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The Science of Hitting
The Science of Hitting
Articles (710) 

FLIR: Headwinds as EST Fades

A look at the company's third-quarter financial results

November 03, 2020 | About:

Last week, FLIR Systems (NASDAQ:FLIR) reported results for the third quarter of fiscal 2020.

As in the second quarter, revenues were unchanged from the year-ago period, with the contribution from growth in the company's nascent elevated skin temperature (EST) detection offerings offset by weakness throughout much of the rest of the enterprise. On a segment basis, Defense revenues declined 13% to $185 million, with Industrial revenues up 9% to $281 million (adjusted for the impact of EST, Industrial revenues declined year-over-year).

The problem for FLIR is that the demand for EST detection offerings has proven temporary. After generating nearly $100 million in revenues for the company in the second quarter, EST delivered roughly $40 million in revenues for FLIR in the third quarter. In addition, based on commentary on the call from CEO Jim Cannon, that number will fall even further in the fourth quarter.

As Chief Financial Officer Carol Lowe noted, this is not likely to change: "We continue to expect demand for EST applications to stabilize at a significantly lower level than what we experienced in the first half of the year."

Collectively, FLIR reported $105 million in adjusted operating income, up 4% from the year ago period, reflecting gross margin expansion and operating leverage due to lower SG&A spend (particularly in areas like travel and marketing). On a segment basis, Industrial reported a 38% increase in operating income, with margins up 650 basis points to 31.2% due to the combination of operating leverage from higher sales and product mix (higher margin EST business). In the Defense Technologies segment, operating income declined by 28%, with margins contracting 430 basis points to 20.9% due to the headwind from lower business volumes.

Non-GAAP earnings per share was $0.64 per share, up 8% year-over-year. However, as I discussed last quarter, it appears to me that management is playing with the numbers a bit. For example, if you look at the adjustments in the press releases for the third quarters of 2020 and 2019, you'll see that $674,000 in purchase accounting adjustments and $101,000 in executive transition costs were added back when they were needed to help the year-over-year comparison, but they went unaccounted for when they hurt the year-over-year comparison. Admittedly, these are relatively small numbers, but I think they point to a consistent theme at FLIR: management appears willing to fudge the numbers a bit and hopes nobody will notice or care. For the sake of investors, I once again hope this is a mistake on my part and not an accurate assessment of what's going on.

Given the pressure on the business, management has needed to be less aggressive with capital returns. After repurchasing $150 million of stock at an average price of $36 per share in the first quarter, the company has been inactive in terms of share repurchases over the past six months.

At quarter end, the company had $320 million in cash and $730 million in total debt (with a net debt to Ebitda ratio of 1). By comparison, the company held a net cash balance on the books two years ago. Simply put, the company is in a less favorable financial position than they were 24 months ago, which will limit their ability to engage in M&A or outsized capital returns for the foreseeable future.

Conclusion

Management's updated guidance implies roughly $1.9 billion in revenues for 2020, which is in-line with the result in 2019. As shown below, after a decade of meaningful revenue growth during the 2000's, with revenues up more than 7 times, the top-line has grown at a roughly 3% compounded annual growth rate over the past ten years.

Early guidance from management suggests a continuation in this trend, with revenues expected to climb low-single digits to mid-single digits in 2021 – and with commentary on the call suggesting that the low end of this range is a more achievable target based on what management is currently seeing in the business. While I remain optimistic about the company's long-term opportunities in some key end markets, most notably ADAS and unmanned defense, I think the reality is that these efforts will take time to materialize, and that the company has issues to deal with in its core business over the coming quarters and years.

For that reason, I'm likely to remain on the sidelines.

Disclosure: None

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About the author:

The Science of Hitting
I desire to own high-quality businesses for the long-term. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with the top five positions accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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