FLIR Systems, Inc.
Q4 2015 Earnings Call Transcript

Published: 11 Feb 2016

[Operator:]

Greetings, and welcome to the FLIR Systems Fourth Quarter and Full Year 2015 Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow a formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce Todd DuChene, Senior Vice President, General Counsel and Secretary for FLIR Systems. Thank you. You may begin.

[Todd M. DuChene:]

Good morning, everyone. Please note that our earnings press release and presentation slides that will be referred to on this call are available under the Events and Presentation 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 expectations. Words such as anticipates, estimates, expects, intends, and believes and similar words and expressions are intended to identify forward-looking statements. All of these statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the press release we issued earlier today for a description of factors that could cause actual results to differ materially from those forecast. The forward-looking statements we make today speak as of today, and we do not undertake any obligation to update any such statements to reflect events or circumstances occurring after today. Let me now turn the call over to Andy Teich, President and Chief Executive Officer of FLIR Systems. Andy?

[Andrew C. Teich:]

Thanks Todd, and welcome everyone to FLIR's fourth quarter 2015 earnings call. With Todd and me today is our CFO, Amit Singhi; COO Tom Surran; Chief Marketing Officer Travis Merrill; Chief of Product Strategy Jeff Frank; and Senior Vice President of Corporate Development Shane Harrison. I'll start the review of the quarter with Slide 3 of the presentation. This morning, we reported fourth quarter revenue of $438 million, up 1% from the prior year, but up 3% on a constant currency basis. Earnings per share were $0.51, which included a gain on an investment, restructuring charges and discrete tax charges. Adjusting for these items, earnings per share were $0.47 compared to an adjusted $0.45 in Q4 2014. Fourth quarter operating income, excluding restructuring charges, was $94 million, up 6% over the prior year. Cash flow from operations for the quarter grew 25% year-over-year. As a result of the strong order intake in Q4 in our government-oriented segments, we finished the year with total 12-month order backlog of $604 million, representing 6% growth over the end of the third quarter and the highest level of backlog since 2008, when our U.S. military business was very strong due to the RAID and G-BOSS programs. In the quarter, we acquired DVTEL, which adds advanced security video management and video analytics solution to expand FLIR's security business in the enterprise market. The impact of this transaction was not meaningful to our operating results for the quarter. Slide 4 shows a summary of the full year, where constant currency revenue growth of 6% helped drive 10% growth in adjusted earnings per share, as we realized significant operating leverage on a restructured cost basis. Cash generation improved significantly, with full year operating cash flow growing 22% over 2014, as better utilization of working capital added to the growth in net income. Backlog trends have been quite positive, growing at an 11% compound rate over the past two years. During 2015, we introduced over 20 new product platforms across our six segments. Eight of those products included our revolutionary Lepton micro camera core, creating new product categories and enabling groundbreaking new price points and capabilities such as IGM, or Infrared Guided Measurement, to a broader set of customers. On Slide 5, you'll see our initial outlook for 2016. As a result of expected softness in many of our European markets and a higher expected effective tax rate for the year, we expect revenues to come in between $1.6 billion and $1.65 billion, and earnings per diluted share to be in the range of $1.60 to $1.70. This represents a revenue growth rate of between 3% and 6% and an EPS growth rate of between 3% and 9% when compared to the 2015 results, after adjusting to exclude the 2015 restructuring charges, investment gain and discrete tax items. We expect our 2016 effective tax rate to be 26% excluding any future discrete items, increasing due to changes in effective foreign tax rates. While our government-oriented business segments had a strong order flow in Q4, we continue to be cautious on this front as our traditionally short cycle business can be event driven and is difficult to forecast. Additionally, for the first quarter of 2016, we expect overall margins to be lower than the first quarter of 2015 due to product mix, a difficult comparable related to shipments to one Middle Eastern customer in the first quarter of 2015, and the non-re-occurrence of corporate expense credits we received. We also announced today a quarterly dividend of $0.12 per share which will be payable on March 4 to shareholders of record as of February 19. This represents a 9% increase to our quarterly dividend of $0.11 in 2015. I'll now hand the call over to Amit to review fourth quarter financial results. Amit?

[Amit Singhi:]

Thanks, Andy. Good morning. The following discussion on pre-tax operating results for the fourth quarter and full year excludes restructuring expenses which totaled $300,000 and $1.4 million in 2015 and $1 million and $17 million in 2014, respectively. On Slide 6, you'll see our fourth quarter financial results. Despite currency headwinds, our revenue, operating income, operating margin, adjusted net income and adjusted EPS all improved year-over-year. Fourth quarter consolidated revenue was $438 million, an increase of 1% compared to the fourth quarter of 2014. Our Security and Detection segments reported increases of 21% and 32% respectively in year-over-year revenue. Our Surveillance, Instruments, OEM & Emerging Markets and Maritime segments reported year-over-year declines of 5%, 5%, 2% and 10% respectively. As we've noted earlier in the year, our Instruments and Maritime segments are most heavily impacted by currency fluctuations. Adjusting for currency impacts, Instruments and OEM & Emerging Markets segment revenues would have been flat year-over-year and Maritime would have shown a year-over-year decline of 4%, primarily due to a change in distribution channel and inventory reductions at a large retailer at year-end. Overall revenue would have shown a year-over-year increase of 3% on a constant currency basis. Regionally, revenue increased in the U.S. and Asia by 5% and 30% respectively. Canada and LatAm, Europe, and Middle East and Africa revenue declined by 4%, 10% and 23% respectively. Sales to the U.S. government increased by about $18 million or 22%, and represented 23% of total revenue compared to 19% in 2014. Consolidated fourth quarter gross margin was 47%, a 2 percentage point decrease compared to last year, primarily driven by weakness in the OEM & Emerging Markets segment related to the consolidation of our manufacturing facilities to improve future efficiencies, as well as overall changes in segment mix and the negative impacts of changes in exchange rates. Operating income and margin improved year-over-year despite adverse currency effects. Our adjusted fourth quarter operating margin excluding restructuring charges was 21%. In the fourth quarter, we recognized a non-operating after-tax gain of approximately $12.7 million related to the sale of an investment that we had in a private technology company. We also reported a tax expense of $34.6 million, which was $24.5 million higher than 2014, primarily due to $7.4 million of unfavorable discrete tax items compared to prior year, when we benefited from the release of approximately $9.4 million of tax reserves. Net income in the fourth quarter was $70.2 million, a slight decrease from last year, and earnings per fully diluted share were $0.51 for both years. Excluding restructuring charges and the impact of the discrete tax items in the fourth quarter of both years and the current year after-tax investment gain, adjusted net income was $65 million compared to $64.1 million in 2014. And adjusted EPS was $0.47 in 2015 compared to $0.45 in 2014. We closed the year with cash of $472.8 million, a decrease of $52.6 million during the quarter. A strong operating cash flow was deployed towards investing and financing activities to improve shareholder value including the acquisition of DVTEL that used $92 million of cash in the quarter. Our cash flow from operations for the quarter were $78.3 million or 112% of quarterly net income as reported. Our cash flow from operations improved year-over-year due to improved net income and better working capital management. In the quarter, we improved our cash conversion cycle by almost 20 days. We had capital expenditures of $18.1 million in the fourth quarter and returned $15.2 million to shareholders through the payment of dividends. We also spent $29.8 million to repurchase 1 million shares or stock during the quarter under the two-year 15 million share repurchase program that we announced in February of last year. On slide seven, you'll see our 2015 full-year financial results. Similar to the fourth quarter, despite the headwinds, our full year revenue, operating income, operating margin, adjusted net income, and adjusted EPS all improved year-over-year. For 2015, our revenue was $1.557 billion, an increase of 2% compared to 2014. On a constant currency basis, full year revenue would have been up approximately 6% year-over-year. Our Security and Detection segments reported year-over-year revenue increases of 27% and 34%, respectively. Our Surveillance, Instruments, OEM & Emerging Markets and Maritime segments reported year-over-year declines of 3%, 2%, 6% and 8%, respectively. Adjusting for currency impact, Instruments and Maritime segments would have shown year-over-year revenue improvement of 5% and 2%, respectively. Regionally, revenue increased in the U.S. and Asia by 5% and 12%, respectively. Canada and LatAm, Europe, and Middle East and Africa revenue declined by 11%, 3% and 9%, respectively. Sales to the U.S. government were flat compared with 2014 and represented 20% of total revenue, consistent with last year. Full year gross margin decreased marginally compared to last year, explained by overall changes in segment mix and the negative impacts of changes in exchange rate. 2015 operating income and margin improved year-over-year despite adverse currency effects. Our adjusted full year operating margin, excluding restructuring charges, was 20%. For the full year, our as reported tax rate was 21% compared to 20% in 2014. Adjusting for the restructuring charges, investment gain and discrete tax items, our 2015 tax rate was 23% compared to 24% in 2014. For the full year 2015, net income was $241.7 million, representing a 21% increase over 2014. EPS of $1.72 for the full year 2015 compared to $1.39, a 24% increase year-over-year. Excluding restructuring charges, the investment gain and discrete tax items for both years, adjusted net income was $220 million compared to $203.8 million in 2014, an 8% improvement. And adjusted EPS was $1.56 in 2015 compared to $1.42 in 2014, a 10% improvement. For the full year, our operating cash flow was $275.8 million or 114% of full year net income as reported. Our cash flow from operations improved year-over-year due to improved net income and better working capital management. We had capital expenditures of $68.2 million in 2015 and returned $61.4 million to shareholders through the payment of dividends. We also spent $123.2 million to repurchase a little more than 4 million shares during the year. In terms of capital deployment over the long term, we plan to continue our organic investments, spending about 3% to 4% of revenue on capital expenditures and 8% to 10% of revenue on R&D. We intend to deploy 100% of our free cash flow going forward, maintaining a dividend payout ratio of about 25% to 30% of net income and using the remainder to fund M&A and share repurchases depending on available opportunities and expected returns. This concludes the summary of our fourth quarter and full-year results. Let me now turn it over to Tom Surran to cover our operational highlights. Tom?

[Thomas A. Surran:]

Thank you, Amit. You will see a summary of our segment operating results on slide eight. Fourth quarter consolidated segment operating income declined 4% and operating margin declined 100 basis points versus the fourth quarter 2014, excluding restructuring charges, due primarily to cost incurred and the consolidation of our four primary OEM & Emerging production and office buildings into a single multipurpose facility. We expect this facility consolidation to result in greater operating efficiency for the business. Moving to slide nine, during the fourth quarter, Surveillance segment revenue declined 5% year-over-year to $150.7 million. In the prior year, we had significant amount of revenue coming out of our Integrated Systems line of business related to COSFPS system delivery and the completion of a large order to a Middle Eastern customer. The unfavorable impact of this comparison offset strength in our airborne, maritime and man-portable lines of business. Surveillance segment operating income of $49.2 million increased 2% versus the prior year when excluding restructuring expenses. This represents a 220 basis point increase in operating margin, driven by reduced operating expenses. Surveillance backlog reduced slightly from Q3 to $309 million. Bookings of $142 million resulted in a book-to-bill ratio of 0.9x and bookings growth of 28% over the fourth quarter of 2014. Full year 2015 bookings of $533 million represented our highest order flow since 2010 when the RAID and G-BOSS programs were active. In January, Surveillance introduced our newest Personal Vision Systems product, the Scout TK handheld thermal monocular. Targeted at outdoor enthusiasts, the Scout TK utilizes an advanced version of our Lepton 3 Core and opens a new category in the market with its retail price of $599. Turning to slide 10, the Instruments segment saw fourth quarter revenue decline of 5% compared to the prior year to $98.6 million. Excluding the effect of the stronger dollar, Instruments revenue was flat with the prior year. Test & Measurement and Science products performed well, while the premium portion of our Building & Predictive Maintenance product saw declines in part due to the delayed shipment of our new flagship T1K product until late in the quarter. Operating margin, excluding the impact of restructuring charges, increased 100 basis points to 35%, and was within 20 basis points of the peak operating margins achieved in Q4 of 2012, as reduced operating expenses helped offset the top line softness. Also in January, the Instruments segment introduced their newest value price handheld thermal spot camera, the TG-130, at the Consumer Electronics Show. Professionals and homeowners can use the TG-130 to pinpoint window and door drafts, missing insulation, water damage and a multitude of other home and structure related problems. Based on our Lepton 2 micro core, the new handheld features a revolutionary price point of $249. On slide 11, you'll see our Security segment operating results. Strong revenue growth continued in this segment, up 21% year-over-year, reaching $68.4 million. Lorex-branded product and FLIR Residential offerings drove top-line growth that was dampened by comparably soft shipments of cool thermal systems as Q4 of 2014 saw significant shipments of these products to a Middle Eastern customer. Security operating profit was $9.2 million, with margin declining 480 basis points, primarily driven by reduced gross margins due to product mix as well as increased marketing expense. As Andy mentioned, we acquired DVTEL at the end of November, which strengthens FLIR Security's presence in the enterprise portion of the security market. This acquisition provides us with significant software capabilities, including sophisticated video analytics and robust video management system or VMS. VMS systems are the central user interface for video security system, and are often the first decision an enterprise customer will make when defining an integrated video security solution. The DVTEL Latitude VMS system will be integrated into the FLIR command and control software suite and will form the backbone of the FLIR integrated video surveillance solutions. The results for the OEM & Emerging segment are shown on slide 12. OEM & Emerging fourth quarter revenue declined 2% versus last year to $49.2 million. Foreign exchange headwinds and timing of orders for military customers negatively impacted shipments in the quarter. This was offset by growth in mobile products and our new unmanned aerial systems or UAS line of business. The UAS line of business was created in the second half of the year to enable commercial and consumer drones with powerful thermal imaging solutions. With the introduction of the FLIR Vue and the more recent announcement of our strategic collaboration with drone industry leader DJI, and our first collaborative product, Zenmuse XT, we are well on our way to building this market. OEM & Emerging operating margins declined 15% due to approximately $5 million in non-recurring expenses related to the move to our new facility and semiconductor foundry in Santa Barbara. This new facility brings significant improvements to our production operations without a material increase in the business expense rate. OEM & Emerging backlog grew nearly $25 million or 22% in the quarter as we received a significant amount of orders for our cooled military cores. Turning to Slide 13, Maritime segment revenues were $36 million, which were 10% below the prior year. Excluding the significant exposure Maritime has to the strong U.S. dollar, revenue was down 4%. Maritime operating income was $600,000 in the quarter, down $800,000 from Q4 of 2014. Profitability was negatively impacted by both currency and competitive pricing pressures. In January, Raymarine introduced the first recreational-class Maritime solid-state digital radar to feature CHIRP technology, the Quantum Wireless CHIRP Radar. CHIRP is a radar technology that uses multiple compressed radar pulses and when combined with FLIR's exclusive ATX target separation technology, the result is unsurpassed radar resolution. The compact size and weight of the Quantum CHIRP sets a new standard for solid-state radars and features WiFi connectivity for ease of installation. On Slide 14, you'll see the Detection segment's fourth quarter summary. Revenue was $34.7 million, which was up 32% over the prior year. The DR SKO program saw an uptick in deliveries, which helped drive 52% revenue growth for the program, while revenue from Detection's products grew 27% year-over-year. Detection operating profit nearly doubled, driven by product mix and product cost reductions. Detection backlog finished the year at $82 million. During Q4, we received another order from the U.S. Department of Defense for our DR SKO system, this one totaling $50 million, for delivery through May 2017. Also in the fourth quarter, Detection's radiation line of business introduced the identiFINDER R200. The R200 represents a new price point in our radiation line of products, extending our reach into the wearable detector market while differentiating the product with high radiological resolution and identification capabilities. That concludes my summary of the segments' fourth quarter. I'll now pass the call back to Andy.

[Andrew C. Teich:]

Thanks, Tom. As I mentioned earlier, the fourth quarter largely met our expectations. Profits and cash flow came in strong despite our modest top line growth. Backlog rose to levels not seen since 2008, when military combat operations were much higher than they are today. Looking back on 2015, we saw a 6% revenue growth rate, though it was masked by the stronger dollar. I'm very encouraged by the continued product innovation that we exhibited in introducing dozens of new products, many of which pushed new limits in performance and value. We leveraged our Lepton micro camera core to create eight new FLIR branded products that enable a much wider audience of users and directly address our barriers of price and awareness. During the year, we completed a company-wide restructuring that has proven very beneficial to our operating efficiency and profitability. We made a meaningful acquisition that we intend to leverage to improve margins, expand our product suite, and strengthen our continued growth in the video security space. And we executed on our commitment to investing in our marketing capabilities, which has resulted in tremendous growth in nearly every metric we use to track awareness and the power of our brand. We're looking forward to 2016 as we continue the quest to become the world's sixth sense. That concludes our comments on the fourth quarter. We'll now ask the operator to open up the call for your questions.

[Operator:]

Thank you. Our first question comes from Noah Poponak with Goldman Sachs. Please state your question.

[Noah Poponak:]

Hi. Good morning, everyone.

[Andrew C. Teich:]

Good morning, Noah.

[Noah Poponak:]

Are you able to share with us what share count is in the denominator of the $1.60 to $1.70 earnings outlook?

[Andrew C. Teich:]

It hasn't changed meaningfully from 2015. We're – at this point, we have some share buyback planned in there. We're not going to provide the specific number, but it's likely to be less than what we had in 2015 as we're going to be little bit more focused on M&A.

[Noah Poponak:]

Okay. So, a little bit of share buyback in there, but if you do the 100% of free cash deployment, as you were just discussing, there would be some potential accretion from anything beyond a little bit of share repurchase?

[Andrew C. Teich:]

That's correct.

[Noah Poponak:]

So, I guess then, if I use that share count, it sort of looks like the guidance implies on an adjusted basis the total segment operating margin of the company to be down in 2016. I know the margins can move around by segment, I know there is some mix in there, but you've done multiple restructurings and it seems like you have pretty substantially reset the cost base and you're getting overall volume. Am I reading that correctly? Is that the right math? And if it is, why wouldn't margins be up next year?

[Andrew C. Teich:]

At this point, I think, Noah, it's really dependent on what the mix is. So, for example, the Security segment is the segment that we expect to still see good growth in 2016 and the margins there, as you know, at this point are lower than the company-wide margins. I think the real wildcard here is what the content of the Surveillance business revenue is going to look like in 2016, because that's probably where we see the most variability in the model, and at this point, the book and bill component of that is difficult for us to predict.

[Amit Singhi:]

The other piece, Noah, is the tax rate as well. So the tax rate as we said is going up from 24% to 26%.

[Noah Poponak:]

Yep. I have that. Yeah. Okay. Maybe you could, Andy, elaborate on that comment on Surveillance a little bit. It looks like the domestic revenue growth was pretty strong in the quarter, international worse, although you had pointed out the headwind from the Middle East program. But – so maybe just talk about what international is doing broadly? And then, as you discuss that variability next year, I guess what makes you say that? Is it just short cycle isn't quite clearly turning, or we're at the inflection for the budget so it's – the timing is unclear, or are there certain programs that could be big movers, maybe if you could just talk about the range of outcomes there?

[Andrew C. Teich:]

Sure. I think there is a couple of things. If we talk about range of outcomes, the first thing is what the environment looks like. The general U.S. DoD environment for us obviously has been improving with a budget in place. I would say, the procurement sentiment there is improving and we saw a nice uptick in U.S. orders in Q4. The issue at this point though that's difficult to determine is, how much of that was pent-up demand versus how much of it is run rate demand. As you know, our business is a short cycle business. I think that the products that we have there are quite relevant to what's going on in the world today. The big wildcard for us also I would say is a Middle Eastern business. That business both on a bookings and revenue standpoint for 2015 was down versus 2014, but it's an area that has tremendous amount of opportunity for us. Particularly if you look at our products in area of border patrol and deployable systems in our Surveillance segment, we're a leader there. We've got CDMQ product that we can respond with rather quickly to demand, and I see that as really being the wildcard for us in 2016, but it's also an area that we have limited visibility. So at this point, we've taken I think an approach that is prudent in terms of forecasting the business based on what we see today.

[Noah Poponak:]

Okay. Do you know off hand what percentage of Surveillance is going to Middle East customers?

[Andrew C. Teich:]

Hang on, we will get that statistic for you.

[Thomas A. Surran:]

Sure. Do they want the quarter or the year?

[Andrew C. Teich:]

Let me look at the full year.

[Noah Poponak:]

Both, I guess it'd be great, if you have it.

[Andrew C. Teich:]

All right. So about 20% for the year and on the quarter, up 20%.

[Noah Poponak:]

Okay. Thank you very much.

[Andrew C. Teich:]

You're welcome.

[Operator:]

Thank you. Our next question comes from Pete Skibitski with Drexel Hamilton. Please state your question.

[Peter John Skibitski:]

Good morning, guys. I was wondering – I might have missed it at the beginning. But DVTEL, can you give us a better sense of what you expect it to contribute in 2016? I think I've seen some of its historics at right around $50 million or so, and wanted to see if you could validate that?

[Andrew C. Teich:]

So, Pete, we're not providing specific revenue numbers on DVTEL. Relative to the total business, it's not meaningful. I think what's more important about DVTEL for us is it fills a very important gap in our Security business and really built on our strategy there of providing a total system solution. DVTEL is largely a software company. They do have hardware products of DVRs and cameras. But for us, it's really more of a software play. It adds a necessary enterprise grade video management system capability to our portfolio offering and also offers some very powerful video analytics. And it's really very critical offering from a technology standpoint for us to be able to round out our value ladder from residential all the way through to enterprise and infrastructure grade of product.

[Peter John Skibitski:]

Okay. I have a question on Instruments as well. Margins in Instruments have just been outstanding. And I'm wondering how you guys are thinking? Are you near peak there in Instruments margin-wise? And is there any risk in that segment revenue-wise? Is that kind of growing in all regions and will new products drive that up in 2016? I was just wondering if you could give more color on Instruments.

[Andrew C. Teich:]

Well, so, Instruments – let me hit your last point first, which is new product introduction in Instruments is really what's been driving the performance there. Instruments, we continue to increase the percentage of Lepton-based product that are being sold in Instruments. Actually we're up to a little bit north of 60% of the total unit volume that we shipped in Q4 were Lepton-based products in Instruments. That said, we continue to build out the value ladder in Instruments. So we launched the T1K during Q4 and began shipments of that very late in the quarter, so it didn't really have a big impact on revenue, but we'll start to see that roll-in in Q1. In terms of regional performance in Instruments, it's a story similar to the rest of the business. The Latin America region has been down fairly sharply. Europe has also been soft for us. We saw nice growth come out of China and expect that to continue there. We've made investments in our distribution organization in China and have a very strong brand there, and demand continues to be strong in China. And we also – Instruments, if we look at the front-end of the business, we saw growth in Q4 in the U.S. market in Instruments. The other thing that's an opportunity and relative to supporting the margins in Instruments is the optical gas imaging business. That was soft for most of the year of 2015. We started to see a little bit of an uptick towards the end of 2015 in the OGI business and we've got a couple of regulations that are coming through from the EPA and the BLM that will support the use of optical gas imaging technologies from a regulatory standpoint. So the draft regulations on that, that have been released and the margins on those products are quite good. I guess, I'd just close with the last point is, is that the markets that you saw in Q4 probably are towards the peak of what we will see from that group, but I think that they are sustainable.

[Peter John Skibitski:]

That's very helpful. I'll get back in the queue. Thanks, guys.

[Andrew C. Teich:]

Thank you.

[Operator:]

Our next question comes from Ben Hearnsberger with Stephens. Please state your question.

[Brandon S. Wright:]

Hey, thanks for taking my question. This is Brandon in for Ben. Just kind of following on your China comment in Instruments. I guess, what's really driving the growth here? And then sticking with Instruments, are you guys seeing any significant drag from oil and gas markets in the U.S.? Thanks.

[Andrew C. Teich:]

Sure, Brandon. So first starting with China, very large market opportunity there. I think as the industrialization matures there, the concept of predictive preventive maintenance is continuing to gain traction. We're moving out of applications like the utility market, which has historically been very strong for us into factories and industrial and process control applications there. As I mentioned in the previous comments, we've invested fairly strongly in distribution and marketing capability in China. So, during the course of 2015, we had to shift the resources from the slower growth EMEA and Latin America regions into China and we're starting to see those investments pay off. Moving over to the oil and gas industry, certainly the low oil prices have affected overall procurements from that segment both in our optical gas imaging and in our mid range instruments products that are used for predictive preventive maintenance. That said, though, again, as I mentioned in the previous comments, the draft regulations that are out from the EPA and the BLM are going to favor the use of optical gas imaging, and I would expect in 2016 we should see an uptick there plus a few. You look at what's going on in the Aliso Canyon with the natural gas leak there. Most of the footage that's been shown on national TV are coming from our cameras, illustrating the benefits of optical gas imaging for natural gas applications.

[Brandon S. Wright:]

Got it. That's great color there. I appreciate it. And then just real quick, a last housekeeping on Instruments. You may have said this. But what were the unit volumes in the quarter? Thanks.

[Andrew C. Teich:]

So unit volumes for Instruments were actually just up slightly year-over-year. The reason for that is we had a very large sell-in of a new product in Q4 of 2014, the product is TG165, which was actually one of our first IGM products that we released. It was a fairly large channel fill. If you take that out, there was nice unit growth from a volume standpoint in Q4. But it was flat when you include that one particular metric.

[Brandon S. Wright:]

Got it. Thanks a lot.

[Operator:]

Thank you. Our next question comes from Jim Ricchiuti with Needham & Company. Please state your question.

[Jim Ricchiuti:]

Thank you. Good morning. Just regarding the commercial focused businesses. Is it fair to say you are seeing the biggest impact of the economic environment in the instrumentation business? I wanted to just go into a little bit more detail as to where you might be seeing some pockets of weakness.

[Andrew C. Teich:]

Sure, Jim. So I would say that the weakness that we are seeing in the commercial side is hitting both Instruments and Maritime. Really, looking at the quarter, Maritime was down more than Instruments was. Instruments was actually flat to up slightly on a currency-adjusted basis in Q4. The issue in Instruments, though, would be around Europe. Europe and Latin America are the two markets that were soft from a bookings and revenue standpoint for us. As I mentioned previously, our response to that is twofold. Number one, a shifting of resources both on the selling and marketing front out of slow growth markets into higher growth markets. And the other issue is the continued cadence of the introduction of new products there. And we've had a slew of – I mentioned eight new Lepton products, most of those were in the Instruments segment. They are getting very good traction in the market. I was just recently at Grainger's National Convention this week – earlier this week and we're showing those products there and getting very strong interest from them. So I think that we're going to see unit volumes continue to grow in the Instruments business and we believe that, as we create these new categories for low cost IGM basis, we are creating new thermographers in the process and those are people that are likely to move up the value ladder over time as they see the value and the efficacy that comes from thermal imaging.

[Jim Ricchiuti:]

And so on Maritime, you really need, it sounds like, some help from the economy to see that business start to turn?

[Andrew C. Teich:]

Yeah. That's true. We've got a number of positive things that are happening in the Maritime sector. The area that's been challenged there has been in the retail segment and our freshwater products. But there – we've launched several new products to include new radar and new sonar. We continue to have the best autopilot out there. Let me flip it over to Tom to talk a little bit more about some of the activities that we've got going, though, in Maritime.

[Thomas A. Surran:]

Yeah. So, Maritime, as Andy mentioned, the retail market is probably where the most price competition is occurring. So it's very aggressive. I think the overall economy share will stimulate boat sales. The low gas pricing should be favorable. So those are some tailwinds that help. What's happening is that aggressive price, we have not been – it's also the largest growing in this retail segment, this fish-finding. It's an area we – Raymarine, when we bought it was not participating. We've created a new product line called the Dragonfly. It's been well received. We are expanding that product line, so we should see some more growth there. The main thing, though, is creating these differentiated offerings so that we can capture share and that's what we've been trying to do. And our offerings always have something a little bit special into them. As you look at the Dragonfly and its capabilities, Andy mentioned the world-class autopilot, the new CHIRP radar that's solid state, lowest power, lightest weight, wireless for ease of installation. That's what's going to drive our growth and probably just hopefully disproportionately to the overall growth of the market, but that's how I would view that.

[Andrew C. Teich:]

One last thing on that, Jim, is that we've been on a quest to inject Lepton into as many of our segments as we possibly can. And one of the things that we did do in Maritime was offer our AX8 unattended sensor, which is a Lepton-enabled product, into the Maritime segment. It's fully integrated to the Raymarine suite as an engine monitoring system, and it's really unique offering, to Tom's comment, about creating unique products. It's unique offering and it's an offering that really deals with one of the most serious problems in boating, which is the potential for fire. So I think that sets an example of how Lepton technology can carry across our segments and create new markets.

[Jim Ricchiuti:]

Okay. Andy, can I slip a question about M&A? The focus, it sounds like you may be stepping it up a little bit. You've been active in the Security area. Do you feel like you've got the pieces in place there and where might you be looking, in broad strokes? I know you can't comment specifically.

[Andrew C. Teich:]

Yeah, sure. I think that as you've noted, we have been active in Security and I think it's been a very successful strategy that we've had in the Security segment. There's still opportunity there. I am not going to go into specifics, but there are still opportunities in that space for us. We want to build a really strong business, a solution-oriented business in that space and DVTEL is an important element of that. But I think on the hardware side, there are still some opportunities for that. Outside of – out of Security, we have opportunities in all six of our segments, and frankly that's probably our biggest challenge. Shane has got his hands full with a very large funnel of opportunities that we're looking at. Obviously, we want to continue to make acquisitions that play to the strengths of our business, of our vertical integration, our Lepton capability, our sales and marketing capability. And we're – Shane has refined our process in terms of how we sift the opportunities in the funnel. And as I mentioned in the opening comments, I expect us to be more active on that front in 2016.

[Jim Ricchiuti:]

Okay. Thanks a lot.

[Operator:]

Thank you. Our next question comes from Jonathan Ho with William Blair. Please state your question.

[Jonathan F. Ho:]

Hey, guys. I wanted to start out with the TG-130. Could you maybe give us a little bit of color in terms of what types of distribution we should be seeing the product in, and maybe what types of channel support or investments you need to make to see this product succeed?

[Andrew C. Teich:]

Sure, Jonathan. It's a good question because TG-130 is somewhat of a unique product for us. It creates a new opening price point in our Instruments business at $249. It's a product that's really sort of unchallenged in the marketplace and I expect that to be the case for some time. It does require some new distribution channels because it's a more DIY, consumer/homeowner, light (44

[Travis D. Merrill:]

Sure. Jonathan, regarding the TG-130 and really more broadly across the IGM portfolio that we are building out, given the higher volume nature and given the more mass audience and target customer for these, not only will distribution have to really be modified to address those new customers, but how we communicate with them and how we market to them is also going to be a bit of a shift. We'll be moving much more toward above-the-line type activities in terms of advertising, driving awareness of homeowners who have maybe never been exposed to thermal imaging, looking at national PR opportunities for some of these products, as well as sort of the blocking and tackling in the lower funnel demand generation activities, primarily again through digital means. Andy mentioned e-commerce, that's going to be an area of focus for us in 2016, and that will allow us to more efficiently bring some of these new offerings that are really targeted more towards consumers to market.

[Jonathan F. Ho:]

Got it. And then just in terms of the guidance, I was just wondering if you guys – I know you don't guide by segment, but is there anything that we should be aware of in terms of either significant shifts in trajectory or any color that we can have to sort of help us model the segment growth, just given there's a wide range of variability by segment?

[Andrew C. Teich:]

Yeah. I don't think any major trends in, significant change in trajectory versus what we saw in 2015. We expect to see continued growth in Security, continued growth in the Detection segment relative to the backlog there. We think that the economic environment – that Instruments and Maritime probably have the biggest exposure to the economic environment at this point. And then as previously mentioned, the wildcard here is really Surveillance, based on what we see in terms of world events. Again, we're very well-positioned there. I think that the technologies and concepts of intelligence surveillance, reconnaissance, targeting, chemical detection I think are quite relevant today. And we're very well-positioned. And I think that our longer-term strategy of CDMQ, commercially developed, military qualified, rapid response capability, the focus of the business to be more oriented towards a system solution-oriented business rather than just selling cameras, is something that's quite relevant today. And particularly as we look at opportunities in places like the Middle East where some of the unrest there is driving demand for border (48

[Jonathan F. Ho:]

Great. Thank you.

[Andrew C. Teich:]

Welcome.

[Operator:]

Our next question comes from Michael Ciarmoli with KeyBanc Capital Markets. Please state your question.

[Michael F. Ciarmoli:]

Hey, good morning, guys. Thanks for taking the question. Maybe to stay on Jonathan's last question there, because I'm struggling with this revenue guidance a bit. I know you're not going to give us DVTEL in terms of revenues. There's been some, I guess, public data out there. Maybe it's $40 million or $50 million. But if the Security segment grows, continues to grow at probably the faster rate and we layer on DVTEL, that's seemingly going to drive the majority of growth. I mean, it seems like the other businesses could be sort of flattish. I mean, can you give us any color in terms of organic growth? Or even if – I know you kind of talked around some of the puts and takes on Surveillance, but do we finally see year-over-year growth in that segment, given the more recent booking trends?

[Andrew C. Teich:]

So we don't give specific segment guidance I think, as you know, Michael. But, generally, I think your observations are largely in line with what our forecasts are at this point. In Surveillance, we're being fairly measured in terms of our expectations for that business going forward, again, just based on the visibility that we have in the business. We had a nice backlog build in Q4. We had book-to-bill in Q2 of 1.2, book-to-bill in Q3 of 1.2 on that business. Book-to-bill dropped a little bit below 1.0 in Q4. But as Tom mentioned in his comments, we saw very nice growth in bookings. The issue that we have in that business though again is determining how much of that was pent-up demand versus future run rate. As I mentioned before, the business is very well positioned at this point. I would say the overall inquiry level in that business has had an uptick and we've got some very nice irons in the fire for medium-term business with the U.S. DoD, but not yet decided. So, we're taking I think a prudent view of that business and we'll look to see how the year develops to revise our thinking on what the full year is going to look like from a growth standpoint in Surveillance.

[Michael F. Ciarmoli:]

Okay. But even from a modeling perspective, and I know not to get into the segments, but I can conceivably model everything flat and basically all the growth in Security, I mean that kind of seems like it would be in the realm of probable outcome for next year given economic headwinds and kind of what you said the way you forecasted Surveillance at a more measured kind of conservative approach?

[Andrew C. Teich:]

Well, we're a bit more optimistic in that.

[Michael F. Ciarmoli:]

Okay.

[Andrew C. Teich:]

I would like to see growth in all of the segments and – but I think it's going to be modest at this point. And again just because of the headwinds that we're going to see a little bit of currency headwind still and more of a concern on the macroeconomics, particularly in Europe, and we may see a little bit of pressure on the growth in the APAC region.

[Michael F. Ciarmoli:]

Okay. Perfect. That's helpful, guys. Thanks.

[Andrew C. Teich:]

Sure.

[Operator:]

Thank you. Our next question comes from Saliq Khan with Imperial Capital. Please state your question.

[Saliq Jamil Khan:]

Great. Thank you. Hey, Andy how are you?

[Andrew C. Teich:]

Good, Saliq. Nice to hear from you.

[Saliq Jamil Khan:]

Hey, after you and I met last month and chatted about the Zenmuse XT, I met with the guys at DJI to see the new products that they are currently working on and how the portfolio continues to expand. What I thought interesting is that, if the Amazon drones one day are able to fly at night, they are going to need imaging cameras with those night vision capability. Having said that, and given your partnership with DJI, how do you view the market potential for unmanned aerial systems?

[Andrew C. Teich:]

Yeah, sure Saliq. I'm actually going to flip this over to Jeff to talk about this, because he has really been leading our entrants into the UAS market.

[Jeffrey D. Frank:]

Good morning, Saliq, this is Jeff. The UAS marketplace is something that's been on our roadmap for quite a long time. We've been the major player in the military space for some time, but we are all watching this kind of explosion occurring in the commercial side and there's really a lot of changes going on there now with respect to, as you point out, regulatory issues and new players coming online. Late in 2015, we basically initiated two vectors into the commercial space. One of them was to create a line of products of our own that have the appropriate capabilities and price points that we think that will help us gain quick inroads into the commercial space and then, importantly, the relationship, the strategic collaboration we created with DJI. We see a tremendous amount of opportunity that is going to come out of this, with the relationship with DJI, the Zenmuse XT compatible with both their Inspire and their Matrice airframes, which, Inspire in particular is kind of the world leading airframe in terms of volume. And as you point out, as the commercial applications start to emerge night time flying, some regulatory issues around night time flying currently, but as those things start to resolve over time. And importantly in a lot of other vertical applications not necessarily related to night time flying, but things like agricultural, building inspection, search and rescue, firefighting, all of these things have strong value – thermal brings a very, very strong value proposition to these spaces. So, we're pretty optimistic about where this is going to lead.

[Saliq Jamil Khan:]

Great. Thanks, Jeff. And the follow-up question I have was regarding the Security division and obviously a lot of people have asked questions regarding it. But, as I take a look at the FLIR FX camera, the capabilities, coupled with what BriefCam technology is able to do, it makes your residential offerings a lot richer and highly competitive. Can you quantify though what the organic growth looks like on the residential connected home division and versus your efforts on the commercial side?

[Andrew C. Teich:]

So, Saliq, we don't go into specific sub segment details. I just want to mention a couple of things about FLIR FX and then I'll ask Travis perhaps to comment a little bit on it as well. But, as you mentioned, FLIR FX had some unique features, Rapid Recap being one of them that has been well received by the market. It was really our first shot out of the canon in the residential and consumer space. So, certainly we have things in the product pipeline that we will refine and broaden that product offering in 2016. The other issue is the fact that we've got the FLIR ONE in the Apple channel, so it's in Apple Stores. We have the outdoor version of the product in the Apple retail environment at this point and that's been gaining nice traction there. I think it's one of the nice nuances of the product that we do offer an outdoor capability which is fairly unique and when you cover – when you couple that outdoor capability together with the Rapid Recap feature, it's really a pretty useful value proposition. Ultimately though that marketplace has the opportunity for the injection of low cost thermal to improve the accuracy of detection and we see it as a fairly rich space and it's really part of our product value ladder and our control the corner strategy. This forms the lower corner of the market. Travis, anything you want to add to the FX story?

[Travis D. Merrill:]

I think Andy summed it up very well. I would just add a couple of points that the FX has really since the launch served as a platform on a number of different dimensions for us. The first one being, obviously, it's a good complement to the Lorex-branded retail based products that we have in the market today. And we believe that's where many of the DIY-type bundled solutions are going to be headed to that type of a form factor. The second is, is really, it's been a great driver for brand awareness growth for us overall and that will continue also in that sort of consumer space as we expand that line and offer more consumer type products. And just thirdly, it allowed us to continue building out our retail capabilities, and Andy highlighted the Apple assortment of that product towards the latter part of last year. So, those three things really have really been strategic benefits to us and we look forward to the continued development and evolution of that platform.

[Saliq Jamil Khan:]

Great. Thank you, guys.

[Operator:]

Thank you. And our last follow-up question comes from Pete Skibitski with Drexel Hamilton. Please state your question.

[Peter John Skibitski:]

Yeah. Thanks. Hey, Andy, I just want to understand from a net level, I think you said you guys introduced 20 new products in 2015. What's the plan for 2016? Are you thinking a lower level of new products, same, more? Just can you give us some color on that?

[Andrew C. Teich:]

Yeah. Sure, Pete. Actually the – what we had in the prepared comments was 20 product platforms. Literally, if you count up the number of SKUs that were launched, it's over hundred. So it's, particularly when you look in the Security segment, there are a lot of products that gets launched there. But the – I think the take-home point was, when we have a product platform and then there is a family tree of products that come off of that, that's what's important in terms of driving growth from a new product standpoint. We don't intend to let our foot off the pedal of the gas here in terms of the development of new products. One of the things that's nice about what we're doing in the business is to create system cores that are easy to integrate across the business, I mean Lepton is a prime example. It's a product that someone can take and turn into a system very, very quickly and this isn't something that we've spoken yet on this call, but I think it's an important factor for the OEM & Emerging business, that in terms of driving the growth of Lepton outside of FLIR and our own organically developed products, we've been making Lepton available through a number of component suppliers and we've been having a number of developer and hacker events to drive the overall awareness of the capabilities associated with Lepton and bring new OEMs into the fold with the product. And one of the key drivers in terms of enabling that capability is that it's a system that is very easy to integrate. This is something that you can basically get power in and video out, it uses conventional CMOS camera interface. And so it's very easy for someone who is familiar with working with conventional visible cameras to be able to also move into the thermal domain with Lepton. So that plays a benefit back into our own business as well and that's why you see that Lepton being enabled in our different segments. I mentioned this in previous calls, but this will certainly be a theme in 2016 that you'll see Lepton expand beyond the Instruments segment where there has been a fairly large focus. We also have new cores planned for the business outside of Lepton. So, there are other areas of business, higher resolution products and cool products will be launched during 2016 from our cores and components group that will ultimately have system level products that will be designed around those cores from our other segments.

[Peter John Skibitski:]

That's great. Thanks so much.

[Andrew C. Teich:]

Pleasure. Great. Well, that was our last – sorry operator, go ahead.

[Operator:]

Thank you. That was the last question. I'll now turn it back to management for closing remarks.

[Andrew C. Teich:]

Great, thank you. Well, thank you all for joining us today. Before we close, I would like to welcome the DVTEL employees to the FLIR family. We look forward to your contribution to our vision for growth. And I'd also like to thank the nearly 3,000 existing FLIR employees for their continued hard work and dedication to our mission. We're making great progress, and the future is really bright. So, thank you all again for joining us on today's call, and we'll see after next quarter.

[Operator:]

This concludes today's call. All parties may disconnect. Have a good day.