FLIR Systems, Inc.
Q2 2017 Earnings Call Transcript

Published: 26 Jul 2017

[Operator:]

Greetings and welcome to the FLIR Systems' Second Quarter 2017 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce you to your host, Todd DuChene, General Counsel. Please go ahead, sir.

[Todd M. DuChene:]

Good morning, everyone. 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 this conference call, 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 expectation. Words such as anticipate, estimate, 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 the actual results to differ materially. Please refer to the press release we issued earlier today for a description of factors that could cause actual results to differ materially from those forecast. The forward-looking statements we make today speak as of today and we do not undertake any obligation to update any such statements to reflect events or circumstances occurring after today. 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 our press release this morning. Let me now turn the call over to Jim Cannon, President and Chief Executive Officer of FLIR Systems. Jim?

[James J. Cannon:]

Thanks, Todd, and thank you all for joining us for FLIR's second quarter 2017 earnings call. With Todd and me today is our CFO, Amit Singhi; our COO, Tom Surran; Chief Marketing Officer, Travis Merrill; and SVP of Corporate Development and Investor Relations, Shane Harrison. Overall, I'd say the second quarter was a sound quarter for full year. Our backlog, our revenue, adjusted gross margin, op margin, net income and EPS were all up year-over-year. I'll start with a review of the second quarter on slide 3 of the presentation. This morning, we reported second quarter revenues of $434 million, which was an increase of 8% over the second quarter of 2016. Our commercial products revenue grew 12% over the prior year and our government products revenue grew 3%, with the addition of our recently acquired businesses that drove most of this growth. Our organic revenues in Q2 were flat to slightly up on a constant currency basis. Surveillance, Instruments and OEM & Emerging segments, each grew over 8% organically; however, that growth was offset by declines in Security and Detection which we'll detail later in the presentation. Adjusted gross profit and adjusted operating income grew 15% and 16% respectively in comparison to the prior year, and adjusted earnings per share for the quarter of $0.42 which represents 14% growth versus last year's adjusted EPS of $0.37. The total company 12-month backlog finished the quarter at $645 million, that's up $37 million or 6% over the end of the first quarter. And total bookings in the quarter were the highest we've seen since the fourth quarter of 2015. We also launched a host of new products in Q2 which we're really excited about, many have already made a nice impact on the marketplace, which Tom will detail as he discusses our performance by segment. If you look on slide 4, you'll see our outlook for 2017. We continue to expect full year 2017 revenues to be in the range of $1.78 billion to $1.83 billion and adjusted EPS to be in a range of a $1.81 to $1.91. This assumes organic revenue growth in addition to the growth associated with our recently acquired businesses. We also announced today a quarterly dividend, quarterly dividend of $0.15 per share which will be payable on September 8, to shareholders of record as of August 25. I'll now ask Amit, to review our second quarter financial results. Amit?

[Amit Singhi:]

Thanks, Jim. Good morning. On slide 5, you'll see our second quarter financial results. Please note all of these financials are on a non-GAAP basis. Reconciliation to GAAP data is included in the slide appendix. Consolidated revenue for the quarter was $434 million, an 8% increase compared to the second quarter of 2016. Exchange rate changes negatively affected revenue growth by about 70 basis points. Excluding the results of acquisitions made in the last 12 months and adjusted for exchange rate changes, year-over-year revenue increased by $2 million or about 0.5 percentage point. Furthermore, excluding the decline in the Security segment, organic revenue growth at constant currency was about 5%. Revenue from the OEM & Emerging, Surveillance and Instruments segments grew 53%, 14% and 10% respectively. Maritime segment was about flat, and Detection and Security segments declined by 25% and 22% respectively. Geographically, revenue increased across all regions except the U.S. which was flat. Sales to the U.S. government increased versus last year by 12% to about $112 million, representing about 26% of total revenue. Consolidated second quarter adjusted gross margin was 49%, about 290 basis points higher than last year. Year-over-year, recent acquisitions contributed 40 basis points and segment mix changes contributed 70 basis points to the increase. This was partially offset by a 30 basis point negative impact from foreign exchange rate changes. Overall, adjusted gross margin improved across all segments except Instruments, which was flat. Our adjusted operating margin for the quarter was 19%, about 130 basis points higher than last year, driven by the increase in gross margin. Our adjusted tax rate for the quarter and estimate for the full year remains at 25%. Adjusted net income for the second quarter of 2017 totaled $58.4 million and adjusted EPS was $0.42, both 14% higher than prior year. Quarterly cash flow from operations was 52% of adjusted net income or $30 million, which was $58 million lower than prior year. First half operating cash flow was 97% of adjusted net income due to strong first quarter performance. Second quarter operating cash flow was negatively affected by higher accounts receivables and inventories, as well as exchange rate changes on the translation of our cash flows and timing of tax payments. In the second quarter, our accounts receivables were up due to increased revenue both quarter-over-quarter and year-over-year, revenue calendarization in the quarter and slippage of some collections. Inventories were up due to new product introductions and timing of shipments. However, our cash conversion cycle improved sequentially and year-over-year. Some items slipped out of the second quarter which we expect to realize in the second half, thereby delivering operating cash flow at over a 100% of adjusted net income for the year, as I've mentioned in our first quarter call. We did not have any acquisition-related outflows in the quarter nor did we repurchase any shares. Our capital expenditures for the quarter were $10 million, slightly lower than last year. During the quarter, we returned $20.6 million to shareholders through the payment of dividends. $4 million higher than prior year as a result of our 25% year-over-year dividend per share increase announced earlier this year. We closed the second quarter with cash of $404 million. This concludes the summary of our financial results. Let me now turn the call over to Tom Surran, to cover our operational highlights. Tom?

[Thomas A. Surran:]

Thank you, Amit. On slide six, you will see a summary of the second quarter results by segments. We saw a strong year-over-year growth from the OEM & Emerging, Surveillance and Instruments segments in the quarter. Growth in the segment level operating income was 18%, which outpaced revenue growth due to improved gross margins and controlled operating expenses. Moving to slide seven to cover the Surveillance segment. Second quarter revenue for the Surveillance was $129.2 million, up 14% from the second quarter of 2016. Airborne, weapon sights and land products were particularly strong compared to the prior year, and the addition of the OTS and UAS businesses added inorganic revenue growth. Operating income for the Surveillance segment was $33 million, up 24% versus the prior year primarily due to product mix. Surveillance booking growth of 24% quarter-over-quarter resulted in Surveillance segment backlog growth of $7 million during the quarter, to $327 million. Good order flow from Europe and Middle East customers helped generate a Surveillance book-to-bill ratio of 1.1 in the second quarter. On slide eight is a summary of our Instruments segment. Revenue of $86 million was an increase of 10% over the second quarter of 2016. Strength in premium handheld plant predictive maintenance cameras and gas imaging cameras drove this increase. Our new mid-range Exx and our high-end T1K cameras helped drive premium PPM product growth of 18% over last year. Backlog for Instruments increased 15% during the quarter from broad bookings activity across many of the Instruments' product lines. Instruments' operating profit in the second quarter increased 20% from the second quarter of 2016 to $23.6 million or 27% of revenue. The revenue growth on operating expenses that were held nearly flat to the prior year, helped improve Instrument's operating margin, 230 basis points versus 2016. In May, Instruments launched the new T500-Series of premium thermography handheld cameras featuring advanced ergonomics, distinguished thermal image quality and auto-calibrating interchangeable lenses. This new product augments our premium PPM product line and sits between the new Exx-Series and the T600-Series. The Security segment's results are summarized on slide nine. Security's revenue of $49.7 million was down 22% compared to last year's second quarter. This decline was largely due to continued softness in the retail channel for visible security systems. Delivery push-outs of approximately $4.5 million negatively impacted Lorex's results. These orders for new product rollouts including a 4K Ultra HD bundle and a wire-free camera system, make us optimistic about the Lorex business in Q3. Security's thermal imaging business had year-over-year growth in the low-teens, which partially offset the decline in the retail business. Security operating income was down $3.1 million year-over-year due to the soft top line and despite improved gross margins from product mix. This month, Lorex introduced two new product lines for the consumer and small business customer. First is the lineup of 4K IP camera bundles that feature 8-megapixel cameras and advanced video compression technology. These systems have approximately four times the number of pixels as their traditional 1080p HD camera, enabling better image zoom and improved identification of objects. Also introduced in July was Lorex's first wire-free camera system. This bundle includes battery-powered HD cameras, advanced motion detection, a wireless DVR receiver, and cloud-based viewing and storage of video. The results for the OEM & Emerging segment are shown on slide 10. OEM & Emerging second quarter revenue was $87.4 million, increasing 53% over last year and reaching another all-time high for the segment. The acquired Integrated Imaging Solutions line of business was a significant driver of this growth, while the organic business also increased double digits with strength in the cooled military camera cores, Lepton cores, and Intelligent Traffic Systems. During the quarter, we commenced shipments of the third-generation FLIR ONE and the FLIR ONE Pro Thermal Imaging accessories for mobile phones. OEM & Emerging operating profit also reached an all-time quarterly high of $26.3 million, with an operating margin of 30%. Product mix helped drive higher gross margins versus the prior year. And order backlog in the OEM & Emerging segment increased 13% during the second quarter to $159 million. Turning to slide 11. Maritime segment revenues were $55.1 million, essentially flat versus the prior year. Shipments of our recently introduced Axiom multifunction display drove MFD revenue growth of 16% year-over-year. Maritime operating income was $9.4 million in the quarter or 17% of revenue, up 340 basis points from the prior year. This was primarily the result of the new Axiom products providing higher gross margins and operating expenses being held largely flat with the prior year. Since last quarter, Maritime has expanded the Axiom line of multifunction displays with the introduction of the Axiom Pro. The Axiom Pro was designed for the serious offshore boater and professional captains by adding a HybridTouch interface to be able to operate the system at all sea conditions and a more powerful CHIRP sonar for superior deep water performance. The Maritime segment also introduced the M500 thermal imager to the boating market. The M500 is a multi-sensor camera system featuring a cooled thermal sensor with a 14x optical zoom lens for greater long-range imaging as well as an HD visible camera, gyro-stabilization, video tracking, and radar integration. Our Detection segment's results are summarized on slide 12. Detection's second quarter revenue was down 25% year-over-year to $26.7 million. Timing of deliveries under our DR-SKO program explains the decline, which was partially offset by strong shipments of our radiation products. Operating margin was down year-over-year from 29% last year to 26% this year, as a result of lower revenue on the operating expense base. Detection finished the second quarter with $86 million of backlog, increasing $12 million from the end of Q1, due primarily to a large order from the U.S. Department of Homeland Security's Domestic Nuclear Detection Office for our R300 compact spectroscopic personal radiation detector. In the second quarter, Detection introduced the Griffin 510 Gas Chromatograph-Mass Spectrometer for using chemical hazard identification. This new man-portable chemical analysis equipment provides the first responders, lab-quality, in-field analysis of solid, liquid and vapor threats. That concludes my summary of the second quarter. I'll now pass the call back to Jim.

[James J. Cannon:]

Thanks, Tom. The second quarter was encouraging from many perspectives. We saw meaningful margin improvement sequentially in year-over-year and our orders were strong. Our recent acquisitions fueled top line growth of 8%, which flowed nicely down to adjusting earnings per share which grew 14%. As we entered the second half, we were focused upon holding these gains while driving organic growth. I'd sum it up by saying that I'm proud of the team, but not satisfied, as we have a lot of opportunity ahead of us. Starting the third quarter with the largest backlog since 2008, leaves us well-positioned for a strong second half. I also want to take this opportunity to thank Amit; thank Amit for his contributions to FLIR. As you're aware, he announced his departure in order to be closer to his family. Over the past several weeks, Amit's worked with the team to ensure a very deliberate handover. Shane will serve as our Interim CFO, while we undergo a search for Amit's successor. And let me close by expressing how excited and humbled I am to serve as the CEO of FLIR Systems. Having been an end user of FLIR technologies throughout the course of my career, as a soldier, as a manufacturer and security integrator, I know firsthand the distinct advantage that our products provide in the marketplace. I've spent the past month on the road visiting with our teams and it's the pride, professionalism and talent of our people that has me most impressed. As I visit with our teams, my message has been focused around a simple task and purpose. Our task is to exceed shareholder commitments with integrity and our purpose is to innovate The World's Sixth Sense in order to save lives and livelihood. I take great pride in that purpose. My priorities in the near term are straightforward; identify how we can create the most shareholder value, organize the business around that effort, and establish the right operational cadences to ensure its execution. I'll now open the call up for Q&A.

[Operator:]

Thank you. We'll now be conducting a question-and-answer session. Our first question today is coming from Jim Ricchiuti from Needham & Co. Please proceed with your question.

[James Ricchiuti:]

Thank you. Yeah. Two questions. First, on the industrial camera business. We're just hearing about pretty strong demand in the factory automation market. And I'm wondering to what extent is this driving growth within the IIS business? And are there some specific verticals where this has been particularly strong for you, if that's the case? And then I have a follow up on the Security business.

[James J. Cannon:]

Sure. Well, our IIS business has done quite well. It's an acquisition, we're really proud of its performance. And this quarter has been outstanding and we are pretty bullish on it going forward. But I'll let Tom answer the question specifically.

[Thomas A. Surran:]

Yeah. As Jim mentioned, we're thrilled with the performance of the IIS team. And as you mentioned, the machine vision business has done quite well. The optical inspection aspect of the business, particularly for the generation changeover in the mobile phones, has driven some recent bookings growth. We expect that revenue to be executed over the next couple of quarters and it's been something that's really been a bit of a surprise for how strong it has been. And we're very pleased with the ability of the team at IIS to capture that share of business.

[James Ricchiuti:]

Got it. Okay. Thank you. And then just with respect to the Security business, I'm wondering, if we strip away for a second the consumer retail portion of the business, I'm wondering how you view the remainder of the business? How satisfied are you with the performance of the professional-grade business, the DVTEL business? Can you give some sense as to maybe how that business, the various segments are performing? Thank you.

[James J. Cannon:]

Sure. See, if we look at our Security segment, you look at the core thermal business. As we mentioned earlier, it grew in the mid-teens in the quarter. So it had a very healthy quarter. And the retail business really comes down to timing. Already product that was delayed at the end of the second quarter shipped into the channel. So we expect that to return to organic growth. I'll just say for Security on whole. It's an important part of our company. Now, going forward, we need to think about how we focus it, certainly. But if you think about critical infrastructure, perimeter security applications, the kind of technologies we provide in the current threat environment, there's a real value there in that business. Now, we've got two products that we mentioned earlier, that Tom noted, that are launching into the retail channel, that'll help bolster that a bit. But no doubt, as we go forward, we're going to continue to work to improve the organic trajectory and profitability of that segment.

[James Ricchiuti:]

Thanks a lot, Jim. Best of luck.

[James J. Cannon:]

Thank you.

[Operator:]

Thank you. Our next question today is coming from Asher Carey from Robert W. Baird. Please proceed with your question.

[Asher Carey:]

Hey, Jim. Good morning. I'd kind of just a general question here. If you could comment on your acquisition philosophy. I'm just curious how you see your philosophy compared to what you've seen FLIR execute on within the many different end markets? And any high-level thoughts on the acquisition criteria? Do you see any room for divestitures? And how quickly do you think you plan on rolling out your formal plan? Thanks.

[James J. Cannon:]

Sure. Well, I will start by saying, acquisitions are a core part of our future growth strategy; no doubt. And when I think about acquisitions, I kind of put them into three buckets, right. There are going to be investments that we make to gain specific technologies, joint ventures perhaps. There are going to be bolt-ons that we do and some of which that we've done many of over the years. Then there are going to be those deals of scale that will be more transformational. First, I want to affirm what our go-forward strategy is. And again, I think five weeks on the job, so I'm going to stop short of publishing that wholesale on this call. But first and foremost, I again affirm what is the clear strategy for the company, and then go out actively work to build an aggressive pipeline of targets that we can go after, be disciplined about the financial hurdles that we have to get over and gain scale. As you know, we have a pretty sound balance sheet. You'll, again, see us very acquisitive as we go forward, but very disciplined as well. As I look across our business, again, acquisitions are going to be critical because we have a lot of segments that frankly we need to gain a lot of scaling, right, to be more competitive. So suffice it to say, it'll be an important part, a critical part of our strategy going forward and it'll be a very disciplined approach.

[Asher Carey:]

Okay. Thank you.

[Operator:]

Thank you. Our next question today is coming from Saliq Khan from Imperial Capital. Please proceed with your question.

[Saliq Jamil Khan:]

Hi. Good morning, Jim.

[James J. Cannon:]

Good morning.

[Saliq Jamil Khan:]

Hey Jim, I know you've only been on the job for the last couple of weeks, but as you spent last several weeks visiting with employees and learning about the business, can you give us a bit of insight into your initial perspective of the FLIR business and the potential improvements that you're seeing?

[James J. Cannon:]

Absolutely. I could talk the rest of the morning about this. I've been on a kind of business tourism trip for the past month trying to get out to as many of our sites as I possibly can. By the end of the quarter, I intend to visit all of our major sites of scale. By the end of the year, I hope to be everywhere I possibly can. I have to say, there is a consistent theme as I've gotten out into the business. Now, we have very different segments with different technologies that serve different end users. But the passion of the people and their connection to our end users has been consistent throughout. As I mentioned earlier, our purpose to innovate The World's Sixth Sense to save lives and livelihood, it's pretty compelling. We're here in Billerica today where the Surveillance business makes weapon sights, man-portable sights, et cetera. And again, when you talk to the folks whether it be in management, in the functions that serve it, on the shop floor that develop the technology, again that real commitment and passion to the end user and the talent of the folks is just absolutely impress me. Now, is there opportunity for us to improve? Absolutely. As I mentioned earlier, there are parts of our business that we need to fuel where we see immediate opportunity, there are parts of the business that we need to feed to gain scale, and there are parts of the business that we need to focus, again, to incubate and develop technologies and/or focus to get them to be accretive with the rest of the businesses. But again, I could talk all day about how proud I am of the folks that work in this company and their talent.

[Saliq Jamil Khan:]

Got it. And then, if you take a look at your past and the work that you've done on the commercial side of Stanley, are you still committed to the retail channel for the Security business with FLIR? And if so, what changes do you envision that you can bring about and where do you think there could be room for opportunities to be able to improve the retail channel more?

[James J. Cannon:]

Sure. Well, no doubt, the retail channel has been a struggle for us, as the business has been lumpy in the second quarter. As we mentioned, as orders didn't get into the channel or product didn't get into the channel, it caused a timing delay and dilution for the whole business. As I mentioned earlier in the third quarter, those products are shipping. We have two new products that will go into the retail channel, so we're going to continue to compete hard on that front. But you're also going to see us focus heavily, as I mentioned, on the critical infrastructure side of the house. Our thermal side of Security grew in the mid-teens in the quarter. And if you think about the current threat environment, you think about the kind of technologies that we apply into critical infrastructure, into force protection, into perimeter security, there are so many opportunities. So you're going to always see us focus on the Security segment, but especially focused upon those perimeter security and force protection, critical infrastructure kind of applications.

[Saliq Jamil Khan:]

Just one last question on my end, guys. If I take a look at the SG&A, that was a larger percentage of revenue as it was same period last year. How do I think about that in the out quarters?

[Amit Singhi:]

So – this is Amit. The overall increase year-over-year, you will see some of that continue in the second half. Some of this is related – in the specific quarter, it's related to some accruals of compensation expense that was calendarized differently last year. But in addition, there's investments in our export licensing processes that we've talked about and some higher legal and CTO investments that we've made, as well as some IT calendarization and personnel adds. So, you won't see the same level of increase in the second half, but the second half will still be higher than the second half of last year.

[Saliq Jamil Khan:]

Great. Thank you, Amit.

[James J. Cannon:]

Thank you.

[Operator:]

Thank you. Our next question today is coming from Jonathan Ho from William Blair. Please proceed with your question.

[Jonathan F. Ho:]

Good morning, and welcome on board, Jim. Just wanted to start out, what specifically caused the security orders to be delayed? And just given the volatility that we've seen in that business so far, what should we be thinking about in terms of maybe a growth rate or a general range for that business for this year?

[James J. Cannon:]

Sure. Well, the delay was really retailers taking inventory into the channel at the end of the quarter. They delayed the orders into the third quarter and, again, that product now is beginning to ship. As I mentioned, the thermal business grew quite nicely. As we go into the second half, we do expect the Security segment to return to organic growth on whole, albeit in the low-single digits.

[Jonathan F. Ho:]

Great. And then in terms of the DR-SKO program, like how large were the orders that slipped out to the subsequent quarter? And do you expect that to be recognized in the third quarter or just in the second half of the year?

[James J. Cannon:]

I expect more shipments for DR-SKO in the fourth quarter. Now, there are still I think $40 million left to ship on that program. That program goes well through 2018. I think Q3, we're going to see continued kind of slowness in the program, but in Q4 we expect a lot of activity. And I also want to highlight for Detection, the Griffin G510. Tom mentioned it, it's a new product that we've launched this quarter. You'll hear more about it. It's something we're really excited about. Across our Detection business, right now if we look at all the programs that are out there to capture, it's probably one of the largest addressable markets we've seen in recent history. Now, a lot of work to go do to capture those programs. That will be going throughout the second half. But specifically to your question with DR-SKO, I probably expect Q3 to be a bit slow, but Q4 to be a strong quarter for it.

[Jonathan F. Ho:]

Thank you.

[Operator:]

Thank you. Our next question today is coming from Michael Ciarmoli from SunTrust. Please proceed with your question.

[Les Sulewski:]

Good morning. This is actually Les in for Michael. Question actually to backtrack a little bit to your approach on acquisitions and maybe take a look at another approach to it. Any thoughts on the long-term strategic direction of the company and – specific to portfolio reshaping, and perhaps any product line that you might see fit for divestitures?

[James J. Cannon:]

Well, again, five weeks on the job, I'll stop short of a wholesale reorganization of the company, our announcement of some big departure of strategy. But suffice to say, there are going to be parts of our business, as I mentioned, that we're going to fuel because we see immediate near-term opportunities. Parts of the business that we need to feed to gain scale, parts of our business that we need to focus. Now, part of that focus, no doubt, will encompass evaluating the portfolio and piece of the portfolio we may need to divest. As I mentioned, we've got a strong balance sheet and the opportunity ahead of us I think to make a lot of sound acquisitions. And you'll see it being pretty balanced, right. We want and we love our Surveillance and Detection business, the government business. In the near term, I think, next three to five years is going to be really strong for us. So we want to focus certainly on that side of the business. But do it with a very balanced approach that we're also continuing to make sound investment on the commercial side. We know the government business is very lumpy at times and hard to predict. And that commercial business smooths out the overall business, if you will, and keeps us whole through those troughs when the government spending slows for a quarter or for a year. And if you look at the commercial side of our business, in particular, IIS and OEM, just outstanding performance in the quarter that we want to really fuel those kind of opportunities.

[Les Sulewski:]

Thank you for that. I guess, as a follow up on the government side. What are your current thoughts on the DoD budget environment? Any sort of major rewards that you are tracking?

[James J. Cannon:]

Well, I mean there is a whole host of programs that we're tracking. I'll just say, with regard to DoD spending, we're bullish in the coming years. We believe absolute dollars on the DoD budget will reach near war-time highs of years ago. There are a lot of programs out there as well as discretionary funds for us to capture. We've got a bevy of new products that we have launched over the past 12 months and that are in the process of being launched that you'll hear about in the second half of the year. And again, it's a critical part of the business. As I mentioned, Detection, in particular, has an environmental programs right now that's greater than they've seen at anytime in recent history, but a lot of work to go do to capture them, and difficult to predict the timing of the DoD spend on these various programs. But suffice to say, there's just a heck of a lot of activity underway.

[Les Sulewski:]

Got it. Thank you. And just, I guess, one more from me and I'll jump back in the queue. In regards to your Maritime business, can you talk a little bit about what drove the margin expansion there and is this rate sustainable? Thank you.

[James J. Cannon:]

Yeah. Tom, why don't you touch on that?

[Thomas A. Surran:]

Sure. As we mentioned in the text, in Maritime we introduced a new product called the Axiom, which is a new generation of MFM and it brings a lot of features to the market. It's faster. It has a new user interface. It's easier to use. And the market has basically identified that as being a great offering. And it's carried much improved margins from us versus the historic product we were offering as an MFD. The improved margins in our MFD line went straight to the bottom as we held expenses. So that's why we saw that improvement. Now, you also heard us talking about expanding that Axiom product line with the new Axiom Pro. So we'll have (34

[Operator:]

Thank you. Our next question today is coming from Brian Gesuale from Raymond James. Please proceed with your question.

[Brian A. Gesuale:]

Yeah. Good morning, guys, and welcome, Jim. Wanted to ask a little bit about the Security business. I think there is a coveted asset there in the thermal side of things that maybe being overshadowed by some of the residential or Lorex-based stuff. Is the Lorex business profitable? And maybe can you talk about the penetration of thermal content in that, whether any exists today or what the rollout for that might be in the future?

[James J. Cannon:]

Well, again, as you mentioned that thermal part of our business is coveted; it's a core, again, component of the company. And if we think about its applications, critical infrastructure, the perimeter force protection, et cetera, in today's threat environment, we're very bullish on it. It's profitable certainly. As I mentioned, it's grown in the mid-teens. When it comes to Lorex and the retail channel, the adoption of thermal technologies, it's a slower curve, right, than you see in some of the critical security applications, enterprise customers, as I mentioned. But there is a lot of capability that comes with it, as you know. There is a lot that we can do in maybe not residential, but in homecare, with thermal technologies that can drive better data analytics, that can help folks that are aging in place, caregivers, et cetera. So again, Security, core part of the business, no doubt. Lorex has been lumpy and we've had some dilution with it. But we do have new products go into that channel. As I mentioned, it's going to return to growth in the third quarter and you're going to continue to see us bring technologies into the Security space, because again of the threat environment. There's also some seasonality with Lorex. So you'll see, as we go into the back half of the year, some improved strength in that retail channel.

[Brian A. Gesuale:]

Great. Thanks, Jim. Wanted to maybe follow up in maybe a broader context. Can you maybe talk about, as you go through your analysis of the portfolio, what are some of the key benchmarks you use to kind of make the decision whether something is core to the FLIR brand? Is it the potential margins, is it the ability to penetrate with thermal content? What are kind of those broad mile markers there that you use to kind of evaluate the business?

[James J. Cannon:]

Sure. Well, as I mentioned, I kind of think of it in these three pieces; fuel, feed and focus. And there are parts of our business right now that are doing spectacular, that we need to really fuel to capture the most near-term gain that we can. I mentioned OEM, I mentioned IIS. Those businesses are doing absolutely phenomenal. We need to make sure that we maintain that tailwind. And then, there are parts of our business that we need to see, in particular, if we look at Surveillance and Detection. We're bullish on the DoD budget going forward for the next three to five years. We want to go out and capture as many programs that we can as well as discretionary funds. And that takes some effort as well as some patience, because the timing to develop those again is hard to predict. And then, as we've mentioned, there are parts of our business that we've got to focus. Certainly Security, as we've talked about on several questions now, is one of those. When I think about, is it core or not core, it's not necessarily thermal. If you look at our Detection business for example, we're applying all sorts of technologies there that aren't thermal that increase awareness. So with our core, we're about increasing awareness and perception to help again solve critical problems that save lives and livelihood. From a business standpoint, I want to kind of tick that box and then be able to lead in that space; have a market space that's defendable, that we can capture first or second place of and gain scale. Obviously, our margins are very important to us. We guard them well. We also want businesses to constantly compete to be accretive.

[Brian A. Gesuale:]

That's great. I'm going to get off the Security business here. I think there is a lot of really interesting things going on in the OEM business. Tom, this maybe a question more geared for you. But can you maybe just take us through the mix of that business, now that we have Point Grey in there, and how we should look at kind of the major buckets within that segments?

[Thomas A. Surran:]

Yeah. Okay. In the OEM business, we have our legacy business which is the camera core business. We have the cooled military camera cores, which are doing quite well at this point in time, primary customer being Northrop Grumman. We've seen strong order demand that will be executing the revenue starting at the end of this year and through 2018. We've got our traffic systems which has had a fantastic quarter, as they've done a lot of work in Europe for tunnels that are being put in. We saw nice revenue growth there. We have our mobile accessories business, which we're just bringing the new FLIR ONE Generation 3 and the FLIR ONE Pro to market. We're starting to ship those. You'll start seeing those at retail outlets very soon, and they're available today on our flir.com. And then, we've got the addition of the IIS business which we spoke about a little while ago. It's done fantastic, not only in the machine vision, but also on the people counting business. They've had a nice revenue growth there. So that's kind of the portfolio that's sitting inside OEM & Emerging.

[Brian A. Gesuale:]

Great. Thanks so much, guys.

[Operator:]

Thank you. Our next question today is coming from Noah Poponak from Goldman Sachs. Please proceed with your question.

[Noah Poponak:]

Hi. Good morning, everyone.

[Thomas A. Surran:]

Hey. Good morning, Noah.

[Noah Poponak:]

Jim, question on your strategy for revealing your strategy. Recognizing it's been a month and so you're not ready to, as you said, give a lot of detail today. I'm actually wondering what milestones we can look for and what you're planning going forward? Are you going to hold an Investor Day? Are you planning to give longer-term targets or are you planning to get in detail about the portfolio or should we be thinking more of you wanting to just deliver and let the results speak for themselves?

[James J. Cannon:]

Well, I think a bit of both. And I like the way you frame it, the strategy to reveal my strategy. I didn't know I had a strategy to reveal. But as we go forward, again, five weeks on the job, today is not the day to do it. But when I think about, again, my path forward, as I mentioned, I want to identify where we think we can drive the most value. I want to focus then on how we organize the business around it, and then get really sharp on the operational cadences required to ensure the execution. If I had to frame it up, I'd say, I want to do a little bit less better. Now, first of all, FLIR has a pretty sound strategy across the segments. If you get into the segments and you talk to the segment leaders, et cetera, and Tom could go segment-by-segment and talk about the things that they're doing both near term and long term to capture business, to develop disruptive technologies. And you saw a bevy of new products that came into the market this quarter that do just that, disrupt us and our competitors as we go forward. But, no doubt, in the coming quarter and quarters, you're going to see the business evolve. It will be just that, an evolution, not a revolution. I don't want to have wholesale change for change's sake, but we will state a concise long-term objective. We will demonstrate the method that we're going to do to accomplish that. But we really want to back it up with deeds not words. We'll spend more time focus on executing and demonstrating to you the results than talking about that strategy. Now, we do intend to have an Investor Day. The date's not set, it will be next year probably end of Q1, beginning of Q2. We've got some work to do again to get that on the calendar and work out those logistics, but you will be seeing an Investor Day get on the calendar for us.

[Noah Poponak:]

Okay. Great. Anything you can tell us about your CFO search. Do you have a sense for when you plan to make a decision there?

[James J. Cannon:]

Sure. It's well underway, we've engaged an outside firm to help us with that. Now, the good news in the interim was Shane Harrison. He's been here seven years, he knows the business well, has a very strong background. He's worked now for several weeks with Amit through this transition and with the teams to make sure that we've got very deliberate coverage. We hope to get through a selection process to a decision probably practically in the next, I'd say, four to six weeks. And then whatever time it takes on board, whatever individual that is. But we're moving as quickly, but deliberately as possible in that regard.

[Noah Poponak:]

Okay. And then just one more question. On the margins for the total business, there has been more than a 100 basis points – call it, a 125 basis points of adjusted segment operating margin expansion first half 2017 versus first half of 2016. Your revenue plan calls for a faster rate of revenue growth in the back half of the year than the first half of the year, which should help the margins. You've taken cost out of the business. Any reason we shouldn't be looking for a similar level of margin change year-over-year in the back half compared to what you had in the first half?

[James J. Cannon:]

Amit, do you want to touch on that?

[Amit Singhi:]

So Noah, you will see margin expansion in the second half as well, as we go forward. As you pointed out, with the revenue growth and higher operating leverage, we should see. Not sure if it's going to be to the same magnitude. There's obviously some level of benefit with the new product introduction that we've gotten close to the launch in these quarters, but there will be an expansion as we go into the second half.

[Noah Poponak:]

Okay. Thanks very much.

[James J. Cannon:]

Thanks, Noah.

[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 closing comments.

[James J. Cannon:]

Again, I want to thank you all for joining us today. I especially want to thank our customers for their trust in our products and our team members for their hard work. Everyone, have a great day.

[Operator:]

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