FLIR Systems, Inc.
Q1 2013 Earnings Call Transcript

Published: 26 Apr 2013

[Operator:]

Greetings, and welcome to the FLIR Systems, Inc. First Quarter 2013 Earnings Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Wit Davis, Senior Vice President, General Counsel and Secretary for FLIR Systems, Inc. Thank you. Mr. Davis, you may begin.

[William W. 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 R. Lewis:]

Thank you, Wit, and welcome to FLIR's first quarter 2013 earnings call. We finished the quarter with revenue of $349 million and earnings per share of $0.353 or approximately 1 halfway between consensus of $0.35 and consensus of $0.36. We had a 13% increase in total from last year. Revenues were unchanged versus the prior year, as we saw slow or delayed deliveries, primarily to our U.S. customers. The total company backlog of $505 million at the end of the quarter was up 10% over the first quarter of 2012. We improved both our gross and our operating margins from the first quarter of 2012. Commercial Systems' organic operating margin was up over 2 percentage points, excluding the impact of Lorex and Traficon, while our Government Systems improved its operating margin by 1.5 percentage points over Q1 of 2012. These results were in line with our expectations for the quarter. The work we have done to lower cost has helped us maintain our strong margins in a challenging environment. The current state of the markets has also created opportunities for us. In April, we borrowed $150 million under a 6-year loan that added very low cost capital to our balance sheet. We continue to generate strong cash flow, with Q1 operating cash flow up over 26% from the prior year, representing 120% of our net income. We intend to deploy this cash in a balanced and opportunistic way, bringing long-term results to our shareholders. During the first quarter, we repurchased 3.8 million shares for $108 million and paid $13 million in dividends and invested $50 million into the business through R&D and capital investments. Our outlook for 2013 has not changed. While we know markets -- some markets will recover faster than others, over different periods of time, we expect to see a gradual recovery out of the troughs that most of our markets have experienced lately. In addition, we are looking forward to introducing some new products that will help spur growth in the second half of this year. We continue to expect the year-end results to come in between $1.5 billion and $1.6 billion in revenue and earnings of between $1.56 and $1.66 per diluted share. Andy Teich, our new CEO in waiting, will now summarize Commercial Systems division performance for the first quarter. Andy?

[Andrew C. Teich:]

Thanks, Earl. The Commercial Systems division finished the first quarter of 2013 with a 5% increase in revenue and 6% increase in operating profit compared to the prior year. Organically, the Commercial Systems division saw a decline of 6% in revenue, but increased operating margin by over 2 percentage points versus last year. The Thermal Vision and Measurement business experienced softness in the high-end government-related Cores & Components business, while Raymarine saw a continued but slowing declines in the EMEA region, as well as lower retail channel orders in the U.S. Raymarine did see good growth in Asia-Pacific, as well as in the non-retail channels in the U.S. The Commercial Systems division Q1 bookings increased 6% over the prior year. TVM bookings dollars increased 11% over the prior year, while Raymarine bookings declined by 8%. TVM's thermography line of business saw bookings dollars decline 7% from a year ago, primarily due to a contracting European economy and a weak building market in the U.S. During the first quarter, we launched our new K-Series fire fighting camera in Europe and, this week, in the U.S. The K-Series is a highly recognized thermal camera that is designed and tested to help first responders find people, locate hotspots and see through smoke under extreme heat and moisture situations. The response thus far has been very positive, and we look forward to launching the product to the rest of the world later this year. TVM's Cores & Components line of business was negatively affected by lower order activity from large customers in the U.S. Order activity for [indiscernible] course was strong, however, with units booked growing over 60% versus the last year. Organically, Security line of business bookings increased dramatically compared to last year and more than tripled when you include Lorex. The addition of Lorex is proving to be a very good combination, and we are excited about plan, design and feature revision that we expect will be highly attractive to the security market. With the addition of our other acquisition, Traficon, we've created a new line of business within TVM called Intelligent Traffic Systems, or ITS. This business will be focused on providing traffic monitoring solutions for stoplight control and traffic incident detection applications. Traficon saw nearly 15% growth in bookings over its first quarter of last year, driven by $2 million in orders for traffic and tunnel projects in Asia. As we anticipated, TVM's maritime business bookings were lower due to strong order from the cruise lines in Q1 last year in the U.S. and in Europe, partially offset by strength in the APAC region. During the quarter, we launched 3 new products

[William A. Sundermeier:]

Thank you, Andy. Government Systems division revenue was down 6% versus Q1 of 2012, while operating margins improved by 1.5 percentage points. Backlog for the division at the end of Q1 was $334 million. Expected stock order flow in the U.S. was partially offset by good international bookings. International orders accounted for 60% of total bookings in Q1. The Surveillance segment finished the quarter with a backlog of $245 million. As expected, the quarter proved difficult for our U.S. customers, who faced the sequestration and continuing resolution uncertainties for most of the quarter. At the end of the quarter, we had a last-minute delay of a major order for additional review that substantially impacted our bookings forecast. We expect the review will be completed, and we will see this order in Q2. We also saw customer-imposed delivery pushouts caused by program integration delays during the quarter. The largest order, though, in the quarter for the Surveillance segment was $22 million to outfit the Afghani Air Force with our BRITE Star gimbals. This award was part of the Light Air Support program, where FLIR was selected as part of the team of suppliers to provide A-29 Super Tucano aircraft to the Afghan military. Asia-Pacific region was active with major bookings in Japan and Taiwan. In Europe, we booked nearly $11 million in orders from customers in Italy, the Netherlands, the U.K. and Finland. And our success in Turkey continued with another $2 million order for our 380-HD gimbals. In the U.S., we received an order from the U.S. Coast Guard for $3 million [ph] of our SeaFLIR imagers as part of the shipboard infrared visual sensor system or SIRVSS program. And the first order from U.S. SOCOM for the SOPMOD program, where FLIR was selected to provide both image intensified and thermal sights to U.S. Special Forces. The Detection segment finished the quarter with $24 million in backlog, largely unchanged from the balance at the end of 2012. During the quarter, we released our Fido X3, a handheld explosive detector and received orders from our customers in China and Qatar, while shipping the first production units to an Australian customer. Bookings from our Chem/Bio and Mass Spec line of businesses exceeded plans, driven by good order activity for our Griffin Trace Detection units and IBAC aerosol for our Detection Systems from customers all over the world, including Russia, China, Iraq and the U.S. The order activity from international markets, which represented over 1/3 of Detection bookings in the quarter, is encouraging and consistent with our strategy to expand our distribution and lessen our reliance on government-funded R&D. Integrated Systems finished the first quarter with a backlog of $65 million. Our J2 program, now called GRSKO [ph], passed the milestone seat [ph] addition [ph] and is heading for LRIP and production. Our facility in Alberta, Georgia has been successful in delivering and passing acceptance testing of the first production units of MSC vehicles for the U.S. Customs and Border Protection with further shipments in the second quarter. That concludes my comments in the first quarter. And Tony will now discuss the financial results in more detail.

[Anthony L. Trunzo:]

Thank you, Bill. First quarter consolidated revenue was $348.6 million, essentially unchanged compared from the first quarter of 2012. Commercial Systems division's first quarter revenue increased by 5% to $211.8 million. The Thermal Vision and Measurement segment posted first quarter revenue of $167.4 million, an increase of 8% compared with the first quarter of last year. Lorex and Traficon, 2 businesses we acquired late in 2012, accounted for $21.8 million of TVM revenue in Q1, while U.S. government-funded revenue in TVM dropped by 40% compared to Q1 of last year. Raymarine revenue declined 5% compared to Q1 of last year to $44.4 million due largely to lower orders from a U.S. major retail customer. Other U.S. channels were up, however, and Asia performed well. Government Systems' Q1 revenue was $136.8 million, a drop of 6% compared with $146.1 million in the first quarter of 2012. Surveillance segment revenue was $110.2 million, down 4% from Q1 of last year. Surveillance experienced strong growth in non-U.S. markets, but this was more than offset by a 23% decline in revenue with U.S. government customers. Detection segment revenue was $12.5 million compared with $19.4 million last year, while Integrated Systems segment Q1 revenue was $14 million versus $12.2 million in Q1 2012. International revenue was 50.9% for the consolidated total in Q1, up from 42.9% of revenue last year, as international revenue increased by 18.7%, while U.S. government revenue on a consolidated basis declined by 21.1%, resulting in a 14% decline in overall U.S.-derived revenue. Commercial Systems international sales made up 56% of its consolidated revenue in Q1 compared to 51.9% in Q1 last year, while 43% of Government Systems revenue came from outside the U.S. compared with 30.4% last year. Total sales to the U.S. government were 22.3% of the total in Q1, down from 28.3% of revenue in the first quarter of last year. Consolidated gross margin was 52.8% for the first quarter compared with 52.4% last Q1, despite a 1 percentage point negative impact from the lower margins at recent acquisitions. All 5 segments saw improved gross margins on an organic basis. Consolidated operating income was $69.1 million, an increase of 1% compared to the $68.3 million in the first quarter of last year. And operating margin was 19.8%, up slightly from 19.6% in Q1 of 2012. First quarter operating income in Commercial Systems was $45.9 million, an increase of 6% compared to Q1 of last year. Thermal Vision and Measurement posted $39.9 million of operating income, up 2% from last year; while Raymarine operating income was $6 million, representing a 56% increase from last Q1 due to improved gross margins and continued cost containment efforts. Despite difficult market conditions, we expect Raymarine's profitability in this year to be meaningfully higher than it was in 2012. Government Systems operating income was $35.7 million for the quarter compared with $35.9 million in Q1 of 2012. Surveillance segment operating income was $35 million, unchanged from Q1 of last year. Improved segment gross margin resulted in a 1.3 percentage point increase in segment operating margin to 31.7% in the quarter. The Detection segment posted $600,000 of operating income last -- this quarter, down from $1.4 million last year due to lower revenue. Segment gross margin improved over 7 percentage points, however, and operating expenses declined by 16%. We expect the Detection segment to show improved performance for the remainder of 2013. Integrated Systems operating income was $200,000 in Q1 compared to an operating loss of $400,000 last Q1. Earnings before interest, taxes, depreciation, amortization and stock compensation in the quarter were $89.2 million, a 1% improvement from Q1 of 2012. Our tax provision for the quarter was 23.1% pretax income and included a $1.6 million discrete benefit from the recognition of research and development tax credits from 2012. For the full year, we continue to expect the tax rate of approximately 25%, excluding the Q1 R&D credit. Cash flow from operations for the quarter was $62 million, representing 120% of net earnings. Between mid February and early April, we repurchased 4.1 million shares of our common stock at an average price of $26.20 per share, including 2.9 million shares pursuant to an accelerated share repurchase program. We also paid dividends during the quarter totaling $13.1 million. Q1 capital expenditures were $12.9 million. In early April, we amended our $200 million revolving credit facility for the syndicated 7 banks to extend the maturity to April 2018 and to incorporate a new $150 million term loan to the facility. This transaction adds to our already strong liquidity, lowers our overall cost of capital and provides us with great flexibility to act on investment opportunities as they arrive, all while maintaining our investment-grade credit ratings. Today, we also announced our regular quarterly dividend of $0.09 per common share, which will be payable on June 7 to shareholders of record as of May 20. Before I turn the call over to Earl, I want to take a moment and congratulate Andy on his appointment as President and CEO. His passion for the business is evident in everything he does, and I'm sure this will be a driving force for the future. Andy and I worked closely together for many years and shared commitment to grow FLIR and deliver value, and I look forward to continuing on that same path well into the future. And finally, I want to thank you, Earl, for all you've done for FLIR, our stakeholders and me, personally. It's been my great pleasure to work with and for Earl for the past 10 years. His thoughtful leadership and dedication to creating value has had a profound impact on FLIR, and his mentorship has meant a great deal to me, personally. Earl, I know the people on this call appreciate all that you've done for them and for FLIR. On behalf of them, I wanted to thank you. With that, I will turn it over to you.

[Earl R. Lewis:]

Thanks, Tony, Andy, Bill. Of course, the most interesting part of your careers now will be producing enough money, so I can enjoy my retirement. With that, we'll have the first question. Operator?

[Operator:]

[Operator Instructions] Our first question comes from the line of Jeremy Devaney with BB&T Capital Markets.

[Jeremy W. Devaney:]

First off, Earl, I just want to thank you for the time over the last few years. I really enjoyed working with you. And best of luck in retirement. But as we look to the capital return strategy of FLIR, hopefully, this might mean that we're going to take another look at the dividend as you move to retirement and think about how to deal with that.

[Earl R. Lewis:]

Yes. I might come at it from a different trajection. You're right, yes, yes.

[Jeremy W. Devaney:]

So tongue in cheek a little bit, but could you talk a little bit about your capital return strategy as we move forward? There's a lot of share repurchase here. Any thoughts on expanding the dividend?

[Earl R. Lewis:]

Well, that -- I'm going to -- most of these answers are going to come from the team. So, Tony?

[Anthony L. Trunzo:]

Yes. So, Jeremy, we -- if you look at what we've done over the last couple of years with the dividend, we introduced it 2 years ago at $0.06. We took it to $0.07 the first year, and then we took it to $0.09 this year. So we -- over the course of a couple of years, the dividends increased by 50%. And we put it in place. I think we said we were starting at a relatively low level with the expectation that it would probably grow as a proportion of our capital deployment over time, and that's effectively what we've done. I don't know that we will be seeking from the Board another change in the dividend this calendar year. But I think the long-term thinking is, as the business grows, we'll continue to grow the dividend and probably deploy a progressively higher, although probably still moderate amount of our net income into the dividend. As regards share repurchase, you saw we did a significant chunk in Q1. There was an opportunity to do a couple of things there in terms of the ASR. So we thought it would be meaningful and appropriate and we went ahead and did that. I would expect that we'll continue to be active buying back shares during the course of the year. So the activity, obviously, depends on the price. Clearly, in Q1, you saw that we were willing to put capital against the share repurchase program in the mid-20s. And going forward, we'll keep a close eye on opportunities to take chunks of shares out of the market at what we think are attractive prices to drive a higher return on equity and help support the EPS going forward.

[Jeremy W. Devaney:]

[indiscernible] for the colors. I really appreciate it. Looking at your order backlog and then also as for the tempo of conversion of backlog, I was wondering if you could comment on what portion of your business is more book and ship versus longer cycle and maybe even drill down a little bit on -- at a subsegment level. Could you stack your units from shortest cycle to longest cycle for us?

[William A. Sundermeier:]

From a business unit perspective?

[Jeremy W. Devaney:]

Yes, sure.

[William A. Sundermeier:]

In the Government Systems business, most all of the Detection business is book and ship business, a very small backlog there. Integrated Systems business, it's probably about 50-50, maybe more towards a 60%, 70% backlog covered. And Surveillance right now is running at about 50% backlog covered, which is more like late '90s, early 2000 kind of historical levels. So we don't have the luxury of what we had in the REIT [ph] days. So there's a lot of book and ship business that happens within the quarter in the Surveillance business right now.

[Andrew C. Teich:]

And on the Commercial business, they are both, the Thermography business and the Raymarine business, are book and ship businesses. Lorex was 100% book and ship business basically. The Traficon business carried some backlog there. It's probably more than 50% of its quarterly revenue comes out of backlog. And in the CVS business, there's backlog both on the Systems side and on the Cores & Components side. And typically, there is more than 50%. Typically, it's probably in the high-60s of backlog coverage there, and that fluctuates around a bit quarter-to-quarter. We've seen it creep up a little bit lately, but our ability to fulfill book and bill has also increased in recent quarters.

[Operator:]

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

[James Ricchiuti:]

Earl, the best of luck.

[Earl R. Lewis:]

Thanks, Jim. You may see me around somewhere.

[James Ricchiuti:]

Sure. I hope to. And, Andy, congratulations, by the way. And, Andy, maybe you can take this question. I just wondered if you can comment a little bit about what you're seeing in EMEA. Do you feel that we're getting toward a bottom here? And what's your sense in terms of the outlook over the next couple of quarters?

[Andrew C. Teich:]

Well, I'd like to say that we're seeing the bottom, and it tends to bounce around a little bit. So there are weeks that we feel like we're on a rebound, and then things slow back down again. The -- it depends on the segment as well and, of course, the country or region. So if I look at the Raymarine business, we've had both challenges in the OEM segment in places like France and Italy, which are large OEM components for us. And then, the weather there this past quarter -- it took a long time for winter to conclude in Northern Europe and the Scandic region, and we feel that had a weighing effect on Raymarine's bookings. In terms of the Thermography business, it's been a bit mixed depending on the segment there. So I would say that the biggest factor that we've seen there is Germany. The things continued to be slow in Germany, and we've actually reallocated resources out of that region into other parts of the world that show stronger growth. So, yes, in conclusion, I would say that we're hoping that we are at a nadir point in terms of the EMEA economy. But I think it is yet to be proven out.

[James Ricchiuti:]

Okay. And, Bill, a quick question for you. You alluded to some pushouts in the quarter. I wonder if you could talk a little bit more about that? Was it meaningful in terms of potential revenue impact?

[William A. Sundermeier:]

The first pushout was really a pretty substantial order that -- we had basically gotten our version of it from the government and signed it, sent it back [indiscernible] a very large delay in us receiving that. We hope to get that here very shortly. The rest of the pushouts were primarily in Integrated Systems, where we had done our part of the integration work, but the rest of the commissioning and the program there were -- the final airport installation and everything that was going on just delayed and delayed the program so that we couldn't count [ph] for revenue. I wouldn't say that it was significant to GS's total revenue. Certainly, it would have helped with the EPS for the quarter.

[Operator:]

Our next question comes from the line of Peter Arment with Sterne Agee.

[Peter J. Arment:]

Congratulations, Earl and Andy. Earl, I'm glad to see you were able to work in the timing of the retirement with boating season.

[Earl R. Lewis:]

Yes. We had been planning on it for 2 years. That's easy to do.

[Peter J. Arment:]

Yes, I figured that. Andy, first question really is on the Raymarine profits. Very nice improvement there. How should we think about the sustainability here, what you're seeing in terms of how you guys have been able to reshape the cost structure there? And then, just -- as my second question, just as the K-Series that you're rolling out in the fire fighting, obviously, the first responder market is big and under penetrated. I mean, you went into a lot details on that at the Investor Day. Can you talk to us a little bit about how -- what's different about this rollout, or what exactly you see as the opportunity here?

[Andrew C. Teich:]

Sure, I'll cover the K-Series one in a moment. Tom, do you want to just comment on sustainability of the Raymarine's profits? I got Tom Surran here, who runs our business. So...

[Thomas Surran:]

So the first -- we will see continued improvement for the balance of the year until the fourth quarter. The actions that we're taking at the end of last year, a little bit -- again, this year, are going to be paying [indiscernible] for this time period. Subsequent to that, we are always going to -- we're introducing new products which have better margins. We're working on being more efficient with how we get those to the marketplace. So I think you'll see substantial improvement this year for the balance of it and then slower but hopefully continual improvement in margins from that point forward

[Andrew C. Teich:]

Yes. I would also say, Peter, that I think, on the cost side, the work has largely been done there. So we're really just looking for those to roll through the income statement at this point. So the real change to the income statement should be in the top line growth that should be bolstered by the new product introductions that we mentioned in the prepared comments. Moving over to the K-Series, so this is a product that we introduced in March in the EMEA region, and we just introduced this week at the FDIC show in Indianapolis. In terms of its differentiating features, there are 2 primary ones. One is it has a very rich feature set. We know this market quite well. We participate in this market in a direct fashion about 10 years ago and have been a core supplier into the market for many years. So we have engineered this product with what we think to be the right feature set. And the second is pricing. We've offered these products at a very compelling price point relative to the feature set, and we're going to be selling the product through a broad-based distribution model. And we're confident that that's going to drive decent volumes as the brand is built and we build credibility for the units out in the marketplace.

[Operator:]

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

[Jonathan Ho:]

Hey, Earl, I just wanted to echo my congratulations as well and also to you, Andy. Just to get the opportunity, it's definitely been a pleasure to work with you over the past few years, Earl, and definitely wish you the best of luck on the retirement.

[Earl R. Lewis:]

Thank you.

[Jonathan Ho:]

Just starting out with Andy. Here, now that you said the opportunity to take the reins -- I just wanted to -- it's maybe a little bit early for this, but just wanted to get -- I mean, any sense of -- any thought process around what you may potentially look at differently or whether there'd be any sort of strategic change that you'd be looking at? Or do you think you're just going to kind of continue along? I just wanted to get a sense from you what the general plan is at this point.

[Earl R. Lewis:]

Let me just make sure you understand. Andy found out about this at 5

[Jonathan Ho:]

Fair enough.

[Andrew C. Teich:]

I had all night to think about it. Well, schematically, Jonathan, I would just mention 2 things. One is a focus on getting the businesses back to stronger top line growth, and I think that's part of the reason that the Board selected me as that is a skill set that has been firmly in my wheelhouse. So it's going to be focused on that. And that will be executed through a combination of sales, marketing and product initiatives. I mean, those are the levers that I typically pull on in terms of driving top line growth. It's been challenging, even in my business in the last 18 months, to deliver that top line growth given the economic conditions. So I'm hoping a combination of some strategic changes and also some improvement in the procurement environment will allow us to deliver the kind of results that I'm expecting out of those initiatives.

[Jonathan Ho:]

Got it. Sorry for putting you on the spot there. I didn't realize it was such a sudden decision.

[Earl R. Lewis:]

The decision was made quite a while ago. The telling of it, due to the rules, at least, I'd say the decision -- that we're pretty sure who was going to take my place, but I wasn't exactly sure when I was going to leave. So that kind of compounded the whole thing.

[Jonathan Ho:]

Fair enough, fair enough. Just as a follow-up, when we look at the Detection business on the Government Systems side, how should we think about the revenue run rate going forward? I mean, is this sort of the correct level at this point, or would you expect that to sort of improve over the course of the year? Just wanted to get a sense, with the release of new product, how we should think about that trend over the course of the year.

[William A. Sundermeier:]

The Detection run rate, I think now that we've got kind of a better stroke between CRAD and product revenue, this is the kind of sales run rate we're going to see. I anticipate it's going to continue to ramp throughout the year with continued strong bookings. But we're getting at where we really wanted to be. The CRAD is right around 20% to 30% and will continue to increase as we get the rest of the product revenue ramped up. We're going to see continued revenue growth that's going to be product-based, which -- the right way to think about this is, the more product revenue we have, the better margins we're going to continue to get out of that business and drop that to the bottom line. So I anticipate we're going to continue to see reasonable growth for Detection throughout the year.

[Anthony L. Trunzo:]

And, Jonathan, just as a sideline, I mean, obviously, Detection saw a significant step-down in Q1. I don't have the exact number right in front of me. I can get it for you, but something north of 80% of that revenue reduction was less -- was lower CRAD. So the product revenue was down a little bit. Getting in the way -- into the detail of it was radiation, mostly.

[William A. Sundermeier:]

We've got some pretty large orders in Q1 [indiscernible] last year.

[Anthony L. Trunzo:]

Right, yes. But the CRAD proportion of that business has dropped fairly meaningfully over the last couple of years, as per the strategy.

[Operator:]

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

[Timothy J. Quillin:]

And, Earl, I'm sure you'll be an active chairman, so I don't view this as you going away, just changing roles. And, Andy, it's -- I think I was telling somebody you've been in the industry for 30 years -- so since you were in grade school. So I'm -- I think we're probably in steady hands. Have you named a successor for Andy in the Commercial business?

[Earl R. Lewis:]

Not yet, but we will do shortly.

[Timothy J. Quillin:]

Okay. And then, on the growth -- the question about growth, I'm just wondering if you could name -- and not beyond current strategy, but the current internal strategies, to jump start growth. I know end markets are challenging, but maybe there's a way that you can outrun the market fundamentals, and if you can just kind of highlight what you're doing to -- on the sales marketing and product initiative side?

[Andrew C. Teich:]

Well, I would say that there are 3 things that address each of those 3 categories. So the first is look for revenue that we can derive from markets that we are not presently addressing, and you've seen that strategy execute in recent quarters in the CS business, and we've spoken about several of those here today, products like Dragonfly going into freshwater market; K-Series going into fire fighting; the MU-series going into high-end stabilized cool for the long-range maritime systems for luxury yachts. So those are all pursuits that represent market segments that we're not present in today. On the marketing front, it's really about promotions and how you communicate those promotions. So we've taken several steps here just within the last few months to change our marketing mix from sort of traditional marketing strategies, trade shows and print to move over to more digital and some direct selling activities via e-commerce. And then the third one is product. And I think those of you on the call that know me and have watched me over the years, I am a product person. I'm very interested in leveraging the technologies that we have internally here. And I think that a greater level of cross-pollinization of the technologies that we have within FLIR between GS and CS is something that you'll see come forward with a focus on creating greater value at a lower cost. And so, that's one that's going to take more work and will take longer time to manifest itself in the market.

[Timothy J. Quillin:]

And then, just more specifically around the guidance for 2013. You're starting with first quarter revenue at the same point that you started 2012. But yet, you're at the low end of guidance, about $100 million higher. So what are the drivers that bridges -- that bridge that gap?

[Andrew C. Teich:]

Well, there is -- it's business that we expect to pick up in the second half of the year in each of our segments. So we haven't articulated the specific elements of growth in each of those segments at this point, but we see the growth coming in the second half of the year, particularly as the Commercial businesses pick up.

[Anthony L. Trunzo:]

And Q2 of last year, I'll add, was unusually soft for a second quarter. So there's a softer comparison in Q2 on the revenue side relative to what we would typically expect in an environment like this.

[Operator:]

Our next question comes from the line of Peter Skibitski with Drexel Hamilton.

[Peter J. Skibitski:]

Just to follow on that last point. TVM, I guess, was down almost 7% organically this first quarter. And again, the kind of -- just to meet the bottom of your sales guidance, it seems like you have to move TVM from down mid- to high-single digits really to kind of up single digits the balance of the year, and you talked about Europe being kind of hard to predict. So can you give us some more color as to why you would feel why that's achievable?

[Andrew C. Teich:]

Well, it's a combination of 2 things. One is that we are seeing some response from the U.S. market in terms of better growth. The other issue is that we've got a lift from the acquisitions that we've done in the TVM segment.

[Peter J. Skibitski:]

Yes. Okay, okay, okay. And then, Earl, on you leaving...

[Anthony L. Trunzo:]

Let me just -- sorry, let me just add. Q1 revenue, if you really break it down, if you look at what happened, we had a significant reset between the U.S. government revenue and international revenue. Even in a weak international environment, the proportion of our revenue that shifted outside the U.S. was fairly dramatic. And that reset in U.S. government revenue appears like it has settled down. So we're not going to face 1 significant headwind that we faced in the last several quarters in a row. I think that's an important -- if you look at the puts and takes, that's an important component of what the next 9 months are going to look like.

[Peter J. Skibitski:]

Okay. So, yes. So -- Tony, so U.S. DoD was down by 23%, you said in Q1. Is that -- should we annualize that? Are there -- are the comps difficult the rest of the year in U.S. DoD? Or are they easy?

[Anthony L. Trunzo:]

No. They're not nearly as difficult as what you saw in Q1.

[Peter J. Skibitski:]

Okay, okay, okay. Got it. And then, on your leaving, Earl, was this something that you've been planning for a while, or was it more recent? I thought maybe we'd get some inkling of it at the Analyst Day, if it was planned. So I was just wondering how long you were thinking about this for.

[Earl R. Lewis:]

13 years.

[Peter J. Skibitski:]

That's -- yes, I've been thinking about it for the last 20, I think...

[Earl R. Lewis:]

You get to a point in time where you just decide it's time, and I felt that it looked like the balance this year should be pretty good. I felt that the costs were in good shape. I felt that the balance sheet was in good shape. I felt that we had a great team of people that run the business. And I'd like to learn how to play golf again.

[Peter J. Skibitski:]

I hear you. Excellent, excellent. Last one for Tony -- or I guess for anyone, but the $150 million term loan, should we think that the M&A pipeline is pretty full, given you taking out this loan?

[Anthony L. Trunzo:]

I'd say that it's maybe not as full as we'd like it to be. We're in a position now where -- Lorex and Traficon, the integrations have gone, I think, very well. Probably better than integrations -- about some of the best integrations we've done.

[Earl R. Lewis:]

No question.

[Anthony L. Trunzo:]

And we've digested them pretty quickly. So I think we're -- we feel like we're in a position to be able to make a meaningful acquisition. I can't tell you that -- we always have a wish list, if you will. How actionable that wish list is, it varies right now. There's not something that's meaningfully actionable. But I wouldn't at all be surprised if that changed during the course of this year. And that's clearly part of the reason we did it. It's hard to -- I mean, we've fixed the rate on that term loan at 2.49%. And as our business grows and our leverage comes down just a little bit, we'll pick up another 25 basis points. So we'll have 6-year money at 2.24%. That's capital that -- given our history of capital deployment, that's capital we just couldn't pass up to put in the barn now for the future.

[Operator:]

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

[Noah Poponak:]

Earl, a big congratulations on your career and the retirement, and I'll be tracking that handicap index you just referred to online. That's publicly available data.

[Earl R. Lewis:]

You're still going to buy me dinner?

[Noah Poponak:]

Absolutely. Happy to. And, Andy, congratulations to you as well.

[Andrew C. Teich:]

Thank you.

[Noah Poponak:]

I wanted to try to drill down into the split of the segment margins in the quarter and what to look for going forward so maybe this is for Tony. If I got the numbers right, Surveillance, $31.8 million. And I don't think I have enough data from when you changed the segment to know if that's seasonally weak, and the discussion there has been mid-30s. I just want to see if there's any change in how you're thinking about that margin. And then, TVM, a little lower than I thought, down year-over-year, has sort of been trending lower on an annual basis. I know there are some drivers of that, that you guys have outlined. Maybe just talk about the -- if that's the new level or not for the ongoing TVM margin.

[Anthony L. Trunzo:]

Yes. So, Noah, on the Surveillance side, margins were -- let me just -- let me orient myself here. They were up sequentially from Q1 of last year. The margins in that business are meaningfully affected by mix shift. There are some products in factories where we have lower margins than we enjoy in others. And we have seen a little bit of that. We may see a little bit more of that shift over the next couple of quarters. But when you look at the standard margins of our products in that business -- or the normalized margins maybe is the better way to put it, we're not seeing any pricing pressure. We did see some mix shift. I don't think that's a structural situation. Will it be softer and then better over the course of the next couple of quarters? Yes, I think it could be. But overall, that business remains highly profitable. Yes, Q2, I mean -- I was getting notes from the other side of the table. Q2 will be a little softer because of mix, but it doesn't really reflect any structural change in the core profitability of the products themselves. And that mix shift, I don't think we see as permanent. Regarding TVM, the Lorex and Traficon together were 21.8% of -- I'm sorry, $21.8 million of revenue at -- I'm going to look at days here, what was it? 7% operating margin, something like that? We carry the -- we carry all the amortization intangibles at those locations, and we don't see them as sort of the cash flow effect. Did you say it was less than 7%?

[Unknown Executive:]

[indiscernible]

[Anthony L. Trunzo:]

Okay. So it was -- combined, it was less than 4% for those 2 businesses. So that should improve over the next little bit as those businesses come up to scale. And a few quarters out, we'll see some of the amortization of the intangibles roll out. But the core TVM business, margins were actually quite strong in the quarter. And I think the trend is actually quite good. And the same is true of the COTS [ph] businesses at Raymarine. We've done a huge amount of product work there that has improved the standard margins fairly dramatically. And I've said this before, but a little bit of growth in that business goes a long way. There's a lot of operating leverage now.

[Noah Poponak:]

That's very helpful. So just to follow up on Surveillance, it sounds like it goes closer to $30 million in the second quarter. Does it then go back into the mid-30s? Is the mid-30 still how you think about the ongoing longer-term run rate in that business?

[Anthony L. Trunzo:]

I think what we've said is low- to mid-30s. And I probably wouldn't change that over the long term. It really is -- it's going to -- we're looking at what the bookings sort of -- what the bookings plan is for the rest of the year would suggest we'd see some nice recovery in the second half. In this kind of environment, there are going to be puts and takes for sure.

[Noah Poponak:]

Got it. And I just wanted to ask one other thing, and this is for anybody who wants to take it and is intentionally open-ended, and that is when and how do you think Europe gets better?

[Unknown Executive:]

Everybody is looking around...

[Earl R. Lewis:]

Well, maybe the how, that's really a tough one. I believe, Noah, there's really structural problems in Europe, and they're -- they've been brought on over years and years and years. So forecasting when or even how Europe's going to get particularly better, I don't see it frankly. I think this -- the malaise of unemployment in Spain, which is at almost 30%, Italy. These numbers are going to be very hard to change overnight. So I think we're in for a long, long haul. And as Andy pointed out, we're moving resources out of Europe and putting them into the Far East, and we will continue that trend as a strategy.

[Operator:]

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

[Michael F. Ciarmoli:]

Andy, congratulations. Earl, congratulations and good luck in retirement.

[Earl R. Lewis:]

Thank you.

[Michael F. Ciarmoli:]

Maybe, Bill, just to look at the Government Systems segment, one of the programs of the mobile surveillance capability you guys talked about that pretty optimistically at the Analyst Day. And to my understanding, I guess, some of those initial deliveries are going to be encumbered with some additional excess cost, pre production. So is there a bit of a margin drag stemming as those initial products roll out and maybe just a general update on that program?

[William A. Sundermeier:]

Sure thing. MCS program, I mentioned in the script, we delivered our first 2 [indiscernible] test units plus 4 production systems, and they were accepted within the last couple of weeks here and have been doing exceptionally well. We've been delivering more systems and anticipate delivering the entire 31 systems to them here in Q2, which is on our original delivery order. So that program was going well. We have a fantastic depot in Tucson to provide immediate repair for the border. But you're absolutely correct, there's going to be a significant drag on margin with the delivery of those 31 systems that we anticipate that -- the drag and the elimination of -- basically the engineering capability that was put into those systems will be eliminated in Q2 along with that. So -- and we're hoping that, maybe later this year, we might receive more delivery orders. But we don't have anything on the forecast in the horizon. What we're excited about is that we've been able to start marketing that around the world, and our funnel is continuing to build around the world and we even had 1 customer say that they paid for the shipment to send that to whoever they're interested in and fly it all the way over there and do the demonstration. So very, very encouraging signs for our COTS business for that capability. And there, we'll be able to enjoy good margins and normal surveillance-type margins for those kinds of products. I'm very, very excited about that business for our future.

[Anthony L. Trunzo:]

Mike, to clarify a point on the margin question, you'll see a substantial uptick in revenue from Integrated Systems in Q2. That will be the bolus of these MSC deliveries, if you will, and they’re not going to have any margin. So you'll see a chunk of revenue, and you'll see fairly poor profitability from that operation for that quarter. And then, the comments that Bill made obviously stand for the -- for going forward.

[Michael F. Ciarmoli:]

Okay. Perfect. And then, just the last one, Tony, Lorex, Traficon, sort of the run rate for the rest of the year, I mean, can we expect maybe an uptick later in the year? Or I guess, is that going to depend on timing, when you guys maybe put -- or implement some of the infrared product or capability into Lorex? How should we just think about those 2 acquired businesses in the revenue trajectory?

[Anthony L. Trunzo:]

Lorex has some seasonality. So you'll see more strength in the second half from Lorex from a revenue standpoint and from a profitability standpoint. Traficon started the year quite well from a booking standpoint. So I think you'll probably see an improvement in revenue from them as well. I think we've said on the last call that we expected somewhere in the $80 million to $100 million revenue range from those 2 acquisitions this year, probably looking at the upper end of that as we...

[Earl R. Lewis:]

Plus also, on the Traficon business, there will be the thermal element. Thermal cameras get rolled into that. I don't think you'll see, on the Lorex business, a tremendous thermal content in this calendar year.

[Operator:]

Our next question comes from the line of Brian Ruttenbur with CRT Capital.

[Brian W. Ruttenbur:]

I just want to understand the weighting of the year. Can you give us some kind of weighting on revenue that second half is going to be heavier weighted or the second quarter is going to be seasonally normal, or any kind of guidance on a quarterly basis?

[Anthony L. Trunzo:]

No, we don't give quarterly guidance. I will -- I guess, what I would say is Q2 of last year was the poorest quarter we had in a long time. And I think there’s reasons [ph] to appropriately recognize that in the outlook we've put forth. And Q4 is always our strongest quarter, and I think it'll be our strongest quarter again this year. Other than that, I think we'll probably leave the comments that we made earlier stand.

[Brian W. Ruttenbur:]

Okay. The other question separately is on SG&A expense. Can you talk about any kind of seasonality, the normal seasonality whether we should have a drop in second quarter versus first quarter? Is that the trend that we should continue to follow?

[Anthony L. Trunzo:]

I think maybe you're over analyzing the SG&A line. I'd have to look at it, but I -- there shouldn't be much in the way of seasonality from quarter-to-quarter. I mean, I'm looking around here at the operating guidance. I don't think there should be a lot of seasonality.

[Brian W. Ruttenbur:]

Yes. Last year, in March period, you did roughly $78 million, then it dropped down to $72 million then roughly around the $70 million, $72 million. And this quarter, you did $78 million. I didn’t know if we're going to be carrying that forward or have a drop.

[Anthony L. Trunzo:]

I can't give you that level of detail without taking a look at it, Brian.

[Operator:]

Our next question comes from Paul Coster with JP Morgan Chase.

[Paul Coster:]

Earl, I believe, for the better part of 10 years, you delivered more better returns than any other CEO in the public market. So pretty amazing and really tough...

[Earl R. Lewis:]

I didn't do it, though. The people here did it.

[Paul Coster:]

Sure. But a tough act for Andy to follow. Tony, the backlog was $505 million. What proportion of that came from the Traficon and Lorex acquisitions? And the separate question is that, either narrowly defined or broadly defined, what proportion of revenues now do you believe is recurring in nature? What are the contractually -- or just simply, you got such excellent kind of a sales replacement cycles that you can see pretty well what's coming?

[Anthony L. Trunzo:]

So I'll answer the first part of that question. The -- recall that we closed the Lorex and Traficon transactions late in December. And as a result, their backlog was included in our Q4 backlog number. The -- when I looked at the impact they had in the quarter, it was minimal, $1 million movement on the backlog of those 2 businesses from the end of the year to now, and the total backlog is a small proportion of our total. It's mid-single digit million.

[Paul Coster:]

And then, in terms of recurring revenue now?

[Anthony L. Trunzo:]

I don't have a number. You're talking about service and those sorts of things?

[Paul Coster:]

Yes. And your sort of replacement parts from the government side -- [indiscernible] where are equipments being replaced [indiscernible] following sort of the reduction in troop deployments in the Middle East that there’s quite a hike in high margin for that life cycle type business. Is that true of Andy's -- of Bill's business?

[Earl R. Lewis:]

I know what you're talking about. There's a lot of government businesses, if you will, that are calling that out as a special opportunity right now. But we don't see that, Paul.

[Operator:]

Our next question comes from the line of Peter Skibitski with Drexel Hamilton.

[Peter J. Skibitski:]

Just a couple of follow-ups for Bill. Bill, sequestration hasn't really kicked in yet. I'm just wondering if you think there's downside risk to your internal forecast for Surveillance because of sequestration. And I'm just wondering what you're hearing about potential for a DoD reprogram or request, and if maybe that could positively impact you guys?

[William A. Sundermeier:]

Sure. Certainly, sequestration is already affecting us, and that procurement offices are still deliberating about what they're supposed to do with their procurements and that's causing a certain drag on it. I think we've -- again, at the Investor Day, we've been very conservative about the year, and it's the timing, for example, these large orders that have been delayed is a side effect of sequestration, literally, and it's going to be -- it's going to drag and still going to get it, but it's been shifting around. So we've been very conservative about the year. And as far as reprogramming is concerned, we certainly hope that the agencies are going to be able to have the ability to do that. I think that will really affect us in a positive way. And so far, we're hearing that that's out there in front of the President and Congress and -- but no definitive response yet on the reprogramming ability that they're going to have.

[Operator:]

Our final question comes from the line of Tim Quillin with Stephens Inc.

[Timothy J. Quillin:]

Number one, could you give us the size of the pushout in the government business? And then, DoD -- and I think Tony had made a point about the government business is starting to face easier comparisons, but the government market is getting worse. And I think you had talked about DoD bookings being down 20% as an assumption for this year. But as you stand right now, is that -- with the sequester now in place, is that an expectation that you have or need to ratchet down?

[Earl R. Lewis:]

Well, I'm going to give it a try. DoD, Tim, is now what's -- the bookings were, I think, 10% or less of our total bookings last quarter -- 10% to 15%, I guess. It depends on how we classify one order we got. I think, by definition, we're pretty well convinced that's not going to get much lower at this point and may go up a little bit in the future. So I think we've seen the trough on that, and our thinking going forward in that...

[Andrew C. Teich:]

Yes. Certainly, we're starting to see the trough. There are some really good bookings out there from a bookings perspective and the pushout of $80 million ID/IQ, and the order size was nearly $20 million on delivery order size. So that's significant to our bookings potential, and that should roll in this quarter and it's just a procurement delay that we had in the [indiscernible] it was going to stay.

[Earl R. Lewis:]

Okay. Thank you, all. I appreciate it. And it has certainly been my pleasure to work with the people sitting around our table here, and with all of you on the phone, and I think, sometimes, a number of our employees listen in as well. I will miss the excitement of this dynamic and robust company. I'm leaving its management to people that I believe are capable and knowledgeable. The new CEO and his team, I think, will do better than I did. They will surely succeed in their future, and I look forward to my new role as Chairman of the Board and as a senior advisor to them. With that, we thank you for calling in.

[Operator:]

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.