FLIR Systems, Inc.
Q4 2018 Earnings Call Transcript

Published: 13 Feb 2019

[Operator:]

Greetings, and welcome to the FLIR Systems Fourth Quarter and Full Year 2018 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 turn the call over to Jay Gentzkow. Please go-ahead sir.

[Jay Gentzkow:]

Good morning, everyone. 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 www.flir.com/investor. 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 are 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 those 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 will 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, Jay. Good morning, everyone, and thank you for joining FLIR's fourth quarter 2018 earnings call. With Jay and me today are Carol Lowe, our CFO; Todd DuChene, General Counsel; Travis Merrill, President of our Commercial Business Unit; Frank Pennisi, President of our Industrial Business Unit; and David Ray, President of our Government and Defense Business Unit. On today’s call, our plan to review the results for the full-year and fourth quarter 2018 highlight our full-year 2019 financial outlook followed by an update on our strategic priorities, including discussion of the two recent acquisitions Aeryon Labs and Endeavor Robotics. Carol will provide further detail on the financial results and outlook before we open the call for your questions. 2018 was truly a defining year for FLIR. During the year, strong organic revenue growth and margin expansion drove record adjusted EPS and operating cash flow. I’ll start the review with full-year 2018 results on Slide 3 of the presentation. This year’s financial performance was historically strong across the board. We finished 2018 with revenues of $1.78 billion, organic top line growth with 6%, with all three business units achieving organic revenue growth above 5%. Our margins expanded reaching adjusted gross margin of 51.8% and adjusted operating margin of 22.7%. Adjusted EPS grew 18% to a record $2.22 per share. Cash flow from operations also achieved record performance, increasing 21%. Strong cash flow enabled us to repurchase 144 million in shares in the fourth quarter brining total 2018 repurchases to 244 million. This morning, we announced initial expectations for our full-year outlook. We expect revenue growth of 8% to 10%, which includes organic growth of approximately 5%. Strong order momentum heading into 2019 and recently announced key franchise program wins give us confidence in delivering our organic growth target. I will note the effect of the partial government shut down has created challenges. However, we view this largely as a matter of timing and are committed to recovering any impact over the balance of 2019. We expect 2019 adjusted operating margin of approximately 22% to 23%. This includes our recent acquisitions and incorporates accelerating investments in our long-term strategy, including unmanned solutions, ADAS, and intelligent transportation systems or ITS. Finally, we expect full-year adjusted EPS to be in the range of $2.30 to $2.36, which includes $0.06 of dilution from the acquisitions. Slide 4 provides information on or results for the fourth quarter. Organic revenue fell below our expectations. The natural lumpiness of the business was aggravated by the government shutdown, which challenged our ability to secure licenses and ship products. We estimate $8 million or 2% of revenue delays in the fourth quarter, primarily impacting the government and defense business unit. While fourth quarter revenue growth was less robust than previous quarters, we’re well positioned for 2019 with organic bookings growth of 20%, compared to the fourth quarter of 2017, as well as significant recent program wins. We also announced a 6% increase in our quarterly dividend to $0.17 per share, which will be payable on March 8 to shareholders of record as of February 22. Turning to Slide 5. I’d like to remind you that in May, we shared our strategic priorities to Fuel, Feed, and Focus the business with the FLIR method as its foundation. I’d now like to update you on our progress. Starting with Fuel, on Slide 6, we advanced many near-term opportunities to gain scale in the business with recent franchise program wins, as well as strong non-programmatic bookings in the fourth quarter we’re well-positioned for continued growth in 2019. In the government and defense business unit, over the last 60 days, we were awarded two contracts to deliver Black Hornet Personal Reconnaissance Systems. In January, FLIR was awarded a $40 million order from the U.S. Army for the next phase of the Soldier Borne Systems program or SPS. The second was an award in December of an $89 million IDIQ from the French Armed Forces we expect to deliver over the next five years. The first task order has already been received for approximately $12 million. I'm really proud of the government and defense team's ability to deliver backlog equal to the fourth quarter of 2017. During 2018, we successfully addressed the sunsetting EO/IR-FP and DR-SKO programs, which represented approximately $92 million of backlog at the end of 2017 as compared with $35 million ending 2018. Recent franchise program wins, strong non-programmatic bookings, and consistent book-to-bill of over 1.0 gives us confidence in our ability to drive future growth. Our industrial business unit won the largest optical gas imaging camera order in FLIR history in the fourth quarter. This family of offerings can detect errant gases such as methane, carbon monoxide, and sulfur hexafluoride, and we’ve invested in this business with the intention of expanding the market to help address health and safety regulations aligned with our mission to save lives and livelihood. We’ve also earned several machine-vision wins across numerous manufacturing and process verticals. During the fourth quarter, the commercial business unit was awarded the contract to secure the Haramain high-speed railway of Saudi Arabia, representing the largest project win in FLIR's commercial security history. Commercial was also awarded a large-scale intelligent transportation project in Hamburg, Germany. Utilizing FLIR’s differentiated thermal solutions with deliveries over 2019 and 2020. This represents a significant win in our ITS division that fuels our strategy to expand offerings in the smart and connected city platform solutions. Turning to Slide 7. Our efforts to innovate differentiated technologies to save lives and livelihood were brought to fruition with one of the most compelling recent quarters for new product introductions. I’ll highlight just a couple of them those. In December, the industrial business unit announced three advanced additions to the Neutrino family of cooled, midwave camera cores, continually innovating at the central level is a key advantage to our technology to fuel growth for the entire business. The Neutrino LC is the smallest, lightest weight, and lowest power consuming Neutrino model available. We also introduced to performance Neutrino models offering the highest resolution midwave camera performance on the market. The Neutrino SX12 produces high definition thermal video, while the Neutrino QX is FLIR’s highest resolution midwave camera core. Both performance models provide crisp imagery at long distance while maintaining a wide field of view. Also, in January, as an extension of advancing our unmanned strategy in the commercial business unit, we introduced Raymarine DockSense. DockSense is a groundbreaking assisted docking system that automates and simplifies the both docking experience. DockSense leverages technologies from across the company to integrate intelligence gathered from surrounding imagery to assist boat owners in tight quarter docking maneuvering. DockSense is an example of our continued effort to move from providing sensors to offering full solutions. Turning to Slide 8. You’ll recall from our Investor Day in May, we articulated a strategy to feed the long-term market opportunity in unmanned solutions. We’ve made two acquisitions to start 2019 to significantly advance that strategy. Building upon the success of the Black Hornet Nano UAS last month we announced the acquisitions of Aeryon Labs to further expand our UAS portfolio. Aeryon Labs is a leading developer of high-performance UAS Solutions for military, public safety, and critical infrastructure markets. Aeryon Skyranger UAS is a vertical takeoff and landing quad-copter with larger payload and lift capability that integrates multiple sensors, including FLIR’s thermal technology, a strong user interface, and advanced flight management software. 20 different militaries around the world use Aeryon’s market leading products for intelligence, surveillance, and reconnaissance operations. The acquisition further establishes FLIR as a leader in the Group 1 UAS space, and reinforces our long-term strategy to provide complete turnkey solutions. Turning to Slide 9. On Monday, we announced a second acquisition in the unmanned space with the signing of an agreement to acquire Endeavor Robotics. Endeavor Robotics is a leading developer of battle-tested, tactical unmanned ground vehicles or UGVs for the global military, public safety, and critical infrastructure models. They are highly mobile and easy to operate ground robots utilize advanced sensing to provide explosive ordnance disposal, reconnaissance, inspection, and hazardous material support at stand-off range. The talented team at Endeavor has a heritage of innovating solutions that are proven to save lives in the field. Having shipped more than 7,000 UGVs to customers in over 55 countries, they are one of the largest UGV providers to the US Department of defense. Having recently won the U.S. Army's Man Transportable Robotic System Increment II, better known as MTRS, Endeavor has momentum with the DoD and is well-positioned for several other franchise program wins. Upon completion, Endeavor will join Aeryon in the unmanned systems and integrated solutions division within the government and defense business unit. The additions of Aeryon and Endeavor significantly advance our strategy to be a leader in unmanned solutions. Furthermore, combined with Prox Dynamics, these acquisitions expand the market penetration of our sensor suite for CBRNE and applications. Aeryon was funded with cash on hand, while Endeavor will be partially funded with existing cash, as well as borrowings under our current credit facility. While we’re not discussing financial specifically, we expect the combined acquisitions to dilute 2019 adjusted EPS by approximately $0.06 per share. We expect the acquisitions to be accretive in 2020 and thereafter. Turning to Slide 10. Along with the inorganic efforts we’ve made to build out the unmanned systems and integrated solutions business, we’ve continued making significant organic investments in the high-growth markets of unmanned, ADAS, and ITS. Harvesting savings from the FLIR method or TFM we're self-funding the talent, processes, and tools to win in these categories long-term. TFM enables us to rapidly advance our long-term strategies and maintain operating margins in-line with our 2021 targets. As an example of our feed efforts in ADAS, at CES in January, the industrial business unit launched our second-generation thermal vision ADK, featuring the high-resolution Boson core. Paired with machine vision algorithms for object classification. The ADK leverages thermal to provide critical data to improve decision making and safety of autonomous vehicles where other sensors experience challenges, such as darkness, shadows, sun glare, fog, smoke, or haze. Also, at CES, we introduced the industry’s first thermal camera equipped commercial test vehicle. FLIR’s autonomous car features multiple FLIR ADK cameras that provide a 360-degree straight view and demonstrate thermal integration capabilities with radar, lidar and visible cameras found on autonomous vehicles today. The autonomous car also features thermal camera enhanced automatic emergency breaking. We will continue to feed target opportunities to position our differentiated solutions in attractive markets with long-term growth trajectories. Turning to Slide 11. As detailed at the Investor Day in May, our strategic priority around focus was largely targeted at re-orienting certain commercial businesses towards the professional, and divesting businesses that did not fit our long-term strategy. In 2019, efforts will focus on one of the most critical parts of FLIR’s mission, the customer experience. I believe there is substantial opportunity to improve all of the touch points our customers have with FLIR and our products, how we communicate? How we quote and sell our products? How we ship and service our products? And most importantly, our customers end-to-end experience using our products in their mission. The FLIR method continues to service the foundation behind our efforts to transform into a world-class operating business. We made significant gains over the past 12 months to 18 months, principally focused on lean manufacturing and continuous improvement. As we go forward, 2019 will include an increased focus on building out other elements of the FLIR method, notably acquisition and integration discipline and global talent development. I will now turn the call over to Carol for her review of financial highlights. Carol?

[Carol Lowe:]

Thank you, Jim. On Slide 12, you’ll see a summary of our fourth quarter and full-year 2018 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. Consolidated revenue for the fourth quarter was $448 million, a 9% decrease year-over-year. Organic revenue growth was in-line with the fourth quarter 2017. While fourth quarter revenue growth was less robust than previous quarters, we are well-positioned for 2019 with organic bookings growth of 20%, compared to fourth quarter 2017, as well as significant recent franchise program wins. Our 12-month backlog finished the fourth quarter at $602 million. Fourth quarter adjusted gross margin improved 300 basis points year-over-year to 52%. Gross margin expansion was driven by favorable mix and productivity gains, driven by the FLIR method. Fourth quarter adjusted operating margin was 24%, 150 basis point higher than last year with margin improvement in all business units. Solid operating leverage led to adjusted net income of $86 million, up 5% for the fourth quarter of 2018. We achieved record adjusted EPS in the quarter of $0.62 per share, 7% higher than the prior year. Adjusted net income was favorably impacted by a 600-basis point decrease in our effective tax rate versus Q4 of the prior year. This was primarily due to the enactment of the U.S. Tax Cuts and Jobs Act, as well as a jurisdictional make shift of our taxable income. During the quarter, we generated cash flow from operation of $98 million. This brings our cash flow from operation for the full-year 2018 to a record $374 million, representing a 21% increase over the same period last year, driven by solid earnings growth and working capital improvement. Turning to capital allocation. In the fourth quarter, we repurchased approximately $3 million shares at an average price of $47.80 per share, bringing our total 2018 repurchases to 5 million shares or $244 million. We expect to continue covering delusion associated with our equity compensation programs, as well as being opportunistic with our share repurchases. We also returned $22 million to shareholders through the payment of dividends increasing our full-year dividend payments to $88 million. Our solid liquidity and $512 million year-end cash balance is enabling the execution of the recent acquisition, primarily with cash on hand. Including the impact of our announced acquisitions, we do not expect our net leverage to exceed 1.9 times by the end of 2019. On the right side of Slide 12, you’ll see our full-year financial results, which Jim covered in his opening comments. Moving to Slide 13, I will highlight performance from each of our business units in the fourth quarter. Beginning with the industrial business unit, fourth quarter revenue was $182 million in-line with fourth quarter of 2017, driven by strength in cooled thermal cores, industrial UAS and automotive solutions, but offset by declines in instruments and uncooled cores and strong prior year comparables. Operating income for industrial was $57 million, 3% higher than the prior year. Operating margin improved 90 basis points year-over-year, due to favorable product mix and productivity gains. The Government and Defense Business unit saw revenue decline 2.5% year-over-year. Deliveries of UAS solutions, integrated system, and maritime systems were top line strength. Revenue growth was offset by declines in CBRNE systems and impact from the government shutdown. Government & Defense operating income was down 2%, compared to the fourth quarter of 2017. Product mix and productivity gains contributed to a 20-basis point margin improvement over the prior year. The commercial business unit’s fourth quarter revenue was down 30% year-over-year, due to $47 million of revenue in the fourth quarter 2017 from the retail security business divested in early 2018. Excluding the divestitures, Commercial Business Unit's fourth quarter revenue grew 5% over last year. We saw continued momentum in ITF, and renewed strength in security. Operating income for the Commercial Business Unit decreased 7% year-over-year. This decrease was impacted by $2 million in prior year operating income from the divested security businesses and $1 million in U.S. import tariff affects. Despite these challenges, operating margin expanded 400 basis points year-over-year. Margin expansion was primarily driven by improved product mix. Turning to this year, we have outlined our 2019 outlook on Slide 14 and I’d like to provide more color on the guidance. Jim has noted the impact of the government shutdown on our fourth quarter 2018 revenue, as well as first half 2019 impact. With that backdrop, we expect revenue for the full-year 2019 of $1.92 billion to $1.95 billion, representing 8% to 10% growth over 2018, including results from the recently announced acquisitions. We expect organic revenue growth to contribute approximately 5%. We also expect the first quarter to be in-line with first quarter 2018, and while 2018 was front-end loaded for revenue growth, we expect 2019 to have stronger revenue growth in the second half. We estimate adjusted operating income margin of 22% to 23%. Adjusted operating margin expectations and include impacts from the previously mentioned acquisitions and incorporates funding accelerated investments in our long-term strategic priority via top line growth and productivity wins from the FLIR method. Finally, our full-year adjusted earnings per share expectation is $2.30 to $2.36 per share. Adjusted EPS guidance includes $0.06 of dilution from the recently announced acquisitions. It also includes a 20.5% adjusted effective tax rate and $25.5 million in net interest expense, as well as diluted share count of 137.7 million shares. In addition, we expect our CapEx to be approximately $50 million to $60 million in 2019. I will now pass the call back to Jim.

[Jim Cannon:]

Thank you, Carol. Last month, I had the honor of joining World Wildlife Fund, or WWF, CEO, Carter Roberts at CES to announce the Kifaru Rising Project, a collaboration between our organization to bring an end to illegal rhino poaching in 10 parks and game reserves in Kenya using FLIR technology. Our collaboration with WWF in the Kifaru Rising Project signifies the broadest scale deployment of FLIR Technology for wildlife protection and represents a vital step to help save these endangered animals. We’re confident in the project's purpose, based on the dramatic results we’ve observed in smaller scale testing with WWF and rangers in Kenya. The Kifaru Rising Project is our first key flagship program introduced as a part of FLIR Hero, the company's new corporate social responsibility platform introduced last year. Please visit flair.com to learn more about this important effort. Again, 2018 was a transformational year for FLIR. We published the new strategy and set the conditions for its success. In 2019, we will work to rapidly advance that strategy. It’s our vision to revolutionize human awareness and perception so that professionals can make better decisions that save lives and livelihood. Lastly, I could not be more proud of the FLIR team for their efforts in 2018 yet never satisfied. I want to thank all of our FLIR teammates around the world for their commitment to our customers mission. I’ll now open up the call for Q&A. Operator?

[Operator:]

Thank you. [Operator Instructions] Our first question today is coming from Peter Arment from Baird. Your line is now live.

[Peter Arment:]

Yes, thanks. Good morning, Jim, Carol.

[Carol Lowe:]

Good morning.

[Peter Arment:]

I know you're not going to get into a lot of the financial details on Endeavor and the deal hasn't closed yet, but just given that what seems to be a very high purchase price given what the private equity firm purchased the company a few years ago, you know, can you maybe just give us some color how the business has changed, just get a better understanding of the business?

[Jim Cannon:]

Absolutely. And we're not going to give specific details, as you cited around the deal and we’re yet to close of course, but if you look at the unmanned space in general, particularly in DoD, as you know in the past three years there’s been great stride. Principally coming together when the 6 strategic modernization priorities were detailed by the secretary of defense and since that time the Army, as well as the other branches have worked to adapt TTPs, also understand the right technologies and how they’re going to conduct that manned/unmanned teaming. So, Endeavor over that period of time has seen a lot of progress working in collaboration with customers around end use cases, and programs have begun to come to fruition. We mentioned the man transportable robot program win, they got MTRS II, but there are several other programs that over the coming 18, 24, 36 months will come to a decision that certainly amplifies the value of Endeavor. And as we look forward into the future and it’s why we're so excited about unmanned opportunities, not just unmanned air and ground, but air ground teaming, manned unmanned teaming, we just see that opportunity continuing to grow. And at our core being a sensor company, all of these unmanned solutions deliver some sort of sensing capability for decision-making purposes. Whether it’s CBRNE detection, EO/IR, et cetera. Also, and lastly, I’ll touch on, you know we mentioned ADAS, a lot of work that we're doing in our industrial business unit around ADAS. And as we build out our unmanned capability in DoD, we see a lot of synergies between work that we're doing with passenger, commercial vehicle trucking with ADAS, with intelligent transportation systems, and infrastructure speaking to sensors on vehicles, as well as the sensor suites and software algorithms machine learning required to have more autonomous flight and unmanned ground vehicles. So, we couldn't be more excited about the future of what Endeavor can bring to FLIR.

[Peter Arment:]

Yes, that’s great. And just as a follow-up, just if I could ask, are you expecting all three segments to show organic growth in 2019 or does the offset, since CBRNE continuing to really kind of – should we expect to have a down year in government?

[Jim Cannon:]

We are targeting all three business units to deliver organic growth. Again, we mentioned at our Investor Day last year, we’re targeting a 5% organic growth CAGR. And we expect all businesses to contribute to that. Certainly, there are some divisions that have a more optimistic outlook of 2019 than others. But on the whole and again, we do expect all three business units to deliver that organic growth and that’s an important metric for us. As we’re moving forward now and have executed the first, let's say sizable acquisitions that we’ve done in some time, making sure that core business is healthy and continuing to grow is an obvious priority for us.

[Peter Arment:]

Appreciate the color and thanks Jim.

[Jim Cannon:]

Thank you, Peter.

[Operator:]

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

[Michael Ciarmoli:]

Hi, good morning guys. Thanks for taking the questions here. Maybe, Jim, not to harp on it, but just to follow-up on Endeavor and that, you know what looks to be a very healthy evaluation based on sales. They’ve got this upcoming complication, the CRS-I contract. I think QinetiQ is the other player there. You know, how did the potential outcome of that award factor into the purchase decision? I mean, did Endeavor where they lacking in certain capabilities or scale, did you hear anything from the customer that would provide you with additional confidence that pulling Endeavor under your sort of umbrella would kind of increased the hit rate of that program? Just trying to figure out how you got comfortable with some of those programmatic unknowns and why make the acquisition so close to a contract decision?

[Jim Cannon:]

That’s right. Well there are several programs that are coming up. You mentioned one that’s immediately, let's say before us, and as we look into due diligence, we looked at all the various programs that are out there in the future. The timing of which knowing also that these programs often slide to the right they really happen sooner than you think and probability of when, because you know there are a lot of folks interested in the unmanned space, but we believe Endeavor, with the fielding of the technology that it already has with the lessons that it’s learned with the IP portfolio that it has is, well-positioned. You know, we also looked at non-programmatic opportunities and other allied military opportunities. Endeavor has been largely focused on U.S. DoD programs. A lot of our strength in the government defense business, as you know, historically has been non-programmatic whether it's trying to capture OCO funds or special operations, forces or with allied nations. So that’s an area that we feel like we could bring some synergy to Endeavor going forward. And then, you mentioned our sensor suites. You know, we’re pretty proud of our CBRNE detection capabilities. We're pretty proud of our ability when it comes to SWaP-C around EO/IR sensors, and those are core capabilities, sensing capabilities that Endeavor will utilize if they bring their products forward and compete on these programs. So, that’s an area of technology synergies that we see, again strengthens their position going forward. But I guess to specifically answer your question, if we did not win any one program that’s pending that would not have dampened our appetite to bring Endeavor to be a part of FLIR. We have a lot of conviction about the future long-term growth trajectories of unmanned capabilities, not just in DoD, but also critical infrastructure, industrial applications that require stand-off, hazardous material management, you know, all the areas where we see ourselves participating in the long-term. Unmanned will continue to grow in the decades to come.

[Michael Ciarmoli:]

Got it. No, that’s extremely helpful. And then, Carol, just if I may, the operating margin and guidance from 2019, 22% to 23% flattish year-over-year. Could you maybe just a little more color or kind of bridge to year-over-year? I mean you’ve got the investment spending assuming there’s maybe a step up in R&D and SG&A, but even what the organic margins may have looked like or how much dilution is on those margins from the acquisitions?

[Carol Lowe:]

Yes, so we’re not breaking out other than providing the dilution associated with EPS for the acquisitions in total. A portion of that dilution is attributable to additional interest expense that we’ll have for the year because of the borrowings that we’ll utilize to fund a portion of the Endeavor Robotics transaction. Overall, Jim commented about the need for investing in our long-term strategies and we’re leveraging the FLIR Method, as well as the topline growth to be able to maintain at that 22% to 23%, and make sure we deliver on our long-term strategic plan commitment we shared in May, which was a target of approximately 23% operating margin. And it's not just about the reinvestment, but if you think about just standard inflationary type increases around compensation benefits, the fact that we’re absorbing that, also absorbing some of the investment needed in the businesses to address the Consent Agreement and other things to move towards a world-class operation. We’re actually very happy that we’re able to fund these investments and maintain our margins in 2019 at what was a 2021 operating margin target of 23%.

[Michael Ciarmoli:]

Perfect. No, that’s helpful. Thank you very much guys. I’ll turn back in the queue.

[Jim Cannon:]

Thanks, Michael.

[Operator:]

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

[Noah Poponak:]

Hi, good morning everyone.

[Jim Cannon:]

Good morning, Noah.

[Noah Poponak:]

I hate to ask the same question three times, but I just had so many questions already this morning from your stakeholders that I imagine will continue to get them, and I think rightfully so, so just wanted to kind of take one more shot at the price paid for these last two acquisitions, just on – I can sort of backup the inorganic revenue in your guidance, and as somebody just asked, we can see the price paid only three years ago, and it’s just quite a high multiple and you’ve sort of changed your balance sheet position pretty significantly. It would seem like you must see something very considerably different than what was in this business three years ago, are the margins much different? Is there something already in the backlog you’ve secured? Just wanted to take one more shot at that. And then, also related, Jim, I thought you had sort of discussed a strategy to want to go more into software and data analytics in acquisitions? And these are pretty hardware oriented, and if you could address that as well?

[Jim Cannon:]

Sure. Well, I mean I won’t retread a lot of the ground that I mentioned earlier, except to say, as we look at long-term growth opportunities that we think are uniquely, you know, fit FLIR’s strength, growth in the unmanned space is compelling for us. It’s a compelling …

[Noah Poponak:]

The industry must have seen that three years ago, right? So, why would the number be so much lower…?

[Jim Cannon:]

Yes, three years ago, technology and industry was in a very different place, I mean these are technologies that are moving weekly, monthly. I mean, if I look at the SWaP-C, that we could drive three years ago, were sensors that we could put into unmanned capabilities three years ago, it was not nearly where it is now. I mean, if we look at what we have with Black Hornet, from Black Hornet 1 to Black Hornet 3 and the capabilities this has on board and something that weighs 33 grams, a very different position, and if you look at it from the user standpoint three years ago, you know, these things and they still have so much more room to go, could be very awkward to employ, you know, requiring a real dedication of the operator that would take them, in a military application, in many cases, out of sight, you know, just operate the equipment. Now more and more we want head up, you know, hands up with the manned/unmanned teaming, you know, working, you know working semi – ultimately, we hope fully autonomously. So, I think in three years, the technology has moved; I think user adoption is continuing to move quickly, but still immature and that's why we’re particularly attracted to this right now. Also, when I think about unmanned going forward, it fits where FLIR historically has been strong. It proliferates the sensor suite that we continue to push with SWaP-C; it has defense applications, as well as industrial applications, you know, professionals that need standoff in autonomous, and the question about software and data analytics, I think couples with these two acquisitions perfectly. We mentioned a lot of the organic investments that we need to continue to make around unmanned and ADAS and ITS in particular, and a lot of those organic investments are to build out a stronger capability around software, machine learning, data analytics, artificial intelligence because we feel, you know, really good about Aeryon and Endeavor’s, you know, hardware capabilities and they have software capabilities, you know, as well. Certainly, it’s a strength of ours with CBRNE sensors and EO/IR sensors. But that piece in between how we, again, get these sensors to be more intelligent, more autonomous, more processing, you know, at the edge et cetera, is an area of specific investment that we’re making organically. It will benefit these two deals, Aeryon and Endeavor, as well as, you know, just about all of our legacy businesses. If you recall, last year, we made a minority investment of a company called CVEDIA that built a synthetic artificial learning city, if you will, that we can populate with imagery, so our cameras can get smarter, and we’re just now, you know, beginning to get that technology end-to-end products. So, certainly appreciate the, you know, the PE firm had a healthy return on their investment. But we believe that this is – has got tremendous growth potential as we go into the out years because more and more as we look specifically at DoD, we know that a direction is set to build out more and more unmanned capabilities, but I think with that, you know, industrial and other first responder applications is – price points and costs, you know, come down will proliferate.

[Noah Poponak:]

I appreciate all that detail. Just one more question, in the organic government and defense business, you had coming into this year the two major program roll-offs. You just made a comment about those being addressed, and then, you’re forecasting the segment to grow organically. Have you had expansions on those programs or have the wins you’ve secured just totally filled the gap? And I guess, you know, how much of the revenue forecast for the year is covered in backlog at this point?

[Jim Cannon:]

Yes, so as we mentioned earlier, right now – last year, we had I think about $90 million between DR-SKO and EO/IR-FP in our backlog. Right now, we’ve got about [30 million]. They do not extend formally as programs; however, we did receive the last tranche of DR-SKO for $28 million just in the backlog now. Now for both, demand continues for EO/IR-FP under the rate program. There is a continued need for those products. How they meet that need going forward is yet to be decided upon. There is potentially a program out there called G-BOSS(NYSE

[David Ray:]

No, I think that was a great answer. The only thing I would add is that when you look at our backlog versus 2018 versus 4Q17, it says the picture that – that we’ve covered that $90 million of backlog that Jim previously discussed, that does not include the $40 million SBS award, which we got the week – first week of January. So, if you count that in, week 1 to week 1, we’re actually $40 million up where we were from Q1 2018 first week of the month of January. So, it speaks to the good thing, all the work being done by our teams to continue to accelerate those program ramps coupled with what we call the scrappiness of those non-programmatic bookings. So, really positioned the business long-term for continued and predictable growth quarter-in and quarter-out.

[Noah Poponak:]

Okay, thanks so much.

[Jim Cannon:]

Thanks, Noah.

[Operator:]

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

[Josh Sullivan:]

Hi, good morning. Just a clarification on the 8% to 10% revenue guidance. What’s the assumption for the timing of the close of the two acquisitions? You know, I know you said Q1 is going to look like Q1 2018, but just curious on the timing on when the acquisitions actually start contributing in 2019?

[Jim Cannon:]

Yes, Endeavor should close in 30 days is the expectation of when it will close. And Aeryon, obviously, is closed now.

[Josh Sullivan:]

And just one on the, you know, the machine vision market. You know, how is consumer electronics market looking at this point? You know, has it bottomed and just what you’re looking at into 2019 from here?

[Jim Cannon:]

Yes, the machine vision business, you know, in 2018 had really tough comparables in the back half – second half of 2018 given all the demand in Asia with mobile, smartphone production, et cetera. You know, since that time through, you know, 2018, the team has worked really hard and won a lot of new business and new process verticals, I’ll say, around fruit inspection, et cetera. But that consumer electronics business right now is pretty slow for us still. We expect bookings growth through 2019 in that business, but booked pretty modest growth because of those dynamics. Frank, do you want to add any color about the business?

[Frank Pennisi:]

Yes, I’ll reinforce some of what Jim said. You know, the smartphone market, the consumer market in general, was huge in 2017. So, we had some really large comps to go up again. Essentially in 2018, we worked a lot of that through our system and pivoted ourselves. We’re in a lot of test and measurement related equipment whether or not to its – whether inspecting optics or life sciences that sort of a thing, as well as people counting, which has been a large growth engine for us where we put our machine vision cameras. So, that’s been able to largely offset the consumer electronics businesses and set us up for really strong bookings growth in 2019.

[Josh Sullivan:]

Good. Thank you. I’ll get back in the queue.

[Jim Cannon:]

Thanks Josh.

[Operator:]

Thanks. Our next question today is coming from Jim Ricchiuti from Needham and Company. Your line is now live.

[Jim Ricchiuti:]

Hi, thanks. You did allude to some wins on the machine vision side, several million-dollar contracts, can you talk a little bit about the types of applications that they were for?

[Jim Cannon:]

Sure. Frank?

[Frank Pennisi:]

Yes, basically the same thing that I mentioned before. The bulk of those were in systems that are sold to other customers that do test and measurement whether that’s inspecting something, whether its spectroscopy, whether its life sciences. We’ve gotten ourselves designed into a number of those systems. The other are people counting where you’re looking at tracking whether it’s in a retail environment, a large growth engine of airports, a lot of those areas happen to be areas where we're designing in as the semiconductor and consumer electronics industry is. If you have strong penetration in is low and we have something they will offset it over time.

[Jim Ricchiuti:]

Got it. On the gas imaging order that you highlighted, we’ve been waiting for this market to develop for a while, is this potentially one of those types of breakthrough wins that may be gets this market where it needs to be in terms of adopting your technology?

[Jim Cannon:]

I don't think that order in particular. I wouldn't characterize it as of breakthrough, but I will say throughout all of 2018 we just saw continued strength in our optical gas finding products. We have also been focused on a lot of innovation around optical gas finding and you will see more of that with the new products and developments through 2019 to make the product more available and accessible to markets that need it. A lot of the growth that we saw in 2018 is tied to regulation, right, around health and safety in various industries, but it’s interesting as we think about and I’ll go back to unmanned for a moment, but as we think about unmanned capabilities and industry the ability to be able to go out and see and quantify gases with autonomous solutions across neighborhoods and such, you know, we see an interesting kind of conversion of unique sensing capabilities we have like optical gas findings with other ways to deliver that sensing solution.

[Jim Ricchiuti:]

Got it. And if I could just slip one more in, just with respect to Endeavor, have you continued to work with them over the years on the explosive detection side of the business I know you were supplying the Fido detector into a bunch of these PackBot robots. Has that relationship been maintained over the years?

[Jim Cannon:]

David, do you want to answer?

[David Ray:]

So, it has been, but it has been through the partnership with the Army and the Joint Program Office for chem-bio detection. So, they have a relationship and have had a historical relationship through that office. And as we've developed our capabilities, there have been opportunities to collaborate in concert with that customer. You know, this acquisition now gives us an opportunity to leverage the R&D power within FLIR and the capabilities that exist today to really be able to take a step function move forward and delivering those total solution and accelerating that next-generation chem-bio detection capability through those UGVs now that were now that were one under FLIR. But principally, it's been as a partnership through our collective conversations with the U.S. Army. Does that make sense?

[Jim Ricchiuti:]

Yes, it does. Got it. Thanks a lot.

[Jim Cannon:]

Thank you, Jim.

[Operator:]

Thank you. Our next question today is coming from Pete Skibitski from Alembic Global. Your line is now live.

[Pete Skibitski:]

Good morning guys. Couple of very quick ones on the two deals. First, for both of them, is the revenue split in terms of government and non-government? Are they both kind of [18% and 19%] government in terms of their revenue? That’s the first one. And then the second one is, do they both sell to the government on commercial terms like most of the rest of your business does?

[Jim Cannon:]

Yes, both of the businesses are almost entirely focused on military and government applications. Principally, as I mentioned with Endeavor a lot of DoD- related programs, and Aeryon does have some first responder and non-DoD government business, but yes both businesses right now are principally focused on government specifically military applications. We think over time, as I mentioned earlier, we have some commercial synergies as we bring together the UIS business, we look at some of our historical strength in non-programmatic, in allied military spending. But their go-to-market and commercial teams operate much like ours.

[David Ray:]

The only thing I would add is, your question about commercial terms that we operate. Largely in a non-programmatic world that’s the case. I will say for some of those franchise programs like MTRS that’s a traditional government program where you have a EMD development phase that transitions to production, which increases the level of customer engagement, but to more traditional DoD approach, and I think that’s an opportunity space that allows us to grow inside of that customer because as the opportunities get bigger they will look more like that than a traditional commercial transaction.

[Carol Lowe:]

David, since you mentioned the MTRS, and we have three questions initially about the valuation around Endeavor Robotics and what was different in terms of what the PE firm paid versus FLIR's assessment of the value. The MTRS is specifically a new program that has been awarded. The team at Endeavor robotics has really focused on winning the program programs of record in a very strategic way and they’ve been really successful. That program is very meaningful. We referenced it in our press release about the acquisition. Also, the Department of Defense has been very vocal about shifting their funding towards UGV significantly over the last couple of years. Jim noted that in his response that just wanted to really emphasize that. We see the opportunity as much greater that the business has created value in the last couple of years, including introducing two new robots. And that’s very differentiated.

[Pete Skibitski:]

Okay. And last one – thank you very much guys, and then last one from me, Jim. There’s been some consolidation ongoing in the defense space at kind of the OEM level, the bigger level, and some of them I think are talking about portfolio shaping and evolving night vision units and I'm just wondering post these deals, are you guys kind of still in the market for deals of similar size kind of that $200 million plus size or maybe take a breather on that for a while and focus on integration?

[Jim Cannon:]

Yes, right now, I mean the principal task ahead of us is to execute a successful integration. As I mentioned in the FLIR method, one of the elements is integration acquisition discipline that’s something particular focus for us right now. Over the longer-term, we’ll remain an acquisitive company. We mentioned with our long-term guidance at the Investor Day. We want to grow organically, but throughout we want to advance very deliberately our strategy. We worked for the better part of the year to develop these opportunities specifically to gain scale in the unmanned space. So, you'll see us continue to be very deliberate, strategic in deals that we approach. But right now, for the near term, our focus certainly is to integrate successfully these deals.

[Pete Skibitski:]

Thank you.

[Operator:]

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

[Louie Dipalma:]

Good morning. Jim and Frank in the third quarter the industrial business in Europe experienced double-digit sales declines, while the U.S. industrials remained very strong. Your pie chart shows the Europe being down $12 million year-over-year in the fourth quarter. I was wondering in general is there anything extraordinary that is occurring in Europe for the Industrials business unit?

[Jim Cannon:]

Frank do you want to?

[Frank Pennisi:]

In general, what I'll just say is, the macroeconomic things or indicators going on in Europe are a little bit sluggish relative to the rest of the world. Europe is actually one of the things that why our growth is a little bit sluggish. I would say Europe was one of the key drivers of that along with large prior year comparables that we had tied to some big transitions that we had. As we move from consumer to professional, we had some smaller-type buys or as we moved over everything over to Boson, we're transitioning customers over. So, we had very large transitions side of that, that gave us some of that prior year comps. And I'll also say that Europe macros were actually playing into that and that's one of the things that we're seeing. Nowhere else in the world, this is largely Europe though.

[Louie Dipalma:]

Okay. And for Carol, in what inning are we in in terms of FLIR Method-related margin expansion? Are there any specific margin expansion projects on the horizon for 2019?

[Carol Lowe:]

So, we have ongoing initiatives and focus around the FLIR Method, and just as a reminder and Jim noted this in his comments that beyond just lean and continuous improvement, there are multiple elements of the FLIR Method, and we're leveraging most all of them across all three of the business units, as well as looking at some of our back-office processes that sit across the entire company. So, we're ramping up on that, we realized actual results we could see in the P&L in 2018 and they are modeled in our guidance for 2019. Of course, we've highlighted that we want to take a large portion of those and invest them back into the business to support our long-term strategic goals for the company. So, we do think at a future date, we will be able to see some margin expansion, but at this time we're still staying with the 23% targeted operating margin over our strategic planning horizon, which runs through 2021.

[Louie Dipalma:]

Okay. And last one for David, the Soldier Borne Sensor was a really nice win. Is all of that $40 million in units to be delivered in 2019? Or will some of that extend into the future years?

[David Ray:]

So, we expect that production program to deliver over 18-month to 24-month period. As part of what we're trying to drive we're looking at how we increase our production capacity to deliver, but short answer is 18 months to 24 months.

[Louie Dipalma:]

Okay. And is there any update on the time line for the G-BOSS infrared and radar prospects?

[Jim Cannon:]

No. That's something that, again there's no update we have right now. It's still to be determined when that will be decided or if that's the path that they go.

[Louie Dipalma:]

Okay, sounds good. Thanks everyone.

[Jim Cannon:]

Thank you, Louie.

[Operator:]

Thank you. Our final question today is coming from Reed Motulsky from Imperial Capital. Your line is now live.

[Reed Motulsky:]

Hi, speaking on behalf of Jeff Kessler. What civil security applications in markets do you see as important focuses going forward specifically regarding cameras and unmanned vehicles?

[Jim Cannon:]

Yes. So, we mentioned that we've had – we've been awarded our largest commercial security project to-date securing the railway in Saudi Arabia in Haramain, which is very important for us. We continue to look in our core markets at critical infrastructure applications etcetera. Why don't I have Travis the CBU President add some more color?

[Travis Merrill:]

Yes sure. I think if we look at the commercial security market, we can look at it from a few different segments that are attractive to us and really where we're focusing our resources. Critical infrastructure still tends to be our bread-and-butter for our thermal line of products and it will continue to be so. That's the way to look at the future, but we are also taking that thermal technology and looking to expand it into outdoor perimeter protection for commercial applications, which is largely unpenetrated today things like public parks, auto and car dealership lots, etcetera. So that will be a longer-term new market development for us leveraging our thermal technology capabilities in a new security vertical. And then finally on the enterprise side, which is largely our visible technology, safe and smart cities continue to be an attractive vertical, and we've had a lot of successes in the last 12 months to 24 months in that key segments as well.

[Jim Cannon:]

And it's interesting, the effort with safe and smart cities coalesces in some ways touches our ADAS effort as we make intersections more intelligent, cities more intelligent, they can communicate with sensors on vehicles. We also think about it, not just from a commercial security standpoint, but ultimately autonomous and assisted driving solutions as well.

[Reed Motulsky:]

Thank you. That was good color. And what types of cores do you guys see being used in these applications? Camera cores?

[Jim Cannon:]

I mean right now our leading SWaP-C core will be the Boson, but depending on the need it could be cooled, uncooled camera cores, again we continue to push the boundaries with size, weight and power to be able to develop and have the best high-rate production for both cooled and uncooled.

[Travis Merrill:]

We'll use Lepton when necessary as well.

[Jim Cannon:]

Yes, Saros is a good example where we've integrated two Lepton cameras, so you can have great perimeter security applications with thermal with analytics that can determine if it's a dog or a pedestrian and initiate EO cameras. So, Lepton is being used as well, but the full suite of FLIR core sensing capabilities is available for the commercial security folks.

[Reed Motulsky:]

Great. Thanks for taking our questions.

[Jim Cannon:]

Thank you.

[Operator:]

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

[Jim Cannon:]

Again, I want to thank you for joining us on the call today and your interest in FLIR. We look forward to updating you on our progress when we report our first quarter 2019 financial results. Thank you, everyone.

[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.