Last week, FLIR Systems (FLIR) reported its earnings results for the second quarter of fiscal 2020.
Revenues in the quarter were unchanged from the year ago period at $482 million, with growth among the company's elevated skin temperature (EST) detection offerings offset by weakness throughout the rest of the enterprise, most notably the Commercial businesses within the Industrial segment. On a constant currency basis, revenues increased by roughly 1%. On a segment basis, Industrial revenues increased 6% to $300 million from the strength in EST, with Defense revenues down 8% to $182 million on continued administrative-relative process delays.
As CEO Jim Cannon discussed on the conference call, the company saw a material tailwind from growth in the EST business in the second quarter:
"We continue to experience demand for thermal EST camera applications from a wide variety of industries, although these thermal cameras cannot detect or diagnose COVID-19, they do serve as a first line of defense and an effective tool to measure of the skin surface temperature of large groups of people entering facilities such as hospitals, airports, train terminals, military installations, businesses and factories. After booking approximately $100 million in EST orders during the first quarter, we recorded approximately $70 million during the second quarter. Revenue contributions from EST products and solutions in the second quarter were approximately $95 million, and we ended the period with EST related backlog of approximately $25 million."
At $95 million, EST accounted for one-fifth of FLIR's business in the second quarter. The problem is what this means for the rest of FLIR. Assuming EST was an immaterial contributor to the company's year ago results, that implies the non-EST business declined by 20%, with the Industrial segment ex-EST down by nearly 30%. In addition, as noted on the call, the EST results in the second quarter are unlikely to be sustained: "As we look ahead to the second half of the year, we expect demand for EST applications to stabilize at levels below what we experienced in the second quarter". In other words, without a material improvement in FLIR's non-EST business, the company will likely report significant revenue declines in the back half of 2020.
Collectively, FLIR reported $126 million in adjusted operating income, up materially from the year ago period on significant gross margin expansion and lower operating expenses, as well as beneficial mix shift in the Industrial segment. Non-GAAP earnings per share was $0.64 per share, up 23% year-over-year. However, that metric is based on year ago non-GAAP EPS of $0.52 per share, compared to the $0.56 per share that FLIR said they earned on a non-GAAP basis when they reported 12 months ago. I've checked the numbers multiple times, but the answer may still be that I'm making an error. I think the actual answer is that management is fudging the numbers a bit and hoping nobody would notice. For the sake of investors, let's hope it's the former and not the latter. When it comes to calculated non-GAAP numbers, investors should always be aware that companies can and do change these metrics, which skews the results.
As I noted three months ago, the company was relatively active with share repurchases in the first quarter, repurchasing $150 million worth of stock at an average price of $36 per share. Since then, as the impact of the pandemic became clearer and the need to preserve cash became pressing, management has paused all repurchases. In addition, as noted on the call, that's unlikely to change for the foreseeable future: "In light of the ongoing uncertainties, we will maintain our capital allocation emphasis on near-term cash optimization."
At quarter's end, the company had $333 million in cash and $847 million in total debt. In July, the company was able to access the capital markets, raising $500 million in ten-year debt at 2.5%, the majority of which will be used to repay the $425 million of debt maturing next year. Needless to say, it sure is nice to be an environment where you can raise half a billion dollars at a low-single digit interest rate.
Conclusion
In April, I wrote an article discussing why I had decided to trim my position in FLIR. Shortly thereafter, with the stock moving in the mid-to-high-$40's on optimism around EST, I sold the rest. I think the concerns that I laid out at that time, which included the lackluster business results, questionable capital allocation and a demanding valuation, largely remain true today. For that reason, I will continue to remain on the sidelines. Based on what I'm seeing today, the stock would likely need to fall below $30 per share before I would consider buying more shares again.
Disclosure: Long FLIR
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