The second suspect in the Boston Marathon bombings is now in police custody, with FLIR playing an important role in his capture; Timothy Alben of the Massachusetts State Police said the following:
“We have what's called a FLIR — a forward-looking infrared device — on that helicopter. It picked up the heat signature of the individual, even though he was underneath what appeared to be the 'shrink wrap' or cover on the boat itself.”
Think about the situation after the police determined the location of the suspect; even with knowing he was under the tarp, authorities were concerned that he might have an explosive device on his person, in one final attempt to cause as much destruction and injury as possible. Being able to see the suspect with infrared may have given police the assurance they needed to approach the boat. Considering that the suspect had sustained serious injuries throughout the day, time was of the essence; infrared imaging was critical to successfully apprehending the suspect in a timely fashion.
On March 7, FLIR Systems Inc. held its investor day to recap fiscal year 2012 results and discuss the outlook for the business heading into 2013. Considering that the investor day was quite long, I’m going to break the presentation up into three articles, in this order: Government Systems (here), Commercial Systems (here) and Corporate/Financial Overview, along with my closing thoughts.
With that, let’s get started with the final article in the series: Corporate/Financial Overview.
Revenues were $1.4 billion in 2012; with an operating margin of 22%, operating income was slightly above $300 million. The two largest segments in the portfolio are TVM in the commercial division ($628 million in 2012 revenues, with a 27% operating margin) and Surveillance in the government division ($486 million in 2012 revenues, with a 33% operating margin). Ironically (based on the common perception), FLIR’s Commercial Systems Division is the larger piece of the business at 56% of total revenues; in the past decade, this division has growth revenues by 740% (from $94 million to $786 million), while the government piece has grown 270% (from $167 million to $619 million) – with FLIR as a whole growing revenues a stellar 440% (from $260 million to $1.4 billion). Over that decade, the company generated a cumulative $1.33 billion in free cash flow – with more than one-third of the total being generated in the previous 24 months.
The company spread 2012’s operating cash flow to multiple sources, including M&A ($106 million for the year, used to purchase Lorex and Traficon), capital expenditures ($58 million), dividends ($42 million; yield was 1.5% at Friday’s close, with the payout ratio around 22%), and share repurchases ($214 million, driven by a privately negotiated transaction to repurchase three million shares in November).
FLIR is increasingly global (with the aforementioned M&A helping drive this trend); international revenues accounted for 49% of the total in 2012, up from 38% in 2008. While revenue in the United States grew a steady 8% per annum in the five years to 2008, revenue in Europe and the rest of the world grew at 14% and 22%, respectively; each of those businesses accounted for roughly $350 million in revenues in 2012, or 25% of FLIR’s total revenue – just $50 million shy from matching the company’s U.S. Government business (27% of revenues, down from 39% five years ago).
I’ve highlighted FLIR’s share repurchase program in the past; let’s get an update from CFO Anthony Trunzo:
“If there was a silver lining [in the stock falling to the high teens late in the year], it was the opportunity for us to -- because of our strong cash flow, to buy back 10.5 million shares at an average price of just over $20 a share. In Q4, we were able to get 3 million shares at $18.55 a share, which was a really signaling -- signature opportunity for us. And our share repurchase program, many of you know this, we're not in the market all the time. We try to be selective about when we're in the market. That program has generated a 44% internal rate of return for us since 2003. And I can say that we, thus far this year, have been active and through open market repurchases and a modest accelerated share repurchase, year-to-date, we purchased nearly 4 million shares.”
The four million shares comment was made in early March; the company likely spent around $100 million on repurchases in the first quarter (we’ll find out for sure with earnings on the 26th). With 145 million shares outstanding, the company will reduce shares outstanding by about 3.5% for the year (noted that they are already close to their full spend on repurchases for 2013).
Mr. Trunzo also noted that the company has worked to directly align executive bonuses with total shareholder return over time, saying the following:
“We put in place a new total shareholder return base equity incentive program, I won't go into the details of it other than to say that over the next 2.5 years, if FLIR does not outperform the S&P 500, none of the shares in this will vest. And to the extent we do outperform the S&P 500, there'll be a vesting of shares for the leadership team at FLIR. And our preliminary proxy was filed last week, the details are in there. I encourage you to read it, and we're happy to answer any questions. But the real focus here is aligning our compensation with performance and aligning it with the interest of our shareholders.”
I followed Mr. Trunzo’s advice and read the proxy; here’s one particularly revealing section:
“The grant date fair value of the entire 2012 TSR Program described above is reflected in the 2012 Summary Compensation Table, even though the program is specifically designed to measure our performance over a three-year time horizon, and no payouts, vesting or any other value realization event can occur unless both (a) we outperform the S&P 500 during the three-year period of the program and (b) three years have elapsed from the grant date. In respect of our CEO, $1.5 million, or 57% of the amount reported in the Stock Awards column of the 2012 Summary Compensation Table is from the TSR Program. The shares underlying the calculation of this amount will only vest to the extent that FLIR outperforms the S&P 500 by 33.33 percentage points for the three-year period of the program. As of December 31, 2012, FLIR had underperformed the S&P 500 since the inception of the TSR Program by 14%, meaning FLIR will need to outperform the S&P 500 by 47 percentage points from the end of 2012 through the end of the program for the shares underlying these grants to vest. In the event these shares do not vest, the forfeiture would not be captured as a reduction in the Summary Compensation Table in any year…"
"The second LTIP component, the TSR Program, is a market-based RSU that provides the opportunity for executives to earn above market awards for above market performance. Based on the analysis provided by Radford, this second LTIP component, at target, provides LTIP awards that approximate the 75th percentile of the Peer Group. The market-based RSUs vest based on FLIR's relative TSR versus the S&P 500 for the three-year period beginning May 1, 2012. It is key to note that vesting only occurs if FLIR's TSR performance exceeds that of the S&P 500. If FLIR's TSR is equal to or below that of the S&P 500 over such three-year period, no market-based RSUs will vest. For each 1% that FLIR's TSR exceeds that of the S&P 500, NEOs earn 3% of the target grant value. Potential awards are capped at 200% of target.”
FLIR’s proxy is a good read, with a clear focus on long term results; the company sets real targets for executives, and rewards or punishes them accordingly. The CEO owns 2% of the company (a stake worth more than $60 million, or 10X his trailing 3-year average total compensation), and key executives all have beneficial ownership of more than 300,000 shares.
Over the past decade, FLIR’s had an average return on equity around 23%; on that measure against the current equity balance, earnings would come in at $370 million. The company has $320 million in cash/equivalents, a current ratio north of 5X, and historically sound capital allocation practices. While the business has stagnated over the past few quarters, there’s little question that the setback is temporary; the long-term opportunities in FLIR’s core markets appear as bright as they’ve ever been, largely due to portfolio and global expansion to address demand. At roughly 15X trailing earnings (and a low teens multiple on normalized ROA and ROE), I believe the market continues to underestimate FLIR’s future growth prospects – growth that should generate considerable shareholder value over time; I continue to believe that intrinsic value is north of $30 per share.
About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with 2-5 positions accounting for the majority of my equity portfolio. From the perspective of a businessman, I believe this is sufficient diversification.