OSI Systems Inc (OSIS) 2007 Q3 法說會逐字稿

Good day, Ladies and Gentlemen, and welcome to the OSI Systems 2007 third quarter Earnings Conference Call. My name is Leticia and I will be your coordinator for today. At this time, all participants are in a listen only mode. We will be facilitating a question and answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded for replay purposes. At this time, I will turn the presentation over to Alan Edrick, Chief Financial Officer. Please proceed, sir.

Thank you. Good morning and thank you for joining us. I'm Alan Edrick, Executive Vice President and CFO of OSI Systems. I'm here today with Deepak Chopra, our President and CEO; and Victor Sze, our General Counsel. Welcome to the OSI Systems 2007 Third Quarter Conference Call. We would like to extend a special welcome to anyone who is a first time participant on our Conference Calls. Please also note this presentation is being webcast and will remain on our website for approximately two weeks. During the third quarter we made progress on several fronts. Highlights include a 17% increase in sales led by a record top line for our Security Division, significant progress on the implementation of the previously announced cost cutting initiatives throughout the Company, and the favorable resolution of our longstanding legal disputes with GE and SAIC. In addition, we were free cash flow positive. Finally we ended the quarter with yet another record backlog, marking the fourth consecutive quarter of backlog increases.

Before discussing our financial and operational highlights in greater detail, I'd like to read the following statement. In connection with this Conference Call, the Company wishes to take advantage of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 with respect to statements that may be deemed to be forward-looking statements under the Act. Such forward-looking statements could include general or specific comments by company officials about future company performance as well as certain responses to questions posed to Company officials about future operating matters. The Company wishes to caution participants on this call that numerous factors could cause actual results to differ materially from any forward-looking statements made by the Company. These factors include the Risk Factors set forth in the Company's SEC filings. Any forward-looking statements made on this call speak only as of the date of this call and the Company undertakes no obligation to revise or to update any forward-looking statements whether as a result of new information, future results, or otherwise. I'll be updating you on the financial performance of the Company, but first, let me turn the call over to Deepak.

Thank you, Alan. And again, good morning. Welcome to OSI Systems third quarter Earnings Conference Call. I'm going to provide you with a brief operational overview of our three business segments before handing the call back over to Alan, who will go into greater detail on the financial performance of the Company, after which we will open the call up to the questions and answers. For the third quarter of fiscal 2007, we reported revenues of $126.5 million, an increase of 17% from $108.1 million reported in the third quarter of fiscal 2006. Our backlog reached a new record of $209 million, an increase of $12 million from Q2. This was again primarily driven due to strong bookings in the Security Division.

The Security Division continued its strong performance this Fiscal Year with another strong bookings quarter. Bookings for the quarter were again strong, increasing the backlog for the division by $9 million to a new record of $124 million, majority of which is shippable in the next 12 months. This was primarily driven by a very strong booking quarter in the international arena for our cargo and vehicle inspection product line. As of March 31, 2007, our cargo and vehicle inspection backlog reached a new high of $67 million versus $47 million for the Q2 quarter. Another area where we continue to perform well is with our new product offering, the MVXR 5000 series of product for the hold baggage market. Non-cargo backlog also for the quarter was very strong and our bookings in the MVXR 5000 product has been very strong. This continues to be a great success story for our new launch. Also in this quarter, we have started the installation for the major order we announced earlier in the MVXR 5000 for an international airport where we replaced the incumbent L-3. We believe that the market dynamics for the Security business are extremely positive, both domestically and internationally, and look for a continued strong performance into the last quarter of fiscal 2007. Q4 will be a significantly stronger revenue quarter for the Security Group. We continue to invest in R&D in those product lines. We continue to look at and work with the U.S. Government and these bookings that we had at the backlog does not include any bookings yet from the CBP -- Customs & Border Patrol -- which we are working with them diligently for -- in the next couple of months when we think that the RFP will come out.

Our CXR product CT Product Development continues in the UK. We are very excited about the prospects in this business, and overall, the quotation activity has never been as strong globally as it is today. We have made some one-off adjustments that Alan will talk about in the Security group. We continue to monitor that. We continue to make it more optimum, and as a matter of fact, we have leased a new building for the continued expansion of growth in this business, and taking three different buildings in which they were spread in California to go to one building in Hawthorne, which will be all done within the next couple of months. Healthcare -- though patient monitoring U.S continued to show weakness, we expect that the fourth quarter ending June will be a relatively strong quarter in shipments compared to Q3. We believe that it will be a profitable quarter. The division has identified as previously mentioned approximately $10 million of annualized cost savings through the integration of the new acquisition Del Mar that we did in July and the global review of the cost structure. These measures have largely been implemented as of March 31, 2007, and Q4, April, May, June, will give a good indication of what the cost reduction on an annualized basis that we can realize. Although there might be still some small things left over, majority of the stuff for one off has been -- it will be behind us in this quarter.

We expect the business to be profitable in the fourth quarter, led by improved sales in North America and benefit of cost savings. Our backlog going into Q3, Q4 is higher than last quarter. April has been relatively a good bookings month both in the U.S. and international. We believe with both better visibility in bookings and the cost reductions that will come into play that Q4 will be a good quarter. We are also looking at manufacturing efficiencies and supply chain. We have set up a Far East facility for trying to move more and more product from U.S. and UK into the Far East to realize better margins, setting the stage up for a turnaround and recovery in 2008. Our R&D commitment continues to be there. Our R&D spending in Healthcare is approximately 40% higher this quarter compared to the last year. We have introduced two new diagnostic cardiology products along with receiving 510(k) approval for launch in the U.S. of new diagnostic cardiology software platforms.

Optoelectronics -- our Optoelectronic and Manufacturing Division continues to see positive top line revenue momentum. Our total revenues this quarter before intercompany eliminations increased by approximately 25%. Although the income from operations, however, was negatively impacted by a $2.8 million loss from our OSI Defense System Business in Orlando, Florida. As we mentioned previously that we had been looking at all divisions of the Company to look at product efficiency, synergies, and cost cutting programs, over the last couple of quarters, we have been focusing on Security and Healthcare. This quarter, we were focusing on the Optoelectronics business. This particular is a one-time charge. We went and looked at the various things in this division and felt that we had to go take a look at some of the one off costs. We have restructured the Company. We have changed the reporting and there were some one-time inventory and other charges related to it. We believe that going into next year, this operation will be profitable and we expect the Opto to return back to its original levels of performance as early as Q4. We have initiated a strategic review of certain non-core operations within the Opto Group with a goal of increasing our focus on the businesses that we believe can create enhanced shareholder value. With that, I'm going to hand it over to Alan to talk in detail about the financials.

Thank you, Deepak. As our top line momentum continues, our management team is highly focused on driving operating margin improvement to significantly improve earnings heading into fiscal 2008. Although we will incur further one-time charges in the fourth quarter resulting from the cost reduction initiatives and other improvements, we expect our Q4 results to show signs of the changes we outlined during our last Conference Call. I'll speak more about this shortly, but first let me review the financial results of the third quarter.

For the third quarter, we reported net income of $3.6 million or $0.21 per diluted share compared to $1 million or $0.06 per diluted share for the same period of fiscal '06. The bottom line results include the recognition of $15 million of pre-tax other income as a result of a favorable settlement with GE, stemming from a dispute arising from our 2004 acquisition of Spacelabs Medical, as well as restructuring charges of $2.2 million associated with our previously announced cost reduction initiatives.

We reported an operating loss of $6 million, which included the restructuring charges of $2.2 million and a $2.8 million loss in our Weapons Simulation Business which is included in our Optoelectronics division which Deepak referred to. As Deepak mentioned, we have restructured this business and expect it will be a positive contributor going forward. Net sales for our third quarter increased 17% from $108 million in fiscal '06 to $126 million in fiscal '07. Our Security and Optoelectronics divisions continue to experience strong top line growth, while sales in our Healthcare division have not yet rebounded back to the degree we anticipate. Our Security Division reported a 24% increase in sales in the third quarter, 39% on a year-to-date basis, led by improved cargo sales which grew 25% over the comparable period last year. Our baggage and parcel inspection, checked baggage screening and People Screening systems also reported significant growth of 23% over the prior year quarter. Our Optoelectronics and Manufacturing Division again had a strong quarter, recording Q3 external sales of $27.8 million, representing an increase of 25% over the third quarter of fiscal '06. The increase in these businesses were partially offset by the performance of our Healthcare division, which was up 9% overall, but down approximately 8% organically after excluding the impact of the Del Mar Reynolds acquisition, which closed in July '06. The Healthcare downturn has continued to be most prevalent in our patient monitoring business, in which sales declined approximately $1.4 million from that of the prior year quarter, with the softness most acute in the high margin North American business. However, there are encouraging signs of recovery in the Healthcare business and we expect a pick up in Healthcare sales beginning in our fourth quarter.

For the third quarter of fiscal '07, the gross margin declined to 34.7% from 39.9% in the prior year period. This decline was due partially to certain charges in our previously mentioned weapons simulation business. In addition, the gross margin was impacted by reduced North American patient monitoring sales, which carry significantly higher gross margins than our consolidated margin, the increased sales of our cargo inspection products by our Security Division which has been operating at lower gross margins as we ship newer products, and the growth in sales of our Optoelectronics and Manufacturing Division, which generally carry lower gross margins than our other divisions. While our gross margin will vary from quarter to quarter, we do expect to see overall improvements going forward.

Our SG&A expenses as a percentage of sales decreased 2.7% for the 2007 third quarter compared to that of the prior year. Excluding over $2 million of SG&A expenses in support of the Del Mar Reynolds acquisition, in absolute dollars our SG&A expenses were essentially flat compared to last year and down sequentially despite a 17% increase in sales, as the impact of cost savings initiatives is materializing, as we seek to leverage the existing infrastructure, as well as a reduction in legal expenses due to the culmination of several costly lawsuits. I'll speak more about the progress in our cost rationalization plans later on in this call.

R&D expenses for Q3 '07 were $11.4 million or 9% of sales, including approximately $1 million absorbed from the acquisition of DMR, for which we launched two diagnostic cardiology products in the third quarter. This was compared to $8.9 million or 8.2% of sales in the prior year. We continue our commitment to invest in our Healthcare division for next generation products. In addition, we are making significant investments across different technologies in our Security product offerings.

Interest expense increased to $1.3 million this year, due primarily to the additional borrowings associated with the acquisition of Del Mar Reynolds in July of '06 and to fund working capital requirements. As discussed we received $15 million from GE, as part of the resolution of a working capital dispute dating back to the acquisition of Spacelabs, which we have recorded as other income, since the resolution was more than 12 months after the acquisition date.

Moving to cash flow, as I've mentioned on the past couple of calls, we have placed significant emphasis on generating free cash flow. We are pleased to report that this focus is paying off. Last quarter, we reported positive operating cash flow and in Q3, we further improved this to generate positive free cash flow with Q3 representing the first quarter in the past nine quarters that we generated positive free cash flow. This was achieved by reducing our DSO by eight days from the end of Q2 as well as increasing our inventory turns, despite a build up in cargo inventory in our Security Division, to meet the increasing backlog in this business. In the third quarter, we generated $4.4 million in operating cash flow, as compared to using approximately $3 million in the same quarter last year. Capital Expenditures were approximately $3.1 million, depreciation and amortization was approximately $4.1 million, and stock based compensation expense was approximately $1.4 million in the quarter. Our net debt decreased approximately $19 million during the quarter, primarily as a result of the positive free cash flow and the settlement with GE. We are pleased to have ended the quarter with a record high backlog of approximately $209 million, led by continued strength in Security, whose backlog increased from $115 million at the end of Q2 to $124 million at the end of Q3.

Now, moving to an update on the progress of reducing our cost base. As we mentioned during our last Conference Call, we commenced a review of our Global Operations in order to integrate recent acquisitions and to rationalize the cost structure. This review resulted in plans to achieve approximately $15 million to $17 million of pre-taxed annualized cost savings. Cost cutting measures are well under way at all divisions, and to date, we have completed over 80% of the plan, with the goal of implementing the remainder of the cost reductions by the end of the current Fiscal Year. The greatest impact of these changes will be evident in our Healthcare division, for which we have targeted in excess of $10 million of annual savings. These measures are expected to positively impact the fourth quarter of fiscal '07, net of anticipated severance and related charges, with the full benefit expected in fiscal '08.

Building long term shareholder value through increased financial performance is our highest priority. There is no doubt that we have a lot of work ahead of us, but we are optimistic about our future prospects and look forward to reporting our results in the coming months. Thank you for listening in on this Conference Call and at this time, I'd like to open the call to questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Tim Quillin representing Stephens, Inc. Please proceed.

Good morning.

Good morning.

You mentioned this, but I guess didn't give the specific number -- but what revenue did you book from large cargo in the quarter? And then if you could talk about what your expectations are for the fourth quarter as well?

Well, this is Deepak here. Alan, you said what your shipments were for the cargo for the quarter?

We talked about the increase in sales, that's correct.

Yes, so if you take that number and we did say our backlog increased to $67 million from $47 million, that can give you a mathematical number of what the bookings were for the quarter.

Okay, I was trying to ask about revenue.

Well, Alan did cover what his revenue was for the quarter in cargo.

What was that, Alan?

It increased approximately 25% in this particular quarter. We don't generally break out what our actual revenues are between cargo and the non-cargo products, but it did increase about 25%.

Okay. What are the expectations for -- there's a pretty big bump up in revenue implied in your full year guidance in the fourth quarter. What are you expecting in terms of large cargo 4Q versus 3Q?

I think that your revenues again, Tim, will be up from Q3 to Q4 in cargo, because obviously the backlog has continued to grow. We want to be a little cautious about it because as you know, the large cargo can fall in and out of a quarter just by a day, so it's difficult to exactly pinpoint it, but the backlog is showing up that Q4 will be a significantly larger revenue for the Security Group as a whole compared to Q3 and cargo will also be up.

Okay. Now, would it be an unusual quarter in Security that you're expecting? Is it a quarter that you would potentially come down to a lower number in the first quarter of '08? Is there anything unusual that I should think about there?

The answer is no, Tim. I think what's happening is that the paradigm has changed. We have had, if you know -- last couple of quarters, our backlog continues to get stronger, continues to set new records. Our revenue continues to set records in growth, and we are very positive about it right now that Q4 will not change or be a unique quarter. I think we will go into the New Year of continued strength in our Security shipments. Like I mentioned, there's a lot of various quotations in the pipeline and we think that Q4 also will be a very good bookings quarter for Security. Keep in mind that CBP hasn't even kicked in yet, and internationally, we have had very big successes. Our MVX Multi-view product line continues to show very good healthy growth. As you know, we only introduced the product less than a year ago, and we are ramping up -- as a matter of fact our factory's running full bore in that product line, so I don't think so that Q4 is an anomaly. I think that we will enter the year next year with a very healthy backlog and continued strength and especially with the visibility we have, I think Q1 could continue to grow.

Okay. That's very helpful, and in terms of the revenue guidance for the full year, the $535 million to $545 million, is there anything -- is there any uncertainty in there in terms of the potential for shipments to slip in the Security business or the Healthcare business? Is it still necessary to have strong bookings for the rest of the quarter to get to your implied revenue guidance? Is there anything that's uncertain there?

Well, Tim, when you use it in that statement, anything, obviously, we are talking about the future. The signals are all very positive. April is over. Bookings were quite good in Healthcare in April. Our backlog, as I mentioned, increased going into Q4 from last quarter in Healthcare, so entering the year and the quarter with a good backlog. Security set a new record in backlog. We've already said Security revenue is going to be high. But I think anything can happen -- like I said, you know how this cargo business is, that you could have everything done and the inspection doesn't happen or the shipment doesn't leave in time or if it's CIF Destination, the other side is not ready to receive it, it might fall off from one to the other. But right now, we are very comfortable with our guidance.

Okay. Thank you, and then just one more question if I may, on the gross margin. Well, I guess one part of it is -- can you quantify the impact of OSI Defense Systems on that impact on the 3Q gross margin? And then is there a normalized rate that we should think about or what kind of level should we be modeling as we look into '08 and look at fourth quarter? Thank you.

I'm going to let Alan give you the (inaudible) details but let me give you my take on it. Gross margin for the Healthcare Business will improve in Q4 because shipments will be higher. More revenue we get out of patient monitoring, better our gross margin. If you don't ship enough, it underabsorbs the factory.

Right.

Secondly, the cost reductions that we have announced kick in, so all indications are that the gross margin in Healthcare will increase. Alan did allude to you -- as we ship more cargo, as you know that the cargo has a lower gross margin compared to our People and Parcel Scanning Business. So as a total revenue, top line increases for the Security Business -- that relatively will show lower gross margin. How much? It depends on the ratio between the two. But then you have to put another equation into it. We've had very negative gross margin in cargo because we didn't have many shipments. So relatively as you start shipping cargo out, even though the gross margin is down, compared to the overall pie, your gross margin for Security growth will continue to improve. Now, what do you model into it going to be difficult for the Company to set up, to sort of guide you. Except I think that Q4 margin might be a better representation going forward what the 2008 is going to look like because your cost reductions will all come into play. So that maybe is after this quarter is over is a better way to monitor what 2008 goes into it. I think Q3 was relatively lower gross margin -- one because of Defense Systems, plus all of the cost cutting have not come into play. Alan?

Sorry, Tim, just building on the first part of your question in terms of what impact did the OSI Defense business have, it had a couple percentage points impact of about $2.5 million to our cost of goods sold.

Okay, thank you.

And your next question comes from the line of Brian Ruttenbur representing Morgan Keegan. Please proceed.

Good, thank you very much. The other questions I had on third quarter revenue, first of all, was a little bit light. And I don't know if you got into this already and I missed it, but why was it light on the Security side? Was it delay in shipments for large cargo over to Fourth Quarter? Maybe you can get into that a little bit why it was only slightly light but what happened there?

Brian, I don't have it in front of me. What was your model for Q3 for Security?

$47 million.

Yes, I think we ended it at what? $45 million and change?

Yes. I didn't know, it was roughly flat with the December period, and I didn't know if there was anything that was going on there. I mean, your backlog was up dramatically. I don't know if it was just a modeling error on my part, or what.

Well a couple million this way or that way definitely is there because of cargo. I mean, it can shift from one quarter to the other as you know, those large ticket items do have --

But did any of that happen in the period?

Well, I'm sure it happened, but I can also say maybe from Q2 to Q3 also there might be some changes. But I think the second part of the question is definitely there were some bookings in Healthcare that did not ship out.

Okay.

So it moved from Q3 to Q4 and that's one of the reasons that we are a little bit more comfortable in Q4 guidance because the backlog has increased going into the quarter. But on the Security side, I think that we have always said from day one, Q4 will be a significantly bigger revenue number than Q3 just because of the way the backlog has been building up. So that as you model it out -- we've said it from last couple of calls, Q4 will not be an incremental increase as we build up to it and you can just do the math. If our guidance is in the $535 million to $545 million, that your Q4 -- if you just look at the first nine months, it's somewhere in the $155 plus million dollars. It's a huge increase from Q3.

Very good. Yes, that was going to be one of my other questions. And do you have a break out split between if it's going to be $155 million to $160 million in total revenue. Maybe my first question should be corporate eliminations -- they were a little bit higher than normal. Should I keep them around the $9.5 million mark, first question?

The corporate eliminations reflect the ongoing increases in the business from our Optoelectronics Group to both our Healthcare division and to our Security Division, so actually as our business in Healthcare and Security increases, which we certainly expect it will, the elimination will go up as well.

Okay, and then can you give us some kind of break out split with Security and Optical and Medical? It sounds like it's going to be a little bit heavier skewed as a percentage of that total $155 million to $165 million in the quarter towards Security. Am I reading that right or I'm hearing the wrong things?

Well, I think there's significant opportunity both in the Healthcare and in the Security side. By practice, we have not provided guidance by operating segment level. We just give a consolidated level.

Okay.

Brian, just to add on to what Alan is saying, that definitely we haven't given guidance. But the backlog build up in Security will continue to drive Security revenues relatively stronger.

Okay. And then another question is about gross margins. You say gross margins are going to be higher. Gross margins would have been around 36 to 37% in the quarter if you kind of X'd out the bad stuff from the Defense Opto. So the fourth quarter last year, for example, you did gross margins of 41%. Is that the kind of numbers that you're targeting internally?

As our business continues to grow, particularly as we've had significant growth in the Optoelectronics side of the business as well as in the Cargo side of the business, whereas Healthcare -- which is a high margin business -- isn't growing at the same rate, we think that the margin that we reported in Q4 of last year may be a little bit difficult to get to. As you've mentioned, backing out the OSI Defense side, we did show margin improvement over Q2 and I think we'll show margin improvement in Q4 over Q3, though probably not to the levels of Q4 last year.

And that margin improvement -- well, the issues that you had down there with the Defense Optical Division -- is that incremental savings, since you did some work down there to the $15 million to $17 million in annual savings that you talked about on your cuts or was that included in that?

That was not included in the $15 million to $17 million.

So how much is that in cuts?

I would look at it more as that amount is sort of non-recurring charges or costs, separate and apart from the $15 million to $17 million, and there will be just sort of a minor amount incremental to the $15 million to $17 million.

Okay, so it was costing you money and now it won't cost you any money. How much was it costing you annually?

It was not costing us certainly any material amount. What we did is we took a look at it, and some of the inventory and other areas. We took some charges associated with that, so it wasn't from a cash flow or a bottom line P&L basis. It wasn't real material to the overall Company, but in bringing it up to where we expect it to be and some of the changes we made, obviously a large non-recurring charge goes through Q3.

And a couple other little follow-up points. On SG&A and R&D -- seasonally, it seems like you have kind of a spike in SG&A and R&D in the fourth fiscal quarter. Should I expect that as bonuses are paid or whatever the reason is for the spike?

The spike is largely related to sales particularly in the Healthcare business where Q2 and Q4 tend to be the strongest quarters and commissions associated with those type of sales. So while we are implementing and implementing very quickly many of the cost reduction initiatives which are manifest in both the cost of goods sold and the SG&A line, you would expect to see probably a little bit of an increase in SG&A in the fourth quarter commensurate with the increase in sales.

So looking at kind of Q2, the December period, would be a good one to model off of to see how that spike versus other periods?

That is correct. Though you'd probably also have to factor in that since Q2 we've implemented a significant amount of cost reductions.

Okay. Great. Thank you very much. That's all I have.

From the line of William Blair & Company, with the next question we have Jeff Rosenberg. Please proceed.

The first question is -- Alan, could you talk about when you look at the $15 million to $17 million of annual savings, how that would break down between lower operating expenses and lower cost of goods sold?

While we haven't broken it out by the geographic breakdown on the P&L, I can tell you it includes quite a bit of consolidation of Manufacturing facilities and headcount reduction in our Manufacturing operation, so a significant percentage of that will flow through cost of goods sold and thus improve our gross margin as we head into Q4 in fiscal '08.

Okay. When we talk about -- I think Deepak touched on this a little bit, but we look at the incremental growth in Q4, a lot of it is going to come from Cargo. Can you talk about the mix of that product, how much of it is new product where you've had limited volume experience versus products where you got pretty good experience curve and feel good about predicting the gross margin? I mean, how much variability do you see as you ramp up so substantially in Q4 in terms of how gross margins might turn out?

Well, Jeff, number one, just want to clarify. I did not say that growth is all going to come from cargo. What I said was the backlog indicates that Security will see a healthy growth in revenue from Q3 to Q4, but we also think that Healthcare is going to have a good quarter in revenue in Q4 versus Q3. Regarding the question about one offs, our backlog now is lining towards what we've been predicting -- that there's repeat production quantities being produced in Cargo and the same time in the People and Parcel Scanning. So hopefully these are multiple units and we can sort of put the (inaudible) behind us for the one off and continue to start producing them in volume and get some economies of scale. But after saying that, as you know that cargo tends to have much more procurement from outside, so it tends to have a lower relative gross margin compared to the People and Parcel Screening. On the other hand, while we concentrate and focus on cargo, keep in mind for the last couple of quarters, even for this quarter, the non-cargo business, especially in the Multi-View X-ray for Hold Baggage continues to show very good backlog and very good bookings.

Okay. And on the new order that you announced this morning, I realize you aren't in a position to provide the value, but any details there about the mix of equipment or the application? Something to give us a little bit better feel for this win?

Well, let me see how I want to phrase it. Firstly, it's all cargo products. It's multiple kinds of products. It's an international customer, and more than that, it's difficult for me to say. It is the largest order in the history of the Company on the international scale. It's all shippable in the next 12 plus months or earlier, and more than that I'm very uncomfortable in saying.

Can you remind us what the previous record was for the largest order? I assume if I go back and look -- I know that in many cases, those were press releases, so there might be some precedent there that you can help us --

Well, the way you should look at that is that you have a pretty good idea what the large cargo systems cost. And you take 17 units and do some kind of volume pricing into it and it puts you into a number which is a pretty high number compared to any other previous order we've announced.

Okay. Fair enough. Last question is just sort of a financial detail. If we are building a model that excludes from an ongoing perspective the GE settlement and the restructuring charge, Alan, what kind of tax rate should we assume on the tax benefit -- should we assume makes sense on the loss?

Well, we're projecting the tax benefit for fiscal '07 to be about 41%. As you look forward into Fiscal '08 and beyond, we expect it to be south of 40.

Okay. Thanks a lot.

(OPERATOR INSTRUCTIONS) And representing Roth Capital, the next question comes from Josh Jabs. Please proceed.

Hi, good morning. In the transition to a second facility in Hawthorne, are you expecting any impact on deliverables? What's the actual process that has to go on there?

It's from the outside, it's a non-event, since we have facilities on both sides, we're moving it very carefully and all improvements are getting done. We don't expect any downtime at all. As a matter of fact as I mentioned, our backlog is such that we are running full bore right now in all our product lines, both in California, UK, and Malaysia.

Okay. And then Alan, maybe, taking a look at where you are currently in the cost savings process, can you estimate in looking at the March quarter what -- on an annualized basis where you were for the quarter and maybe where you exited the quarter?

Yes, the cost reductions that we were doing really fell into different aspects of the quarter. Much of them were -- some were done in January, February, and March. We really believe we're done -- by the end of the quarter we were done with over 80% of the $15 million to $17 million. And I'd tell you we're probably closer to the high end of the range than the low end of the range. So a significant portion was completed in the quarter. And then when you net that with the different charges we associated with that, you can probably just sort of kind of do the math but if you take 80% of the $15 million to $17 million, that will tell you where we exited the quarter.

And just to add on to what Alan was saying, I just want to clarify that the quarter still had a lot of different moving parts and that's why we continue to tell you guys, Q4 will be a very good example of what the annualized savings all can be. Because right now, there's still a lot of convolutions in it, though we have implemented 80% of that, but the total impact can only be felt after it's done. We've been at it for some time and we expect Q4 will still have some ones off, but we should be able to identify a much cleaner way by the end of Q4.

And then Deepak, maybe on the R&D side, can you give us, I mean, it crept up a little bit in the quarter. As we look out into '08, can you -- I know some of this is is coming from the Healthcare side now as well as what you've been doing on the Security side, but can you give us some indication, maybe on an absolute basis where you see that number going?

Well, as you know, we are committed to it and we got a lot of R&D going into both the Healthcare and Security Group. The R&D is up 40% from last year, but some of that has to do with the Del Mar acquisition also. I think what you see right now in the Q3 with a couple of million dollars more annualized could be the number to use for next year, but as we go into the budget process, we would look at it. R&D is one thing that we are not sort of -- we are not cutting R&D down. I mean, we basically are focusing on it. We are getting organized. We made some reorganizations even in the Healthcare R&D leadership, just to focus the group. We are looking at the R&D in the cargo and the high energy. We've consolidated some groups together in that area. As you know, the CXR in England -- we continue to spend money in that product line which doesn't give us any revenue even in 2008 until later on. But I think if you have to model it at this stage, take the Q3 number and annualize it and add a couple more million dollars to it. Maybe Alan, anything you want to add to it?

I think that's a good way to look at it. As we look into next year, it will probably come down a little bit as a percentage of sales, but on an absolute dollar basis as you asked about, the Q3 run rate is probably indicative of what we can see next year -- maybe with some slight increases.

So somewhere getting close to around $12 million a quarter ?

Correct.

Okay.

But as Alan mentioned, again, we are very positive going into the New Year. We have said that before. This year, we're trying to make a transition year to clean up as much as possible. Backlog is very strong. The Order Board or what we call the funnel activity both in Healthcare and Security look pretty strong, so we think there's going to be a healthy top line growth in 2008, which as a percentage of R&D -- as a percentage of revenue, as Alan mentioned, will come down.

Okay, and then finally you mentioned that there hasn't been really any big domestic awards on the Security side. Are those discussions ongoing right now? Can you give us a little more color as to how comfortable you are that those are orders that are going to come through in this Fiscal Year?

Well, all we can say is that -- I'm going to use the word domestic. We've had a lot of success in the other government agencies. The one I'm emphasizing that you've and I've talked about is the CBP. CBP is a big buyer. CBP has done, they bought some units a year ago. They've done a lot testing. They've looked at how logistically to use them. We are in discussions with them. We are told that the RFP might be out in the next couple of months. But more than that, I can't say anything. All we can say is we are very excited about it. We've got good reviews. Our units are performing well, and also there is all indications that whenever and if that ever happens, we will definitely be a recipient.

Great. Thanks, guys.

And your next question comes from the line of Josephine Millward representing Stanford Group Company. Please proceed.

Good morning.

Good morning.

Deepak, can you just clarify on the CBP prospects -- you said that an RFP might be coming out in a few months. I was under the impression that the CBP might be placing their Cargo Security order on an existing IDIQ contract.

Well, yes and no on both of them. As you know, we do have an IDIQ with CBP.

Right.

But I think even that, the way I'm told the system works is that they would go back from that and go back to the vendors and ask for some questions and numbers and features.

Okay, because if you're expecting a new RFP, I think in terms of timing this could take much longer than what we had originally anticipated -- which we were looking for U.S. Government Cargo orders at the beginning of this year and it's been delayed. My understanding was that it's been delayed until the May to June timeframe, but it sounds like it might be even later. Is that right?

I don't know. I mean, like I said a couple of months. I think that we have the same information you have, May to June. We're already in May.

Right.

So when it comes out, it comes out. The way I was trying to say that is that all our backlog that we have does not have any CBP in it yet. So that our intake in Cargo, our intake in the other areas of Security are all without any CBP margin.

Okay, can you just confirm that your Security booking looks like it was about $54 million during the quarter. Does that sound right based on the numbers you provided?

I think you're about right.

Okay. You announced a development contract from the DNDO recently for radiation detection. Can you talk about what that means in terms of your positioning for the next generation ASP and Cars programs?

Firstly, I want to clarify it that we did not announce it. The government announced it.

Okay, right.

I just want to be careful. We did not announce it and frankly we would not like to announce it, but the government beat us to it. We are one of the recipients of nine companies that got a contract total number that they let out was $8.8 million for mass research on nuclear-detection technology. We are one of the recipients of it. Basically, what they are doing is as you know, the Cars program which was done about a year ago, that is looking to deploy prototypes in 2009. The present development contract that we got, we're going to deploy our prototypes this Fall, somewhere in the August to September time period. The Cars program is looking for a high throughput inspection of low density cargo so they could sort of check it with the truck, with a driver already in it. But because the driver is in it, it's only for low density cargo and it has some limitations for high density -- whereas the program that we got is also for high throughput, maybe not as high throughput as the Cars, but the most important thing is that it is to scan trucks in a portal mode so that we do not inspect the driver area -- we inspect this cargo section behind it. But because we can do it in a portal mode and there's no driver involved, we can do it for high energy inspection and inspect both the low density and the high density cargo. So we think that overall, this will get for testing before Cars. It has in our opinion better application, both here and internationally because we do high density. And it will get mounted on to our present cargo systems all in the form of a portal.

Okay, so -- but the one that DNDO recently announced is separate from your development with the Department of Homeland Security, right?

No. It's the same. What I said was that this is the contract grant that DNDO announced in which we are participating.

But they've actually selected nine companies to do this?

They have given contracts to nine companies and we are one of them.

Okay. Can you talk a little bit about your outlook on the Multi-View system for international airports? It looks like this is doing better than you expected, and I believe at the beginning when you launched this program, you were looking to take 2 to 5% of the market share. Do you have a reassessment? Do you think you can do more than that now?

Well, I don't remember giving any percentage of the market and I won't even say that we are doing better than expected. We never tell that to our own internal Marketing people -- we should do better and better. All I can say is that we have a very healthy backlog. This product has been received very well. Most of the customers who have looked at it, they like it very much. Our factory's full bore producing this product, and we continue to look at more and more customers out there and converting the incumbent from the other people to our product. More than that, I think that at this stage, one thing we can definitely say that we've never said before 2 to 5%, we definitely would like to get maybe 20 to 25% of the market. There's no reason why not.

Okay, great. Thank you.

And with Jefferies & Company, the next question comes from Matthew McKay. Please proceed.

Good morning, guys.

Good morning.

First of all, a question for Alan. If you could talk a little bit about just the impact to working capital specifically on inventory and Accounts Receivable? Just sort of what your expectations are for inventory turns and DSO going forward, based upon all of the restructuring that's going on?

Our team has really rallied behind the focus on improved working Capital Management, primarily in the area of DSO and inventory turns as you just mentioned. Our businesses are quite different between Healthcare, Security and Opto in terms of what type of expectations you can place going forward for DSO reductions or inventory turns, as well as the change in the mix of the business such as the heavy backlog we now have in Security and the cargo business. But I think what is safe to say is though we've made progress in Q2 and Q3 on improving both DSO and inventory turns, I think there's more work to be done and we can continue to improve in those areas.

So on an absolute level of inventory, should we expect the inventory level to kind of be flat line, potentially go down a little bit here just as you improve the management of it?

I would expect that the inventory turns will continue to increase, but on an absolute dollar basis it's likely that inventory dollars going forward will increase as well, given that some of the products that we're now shipping have such long lead times and heavy material components.

Okay. And then just you mentioned it briefly in the prepared remarks, but should we be looking for any upcoming milestones on the RT side out of the UK and anything out of Manchester Airport recently?

Well, we continue to look at milestones. Internal milestones that we have put on to the progress of it. We are cautiously optimistic. We look at it from weekly and monthly basis. I don't think so that we are going to do any outside publicity until we actually get out with a product in the test phase at Manchester or wherever else. All we can say is that we continue to be optimistic cautiously and spend wisely.

Okay, any idea when you might move to a test phase at Manchester?

Well, the answer is no. I don't have a date, a specific date. I think we've said that it's in the late 2008, Jeremy?

Yes.

Okay. I think that takes care of me. Thanks a lot, guys.

And your next question comes as a follow-up from the line of Tim Quillin, representing Stephens, Inc. Please proceed.

Yes, just a couple quick questions. One, what level of charges do you expect in 4Q relative to the restructuring?

The fourth quarter -- we expect that will be in the neighborhood of several million dollars.

Okay. Are there new things that you're identifying in that or so you're saying it would be higher than 3Q. Is there some specific rationale for that?

It should be in the same neighborhood as the third quarter where we did $2.2 million, plus or minus a bit. It's a continuation of the efforts in this initial $15 million to $17 million, plus probably a couple incremental things that we've identified as well.

Okay, several million scared me a little bit.

Okay.

And then can you give as much as possible an update on the L-3 lawsuit? Thank you.

Yes. Both sides have filed notices of appeal, and we're advised by our counsel that given the history of the second circuit there that we're looking at something probably towards fall as far as oral arguments. And then once oral arguments are done, we'll see what the judges come back with.

Okay. Is there -- would you be interested or can you initiate talks to discuss the settlement or is that something that L-3 would have to initiate?

Well, that's a pretty loaded question, Tim. Both sides can definitely initiate. It's a free world. I think that there are no ground rules -- who can initiate, who cannot. I think the best thing we can say is that it's in the interest of both companies to initiate it.

Okay, thank you.

Ladies and Gentlemen, this now concludes the question and answer session. At this time I will turn the call over to Mr. Chopra for closing remarks.

Thank you very much. Just to summarize it, as Alan has said, we definitely are focused on the bottom line. We definitely continue to look at various groups. We want to put as much behind us as possible of one off and clean it up so that we can set ourselves to a clean 2008. I've said that 2007 is a transition year. We are very much focused into it. All the groups are being looked at. Security has a great future -- we are entering Q4 with a strong backlog. We think that as CBP kicks in, we should definitely participate into it. Activity continues to be strong. Although Healthcare patient monitoring in the U.S. is weak, we are aggressively integrating the new acquisition, sizing the operation properly, and can capitalize on the cost savings. We are looking at manufacturing efficiencies to increase our gross margin. And in the Opto area, which is a very predictable business, we continue to perform well on the top line. And we looked at the defense systems and I don't know that there's anything else left over. We look forward to a strong closure of the year in Q4 and to set up the stage for a very strong 2008 both in the top line and on the bottom line. Thank you very much.

Thank you for your participation in today's conference. Ladies and Gentlemen, this concludes the presentation. You may all disconnect and have a good day.