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MarketScreener Homepage  >  Equities  >  Nasdaq  >  FLIR Systems Inc    FLIR

FLIR SYSTEMS INC

(FLIR)
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FLIR : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

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05/02/2019 | 02:29pm EDT

Forward-Looking Statements This Quarterly Report on Form 10-Q (the "Report"), including "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part I, Item 2, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding future events and the future results of FLIR Systems, Inc. and its consolidated subsidiaries ("FLIR" or the "Company") that are based on management's current expectations, estimates, projections and assumptions about the Company's business. Words such as "expects," "anticipates," "intends," "plans," "believes," "sees," "estimates" and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements due to numerous factors including, but not limited to, those discussed in "Risk Factors" section in Part II, Item 1A of this Report, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part I, Item 2, and elsewhere in this Report as well as those discussed from time to time in the Company's other Securities and Exchange Commission filings and reports. In addition, such statements could be affected by general industry, economic, and market conditions. Such forward-looking statements speak only as of the date of this Report or, in the case of any document incorporated by reference, the date of that document, and the Company does not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this Report, or for changes made to this document by wire services or Internet service providers. If the Company updates or corrects one or more forward-looking statements, investors and others should not conclude that the Company will make additional updates or corrections with respect to other forward-looking statements.


Consolidated Operating Results
The following discussion of operating results provides an overview of our
operations by addressing key elements in our Consolidated Statements of Income.
The "Segment Operating Results" section that follows describes the contributions
of each of our business segments to our consolidated revenue and earnings from
operations. Given the nature of our business, we believe revenue and earnings
from operations (including operating margin percentage) are most relevant to an
understanding of our performance at a segment level. Additionally, at the
segment level we disclose backlog, which represents orders received for products
or services for which a sales agreement is in place and delivery is expected
within twelve months. Backlog is not an absolute indicator of future revenue
because a portion of the orders in backlog could be canceled at the customer's
discretion. While the backlog is subject to order cancellations, we have not
historically experienced a significant amount of order cancellations.
Revenue. Consolidated revenue for the three months ended March 31, 2019,
increased by 1.2 percent year over year, from $439.6 million in the first
quarter of 2018 to $444.7 million in the first quarter of 2019. Increases in
revenues for the three month period in our Industrial and Government and Defense
business units were partially offset by declines in the Commercial business
unit.
The timing of orders, scheduling of backlog, and fluctuations in demand in
various regions of the world can give rise to quarter to quarter and year over
year fluctuations in the mix of revenue. Consequently, year over year
comparisons for any given quarter may not be indicative of comparisons using
longer time periods. We currently expect total annual revenue for 2019 to be
higher than 2018 revenue, however, unexpected changes in economic conditions
from key customer markets or other major unanticipated events may cause total
revenue, and the mix of revenue between our segments, to vary from quarter to
quarter during the year.
International sales accounted for 45.4 percent and 48.7 percent of total revenue
for the quarters ended March 31, 2019 and 2018, respectively. The proportion of
our international revenue compared to total revenue will fluctuate from quarter
to quarter due to normal variation in order activity across various regions as
well as specific factors that may affect one region and not another. Overall, we
anticipate that revenue from international sales will continue to comprise a
significant percentage of total revenue.
Cost of goods sold. Cost of goods sold for the three months ended March 31, 2019
were $211.1 million compared to cost of goods sold for the three months ended
March 31, 2018 of $221.7 million. The decrease in cost of goods sold for the
three month periods is primarily related to the decline in our Commercial
business unit, which was largely a result of our divestiture of the Consumer and
Small and Medium-sized ("SMB") Security businesses as announced in February
2018.
Gross profit. Gross profit for the quarter ended March 31, 2019, was $233.7
million compared to $217.9 million for the same quarter last year. Gross margin,
defined as gross profit divided by revenue, increased from 49.6 percent in the
first quarter of 2018 to 52.5 percent in the first quarter of 2019. The increase
in gross margin for the three and nine month periods was primarily due to
product mix in the Government and Defense business unit and product mix and
productivity improvement in the Industrial business unit.

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Research and development expenses. Research and development expenses for the
first quarter of 2019 totaled $48.0 million, compared to $44.6 million in the
first quarter of 2018. Research and development expenses as a percentage of
revenue were 10.8 percent for the three months ended March 31, 2019 and 10.1
percent for the three months ended March 31, 2018. We have, and will continue to
have, fluctuations in quarterly spending depending on product development needs
and overall business spending priorities and believe that annual spending levels
are most indicative of our commitment to research and development. Over the past
five annual periods through December 31, 2018, our annual research and
development expenses have varied between 8.5 percent and 9.9 percent of revenue,
and we currently expect these expenses to remain within that approximate range,
on an annual basis, for the foreseeable future.
Selling, general, and administrative expenses. Selling, general, and
administrative expenses were $104.6 million and $107.7 million for the quarters
ended March 31, 2019 and 2018, respectively. The decrease in selling, general,
and administrative expenses year over year is primarily attributed to a $15
million regulatory settlement recorded in the first quarter of 2018 partially
offset by acquisition related expenses for acquisitions occurring in the first
quarter of 2019. Selling, general, and administrative expenses as a percentage
of revenue were 23.5 percent and 24.5 percent for the quarters ended March 31,
2019 and 2018, respectively. Over the past five annual periods through
December 31, 2018, our annual selling, general and administrative expenses have
varied between 19.4 percent and 21.8 percent of revenue, and excluding the
impact of the $15.0 million regulatory settlement cost described above, we
currently expect these expenses to remain within that approximate range, on an
annual basis, for the foreseeable future.
Loss on sale of business. During the first quarter of 2018, we recorded an
additional pre-tax loss on the sale of our Consumer and SMB Security businesses
of $10.2 million. See Note 20, "Business Acquisitions and Divestitures," of the
Notes to the Consolidated Financial Statements for additional information.
Interest expense. Interest expense for the three months ended March 31, 2019,
was $5.5 million, compared to $4.1 million for the same period of 2018. Interest
expense for the three month period in 2019 was primarily associated with the
$425 million aggregate principal amount of our 3.125 percent senior unsecured
notes and interest on amounts drawn under our credit facility. Interest expense
for the same period in 2018 was primarily associated with the $425 million
aggregate principal amount of our 3.125 percent senior unsecured notes.
Income taxes. Our income tax provision of $13.0 million for the three months
ended March 31, 2019, represents an effective tax rate of 17.4 percent. Our
income tax provision for the three months ended March 31, 2018 was $15.4
million, which represented an effective tax rate of 28.2 percent. The effective
tax rate for the three months ended March 31, 2019 is lower than the United
States Federal tax rate of 21 percent mainly due to a reduction in previously
non-deductible interest expense and excess tax benefits from stock compensation,
offset partially by state taxes, higher tax rates applied to income earned in
certain foreign jurisdictions, and other discrete items.
During 2018, the Swedish Tax Authority ("STA") issued a reassessment of tax for
the year ending December 31, 2012 to one of our non-operating subsidiaries in
Sweden. The reassessment concerns the use of tax credits applied against capital
gains pursuant to European Union Council Directive 2009/133/EC, commonly
referred to as the EU Merger Directive, and assesses taxes and penalties
totaling approximately $321.6 million (Swedish kronor 3.0 billion). We believe
the STA's assertions in the reassessment are not in accordance with Swedish tax
regulations and plan to defend our positions with the STA and through the
Swedish court system, as necessary. Consequently, no adjustment to our
unrecognized tax benefits has been recorded in relation to this matter.

Segment Operating Results The Company is currently organized into three reportable segments. The three reportable segments continue to be the Industrial business unit, Government and Defense business unit and the Commercial business unit. See Note 19, "Operating Segments and Related Information," of the Notes to the Consolidated Financial Statements for a description of each operating segment, including the types of products and services from which each operating segment derives its revenues.

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Industrial

Industrial business unit operating results are as follows (in millions, except
percentages):
                            Three Months Ended March 31,
                               2019               2018
Revenue                  $       179.4$       170.7
Earnings from operations          56.9                45.5
Operating margin                  31.7 %              26.6 %
Backlog, end of period             173                 179

Industrial business unit revenue for the quarter ended March 31, 2019 increased by 5.1 percent compared to the same period of 2018. The increase in revenue for the three month period ended March 31, 2019, compared to the same period of 2018, was predominately attributable to strong growth across the cooled cores and UAS product lines partially offset by volume declines in the Integrated Imaging Systems (IIS) business. The increases in earnings from operations and corresponding operating margin for the three month period ended March 31, 2019, compared to the same period of 2018, were predominately attributable to favorable product mix in the OEM cores business and productivity initiatives to improve manufacturing efficiency across all divisions. The decline in backlog during the three months ended March 31, 2019 is primarily attributed to productivity initiatives executed during the period to reduce lead times for customer deliveries of our machine vision and volume hand-held product lines. Government and Defense Government and Defense business unit operating results are as follows (in millions, except percentages):

                            Three Months Ended March 31,
                               2019               2018
Revenue                  $       173.4$       159.3
Earnings from operations          48.3                46.2
Operating margin                  27.8 %              29.0 %
Backlog, end of period             451                 357


Government and Defense business unit revenue for the quarter ended March 31,
2019 increased by 8.8 percent compared to the same period of 2018. The increase
in both revenue and earnings from operations for the three month period ended
March 31, 2019, compared to the same period of 2018, was primarily driven by
increased volumes of UAS products and surveillance systems as well as the
partial period revenue related to the acquisitions of Aeryon Labs Inc. and
Endeavor Robotics Holdings Inc. during the quarter ended March 31, 2019. The
decline in operating margin for the three month period ended March 31, 2019,
compared to the same period of 2018 is also attributed to the inclusion of the
results from these acquisitions. See Note 20, "Business Acquisitions and
Divestitures," for further information. The increase in year-over-year backlog
is primarily driven by timing of orders and subsequent timing of deployment of
major programs in addition to the first quarter of 2019 acquisitions as noted
above.
Commercial
Commercial business unit operating results are as follows (in millions, except
percentages):
                            Three Months Ended March 31,
                              2019               2018
Revenue                  $      92.0$       109.6
Earnings from operations        12.9                14.5
Operating margin                14.1 %              13.2 %
Backlog, end of period            48                  60




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Commercial business unit revenue for the quarter ended March 31, 2019 decreased by 16.1 percent compared to the same period of 2018. The decrease in both revenue and earnings from operations for the three month period ended March 31, 2019 compared to the same period of 2018 was primarily due to the divestiture of our Consumer and SMB Security business during the first quarter of 2018 and volume declines in our Outdoor and Tactical Systems ("OTS") business. The decrease in year over year backlog is primarily attributed to a shift to non-current backlog for certain orders as well as volume declines in the OTS business.


Liquidity and Capital Resources
At March 31, 2019, we had a total of $284.4 million in cash and cash
equivalents, $95.2 million of which resided in the United States and $189.2
million at our foreign subsidiaries, compared to cash and cash equivalents at
December 31, 2018, of $512.1 million, of which $327.0 million resided in the
United States and $185.1 million at our foreign subsidiaries. The decrease in
cash and cash equivalents during the three months ended March 31, 2019, was
primarily due to cash used for business acquisitions of $579.6 million, common
stock repurchases of $25.0 million, dividend payments of $23.0 million, a
minority interest investment of $5.0 million and capital expenditures of $9.1
million, partially offset by cash provided from operations of $55.5 million, net
proceeds of $348.1 million from our revolving credit facility and long-term
debt, and proceeds of $9.7 million from shares issued under our stock
compensation plans.
Cash provided by operating activities during the three months ended March 31,
2019 totaled $55.5 million, which primarily consisted of net earnings, adjusted
for depreciation and amortization, stock-based compensation, other non-cash
items and changes in working capital. The increase of cash provided by operating
activities in 2019 over 2018 was due to an increase in net income and working
capital improvements.
Cash used by investing activities for the three months ended March 31, 2019
totaled $590.7 million, which consisted primarily of business acquisitions, a
minority interest investment and capital expenditures in the ordinary course of
business.
Cash provided by financing activities for the three months ended March 31, 2019
totaled $308.3 million, which primarily consisted of cash provided from net
proceeds from our revolving credit facility and long-term debt, and proceeds
from shares issued under our stock compensation plans, partially offset by
repurchases of shares of our common stock and the payment of quarterly
dividends.
On March 29, 2019, we entered into a Second Amended and Restated Credit
Agreement ("Credit Agreement") with Bank of America, N.A., JPMorgan Chase Bank,
N.A., U.S. Bank National Association, Citibank, N.A., MUFG Union Bank, N.A., and
the other lenders party thereto. The Credit Agreement amended and restated the
Company's existing Amended and Restated Credit Agreement, dated as of May 31,
2016 ("Existing Credit Agreement"). The Credit Agreement provides for a $650.0
million unsecured revolving credit facility, a $100.0 million unsecured term
loan facility available in U.S. dollars amortizing at 5.000 percent per annum,
and a $150.0 million unsecured term loan facility available in Swedish kronor
amortizing at 5.000 percent per annum. The Credit Agreement has a term of five
years and matures on March 29, 2024. In connection with the closing of the
Credit Agreement, we made an initial borrowing of $100.0 million in revolving
loans, $100.0 million in term loans in U.S. dollars, and the equivalent of
$150.0 million in term loans in Swedish kronor. Additionally we repaid in full
all outstanding amounts, consisting of revolving loans in an aggregate principal
amount of $375.0 million, under the Existing Credit Agreement.
We have the right, subject to certain conditions, including approval of
additional commitments by qualified lenders, to increase the availability under
the revolving credit facility by an additional $200.0 million until March 29,
2024. The Credit Agreement allows us and certain designated subsidiaries to
borrow in United States dollars, European euros, Swedish kronor, British pound
sterling, Japanese yen, Canadian dollars, Australian dollars, and other agreed
upon currencies. Interest rates under the Credit Agreement fluctuate depending
on the type and tenor of the borrowing, with the most common being a
Eurocurrency rate loan based on the published Eurocurrency rate (i.e. LIBOR) in
which the loan is denominated. Any amounts outstanding under the Credit
Agreement bear interest, at our election, at either (A) the rate of interest
paid for deposits in the relevant currency (the "Eurocurrency Base Rate") plus
an applicable margin between 1.000 percent to 1.375 percent, or (B) the highest
of (i) the federal funds rate plus 0.500%, (ii) the prime lending rate of Bank
of America, N.A. or (iii) the Eurocurrency Base Rate plus 1.000%, in each case
plus an applicable margin between 0.000% and 0.375%, depending on our
consolidated total leverage ratio. At March 31, 2019, the borrowing rate on the
revolving loan was 3.749 percent per annum, the borrowing rate on the U.S.
dollar term loan was 3.851 percent per annum and the borrowing rate on the
Swedish kronor term loan was 1.243 percent per annum. The Credit Agreement
requires us to pay a commitment fee on the amount of unused revolving
commitments at a rate, based on our consolidated total leverage ratio, which
ranges from 0.125 percent to 0.200 percent of unused revolving commitments.
At March 31, 2019, the commitment fee on the amount of unused revolving credit
was 0.175 percent per annum. The Credit Agreement contains one financial
covenant that requires maintenance of a consolidated total leverage ratio with
which we were in compliance at March 31, 2019. The credit facilities available
under the Credit Agreement are unsecured. The Credit Agreement also contains
language providing for the adoption of a LIBOR successor rate consistent with
market practice.

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To manage the interest rate risk arising from the variability in interest
expense attributable to amounts drawn under the Swedish kronor term loan, we
entered into a floored amortizing interest rate swap with a Swedish kronor
notional amount equivalent to $150.0 million. The interest rate swap was
designated, and effective, as cash flow hedges.
We had $11.0 million of letters of credit outstanding under the Credit Agreement
at March 31, 2019, which reduced the total availability under the revolving
commitments under the Credit Agreement.
In June 2016, we issued $425.0 million aggregate principal amount of our 3.125
percent senior unsecured notes due June 15, 2021 (the "Notes"). The net proceeds
from the issuance of the Notes were approximately $421.0 million, after
deducting underwriting discounts and offering expenses, which are being
amortized over a period of five years. Interest on the Notes is payable
semiannually in arrears on December 15 and June 15. The proceeds from the Notes
were used to repay our 3.750 percent senior unsecured notes that were due
September 1, 2016, and are being used for general corporate purposes, which
include working capital and capital expenditure needs, business acquisitions,
and repurchases of our common stock.
On February 8, 2017, our Board of Directors authorized the repurchase of up to
15.0 million shares of our outstanding common stock. This authorization expired
on February 8, 2019. On February 7, 2019, our Board of Directors authorized the
repurchase of up to 15.0 million shares of our outstanding common stock. This
authorization will expire on February 7, 2021. As of March 31, 2019, a total of
0.5 million shares have been repurchased under the February 7, 2019
authorization.
As of March 31, 2019 and December 31, 2018, the Company has accrued income tax
liabilities of $42.9 million related to the transition tax enacted on December
22, 2017 as part of the Tax Cuts and Jobs Act. Of the amounts accrued, none are
expected to be due within one year. The remaining transition tax will not accrue
interest and will be paid in annual installments beginning in 2020 through 2024.
We have not provided United States, state or foreign income taxes for earnings
generated after January 1, 2018 by certain subsidiaries outside the United
States as we currently intend to reinvest the earnings in operations and other
activities outside of the United States indefinitely. Should we subsequently
elect to repatriate such foreign earnings, we would need to accrue and pay state
and foreign income taxes, thereby reducing the amount of our cash. United States
taxes would generally not be payable due to changes made by the Tax Act.
During 2018, the Swedish Tax Authority ("STA") issued a reassessment of tax for
the year ending December 31, 2012 to one of our non-operating subsidiaries in
Sweden. The reassessment concerns the use of tax credits applied against capital
gains pursuant to European Union Council Directive 2009/133/EC, commonly
referred to as the EU Merger Directive, and assesses taxes and penalties
totaling approximately $321.6 million (Swedish kronor 3.0 billion). We believe
the STA's assertions in the reassessment are not in accordance with Swedish tax
regulations and plan to defend our positions with the STA and through the
Swedish court system, as necessary. Consequently, no adjustment to our
unrecognized tax benefits has been recorded in relation to this matter.
We believe that our existing cash combined with the cash we anticipate
generating from operating activities, and our available credit facilities and
financing available from other sources will be sufficient to meet our cash
requirements for the next twelve months. We do not have any significant
commitments nor are we aware of any significant events or conditions that are
likely to have a material impact on our liquidity or capital resources.


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Off-Balance Sheet Arrangements As of March 31, 2019, we did not have any off-balance sheet arrangements that have or are likely to have a material current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

Recently Issued Accounting Pronouncements In November 2018, the FASB issued ASU No. 2018-18, "Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606" ("ASU 2018-18"). The standard clarifies that certain transactions between collaborative arrangement participants should be accounted for under ASC 606, when one participant is a customer, and specifies that a distinct good or service is the unit of account for evaluating whether the transaction is with a customer. The standard also provides some guidance on presentation of transactions not in the scope of ASC 606. The standard is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted as long as a company has already adopted the guidance in ASC 606. The Company plans to adopt the standard as of January 1, 2020 and is currently evaluating this guidance to determine the impact it may have on its consolidated financial statements.

Critical Accounting Policies and Estimates Preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Management believes the most complex and sensitive judgments, because of their significance to the consolidated financial statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Readers should refer to Management's Discussion and Analysis and the critical accounting policies and its use of estimates as reported in Note 1, "Nature of Business and Significant Accounting Policies" and Note 14, "Contingencies" of the Notes to the Consolidated Financial Statements included in the Form 10-K for the fiscal year ended December 31, 2018. Actual results in these areas could differ materially from management's estimates. There have been no significant changes in the Company's assumptions regarding critical accounting estimates during the first three months of 2019.

Contractual Obligations There were no material changes to the Company's contractual obligations outside the ordinary course of its business during the quarter ended March 31, 2019, other than the $100 million borrowed under the revolving credit facility and $250 million borrowed under the term loan facility and related interest under the Credit Agreement, as described above in "Liquidity and Capital Resources."

Contingencies

See Note 17, "Contingencies," of the Notes to the Consolidated Financial Statements for the disclosure of certain matters by the Company to the United States Department of State Office of Defense Trade Controls Compliance, communications to the Company from the United States Department of Commerce Bureau of Industry and Security, and the Company's current estimates of the range of potential loss associated with quality concerns identified by the Company regarding certain SkyWatch Surveillance Towers.

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