FLIR Systems, Inc.
Q3 2009 Earnings Call Transcript

Published: 21 Oct 2009

[Operator:]

Good morning. My name is Rebecca, and I will be your conference operator today. At this time, I would like to welcome everyone to the FLIR Systems third quarter 2009 financial results conference call. I will now turn the call over to Mr. Wit Davis, Senior Vice President, General Counsel and Secretary of FLIR Systems. Sir, you may begin.

[Wit Davis:]

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 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?

[Earl Lewis:]

Thank you, Wit, and thank you all for joining us this morning. Q3 was another good quarter for FLIR. Earnings per share were up 9% to $0.38 and a 3% increase in revenue. Commercial Vision Systems revenue increased by 15% its best growth since Q3 of last year, and Government Systems revenue was up 7%. Our Thermography sales declined 12% in the quarter. However, order trends improved our Q3 bookings were near the levels of Q3 ’08. Quarterly operating income increased 17% from Q3 of last year to a record $89 million resulting in a record operating margin of 31.3%. Our continued focus on cost containment yielded 8% reduction in the SG&A expenses from last year. Operating cash flow was $67 million and year-to-date operating cash flow of $199 million, represents a 117% of our net income. Our total backlog increased by $10 million to $608 million at the end of Q3. Government systems orders were seasonally strong, so we added to the backlog. Thermography orders also improved significantly from the first half levels, and CVS bookings were also very good, although our backlog was impacted by a debooking of a large order due to a program delay. We are fully expect to rebook this order in the near future. During the quarter, we repurchased approximately 1.1 million shares of our common stock at an average price of $21.40 per share. Thus far in ’09, we have repurchased 3.2 million shares at an average of $22.64. Also during the quarter, an additional $30 million of face value of our senior convertible notes were redeemed, reducing the base amount outstanding to approximately $61 million. The remaining notes are callable at FLIR’s option in June of next year and we anticipate doing so at this time – in that time. Today, we announced the acquisition of OmniTech Partners, a leader in the development and manufacturing of image intensification and fused I-square and thermal imagers for $42 million in cash. This transaction extends FLIR’s product line and technology base in the image intensification, a large adjacent market to our core infrared capability. We see significant distribution synergies in this combination. But clearly the most interesting opportunity is in the area of fused, thermal and I-squared imaging. We expect this transaction to generate good returns on our investment and to immediately add to cash flow, while being immaterial to GAAP earnings per share in Q4 in 2010, due to the intangible amortization. We are delighted to welcome the 70 plus employees of OmniTech to FLIR. Our three division Presidents are here with me to comment in greater detail the results of their businesses in Q3. We will start with Andy, President of Commercial Vision Systems. Andy?

[Andy Teich:]

Thanks Earl. Commercial Vision Systems Q3 revenue was $52.6 million an increase of 15% compared to the third quarter a year ago, and the fastest growth in the year. Total unit volumes were up over 15% indicating a shift to higher volume lower-priced products. Backlog decreased $15 million during the quarter to $93 million due entirely to the cancellation of a large order resulting from a delay in project timing. Excluding the cancellation, orders were up modestly from last year driven by outstanding bookings in Europe, resulting in total backlog at the end of Q3 being up by 14% over the third quarter a year ago. Operating income for Q3 was $11.7 million, up 16% from the prior year. Operating margins were 22%, which is basically flat with prior year. Demand in the US security and surveillance market increased significantly compared to the prior year with orders up 24% and unit volumes up over a 100%. Bookings were particularly strong in the nuclear power industry where new nuclear regulatory commission regulations require 24/7 surveillance by the end of April of 2010. We had two major product launches during the quarter. First in the July, we launched the H-Series line of handheld thermal imagers, initially addressing the law enforcement market the H-Series family of products has applications across a wide-variety of applications where a low-cost handheld thermal imager is needed. The H-Series offers four times the resolution of comparable older generation systems at about half the price. The units have a rich feature set including digital image capture, digital movie recording, multiple lenses and optional wireless video transmission. Initial response from the law enforcement community has been outstanding. At the AFA’s trade show in September, we launched 18 new security products in four entirely new product families. These products feature full Internet protocol connectivity, built-in nexus networking software, advanced video analytics capabilities, and of course lower price points. One of the four product families features low-life color imaging using an EMCCD camera provided by Salvador Imaging, which is now known as FLIR Advanced Imaging Systems that we acquired during Q2. With these new product lines, we are very well positioned to expand multiple segments of the security and surveillance markets including critical infrastructure, commercial and residential. In the maritime market, orders were up significantly compared with last year, driven by continued market penetration and the recent launch of our M-Series midrange maritime line. The strong performance of the maritime segment this year in a very weak overall new boat markets provides convincing evidence that the maritime market offers significant growth opportunities. As a result, we will continue to expand our product line to grow this potentially very large market. In September, we launched the First Mate, the world’s first waterproof handheld high-performance maritime thermal night vision camera for under $3,000. This unit which is a derivative of the new H-Series line discussed earlier, the First Mate underscores the benefits of our highly flexible product development strategy. Given the compelling advantages of infrared technology and the maritime environment and the expanding breadth of our product line, we expect to see strong growth going forward from this segment. Demand in our cores and components segment was up slightly from the prior year as slow automotive orders offset growth in another segments. Excluding auto, unit volumes were up nearly 200% over the prior year, highlighting the breadth of our OEM customer base and the success of our new top platform. We continued to capture additional customers and we believe gain market share. Looking to the fourth quarter and beyond, we see strong performance driven by a stabilizing economy and the launch of new products in each of our major market segments during the year. Also in the fourth quarter, a second premium automotive manufacturer will launch a new vehicle that includes the Night Vision II system with pedestrian detection that we’ve developed together with our partner Autoliv's. We are excited about this launch and expect this manufacturer to launch NV II and additional vehicle lines next spring. That concludes my comments. Let me now turn the call over to Arne Almerfors, President of the Thermography Division.

[Arne Almerfors:]

Thanks Andy. Thermography revenue in Q3 was $69.9 million, a decrease of 12% from the third quarter of 2008, but up 5% from the second quarter reflecting stabilizing markets overall. Asia Pacific continued to perform exceptionally well with the revenue up over 50% from the prior year due to strong growth in China, Japan and Korea. Over the past several years, we have greatly expanded our organization in Asia Pacific to gain better access to customers and controlled distribution and branding. As a result of these efforts, we expect continued strong growth in Asia Pacific in 2010 and beyond. In fact, China has already emerged as the second largest market for FLIR Thermography behind only the US. Thermography’s operating margin in Q3 was 26%, up from 21% last year due to improved gross margins and other cost controls. Our Q3 gross margin was the highest in two years, resulting in a 9% increase in operating income to $18 million. Despite lower revenue, year-to-date operating margins are up 4%, highlighting our ability to maintain pricing, drive efficiencies and control cost in a tough economic environment. From a market segment perspective, the building market continued to do well in the third quarter, and now represents over 30% of our revenue. We also saw a strong demand for channels used to detect elevated body temperatures in an effort to contain swine flu, particularly in the Asia Pacific region. The electrical, mechanical and gas imaging markets were again weak in the third quarter reflecting continued depressed capital spending activity. We have continued to seek out emerging market opportunities for Thermography cameras. One example is the food safety market where the thermal cameras have been used to assure that food is kept within critical temperature tolerances throughout the entire food delivery supply chain, reducing the risk of food-borne illnesses. And for this applications, thermal cameras are beginning to replace spot pyrometers due to their higher capacity, better quality and lower labor requirements. As price points with Thermography cameras continue to decline, we expect this application to grow rapidly. In fact, we are seeing strong safety and food safety test market activity in Japan. In the high water mark segment, we recently reduced the price of our low-cost i5 camera to $1995 from $2995, the lowest cost Thermography camera in the world by a significant amount. We also introduced the i7 camera, a higher resolution variant of the same platform to a $2995 price point. The initial market response to the i5 price reduction has been excellent. The volumes are up more than over three fold. Our continued cost reduction efforts have allowed us to attain the price point of gross margins that are consistent with overall divisional margins. Looking forward, we do foresee normalcy and improvement in Q4. Volumes should remain strong as competitive dynamics remain stable. And looking beyond 2009 are high-quality low-cost product portfolio. The high-volume production capacity positions us to continue to lead the dynamic Thermography industry. That conclude my comments. So let me now turn the call over to Bill Sundermeier, President of Government Systems Division.

[Bill Sundermeier:]

Thank you, Arne. Government Systems third quarter revenue was $163 million, an increase of 7% from the prior year and Q3 operating income of $71.8 million was up 12%. Operating margins of 44% remain near record levels resulted strong mix, operating leverage and cost control. Total backlog was $487 million at September 30th, up approximately $20 million compared to June 30th. Third quarter order activity in the US rebounded from a solid first half of the year, reflecting broad based customer demand. We have received over 90 orders during the quarter for a wide variety of products and applications with air borne systems and land based systems contributing equally to growth. In addition to the $37 million BETSY order we received early in Q3, we received a $10.6 million follow-on order from NSWC Crane under our previously received $125 million requirements contract for BRITE Star II multi-sensor systems. Including this order, approximately $90 million has now been ordered under the contract. We have received multiple orders related to Black Hawk operations in the US, including a $15.4 million order for Star Sapphire systems from the US army to support ongoing Medevac missions, and a $22 IDIQ contract for Star Sapphire II turret assemblies to support search and rescue and Medevac helicopters currently in service. These orders demonstrates the value of our systems to support the diverse missions of the Black Hawk platform. Q3 was also a strong quarter for Recon III handheld systems with approximately $14 million orders from 15 different customers. During the quarter, we celebrated the sale of our 1000th Recon camera. Quarter activity remained robust internationally as well led by a $7.2 million order from the Indian Air Force for a Star Sapphire III systems for military defense airborne machines, for Ministry of Defense Airborne missions and a $4.9 million order from the Colombian Military for Star Sapphire III systems for airborne day and night counter narcotic and counter insurgency missions. Year-to-date, international orders have been exceptional. We announced a memorandum of understanding with Sofradir, a major French military contractor to provide us with specialized dual band infrared sensors for our emerging high end applications worldwide. As Earl mentioned in his comments, we are well pleased today with today’s purchase of OmniTech Partners. OmniTech enhances our position in the thermal weapon site market and adds image intensified capability to our product line. We see great potential in combining OmniTech strength and weapon mounted systems and image intensified product design and technology with FLIR’s low cost infrared capabilities and worldwide distribution. In particular, we believe there is a large opportunity to deliver high-performance low-cost fused imaging systems that bring the benefits of both technologies to the soldier and soldier-based market for 24/7 operation. We expect soldier-based systems to be a growth area for FLIR and the acquisition of OmniTech significantly enhances our position in this market. I would like to add my enthusiastic welcome to OmniTech’s talented employees. We are delighted to have you on the FLIR team. Looking forward, we expect fourth quarter orders to be seasonally lower than Q3. That said, our visibility into 2010 has improved and we are still tracking to our goal of flat revenue compared with 2009. We remain very bullish on the long-term prospects for infrared systems in military applications and look forward to expanding our current markets while entering new markets and new applications. That concludes my comments. Let me turn the call back to Earl.

[Earl Lewis:]

Thank you all. Our Q3 results again demonstrate the strength of our business. We believe we have the lowest cost in our industry, a well diversified base of revenue, growing product lines and increased brand awareness. We are confident these strengths combined with our market and product development efforts this year will result in split growth for both of our Commercial businesses as the world economy recovers. Our Government System business is also well positioned for the future with proven products, low cost and outstanding customer service and support. We are seeing continued excellent cash flow has helped us to maintain a strong balance sheet through this economic period. We will continue to deploy this through stock buybacks, acquisitions and capital equipment to improve our productivity. The acquisition of OmniTech and the Salvador Imaging in Q2 are good examples of the opportunities available. We will continue to pursue these acquisitions to expand our product lines, our distribution and our technology base. Looking to the rest of the year, we expect seasonal strength in Thermography, continued strong deliveries in Government Systems to support a solid Q4. As a result, it appears likely we will be at or above the top end of our current full-year earnings per share outlook on the $1.40 to $1.44. We are just now entering our budget planning for 2010 and we will provide a full-year outlook on our conference call in early February. Before I turn the call over to Steve for a review of the financials in detail, I would like to again thank our dedicated employees for their focus, execution, and continued contributions to our success. Steve?

[Steve Bailey:]

Thank you Earl. I will quickly try to summarize the quarterly financials here. Revenue for the third quarter of 2009 totaled $285.6 million, an increase of 3% from the same quarter last year. Revenue from Government Systems amounted to a $163 million, a 7% increase as compared to the third quarter of 2008. Our revenue from Thermography of $69.9 million, a decrease of 12% over the third quarter of 2008, and revenue from our Commercial Vision Systems Division of $52.6 million was an increase of 15% as compared to the third quarter of 2008. For the quarter, revenue is distributed 57% from Government Systems, 25% from Thermography, and 18% from the Commercial Vision Systems. Our international revenues for the quarter were $124.3 million, which were 44% of total revenue, while revenues from the US government sales of $125.1 million was also accounted for 44% of consolidated revenue during the period. For the first nine months of 2009, the revenues totaled $835.5 million, an increase of $60.9 million or 8% in the same nine-month period of 2008. Year-to-date revenue from Government Systems of $285.6 million increased $88.5 million or 22%. Thermography revenue of $200.6 million decreased 16% and revenues from Commercial Vision Systems of $149.3 million increased $11.1 million or 8% over the first nine months of 2008. Year-to-date Government Systems revenue is 58% of total revenue, while Thermography and Commercial Vision Systems represent 24% and 18% respectively of total revenue. For the first nine months of 2009, international revenues of $339 million or 41% of the total revenue were revenues from US government sales of $375.3 million or 45% of consolidated revenue for the nine-month period. We closed the quarter with a backlog that is orders enhanced delivery within the next 12 months of $608 million, a net increase of $10 million or 2% during the quarter from the second quarter of 2009. At quarter-end, division backlog amounted to $487 million for Government Systems, $28 million in Thermography, and $93 million in Commercial Vision Systems. Gross margin for the quarter was 57% of revenue, up slightly from 56% of revenue in the third quarter of last year. For the first nine months of 2009 gross margins were 58% as compared to 56% for the same nine-month period of 2008. Research and development expenses of $21.3 million or 8% of revenues for the quarter as compared to $21.6 million or 8% of revenue third quarter of 2008. For the first nine months of 2009, the company has incurred research and development expense of $66.9 million or 8% of revenue as compared to $68.3 million or 9% of revenue during the same period of 2008. Selling, general and administrative expenses for the third quarter of 2009 of $52.2 million were 18% of sales as compared to $57 million or 21% of revenue for the same period of 2009. The decrease in cost attributable to the lower selling cost in our Thermography operations, lower legal costs, and in general lower administrative costs from all operations during the period. For the first nine months, selling, general and administrative expenses were $158.2 million or a 19% of revenue as compared to a $167.9 million or 22% of revenue in 2008. Earnings from operations for the third quarter totaled $89.3 million or 31% of revenue as compared to $76.7 million or a 28% of revenue in the third quarter of 2008. The 17% or $12.7 million improvement in operating profit is compared to the third quarter of 2008 as a result of a 3% increase in revenues and a 5% improvement in gross margins generated administrative operating cost savings for the same period. For the nine months of 2009, earnings from operations were $257.3 million or 31% of revenue, an increase of $60.9 million or 31% over 2008. Interest expense for the quarter totaled $1.2 million as compared to $3.5 million for the same period last year. For the first three quarters of 2009, interest expense was $5.7 million as compared to $10.9 million in 2008. The majority of the interest expense relates for a convertible notes and the decrease in the year-over-year interest expense is due to notes that were converted to shares in December of 2008, March 2009, and July of 2009. To date, the company has converted a $148.5 million of face value of convertible notes to shares. The face value in remaining notes outstanding after prior conversions is approximately $61.5 million and are subject to call in June 2010. During the quarter, the company incurred $1.7 million of net other expense. This includes $3.1 million of currency losses partially offset by $1.4 million of interest and other income. Year-to-date and other expenses amount to $1.7 million includes currency losses of $4 million and interest and other income of $2.3 million. Based on an anticipated mix of foreign and domestic income for the full year and year-to-date true-ups from prior periods, there were recognized discreet items in the current quarter, the effective tax rate for the quarter was approximately 31%. And we expect the annual rate to approximately 32% to 33% for the year. For the third quarter, net earnings were $60 million or $0.38 per diluted share. The 10% or $5.3 million increase in net earnings compares to net earnings of $54.8 million or $0.35 per diluted share for the same quarter of 2008. For the nine months of 2009, net earnings of $170 million or $1.07 per diluted share, a $34 million or 25% increase over the same period of 2008. We finished the quarter with cash of $403.3 million as compared to Q2 quarter and cash balance of $346.4 million and a year-end 2008 cash balance of $289.4 million. Our cash provided from operating activities during the quarter totaled $67.4 million. Cash used in investing activities for the quarter of $3.2 million is primarily applied as net capital expenditures of $4.8 million and $1.6 million were provided by other investments. Cash used by financing activities of $18.2 million during the quarter included repurchase of approximately 1.1 million common shares for $24 million or $21.40 per share, and the receipt of $4 million from the exercising stock options during the period. Year-to-date cash provided by operating activities was $199.4 million. Cash used in investing activities for the first nine months of 2009 of $44.2 million includes $31.6 million of net capital expenditures and $12.5 million spent for acquisitions and other investments. Cash used by financing activities of $55.9 million year-to-date primarily relate to the cash used of $73.2 million to repurchase approximately 3.2 million common shares at an average price of $22.64 per share, partially offset by $19 million generated from employee equity programs. This concludes the summary of third quarter financial results and 2009 year-to-date. And let me turn the call back now to Earl.

[Earl Lewis:]

Okay. Thanks Steve. And Rebecca, we are ready for some questions.

[Operator:]

(Operator instructions). Your first question comes from the line of Tim Quillin with Stephens Incorporated.

[Tim Quillin:]

Good morning.

[Earl Lewis:]

Good morning, Tim.

[Tim Quillin:]

Can you tell us when you are scheduled to complete deliveries of orders currently in backlog related to the BETSY program? And what are the prospects for additional orders with either the $40 million remaining value under the current contract or other new army or marine contract vehicles?

[Earl Lewis:]

Bill?

[Bill Sundermeier:]

Sure. Presently, our BETSY schedule is through Q1. And depending on their uptick, where they might go into the first part of Q2 as well. And right now, as far as we look into the remainder of the IDIQ, which is a little more than $30 million is left under that, we don’t see in the funnel right now any demand, although sparing does has happened over period of time and perhaps first part of next year some sparing orders that might appear to have consume the rest of that. Both the army and the marine corp. are heading towards their program of record capabilities, so they are both thinking about doing that. They had – army have issued their RFP, maybe with the ending of the IDIQ, we might see that in the first part of next year. So marine core we believe is going to separate from the program and do their own program of record for their GBOSS program. And as General Cole has mentioned to us, we'll not necessarily BETSY becoming a program of record, but portions of BETSY becoming program of record and he specifically mentioned raid. So that’s our current status on the program.

[Tim Quillin:]

Okay, thank you. And Bill, you had mentioned that 4Q orders are expected to be seasonally lower than 3Q and typically burn the whole backlog in the Government business. In 4Q, should we expect that again this year? Thanks.

[Bill Sundermeier:]

I don’t know if you heard me.

[Earl Lewis:]

Tim, he said, yes.

[Tim Quillin:]

Okay.

[Bill Sundermeier:]

Okay, sorry.

[Tim Quillin:]

Thank you.

[Earl Lewis:]

That’s our absolute quality. He said, yes.

[Tim Quillin:]

That was definitive. Thank you.

[Operator:]

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

[Earl Lewis:]

Yes Jonathan.

[Jonathan Ho:]

Just a quick question for Andy. With regard to the contract that was pushed out in CVS, can you maybe give us some additional color as to what customer that was or potentially what segment within CVS that contract order was from?

[Andy Teich:]

Yes, Jonathan, I – unfortunately the customer in this particular case has restricted us from communicating publicly about the nature of the order. What I can tell you is that we have a pretty high degree of confidence that the order will get rebooked. The customers requirements, their customers requirements just extended a little bit further out in time and they as a result were unable to meet the delivery commitments that they had committed to in the order. And so as a result of that, they had to cancel the order and they will rebook at the pieces, they have already rebooked a portion of it. So I am confident that we will recapture it.

[Jonathan Ho:]

Okay, that’s helpful. And the second question is for Arne on the Thermography side. Can you talk a little bit about – the backlog actually went up by $5 million. Number one, was that tied to sort of the low end. And number two, what’s the demand outlook for sort of the high-end products that we are seeing more pent up demand that could potentially come true into 2010 and how should we sort of think about that in terms of the high end?

[Arne Almerfors:]

Okay. Let me take the first question about backlog. I mean due to the efforts in supporting the swine flu deliveries in the Asia Pacific, we actually turned out having backlog on key and A series product lines in there, but we did manage to deliver, manage to put. So we are building backlog in the right region in that respect. Going forward, we expect the high volume part of our business still to continue and the high value as we call it relating to the more advanced products will pickup when we see a recovery in the economic. And we are – strongly believing that will happen in the early part of next year, but we need to see the proof of it.

[Jonathan Ho:]

Great, thank you.

[Operator:]

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

[Earl Lewis:]

Hi Chris.

[Chris Donaghey:]

Hi, good morning, guys. Nice quarter Earl. So obviously maintaining a fairly positive outlook for 2010, can you just talk a little bit about visibility into 2010 with the backlog improving, I understand that helps. But maybe just qualitative walk us through – qualitatively walk us through the range of different opportunities that you are seeing and how does the pipeline feel for new business going into next year?

[Earl Lewis:]

The pipeline is always been positive for us. I mean, we see tremendous opportunities for us there, for the Government Systems business over the next five years, only for three or four very fundamental reasons that the products that we offer is the exact products that we are going to need for what the government’s trying to do whether we are in Afghanistan or not. So there is a fundamental underpinning I believe of our government business. What we have not been able to do very successfully is to applying specific programs that we think we may win or we may not win in the next six to 12 months. And that, I've become in my older age very cautious about listing them, and still am to this point. But I guess to your real question, clearly our visibility in 2010 has improved with our Q3 order intake. We will have to see what Q4 brings. We have said right along that we don’t really know what the raid BETSY program will bring for us next year. We think our customers are very happy with that product. We think they will try to use more of them, because they have been very successful and curtailing the Americans being built. So all of our products in Government, our future in the foreign military sales looks good next year as well. But we haven’t gone through yet and put together our 2010 detailed budget which is where we try to assign specific percents to all of the different programs we are working on. And until that’s done, it’s a little difficult just to say we are certainly where we will end up next year. Underlying all, I feel very comfortable that we will be able to have a good year next year. I feel that the Commercial businesses both of them should improve next year and I believe that their margins will also probably improve next year. Above and beyond that, I hate to speculate much because we just haven’t done our homework to do that yet, Chris.

[Chris Donaghey:]

That’s great, thanks Earl. And just a quick follow-up question for Andy. Andy, you know that perhaps last year Q4 was unusually weak versus Q3 on a sequential basis and that was sort of out of character with the three previous years. How should we be thinking about Q4 for your business this year? Thanks.

[Andy Teich:]

Yes, Chris, last year there’s no question that Q4 was weak for us because of the effect of the economy. We had very weak auto bookings, we had very weak maritime bookings, those businesses were the first and the worst hit. I have seen very nice responses in both of those segments already. We had a very strong Q3 in maritime, I see the auto business picking up, we have got a new auto OEM coming on in Q4. The pipeline is robust for Q4 right now, our unfactored prospects is at highest levels we have seen ever in the history of the business. So I am feeling really good about Q4 right now.

[Earl Lewis:]

When Andy says, the unfactored prospects, again we take a list of all the potential orders and try to assign probabilities so they are coming to – so we are starting with a higher total potential than we have in the past, ever in the past.

[Andy Teich:]

In CVS – and sorry, I mean I think the only issue is timing if some for reason, the timing of those works is disrupted perhaps by a disruption in the economy that’s unforeseen, but given the current path, I think it looks good.

[Chris Donaghey:]

Great thanks guys.

[Operator:]

Your next question comes from the line of Paul Coster – JPMorgan.

[Earl Lewis:]

Good morning, Paul.

[Paul Coster:]

Good morning, everyone. First question is – maybe it’s Andy, maybe it’s Bill. I think it's a toss-up between the two of you. But what’s the latest on border control applications and particularly the flow of orders coming through from EADS and Saudi Arabia?

[Andy Teich:]

Paul, I think as we have talked about them in the past, the majority of border control business is being conducting around the world today is going through large system integrators. People like EADS and Siemens and Indra, Raytheon and others, so that falls under my domain. In terms of Saudi, we have – that program continues to move forward. The – our primary customer in that case EADS is reluctant to release information about the progress of that business. But I can tell you that it continues to move forward favorably. We delivered systems into that program in Q3. The first set of systems that have been ordered under that program has been delivered, received in country and are being commissioned at this point. And we have several other major programs that are going on both in Eastern Europe and in the Middle East, which – some of which are expected to come to fruition in Q4.

[Paul Coster:]

All right. And then, Bill you talked about your long-term bullish outlook for your business, the government systems business. And I know from Earl’s remarks, you are reluctant to talk about specific programs that you are bidding on, but thematically what is the big growth opportunity for you is it on the ground, is it mobile fixed. Can you give us some kind of color of way you think the long-term growth is going to come from?

[Bill Sundermeier:]

Multiple segments, you know that US is certainly focused on ISR activities and providing more ISR capability to the folks in the theatre around the world. So we have always been strong in the airborne platforms and we are really certainly with the experience that we have had in with the raid platform quickly moving into force protection applications and ground based. Of course our two newest initiatives have certainly been worldwide vehicle solutions, both mass mounted viewers and situational awareness cameras for military vehicles, and of course with the acquisition of OmniTech, we have really have strengthened our soldier based products. We are going to the thermal weapons site market and soldier-based products for viewers. So I think we are getting started there and I see really good expansion in soldier-based area. If that answers the question?

[Paul Coster:]

Yes, thank you.

[Operator:]

The next question comes from the line of Brian Ruttenbur with Morgan Keegan & Company.

[Brian Ruttenbur:]

Hi. And first question is about OmniTech. And I believe that this used to be – was going to be part of the O'Gara IPO. And as I recall, it had below average gross margins. Can you talk about what your plans are with them if in fact this is the same OmniTech, and where you see this thing going forward?

[Earl Lewis:]

Well, Bill why don’t you? But I don’t – let me just try to say this way, if it was back then and you looked at below average gross margins, it won’t be another year.

[Brian Ruttenbur:]

Well, below your company average gross margins.

[Steve Bailey:]

Sure, but with this gross margins, of course we are going to continue to improve that by infusing our cameras into their product lines and continue to not only gross margins but operating margins as well.

[Earl Lewis:]

We do see a terrific opportunity particularly the use of thermal detectors from Andy’s business for example in OmniTech which would give them a big advantage in the marketplace and improve our overall margins as well. And we think that that business is going to expand. And what we have seen is our businesses is traditionally as volume goes up, our cost go down pretty significantly. And that leverage we have been able to do across all of our businesses pretty consistently now. And I don’t believe, I thought their gross margins were in the high 40s, so they are not bad gross margins let’s put that way. And we do see opportunity to improve their overall operating margin.

[Brian Ruttenbur:]

Okay. And then my follow-up is CapEx in the quarter, US dollar impact and one another one that the de-booking order, how big was that? Was that a single order for $20 million or –

[Steve Bailey:]

It was a single order for $15 million, Brian.

[Brian Ruttenbur:]

Okay. And then the CapEx and the US dollar – try to throw everything all as one question.

[Steve Bailey:]

We got it.

[Tony Trunzo:]

Brian, while we are digging up numbers, it's Tony. One other comment on OmniTech, these guys they do a very good job running that business. And as you probably recall, the operating margins are actually quite good. We have seen opportunities because of the vertical integration to approve the margins overall and some of that will certainly reflect through in the gross margin. These guys are doing a really good job running a business of that scale with the margins that we generate.

[Brian Ruttenbur:]

Very good.

[Steve Bailey:]

Brian, if you are looking at the CapEx in Q3 was $3.2 million.

[Brian Ruttenbur:]

Okay.

[Steve Bailey:]

And that’s probably relatively low, but generally we will probably look for the balance of the year to stay them probably our depreciation line.

[Brian Ruttenbur:]

And the US dollar impact did you say.

[Steve Bailey:]

The US dollar – well during the quarter the impact on revenues was about 2% or –

[Bill Sundermeier:]

Yes, we had a $6.5 million swing though from Q3 of last year to Q3 of this year in the other income line.

[Earl Lewis:]

Yes that was the big, big deflect. Q3 last year, we booked $3.5 million I believe were positive and in this quarter it was three negative. So it was a little over $6 million swing and we sort of marked-to-marketing our cash positions around the world.

[Brian Ruttenbur:]

Okay. And now that’s impacted directly your operating profit, right?

[Earl Lewis:]

Steve, I always hesitate on that.

[Steve Bailey:]

In terms of the currency loss is not a part of your operating margins rate.

[Brian Ruttenbur:]

Okay, very good. Thank you.

[Operator:]

Your next question comes from the line of Jim Ricchiuti with Needham & Company.

[James Ricchiuti:]

Good morning. Arne, a question for you, you talked a little bit about the strength in the Thermography business in Asia Pacific. Would you be willing to just share with us what percent of Thermography revenue right now you are seeing out of Asia Pacific. I mean I have got a follow-up question with respect to the comments you made about China.

[Arne Almerfors:]

Yes, I mean they are improving. The relative relation that we are – or significance of that part of our business is improving. They are still not up on the same level as EMEA and Americas. But I am – I personally believe that they will be at one or two years. So it’s a positive growth. A comment here which I think is important is that we have over the last two or three years focused on setting up the structure by establishing subsidiaries in all of these important monitors, which has enabled us to support the customers in a different way than we could before. And that’s a very, very important part of the success improving the business in this territory.

[Earl Lewis:]

And the last four or five years, you have probably opened up just 10 or 12 clear offices around the world, and most of those are in the Pacific.

[James Ricchiuti:]

Arne, the business in China, since I believe you said it’s now the second biggest country market behind the US, what’s the profile of that business like versus a your traditional business and other in more mature regions?

[Arne Almerfors:]

I would actually say that the profile of our Chinese business is very similar to the one we have in our mature markets like in Europe and US. I mean we have had for just as a comment here we have had very little swine flu impact on the Chinese revenue. So it’s more selling into the utility business, electrical and mechanical. So it’s a very traditional infrared business that we are developing in China right now.

[Earl Lewis:]

We for example giving away margin to gain market share in China. It’s what running it like the rest of our businesses.

[James Ricchiuti:]

Okay. And just in general, how was the catalog business in the quarter, Arne?

[Arne Almerfors:]

The catalog business is improving consistently I mean that has been in Q3 as well, and that we are broadening the concept of catalog companies. We have the Grainger in the US, we have the Transcat in Japan, and we are consistently building that kind of a relationship in different markets.

[James Ricchiuti:]

Okay, thank you.

[Operator:]

Your next question comes from the line of Steve Levenson with Stifel Nicolaus.

[Steve Levenson:]

Hi everybody.

[Earl Lewis:]

Hi.

[Steve Levenson:]

The OmniTech acquisition is pretty interesting. Do you expect to make or purchase the I-square 2s going forward?

[Earl Lewis:]

Purchase.

[Steve Levenson:]

Okay. Is that something you think you will get the equity, forgive me for not knowing the right term. But is that something where you will be able to replace them with thermal sensors, or do you think that will always be an I square product?

[Earl Lewis:]

How many I square products are in the field. We have that number.

[Steve Bailey:]

Over half a million.

[Earl Lewis:]

Yes, it’s hundreds and hundreds of thousands. And we think the fusion part of that business is one of the more interesting ones, where we have combined retroactively or proactively thermal imaging with I square.

[Steve Levenson:]

Is that something where – I am sorry, forgive me. Let me come back to that.

[Earl Lewis:]

Sure.

[Steve Levenson:]

On the mix going forward, do you expect the US government and international contributions to be about the same or do you see any variance in that?

[Earl Lewis:]

International’s been growing faster.

[Bill Sundermeier:]

So I would probably think that trend may continue.

[Steve Levenson:]

Okay.

[Bill Sundermeier:]

It’s a whole international as percent of our –

[Steve Bailey:]

44.

[Bill Sundermeier:]

44 for Q3.

[Earl Lewis:]

Yes, if you want to think about trends and our guess is to trends I would say US government – our government does would be less as a percent and foreign governments would be a higher percent over the next five years as a general trend.

[Steve Levenson:]

Thanks. Let me go back. On OmniTech again, is that mostly a special operations command product now that you think you can migrate to the general military?

[Bill Sundermeier:]

Actually, I think it can go to general military, that vast majority of I squared devices are and the regular green army. And the real benefit here is that this is a low-cost solution. We will be able to clip on to it existing I squared devices. For the future, we are investing in EMCC technology with Salvador Imaging now clear as and we see some advantages of that technology as a digital technology that combines an infrared can provide a valuable technology. But that’s where the future – in that direction. But right now OmniTech’s focus is clip-on thermal on to I squared devices in a retro market.

[Steve Levenson:]

On the SG&A and the cost reductions, other than selling expenses that you mentioned related to Thermography, do you expect the other cost reductions to stay?

[Earl Lewis:]

You know our legal expenses have been very, very high. And they have tended down a little bit in the last quarter. So which is very, very positive. Hopefully, we will able to maintain that with this positive result we got recently from the Raytheon suite. Other than that we’ve really been containing cost more than reducing them. We have not reduced employment for example, we have held salaries and check, we’ve been very cautious in hiring – our selling expenses I think were relatively flat actually in total year-to-year. And what was the other large – we had one other large expense? Yes, our bonus. We accrue bonus based on changes in EPS. That was less in the quarter than last year, because last year we had such a large increase in EPS. But overall, we have tried to keep employment the way it was even through this – these are difficult time for lots of people. We value the employees and we have tried very hard to not have any reduction in employment, but we all have sort of said, okay, let’s not have salary increases, and we will probably have smaller bonuses this year. And other than that, everything is kind of held about the same.

[Steve Levenson:]

Last item is was there anything you were expecting from the stimulus plan that you did see or anything that you – that was delayed that seems like they are pretty slow in spending that money, things that you expect to see.

[Earl Lewis:]

Yes, Andy has a comment and I have one too. So I will go first up. The one that has surprised me is in the United States, they have put literally billions of dollars towards weatherization, and that’s been defined as improving basically the energy performance of people’s homes. And the best possible way to do that is to do an inspection with Thermography equipment to see where insulation and caulking and other activity can be used to reduce heat flow or air condition and improve it. And that money – and it is significant money we haven’t seen it. I don’t know you read lots of different things about the “stimulus”, but I haven’t got stimulated by it yet. Andy?

[Steve Levenson:]

Hope you will be.

[Earl Lewis:]

Could see some.

[Andy Teich:]

Yes, Steve, we have seen a couple of things, it’s not been significant, but I think it’s the initial indications of something that could be more significant. First is there was the line item for the Coast Guard for navigation aids, and we have seen some procurement of maritime systems through our commercial dealer network that the customers have indicated that it’s been funding that has come from that line item. And the second one, probably more significant one that I were just starting to see some initial procurements come off of there was $2 billion that was put into the Edward Bern Grant Foundation, which is a law enforcement grant that I think the timing of our H-Series launch with the very rich feature set based product at $5000 going into an environment where law enforcement communities are getting an additional $2 billion of funding to improve their operations. And police force protection is going to be – that that those could match up well and we have some – seen some initial procurements of that since the launch of that product. But all-in-all, I don’t think I can add up to $100,000 we can attribute so far to quote stimulus money.

[Steve Levenson:]

Something to look forward to. Thanks a lot.

[Andy Teich:]

Look forward to it.

[Operator:]

Your next question –

[Steve Bailey:]

Excuse me, if I can interrupt for a moment, I want to correct the prior statement I made to the question regarding CapEx spending during the quarter, it was – I stated $3.2 million, it was actually $4.8 million. Just to clarify that with.

[Earl Lewis:]

Okay next question.

[Operator:]

Your next question comes from the line of Ajit Pai with Thomas Weisel Partners.

[Earl Lewis:]

Good morning.

[Ajit Pai:]

Couple of quick questions. I think the first one is just looking at the operating margins. I think you have delivered record operating margin already. And based on the commentary you have provided, you are talking about further operating leverage as well as potential to bring down cost in certain areas. Could you sort of give us some idea where those margins could go over the next 24 to 36 months?

[Earl Lewis:]

I would not predict an increase in our percent of operating margins for our company.

[Ajit Pai:]

And what would be – why would it not be going up if your Commercial Vision Systems are below what their margins have peaked at historically?

[Earl Lewis:]

Yes, sure, fair enough. Yes, fair question. The estimate – my estimate and if we go around the table, we might get different one. So keep in mind that’s the background we would like to say is that our operating margins in our Government Systems business will over the long run come down and our operating margins in our Commercial businesses over the long run will go up. And I think that the combination will be and hopefully we can maintain around the 30% range. But I do not expect operating margins to go up much more – I don’t expect it will go up from where we are today as a percent. We hope that the top line grows now faster going forward in our Commercial businesses than they have in the last year and that will add the EPS. And we hope that the Government businesses will at least maintain their adjusting sales next year be a little bit positive. But to predict an increase in operating margins from our 31% would be I think – well what guards you against these kinds of statements and that’s what it would be one of those kinds of statements.

[Ajit Pai:]

Got it. Okay, the second question would be just looking at the price lash that you did on your i5 camera, it’s pretty material like over 30%. So just in terms of understanding the low end of the market over there, what sort of drove that, was it economically driven, was it like a competitive response driven and you are talking about volumes going up playing materially based on that, so the price of elasticity is working, is it just purely to do with price of elasticity? And will margins be comparable, are we able to engineer out significant costs?

[Earl Lewis:]

That trend of driving these prices down is what we are doing in the Commercial business into a certain extent, to a lesser extent actually than the Government business, but that’s what we wanted to do, that’s exactly what we wanted to do. That product was designed with a very, very good gross margin. We planned to bring it down as volumes increased and that’s exactly what we are doing. That’s just absolutely part of our plan, game plan in Andy’s business and Arne’s business is the exact same thing. It’s just the key knocking that down. The introduce – what was the flash light selling for – for example.

[Andy Teich:]

About 10k.

[Earl Lewis:]

And we just introduced the H series at half of that. So I mean that’s what we are doing. And that’s our game plan. And this one was pretty dramatic, because it’s sitting at the bottom end of our product line. So you now see the lowest price thermal imagery in the world by far with good gross margins.

[Ajit Pai:]

And has it been a – do you see any –?

[Earl Lewis:]

No that is not a reaction to the competitor. Our competitor – our next price level –

[Arne Almerfors:]

3.5.

[Earl Lewis:]

This is like 4. Twice of that.

[Ajit Pai:]

Got it.

[Earl Lewis:]

Two types of pricing.

[Ajit Pai:]

Yes, okay, thank you so much.

[Operator:]

Your next question comes from the line of Randy Cuiersen with Barren Capital.

[Randy Cuiersen:]

Good morning, guys.

[Earl Lewis:]

Hi Randy.

[Randy Cuiersen:]

A few quick questions. First, Andy, in your business, could you give us a sense of the size of boating as part of your business? And also an update on the cores that you sell into the UAV market and how that’s shaping up and growing?

[Andy Teich:]

Sure. Okay. So Randy first one the – the maritime business today is about 10% of the total of CVS, but it’s the fastest growing segment within the group now that the market has responded. And I think has a great opportunity for 2010 spurred by two things, one is the obvious response of the market as the people start to spending the money on boats again. And number two is that we have launched two pretty major products into that market during 2009, the M-Series and then the First Mate which is the handheld products. The second area is UAVs, and our biggest customer in the UAV segment is AeroVironment, and Raven is currently under digital upgrade right now which we are supporting with our current photon product. But also we expect to have a very strong integration of our new Tao product into AeroVironment’s products and products beyond the Raven and other products that they are working on there, the Wasp and Switchblade. The thing that’s nice about the Tao is that it offers a 50% reduction in weight, a 50% reduction in size, and about 30% reduction in power consumption, and those are all very important factors for the UAV market. So we have a good partnership with them. I think they like what they are seeing from us in terms of product development and we expect to be a major player in their products going forward.

[Randy Cuiersen:]

The quick follow-up question I have that’s I guess related to both Thermography and your business Andy is the outsourcing of the detectors or the – into AMI, how’s that going or what’s the timeline for that and how’s that affecting margins?

[Andy Teich:]

Okay. So the AMI has been renamed or called ON Semiconductor now. They were purchased by ON semi. And that’s up and running, and has been up and running since the early part of 2008. Right now, we are getting about half of our uncooled production is coming from ON Semiconductor. They – we only put our 25 micron line on semi, so products like the photon and most of what I was selling through my division was a 38-micron product which was produced exclusively on our fab. Now we are doing the new products, the 25-micron based products in both ON semi and in our own fab. The Tao is based on 25 micron – almost everything Arne sells is 25 micron. And all new products that I have done are all 25 micron. So the partnership is going great. In terms of affecting margins, this year there really is no impact as a result of running both fabs. As we wind down our fab and rely more exclusively ON semi’s production we will probably some cost improvement.

[Randy Cuiersen:]

Thank you. Thank you very much. And just last quick question is just on Thermography, do you have an FX adjusted revenue growth number? Thanks guys.

[Steve Bailey:]

It think foreign exchange affect on revenue was 2%.

[Randy Cuiersen:]

Thanks guys.

[Earl Lewis:]

Operator, we have one more question.

[Operator:]

Okay. Your final question comes from the line of Jeremy Devaney with BB – I am sorry with BB&T Capital Markets.

[Jeremy Devaney:]

Good morning, everyone. Let’s go with Earl and Tony and Bill, just one quick question on or a couple of quick questions on OmniTech. Mike’s previously visited with OmniTech, and thought they had a fuse sensor technology, where do you expect to be able to leverage this technology within your business and with which customers?

[Earl Lewis:]

Sure Bill.

[Bill Sundermeier:]

Sure. Well Omni is certainly is pursuing – there was an earlier question on special forces, there – then was special operators, but we will be heading towards green army and marine corp. In total, all those certainly have I squared devices. In addition, can head into areas like law enforcements, SWAT teams, federal law enforcement, all have I squared devices as well. And we see a very large potential in an add-on market space, a very, very large I square business that exist today.

[Jeremy Devaney:]

All right, terrific. And then following on along those lines with the army and marine corp. At one point, OmniTech has an opportunity there partnering with ITT for – it was a large army opportunity. Do you know where that stands? And then also the large majority of their previous business I believe was with the marine corp. from weapon sites. Where does that marine corp. contract stand right now? And then also can you give us an update on OmniTech’s backlog?

[Earl Lewis:]

Well, there – I don’t know what their backlog – we haven’t – since we closed three weeks after the closed – three weeks after the close of order there is no backlog in our backlog that was reported today. At the end of this quarter, I don’t know how I would forecast their backlog. But it’s probably in the high teens at the end of this year. We will know more, I don’t know how they do the score [ph]. They do have one or two IDIQs and those are not in the backlog because they haven’t reported in that $15 million to $20 million backlog as we expect by the end of this year. They have an IDIQ that’s significantly larger than this, which we would not include in our backlog going forward. And again whether they actually ordering all or not, we don’t know, but there is a high probability they will.

[Bill Sundermeier:]

And Jeremy in terms of the relationships they have had previously, and we will – as we get down integrate into our business, we will talk about what the opportunities are and how they develop consistent with how we communicate our other operation.

[Jeremy Devaney:]

All right, terrific. Looking at the CVS business, Andy, if we could talk for a minute about the NURC requirements that are going on, how large in dollar terms do you anticipate the nuclear security market to be through the April end? And then what other types of opportunities related to security regulations are you seeing in other markets?

[Andy Teich:]

Okay Jeremy, so the regulation that we are talking about I believe it’s called NRC regulation 73.55, which requires 24/7 surveillance at or persistent surveillances as they described at nuclear power plant. It’s a bit tough for us to fully scope that market. We’ve seen requirements emerge in the last – during Q3 and into Q4 amounting to something on the order of about 600 units so far. I think the potential there could be double that number. The tough part about predicting the volume of that – I am sorry, the dollar value of that is what systems they buy, because different facilities are taking very different approaches, so we are seeing some facilities that are taking an approach of putting a lot of low-end cameras from our SR product line-in and we have seen other facilities take the approach for putting a smaller number of higher priced midrange systems into them. In general terms, we are probably looking at a something on the order of maybe a $2 million to perhaps up to $4 million opportunity here depending on the type of systems that are selected, could go higher than that. In terms of other segments, we haven’t seen any definitive federal mandates for requirements into other segments, but we are seeing increasing activity in critical infrastructure and we are seeing some increasing activity in petrochemical and some port activity in maritime domain or in a system. And I don’t know if there is a federal mandate lying behind us, we have not seen indication of such at this point.

[Jeremy Devaney:]

Excellent.

[Andy Teich:]

Just want to follow-up, I know that we mentioned US military, but I want to mention to that OmniTech has done a really good job in getting traction internationally and we think when we get this product to our international channel that will just continue to grow since it is not just a US-only, but really a worldwide opportunity for us.

[Jeremy Devaney:]

Excellent. Excellent. Thanks guys. That’s all we have got.

[Earl Lewis:]

Okay. Operator, I think we are done. Thank you all for calling in today and appreciate your comments and your questions. Look forward to talking to you in February about the end of the year in 2010.

[Operator:]

This concludes today’s conference call. You may disconnect.