FLIR Systems, Inc.
FLIR SYSTEMS INC (Form: 10-Q, Received: 11/08/2013 17:00:45)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________  
FORM 10-Q
______________________________________
(Mark one)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from             to             
Commission file number 0-21918
______________________________________  
FLIR Systems, Inc.
(Exact name of Registrant as specified in its charter)
______________________________________
Oregon
 
93-0708501
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
27700 SW Parkway Avenue,
Wilsonville, Oregon
 
97070
(Address of principal executive offices)
 
(Zip Code)
(503) 498-3547
(Registrant’s telephone number, including area code)
______________________________________  
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes   x     No   ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large accelerated filer
   x
 
Accelerated filer
   ¨
Non-accelerated filer
   ¨
 
Smaller reporting company
   ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x
At October 31, 2013 , there were 141,654,996 shares of the Registrant’s common stock, $0.01 par value, outstanding.






INDEX
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 




PART 1. FINANCIAL INFORMATION  
Item 1.
Financial Statements

FLIR SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Revenue
$
358,141

 
$
332,230

 
$
1,096,053

 
$
1,018,973

Cost of goods sold
185,251

 
158,877

 
549,134

 
492,865

Gross profit
172,890

 
173,353

 
546,919

 
526,108

Operating expenses:
 
 
 
 
 
 
 
Research and development
32,986

 
29,593

 
109,271

 
103,674

Selling, general and administrative
76,365

 
69,523

 
234,706

 
219,181

Total operating expenses
109,351

 
99,116

 
343,977

 
322,855

 
 
 
 
 
 
 
 
Earnings from operations
63,539

 
74,237

 
202,942

 
203,253

 
 
 
 
 
 
 
 
Interest expense
3,696

 
3,096

 
10,361

 
8,930

Interest income
(256
)
 
(268
)
 
(721
)
 
(1,073
)
Other expense (income), net
53

 
2,175

 
(536
)
 
1,190

Earnings from continuing operations before income taxes
60,046

 
69,234

 
193,838

 
194,206

Income tax provision
13,560

 
13,285

 
45,558

 
47,027

Earnings from continuing operations
46,486

 
55,949

 
148,280

 
147,179

Loss from discontinued operations, net of tax

 
(44
)
 

 
(2,042
)
Net earnings
$
46,486

 
$
55,905

 
$
148,280

 
$
145,137

 
 
 
 
 
 
 
 
Basic earnings per share:
 
 
 
 
 
 
 
Continuing operations
$
0.33

 
$
0.37

 
$
1.04

 
$
0.96

Discontinued operations

 
(0.00
)
 

 
(0.01
)
Basic earnings per share
$
0.33

 
$
0.37

 
$
1.04

 
$
0.95

 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
Continuing operations
$
0.32

 
$
0.37

 
$
1.02

 
$
0.95

Discontinued operations

 
(0.00
)
 

 
(0.01
)
Diluted earnings per share
$
0.32

 
$
0.37

 
$
1.02

 
$
0.94

 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
141,863

 
150,878

 
142,849

 
152,820

Diluted
144,231

 
152,327

 
144,831

 
154,758





The accompanying notes are an integral part of these consolidated financial statements.
1



FLIR SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
 
 
Net earnings
$
46,486

 
$
55,905

 
$
148,280

 
$
145,137

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
22,587

 
22,694

 
5,560

 
15,812

Fair value adjustment on interest rate swap contracts
(408
)
 

 
1,119

 

Comprehensive income
$
68,665

 
$
78,599

 
$
154,959

 
$
160,949


























The accompanying notes are an integral part of these consolidated financial statements.
2



FLIR SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
(Unaudited)
 
 
September 30,
2013
 
December 31, 2012 (as adjusted)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
492,199

 
$
321,739

Accounts receivable, net
281,611

 
335,163

Inventories
376,033

 
381,378

Prepaid expenses and other current assets
98,001

 
96,006

Deferred income taxes, net
31,659

 
30,960

Total current assets
1,279,503

 
1,165,246

Property and equipment, net
229,844

 
211,615

Deferred income taxes, net
32,235

 
32,223

Goodwill
567,611

 
562,586

Intangible assets, net
157,489

 
175,823

Other assets
59,194

 
41,442

 
$
2,325,876

 
$
2,188,935

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
93,861

 
$
94,156

Deferred revenue
30,308

 
29,465

Accrued payroll and related liabilities
39,139

 
41,506

Accrued product warranties
13,464

 
13,169

Advance payments from customers
13,585

 
12,150

Accrued expenses
41,977

 
32,772

Accrued income taxes

 
11,943

Other current liabilities
4,479

 
6,406

Current portion long term debt
15,000

 

Total current liabilities
251,813

 
241,567

Long-term debt
376,163

 
248,319

Deferred income taxes
18,828

 
17,351

Accrued income taxes
22,410

 
22,812

Pension and other long-term liabilities
50,151

 
58,985

Commitments and contingencies

 

Shareholders’ equity:
 
 
 
Preferred stock, $0.01 par value, 10,000 shares authorized; no shares issued at September 30, 2013, and December 31, 2012

 

Common stock, $0.01 par value, 500,000 shares authorized, 141,620 and 145,814 shares issued at September 30, 2013, and December 31, 2012, respectively, and additional paid-in capital
61,892

 
171,546

Retained earnings
1,528,399

 
1,418,814

Accumulated other comprehensive earnings
16,220

 
9,541

Total shareholders’ equity
1,606,511

 
1,599,901

 
$
2,325,876

 
$
2,188,935



The accompanying notes are an integral part of these consolidated financial statements.
3



FLIR SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
Nine Months Ended
September 30,
 
2013
 
2012
(As adjusted)
CASH PROVIDED BY OPERATING ACTIVITIES:
 
 
 
Net earnings
$
148,280

 
$
145,137

Income items not affecting cash:
 
 
 
Depreciation and amortization
44,978

 
44,859

Deferred income taxes
(38
)
 
599

Stock-based compensation arrangements
20,673

 
19,997

Other non-cash items
1,485

 
(1,864
)
Changes in operating assets and liabilities, net of acquisitions:
 
 
 
Decrease in accounts receivable
52,856

 
41,476

Decrease (increase) in inventories
6,481

 
(22,427
)
Increase in prepaid expenses and other current assets
(2,142
)
 
(15,367
)
(Increase) decrease in other assets
(4,911
)
 
450

Decrease in accounts payable
(374
)
 
(6,720
)
Increase (decrease) in deferred revenue
808

 
(4,382
)
Decrease in accrued payroll and other liabilities
(9,865
)
 
(21,438
)
Decrease in accrued income taxes
(12,347
)
 
(14,501
)
Increase in pension and other long-term liabilities
3,907

 
6,852

Cash provided by operating activities
249,791

 
172,671

CASH USED BY INVESTING ACTIVITIES:
 
 
 
Additions to property and equipment, net
(36,997
)
 
(39,188
)
Business acquisitions, net of cash acquired
(20,073
)
 

Other investments

 
(3,000
)
Cash used by investing activities
(57,070
)
 
(42,188
)
CASH USED BY FINANCING ACTIVITIES:
 
 
 
Proceeds from long-term debt, including current portion
150,000

 

Repayments of long-term debt
(7,500
)
 

Repurchase of common stock
(133,049
)
 
(129,010
)
Dividends paid
(38,695
)
 
(32,020
)
Proceeds from shares issued pursuant to stock-based compensation plans
5,953

 
7,117

Excess tax benefit of stock options exercised
928

 
1,231

Other financing activities
(1,273
)
 
(139
)
Cash used by financing activities
(23,636
)
 
(152,821
)
Effect of exchange rate changes on cash
1,375

 
5,981

Net increase (decrease) in cash and cash equivalents
170,460

 
(16,357
)
Cash and cash equivalents, beginning of period
321,739

 
440,846

Cash and cash equivalents, end of period
$
492,199

 
$
424,489









The accompanying notes are an integral part of these consolidated financial statements.
4


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



Note 1.
Basis of Presentation
The accompanying consolidated financial statements of FLIR Systems, Inc. and its consolidated subsidiaries (the “Company”) are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, these statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the Company’s consolidated financial position and results of operations for the interim periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012 .
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the year ending December 31, 2013 .

Reclassifications and Adjustments to Prior Year
The Company made certain reclassifications to the prior year's financial statements to conform them to the presentation as of September 30, 2013 . In addition, the December 31, 2012 balance sheet has been adjusted for purchase price allocations of the Lorex and Traficon acquisitions. See Note 18, "Business Acquisitions," of the Notes to the Consolidated Financial Statements for additional information. These reclassifications and adjustments had no effect on consolidated net earnings, shareholders' equity or net cash flows from operating, investing or financing activities for any of the periods presented.


Note 2.
Stock-based Compensation
Stock-based compensation expense and related tax benefit recognized in the Consolidated Statements of Income are as follows (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Cost of goods sold
$
672

 
$
895

 
$
1,902

 
$
2,516

Research and development
1,388

 
1,297

 
3,675

 
3,771

Selling, general and administrative
5,288

 
4,405

 
15,096

 
13,710

Stock-based compensation expense before income taxes
7,348

 
6,597

 
20,673

 
19,997

Income tax benefit
(2,295
)
 
(2,005
)
 
(6,696
)
 
(6,067
)
Total stock-based compensation expense after income taxes
$
5,053

 
$
4,592

 
$
13,977

 
$
13,930

Stock-based compensation costs capitalized in inventory are as follows (in thousands):
 
 
September 30,
 
2013
 
2012
Capitalized in inventory
$
789

 
$
514

As of September 30, 2013 , the Company had $50.4 million of total unrecognized stock-based compensation costs, net of estimated forfeitures, to be recognized over a weighted average period of 2.0 years.  

5


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 2.
Stock-based Compensation - (Continued)

The fair value of the stock-based awards granted in the three and nine months ended September 30, 2013 was estimated with the following weighted-average assumptions:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Stock option awards:
 
 
 
 
 
 
 
Risk-free interest rate
0.6
%
 

 
0.3
%
 
0.4
%
Expected dividend yield
1.1
%
 

 
1.5
%
 
1.3
%
Expected term
4.5 years

 

 
4.3 years

 
4.2 years

Expected volatility
31.4
%
 

 
33.7
%
 
39.7
%
Market-based restricted stock awards:
 
 
 
 
 
 
 
Risk-free interest rate

 

 
0.3
%
 
0.4
%
Expected dividend yield

 

 

 

Expected term

 

 
2.2 years

 
3.0 years

Expected volatility

 

 
28.8
%
 
30.7
%
Expected volatility of S&P 500

 

 
18.1
%
 
19.6
%
Employee stock purchase plan:
 
 
 
 
 
 
 
Risk-free interest rate

 

 
0.1
%
 
0.2
%
Expected dividend yield

 

 
1.5
%
 
1.3
%
Expected term

 

 
6 months

 
6 months

Expected volatility

 

 
25.0
%
 
27.4
%

The weighted average fair value of stock-based compensation awards granted and vested, and the intrinsic value of options exercised during the period were (in thousands, except per share amounts):  
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Stock Option Awards:
 
 
 
 
 
 
 
Weighted average grant date fair value per share
$
7.65

 
$

 
$
5.92

 
$
6.43

Total fair value of awards granted
$
278

 
$

 
$
6,095

 
$
4,104

Total fair value of awards vested
$
33

 
$
38

 
$
5,059

 
$
6,023

Total intrinsic value of options exercised
$
1,910

 
$
3,278

 
$
3,748

 
$
5,637

Restricted Stock Unit Awards:
 
 
 
 
 
 
 
Weighted average grant date fair value per share
$
31.30

 
$
19.84

 
$
23.91

 
$
17.23

Total fair value of awards granted
$
2,427

 
$
121

 
$
28,063

 
$
30,643

Total fair value of awards vested
$
222

 
$
174

 
$
13,541

 
$
12,276

Employee Stock Purchase Plan:
 
 
 
 
 
 
 
Weighted average grant date fair value per share
$

 
$

 
$
5.25

 
$
5.02

Total fair value of shares estimated to be issued
$

 
$

 
$
552

 
$
1,106


6


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 2.    Stock-based Compensation - (Continued)
The total amount of cash received from the exercise of stock options in the three months ended September 30, 2013 and 2012 was $2.0 million and $1.5 million , respectively, and the related tax impact realized from the exercise of the stock options was a benefit of $0.4 million and $0.8 million , respectively. The total amount of cash received from the exercise of stock options in the nine months ended September 30, 2013 and 2012 was $3.7 million and $3.1 million , respectively, and the related tax impact realized from the exercise of the stock options was a benefit of $0.3 million and $0.1 million , respectively.

 Information with respect to stock option activity is as follows:
 
Shares
(in  thousands)
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term
 
Aggregate
Intrinsic
Value
(in thousands)
Outstanding at December 31, 2012
6,642

 
$
21.64

 
4.7

 
 
Granted
1,030

 
24.58

 
 
 
 
Exercised
(266
)
 
14.07

 
 
 
 
Forfeited
(8
)
 
21.40

 
 
 
 
Outstanding at September 30, 2013
7,398

 
$
22.32

 
4.9

 
$
70,176

Exercisable at September 30, 2013
6,032

 
$
21.75

 
3.9

 
$
60,831

Vested and expected to vest at September 30, 2013
7,329

 
$
22.30

 
4.9

 
$
69,709


Information with respect to restricted stock unit activity is as follows:
 
 
Shares
(in  thousands)
 
Weighted
Average
Grant Date
Fair Value
Outstanding at December 31, 2012
2,372

 
$
21.30

Granted
1,173

 
23.91

Vested and distributed
(556
)
 
26.71

Forfeited
(140
)
 
24.84

Outstanding at September 30, 2013
2,849

 
$
23.74

During the nine months ended September 30, 2013 and 2012 , the Company granted approximately 1,166,000 and 984,000 time-vested restricted stock units, respectively. The fair value of time-vested restricted stock units is fixed and determined on the date of grant based upon the Company's stock price on the date of grant. The weighted average fair values of the time-vested restricted stock units granted during the nine months ended September 30, 2013 and 2012 were $23.96 and $21.67 , respectively.
During the nine months ended September 30, 2013 and 2012 , the Company also granted approximately 7,000 and 795,000 market-based restricted stock units, respectively. These units may be earned based upon the Company's total shareholder return compared to the total shareholder return of the S&P 500 Index over a three year period. The fair value of the market-based restricted units was determined and fixed on the date of grant using a lattice-based option-pricing valuation model that incorporates a Monte-Carlo simulation and considered the likelihood of the Company achieving the market-based condition. The fair value of the market-based restricted stock units granted during the nine months ended September 30, 2013 and 2012 was $15.87 and $11.73 , respectively.
There were approximately 125,000 shares issued under the 2011 Employee Stock Purchase Plan ("ESPP") during the nine months ended September 30, 2013 and approximately 3,728,000 shares remain available under the ESPP at September 30, 2013 for future issuance. The total amount of cash received from the issuance of ESPP shares in the nine months ended September 30, 2013 was $2.1 million . Shares issued for ESPP purchases are newly issued shares.




7


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 3.
Net Earnings Per Share
The following table sets forth the reconciliation of the numerator and denominator utilized in the computation of basic and diluted earnings per share (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Numerator for earnings per share:
 
 
 
 
 
 
 
Earnings from continuing operations
$
46,486

 
$
55,949

 
$
148,280

 
$
147,179

Loss from discontinued operations

 
(44
)
 

 
(2,042
)
Net earnings for basic and diluted earnings per share
$
46,486

 
$
55,905

 
$
148,280

 
$
145,137

 
 
 
 
 
 
 
 
Denominator for earnings per share:
 
 
 
 
 
 
 
Weighted average number of common shares outstanding
141,863

 
150,878

 
142,849

 
152,820

Assumed exercises of stock options and vesting of restricted stock awards, net of shares assumed reacquired under the treasury stock method
2,368

 
1,449

 
1,982

 
1,938

Weighted average diluted shares outstanding
144,231

 
152,327

 
144,831

 
154,758


Certain stock-based compensation awards are excluded for purposes of calculating diluted earnings per share since including such stock-based compensation awards that would have been anti-dilutive. Stock-based compensation awards for the three and nine months ended September 30, 2013 , which aggregated 136,000 shares and 478,000 shares, respectively, and for the three and nine months ended September 30, 2012 , which aggregated 6,792,000 shares and 3,100,000 shares, respectively, have been excluded for such purposes.


Note 4.
Fair Value of Financial Instruments
The Company had $106.0 million and $5.9 million of cash equivalents at September 30, 2013 and December 31, 2012 , respectively, which were primarily investments in money market funds. The Company has categorized its cash equivalents as a Level 1 financial asset, measured at fair value based on quoted prices in active markets of identical assets. The fair value of the Company’s forward currency contracts and interest rate swap contracts as of September 30, 2013 and December 31, 2012 are disclosed in Note 5, "Derivative Financial Instruments," of the Notes to the Consolidated Financial Statements below and are based on Level 2 inputs. The fair value of the Company’s senior unsecured notes as described in Note 13, "Long-Term Debt," of the Notes to the Consolidated Financial Statements is approximately $258.2 million based upon Level 2 inputs at September 30, 2013 . The fair value of the Company's term loan, also described in Note 13, approximates the carrying value due to the variable market rate used to calculate interest payments. The Company does not have any other significant financial assets or liabilities that are measured at fair value.


Note 5.
Derivative Financial Instruments
Foreign Currency Exchange Rate Risk
The gains and losses related to outstanding derivative instruments recorded in other expense (income) are offset, in general, by the reciprocal gains and losses from the underlying assets or liabilities which originally gave rise to the exposure. The net amounts of these realized and unrealized gains and losses for the three and nine months ended September 30, 2013 , were a gain of $1.4 million and a loss of $2.1 million , respectively. The net amounts of these gains and losses for the three and nine months ended September 30, 2012 were gain s of $2.6 million and $2.9 million , respectively.  


8


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 5.
Derivative Financial Instruments - (Continued)

The following table provides volume information about the Company's foreign currency hedge volume. The information provided is in United States dollar equivalent amounts. The table presents the net notional amounts at contract exchange rates (in thousands):
 
September 30,
2013
 
December 31,
2012
Swedish kronor
$
106,658

 
$
98,385

British pound sterling
7,612

 
15,619

Australian dollar
4,247

 
7,022

Japanese yen
3,729

 
5,157

Euro
9,611

 
2,232

Brazilian real
3,897

 

Other
971

 
622

 
$
136,725

 
$
129,037

At September 30, 2013 , the Company’s foreign currency forward contracts, in general, had maturities of seven months or less.
The fair value carrying amount of the foreign currency forward contracts included in the Consolidated Balance Sheets are as follows (in thousands):
 
September 30, 2013
 
December 31, 2012
 
Other Current Assets
 
Other Current Liabilities
 
Other Current Assets
 
Other Current Liabilities
Foreign exchange contracts
$
1,045

 
$
17

 
$
2,106

 
$
229


Interest Rates
The Company's outstanding long-term debt at September 30, 2013 consists of fixed rate notes and a floating rate term loan. The Company maintains its floating rate revolver for flexibility to fund working capital needs and for other uses of cash. Interest expense on the Company's floating rate debt is typically calculated based on a fixed spread over a reference rate, such as LIBOR (also known as the Eurocurrency rate). Therefore, fluctuations in market interest rates will cause interest expense increases or decreases on a given amount of floating rate debt.
The Company is managing its interest rate risk related to floating rate debt by entering into interest rate swaps in which the Company receives floating rate payments and makes fixed rate payments. The impact of the interest rate swaps is to fix the floating rate basis for the calculation of interest on the term loan at the levels indicated in the table below. The effective interest rate paid is equal to the fixed rates shown below plus the credit spread then in effect. At September 30, 2013 , the effective interest rate on the term loan was 2.49 percent . As of September 30, 2013 , the following interest rate swaps were outstanding:
Contract Date
 
Notional Amount
(in millions)
 
Fixed Rate
 
Effective Date
 
Maturity Date
March 15, 2013
 
$
73.1

 
1.0165
%
 
April 5, 2013
 
March 31, 2019
March 29, 2013
 
73.1

 
0.97
%
 
April 5, 2013
 
March 31, 2019
Interest rate swaps are recorded as an asset or liability in the Company's Consolidated Balance Sheet at fair value. Gains and losses on cash flow hedges are recorded as an adjustment to accumulated other comprehensive (loss) earnings, except that any gains and losses on ineffectiveness of cash flow hedges would be recorded as an adjustment to other expense (income).

9


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

The net fair value carrying amount of the Company's interest rate swaps was $1.8 million , of which $2.8 million and $1.0 million have been recorded to other assets and other current liabilities , respectively, in the Consolidated Balance Sheet as of September 30, 2013 .


Note 6.
Accounts Receivable
Accounts receivable are net of an allowance for doubtful accounts of $7.9 million and $6.6 million at September 30, 2013 and December 31, 2012 , respectively.


Note 7.
Inventories
Inventories consist of the following (in thousands):
 
 
September 30,
2013
 
December 31,
2012
Raw material and subassemblies
$
222,573

 
$
231,273

Work-in-progress
56,289

 
50,644

Finished goods
97,171

 
99,461

 
$
376,033

 
$
381,378



Note 8.
Property and Equipment
Property and equipment are net of accumulated depreciation of $214.8 million and $190.5 million at September 30, 2013 and December 31, 2012 , respectively.


Note 9.
Goodwill
As of September 30, 2013 , the Company completed its annual review of goodwill and has determined that there have been no triggering events or indicators of impairment on its recorded goodwill. The carrying value of goodwill by reporting segment and the activity for the nine months ended September 30, 2013 are as follows (in thousands):
 
 
Thermal Vision and Measurement
 
Raymarine
 
Surveillance
 
Detection
 
Integrated Systems
 
Total
Balance, December 31, 2012
(as originally reported)
$
253,226

 
$
100,744

 
$
90,817

 
$
38,162

 
$
20,129

 
$
503,078

Adjustments
59,508

 

 

 

 

 
59,508

Balance, December 31, 2012
312,734

 
100,744

 
90,817

 
38,162

 
20,129

 
562,586

Goodwill from acquisitions

 

 

 

 
2,462

 
2,462

Currency translation adjustments
2,158

 
277

 
87

 

 
41

 
2,563

Balance, September 30, 2013
$
314,892

 
$
101,021

 
$
90,904

 
$
38,162

 
$
22,632

 
$
567,611


During the nine months ended September 30, 2013 , the Company updated the purchase price accounting associated with the Lorex and Traficon acquisitions resulting in an increase in goodwill of $59.5 million which was retrospectively adjusted. See Note 18, "Business Acquisitions," of the Notes to the Consolidated Financial Statements for additional information.



10


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 10.
Intangible Assets
Intangible assets are net of accumulated amortization of $110.2 million and $90.3 million at September 30, 2013 and December 31, 2012 , respectively.


Note 11.
Revolving Credit Facility
At September 30, 2013 , the Company had no borrowings outstanding under its revolving credit facility pursuant to the Credit Agreement, dated February 8, 2011, with Bank of America, N.A., U.S. Bank National Association, JPMorgan Chase Bank N.A. and other Lenders, and $13.2 million of letters of credit outstanding, which reduces the total available credit under the Credit Agreement to $186.8 million .

On April 5, 2013, the Credit Agreement was amended to extend the maturity of the revolving credit facility from February 8, 2016 to April 5, 2018 . The amendment also incorporated a revised schedule of interest rates.
  

Note 12.
Accrued Product Warranties
The following table summarizes the Company’s warranty liability and activity (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Accrued product warranties, beginning of period
$
16,791

 
$
15,322

 
$
16,152

 
$
16,046

Amounts paid for warranty services
(1,128
)
 
(2,465
)
 
(5,273
)
 
(6,722
)
Warranty provisions for products sold
768

 
1,689

 
5,309

 
4,823

Currency translation adjustments and other
160

 
646

 
403

 
1,045

Accrued product warranties, end of period
$
16,591

 
$
15,192

 
$
16,591

 
$
15,192

Current accrued product warranties, end of period
 
 
 
 
$
13,464

 
$
13,094

Long-term accrued product warranties, end of period
 
 
 
 
$
3,127

 
$
2,098



Note 13.
Long-Term Debt
Long-term debt consists of the following (in thousands):
 
September 30,
2013
 
December 31,
2012
Unsecured notes
$
250,000

 
$
250,000

Term loan
142,500

 

Unamortized discounts and issuance costs of unsecured notes
(1,337
)
 
(1,681
)
 
$
391,163

 
$
248,319

Current portion, long-term debt
$
15,000

 
$

Long-term debt
$
376,163

 
$
248,319


In August 2011, the Company issued $250 million aggregate principal amount of its 3.750% senior unsecured notes due September 1, 2016 (the “Notes”). The net proceeds from the issuance of the Notes were approximately $247.7 million , after deducting underwriting discounts and offering expenses, which are being amortized over a period of five years. Interest is payable on the Notes semiannually in arrears on March 1 and September 1 . The proceeds from the Notes are being used for general corporate purposes, which may include working capital and capital expenditure needs, business acquisitions and repurchases of the Company’s common stock.

11


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 13.
Long-Term Debt - (Continued)
The Credit Agreement amendment of April 5, 2013, discussed in Note 11, "Credit Agreements," of the Notes to the Consolidated Financial Statements above, incorporated a $150 million term loan facility that matures on April 5, 2019 . On April 5, 2013 the Company drew down $150 million under the term loan facility. Interest is accrued at the one-month LIBOR rate plus the scheduled spread and paid monthly . Quarterly principal payments of $3.8 million commenced on June 30, 2013 and will continue through December 31, 2018 with the final maturity payment including any accrued interest due on April 5, 2019.


Note 14.
Shareholders’ Equity
The following table summarizes the common stock and additional paid-in capital activity during the nine months ended September 30, 2013 (in thousands):
 
Common stock and additional paid-in capital, December 31, 2012
$
171,546

Excess income tax benefit of common stock options exercised
347

Common stock issued pursuant to stock-based compensation plans, net
2,058

Stock-based compensation costs
20,990

Repurchase of common stock
(133,049
)
Common stock and additional paid-in capital, September 30, 2013
$
61,892

During the nine months ended September 30, 2013 , the Company repurchased 2.1 million shares of the Company's common stock through open market transactions and entered into an accelerated share repurchase program at a notional amount of $75.0 million under which the Company received 2.6 million shares in March 2013 and an additional 0.3 million shares in April 2013. The repurchases were under the February 2013 authorization by the Company’s Board of Directors pursuant to which the Company is authorized to repurchase up to 25.0 million shares of the Company’s outstanding common stock. This authorization expires in February 2015 .
On February 9, 2011, the Company’s Board of Directors adopted a dividend policy under which the Company intends to pay quarterly cash dividends on its common stock. Accordingly, a dividend of $0.09 per share of outstanding common stock was paid on September 6, 2013 to shareholders of record as of the close of business on August 19, 2013 . The total cash payments for dividends in the nine months ended September 30, 2013 was $38.7 million .

Note 15.
Contingencies
The Company and its subsidiary, Indigo Systems Corporation (now known as FLIR Commercial Systems, Inc.) (together, the “FLIR Parties”), were named in a lawsuit filed by Raytheon Company (“Raytheon”) on March 2, 2007 in the United States District Court for the Eastern District of Texas. Raytheon's complaint, as amended, asserted claims for tortious interference, patent infringement, trade secret misappropriation, unfair competition, breach of contract and fraudulent concealment. The FLIR Parties filed an answer to the complaint on September 2, 2008, in which they denied all material allegations. On August 31, 2009, the court entered an order granting the FLIR Parties' motion for summary judgment on Raytheon's trade secret misappropriation claim based on the FLIR Parties' statute of limitations defense. Raytheon abandoned all of its other claims except its claims relating to four patents (the “Patent Claims”). On August 11, 2010, the FLIR Parties and Raytheon entered into an agreement in principle to resolve the remaining Patent Claims, which resulted in a payment of $3 million by the FLIR Parties to Raytheon and entitles the FLIR Parties to certain license rights in the patents that were the subject of the Patent Claims. The parties appealed certain rulings of the District Court to the United States Court of Appeals for the Federal Circuit which on August 1, 2012 reversed the judgment of the District Court and remanded the case for further proceedings consistent with the appellate court's opinion.  The Company intends to vigorously defend itself in this matter and is unable to estimate the amount or range of potential loss, if any, which might result if the outcome in this matter is unfavorable.



12


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 16.
Income Taxes
As of September 30, 2013 , the Company had approximately $29.8 million of unrecognized tax benefits all of which would affect the Company’s effective tax rate if recognized. The Company anticipates an immaterial portion of its net unrecognized tax benefits will be recognized within 12 months as the result of settlements or effective settlements with various tax authorities, the closure of certain audits and the lapse of the applicable statute of limitations.
The Company classifies interest and penalties related to uncertain tax positions as income tax expense. As of September 30, 2013 , the Company had approximately $2.8 million of net accrued interest and penalties related to uncertain tax positions.
The Company currently has the following tax years open to examination by major taxing jurisdictions:
 
 
Tax Years:
US Federal
2010 – 2012
State of Oregon
2009 – 2012
State of Massachusetts
2009 – 2012
State of California
2008 – 2012
Sweden
2007 – 2012
United Kingdom
2008 – 2012
Belgium
2011 - 2012



Note 17.
Operating Segments and Related Information
Operating Segments
The Company has two business divisions: Commercial Systems and Government Systems.
Commercial Systems Division
The Commercial Systems division is focused on the design, manufacture, and marketing of instrument, sensor, and electronics solutions that facilitate improved situational awareness and environmental analytics for commercial customers. The division is comprised of two operating segments: Thermal Vision and Measurement and Raymarine. The Thermal Vision and Measurement segment provides advanced thermal imaging solutions for emerging commercial and industrial markets that enable people to see at night or through adverse weather conditions and to capture, measure, and analyze temperature data. The Raymarine segment provides electronics for the maritime market and is a leading global provider of fully integrated “stem to stern” networked electronic systems for boats of all sizes.
Government Systems Division
The Government Systems division designs, manufactures, and markets advanced imaging and detection systems for government markets where high performance is required. The division is comprised of three operating segments: Surveillance, Detection, and Integrated Systems. The Surveillance segment provides enhanced imaging and recognition solutions to a wide variety of military, law enforcement, public safety, and other government customers around the world for the protection of borders, troops, and public welfare. The Detection segment produces sensor instruments that detect and identify chemical, biological, radiological, nuclear, and explosives (“CBRNE”) threats for military force protection, homeland security, and commercial applications. The Integrated Systems segment develops platform solutions for combating sophisticated security threats and incorporates multiple sensor systems in order to deliver actionable intelligence for wide area surveillance, intrusion detection, and facility security.

13


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

  Note 17.    Operating Segments and Related Information - (Continued)
Operating Segments - (Continued)
Operating segment information is as follows (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Revenue – External Customers:
 
 
 
 
 
 
 
Thermal Vision and Measurement
$
177,100

 
$
149,540

 
$
519,453

 
$
447,922

Raymarine
35,800

 
31,659

 
127,087

 
125,443

Surveillance
102,966

 
115,915

 
331,824

 
350,005

Detection
13,103

 
15,401

 
40,016

 
50,467

Integrated Systems
29,172

 
19,715

 
77,673

 
45,136

 
$
358,141

 
$
332,230

 
$
1,096,053

 
$
1,018,973

Revenue – Intersegments:
 
 
 
 
 
 
 
Thermal Vision and Measurement
$
5,201

 
$
3,076

 
$
12,397

 
$
12,527

Raymarine

 

 

 
4

Surveillance
8,240

 
5,260

 
22,520

 
17,246

Detection
1,836

 
1,027

 
6,098

 
1,803

Integrated Systems
384

 
295

 
1,082

 
1,342

Eliminations
(15,661
)
 
(9,658
)
 
(42,097
)
 
(32,922
)
 
$

 
$

 
$

 
$

Earnings (loss) from operations:
 
 
 
 
 
 
 
Thermal Vision and Measurement
$
43,744

 
$
42,916

 
$
125,509

 
$
109,651

Raymarine
2,050

 
374

 
14,345

 
9,944

Surveillance
30,535

 
39,243

 
100,835

 
114,965

Detection
1,354

 
1,131

 
3,265

 
801

Integrated Systems
(97
)
 
1,333

 
112

 
1,267

Other
(14,047
)
 
(10,760
)
 
(41,124
)
 
(33,375
)
 
$
63,539

 
$
74,237

 
$
202,942

 
$
203,253



 
September 30,
2013
 
December 31,
2012
Segment assets (accounts receivable, net and inventories):
 
 
 
Thermal Vision and Measurement
$
249,972

 
$
265,197

Raymarine
66,185

 
74,980

Surveillance
283,809

 
317,944

Detection
24,858

 
31,861

Integrated Systems
32,820

 
26,559

 
$
657,644

 
$
716,541



14


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

  Note 17.    Operating Segments and Related Information - (Continued)
Revenue and Long-Lived Assets by Geographic Area
Information related to revenue by significant geographical location, determined by the end customer, is as follows (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
United States
$
191,261

 
$
185,222

 
$
576,278

 
$
536,150

Europe
81,748

 
61,507

 
260,474

 
231,374

Other international
85,132

 
85,501

 
259,301

 
251,449

 
$
358,141

 
$
332,230

 
$
1,096,053

 
$
1,018,973

Long-lived assets by significant geographic locations are as follows (in thousands):
 
 
September 30,
2013
 
December 31,
2012
 
 
 
(As adjusted)
United States
$
596,967

 
$
583,008

Europe
362,959

 
355,497

Other international
54,212

 
52,961

 
$
1,014,138

 
$
991,466



Major Customers
Revenue derived from major customers is as follows (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
US Government
$
89,866

 
$
91,714

 
$
282,470

 
$
265,976



15


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 18.
Business Acquisitions
In December 2012, the Company acquired Lorex Technology Inc. ("Lorex"), a provider of consumer oriented and professional grade video surveillance systems, for approximately $61.2 million in cash. At December 31, 2012, the Company initially reported the net tangible assets of $19.1 million in the respective balance sheet accounts and the excess purchase price of $42.1 million in other assets.
The Company has since performed a purchase price allocation which resulted in an allocation of $15.1 million of identifiable intangible assets and $31.1 million of goodwill in conjunction with the Lorex acquisition, which has been recorded in the Company’s Thermal Vision and Measurement segment. This goodwill consists largely of the ability of Lorex to provide the Company domain knowledge and distribution channels in adjacent security markets. These purchase price adjustments have been applied retrospectively to the December 31, 2012 balance sheet.
The allocation of the purchase price is as follows (in thousands):
Cash acquired
$
1,170

Accounts receivable, net
10,183

Inventories
13,967

Property and equipment
1,049

Other assets
3,004

Liabilities
(10,252
)
Net tangible assets
19,121

Net deferred taxes
(4,189
)
Identifiable intangible assets
15,100

Goodwill
31,138

Purchase price
$
61,170

None of the goodwill recognized is deductible for income tax purposes.
The identifiable intangible assets and the estimated useful life of each are as follows (in thousands):
 
Estimated
Useful Life
 
Amount
Lorex Trade Name
indefinite
 
$
6,800

Customer Relationships
7 years
 
8,300

 
 
 
$
15,100

Also in December 2012, the Company acquired Traficon International NV ("Traficon"), a provider of video image processing software and hardware for traffic analysis applications, for approximately $46.3 million in cash. At December 31, 2012, the Company initially reported the net tangible assets of $5.1 million in the respective balance sheet accounts and the excess purchase price of $41.2 million in other assets.
In April 2013, the Company made an additional payment of $2.1 million in cash as an adjustment to the purchase price. The Company has performed a purchase price allocation which resulted in an allocation of $20.1 million of identifiable intangible assets and $28.4 million of goodwill in conjunction with the Traficon acquisition, which has been recorded in the Company’s Thermal Vision and Measurement segment. This goodwill consists largely of the ability of Traficon to expand the Company's presence in the global traffic monitoring market through the provision of domain expertise and distribution channels. These purchase price adjustments have been applied retrospectively to the December 31, 2012 balance sheet.

16


FLIR SYSTEMS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 18.
Business Acquisitions - (Continued)
The allocation of the purchase price is as follows (in thousands):
Cash acquired
$
181

Accounts receivable, net
6,435

Inventories
2,853

Property and equipment
179

Other assets
657

Liabilities
(5,248
)
Net tangible assets
5,057

Net deferred taxes
(5,166
)
Identifiable intangible assets
20,102

Goodwill
28,370

Purchase price
$
48,363

None of the goodwill recognized is deductible for income tax purposes.
The identifiable intangible assets and the estimated useful life of each are as follows (in thousands):
 
Estimated
Useful Life
 
Amount
Patented/Proprietary Technology
10 years
 
$
5,951

Backlog
1.5 years
 
1,852

Customer Relationships
12 years
 
12,299

 
 
 
$
20,102

In April 2013, the Company acquired Marine and Remote Sensing Solutions, Ltd. ("MARSS"), a developer of software and sensor control systems for use in maritime security applications, including above and below water port security and ship-based man overboard detection, for approximately $3.2 million in cash.
In August 2013, the Company acquired certain tangible assets and intellectual property related to the design and manufacturing of wafer-level optics from DigitalOptics Corporation East for approximately $14.9 million in cash. The tangible assets, including property, equipment and inventory, and intellectual property that were acquired are included in the Consolidated Balance Sheet as of September 30, 2013 and are included in the Thermal Vision and Measurement segment assets in Note 17, "Operating Segments and Related Information," of the Notes to the Consolidated Financial Statements. The Company has preliminarily recorded $5.0 million in property and equipment and $9.9 million in other assets as of September 30, 2013 . The allocation of the purchase price is subject to the final determination on the valuation of the assets acquired. The valuation is expected to be finalized by December 31, 2013.
The operating results for these acquisitions are included in the Company's 2013 results of operations.
These acquisitions are not significant, either individually or in the aggregate, as defined in Regulation S-X of the Securities and Exchange Commission, compared to the Company’s overall financial position.


Note 19.
Subsequent Events
On October 15, 2013, the Company announced a proposed realignment of some of its production and engineering operations that will result in the closure of up to six of its global locations and the transfer of these operations to larger Company facilities. The Company also announced its intention to consolidate its optics and laser manufacturing operations. The Company expects to record pre-tax restructuring charges in the fourth quarter of 2013 of approximately $27 million to $30 million related to these and other cost reduction actions.
On October 23, 2013 , the Company’s Board of Directors declared a quarterly dividend of $0.09 per share on its common stock, payable on December 6, 2013 , to shareholders of record as of the close of business on November 18, 2013 . The total cash payment of this dividend will be approximately $12.7 million .


17



Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements
This Quarterly Report on Form 10-Q (the “Report”), including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding future events and the future results of FLIR Systems, Inc. and its consolidated subsidiaries (“FLIR” or the “Company”) that are based on management’s current expectations, estimates, projections, and assumptions about the Company’s business. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “sees,” “estimates” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements due to numerous factors including, but not limited to, those discussed in the “Risk Factors” section of the Company’s Annual Report on Form 10-K filed for the fiscal year ended December 31, 2012 , “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2, and elsewhere in this Report as well as those discussed from time to time in the Company’s other Securities and Exchange Commission filings and reports. In addition, such statements could be affected by general industry and market conditions. Such forward-looking statements speak only as of the date of this Report or, in the case of any document incorporated by reference, the date of that document, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this Report, or for changes made to this document by wire services or Internet service providers. If we update or correct one or more forward-looking statements, investors and others should not conclude that we will make additional updates or corrections with respect to other forward-looking statements.

Results of Operations
The following discussion of operating results provides an overview of our operations by addressing key elements in our Consolidated Statements of Income. The “Segment Operating Results” section that follows describes the contributions of each of our business segments to our consolidated revenue and earnings from operations. Given the nature of our business, we believe revenue and earnings from operations (including operating margin percentage) are most relevant to an understanding of our performance at a segment level as revenue levels are the most significant indicators of business conditions for each of the respective segments and earnings from operations reflect our ability to manage each of our segments as revenue levels change. 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.
Revenue. Consolidated revenue for the three months ended September 30, 2013 increased by 7.8 percent year over year, from $332.2 million in the third quarter of 2012 to $358.1 million in the third quarter of 2013 . Consolidated revenue for the nine months ended September 30, 2013 increased by 7.6 percent year over year, from $1,019.0 million in the first nine months of 2012 to $1,096.1 million in the first nine months of 2013 . Our Thermal Vision and Measurement ("TVM"), Raymarine, and Integrated Systems segments reported increases in revenue year over year, while our other two segments reported decreases in year over year revenues. The increase in revenue from our TVM segment was due to revenue from two companies acquired late in 2012, while the increase in revenue from our Integrated Systems segment resulted from higher year over year deliveries on large programs for that business.
The timing of orders, scheduling of backlog and fluctuations in demand in various regions of the world can give rise to quarter to quarter and year over year fluctuations in the mix of revenue. Consequently, year over year comparisons for any given quarter may not be indicative of comparisons using longer time periods. While we currently expect total annual revenue for 2013 to be approximately three to seven percent higher than 2012 revenue, unexpected changes in economic conditions from key customer markets or other major unanticipated events may cause total revenue, and the mix of revenue between our segments, to vary from quarter to quarter during the year.
International sales accounted for 46.6 percent and 44.2 percent of total revenue for the quarters ended September 30, 2013 and 2012 , respectively, and 47.4 percent for both the three and nine months ended September 30, 2013 and 2012 , respectively. The proportion of our international revenue compared to total revenue will fluctuate from quarter to quarter due to normal variation in order activity across various regions as well as specific factors that may affect one region and not another. Overall we anticipate that revenue from international sales will continue to comprise a significant percentage of total revenue.
Cost of goods sold. Cost of goods sold for the three and nine months ended September 30, 2013 was $185.3 million and $549.1 million , respectively, compared to cost of goods sold for the three and nine months ended September 30, 2012 of $158.9 million and $492.9 million , respectively. The year over year increase in cost of goods sold primarily relates to increases in revenues and changes in product mix.

18



Gross profit. Gross profit for the quarter ended September 30, 2013 was $172.9 million compared to $173.4 million for the same quarter last year. Gross profit for the nine months ended September 30, 2013 was $546.9 million compared to $526.1 million for the same period of 2012 . The increases in gross profit were primarily due to increases in revenues. Gross margin, defined as gross profit divided by revenue, decreased from 52.2 percent in the third quarter of 2012 to 48.3 percent in the third quarter of 2013 and from 51.6 percent in the first nine months of 2012 to 49.9 percent in the first nine months of 2013 . The decreases in gross margins were primarily due to lower gross margins of products sold by Lorex, a portion of our TVM segment that was acquired in December 2012, and product mix changes in our Integrated Systems and Surveillance segments.
Research and development expenses. Research and development expenses for the third quarter of 2013 totaled $33.0 million , compared to $29.6 million in the third quarter of 2012 . Research and development expenses for the first nine months of 2013 and 2012 were $109.3 million and $103.7 million , respectively. Research and development expenses as a percentage of revenue was 9.2 percent and 10.0 percent for the three and nine months ended September 30, 2013 , respectively. Research and development expenses as a percentage of revenue was 8.9 percent and 10.2 percent for the three and nine months ended September 30, 2012 , respectively. Over the five annual periods through December 31, 2012 , our annual research and development expenses have varied between 8.0 percent and 9.8 percent of revenue, and we currently expect these expenses to remain within that range in the near future.
Selling, general and administrative expenses. Selling, general and administrative expenses were $76.4 million for the quarter ended September 30, 2013 , compared to $69.5 million for the quarter ended September 30, 2012 . Selling, general and administrative expenses for the first nine months of 2013 and 2012 were $234.7 million and $219.2 million , respectively. The increases in selling, general and administrative expenses for the third quarter year over year were attributable to the addition of operating expenses of businesses acquired in December of 2012, offset by cost containment efforts taken across the Company in 2012 in response to the lower revenues during that year. Selling, general and administrative expenses as a percentage of revenue were 21.3 percent and 20.9 percent for the quarters ended September 30, 2013 and 2012 , respectively and 21.4 percent and 21.5 percent for the nine months ended September 30, 2013 and 2012 , respectively. Over the five annual periods through December 31, 2012 , our annual selling, general and administrative expenses have varied between 19.2 percent and 23.8 percent of revenue.
Interest expense. Interest expense for the third quarter and first nine months of 2013 was $3.7 million and $10.4 million , respectively, compared to $3.1 million and $8.9 million for the same periods of 2012 . Interest expense is primarily associated with the $250 million aggregate principal amount of 3.750% senior unsecured Notes due September 1, 2016 issued in August 2011 and the $150 million term loan that was drawn on April 5, 2013.
Income taxes. The income tax provision of $13.6 million for the three months ended September 30, 2013 represents a quarterly effective tax rate of 22.6 percent . We expect the annual effective tax rate for the full year of 2013 to be approximately 24 percent, excluding discrete items. The effective tax rate is lower than the US Federal tax rate of 35 percent because of the mix of lower foreign jurisdiction tax rates, the effect of federal, foreign and state tax credits and discrete adjustments.

Segment Operating Results
Thermal Vision and Measurement
Thermal Vision and Measurement operating results are as follows (in millions):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Revenue
$
177.1

 
$
149.5

 
$
519.5

 
$
447.9

Earnings from operations
43.7

 
42.9

 
125.5

 
109.7

Operating margin
24.7
%
 
28.7
%
 
24.2
%
 
24.5
%
Backlog, end of period
 
 
 
 
183

 
167

Revenue for the three and nine months ended September 30, 2013 increased by 18.4 percent and 16 percent , respectively, compared to the same periods of 2012 . The increases in the three and nine months ended September 30, 2013 are primarily due to the combined revenue of $32.9 million and $86.4 million, respectively, reported by Lorex and Traficon, which were acquired in December 2012. For the nine months ended September 30, 2013 there were slightly lower revenues in several of our other product lines, a portion of which was due to lower demand from cores and components customers, including US Government funded customers. The increases in earnings from operations for the three and nine months ended September 30, 2013 compared to the same periods of 2012 were primarily due to the cost containment efforts taken during the second quarter of 2012 and the

19



earnings from operations of the acquired businesses. The rise in backlog at September 30, 2013 compared to September 30, 2012 was a result of the addition of backlog reported by Lorex and Traficon.
Raymarine
Raymarine operating results are as follows (in millions):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Revenue
$
35.8

 
$
31.7

 
$
127.1

 
$
125.4

Earnings from operations
2.1

 
0.4

 
14.3

 
9.9

Operating margin
5.7
%
 
1.2
%
 
11.3
%
 
7.9
%
Backlog, end of period
 
 
 
 
5

 
6

Revenue for the three and nine months ended September 30, 2013 increased by 13.1 percent and 1.3 percent , respectively, compared to the same periods of 2012 . The year over year increase in revenue for the three month period is primarily due to increased deliveries in the Americas and Europe, partially related to new product introductions. The increases in earnings from operations for the three and nine months ended September 30, 2013 compared to the same periods of 2012 were primarily due to realizing the benefit in 2013 of cost containment efforts taken during the second quarter of 2012 and higher revenues.
Surveillance
Surveillance operating results are as follows (in millions):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Revenue
$
103.0

 
$
115.9

 
$
331.8

 
$
350.0

Earnings from operations
30.5

 
39.2

 
100.8

 
115.0

Operating margin
29.7
%
 
33.9
%
 
30.4
%
 
32.8
%
Backlog, end of period
 
 
 
 
276

 
289

Revenue for the three and nine months ended September 30, 2013 decreased by 11.2 percent and 5.2 percent , respectively, compared to the same periods of 2012 due to reduced procurement activity by both US and international government agencies. The decrease in earnings from operations for both the three month and nine month periods were primarily due to lower revenues and lower gross margins due to changes in product mix.

Detection
Detection operating results are as follows (in millions):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Revenue
$
13.1

 
$
15.4

 
$
40.0

 
$
50.5

Earnings from operations
1.4

 
1.1

 
3.3

 
0.8

Operating margin
10.3
%
 
7.3
%
 
8.2
%
 
1.6
%
Backlog, end of period
 
 
 
 
24

 
24


Revenue for the three and nine months ended September 30, 2013 decreased by 14.9 percent and 20.7 percent , respectively, compared to the same periods of 2012 , which was primarily due to lower research and development contract revenues. Earnings from operations increased for the three and nine month periods year over year due to reductions in operating expenses, which included $2.8 million of restructuring charges in the nine months ended September 30, 2012 partially offset by lower revenues.

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Integrated Systems
Integrated Systems operating results are as follows (in millions):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2013
 
2012
 
2013
 
2012
Revenue
$
29.2

 
$
19.7

 
$
77.7

 
$
45.1

(Loss) earnings from operations
(0.1
)
 
1.3

 
0.1

 
1.3

Operating margin
(0.3
)%
 
6.8
%
 
0.1
%
 
2.8
%
Backlog, end of period
 
 
 
 
35

 
79


Revenue for the three and nine months ended September 30, 2013 increased by 48.0 percent and 72.1 percent , respectively, compared to the same periods of 2012 , which was primarily due to the timing of large program deliveries during both the three and nine months ended September 30, 2013 . The decreases in earnings from operations for the three and nine months ended September 30, 2013 compared to the same periods of 2012 were primarily due to lower margins recognized on program deliveries in 2013. Margins are expected to improve in 2014. Backlog at September 30, 2013 reflects a decrease of $44 million compared to September 30, 2012 due to those program deliveries in 2013 and the reduced intake of program orders in 2013, particularly from US government customers.


Liquidity and Capital Resources
At September 30, 2013 , we had a total of $492.2 million in cash and cash equivalents, of which $236.9 million was in the United States and $255.3 million was at our foreign subsidiaries, compared to cash and cash equivalents at December 31, 2012 of $321.7 million , of which $150.3 million was in the United States and $171.4 million was at our foreign subsidiaries. The increase in cash and cash equivalents was primarily due to $150 million borrowed against a term loan facility and cash from operations, partially offset by $133.0 million spent for the repurchase of shares of our common stock, capital expenditures of $37.0 million , and dividends paid of $38.7 million during the period.
Cash provided by operating activities totaled $249.8 million for the nine months ended September 30, 2013 , which primarily consisted of net earnings, adjusted for non-cash charges for depreciation and amortization and stock-based compensation, and net collections of our accounts receivable, partially offset by net increases in other working capital components.
Cash used by investing activities totaled $57.1 million for the nine months ended September 30, 2013, primarily consisting of the acquisition of Marine and Remote Sensing Solutions, Ltd for $3.2 million, the acquisition of certain tangible assets and intellectual property of DigitalOptics Corporation East for $14.9 million, and capital expenditures of $37.0 million.
Cash used by financing activities totaled $23.6 million for the nine months ended September 30, 2013 , which primarily consisted of cash received from the term loan offset by the repurchase of shares of our common stock and the payment of dividends.
On February 8, 2011, we signed a Credit Agreement (“Credit Agreement”) with Bank of America, N.A., U.S. Bank National Association, JPMorgan Chase Bank N.A. and other Lenders. The Credit Agreement provides for a $200 million, five-year revolving line of credit. On April 5, 2013, the Credit Agreement was amended to extend the maturity of the revolving credit facility from February 8, 2016 to April 5, 2018 in addition to incorporating a $150 million term loan facility maturing April 5, 2019. We have the right, subject to certain conditions including approval of additional commitments by qualified lenders, to increase the line of credit by an additional $150 million until April 5, 2018. The Credit Agreement allows us and certain designated subsidiaries to borrow in US dollars, euros, Swedish Kronor, pound sterling and other agreed upon currencies. The Credit Agreement requires us to pay a commitment fee on the amount of unused credit at a rate, based on the Company’s leverage ratio, which ranges from 0.25 percent to 0.40 percent. The Credit Agreement contains two financial covenants that require the maintenance of certain leverage ratios with which we were in compliance at September 30, 2013 . The five-year revolving line of credit available under the Credit Agreement and the term loan facility are not secured by any of our assets.
As noted above, the Credit Agreement amendment of April 5, 2013 incorporated a $150 million term loan facility that matures on April 5, 2019 . On April 5, 2013 we drew down $150 million under the term loan facility. Interest is accrued at the one-month LIBOR rate plus the scheduled spread and paid monthly. By entering into interest rate swap agreements, we have effectively fixed the basis for calculating the interest rate on the term loan. The effective interest rate paid is equal to the fixed rate in the swap agreements plus the credit spread then in effect. At September 30, 2013 , the effective interest rate on the term loan was 2.49

21



percent . Principal payments of $3.8 million are made in quarterly installments which commenced on June 30, 2013 and will continue through December 31, 2018 with the final maturity payment including any accrued interest due on April 5, 2019.
At September 30, 2013 , we had no amounts outstanding under the Credit Agreement and the commitment fee on the amount of unused credit was 0.25 percent . We had $13.2 million of letters of credit outstanding at September 30, 2013 , which reduced the total available credit under the Credit Agreement.
On August 19, 2011, we issued $250 million aggregate principal amount of our 3.750% senior unsecured notes due September 1, 2016 (the "Notes"). The net proceeds from the issuance of the Notes were approximately $247.7 million, after deducting underwriting discounts and offering expenses, which are being amortized over a period of five years. Interest is payable on the Notes semiannually in arrears on March 1 and September 1. The proceeds from the Notes are being used for general corporate purposes, which may include working capital and capital expenditure needs, business acquisitions and repurchases of our common stock.
On February 6, 2013 , our Board of Directors authorized the repurchase of up to 25.0 million shares of our outstanding common stock. As of September 30, 2013 , there were approximately 20.0 million shares still remaining for repurchase under this authorization, which expires on February 6, 2015 .
United States income taxes have not been provided for on accumulated earnings of certain subsidiaries outside of the United States as we currently intend to reinvest the earnings in operations outside the United States indefinitely. Should we subsequently elect to repatriate foreign earnings, we would need to accrue and pay United States income taxes, thereby reducing the amount of our cash.
We believe that our existing cash combined with the cash we expect to generate from operating activities and our available credit facilities and financing available from other sources will be sufficient to meet our cash requirements for the foreseeable future. We do not have any significant capital commitments for the current year nor are we aware of any significant events or conditions that are likely to have a material impact on our liquidity.

Recent Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update No. 2013-02, "Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income" ("ASU 2013-02") which establishes new requirements for disclosing reclassifications of items out of accumulated other comprehensive income and includes identification of the line items in net earnings affected by the reclassifications. ASU 2013-02 is effective for annual and interim periods for fiscal years beginning after December 15, 2012. Accordingly, the Company adopted ASU 2013-02 on January 1, 2013. The Company did not have any reclassifications during the first nine months of 2013 that would require additional disclosure under this pronouncement.
In March 2013, the FASB issued Accounting Standards Update No. 2013-05, "Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity" ("ASU 2013-05") which addresses the accounting for the cumulative translation adjustment when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. ASU 2013-05 is effective for annual and interim periods beginning after December 15, 2014. Accordingly, the Company currently intends to adopt ASU 2013-05 on January 1, 2015 and does not expect the adoption of ASU 2013-05 to have a material impact on its consolidated financial statements.
In July 2013, the FASB issued Accounting Standards Update No. 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists" ("ASU 2013-11"). ASU 2013-11 amends the guidance related to the presentation of unrecognized tax benefits and allows for the reduction of a deferred tax asset for a net operating loss ("NOL") carryforward whenever the NOL or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. ASU 2013-11 is effective for annual and interim periods for fiscal years beginning after December 15, 2013, and early adoption is permitted. Since ASU 2013-11 relates only to the presentation of unrecognized tax benefits, we do not expect our adoption of ASU 2013-11 in January 2014 will have a material effect on our financial position, results of operations or cash flows.

Critical Accounting Policies and Estimates
The Company reaffirms the critical accounting policies and our use of estimates as reported in our Form 10-K for the fiscal year ended December 31, 2012 . As described in Note 1, Nature of Business and Significant Accounting Policies," of the Notes to the Consolidated Financial Statements included in the Form 10-K for the fiscal year ended December 31, 2012 , the determination of fair value for stock-based compensation awards requires the use of management’s estimates and judgments.

22



Contractual Obligations
There were no material changes to our contractual obligations outside the ordinary course of our business during the quarter ended September 30, 2013.


23



Item 3.
Quantitative and Qualitative Disclosures About Market Risk

As of September 30, 2013 , the Company has not experienced any changes in market risk exposure that would materially affect the quantitative and qualitative disclosures about market risk presented in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012 , other than the following:
Interest Rate Risk
Our exposure to changes in market interest rates relates primarily to interest paid on our floating rate long-term debt. Our floating rate long-term debt consists of the $150 million borrowed under our term loan facility that bears interest at the one-month LIBOR rate plus a scheduled spread. Fluctuations in market interest rates will cause interest expense increases or decreases on such long-term debt.
As our risk management objectives include mitigating the risk of changes in cash flows attributable to changes in the designated one-month LIBOR rate for the term loan facility, we entered into interest rate swaps for the aggregate notional amount of $150 million and fixed interest rates of 1.016 percent and 0.97 percent effective at the time the term loan was drawn to hedge this exposure. Changes in the cash flows of the interest rate swaps are expected to exactly offset the changes in cash flows attributable to fluctuations in the one-month LIBOR based interest payments. The net effect of these swap agreements is to convert the floating interest rate basis to fixed rates of 1.016 percent and 0.97 percent.
See Note 5, “Derivative Financial Instruments-Interest Rates,” Note 11, “Credit Agreements,” and Note 13, “Long-Term Debt,” of the Notes to the Consolidated Financial Statements and Item 2 of Part I, “Management's Discussion and Analysis of Financial Condition and Results of Operations,” for additional information on the Company's interest rate risk.



Item 4.
Controls and Procedures

Evaluation of Disclosure Controls and Procedures
As of September 30, 2013 , the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as such term is defined in Rule 13a-15(e). Based on the evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective such that information required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
Changes in Internal Control Over Financial Reporting
There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ended September 30, 2013 that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting.

24



PART II. OTHER INFORMATION

Item 1.
Legal Proceedings

The Company is subject to legal proceedings, claims and litigation arising in the ordinary course of its business. See Note 15, “Contingencies,” of the Notes to the Consolidated Financial Statements for additional information on the Company’s legal proceedings.


Item 1A.
Risk Factors

There has been no material change in the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012 and Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013.


Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

During the three months ended September 30, 2013 , the Company repurchased the following shares:
 
Period
Total Number
of Shares
Purchased (1)
 
Average
Price Paid
per Share
 
Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs
 
Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs (2)
August 1 to August 31, 2013
500,000

 
$
32.44

 
500,000

 
 
Total
500,000

 
$
32.44

 
500,000

 
20,014,479

(1) The share repurchases were through open market transactions.
(2) All share repurchases are subject to applicable securities law, and are at times and in amounts as management deems appropriate. On February 6, 2013 , our Board of Directors authorized the repurchase of up to 25.0 million shares of our outstanding common stock. This authorization will expire on February 6, 2015 .


25



Item 3.
Defaults Upon Senior Securities
None.


Item 4.
Mine Safety Disclosures
Not applicable.


Item 5.
Other Information
None.


Item 6.
Exhibits

Number
  
Description
 
 
 
10.1