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Edited Transcript of FLIR earnings conference call or presentation 6-May-20 1:00pm GMT

Q1 2020 FLIR Systems Inc Earnings Call

WILSONVILLE Jun 13, 2020 (Thomson StreetEvents) -- Edited Transcript of FLIR Systems Inc (Pre-Reincorporation) earnings conference call or presentation Wednesday, May 6, 2020 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Carol P. Lowe

FLIR Systems, Inc. - CFO & Executive VP

* James J. Cannon

FLIR Systems, Inc. - President, CEO & Director

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Conference Call Participants

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* Andrew Edouard Buscaglia

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* James Andrew Ricchiuti

Needham & Company, LLC, Research Division - Senior Analyst

* Louie DiPalma

William Blair & Company L.L.C., Research Division - Analyst

* Michael Frank Ciarmoli

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* Peter J. Arment

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Peter John Skibitski

Alembic Global Advisors - Research Analyst

* Lasse Glassen

ADDO Investor Relations - MD

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Presentation

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Operator [1]

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Greetings, and welcome to the FLIR Systems, Inc. First Quarter 2020 Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Lasse Glassen, Managing Director, Investor Relations. Thank you. You may begin.

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Lasse Glassen, ADDO Investor Relations - MD [2]

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Thank you. Good morning, everyone, and thank you for joining the call. Please note that our earnings press release and presentation slides referred to on this call are available in the Events & Presentations section of FLIR's Investor Relations website at www.flir.com/investor.

Before we begin, I'd like to remind you that statements made on this call, other than historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are based on current expectations. Words such as anticipates, estimates, expects, intends, believes and similar words and expressions are intended to identify forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations. Please refer to the earnings press release we issued earlier today as well as FLIR's SEC filings for a description of factors that could cause actual results to differ materially from these statements, including, among others, risks related to COVID-19. All information discussed on this call is as of today, and FLIR does not intend and undertakes no duty to update for future events or circumstances. During the call, we will discuss GAAP and non-GAAP financial measures. A full reconciliation from GAAP to non-GAAP measures is available in this morning's earnings press release.

With that, it's now my pleasure to turn the call over to Jim Cannon, President and CEO of FLIR Systems. Jim?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [3]

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Thank you, Lasse. Good morning, everyone, and thank you for joining FLIR's First Quarter 2020 Earnings Conference Call. Speaking with me on the call today is Carol Lowe, our Chief Financial Officer.

Before I begin, I would like to quickly note, as part of our previously announced restructuring activities through Project Be Ready, we've consolidated our businesses into 2 segments: Industrial Technologies and Defense Technologies beginning in the first quarter. All commentary regarding the performance of our business segments will be referenced as such.

Today, I will provide commentary on our Q1 financial and operating performance and our response to the COVID-19 pandemic. It goes without saying that COVID-19 represents an unprecedented challenge to our global society. I would like to sincerely thank all of the health care workers and first responders for their courageous efforts to help those in need.

We are extremely proud that FLIR products and technology are playing a critical role in helping people combat the spread of this virus. We continue to experience increased demand for our thermal cameras for use in elevated skin temperature or EST screening. Although these thermal cameras cannot detect or diagnose COVID-19, the cameras do serve as an effective tool to measure the skin surface temperature of people entering public areas, such as hospitals, airports, train terminals, businesses and factories. In fact, we've been using our own technology to screen employees for EST when they enter our facilities. FLIR cameras have a history dating back to the SARS virus in 2003 and then H1N1 in 2009 of detecting elevated skin temperatures through screening.

I'd like to extend my gratitude to our employees for their commitment as we work to ensure that governments, first responders and businesses across the globe have all appropriate EST resources during this challenging time.

I would first like to discuss how we expect COVID-19 to impact our business. Both the headwinds and the tailwinds and the actions FLIR is taking to address this extraordinary situation.

Please turn to Slide 3. As we work to fulfill our mission to save lives and livelihood, FLIR has been deemed an essential business, and all of our manufacturing facilities remain open and operational. In this environment, the health and safety of our employees is our top priority. Given the various safer at-home restrictions, we swiftly transitioned approximately 2/3 of our workforce to working remotely. For our FLIR employees on the front line, directly involved in manufacturing or distribution, we're taking all the precautionary measures and have enacted stringent protocols to ensure their safety.

In light of COVID-19, we are experiencing a dramatic and rapid increase in demand for thermal EST camera applications, which we expect will continue for the remainder of the year. However, the demand has put stress on our supply chain and manufacturing capacity. To address this, we're reallocating internal resources, leveraging the strength of our relationships with our world-class suppliers and optimizing manufacturing capacity through investments of relatively small amounts of capital that allow us to exponentially scale EST camera production to meet growing customer demand. We will continue to do everything we can to deliver this technology to all of those on the front line to help mitigate the spread of COVID-19 around the world. The tailwind provided by the strong demand for our EST products has helped to offset some of the headwinds to our businesses that we have experienced as a result of COVID-19.

Within the Industrial Technology segment, we're seeing continued softness in demand for our more commercially centric businesses, such as Maritime and Security products. We continue to see demand in our Defense Technology segment, particularly in our unmanned business. However, we have experienced operational challenges due to COVID 19. Of note, we face some administrative-related process delays in securing customer sign-offs and procuring the licensing for foreign sales as government agencies and overseas customers transitioned to remote work policies. Again, at this time, these delays have essentially resulted in shifting the timing of revenues and bookings from Q1 to Q2 or later in 2020.

While we are experiencing unprecedented demand for our EST solutions, we've grown opportunities within many of our core markets, most notably Defense. COVID-19 has brought ongoing macroeconomic uncertainty, an overall lack of visibility into future demand trends and elevated level of risk in our supply chain. As a result of this uncertainty and supply chain risk, we are withdrawing our previously issued outlook for the full year 2020. While we are not providing specific guidance in the current environment, Carol will provide some color on our expectations for the second quarter.

Despite the near-term challenges we face from the COVID-19 pandemic, we remain very confident in our long-term strategy. Our strategic priorities outlined on Slide 4 of the presentation continue to emphasize professional end market customers with a focus on: Leadership in sensor solutions; unmanned and autonomous solutions; airborne ISR and decision support. While we continue to make tangible progress toward advancing these priorities, it goes without saying that responding to and fulfilling the increased demand for our elevated skin temperature products has become an extraordinary priority in this time of crisis.

Now let's move to an overview of our first quarter performance. Please turn to Slide 5. As announced earlier this morning, we reported first quarter revenue of $451 million, reflecting gross of 1.4% compared to the prior year quarter.

Total bookings of $502 million were driven by strong demand for products in our Industrial Technology segment, in particular, applications related to EST screening.

Our Defense Technology segment also experienced notable orders related to our unmanned systems and solutions. Total bookings in the first quarter were down 6% as the prior year quarter included 2 large unmanned franchise program awards. However, at quarter end, our total backlog was a record $859 million, reflecting an increase of 3% compared to the balance at the end of the first quarter 2019.

Adjusted gross profit decreased 3% compared to the prior year quarter, primarily due to softness in our adjusted gross margin from a shift in product mix favoring lower margin unmanned programs.

Adjusted operating income declined 23%, and adjusted operating margin was down 516 basis points year-over-year. Carol will discuss in more detail.

As noted on Slide 6, our Industrial Technology segment continued to generate momentum with significant new program wins. As I mentioned earlier, various FLIR product lines used for EST applications related to the COVID-19 pandemic have seen a surge in demand. FLIR has long been recognized as a global leader in thermal cameras for EST-related applications, with unique functionality, including advanced measurement tools, and alarms to enable faster critical decisions. Of note, several FLIR models offer a screening mode, a built-in feature that detects people with an elevated skin temperature compared against the sample of average temperature value. Screening mode is designed to rapidly increase accuracy, ease of use and speed of existing screening procedures.

Late in the first quarter, we announced our latest offering the FLIR A400/A700, which were planned for introduction prior to the COVID-19 crisis. And aggregate EST-related bookings totaled approximately $100 million in the first quarter. The vast majority of these orders are expected to be shipped and booked as revenues within the next few quarters. Demand has come from a wide variety of customers and numerous industries, including hospitality, transportation, manufacturing and others. In addition, many companies are looking to install this technology in their facilities in anticipation of lifting the shelter-in-place orders and as the global economy shifts to plans for reopening business. While it remains unclear what the longer-term marketplace demands for EST screening technology will ultimately become, we are working aggressively to fulfill customer demand in the near-term and to do our part to help prevent the spread of this virus.

Please turn to Slide 7. The Industrial Technology segment also continues to make progress with opportunities in the rapidly developing Advanced Driver Assistance Systems or ADAS vertical. Along with the award we announced on the fourth quarter call to provide thermal cameras to a leading robo taxi disruptor, during the first quarter, we signed a similar agreement with another leading self-driving technology company. In addition, during the first quarter, we established a strategic partnership with Foresight, a technology company engaged in the design, development and commercialization of sensor systems for the auto industry.

Let's turn to Slide 8. In the first quarter, our Defense Technology segment was awarded a $23 million multiyear production contract by the U.S. Air Force for more than 180 of the company's Centaur unmanned ground vehicles or UGV. Centaur is a remotely operated, medium-sized UGV system that provides a standoff capability to detect, confirm, identify and dispose of hazards. Following this award from the U.S. Air Force, we also received a separate $18.6 million award from the U.S. Marine Corps for more than 140 FLIR Centaurs plus spares. Finally, just this week, we received a separate $9.2 million order from the U.S. Navy for more than 70 FLIR Centaurs. As you may recall, Centaur was originally chosen by the U.S. Army for its Man Transportable Robotic System Increment II or MTRS II. We are honored that the FLIR Centaur has become the platform of choice for 4 branches of the military and that the MTRS II program can serve as a procurement channel.

In addition, subsequent to the end of the first quarter, the Defense Technology segment was awarded an additional $21 million contract from the U.S. Army to deliver its FLIR Black Hornet 3 Personal Reconnaissance System or PRS. The advanced nano-unmanned aerial vehicles will support platoon and small unit level surveillance and reconnaissance capabilities as a part of the Army's Soldier Borne Sensor program. Back in January 2019, the U.S. Army awarded FLIR the initial $40 million contract for Black Hornet 3s to support the SBS program, which we are currently delivering. In total, FLIR has delivered more than 12,000 Black Hornet nano-UAVs to defense and security forces worldwide.

In the near term, we continue to release new products to feed and support the growth of our strategic priorities while simultaneously improving safety and efficiency for professionals. A few of our recent product releases are outlined on Slide 9. Overall, I'm very pleased with the momentum we are driving as evidenced by new franchise awards and innovative products we're bringing to the marketplace.

To ensure our readiness to capitalize on the growth opportunities in front of us, late last year, we launched Project Be Ready, highlighted on Slide 10, which positions FLIR to compete, win, execute and deliver in the quarters and years ahead. Project Be Ready aims to reduce the complexity of our business to help it scale over the longer term, while removing cost in the near term. Through Project Be Ready, we will be a leaner, more nimble organization and be better positioned to respond to a prolonged downturn or sudden disruption in the marketplace. We remain committed to better aligning our expense base with our revenue profile, and continue to expect to reduce our operating expenses in 2020 through the ongoing execution of Project Be Ready.

As previously communicated, we expect to achieve an annual run rate cost savings of approximately $30 million to $45 million. A significant portion of which will be reinvested to enable and drive long-term growth. To date, the majority of the annual run rate savings have been identified. We look forward to sharing our progress on future calls.

As a part of our transformation, we are further streamlining our management structure by eliminating the Business Unit President leadership roles previously held by David Ray and Frank Pennisi. This action will result in cost savings, provide a more direct line of communication and accountability with our lines of business general managers and increase the level of interaction that I have with our customers. As shared on our fourth quarter earnings call, we have eliminated the Commercial Business Unit. And as a result, Travis Merrill is also leaving FLIR. David, Frank and Travis' leadership and contributions to FLIR have been meaningful. On behalf of the Board and the senior leadership at FLIR, I would like to thank them and wish them all the best.

These structural changes to our organization do not alter the way FLIR goes to market or the way we are organized to engage with our customers. As FLIR's transition progresses, we are streamlining our organization in a manner that best positions the company for success as we move forward during a period of uncertainty.

In addition to these structural changes, we are also working to simplify FLIR's product portfolio and better align our businesses with our 4 key strategic priorities. As part of this process, we discontinued several noncore consumer-centric product lines within the Outdoor and Tactical Systems, or OTS business. However, given marketplace dislocation resulting from the COVID-19 crisis, we have decided to suspend efforts to sell our Raymarine's nonthermal maritime electronics business. We continue to believe our Maritime business is best-in-class in its industry with compelling and innovative products that make it an extremely attractive asset. We have clear expectations relative to the valuation of the Raymarine assets and in light of the challenging macroeconomic conditions have made a decision to maintain the maritime electronics business for the foreseeable future.

Finally, I want to recognize the important role our Board is playing during the COVID-19 crisis, participating in more frequent updates on the impact to our business and providing perspectives to our management team. In particular, we benefited from the advice and guidance of our Chairman, Earl Lewis, who has shared his decades of experience, including over a decade of leading FLIR. As we navigate through this time of transition and uncertainty, we have requested Earl to provide additional time and efforts as a trusted adviser, as I continue to focus on important strategic initiatives and the operational performance of the business. I appreciate the time and dedication that Earl, along with the rest of the Board, will continue to invest in positioning FLIR for sustained growth in the long-term.

With that, I'll now turn the call over to Carol for additional details on the first quarter's financials. Carol?

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Carol P. Lowe, FLIR Systems, Inc. - CFO & Executive VP [4]

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Thank you, Jim. Looking at Slide 11. You'll find a summary of our first quarter financial results.

Please note with the exception of revenue, all of these financials are on a non-GAAP basis. As previously noted, beginning in the first quarter, we have simplified our non-GAAP financial measures to enhance the comparability of our core operating performance on a period-to-period basis. Reconciliation to GAAP data is included in the appendix.

We generated $451 million in revenue for the first quarter. Revenue was negatively impacted by foreign currency exchange rates, which reduced growth by approximately $6 million or 1%. First quarter bookings of $502 million declined 6% compared to the prior year, primarily due to the difficult comp in the year ago period, as noted by Jim. That said, our total backlog at the end of the quarter was a record $859 million, reflecting a 3% increase relative to the prior year quarter, driven by strong demand for our EST cameras.

Adjusted gross profit was $229 million, resulting in adjusted gross margin of 51%, reflecting a 252 basis point decline compared to the prior year quarter. Despite productivity gains achieved through the FLIR method, margin reflected a mix shift towards lower-margin products in both segments. The margin decline was anticipated as we are in the beginning stages of the transition from the completion of certain large, higher-margin contracts and the execution of our strategic priorities to generate a steady stream of long-term revenue through future franchise programs and awards.

Adjusted operating income was $76 million, resulting in adjusted operating income margin of 17%, down approximately 516 basis points compared to the prior year quarter. Adjusted operating margin was primarily impacted by the lower gross margin, higher R&D expenses to support future franchise programs and deferred compensation costs.

After adjusting for discrete items flowing through GAAP income tax expense, our adjusted effective tax rate for the first quarter was 19%, down from 20.5% compared to the first quarter of 2019. Adjusted diluted earnings per share was $0.42 in the first quarter.

In terms of the consent agreement, we are now halfway through our 4 year time line. Under the terms of the agreement, we agreed to pay a $30 million penalty, half of which is suspended, provided we use those funds to improve our compliance. During the first quarter, we completed the first required audit, which was a major milestone for our compliance efforts. Our global trade compliance ongoing operational costs outside of the consent agreement costs are at a current annual run rate of approximately $15 million.

Please turn to Slide 12. For the first quarter, cash provided by operations was $51 million. We used our cash flow from operations to fund our capital allocation priorities of investing in the growth of our business and returning value to our shareholders. We invested $13 million in capital expenditures and returned capital to shareholders through the repurchase of $150 million of common stock and the payment of $23 million in dividends. However, I'd like to note that we have not initiated share repurchases since the escalation of the COVID-19 pandemic.

At March 31, 2020, our cash balance was approximately $309 million, and we had approximately $260 million in borrowing capacity within our credit facility. We are comfortable with our current liquidity position. However, in light of uncertainties driven by COVID-19, our capital allocation priorities will place an emphasis on near-term cash preservation. Beyond the cost savings initiatives we are currently implementing as part of Project Be Ready, we will focus on working capital management and are postponing all nonessential capital expenditures.

That said, we remain committed to our investments supporting our 4 strategic priorities that will drive long-term revenue growth, and we expect to continue to provide returns to our stockholders in the form of quarterly dividends. However, in accordance with our efforts for prudent cash preservation, we do not plan to be active in regard to share repurchase activity for the foreseeable future.

While not a new matter and previously disclosed in our 10-K and 10-Q filings, I'd also like to note that at the end of March, one of our nonoperating subsidiaries in Sweden received an adverse tax judgment regarding the Swedish Tax Authorities, or STA, reassessment of tax for the year ended December 31, 2012. We do not agree with the court's judgment and intend to appeal. Additional details regarding this matter will be available in our Form 10-Q, which will be filed today.

Turning to Slide 13. I will highlight the performance from our key business segments. Beginning with Industrial Technologies, first quarter revenue was $276 million, up 2% year-over-year due to the increased demand for elevated skin temperature cameras as a result of COVID-19. Revenues were partially offset by lower volumes in our Maritime, OTS and Security businesses.

Segment operating income was $64 million, down 7% year-over-year, driven by a combination of unfavorable product mix and a noncash loss of disposal of equipment. As a result, operating margins declined 218 basis points year-over-year. In the first quarter, Industrial Technologies bookings were $336 million, reflecting a book-to-bill ratio of 1.21, and total backlog was $330 million at March 31, 2020.

Defense Technologies segment revenues were $175 million in the first quarter, an increase of 1% year-over-year, which includes contribution from the unmanned acquisition. Segment operating income for Defense Technologies declined $14 million year-over-year due to a shift in product mix to lower margin unmanned programs, which impacted gross margin, and higher research and development expenses to support our pipeline of large franchise programs, which are expected to be a source of growth in the future.

In the first quarter, Defense Technologies bookings were $166 million, reflecting a book-to-bill ratio of 0.95, and total backlog was $529 million at March 31, 2020.

Before I hand the call back to Jim, I would like to discuss our near-term outlook. As mentioned earlier, considering uncertainties resulting from COVID-19, we have withdrawn our previously provided outlook for fiscal year 2020. Thus far, in the second quarter, we are seeing many of the same trends experienced in the first quarter. The demand for EST and Defense Technologies remains strong, which is offsetting softness in other parts of our business, such as Maritime and Security products. Based on current expectations, we believe second quarter performance for both revenue and adjusted diluted earnings per share will be moderately favorable to our first quarter 2020 results. Thank you for your time and attention.

I will now pass the call back to Jim for closing remarks.

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [5]

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Thank you, Carol. As we navigate the evolving and uncertain environment, we remain focused on the task at hand. Supporting our employees, valued customers and partners, while ensuring business continuity and proactively managing operational challenges. We look forward to emerging from this crisis as a stronger enterprise that has stepped up in a time for need for the key stakeholders we serve.

With that, I'd now like to open up the call for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Peter Arment with Baird.

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Peter J. Arment, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [2]

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Jim, thanks for all the details on the EST bookings. Maybe just starting there, provide us, I guess, a little color what you're thinking about the, I guess, what this product category would have been maybe a single-digit revenue contributor in the past, and it's obviously going to become a lot more meaningful. How are you thinking about kind of handling all this capacity? And then I'll just have a follow-up related.

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [3]

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Yes, Peter, that is the #1 priority that we're focused upon in the company right now. If you reflect back to our last earnings call, a question came up about EST, and we didn't consider it a needle mover at that time. We have a lot of experience with this dating back almost 2 decades, really beginning with the SARS outbreak in 2003, N1H1 (sic) [H1N1], Ebola, et cetera. And we would see spikes in demand. We learned a lot about the technology and a lot of tradecraft about how it really works and its benefits and limitations in the field. But after the past earnings call, as the full weight of the pandemic began to get felt, much more awareness came around the world. Historically, our market has really been in APAC. And principally looking at applications at ports and at borders, and that's still, of course, a core customer.

But as the virus moved into Europe and ultimately, across North America, we've seen a whole host of what we would call nontraditional customers, factories, distribution applications, all sorts of areas that now want to return to work. And we've seen the demand come really in waves. First, with those traditional customers at ports and borders governments, beginning in APAC, but then with essential businesses that needed to operate through the height and continue to operate through the height of the pandemic to create a safe work environment. And now very different customers than we would talk to in the past, is a whole host of different industries return to work. If we look at the practical constraints that we have right now.

Again, we mentioned, we booked about $100 million of business in the first quarter. We've shipped about, let's say, $30 million to $50 million of that business. We expect the demand in the second quarter to maintain. And unlike past pandemics, SARS, N1H1, et cetera, we would see a spike in demand and then when it began to subside, that demand would quickly drop. There would be a small run rate of business for spares and replacements at airports in Korea and Japan, for example. This feels very different. We know we don't have a vaccine. We know this virus transmits unlike any other. We expect through the summer and into the fall and winter, we have to continue to take precautions. Again, never seen anything like it.

The biggest strain is on our supply chain. If we look at our capacity, and there are really 2 areas for EST for us. The largest is our complete solutions. Our A series cameras, T series, E series cameras, and those cameras, along with software, provide a turnkey solution to screen for elevated skin temperatures. But we also produce infrared camera cores that other people are purchasing from us to integrate into screening applications that they are building with their own software, et cetera. The split right now of that demand is probably 75% towards our complete solutions and about 25% on cores that others are using directly.

We've got a tremendous amount of capacity ourselves with some modest investments in CapEx. We invested a little under $3 million all told to expand our calibration equipment and some other test equipment. We're able to exponentially scale our output. But the real weak point has been on our vendors. We're very vertically integrated with the core technology, but there are a host of different components, commodities, circuit boards and such that we source. And through this past quarter, as some of those businesses weren't deemed necessary and had to shut down or they had limited work schedules or just frankly, the demand that we placed on them outstripped their ability to meet it, we've been working really hard to bolster those suppliers to find alternate forms of supply and also think out of the box. For example, we are now working with General Motors, as General Motors has a much more robust supply chain and a lot of leverage with existing vendors that we had to help us shore up supply.

So right now, day in, day out, that's really a key, the #1 priority, if you will, in the business to make sure we maximize upon this opportunity. Long-winded way to answer your question, Peter, but wanted to give you that context.

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Peter J. Arment, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [4]

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No, I appreciate all that color. And just so we have the -- it sounds like the pace has continued. So does this -- do you think this ultimately continues to offset the weakness that you're seeing in Maritime, OTS and sort of Security when you're thinking about kind of the balance of the year, just how that plays out?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [5]

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Yes. As we mentioned earlier in the prepared remarks, when we look at the full year, we've suspended that guidance because, again, there's just so much uncertainty. But when I think about what we see in front of us immediately, and as Carol mentioned, in the second quarter, we do expect the business to make moderate improvements. A couple of notes. One, we expected the first quarter to be a low point for us with regard to margin. That's why we gave guidance around the first quarter. It's why we launched Project Be Ready. Project Be Ready is now gaining full traction. And the products that are used for EST applications are historically in line with our margin rates. Where in our defense business, of course, the unmanned mix, mixes us down with margins until we scale that.

So in the near-term being the second quarter, yes, we do see this demand in EST offsetting headwinds we see in our more commercially centric businesses. How that demand continues to materialize and how we scale our supply chain? Again, right now, the governor on this is our supply chain. How we scale that supply chain into the second half will determine that second half performance. But there are still a lot of communications we're having with customers that are looking at very large-scale deployments that have yet to materialize as folks want to return to work and ensure that their workplace is a safe place to operate.

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Operator [6]

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Our next question comes from the line of Andrew Buscaglia with Berenberg.

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Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [7]

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Quick question on -- a follow-up on that EST demand. Are you seeing -- first off, can you give an indication if it is -- is this stuff higher-margin relative to other stuff you're selling in that other instrumentation devices you're selling? And then secondly, is FLIR -- a lot of other companies selling this stuff, so is FLIR differentiated in that? You have FDA approval. Is that a very important aspect of this? And are there other competitive advantages you can point out?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [8]

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Sure, Andrew, happy to. First, with regard to your question on margin, our A series, T Series and E series cameras as well as our camera cores from our components business that we provide to others for their solutions, those margins are in line or accretive to the overall company. As we mentioned earlier, and I noted with Peter, the rapid growth we continue to see in the unmanned business, of course, has a dilutive margin as it scales. But these products are in line with our historical margin rates or even accretive.

And with regard to the second part of your question. Again, we have 2 decades, almost 2 decades of experience, 17 years of experience doing this. And we've learned a lot of lessons over that period of time. A couple of points I want to emphasize. This technology is getting a lot of attention and not all of it is accurate. No one technology can combat this virus. We can very effectively screen for elevated skin temperatures, but that doesn't necessarily mean that you have the virus, and it can't diagnose someone who does. But used with secondary screening for 17 years, it has been extremely effective. But in the course of those 17 years, we've learned a lot.

For example, there are a lot of ambient conditions that can make one's skin temperature be elevated. There are different parts of the face or body where you can get a better reading than other parts of the face or body. You've got to constantly calibrate the technology, and we've revolutionized and pioneered applications looking at relative body temperatures as opposed to absolute. An example, if you're in a hot parking lot, entering a building, everyone who enters that building could have elevated skin temperature.

So if you don't really deeply understand the technology and have the experience that we have to look at that relative temperature in that one individual that stands out, you can get false readings. And that's so important now as we look at mass applications. It's one thing at a customs checkpoint for one person to present, get an image, study that image. It's a whole another when you have factories or other large workplaces with shifts trying to transition. And that's where it's hard to replace 17 years of experience in doing this. So I'm very confident in our capabilities and abilities to lead.

But we're also partnering with all sorts of other folks in the industry to make sure that as this technology is deployed, it's deployed with the proper application, in the proper environment and with the right training. We do have concerns that we see a lot of folks pop up in the marketplace making claims that, frankly, the science can't support. We rely deeply and consider ourselves thought leaders in that regard.

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Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [9]

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Yes. Okay. Okay. And then as it pertains to Raymarine, why the -- it sounds like there is a change of heart or something between now and last quarter. What were the conversations you've had that you're now deciding to keep it? Is it a matter of just a valuation? Or what's changed there?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [10]

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So we've always considered our Raymarine-branded marine electronics products best in industry. They're industry-leading products and capabilities, differentiated and a strong brand. But as we said on the earlier call, it does have commercial orientation, and we've pivoted more and more to professional users. As we look at COVID-19, that pivot to professional users was a very wise one because, by and large, our defense segment, our other industrial segments that are essential to work during this period, fortunately able to weather this storm more than that more commercial centric business exposure could have.

No one could have predicted the pandemic. We entered into a fulsome process. We got well down that process with several bidders. But with the pandemic, I mean, we see the M&A market, in general, seizing up. We're also very clear out about the value of that business. It's not a business that's on fire. It is a good business in the industry that operates in with a lot of differentiated technology, like DocSense, an assisted and autonomous docking solution that's not really yet gotten into market. So we thought it prudent to suspend that process to run the business for the foreseeable future. It certainly does have more headwinds than more of the defense or professional industrial exposure that we have. But we think with the actions that we're taking with Project Be Ready and otherwise, we understand and expect what those headwinds could be.

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Operator [11]

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Our next question comes from the line of Louie DiPalma with William Blair & Company.

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Louie DiPalma, William Blair & Company L.L.C., Research Division - Analyst [12]

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It seems as though elevated skin temperature momentum, which was already took on another life in April with the Amazon report. You said you achieved EST bookings of $100 million in the first quarter, if I get that right. Are you able to quantitatively or qualitatively provide color on how bookings and the pipeline tracked after the quarter ended just because it seems as though demand may have exploded after the quarter ended?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [13]

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Yes. So right now, again, realized about $100 million in bookings split, 75:25 between full solutions and those camera cores that other companies are deploying into their solutions. We expect in the second quarter that trend to continue. And we've yet to see some of the, let's say, wholesale implementations that would be associated with some of the return-to-work discussions that are having these industries open back up. So in the near term, being the second quarter, we certainly expect that demand curve to continue, and we have a lot of internal debate. Right now, we not only have an obligation to our shareholders to maximize this, but our society to maximize this. And we take that obligation very seriously.

In February, as I mentioned, as we look at past pandemics, we did not expect this level of demand. So whether it's capital that we're deploying, whether it's what we're doing to bolster our supply chain, we are preparing internally for exponential demand. Now whether or not that realizes as we go through the second quarter or second half of the year, it's impossible for me to say. But we're bracing for that, so that we can help, in our small way, combat the spread of this virus.

So you're right, this has certainly become front and center, as I mentioned in the prepared remarks. We remain committed to our 4 strategic pillars that I've mentioned, airborne ISR, unmanned, decision Support, et cetera. But this right now is our #1 priority as a company to make sure we do all we can.

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Louie DiPalma, William Blair & Company L.L.C., Research Division - Analyst [14]

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And can you also discuss the impact of the pandemic on non-programmatic DoD spend that you're involved with. I know that your drone programs receive a lot of the limelight. But as a percentage of revenue, I think your non-programmatic products are more impactful. Can you just talk about how those are faring and what the trajectory should be?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [15]

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Sure. Absolutely. If we look at first quarter book-to-bill for our Defense Technology business, it was just below 1. Since then, we've received the Soldier Borne Sensor Tranche 2 award, which we did expect to get in the first quarter, delayed a little bit. That got us above that book-to-bill of 1.0, if you will. I have to say, the Department of Defense has been working very hard to make sure that the industrial base stays intact, that the modernization priorities that they're undertaking press forward. We've seen just tremendous cooperation from the Department of Defense. But as they've transitioned to work remotely to be safe as other licensing agencies have done the same, we see a natural delay in some of the administrative processing, decision-making, et cetera. I also mentioned the MTRS Increment II with the Air Force, the Navy, the Marine Corp. on the ground robot side. So to your point, programs are moving forward, but we do expect there to be delays.

On the non-programmatic side, a lot of which is our international business, we see a similar dynamic. We see delays in decisions as again, folks are working remote. They're not perhaps prepared, or it's not necessary to take delivery right now. They can wait a month or a quarter, if you will. But we don't see the demand evaporating all together. So as I think about the Defense Technologies business, I think it's going to be relatively on track. However, I do think we're going to continue to see delays, if you will. But when we think about elevated skin temperature and you think about protecting forces, we see elevated skin temperature also as a force protection technology as the Armed Forces and Foreign Allied militaries need to protect their forces from the sickness as well.

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Operator [16]

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Our next question comes from the line of Jim Ricchiuti with Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [17]

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Just on -- I'll chime in with a few of my own EST questions. You mentioned force protection. Are you seeing business yet within your traditional defense customers for EST?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [18]

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Yes, we are. And I can't go into specifics of different areas where our orders we've seen. But yes, as you could imagine, maintaining a healthy and able fighting forces is very important. And so we very much look at this as a force protection effort. So yes, we are having those discussions.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [19]

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Are you reallocating R&D resources, Jim, to -- for future product development in this area? This gives us an idea how you view this business opportunity, maybe intermediate to longer term.

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [20]

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Oh, we absolutely are. As I mentioned, our 4 strategic pillars remain intact. But we have not only reallocated R&D effort. We've reallocated sales support. We've reallocated training. We've reallocated capital. We've reallocated manufacturing capacity. It -- no question, it's the most immediate and real demand that we see in the company right now. Again, how it sustains itself into the second half, no one could say. I certainly didn't predict this demand a couple of months ago. But we are literally all hands on deck. And as I mentioned, really working hard with our vendors and suppliers, and I can't thank them enough. Sometimes it's little things like an aluminum magnesium camera housing that we get from a particular vendor that we just outstripped their demand or they were deemed not essential to come to work. And the various authorities who've been very proactive in working with us to help make our supply chain essential as well so we can get this technology out there.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [21]

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Is the decision to pull the guidance for the year is that almost entirely due to the uncertainty in the commercial business? Or to what extent is the defense business delay contributing to that as well? Would you have pulled the guidance otherwise out of nothing?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [22]

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I would say, certainly, the commercial impact is dramatic, and we don't know where it's going to go. I mean, we look at Maritime, right now, folks aren't rushing out and buying new boats, and that's probably not going to change in the near term. Also, commercial security applications, data centers and others, while they're deemed essential upgrades and such, they can be delayed, if you will, postponed or foregone. We also look at our traditional instruments channels that would sell into industry, a lot of those industries closed. Those factories shut down. So that demand dropped as well, and we're not sure exactly where or when they'll reopen. Again, EST has been a bright spot to cover a lot of those headwinds, and we think it will build.

And then on the Defense side, we don't see a radical drop in demand, but we do expect continued delays. And how that impacts future quarters or how it falls inside a calendar year or the government fiscal year, it's just so uncertain. I couldn't really articulate it with real surety. So we thought it prudent to give some insight from what we see immediately, second quarter. We think it's going to improve to the first. We've got not just the demand we mentioned, but Project Be Ready. We've executed a significant effort to save costs to address the expected margin rates we had in the first quarter, $30 million to $45 million that we expect to capture. And while we didn't realize much of that in the first quarter because we're really doing the work to prep it, it will begin to impact the second quarter and going forward.

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Operator [23]

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Our next question comes from the line of Michael Ciarmoli with SunTrust Robinson Humphrey.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [24]

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Jim, maybe just on -- you've obviously got this big spike in demand here, but if we look at that $100 million in bookings, I guess I'm just trying to get a sense, the core backlog down pretty significantly. I mean, can you talk about what you're seeing? I mean, you kind of were just alluding to it with the instrument channel, the commercial, but any kind of expectations for the industrial automation, building inspection, petrochemicals, kind of, what you're seeing from an ordering environment from those commercial industrial customers and maybe what the expectation is going forward?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [25]

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Yes. That's a great question, and it's sort of -- not trying to dodge at all, but it's sort of all over the place and very erratic. So we look at Machine Vision, for example. We've seen a bounce back a bit in Machine Vision in APAC. As now in Japan, in Korea and China, some of those factories are getting back to work. How sustainable that is? Or is it just some pent-up demand that's sort of popping? Really don't know the answer to that. And then on the inverse, we've got a people counting camera business that's a part of that Machine Vision business that's in the components group. And that service is retail. And that literally dropped to 0 as retail operations have stopped. You mentioned petrochemical and such, our optical gas imaging cameras, cooled and uncooled, have been a driver of growth and strong margin in that space for the prior 4, 6 quarters, if you will. And we have seen a slowdown there. But the indications that we're getting is that it's not a fundamental change in demand, but folks are working to preserve cash. And sometimes those are purchased as a capital investment. And so they still want them, but they're delayed in making decisions as everyone's trying to figure out how this plays out.

So that's a very clumsy way to try to answer your question. I guess I'd say it differently in that, that as we look at these demand patterns, certainly, those industries that are deemed not essential, we've seen demand drop to near 0. How that comes back and manifest itself when and if folks return to work later in the second quarter, third quarter, fourth quarter, who knows, but we do expect there will be some pent-up demand. But those core industrial first responder, defense demand patterns are relatively intact, if delayed.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [26]

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Got it. And then just back on to the temperature scanners, the body temperature -- elevated skin temperature. Can you talk about what your ASPs are for both the cameras and the cores? And then hard to tell, I don't know if you have a market share that you guys think you have or any of your partners that have been out there. I think ICI was one that made headlines, potentially selling to Amazon. Do you sell cores to them? Because it looks like they have complete products, but then they also sell your cores. Can you just give us a little bit more color on sort of ASPs market share and maybe who you're competing or who your partners are with out there?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [27]

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Sure. Right now, our average selling prices range between $5,000 and $15,000. They can be much more expensive than that depending on what the customer wants for very sophisticated integrations, if you will. We are working also actively on much lower cost applications, but we're very cautious, and we really want to make sure everybody understands. You can't just take any thermal camera and point it at someone and get an effective screening tool for their surface temperature without tremendous amount of false alarming that really wouldn't affect what we want, and that is people to move freely back into the workspace and/or other applications, public areas and be safe. We are the market leader with this. We have been doing this for the better part of 17 years. And over that period of time, we've learned a lot of different ways, pitfalls, applications and tradecraft and how this is used.

As I mentioned earlier, we've created and led with some of the thought leadership about the way to do it. You can measure one's absolute surface temperature with the thermal camera. That doesn't necessarily mean that they have a fever and could be a risk. And you've got to constantly calibrate. We've designed technologies to self-calibrate and look at relative body temperatures, so 10, 20, 30 people coming in through a door as ambient conditions change from early morning to the heat of midday, identifying that one person or two or those that have a body temperature other than -- higher than others is so important. So we really caution people to look at and understand the real technology before they put just any thermal camera at the door and they think that they're safe because there is and are a lot of folks that have popped up overnight that we think are marketing solutions that don't do what they're intended to do.

But as I said, we do consider ourselves a market leader here. This has been something we've done for a long time. And some of these other solutions you see from really good and reputable companies that are out there working, I can't mention them by name without their permission, but they do utilize our thermal cores. Again, as I mentioned, of the $100 million of bookings we got in the first quarter, about 25% of that were cores that we're providing to other companies and are being sold under their brand.

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Operator [28]

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Our final question comes from the line of Pete Skibitski with Alembic Global Advisors.

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Peter John Skibitski, Alembic Global Advisors - Research Analyst [29]

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A couple of questions. Jim, on the management changes, they seem pretty meaningful. Is it basically you've eliminated the 3 former sector heads and now you have the product line, kind of, general managers reporting directly to you? Is that kind of what's happened? And should it make us nervous in terms of you've lost a lot of tenured people, right? And it sounds like maybe you kind of have more responsibility than you did maybe a year ago in terms of direct product line management. So can you walk us through that a little bit?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [30]

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Yes, Mike, I'm glad you brought that up. That was a tough decision. David Ray, Frank Pennisi, great leaders, contributed a lot. Frank had been with the business for over 4 years; David, almost 3. We announced in the first quarter with the combination of the Commercial Business Unit and the Industrial Business Unit, the Travis Merrill would be departing. Travis Merrill had been with the business for, I think, the better part of 7 years. They were trusted leaders. They contributed a lot. Each one of them, whether it be their technical competence, their leadership, et cetera, I can't say enough good things about them. That was a tough decision.

As we entered into this pandemic, and we looked at our performance in the first quarter, we expected it to be at a historical or at least a recent margin low. That's why we executed Project Be Ready to drive margins and rightsize the business. We looked at where the revenue was and the slow growth that we had seen, and we studied spans and layers of the organization. We're organized in 2 segments, each that have 2 lines of businesses. Those lines of businesses are led by very seasoned and tenured general managers. Rickard, for example, who leads our Solutions line of business, where the primary effort for EST is, he's been with the company over 17 years. He was with the company leading R&D during the SARS outbreak and N1H1 and Ebola. Paul Clayton, who leads the Components business, almost a decade's worth of experience.

So we were very fortunate that we have well-tenured, seasoned leaders at the LOB level that have a deep technical knowledge and that's how we interact with our customers. That's how we interact with our supply base. And we're not changing that. How we go to market, how we contact customers, how we interact with our vendor base, all unchanged. This essentially is eliminating a layer of leadership between me and those LOB leaders as given the uncertainty of the times that we're in, I felt I needed to move to be closer to the businesses. But it was a tough decision. And of course, we regret it because they're valued members of our team, and we wish them all the best going forward.

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Carol P. Lowe, FLIR Systems, Inc. - CFO & Executive VP [31]

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And Tim, I'll just note also you asked about Jim's level of direct reports and everything. He has the same number of direct reports, other organizational changes that we've made. So it doesn't create an extra burden for him and allows him to be closer to the businesses and to the customers. I think that is it.

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Operator [32]

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Go ahead, Mr. Cannon, do you have any closing remarks?

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James J. Cannon, FLIR Systems, Inc. - President, CEO & Director [33]

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Yes. I want to thank you all for joining our call today. I especially want to thank the FLIR team. If you would have told me 6 months ago that 2/3 of our workers would work remote and 1/3 come in and work every day in the midst of a pandemic like this and maintain the productivity and output, it would have amazed me. But the resilience of our team, I cannot be more proud of. And on behalf of the entire FLIR team, and the Board of Directors, I want to thank our first responders and our health care workers on the frontline. Thank you all.

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Operator [34]

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Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.