FLIR Systems, Inc.
Q2 2009 Earnings Call Transcript

Published: 24 Jul 2009

[Operator:]

(Operator Instructions) Welcome everyone to the FLIR Systems Second Quarter 2009 Financial Results Conference Call. I now will turn the call over to Mr. Wit Davis, Senior Vice President, General Counsel and Secretary of FLIR Systems.

[Wit Davis:]

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 as 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 Lewis:]

We are pleased with our second quarter financial performance. Earnings per share for the quarter were $0.35 up 21% from last year on a 7% increase in revenue. Excluding the effects of a stronger US dollar, revenue increased by 12% in Q2. Our gross and operating margins remained at record levels that we saw in Q1 and operating cash flow is again strong at $58 million. Our 12 month backlog at the end of the quarter was $598 million. As expected, backlog declined from historical high levels in our government systems division while we increased backlog in our Thermography and particularly in our Commercial Vision Systems. During the quarter we repurchased approximately 1.1 million shares of our common stock at an average price of $25.23. Thus far in ’09 we’ve purchased 2.1 million shares at an average price of $23.30. Our repurchase authorization has approximately 18 million shares remaining and we will continue to evaluate share repurchase based on market conditions, our capital structure and alternative investments. In early June we acquired Salvador Imaging for $13 million in cash. This company, which has been renamed FLIR Advanced Imaging Systems, is a leader in what we believe to be a very promising low light technology directly adjacent and complimentary with our core infrared capability. AIS will operate as part of our Commercial Vision Systems Division and we plan to introduce the security camera using their technology this year. AIS will not be material to earnings or revenue in 2009 but we do expect good growth and synergy opportunities in 2010 and on. We are delighted to welcome the 20 employees of AIS to FLIR. Our three division presidents are here with me to comment in greater detail on the results of their business in Q2. When they are done I’ll come back with some additional comments on the business. We’ll start with Andy Teich, President of our Commercial Vision Systems.

[Andy Teich:]

Commercial Vision Systems Q2 revenue was $50.8 million an increase of 4% compared to the second quarter a year ago. Excluding the effects of exchange rates, revenue increased by 7% compared with last year. Orders were strong as backlog increased by $13 million during the quarter to a record $108 million, driven by strong order activity internationally. Operating income for Q2 was a record $13.3 million up 39% from the prior year. Operating margins were 26% also a record for the division due to higher gross margins from a favorable product mix and effective cost control. Demand in the security and surveillance market grew nicely over the prior year with unit volumes up 16%. During the quarter we receive an initial $2.4 million order for our long range HRC multi-sensor systems from DS, a global leader in aerospace and defense. The systems are to be installed along the Saudi northern border for long range security and surveillance missions under DS recently awarded Saudi border guard development program. Systems will be deployed on towers along specific sectors of the border and will be networked with radar and other sensing equipment to form an integrated system. Based on our selection for the initial installation and our strong working relationship with DS we have a major opportunity for continued participation in this program as well as additional border programs that DS has been awarded. In the maritime market orders were up appreciably during the quarter and our new M-series midrange product line accounted for over 20% of the unit volume. Of note was a large 34 unit order for M-series cameras from Sydney, Australia ferry service. In addition to the M-series we sold several premium Voyager II cameras to mega yacht owners through dealers in Europe and Asia. We are pleased with the recent growth in the maritime market despite weak economic conditions and believe we are particularly well positioned in this market for an economic recovery. In the important components market demand for un-cooled camera cores was up 27% over the prior year driven by strong demand for the new Tau camera core. Tau is the smallest, lightest, lowest powered un-cooled camera core in its class and with the impressive initial market response we are optimistic Tau will be widely adopted in the industry. In the automotive market together with our partner Autoleave we are pleased with the launch of the new Night Vision II system with pedestrian detection on the BMW 7-series. Although 7-series sales are down we estimate the take rates for Night Vision II system has doubled compared with Night Vision I to approximately 30%. Here too we think this product positions us exceptionally well in the recovering economy. Finally, earlier this month we announced the launch of the new H-series line of handheld law enforcement thermal imaging cameras. These feature rich low price cameras are purpose built for the law enforcement community which we believe is a large under penetrated market for our thermal imagers. The H-series is the latest example of our strategy to expand the market to thermal imaging by offering innovative new products and low prices through our large global distribution network. Municipal budgets are tight but with stimulus money potentially available over the next several months we are optimistic that many cities and counties will outfit their officers with the potentially life saving technology. Looking forward with our recently upcoming major product launches, FLIR continues to lead the commercial infrared industry and is well positioned to resume strong growth when the worldwide economy begins to recover. Until then we expect modest growth to continue. That concludes my comments. Let me now turn the call over to Arne Almerfors, President of the Thermography division.

[Arne Almerfors:]

Thermography revenue in Q2 was $66.8 million, a decrease 17% from the second quarter of year 2008. Excluding the effect of exchange rates Thermography revenue was down 9% compared to the prior year. Demand remained soft around the world with a slight sequential improvement in the US offset by modest declines in Europe. Asia/Pacific remains the bright spot with demand up nearly 40% from the prior year. In general world Thermography markets appear to be bottoming out with no visible trend either up or down. Thermography operating margin for Q2 was 23% up 4% from the prior year due to effective cost controls and strong gross margins. Operating income in the second quarter was $15 million up 1% from the prior year and its operating income is up 1% from last year. From a market perspective the building market which includes building diagnostics, [inaudible] auditing, facility management, HVAC and plumbing and moisture restoration continued to do well in the second quarter. In addition, we experienced an increase in demand for camera used to identify people with elevated body temperatures in an effort to contain Swine Flu, particularly in the Asia, Middle East and Latin America. The related mechanical and gas image markets were again down in the quarter due largely to the weak economy. We expect the new DF-series cameras we announced last month will help expel the gas image market but it will take time to gain traction in the weak economy. Overall, the Thermography division is executing its strategy effectively despite the current economic conditions. Feedback from our channel partners have been very positive particularly with regulatory position. We believe the steps we are taking during the recent economic downturn have further enhanced our leading position in the Thermography marketplace. For example, we have realigned our direct and third party distribution channel to even more effectively target each unique market segment. Moving forward with the weak economic conditions we’ll limit growth for the remainder of 2009 but we do expect normal seasonal improvement in the second half of the year. We have yet to see any impact from the US stimulus package and do not expect much of any impact in 2009. We should remain strong for the remainder of the year as cost protrudes remain in place and competitive dynamics remain stable. Looking beyond 2009 our high quality, low cost product portfolio and high volume production capacity positions Thermography for rapid growth when economic conditions improve. That concludes my comments. Let me now turn the call over Bill Sundermeier, President of the Government Systems Division.

[Bill Sundermeier:]

Government System second quarter revenue was $160.4 million an increase of 22% from the prior year. Q2 operating income of $72.4 million was up 37% from the prior year and just under the record levels of the prior two quarters. Operating margins of 45% tied the record set in Q1, the result of strong product mix, operating leverage and cost control. Twelve month backlog was $467 million at June 30th compared to $504 million at March 31st. Second quarter order activity was once again strong overseas as international orders accounted for more than 50% of the total. While the pipeline and timing of cuts and program opportunities in the US is currently soft we received over 80 cuts orders during the quarter for a wide variety of productions and applications, demonstrating the depth and breadth of our customer base and application. FLIR’s competitive positioning and market share are unchanged and we are well prepared to react to changes in the dynamic and broad market. In June, FLIR was selected by Sikorsky Corporation to provide the 9” talon multi-sensor system for Sikorsky’s HH-60M Blackhawk Helicopter program. The US Army will utilize these sensors in combat, search and rescue, and medevac missions flown by US Army, US Army National Guard and US Army Reserve units. Contract details are still being finalized but the multi-year opportunity is potentially in excess of 300 units. FLIR is the sole approved provider of sensors systems in the talon class to the Blackhawk which is one of the most successful helicopter platforms in the world. FLIR is well positioned to participate in future Blackhawk deployments both domestic and international. Since the end of Q2 we received a delivery order of $37 million from the US Army, Space, and Missile Defense Command under a $358 million IDIQ contract for the BETSY program. This order was booked in the third quarter. In total we have now received orders totaling $317 million under this IDIQ. We expect delivery under this order to begin in late 2009 and continue into 2010. The current IDIQ has been extended until next March and we look forward to future opportunities to partner with the US Army and Marines on force protection solutions. Improving upon our industry leading portfolio of airborne multi-sensor systems, during the quarter we introduced the Star HD Generation II. While we already lay claim to the only full HD IR sensor system the new Star HD Gen II system provides the operator with full spectral imaging in HD meaning the system has an HD resolution from its visible low light and mid weight infrared sensors, making it the most capable ISR system on the market. We believe that the Star HD Gen II is positioned to expand our share of this market. Going forward, despite the current softness in the US activity we are optimistic about the long term prospects for infrared systems in military applications. With our proven commercially developed military qualified model we provide outstanding value to our customers and look forward to increasing our share of future award opportunities. That concludes my comments. Let me turn the call back over to Earl.

[Earl Lewis:]

We are very pleased with our performance in the first half of this year. We have clearly seen the effects of currency swings in the worldwide recession in our commercial businesses. Through careful cost control and focus on sound execution we have been able to continue to achieve strong financial results. However, primarily due to the unfavorable currency markets and the continued weak economic conditions, we are going to reduce our revenue outlook for the year by approximately $100 million. Note in the first half the currency effect has been approximately $33 million. This will bring the new range to $1.1 to $1.15 billion. Also, we are going to narrow our previously announced outlook for the 2009 EPS number to the lower side of our range $1.40 to $1.44. We believe FLIR is in the strongest competitive position in its history. Our technology is among the best in the world, our costs are low, and our distribution and product lines are the broadest in the industry. We will continue to pursue proven strategies of driving down our costs and expanding markets to drive our growth. I’m excited about our future and I see continued opportunities for FLIR to grow well into our future. Before I turn the call over to Steve for review of our financials I’d again like to thank our dedicated employees for their terrific focus, their execution, and their continued contributions to our success.

[Steve Bailey:]

Revenue for the second quarter 2009 was $278 million an increase of 7% from the same quarter last year. Revenue from Government Systems amounted to $160.4 million a 22% increase as compared to the second quarter 2008. Revenue from our Thermography division was $66.8 million a decrease of 17% over the second quarter 2008 with half of the decline due to currency exchange rates and their major principally to changes in product mix. Revenue from our Commercial Vision Systems division of $50.8 million was an increase of 4% as compared to the second quarter 2008. For the quarter, revenue was distributed 58% from Government Systems, 24% from Thermography, and 18% from Commercial Vision Systems. Our international revenues and revenues from sales to the US Government for the quarter of $114.2 million and $115.3 million respectively each accounted for approximately 41% of our total revenue during the period. For the first half of 2009 revenues totaled $550 million an increase of 10% from the same six month period of 2008. Year to date, revenue from Government Systems have $322.6 million increased 32%, Thermography revenue while $130.7 million decreased 18% and revenues from Commercial Vision Systems of $96.7 million increased 5% over the first six months of 2008. Year to date, Government systems revenue is 58% of the total revenue while Thermography and Commercial Vision Systems represent 24% and 18% respectively of total revenue. For the first half of 2009 international revenues of $214.7 million were 39% of our total revenue, while revenues from US Government sales of $238.7 million were 43% of consolidated revenue. We closed the quarter with a backlog of $598 million a decrease of $19 million or 3% during the quarter and a decrease of 10% or $65 million of our backlog at the end of year 2008. By division, backlog amount to Government Systems of $467 million a decrease of $37 million during the quarter and a decrease of $85 million or 15% over year end 2008. Thermography backlog of $23 million represents a 28% increase during the quarter and a 21% increase over year end 2008. Commercial Vision Systems backlog was $108 million was a 14% increase during the quarter and 19% increase over year end. Gross margins for the current quarter of 58% of revenue that’s compared to 56% of revenue in the second quarter of last year with most of the improvement related to cost efficiency gains in all operations. For the first half of 2009 gross margins were 58% that’s compared to 56% for the same six month period of 2008. Research and development expenses of $23.2 million were 8% of revenue for the quarter that’s compared to $23.5 million or 9% of revenue for the second quarter 2008. For the first six months of 2009 the company has incurred research and development expense of $45.6 million or 8% of revenue. Selling, general and administrative expenses for the second quarter 2009 of $54.1 million were 19% of sales that’s compared to $58.4 million or 22% for the same period in 2008. For the first half, selling, general and administrative expenses were $106 million or 19% of revenue that’s compared to $111 million or 22% of revenue in 2008. Earnings from operations for the quarter totaled $84.7 million or 30% of revenue, that’s compared to $64.7 million or 25% of revenue in the second quarter of 2008. The 31% or $20 million improvement in operating profit is compared to the second quarter of 2008 as the result of our 7% increase in revenues while with improved gross margins while incur a 6% operating cost decrease for the same period. For the first half of 2009 earnings from operations were $168 million or 31% of revenue an increase of $48.2 million or 40% over 2008. Interest expense for the quarter totaled $1.7 million that’s compared to $3.6 million for the same period last year. For the first half of 2009 interest expense was $4.5 million that’s compared to $7.4 million in 2008. The majority of the interest expense relates to our convertible notes and the decrease of the year over year interest is due to notes that were converted in December 2008 and March 2009. Through June 30, 2009, the company has converted $118.5 million in notes to shares and subsequent to the end of the quarter the company has converted an additional $30 million of notes. Face value of the remaining notes outstanding after the July conversion is approximately $61.5 million. During the quarter the company incurred net other expenses of $1.1 million including $1.9 million of currency losses and earning $500,000 of interest income. Year to date, the company has incurred nominal net other expense including currency losses of $1 million and interest income of $1.1 million. Based upon the anticipated mix of foreign and domestic income for the full year the effective tax rate for the quarter is approximately 32% and we expect the annual rate to approximately 32% to 33% for the year. For the second quarter net earnings of $55.7 million or $0.35 per diluted share. The 25% or $11 million increase in net earnings compared to net earnings of $44.6 million or $0.29 per diluted share for the same quarter of 2008. For the first six month of 2009 net earnings are $109.9 million or $0.70 per diluted share, a $28.8 million or 35% increase over the same period of 2008. We finished the quarter with cash of $346.4 million that’s compared to first quarter’s ending balance of $327.3 million and at year end 2008 cash balance of $289.4 million. Our cash provided from operating activities during the quarter totaled $57.7 million. Cash used in investing activities for the quarter of $30 million was primarily applied as $13.1 million for the acquisition of Salvador Imaging and capital expenditures of $16.9 million which included the purchase of a building in Sweden for approximately $9 million. Cash used by financing activities of $21.6 million during the quarter included common stock repurchases of $28.1 million for 1.1 million shares at an average price $25.23 per share, while receiving $4.6 million from the exercise of stock options in employee stock plan. Year to date, cash provided by operating activities was $132.1 million, cash used in investing activities for the first half of 2009 were $41 million includes cash used for the acquisition of Salvador Imaging as previously mentioned, $26.8 million of net capital expenditure and $1 million of other investments. Cash used by financing activities of $37.7 million year to date includes the repurchase of common stock of 2.1 million shares for an average of $23.30 per share and the receipt of $9 million from the exercise of stock options and employee purchase plan. This concludes the summary of second quarter and year to date 2009 financial results. I’ll now turn the call back to Earl.

[Earl Lewis:]

I think we’re ready for questions.

[Operator:]

(Operator Instructions) Your first question comes from Tim Quillin – Stephens, Inc.

[Tim Quillin:]

With regards to the Government business we saw a quarter to quarter decline in revenue for the first time I can remember. It’s a little bit hard from the outside to know exactly when your deliveries are scheduled and so I’m just wondering if you could give us a sense of how much Ray, G-Boss, BETSY, I guess particularly BETSY is impacting the timing of revenue, how it impacted 1Q to 2Q and what the second half looks like versus the first half. What kind of order activity you expect on the Government side in 3Q?

[Bill Sundermeier:]

As we mentioned before we’ve been level loading our factories especially in Portland because of this quality of Ray systems that we’ve had out there and the level loading I expect to continue the second half of this year. The demand we certainly have a large backlog and we’re pushing them out as fast as the Ray group would like them and want to deploy them. This most recent order that we had kind of reiterated the vast majority of that will probably land in the first half of 2010. I think you’re going to continue to see us in the same kind of space here for the remainder of the year for revenue. Whether or not it’s up 5% or down 5% it really depends on some of the costs and timing of those orders.

[Operator:]

Your next question comes from Jonathan Ho – William Blair & Company

[Jonathan Ho:]

On your revised guidance, can you maybe give us a little bit more color by segment in terms of your expectations and maybe a breakout of I guess how it impacts by segment the reduction.

[Earl Lewis:]

I don’t have that handy but basically the number one delta from our original guidance is our Thermography business which continues to disappoint in that we keep thinking that it really should be returning and getting stronger and yet it really didn’t in Q2. Two things in Thermography in Q2, one is you noticed that the backlog actually went up and when you adjust for currency we were down I think 3% or 4%, I forgot the exact number. When you include the backlog and currency the order rate wasn’t down anywhere near what it was in Q4 compared to Q4 a year ago or Q1. The rate seems to be improving but I think we feel at this point we’d rather say that that business is going to continue to be weak for the balance of the year. Our Commercial CVS business while it had very strong orders we don’t see the double digit growth we might have year ago. That’s the majority of the delta. Our Government Systems business we’re trying very hard as you know to try level that out between this year and next year. If a little of that backlog slips into next year that’s probably okay with us. Its really not one division, I think its all three that we’ve reduced our expectations slightly from where we were at the end of the year.

[Operator:]

Your next question comes from Brian Gesuale – Raymond James & Associates

[Brian Gesuale:]

I was wondering maybe if you could give us a little bit more color on distribution and then maybe talk a little bit about the ongoing relationship with Grainger specifically.

[Earl Lewis:]

I think that that relationship continues to get stronger for us. We’ve been very, very pleased with how well they’ve done for us as a company and I think they with us. Arne might have some more color.

[Arne Almerfors:]

I agree with you we are very pleased with the cooperation we have with Grainger and see very positive signs going forward in the [inaudible] and it’s a challenge to both of us to see what we can do in the future about this relationship.

[Earl Lewis:]

I believe we’re taking market share there.

[Arne Almerfors:]

We are.

[Operator:]

Your next question comes from Peter Arment – American Technology Research

[Peter Arment:]

On the Tau camera core could you maybe give us just a little more color on, you mentioned its being well received but how things are changing with customers. Then also I think you mentioned the 16% increase in volumes for security maybe if you could provide a little more insight there that would be great.

[Andy Teich:]

On the Tau issue, Tau has been doing very well in the market and a couple of years ago when we set out to develop that product we identified some areas of improvement in our proton core which were selling at that time and still sell today that we felt would open doors with people that were using cores from other suppliers in the industry. Tau does a very nice job of addressing those issues and we believe offers capabilities that other cores don’t offer on the marketplace, for example, the ability to have several different formats in terms of pixel in the same size of compact in the product. We had several companies that are using fairly large volumes of Thermal cores out there that have switched from using a competitive product to using our product. Focus One is one of those I think we mentioned perhaps during the last conference call in the prior market launched a new product using the Tau core which we’re quite pleased about and I think they’re quite pleased with us. On the security sector we continue to see increased volumes of our un-cool products so this is products in line of products we call FR series and these are singled field of view cameras that are basically a drop in replacement for standard CCTD installation and we’re seeing those things go into everything from nuclear power plants, infrastructure protection programs, ports, airports, then even things like golf courses and private residences where they like the fact that this is really a green solution to a problem meaning a solution that does not involve continuous lighting of an area in order to maintain surveillance.

[Operator:]

Your next question comes from [Mark Strough] – JP Morgan [Mark Strough] – JP Morgan We saw that Fluor and Dynacore have been awarded contracts to build army bases in Afghanistan. Do you believe that the existing Ray G Loss BETSY contract anticipated this build out and if not what do you think would be the funding vehicle for the sensors for these bases and would this be potential upside for FLIR in either ’09 or ’10?

[Bill Sundermeier:]

I think that they anticipated this build out when the directional IDIQ from what we can tell right now they’re still deciding how many systems are going to perhaps leave Iraq and go to Afghanistan or are they going to leave them in Iraq and add additional to Afghanistan. Of course we’re hoping for the later that would give us some more potential. If there are more to be added it’ll go through another contracting vehicle as far as we can tell where they would issue an RFP for a competitive solicitation, that’s what we can determine right now. We do know that their parts, are working on an RFP but don’t have a good, we thought there might be an RFP out by now but they’re still holding on to that. We don’t have an accurate timing of when that might happen.

[Earl Lewis:]

Clearly I think that announcement was for 200 new bases from memory. Typically somewhere between two and four sensors per base, the opportunity could be as much as 800 sensors. The question is what kind, the terrain I believe is different there, how you might mount them is different, what kind of sensor you might use may or may not be the same. I think that the distances might be less in general, a lot to be determined. We’d be speculating regarding what they do with the existing hardware but I’m not 100% sure the existing hardware is a great match for that terrain or that mission. New hardware could very well be possible and it could very well be in larger quantities because of the number of bases. We have not figured that into anything this year.

[Operator:]

Your next question comes from Chris Donaghey - SunTrust Robinson Humphrey

[Chris Donaghey:]

I understand you’re trying to level load the factories right now and just based upon what you’re seeing from an order flow or pipeline of order flow, how comfortable are you as you move into 2010. I know you’ve been working to try to make sure that you can squeeze out a few points of growth if you can in 2010. How comfortable are you at this point that that plan is building as you would expect.

[Earl Lewis:]

The real issue is the order entry side. We know how to manage our backlog and we are, that’s the relatively easy part. The question is what’s going to be the fill rate in the second half of this year relative to what we’ll be able to do in 2010. Still a little bit undecided on that, that’s a little bit up in the air. There was some slowness in Q1 and Q2 relative to DOD, I don’t know whether that’s going to continue or not. I know that they’re going to deploy more people in Afghanistan, which may be a plus. We know that there’s some other programs that we’re working on that can be a plus but today all we know is what our existing backlog is, our forecast for entry for the next part of the year and we think that we’re on track to obtain what we’re trying to do which is to have the two years be essentially about the same in Government. That’s a plan, so we talked about I believe two quarters ago and we’re sticking with that plan. Right now I believe with our existing backlog we’re probably in pretty good shape to execute that.

[Chris Donaghey:]

The IDIQ backlog if you have it. With the new level of notes that are left to convert what interest expense should be for the back half of the year and what the interest add back would be on the earnings per share calculation.

[Earl Lewis:]

Whatever that number is it’s the identical number. In other words on the convertible it’s the same take out as add back. We did have an opportunity; we did acquire roughly $30 million worth of convertible bonds early this quarter so I think our number now is down around 55 or so of whole convertible debt. That interest rate is exactly equal to what you add back. Its 3% from memory so it would be 3% and 55 taken out and added back. Oh that’s right they changed the rules. I’m sorry.

[Steve Bailey:]

We’re just in the process of looking it up here for you. We don’t have a roll up of the IDIQ backlog right now; we’ll have that for you in the next couple of days. I shouldn’t say IDIQ backlog, the IDIQ unfilled. We’ll have that for you in the next couple days.

[Earl Lewis:]

It can’t be a lot of money.

[Steve Bailey:]

For Q3 we’re looking at an add back of about $588,000, about $900,000 on the interest and amortization expense. You can call back sometime too we can give you a better breakdown.

[Operator:]

Your next question comes from Brian Ruttenbur - Morgan Keegan & Company

[Brian Ruttenbur:]

The mix of revenue for the next couple quarters for the rest of the year you gave guidance of revenue and earnings on the year and you produced about $0.70 in earnings in the first half of the year. Can you tell us how maybe go to earnings first, how the earnings are going to shake out for the second half of the year? You did $0.35 and $0.35 so you expect third quarter be down a little bit from that level and then fourth quarter up or can you talk about that a little bit.

[Earl Lewis:]

Roughly we think $0.35 again and then slightly more Q4.

[Brian Ruttenbur:]

Revenue breakdown imaging Thermography do you expect on the imaging side revenue to be up sequentially in the third quarter?

[Earl Lewis:]

I think about where we are. I don’t think it’s going to be up much or down much. I think that this year is going to be a pretty consistent quarter to quarter. Q4 historically our Thermography business is much stronger so we would expect to see that happen again. Otherwise I would say that would be the flow out of the quarters Commercial and Government and Thermography in Q3 would be like Q2 and Q4 the Thermography business should be stronger.

[Brian Ruttenbur:]

The imaging business should be flat from Q3 then to Q4.

[Earl Lewis:]

It’s traditionally up a little bit so I would expect it to be up a little bit as well.

[Brian Ruttenbur:]

Can you talk a little bit about the Government backlog decline a little bit more about that? Were there any specific programs that hit you or any cancellations that hit you?

[Earl Lewis:]

No cancellations.

[Operator:]

Your next question comes from Steve Levenson – Stifel Nicolaus

[Steve Levenson:]

At the Paris air show you introduced a new Star SAFIRE, can you tell us a little bit about the significance of the short wave infrared sensor in that and what you think that do for business. Unrelated, what drove the good growth in the Pacific during the quarter?

[Bill Sundermeier:]

At Paris air show we really wanted to grow out our second generation Star SAFIRE HD. The first generation of that provided HD sensors in every one of the channels. We had a low light eye square device that we actually provided HD so we had visible eye square HD and medium weight infrared and that was the 720P if you know the different definitions of HD now we’re moving on to 1080P in the visible. Short wave which is a better sensitive camera the eye squared cameras we were trying to put low light into our systems which you have to reduce the F number to be on the see as far as we do. The short wave cameras give us a lot more sensitivity, it gives us a bunch of night glow operations and allows us to see identifications on boats, on buildings, see into windows, and augment that. Of course if we do that with all the different sensors so you’ll have the best of all those worlds. Its going to help us also some things that we can do once we have short wave in our systems allows us to see designation spot. We can augment being able to help designation systems and then eventually migrate that into our designation systems to be able to see the spot. It’s really a very broad spectrum imager now continuously from visible all the way into the medium wave through low light. The first of its kind and really with all the intensification on ISR here and the budget I think that it’s going to provide a nice prospect from solution in full HD across all sensors. There are other competitors out there that might have one HD camera in and are calling their cameras HD but we have all of our sensors being full HD into the cockpit. Really is going to separate us out in the market space having the most advanced high definition system available.

[Earl Lewis:]

I think the second part of your question related to Arne’s comment on the growth in the Pacific.

[Arne Almerfors:]

We are very pleased with the effort that we have achieved. We have over the last year consistently been working to build up a new structure for us in this territory. As of today we are now placed with our own companies in Japan, Korea, China, Hong Kong, Australia, etc. There is definitely support in the fact that we can now build our business with our own sales force in combination with extended distribution efforts that we have built through the years. That’s part of the reason of the success that we see right now.

[Steve Levenson:]

Was any of it related to Swine Flu and is that sustainable?

[Arne Almerfors:]

This growth is going to be sustainable but of course in order we have an impact of the Swine Flu.

[Earl Lewis:]

The Swine Flu we did receive our first order in Europe for these camera for identification of people with fevers and it does appear that there are a number of other people entrusted in isolating perhaps even earlier maybe even when people get on airplanes determine weather they have a fever or not. Whether that’s repeatable or not I think the question is do people want to know if people are sick on airplanes or off airplanes I think that when you have this issue of course it becomes very much the forefront we don’t know how to predict that we don’t have a big number for swine flue in our plan for this year that is an upside potential and I’m glad you brought it up.

[Operator:]

Your next question comes from Michael French – Morgan Joseph

[Michael French:]

I had a question about development in the marketplace since the last call your competitor access technologies was sold to General Dynamics and just wondering if you think that this is going to impact the dynamics in the marketplace?

[Earl Lewis:]

No I do not. That’s a fairly easy question to answer. Their business was roughly 75% manufacturing lenses for different applications including infrared, about 25% actually making infrared cameras. We don’t I believe by the statements that they’ve made that they think that a lot of their capability will be used internally within the company. They’ve been a competitor of our, as you pointed out, they’ll continue to be a competitor but I don’t believe there’s going to be a big change one way or the other.

[Operator:]

Your next question comes from Ajit Pai - Thomas Weisel Partners

[Ajit Pai:]

On the cost side how much more potential is there for you folks to cut costs further, and what sort of broad areas could you focus on? The second question would be uses of cash that you have and the acquisitions, how you’re thinking about them right now and what potential do you see over there over the next 15 to 24 months.

[Earl Lewis:]

Cutting costs is something that’s a continuous activity. Our strategy has been now for nine years or 10 years is to reduce our costs and to pass most of it on to the customer. We’re going to just continue to do that. As our volumes increase and our volumes did increase fairly significantly again in Thermography and in Commercial Vision in Q2 that cost savings that you get out of the learning curve and high volumes we try to pass on. We’ve been keeping a little more of it as you can tell because our gross margins have been increasing. Our ability to cut costs and reduce our costs continues. There is plenty of opportunity in that area for us over the next five years. As far as our cash goes, we’ve historically tried to deploy it in relatively equal amounts in stock buy back for example and acquisitions. There are a number of acquisitions we’re looking at today, I’d say it’s probably more than normal but that’s a fair statement. We think that there are some opportunities there because we believe the prices have finally become a little more realistic. They weren’t last year and they are starting to be more realistic. I think we will have an opportunity to deploy some cash in the second half of this year for acquisitions.

[Operator:]

Your next question comes from Michael Ciarmoli - Boenning & Scattergood, Inc.

[Michael Ciarmoli:]

I want to be clear, with the level loading of the Government Systems business it sounds like you’re targeting 15% growth in ’09 and I’m just wondering if that’s also the kind of growth target for 2010? Just a follow up on the access question, Gyrocam was recently acquired last night by Lockheed, I wanted your thoughts on that one and if that was a company you guys were looking at in terms of an acquisition?

[Earl Lewis:]

It was fairly public that that company was for sale. We did of course know about it. They were very successful in winning one program; I think it’s called VOSS. We weren’t 100% sure where that program was going to go in the next two to three years so it made it very difficult for us to value the business. We did look at it. I don’t believe again just like Access that there will be a significant or a big change to the competitive environment about these companies buying these businesses. Large companies tend to not do too well selling components to other large companies. I don’t think that by these large companies absorbing these businesses they necessarily will become more competitive in those environments because I think they tend to want to use the products that are made themselves. That’s why they do it, sort of a backward integration activity just like FLIR has over the years. I just don’t see that as material to us one way or the other. We don’t expect Government business to grow 15% next year. We’ve been pretty open in terms of thinking that the plan is to try to keep it at about the same level as of this year. If we get some slight growth good but we don’t see, its very difficult when you have one fairly large program like this BETSY program to predict another large program to take its place. What we’ve said to this question is that we think that this year and next year will be more alike than they would be traditionally in our business where you see a sequential growth year over year. That’s what we’ve been trying to do with that business. The other side of the coin is we do suspect 2010 we’ll see both our commercial business accelerate.

[Operator:]

Your next question comes from Tim Quillin – Stephens, Inc.

[Tim Quillin:]

You’ve talked a little bit about this, gross margins have clearly improved this year, that hasn’t necessarily been your strategy because efficiencies that you gain you like to push to customers to drive growth. How are you thinking about it, is that a sustainable level at 58% is that the way you’re thinking about second half guidance and then is that the way we should think about the gross margin profile going forward and how will mix play into that as well.

[Earl Lewis:]

Gross margin is very strong for us right now, it’s at 58%. Traditionally we’re more like 55% or 56%. We would try to hold in that range. The mix can throw that a couple of points one way or the other. I wouldn’t read anything into one way or the other. We’d like to be a little higher actually if I could. If we could have gross margin in the 58%, 59% sustainable I wouldn’t mind that. We’re not planning on that, we’re planning more on the 56%, 57%, 58% and having it vary between those numbers. I wouldn’t read that we’re trying to get to 60% because we’re not. I wouldn’t read we’re going to be at 58% because we’re not. I think where we are is about where we should be.

[Operator:]

Your next question comes from [Mark Strough] – JP Morgan

[[Mark Strough]:]

If you could dig down into the Government Systems gross margin, your outlook there.

[Earl Lewis:]

Pretty consistent. That can be mix driven if we had one of the large, large programs, gross margin would come down because those are typically more cost competitive on the material overhead that you’re going to have. Given a continuation as business is I would suspect that the gross margin maybe will come down a little bit because it’s a little rich right now.

[Operator:]

Your next question comes from Jonathan Ho – William Blair & Company

[Jonathan Ho:]

A follow up in terms of the CVS backlog increase, how large do you think the opportunity for EADS can potentially be and also with regard to the CVS backlog where did that increase come from?

[Andy Teich:]

Two things, the first is the EADS opportunity, the Saudi border program is a five year program and at this point involves in the neighborhood of about 200 systems. That’s going to be spread over five years so we look at is as a nice foundation builder for us if we receive subsequent awards on that the total dollar value is in the $8 to $10 million range per year that we would see out of that over a five year period. Your second question was in regard to growth in the backlog, we’re spread pretty evenly across the different segments within our business so we saw additions in backlog in the maritime sector for our higher performances as I mentioned the sales that we made into [metaya] community and also into the commercial shipping opportunities in those went into backlog. The security sector we had quite a bit of activity there, order activity that I discussed that was also put into backlog and in our forestry components area much of the Tau ordering that was done during the quarter went to the backlog as well.

[Operator:]

Your next question comes from Michael Lewis - BB&T Capital Markets

[Michael Lewis:]

My primary question is if you could talk about what your expectations are with regard to re-tapping some of the gimble systems that you deployed over say the last three, four, or five years. Would you expect to see a new contract opportunity play out or with the Army and other customers actually just contract with you system by system basis?

[Bill Sundermeier:]

Your question is upgrading to new systems and we have quite a bit of that going on all the time. A couple of quarters ago the Royal Australian Air force decided to upgrade from their standard Star systems to HD systems and gave us several million dollar contract. Those are ongoing typically they don’t compete, they use upgrade money or sustainability money to be able to do that. We tend to announce those if they’re fairly large $3 or more million. That is ongoing. Here with the medevac program many years ago they were on a Star II, they have a few of those systems but primarily they wanted to get onto a new platform that was lighter to see a lot better and that would literate itself. The military tends to use sustainability, maintenance dollars, instead of doing competition that’s why we’re seeing those go. We do a fair amount of upgrade to new technology. With HD coming online as we see more and more cockpit upgrade to be able to handle the HD display I think we’ll see surge in HD deliveries.

[Michael Lewis:]

The reason why I asked the question is because if you look at sources like [inaudible] I’ve seen a surge here over the last three to six months with regard to pre-solicitation for replacements of systems so that’s where I’m kind of trying to understand what does it look like in the future with regard to all the many hundreds of systems you’ve already deployed.

[Bill Sundermeier:]

Obviously there is a resurgence because of the ISR mandates that’s out there. I’m hoping that those requests for information do turn into RFPs in the end of this year and 2010 we do see a resurgence there. We have hundreds and hundreds of systems out there we’d like to upgrade them and certainly upgrade the competition to our systems especially since we have state of the art right now.

[Michael Lewis:]

With regard to the P&L there was a swing, I’m not sure I caught up on the call a little bit late today, there was a swing in other expenses in Q2 it went from a positive $3.6 million last year to a negative $1.1 million. What exactly was that?

[Earl Lewis:]

Currency. About a $0.01 to $0.015 a share compared to Q1. That’s way beyond the operating side of our business. That does conclude our call. I think that this certainly was an interesting quarter. I hesitate with these numbers but I am one that plays with them. I think that if we are lucky to sustain our delta and backlog of roughly $20 million this quarter over a number of quarters that would be about 30 quarters to leap the backlog at that rate. That was a quarter made up of no particularly big contract wins. If you evaluate our business in that basis it tells you how strong we really were this quarter and it was a great quarter. Thank you all for listening and look forward to talking to you at the end of Q3.

[Operator:]

Thank you for joining today’s FLIR System Conference Call. You may now disconnect.