, Andy. Government Systems division revenue was down 16% versus the prior year. That ticked up 2% sequentially. Bookings grew 41% compared to the second quarter of 2011 and 17% sequentially over the first quarter. This resulted in our backlog increasing $22 million since the end of the first quarter to $334 million. As we have communicated to you in the recent past, our current focus is on securing orders and strengthening backlog as we set the business up for return to growth, and second-quarter bookings show we are making progress.

Divisional operating margin percentage was essentially flat compared to the second quarter of 2011 despite nearly $30 million less in revenue this year. Our ability to maintain margins has been the result of the operational streamlining decisions we made in the second half of last year.

During the second quarter, we reduced staff and are consolidating several locations in the Detection segment in order to position that business to grow profitably as we change the mix away from contract R&D business towards product sales.

Surveillance segment bookings were up 46% over Q2 of 2011, finishing the quarter with a book to bill of 1.1 and contributing $7 million of backlog increase. Surveillance received an $18 million order from the U.S. Navy for our SeaFLIR thermal systems for installation on Navy patrol boats. We continued our success with the U.S. Army's MEDEVAC helicopter platform with a $9 million order for our Star SAFIRE II systems. Our presence in the unmanned aerial vehicle space continue to build with the receipt of several orders totaling over $8 million for thermal systems to be used on the U.S. Military's Fire Scout UAV. We also received an $8 million order from a U.S. customer to upgrade existing 9-inch gimbals to include laser designators.

International bookings represented over 40% of surveillance bookings in the quarter, with the orders evenly distributed between Europe, Middle East and Asia-Pacific. BAE Systems chose FLIR to provide the sighting and driver vision equipment for their CV90 combat vehicles for their Norwegian Army in orders that total more than $11 million. Two Middle Eastern countries ordered over $10 million worth of our troop-level Recon systems. We also received an order from the Australian Defence Force for 4 of our Star SAFIRE class HD systems.

The Detection segment ended the second quarter with $23 million in backlog. Notable orders in the quarter included a $1.9 million order from the U.S. Air National Guard for our Fido handheld explosive detectors, a $1.3 million order from the U.S. Civil Support Teams for our IBAC bio-aerosol detection systems and a $900,000 order from the Korean Chem/Bio mass spec program. We expanded our mass spec product line with the introduction of the Griffin 824 TDMS, a system that is used for narcotics and explosives trace detection.

Detection segment also made significant operational changes during the quarter, consolidating a number of production sites. This restructuring resulted in charges of $2.3 million in the quarter, but we believe the effort will significantly improve the efficiency of the segment in the near future.

Integrated Systems added $17 million to backlog during the quarter as bookings more than doubled compared to the second quarter of 2011, and reached the highest level since we established the segment in 2010. As of the end of the quarter, Integrated Systems' backlog stands at $62 million. Order growth was driven by several key wins, primarily the receipt of an $18 million order from the U.S. Army for force protection systems.

Our J2 development program for the U.S. DoD, which is now known in Defense Department as CBRN Dismounted Reconnaissance Systems, DRS, received additional funding during the quarter and is tracking for production to begin next year.

Also notable during the quarter was the opening of our European sales and support office that will serve the European and North African areas. Additionally, we established an on-the-ground presence in China, and we anticipate we'll accelerate the activity we see from China and Southeast Asian markets.

Overall, the second quarter for Government Systems progressed largely as expected, while economic and political headwinds remain in this business, we are confident in our ability to manage through these cycles. When we look at our global opportunity pipeline, we see activity in the near term and midterm that supports our belief that we see a return to growth in the Government Systems business in coming quarters.

Since the end of the quarter, we exhibited at the Farnborough Airshow, the largest air show of the year. As the headline sponsors for Farnborough's new aviation security zone, we demonstrated our live command-and-control center in the exhibit hall, which utilized our command space software for a fully functional airport perimeter security system. This command-and-control center was surrounded by a functional airport passenger and baggage screening demonstration using our newest array of radiation, explosive detection, infrared, radar and biohazard detection products, enabling us to demonstrate a complete internal and external airport security installation. This exhibit once again showcased our strategy of manufacturing and integrating the industry's broadest array of infrared and [indiscernible] sensors for protection of critical and sensitive infrastructure.

That concludes my comments in the second quarter, and Tony will now discuss the financial results in more detail. Tony?

Anthony L. Trunzo

Thanks, Bill. Second-quarter consolidated revenue was $338.3 million, a decrease of 14% compared to $391.6 million in the second quarter of 2011. Commercial Systems division second-quarter revenue decreased by 12% to $189.8 million. The thermal Vision and Measurement segment posted second-quarter revenue, $142.6 million, a decrease of 13% compared with the second quarter of last year. TVM's revenue decline was the result of weakness in Predictive Maintenance and Building sector and Thermography line of business and delayed order intake in the cores and component lines of business, offset by growth in the PVS and Security businesses. Raymarine revenue declined 6% to $47.2 million compared to $50.2 million in the second quarter of 2011, as growth in the Americas region was more than offset by declines in the European market.

Government Systems Q2 revenue was $148.5 million, a decline of 16% from $176.5 million in the second quarter of 2011. Surveillance segment revenue was $119.5 million compared to $141.5 million in Q2 of last year. The flow through of lower backlog was the primary reason for the lower revenue. Detection segment revenue decreased by 9% in Q2 to $15.7 million due to planned reductions in contract R&D work. Product revenue from Detection increased by 10% compared to last Q2. Integrated systems segment Q2 revenue was $13.3 million, down from $17.8 million in Q2 2011, which saw the completion of a major project.

International revenue was 55.1% of the consolidated total in Q2, up from 49.9% of revenue last year, reflecting primarily the decline in revenues from U.S. government in both divisions. Commercial Systems' international sales made up 62.9% of its consolidated revenue in Q2 compared to 58.8% in the second quarter of last year. While 45% of Government Systems revenue came from outside of the United States compared with 39.1% last year. Total sales to the U.S. government were 22.4% of the total in the second quarter down from a revised 28.5% of revenue in the second quarter of last year.

Consolidated gross margin was 50.3% for the second quarter. Excluding the restructuring charges that impacted cost of goods sold, gross margin for Q2 was 51.3%, down 1.2 percentage points from the prior year. The lower gross margin is largely the result of overhead absorption and product mix changes in Commercial Systems, partly offset by improvement in Integrated Systems gross margin.

Consolidated operating income was $60.7 million compared with $41.8 million in the second quarter of last year. Excluding this year's restructuring charges and last year's onetime litigation settlement expense, operating margin declined slightly to 20% from 20.6%.

Second-quarter operating income in Commercial Systems was $33.1 million. Excluding restructuring charges, operating income was $37.7 million, a 31% decline compared with the second quarter of last year. Thermal Vision and Measurement posted $27.4 million of operating income. Excluding restructuring, TVM operating income was $30.6 million, compared with $47.1 million in Q2 of 2011. Raymarine operating income was $5.7 million, representing a 12.1% operating margin. Excluding restructuring charges, Raymarine operating income was $7.1 million or 15.2% of revenue.

Government Systems' operating income was $39.4 million for the quarter compared with $43.6 million last Q2. Surveillance segment's operating income was $40.8 million, down $5.7 million from last year due to lower revenue. Lower operating expenses helped to increase operating profit margin by 1.3 percentage points to 34.2%. The Detection segment had an operating loss of $1.8 million and earned $500,000 excluding $2.3 million of restructuring charges. This compares to the second quarter of 2011 operating loss of $3 million. The improvement was due to lower SG&A expenses and the roll-off of $2.1 million in acquisition-related inventory charges last Q2. Integrated Systems operating income was $300,000 in the quarter.

Earnings before interest, taxes, depreciation and amortization and stock compensation in the quarter were $82.8 million. Interest expense during the quarter was $2.8 million, an increase of $2.3 million from last year due to the $250 million and 5-year notes we issued last August. Our tax provision for the quarter was 27% of pretax income, compared with a Q2 2011 provision of 31.6% to the pretax income. Cash flow from operations for the quarter was $77.2 million, representing 188% of net earnings driven by a strong receivables collection.

During the quarter, we repurchased 3 million shares of our common stock at an average price of $21.60 and paid dividends totaling $10.7 million. Capital expenditures in Q2 were $13.5 million.

That concludes the summary of our second quarter financial results. Let me now turn the call back over to Earl.

Earl R. Lewis

Thanks, Tony, and Rob. We're ready to take some questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Jeremy Devaney of BB&T Capital Markets.

Jeremy W. Devaney - BB&T Capital Markets, Research Division

Andy, I wanted to start with you and take a look at these cores and components. I know normally you're reluctant to break it down at the granular level we're probably looking for, but if you could us some clarity on what kind of volume you saw in cores and components and the EBIT sensitivity to that volume to help us better understand what went on in the quarter? And then also what you're seeing with that customer behavior, the buy versus defer decision, primarily focused in Europe?

Andrew C. Teich

Well, I'll start with your last question there. In terms of the customer behavior, as I mentioned in the script, we had about almost $30 million of orders that we were expecting during the quarter move out of the quarter into the second half. We don't feel that we have lost any of those orders to competition. It's just delays in procurements. We don't do a tremendous amount of cores and components business in Europe, so there's not a lot of sensitivity there. The primary business that we do in the cores and components area in the European market, we do some in the security space, and then the rest of it is mostly internal sales through GS. In terms of overall volumes, the uncooled volumes, I don't have the specific number, but I think the uncooled volumes were actually up. The area that was down for us from a revenue perspective were cooled systems. And again, that system in a delay of customer acceptance of some of those cooled systems, and that does affect the margin mix because the cooled cameras tend to have a high gross margin associated with them.

William A. Sundermeier

Jeremy, overall cores and components unit volumes were up by about 14% in the quarter, but, as Andy said, the mix shift was strongly toward uncooled from cooled.

Andrew C. Teich

Yes. The one other thing I'll mention, Jeremy, is that auto was down and that -- so interestingly, when you look into that uncooled number being up 14%, that's pretty significant because auto was down somewhat, so the -- there's not a lot of revenue associated with the auto piece but it does affect our volumes.

Jeremy W. Devaney - BB&T Capital Markets, Research Division

Interesting. Those details are really helpful. Tony, I was wondering, when we look at guidance, the last couple of quarters, it seems there's been a little bit of misstep with forecasting and I know you utilize a guidance methodology of bottoms up from the sales channels, can you talk a little bit around what you're doing to possibly change that methodology or correct for any variation that you're seeing in that methodology between the forecast and the actual? And then also, in your original press release, you commented that you have a high level of confidence that the fourth quarter profitability would return. What are you seeing in your order flow or your backlog that's giving you that high level of confidence, and how should we view that considering the forecasting missteps we've seen?

Anthony L. Trunzo

I don't think we've changed our methodology for forecasting at all. Bottoms up is still the right way to go. You get a sense for every market, you get a sense for what's happening out of the field. And we have -- we talked to -- we internally spend time on the phone every week with the people in the field to understand what's going on. Whatever we get from the field, we're going to apply management judgment, too. And clearly, we've done that in the case of our outlook for the second half of this year because there are uncertainties at the macro level that somebody's looking at a new divisional market just might not see. So I think clearly, we've done that maybe at a level of a little bit different that we have historically. But we haven't changed the model at all because the model holds up pretty well. I'm sorry, the second part of your question related to -- oh, to the fourth quarter. When we look at the -- particularly in Bill's business, there's a lag between the orders coming in and the revenue translation, and that's kind of what you saw in the last couple of quarters. You're seeing a reflection of soft order flow dating back quite a while. When we look at what's happened the last couple of quarters and what we think we're going to see in the third quarter, we feel like Q4 is going to be a very solid quarter for Bill's business, and it's traditionally solid for Andy's. The -- I want to correct your comment, we didn't say return to profitability in the fourth quarter, we said return to growth in the fourth quarter, and that reference really relates to growth in earnings per share.

Earl R. Lewis

Just one more comment on that. If you looked at a year ago, Q3 for our Government business, it was, by far, the largest. It always has been, frankly, relative to our bookings. We suspect that this year will be no different given the review of the different programs. That then tends to be shipped more in Q4. In addition, the Thermography business has always been much stronger in Q4 than it has been in Q3 or 2. We don't suspect that's going to change either, and our internal forecasts say that's going to be the case. So Q4 is sort of boiling up to be a strong quarter for us.

Operator

Our next question is from the line of Peter Arment of Sterne Agee.

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

Just a question, I guess, for Bill. I guess, we all get the lumpiness in the timing around the Government business here domestically. Can you give us kind of -- I know you gave us a little bit of a rundown on the international front, but just a little more detail. It seems like there's always been a big opportunity on the borders front. Are you seeing any movement there? And maybe just a little more color on the international volumes potentially.

Anthony L. Trunzo

Sure. Our international business is, in the Middle East, is certainly improving steadily. Europe was rather soft this last quarter, and looking at the forecast for the second half of the year is coming back for us. The strongest part has been the Integrated Systems group. And you're correct when it comes to borders or infrastructure security, they're growing rapidly and a lot of those opportunities are in the Middle East and we're starting to set our sites on the Asian markets as well because there's some pretty strong demands over there for airport security and other protection. So we were only 40% in Q2 in the bookings, and I anticipate that's going to continue to increase over the remainder of the year.

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

Okay. And just a follow-up to that, any movement here domestically within -- I know we've all talked about for a number of years, the different versions of SBInet and what it's eventually was going to become. Has there been any movement or potential on developments there?

Anthony L. Trunzo

There's a new program out there called IFT, Integrated Fixed Towers, and proposals went out for those, and we have bid into that program cameras as well as partners for integrated systems. And the timing on that, we're hoping sometime second half of the year something will be announced in that arena.

Earl R. Lewis

You might want to mention MSC.

Anthony L. Trunzo

Yes. MSC is a great program for us, though it was delayed 6 months. We did receive a conditional acceptance, and we're working with DHS to move towards [indiscernible] later this year.

Earl R. Lewis

As you remember, that's about $100 million IDIQ for us for U.S. borders.

Operator

Our next question is from Tim Quillin of Stephens Inc.

Timothy J. Quillin - Stephens Inc., Research Division

Andy, on the traditional thermography market, can you give us a sense of the breakdown between lower-end kind of I -- E-series, midrange T-Series and P-series, and maybe how far you feel like you are through a product cannibalization cycle?

Andrew C. Teich

Okay. Well, the interesting thing about Q2 is that we saw the strongest growth in our E-Series product range. And historically, we have been seeing the strongest growth in the iX series, which is the lowest-end product. And that leveled off in Q2 when we saw the growth on the E-Series, and I think that's because of the feature set that's available there, the Wi-Fi capabilities and so forth, the users very much like that. In terms of the cannibalization effect, I think it has leveled off. I don't really think we're going to see further cannibalization. And particularly, given the fact that we introduced the T400 line, that -- I think that the lack of that product in previous quarters was actually driving more cannibalization, because when we launched the E-Series with this very rich feature set, our customer will look up into the line to the previous T300 Series, it was lacking those rich features that were available in the E-Series, and we have now solved that issue by offering the T400 line in between the E-Series and T600 line. So I expect the product distributions to be much more consistent to what we've seen in the past in that business.

Timothy J. Quillin - Stephens Inc., Research Division

Okay. And then on the cores and components piece, the cooled cameras that were -- where you had some slippage there, what were the end markets? Is that Government end markets? And maybe if you could talk about how big is the Government piece of that cores and components business right now, or maybe also how big is it as a percent of overall Commercial revenue now?

Andrew C. Teich

So Tim, if I look at the Q2, the issue that we had in Q2 for the cores and components piece and I look at the top 11 customers there, essentially, 4 of those are strict Commercial customers. The rest of them are customers that would be supplying into government or military space. The latter, most of them are -- they're actually pretty much evenly split between cooled and uncooled opportunities. Most of our cooled product is going to customers like Northrop Grumman. In the case of those systems, these were just push-outs to the right. I don't have a concern about loss of competition there or the program's going away. I'm quite confident at this point that those programs will come to fruition in the second half.

Operator

Our next question is from Michael Lewis with Lazard Capital Markets.

Michael S. Lewis - Lazard Capital Markets LLC, Research Division

Earl, question for you, then a follow-up for Bill. Directionally, as we look into Q3, could you help us out with some revenue expectations for GS versus CS?

Earl R. Lewis

Revenue expectations. Well, let me go back. On an order front, the GS Q3 orders look very promising to us. The Integrated Systems business particularly looks like that should have very good growth. And let me go back even further, the reason we bought ICx was this idea, this concept of putting together multiple sensors and providing to customer with those sensors all linked together. And I think a previous question was on SBInet and its failure was based on the fact that they couldn't link these sensors together. We now have these packages for multiple sensors for multiple applications that we can package and sell. That business does look like it will grow very, very well in Q3, Q4. Our traditional Surveillance business looks like that will be strong as usual in Q3 and we have a number of opportunities that we'll book. So our traditional real concern about what's going to happen with the GS business over the next couple of quarters, I don't see that as an issue. I think we have plenty of opportunity and I think we'll be successful. As Andy mentioned, the cores business is a timing issue, and I think that we'll see in Q3 that, that will come back to us. The Thermography business looks like it's a little weaker than we thought it was going to be for the year. But with that said, as I mentioned earlier, Q4 will be fairly strong. So I believe in what we've said for the balance this year and we'll perform to those issues. I'll also point out the decisions that we've made to reduce costs mean that our breakevens are significantly lower than they were 1 year ago. If you look at our operating margin, it was about 20% versus 20.6%, I believe, 1 year ago. With some growth, we would expect some very good EPS results.

Michael S. Lewis - Lazard Capital Markets LLC, Research Division

That's very helpful. And then, Bill, shifting gears. In your prepared remarks, you discussed that you're focusing on securing orders. You do expect to see growth some time here in the future. Where does your bid submitted pending approval stand right now? And what do you plan to submit over, say, the next 6 months in GS?

Anthony L. Trunzo

With regards to borders, the U.S. border?

Michael S. Lewis - Lazard Capital Markets LLC, Research Division

No, with regard to the entire GS business.

Earl R. Lewis

Well, planned to or already have? I mean, Q3, for the most part, we've bid already. So those -- that information or knowledge is, is well in hand. Same with the Integrated Solutions business. Most of that, we've bid already for Q3 orders and Q4.

Anthony L. Trunzo

I'd say that our proposal activity is on the increase for the second half of the year, we're still seeing some more large proposals out there. The magnitude of what I foresee us proposing in the second half is bigger, but I couldn't quite quantify it.

Operator

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

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

Earl, on the $17 million, I guess, annualized cost takeout, that's pretty significant I mean 5% of EBIT. Can you kind of update us on your target margins?

Earl R. Lewis

Well, we want to return to our previous margins and those actions will allow us to get there at a lower breakeven point. I mean, those numbers are relatively easy to calculate. Remember, we took a significant amount of cost out a year ago right about now from Bill's business. And this year, we've taken some more out of part of Bill's and a hunk Andy's expenses have also gone away. We think those are prudent given the fact that our order entry in our markets were slower than we anticipated. But let me turn that around for a second and say, the one thing that we did do is we banked about $40 million worth of orders that we didn't ship. And those have a significant profit associated with them if they had gone out. So the backlog going up is extremely important to us in Bill's business. And actually, in Andy's business, we wouldn't have expected the backlog to go up, but it did because of the order frequency came in very late in the quarter.

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

Got it, got it. And then maybe, Tony. Tony, can you tell us what share count you're assuming in your about $1.40 to $1.50 guidance?

Anthony L. Trunzo

I can give you some thoughts on that, but before I do, I just want to kind of address the margin question for a minute. Again, because if you look at it on a segment basis, this quarter on substantially lower revenue, Surveillance business did a little more than 34 points of operating margin. So -- and we've talked about that being a mid 30s operating margin kind of business. They've got their cost structure right even at the current scale of revenue. So from that standpoint, I think that's kind of done. Andy's business took a hit before because of the weak bookings and the decline in sales, we did take some costs out, but I think we'll see a return to margins there, too. The place where we're not at our target margins, if there really necessarily is such a thing because we always want to bring them up, is in the Surveillance, Detection and Raymarine. We had a good progress at Raymarine because of the costs that we took out that Earl talked about, and the cost reductions that -- the restructuring that happened this quarter was in Bill's business with most heavily skewed toward the Detection business. So in the places where we're maybe short of what we think are the right margins for the business, that's where we're taking the costs out right now. In respect to share count, we do expect that we're going to continue to buy back shares in the second half. We typically haven't given formal guidance to that, but I can tell you that we will continue to buy back shares, something reasonably close to the pace we've had over the last couple of quarters, I think, is the expectation. But we've got a $0.10 range for the second half of the year, which is a little bit more than we typically have halfway through the year. And that's partly because of the uncertainty that Earl mentioned in his prepared remarks and partly related to the fact that things like share counts will have some flexibility in them in terms of what we ultimately decide to do.

Operator

Our next question is from Noah Poponak of Goldman Sachs.

Noah Poponak - Goldman Sachs Group Inc., Research Division

So when we're discussing Government growing in the fourth quarter and being better in the fourth quarter and referring back to last year, I guess referring to orders getting better kind of now during the third quarter into the end of the year and that driving that, and you're referring back to last year when the third quarter order number was significantly better than every other quarter that year and that kind of giving you confidence that the business can start to grow again. The thing I struggle with that is, when we saw that last year, Government in the third quarter declined to the mid-teens percentage organically, and then did it again in the fourth quarter and then kept doing it into the first half of this year. And it looks like the reason that happens is the trailing 12 months number in terms of book-to-bill stays below 1 and you're still comping against -- or last year, you were still comping against much higher numbers in 2010. And so as I'm looking at the back half of 2012, both of those things seem to still be true. So...

Earl R. Lewis

No. No, no. hold it. We added a backlog in Q1, we added a backlog in Q2.

Anthony L. Trunzo

I think Q2 of last year, we've been...

Earl R. Lewis

Q2 last year, we took it way down. Remember, that was the worst order quarter we've ever had in history, Noah. From memory it was like $85 million. I mean, just an absolute blowout. And that, of course, hurt us tremendously into the Q3, Q4. In this year, we've actually added the backlog and that has a positive effect on how you feel anyway. That's for sure.

Noah Poponak - Goldman Sachs Group Inc., Research Division

Yes. But the fourth quarter order number was, I mean, on a book-to-bill basis, was even worse than the second. And so just on a trailing 12 month, and maybe that's not quite the right number for you...

Earl R. Lewis

That's not my recollection.

Anthony L. Trunzo

Noah, I'm looking at it right now. And 1, 2, 3 -- the trailing 12-month book to bill is -- I have to figure out if it's north of 1 here, but certainly in the last couple of quarters, it's turned positive. And last Q4 was -- I mean it's probably hard to forecast going forward more than a quarter or 2. Last year's -- this year's Q4 looks better than last year's Q4 for us.

Earl R. Lewis

And again, the key is the second quarter this year, which was positive versus significantly negative. And that I think sets up a Q3, which we think should be pretty good in Surveillance and Integrated Systems both, and I think that, that will give us some momentum into Q4 as well.

Noah Poponak - Goldman Sachs Group Inc., Research Division

Okay. I'll definitely follow up off-line on those numbers. As you move into 2013, Earl, do you think the total company grows revenue, and perhaps, if you wanted to say by segment as well?

Earl R. Lewis

Well, Noah, we've set up a lot easier comparison. I mean, yes is the answer in both segments. That's given sequester, some form of rational actions by Washington. If it's completely irrational, a little bit hard to predict. But I think one of the important points is a number that we put out, U.S. government totaled 22% of FLIR this last quarter. I mean it's decline, decline, decline, decline. So we're slowly becoming much more important for borders and security, airport security and things like that than pure military, DoD. But yes, we will grow both our businesses next year.

Anthony L. Trunzo

Noah, trailing book to bill last 4 quarters is right at 1 for the Surveillance business.

Operator

Our next question is from Jonathan Ho of William Blair.

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

Just following up on Noah's question. Can you maybe give us your thoughts around the contingency planning for sequestration and maybe what you think some of the outcomes are for FLIR?

Earl R. Lewis

I don't know, Bill can speculate, I can speculate, if that's what it is, it's speculation. The one thing we can do and we have done, we're trying very hard to do is move these businesses into little less dependency on Department of Defense and more on Homeland Security worldwide, and we've been pretty successful in that. Again, I'll go back to the Q2 numbers of only 22% being total Government, total U.S. Government. I don't have the DoD part of that, do we somewhere? I don't know.

Anthony L. Trunzo

We do.

Earl R. Lewis

Which will be, again, even smaller. So while sequester is a very scary event for everyone in these businesses, I think what we've done in terms of cost reduction, in terms of focusing on these Integrated Systems for Homeland Defense, is the right strategy for FLIR for the future.

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

Got it. And just in terms of the Raymarine business, are you guys seeing sort of a turnaround there at this point, or should we just kind of perceive I guess consistent results just as the macro environment versus...

Earl R. Lewis

Q2 is always the best for Raymarine, so it won't be as good Q3 and 4. The turnaround that we have seen, as far as I'm concerned, is a result of the work that Andy and Tom have done to reduce costs and significantly improve the product line. The market has been no help whatsoever.

Andrew C. Teich

Jon, I'll just add 1 point to that, which is, we -- the Raymarine business has had a strong dependence on OEMs and particularly so European OEMs, which have been very hard hit. With the product developments that we've been doing in that business, we've been continually developing products that will address some new markets where Raymarine typically had not been present, and those are freshwater markets, retail markets, things like that. And so we have to sort of shore up the core business first and we've done that, and now, we're embarking on those new markets and I think that, that will bring some new opportunities to us because of its spaces that we have not competed in, in the past. And they are also spaces that have not been as hard hit by the economic conditions. Also just reiterating, I think Andy said it, but I'll repeat it, the infrared business relative to our marine businesses in total has been growing at a very, very good rate. So it's more the traditional businesses that we acquired that haven't done as well.

Operator

Our next question is from Michael Ciarmoli with KeyBanc Capital Markets.

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

Maybe one for Earl and one for Tony. Earl, just based on the commentary, are we to believe that despite presidential election noise, continuing resolution, anything that's going on with Washington, this business can improve in the fourth quarter? I mean, is there even more pressure to secure some of these bookings or achieve some stated goals in the third quarter, potentially hedge against some of these fourth-quarter headwinds?

Earl R. Lewis

I'm not sure what the question really is relative to pressure. I'm sure if you ask the people in our company whether I provide pressure on them, you'd probably get an answer like yes.

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

No, I'm just thinking, you're going to have a continuing resolution. I mean, your planning, as you see it today, all of these potential disruptions from Washington, regardless of those, you should be able to achieve your stated growth plans for fourth quarter on the Government side?

Earl R. Lewis

I certainly believe so, because I believe that the programs that we're involved in and when they will be, we believe let will be such that we'll have a fairly strong Q3 in order bookings for the Government group. I can't guarantee it, but I'm very positive we will be much better than a 1 book to bill in Government Systems in Q3, much better. We've got some internal numbers that are significantly better but we're not going to bet on those at this point.

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

Okay, fair enough. And then, Tony, just longer term on the company's target business model. I mean, FLIR has clearly proven to be -- or clearly not proven to be immune from industrial cyclicality, I mean, is the 20% EPS growth rate really achievable throughout the cycle here? It seems that there are so many factors needed to get to 20%, it just seems a little bit unrealistic. I mean, if you guys thought about revisiting that long-term model?

Anthony L. Trunzo

Well, a couple of things about that, Mike. I mean, we have a lot of resources at our disposal for growth here. When you look at the challenges that we face, it's really largely been related to Government spending. Even in Andy's business, the impacts on the cores business, we talked about where that came from. I think that over the intermediate term, that's still an appropriate objective for the company. We may get there a little bit of a different way than we did when we were enjoying lots of tailwinds from a top-line standpoint. But if you look at what we've done in terms of getting the cost structure right in our -- in some of our businesses, if you look at the opportunity available in places like Raymarine and the Detection and Integrated Systems businesses, there's a lot of growth yet to be had in the P&L. And then you look at some of the other things we've done in terms of bringing the share count down, in terms of being a little bit more -- making some good progress on the tax rate, I think there's a lot of different pieces. But when you put them together, that kind of growth rate is still achievable for this company.

Earl R. Lewis

The reason I would have trouble backing off of something like that is that over the long, long run for these businesses, the market penetration still is very, very small. And I hate to sound like a band here, but policemen, firemen, houses, boats, planes, trains, buses, these will all use infrared equipment. And we believe we will be the person supplying that, and therefore, 20% number on average over time ought to be achievable.

Operator

Our next question is from Brian Ruttenbur with CRT Capital Group.

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

A lot of my stuff has been asked from a couple of different angles, but let me just ask it very straightforward, mid [ph] to business long-term the business model, just tell me revenue for DoD and Government, what the plan is, I just want to be clear on it. We talked about your long-term plans a little bit, but I just want to make sure I'm clear on that.

Earl R. Lewis

Well, over the long-term, I think there's no reason that the Government business that we call Government shouldn't grow by 10% or more. I think that, that, when you think about borders and security and some of the applications that they're engaged in, particularly at airport securities, is an attainable number. Commercial businesses I have always thought should be in the 20% growth rate sometime. Raymarine will slow that up until the market changes, there's no question. But when you look at our systems, our systems activity, you know, Andy, our CVS business for example, commercial, personal systems business is growing at huge percentages, let's put it that way, I mean, doubling each quarter and start from a small base, there's no question, but those kinds of opportunities are there for us and we'll have to make sure we take advantage of them.

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

Okay. And then the DoD part of your business is going to be what percent long-term?

Earl R. Lewis

Oh, boy. It's certainly getting smaller and smaller. I wouldn't predict it to be growing, that's for sure. Do we know what percent of the total orders in Q2 are DoD?

Anthony L. Trunzo

In Bill's business, we do. In fact, I put that number back away. I don't have the data handy. Let's see, so the U.S. Military as a percent of total Government Systems sales...

Earl R. Lewis

That's revenue. I was thinking the orders side more.

Anthony L. Trunzo

Yes, I don't have the orders numbers.

Earl R. Lewis

All right.

Anthony L. Trunzo

But I think, Brian...

Earl R. Lewis

It's 22 on revenue, right? [indiscernible]

Anthony L. Trunzo

U.S. government.

Earl R. Lewis

And so maybe 3 quarters of that, if I was to estimate, would be DoD, maybe less. So we'd be in the high teens right now in the Department of Defense.

Anthony L. Trunzo

Yes. And I don't know that -- it's probably among the -- if you look at all of our markets, it's probably among the slower growers, not the slowest grower. But I don't know that we necessarily are going to see a huge decline in that market. I mean, we're going to continue to try to grow market share there. If the market for ISR stays flat, which is a more conservative estimate than what a lot of the third parties say, we should be able to continue grow that business on an absolute basis, not as a percent, but on an absolute basis.

Operator

Our next question is a follow-up from Jeremy Devaney of BB&T Capital Markets.

Jeremy W. Devaney - BB&T Capital Markets, Research Division

So this is actually is the good segue from where we were just talking about with Tony in terms of market share. We recently saw [indiscernible] announce in EO/IR JV over in Europe. Looking back at your Analyst Day slides from this past winter, you had them pinned combined at about 10% of the total market share, the JV would leapfrog them ahead of you guys by about 1 point in market share. I was wondering whether you could talk a little bit around what you're seeing as your current market share globally, and whether or not you're seeing the environment become more competitive? And then also, if you can talk a little bit about the win rate in PS, in the customer award tempo in PS, that would be extremely helpful.

William A. Sundermeier

Sure thing. Well, with some consolidation on market spaces, certainly, our percentages will change, although we continue to take market share around the world, and internationally we're still very, very strong on lots of different platforms with fixed-wing and helicopter in that space, and we're certainly growing all of our IS and Detection business internationally quite well. So we think we'll continue to add to our market share around and carve away as this DoD business is concerned, we're going to take market share there. But of course, our strategy is to focus on other markets, which are more DHS, border, airport expand [ph] which has been our tradition, take these military technologies into other market spaces. So that -- it's going to continue to happen over the next year, but we're still taking market share in the space that we're in.

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

All right. That's fair. And then, Earl, previously, you've given a 25% consolidated EBIT margin target. I would thought we might see it in a quarter this year. It appears that's off the table for right now. Could you give us a little bit more color on that? And Tony, the tax rate guidance for the full year?

Anthony L. Trunzo

Can we ask where the -- what the 25% number is first?

Earl R. Lewis

Yes, he said EBIT.

Anthony L. Trunzo

I don't know we gave a target.

Earl R. Lewis

Forecasting EBITDA.

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

Last year at the Analyst Day, you did specifically call out in the quarter 25% plus EBIT target.

Earl R. Lewis

For the company?

Anthony L. Trunzo

In the quarter...

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

Not on a full-year basis.

Anthony L. Trunzo

In which quarter?

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

You indicated that it was achievable in a quarter but not on a full-year basis.

Earl R. Lewis

Oh, okay. Well, that's -- clearly, Q4 for us will be very strong in that regard but I'll have to go back and...

Anthony L. Trunzo

We have to look at the context there. I'm not sure -- I'm not 100% sure what the context was...

Earl R. Lewis

What was the question again? Let me make sure I understand where we're headed.

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

Last year at the Analyst Day, there were some clarification given around this to really detail your comments, but you had said that the 25% EBIT was achievable company-wide within a quarter and you thought that you could see it within a year to 18 months. Is that totally off the table now?

Earl R. Lewis

Well, certainly we've had significant disappointment in Q2, I mean, probably, I guess we have to end this call in a munite. But my comment relative to the Q2 is that this company is extremely disappointed with what happened in our performance in Q2, and we've taken a number of actions as a result of that, all of which are very unpleasant for us, for employees and for the way we'd like to be running the business over the future. And it is disappointing and it's our job to fix that, and I believe the actions that we've taken so far are doing that. We've consolidated a number of the ICx businesses in the last 3 to 6 months; we've actually moved our Thermography business into a new building that we purchased that has a significant lower cost; we've reduced our headcounts; we've gone after our suppliers, if you will, in a very sort of hard way to get them to reduce their costs on us, so we've taken those actions that we think are prudent. In certain cases, we've even increase prices slightly where we have some pricing power. So as a company, we're doing what we need to do to return to the kinds of margin and operating performance that FLIR has generated in the past, and I believe we will do that. I'd have to go back and see exactly what I said about 25%. My constant desire for this business is to improve on what we did last quarter or last year in the similar quarter, and that's what we all sort of run to. So sometimes I don't associate necessarily with a particular number, except as it relates to the previous quarter or year's performance, but I'll go back and check on that.

Do we have any other questions, operator?

Operator

Yes, sir. We have a follow-up from Noah Poponak of Goldman Sachs.

Noah Poponak - Goldman Sachs Group Inc., Research Division

So Tony, you alluded to potentially getting to growth rates or shareholder return targets in different ways than in the past. What about the balance sheet? Because you've been running a relatively large net cash position for a while now. The rates are low, the stock is down, why not take the balance sheet to still something conservative 15%, 20% net debt to cap and do whatever you think is the best thing to do with that capital to enhance shareholder returns?

Earl R. Lewis

Well, we will.

Anthony L. Trunzo

Couple of things. First of all, the prior question, [indiscernible] the tax rate, that 27% rate is a good number for the quarter -- I'm sorry, for the year, at least for now. So I think we've talked for a long time about balancing our capital deployment between internal investment, buying back shares, the dividend and acquisitions. I think we would not hesitate to burn down our cash position for the right kind of acquisitions, and we feel like we're in a position to consider doing something like that again. Buying back shares, there's always a tension associated with it, right? I mean, it's an attractive thing to do when you believe the intrinsic value of the stock is below -- the value of stock is below the intrinsic value. The fact that we bought back 3 million shares last quarter and intend to buy back more this second half tells us that we think that's the case. How hard do you want to push on that?

Andrew C. Teich

Well, we worked really hard to get an investment-grade credit rating, and that BBB- is pretty important to us because it avails us to capital access for acquisitions and other types of things that we'd like to do. We have a lot of stake, we have a lot of cushion under that rating today because of the [indiscernible]. If you were to say, given appropriate investment opportunities, what would we like to see in terms of debt to cap for the company? I think about it in terms of debt to EBITDA, net debt to EBITDA inside of 1x, maybe even at 1x, is probably fine, rating it in terms of the risk profile. I'm just not sure we'd want to go all the way to that level just by buying back shares.

Noah Poponak - Goldman Sachs Group Inc., Research Division

Has the company ever thought about a special dividend? I mean, is the top line is flat and you think it's close to flat for a little while because of the intermediate pressures you've talked about? You generate so much cash, you'd put yourself back in a net cash position pretty quickly even if you did something.

Earl R. Lewis

I don't like them, Noah. I just don't. I don't think onetime dividends really are what we're trying to do. We're trying to really reward shareholders over the long run and shareholders that are with us over the long run. Onetime dividends to me just encourage activity other than that. So I'd prefer to maybe see what the tax rates are and then decide how much we increase dividends next year. I mean, that's a looming issue in my mind of whether shareholders are going to want us to increase dividends or not. In terms of buy back, our 3 million shares last quarter and I'm not going to predict exactly how much we'll buy this year. But clearly, this quarter rather, but clearly, we think the stock is underpriced, so we will be buying. The last use of our cash is acquisitions, and we are looking at a couple right now that seems to make some sense for us over the long run. They're not huge, but they're not small either. So we think we can deploy our cash properly for our shareholders.

Thank you, and thanks everybody for listening in. We really appreciate it. We are, again, sort of apologetic about Q2 and we're going to work hard to make sure that doesn't happen again. Thanks again.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: FLIR Systems Management Discusses Q2 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts