As promised, I will continue to update readers on the progress at FLIR Systems (FLIR), which I originally pitched back in May of last year (here); without any further introduction, let’s dive into the second quarter results:
Revenue in the quarter crossed $389 million, up 15% compared to second quarter of 2012; revenue from Commercial Systems was up 17% to $222 million (57% of the total), with revenue from Government Systems up 13% to $168 million.
Digging into the segments, we get a very different picture than what’s portrayed in the headline figures. The Thermal Vision and Measurement segment (TVM), which accounts for the majority of Commercial Systems sales, reported sales growth of 23% from the year ago period; however, this growth was all but entirely driven by M&A (Lorex and Traficon, both of which were acquired in late 2012). On an organic basis, the division’s top line was essentially flat year over year. As management noted, the company continues to face a challenging macro environment, which impacts high-end science and predictive maintenance markets (with one notable exception being China, where Thermography orders increased more than 20% in the quarter).
In the Government Systems division, Surveillance – which accounted for 70% of GS’ sales in the quarter – declined marginally from the year ago period; the 17% revenue growth mentioned above was entirely driven by Integrated Systems, were the company reported $34.5 million in sales, an increase of 160% from the prior year. This growth was the result of deliveries under the MSC program to U.S. Customs and Border Protection – which is just one example of how the Department of Homeland Security (DHS) is becoming increasingly important to FLIR’s future.
Another positive for the Government Systems division was bookings growth; this was most apparent in Surveillance, where the backlog increased by $24 million sequentially. Across the entire company, backlog increased to $528 million in the quarter, with an even split in the growth among the two divisions over the past year; the book-to-bill ratio jumped to 1.1, with FLIR generating its highest quarterly bookings since 2008. These figures must be considered in the context of weak Department of Defense orders (“As we went into this year, we anticipated about a 20% decline in U.S. DoD orders, and it's actually been slightly worse than that”); this weakness has been offset by order flow from other federal agencies, and 30% bookings growth from international customers; the original thesis for FLIR is slowly but surely playing out as expected.
On a company-wide basis, organic revenue grew six percent. This is the first quarter of organic revenue growth that the company has reported since early 2011.
Working down the income statement, operating income in the second quarter increased by 16% to $70 million, and net income increased 22% to $50 million (with the delta explained by a lower tax rate in the current quarter, as well as a charge tied to discontinued operations in the prior year). On the bottom line, earnings per share increased by 30%, with shares outstanding down more than 7% from the year-ago period. This management team continues to deserve praise for the sound capital allocation decisions they’ve made in the preceding 24 months.
At quarter end, the company was sitting on nearly $500 million in cash and equivalents, against $380 million in long term debt (3.75% notes that don’t come due for another three years). The current ratio is a solid 4.8x, with the company continuing a cautious financing approach that has allowed them to repurchase shares and engage in M&A opportunistically in the past; based on their recent track record (which admittedly includes work left to be done on recent deals before they can be declared a success), this is an approach that seems to fit the company quite well.
In the first half of 2013, the company’s generated just short of $200 million in operating cash flow, with a change in working capital making the year-over-year comparison (up 55%) relatively meaningless; the more important point is that against capital expenditures of $23.2 million year to date (remember, most of the company’s investment is expensed through the income statement as R&D), FLIR continues to generate a significant amount of excess cash.
Year to date, the company has repurchased 4.5 million shares (total cost of $117 million) at an average price of $26 per share. Management reaffirmed the revenue and earnings per share outlook for the full year, with midpoints of $1.55 billion and $1.61 per share, respectively; at the current quarterly payout of $0.09 per share, the dividend yield is just over one percent. While I’m not gung-ho about adding to FLIR at these levels, I’m nowhere near liquidating my position. This is an attractive business with solid growth potential extending many years into the future along with sound management, and I won’t be going anywhere unless I’m being paid a pretty penny to do so. I would be in the market looking to add to my holdings in the mid $20s per share.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of my portfolio (currently two). In the eyes of a businessman, I believe this is adequate diversification.