I pitched FLIR Systems (FLIR) to investors in May of last year (up 20% or so since that time), and have penned periodic updates on the thesis every few months; with fourth quarter results reported this past week, now seems like an appropriate time to do so once again.
FLIR reported Q4 revenue of $386 million, off about 5% from the year ago period; Commercial Systems was down 5% (with Europe continuing to give the company trouble) and Government Systems was down 4% due to the continuation of “procurement sluggishness”.
For the full year, revenue was off 9%, to $1.45 billion; in its 2013 guidance, management expects revenue in 2013 to $1.5 billion to $1.6 billion, up 7% to 14% compared to 2012 – with the midpoint dead in-line with FY2011 results. Obviously, this is disappointing for a company that grew the top-line 19% per annum in the four years up until 2011; with that said, these type of blips are what create opportunity in an increasingly short-sighted world, and I think sitting through the past 24 months will prove to be small potatoes for FLIR investor’s long term.
While revenue was hit pretty hard for the year, the company kept costs under control: for example, SG&A was off more than 21% for the full year, in anticipation of continued macroeconomic weakness on the consumer side (affecting industrial production, Raymarine, etc), as well as concerns about government spending with the potential impact of sequestration.
As a result of this material reduction in expenses (partially offset by 170 basis point reduction in gross margins), operating income was only -3%, to $303 million; net income was essentially flat at $222 million (lower tax rate was the bridge between EBIT and NI), with diluted EPS up 5% from 2011, to $1.45 per diluted share, due to significant buyback activity (10.5 million shares repurchased in 2012 at an average price of $20.47, with shares out now to 153 million). For 2013, the company is targeting $1.56 to $1.66 on the bottom line, implying growth of 8-14%.
As I noted in my write-up last year, part of this story is dependent upon management’s solid track record on capital allocation: they’ve shown a knack for making share repurchases when the stock is cheap, a far too uncommon practice. Considering that I still think FLIR common is quite attractive, I was happy to see the following in the Q4 release:
“Also today,FLIR announced that its Board of Directors approved a new share repurchase program that authorizes up to 25 million shares to be repurchased over the next two years, replacing the previous program that expires onFebruary 9, 2013. This authorization represents approximately 17% ofFLIR's outstanding common stock as ofDecember 31, 2012.”
In addition to share repurchases, the company paid $42 million in common stock dividends in 2012; with a 29% increase in the dividend announced along with the Q4 call (quarterly from $0.07 to $0.09), the dividend should cost about $50-52 million in 2013 (small adjustment for buyback activity throughout year, assuming shares out decrease by 5% or so). At the mid-point of the company’s 2013 target, the payout ratio is a rather paltry 22%; while I would rather see this money spent on buybacks at this level (which management is doing), this just gives you an idea of how much upside there is in the payout with time (assuming low-mid teens EPS growth, the dividend could easily CAGR at 20-25% for 5+ years).
FLIR's backlog of firm orders for delivery within the next twelve months was approximately$520 million as of yearend, up $64 million – or 14% - from December 31st, 2011. The company ended the year with $322 million in cash/equivalents, and $1.16 billion in current assets; this compares to $240 million in current liabilities, and $250 million in long term debt (3.75% of senior unsecured notes, due September 2016).
As expected, a lot of the focus remains on U.S. Government spending; while this is undoubtedly an important factor (and important to the company’s leadership position of higher volumes – where FLIR has a 3X advantage gap over their closest competitor - and lower prices to increase adoption of their core technology), FLIR’s underlying results will becoming increasingly untied to Defense spending with time (along with a reduction in low-margin contract R&D). Here’s a great example of the global opportunity, as highlighted by commentary around Surveillance bookings (a Government Systems division) on the call:
“The Surveillance segment finished the quarter with backlog of $261 million. Surveillance book-to-bill of 0.8 was the highest fourth quarter ratio since 2008. Our international markets contributed 55% of Surveillance segment bookings in the fourth quarter, as our initiatives to build out our worldwide sales staff bear fruit.
The largest order in the Surveillance segment during the quarter was for over $17 million to outfit the fixed-wing aircraft of the Afghan Air Force with several of our Star SAFIRE III gimbals. We also won a $12 million contract to support the Brazil police force's security initiatives for the upcoming World Cup and Olympic Games. We were awarded a $4 million award to outfit Canada's Special Operations Command with technical thermal scopes. A $3 million award for our Star SAFIRE HD systems for the Turkish Land Forces shows our growing presence in Turkey, which historically has been a sole source market for another company.
These orders are an example of how our customer and countries list continues to expand as a result of our diversifying sales organization and a growing set of high-quality, high-value products. This has been a key element of our strategy, and we will continue to invest our own dollars to innovate cutting-edge products and to build out our global reach.”
As always, the potential applications for the company’s technology seem to be expanding; for example, here’s what was said on the call about the recent Traficon acquisition, and an emerging application (at this point, in California) for traffic:
“Today, in traffic, the common solution is to use visible cameras. And visible cameras have issues with sun glint, sunrise, sunset, fog, haze, shadows, and headlights. Those are all issues. And the other thing that's becoming quite prevalent and will be a vector that we'll pursue are bicycle detection and pedestrian detection. And California has got a particular initiative going on in that area right now. All of those things are much easier to do with thermal because you don't deal with color, you don't deal with effects of sun glint, sunrise, sunset, obscurants, and all of those things go away. You've got a black and white image that's very easy to do analytics on. So I think the group of engineers that we've got right now with the Traficon team are very much looking to develop, looking forward to refine those algorithms for thermal cameras… The good news here and what you really alluded to is that the penetration rate is still quite low. So the total opportunity, I think, it’s significant as intersections are developed or upgraded around the world. And that's just one piece of Traficon's business.”
To conclude, the core investment thesis presented from last May remains intact; the management team’s solid capital allocation record remains key, with share leadership and application expansion in the core business driving volumes higher and prices lower, a virtuous cycle that I expect to continue (partly fueled by M&A, like with Traficon, which positions the company to expand its leadership in emerging applications). For me, I’m content with sitting still at current levels, and wouldn’t warrant further thought unless it crept into the low/mid $30’s per share; as always, I’m hoping for a pullback to buy more – and the politicians might provide us with some help in the ensuing weeks.
About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with a handful of positions accounting for the majority of the total. From the perspective of a businessman, I believe this is sufficient diversification.