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FLIR Systems: Managing Through a Difficult Year

FLIR Systems (NASDAQ:FLIR) recorded third-quarter results for fiscal 2019 on Thursday.

It was a somewhat disappointing quarter, with revenues increasing 8% to $471 million on low single-digit organic growth (the remainder was attributable to recent acquisitions).

This reflects strength in the comp Government & Defense segment, with a 10% increase in organic revenues and contributions from Aeryon Labs and Endeavor Robotics leading to 24% revenue growth year over year. In addition, while the reported segment results show material degradation in operating margins, this reflects the headwinds associated with bringing on those recent acquisitions (organic segment profit margins improved by 160 basis points sequentially).


This was offset by a 5% revenue decline for the Commercial segment, which struggled in the quarter. As CEO Jim Cannon noted on the call, "several product lines... continue to face headwinds and some key end markets served [by Commercial] were negatively impacted by geopolitical and macroeconomic factors." The sales headwind led to a significant decline in profitability, with operating margins contracting 290 basis points to 9.3%. As management noted on the call, they expect "continued headwinds" in the segment in the fourth quarter.

While the pace of organic growth in the quarter - and through the first nine months of the year - has been below management's expectations, there are reasons to believe it will improve in the coming years. For example, bookings increased 13% in the quarter (and up 14% year to date), with the current and total backlog climbing mid-teens due to "important franchise program wins."

For the quarter, a low single-digit increase in operating income in the Industrial Business Unit and the Government and Defense Business Unit was offset by the weakness in the Commercial Unit. As a result, consolidated adjusted operating income declined 4% to $102 million, with margins falling 280 basis points to 21.6%. Adjusted earnings per share increased by 3% in the quarter, with the gains attributable to a lower share count and help from a lower tax rate.

Year to date, cash flow from operations was marginally higher to $277 million. Over the same period, the company has spent $125 million on repurchases (up 25% year over year), $69 million on dividends and $602 million on acquisitions (Aeryon Labs for $206 million, Endeavor Robotics for $386 million and New England Optical Systems for $22 million). There were 136 million diluted shares outstanding at quarter's end, a decline of roughly 3% over the past year (repurchased at an average price of $50 per share).

The balance sheet has weakened due to these outsized outflows. At the end of the third quarter, FLIR had $360 million in net debt compared to $90 million in net cash a year ago.

As a result of the weak year to date organic revenue growth and despite help from a lower than expected effective tax rate, management cut their guidance for 2019 adjusted earnings per share. At $53 per share, the stock trades at roughly 23 times forward earnings.

Conclusion

2019 has been a lackluster year for FLIR, particularly in the Commercial Business Unit. Organic revenues have only increased 2% year to date, with the remainder of growth (including revenue increase of 7% through the first nine months of the year) attributable to the previously mentioned acquisitions. In addition, adjusted operating margins have contracted 80 basis points (to 21.5%), resulting in low single-digit operating income growth through the first nine months of the year. Again, this reflects the dilutive impact of the recent acquisitions that FLIR has completed.

That said, I still think there's some reason to be optimistic about what lies ahead. As I noted back in April, I like the vision that CEO Jim Cannon has put forward for the company; in his words, "deploying sensors, and ultimately solutions, that help people make good decisions." I like that they have become more aggressive with the balance sheet, and I believe that the acquisitions they've completed in areas like unmanned applications could be material for the business over the long run. There is also the organic results they've delivered in areas like ADAS to consider, which Cannon has said "might be the largest single opportunity for FLIR over the next decade."

I've owned a stake in FLIR for more than five years, but it has never been a large position. I don't think it's cheap enough for me to get overly excited at the current valuation, but I would likely add more if the stock fell to the low-to-mid-$40s per share. For now, I'll wait and see what Mr. Market is willing to offer in the months ahead.

Disclosure: Long FLIR Systems.

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This article first appeared on GuruFocus.