FLIR Systems, Inc.
Q3 2010 Earnings Call Transcript

Published: 26 Oct 2010

[Operator:]

Good morning. My name is Latika, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2010 Results Conference Call. [Operator Instructions] Mr. Wit Davis, you may begin your conference.

[William Davis:]

Good morning, everyone. Before we begin this conference call I need to remind you that other than statements as to historical facts, 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:]

Well, thank you, Wit. Good morning, everyone, and thank you all for joining us today. We had a successful third quarter with earnings of $0.39 per share on a 16% increase in revenue. Our Commercial Vision Systems revenue was up 17% over the third quarter of 2009 to $61 million, and the division posted a 54% increase in their operating income. Thermography revenue increased 4%, excluding the Extech printer division, which was sold in the fourth quarter of 2009 and generated 19% growth in operating income. While Government System revenue was essentially flat, operating margins remain robust at 38%. Our order activity for Government Systems was strong. Backlog increased by approximately $10 million. During the first week of the fourth quarter we closed the acquisition of ICx Technologies. We purchased the company for $232 million, net of their closing cash balance. This business was attractive for its technology leadership in chemical, biological, radiological, nuclear and explosive detection. It expands our footprint by adding products in these emerging detection sensor categories. ICx also augments our surveillance capabilities by adding integration services and advanced radars to our portfolio. We believe there's significant opportunity to reduce costs, increase profitability by leveraging the FLIR operating model and focusing on the strength of ICx products and employees. This quarter again demonstrates our ability to produce strong, profitable results. We have never felt better about our mix of products, diversity of our markets, our ability to innovate and our operational and financial flexibility. I'm now going to turn the call over to Tom Surran, who's filling in for Andy Teich while he attends the advanced management program at Harvard. Both Tony and Bill are scheduled to attend this program next year. Tom will discuss the results in the Commercial Systems division. Tom?

[Tom Surran:]

Thanks, Earl. Commercial Systems revenue, excluding Raymarine, was $132 million, up 8% over the third quarter results for CVS and Thermography last year. Operating income, again excluding Raymarine, increased 33% over the prior year to $40 million. Thermography revenue was $71 million, an increase of 4% over the third quarter of 2009 when you exclude that divested Extech printer division revenue from the third quarter of 2009. Profitability improved significantly with operating income reaching 31% of revenue, or $21.8 million. This represents a 19% increase over the prior year and our best operating margin performance since 2007. Unit volumes were up approximately 30% overall, and they doubled for the high-volume i5, i7 series cameras. The U.S. showed significant improvement in the high-end P-Series and T-Series sales, and we are seeing significant growth in the sales of our gas finder products. The electrical, mechanical and building markets, which together make up over 50% of Thermography revenue, were flat during the quarter, in part due to the EMEA region being down compared to the third quarter of the prior year. Looking ahead to the fourth quarter, we expect to see the usual seasonal increase in our Thermography business. We continue to innovate and expand the applications for our products, and margins should remain strong as we continue to control costs and utilize our Sonia [ph] manufacturing site. For the Commercial Vision Systems business, we saw another excellent quarter. Revenues were up 17% over the prior year to $61.4 million. Operating income was $18.1 million, up 54%, and yielding an operating margin of 29%. Compared to the third quarter of 2009, CVS operating margin improved over 700 basis points due to a favorable product mix, higher volumes and lower costs. Additionally, CVS backlog increased 12% over the second quarter this year to $116 million. Demand in security and surveillance was very strong. Our growing global dealer base is driving awareness of our technology. And as a result, we saw strong growth in the number of orders for security and surveillance products. Cores and Components bookings were also up, reflecting strong demand for our new uncooled Tau cores from our OEM customers. We are also seeing robust orders internationally for camera cores made by the former Cedip operation in France. Interest in our new short wave infrared Tau cameras has been strong as has the reception of our new color night vision cameras, which use EMCCD technology. We expect great things from these products in 2011 and beyond. Auto continues to perform very well with bookings up significantly over the prior year, driven by the inclusion of our products in certain Audi models. Our Maritime bookings increased 50%, with the mix shift towards higher ASP products. We completed our first full quarter with Raymarine, and performance was good. Revenue was $36.9 million, in line with our expectations for the seasonally weakest quarter of the year after the summer's boating season. Operating income was $1 million, up significantly from a loss in the prior year. Gross margins increased, while we continue to reduce operating expenses, showing our operational improvement plans are beginning to bear fruit. There is more opportunity for improvement, and we are excited to be launching the integrated Raymarine branded thermal cameras at this fall's maritime trade shows. Overall, we are pleased with the performance of Commercial Systems, and we expect a strong fourth quarter, particularly in CVS. Being more dependent on macroeconomic trends, Thermography is expected to see a more modest growth experience to sustain worldwide economic growth. Now Bill will discuss the Government Systems division.

[William Sundermeier:]

Thank you, Tom. Government Systems revenue in the third quarter was $163.2 million, unchanged from the third quarter of 2009. Operating income was $62.2 million, or 38% of revenue. Order activity was good during the quarter and our 12-month backlog came in at $386 million, up $10 million from the second quarter of this year. Airborne systems as well as ground-based applications saw strong orders in Q3. Domestically, we saw better orders from the U.S. government as their fiscal year came to a close at the end of September. We received an $18.5 million order from a U.S. agency for onboard aircraft systems, as well as a $14.4 million order for BRITE Star IIs from the Navy, which showcases our ongoing success with the Marine Corps NTIS program. Force protection initiatives continue to show strength, as we received a $5.3 million order for our Star SAFIRE HD gimbal system. Additionally, we were awarded a $63 million IDIQ from the U.S. Army for spares for the RAID program. While no new RAID system orders are expected in the near future, we continue to provide service and spares that deal with systems. Our international business continues to grow as we were awarded a $4.1 million contract from a European helicopter manufacturer. We continued our penetration at the soldier level with the $2.1 million order to a European agency for weapon scopes. Investments in sales and service operations around the world are growing our footprint into key emerging markets, such as in Northern Africa, India and Russia. Additionally, we had an official opening in Q3 of our new operation center in Riyadh, Saudi Arabia in order to increase our service capacity in the region. Overall, we are seeing our efforts to expand our troop level and other ground-based exposure succeed as we received over $30 million in orders for our recon handheld products during the quarter. Our Boston location had its best booking quarter ever, suggesting particular strength in smaller gimbals and handheld products that incorporate latest feature sets into smaller, lighter systems. Excluding ICx, our revenue and profit outlook for all of 2010 has not changed. We currently anticipate a challenging environment for fourth quarter bookings, as we navigate a difficult spending environment, especially in the U.S. Over the longer term, we see significant opportunity as users recognize the merits of innovations such as digital high-definition systems, and the market evolves from analog to HD. The close of the ICx acquisition is an exciting event for Government Systems and for FLIR. The inclusion of their products and platforms will allow us to expand our leadership in force protection in government agencies around the world with everything from thermal sensor systems and radars to explosive detectors and integrated systems. We continue to work on the integration of the business into our division. ICx's solid IP portfolio, dedicated employees and culture of innovation will indeed be a solid fit with FLIR, and we expect excellent opportunity for sustained growth. I'll turn the call back over to Earl.

[Earl Lewis:]

Thanks, Bill. The FLIR operating model continues to succeed as shown by these third quarter results. We continue to penetrate our infrared markets. Our customer base is growing, along with the applications and use of tools that we make in the field. We're optimistically diversifying into areas of growth, exemplified by our two latest acquisitions, Raymarine providing us with adjacent markets, and ICx providing us with adjacent products. We are leveraging in our leadership in the industry to drive down cost and build awareness, which is working to grow the size of our addressable markets. These strategies have not changed and we continue to execute on these goals. Our challenge as we enter the last quarter of the year is to gain more clarity in how the changing dynamics of the U.S. military spending will impact our overall Government Systems business. I'm encouraged with the growth of Government Systems as shown in the face of this macro environment. Our U.S. military revenue represents less than 25% of our total revenue. And while we continue to see significant opportunity in this important market, we are very pleased with the diversification we have, not only within GS, but across the company. Commercial Systems continues to grow rapidly by executing on the vision of infrared everywhere, and has successfully improved profitability along the way. Thermography is a leader in smart goods, and we see renewed growth ahead. Our two acquisitions will add meaningfully to our growth in the years ahead. Our balance sheet remains strong. It provides us with substantial flexibility in 2011. Our guidance for 2010 is improved based on the outlook for Q4 and the impact of our acquisitions. We now estimate our full year earnings per share will be in the range of $1.53 to $1.56. We are increasing our revenue outlook range for the year to $1.375 billion to $1.4 billion to reflect the addition of ICx. Including the costs associated with acquisitions, we expect both ICx and Raymarine to be profitable in Q4 2010, and substantially accretive in 2011 and beyond. Now Tony will go through a detailed review of our financials.

[Anthony Trunzo:]

Thanks, Earl. Third quarter revenue increased 16% overall, and 4% excluding Raymarine. Revenue growth in constant currency terms without Raymarine was 5%. Commercial Vision Systems revenue increased 17%, with particularly good growth in transportation, cores and personal vision systems market. Thermography sales increased 2% during the quarter, or 4% when excluding Extech's printer division revenues for Q3 2009, aided by better demand in the U.S. for gas imaging products, and strength in test and measurement markets. Government Systems revenue was unchanged from the third quarter of 2009. International revenue was 32.9% of the total in Government Systems. And for the entire company, international revenue was 41.9% of the total, compared with 43.5% in the third quarter of 2009. Sales to the U.S. government represent a 35.9% of total revenue in Q3, down from 43.8% of revenue in the third quarter of last year. Consolidated gross margin was 54.8% for the quarter. Excluding Raymarine, gross margin in Q3 was 57.1%, compared with 57% in the third quarter of 2009. Consolidated operating margin in the third quarter was 25.8%, and 28.7% excluding Raymarine. This compares with an operating margin of 31.3% last Q3. Government Systems operating income for the quarter was $62.2 million, compared with $71.8 million in the third quarter last year. GS operating margins remained robust at 38.1%, versus the near record level of 44.1% in Q3 of 2009. Thermography operating income increased by 19% to $21.8 million, yielding an operating margin of 30.7%, up 4.6 percentage points over Q3 2009, and the highest Thermography operating margins since 2007. Commercial Vision Systems earned an operating income of $18.1 million in Q3, up 54% last year, while CVS operating margin increased by 7.1 percentage points to 29.4%. Corporate expenses in the third quarter were $17.2 million, an increase of $4.8 million from last year. Included in the Q3 corporate expenses was $2.5 million of costs associated with the ICx acquisition, and an accrual of $3 million related to an agreement in principal to settle all pending patent claims associated with the litigation matter dating back to 2007. Excluding these items, corporate expenses were down 6% compared to Q3 2009. Raymarine reported third quarter revenue of $36.9 million and operating income of $1 million. We substantially completed the purchase price allocation for Raymarine during the quarter, and included in the Q3 results was approximately $1.2 million in amortization of intangible assets. Going forward, intangible amortization at Raymarine will be approximately $900,000 per quarter. Raymarine made good progress in reducing run rate expense and streamlined the supply chain during the quarter, and we expect further improvement in these areas moving forward. Q4 is a seasonally slow period in the marine electronics business, but we do expect Raymarine to be profitable in Q4. Other income for the quarter totaled $1.1 million, a swing of $2.7 million from Q3 of 2009. The majority of other income related to a currency gain of $606,000, as compared to a currency loss of $3 million in Q3 2009. Our tax rate for this quarter was 27.2%, compared with 30.5% in Q3 2009. This year's third quarter tax expense was favorably impacted by the release of tax reserves, driven by the expiration of certain statutory periods in the U.S., partly offset by the capitalization for tax purposes of $2.5 million in expenses associated with the ICx acquisition. In total, nonrecurring expenses related to the ICx acquisition and the legal reserve were largely offset by our lower tax rate. Cash flow from operations for the quarter was very strong at $85.1 million, compared to $67.4 million last Q3. Investments for the quarter were modest, with 99,000 shares of stocks repurchased for a total of $2.4 million, and $7.2 million in capital expenditures. As a result, cash on hand increased by $95.4 million to $380 million. Moving to the balance sheet. The largest shift during the quarter was due to the substantial completion of the purchase price allocation for Raymarine, which reallocated $128 million from other assets equally to goodwill and intangible assets. One item still to be completed is the allocation of certain tax assets associated with Raymarine, which will be concluded in Q4. We completed the previously announced acquisition of ICx Technologies on October 4 for a total of $232 million, net of $36 million in cash acquired. In Q4, we will complete the purchase price allocation for ICx, and currently estimate amortization of intangible to be in the range of $2 million to $3 million in Q4. In addition, we anticipate additional transaction expenses of approximately $2 million to $3 million during the quarter. Including all of these items, we do expect ICx to be profitable in the fourth quarter. Including all of these items, we now anticipate earnings per share for all of 2010 to be in the range of $1.53 to $1.56, compared with our previous full year EPS outlook of $1.48 to $1.53. Our full year revenue outlook including ICx and Raymarine is now $1.375 billion to $1.4 billion. This concludes the summary of our third quarter financial results. Let me now turn the call back to Earl.

[Earl Lewis:]

Okay, great. Thanks, Tony. And operator, we're ready for questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Peter Skibitski [SunTrust Robinson Humphrey].

[Peter Skibitski:]

Earl, Thermography really seems to be continuing to struggle a bit despite a fairly easy comp to last year. And I'm just wondering, is there a particular region that's struggling? And kind of what do you think needs to happen for the unit to return to double-digit growth and kind of get there?

[Earl Lewis:]

Well, I guess, yes, absolutely there is a region. Our European revenue was not what we expected this quarter. And our U.S. was way ahead of what we expected, and so is the Far East. We continue to have issues in Europe. And some of those are management, internally. We're in the process of restructuring Europe, and we're still doing that. And I think once that's completed, which I believe should be this quarter, we'll see that improve.

[Peter Skibitski:]

I mean, x Europe, how's the rest of the world looking? Is it kind of...

[Earl Lewis:]

Terrific. U.S. was very strong. Far East was very strong. Yes. Both were very, very good quarters. And actually, both of those are off to a good start this year.

[Peter Skibitski:]

Are we talking double-digit type growth or kind of high single?

[Earl Lewis:]

U.S., I think it was double. And EMEA, or the Far East, was double as well, yes.

[Peter Skibitski:]

I just want to ask you, valuation-wise if stocks fairly come in the past month or so. And I'm just wondering if that changes your view on capital deployment going forward? Or do you start to look at share repurchases more as an option? Or are you still kind of looking at more at acquisitions, or on that front?

[Earl Lewis:]

Maybe let me answer that differently. We, right now, have two pretty good-sized acquisitions, one in each of the divisions that we've got to manage. Until we feel that those businesses are up and running and as profitable as we think they should be, we're probably not going to be buying any large companies right now. And our stock is clearly attractive. So that's the way, I guess, I would suggest at least in the next couple of quarters we might allocate our capital.

[Operator:]

You're question comes from the line of Peter Arment from Gleacher & Company.

[Peter Arment:]

Question, I guess following up on Thermography. You mentioned the high end, and particularly, Gas Finder is starting to come back. Are we kind of hitting an inflection point finally where we're seeing some increased demand? You said the U.S. was strong.

[Earl Lewis:]

We certainly hope so. There's a potential of a ruling that will come this quarter. And some of, I think, the buying that we've seen is due to people anticipating that ruling that will select essentially the Gas Finder product line for EPA measurement of both, I think. I'm not sure which gases they're specifying in this, but there is a potential ruling that should help us in that area. And I think we've seen some anticipation. We're also seeing European demand increasing for the Gas Finder.

[Operator:]

Your next question comes from the line of Tim Quillin from Stephens Inc.

[Timothy Quillin:]

In terms of the government business. And Bill you talked about a challenging environment here in the fourth quarter. But reflected in the guidance is the expectation that you'll have a pretty strong shipping quarter, revenue quarter in the fourth quarter, but bookings might be impacted by the timing of budgets. And when do you see -- and I know the crystal ball is cloudy -- but when do you see the potential for bookings to improve in the Government business?

[William Sundermeier:]

Well, Tim, the continuing resolution is going on until December 3. And we're anticipating the defense budget to be released, hopefully in that kind of timeframe. There are definitely things that are in that budget that are headed our way that should help improve things. So I've been fairly impressed with Q3's bookings. It’s about where we thought it was going to be. And Q4 will give us what we need to build very strong. I want to say that even though in Q3 our revenue was flat. Q3 of last year, however, had over $30 million of RAID shipments in it, and this quarter there was less than $3 million of RAID shipments in Q3. And Q4 we'll have very few. So we're getting other opportunities to throw in that pipeline. But really kind of anticipate in the new year as we start to see resurgence once the defense budget gets back on track and some of the other opportunities that we're chasing continue to be pushed to the right. So I'm hoping that in the new year we'll start to see a pickup.

[Earl Lewis:]

Tim, just for avoidance of doubt. We did book a $63 million IDIQ in Q3. However, there was only $1.4 million of that was actually an order on FLIR. So in our backlog delta of $10 million improvement, there was only $1.4 million from that $63 million IDIQ.

[Operator:]

Your next question comes from the line of Brian Ruttenbur from Morgan Keegan.

[Brian Ruttenbur:]

Question about fourth quarter. You talked about Thermography. Can you talk about Thermography in the fourth quarter? If it's going to be up year-over-year versus fourth quarter '09?

[Earl Lewis:]

I know what we're planning on for Q4, but I don't know what we did last year Q4.

[Brian Ruttenbur:]

You did $84.8 million in Q4 '09.

[Earl Lewis:]

I think, right now, we're thinking it's not up much in Q4.

[Operator:]

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

[Paul Coster:]

I know the Pentagon's looking to a $60 billion arms deal with Saudi Arabia, which will include Apache and Black Hawk helicopters. You setting up an office in Saudi Arabia? Are the two related? Is that office looking at that contract in particular? Or border security? Or all of the above?

[Earl Lewis:]

All of the above, Paul. There is some of that $60 billion that we expect that will flow to FLIR. The office there is due to that other work that we're doing there and some border work.

[Paul Coster:]

Five years from now, three years from now, is this going to be an IR company? Or it is something else? I think you probably know, the play [ph] in the market around the multiple for the stock kind of hinges on whether this is a pure play or not and what the growth rate associated with it is.

[Earl Lewis:]

Well, are you talking about the current multiple, Paul?

[Paul Coster:]

Yes.

[Earl Lewis:]

Or future multiple. We'll be an IR company. These two acquisitions both are based, as I mentioned in my script, on their ability to add to IR, our ability to use them to increase IR. So IR is going to be the heart of this company. I don't see that changing. The issue is that packing on $10 million acquisitions is probably not so good either. Having the multiple sensors driven by IR, we believe, is a good strategy. So I don't see us ever really not being an IR company. Those markets are just too big, too high growth for us to ever abandon. Adding on products, adding on markets, I think, is a valid thing in a relatively slow period. Which is what we've been going through the last couple of years.

[Operator:]

Your next question comes from the line of Noah Poponak from Goldman Sachs.

[Noah Poponak:]

You haven't had Raymarine very long. But I wonder if you can give us maybe the early read, and maybe even some specific examples, of the new customer conversations you're able to have now that you're offering the one-stop shop that the businesses separately were not able to offer?

[Earl Lewis:]

Absolutely. Tom, do you want to -- this relates I think to where we've able to sell some infrared equipment, where that's helped Raymarine, and vice versa.

[Tom Surran:]

Yes. So we've introduced what we're calling the T-Series products to the maritime markets through Raymarine. We're introducing that integrated into the MFDs, so that through, say, what’s called the E-series product, Raymarine's MFD, you have touch control of that imager. The response by the market has been exceptionally strong. We've bought that out to some of the boat shows that are occurring now and will be occurring to the winter. And everyone who sees the product loves the integration. They understand the value to the boater and how that will increase their usability of the boats.

[Earl Lewis:]

I think we've actually booked a couple of orders that we might not have gotten without the integration of infrared into a Raymarine suite of products.

[Noah Poponak:]

You are already seeing that?

[Earl Lewis:]

Yes, we've already seen that. I think there was like two orders or one that were fairly large.

[Tom Surran:]

It is coming to it. It's actually being a differentiator to us in the market place. And there was a specific order that occurred for a safety organization where the ability to have the integration of the night vision into the suite of electronics was the basically key deciding factor in selecting Raymarine products.

[Earl Lewis:]

There's an awful lot of “wow” factor in this. And people do really like it. The fact that it's integrated now with the radars, with the GPSs, with the Depth Sounders, et cetera, means it's really very much a part of a boater's experience. And I see this as a -- just right now, we're starting to demo that. And it's been very favorably received by the press and by people who've seen it.

[Operator:]

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

[James Ricchiuti:]

Question on the ICx acquisition, Earl. In the past, the company has struggled with getting the profitability. They've been investing quite a bit in the business, and you expect the business to be profitable in Q4. And I wonder, how much of that is just the elimination of the public company expense? Or have you already begun to streamline the business and consolidate a little bit of the operations?

[Earl Lewis:]

That's a multi-headed answer, unfortunately, Jim. Yes, of course, we'll save some of the money as a result of not being a public company anymore. The other thing is Q4 is traditionally, I think, pretty good for them. And so they’ll have pretty good revenue in Q4. I think the real issue your pointing at here is they historically have had not been very good at forecasting their profitability or meeting their numbers that they have. And I think one of the big reasons for that is that it is a company that is very much decentralized. It has multiple locations. I think it's more like 30 locations around the U.S., and some in Canada and Europe. And it's been relatively tough to manage. It has not been well integrated. And I don't mean that negatively to previous management. I just think that there is some integration that needs to be done. And I think there's some trimming that needs to be done. And that will be a process that we are beginning. I think the people at ICx are excited about the opportunity to join FLIR. They can see where our products and their products can add value to the customer together, particularly when we integrate them together. So I think there's a lot of work to be done, clearly. But I think the people at ICx are up to it. I think we're up to it. And we have begun.

[James Ricchiuti:]

Do you expect to have this integration fully complete by the second half? Or at the end of the first half of next year? And I wonder if you could also comment on the backlog for ICx.

[Earl Lewis:]

That's a good question, Jim. I don't have that number. I should have it right now, but I actually don't. It wouldn’t surprise me to be $50 million, $60 million, $70 million, somewhere in there. But I actually don't have it. I've been kind of asking for it, but don't have it yet. Integration should be done, I'd say, middle of next year. I think we should be complete. We'll try to get it done sooner than that. But as you know, we already have the plan. We're not waiting on the plan anymore. Bill's done a great job pulling that together, and going in meeting with all the people at ICx. So I think the plan is there. We know what we want to do. We want to have some meetings before the end of this year with the different ICx managers to get their input on how they want to run their business next year, and then we'll start implementing probably early next year. And there's no reason why we shouldn't be done by the end of the second quarter.

[Operator:]

Your next question comes from the line of Josephine Millward from The Benchmark Company.

[Josephine Millward:]

Earl, can you talk about what your expectation is from ICx in Q4 in terms of revenue contribution? Are we talking about $40 million? $60 million?

[Earl Lewis:]

Yes, I think it's more like the latter number, but we don't have a handle on it yet completely. We know that they should have a good Q4. They've indicated that there's some pluses and minuses, and going into the making the sausage probably isn't good here. But we think it should be a fairly good quarter in that range you mentioned.

[Josephine Millward:]

So roughly $60 million?

[Earl Lewis:]

Yes, the question, of course, Josephine, is what does roughly mean? And if you want to accept $60 million with a roughly, that's what I put on the table now.

[Operator:]

Your next question comes from the line of Jeremy Devaney from BB&T Capital Markets.

[Jeremy Devaney:]

A quick couple of accounting questions for you. Tax rate for fourth quarter? Any indication what we're looking at?

[Earl Lewis:]

A little bit better than our traditional number, but not as good as Q3.

[Jeremy Devaney:]

And then depreciation and amortization expense in this quarter?

[Earl Lewis:]

I’ll have to look that up. We'll take some more questions and we'll interrupt and let you know.

[Operator:]

Your next question comes from the line of Michael Ciarmoli from KeyBanc Capital Markets.

[Michael Ciarmoli:]

Earl, I guess, I think the numbers were thrown out on the RAID, both last quarter '09 and this quarter. So it looks like the core Government business grew 20% year-over-year. ICx next year? Where do you see that growth rate going?

[Earl Lewis:]

We're, right now, doing that. And we don't have that pinned down. We are putting together plans for solid growth of the non-RAID business. And we believe we will have solid growth of the non-RAID business. We're not prepared to put out any numbers yet, but we will have growth in the non-RAID business next year. It will be positive growth.

[Michael Ciarmoli:]

You're adding, obviously, a significant number of revenues through Raymarine and ICx. Do operating margins trend below 25%? Or do you think you can kind of rapidly improve the margin structures of both those companies to get them more in line with FLIR kind of in the Q1, Q2 timeframe?

[Earl Lewis:]

Let me back up a second here. We would expect two things, probably. One is that the revenue growth won't be so good in both of those businesses because neither one we want to push on the growth side so much as we do on the operating income side. We think that there's plenty of very nice good products in ICx that earn good margins. We want to emphasize those. We want to deemphasize those that aren't earning a good margin. So we will see modest growth, perhaps, in both of those businesses. I wouldn't suspect they'll be at 25% in terms of operating income. Maybe by the end of next year. The fourth quarter, maybe. But certainly not for the year. The question asked before. Depreciation and amortization in Q3 was $14.4 million.

[Operator:]

Your next question comes from the line of Peter Skibitski [SunTrust Robinson Humphrey].

[Peter Skibitski:]

Just want to follow on to an earlier question and this is kind of philosophical. On the point of kind of moving from a pure play infrared detector and infrared sensor company to a broader sensor company. I'm just wondering how hard or how easy a decision that was for you guys to make? If you look at Raymarine and then ICx, is it something you really struggled with? What sort of a different business model you'd have to use? Or was it an easy decision for you?

[Earl Lewis:]

Well, that's an interesting question. What we're about is -- we want to return better results to the shareholders. And looking at Raymarine, we thought we saw an opportunity to significantly increase infrared in that market. The concern I think people have is the fact that it was a large acquisition. It was $180 million, and therefore a change in our company. If Raymarine was a $60 million company, I would have been just delighted to buy it. You don't have your pick in that decision-making. Yes, it was a relatively large company compared to FLIR, but you say was it difficult for us to? No, I don't think so. I think in the beginning, we struggled a lot. Then as we understood what the ability of that business might be to grow infrared, and therefore, how profitable it might be. And it as a business by itself, was a very good business. It became more interesting for us to buy it. ICx, on the other hand just gives us a lot more sensors. And eventually, we see these sensors being in combination with infrared in many applications. Right now, we know that radar and infrared that ICx makes is clearly 100% in our camp, if you will, today. Overtime, these other sensors will be used with infrared sensors. So yes, I guess, but also, the timing was right for us. The economy was bad. The prices of these companies were, I think, exceptionally good. And their future is exceptionally good as stand-alone companies. So a whole bunch of things went in to the thinking. I don't think there was a lot of fighting internally about whether we're dampening our infrared business or not. That wasn't discussed.

[Anthony Trunzo:]

Peter, we've spoken for the last couple of years about the powerful cash generating ability of this business, giving us the opportunity to leverage into adjacent products, adjacent technologies and adjacent markets. And it wasn't by accident that we were communicating that. When we look at our acquisition opportunities and the opportunities to invest that cash, those are really the key areas. And Raymarine and ICx fit very nicely into that sort of paradigm. It doesn't mean that infrared isn't going to be a terrific growth market. Doesn't mean that it's not going to be our core going forward. But we clearly have an opportunity to drive value, not only from the terrific core business that we have, but also from doing logical acquisitions that are adjacent in the way we've tried to communicate to the investment community.

[Earl Lewis:]

Yes, turning that on its ear. There was no one at the table in these discussions that ever thought, "Gosh, infrared is not going to grow, we better buy something." That has never crossed anyone's mind. At least anyone I know in this company.

[Operator:]

Your next question comes from the line of Michael Lewis from Lazard Capital Markets.

[Michael Lewis:]

Earl, quick question for you, and it's more qualitative. If you look at the airborne systems, and we back out the historical work that you've done Oconus, overseas, the overall business appears pretty strong. It's at least stable, but it does appear strong in my opinion. Would you agree with that assessment? And also, it's been a little while since we've gotten an update on you on your defense maritime opportunities that you're looking at going in the next few quarters. Can you talk a little around that for us?

[Earl Lewis:]

Yes, I think those are good questions for Bill. Clearly, we just booked a -- well, go ahead.

[William Sundermeier:]

Sure. Outside of the Oconus opportunities and what we have done there, our airborne platforms are extremely strong and continuing to be. As, in fact, here at AUSA, which is next week, we'll be showcasing our multispectral star HD systems. We’re on our second generation of high-definition camera systems and putting in a shortwave infrared camera as well. So we'll have visible shortwave, long wave. We're out there on the leading edge of technology. I just saw an announcement this last week where one of our competitors is actually getting funded by the government to improve their system to our kind of capability, and we're already there. So we're very strong in both the large gimbal, and in the small gimbal platform as well, as it moves to HD and [indiscernible] systems. So those systems are being accepted around the world. It's not just a U.S. phenomenon for us, but actually we're very, very strong internationally with our airborne products. Switching to maritime. The SPS program, which we've re-won this last quarter and announced, is a great maritime for us. As you may know, we're putting two sensors on all the Navy ship. And we've started with the Aegis cruisers and are now going to be working through the next fleet over the five years to add our sensors. And we can boast that in the first round of that, we were one of the only products, if not the only product, to pass [indiscernible]. Actually even blowing up one of our sensors to make sure that it wouldn't send shrapnel around the deck of the ship. So very strong there as well with our small boats. With SeaFLIR. With the Coast Guard. These are all opportunities and great customers that we've had on board for a long time. So maritime opportunities grow slower than the airborne ones, but we think that we're very well established in the Navy and the Coast Guard and ships abroad as well. We'll have some international ship programs in the future as well.

[Operator:]

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

[Jonathan Ho:]

You guys have talked a little bit about the challenges that you're seeing in the Government Systems visibility. Can you maybe talk about your thought process in terms of the backlog exiting the year relative to your prior expectations? And also your outlook for government systems? I'm talking about the core here excluding the ICx contribution as we start to look at 2011, and whether that's changed at all?

[Earl Lewis:]

I think we sort of answered that couple of times, Jonathan. We haven't completed our budgeting process for next year yet. We are taking a good hard look at it. We believe so far anyway, that we will see growth in the business excluding the work that we did on RAID. Again, we don't know what RAID will bring us next year. That's still a wildcard and could affect our thinking one way or the other. I think Bill mentioned, and we mentioned previously, we are bidding some fairly good-sized programs. These are very hard to predict for us. It's very hard to give you any insight as to whether we will win them or we won't them. We do believe that our core growth will be positive next year. And every indication, so far, in our pre-budget meetings has been to that effect. I don't know how to tell you anything more. Q4, you mentioned. Q4 is traditionally a relatively weak order entry quarter for us in the Government Systems business. And as of right now, we're not predicting it to be as strong as Q3.

[Operator:]

Your next question comes from the line of Michael French from Morgan Joseph.

[Michael French:]

Question is on Thermography and the weakness in Europe. Perhaps you could explain the reasons behind that? And when we should expect to see a rebound?

[Earl Lewis:]

Well, let me ask Tom to do that. That's an opinion question I think in some ways.

[Tom Surran:]

As Earl mentioned, we did have some operational issues. In looking at the Thermography business, we have put someone who has run the Commercial Vision Systems, previously run Thermography operations. An exceptionally strong manager in charge of the EMEA region. He had some issues he had to address. And in doing so, they created some disruptions. In the long term, all those actions are going to be very beneficial to the company. So we're in a period of pain as that's occurring. Now at the same point in time, there are some issues in the region in Europe. We're seeing some softness in France because of the building regulations. We're seeing some weaknesses in Italy because of the industrial market. Those things, that's the macro economic trends. But in terms of our ability to execute over the next several months, and by the end of the year, we'll be positioned to execute extremely well in Europe.

[Operator:]

We do have a follow-up question from the line of Tim Quillin.

[Timothy Quillin:]

With regards to your discussion on ICx and Raymarine's outlook for 2011, where are those companies going to end up in revenue? Kind of pro forma as if they were here the whole year in 2010?

[Earl Lewis:]

I think what Tim is asking is what do we expect the revenue to be for these two acquisitions next year.

[Timothy Quillin:]

Yes, right.

[Earl Lewis:]

Tim, I don't know. Raymarine will grow next year compared to its performance when we didn't own it. That I'm sure of. Raymarine will do more in revenue next year than it did last year. Next year now being 2011. Last year being 2010. ICx is different issue. There are parts of ICx that I don't know necessarily we're going to keep. So I think that really very much remains to be seen. I would be surprised if we would see top line growth in ICx next year given the operating margin improvement that needs to be done there. So that's my opinion right now.

[Operator:]

We do have a follow-up question from the line of Peter Arment from Gleacher & Company.

[Peter Arment:]

Just a follow-up question regarding your comments regarding, I guess, the convergence between the IR and the radar you mentioned with ICx. I guess it sounds like there's some near term opportunities that you're seeing that are, I guess, right in your wheel house over the next 12 months. My question is related to how we think about the margin of that product going forward? Is ICx, I know they develop a lot on their own in their own IP, but is some of the stuff that they did with radar, was it government funded? Or would it come through at a lower margin? I'm just curious of your comment.

[Earl Lewis:]

No, the radar business is good margin and mostly developed by them and owned by them. So I think that we should see in that particular business. And let me expand that comment. They have products that they have developed that have extremely good margins. Some of them are better than ours. And those are products that we want to push on and grow. Radar is one of those. Some of their explosive detection is another. Some of their radiological work that they've done is another. Some of their chemical biological tools are very good margin. So when you kind of cut through their business, there's some very, very nice parts of it. Radar is an immediate link as you point out, some of the others will take longer. But over the long run, eventually, people are going to want to see a threat and they're going to want to measure that threat. And we see the threat today. We don't measure it today. When ICx comes along we'll be able to measure it. And we'll find different ways of integrating that scene and measuring with our equipment. So over the long run those sensors will integrate all of them. Right now, the immediate integration is radar. To your point.

[Operator:]

We do have a follow-up question from the line of Noah Poponak from Goldman Sachs.

[Noah Poponak:]

Tony, you started to briefly discuss cash flow. The free cash to net income coverage in the company, I guess, has been mixed in the past because you've been growing so fast. In '09 and '10, you're basically doing 100% of net income with slower growth. Is that kind of the new norm for the company and what we should be thinking about going forward? Or is it not as the commercial businesses reaccelerated?

[Anthony Trunzo:]

I think, I mean, if you go back, you can go back six, seven years, and see that our free cash flow is about 105% of net income for that entire period. It does bounce around a little bit. Q2, we were 75%, 78% of net income. Q3 we were, I think, 130% of net income. So it's not going to be stable every single quarter. We'll see movements around in the mix of current assets and current liabilities. But overall, this business, I think one of the hallmarks of it is, its ability to grow fast and generate substantial free cash flow that we can either return to shareholders or invest outside of the core. And I think that's going to continue. I sort of look at the 100% of net income level as the benchmark. Just move it over any given period of a few quarters, I think that's sort of the benchmark of good performance. And we ought to maybe do a little bit better than that.

[Earl Lewis:]

I don't think it's changed that much. I don't know. I think as Tony points out, on an annual basis we've been pretty consistent in that regard.

[Operator:]

We do have a follow-up question from the line of Steve Levenson from Stifel, Nicolaus.

[Stephen Levenson:]

In relation to the spares order that you and Bill were discussing before. The Army did file a justification of approval to award that contract to you without a full and open competition. Do you think that's going to have any impact on their decision on the re-compete?

[Anthony Trunzo:]

Our current thinking right now is that as the Army moves to the program of record in 2012 that they're putting in room for a sustainment, and actually won't re-compete the investment program. So that's the current thinking right now and what we see afoot. And they're putting in money in the palm for just that kind of sustainment activity which could potentially be upgrades for us as well.

[Earl Lewis:]

We've done a very good job with that customer, and I think they're very happy with our work. So we'll see. Then they have their rules as well, so that's kind of how we look at that one.

[Operator:]

We do have another follow-up question from the line of Brian Ruttenbur from Morgan Keegan.

[Brian Ruttenbur:]

The cash at the end of the year is going to be how much?

[Earl Lewis:]

Around $200 million.

[Brian Ruttenbur:]

About $200 million. And you won't have any debts though, right? You'll have right around the $200 million making 0.5% or less than 0.5% returns?

[Earl Lewis:]

Or less than that, yes.

[Brian Ruttenbur:]

SG&A in the fourth quarter and R& D. Can you give us a roundabout number? A range?

[Earl Lewis:]

It's not going to change much.

[Brian Ruttenbur:]

And then SG&A and R&D next year with the acquisitions all in there, are we going to have a drop from fourth quarter to first quarter? I know you're going to be making some cuts and some changes. What should we be looking for in terms of modeling going forward?

[Earl Lewis:]

I can't build your model yet because I haven't built mine. We've got to go through it. The traditional businesses are going to be not big changes. The two we've got to spend some time on. What will ICx do in that regard? And what will Raymarine do? Frankly, we just have not done that yet. So I hate to throw out numbers that we’ll come back and regret. Directionally, ICx will probably a little less in terms of its percent R&D that we pay for, if you will. And directionally, I think Raymarine would be a little bit less than our traditional R&D that we pay for. But that's just an opinion. ICx may have some fantastic wonderful idea that we want to fund that we haven't got into yet. So I hate to put numbers on it yet.

[Operator:]

We do have a follow-up question from the line of Josephine Millward from Benchmark Company.

[Josephine Millward:]

Bill, you mentioned that you expect the defense budget to get done possibly in December. Now as you know, this budget could get pushed up potentially to February and March. Or maybe even later next year, depending on the outcome of the elections. So if that happens, how would that impact your government outlook for next year? And before I get cut off, can you also give us the split between U.S. and international on your government bookings and backlog. And also comment on the U.K. government's proposed defense spending cuts?

[William Sundermeier:]

Well first, certainly, I mentioned the continuing resolutions until December. And the defense budget certainly could get delayed, and then the things that we're anticipating happening in Q1 could get delayed a little bit further. So I think that kind of answers itself. For the things that are within that defense budget, which in no way is our entire plan for Q1, so it'll have an impact, but eventually it will get spent. As far as international and U.S. mix. We mentioned in Q3 that the U.S. component was stronger of course because of the end of year fiscal budget. But our international orders still remained strong. And I don't have a mix for you there as a percentage for Q3. And then U.K., with their recent announcement of reducing troops and saving money, of course, it's going to be a very difficult environment. Although we have done quite a bit of business in the U.K., especially with the special operation forces, but not as much with the regular forces there. And it's been an area for us to try and penetrate in the MoD in the U.K. And I think that's going to be even more difficult in this environment. So it hasn't been a large mix of our revenue and our bookings in the past. So we'll continue our focus in other parts of Europe in the Middle East to keep our international business strong.

[Operator:]

Your final question comes from the line of Michael Ciarmoli from KeyBanc Capital Markets.

[Michael Ciarmoli:]

Do you have the IDIQ number that's not in your backlog? And I guess, just Earl, if you can comment, you said you had a number of proposals out there. Given the DoD's efficiency push, other budgetary pressures, are you seeing anything change in the pricing environment for these new contracts you're bidding on?

[Earl Lewis:]

The numbers I gave you were the IDIQ, and it was $61.4 million, I think, from memory. And of that, roughly $1.4 million, we actually showed as part of our backlog, our bookings in Q3. Pricing, I don't believe has been an issue in the programs we bid to date, any more so than it always has been. Most of our bidding is based on our own internal cost structure and our own estimates as to what the customer can pay. As opposed to the development programs that a number of other companies have to bid on that are cost plus. So I don't see, in fact I think if you really say what's the margin change that we see going forward due to new procurement regulations, I don't expect we'll see that have a big impact on us next year. A much bigger impact is, for example, is the mix between domestic and international. And you asked me for what?

[Anthony Trunzo:]

Mike, I think you're asking for what our total IDIQ unordered balance is? And if that was your question, we don't have that number for the end of Q3 yet.

[Earl Lewis:]

The one I said was the order that we received in Q3. Well, thank you all. I got the feeling perhaps everybody was getting cut off a little quick. If that's the case, give any one of us a call and we'll try to continue whatever questions you want to have answered. I think we do have to bring it to a close. We thank you very much and appreciate it. And look forward to talking to you at the end of Q4.

[Operator:]

Thank you. This does conclude today's conference call. You may now disconnect.