FLIR Systems, Inc.
Q2 2008 Earnings Call Transcript

Published: 1 Aug 2008

[Operator:]

Good morning, my name is Andrea and I will be your conference operator today. At this time, I would like to welcome everyone to the FLIR System's Second Quarter 2008 Financial Results Conference Call. I will now turn the conference over to Mr. Wit Davis, Senior Vice President, General Counselor and Secretary of FLIR System. Sir, you may begin.

[William W. Davis:]

Thank you and good morning, everyone. Before we begin this conference call, I need to remind you that other than statements as to historical facts; the statements made on this conference call are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are based on our current expectations. Words such expects, anticipates, intends, believes, estimates and variations of such words and similar expressions are intended to identify such forward-looking statements. All of these statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the press release we issued earlier today for a description of factors that could cause actual results to differ materially from those forecast. The forward-looking statements we make today speak as of today and we do not undertake any obligation to update any such statements to reflect events or circumstances occurring after today. Let me now turn the call over to Earl Lewis, Chairman and CEO of FLIR Systems. Earl?

[Earl R. Lewis:]

hank you Wit, and thank you all for joining us this morning. Our second quarter was another outstanding quarter. We set record for orders, revenue, operating profit, and ending backlog, and our performance was excellent in each of our divisions. Earnings per share for Q2 increased by 53% over Q2 last year to $0.29 a share, another 42% increase in revenue to $261 million. All three divisions saw a solid growth with Government Systems leading the way with growth of 46%. Earnings before taxes increased by 66% to a record $66 million. Orders were also strong in all three divisions resulting backlog at the end of the quarter of a new record to $572 million up $101 million compared to the end of first quarter. Government systems backlog in particular continued its rapid growth, increasing by 93 million. Compared to the end of last year our total backlog is up $179 million up 46%. Our second quarter operating margin was 24.8% up over 2 percentage points from the second quarter of 2007. Operating margins were particularly strong in our Government systems division, as they once again achieved a record performance. Thermography margins were down from historical levels due to the impact of Cedip and Extech acquisitions. We expect their margins to improve overtime as synergies from these acquisitions are realized. Cash flow from operations for the quarter was $8 million. We aggressively expanded working capital to address our anticipated growth. With that introduction each of the three Presidents will comment in greater detail on the results of their businesses in Q2. And I'll comeback at end of the call with additional comments about the second half of '08. Let's start with Arne Almerfors, President of our Thermography division. Arne?

[Arne Almerfors:]

Thank you, Earl. Thermography revenue increased 40% over the second quarter of 2007. Excluding the Extech and Cedip acquisitions, traditional Thermography revenue grew by 16%. We saw growth from all areas of the world during the quarter with particular strength in the America and Asia. During the quarter, we launched our new FLIR i5 low cost thermal imaging camera. The FLIR i5 is the least expensive full-function thermography camera ever offered by a major manufacturer and it's targeted at the emerging markets for inexpensive thermography cameras for commercial applications. The i5 highlights the value created through our strategy of developing low-cost high-performance products for price elastic markets. It is been offered at a price 30% to 40% below our previous lowest priced camera. Initial sales since launch have exceeded expectations and we expect volumes to grow significantly as we continue to develop our high volume distribution channels. This product is being produced in our factory in Tallinn, Estonia, which has done an excellent job in ramping up production at a very competitive cost. The T-series, which is positioned between the P and the E product families, also did very well in Q2. We have a sequential dues over the first quarter of over 30%. As expected the i5 did cause some cannibalization of the InfraCAM product line and the T-series and the InfraCAM have caused the older T-series line to decline. Overall these four product lines are showing very good revenue and margin growth. And unit volumes were up by 44% compared to the Q2 of last year. We intend to continue our successful strategy of introducing new product updates to drive growth and maintain appropriate product segmentation in the market. Our high-end R&D products and the GasFindIR line again saw very strong demand during the second quarter and we expect these markets to continue to do well in the second half of the year. Many of our products including GasFindIR offer significant benefits in the effort to save expensive energy and reduce harmful greenhouse gases. We anticipate these two more [ph] market sides to provide positive momentum in future periods. Operating income for the quarter was 15.2 million and operating margin was 19% down from 25% last year due to the amortization of intangibles from the Cedip and Extech acquisitions and from the consolidation of Extech's instrumentation business which has a lower intrinsic margin structure than traditional thermography. Gross margins and operating margins in our traditional thermography business were essentially unchanged from Q2 of last year. We expect to see improvement in overall thermography margins going forward as expected synergies from the recent acquisitions are realized. The integration of both Cedip and Extech is proceeding as planned. As Cedip we are in the process of integrating the sales and distribution infrastructure to eliminate the redundant expenses and to provide increased distribution for both FLIR and Cedip products. We expect to have the Cedip fully integrated by the end of 2008. For Extech, we expect to realize significant value from the sale of new lower price thermography products such as the i5, through their high volume distribution channel. Initial phase of the Extech branded i5 will be modest, but we expect to begin offering the i5 through their large catalog based distributors in the coming quarters, which should accelerate growth. Looking to the remainder of 2008, we foresee continued growth. Our focus will on the integration of our acquisitions and expanding our high volume distribution capabilities worldwide while increasing margins to more historical levels. Looking longer-term, we are very excited about the growth prospects for the Thermography business as we expand the market by driving down the cost infrared technology. And that concludes my comments. And let me now turn the call over to Andy Teich, President of our Commercial Vision Systems Division. Andy?

[Andrew C. Teich:]

Thanks, Arne. Commercial Vision Systems Q2 revenue increased 32% compared to Q2 a year ago to a record $48.8 million. Orders were also a quarterly record and we added $6 million to backlog. Orders were very good in all of our served markets during the quarter with particular strength in the security and surveillance market. Regionally, order growth in Asia Pacific was outstanding growing five times over the last year. Our operating margin for the second quarter was 20% down from 24% in the second quarter of last year due entirely to a shift in product mix. We expect better margins in the second half of 2008 and as the scale of our business grows, the recent quarterly fluctuation in our margin should ease. Revenue more than doubled in the security and surveillance market compared with Q2 last year, with outstanding growth worldwide. One area of strength is in broader programs around the world. Most notably, we made several significant deliveries to Boeing for the SBInet program in Q2 with our newest long range camera, the ThermoVision HRC Multisensor. We have customized this product solution to meet Boeing and CBP's specific program requirements, by including our networking software, Nexus, and our own laser rangefinder and laser point... pointer modules within the camera system. Our products are performing very well and we expect additional orders from this customer in Q3 and beyond. In maritime, revenue growth was a healthy 40%. We continue to market aggressively into this market and product awareness continues to increase rapidly. This will position us for continued strong growth throughout the voting season. In the automotive market, orders from Autoleave [ph] were strong in Q2, particularly for our new Night Vision II product in anticipation of its launch this September. We are very pleased with the performance of the new product and understand that it will be featured as one of the two major innovations in the 2009 BMW lineup. In the general aviation segment, orders were up moderately, driven by a strongly resurgence in the airborne law enforcement market which was offset somewhat by a soft broadcast market. At the recent ALEA National Convention we introduced our new Ultra-9 HD. A revolutionary six-payload CEU-less 9-inch gimbal for the high definition visible camera 640x480 cooled infrared sensor and an advanced lowlight EMCCD camera. One vertical market that is approaching a level of broad adoption of infrared technology for security application is the petrochemical industry. This segment increasingly requires specialized solutions for their unique environment. To further addresses this growing market we are developing a line of products to specifically meet their unique need with the launch expected in early 2009. We continue to see good results from the initial parts received from AMI semiconductor, now owned by ON Semi, our partner in the manufacture of low cost un-cooled sensors. Initially yields are exceeding our expectations and the sensors are of very high quality. We are on track for production quantities by late this year. In April we announced the acquisition of Ifara Technology, a leading provider of networking middleware used to create sensor network. In the coming months we intend to make Ifara's Nexus technology available to other manufactures and system integrators on a much larger scale. Also all relevant new products being developed at FLIR will host Nexus in the native hardware, making our products easy to network and simple to integrate with other systems like radar, access control devices and legacy CCTV systems. As part of the integration process we've renamed Ifara, FLIR Networking System and are excited about its prospects. Looking forward we expect continued solid growth in CVS for the reminder of 2008. Our markets are as strong as ever and our strategy is working very well. And with that I'll now pass the call on to Bill Sundermeier, who is calling in from Germany, for his comment on the Government Systems results.

[William A. Sundermeier:]

Thank you Andy. Q2 was another outstanding quarter for Government Systems Division. Revenue was a record $131.6 million up 46% over last year. Orders were also a record as backlog increased by $93 million to an all time high of $464 million. Demand was strong across our diversified global customer base and we once again significantly increased our long term program business both in terms of funded backlog and IDIQ contracts. The IDIQ contract base not in the backlog at the end of the second quarter was a record $564 million. Our proven commercially developed military qualified strategy has enabled us to realize substantial operating leverage. Q2 operating profit was a record $53 million and operating margin was also a record at 40%. With the growth in the business an excellent visibility due to the substantial backlog and long-term contracts, our factories are operating at high levels of efficiency improving overall profitability levels. Our Poland's factory in particular has achieved outstanding results due to its excellent backlog. During the quarter we received $538 million IDIQ modification and a delivery order against it for $112 million from the U.S. Army Space and Missile Defense Command for force protection applications. Both the order and the IDIQ size were records for FLIR. We're very proud that the Star SAFIRE III systems we deliver under these long-term contracts have been protecting our troops overseas for the past several years, and we look forward to providing additional systems in the future. Given the current unordered IDIQ balance and strong demand from our customers, we expect to see additional orders for this mission over the next few quarters although the specific timing and amounts are not yet certain. We also received a significant number of additional orders and IDIQs during the quarter for a wide range of products from a diverse international and growing customer base. Internationally we received a $7 million order from the Columbian Ministry of Defense for our Star SAFIRE HD multi-sensor system, for counter terror... excuse me, counter-terror and counter-narcotic missions, and a $4 million order also for the Star SAFFIRE HD from the UK police and $3.5 million international order for our BRITE star DP laser designation systems for counter-terror interdiction missions. Domestically, we received several major delivery orders, including a $23 million order from the U.S. coast guard for a variant of our Talon 9-inch multi-sensor system to be installed on helicopters, and a $9 million order for our SeeSPOT III+ high performance thermal imagers for use by the U.S. Air Force. We also received two IDIQ contracts for variance of our successful re-comp three hand-held imager totaling $75 million, one of which represents our largest single contracted date for un-cooled military system. Given the large opportunity within the U.S. military for un-cooled systems, we're looking forward to demonstrating our capabilities in this area which leverages FLIRs high-volume low-cost un-cooled commercial businesses. Overall the level of program activity we're seeing both in the U.S. and internationally is stronger than ever. We remain optimistic for the remainder of 2008 and into 2009 as our expanding customer base realizes the value provided by our products and our commercially developed military qualified model. With a record backlog, a significant base of long term contracts and substantial ongoing opportunities confirmed by our recent attendance at the Eurosatory and Farnborough air shows, the future continues to look bright. That concludes my comments. Let me turn the call back over to Earl.

[Earl R. Lewis:]

Thank you Bill, I appreciate very much. And as much as I love very positive surprises the first IDIQ you mentioned was for $358 million, not $538 million.

[William A. Sundermeier:]

Okay.

[Earl R. Lewis:]

We would probably have to explain that later, anyway, so get that done. Well as you heard from our three Presidents, our business is very strong. Our strategy to drive down the cost of infrared technology and the pioneer of this technology in the new and diverse markets, has enabled FLIR to continue it's successful focus on growing the overall market for infrared products. We expect that all three of our businesses to have a very good second half this year. Government Systems is exceptionally well positioned with its large backlog and continued strong market demand. Thermography will focus on integrating the threesome acquisitions and expanding this distribution for low cost markets. And CVS has significant opportunities across multiple markets. Thus based on our first half result and these expectations for the remainder of this year, we are increasing our revenue earnings per share outlook for 2008 revenues and earnings per share outlook for '08. We now expect the full year '08 revenue between 100... $1.05 billion and $1.1 billion represented an increase of 35% to 41% from last year. We expect full year earnings per share of between $1.18 and a $1.25 up between 33% to 40% from last year. These new numbers compare with our previous outlook for revenue in a range of $1 billion to $1.05 billion and earnings per share in the range of $1.13 billion to $1.20 billion, in other words about $0.05 per share. With that Steve the call is up to you to provide more detail, and then we will come back for some questions.

[Stephen M. Bailey:]

Thank you Earl. The financial information discussed today includes operating results of Cedip Infrared Systems, which was acquired early in the first quarter 2008 and Extech Instruments which was acquired in the fourth quarter 2007. Extech's results are included in the Thermography division of financial results and Cedip financial results are primarily included in Thermography for the portion of their operations are recorded through the commercial Vision Systems and Government Systems divisions as well. For 2008 we will provide appropriate disclosure of material results from Cedip and Extech to assist in understanding the comparisons to FLIR 2007 pre-acquisition results; references to period beyond 2008 belong... beyond a fully consolidated and integrated basis with FLIR operations. With that, revenue for the second quarter 2008 totaled $261 million, an increase of 42% from the same quarter last year. Revenue from government systems amounted to $131.6 million, a 46% increase as compared to second quarter 2007. Revenue from Thermography was $80.6 million, an increase of 40% over the second quarter 2007, or a 16% organic increase excluding Cedip and Extech revenue. Revenue from our Commercial Vision Systems division up $48.8 million, an increase of 32% as compared to second quarter 2007. For the quarter, our revenue was distributed as 50% from Government Systems, 31% from Thermography, and 19% from Commercial Vision Systems. International revenues for the quarter of $105.7 million were 40% of our total revenue. Our revenues from U.S. government sales of $102.1 million accounted for 39% consolidated revenues during the period. For the first half of 2008 revenues totaled $497.9 million an increase of 44% for the same six-month period of 2007. Year-to-date, revenue from the Government Systems of $245.3 million, an increase of 43%; Thermography revenue of $160.1 million, an increase of 44%, 17% organically; and revenue from Commercial Vision Systems of $92.5 million, an increase of 47% over the first six months of 2007. Year-to-date Government Systems revenue was 49% of total revenue, while Thermography and Commercial Vision Systems represents 32% and 19% respectively over total revenue. For the first half of 2008, international revenues of a $193 million were 39% of our total revenue while revenues from the U.S. government sales of a $119.4 million with 38% of consolidated revenues during the six-month period. If we look at the quarter with a backlog of these orders and hand for delivery within the next 12 months of $572 million and the increase of $101 million or 21% during the quarter, and an increase of 46% or $179 million over our backlog as of yearend 2007. By division, backlog amounted to Government Systems of $464 million, an increase of $93 million during the quarter and an increase of $159 million or 52% over yearend 2007. Thermography backlog of $22 million represents a 10% increase during the quarter and a 16% increase over yearend 2007. Commercial Vision Systems backlog of $86 million, a 7% increase during the quarter and 26% increase over yearend. Gross margins for the current quarter was 56.2% of revenue as compared to 53.8% in the second quarter of last year with the most of the improvements related to cost efficiency gains in our Government Systems. For the first half of 2008 gross margins were 55.7% as compare to 54.7% for the same six-month period of 2007. Research and development expense of $23.5 million or 9% of revenue for the quarter as compared to $17.9 million or 9.7% of revenue for the second quarter of 2007. For the first six months of 2008, the company's incurred research and development expense of $46.7 million or 9.4% of revenue. Selling, general and administrative expense for the second quarter 2008 of $58.4 million were 22.4% of sales as compared to $40.1 million or 21.7% for the same period of 2007. The increase in costs include in the addition of Cedip and Extech operating expenses when compared to 2007 in addition to general cost increases incurred in support of our ongoing business activities. For the first half selling, general and administrative expenses were $111 million or 22.3% of revenue as compared to $75.9 million or 22% of revenue in 2007. Earnings from operations for the quarter totaled $64.7 million or 24.8% of revenue as compared to $41.2 million or 22.3% of revenue in the second quarter 2007. The 57% or $23.5 million improvement in operating profit as compared with second quarter of 2007 is a result of our 42% increase in revenues with improved gross margins while incurring a 41% operating cost increase during the period. For the first half of 2008, earnings from operations were $119.8 million or 21... excuse me, or 24.1 [indiscernible], an increase of $42.6 million or 55% over 2007. Interest expense for the quarter totaled $2.3 million as compared to $2.6 million to same period last year. Interest expense of $1.8 million relates to the interest cost and amortization of transaction costs of the $210 million convertible notes. Remaining interest expense of $500,000 during the quarter relates to credit line and other debt borrowings during the quarter. Year-to-date, interest expense amounted to $4.8 million of which $1.2 million was related to credit line and other debt borrowing. During the quarter, the company earned $3.6 million of other income, including $752,000 currency gain and $2.9 million of interest and other income. Year-to-date as our income amounts to $3.7 million including currency losses of $528,000 with interest and other income of $4.2 million. Based on the anticipated mix of foreign and domestic income for the full year, the effective tax rate for the quarter was approximately 31.2% and we expect the annual rate to approximate 30% to 32% for the year. For the second quarter, net earnings are $45.4 million or $0.29 per diluted share. The 56% or $16.4 million increase of net earnings compares to net earnings of $29.1 million or $0.19 per diluted share for the same quarter 2007. For the first six months of 2008 net earning are $82.8 million or $0.52 per diluted share, a $27.4 million or 49.6% increase over the same period of 2007. We finished the quarter with cash of a $177 million as compared to a Q1 ending balance of $159.1 million in the yearend 2007 cash balance of $203.7 million. Our cash provided from operating activities during the quarter totaled $8.2 million while increasing working capital by $20 million and accounts receivable and $16.7 million in inventory. Cash used in investing activities for the quarter of $22.2 million was primarily applied as $11 million for acquisition costs, capital expenditures of $6.1 million and $5.1 billion was applied to other investments. Cash provided by financing activities of $32.5 million during the quarter included a net debt repayment of $880,000 while receiving $21.3 million from the exercise of stock options and employee stock plan. Year-to-date cash provided by operating activities was $63.4 million or cash used in investing activities for the first half of 2008 of $102.6 million and that... includes cash used for the acquisition of Cedip and Ifara of $79.2 million, $16.1 million of capital expenditures and $7.3 million of other investments. Cash provided by financing activities of $4 million year-to-date includes a repayment of debt of $20.2 million and $26.9 million received from the exercise of stock options and employee purchase plans. This concludes the financial summary for second quarter and I'll turn the call back to Earl.

[Earl R. Lewis:]

Thank you very much, Steve. And with that operator, we're ready to take our first question. Question And Answer

[Operator:]

Your first question comes from the line of Tim Quillin with Stephens, Inc.

[Earl R. Lewis:]

Hello, Tim Quillin.

[Timothy Quillin:]

I like that. Good morning.

[Earl R. Lewis:]

How are you?

[Timothy Quillin:]

Great quarter.

[Earl R. Lewis:]

Thank you.

[Timothy Quillin:]

What can you tell us about the timing of shipments of the $112 million order from Army Space and Missile Defense Command? Did all of that $112 million go into your backlog?

[Earl R. Lewis:]

Almost all of it, Tim.

[Timothy Quillin:]

Okay. And then in terms of the remaining IDIQ value, a bill alluded to the potential for additional orders. But how should we think about the timing of additional orders and shipments under the remaining contract value?

[Unidentified Company Representative:]

Well as you know, these IDIQs are just that; they are indefinite delivery and definite quantity. And so the prediction of when we will get the releases on the... what was it, $562 million, I think, is the total we have now in both contracts in hand, is very difficult to predict. We did go back historically and look at that and it does seem like the take rate on that historically has been pretty good. In another words eventually they take them all; but predicting exactly when the releases will be is pretty hard, Tim.

[Timothy Quillin:]

And just one additional question regarding the un-cooled military market, and I think specifically the DV contract opportunity. How are you approaching that and do you have right now a product that meets the specs for DV or do you need to come up with a different sensor before the proposals are submitted. Thank you.

[Earl R. Lewis:]

We're approaching it very carefully. This is a major, major exercise in terms of our proposal. We believe that we currently have as good a product or better than they're using today. The special occasions for it are as they would like and we have to modify some of the things that we've done to get there. But we don't see anything in the design that they're asking for that we do not think we can meet; put it that way.

[Timothy Quillin:]

Thank you.

[Operator:]

Your next question comes from the line of Paul Coster with JP Morgan.

[Earl R. Lewis:]

Good morning, Paul.

[Mark Strouse:]

Hi it's actually, Mark Strouse on behalf of Paul.

[Earl R. Lewis:]

Hi Mark.

[Mark Strouse:]

Hi. Can you just give us an update on status of ARH? Is there any possibility of maybe getting back on that program?

[Earl R. Lewis:]

Got a half an hour. We're not off the program, we are on the ARH program. We have an order from... I know it's going to sound odd and I don't mean it to be but that's the status of the program. We have an order for I think 30 some odd systems, maybe high 20s. For the first 20 or so of the systems we've been through, lot [ph] we passed it. We also know as you're inferring that there's a common sensor that the military has selected to go on it at some point in the future. This is very difficult for us to understand, it's a great deal of money to put another product on a helicopter, we're qualified to supply the product for it. How that will play out, where the money is going to come from to adopt their product to this helicopter, we don't know. We're just going to have to wait and see, but as of now we are on the ARH program.

[Mark Strouse:]

Okay, thanks for that. And then, Andy, can you go back and just tell us a little more about the products that are going to be launched for the petrochemical industry?

[Andrew C. Teich:]

Well I don't want to reveal too much about what we're working on there other than that that market has unique requirement. I think it's not too difficult to figure out what some of those things are but we do think that there's going to be increasing federal push and funding to protect petrochemical facilities and they do have unique requirements. We're seeing increasing orders coming from some of the major petrochemical companies and that's both I think is the function of the need there and the fact that those individual... those businesses are in pretty high cotton right now in terms of their revenue. So we're looking to capitalize on that by developing some of these unique capabilities to address their specific needs.

[Mark Strouse:]

Okay. Thank you very much. Congrats on the quarter.

[Andrew C. Teich:]

Thank you.

[Operator:]

Your next question comes from the line of Chris Donaghey with SunTrust Robinson.

[Earl R. Lewis:]

Morning, Chris.

[Chris Donaghey:]

Congratulations on the quarter. Bill I was wondering if you could talk a little bit about structurally what's going on with G-BOSS and BetSEA [ph]. Do you have any better visibility on how the two programs are going to be combined and if some of the numbers that we've seen are additive or are they duplicative, how should we be thinking about those programs?

[Andrew C. Teich:]

Sure. Really they're their own individual programs, so the Army certainly has BetSEA and the Marine Corps has G-BOSS [ph] and we're... G-BOSS with these last orders that have come in have fulfilled their requirements and we are anticipating kind of moving forward maybe they'll do some sparing, they'll certainly have a service contract with us, that kind of thing for those kinds of the systems for both the T3000s and Star IIIs. But pretty much in the out quarters we're going to be seeing the army through that IDIQ vehicle, be purchasing systems alone for the most part. So it's there requirements, which are the substantial portion of that $300 million plus IDIQ. That answer if for you?

[Chris Donaghey:]

Yes. And then Andy, on SBInet at this point is it... should we expect to see more orders per SBInet or is now Boeing going to go out and evaluate the different technologies that are out there and what 're your expectations there?

[Earl R. Lewis:]

Well Boeing went through a process where they qualified a couple of vendors to meet the second round of system requirements and in that second round was actually replacing some of the systems from the first deployment known as project 28. So we are vendor, we are one of those vendors that has been qualified, but to our knowledge, we had received the lion's share, if not all of the orders that Boeing has issued to date for this refit requirement for project 28 and then there are subsequent sections of the border that are going to be receiving this same system solution. That said, the systems that we have been delivering together to them, this HRC multi-sensor product customized for their specific needs as I mentioned in the preamble comments, I think they are very satisfied with. So I do expect to continue to receive a lion's share of the orders coming from that program.

[Chris Donaghey:]

Okay, that sounds great. And then Earl, I don't know this maybe confusing way of asking this question. But as I look at your firm backlog, now at $572 million and then IDIQ backlog of $564 million plus you had the two pretty large, well or decent size IDIQs coming after the quarter closed. As I look at that on a percentage basis, your backlog now represents a significantly larger percentage of your next 12 months of revenue then it has ever at least since I've been tracking that. So structurally from the order perspective, are the orders just getting longer-term in nature, are you not doing as much book-and-ship type growth? And how do you feel about visibility for the next 12 months, given these percentages?

[Earl R. Lewis:]

It's not a confusing question. I think it was three years ago, we set out to say look, we can't really run this Government business that we have on this book-and-ship basis, many of you remember the sawtooth situation we had back then, where we were literally waiting for the order to come in to make our quarter in that business which was not very difficult to manage. And so we set out to say can't we somehow better participate in longer-term programs that would give us better visibility, so we could manage our business better and have it been more predictable; things normally that are liked by Wall Street and they are liked by us because it's a lot easier to run a business when you have predictability. So I'm just delighted with the fact that we have been able to execute that strategy in the Government side in build up of backlog and visibility in the IDIQ side. With that said I think your comments are correct. We have a very good visibility between now and the end of year, extremely good visibility in the Government side and into next year. It does make our management of this business significantly... I hate to use the word easier in front of Bill but better, and I think that the results are showing that. I'm not sure I might have completely answered your question other than to say your observations are 100% correct, it is exactly what we've been trying to do.

[Chris Donaghey:]

Great. Well again congratulations on the quarter, Earl.

[Earl R. Lewis:]

Thanks.

[Operator:]

[Operator Instructions]. Your next question comes from the line of Michael Lewis of BB&T Capital Market.

[Earl R. Lewis:]

Michael?

[Michael Lewis:]

Thanks for taking my call. Quick question for Bill and then one for Arne here. Bill I was wondering, did you say that the EBIT margin and the GS segment was 40% in the quarter?

[William A. Sundermeier:]

And it was.

[Michael Lewis:]

Okay. So how sustainable is this EBIT margin considering we're appearing in the government space?

[William A. Sundermeier:]

I would say that, that quarter was particularly good but as I'm looking towards the future as long as we can keep this backlog fairly high and our mix appropriate, it's going to be in that area.

[Michael Lewis:]

Okay.

[Earl R. Lewis:]

I keep in mind Bill has a very healthy mix of international revenue.

[Michael Lewis:]

Yes. And that's actually my next question, I was wondering what's the proportion of the Government services business that's made up by coalition partner revenue at this time, and how is that shifted from say this time last year?

[William A. Sundermeier:]

Well there's... I don't know if I can talk... say that it was coalition partner but our... certainly our international business has been very strong and it's not 50% presently because of the large contracts that we have been getting in on the rate program but it is certainly increasing. So our mix probably right now is about 60% U.S. and 40%... excuse me, 60% U.S. and 40% international and that's going to remain strong, if not stronger, I'm hearing you're up trying to continue to pushup our international business and make that a stronger mix.

[Michael Lewis:]

I will say over that [ph].

[William A. Sundermeier:]

Okay.

[Michael Lewis:]

That's very good, appreciate that comment there. And then just very quickly with regard to Arne, could you just talk a little bit about your commentary when you discuss the weakness in E cameras due to the demand in the T series. Now, I guess my question's pretty simple. I was wondering if you could quantify this force, is the E camera category down 10%, 30%, 50%, can you help us out with regard to how that mix shift has caused the decrease in E?

[Arne Almerfors:]

Yeah, I mean first to give a comment to this one, I mean we anticipated E to drop. I mean we had this kind of cannibalization as we call it. But that's a decided, you could say, cannibalization. So the fact that is being some of is continued is in accordance with our planning, I mean we definitely need to introduce new products and at the same time old products will leave the mat. And the drop is significant and that's expected.

[Michael Lewis:]

Okay, thank you very much, very much appreciate it.

[Earl R. Lewis:]

Just to catch one point here. The overall... and it wasn't in my script, I probably should have put it in. Our international sales as a percent of our total sales was up to the company in Q2.

[Operator:]

Our next question coming from the line of Brian Ruttenbur from Morgan Keegan.

[Brian Ruttenbur:]

On SG&A expense, it was up sequentially as a dollar amount and as a percentage. Can you talk about what the plans are kind of going forward for SG&A. Was there anything one time in nature and in that... in the quarter?

[Earl R. Lewis:]

A... probably a difference of opinion between my plans and the three division presidents' plans.

[Brian Ruttenbur:]

Was there is a big party by the division presidents?

[Earl R. Lewis:]

Now there is one thing that we are unfortunately wind blowing against us in that category and that's the legal side of our business we have, a situation where, I think, most of you know that Raytheon is suing us, that's an expensive deal to defend against; it will be over early next year. In addition we have done some sort of extra work in marketing in order to launch a number of new products that we're launching this year. We've increased our marketing expense and our selling expense at probably a greater rate than we would normally. Those are the two areas that I would comment on that are perhaps a little bit higher than our growth rate in the top-line, but each... I'd just as soon have each President talk about it. Bill, Andy and Arne, have any comments on your SG&A expense?

[Arne Almerfors:]

No I could certainly say that, yes we have spent somewhat more on marketing due to the launch of the new FLIR i5 which was a huge launch for us and then that's some of the reason, as I said, marketing went up somewhat.

[Earl R. Lewis:]

Let me just interject one other point that I forget about. The acquisition of the two companies has caused us a very high rate of amortization; Steve I don't know if have the number handy but...

[Stephen M. Bailey:]

For the quarter it was up $3.3 million.

[Earl R. Lewis:]

Yes, that relates to those two acquisitions that will not be with us if anyway near that rate next year.

[Stephen M. Bailey:]

The $3.3 million during the quarter was a catch-up for the first half of the year and it will be significantly less than that next year as a large portion of that is a one-year amortization that will take place.

[Brian Ruttenbur:]

Okay. So will there be a drop in the third and fourth quarters from the second quarter period in amortization?

[Earl R. Lewis:]

Yes a little bit, because we had a double in of $1 million...

[Stephen M. Bailey:]

We had a double in about $1 million. So it'll be down about that, otherwise unfortunately we don't trust here [ph].

[Brian Ruttenbur:]

And will mark... will the marketing drop in the third and fourth quarters?

[Earl R. Lewis:]

No, I think marketing probably will... well probably yes, in that people take vacations and that ends up getting charged the balance sheet, I don't if realized how that works, but in terms of absolute expense, I would think the second half might be a tad more than the first half.

[Unidentified Company Representative:]

We had our worldwide sales meeting in Government systems in that quarter and that was an anomaly for that quarter.

[Brian Ruttenbur:]

Okay, and how much was legal?

[Earl R. Lewis:]

We don't disclose that but it was too much.

[Brian Ruttenbur:]

Okay. Very good. And then did you guy finish answering all the question on G&A, did you want to continue going around the table or...

[Earl R. Lewis:]

Yes, sure Andy, you want to comment?

[Andrew C. Teich:]

Well my SG&A expense increased but not at the same rate that revenue increased. Our selling expense went up the same as revenue but marketing and G&A and amortization option expense actually increased at a rate lower than revenue.

[Earl R. Lewis:]

Which is what we tend to try to target to do, frankly, to be perfectly honest.

[Brian Ruttenbur:]

And then I guess moving it on the another question on gross margin. Gross margin was strong in the second quarter even though there was the mix of business looks like it would have... it should have been a little bit lower than that. Can you talk about... is this all from cost efficiencies and can we expect this going forward as imaging maybe grows at a faster rate than thermography.

[Earl R. Lewis:]

Well it's an interesting question. Clearly our gross margin's a little bit better. And I think that the balance of this year we would expect about that gross margin percentage, given the mix of products that we have in the backlog. That's pretty much driven by mix and volume through the factory and as the volumes have been increased in a pretty dramatic rate you absorb more of the overhead of course some and you get a better gross margin. We... I do not have much in the way of pricing pressure that we can point to in terms of affects on the gross margin. We do think that we are just absorbing more of our cost at a higher rate with a more throughput to our factories. And I think that's probably without studying it in detail, probably good for a point or two, and I don't see that changing this year.

[Operator:]

Your next question comes from the line of Jonathan Ho of William Blair.

[Earl R. Lewis:]

Jonathan.

[Jonathan Ho:]

Great quarter. Couple of quick questions. First can you give us a quick update on the MRTB and the product that you guys are bidding into that program?

[Unidentified Company Representative:]

For...Bill you want to comment.

[William A. Sundermeier:]

Well we've certainly provided a good proposal with bid samples into that and we're waiting for a response. So we are anxious of course we think we have a great product.

[Jonathan Ho:]

Are you guys putting I guess a new product into this category or is it kind of a variant of the Recon?

[William A. Sundermeier:]

Exactly, it's more of a variant to the Recon.

[Jonathan Ho:]

Okay.

[William A. Sundermeier:]

And we won the HHI-MR program which again was another variant in the uncooled space and we're very excited about that, and of course then the MRTB is going to be in between if you will... those two. So... actually no... sorry the MRTB is a lower end version of it. So just an uncooled system and we have nice bid samples, they are up and working and working well; so we are hopeful.

[Jonathan Ho:]

Is it going to be, I guess say bake-off for that competition?

[William A. Sundermeier:]

Yes,absolutely, there will be a competition, basically with these bid samples and they will evaluate them and along with the proposal to decide a winner.

[Operator:]

Your next question comes from the line of Peter Arment of American Technology.

[Earl R. Lewis:]

Good morning Peter.

[Peter Arment:]

Hey good morning Earl. You have did all my questions, maybe Earl you could just talk a little bit about M&A if a... what you might be thinking for the balance of this year as we go into 2009, any color on that aspect, thanks Earl?

[Earl R. Lewis:]

We're certainly looking, we really are I think at the... as of right now we're engaged in a couple of conversations with two companies, hate to predict how those will work out because we just really don't know. But there is some activity and as you might imagine with our current growth rate and our cash flow we're interested in possible acquisitions.

[Jonathan Ho:]

Okay. Thanks again; nice quarter.

[Operator:]

Your next question comes from the line of Michael Ciarmoli of Boenning & Scattergood.

[Earl R. Lewis:]

Hi Michael.

[Michael Ciarmoli:]

Hi thanks for taking my call, good quarter.

[Earl R. Lewis:]

Thank you.

[Michael Ciarmoli:]

Most of my questions have been answered already. Can you talk a little bit, I guess, Bill, about the competitive landscape on the government side of the business? I know there seems to be one smaller public company out there that seems to be aiming for you guys or are you seeing more competition on these proposals from new players and are you... how... what's your thought process and how your products back up against some of these new guys?

[William A. Sundermeier:]

Well, competition has always been strong. But I think it's even stronger now that... I worry more about the larger players, there's the incumbents in breaking into some of their businesses and taking the market share away. So I haven't really been too focused on some of the new players although with our vertical strategy, and knowing from the inspector all the way to the connector on all of our system we have a great vertical scenario here to be very-very competitive and even though they've done in a few places in the chinks of our armor in the long run, been able to have the detector and optics and all that capability, we'll be able to continue to produce products that will be much more competitive in the future. So my focus is really taking market share away from a much larger company using our CDMQ strategy.

[Michael Ciarmoli:]

Okay.

[Earl R. Lewis:]

If you look at the size of these markets and the growth rates that they are... we are clearly in the government side a small player, so I don't know why a small player would be targeting us there frankly.

[Michael Ciarmoli:]

Right. Okay.

[Earl R. Lewis:]

Doesn't make much sense logically.

[Michael Ciarmoli:]

And then if you can, obviously there's some big programs out there, does program concentration within your current backlog... can you give us a sense of, I guess what do you see maybe on the horizon... it seems like the BetSEA [ph] program, obviously we've got the big DVD... DVE out there for bid, but is program concentration a near-term concern of yours and what do some of the, I guess, pipeline projects look like, that might help to diversify that exposure in the near-term on the government business?

[Earl R. Lewis:]

I will answer but maybe Bill's answer's more relevant. But just as an overview I think now it clearly does concern us. We think there is a number of programs in the pipeline that show potential for very continued growth in that market. I... we have to win them though. I mean that that's the new game we're in. We will have a big program and we have to replace it with another program or multiple programs that equal to it and we're very conscious of that and working very hard to do just that. And Bill your comments?

[William A. Sundermeier:]

YesI just have to echo that. I mean in this last quarter was... even though we received the $358 million IDIQ, we've received so many other smaller ones... I am looking at them here for $49 million and $25 million and we're really executing on our strategy of I hope again someday in future to win another $100 million... $200 million of program that's out there. So we're continuing to fill up the pipeline and we do have a very long list of pursuits in the short-term and in the long-term that we're working to help them continue to fill up that pipeline and that's the mission there is to continue to build on that IDIQ base and we see lots of opportunities and Earl's absolutely right. We've got to win them. I still see a lot more this year for us to pursue.

[Operator:]

And you have a follow-up question from the line of Tim Quillin of Stephens, Inc.

[Timothy Quillin:]

Hey just a real quick question regarding seasonality and I guess in the past two or three or four quarters, you've been helpful and in terms of helping us determine how the quarter goes and I know you don't give quarterly guidance. But in the past there's been some seasonality in the third quarter where it's been a little bit of a low relative to second quarter. And I know that that's less the case now but how should we think about 3Q numbers.

[Earl R. Lewis:]

Well, traditionally Europe is slower in the third quarter. But we have to keep increasing our output in the Government Systems group and I think all in all we're not going to a go into a low in Q3. It would probably put us in too deeper hole for where we have to get to by the end of the year. So we are just going to keep right on driving and I don't think we'll see the same depth that we have historically in Q3, but I will have to look at the numbers.

[William A. Sundermeier:]

Last year we... we look as last year, we were pretty leveled between Q1 and Q3.

[Timothy Quillin:]

Okay. Can you give us any sense of how backlog is going to hit in 3Q or how much a backlog hits in 3Q or how the backlog converts over the next couple of quarters? I could but I won't. Just say I guess getting back to the question your backlog relative to forward numbers.

[William A. Sundermeier:]

I understand... I understand

[Timothy Quillin:]

Give me the guidance?

[William A. Sundermeier:]

Right now we believe our order flow will be strong in Q3.

[Timothy Quillin:]

Okay. Thank you.

[Earl R. Lewis:]

You are welcome Tim.

[Operator:]

And there are no audio questions at this time.

[Earl R. Lewis:]

Great. Well, again a number of people have thanked me and the team here, I would like to thank the employees of FLIR again. They have performed outstanding and continue to. And we hope to be able to continue these kinds of results for this year and the next year. Thank you all for tuning in.

[Operator:]

This concludes today's conference call. You may now disconnect.