OSI Systems Inc (OSIS) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2006 OSI Systems earnings conference call. My name is Michelle and I will be your audio coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating an audio question-and-answer session towards the end of today's presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. Victor Sze, General Counsel. Please proceed sir.

Thank you very much and good afternoon. On the call today are OSI Systems Chairman and CEO, Deepak Chopra, 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 10-K filed with the SEC.

For a limited time, we will make a Webcast replay of this presentation available on the Investor Relations section of our Website. Our Website address is www.OSI-systems.com. Please note that the date of this conference call is November 3, 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. Let me once again welcome you all to the first quarter 2006 earnings call on revenue for the quarter. Revenues for the quarter were 101.9 million, an increase of 16% from 87.6 million reported for the first quarter of last year. Net loss for the first quarter of fiscal 2006 was 4.2 million, including some various onetime charges that Mr. Wadhawan will go in.

Mr. Anuj Wadhawan, the CFO, will cover the financial highlights; I am going to cover the various business segments of the Company and how they performed in the quarter and give a brief summary of what is happening in these businesses and their outlook.

Overall, the Company continues to make progress towards returning to profitability in fiscal 2006. In the quarter, we reduced our operational losses when compared to the fourth quarter of fiscal 2005 and expect to return to profitability in the second quarter of fiscal 2006.

Optoelectronics manufacturing group. As mentioned earlier, we have had weak sales for the Defense Opto segment of our business for the past year. But with new bookings announced in this quarter, we feel that segment of the Opto group will start doing well. Our backlog is quite strong in that segment. Overall, the Opto business is looking quite healthy for the fiscal 2006, although in this first quarter, the operating income was down due to the product mix of lower revenues in the higher margin Opto products and increased revenue in contract manufacturing business, which inherently has lower margins. The Opto product line should return to its double-digit operating income in the remainder of the year.

The Commercial Opto area, especially sales to the medical sector for CT scanner medical electronics, has shown some significant growth with our new products. The Security segment, the People and Parcel Screening product line continues to show growth. We continued to invest heavily, as mentioned previously, in the R&D, especially for entering into the automated check baggage product line. We are still on track to introduce our high-speed non-certified product line in the second half of fiscal 2006 and expect to generate revenues in this fiscal year.

High-speed electronics CT product continues to make progress, as mentioned earlier. The body scanner product, Secure 1000, continues to generate revenue and interest from the aviation sector. We did not -- we did announce on October 11, 2005 receiving an R&D grant from the TSA to enhance the backscatter technology for personal screening. We continue to monitor, although cautiously, the progress in the aviation sector, especially in the UK. We believe we are well-positioned to capitalize on this product if TSA goes forward with backscatter technology for passenger screening at U.S. airports.

Cargo and Vehicle Inspection product line. As mentioned in the last conference call, this still continues to be a big challenge overall for us, although we are very happy to announce that our order intake, both from the U.S. government and from international customers, has been quite strong in the last couple of months. Our backlog is significantly up and we believe that there is better visibility today than ever before that the Company has for the next couple of quarters. As mentioned earlier, the quotation activity, especially internationally, continues to look very strong. These booked orders will start shipping in the next couple of quarters, which will improve the overall performance of the Security group.

Healthcare group. The revenue for the Group was 51.4 million, which was up 20% from the first quarter of fiscal 2005. Even adjusting for the Blease acquisition which was completed in February 2005, revenues grew approximately 9% year-over-year. First quarter, as we have mentioned before, is historically the weakest quarter for the Healthcare group. We continue to invest in this sector, and as mentioned previously, have increased our R&D in this branch.

Our manufacturing gross margins for the patient monitoring product line continued to improve due to the Ultraview product line introduction which was launched in August 2004, and the product line will be fully converted to the Ultraview product line by the end of fiscal 2006.

We have also started implementing SpaceLabs' manufacturing practices to the Blease product line which will increase our manufacturing gross margin for the Blease anesthesia machine product lines.

The customer satisfaction continues to improve for our products. We are receiving very good feed back from our customers both in quality and customer satisfaction. September was an all-time high for achieving record bookings in the healthcare sector, especially for the patient monitoring product line. Historically, Q2 is a very strong quarter for patient monitoring sales, especially North America. Our integration of Blease continues to do well and we believe that for the full year Blease, as mentioned earlier, will be accretive to earnings.

The highlight for the Group is its successful IPO in the UK on AIM. This establishes an independent value for the Healthcare group as it pertains to the overall valuation of OSI. Most importantly, it gives Spacelabs Healthcare a strong balance sheet and a stock currency which can be used to grow the business both organically as well as by strategic acquisitions.

OSI post-IPO still owns 80% of the Company with 20% floated on AIM UK. SpaceLabs Healthcare commenced trading on October 31, 2005 under the ticker symbol SLAB, with a market capitalization of approximately $150 million, plus a $35 million debt owed to OSI Systems.

Our overall Company backlog is at an all-time high of $141 million, which is approximately 50% higher than the June ending quarter. These bookings in all segments, especially Cargo and Vehicle Inspection product lines, Healthcare and Opto is the resultant with this backlog. With that, we have great visibility for the remainder part of this year to look at as we implement and execute the next couple of quarters. With that, I will hand it over to Anuj for the financial comments.

Thanks, Deepak, and good afternoon to everyone. Financial highlights. Revenues. Our revenues for the first quarter of fiscal 2006 were 101.9 million compared to 87.6 million for the first quarter of last year, an increase of 16%. Revenues from the Security and Inspection side of our business for this quarter were 27 million, or 27% of total revenues; Healthcare 51.4 million, or 50% of total revenues; and Optoelectronics, 23.5 million, or 23% of total revenues. In addition, the Optoelectronics group had 4.2 million of intercompany revenues from our Security and Healthcare groups which were eliminated in consolidation.

Net loss for the quarter was 4.2 million compared to net income of 1.3 million for the first quarter of last year. Diluted loss per share for the quarter was $0.26 compared to diluted income per share of $0.08 for the first quarter of last year.

In the first quarter of fiscal 2006, we adopted FASB 123R and recorded a stock-based compensation expense of 1.2 million. For fiscal 2005, we did not include any stock-based compensation expense. For fiscal 2006 we anticipate stock-based compensation expense to be approximately 5 million.

In the first quarter of fiscal 2006, we consolidated facilities in our Optoelectronics and Security groups and recorded a restructuring charge of 800,000. Subsequent to the quarter, we have reached a final settlement with a previously disclosed international receivable for our Cargo and Vehicle Inspection product line. Under the terms of the settlement, we have recovered the majority of our equipment and have recorded an additional bad debt expense of 657,000 in the first quarter of fiscal 2006.

To give you the breakdown of revenues, on the Security side of our business, revenue decreased by 10% to 27 million in this quarter compared to 29.9 million last year's first quarter. The decrease in revenues in this quarter compared to last year's first quarter was primarily due to a decrease in revenues in our Cargo and Vehicle Inspection product line by 5.4 million and was offset in part by an increase in Baggage, Parcel and People Screening product line by about 2.5 million.

On the Healthcare side of our business, revenues increased by 8.6 million, or 20%, to 51.4 million in this quarter compared to 42.8 million in the last year's first quarter. The increase in revenues was primarily due to increased revenues from patient monitoring systems and inclusion of revenues of Blease Medical of 4.5 million, which was acquired in February 2005.

On the Optoelectronics side of our business, revenues increased by 58% to 23.5 million in this quarter compared to 14.9 million in the last year's first quarter, primarily due to increase in revenues in the contract manufacturing product line and commercial opto. Our gross margin for this quarter was 36.3% compared to 38.6% for the last year's first quarter. The decrease in gross margin was due to the change in revenue mix, with lower revenues of Cargo and Vehicle Inspection systems and higher revenues of contract manufacturing products, which has lower gross margin.

SG&A for the first quarter was 33.4 million compared to 24.8 million for the first quarter of last year and 35.7 million for the fourth quarter of last year. The increase in SG&A in the quarter compared to last year's first quarter was primarily due to higher litigation costs and Sarbanes Oxley implementation expenses of 2.4 million, inclusion of stock-based compensation of 1.1 million, additional bad debt expense of 657,000. The increase in SG&A was also due to additional SG&A spending to support higher revenues by our healthcare group and the inclusion of SG&A expenses of our recent acquisition of Blease Medical totaling $2.8 million.

R&D for the first quarter of fiscal 2006 was 8.7 million compared to 6.7 million in the first quarter of last year and 9.5 million for the fourth quarter of last year. The increase in R&D spending for the first quarter of fiscal 2006 compared to last year's first quarter was primarily due to increased R&D spending on the development of our hold baggage screening and cargo and vehicle inspection systems. The increase was also due to higher R&D spending in our healthcare group and inclusion of R&D spending of Blease Medical.

Operating loss for the quarter was 6.5 million compared to an operating income of 1.8 million for the first quarter of last year. Operating income for the quarter was negatively impacted by stock compensation expense of 1.2 million, litigation and Sarbanes Oxley implementation expense of 2.4, restructuring charge of 800,000, and bad debt expense of 657,000. Without these charges, our operating loss for the quarter was 1.4 million.

Our tax rate for the quarter was 40% compared to 31.5% for the first quarter of last year. The change in tax rate was primarily due to incentive stock option expense included in the stock compensation expense which does not qualify for tax deduction, and change in mix in income from U.S. and foreign locations due to tax differences between countries.

At the end of September 2005, we had cash of 16.1 million compared to 14.6 million at the end of June 2005. Our cash borrowings under the bank lines of credit at end of quarter were 26.4 million compared to 15.8 million at the end of June 2005. These additional bank borrowings in the quarter were used for working capital and the purchase of capital equipment. As of today we have paid down our bank lines of credit by 22 million.

Our backlog has increased to 141 million, or 50% at the end of September 2005, compared to 94.7 million at the end of June 2005. Of the total backlog, Cargo and Vehicle Inspection backlog has increased to 46 million at the end of September 2005 compared to 17 million at the end of June 2005. We expect our revenues for the second quarter of fiscal 2006 to be 111 million to 114 million and expect to be profitable in the second quarter of fiscal 2006.

With that, I will open it up for questions.

(OPERATOR INSTRUCTIONS). Tim Quillin, Stephens Inc.

Did you say what the large cargo backlog was at the end of September?

46 million compared to 17 million end of June.

46?

Yes.

I'm trying to figure out how to model the Optoelectronics business for the rest of the year. And it sounds like there's a couple of different trends right now. One is that the contract manufacturing business has picked up. I don't know how sustainable that is. And then Defense Electronics should become stronger maybe here in the latter part of the year. Can you just help me figure out relative to the first-quarter revenue of 23.5 million what should I expect here for the next couple of quarters?

I think that -- I can't give you an exact revenue number, but you're absolutely right; the electronics portion of the business inherently is a lower margin business. I think it will remain in the same kind of line. And then, the Defense Opto and the Commercial Opto both should pick up. And what I said was that the way you should model it is that we have inherently historically been in double-digit operating model. And for the remainder of the year -- I mentioned that in my presentation, Tim, that for the remainder of the year it should go into the double-digit model for the operating income.

Does that imply then that the contract manufacturing business is going to drop off?

I can't pin it down to whether it's drop 1 million or 2 million. I don't think it's going to drop, but it might change from quarter to quarter by a couple of million. But inherently it is a low margin business compared to the Defense Opto and the Commercial Opto, especially in the medical CT area that -- we have seen some good growth coming out of that product line that we have been developing for a lot of years. And we think that has better margins. So, that even if the revenue from the Optoelectronic contract manufacturing drops by a couple of million, we think overall the operating income should improve to the levels that we are used to seeing for the previous couple of quarters. This quarter, unusually, was down. But it should bounce right back.

And then, SG&A expenses are kind of inherently difficult to model right now because of the litigation costs especially. But is there -- within the Company, are there initiatives going on right now that would lead you to believe that you can take additional cost out of SG&A and out of overhead throughout the year?

You know, we always keep saying that we have initiatives in place. So, frankly speaking, we -- every quarter we look at it. But if you look at going forward, we have also said that we are hoping that the litigation, though we can't pin it down in a certain quarter -- but the LT trial, for example, moved from originally November into the February time period. So, even if there is some slippage or something, we are hoping that in the next couple of quarters -- definitely by the end of fiscal year -- we will clear out the decks of the two expense of litigations we are involved in. And, obviously, the Sarbanes Oxley is going to taper off. And we believe that if you look at our guidance for Q2, and you look at what we have said that Q1 inherently is the weakest for the medical area. And as you see the backlog increasing significantly in our product lines, especially large cargo. As those result into shipments, your SG&A as absolute dollars might not change much, except that reduction of the Sarbanes and the litigation going away. But as a percentage of revenue as Q2, Q3, Q4 powers upwards, you start seeing as a percentage of revenue that SG&A will come back, come down.

Very good. Just one detail on the tax rate. What tax rate should we expect for the remainder of the year?

It will be -- I think it will be pretty much in the same range what we have for Q1, at about 40%

But you've got to look at -- just to add on to it -- one of the things that's going to happen is that with the Spacelabs Healthcare now, as that changes and as the foreign subsidiaries make more money compared to the U.S. side, it might have some impact over on the taxes. So, I would think that it is weighted so much from one quarter to the other, conservatively I think if you use 40 or slightly below 40, that's where it is going to fall.

That's fair. Deepak, on kind of the big picture now with the medical business, you kind of alluded to using the stock now that you have in Spacelabs to make acquisitions. I mean, what are the next steps in building that business and what are your goals for that business over the next couple of years?

We have always maintained and we have shared with you that we believed that it was important for us strategically to unlock the value, or what I call it, at least to even get any value from the healthcare group from the parent company evaluation. And we have demonstrated that. We believe that we want to grow the business -- organic growth which we think we are targeting towards is a 10, 11%. And we think that with the right strategic acquisition, using the currency -- whether it's balance sheet, which is unencumbered 20, $25 million (indiscernible) line for the Spacelabs Healthcare group -- they have cash, they have currency. If we could go there with strategic acquisition, as you know that it's a leverage business that you can really leverage the SG&A of the healthcare business if you can find something else which is complementary and tack onto the Spacelabs product line. We believe that we can grow that business aggressively quite fast beyond the 10, 11% organic growth. But keep in mind, we don't have (indiscernible) identified already right now of the company that we want to go after. We have some targets. We have some ideas what we want to do. But it's going to be a tedious process to find the right acquisition and then to negotiate the right price. But we definitely have shown our aggressive nature to grow that business. And we believe we can grow that franchise quite fast.

In the meantime, our idea is to continue to squeeze margin improvement, continue to operate towards the model that we have said that as the revenue picks up, we can get into the double-digit operating income model. We were able to demonstrate it last December quarter that it operates to about 9%, and we believe we are sitting now with an all-time record bookings. We believe that this is going to be a very strong quarter for medical in the December quarter.

One last question if I may. You talked about profitability or achieving profitability in the current quarter, in the second quarter. But it is a seasonally-strong quarter for Spacelabs. Should we think about going back to a breakeven level in the March quarter because of the Spacelabs seasonality, or do you expect to stay profitable for each of the remaining quarters of the year?

Keep in mind that revenue does definitely define the profitability. We believe that we can continue to -- we have always been -- we will continue to be profitable, as we have historically proven, both in the healthcare sector and the opto sector in the March quarter and the June quarter. I think the real challenge is what are we projecting for the security business. And maybe Ajay can answer. But with a $47 million backlog versus 17 million for just the large cargo, as that starts shipping out into the March and the June quarter, overall the Company should start approaching towards profitability not just because of a strong quarter from the medical group. The people and parcel scanning business is showing growth, it is profitable. And if we can get this litigation behind us, we should definitely get all cylinders fired up. Ajay, you want to add something?

Yes. I think you put it very well. We are looking at the security group. All signs in the security group right now are positive. Our backlog, not just in the cargo but in our conventional business, is up as well. Cargo business, as Anuj Wadhawan pointed out, has gone from 16 to 46 million. Some of it we are able to turn very fast; some of it is going to take us a quarter or two. We feel very encouraged and very comfortable that our visibility has grown tremendously. So, all indications in the security group right now are positive.

I'm just going to add on to it. One of the things as you model -- obviously, we are all learning like all the companies, and we are the first ones out of the gate with this FASB cost for the stock options. And we -- you should figure that in. We have given you an indication of what we look at right now, estimate for the whole year and for this quarter. But we believe that we have the right things going forward. And with some more bookings that we expect in the cargo business, we believe that what's going to happen in Q2 should be looked at as hard work sign (ph) that we are turning the corner towards profitability for the remainder of the year.

Brian Ruttenbur, Morgan Keegan.

Just trying to understand the current quarter, first of all. Can you tell us where your current cash and debt is? As I calculate, you're at 27 million of cash and no debt. Is that correct, or is that incorrect calculation on my part?

Currently, what (indiscernible) 27 million what we have received from this Spacelabs IPO. And out of that, we had take down about $22 million in debt. And balance, we're going to keep it with the Spacelabs.

Let me back up and just say -- can you tell me how much debt and how much cash you have right now?

Currently at the end of September I have about $16 million in cash and $25 million in debt.

How much cash do you have right now and how much debt do you have right now?

Maybe the way we should answer it is -- because right now is a very difficult number --

I see what you're saying, because things fluctuate in the middle of the quarter.

The macro picture is that after returning 22 million, which we did -- we got $22 million from the proceeds that Spacelabs Healthcare paid to the parent company to get down its debt intercompany of 57 million down to 35 million, which was an intercompany debt. 22 million that OSI Systems received we paid back to the bank debt, which was almost our cash borrowings that we had. Obviously, we have some LCs out there, and maybe a couple of million more outstanding in various parts of the world. But basically, you can call it as that we are almost debt free, except for some LCs of 8, $9 million (indiscernible) and a couple of million dollars on the -- borrowed from various places. On the other side, Spacelabs Healthcare has approximately 5, 6 million cash plus float, maybe another 6 or 7 -- so, about 11 million cash, 25 million approximately borrowing capacity, and the rest of the Company has another 20-plus million borrowing capacity.

Another way to look at it, Brian -- you look at the cash at the end of September, and you've got basically in Spacelabs an additional $5 million because of what we raised. So, we don't know what the exact cash number is, but you can probably calculate it yourself there.

That helps me a lot. Thank you. The next question I have is -- is the right way to look at your quarter ex the 800,000 charge -- there was a lot of noise, obviously, in your quarterly report; I'm just trying to sift through it. But in the September quarter that you just recorded, you had a $800,000 onetime kind of restructuring -- we'll call it onetime restructuring charge. That is your only onetime item. Is that a correct statement or not?

You had that and plus you had a onetime bad debt charge for approximately 650,000 as well.

Okay.

Just to clarify that, Brian, the $650,000 bad debt charge is of the same customer that we took a 2.5 million in third quarter last year. We basically said at that time we are going to get to this -- we repossessed most of the equipment, the majority of the equipment, which we are putting back into inventory. Taken a conservative view of writing off another 650, 7000 (ph). So, whenever we sell this equipment, obviously, there is going to be a difference between sale price and the manufacturing cost. So, that one time we clean out the 650, the 800,000 is a restructuring (indiscernible) 500,000 is for the security group in the UK, where we had a couple of buildings. We bought a new building. We consolidated all the operations into one building. And there was a $300,000 charge associated with Defense Optoelectronics. We had two facilities -- one in Florida, one in California. And after we got that booking that we announced, we basically were able to make the decision to move everything to Florida. And we took a onetime charge.

Let me move forward. On your earnings per share that you said -- is it going to be cash flow or earnings per share positive that you're giving guidance for in the December period?

In the guidance for December?

Yes.

We are basically saying that we will be at EPS profit.

Just so I understand -- I think that Tim was trying to get to this, too, and may have and I just missed it. Your SG&A expense going forward should be down from September to December. Is that right?

If you look at the SG&A, we are saying that in that SG&A, the litigation expenses -- we still don't know where it's going to fall for the next couple of quarters. We can't comment on it. But the Sarbanes Oxley related expense should significantly come down. The rest of the SG&A -- if the stock option thing is going to remain the same -- and we believe there might be some movement in there -- but as you look at the revenue pickup -- for example, 101 million in Q1 to our guidance of 111 to 114 million, as a percentage of revenue it should start coming downwards.

It sounds like SG&A will be down quarter-to-quarter because of Sarbanes Oxley. R&D should remain flat with first quarter. Is that right?

I think so.

I'm having trouble just trying to back into this profitability. Using the midpoint in your range, which is 112.5 million in the December period, and using a gross margin at the midpoint of the range of 36%, I get gross profit of 40.5 million. And I'm just trying to -- you're going to have to have a dramatic drop then in SG&A expense, is the only thing that I could look at. Is that what you're telling me from September to December to get to that kind of breakeven number? I didn't know if I'm missing something else in this calculation, because I got 30 to 33 million of SG&A and R&D of 8.7. I'm just trying to get to where there's profitability there.

You just did your own math. And if you reduce the restructuring and the bad debt out of it, you automatically can start looking at a positive number (multiple speakers)

So, it's all coming out of the SG&A line.

It's basically coming up -- as you take your gross margin number, you multiply by your increased revenue. And you keep your SG&A approximately the same and take out the bad debt and the restructuring, and you can start looking at where it's going to fall. You're absolute right.

That helps me out a lot. What do you guys see out there in terms of the competitive environment? Now that I have hit you with all this minutiae -- I apologize -- just trying to understand that. On the macro environment, can you talk a little bit about what you see out there on the competitive front, maybe some large government procurements either from the DOD or from customs? Or what is going on out there in terms of grant dollars coming down for border security and port security?

Ajay, you want to take it? I presume he is talking about security.

Yes, I am talking in the security realm.

There is a lot of activity going on right now. Let me just go through the grants. We are involved in various grants that we submitted to the government. Some we have received positive indications on; some we're still waiting on. And that activity really is related to both DHS and DOD areas. In terms of contracts, I think both international as well as domestic -- I'm not going to go into whether it's DHS, DOD -- but we have had success. And we see that activity being pretty strong right now.

Can you specifically address the U.S. Customs grant, $120 million that was coming down for port security? What is going on there and the status of that?

I have heard all kinds of numbers out there, but customs has come in and issued some IDIQs -- that's indefinite delivery, indefinite quantity -- contracts. And we are one of the recipients of that contract. They have looked at various product lines that we have, from x-ray to gamma to TNA, that are on the IDIQs. They have released an amount for initial procurement that for competitive reasons I'm not going to go through. But the key thing over here is it's not just the initial amount that they've released, it's the fact that it's an IDIQ contract going forward.

(multiple speakers) public announcement by you guys yet?

We have not talked about it, no.

Tim, just to emphasize what Ajay is saying. Overall, in the DOD sector -- obviously, the other company you follow; they have been very successful. We announced a $6.6 million contract. We are quite excited about the new addition and the relationships that we are developing for our products. In the CBT part of business, the government did announce a long time ago about 121 million. We are told that nowhere close to that has been actually spent. And whatever monies that people have received, basically everybody is keeping it very close to their chests for competitive reasons. And what Ajay is saying -- that we have received it, but we are basically not talking about it.

Last question. Can you tell me when you will start talking about that?

I think that this is all you're going to get from us.

Until you start shipping, or what?

I guess that overall backlog is a good indication of where that business has gone in one quarter, from 16 million backlog that we have announced to 47 million.

(multiple speakers) some of that backlog increase was related to this IDIQ?

No, we have not said it. It's part of it. It's got other things in it. We have made some announcements. It's a combination of both international and domestic. And as you know, the indefinite delivery and indefinite quantity is a -- we have one for our large (indiscernible) which is three years old. The government can buy a lot of product; the government can buy zero. The good news is that we are on the procurement list with our products. That means that if they ever decide to buy it, we are (indiscernible) qualified (indiscernible) to that.

Jeff Rosenberg, William Blair.

I still wanted to follow up on kind of trying to triangulate the increase in your backlog on large cargo was about 30 million and you've only announced two-thirds of that. Is that because the other stuff is confidential and you can't talk about it, or was it smaller orders maybe a little bit? Because normally we would get a pretty good idea of all the orders that add up to your increase in backlog.

You answered your own question. All of the above.

On the other 16 million of the increase in backlog, is that mostly on the opto side? I mean, how are you looking at healthcare backlog? Usually you don't see too much there. Is it mostly some of the CT stuff you talked about and a surge in new contracts there?

Well, we did announce the $7.2 million for the Defense Opto. We've got some additional bookings in the opto. You're absolutely right. The backlog is not a good indication of the healthcare side, except we did say today and in our news release. But it was a very strong bookings. It's very difficult to pin down when you book and when you ship out. But relatively from historical last couple of years, Spacelabs Healthcare had a very strong booking September. This is an inherently historically strong quarter to begin with, but it's difficult to pin down backlog increase. All the product lines -- what Ajay said before -- not only in the large cargo (indiscernible) backlog increase in international which is normally an inventory turns business. There's backlog increase in Defense Opto. There's backlog increase in Commercial Opto. And there is definitely (indiscernible) very strong booking -- backlog increase in (indiscernible). And in the history of the Company, we've never had $141 million backlog, which is approximately 50% higher than the June quarter. In one quarter the backlog is up 50%.

That's a great jump. And the business that you can ship in the December quarter -- the Guard's order -- that -- if you had inventory there, you should be able to ship most of that, and the rest of it would -- you would think would be shipping within 12 months. Or does it even stretch out longer than that?

I think the vast majority of the large cargo is going to ship in this fiscal year. You might slip a couple of months here or there. But in terms of what's going to ship this quarter or next quarter, you know, it really is -- it really is dependent on how quickly we can turn some of these things around. So, we are trying to ship it is fast as possible, but we're not talking about 12 months down the road.

Just to add on to what Ajay was saying, all $47 million is shippable in this fiscal year. And some might -- timing-wise might fall one month, two months this way. It's difficult on this large cargo, as you know, to sort of pin down which quarter it will go in because it inherently -- whether it is inspection related or shipping related -- it might change by -- from end of one quarter to the beginning of next quarter. But for practical purposes, all 47 million, as Ajay mentioned, is shippable in this fiscal year, give or take a couple of months.

All right. That suggests some upside in terms of looking in the early calendar '06 quarters. How should we think about the margin of that security shipment, those large cargo shipments? I mean, you are holding a relatively steady gross margin for this quarter, but it doesn't sound like you're going to see the real -- the lion's share of that I'm guessing is going to ship in the back two quarters of the fiscal year. How should we think that affects the mix in terms of gross margins? Do you think gross margins will come down? I would think that the gross margins would be lower there. Any sort of preliminary look at that?

No. I think the way that you -- you are very astute; you read it right. Q2 -- the number you book is very difficult to ship it fast out. But we have also said historically -- Ajay has made comments on many, many conference calls -- inherently large cargo has lower margins than the people and parcel scanning business because a lot of outside procurement. Obviously, our medical product line has very good margins. So, our guidance is only for Q2. And then you'll have to blend it depending on how fast the cargo ships how the margin will change. But at the same time, as long as there is growth in all the other product lines, that the margin might fall in -- for the whole year last year it was pretty much in the same area. So, it's difficult to sort of plan it back accurately what the margin is going to be, but I think that with the revenues -- the size that has become, it's within a percentage point one way or the other, the margins. Two point left or right.

That last thing you said I'm not I understood. What's within a percentage point, 1 point or the other?

If you're shipping approximately $110 million in the quarter, and if you are going to ship another 4 or $5 million of the cargo business, there is enough movement between healthcare, cargo, people, parcel screening, defense opto, commercial opto, that the margin -- what I'm saying is overall for the Company -- is not going to move much by than a couple of percentage points. Ajay, you want to add?

The margin percentage, the gross margin percentage is what we're talking about.

Right. But I guess I'm thinking that the lumps could be a lot larger than a couple of million. If you are going to ship most of this in fiscal -- you've got 46 million. And you can't get much of it done this quarter. Your guidance doesn't suggest you will. So, you could be shipping an incremental 10 to 15 million on top of what you have been doing. And if that is at lower margins (indiscernible) it will still be, obviously, incrementally gross profit dollars. There's certainly -- I just wanted to get a feel for -- if we're making certain assumptions, I assume we should expect gross margins to be lower. And given the size of the lumps -- I haven't done the math, but I would assume it could be greater than a percentage point or two.

I think -- you know, we can obviously look at the gross margins. The key point, obviously, is that it's going to definitely benefit the bottom line.

Right. I just wanted to be reasonable about how much. There's no question it's incremental and it's great.

Jeff, you know, the thing is just for the nature of the business -- he just said it -- it is very difficult to plan a certain cargo vehicle inspection product shipment in a certain quarter. So that if you do it -- yes, from quarter-to-quarter it might get some lumpiness. But I'm also emphasizing our backlog has increased in all segments. And we are hoping that if it continues that way that it will have the ability for growth. And you look at it as incremental, not just as a replacement.

Navid Malik, Collins Stewart.

Just a couple of questions. Firstly on Blease. If you're looking at the margin improvements across Spacelabs as you make these productivity improvements in terms of manufacturing within Blease, are you expecting the margin to phase positively throughout the year quarter-by-quarter? And the second question is -- you talk about a record quarter for this year. I appreciate you have only had Blease since February. But if you are looking at Spacelabs monitoring and say MedData (ph), are you seeing sort of record quarters or record orders specifically across most of those segments?

The answer to your first question is we have always said that the Blease margins as we bought the company -- because of just the size of the business they couldn't leverage it enough -- were not as good as it should be. As we put the Spacelabs' manufacturing practices, as we leverage our purchasing power, we expect as the year progresses that we will continue to show improvement in our manufacturing gross margin, both in Blease and for the whole company, as we start shipping the product out. As you also know in the Spacelabs area, as the Ultraview product line continues to go into the whole replacement base, it has better manufacturing gross margin. So, you're absolutely right that in the Q2, in the Q3 and the Q4 as far as manufacturing gross margin goes, the healthcare group should continue to show better manufacturing gross margin.

Regarding the answer to your second question is that no, we are not saying that there were record bookings for all product lines in the healthcare group. Monitoring showed a very healthy growth. Blease -- we are quite satisfied with its performance. It's doing well. MedData is a very small portion of our business. And as you know, we are trying to focus that business because it's a different model than a capital equipment sale. We are working with the pharma companies. We believe that that business will grow, but it's a very small portion of our business.

Regarding the other area, the oximetry, the OEM business, those come in various parts of the year because it comes on master contracts. And depending on when it falls, you can see a little bit of increase or decrease. But again, it's a small portion compared to what happens in the monitoring. So, when we look at the total health of the Company in the healthcare area, if you just look at monitoring and anesthesia, it equates for a very large -- about 85% of the total group, so that we are quite excited about what we're entering Q2 with.

(OPERATOR INSTRUCTIONS). Jason Zao (ph), AJB Capital (ph).

I just had a quick question on the security side of the business. I was wondering if you can give us a quick update on TSA and kind of where the personal scanning is at. And I was wondering if that was in the backlog. And I have a follow-up question.

I assume you are talking about the Secure 1000 personal scanners. We did -- as Deepak mentioned, we did announce a $800,000 contract for them to go and work on some features in our software. We are actively working with the TSA to come up with the requirements that they are looking for. And that is the only thing that would be in our backlog as far as TSA is concerned for the personal screeners. Now, we are actively pursuing the personal screeners in other places. For example, at Heathrow Airport, we do have some of our Secure 1000 units that are actually being used. If you walk to Terminal 4, you will see them there. And we're looking at not just aviation, but we are looking at non-aviation areas as well where the Secure 1000 can be used.

Just to comment on it, just what Ajay is saying we want to emphasize -- Secure 1000 backscatter technology, people screening -- it has never been the Company's guidance that it's a big aviation (indiscernible). And we don't have any backlog. We sold three units to Heathrow. We are working on grant money from the TSA. There's a lot of interest but there has been no real orders or projections from our side for aviation body scan.

When do you expect them to make a decision in terms of how many to order or when do you think deployment will happen?

The honest answer is I don't know.

Gentlemen, I am currently showing we have no questions in the queue at this time.

Thank you very much for listening to us. I want to summarize with it is that we've had some tough couple of quarters. We are on the road to recovery. We believe that Q2 will be profitable. We have a very strong backlog. The activity for large cargo, especially in the international sector, continues to be strong. We are working on many, many projects with the IPO. We have strong balance sheet, a separate identity for our healthcare growth. We have strategy in place, both from an organic gross, at the same time looking at strategic acquisitions. And we are hoping and working towards resolving the litigation in this fiscal year. And we believe that both sectors of our business are growth opportunity. And with the latest bookings that we have in the large cargo the remainder of the year, though cautiously, we will continue to work to improve the profitability of the Company. Thank you very much.

Ladies and gentlemen, thanks for your participation on today's conference call. This does conclude your presentation and you may now disconnect.