OSI Systems Inc (OSIS) 2005 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the OSI Systems Incorporated quarterly earnings 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, October 28, 2004. I would now like to turn the conference over Victor Sze, General Counsel. Please go ahead, sir.

Thank you and good afternoon. On the call today are OSI Systems' Chairman and CEO, Deepak Chopra, the President of the Security Group, Ajay Mehra, 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 to 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.

During today's conference call, we may refer to both GAAP and non-GAAP financial measures of the Company's operating and financial results. For complete information regarding non-GAAP measures, the most directly comparable GAAP measures and a quantitative reconciliation of these figures, please refer to today's press release regarding our first-quarter results. The press release will also be filed with the SEC as part of a Form 8-K.

For a limited time, we will make a webcast replay of this presentation available on the Investor Relations section of our Web site. Our Web site address is www.OSI-systems.com.

Please note that the date of this conference call is October 28, 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 expressed written consent of OSI Systems is prohibited.

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

Thank you, Victor. Once again I welcome everybody to the Q1 2005 conference call.

First-quarter 2005 revenues came in at 87.6 million with earnings per diluted share of 12 cents before a 4 cent charge related to Spacelabs' amortization and retention expenses.

Mr. Anuj Wadhawan, the CFO, will cover the financial highlights. I'm going to talk maybe longer than the normal conference call this time to talk about the various business segments of OSI Systems and the dynamics in these segments.

As mentioned in our previous conference call in August, we committed to start segmenting our business into three operating segments, namely security, medical and Optoelectronics manufacturing, and corporate separate. Both security and medical segments of our businesses are primarily end-product businesses, whereas our Optoelectronics business and manufacturing is an OEM sector where we supply, to end-product manufacturers, key components and subsystems. Not only do we supply to other end product manufacturers, but this growth also supplies inter-company through the security and medical groups of OSI. This makes us a unique company and allows us to be more proactive, both in supplying quick-delivery products and technology innovations. It allows us to leverage our manufacturing and capture additional manufacturing margin.

Opto Group's external revenue for this quarter and was 14.9 million with an additional inter-company revenue of 4.3 million, which gets eliminated in the consolidation. This business, as we have mentioned earlier, inherently has a lower manufacturing gross margin but also has lower related SG&A expenses.

Customers are very broad-based, both in products and geography. There is no heavy concentration in any one segment, although, post-9/11, it has increased its revenue in the defense -- (technical difficulty) -- segment, which as mentioned in our last conference call, is weak and for the foreseeable future continues to be weak.

The other sectors in the commercial environment have more than enough compensated this weakness in the defense Opto sector. This sector caters to a very broad customer base, like in the medical area, scientific instrumentation, construction, security, etc. All these sectors are doing well, especially in the contract manufacturing area. This business segment builds (ph) hardly anything to inventory. Almost all business is done with a planned delivery schedule and on a purchase order and has relatively long-term visibility. All research and development is paid for by the customer, and the majority of the products are custom and invariably key components for subassemblies for the customers. Business is conducted by word-of-mouth and reputation and proprietary technology plays a key role although patterns are very rare. Customers tend to buy not primarily on price but technical and delivery and reliability.

Our forecast for the systems business and the Opto is that it will grow and continue to be profitable for the remainder of the year even though the defense Opto segment will remain weak.

Out of the 4.3 million inter-company shipments, a majority of it was for the security group inside the Company, although, as mentioned previously, that, in the latter part of our fiscal year, the Medical group will become larger than the Security group for this inter-company sale.

Let me talk about the Security group. Revenue for the Security group was 29.9 million versus 23.8 million for first quarter last year, an increase of 26 percent. This business continues to be strong, both domestically and internationally, and also in both segments, conventional parcel and large cargo.

In the conventional parcel sector business, this continued strength is both in domestic and international and even as the U.S. domestic airports under TSA have sort of saturated, many people continue to ask us where is this business coming from, domestic or international? Our answer has always been, in both. For competitive reasons, we cannot answer any more details on where it comes from and because of this, the Company does not disclose all of its orders that it wins.

It is an inventory turn business and the majority of the business booked in a quarter ships in that quarter, or sometimes might flow into the next quarter. Order size can be anywhere from one machine to hundreds of machines. Most models of these machines are standard Rapiscan products with some customization for unique customer requirements.

The majority of the machine is built in-house, in our Malaysian facility, although we have manufacturing both in the U.S. and in the UK, with the electronics and detectors coming from sister companies. Thus, manufacturing margin capture inherently is higher than the cargo business. Also, delivery, which is very important for the customer, is easy to plan and faster than our competitors can react to, which is quite a big advantage.

We have an ever-increasing installed base, which is approximately over 12,000 units of x-ray machines and 30,000 units of walk-through gates, with a very good brand recognition, both for quality and technology innovations.

In the Department of Homeland Security Appropriations Bill of fiscal 2005 that the President just signed, there are numerous line items for enhanced checkpoint security. As we know, one of the fundamental problems facing our airports is passenger throughput. We are working with the TSA on this issue and feel that we will participate in getting our share of the business, as approximately 40 (ph) percent of the domestic airport checkpoint machines are Rapiscan.

The other challenge facing our airports is the need for explosive detection at checkpoint security, both for carry-on and people standing. Our patented electronic high-speed CT scanner, which we have mentioned before, is in development, fits into this for checkpoint security, and our Secure 1000 body scanner, based upon patented backscatter technology, fits into people inspection.

Since the Russian plane tragedy, which is suspect due to suicide bombers, the interest has heightened for these needs, especially for the body scanner. Our business for Secure 1000 body scanner is up from a year ago and is even up from six months ago.

As we mentioned in the last conference call, we have also accelerated our internal R&D spending for the electronic high-speed scanner. Besides checkpoint and people-screening, the other area of growth in this product line is for small-parcel screening, especially internationally.

On the large cargo-screening sector, this business, although slow in growth, has the highest potential of growth. There are many significant line items in the Appropriations Fiscal 2005 Bill that apply to our products and technology. We believe that, as the government starts rolling out this requirement, we are well-positioned with our diversified product line.

We have always maintained that, in the final analysis, this is a solutions and logistics provider product. No one technology or product is a silver bullet. We have continuously invested in R&D to broaden our product and technology platform. We are the only company in this space that has technology and products covering x-ray, gamma and material-specific, both with our PFNA and TNA technology. We offer a broad product line, both with fixed, relocatable and mobile scanners, and are the only company in this space that have successfully deployed hybrid technology products. Our fixed-site and relocatable scanners are placed, over the last year, in many international locations. Our gamma mobile scanners also have been placed at various locations and lately, our mobile high-energy Eagle scanner just got placed and working successfully at the Port of Savannah, Georgia for the U.S. Customs. Two additional such Eagle scanners are scheduled for placement in the near future.

Our Ancore TNA-based mobile scanners just got placed by the U.S. Air Force for Force protection at an undisclosed international base.

Finally, our material-specific PFNA-based large truck scanner starts internal testing in November/December of this year at El Paso with land government handover scheduled for early January, 2005. Just a cautionary note -- that these dates may change slightly, depending upon the customer.

Our backlog in the Security group has increased 45 percent from last winter quarter. Our backlog for cargo has gone up from 12.5 million to 16.5 million for this quarter, and our shipments in the quarter for large cargo were approximately 9 million.

Activity continues to be very strong in this segment. We are working on numerous large, potential, large cargo orders, both domestically and internationally. There are many line items like CSI, port security, air cargo, radiation detection, etc., in the appropriations bill (indiscernible) 2005, which apply to our technology and products. There are also R&D grants money available for various technologies that we feel that are in line for our technology and products.

Our challenge in this product line, beyond El Paso PFNA for truck scanning, is to look at air cargo for PFNA. While break bulk (ph) cargo is being looked at for certified EDS equipment, airports and airlines would rather inspect bulk cargo on a pallet or a ULD without breaking it into smaller packages, and then repackaging them into the ULD, or palettes. We believe that our PFNA technology is ideally suited for this application. Successful trials at El Paso will not only demonstrate our technology for truck-scanning but for other applications like bulk air cargo.

Checked baggage explosive detection -- as you all know that the present systems have two serious drawbacks, mainly throughput and positive false-alarm rate, which makes the in-line installation for these systems very expensive and cumbersome. We believe that our electronic, high-speed 1200-bags-an-hour CT scanner will be a leapfrog technology, as it will reduce the in-line installation cost and space, which is a premium product at an airport. Our goal is to have radar (ph) products for testing in April/June of next year.

So, in summary, we are very bullish about our Security group. We believe that a broad technology and product portfolio will ultimately be the right solution for capturing a broader customer base, both domestically and internationally, and we continue to spend heavily into R&D in this group.

Healthcare -- revenue for the Healthcare group was 42.8 million with the majority of it due to Spacelabs acquisition. We are very happy to report that this is the second consecutive profitable quarter for this group. The products in this group are patient monitors, non-invasive Pulse Oximetry probes and monitors, medical data for new cardiovascular drug-testing and x-ray scanners for osteoporosis. Spacelabs has launched the new Ultraview SL product line of monitors and (indiscernible) clinical suite ICS, a suite of software applications that enables enterprise-wide access to patient data. It has been well-received and our challenge is to stabilize the customer base by giving them comfort that we will be there for them and to go back to the old tradition of what Spacelabs was famous for -- technological innovation.

Initial input is that the customers are very happy to have another alternate for the Big Three. Our job is to deliver innovative products with good quality and service. At the same time, the Spacelabs outsource manufacturing is being brought in-house. As mentioned earlier, although it has already started, we will start seeing the impact in the second half of this fiscal year with full benefit to the operating line next year. The Health group operating income will continue to show positive growth as the year progresses. We believe that, in the near future, it can deliver similar operating margins as its peers, given the time for us to stabilize the growth.

Dolphin oximetry products continue to show very healthy growth from quarter to quarter. Our relationship with our distributor, CONMED, continues to provide higher sales. This business, as mentioned earlier, continues strong growth. Though cautionary, it is still a very small portion of our total revenue. Just to give you the flavor, from about $1 million a quarter, this business is now approaching between 3.5 to $4 million a quarter.

Before I hand it over to Anuj Wadhawan for the financial highlights, on the question of our previously mentioned analysis for strategic reorganization options, we have nothing more to report except we are continuing our fact-finding and analysis and looking at all possible viable options, especially the timing. Thank you.

Thanks, Deepak.

Financial highlights -- the Company's revenues for first quarter of fiscal 2005 were 87.6 million, compared to 38.6 million for the last year's first quarter, an increase of 127 percent. Revenues from the security and inspection side of our business for this quarter were 29.9 million, or 34 percent of total revenues. Revenues from the healthcare side of our business were 42.8 million, or 49 percent of total revenues. Revenues from the Optoelectronics side of our business were 14.9 million, or 17 percent of total revenues.

The net income for the quarter was 1.3 million, compared to 1.3 million for the first quarter of last year. Diluted earnings per share were 8 cents, compared to 9 cents for the last year's first quarter. Excluding a pretax charge of 549,000 for management retention bonus and 354,000 for a charge for the amortization of intangible and fixed assets relating to Spacelabs acquisition, in the first quarter of fiscal 2005, diluted earnings for the quarter were 12 cents.

To give you the breakdown of revenues, on the security side of our business, revenues increased 26 percent to 29.9 million this quarter from 23.8 million for the last year's first quarter. The increase in revenues were primarily due to increased sales in conventional and large-cargo business and inclusion of Aracor's revenue and was offset in part by lower sales to TSA.

On the healthcare side of our business, the revenues grew to 42.8 million this quarter from 3.3 million for the last year's first quarter. The increase in revenues were primarily due to the acquisition of Spacelabs.

On the Opto side of our business, revenues increased 29 percent to 14.9 million this quarter from 11.6 million for the last year's first quarter. The increase in revenues were primarily due to acquisitions of OSI Electronics and OSI LaserScan and was offset in part by the decrease in revenues from defense Optoelectronics. In addition, Opto Group had inter-company revenues from our security and healthcare groups of 4.3 million in the first quarter of fiscal 2005, compared to 2.7 million in the first quarter of 2004, which have been eliminated in the consolidation.

Gross margin for the first quarter was 38.6 percent, compared to 32.5 percent for the first quarter of last year and 38.2 percent of the fourth quarter of fiscal 2004. We expect gross margin for the second quarter to be similar to the first quarter of fiscal 2005. The increase in gross margin in the first quarter of fiscal 2005, compared to the first quarter of 2004, was primarily due to change in the product mix in our security business, inclusion of Spacelabs' shipment, which inherently has higher gross margins and was offset in part by lower sales of defense Optoelectronics, which has higher gross margin, and inclusion of revenues of OSI Electronics, which have lower gross margins.

R&D for the quarter was 6.7 million, or 7.6 percent of revenues, compared to 2 million, or 5.3 percent of revenues, for the first quarter of last year. The R&D spending increased mainly due to inclusion of R&D spending of Spacelabs of 3.6 million and significant increase in R&D spending on the security side.

SG&A for the quarter was 24.8 million, compared to 7.5 million for the first quarter of fiscal 2004. The increase in SG&A for the quarter, compared to last year's first quarter, was primarily due to increased headcount in sales and marketing for our security business, inclusion of SG&A expenses for acquisitions, and an increase in headcount in corporate and professional fees, and was offset in part by lower legal costs associated with (indiscernible) litigation.

Operating income for the quarter was 1.8 million, compared to 1.9 million for the first quarter of last year. Operating income from the security side of our business was 2.4 million compared to 2.2 million for the first quarter of last year. Operating income from the healthcare side of our business was 235,000, compared to a loss of 338,000 in the first quarter of fiscal 2004. Excluding management-retention bonus and the charges for the amortization of intangibles and fixed assets relating to Spacelabs acquisition, operating income for the quarter was 1.1 million. Operating income from the Opto side of our business for the quarter was 1.7 million, compared to 1.3 million for the first quarter of fiscal 2004.

Our tax rate for the quarter was 31.5 percent. Our tax rate is dependent on the mix of income from the U.S. and foreign locations due to tax differences between countries. We expect our tax rate for the six months ending December 31, 2004 will be approximately 28 percent due to retroactively including the R&D tax credits extended by the Working Families Relief Act of 2004, which was passed in October, 2004.

Our balance sheet remains very strong with approximately 25 million in cash and over 60 million in available bank lines of credit. Our backlog at the end of September was over 92 million, including large-cargo backlog of over 16.5 million.

Our revenue guidance for the second quarter of fiscal 2005 to be 97 to 99 million with diluted earnings per share to be 19 to 21 cents before management-retention bonus and amortization related to Spacelabs acquisition. We reiterate our revenue guidance of 392 million for fiscal 2005.

With that, I will open it up for questions.

(OPERATOR INSTRUCTIONS). Euleai Gloomey (ph) with Morgan Keegan.

Hi. This is Brian Ruttenbur with Morgan Keegan. I'm not Euleai (ph). The first question I have is can you explain the cash situation again? I didn't catch that. What kind of cash do you have and what kind operating cash generation or burn did you have in the period?

What we have now is about $25 million in cash, which is lower by about $15 million at the end of the year, June 30, 2004. Out of that, we've used about $10 million for working capital for our Spacelabs and securities businesses, paying down our payables and another about 4 to 5 million have been used to buy back stock and other minority shareholdings in our Dolphin group.

Okay. Can you give us some kind of estimate on cash burn or generation, going forward? Do you anticipate -- you know, in the December quarter alone, do you anticipate cash generation or cash burn?

As you see, we have been probable overall, and it depends upon the timing ho wit goes on the working capital. Overall, for the whole year, we will be generating cash.

Jus to add onto it, to clarify, if you noticed, on the balance sheet, $9 million of trade payables came down. Receivables are pretty much the same; inventory is pretty much the same. So a big portion of the cash got used to pay down trade payables just for the timing.

The second clarification, on the 4 to $5 million of the various things that Anuj mentioned, approximately 107,000 shares at 14.73, about 1.5, $1.7 million got -- $1.6 million got used for the buyback. The other one was the buying the minority interest in Dolphin Medical. The third item was the payment towards Spacelabs for things like the audit and some of the other expenses to do with the Spacelabs closing.

Great. Then on the year -- for the remainder of nine months of this fiscal year, do you anticipate generating cash or using cash from this level?

We expect to generate cash for the whole year.

Okay, great. The final question I had was on -- I'm sure this is going to come up and I might as well bring it up -- a potential spin-off or evaluating strategic alternatives, breaking up the Company, all of that has been talked about. Can you address that and what stage you are in right now and what you think about that?

Well, I think our position is what I said but I anticipated the question. Basically, we haven't completed our analysis; we are looking at it. This is the first quarter that we have segmented the businesses. We're looking at the businesses of stand-alone; we're looking at various other alternatives; we're talking to various bankers; we're getting as much data as we can. Right now, we're not prepared to talk any more detail of which way or what alternate options we are going to work towards. We are still looking at it.

Steve Gish with Roth Capital Partners.

Good afternoon. Anuj, you had mentioned your expectation of the 28 percent tax rate. Just for clarification, do you mean for Q2 or for the six months?

For six months, because this tax has been -- the tax credit is going to be retroactive.

Okay. What was the total backlog at the end of the quarter?

At the end of the quarter, the backlog was $92 million.

When Deepak had mentioned a figure for the backlog and revenue for the cargo group, that includes the acquired companies Aracor and Ancore?

92 million includes that, the total backlog for OSI. In that, we have large-cargo backlog of $16.5 million, which includes Aracor, Ancore and other large-cargo for Rapiscan.

Okay, great. How much were your legal expenses?

Legal expenses, as I say, (indiscernible) litigation was down in the $200,000.

Steve, this is Deepak. Just to clarify the backlog, compared to last quarter, where the same apples-to-apples comparison, backlog went up from 12 million -- (technical difficulty) and a half million approximately -- (multiple speakers).

(Multiple Speakers) -- large cargo.

For the total security group, we haven't given a number but we have said that, from sequential quarter-to-quarter, the backlog for the total security group is significantly higher by 45 percent.

Okay. You know, you have given us the sequential or the year-over-year comparisons for the three Defense segments, but could you help us probably in terms of giving us what those revenues would like on a sequential basis, since you've changed the reporting segments?

Oh, it's difficult, because segments were not properly broken up. I think that you have looked at at least the security. We said, on the last conference call -- (multiple speakers) -- was in the '30s, which somebody asked a question to split even (indiscernible) in the '20s for the conventional parcel; the remaining was cargo. We had also said that 47.5 million approximately was the Medical, which included 41 and change from Spacelabs. So, that is kind the of detail for the last Q4 that we have, but those are the two big sectors.

Did you have any revenue from EnVision (ph) in not this quarter but a year ago in the Security group?

Very little, less than a couple of hundred thousand.

Okay. Then just one more thing -- you had mentioned the operating income for the Healthcare group. How much of that came -- how much of a percentage of that came from Spacelabs versus Dolphin Medical?

Well, we don't break it up into it because I mentioned, in my previous saying, that we have looked at the business into all healthcare. We have taken some segments of the Spacelabs business, namely med data and ABP (ph), combined with osteo and oximetry, so it's no more our Spacelabs and Osteo. Basically, it's patient monitoring; it's oximetry; it's osteoporosis; it's ABT med (ph) data. So some of it's difficult to break it up between that, except we can tell you that the oximetry business, both branded products and OEM, continue to show significant growth from sequential quarter by quarter.

Great. You had talked a little bit about the El Paso site. Will investors have an opportunity to see the PFNA system up and running down there?

I think, once we hand it over to the government, we can definitely talk to the government. It really depends on customs and DOD, what they decide. But we can definitely try and set something up at a later date.

I think the plan was that, during our testing time, we are trying to get a time element before we handover the system for making an open house. Obviously we need permission from the El Paso people.

(OPERATOR INSTRUCTIONS). Tim Quillin with Stephens, Incorporated.

Good afternoon. On your revenue guidance for the second quarter, could you break that out a little bit, you know, by the segments and kind of give us a rough idea of what your expectation is in each of the segments?

You know, we have made a decision that we're not going to break down the guidance right now. All we can tell you is that both the Healthcare sector, which we said last time, and Security, both look like they would grow in the second quarter.

I know Spacelabs tends to be seasonally strong in the second quarter. I mean, how big of a component of the quarter-to-quarter growth is Spacelabs?

It's very early in the game for us to pin a number. I think I would rather have the discussion of the Healthcare group -- because like I said, Spacelabs has a couple of products into it. On the other hand, we are also going into the quarter with a very good backlog in the security area.

Great. Also, to help on comparability -- and I understand it's somewhat hard to break out but I would think, this quarter, you would be able to say how much of the medical revenue was Spacelabs.

Again, the problem is that we have taken the Spacelabs products and broken them by product a little bit -- patient monitoring, which is the biggest product. Med data is the medical data services, ABP is the ambulatory blood pressure monitoring, osteoporosis in Dolphin, so there are a couple of different groups into it and it's very difficult to now break down and give inter-mix on management. It's very difficult to break down into what is Spacelabs, because Spacelabs has multiple products.

Okay. As far as the operating income by segment, I guess if we add up the three segments' operating income, we get to something like 4.3 million, and so I guess the corporate overhead is about 2.5 million. Is that correct?

That's correct.

If you look at the last piece of paper attached to the table, it's 2364.

Okay, I need to read the whole press release. Okay. Anuj, as far as the tax rate goes, beyond the first six months here, what kind of expectations should we have in the second half of the year and forward?

At present, what we're looking ,it's going to be around a 28 percent range for the whole year.

Very good. Thanks, gentlemen.

First quarter is higher, second quarter would be lower but if you average it out for the whole year, it will be around 28 percent.

Thurman Willis (ph).

I'd like to congratulate the management for showing a profit in the Spacelabs segment. I'm a little confused, as a shareholder of recent, as to why your stock trades at the level it does. When you take the recent sales of security businesses, it would appear to me, from your revenues, that your stock, on the security business alone, ought to be trading where it is, of course minus cash. Why is it that management thinks that the Street gives you such a poor reception, considering that all these segments are profitable and the strides that management has made to do such a good job here? I am just a little perplexed by it as we look at enhancing shareholder value.

Then my second question is, the monies that may come from General Electric on the Spacelabs acquisition, could you comment on that?

Well, on the first question, Thurman, management doesn't have any speculative answer. We, going forward -- last conference call, committed to segment the business. We have done that and that gives a much better clarity of the top line and the operating income and could hopefully be a guide to the analyst community to look at the peers and the comps.

On your second question, we basically, at the last conference call, mentioned that our number was somewhere in the 25.9 million. They came back and gave us a number of 7.8 million, approximately. The way the purchase agreement is written, that the next step is a cooling period to try to narrow the gap between the two parties, which we can tell you, at least from management's perspective, there has been no success. So, the next step basically is for both sides to choose their recommended auditor -- arbitrator -- and then it goes to a final ultimate arbitrator, which is binding. We are hoping that, some time by the first quarter of next calendar year, that means by March time period, it will get a settlement. But as our news release says, that whatever that settlement is, it definitely is higher or equal to 7.8 million, and it definitely is maximum to lower of 25.9 million. Whatever the final number would be, it would reduce our amortization.

Thank you. If I could follow up with one other question relative to your litigation with L3? Can you comment on that? I think you stated that your legal expenses during the quarter, relative to that, was 200,000.

The legal expense is down versus last quarter primarily because, you know, the situation is much the same as we described in the last quarter. Each side has submitted a summary judgment motion and we're now awaiting a response from the court, so we are in holding pattern right now.

Again, one other final thing -- your stock repurchase program -- is it 1.5 million, is that correct?

Approximately that's left, about 1.48 and change.

Can you comment on how aggressive management may or may not be in that acquisition program?

I don't know how to answer that. We basically look at, from time to time, what the status is and if past has been any proof of it, we have bought back a total number of 1.5 million shares since the last couple of years.

Well again, I congratulate you on these three segments, breaking that out, and I think the Street will realize the value relative to what you have done. Thank you.

Jeff Rosenberg with William Blair.

Let's see, the first question, just to make sure I understand one I guess housekeeping item -- but the 9 to 11 cents guidance you gave, did that include the tax retention bonus and the amortization, or was it exclusive of that?

It was before management retention bonus and amortization charges but for second quarter, 19 to 21 cents is (indiscernible) retention bonus and amortization related charges.

Thanks, Anuj. If I'm thinking about it right, it sounds like you had about 13 million in large cargo orders this quarter, because you said you shipped 9 and the backlog went up about 4. Can you give us a little bit of detail about what some of those -- I would assume that would include some sizable orders -- a little color there as to where that came from?

The best way for me to answer that -- you know, we obviously don't want to announce every single order we get but, for competitive reasons, especially on the large cargo, we have opted not to announce everything we're getting. So you're absolutely right; we have got the orders but we have not specifically said what they are.

Typically on, large cargo, if you get an order this quarter, it tends to ship out over a longer period of time than a quarter or two. I mean, I guess I'm driving at sort of is -- is there something different in terms of the product mix that maybe it turns faster this quarter, or a little bit of flavor for how that product parcels out over the next couple of quarters?

I think the best way to answer that, Jeff, is that we have some of our mobile systems. We end up shipping them very quickly, within a quarter or two. The fixed-site or relocatable systems tend to take longer, 9 to 12 months, and sometimes slightly longer. Really, I think, at this point, that's all I would like to comment on, on what we're going to do or what kind of business that was.

I think, Jeff, just to clarify what Ajay said, a couple of quarters ago, on a conference call, we did say that, even in the large cargo business, there is a segment, namely the gamma trucks, which we had said we've started building in anticipation and to take that leverage because there was a delivery incentive (inaudible) people who can ship faster, so some portion of even the large cargo business, as Ajay mentioned, is being treated as inventory turns business for us.

I guess I'm just probing as to whether or not that has grown as a percentage of the orders you're getting, because given healthy guidance in terms of growth this quarter and normally, you don't see that sort an immediate pop, so I mean, has there been a shift towards more of that fast-turning business?

I think, for competitive reasons, I hope you can appreciate that we are not trying to dodge it. We would rather not say because we have a very diversified, broad product line, and especially in the international sector, we just don't feel comfortable talking about which product, which place, and how it's coming and going.

That's fair. I was just looking to kind of broadly sort of look for the characterization of it, but that's okay.

Just on the Spacelabs margins, if I'm calculating it correctly, it looks like today you are a little less than 3 percent operating margins. I apologize if I'm not as familiar with what the peer group would suggest or get to but maybe a little bit of color there as to what you are looking for in terms of the operating margin target? More importantly, is it gross margin as you continue to bring in the manufacturing in-house, or is it just leverage of the SG&A? I mean a little bit of where we should expect to see the margin expansion coming from.

To put the right answer to that is, one, is that definitely, in this business, as we mentioned before, it's a pretty leveraged business whereas material is concerned. So that means that, once you cross that magic number of breakeven, as more business comes in, it starts pushing a lot more to the bottom line. So leveraging the SG&A, as the revenue picks up, definitely will improve the operating margin. We have said that that will happen.

The second thing is we have the extra advantage, compared to somebody else, that we also want to bring in the manufacturing, but we want to make sure that we give you the flavor that the manufacturing that we are bringing in-house might not appear on the Healthcare group margin; it might end up in the Opto business margin. Because we've always practiced (indiscernible) transaction on comparative pricing between our end product customer, meaning ourselves, because we do also sell to the end-product competitors of end products, so we want to keep it very fair. So I think it's going to be a combination of both. As the revenue picks up, it will increase the operating margin.

As to your question about where we should be, I think that, given the time and ability by hopefully sometime in next year, there is no reason why the Healthcare group, provided that the revenue remains, should not approach 8 to 10 to 11 percent operating income margins.

How much do you need to grow in order to have the critical mass where that's a target you should expect of yourself?

It's difficult to say but you know, we are already in the positive, we are already profitable. So that means that we are already beyond that number. So that any amount of extra revenue that comes in the Healthcare group will change the operating income line quite a lot.

Okay.

We are saying to you that, over the next couple of quarters, as I mentioned, that the revenue growth is expected, both in the Medical/Healthcare group and Security, both happen to have healthy margins. If you look at our security, even though we shipped 9 million -- and we have said it before -- that cargo tends to have lower margin than the conventional parcel. Our operating income in our segmentation is approaching about 8 percent on the security side even.

Jeff Rosenberg; Yes? But you've been there before, right?

Yes.

Ben Stoler (ph) with HS Capital.

Congratulations on the quarter, guys. Just referring to some comments made earlier, I guess there's a level of frustration building up in shareholders, the current shareholder base, in terms of how you're going to deliver shareholder value. Can you talk about how many dollars were set-aside to explore this process, as well as the financial bankers that you have employed and exactly who they are and what the timing will be? I guess the level of frustration really comes from looking at the other security businesses, let alone just the security businesses that are trading, like American Science, at three times their forward revenue on a TEV (ph) basis versus us that trade at a paltry multiple of 0.6 or so. Just elaborate a little bit about the process and the budget and the timing.

Number one, we're not going to comment on the bankers we're talking to. I think that we have said -- and it's no insult to our present analysts -- we are not talking to any of our present bankers. We are in the preliminary discussions with some big bank houses. We're not going to comment on the budget or so; it's a process we're looking at. There is no comment we can make about ASNE (ph) 3X because that's almost like saying, you know, a couple of quarters ago, they were a different number, people come up and down. We are building a business. We're looking at all options available at this stage but beyond that, it's very difficult to comment of how many bucks we're putting into it. This is not a PR game; this is an analysis of what is best, both for the businesses -- most important -- and automatically, the businesses and the segmentation is the first step. We are not stopping; we have to continue looking at the analysis, but we haven't completed it.

Absolutely, I agree 100 percent but you do have a duty to the shareholders, especially shareholders who have participated in the pipes above, to deliver the shareholder value and deliver on the value that has been created there. There is significant value. I'm a big believer in the Company and I have been for a while, and I believe you are the right person to deliver it, but we need a commitment from you and the Board that that will be delivered in a timely manner.

Well, we have a commitment to the shareholder, as you know, I myself am a large stockholder. We're looking at all alternatives. At the same time, I want to emphasize that segmentation has been a very big step for us to now go show, to the Street, of the businesses, and people can get the comps, they can look at the growth rates. Our revenue in the security business, by our segmentation, is higher than, for example, the quarterly revenue that got reported on AS&E (ph). We have still places to go; we have a broadening of our product line; we're spending a lot of money in R&D.

On the other hand, we also have what we call joined-at-the-hip, which has been a tremendous asset for the business. That business caters to both sides of the businesses. So it's not a simple split that we can just overnight come up with. We're looking at all the answers. Definitely, we assure you that we are not sort of thinking that shareholder value is not important. At the end of the day, that's most important. At the same time, if we do whatever we do, we what must make intelligent decisions that the business, if hypothetically it spins or don't spin-off, so what's leftover is a viable business.

Absolutely, I agree with everything you just said, especially with the last part in that there are three very good businesses, two specifically, and that we need to deliver value (indiscernible) back to the shareholders. Thank you, and good quarter.

(OPERATOR INSTRUCTIONS). We have a question from Brian Russo with Criterion Research Group.

Any thoughts on the timing of the TSA setting standards for a passenger carrying in-baggage screening, and any, you know, factors or issues that are being considered by the TSA?

Could you repeat your question again, please?

Any thoughts or comments on when the TSA might set the new standards for carry-in baggage screening?

Well, right now, we're not aware of any specific timetable of next (ph) standards. I think that, with the new Homeland Security appropriations fiscal 2005 -- by the way, just a side remark, I would recommend that, if people can get a copy of the summary of the Department of Homeland Security appropriations, it's pretty well-defined of the various places of the funding. There is no specific timetable.

I think the thing we talked about -- throughput is very important at a checkpoint. After what happened in Russia, explosive-detection equipment, both for suicide bombers and for the baggage, carry-on baggage, is important. We believe that we have technology to offer in both and we're working with them, but there is no standardization and timing that is being talked about right now. I think it's an evolution.

Okay. My next question is, are you currently involved on the security side in any pilot program sponsored by the TSA? Then lastly -- well, that's all. Thanks.

The answer is yes; we are involved with the TSA on pilot programs. Specifically, we are talking to them right now on the body scanner. There are a couple of other programs we are involved with, which, at this point, I don't think it's appropriate for me to comment on.

Just to add onto that is that there are lots and lots of various places, as I mentioned earlier. As we speak right now, we are being considered and we are in the talk stage with the various government bodies, but we can't comment on it any more.

Have you recently received any grants from the government in security in any of the new projects like the Manhattan project or the Phoenix project?

Well, I would answer that we definitely can tell you, on the Manhattan 2 project, we're not in it. On the other programs, I would refrain from commenting on it because some of them are live and I would think, for competitive reasons, I would rather not say. But, I would add onto it that Manhattan 2 project is approximately 11 small Phase I grants, about 1/2 million on the average each. We are -- in our electronic CT, we've said to the Street, we're not waiting for any government money; we are continuing to aggressively spend money into it and that is geared up specifically for both high-speed, high-throughput CT both for carry-on baggage and with a little bigger (indiscernible) for the checked baggage.

Okay, thank you.

Larry Dunn (ph) with PCI (ph) Partners.

Just congratulations. I have been following you for quite a few years and I've never seen you in such a position now where you could really start getting some orders from a lot of different areas. A couple of quick questions, actually. Could you kind of talk a little bit about your recent order with the Navy? Is that your first order with the Navy? How big could that be and could it lead to other business with the Navy?

Then I know, on your June 3rd, you have an order that included the (indiscernible). I think it was an international order, if I'm correct. I'm just wondering if you shipped that yet.

Then the last is on your Eagle system that you've got up in Savannah. Have you have gotten any feedback, if you could give us a little information on that. I actually have one thing about medical after you talk about that.

Let's start off with the Secure 1000. Whether that order has specifically shipped or not, I don't know, but as Deepak mentioned earlier, we have seen increased interest in the Secure 1000. We were seeing some interest before the Russian airplane tragedy. We've definitely seen some pickup after that. Going forward, we think that segment of the business is going to grow.

Can I ask you one thing about the Secure 1000? Does that have backscatter technology?

Yes, it does. We have patented backscatter technology for the Secure 1000.

You know, that's funny. I was on your competitor's conference call yesterday and they were kind of making it sound like they are the only ones who have backscatter technology because they're getting one product out there.

We can comment on it. I mean, our Secure 1000 with patented backscatter technology has been in existence for the last five, six, seven years. We are very bullish about it. We think that we have a very unique product, have tremendous advantages over the other company you are referring to, like size of the machine, the price and the most important, a lower dosage and possible (inaudible) some unique, patented protection. That's where we stand on that technology.

Do you want to go back, Ajay, to the rest of the question?

As far as the Eagle unit we installed in Georgia, we're getting positive feedback. Obviously, it's a 6 MME (ph) system. The biggest difference there is with what Customs has been deploying has been gamma systems, which can only penetrate through about 175 mm or less of steel. So in other words, they would only go through about 50 percent or less of cargo coming in, versus these machines are able to penetrate anywhere from 95 to 98 percent of containers, so you don't have to unpack the containers. So we have developed this with U.S. Customs, and they are obviously deploying it and we will hopefully get some more feedback, going forward.

Now, if the feedback is real positive from them, is there a chance that could lead to -- I mean, I don't know really how many the U.S. Customs decides at other ports. Is there a chance it could lead to future orders, or is it just one individual spot?

If the feedback is positive, there's always a chance -- (multiple speakers) -- future orders.

Just to comment on that, I didn't say it; we already are -- we already have two additional orders for Eagle, and we are building and we have said that, that the other two are going to be deployed in a very short period. So, we are hoping that not one but three systems will be out very soon, which will give us much better data.

One thing we can tell you with surety -- that there is no other system which can penetrate and have the mobility that is needed at a port, compared to an Eagle. Eagle was specifically designed under the tutelage of U.S. Customs for that application.

Just to add onto that is, you know, we have an original system that had been sold again to U.S. Customs. That is currently being used on the El Paso/Mexico border as well. You had one more question -- (Multiple Speakers).

It was about the Navy and the product, but the one other thing -- on the medical business -- I mean, so there's a chance, let's say, in calendar 2006, you could have a 10 percent margin on a $200 million business, which could give you, like, 20 million in operating income. I mean, it seems kind of reasonable that far out, which would be about, at this point, two times what you paid for the thing and most things will go for 10 times that multiple, you know, at 200 million or 1 times revenue. Is that all crazy, what I'm saying?

Number one, too correct it, we said that, by next year, we could start approaching to the annualized rate of that. Give us a little bit more time, but the rest of your question, I don't know what the 10 times or 5 X is or whether what I paid for it. I think the issue is that we believe very strongly that the business, healthcare business, can approach what the comps out there are and by segmentation and improvement in the operating income as we go forward, hopefully will determine what the valuation is.

I mean, because I was up there visit Spacelabs and I was quite impressed with the people and what you have going there. The big issue is that you paid such a little amount for the company, everyone thinks you got something that is worthless. I guess time will tell them otherwise.

Well, we've had two consecutive quarters of profitability and I understand some of the reservation because of the past accounting and the losses of Spacelabs. We can only tell you that it's been two consecutive quarters. We have said, to the Street, growth for the remainder of the year. We have said it's going to be profitable. We think it's going to be a good, healthy franchise with the additional benefit of manufacturing synergies, not to mention the ability of the installed base and the distribution channel for our oximetry razor blade placement business.

Coming back to your other question about the Navy, Ajay, maybe you want to comment on.

This was a unique product for us. Basically, their x-ray machines are all weather-proof x-ray machines that can be deployed outside at ports or on ships without corroding. So, we think it's a new product for us. Yes, it does open up avenues for us within Navy and DOD. We've done other business with them as well but we're looking forward to the next year.

Thank you very much and a good quarter.

There are no further audio questions at this time.

To summarize it, I want to thank everybody for their patience to listen. I know this is a little longer, and I wanted to emphasize that I took extra time to talk about the segmentation and the various businesses. I'm hoping that if any of you people have any other additional questions, that please do talk to us. We are very bullish on our security business. We have no intention of de-focusing. We've continued to grow that business; we've continued to invest heavily. We continued to what I call short-term earnings sacrifice for putting money and R&D to grow that product line.

One thing that is different and that has been our strategy -- we do not want to make a single (indiscernible) or a single-product company. Now, we are paying the dues. We want a very broad product line, and we believe that patience and perseverance and a broad product line would be the ultimate solution, because there is no silver bullet.

In our Healthcare business, we want to stop thinking about that we got a very good deal. We want to take this franchise, grow the business. Spacelabs, though has had a checkered past, but they also have a very, very know name for technological innovation. We want to get back to it. Customers are very anxious to have an alternate to the Big Three. Our job is to be more nimble; our job is to tell the customers we're there to stay; our job is to take that business, grow that business. If it needs a more broader product line, we have to look at strategic partnerships and whatever else it takes to grow that business profitably.

Our Opto business is a business which is very critical to our other two product lines. It supplies inter-company, which gives us the leverage of manufacturing margin. We are able to learn and deliver product and participate in a very broad product line. Keep in mind that both businesses that we acquired, both business product lines in security and healthcare, fundamentally started our ability to look at those businesses from the Opto side.

With that, we have still challenge to continue to improve our operating margin. We're going to continue to do that. We have a strong backlog, strong balance sheet, stable management and we plan to deliver to our commitment that we've given you. Thank you.

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