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FLIR > SEC Filings for FLIR > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for FLIR SYSTEMS INC

Form 10-K for FLIR SYSTEMS INC


3-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Overview
FLIR Systems, Inc. ("FLIR," the "Company," "we," "us," or "our") is a world leader in sensor systems that enhance perception and awareness. We were founded in 1978 and have since become a premier designer, manufacturer, and marketer of thermal imaging and other sensing products and systems. Our advanced sensors and integrated sensor systems enable the gathering and analysis of critical information through a wide variety of applications in commercial, industrial, and government markets worldwide.
Our goal is to both enable our customers to benefit from the valuable information produced by advanced sensing technologies and to deliver sustained superior financial performance for our shareholders. We create value for our customers by providing advanced surveillance and tactical defense capabilities, improving personal and public safety and security, facilitating air, ground, and maritime navigation, enhancing enjoyment of the outdoors, providing infrastructure inefficiency information, conveying pre-emptive structural deficiency data, displaying process irregularities, and enabling commercial business opportunities through our continual support and development of new thermal imaging data and analytics applications. Our business model meets the needs of a multitude of customers - we sell off-the-shelf products to a wide variety of markets in an efficient, timely, and affordable manner as well as offer a variety of system configurations to suit specific customer requirements. Centered on the design of products for low cost manufacturing and high volume distribution, our commercial operating model has been developed over time and provides us with a unique ability to adapt to market changes and meet our customers' needs.
Through December 31, 2013, our business was organized into two divisions:
Commercial Systems and Government Systems. Within these divisions, we had five reporting segments: Thermal Vision & Measurement and Raymarine, which comprise the Commercial Systems division; and Surveillance, Detection and Integrated Systems, which make up our Government Systems division. For a more detailed description of our segments, see "Business Segments" within Item 1. Effective January 1, 2014, we are realigning our business operations which is resulting in the elimination of our division structure and formation of six operating segments. This Management's Discussion and Analysis of Financial Condition and Results of Operations is prepared and reported based on our reporting structure as of December 31, 2013.
International revenue accounted for approximately 50 percent, 49 percent and 48 percent of our revenue in 2013, 2012 and 2011, respectively. We anticipate that international sales will continue to account for a significant percentage of revenue in the future. We have exposure to foreign exchange fluctuations and changing dynamics of foreign competitiveness based on variations in the value of the United States dollar relative to other currencies. Factors contributing to this variability include significant manufacturing activity in Europe, significant sales denominated in currencies other than the United States dollar, and cross currency fluctuations between such currencies as the United States dollar, euro, Swedish kronor and British pound sterling. The impact of those fluctuations is reflected throughout our consolidated financial statements, but in the aggregate, did not have a material impact on our results of operations. We experience fluctuations in orders and sales due to seasonal variations and customer sales cycles, such as the seasonal pattern of contracting by the United States and certain foreign governments, the desire of customers to take delivery of equipment prior to fiscal year ends due to funding considerations, and the tendency of commercial enterprises to fully utilize annual capital budgets prior to expiration. Such events have resulted and could continue to result in fluctuations in quarterly results in the future. As a result of such quarterly fluctuations in operating results, we believe that quarter-to-quarter comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indicators of future performance. We expect that certain exogenous macroeconomic factors, including reduced spending by United States government agencies and economic weaknesses in certain geographic markets, present challenges for us and render predictions regarding future performance difficult to make.
Critical Accounting Policies and Estimates This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates, including those related to revenue recognition, bad debts, inventories, goodwill, warranty obligations, contingencies and income taxes on an on-going basis. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors. We believe the following critical accounting policies and the related judgments and estimates affect the preparation of our consolidated financial statements.


Revenue recognition. The majority of our revenue is recognized upon shipment of the product to the customer at a fixed or determinable price and with a reasonable assurance of collection, passage of title to the customer as indicated by the shipping terms and fulfillment of all significant obligations. We design, market and sell our products primarily as commercial, off-the-shelf products. Certain customers request different system configurations, generally based on standard options or accessories that we offer. In general, our revenue arrangements do not involve acceptance provisions based upon customer specified acceptance criteria. In those circumstances when customer specified acceptance criteria exist, revenue is deferred until customer acceptance if we cannot demonstrate that the system meets those specifications prior to shipment. For any contracts with multiple elements (i.e., training, installation, additional parts, etc.) we allocate revenue among the deliverables primarily based upon objective and reliable evidence of fair value of each element in the arrangement. If objective and reliable evidence of fair value of any element is not available, we use an estimated selling price for purposes of allocating the total arrangement consideration among the elements. In addition, judgments are required in evaluating the credit worthiness of our customers. Credit is not extended to customers and revenue is not recognized until we have determined that collectability is reasonably assured.
Allowance for doubtful accounts. Our policy is to maintain allowances for estimated losses resulting from the inability of our customers to make required payments. Credit limits are established through a process of reviewing the financial history and stability of each customer. Where appropriate, we obtain credit rating reports and financial statements of the customer when determining or modifying their credit limits. We regularly evaluate the collectability of our trade receivable balances based on a combination of factors. When a customer's account balance becomes past due, we initiate dialogue with the customer to determine the cause. If it is determined that the customer will be unable to meet its financial obligation to us, such as in the case of a bankruptcy filing, deterioration in the customer's operating results or financial position or other material events impacting their business, we record a specific allowance to reduce the related receivable to the amount we expect to recover given all information presently available. Actual write-offs during the past three years have not been material to our results of operations. We also record an allowance for all other customers based on certain other factors including the length of time the receivables are past due and historical collection experience with individual customers. As of December 31, 2013, our accounts receivable balance of $286.6 million is reported net of allowances for doubtful accounts of $7.7 million. We believe our reported allowances at December 31, 2013, are adequate. If the financial conditions of those customers were to deteriorate, however, resulting in their inability to make payments, we may need to record additional allowances that would result in additional selling, general and administrative expenses being recorded for the period in which such determination is made.
Inventory. Our policy is to record inventory write-downs when conditions exist that indicate that our inventories are likely to be in excess of anticipated demand or are obsolete based upon our assumptions about future demand for our products and market conditions. We regularly evaluate the ability to realize the value of our inventories based on a combination of factors including the following: historical usage rates, forecasted sales or usage, product end of life dates, estimated current and future market values and new product introductions. Purchasing requirements and alternative usages are evaluated within these processes to mitigate inventory exposure. When recorded, our write-downs are intended to reduce the carrying value of our inventories to their net realizable value and establish a new cost basis. As of December 31, 2013, our inventories of $344.7 million are stated net of inventory write-downs. If actual demand for our products deteriorates or market conditions are less favorable than those that we project, additional inventory write-downs may be required in the future.
Goodwill. We have recorded goodwill in connection with our business acquisitions. We review goodwill during the third quarter of each year, or on an interim basis if warranted, for impairment to determine if events or changes in business conditions indicate that the carrying value of the goodwill may not be recoverable. Such reviews assess the fair value of the assets based upon our estimates of the future cash flows we expect the assets to generate within the boundaries of the applicable reporting units of the Company. Our review in the current year indicated that no adjustments were necessary for the goodwill assets, which have a carrying value of $575.7 million as of December 31, 2013. Product warranties. Our products are sold with warranty provisions that require us to remedy deficiencies in quality or performance of our products over a specified period of time, generally twelve to twenty-four months, at no cost to our customers. Our policy is to record warranty liabilities at levels that represent our estimate of the costs that will be incurred to fulfill those warranty requirements at the time that revenue is recognized. We believe that our recorded liability of $17.7 million at December 31, 2013 is adequate to cover our future cost of materials, labor and overhead for the servicing of our products sold through that date. If actual product failures or material or service delivery costs differ from our estimates, our warranty liability would need to be revised accordingly.


Contingencies. We are subject to the possibility of loss contingencies arising in the normal course of business. We consider the likelihood of loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss in determining loss contingencies. An estimated loss is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted.
Income taxes. We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of the assets and liabilities measured using the enacted tax rates in effect in the years in which the differences are expected to reverse. Valuation allowances against deferred tax assets are recorded when a determination is made that the deferred tax assets are not more likely than not to be realized in the future. In making that determination, on a jurisdiction by jurisdiction basis, we estimate our future taxable income based upon historical operating results and external market data. Future levels of taxable income are dependent upon, but not limited to, general economic conditions, competitive pressures and other factors beyond our control. As of December 31, 2013, we have determined that a valuation allowance against our net deferred tax assets of $13.5 million is required. If we should determine that we may be unable to realize our deferred tax assets to the extent reported, an adjustment to the deferred tax assets would be recorded in the period such determination is made. Consolidated Operating Results
The following table sets forth for the indicated periods certain items as a percentage of revenue:

                                                                      Year Ended December 31,(1)
                                                                              2012                 2011
                                                           2013         (as adjusted)(2)     (as adjusted)(2)
Revenue                                                   100.0  %            100.0  %             100.0  %
Cost of goods sold                                         50.7                47.7                 46.3
Gross profit                                               49.3                52.3                 53.7
Operating expenses:
Research and development                                    9.9                 9.8                  9.5
Selling, general and administrative                        21.6                20.8                 23.9
Restructuring expenses                                      1.7                 0.1                    -
Total operating expenses                                   33.2                30.7                 33.4
Earnings from operations                                   16.1                21.6                 20.3
Interest expense                                            0.9                 0.8                  0.4
Interest income                                            (0.1 )              (0.1 )               (0.1 )
Other (income) expense, net                                (0.1 )               0.1                 (0.1 )
Earnings from continuing operations before income taxes    15.3                20.8                 20.1
Income tax provision                                        3.5                 4.7                  5.7
Earnings from continuing operations                        11.8                16.0                 14.4
Loss from discontinued operations, net of tax                 -                (0.2 )               (0.1 )
Net earnings                                               11.8  %             15.8  %              14.3  %


_______________
(1) Totals may not recompute due to rounding.

(2) Certain expenses have been reclassified to conform to the presentation for the year ended December 31, 2013. See Note 1 to the Consolidated Financial Statements in Item 8 for additional information.

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 for 2013, 2012 and 2011. 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.
The operating results for 2012 do not include any amounts from either operations of Lorex Technology, Inc. ("Lorex) or Traficon International NV ("Traficon") which were each acquired in December 2012, as any such amounts were not significant.


Revenue. Revenue for 2013 totaled $1,496.4 million, an increase of 6.5 percent from 2012 revenue of $1,405.4 million. The increase was primarily due to increased revenue from our Thermal Vision and Measurement, Raymarine and Integrated Systems segments. Thermal Vision and Measurement's 2013 revenue included revenue from our acquisitions of Lorex and Traficon. Continued reductions in demand for certain products from United States government agencies resulted in decreased revenues in our Surveillance and Detection segments. Revenue from United States government customers declined by $18.6 million from 2012 to 2013.
Revenue for 2012 totaled $1,405.4 million, a decrease of 9.0 percent over 2011 revenue of $1,544.1 million. Each of our operating segments, except Integrated Systems, reported decreases in year over year revenues due to reduced demand for our products from United States government and Middle East government agencies and weaker world-wide economic conditions resulting in lower demand for many of our commercial product lines. The decline of $138.7 million in year over year revenue included a decline of $71.3 million from United States government customers.
International revenue in 2013 totaled $740.7 million, representing 49.5 percent of revenue. This compares with international revenue in 2012 which totaled $687.5 million, representing 48.9 percent of revenue, and $740.6 million in 2011, representing 48.0 percent of revenue. While the sales mix between United States and international sales may fluctuate from year to year, we expect revenue from customers outside the United States to continue to comprise a significant portion of our total revenue on a long-term basis.
Cost of goods sold. Cost of goods sold for the year ended December 31, 2013 and 2012 was $759.4 million and $670.2 million, respectively. The increase is primarily due to the increase in revenues year over year as discussed above and changes in product mix. In addition, for the year ended December 31, 2013, cost of goods sold included $1.7 million of inventory write downs related to our restructuring activities.
Cost of goods sold in 2012 was $670.2 million, compared to cost of goods sold of $714.7 million in 2011. The year over year decrease in cost of goods sold primarily relates to the lower year over year revenues and changes in product
mix. For the year ended December 31, 2011, costs of goods sold included charges of $7.3 million for the amortization of fair value adjustments on inventory acquired through the acquisition of ICx in 2010. Cost of goods sold includes materials, labor and overhead costs incurred in the manufacturing of products and services sold in the period as well as warranty costs. Material costs include raw materials, purchased components and sub-assemblies, outside processing and inbound freight costs. Labor and overhead costs consist of direct and indirect manufacturing costs, including wages and fringe benefits, operating supplies, depreciation and amortization, occupancy costs, and purchasing, receiving and inspection costs. Gross profit. Gross profit for the year ended December 31, 2013 was $737.0 million compared to $735.2 million in 2012. Gross margin, defined as gross profit divided by revenue, decreased from 52.3 percent in 2012 to 49.3 percent in 2013. The decrease in gross margin in 2013 was primarily due to unfavorable product mix in our Surveillance and Thermal Vision and Measurement segments, and the inclusion of lower gross margin revenues from our acquisition of Lorex, a portion of our Thermal Vision and Measurement segment. Gross profit for the year ended December 31, 2012 was $735.2 million compared to $829.3 million in 2011. Gross margin decreased from 53.7 percent in 2011 to 52.3 percent in 2012. The decrease in gross profit in 2012 was primarily due to the lower revenue year over year and a lower consolidated gross margin. Gross margin decreased in 2012 from 2011 primarily due to a shift in product mix in both our Thermal Vision and Measurement and Surveillance segments and reduced absorption of fixed costs due to lower revenues, partially offset by the elimination of 2011 amortization expenses related to fair value adjustments on inventory of ICx. Research and development. Research and development expenses were $147.7 million, or 9.9 percent of revenue, in 2013, compared to $137.4 million, or 9.8 percent of revenue, in 2012, and $147.2 million, or 9.5 percent of revenue, in 2011. The increase in research and development expenses in 2013 was partially due to the costs associated with the development of several new products primarily in our Thermal Vision and Measurement segment and the operations of Lorex and Traficon. The decrease in research and development expenses in 2012 from 2011 was primarily due to cost containment efforts in light of the decrease in revenue. We believe that spending levels are sufficient to support the development of new products and the continued growth of the business. We expect research and development expenses to be approximately 8 to 10 percent of revenue on a long-term basis.


Selling, general and administrative expenses. Selling, general and administrative expenses were $322.7 million, or 21.6 percent of revenue, in 2013 compared to $292.5 million, or 20.8 percent of revenue, in 2012 and $368.9 million, or 23.9 percent of revenue, in 2011. The increase in selling, general and administrative expenses in 2013 was primarily due to higher compensation expense and the inclusion of expenses of Lorex and Traficon. The decrease in selling, general and administrative expenses from 2011 to 2012 was primarily due to the payment of a $39.0 million litigation settlement in 2011, cost control efforts taken in 2012 in light of the revenue decline and lower annual incentive expenses. While selling, general and administrative expenses may be affected in the future by acquisitions with different cost structures, we anticipate selling, general and administrative expenses to increase at a slower rate than revenue in our existing businesses.
Restructuring expenses. During the years ended December 31, 2013 and 2012, we recorded net pre-tax restructuring expenses totaling $27.5 million and $2.0 million, respectively. Of the restructuring expenses recorded in 2013, $25.8 million is recorded in operating expenses and $1.7 million is included in costs of goods sold. In the fourth quarter of 2013, we initiated a realignment plan that includes closing six not-to-scale sites in the United States and Europe and a transfer of those operations to larger facilities. We are also consolidating our optics and laser manufacturing businesses to better realize the benefits of vertical integration in these areas. The total costs expected to be incurred related to the realignment plan is approximately $38 million and we expect to complete the majority of the actions and recognize the remaining expenses of approximately $11 million during the year ending December 31, 2014. No specific plans for significant additional actions have been finalized at this time. In 2012, we recorded restructuring expenses associated with the relocation of one of our manufacturing facilities in Europe to an existing facility in the United States.
Interest expense. Interest expense totaled $14.1 million, $11.7 million and $5.5 million for the years ended December 31, 2013, 2012 and 2011, respectively. Interest expense is primarily attributable to the $250 million aggregate principal amount of 3.75 percent senior unsecured notes due September 1, 2016 that were issued in August 2011 and the amortization of the costs related to the issuance of the notes and the $150 million term loan that was drawn on April 5, 2013.
Income taxes. Our income tax provision was $52.0 million, $66.6 million and $88.4 million in 2013, 2012 and 2011, respectively. The effective tax rates for 2013, 2012 and 2011 were 22.7 percent, 22.8 percent and 28.4 percent, respectively. The mix in taxable income between our United States and international operations has a significant impact on our annual income tax provision and effective tax rates. Our effective tax rate is lower than the United States federal tax rate of 35 percent because of lower foreign tax rates, the effect of foreign, federal and state tax credits and other discrete items such as amended tax filings and business dispositions. The full year impact of a multi-year agreement, effective August 1, 2012, with a European jurisdiction was the primary reason for the effective tax rate in 2013 being comparable to that in 2012. The effective tax rate decrease from 2011 to 2012 was primarily due to the partial year impact of the multi-year agreement, the effect of amended state tax filings, and the impact of revaluations of deferred tax assets and liabilities due to changes in certain foreign statutory tax rates. We expect the effective tax rate for 2014 to be approximately 23 to 25 percent excluding discrete items.
At December 31, 2013, we had United States tax net operating loss carry-forwards totaling approximately $39.8 million which expire between 2018 and 2031. In addition, we have various state net operating loss carry-forwards totaling approximately $75.1 million which expire between 2018 and 2033. The federal and state net operating losses were primarily generated by ICx Technologies, Inc. prior to being acquired by us in 2010. Finally, we have various foreign net operating loss carry-forwards totaling approximately $101.5 million which expire between 2018 and 2033.
Tax benefits as described above are recorded as assets when the benefits are more likely than not to be recognized. To the extent that we assess the realization of such assets to not be more likely than not, a valuation allowance is required to be recorded. We believe that the net deferred tax assets of $44.0 million reflected on the December 31, 2013 Consolidated Balance Sheet are materially realizable based on future forecasts of taxable income over a relatively short time horizon, but we have determined that a valuation allowance against our net deferred tax assets of $13.5 million is required, primarily related to certain acquired net operating losses. A valuation allowance is required when it is more-likely-than-not that all or a portion of deferred tax assets may not be realized. A review of all available positive and negative evidence is considered, including past and future performance, the market environment in which we operate, utilization of tax attributes in the past, length of carryback and carryforward periods, and evaluation of potential tax planning strategies when evaluating whether the deferred tax assets will be realized.
Discontinued operations. In 2010, in connection with the acquisition of ICx, we began to pursue the sale of certain business units of ICx and the results of operations for such business units were reported as discontinued operations until their respective dispositions. During the second quarter of 2012, we sold the remaining two business units reported as discontinued operations. The operating losses of those operations, including insignificant associated losses recognized subsequent to their disposal, and the net losses on the sales of the . . .

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