OSI Systems Inc (OSIS) 2004 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the OSI Systems, Inc. fourth-quarter 2004 fiscal year end conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Thursday, August 26, 2004.

I would now like to turn the conference over to Mr. Victor Sze, General Counsel for OSI. Please go ahead, sir.

Thank you very much, and good afternoon. On the call today are OSI Systems Chairman and CEO Deepak Chopra; the President of the OSI Security Group, Ajay Mehra; Dave Tilley, interim President of Spacelabs Medical; and OSI's Chief Financial Officer, Anuj Wadhawan.

During our presentation this afternoon, we will make forward-looking statements concerning upcoming events and our expectations regarding the Company's financial performance. Each time we do, we will try to identify these statements with words such as expect, believe, anticipate or other words that indicate potential events. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those in the forward-looking statements. Please consider the risk factors contained in today's press release and stated during this conference call, as well as the risk factors described in our latest Form 10-K filed with the SEC.

For a limited time, we will make a webcast replay of this presentation available on the investor relations section of our website. Our website address is www.OSI-systems.com. Please note that the date of this conference call is August 26, 2004. Any forward-looking statements we make today are based on assumptions that we believe to be reasonable as of today. We undertake no obligation to update these statements as a result of future events.

Finally, this conference call is the property of OSI systems, and any recording, reproduction or rebroadcast of this conference call without the express written consent of OSI Systems is prohibited.

I'll turn the call over now to our CEO, Deepak Chopra.

Thank you, Victor. I want to welcome everybody to the OSI Systems fourth-quarter and fiscal 2004 conference call. 2004 has been a busy and exciting year for us. We had record revenues of 95.8 million for the Q4 and 247.1 million for the year. Mr. Wadhawan, the CFO, will go more into the details on the financial numbers.

2004, from the start, has been very busy for us in acquisitions. We have done approximately five acquisitions in the year, with three of them in the optoelectronics and defense electronics sector, ARACOR in January in the security, and our largest acquisition, Spacelabs, on March 19 for the medical sector.

The Q4 has been an extremely busy period for the management. We have been busy in integrating the Spacelabs Medical Company into OSI. Q4 was the first full quarter for Spacelabs under OSI since we acquired them from General Electric on March 19, 2004. I am happy to report that Spacelabs revenue for the quarter was 41.7 million. This in its perspective weights (ph) to an annualized revenue of approximately 167 million, compared to trailing 12 months unaudited revenues of 150 million.

We are very excited about the Spacelabs products. Spacelabs introduced their new patient monitoring product line, Ultraview, on June 1, 2004, which has been very well-received in the marketplace. Not only did Spacelabs have a great revenue for the quarter, but I am very pleased to report that Spacelabs was profitable and contributed positively to the OSI earnings.

We are busy integrating our medical product lines -- namely Spacelabs, Dolphin Medical and Osteometer -- into the OSI medical group, and looking at various integrating strategies, as far as marketing and sales are concerned.

On the manufacturing side, as mentioned in our previous conference call, we have started integrating Spacelabs outsourcing into OSI companies to leverage our manufacturing. The contribution from this effort through the operating margin should start in Q3 2005, which is the January-February quarter, and is targeted for full integration by end fiscal 2006.

Dolphin oximetry product line continues to grow through our exclusive US distributor, CONMED. We are also looking at the possibility of Spacelabs' distribution channel to start carrying Dolphin Nellcor-compatible sensors under the Spacelabs trade name, especially to cater to the Spacelabs installed base, which, as mentioned before, is approximately 100,000 units, with 60,000 units in US, 30,000 in Asia and 10,000 in Europe.

Our medical group is approaching the critical mass needed. Its revenue is approaching approximately $175 to $180 million annualized rate. Our challenge continues to be to stabilize Spacelabs, integrate the various medical products into the OSI medical group and build customer confidence and loyalty. Of the facilities, we are also looking at the facilities in the medical product line to see if there is any consolidation possibility.

Security group -- this year has been a challenging year for the security group. A year ago, we had a $20 million hole in our revenue going into 2004, due to one-time InVision order. We are very happy to report that we have filled this void by growth both in the conventional and cargo product lines. Overall, our security business, excluding InVision, has grown approximately 16 percent from 2003. This has come both from generic and our strategic acquisition of ARACOR for large cargo.

We continue to invest heavily in R&D in the security area, with Rapiscan x-ray and gamma products, Ancore's pulsed fast neutron activation and thermal neutron activation products, and ARACOR's mobile x-ray Eagle systems, which we believe rounds it to the broadest product line in the industry.

We have made good progress in our EDS endeavor to compete against InVision and L-3 in the checked baggage arena, with our ongoing development of high-speed electronic CT. Results are very promising, and so going forward, we have increased our R&D spending in this product, and expect beta products to be available in the first half of calendar 2005 or Q3-Q4 of fiscal 2005.

Although domestically, large cargo market continues to be slow, we remain optimistic with over $10 million of new bookings in large cargo in the last two months from the international sector. Our large PFNA installation in El Paso is scheduled to be handed over by late fall of this year. Overall, our security business continues to grow, and we are optimistic about its future and continue to invest in product development, marketing and sales and infrastructure.

Opto group -- as mentioned earlier, this business continues to be soft. Our growth, although, has come from strategic acquisitions. Our contract manufacturing business has shown growth both externally and is very busy integrating Spacelabs outsourcing.

Our defense electronics business is quite weak, especially the weapon simulation product line. We are looking at various alternatives, including consolidation of facilities, reengineering the product line, et cetera. This portion of the business going forward is especially quite weak in Q1 and Q2 2005. Overall, for the full 2005 year, we expect all three product lines -- security, medical and opto -- to grow profitably.

We have also decided, due to the different segments needing different manufacturing, engineering and management, to look at various alternatives including, as mentioned in our news release, to start segmenting by this quarter, Q1 2005, onwards, on the segmentation from geographically to business segments. In addition, the Company is exploring and evaluating various strategic reorganization options for its business segments, although it's at very early stages.

And with that, I will hand it over to Anuj to talk about the financial numbers.

Thanks, Deepak. Good afternoon, everyone. On the financial highlights -- the Company's revenues for the fourth quarter of fiscal 2004 increased 88 percent to 95.8 million, compared to 50.9 million for the last year's fourth quarter. Revenues from security and inspection side of our business for this quarter were 31.4 million or 33 percent of total revenues. Revenues from optoelectronic and medical imaging side of our business were 64.4 million or 67 percent of total revenues.

The net income for the quarter was 2.2 million, compared to 5.2 million for the last year's fourth quarter. Diluted earnings per share was 14 cents, compared to 35 cents for the last year's fourth quarter.

Revenues for fiscal 2004 were 247.1 million, compared to 182.6 million for fiscal 2003, an increase of 35 percent. Revenues from security and inspection side of our business for the year were 117.8 million or 48 percent of total revenues. Revenues from optoelectronic and medical imaging side of our business were 129.3 million or 52 percent of total revenues.

The net income for the year was 10 million, compared to 15.8 million last year. Diluted earnings per share were 65 cents, compared to $1.09 for the last year. Diluted earnings for the fourth quarter included a 5 cent charge for management retention bonus and 2 cents for the amortization of intangibles and fixed assets recorded in connection with the Spacelabs acquisition.

To give you the breakdown of revenues, on the security side of our business, revenue decreased 10 percent to 31.4 million this quarter from 34.9 million for the last year's fourth quarter. Revenues for the year decreased 2 percent to 117.8 million this year from 120.8 million last year. Revenues for the fourth quarter of fiscal 2003 and for fiscal 2003 whole year included shipments of 2 million and 19 million, respectively, to InVision compared to zero for the fourth quarter of fiscal 2004 and 347,000 for fiscal 2004. The decrease in InVision revenue was offset in part by increased sales in conventional business and in large cargo, primarily due to acquisition of ARACOR. Excluding shipments to InVision, security revenues increased for fiscal 2004 by 16 percent. On the opto and medical imaging side of our business, revenues grew 301 percent to 64.4 million this quarter from 16 million for the last year's fourth quarter.

For the year, revenues grew 109 percent to 129.2 million from 61.9 million last year. The increase in opto and medical imaging side of our business was primarily due to acquisitions of OSI Electronics, OSI Defense, OSI Laserscan and Spacelabs. These acquisitions revenues for the quarter and the year were 49.8 million and 70.6 million, respectively, and was offset in part by a decrease in revenues from defense optoelectronics.

Gross margin for the quarter was 38.2 percent, compared to 32.2 percent for the fourth quarter of last year and 31.8 percent for the third quarter of this year. Gross margin for the year was 33.7 percent, compared to 32.8 percent last year. The change in gross margin was mainly due to inclusion of Spacelabs shipments, which has a higher gross margin. We expect gross margin for the first quarter of fiscal 2005 to be similar to fourth quarter of fiscal 2004.

R&D for the quarter was 6.7 million or 7 percent of revenues, compared to 2.4 million or 4.7 percent of revenues for the fourth quarter of last year. R&D for the year was 14.6 million or 5.9 percent of revenues, compared to 8.9 million or 4.9 percent of revenues for last year. The increase in R&D was largely due to increased R&D spending on security side of our business and inclusion of R&D spending of acquisitions, especially Spacelabs. Approximately 3.6 million of R&D costs of recent acquisitions were included in the fourth quarter of fiscal 2004, as we have excluded R&D spending for the development of high-speed electronic CT and expect R&D costs to increase.

SG&A for the quarter was 26.1 million or 27.3 percent of revenues, compared to 8.1 million or 15.9 percent of revenues for the previous year's quarter. SG&A for the year was 54.2 million or 21.9 percent of revenues, compared to 29.2 million or 16 percent of revenues for last year. The increase in SG&A in the quarter and the year was primarily due to increased headcount in sales and marketing, and increased administrative expenses, and inclusion of SG&A expenses of acquisitions and higher legal costs associated with L-3 litigation.

An increase in the SG&A compared to the third quarter of fiscal 2004 was primarily due to inclusion of full quarter's SG&A expenses of Spacelabs. Approximately 16.7 million of SG&A of recent acquisitions, especially Spacelabs, which inherently has higher SG&A, and 635,000 of legal costs associated with L-3 litigation were included in the fourth quarter of fiscal 2004. And approximately 20.5 million of SG&A's of recent acquisitions and 1.8 million of legal costs were included in fiscal 2004.

Our tax rate for the quarter was 27.7 percent, and tax rate for fiscal 2004 was 25.3 percent, compared to 29 percent for fiscal 2003. The reduction in tax rate for fiscal 2004 was due to favorable redefinition (ph) of a tax contingency. Our tax rate is dependent upon the mix of income from the US and foreign locations due to tax differences between countries.

Our balance sheet remains very strong. We have approximately $40 million in cash and over 60 million in bank lines of credit.

Our DSOs are approximately 76 days, compared to 85 days last year.

Our backlog at the end of June 2004 was approximately 87 million, including cargo backlog of approximately 14 million. Since then, we have booked over 10 million in large cargo orders.

On the guidance, we reiterate our revenue guidance of 392 million for fiscal 2005, and our revenue guidance for first quarter of fiscal 2005 to be approximately 90 million, diluted earnings per share between 9 to 11 cents before management retention bonus, and amortization expenses related to Spacelabs acquisition.

With that, I will open it up for questions.

(OPERATOR INSTRUCTIONS). Tim Quillin, Stephens, Inc.

If you could break down your $90 million revenue guidance between security, optoelectronics and Spacelabs, I would find that extremely helpful.

Tim, we sort of have not sort of fine-tuned it, but we can give you some idea. The medical side, which is primarily Spacelabs, is approximately half, about 45 million, with Spacelabs being the big chunk of it, close to 41 to 42 million. The remaining half is security and opto, are difficult to break down a little bit in that, but I think that the security business is pretty much like the historical plus/minus 1 million or 2, depending on where certain large cargo (ph) falls. Opto is the weakest, with OSI Defense and the defense electronics being the weakest sector.

What is the reason for the weakness in the defense electronics business? Is it a disconnect in orders on the MILES business that you expect to pick up later in the fiscal year, or is it weakness that we might see forever?

Well, a combination. Basically, the plus primarily is the delay, especially internationally, for the MILES or weapon simulation kind of programs. But more than that, also, we were working with Lockheed on the MILES 2100, and basically Lockheed lost that contract for the time being, which hasn't had -- it has had an effect on us. We were banking upon that, but it's what I call for the time being that there is more activity going on.

There's lots of activity, both domestic and international, in that product line. As you know, that cycle -- if you miss one cycle it takes some time to get back into the cycle. So the way I want to leave you the message with it is that portion of our business has had some very good couple of years, and now we are in a valley, sort of, that some times to come, couple of quarters, it's going to be down. We are re-looking at it. We are re-looking at strategic alliances besides Lockheed with other players. We are looking at reengineering some of the products. But overall, that sector is weak, and our projections for the coming year, especially for the first half of the year, is weak for the sector.

Right. And then, as far as the -- so the $90 million, in order to get to your full-year guidance, you have to have a pretty good ramp-up over the course of this year. Is there any particular areas -- I mean, are you going to have to have better than 5 percent sequential growth in every quarter to get close to your guidance? Is there any particular area that is going to drive that growth, or an area where you have confidence you're going to see that kind of growth?

Well, firstly, if you look at what Q4 was, Q4 came in at $96 million. So if you take $96 million and you annualize that, you are pretty much there. So the way that you look at that is that besides the weakness in the opto, especially in the defense electronics, we are projecting healthy growth in both the security sector and in the medical product line. I mean, if you just annualize the number that I gave you for the medical, it's about $45 million of what was Q4, and you multiply by 4, you are already looking at about $180 million rate for the medical group. So that we expect and feel quite comfortable of the guidance for 392 million for the whole year, and kind of historically, Q1 is always weak for us.

On the other hand, Spacelabs, which is a new addition to the product line, historically has a very strong December quarter. And maybe, David, you can comment on it why. But historically, December quarter is a very strong quarter for medical products.

That has always been the case with hospital end-of-year's contributing greatly to that in the US.

We are also, Tim, still projecting that security will continue to grow so that both sectors, security and medical, will grow. In addition, opto will also grow, but the defense electronics sector is weak.

Right. So the key is really to refill that defense electronics business over the next couple quarters. What kind of revenue from large cargo did you book in 4Q?

I think Q4, David, was approximately 9 million.

And the retention bonuses -- what are your expectations going forward? Is this going to be at the same run rate over the next few quarters, or a little bit lower than that over the next few quarters?

We have received, at the close, close to about 5.9 million. And out of that, 2 million was expensed in GE, and we have expensed 1 million in the fourth quarter. The balance was left at about 3 million over 6 quarters.

So the rate, the answer your question is, on a quarterly rate, it is going to be less than the rate this time, because this retention had an extra loading-up for some of the employees which had a 90-day window to pay some retention bonuses.

And just lastly, the cost related to the L-3 litigation -- do you expect those to drop off here in the next few quarters?

Well, you know, that's a difficult question. We basically have committed to all of you to report as we spend. We are right now -- maybe the better way to answer that is the status is that we are waiting for judgment from, or the guidance from the judge to go -- Victor, do you want to --

Yes. There's currently -- both sides have summary judgment motions submitted to the court, and we are waiting for a response from the court on those. So right now, we're in a little bit of a quiet time in that case. But when you start talking about quarterly periods, a lot of things happen in litigation during quarterly, three-month periods, and that’s a little bit difficult to predict on that basis.

But we did state in the last conference call that we expect that the judge will give a ruling whether the case goes forward. In that case, when you start getting spending more money into it, you are into the trial period. Or the judge might say by looking at all the discovery that you guys have provided, we don't have a valid case. In that case, it stops.

So what Victor is saying is that we're in a lull period right now, and I think we are confident we can say that July-August-September quarter will be lighter than the previous two quarters.

Jeff Rosenberg, William Blair.

First, you gave us the gross margin expectation for the current quarter. Can you give us a sense, on an absolute basis, how much operating expenses are likely to change? Are we just looking at sort of negative leverage as you have less revenue, is why we're seeing lower EPS, or are you going to be able to reduce expenses somewhat quarter on quarter?

Well, Jeff, I think, as we said in the last conference call, this is a (inaudible) quarter with full Spacelabs into it. I think Q4 is a good example of the fixed costs going forward. And you are absolutely right; you can see it from a 95.8 million quarter earnings contribution to a 90 million. And then you can basically look at our guidance and take the rest of $300 million into the Q2, Q3, Q4; and you definitely leverage your costs.

So the answer is yes. You basically are in a mode where Q4 is a good representation of the cost. Anuj, do you want to add onto it?

Yes. Give-and-take -- I mean, our R&D, as said, may go a little bit higher. SG&A, with the litigation, may go a little bit lower. But overall, it will be in the same neighborhood.

And if you look out over the course of -- I don't know if it's all of next fiscal year, or maybe even to the full course of bringing manufacturing in-house, what magnitude of gross margin improvement are you targeting, as you go through this process with Spacelabs?

I think that our margins overall -- obviously, depending a little bit on the mix -- is approaching close to the 40 percent (ph) range. And again, like we said last time, and I said it in my talk before, the present margin of Q4 does not reflect the added contribution by the manufacturing that is moving from outsourced Spacelabs to inside the Company, which is scheduled to kick in by the Q3-Q4, and should be completely assimilated by the end of 2006. So as that kicks in, you will see some additional margin improvement, maybe a point or so.

So somewhere in the low 40's is where you're hoping to achieve as you go through this integration?

That's right. And also keep in mind that one thing -- as our opto business weakens, it has weakened, their margins tend to be lower than the security and the Spacelabs, so that all of the revenue is going to be in the 90 million region, the margins should be quite good.

Given all that, can you give us some sort of feel, if you look out past the next couple of quarters as you have got lower revenue, what sort of operating margin you are trending toward, I don't know, a year from now? I mean, just in terms of as we try to think about thinking about earnings a few quarters out?

I think if you build the $300 million over 3 quarters, look at Q4, give or take some, as the baseline for fixed costs, that means that you are operating between 39-40 percent operating gross margin. If your cost structure in the same plus-minus something, that tells you pretty good of what your earnings potential is for the next couple of quarters and next year. And increase R&D a little bit; I think even on the R&D Spacelabs is pretty much in line to where it's going to fall. Security -- pretty much we have increased it and now you are going to see some incremental (inaudible) more into it as we go into our CT. But I would think that Q4, give or take a little bit, Jeff, is a good example of the fixed costs.

Ajay, could you provide some color on -- I guess most of the orders you have seen after the quarter in cargo are in that Dubai and Korean order -- what sort of equipment that was from your various different product lines, with just a little bit more detail on that business you won there?

You know, most of that equipment is x-ray-related. I really don't want to go into the particulars, for competitive reasons. We did announce also an order from Hong Kong on there as well. So it's been on the x-ray side. We are obviously looking at other areas, as well. We're looking to deliver our first units very shortly on the TNA side to the U.S. Air Force. That should happen towards the latter part of this quarter and next quarter, and I think that will give us leverage on how these units work, and what they do with automatic detection. So we're looking again on large cargo, both internationally, activity is strong domestically. We have got our first system in place for ARACOR Eagle. We expect that to be accepted by US Customs over the next few days. It's in the port of Savannah, in Georgia. And I think, once that's in place, obviously you would want to talk to customs how they like the system and what the future potentials are.

Deepak mentioned what is going on with PFNA. We expect that system to be there in the late fall. So I think we're seeing the momentum growth, even though right now in the US it is slow. But hopefully, over the next few months, we will see that change.

Is there any revenue from things like the PFNA from a percentage-of-completion perspective? Are you seeing any revenue from that, as you finish up the project?

We have seen a little bit, and I think there is a little bit leftover as it is. But the majority of it is already taken care of, since we're approaching the end.

I think, Jeff, just to add onto it is that besides cargo, as we said last time, even without the full quarter (ph) of TSA, conventional business both domestically and international continues to do well.

It sounds like if you said you had 9 million in cargo revenue, you did another quarter sort of in the low 20's on conventional. Is that right? It sounds like it's holding pretty steady at the levels it's been at recently?

Yes, it is.

(OPERATOR INSTRUCTIONS). Andy Schopick, Nutmeg Securities.

First, I would like to ask just in a general sense why -- what are the primary reasons why large cargo remains slow domestically? How much of it's political, how much of it is just other factors?

I don't know whether cargo is Democratic or Republican.

There's a lot of compelling reasons why this should be a very large opportunity for the Company.

We think so. We have continued to invest for the last couple of years in broadening our product portfolio, and we're confident in saying that we have the broadest portfolio in cargo. I think the thing to do is that this is not like a checked baggage quick decision, with very few containers getting inspected, incoming. This is a very big challenge for the government. It's just trying to grapple around, get their arms around what technology works, what are they looking for. There are no standardization. And we have said that in previous conference calls. One of the reasons why the El Paso system is very important -- because that is going to be used as a site by the US Customs to test various technologies against PFNA, and be able to hopefully come out with some kind of standards that everybody can apply to.

The second thing is that, while this looks like it's slow domestically, everybody does understand that this is one challenge that the US government has. But it's not a sole problem of US. It is going to involve your trading partners. So a lot of the trading partners, especially in Asia, continue to build up their strategy of how they are going to inspect their requirements and needs are a little different. They not only want to cater to the security angle for the export out, but they also have a duty of vision or duty retrieval (ph) dollars for goods coming in. So they look at that as maybe a return on investment. They look at that in combination to what they need for the security side. And slowly and slowly, we as a company are one of the very few companies in this space that we continue to build an installed base outside United States, with various technologies in the international sector, which will help us as the total sector starts looking at what is really needed.

So, though it's slow, we continue to make inroads. And our business, slowly but surely, in cargo continues to grow.

Okay, couple of more. How much of your current revenue expectation for the current fiscal year includes government programs yet to be funded? Are there any issues with respect to funding in relation to your revenue projections?

Ajay, do you want to take it? I mean, we are not very dependent on -- we have said that.

You know, we have said that before. We look at our commercial side of our business; obviously the government side of our business is growing from where it used to be. There are always funding issues. In terms of what funding is left, what needs to get done, we don't particularly look at that, because we're not looking at large amounts of funding coming in, like InVision or L-3; we're looking at with their examiner machines or their other CT machines. So it's not something, really, to look at. Obviously, funding is always an issue. But we really look at it from a quarter-to-quarter basis. And as, I think, Deepak pointed out, if it becomes government-mandated on the cargo business, then we would, obviously, be looking more and more in terms of what government funding is.

Okay. Also, on the comment about the reassessment of the value of Spacelabs, the potential here for an adjustment, if you will, in the purchase price, can you comment a little further about what is involved there, what the timeframe might be in terms of any final decision on this $25-plus million downward purchase adjustment?

Well, the way that the contract is, like in any other deal, at the time of close, there are purchase price adjustments, depending upon the balance sheet or the capital that we inherit. They had given us some information of the closing. We had a finite number of days to respond back with our analysis, which we have done. Now, GE has a finite amount of time to look at what we have forwarded is the price adjustment of 25.4 million. And the way the system works is they will get back to us; either we will both agree, or then we both have the ability to ask for like arbitration, independent audit from our side, auditors from their side, and then a third party will look at it. In the end, common sense will prevail, and it will get settled in. It's not black magic; it's accounting. And we're hoping that it’s over the next three to four months.

Okay. It does represent a significant percentage of the actual purchase price that you paid.

That is a good observation.

And lastly, Spacelabs. Are there specific margin goals that you are trying to achieve, or that you believe are obtainable in the business, as we progress through the fiscal year? Can you give us some guidance on what you would like to operate that business on, on kind of a stand-alone basis? And how much deferred tax credits or NOLs are associated with that business?

The second one is more easier to answer. It's zero.

Zero?

Yes. And the first one is we have said the industry norms -- and Spacelabs is operating in the industry norms -- are in the low to mid 40's.

On the gross margin?

Manufacturing gross margin. So that our target is in that area. And then we are going to -- as we mentioned before, we are in a unique situation that if we can bring more and more manufacturing in-house, we might have an extra play of a point or two in manufacturing gross margin, compared to other competitors who are not vertically integrated.

But at the operating margin level, is this a 10 percent, more or less, kind of business? Or what is your expectation, in terms of what you would like to achieve in operating profitability for Spacelabs?

I think that I would like to say that the range, though you might not like the answer, is maybe between 6 to 11 percent. It's going to take us some time to get into that mode, but I think a target of double digits is a good target.

Steve Gish, Roth Capital Partners.

Deepak, you talked a little bit about the Company's broad product portfolio, which was enhanced with ARACOR and Ancore, and you also talked about the CT-based development. Have you given any thought to either licensing, purchasing or developing a technology or to have a competitive product for the explosive trace technologies, the bomb sniffer type stuff?

Well, mostly I am going to start off by saying that we never comment on what are the other things we're looking at. But after that, I would say that we have already started investing, as we have told you, in the EDS side of the business, to competing with L-3 and InVision. But that leaves one sector untouched, means trace detection. I would think, as good managers, we have got to look at that sector, too.

And for my clarification, does ARACOR include a nondestructive testing piece?

The answer is yes, though Ajay mentioned in the last conference call that that portion of the business is a pretty small portion of the business.

Yes, very small.

Is that an area that you see that there could be potential growth that you might pursue more aggressively?

Are you trying to refer to it that some other company is trying to divest a portion of NDT (ph)?

Maybe.

You know, we are a real opportunist company. We look at it, though I would like to say that that's not a primary focus. On the other hand, portions of that business are interesting to us.

And in the last conference call, you talked about the XRD1000 participating in the breakable (ph) cargo trials. A couple of your competitors mentioned recently participation in those programs in several airports. Is OSIS still participating?

Do you want to take that? The thing is that, number one, Steve, as you know -- and you have been very astute in this environment -- government was only looking at originally certified systems. We are not certified. We took our bad term (ph) and was very happy that the government would consider to do testing. They did. We are not certified EDS, but we had weakness to begin with. The preliminary tests came out that we had some weaknesses, and now we are addressing them, retesting them, reconfiguring our software. That program is in very early stages. We are getting the units tested, both for jet baggage internationally and domestically, and in the breakable cargo. But I would not say that OSI should be considered as a direct shoe-in compared to the L-3 and InVision if they lean towards a certified EDS system only to do the breakable cargo.

And the 10 million in additional backlog you mentioned -- does that include the $7 million cargo order plus the 2.4 million in service, or is there another order?

(multiple speakers). It includes those 2, yes.

It includes those 2.

And on the turn (ph) business for security, was any of that business with the TSA? If not, where are your systems being fielded? What types of industries?

Do you want to answer if there is any TSA? Because the other side of the business, we are only going to tell him, we're not going to talk about it.

There was a small amount of TSA machines in there. But in terms of where the other business is, I think for competitive reasons I'd rather keep quiet.

Steve, we are not going to dodge your question. But it's a very competitive market. Everybody protects very closely their customer base, except for the large ones, which everybody and our competitors know, and we did announce the Hong Kong. But that business continues to do well, and it's both -- we have said it in the last conference call, both domestically and internationally. But to go beyond that, we feel uncomfortable.

And just one final question. You have already kind of talked about this a little bit, but with respect to Spacelabs, is there any low-hanging fruit on the SG&A line that we could see some cuts from here in the near term?

I am going to answer the opposite way, that as I alluded in my talk, that the trailing 12 months was 150 million. Their first quarter, at 41.7 million, already pushed them at about 167 million rate. I would think that, as we have said, towards the 392 million total company projection, that I think that the better way to look at it is it is leveraging your SG&A and R&D and marketing kind of thing by extra revenue, and we feel very comfortable to say that Spacelabs revenue should grow. December should be a strong quarter for Spacelabs. That is historical.

Brian Ruttenbur, Morgan Keegan.

I just have a couple questions. First of all, on the charges in the quarter, the amortization and management -- I know there was a couple questions around that. And it looks like going forward, you're going to have six more quarters of management incentives, of charges for that. Then, how long is the amortization charge going to go, if I'm correct on the first assumption?

Well, the first thing you have said is both of them is right, except that somebody asked before, to Anuj, it was heavy loaded on the retention bonus for this quarter. We have approximately $3 million left, spread over six quarters, approximately. So that number should go down, but it's there.

On the other issue, it's going to continue at 2 cents per quarter until it gets resolved. And once it gets resolved with GE, it could have the possibility of a reduction, it could have the possibility of completely disappearing, or it could have the possibility of a one-time gain.

And, again, the timing -- you said that that would be resolved?

Well, we think -- and this is a very systematic approach to this. I think, in the next three to four months, but might slip a month or so. Basically, it's right now being discussed between the two companies, and it should come to a conclusion soon.

The backlog -- also, a second question on backlog. You said you had 87 million of backlog at the end of June, and you said 14 million of that was cargo, and you have increased your backlog by 10 million since that time, as I recall, previously, in the conference call. What is your current backlog, then, in total, currently?

It's the middle of the quarter. It's going to be difficult. We can give you a little bit better indication that at the end of June, Spacelabs backlog was also about 20-plus million.

22 million.

22 million. It was pretty much in line to what we said in the previous conference calls. I don't know, to answer your question specifically, in the middle of the quarter, because some of the backlog -- you know, we don't know what we shipped. We haven't put the numbers together into it what we booked. The cargo is the one that -- because you guys ask all the time, and large cargo doesn't normally ship at the same quarter we book. So we have sort of taken the time to go break that down for you.

And the last question just real quick. Cash generated from operations -- do you have that, cash for the balance sheet that you generate?

For the year, (multiple speakers) we have used about $8 to $9 million in operations. Primarily we're building up inventory for higher projected shipments, and our receivables are up because of higher shipments.

How about in the quarter? Do you have that?

I don't have it handy with me.

Do you anticipate generating free cash in 2005 -- I'm talking about cash to the balance sheet -- or do you anticipate using cash in fiscal 2005?

For fiscal 2005, I anticipate we will be generating cash from operations.

Do you have an estimate on that, a range?

It's kind of difficult, because the timing of the shipments, and as we get the orders, we may build up inventory. It's kind of difficult to give the number exactly what the number is going to be. But definitely, we are pretty much there in terms of working capital, and as a result, we anticipate we're going to be positive in generating cash from operations.

Also, on top of that, Brian, when we settle with GE, we should get some decent amount of cash from them.

Gentlemen, there are no further questions at this time. I'll now turn the call back over to you. Please go ahead.

Thank you very much. In summary, this has been an exciting year. We definitely are aware of it, that our earnings are down, and we are looking at -- the consolidation continues. First quarter is weak. We are looking at the opto area, as I mentioned, the consolidation. But the medical business we are very excited about. The security business we are very excited about. We continue to invest in R&D, and we are well-poised for after the El Paso tests. Hopefully, some standardization comes out it, and our varied hybrid technologies in our installations worldwide, we should be able to capture full amount of that business.

With that, thank you very much.

Ladies and gentlemen, this concludes the conference call for today. We thank you for your participation, and ask that you please disconnect your lines.