OSI Systems Inc (OSIS) 2005 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the 2005 first quarter OSI Systems Earnings conference call. My name is Bill and I will be your conference coordinator for today. At this time all participants are in a listen only mode. However, we will be facilitating a questions and answer session towards the end of today‘s conference. [Operator Instructions]. I would now like to turn the call over to your host for today’s presentation, Mr. Victor Zee, General Counsel. Please proceed, 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, 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 10K 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, and most directly comparable GAAP measures, and a quantitative reconciliation of these figures, please refer to today's press release regarding our third quarter results. The press release will also be filed with the SEC as part of our Form 8K. For a limited time we will make the web cast 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 the conference call is May 4, 2005.

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. And once again we welcome everybody to the Q3 fiscal 2005 earnings conference call. Third quarter revenues were $94.2 million which included $2.6 million from Blease Medical Holdings which was acquired in February 2005. The net loss for the third quarter of fiscal 2005 was $0.18 per share. Mr. Anuj Wadhawan, the CFO, will cover the financial highlights. I’m going to cover the various business segments of the company and how they performed in the quarter.

The optoelectronics and manufacturing group reported external revenues of $17.3 million versus $16.5 million for the second quarter. The Inter-company revenues were $5 million versus $5.6 million for the second quarter. The commercial side of our opto business continues to be strong while the defense opto segment continues to be weak. In the commercial sector, the area that is growing very well is in the medical area. We have started consolidating OSI Defense Systems and Rapitec, our two wholly owned subsidiaries in the defense opto segment.

Most of the marketing and engineering has been consolidated into the OSI Defense Systems Florida operations and all manufacturing has been consolidated into the UDD sensors California plant with only a small engineering group left in Rapitec California facility. This consolidation will continue in Q4 and might spin into the Q1 next year. Commercial opto sales and margins overall more than compensated for the negative performance in the defense opto segment. Inter-company revenue was down from Q2 primarily due to the shipments to the medical group due to the timing issues. The group continues to make progress in capturing additional inter-company revenue, especially for the medical group. This is evident by the nine month results that inter-company revenues increased by $3.6 million to $15 million from 11.4 for that comparable period a year ago. Our overall vision for transporting majority of the Spacelabs outsource procurement to the inside has not changed and is on track. As mentioned previously, the full impact of that will result positively to our margins by late fiscal 2006.

Healthcare group. Revenues were $47.8 million for this quarter. Included in this revenue was $2.6 million from Blease Medical Holdings which was acquired in February 2005. This $2.6 million was approximately for two months, February and March. Blease, a U.K. manufacturer of anesthesia systems, vaporizers and ventilators, was a strategic decision for OSI. In many parts of the world where cross-selling of anesthesia and patient monitoring systems is a common place and although when we bought Spacelabs it included a multi-year license from General Electric for their DatexOmeda anesthesia machine for sale in Europe, we felt that long-term we need to control our own destiny especially if we want to be a global player. We are busy integrating Blease into the OSI healthcare group. As mentioned previously, Blease’s revenue will be earnings neutral short term until we fully integrate it into the group and achieve manufacturing and operating synergies.

Their trailing 12 month revenue before acquisition was approximately 10 million or approximately $18.5 million dollars. Our short term plan for the next two to four quarters is to leverage their installed base worldwide, especially in U.K. and Asia and develop new integrated products with Spacelabs monitors. Our plan is to stabilize that part of the business and that part of the world before entering the U.S. market with the Blease product. As mentioned previously, March quarter traditionally is a softer quarter for patient monitoring sales in the U.S. December, which we had mentioned before and demonstrated was a very strong quarter, especially for patient monitoring revenues.

It is an inventory turns business and can have some shipments which, due to various reasons, can slip from one quarter to the other. Q3 had approximately $1.5 million of shipments for patient monitoring in U.S. That slipped from Q3 to Q4. As you know, this business is highly leveraged and has very high material margins associated with it, with the result that the profit for the healthcare group could have been better for the quarter. This additional revenue would have gone into Q3 and added onto our profits.

Oximetry product line performed to budget. We had mentioned previously that Q3 will not be as strong as Q2. Q4 is forecasted to be stronger than Q3, but not as strong as Q2. We are quite satisfied with the performance of the group overall. This will be our fourth consecutive profitable quarter for the healthcare group, although we still have work to be done to improve our operating margins. Going forward, the company has increased healthcare R&D expenditure on an incremental basis compared to the third quarter run rate. We have a host of new products to bring to the market in the near future. Annualized, our run rate for the healthcare group is reaching approximately $200 million.

For comparison purposes, Spacelabs added 12 month trailing revenue ending June 30, 2004 of approximately $150 million. Right now they are approximately annualized to approximately $170 million, an increase of approximately 13%. This does not include Dolphin Oximetry, Osteometer and Blease products. Our challenge for the growth continues to be to improve manufacturing gross margins, leverage and optimize marketing and sales, and integrate Blease, Spacelabs and Dolphin into the healthcare group. Our plan is to consolidate all these companies into one brand in the near future as we have done in the security group under the name Rapiscan.

Security Group. Revenues for the group was $29 million versus $32 million for Q2. The decrease in revenues was all due to the cargo and vehicle inspection product line. People and parcel scanning product revenues were 24.3 million versus 23.6 million for Q2. Our people and parcel scanning product line continues to perform well. We have a broad product line and we continue to invest heavily in R&D to fill the holes that are products that we don’t have. For example, we do not have a product in automated check baggage area. As we have mentioned previously, we have accelerated our R&D investment in this area, both for the high speed inline integrated system and CT based certifiable systems to compete with L3 Examiner and Envision’s CTX, now GE products.

Our internal R&D costs are approximately $900,000 a quarter for these products. A year ago, this number was approximately half. No revenues are expected until late fiscal 2006. We have also announced a strategic alliance with Implant Sciences for their trace detection products where we have a private label deal for their handheld and standalone desktop products. This allows us to package these products together with x-ray machines and metal gates at a checkpoint like Smith Industries do. Although we need some additional work to be done as far as packaging and labeling is concerned, it also allows us to look at next generation trace portals to compete with General Electric and Smith Industries and possibly the possibility of integrated x-ray trace products.

Our Secure 1000 products are selling quite well and it is public knowledge that TSA is starting pilot programs to look at these technologies for aviation security. It is also official that we have been in trials for the last 6 months in the U.K. for aviation deployment of Secure as an alternate to pat down search. This whole product line is profitable for the quarter and has always been profitable.

Cargo and vehicle inspection product line. Many of you feel that OSI in their last conference call or other times sound defensive and apologetic when we talk about our cargo initiative. We want to reiterate that we continue to be bullish on this marketplace and continue to invest heavily towards the future. As a company, we have received maximum amount of funding from the U.S. government to develop these products compared to any of our competitors. But it’s not enough. We continue to invest from our own money and absorb losses as we believe when the market makes some standardization, we will have the right product portfolio to cater to the needs.

Last month, Department of Defense conducted an open house at El Paso for our BF&S system. There were approximately 150 attendees with many international invitees This was a Department of Defense Open House, not OSI or Rapiscan. Preliminary results and observations by all present were positive. It so happens that even our Eagle mobile x-ray unit was also in operation and got positive operational feedback from the officers who were using them. We continue to wait patiently and as we have mentioned previously, the Eagle performance report which was due initially end of April, we think will slip to end of May and the pre-FNA, pre-deployment testing pushed the decision-making to sometime in August/September of what we do with this product line. We want to wait until we get some kind of feedback from the U.S. government on these products. In the meantime, we have started work on the Houston BF&A air cargo project. We have also increased our presence in Washington.

Regarding the Gamma products, we are in a bitter patent lawsuit dispute with SAIC. The reason we have not talked about that on our previous conference calls because previously the spend was not that big until this quarter, that is Q3. We believe that their claims are baseless. We believe they are bent upon us walking away from this business so that they can maintain their monopoly. We are not going to give it up. We believe competition is good for the customer. In the U.S., that happens to be the U.S. government. But as it shows in our Q3 numbers, this lawsuit is very expensive. Q4 and near future, it will continue to get even more expensive.

L3 Lawsuit Status. The judge in the case in New York finally gave his ruling. We are very happy with the ruling. Victor Zee will take any questions in the questions and answers. All I want to summarize it are claims for the time being have survived. Case goes forward but unfortunately lawsuits are expensive. L3 litigation cost has been minimal for the past two to three quarters, but it will start ramping up in Q4 due to the discovery phase. We are heavily involved internally with our own resources and our lawyers with the data collection for our damages claim which is due in early June.

On the GE balance sheet dispute, it is still not resolved. We continue to talk but no resolution has been reached The gap between their offer of approximately $8 million and our demands of $25 million are significantly apart. Regarding the bad debt for the last cargo inspection product line that happened this quarter, it’s unfortunate, and in the question and answers, Ajay will take some more questions. I only want to make a comment that it’s very unfortunate, it happened, the dispute is nothing to do with performance. It’s to do with the customer’s inability to pay per the agreed payment terms which forced us to pull our service people out and to put the customer on notice. With that I’ll hand it over to Anuj Wadhawan for the financial highlights.

Thanks, Deepak. Good afternoon, everyone. Financial highlights for the third quarter of fiscal 2005. The company’s revenues for the third quarter of fiscal 2005 were $94.2 million compared to $61.5 million for the third quarter of last year, an increase of 53%. Revenues from the security side of our business were $29 million or 31% of our total revenues. Healthcare 47.8 million or 51% of total revenues, optoelectronics and manufacturing 17.3 million or 18% of total revenues. The net loss for the quarter was $2.9 million compared to net income of $3.4 million for the last year’s third quarter. Loss per share for the quarter was $0.18 compared to diluted earnings of $0.23 for the last year’s third quarter.

Revenues for the 9 months of fiscal 2005 are $284.3 million compared to 151.3 million for the 9 months of last year, an increase of 88%. Diluted earnings for the 9 months of fiscal 2005 were $0.05 compared to $0.52 for the last year’s 9 months. To give you the breakdown on the security side of our business, revenue decreased by $4.7 million or 14% to $29 million this quarter from 33.7 million for the last year’s third quarter. The decrease in revenue was primarily due to a decrease in domestic and international vehicle inspection systems and was offset in part by higher sales of people and parcel scanning products.

Revenue from cargo and vehicle inspection systems for the third quarter were $4.7 million compared to 10.2 million for the last year’s third quarter and 8.4 million for the second quarter of fiscal 2005. Revenues for the healthcare group of our business for the third quarter of fiscal 2005 increased by 453% to 47.8 million from 8.6 million for the last year’s third quarter. The increase in revenues were primarily due to inclusion of revenues from Spacelabs which was acquired in March 2004 and revenues from Blease Medical which was acquired in February, 2005, and increased sales of pulse oximetry products.

Revenues from optoelectronics and manufacturing side of our business for the third quarter of fiscal 2005 decreased by 10% to 17.3 million from 19.2 million for the last year’s third quarter. The decrease in revenues were primarily due to lower sales of electronics from our OSI Electronics subsidiary. In addition, our optoelectronics and manufacturing group captured $5 million of inter-company revenues from security and healthcare groups for the third quarter of fiscal 2005 compared to 4.3 million for the last year’s third quarter. And for 9 months, $15 million this year from $11.4 million last year’s 9 months, which has been eliminated in the consolidation. The increase in inter-company revenues was due to capturing additional business from our healthcare group.

Gross profit. Gross profit for the third quarter of fiscal 2005 was 35.2% compared to 31.8% for the last year’s third quarter and 35.6% for the second quarter of fiscal 2005. The increase in gross margin in the quarter from last year’s third quarter was due to inclusion of Spacelabs shipment which inherently has higher gross margin and also has higher SG&A and R&D expenses compared to our other products. This increase was partially offset by low gross margins from the sale of cargo and vehicle inspection products in our security group. We expect gross margin for the fourth quarter of fiscal 2005 to be similar to the third quarter of fiscal 2005.

SG&A. SG&A for the quarter was 30.3 million or 32.2% of revenues compared to 12.4 million or 20.2% for the last year’s third quarter and 25.6 million or 25% of revenues for the second quarter of fiscal 2005. The increase in SG&A in the third quarter of fiscal 2005 compared to last year’s third quarter was primarily due to inclusion of SG&A of Spacelabs and compared to second quarter of fiscal 2005 by establishing a bad debt reserve of 2.5 million for our international cargo and vehicle inspection receivable, inclusion of SG&A of Blease Medical of $700,000 which was acquired in February 2005, and higher litigation and Sarbanes-Oxley implementation expenses. The SG&A expenses for Spacelabs for the quarter was $14 million compared to $1.8 million for the last year’s third quarter.

R&D. R&D for the third quarter of fiscal 2005 increased to $7.3 million compared to $3.5 million for the last year’s third quarter and $7.1 million for the second quarter of fiscal 2005. The increase in R&D spending for the third quarter of fiscal 2005 compared to last year’s third quarter was primarily due to inclusion of R&D spending of Spacelabs medical and increased spending on security and inspection products. We expect our R&D spending to increase in the fourth quarter and going forward compared to third quarter of fiscal 2005 due to increased R&D spending in our healthcare group. For the third quarter of fiscal 2005, we had an operating loss of $4.8 million compared to operating income of $3.6 million for the third quarter of fiscal 2004.

The operating income for the 9 months of fiscal 2005 was $259,000 compared to operating income of $9.6 million for 9 months of last year. The operating loss for the quarter and decline in operating income for the 9 months of 2005 compared to prior year periods was due to continued weakness in our cargo and vehicle inspection product line, establishment of a bad debt reserve and higher litigation and Sarbanes-Oxley implementation expenses. We had a tax benefit of $2 million in the third quarter of fiscal 2005 compared to a tax expense of $739,000 for the third quarter of last year. Also included in the tax benefit for the quarter a benefit of $626,000 was due to a favorable outcome of a tax contingency. Our tax rate is dependent on the mix of income from the U.S. and foreign locations due to tax differences between countries.

Our total backlog at the end of March 2005 was approximately $93.5 million compared to $96.5 million at the end of December, 2004 and $92 million at the end of September, 2004. Backlog for cargo and vehicle inspection at the end of March 2005 was approximately 20 million compared to 23 million at the end of December 2004. At March 31, 2005, we had 12.9 million of cash and cash equivalents compared to 29.1 million at the end of December 31, 2004.

In addition, we borrowed 7.5 million cash from our lines of credit in the quarter and used $9.3 million for the acquisition of Blease Medical in February 2005, $2.3 million for the down payment towards the purchase of a facility in England and approximately $9.3 million for operating activities. Cash used in operating activities was primarily due to increase in accounts receivable and inventory associated with the timing of the product shipments.

We are revising our revenue guidance to $102 million to $104 million for the fourth quarter of fiscal 2005 due to significant increase in litigation expenses from those incurred in the third quarter and continued Sarbanes-Oxley implementation expenses. The company lacks adequate visibility to provide earnings guidance for the fourth quarter of fiscal 2005. With that, I will open it up to questions.

[OPERATOR INSTRUCTIONS]. Our first question comes from the line of Mr. Steve Gish of Roth Capital Partners. Please proceed, Sir.

Good afternoon. Deepak, you said in your opening comments the Secure 1000 is selling quite well. Can you maybe quantify that a little better for us?

Ajay, do you want to address that?

Obviously Deepak mentioned we’ve been having trials at Heathrow. We’re talking to TSA which you’re well aware of. We’ve had some significant sales in other areas as well, but really for competitive reasons, I’m really not going to go over that. I’m a little uncomfortable with our competitors finding out what we’re doing. But it’s been a very positive 3 or 4 months for the Secure 1000.

Steve, just to add onto it, because I know your next question is going to be can we at least talk about whether it’s domestic or international. We’re not going to answer that. All we can say is that all the sales activity in non-aviation.

Okay. With respect to the security group, if you exclude the cargo on the normal turn business, is the pickup you‘ve seen, is it attributable to this product or is it a combination of products?

I would say without going into - - I don’t have it in front of me, but I would say it is, from quarter to quarter you can understand, backlog will come in and ship some product more than the other, but overall that product line continues to be strong all over. Ajay, you want to add something?

No, that’s true.

Okay, and the retention bonuses related to the Spacelabs acquisition - - how many more quarters do we have of that?

It will finish in October, 2005, so 1.5 more quarters.

Okay, great. And Anuj, can you disclose what the Sarbanes-Oxley expenses have been year to date and what you’ve budgeted for at this point?

For third quarter it was over $750,000 and year to date it’s close to about $1 million.

Okay.

And just to add onto it, it’s approximate and Q4 looks like, because now we’re getting to the June ending, it’s not going to slow down. If at all, it will continue at this rate, including additional resources put by the company.

Sure, and that’s not unexpected I don’t think. And then on the cash flow, the 9.4 million outflow, is that for the 9 months or for the quarter?

It’s just for the quarter. For 9 months it’s approximately $13 million.

Okay, so how much availability do you have on your credit lines?

We have a total worldwide $70 million lines of credit available to us.

7,0?

7,0.

Okay, thank you.

Steve, just to add onto the cash flow for the quarter, as Anuj mentioned, it was also timing related because this quarter the shipments were heavily SKUd towards March. So it ended up, and then some of the - - as you can see, cargo revenue was down and I mentioned in my presentation that there was some missed revenue in the Spacelabs area with the result that inventory increased but inventory is scheduled to go down now at the end of Q4.

Okay, maybe you could just comment on the 2.3 million down payment for the purchase of the facility in the U.K. Is that for the Blease product or for some other product line?

No, that’s on the security group. We’ve been in 3 different facilities for several years. I think moving into one facility increases our manufacturing capabilities, especially with some of the new products on the HBS and cargo side that we’re coming into. It’s going to make us more efficient cost wise as well as from a manufacturing standpoint. As well, we are sharing some of that space with Spacelabs so it cuts some of the costs down as well. So all in all, it was a very good move for us at the right time.

Okay, thanks Ajay.

Thank you very much, sir. Ladies and gentlemen, your next question comes from the line of Mr. Brian Ruttenbur of Morgan Keegan. Please proceed.

Okay, thank you. A couple quick questions. On the tax benefit going forward, it sounds like about $600,000 was one time. Can you talk a little bit about any additional tax benefits you anticipate going forward or was the entire tax benefit that you got this quarter one time in nature?

The $626,000 is just a one time because of a favorable outcome of a tax contingency and going forward on an annual basis, as I mentioned earlier, our tax rate is dependent upon mix of our income between different countries because the rates vary differently from almost 10% to 37%. And also sometimes if you have losses and you take the benefit of the losses, that also makes the effective tax rate vary.

Okay, I guess I’m trying to figure out what kind of tax loss you’ll have this next quarter. And assuming that you have a similar mix this next quarter in terms of revenue, then you would have a similar tax benefit, right?

Our effective tax rate for this year we are looking at around 14 to 16%.

All right. And SG&A, it sounds like SG&A in the fourth quarter is going to be up from third quarter but you don’t know by how much at this point, is that correct?

That’s true and it’s primarily to do with the litigation and Sarbanes-Oxley. The litigation is really a big unknown, Brian, because L3 has been sitting dormant for the last couple of quarters. And Q2 hardly had any SAIC so we didn’t even discuss it. Q3 was a very heavy load, so Q4 is going to be both litigations in full swing. So we cannot really guesstimate, not to mention the dispute with GE. So that’s one of the reasons we saw after what happened in Q3, we just basically got blindsided.

Can you at least talk about your total litigation cost in Q3? How much was it for everything, your litigation?

I can give you an approximate number.

Yeah, I’m just trying to get a ballpark.

Actually, I see the litigation cost was about $800,000 and L3 was very minimum.

Okay. And then the last thing, on your cash flow and your receivables, you anticipate that this quarter will be stronger cash flow, that there won’t be as much weighted to the back end of the quarter?

As Deepak mentioned, we expect inventories to go down and receivables is just going to depend on the timing, if we receive cash on June 29th or July 2nd. But overall for the whole year, definitely we’ll be using, cash utilization will be there from the operating side.

But definitely Q4, Brian, cash requirement will be less because in Q3 we did the Blease, we did the building, and a lot of the shipments were SKUd towards the end of March. That means by May, we’ll start seeing some relief into it and then the question is whether we can ship in a timely fashion or again it gets into the June SKU. But overall Q3 was the heaviest.

Okay, then actually I have one more question. On your credit line, the $70 million credit line, is there any talk of that being cut given your recent poor performance or anything like that, or is that pretty much solid and in place?

We haven’t heard any negation. We have talked to the banks and there have been some covenants which we violated and in fact the bank has given us [inaudible] for that. And absolutely we have not, there’s no negative impact so far because the bank is in tune with what’s been happening with the company.

Okay. Thank you very much.

Thank you very much, Sir. Ladies and gentlemen, your next question comes from the line of Mr. Michael Bartlett of William Blair. Please proceed.

Hi, it’s Jeff Rosenberg. I guess first of all, if you look at your $8 or $9 million sequential revenue growth expectation for the quarter, can you break it down in terms of how you expect it to divide up between the different operating groups?

Yeah, let me take that. Firstly, keep in mind, Blease was only there for 2 months in the Q3, Jeff. So if you just do the same thing for the full quarter, that’s between 4 to 4.5 million would be Blease related. Secondly is we have said that Q4 will be stronger than Q3 in the medical, especially in Spacelabs. Not as strong as the Q2 quarter, but stronger than Q3, but subject to some timing issues again. Sometimes it happens at the end. Security, Ajay, you want to comment? And I think that parcel looks pretty good.

Yeah, I think security looks stronger than it does in Q3. And just on adding on Deepak’s comment, Blease is not 4.5 million overall. Keep in mind we had a couple of months of Blease last quarter. So you’re looking at stronger sales in medical as well as in security as well.

Okay, and similarly, I don’t know if you just addressed this a minute ago, but the schedule for the $20 million of cargo backlog, I mean, is it - - do you expect - - it seems like most of that has been on the books for at least the last quarter in terms of in backlog. I mean, how - - is it over the next 6 months that that should ship out or a significant portion of it? Or how much should we expect to ship in the next 2 or 3 quarters?

It’s a combination. Some of it is shippable the next quarter or two, but keep in mind there are some grant R&D projects in there that we said are one time projects that are shippable over the next 12 months or even longer. So I think you’re going to see that backlog go down or get used up. Obviously we’re looking at the potential of bringing in more orders. But as far as the actual backlog is concerned, it’s anywhere from shipments in the next quarter to the next 12 to 15 months.

Jeff, just to add on to it, if you’re trying to work out your model, we’ll reach to the point where on the cargo area, there is almost like a fixed expense. And whether we ship a couple million more or ship a couple of million less, the losses or the negative contribution by cargo is pretty much in that line where last couple of quarters has been. Because most of the shipments that we have don’t have much margin attached to it.

Right. Okay and switching to a different look at things, my rough calculation is that your guided revenue for this quarter, you’ll be at about operating breakeven, whereas two quarters ago you had a 3.7% operating margin there. Is there anything you can do to reduce expenses to going forward as you look out more than just the next 3 months? Or should we really just look for growth to be the only way back to leveraging and getting back some positive operating income?

Well, Jeff, number one, you should really look at it that when we gave the original guidance a couple of quarters ago, we had no idea about what we expected and what really happened in the litigation side. We underestimated Sarbanes-Oxley, it’s implementation. So that what’s happened is that without saying [inaudible] significantly increased, somebody asked us, Brian asked us what our legal litigations expenses for Q3 were. With just SAIC, it was about $800,000. Now we are saying we are hot and heavy in SAIC and L3. So the question is that that number is so unknown that I would not venture what to make out of that area.

On the other hand, we definitely don’t have a manufacturing gross margin issue as such. Maybe a point this way or that way, but we have said it that our manufacturing gross margins for the company would remain in the same 35, 36% range. SG&A definitely is the place that short term, there is not much we can do to change Q4, because even if we want to look in the administrative side, every pair of hands that is available is doing Sarbanes-Oxley implementation. Every person we can get our hands on is involved in getting data collected together for the damage suit in L3. So it’s not much that we can do in Q4 to look at below line, but we definitely must address that and going forward, we are going to address it and we intend to bear down on SG&A costs.

Okay, thank you.

Thank you very much, Sir. Ladies and gentlemen, your next question comes from the line of Michael, I’m sorry, Mr. Tim Quillin of Stephens, Inc. Please proceed.

Good afternoon. Just to clarify on the fourth quarter you raised guidance by essentially $6 million, and that is what you’re expecting Blease to contribute in the fourth quarter?

No. If you look at the average, Tim, for Q3 the number was $2.6 million for two quarters, for two months. That means if you quarterize it, that number is approximately $4, $4.5 million. So there is growth - - our original guidance a couple of quarters ago of $96 to $98 million, on the higher side we are reaffirming that without Blease, that revenue is still intact, maybe slightly higher.

Okay, so 4 to 4.5 from Blease in the fourth quarter plus the high end of your previous revenue guidance.

That’s right.

Okay, and then if you end up - - it sounds like you expect to be sequentially up in the healthcare group and I think that even if you’re just up a little bit, it looks like you’d be close to 10% year to year revenue growth organically without Blease. Is that realistic?

I think that number is higher. I think I said that without Blease, your organic for the full year, I think you’re going to approach closer to 12%. Just Spacelabs alone is 13% and I know that the oximetry is up, so I think that the number is maybe approaching 13, 14%.

Okay, well that’s good to know. And the operating margins in the healthcare group, I think excluding the retention bonuses in the first 9 months is about 5.7%. And maybe would be a little bit higher in the fourth quarter just because it’s seasonally strong. But were can, from 5.7%, where can it go over the next couple of years?

Well we have said that given some time, keep in mind that 4 quarters ago, the business we bought was losing $20 million. So we are on a positive track. We’ve had 4 consecutive quarters of profit. We think, given time and revenue and leveraging our marketing and our sales organization with Blease and everything put together, stabilizing R&D which we know will increase for the next couple of quarters to get some products out there, dropping out 1 or 2 percentage points on the manufacturing gross margin, we have said before that this product line can get to double digits, 10 to 11% operating income. And the demonstration of that is the December quarter. That means that if we can get it to the 54, 55 plus Blease. So that means that right now if you can get up you can get to $60 million, that means a 5 to 7% more increase, you can get to 11, 12% without even anything else. It’s highly leveraged business.

That’s right. And how about the sustainability of those growth rates? I mean, looking forward into ’06 and ‘07, is it realistic for investors to expect double digit growth from the healthcare group?

I think we have set it for the next couple of years because of the Spacelabs large installed base, because of some of the erosion that now we want to sort of to have that back, combine with Blease, hopefully one plus one is more than two. Hopefully Blease, with our ability to grow, can do better than 10% growth overall for the next couple of years. We definitely internally are projecting double digit growth.

Very good. And just lastly on Sarbanes-Oxley, how do you feel about the potential for material deficiencies or material weaknesses there? Is there - - do you feel like there’s any chance of that happening or are you in pretty good shape as far as Sarbanes-Oxley is concerned? Just where are you right now?

You already know my answer. I don’t know. We are putting every resource that there is availability. I think we have 23 consultants working in various locations for the last quarter. We are trying to get to the end with hopefully no deficiencies but you’ve seen the news that’s coming out from all public companies. I think that if we come back at the end with no black marks, I’ll be surprised. I’m hoping that the black marks are in areas which are not material.

Well is there any particular areas that are causing you particular problems right now?

It’s always the same. It’s revenue recognition, it’s controls for inventory, obsolescence, it’s A/R, accounts receivable, it’s fraud. You’ve got to look at all these and that’s what we are doing. And unfortunately for us, we have 11 companies all over so we have the infrastructure of maybe a much larger company than what we are. But by definition, anything which has more than 5% of assets basically becomes one of the identities that have to fall in place. So we are doing the best we can and right now inside the company money is no object to get to the end.

I don’t think that you’re going to find that our experience is much different from what you see in the news and in the press these days.

Yeah, just because of the disparate companies within OSI, it seems like it could be a particular challenge. And Deepak, I can’t let you go without explaining what you meant by fraud.

Well basically that’s one of the requirements of the entity controls of the risk management and fraud across the board, across the whole company. That is a requirement. Fraud prevention.

Basically the controls over fraud prevention, potential fraud prevention.

Gotcha.

It’s just standard that every company under the cost proposal has to have.

I just wanted you to explain that a little better. It just sounded like you were worrying about fraud.

No. What I’m saying is there are 4 or 5 items which are top of the list of every company.

Understand.

And in one of them, by definition, for example, you have to do the analysis that can the accounts receivable be manipulated? Could you have somebody getting - - you’ve got 2,000 employees working but you’re getting paychecks in the company for 3,000, so you have 1,000 additional paychecks. Can you have the ability that your vendors are getting extra money for material that they haven’t delivered? So those are standard things that everybody has to have. It’s process in place for fraud prevention and those are some of the requirements. And the reason I brought that up is, as late as yesterday, we are putting a team together to now get to the end and these are 5, 6, 10, 12 things that the auditors have said, you must at the end of the finish line, you must have established process controls for these items.

Right. Thank you for the clarity. I appreciate it. Thanks, gentlemen.

Thank you very much, Sir. And ladies and gentlemen, thank you for participating on our Q&A session for today. I’d like to turn the call back over to Mr. Chopra for any further comments he has or any closing remarks he’d like to make. Please proceed, Sir.

Is there any other questions?

We do have a - - it looks like we have a follow up from Mr. Gish if you’d like to take it.

Yes.

Just on the bad debt reserve - - when did you detect that and have you changed any of your procedures to prevent a similar circumstance in the future?

First, we discovered - - we’ve been working for the last 30 days, and frankly speaking, one of the reasons we were late in our pre-announcement, because we were trying to work the issue out with the customer. So we did not get the final resolve until 24 hours before we put the news pre-announcement out. Because as you can imagine, with the result changes all your tax, all your numbers change and we could not have gone with the preliminary news and then said by the way we have a bad debt reserve potential and them come back and put a number. So we had to delay it. As far as what happened to it, it’s shipments of various products including Gamma trucks and some x-ray machines over a couple quarters approximately a year ago. And the customer has inability to pay. We had got some deposits up front and there is nothing we could have done differently and our controls are still the same. We do these businesses as we mentioned to you. We look at the references. We check the capability. We take money up front. These are standard products and we’ve always maintained to you, sooner or later, we’ll get our money back because the machine will stop functioning and we pulled our service people off anyway. So there is no change in control as such that we could have done and it happens.

Okay, and then the Sarbanes-Oxley review of internal control - - is the Spacelabs acquisition exempt from that this first year?

No.

It is included?

Yeah.

Okay, and this lawsuit with SAIC, what court jurisdiction is that in?

That’s in Los Angeles Federal Court.

Okay. Thanks.

Thank you very much, Sir, and at this time we have no further questions in queue.

Thank you very much for listening to us. This has been a tough quarter. We have a lot of work to do. We really believe in our strategy. A couple of you, I’m sure a couple of quarters ago questioned our judgment to buy Spacelabs. I think it was a right move. We believe in broad product lines. Both businesses are growth oriented, growth businesses, have the ability to make profit. All our businesses are profitable except cargo. We want to put the record straight that that is a growth opportunity. We believe into it. We are investing heavily into it. We are receiving funding from the government, there are other grants that we have received of other broader product lines that for competitive reasons we don’t want to talk about it. We definitely have work to do on below line and we are working diligently to pass the Sarbanes-Oxley. And these two litigations that we are involved in is unfortunate but we believe in our rights, and on the SAIC side, we are not going to fold our tent. We have to go forward. That product line fits into our product line and on the L3 matter, we are very happy with the judge’s decision. And we are hoping that both these litigations will come to a conclusion in the next 4 quarters. Thank you very much.

Thank you very much, Sir. And thank you, ladies and gentlemen for your participation in today’s conference call. This concludes the presentation and you may now disconnect. Have a good day.