FLIR Systems, Inc.
Q3 2013 Earnings Call Transcript

Published: 24 Oct 2013

[Operator:]

Greetings, and welcome to the FLIR Systems, Inc. Third Quarter 2013 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 of 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 Andy Teich, President and CEO of FLIR Systems. Andy?

[Andrew C. Teich:]

Thank you, Wit, and thank you, everyone, for joining us this morning for FLIR's Third Quarter 2013 Earnings Call. Along with me on the call today is our CFO, Tony Trunzo; Bill Sundermeier, the President of Government Systems; and Tom Surran, the President of our Commercial Systems division. As we stated in our press release last Tuesday, third quarter results did not meet our expectations. Order flow from government customers that derived their funding from the U.S. government slowed dramatically during the latter part of the third quarter. The budget flush that we normally see from our U.S. government-funded customers in the third quarter did not happen this year. Instead, we experienced a significant reduction in procurements, delays in administrative processing and program shifts. The result was lower-than-expected bookings and a reduction in our expectations for fourth quarter shipments. For the third quarter, we recorded revenue of $358 million and an earnings per share of $0.32. While revenue grew 8% versus the third quarter of 2012, our margins were impacted by mix change and the revenue shortfall in relation to our plan. Total company backlog at the end of Q3 was $523 million, and the quarterly book-to-bill ratio was 1. We grew operating cash flow 13% versus the prior year, and year-to-date operating cash flow was up by 45%. The Commercial Systems division increased revenue 17% versus the third quarter of 2012, with all 3 geographic regions posting positive growth for the first time in 2 years. Government Systems division revenue declined 4% year-over-year, and U.S. bookings were soft compared to usual third quarter activity. Government Systems international bookings continued to grow, and Government Systems booked $236 million in IDIQ awards during the quarter. We announced a proposed realignment plan last week that will result in the closure of up to 6 manufacturing and R&D sites, the movement of those operations into other larger FLIR locations, the consolidation of optics production capabilities and the consolidation of laser manufacturing operations. We have also taken action to reduce cost beyond the business realignment, due to the operating environment we anticipate for the foreseeable future. I'm confident that these initiatives will significantly benefit us going forward. We will improve in efficiency, particularly in manufacturing and R&D, by better positioning our teams to collaborate and share best practices, ideas and assets, and we will reduce overhead through rationalization of production and support organizations. We've adjusted our outlook for 2013 based on operating environment and now expect between $1.45 billion and $1.5 billion of revenue and earnings of between $1.38 and $1.43 per diluted share for the full year 2013. This range excludes restructuring charges that we will record in the fourth quarter related to the 2 initiatives discussed, as well as approximately $3.5 million associated with the accounting for the payout of executive retirement benefits that we will incur in the fourth quarter. I'll now ask Tony to review the financial results for the third quarter. Tony?

[Anthony L. Trunzo:]

Thank you, Andy. Third quarter consolidated revenue was $358.1 million, an increase of 8% compared to last year. Organically, revenue declined by 2%, due primarily to the impact of delivery delays and lower-than-expected book-and-ship business in our government businesses. International revenue was 46.6% in the consolidated total in Q3, up from 44.2% in the third quarter of 2012, due to substantially improved international performance in the TVM segment. International sales made up 51.3% of Commercial Systems consolidated revenue in Q3, compared to 47.2% in Q3 last year, while 39.7% of Government Systems revenue came from outside the United States. Sales to the U.S. government were 25.1% in the consolidated total in Q3, down from 27.6% of revenue in the third quarter of last year. Consolidated gross margin was 48.3%, down 3.9 percentage points from 52.2% for the third quarter of last year. TVM gross margins were down 3.5 percentage points, entirely attributable to inclusion of Lorex revenue at lower margin. The remainder of the TVM business had better gross margins than in Q3 last year. Surveillance segment gross margins were down 2.9 percentage points compared to Q3 2012, due to weaker mix and lower absorption of overhead. Consolidated operating income in Q3 was $63.5 million, a 14% decline from the third quarter of last year. Third quarter operating margin of 17.7% compared to 22.3% last Q3, with the decline due largely to lower gross margins, as previously described. Earnings before interest, taxes, depreciation and amortization and stock compensation in the quarter were $85.2 million. And EBITDA margin was 23.8%, compared to $95.2 million and an EBITDA margin of 28.6% last Q3, also the result of the drop in gross margin. Our tax provision for the quarter was $13.6 million, equal to 22.6% pretax income, versus 19.2% last Q3. Q3 2012 tax expense was positively impacted by discrete items totaling $5.2 million. Q3 2013 had only nominal impact from discrete items, but the quarterly tax expense does reflect a catch-up for a slight rate adjustment for the year. Cash flow from operations for the quarter was $52.5 million, representing 113% of net income. Through 9 months, cash flow from operations of $249.8 million represents 168% of net income, an increase of $77.1 million or 45% from the first 9 months of last year, and we continue to focus on this important metric. During the third quarter, we repurchased 500,000 shares of our common stock at an average price of $32.44 per share and paid dividends totaling $12.8 million. Through 9 months, we have returned $171.7 million of capital to shareholders via the repurchase of 5 million shares for a total of $133 million and the payment of $38.7 million in dividends. We expect continued share repurchase during Q4, with the actual amount depending on the share price, as well as our expectation surrounding M&A and other high return cash deployment opportunities. The business realignment we announced last week is well underway. Three of the facilities we are proposing to close are in Europe, and require us to consult with local works councils prior to moving ahead. We expect these consultations to conclude late in Q4 or early in Q1 next year, at which time we anticipate proceeding with the relocation. The 3 U.S. closures are well underway, with 2 of them to be completed by year end. We expect to recognize the majority of the costs associated with the realignment in Q4, although certain expenses will occur in the first half of 2014. For Q4, we expect charges associated with the realignment and additional cost reductions related to the current business environment to total between $27 million and $30 million, with the majority of the costs associated with severance and facilities exit costs in Europe. Savings from these actions are expected to exceed $20 million per year when fully implemented in the second half of 2014. In addition to the cost for the realignment and restructuring, we will have an expense of approximately $3.3 million associated with the payout of retirement benefits from our supplemental executive retirement plan in Q4. None of these costs are included in the revised outlook we have provided. While Q3 results accounted for part of our reduced 2013 outlook, roughly 2/3 of the reduction is related to our expectation of continued weakness in our government businesses in Q4. Third quarter bookings were below normal levels, which we expect will impact Q4 shipments. In addition, we have seen longer lead times for licensing and order acceptance processes, both domestically and internationally. Our outlook for the commercially-oriented business units remain in line with our original expectations. That concludes my comments, and I'll turn the call over to Tom Surran to cover Commercial division results.

[Thomas A. Surran:]

Thank you, Tony. The Commercial Systems division finished the third quarter with a 17% increase in revenue compared to the prior year, and a 2% decline on an organic basis. Growth in the Raymarine, FLIR-branded maritime and PVS businesses was offset by declines in the OEM and security lines of business, due to reduced shipments to government-funded customers. The thermography line of business grew revenue for the first time since Q1 2012 with all 3 geographic regions posting positive growth. Raymarine revenue increased 13%, its best growth quarter since we acquired the business in 2010. And operating income quadrupled compared to Q3 2012. Lorex and Traficon businesses we acquired at the end of 2012 continue to perform well on the top line and both had improved operating margins in the quarter. On a regional basis, Commercial Systems grew revenue in the Americas by 17%; in EMEA by 27%; and APAC by 1% in comparison to the third quarter 2012. The EMEA region returned to organic growth for the first time since 2011 with all lines of businesses growing over the prior year. Commercial Systems Q3 bookings increased 7% over the prior year but declined 13% organically, primarily due to weak order flow from government-funded customers in the OEM line of the business. Excluding orders received from government-funded OEM customers, Commercial Systems bookings increased 8% organically year-over-year. Bookings in the security business -- moving to segment bookings, we saw a 5% increase over the prior year in TVM bookings, with strength in our non-Thermography businesses -- systems businesses and the addition of Lorex and Traficon bookings being partially offset by weak OEM bookings. TVM's OEM businesses booking dollars declined year-over-year as a result of a weak order flow from military OEMs. However, unit volumes continue to increase, driven by demand in automotive and other uncooled core markets. TVM's Thermography line of business saw bookings dollars decline 1% from a year ago. Growth in automation, firefighting and gas imaging markets was offset by weakness in the high-end R&D, predictive maintenance and building markets. On October 1, we introduced the new Ex product line, significant improvements to our Exx line, as well as a new FLIR-branded test and measurement line. The new Ex product line offers an unprecedented level of performance in an entry-level product, including our patented MSX technology, which combines the best of visible and thermal imaging. It would be difficult to ascertain the impact the anticipation for these products had on Q3 bookings Bookings in the security business increased organically by nearly 20% versus last year and tripled with the inclusion of Lorex. Year-to-date, security bookings have increased nearly 50% organically compared to the first 9 months of 2012. This success was driven by demand for border and perimeter surveillance systems, along with solid unit increases in uncooled systems, particularly in Asia. TVM's Intelligent Traffic Systems line of business had another strong quarter, with results that well exceeded our expectations. In the fourth quarter, ITS will begin shipping its thermacam system. This is the first product to integrate the ITS traffic analytics and the thermal imager into a single package. The Personal Vision System line of business grew bookings by over 30%, helped by strength in the EMEA and Americas region. TVM's maritime business grew over 15% compared to Q3 of 2012 and showed growth across all regions. Raymarine's bookings dollars grew nearly 15% versus third quarter of 2012, with all 3 regions growing and the Americas up nearly 15% and EMEA region up 10% year-over-year, the first quarter of bookings growth in the region since our acquisition of the business. During the third quarter, Raymarine introduced several new products, including a 7-inch version of its lower-priced A-Series, as well as the integration of its successful DownVision technology, first introduced in the Dragonfly into the A-Series and a black box version of the DownVision technology, which can be networked into existing Raymarine MFDs. As Andy mentioned, we completed a strategic review of our Commercial Systems operating footprint with a focus on efficiency and cost improvements. As a result of this work, we expect to close up to 3 facilities and have staff reductions, which will improve our total overhead cost structure, as well as streamline product development. That concludes my comments on Commercial Systems, third quarter. I'll now pass the call over to Bill Sundermeier, who will discuss the result of our Government Systems. Bill?

[William A. Sundermeier:]

Thank you, Tom. Government Systems division revenue declined 4% versus the third quarter of 2012, ending the quarter with a backlog of $334 million, $5 million lower than Q2. Bookings for the quarter were below our expectations, due primarily to more than 50% year-over-year decline in orders from the U.S. DoD. Divisional book-to-bill was 1.1, helped by 12% year-over-year growth in orders from international market. Lower-than-planned volume and a less favorable product mix resulted in a quarterly operating margin decline of nearly 6 percentage points versus the prior year. The margin remained consistent with the second quarter of this year. While the Surveillance segment grew backlog 3% over Q2 of this year, finishing at $276 million, orders from U.S. customers were weak compared to normal third quarter activity. International orders reached 50% of surveillance bookings in the third quarter, which helped offset the domestic weakness. Despite slow-funded order activity, we had one of the best quarters ever in IDIQ awards, winning $236 million in 5-year contracts for maritime, airborne and tower-mounted imaging application. The largest funded order in the quarter for the Surveillance segment was $13 million to outfit a Middle Eastern nation's helicopter platform with our 260-HLD compact imaging and laser designation system. We also received 2 orders totaling $11 million from the U.S. Navy for several of our BRITE Star II gimbal systems and related spares. Notable international bookings included 2 orders totaling $12 million from integrators working with the Korean and U.K. militaries, who will be adding our Star SAFIRE HD systems to their respective airborne platforms. On the new product front, we continue to improve upon our latest high-definition imaging system designed for airborne and maritime applications. Qualification and LRIP, limited rate initial production, of our Star SAFIRE 380-HD gimbal is proceeding with excellent results. Additionally, we developed the SeaFLIR 280-HD system for the Patrol Boat Electro-Optical (sic) [Optics] System or PB-EOS program, one of the IDIQ awards we won in the third quarter, and we continue to finalize the production plans for this groundbreaking maritime solution. In order to win this highly competitive $50 million award, all bidders were asked to submit a working bid sample in a very tight time frame. Given our commercially developed military qualified operating model that leverages internally funded R&D for very rapid development, with a focus on low overall production costs, we were well positioned for such an RFP. We are hopeful that government procurement practices tend toward this bid model going forward. As a result of the strategic operational review we completed in the third quarter, the Surveillance segment will undergo structural changes to some of its operations. These changes will include the consolidation of our 2 main laser businesses in our Bozeman, Montana site, combining 2 domestic optics manufacturing operations into our Pittsburgh facility, consolidating the several engineering and production teams in Sweden into our Täby, Sweden location. We're also taking additional costs out of the Surveillance segment and modifying the sales organization to better position the business to generate top and bottom line growth in the face of weakened government procurement environment. All of these changes will enable improved R&D processes, reduced operating and administrative overhead and align product development with production ultimately resulting in improved innovation and profitability. Next, moving to Detection. The segment finished the quarter with $24 million in backlog, up slightly from Q2 of this year. Operating margin reached double digits for the first time since acquisition of ICX in 2010. Orders for Detection products and service were 95% of total Detection order flow during the quarter, a trend that follows our strategy to focus the business on product sales and reduce the amount of funded cost plus R&D. Notably during the quarter, our Explosives line of business had bookings growth of over 50%, driven by the success of our new Fido X3 handheld detector, which significantly shortens screening time and extends capabilities. Our plan to improve Detection segment margins takes another step in Q4 as we take out additional cost and begin to execute on our proposal -- proposed plan to consolidate the Germany radiation operations into the Oak Ridge, Tennessee location. Integrated Systems segment backlog declined by $12 million during the quarter, due primarily to shipments of 13 MSC systems to the U.S. Customs and Border Patrol. During Q3, Integrated Systems delivered the first production units of the DR-SKO multi-threat identification system and booked $9 million in additional LRIP funds under the program. Integrated Systems during the third quarter completed production of the first 3 MVSS systems, which is the international variant of the MSC mobile border surveillance system, a solution that is proving quite valuable to many of our customers in the Middle East. We are adopting the facility realignment plan in Integrated Systems as well, which will include the closure of our Alpharetta, Georgia facility and the move of those operations to Elkridge, Maryland facility, a site that has been instrumental in winning several large awards. That concludes my summary of Government Systems third quarter. I'll pass the call back to Andy.

[Andrew C. Teich:]

Thanks, Bill. That concludes our prepared remarks, and we will now open the call up for questions. Operator?

[Operator:]

[Operator Instructions] Our first question comes from the line of Noah Poponak with Goldman Sachs.

[Noah Poponak:]

Guys, given what happened with the pre-announcement, I kind of wanted to just ask about forecasting. It's just surprising to see a company of this quality have this happen, I guess, a few times in a relatively short window. And I guess, in the past, sometimes you've been asked if a guidance range includes a continuing resolution or how you factored in sequestration or whatever other top-down budget activity, and I think the answer has always sort of been, "We don't think about it that way. We're doing it bottoms-up." And I don't know what's right top-down, bottoms-up, they're probably both very difficult in the current environment. But I'm sort of wondering how you're thinking about how you need to change your forecasting methodology or if you're finding that there's something broken in the communication between the managers doing these bottom-up plans and the executive team or something else like that, that you're digging into and discovering, given that this keeps happening.

[Andrew C. Teich:]

Noah, this is Andy. The biggest issue here is that we had, in Q3, a situation occur that was unprecedented. In the 29 years that I've been in this business, I've never seen a September where we haven't had a significant budget flush related to U.S. government end of fiscal year spending. And this year, it was almost 0 that came in. And that's something that, given the fact that we haven't seen it happen once in the last 29 years, has led us not to think that it was going to happen this year. Going forward, there are a couple of things. I mean, we still don't really understand what the environment is going to be like relative to continuing resolution and sequestration. And frankly, our customers don't either. We're in Washington, D.C. today here making this call and we're with many of our army customers at the AUSA show this week, and certainly there are a lot of questions that are being asked on both sides of the customer/supplier relationship here in terms of understanding what the budget situation is going to look like going forward. So in terms of dealing that, I think that we've just got to be conservative. We've got to continue with the bottom-up approach, and those items that are in the bottom-up approach that have U.S. government funding behind them, we've got to put a higher level of factoring on in terms of the probability of those things coming through. When I say higher level, I mean lower probability of factoring and that's part of what you're seeing here in our Q4 outlook.

[Anthony L. Trunzo:]

Noah, it's Tony. I just want to -- your direct question about bottoms-up versus top-down. We spent a fair bit of time over the last -- not just the last couple of days, but the last couple of weeks, looking very carefully at what was in our plan that didn't happen. And specifically, for each one of those significant orders, why it didn't happen. I don't think it's appropriate to get into that specific discussion item by item on this call, but I think that we have come to understand in this kind of environment just how much risk there is in things that are just simple timing. How long does it take to get a -- the entire licensing process completed? How long does it take to walk a customer through the entire procurement process, all the way through to delivery? Those kinds of things are different than they were in the past, and I can tell you that we've been spending a significant amount of time as a management team making sure that we understand how they're different and how that's going to affect our outlook going forward. And frankly, I think you see that reflected in what we're saying about Q4.

[Noah Poponak:]

Okay, that's helpful. Just one follow-up on the surveillance margin. It's trended lower through the year. Obviously, there are some unique things happening in the year. But -- and there's some restructuring going on that presumably helps going forward, and obviously, volume would help. But in the past, the discussion was that could stick into the mid-30s, maybe low- to mid-30s. Just sort of wondering what the latest medium to long-term thought process is on the right level for the surveillance margin.

[Anthony L. Trunzo:]

Noah, I think -- it's Tony again. I think at the current levels of volume and the current mix we have, it's going to be tough to get back to 30%. The business has to be either a little bit larger or we have to see a stronger mix because there are certain products -- some of our Portland products are the most profitable in this segment. That mix has gone more toward Boston products, which tend to carry a little bit lower margin. Until one of those 2 things happen, getting the margins back over 30% is going to be a challenge. We're not going to give 2014 guidance until our February call when we announce our Q4, but at that point we'll be able to address, I think, more clearly exactly what the impact of the cost reductions are going to be and what the longer-term outlook for margins in Surveillance is going to be. It's still a remarkably solid business in terms of profitability. We've seen, to go back and look from peak to trough, that the business is probably down more than 1/3 from peak to trough in terms of revenue. And the margins have come down but still being able to carry operating margins at that level, while offering our customers the value proposition that we offer, we think, is still pretty good. And we want to be careful about paring back too much on the infrastructure in that business to save cost today and keep those margins up when we do expect over time that our model is going to be one that's going to get a better market share in the total market for our products.

[Operator:]

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

[Peter J. Arment:]

Tom, I guess this question is for you. It's nice to see the Commercial businesses are showing some improvement, really, across the board, it sounds like in a different geographical regions, albeit off a low base probably, but maybe if you could just give us a little more color or elaborate a little bit of what you're seeing in terms of some of the products or markets or whether you want to take it by region. Just give us a little more color if you can.

[Thomas A. Surran:]

Well, that's a fairly broad question. So what we're seeing, I guess, just in terms of the regions, Americas, we're seeing fairly good strength in most of the TVM business, excluding our OEM, our systems business doing very well. On the Thermography, we're seeing a bit of a recovery or at least some level of stabilization in EMEA, reasonably good numbers on Americas. APAC is a bit of a mixed bag. We've got some countries in that region that are doing quite well for us, such as China, and then we have some others that are struggling, offsetting some of those gains.

[Peter J. Arment:]

And how does the product refreshes that, historically, you've done -- I mean, you just did a big refresh with -- on the -- with the E-Series. And how typically is that done on the rollouts in terms of the different regions?

[Thomas A. Surran:]

In terms of the rollout, the timing of it -- there is a sequence to it, but for the most part the Ex and Exx were all introduced on October 1, and then worldwide through the month of October. So there's a little bit of a kind of a pattern that we have to kind of go through in rolling those out. The test and measurement was introduced in America on that date, October 1. It'll be introduced worldwide on January 1.

[Andrew C. Teich:]

Peter, this is Andy. I wanted to pick up on 2 other things there, relative to strengths in the Commercial business and they really come down to 2 specific issues. First, you touched upon, which is the new products. Yes I think we've demonstrated as a company, that we have the ability to define and execute new product designs that are successful in the market. I think Raymarine is a great story here. We had 13% increase in revenue, 15% increase in bookings this quarter, and that's entirely driven by the product refresh that's been done there because the market is still a pretty tough market in that space. On the Thermography side, we launched 13 new products on October 1 to the public. One of the things that I think was fairly remarkable about that is that on the day that we launched those products through our distribution channel, which was midway through September, we had approximately 2,000 units of the Ex series ready to ship. So we were -- that was, I think, unprecedented for us as a company that we're ready to hit the shelves immediately and get those dealers ready to sell those units when it was publicly released on October 1. And then, the last thing I'll say is that the integration of the acquisitions, if you look at the last few acquisitions we've done on the Commercial side, Raymarine, Traficon and Lorex, these businesses are all improving. They're all growing and they've all been well integrated. And I think that, that presents a model for the future for FLIR's execution on the Commercial business.

[Operator:]

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

[Timothy J. Quillin:]

So in terms of the margins, and I guess this is both for thinking about the overall company's gross margins especially, and then on TVM's margins that have been impacted by Lorex and Traficon. I don't think as part of your restructuring, you're specifically looking at improvement on those acquired companies. But I'm trying to figure out what the pace of improvement might be in TVM overall as you integrate those companies and maybe how you get those up to overall TVM margin levels and how that also might impact corporate gross margins and directionally where you're going and maybe if you have targets for corporate gross margin and corporate -- or excuse me, and segments operating margin on TVM, that would be great.

[Anthony L. Trunzo:]

So Tim, we -- the Lorex business is a unique business model within FLIR. We've got a little bit of it in test and measurement, but Lorex gross margins are less than half what the rest of -- what the rest of TVM experiences from a gross margin perspective. That's not poor execution; that's just a different business model. And when we acquired Lorex, we realized that -- when we acquired Lorex, we wanted them to continue to operate the way they operate because it's different. And the long-term plan for that business is to inject more of our technology into it, drive more value through that channel and thereby improve the gross margin. Tom and Andy may want to comment, but I think it's difficult when you have an ODM business like that where you're sourcing product that you're designing and packaging and distributing but you're sourcing it from somebody else. You're just not going to see the same level of gross margin. As that proportion of -- as Lorex, as a proportion of the total, grows this year, just because it's the first year we've owned them, it's having a dilutive effect on our margins. That's not a surprise to us. The rest -- we have a strong focus on making sure that we don't see deterioration in the rest of TVM, and we're not. So again, I think when we look to next year and talk to you guys about what the outlook is going to be for next year, we'll think about how we can do this, but maybe we can help you understand what that ODM/Lorex type business looks like in terms of margin and what proportion of the businesses it will be and then be able to highlight the remaining piece of TVM and what the margins will look like in that business. I do think there's an opportunity to improve margins in the Lorex business but that's going to come, as I said, from the evolution of our technology and bringing low-cost thermal technology to that marketplace, which is clearly part of the strategy.

[Andrew C. Teich:]

Tim, a couple other things here. Overall margins TVM margins, if you take out the acquisitions of Lorex and Traficon, were actually up 100 basis points year-over-year. So there is some improvement there. On the Lorex side, Lorex's business consists of 2 components. You've got the consumer piece under the Lorex brand and then formally, there was the Digimerge brand, which we've converted to the FLIR brand that attacks the professional piece, and the margins are significantly better there. They're not up to the same standard as the rest of FLIR's business, but they're improving and that business is growing very nicely. So there's an opportunity there. Traficon itself has excellent margin, so its margins are very much in line with the rest of FLIR, not dilutive to them at all.

[Timothy J. Quillin:]

. Okay. And then just a couple detailed questions. I guess, one, the $20 million in annual savings from your restructuring, how might that be spread across cost of goods sold, SG&A and R&D? And then what percent of the TVM business is government Cores & Components?

[Anthony L. Trunzo:]

So the breakout of the 3 -- the majority of it is going to come from SG&A. You will see some in COGS associated with lower facilities costs and you'll see some in R&D because we're -- the facility that we have in Germany that we're proposing to close is primarily an engineering facility. And when we basically move that capability to Oak Ridge, it should be at somewhat of a lower cost. I don't have a precise breakout for you at this point but you brought up something that I meant to mention, which is in terms of the charge itself, approximately 80% of it is going to be cash expenditure, either in Q4 or in a future period, because the majority of it is related to severance costs and to facilities closure cost. But I think you'll see, if the model holds and we'll still be working through it, I think you'll see about 70% of the total benefit come through the SG&A line. And there was a second question?

[Andrew C. Teich:]

So how much is the Cores -- I mean, so the other piece of your question was how much of the Cores business relates to U.S. government-funded customers. And that answer is about 50% to 60%. It's a much smaller percentage than [ph] our other lines of business.

[Operator:]

Our next question is coming from the line of Jim Ricchiuti of Needham & Company.

[James Ricchiuti:]

I may have missed it. Did you give the dollar number in terms of revenue that Lorex and Traficon contributed in the quarter?

[Anthony L. Trunzo:]

We didn't, actually. We gave the organic and inorganic, and the delta is already -- while we're here, I can calculate it for you.

[James Ricchiuti:]

It looks like it's around -- that's right, maybe around $35 million?

[Anthony L. Trunzo:]

Tom has it.

[Thomas A. Surran:]

He wants the revenue for Lorex?

[Anthony L. Trunzo:]

And Traficon.

[Thomas A. Surran:]

Okay. $25 million approximately -- do you want me to be exact, Tony? $25 million on Lorex. Traficon was $8 million.

[James Ricchiuti:]

Okay. How is the -- we don't have a lot of experience with that business but maybe you could talk a little bit about the seasonality of that business in Q4.

[Thomas A. Surran:]

For Lorex?

[James Ricchiuti:]

For both.

[Thomas A. Surran:]

Well, Traficon doesn't have a seasonality that we have seen. It's pretty -- there are large orders. So I don't want to say it's smooth. And in terms of what we see in seasonality so far of Lorex is that Qs 2 through 4 are fairly stable, a little bit of a spike. Q1 is the quiet quarter, okay. So you kind of start getting the stock up in Q3, 4 [ph] split for the seasonality if there is a little bit, for the holiday season there is some retail component to our security business. And then you see a little bit of a quietness in Q1.

[James Ricchiuti:]

And one final question, if I may. Just looking at the Thermography business, historically that's been a good -- Q4 has been a good quarter for that business. You have what looks like a pretty good slate of new products that are hitting the market, some improvement on the macro side in Europe. How should we think about Thermography in Q4?

[Thomas A. Surran:]

This year, Thermography business, it does have a strong fourth quarter. We will have a strong fourth quarter relative to the quarters so far this year. The question is, I guess, you could ask relative to prior year, that's going to be a tougher challenge for us. We're hopefully going to be able to get close to those kind of prior year numbers. That's kind of where the target would be. But we still will see a significant sequential improvement over Q3.

[Andrew C. Teich:]

Jim, this is Andy again. The Thermography business has been in a tough operating environment. We've had some of the high-growth regions have slowed down. China did well in Q3. We expect it'll do well again in Q4 but some of the other regions, Japan, Australia, Brazil have had both currency effect and the markets have been a bit soft. I think the wildcard for us is how the new products do in Q4. The launch of the products went extremely well. We were very aggressive in the marketing plans behind the launch of the new products and initial lead activity looks very good, but we're just not sure how that's going to affect overall volumes and mix between these new entry-level products and the higher-end products.

[Operator:]

Our next question will be coming from the line of Michael Ciarmoli with KeyBanc Capital Markets.

[Michael F. Ciarmoli:]

Maybe, Andy and Tony, if I can just follow up on Noah's line of questioning. It seems like we're going to have the sequestration kind of environment in place, perhaps through the presidential election. We're going to see more forced structure cuts next year. We're already hearing about potential cuts to tactical aircraft and readiness in terms of helicopters. So I mean, what do you really have to do differently, or how can you get comfortable forecasting in this environment, I mean? And I'm just trying to understand if you guys have been losing share to some of the larger players out there who have bigger lobbyist presence? I mean, is that putting you -- the amount of money you spend in Washington, is that putting you a little bit behind the eight ball? I'm just trying to get a better context of what can be done to kind of change the methodology given that the environment may actually worsen before it gets better.

[Andrew C. Teich:]

In the -- I don't think that -- to address your first question about are we losing share, I don't see that at all. We track the business that we're in pursuit very closely and understand what happens with it, and I haven't seen any significant competitive losses. And to the contrary, we've had some decent wins in direct head-to-head competition situations. Forecasting the business going forward, I agree with you. We're in a difficult environment because you don't know exactly where the cuts are going to come from. With that said, our CDMQ model, I think, is a very fiscally responsible model. It offers customers the ability to get a product for 100% of the procurement dollars, rather than have their procurement dollars split between development and procurement. And our solutions tend to be priced more competitively relative to the large defense contractors that are out there, and our filling [ph] experience is very good. We filled [ph] a lot of product in Iraq and Afghanistan, in the last few years, and the feedback from the performance and reliability of those products is excellent. The last thing I'd like to mention is if you look at what's happening with the current procurement style, and Bill had a little bit of this in his prepared remarks, is that we're seeing more and more procurements, where a specific performance requirement is written. And the procurement process requires that a bid sample be delivered together with the bid and that has to go through field testing, and that ultimately determines the winner. The PB-EOS program that Bill mentioned in his comments is a prime example of that for the Patrol Boat Electro-Optical System for the U.S. Coast Guard. And there was strong competition because there's lots of people out there interested in getting this kind of business right now and we prevailed because we delivered a solution that was developed in a very short time line and performed extremely well in the field. And that's something that product, which is our Star SAFIRE 280-HDc, (sic) [380-HDc] is going to be a product that will have much broader applicability than just that single U.S. Coast Guard program under our CDMQ model.

[Michael F. Ciarmoli:]

Okay, that's fair. What about the lobbyist spending in kind of Washington presence? I mean, is that something you guys lack in relation to peers? Do you need to boost and bolster your efforts there? I mean, how do you view kind of that dynamic of the business?

[Andrew C. Teich:]

Well, there's no question that we don't have the same clout there as the major defense contractors because we're a smaller business than they are. But that said, I think we do pretty well for our fighting weight. We have a military advisory board that is very well staffed and we get excellent support from the members of that group. And we fight differently than the large defense contractors, and that's part of what makes us attractive to our customers. So I think we'll see over the long term which of these models is ultimately successful but I believe that the CDMQ model that we are, have been and continuing to pursue is one that ultimately is going to be the victor in the style of procurement that the U.S. government's going to have to go to in this environment of constrained spending.

[Operator:]

And moving on, our next question will be from the line of Jonathan Ho with William Blair.

[Jonathan Ho:]

I just wanted to get a little bit of a better understanding around sort of the export-import of licenses and how you're thinking about timing in terms of those orders. Were any canceled or is this merely a shift to the right? And does it come back in the fourth quarter potentially, now that things have maybe gotten a little bit better? I just want to get a sense from how you're thinking about that?

[William A. Sundermeier:]

Sure, Jonathan, it's Bill. We had a few orders that were in Q3 that with export delays are going to move to Q4. So we do anticipate those happening in Q4. But Q4 is also a difficult quarter for us with all the holidays to get the licenses through. So if we don't have those licenses in by the end of this month, it makes it much more difficult. So we've looked at that in forecasting the fourth quarter already in anticipation. That's in our numbers in our forecast for this year.

[Jonathan Ho:]

Got it. And would it be safe to assume that if it doesn't come in, in the fourth quarter it then just slides to the first quarter and then maybe things normalize? Or is there sort of a permanent flight out? I just want to make sure I understand that.

[William A. Sundermeier:]

If it doesn't happen, we tend to never lose things that we have orders and just timing for export licenses, so it would just move into the first quarter. But I'd say in general, we've done extremely well internally in getting licenses done through the process. We have an excellent, excellent team that works on that, but just fourth quarter is a tough quarter when it comes to just the number of working days and getting things processed.

[Jonathan Ho:]

So just in terms of price elasticity, I just wanted to understand how you guys are thinking about that at this point. I know that the new E-Series is coming in at pretty revolutionary sort of sub $1,000 price range for the features that you're offering. But I mean I just want to get a sense of are you anticipating sort of a material pickup in volumes with the rollout of this? Or with your market testing and field testing, your sense of elasticity going forward? I mean, is it still there? Is there an inflection point? Just your current thoughts on that.

[Thomas A. Surran:]

One, yes. The amount of value that's being offered by the Ex line is incredible. And then two, at that price point to be able to get the kind of products such as bringing MSX into an entry-level product, the level of resolution, the capabilities of that camera, like you said, it really is a special product. In terms of are we going to continue to bring thermal imaging to new price points? Absolutely. Will we see a specific inflection point? That's hard to ascertain. I think that we expect to continue to see elasticity in the market that we -- that is one of the things that we're going to be pulling -- pushing harder and harder on. And the timing of it, it's just going to be a sequence of products that continue to push on bringing thermal imaging at new price points with new value propositions to new customers.

[Andrew C. Teich:]

Jonathan, I'll add one other thing. This is Andy again. We've stated several times in the past that we think that there are 2 issues that are sort of barriers to much broader scale acceptance of this technology at the lower price point and that's price and awareness. And as we've stated, we have a major effort underway to create a new camera core at a much lower price point and -- that would be built at much larger volumes. And that development is -- continues to progress well and is running on schedule at this point, both technically and from a cost standpoint. But also, we will be stepping up our activities in terms of awareness building. We've already started that activity midway through Q3 with the buildup to the launch of Ex-Series, and we will continue that. And I think we've got to pull on both of those levers simultaneously. Some of the cost savings that we discussed in these realignment activities is going to be directed towards marketing to increase the level of marketing that we're doing there to drive that awareness that's going to be needed in order to get the volumes that we're looking for.

[Operator:]

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

[Brian W. Ruttenbur:]

Yes. The questions I have on the manufacturing side, first of all, what is your current capacity, number of facilities? What do you think you can produce out of that in terms of total volume? And let's just say, since everybody has been so negative, what if markets come back and come back strong, what -- and you're closing all these facilities, what can you produce? Can you go back to your 15% growth target off of those factories? Are you going to have to expand or add capacity?

[Anthony L. Trunzo:]

So Brian, it's Tony. Something really important to try and differentiate here and it's unfortunate that the way events rolled out that these 2 things got conflated. But the realignment, the closure or proposed closure of those 6 facilities, the moving of optics and the consolidation of some of our operations in Sweden, they were all developed well before we had a full understanding of what the current environment was going to present. And they were developed well before we realized that the year was not going to be what we had originally expected. They were strategic in the sense that it was appropriate for us to do some pruning of small under-scaled facilities into larger facilities. And there's a few aspects to that, in addition to the obvious cost savings that are important. There's a strong effort underway within FLIR to be more efficient not just in terms of things like overhead, which this will do, but also be more efficient with our core resources like R&D, and consolidating them into some of our larger facilities, which gives us the opportunity to flex resources, to encourage the kind of collaboration that's necessary and relocating operations into places where all of FLIR can benefit from the lift that vertical integration provides, such as in optics. These things were all developed strategically to position the business for more growth. They were not done in reaction to what we saw as a smaller business. It was quite the opposite. When you look at the facilities that we're either closing or proposing to close, I think the largest one had 75 people, something in that range. And in every case, they're moving to a larger FLIR facility with more infrastructure and more resources. And in none of those cases is there going to be any meaningful reduction in capacity at all. We will have, for the foreseeable future, internally, where we manufacture internally, plenty of capacity to continue to meet what we do expect to be increasing volumes.

[Andrew C. Teich:]

Brian, I'll add one other thing to that, which is, I've been through a number of these cycles in the past and they always have a somewhat different complexion but they also have typical -- a similar outcome, which is at some point, they resolve themselves and the volumes come back strong. And frankly, in the past situations that have been in these things, we probably haven't been ideally positioned to really capitalize on that surge in volume, and this time, we absolutely are. And I think we are better positioned than anybody in the industry to capitalize on it at this point.

[Brian W. Ruttenbur:]

Very good. Last question, have you seen any pickup of order activity since the end of the quarter, since the government has restarted? And has there been any surge or orders actually coming through beyond the IDIQs?

[Andrew C. Teich:]

I'll let Bill and Tom talk about each of their businesses there.

[Thomas A. Surran:]

We've seen some small -- helpful finds. In particular, we have a business that sells what we call science cameras into the government and that had really been shut down in the third quarter. And as soon as -- they're basically the fourth quarter and people got back to work in Washington, we did see some orders start coming through that we had expected in Q3. Suddenly, people were trying to get those in. Those were more indicators rather than large volume, but it was a nice indicator.

[William A. Sundermeier:]

This is Bill. So far, we still continue to wait on some orders that we were promised in Q3. So -- I still believe that they're going to happen in Q4, but the shutdown has certainly impacted their ability to deliver them to us.

[Andrew C. Teich:]

Okay, we'll take one more question. We're coming up on the hour here, operator.

[Operator:]

And then final question is coming from the line of Tim Quillin of Stephens.

[Timothy J. Quillin:]

I wonder if you could talk about the remaining steps in the development of the next generation infrared core. And then give us -- possibly give us a preview of the potential new markets, especially that FLIR might be able to enter with the products that are enabled with that new core.

[Thomas A. Surran:]

We're very encouraged by where we stand in the development of the product. We're still ironing out a few things. We are working on a variety of products for the integration of that into a variety of markets. And you're right, the price point that we'll be able to address with this new technology opens up a number of markets. I'm not sure we want to communicate all those markets at this time, but it's exciting for us to be able to see those opportunities coming available. The technology -- the level of imaging we're getting, where we stand and being able to ramp production, all on positive signals.

[Andrew C. Teich:]

Tom, this is Andy. Every one of the businesses that we have today is a potential socket for this technology, and we will inject this technology into all of our existing businesses first. We'll probably pick 1 or 2 other new market opportunities to go after in the early days with this that I think will take time to develop, as did the other markets we built over time in Maritime, PVS and Security. And then, of course, we'll offer it as a core. So we'll be a merchant supplier of this technology and it will be available as a core once the product is released.

[Timothy J. Quillin:]

And no teasers on what markets those might be, though?

[Anthony L. Trunzo:]

Nice try, Tim.

[Andrew C. Teich:]

Not yet but we'll have -- we'll be talking about that in '14.

[Operator:]

There are no further questions at this time. I'll turn the floor back to management for closing comments.

[Andrew C. Teich:]

Thank you. And thank you, everyone, for joining us today on the call. As we mentioned, certainly, we're not pleased with the results that have happened, thus far, particularly driven by the activities in the government business but we do see a bright long-term future for the business. We're focused on making sure that the business is rightsized at this point for the environment that we're dealing in and such that we can capitalize on the technologies and the vertical integration benefits that we have within the company. I do want to take a moment to thank all of the FLIR employees in supporting us through this last quarter and in supporting the vision that we have for the business going forward. The employee base has been very responsive in terms of supporting the changes that we've recently introduced, and frankly, in supporting me as the new CEO of this business. And I want to thank them all for their dedication and thoughtful work on that. With that, operator, we'll close the call. Thank you, everyone.

[Operator:]

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