FLIR Systems, Inc.
Q2 2019 Earnings Call Transcript

Published: 24 Jul 2019

[Operator:]

Greetings, and welcome to the FLIR Systems Second Quarter 2019 Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.It is now my pleasure to introduce your host Carol Lowe, Executive Vice President and Chief Financial Officer. Ms. Lowe, please go ahead.

[Carol Lowe:]

Thank you. Good morning everyone, and thanks for joining the call. Please note that our earnings press release and presentation slides referred to on this call are available under the Events & Presentations section of flir.com in our Investor section.Before we begin, I need to remind you that statements made on this call other than historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and based on our current expectations.Words such as anticipates, estimates, expects, intends, and believes, and similar words and expressions are intended to identify forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially.Please refer to the earnings press release we issued earlier today for a description of factors that could cause actual results to differ materially from these forecasts. The forward-looking statements we make today, speak as of today and we do not undertake any obligation to update any such statement to reflect events or circumstances occurring after today.We'll be discussing our results for the quarter primarily on an adjusted non-GAAP basis. We believe that non-GAAP information is useful, because it can enhance the understanding of our core ongoing operating results and facilitate consistent comparison of results over time. A full reconciliation between GAAP and adjusted measures is in this morning's earnings press release.With that, it's my pleasure to turn the call over to Jim Cannon, President and CEO of FLIR Systems.

[Jim Cannon:]

Thank you, Carol. Good morning, everyone, and thank you for joining FLIR's second quarter 2019 earnings call. With Carol and me today are Travis Merrill, President of our Commercial Business Unit; David Ray, President of our Government & Defense Business Unit, and Sonia Galindo, FLIR's new Senior Vice President, General Counsel, Secretary, and Chief Ethics and Compliance Officer. Sonia brings the wealth of experience and we're excited to have her on the executive team.Frank Pennisi, President of our Industrial Business Unit has a travel conflict and is unable to attend the call. On today's call we will focus on a few key messages. First, we achieved organic revenue growth while lapping prior year double-digit growth.Second, our expanding organic operating margins have allowed for reinvestment in the areas poised for long-term accelerated growth. Third, our Government & Defense business unit continues to achieve strong growth having successfully replaced large sun-setting programs.And lastly, we continue to make exciting progress on our strategic initiatives to fuel, feed and focus the business with the FLIR Method at the foundation to drive long-term value creation. I'll start the review of the quarter on slide three of the presentation with a few financial highlights. Carol will provide more color later in our prepared remarks.As announced earlier this morning, we reported second quarter revenue of $482 million, total revenue growth with 6% and on an organic basis growth was in line with our expectations at 3%. Second quarter organic revenue growth laps the 11% organic growth posted a year ago.Foreign currency exchange negatively impacted growth by 1%. Total bookings were down 3% compared to prior year due to orders originally planned for the second quarter materializing in the first quarter of the year.Recall, we experienced significant franchise program wins and non-programmatic orders in the Government & Defense and industrial business unit in Q1. For the first half of 2019, total bookings are up 14%, total company 12-month current backlog increased 12% to $670 million compared to the balance at the end of the second quarter 2018. Total backlog also increased 12% to $809 million over the same period.Adjusted gross profit increased 5% versus second quarter 2018. Adjusted gross margin decreased 70 basis points to 52%. Continued improvement in organic gross margins driven by productivity initiatives through the FLIR Method and product mix were offset by the early ramp of recent acquisitions.Adjusted operating income was in line with prior year. Adjusted operating margin was down 140 basis points in comparison to last year due entirely to the dilutive effect of recent acquisitions. We are maintaining our full year 2019 guidance.We continue to expect full year revenue growth in the range of 8% to 10%, which includes organic growth of approximately 5%. As we outlined on the first quarter call and unlike last year we expect second half quarterly seasonality to return to historical averages with particular strength in the fourth quarter.We also continue to expect full year adjusted earnings per share of $2.30 to $2.36. As communicated on the first quarter call, our 2019 adjusted EPS outlook includes approximately $0.06 of dilution from the Aeryon Labs and Endeavor Robotics acquisitions.We realized the majority of that dilution in the second quarter of 2019 and expect these high growth businesses to scale sequentially from the third to the fourth quarter. Finally, we announced the quarterly dividend of $0.17 per share which will be payable on September the 6th to shareholders of record as of August 23rd.We've made continued progress on our strategic priorities to fuel, feed and focus the business with the FLIR Method as its foundation. I'd like to highlight a few key second quarter developments that will fuel our business in the near-term, feed delivery of our strategic plan and also address more specifics of the FLIR Method.We'll start with fuel on slide four where we advanced many near-term opportunities to gain scale on the business. In the second quarter the Government & Defense business unit was awarded a $44 million purchase order from the U.S. Department of Defense to deliver unmanned PackBot robots, FirstLook robots and associated accessories with deliveries beginning in the fourth quarter of 2019.This order is further evidence of the alignment of our long-term strategic plan to position FLIR as a leading unmanned solutions provider with the DOD's modernization priorities which include utilizing unmanned solutions to protect the war fighter.Our Industrial & Commercial business units also continue to advance franchise programs. As an example in the second quarter FLIR was awarded a $17 million nationwide program to protect critical infrastructure in Asia representing the largest commercial security project win in FLIR's s history. This win is a testament to our growing solution orientation with thermal camera, visible camera and software capabilities all part of FLIR's winning proposal.Turning to slide five, FLIR has launched many exciting new products across the portfolio since our last earnings call. And I'd like to highlight a few. Earlier this month the Industrial Business Unit launched the new people counting sensor for retail business environments call the Brickstream 3D Gen 2. This new version includes a unique employee filtering feature designed to provide retail and shopping businesses with more accurate customer traffic data and sales conversion metrics.Additionally, in June the Commercial Business Unit launched TrafiData, an intelligent thermal traffic sensor solution for smarter and safer cities. This is a thermal traffic camera that operates in all conditions, integrated with the recently acquired a cyclic data analytics platform to detect, track, classify and communicate insights to traffic managers. This product is a great example of how FLIR is integrating more software capabilities into our sensors to facilitate customers making more intelligent decisions to save lives and livelihood.Also in June the Government & Defense business unit introduced several upgrades to the Griffin 510 portable gas mass spectrometer to help responders analyze and identify drugs, chemical agents and other toxic substances faster and more effectively during field operations. Major new features on the G 510 give users access to an expanded onboard drug library, as well as the new quick search capability for chemicals and hazardous substance.Lastly, we introduced our second regional dataset for autonomous vehicle makers. The enhanced San Francisco dataset features over 10,000 annotated images across 11 image classes in multiple weather conditions. With this much improved data set developed at the epicenter for many ADAS developers.It serves as a reference to demonstrate the increased awareness and therefore safety that thermal brings the challenging conditions in our urban environment. With over 15 years of experience in automotive FLIR has the only automotive qualified thermal sensor that is deployed in over 600,000 cars today for driver warning systems.As highlighted on slide six we made additional strategic investments in the second quarter that will feed delivery of our long-term strategic plan. As you know in early April we continued our minority investment strategy via our investment in drone base, a global drone operations company that provides businesses access to one of the largest Unmanned Aerial Surveillance or UAS pilot networks.Also during the second quarter we acquired New England Optical Systems or NEOS, a recognized leader in niche optical applications for the design and manufacture of high end optical lens assemblies used for visible, thermal and multi-spectral cameras. Their thermal zoom solutions are enabled by the NEOS electronic lens controller, which provides enhanced focus performance while zooming as well as predictive maintenance metrics.This investment continues our vertical integration strategy delivering a complete camera solution to our commercial and defense customers. We're pleased to welcome the NEOS team to the Industrial Business Unit.Turning the slides seven, in 2018 we introduce the FLIR Method, which is comprised of six elements with an emphasis on one FLIR Lean Management and continuous improvement. In 2019 we are building upon our 2018 momentum, while implementing the elements of acquisition and integration discipline, customer driven innovation and talent management.With some of the largest acquisitions in FLIR's history recently completed, the discipline around people, process and technology continues to be refined. The integration of our recently acquired unmanned businesses continues as planned and we strive to achieve world-class performance around this TFM element.As an example of our customer driven innovation, FLIR can point to winning the prestigious Red Dot Award for excellence in industrial design in each of the last three years. Lastly, I'd like to discuss the talent management element of the FLIR Method.In addition to providing employees with leadership and development opportunities, we hold a robust Global Talent Review or GTR to align key talent with our long-term strategic objectives. In fact, we completed our second annual GTR in June here in our new Arlington Virginia headquarters.Let me now turn the call over to Carol for her review of the second quarter financials. Carol?

[Carol Lowe:]

Thank you, Jim. On slide eight is a summary of our second quarter financial results. Please note, with the exception of cash flow all of these financials are on a non-GAAP basis. Reconciliation to GAAP data is included in the filed appendix.Jim has already highlighted our Q2, 2019 revenue growth of 6.5%, adjusted gross profit increase of 5% and flat adjusted operating income as compared with Q2, 2018, while growth in operating margins decline on a year-over-year basis both expanded organically.As expected and previously communicated the acquisitions made to advance our unmanned strategy negatively impacted margins. These investments are critical to the execution of our long-term strategy and we look forward to their positive contribution to our second half performance especially in Q4.Operating cash flow reached $121 million in the first half of 2019 compared to $153 million in the first half of 2018. The decline in operating cash flow as compared to 2018 was due to timing and certain working capital balances as well as other operating assets and liability.In the second quarter, we've repurchased approximately 500,000 shares for $25 million increasing our year-to-date share buyback to approximately 1 million shares. We also returned $23 million to shareholders in Q2 through the payment of dividend for year-to-date payment of $46 million.Our cash balance at June 30, 2019 was approximately $269 million. As Jim mentioned regarding our 2019 outlook we continue to expect full-year revenue growth in the range of 8% to 10% which includes organic growth of approximately 5%.As we have communicated since first providing our 2019 outlook in February, we expect stronger second half revenue growth versus the first half. We currently expect Q4 to be stronger than Q3 with both higher revenues and higher earnings generated in the last quarter of the year.Our full year adjusted earnings per share outlook of $2.30 to $2.36 includes approximately $0.06 of dilution from our recent unmanned acquisition with slightly more than half of that dilution already reflected in the second quarter results.Turning to slide nine, I will highlight performance from each of our business units. Beginning with the Industrial Business Unit, second quarter revenue was $189 million driven by strength in cooled thermal cores that was largely offset by lower demand for test and measurement product and the transition from handheld to UAS based offering.It is important to note that the Industrial Business Unit delivered impressive growth of 14% in Q2, 2018. Operating income for Industrial was $62 million, 7% higher than Q2 2018. Operating margin improved 200 basis point year-over-year driven by favorable product mix and productivity gains achieved through the FLIR Method.The Government & Defense business unit saw revenue growth of 23% year-over-year including contribution from the Endeavor Robotics and Aeryon Labs acquisition. On an organic basis the business grew by 13%, lapping 11% organic growth the previous year.Government & Defense showed strength across all businesses and was led by growth in UAS and Surveillance. Government & Defense operating income increased 8% compared to the second quarter of 2018. Total operating margin decline 350 basis points due entirely to the recently acquired unmanned businesses.During the second quarter, Government & Defense current backlog reached $472 million to end the quarter, a 34% increase over the second quarter of 2018, having successfully replaced large end-of-life program, book-to-bill for Government & Defense stands at 1.2 for the first half.The Commercial Business Unit second quarter revenue was down 7% year-over-year including 3% negative impact of foreign currency exchange. The Maritime business is experiencing negative growth that correlates directly to industry condition.Additionally, the OTS realignment has created near-term headwind. But we're pleased with the team's effort to reposition our products for the professionals. We experienced healthy topline right in the second quarter and our ITS and Security businesses. Operating income and operating margin for the commercial business decreased 25% and 300 basis points year-over-year respectively.Despite record productivity improvement through the FLIR Method, revenue declines in our Maritime business and OTS businesses, foreign currency exchange and U.S. import tariff negatively impacted our financial performance in the second quarter. While it was a challenging quarter for commercials and we expect these headwinds to persist, we are committed to our full-year 2019 guidance.I will now pass the call back to Jim.

[Jim Cannon:]

Thank you, Carol. I'm pleased with the overall performance we delivered in the second quarter. But as our team often hear me say; I'm proud but not satisfied. We are committed to driving stronger organic growth in the second half of the year and our current backlog positions us well to deliver revenue growth for 2019 of 8% to 10%.We will continue to accelerate our efforts leveraging the FLIR Method and remain diligent in our daily tasks to consistently exceed our commitments with integrity and/or purpose to innovate the world's sixth sense to save lives and livelihood.I'll now open up the call for Q&A. Operator?

[Operator:]

Thank you. We'll now we conducting a question-and-answer session. We ask you please ask one question, one follow-up then return to the queue. [Operator Instructions] First question today is coming from Asher Carey from Baird. Your line is now live.

[Asher Carey:]

Hey, Jim, just first clarification; you have adjusted out of $4 million cost that previously wasn't included. What was that charge in the quarter?

[Carol Lowe:]

So, are you looking at the GAAP reconciliation?

[Asher Carey:]

That's right. Yes.

[Carol Lowe:]

Okay. Which specific items, I mean…?

[Asher Carey:]

It's classified as other, 3.951?

[Carol Lowe:]

So there were certain expenses that related to some older legal matters as well as some product warranty for a company that FLIR had purchased and those warranties extended to contracts that existed prior to the acquisition. So it from items that were very dated that not related to any current operations within the past two to three years for the company.

[Asher Carey:]

Got it. Okay. All right. Thank you. And just as a quick follow-up on industrial performance, segment was up in tough comps, but we still had a great quarter. I was wondering if you could – you curious to hear about any specific areas of strength, the areas of weaknesses that you saw in the quarter?

[Jim Cannon:]

Yes. Our industrial business, we're really proud that they lap some really strong organic performance in the prior years as we mentioned. And at -- the heart of it are OEM business there that makes various sensors and components for other companies as well as feed the rest of FLIR continues to have great success. They are probably one of the earliest adopters of the FLIR Method with lean projects throughout the business. And they've done a really good job ramping and scaling production of our uncooled cores, the Boson, in-sourcing other products as well as Neutrino cooled cores. Also important to note in the industrial business our machine vision business. You know that it benefited from a boom in smartphone production Asia. That was a very difficult thing to comp. And we've seen in the quarter a return to positive bookings as they focus on a host of different industries, life sciences, for example in North America. So, really proud of the Industrial Business Unit's efforts throughout the quarter and continued efforts as we go in the second half.

[Operator:]

Thank you. Our next question is coming from Jim Ricchiuti from Needham & Company. Your line is now live.

[Jim Ricchiuti:]

Thank you. Question just with respect to the normal seasonality in the second half and the sequential ramp from Q3 to Q4. Is that mainly driven by the Government & Defense business? Or are you expecting a stronger sequential business conditions in some of the other business units as well?

[Jim Cannon:]

Yes. We really see it across most all of our businesses. You know last year was an abnormal year. Typically FLIR has a stronger second half than a first half. Last year we had a very strong first half. As we look at the bookings that we've made entering the year and current backlog not just in Government & Defense, but across a host of the businesses we see a return to that sort of more normal seasonality with stronger second half versus first half and in particular as we noted, the fourth quarter. We see a ramp from Q3 into Q4 with particular strength in the fourth quarter.

[Jim Ricchiuti:]

Thank you. And just a follow-up question if I may, Jim. You alluded to I think some headwinds and some of the industrial commercial areas of the business. And I wonder if you could be a little bit more specific as to where you're seeing and maybe what's changed in that regard from earlier in the year?

[Jim Cannon:]

Yes. There are really two places where we're seeing these headwinds inside of our Commercial Business Unit. In our Commercial Business Unit, our traffic business continues to flourish, growing at a pace that's leading the company and expanding margin. But in two parts the Commercial Business Unit, the OTS or Outdoor and Tactical Systems business, if you'll recall last year we made a deliberate decision to reorient that towards the professional. So, we made some moves in the business. We rationalized the product offering. We're focusing upon different channels to market. And we're seeing what we expected is near-term headwinds as we pivot that business towards professional law enforcement or foreign paramilitary organizations.The Maritime business, though have seen some headwinds from macroeconomic concern. Ass we entered the year we had good innovations across the Maritime business with our Axiom MFDs, with the DockSense product that has assisted docking solution that we premiered at the Miami Boat Show and others with great response. But you know partially due to weather concerns and other macroeconomic concerns we see new boat registrations down. We see boat sales down, and that slowing growth in the Maritime industry in general is translated into negative growth in our Maritime business.Now, we also have been working in our Maritime business to expand the customers that we focus upon. So, in late 2017 we won the SINS program with the Coast Guard. We've been innovating features into our MFDs to help the professional on the water with search and rescue and border protection. And we've seen some wins in those areas. But not enough to offset the slowing new boat registration and new boat sales that affect our Maritime business directly.

[Operator:]

Thank you. Our next question today is coming from Michael Ciarmoli from SunTrust. Your line is now live.

[Michael Ciarmoli:]

Hey, good morning guys. Thanks for taking the questions here. Carol, maybe first, just housekeeping. On the slide nine where you're showing the segments, you're showing a government book-to-bill of 0.96. But I'm coming up with something closer to 1.2 considering the backlog expanded year-over-year. Is that accurate, I mean it -- the book-to-bill was above one in Government for the second quarter?

[Carol Lowe:]

Yes, so we -- for government for the -- well for the second half, we have 1.2 on the book-to-bill, and then for the quarter we're at 0.9 in total.

[Jim Cannon:]

For the first half.

[Carol Lowe:]

Yes, for the first half and in the quarter is the lower amount.

[Michael Ciarmoli:]

Okay. Got it. And then just maybe sticking with government, maybe could we get a little bit of color on the program pipeline. Any opportunities that are out there either large or small, domestic and international and kind of how your view in the current marketplace even with the -- what looks to be a three-year budget deal in place?

[Jim Cannon:]

Yeah, David, do you want to address that question?

[David Ray:]

Sure. So, we're continuing to see some expansion in our current rate program out of our core gimbal business. We think the modernization efforts now that the government has a budget in place is going to continue to flourish in the second half and we expect to see some benefit there. There deals we have internationally that we expect to close in the second half. But also there is some franchise programs as part of our new acquisitions, the [Indiscernible] opportunity as well as Robotic Combat Vehicle in Endeavor that really a promising sort of longer-term efforts that will see some opportunities for growth, with respect to new bookings in the second half of the year. So, on balance between those franchises and the backlog we build we've built in the first half of the year. It's going to be a good mix of continuing to execute was expected in the second half with continuation of building that backlog into 2020.

[Jim Cannon:]

And I'll just add, David. The second half is really important to us with our Soldier Borne System program. As you know, we were awarded that earlier in the year. We've been working really hard to field that program. It's now been fielded to the initial units to receive the Black Hornet. And so, we're working very hard through the second half of the year to make sure that program is successful as it is so important to protect our soldiers on the battlefield.

[Operator:]

Thank you. Our next question is coming from Jeff Kessler from Imperial Capital. Your line is now live.

[Jeff Kessler:]

Thank you. I know you visited the Maritime situation before. But just wondering -- the -- you did have a very large amount of new product introduction particularly control systems, control panels for boats. And I'm wondering even with the amount of new products you had out there, the decline in registrations offset that is what you're saying?

[Jim Cannon:]

That's correct, Jeff. Yes, we're again real pleased with the performance of our products and the share we've been able to capture with MFDs and other controls. I mentioned DockSense earlier. Also, I am pleased with the team's effort to shift into professional markets in the Maritime arena. We mentioned Maritime Law Enforcement Border Protection et cetera, but those efforts still aren't quite mature enough to offset the decline that we see in new boat sales and with those new boat sales typically that directly drives the adoption of our products. So yes, Jeff, you're correct with that state.

[Jeff Kessler:]

If we just move into some of your sensors and the use of those sensors in what we call safe cities programs because as you know securities the area where I am most familiar. And I'm wondering what the progress you see there as I know this is a very long -- a very long tailed type of development that goes on. But, it's something that I asked the company that once or twice a year, just to give me an idea of where we are in terms of the adoption of various cores and including various cameras that includes your cores for purposes of both civilian and security use in the -- I'm going to call safe cities or secure cities model programs?

[Jim Cannon:]

Yes. We see that adoption really in two areas, right now. I mentioned earlier in the prepared remarks, the TrafiData that we've introduced with our intelligent traffic systems. We see more and more of a fusion between traffic management, intersection management and monitoring as well as connected and safe cities. So, with the acquisition that we did last year of Acyclica, having data and data set management along with that software, along with the sensors in such and intersections help not just traffic management, but safe cities.Also I mentioned, we had in the quarter, our largest ever $17 million award for our core security business. Monitoring critical infrastructure, something we've long focused on, whether its power, water, utilities and more and more we see strength in data centers, using thermal cameras, really our bread and butter or staple kind of products to secure data centers, because of their obvious benefits.We've also been working to -- with the Saros camera introduced, combined, visible and IR-fused sensors with analytics that can determine whether it's a deer, or a dog versus a pedestrian that's approaching a perimeter and integrating low cost radars, with those solutions as well. So, more and more across the world, but also particularly North America, we see real brand strength and our brand being a U.S. company securing critical infrastructure where concerns around cyber security and otherwise continue to persist.

[Operator:]

Thank you. Our next question today is coming from Josh Sullivan from Seaport Global. Your line is now live.

[Josh Sullivan:]

Hey, good morning.

[Jim Cannon:]

Good morning, Josh.

[Josh Sullivan:]

Just within that guidance for accelerated growth in Q4 and on the defense portfolio. The two-year deal here provides the backdrop, but if we still get even a short continuing resolution in Q4. Does that impact your outlook anyway? Is that already factored in?

[Jim Cannon:]

Well, certainly, we don't want a continued resolution or any form of the government shutdown. That absolutely would impact our business. Right now though we do have some bookings, we want to still go capture, but with the backlog that we have. Again, we have confidence in the guidance that we've issued now. Again, if there is a sustained CR shutdown et cetera, I can't say that's fully anticipated inside of our guidance. But we're cautiously optimistic, and with the bookings that we have now with the backlog that we have now, we have confidence in that guidance that we've issued.

[Josh Sullivan:]

Right. And then just one on the industrial portfolio. Can you dig into the geographic performance? Where are the strength? Any standout to product outperforming or underperforming in Asia?

[Jim Cannon:]

The strength is really been in the U.S. In Asia, we've seen some softness. We've seen some softness in our machine vision, business in Asia. Now that can partially be attributed to the boon that we had in smartphone production that slowed, if you will, but also for our instruments business, we had a slow down in the first half related to some import issues that we needed to address. But in the U.S. and in Europe, but particularly U.S. our cooled cores have really seen a lot of strength. So the geographic performance probably -- principally, I'd say, U.S. or North America centric, but also Europe as well.

[Operator:]

Thank you. Our next question is coming from Louie DiPalma from William Blair. Your line is now live.

[Louie DiPalma:]

Good morning, Jim, Carol, David, Travis and Sonia.

[Jim Cannon:]

You got a soft cover, Louie. Good morning to you.

[David Ray:]

Good morning.

[Louie DiPalma:]

Defense media report suggests that the U.S. Army's three-year outlook for the Soldier Borne Sensor program is set to scale from around 1,150 systems to over 9,000 systems over the next three years. And the published President's budget request for Robotics which includes Soldier Borne Sensor and the Endeavor MTRs II program shows the budget, increasing from $100 million in 2020 to $209 million in 2023. Is that media report in the budget, generally consistent with your expectations for how Soldier Borne Sensor and Endeavor scales over the next three-years?

[Jim Cannon:]

Yes, I'd say directionally. Now again, we want to push much more adoption. As I mentioned earlier, that's why right now, the second half is so important to us when we look at the Soldier Borne System. It has been fielded now. Its been noted in the media with the third Brigade Combat team of the 82nd Airborne Division and as they now are adopting tactics techniques and procedures and we're learning about its use. Again, we couldn't believe more and it's lifesaving capability to give that non-line of sight Personal Reconnaissance at the squad level. So yes, I would say directionally that makes sense. But I think there's still a lot of discovery happening, we know that one of the major modernization priorities of DOD is unmanned systems.And as you know with the acquisitions of Endeavor and Aeryon, we're very focused on that Group One, that small squad platoon company level organic unmanned capability. And we know that that's going to continue to proliferate over the battlefield. So, while we directionally sort of agree with those published comments that we have now, I think what we're going to find in the coming quarters and years as these systems get deployed is tactics and techniques develop around them, in their made a part of doctrine and as we continue to innovate and evolve to make them more capable and accessible, we hope to push that number higher because again it's got such a unique in defining capability that we can provide to war fighter.

[Louie DiPalma:]

Okay. And on this subject of unmanned systems, at a high level, can you talk about the role that FLIR plays in counter drone systems? Last week, or it might have been two weeks ago there was a high profile incident in the Middle East of a drone being taken down by a counter drone system and at the Sea-Air-Space Show a lot of the different defense contractors talked about FLIR's involvement in counter-drones, but you guys haven't really been vocal about it on your earnings call. Can you discuss, I guess what systems or the general rule that you guys plan to counter UAS?

[Jim Cannon:]

Sure, what we do in several areas. First, I'm proud to say, the article that you've mentioned it was our Neutrino cooled core. That was a part of that system that down that aircraft. So, we participate at the sensor level with other companies that we provide cooled cores and other sensors into their counter UAS solution. We also are working on our own counter UAS solution and we've demonstrated it in several applications using our own radars, our own EO/IR systems.Now we focused on the detect loop. We don't have any technologies or solutions around the defeat loop. So our emphasis has been on providing cooled components and other sensors to folks that are integrating into their counter UAS solutions, as well as our own organic counter UAS solution. But our solution is focused more on domestic applications to detect. We don't have any technologies and right now we're not pursuing any technologies on the defeat loop of that counter UAS solution.

[Operator:]

Thank you. Our next question is coming from Noah Poponak from Goldman Sachs. Your line is now live.

[Noah Poponak:]

Hey, good morning everyone.

[Jim Cannon:]

Good morning, Noah.

[Noah Poponak:]

Can you hear me, okay. I'm hearing some feedback, and I'm on a cell phone.

[Jim Cannon:]

I've got you now. Yes. You cut out for a minute, but I can hear you now well.

[Noah Poponak:]

All right. Maybe I'll just shout. I actually wanted to go back to the adjustments from GAAP to adjusted and also as it pertains to cash flow, because there is just more and they're larger in the quarter. And historically, the cash flow is always been there. But in the quarter the cash flow to the adjusted earnings there is a little bit weak.So, the first part of the question was just, at what point in time -- I understand the intangible amortization is non-cash, you're getting to a cash number, but at what point in time do we just not have the acquisition expenses, the management transition expenses, all of these other expenses. At what point in time do we have a cleaner number? And then Carol on the free cash, I know it's lumpy quarter-to-quarter, but where should we expect free cash to come in for the year relative to your adjusted earnings guidance?

[Carol Lowe:]

So, let's talk about the GAAP and non-GAAP items first. So, as you noted, we'll continue to have the amortization of the intangible assets related to acquisitions as one of the reconciling items, because we report at adjusted operating income, not EBITDA. That's how some companies address that different. We expect the executive transition costs to be complete at the end of this year largely complete. As well as it relates to acquisition-related expenses, those will primarily depend on whether or not we are competing an auction process or their investment bankers involved and that is largely determined by the size of the deal and in terms of who we bring in for support for legal and other special services that are needed in terms of valuation that's required. Those will continue to see and again it's just going to be driven by the volume of M&A that we're doing. And those are the larger items.As we relate to cash flow, I guess one thing just to provide a little bit more clarity about the -- when you first look at the decline year-over-year in cash flow, it's really driven by the timing of when sales are realized and we had higher sales in June of 2019 as compared to 2018 when you then compare that to June of 2018 compared to 2017. So last year, cash flow was benefited by receivables and timing of sales, it was a positive net $12 million to cash flow. This year for the first half it's a negative $35 million, again just on timing. So that's the net delta when you're comparing 2018 cash flow to 2019 cash flow of approximately $47 million. So that's a big impact of it. We've not really provided guidance on cash flow. We expect to continue to be able to exceed at the cash flow from operations level. We've always been at more than 100% and will expect to continue to deliver that on a year-on-year basis.

[Noah Poponak:]

Okay. I appreciate that. That's really helpful. And then I just wanted to ask on the government margin, kind of 31 and change, at the end of last year, 27 and change in the first quarter than 24 and change this quarter. And I totally get the acquired businesses and some of the new efforts there and the potential to grow revenues significantly from them, but them to dilute the margin, but I don't know how much they dilute the margin sustainably. And so I guess, which of the last four quarters is more indicative of the kind of normalized two to three year out run rate margin in that business?

[Jim Cannon:]

Well, I mean, we don't want to guide the future specific margins of our Government & Defense Business Unit, except to say as we've talked about before. We're constantly managing that arbitrage between competing for larger programs that could have a dilutive effect, as well as driving innovations and non-programmatic business that can be accretive. You mentioned the acquisitions and we talked about there dilution inside the quarter is they advance through the year we expect them to begin to contribute to positive margins in the Government & Defense business. So as we've said at the macro level, we are still committed to 23 points operating margin and the Government & Defense business is a key contributor to us maintaining or exceeding that guidance.

[Operator:]

Thank you. Our next question is a follow-up from Michael Ciarmoli from SunTrust. Your line is now live.

[Michael Ciarmoli:]

Hey, thanks guys. Thanks for taking the follow-up here. Just to maybe stay on that. I mean, you've got the 29%, 2021 bogey out there for government margin. So is that still good? And then separately, you've got that 2021 target of 30% for Industrial margins and I mean on that front, you put up close to 33%, it sounds like you're even dealing with some headwinds in the instrument margins. So should we be thinking there could be upside to that industrial margin longer term and then basically 29% still good for government?

[Jim Cannon:]

Yes. I mean, as we've talked about in our Investor Day, and we still remain committed directionally to those kind of margins in the businesses. But quarter-to-quarter, we have lumpiness across all of our business units that can drive margins a couple of 100 basis points one way or the other. So I wouldn't say, after one quarter that's sustained upside for industrial and/or dilution for Government & Defense. Again as the business mix ebbs and flows, but I will note across all the businesses, Industrial, in particular, but Government Defense and Commercial as well, we're also working really hard with the FLIR Method to drive productivity.And we've seen now well into 2019 that effort beginning to take effect. So whether it be some tariff headwinds that we've seen in the Commercial Business Unit or mix shifts or -- as we mentioned, some of the dilutive effect of the recent acquisitions. We've got a productivity engine that I'm real proud of right now that's beginning to fire. So, again as we go back to what we communicated at Investor Day and what we're guiding to in the year now, still very much in line with that direction.

[Operator:]

Thank you. We reached the end for our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

[Jim Cannon:]

Well, again I want to thank all of you for joining the call today, as well as your interest in our company. As always I especially want to thank the over 4,000 FLIR employees across the globe for their continued passion and dedication to our customers. We look forward to updating you on our third quarter 2019 financial results in October. Thank you.

[Operator:]

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.