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 by the Company 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 year ended December 31, 2009.

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All 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, 2010.

Reclassification

A reclassification of $9.3 million has been made from other current assets to other current liabilities on the December 31, 2009 balance sheet to properly classify the balance of value added taxes payable as a current liability. This reclassification had no impact on previously reported results of operations or shareholders' equity.

Note 2. Accounting for Convertible Debt

In June 2003, the Company issued $210 million of 3.0 percent senior convertible notes due in 2023. The net proceeds from the issuance were approximately $203.9 million. The Company determined that the expected life of the notes should be seven years since the notes were first redeemable in June 2010. The Company estimated that its nonconvertible borrowing rate for debt with a seven year maturity issued in June 2003 was 6.0 percent. Accordingly, the value of the liability component of the notes at the time of issuance was $174.4 million and the value of the equity component was $35.6 million.

In June 2010, the remaining $58.8 million of the outstanding convertible notes were converted into 5.3 million shares of the Company's common stock in non-cash transactions.

The carrying amounts of the convertible notes are as follows (in thousands):

The unamortized discount and issuance costs were amortized through May 2010. The effective interest rate of the convertible notes was 6 percent. Interest and amortization expense of the convertible notes recognized in the Consolidated Statements of Income are as follows (in thousands):

Note 3. Stock-based Compensation

Stock-based compensation expense and related tax benefit recognized in the Consolidated Statements of Income are as follows (in thousands):

Stock-based compensation costs capitalized in inventory are as follows (in thousands):

As of September 30, 2010, the Company had $34.9 million of total unrecognized stock-based compensation costs, net of estimated forfeitures, to be recognized over a weighted average period of 1.9 years.

The fair value of the stock-based awards, as determined under the Black-Scholes model, granted in the three months and nine months ended September 30, 2010 and 2009 was estimated with the following weighted-average assumptions:

The 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):

The total amount of cash received from the exercise of stock options in the three months ended September 30, 2010 and 2009 was $5.6 million and $4.0 million, respectively, and the related tax benefit realized from the exercise of the stock options was $2.8 million and $1.9 million, respectively. The total amount of cash received from the exercise of stock options in the nine months ended September 30, 2010 and 2009 was $9.0 million and $10.4 million, respectively, and the related tax benefit realized from the exercise of the stock options was $5.7 million and $6.1 million, respectively.

Information with respect to stock option activity is as follows:

Information with respect to restricted stock unit activity is as follows:

There were approximately 124,000 shares issued under the 2009 Employee Stock Purchase Plan during the nine months ended September 30, 2010 and there were approximately 4,749,000 shares available at September 30, 2010 for future issuance.

Note 4. 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):

The effect of stock options and restricted stock units for the three and nine months ended September 30, 2010 that aggregated approximately 517,000 shares and 421,000 shares, respectively, and for the three and nine months ended September 30, 2009 that aggregated approximately 830,000 shares and 663,000 shares, respectively, has been excluded for purposes of calculating diluted earnings per share since the effect would have been anti-dilutive.

Note 5. Fair Value of Financial Instruments

As of September 30, 2010, the Company had $259.8 million of cash equivalents, 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 as of September 30, 2010 was not significant. The Company does not have any other financial assets or liabilities that are measured at fair value.

Note 6. Foreign Currency Exchange Rate Risk

The Company's foreign businesses enter into contracts with customers and vendors that are denominated in currencies other than their functional currencies. To protect the functional currency equivalent cash flows associated with certain of these contracts, the Company enters into foreign currency forward contracts. The Company's activities involving foreign currency forward contracts are designed to hedge the changes in the functional currency equivalent cash flows due to movements in foreign exchange rates compared to the functional currency. The foreign currencies hedged are primarily the Euro, the Swedish Kronor, the British Pound Sterling, and the Australian Dollar. The Company manages exposure to counterparty non-performance credit risk by entering into foreign currency forward contracts only with major financial institutions that are expected to fully perform under the terms of such contracts. Gains and losses on foreign currency forward contracts are recognized in income at the end of each reporting period based on the difference between the contract rate and the spot rate. The net amount of the gains and losses related to outstanding derivative instruments recorded in income for the three months and nine months ended September 30, 2010 was a net loss of $2.1 million and a net loss of $4.4 million, respectively. These gains and losses are offset on the statement of income by the reciprocal gains and losses from the underlying assets or liabilities which originally gave rise to the exposure.

Notional amounts are used to measure the volume of foreign currency forward contracts and do not represent exposure to foreign currency gains or losses. The table below presents the notional amounts of the Company's outstanding foreign currency forward contracts by currency at September 30, 2010 (in millions):

At September 30, 2010, the Company's foreign currency forward contracts had maturities of 45 days or less.

Note 7. Accounts Receivable

Accounts receivable are net of an allowance for doubtful accounts of $2.9 million and $2.0 million at September 30, 2010 and December 31, 2009, respectively.

Note 8. Inventories

Inventories consist of the following (in thousands):

Note 9. Property and Equipment

Property and equipment are net of accumulated depreciation of $131.3 million and $102.9 million at September 30, 2010 and December 31, 2009, respectively.

Note 10. Goodwill

The carrying value of goodwill by reporting segment and the activity for the nine months ended September 30, 2010 is as follows (in thousands):

Note 11. Intangible Assets

Intangible assets are net of accumulated amortization of $67.6 million and $53.0 million at September 30, 2010 and December 31, 2009, respectively.

Note 12. Accrued Product Warranties

The following table summarizes the Company's warranty liability and activity (in thousands):

Note 13. Credit Agreements

At September 30, 2010, the Company had no borrowings outstanding under its Credit Agreement, dated October 6, 2006, with Bank of America, N.A., Union Bank of California, N.A., U.S. Bank National Association and other Lenders, and $8.5 million of letters of credit outstanding, which reduces the total available credit to $291.5 million.

On July 7, 2010, the Company entered into an uncommitted letter of credit agreement with Bank of America to support letters of credit whose expiration would extend beyond the current Credit Agreement. At September 30, 2010, the total value of letters of credit outstanding under this facility was $6.5 million.

Note 14. Long-Term Debt

Long-term debt consists of the following (in thousands):

Note 15. Shareholders' Equity

The following table summarizes the common stock and additional paid-in capital activity during the nine months ended September 30, 2010 (in thousands):

During the nine months ended September 30, 2010, the Company repurchased approximately 1.3 million shares of the Company's common stock under the February 2009 repurchase authorization by the Company's Board of Directors pursuant to which the Company is authorized to repurchase up to 20.0 million shares of the Company's outstanding common stock. This authorization will expire in February 2011.

Note 16. Comprehensive Earnings

The following table sets forth the calculation of comprehensive earnings for the periods indicated (in thousands):

Note 17. 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. On August 11, 2008, Raytheon Company was granted leave to file a second amended complaint. The 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 second amended complaint and counterclaims 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. On October 27, 2010, the parties finalized the agreement which results in a payment of $3 million by the FLIR Parties to Raytheon. The agreement entitles the FLIR Parties to certain license rights in the patents that were subject of the Patent Claims. It is anticipated that the parties will appeal certain rulings of the district court to the United States Court of Appeals for the Federal Circuit. 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.

On July 10, 2008, William J. Parrish and E. Timothy Fitzgibbons (collectively, "Plaintiffs") filed an action against FLIR Systems, Inc. its affiliate Indigo Systems Corporation (now known as FLIR Commercial Systems, Inc.), Earl R. Lewis and James A. Fitzhenry (collectively, "Defendants") in California Superior Court for the County of Santa Barbara asserting claims for negligent and intentional tortious interference with prospective economic relations. The claims arose from a prior action in the same court in which then-defendants Parrish and Fitzgibbons prevailed. On November 20, 2009, Plaintiffs amended their complaint to add a malicious prosecution claim, as well as two additional claims for negligent and intentional tortious interference with prospective economic relations. The original tortious interference claims have been dismissed as have the later-filed tortious interference claims as to the individual defendants. On July 19, 2010, Plaintiffs further amended their complaint to name the Company's former counsel in a prior action as a defendant. The claims against the former counsel were subsequently dismissed without prejudice. The case is currently set for trial in March 2011. Defendants intend to vigorously defend themselves in this matter and are unable to estimate the amount or range of potential loss, if any, which might result if the outcome in this matter is unfavorable.

Note 18. Income Taxes

As of September 30, 2010, the Company had approximately $13.2 million of net unrecognized tax benefits of which all $13.2 million would affect the Company's effective tax rate if recognized. The Company anticipates a 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 statutes of limitations.

The Company classifies interest and penalties related to uncertain tax positions as income tax expense. As of September 30, 2010, the Company had approximately $320,000 of net accrued interest related to uncertain tax positions.

The Company currently has the following tax years open to examination by major taxing jurisdictions:

Note 19. Operating Segments and Related Information

Operating Segments

Operating segment information is as follows (in thousands):

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):

Long-lived assets by significant geographic locations are as follows (in thousands):

Major Customers

Revenue derived from major customers is as follows (in thousands):

Note 20. Business Acquisitions

In May 2010, the Company acquired all of the outstanding stock of Raymarine Holdings Limited ("Raymarine"), a leading provider of a comprehensive range of electronic equipment for recreational boating and light commercial marine markets, for approximately $177.8 million in cash.

The Company has recorded $63.9 million of identifiable intangible assets and $85.5 million of goodwill, in conjunction with the Raymarine acquisition, which has been recorded in the Company's Raymarine business segment. Goodwill consists largely of the ability of the Company and Raymarine, working together, to grow the combined businesses through the integration of each other's products, market presence, distribution channels and domain knowledge.

The preliminary allocation of the purchase price is as follows (in thousands):