OSI Systems Inc (OSIS) 2009 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the first quarter 2009 OSI Systems earnings conference call. My name is Stacy, and I'll be your conference moderator for today.

(OPERATOR INSTRUCTIONS)

I would now like to turn the presentation over to your host for today's call, Mr. Alan Edrick, Chief Financial Officer. Please proceed.

Thank you. Good morning. Thank you for joining us.

I am here today with Deepak Chopra, our President and CEO; Ajay Mehra, President of our Security Division; Victor Sze, our General Counsel; and Jeremy Norton, our Vice President of Investor Relations.

Welcome to the OSI Systems fiscal 2009 first 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 that this presentation is being webcast and will remain on our website for approximately two weeks.

Before discussing our financial and operational highlights, I would 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 on this call about future company performance, as well as certain responses to questions posed to company officials about future operating matters.

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

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.

With that disclaimer out of the way and before turning the call over to Deepak, I will provide a high-level overview of our performance during the first quarter and our recent accomplishments. And following this, Deepak and I will discuss the market outlook in Security and in Healthcare, and in particular the uncertainty in the near-term Healthcare capital procurement cycle, and the aggressive steps we're undertaking.

So now let's take a broader look at the quarter. We're successfully executing the strategy that we announced some time ago to improve our profitability and our cash flow. We have highlighted this game plan on our prior conference calls over the past year, and we continue to see positive results. Our fiscal year 2008 financial performance demonstrated significant improvement, and provided compelling evidence the changes that we first started implementing in fiscal 2007, and which we continue to build upon, are leading to improved earnings.

You can see the benefits in our results again this quarter. Our progress was reflected in Q1 2009 with highlights as follows. First, we achieved a 13% increase in first quarter sales. Strong sales in our Security and our Opto divisions drove our revenue growth and overcame some weakness experienced in our Healthcare business.

Second, excluding non-recurring charges, we delivered earnings per share of $0.04 for the first quarter of 2009, compared to a loss of $0.12 last year. We set a goal to be in the black in the first quarter, which is historically our weakest, and we achieved this objective. Increased sales, coupled with our improved, more efficient cost structure, led to this positive bottom-line performance.

Third, we shattered our previous cash flow records, as we generated nearly $15 million of operating cash flow and $13 million of free cash flow for the quarter. This follows the $9 million of operating cash flow generated in last year's fourth quarter.

Fourth, our Security bookings also set a new record for a quarter at $91 million, leading to a strong quarter and a record backlog in our Security division and a total backlog for the company of $231 million. Equally important, we announced several strategic awards in air cargo for the CT checked baggage systems, which represent significant future growth opportunities. I will be updating you further on the financial performance of the company, and steps we will take to address the softness in the Healthcare sales.

But first, let me turn over to Deepak.

Thank you, Alan. Again, good morning, and welcome to the OSI Systems first quarter fiscal 2009 earnings conference call.

As Alan mentioned, we have begun the year on a positive note, achieving a profit in the first quarter for the first time since fiscal 2005. Inherently, this quarter has been the weakest quarter for us. As Alan mentioned, our year-on-year revenue for the quarter increased 13% to $148.2 million. While excluding the impact of impairment, restructuring and other one-time charges, operating income improved by approximately $3.7 million to an operating profit of $1.9 million, and earnings per share improved by $0.16 to $0.4 from a loss a year ago, on a normalized basis from the same period of last year.

On a divisional basis, the Security and Optoelectronics divisions performed very well, with both divisions improving their revenue top-line by 20% and 23% respectively. Bookings in the first quarter were also very strong, as represented by the company's ending backlog of $231 million at the end of the quarter. This was primarily led by very strong bookings of approximately $91 million for our Security division.

The Healthcare division faced some challenges in the first quarter. It's also a weak quarter for the Healthcare group. This was direct result of the credit crisis occurring, especially in North America. As a result, sales for the first quarter declined by approximately 3% when compared to the first quarter of the prior fiscal year. Our customers in North America primarily tend to be hospitals. They're typically dependent on the credit markets to finance purchases of capital equipment. As you have seen and read about, this has been a very tough, challenging couple of months and led to our Healthcare customers in North America delaying the planned orders. As to the extent of how long the situation will last and to the impact this may have on our international business, it is uncertain at this time.

But we remain confident that we have not lost orders to any competitors. This is a result of our customers' inability to give us any visibility of when their structure would improve to be able to access the credit markets. We are watching the markets very closely, but as prudent managers we have moved very quickly to address the challenges we face due to this credit crisis. As announced, we are in the process of implementing proactive measures to address our overall cost structure in our Healthcare group, especially North America.

This, though, was not a surprise, but it happened very fast at the end of the quarter, and the 3% revenue loss that we had was due to the push. And after doing the analysis and talking to the customers, the company as prudent managers immediately implemented a cost structure review of our Healthcare group. We are in the process of implementing that as we speak.

On a positive note, the international business of the Healthcare division performed above or well to our internal estimates budget. We do not see any weakness today, but we are very cautious to make sure that this does not spill over to that part of the business. We also in this quarter launched a new ultralightweight patient-monitoring product line under the trade name [Alance]. It is the first time developed by our global development team in our new facility in Suzhou, China. Its compact design is suited to a broad range of international markets, providing connectivity and high-performance in the [critical] environment. During the quarter, we also had launching meetings in many international countries, and I'm very proud to announce it's been a great success, and we already started getting a good, appreciable amount of bookings from our customers.

Moving over to the Security division. This has been a great quarter for the Security division. As mentioned before, the division booked $91 million of new orders, both domestically from the US Government's various agencies and in the international market. The continued strength comes from our cargo and advance technology in people screening and commercial x-ray systems. The backlog for the division now stands at a record $141 million, providing very good visibility for the remainder of the fiscal year.

Subsequent to the completion of the first quarter, we also had announced two very significant announcements that I would like to focus on. The first one was an order for $3 million from an undisclosed US-based air cargo company for high-speed x-ray systems for the inspection of air cargo. This represents the largest order to date for Security inspection systems for air cargo, and is a direct result of the US government's mandate for 100% inspection of air cargo on passenger planes by August 2010, and to achieve 50% inspection by February 2009. The opportunity in both domestic and international markets is very significant, and we expect that our technology is rightfully suited, with various models and various price points to address the need of this market.

Secondly, today we announced that we have received approximately a $6 million contract from the TSA for further development and delivery of our revolutionary patented realtime tomography solid-state high-speed check baggage system. We have been talking about it on various conference calls in the past that we have been spending internal funds for the last couple of years developing this revolutionary system. We think it's the industry first. We are very, very happy and proud that TSA has given us the validation of our approach to this technology. The RTD utilizes patented realtime tomography technology to generate high-resolution, 3D x-ray images of passenger bags, to detect potential threats more accurately, and at a throughput which is greater than the systems currently deployed.

Just to emphasize, the Rapiscan RTD is designed to offer the following advantages over the current legacy CT systems -enhanced threat detection, increased throughput, ease of integration and lower total overall cost of ownership. In the last conference call, we also did say that we will start showcasing this system in the international area of - before this fiscal year ends. With this validation of the TSA, we are very excited about it. The marketplace for this product compared - by a Homeland Security analyst at Frost & Sullivan, David Fishering, the global annual sales market for automated high-speed baggage inspection systems is estimated to be over $600 million in 2008, and is expected to increase by 5% to 7% per year over the next five years, presenting a further significant opportunity for the company.

On the Opto division, it also gave a very good increase in its revenue. It grew about 23%, driven primarily by the continued participation in the CREW 2.1 program with the US Department of Defense.

With that, I'm going to hand the call back over to Alan to talk in greater detail about our financial performance, before opening the call for questions. Thank you.

Thank you, Deepak.

We remain highly focused on driving earnings and cash flow improvement. Our management has systematically executed our strategy to obtain these goals, and this focused effort is paying off. I will speak more about this shortly.

First, let me review the financial results of the first quarter. As we mentioned earlier, overall net sales for the first quarter increased 13% to $148 million in fiscal '09, from $131 million in fiscal '08. On a divisional basis, the Security group reported another solid quarter with 20% sales growth, with a strong backlog providing excellent visibility for the near future. Once again, our Opto group had a tremendous quarter, increasing revenues overall by 23% and third-party sales by 35%, driven by strong shipments on a defense-related government contract. Our Healthcare division reported a 3% decline on the top-line, as certain expected first-quarter orders were delayed by the customers.

Our bottom line for the first quarter in 2009 market steadily improved, as we reported net income of $100,000 or $0.10 per diluted share, compared to a loss of $2.1 million or $0.12 per diluted share for the same period of fiscal 2008. Excluding impairment, restructuring and other charges, net income for the first quarter of fiscal '09 would have been approximately $0.7 million or $0.04 per diluted share. This result is a especially important, given that we achieved it in the seasonally-challenging first quarter.

For the first quarter of '09, our gross margin of 33.5% was essentially flat as compared to the first quarter of fiscal 2008, declining 20 basis points primarily due to significant growth in our Security and Opto division sales, which generally carry lower gross margins than that of our Healthcare business. While our gross margin will vary from quarter-to-quarter as a result of a number of factors including product mix, unit volumes, pricing, inventory reserves and capacity utilization, we do expect to see overall improvements in fiscal 2009.

During the first quarter, we realized further operating efficiencies, continuing the momentum evident in fiscal 2008. Our SG&A expenses as a percentage of sales decreased by 220 basis points for the first quarter to 25.4% from 27.6% in fiscal 2008, and by a 410 basis-point improvement from 31.5% in fiscal 2007. Research and development expenses were $10.2 million or 6.9% of sales, compared to 7.4% of sales in the same period last year. In absolute dollars, such costs increased a half a million dollars from that of the prior year.

We continue to invest significant resources and technologies that will add value to our Security and our Healthcare product offerings. As a result of these programs, we believe that the company is well-positioned to capture major opportunities throughout the global marketplace in the future. Our effective tax rate for the quarter was 34.5%, compared to 35.1% in Q1 last year. Our provision for income taxes is dependent on the mix of income from US and foreign locations, due to tax rate differences among such countries, as well as due to the impact of permanent taxable differences.

As we move to cash flow, during the quarter we generated operating cash flow of $14.7 million, driven by improved profitability and our ongoing focus on working capital management, including the receipt of significant customer advances. Capital expenditures were $2.2 million, and depreciation and amortization was $4.4 million. Generating strong operating cash flow will continue to be a top priority in fiscal 2009.

Finally, based upon the economic climate impacting our Healthcare division, as Deepak discussed, we are unable to provide guidance until the outlook becomes clear. We're taking proactive steps to aggressively right-size our cost structure in Healthcare in light of the softness experienced in Q1, and the anticipated continued softness in Q2.

During fiscal 2008, we transformed our company in into a sustainable organization and a consistent performer. Economy not withstanding, we also built a strong foundation for significant future earnings power. We realized the benefits of the efforts in Q1, and we continue to implement a strategy aimed at driving further improvement.

Thank you for listening in on this conference call, and at this time I would like to open the call to questions.

Thank you.

(OPERATOR INSTRUCTIONS)

Your first question comes from the line of Brian Ruttenbur with Morgan Keegan & Co. Please proceed.

Great, thank you. Can you give us an update on litigation with L3, and where that stands?

Hi, Brian, it's Victor Sze.

Hey, Victor.

Where it stands now is it's on remand to the District Court in New York. As of yesterday, I know that nothing has been calendared by the District Court, so it's a just question right now of standing in queue at the District Court for the next day.

Okay. So what does that mean? Speak in eighth grade normal English, going to remand in District Court. That means the District Court will review it, is that right?

That means that the Appellate Court has said that some errors were made at the trial, and therefore they want essentially what is a do-over.

Of the entire court proceedings? The whole proceeding would start over?

Not of the entire proceeding. It's really more the trial. The discovery, which really took a bulk of the time the first time around, the facts are the facts and so the discovery is not really repeatable. I suppose that it's possible there may be additional discovery performed, but that will not be, you know, quote-unquote, redone. So really, it's the trial.

Okay, so how much do you anticipate spending on that? It wouldn't be as expensive as the first trial, is that correct, because of the discovery, you would not have to redo that?

That is a pretty safe bet.

Okay, and then can you talk about, switching over probably to Alan, cash generation going forward. You had a good cash generation quarter. I assume, that you can continue generating cash going forward. Can you talk a little bit about that?

Sure. Yes, we were very pleased with the improvements that we have been seeing in the cash flow and, namely, the last two quarters in particular and we anticipate that cash flow generation will continue to be good, though there will be variation from a quarter-to-quarter perspective, based upon customer advances, based upon inventory growth and profitability associated with each quarter. But overall, very pleased with the very positive steps the entire team has taken to significantly change the cash flow position of OSI Systems.

Give that this was your seasonally weakest quarter, assuming the economy doesn't go off the total deep end, your cash generation should be at these levels or better going forward? Or was there something where you collected on previous quarters better or, you know, I was trying to figure out if this was a one-time cash generation this strong?

This is -- we had some significant customer advances that we received in the quarter, which significantly favorably impacted our cash flow. Given that Q1 is, as you pointed out, typically our seasonably weakest quarter, we generally collect the sales from Q1 and Q2. So there is always that lag effect.

So I wouldn't necessarily say that Q1 is indicative of all quarters, but I would say the positive trend we're seeing in Q1 is something to be looked at because we clearly have - we have clearly made a difference in our working capital improvement initiatives, as well as the overall profitability of the company, which has significantly positively impacted our ability to generate cash flow on a more consistent basis.

Okay. Do happen to know tangible book right now? Where your tangible book value is?

Yes, I'll be happy to get back to you after the call on that.

Okay. Last question, when do you expect -- or do you expect backlogs will drop in the December period? It seems like things are going well, but seasonally backlog sometimes drop in the December period or the March period. You anticipate that to be consistent this year?

Well, Brian, keep in mind that three different divisions, the Healthcare division doesn't rely too much on backlog because they book and ship at the same time, and this is relatively a stronger quarter than the Q1. Security had a fantastic bookings. There are enough in the pipeline. There is enough quotation activity that if - the start of the lineup, there could be a strong booking quarter for Security. And on the Opto side, there is in print that IT&T has got a follow-on order from the DOD, which we are quite confident that we would participate into it. So Idon't know what the backlog will ultimately be, but we're expecting Q2 will also be a strong booking quarter for us, for the company.

Okay, thank you very much.

Your next question comes from the line of Michael Kim with Imperial Capital. Please proceed.

Hi, good morning, guys.

Good morning.

A couple of questions. First, if you could provide a breakout on the Security business between cargo and vehicle equipment versus some of your more conventional systems, baggage, parcel, some of your people-screening systems. I don't know if you could provide a breakout or a mix between them?

Sure. Sure. In terms of the particular quarter, our conventional sales in Security were $38 million, while our cargo sales were about $21 million.

Okay.

Representing - in the quarter, our conventional growth was outstanding at 31% and our cargo growth was 5%.

Right. And what was the international mix in Security? How much of that came from international customers versus domestics?

We don't break it out by division from the global on the international basis. But we have had continued success on the international front, maybe Ajay can provide a little additional color?

If you look at the Security side, I don't know exactly what the breakdown is, but we have seen continued growth and strength not just domestically but internationally as well, and as we continue to introduce new products going to new markets internationally, we have seen - we're seeing some very strong growth there.

Okay. Great. On air cargo, I don't know if you could provide more detail on how the equipment purchases are being funded. I think TSA has been pushing this down to the air freight forwarders and this is how - are they relying on some type of equipment financing, which in which case they may see the same type of impact your hospital customers have had in your Healthcare business? Or is there - any details will be helpful.

I think the way the air cargo - as Deepak mentioned, the TSA came out and said that 50% of all air cargo lines of passenger jets have to be screened by February '09, and by August '10 all of it has to be screened. TSA has got some pilot programs out there. There is some - you know, there is some funding available. I think that is a question better asked with the freight forwarders. But at this point, we believe that at the end of the day the freight forwarders have to do what the TSA tells them to do if they want to get air cargo onto aircraft.

Just to add on to that, this is Deepak here, I think what Ajay is saying is that initially I think there are certain freight forwarders who are participating in TSA's pilot program. Some funding or a portion of the funding comes from the TSA to these freight forwarders. There are certain amount of equipment of various vendors that had been put on an approved list by the TSA, from which the freight forwarders can independently go and make a decision which one they want to buy and, ultimately, this is going to be a little difference than the capital equipment market and the Healthcare, because in the Healthcare market it's not a requirement for them to come up with the new[ tower] of construction or to replace them or to delay their replacement.

Whereas, in this particular case, there is a mandate by the TSA that 50% of all the freight getting onto a passenger plane must be inspected by February 2009, which is less than four months away, and 100% of the freight getting on to the passenger planes must be inspected by all carriers, if they want to put the packages onto a passenger plane by August 2010. So it's a requirement that they all will have to do it. Not that one people can do it and the other people don't, everybody has to buy something to do it.

Okay. Great. And then just on the solid-state CT machine, I think in the past you talked about international opportunities, some airports, you know, that there may be an opportunity for you. Can you talk about anymore details or an update on that front?

Well, the way to answer that question is that we have been developing this with our own money for a broad marketplace, which, as I mentioned, by Frost & Sullivan is about $600 million-plus dollars for a year, growing well for the next five years. So it's not directed at a single airport or single customer. This is a product which today, the people who are supplying this product are the L-3s and the GEs of this world. There are approximately a thousand machines out there, both domestically and internationally. We have a very close relationship with Manchester Airport, I think it's a given that the first showcase will be there.

By this order that we got from TSA, it validates that we have a product which the government likes and this money will go quite good for us to go accelerate our development. And we are going plan to deliver these products through certification and to start showcasing in the near future. It's a broad product line and the market is huge. So we believe and are very excited that this is not directed at one or two specific customers. It's a new marketplace that Rapiscan has the access of it, and we always said it's a 2009-2010 game.

We want to be and will be a player to compete with the L-3S and GEs of this world with our product, and we believe that it's a quantum leap in technology and performance, and gives definitely some great advantages to the customer, especially in the cost-to-own, in service, installation, and since it has no moving parts. So this is a great milestone for the company to get the validation from likes of TSA, which will definitely bring more interest and focus from the rest of the world.

As you look out in the 2009-2010 with this product, is the opportunity primarily replacing or displacing machines that are already deployed at this point, or are we looking more at new terminals, new builds, new airports as the primary driver? Both. Both.

There has been -- it's -- a down time, where because of lack of the right performance machines, the customers have delayed replacement of their 7 to 10-year-old machines. At the same time, new installations are not taking place because there is no technology that is available. So we believe that a faster machine with better throughput, less installation costs, better threat detection, will rejuvenate the market to start looking at replacements like - faster because it pays itself off. At the same time, new systems and set up, putting them stand-alone in concourses. They would go to the in-line system because of the ease of installation.

And just, you know, touching on pricing. I know you can't go into any real detail yet, but just given the advantages that this product has, you know, would you expect to be able to price this at a premium to the conventional machines we see today?

I am not going to comment on it. All I can tell you is that when we're ready to sell and take orders, we will make sure as good businessmen, we're going to price it for what it does. What advantages it does to the customers and the cost of ownership. All we can tell you is that at the present price structure, and we have said it before, we will make very good margin.

Wonderful. Perfect. Thank you very much.

Your next question comes from the line of Beth Lilly with Gabelli. Please proceed.

Hi, Beth Lilly with Gabelli.

Hi, Beth.

Hi, Alan, hi Deepak. I wanted to ask a question couple of questions. One is, I wanted to better understand this $6 million award. Now, so in essence this is the TSA validating your RTT product, saying this is for real and we've placed $6 million worth of orders with you, and we want to you place those machines in airports. Is that correct?

I think that we would like to be a little bit more vague in the answer. We don't want to comment whether it's going to the airport or not. All we want to say is that it validates our commitment to this thing, and TSA will receive the machine.

I think I can just. -- we're going to work closely with the TSA, and really going into - at this time we're really not at liberty to go into more specifics than that.

The thing I want to emphasize is we have been talking about it for the last couple of conference calls. I think the important thing is, this finally does the last hurdle that everybody out there in the field had a doubt whether our technology would work, whether our technology would get validated by TSA. We have achieved that. This is a great milestone. Bigger than what people realize it. What it really says to the world, the L-3s and GEs and Analogics, Rapiscan that does have a technology which is superior, does better performance and now it's validated by TSA.

Uh-huh.

It's very important for us to get that message across.

And is this typically what happens with the new technology? I know that the technology doesn't change, you know, on a monthly or quarterly basis, but it's more of a, evolutionary thing. Is this typical, where the companies will spend the money and then the way you get validation and you know that the TSA is, in essence, going to put you on a list, is they then -- I mean this validates your technology, and so this is an important step and this is just -- do you understand what I'm asking?

No, I don't, but I just make a comment to say we are one of the only companies in this space for the last couple of years. We have spent our own money developing this. Every other company got money from TSA. We feel very good about it that ultimately we have also reached that club.

Other companies have gotten money for the TSA and you haven't?

We now have it.

Uh-huh interesting. Okay. Okay. Okay. The next thing I want to ask you about is I want to get clarification on the cargo market, in the sense of did I hear you correctly that the TSA is funding - is paying for the funding for the cargo market? Or is it the airlines?

There are pilot programs in existence of TSA that they have given some assistance, whether it's fully covered or not fully covered, to some freight forwarders who are participating in these pilot programs, and we got an order from a freight forward.

Uh-huh. Okay. So right now the money's coming through the TSA but at some point, I mean if there has to be compliance by the second quarter of '09, is that what you said?

By February 2009 for 50% and August 2010 for 100%.

Okay. So to get that kind of compliance, you're going to have to start spending money. Either the TSA is going to have to spend the money or the cargo companies will?

Either that or it gets passed over to the guy who is putting the package through.

Right. Yes. Okay. Right. Okay. All right. Okay. I wanted to just get a little better sense of - you're not giving guidance for the rest of '09. Is that strictly tied to the Healthcare business?

The answer is yes. And I want to emphasize, because we scratched our head what to do. This happened pretty fast at the end of the first quarter. But pushed - I want to emphasize it, we have not lost any orders, but hospitals in the United States, they depend on funding from either charitable organizations or floating municipal bonds or other ways of doing funding, and as you know, September-October is pretty much - it's deep freeze. So with that thing getting pushed, we just took a very brief - a very strong analysis, and we didn't want to wait because we do not know how long this is going to last and we've basically gone in, our international business is solid, our Security business is doing very well, Opto business is doing very well. In the Healthcare even, international as I mentioned is on budget or better but, you know, we're watching carefully. Because this flu can spread to that side of the world, too.

Definitely US, there is a lot of what I call a lack of visibility from hospitals because of the credit crunch. And that prompted us of taking the guidance off, and I think that everybody's prediction is the next couple of months, when things settle down, I think by the next conference call we'll have a clearer picture but we're not waiting. We are addressing our cost structure in Healthcare right away, and we plan to be there stronger and better as we come out of this and, again, it's nothing to do with our company. We feel very strongly we're doing everything right but we just can't wait, so we have taken the right actions.

Is that to say that your Healthcare business might lose money this year?

We don't plan to let that happen.

Yes, because you have taken out a lot of costs out of your Healthcare business over the last couple of years.

We have also said in in today's conference call that we're actively involved in taking more costs out of the Healthcare group as we speak.

Uh-huh. Okay. Okay, so you think by the end -by next quarter you will have a better sense?

Definitely we're hoping that we'll have a better visibility.

Okay. One other question. On the Healthcare side, what percent of your revenues is domestic and what is international?

We only break out our - the split in a geographic basis on an OSI overall. We don't break that out on a divisional basis.

Okay.

Just to say that we have, Alan, would you say that in a general term, it's a US-based company SpaceLabs and a big chunk of the revenue is still dependent upon the US.

That's correct. The majority.

And that - just to give another, put in the next perspective. The first quarter, they are only down by 3% in the Healthcare, and primarily it's directed to the North American, the rest of the business did well.

Okay. Those are all my questions. Thank you.

Your next question comes from the line of John Croke with Jefferies & Company. Please proceed.

Good morning.

Good morning.

Your commentary this morning with respect to the pressures you're see in the Healthcare business have been primarily centered on what is happening in the credit markets. I was wondering if you could step back for a second, kind of put that aside for a moment, and just think about the bigger macroeconomic pressures that we're seeing, and some of the fiscal pressures that are being experienced at the Federal and State level. How do you see these trends playing out in your Healthcare business, putting aside what we're seeing in the credit market?

That is a hundred-dollar question. You have to also put into the election going on. We don't know what is going happen after November 4th going into next year. Democrats, Republicans, they both have different Healthcare plans. They both look at this in a different environment, and that definitely will have impact on everybody's Healthcare strategy. Just to say that our capital equipment is bought by hospitals either for a replacement of their old technology or in many cases to reduce dependence on paper, to do better connectivity. I mean a new tower opens or a new ward opens, and the more beds they can work do into what I call the high-tech connectivity, the better the revenue and profitability the hospital gets. So, monitoring is almost a lifeline. If you want a patient, you have to have monitors.

So it's difficult to predict overall what is going to happen to the markets from the Federal, what is happening over the election, what they're going to do. But we believe that if you ignore the credit crunch, and that is why this happened, what we said the last couple of days of the quarter when things started getting pushed, and our ability to react fast to look at the cost structure, once this thing gets settled down, there is enough visibility both domestically and internationally of where the orders are and the customer's ability to buy. These are not million-dollar items. These are $15,000, $20,000 monitors. So these are not like the CT scanners and ultrasounds of multimillion items.

Understood. That is very helpful. You mentioned that there haven't been any cancellations of orders in the Healthcare business. How is your receivables quality? Have you guys been stretched out at all there or are things performing pretty normally?

The receivables are really still performing quite consistently. So we haven't seen any major challenges there.

Okay. Great. And with respect to your plans to address some cost opportunities in the business, is the $800,000 we saw in the September quarter, is that more related to prior projects or does is that include some of the actions you have already taken?

The $800,000 in Q1 related to the prior projects, as you mentioned. We are aggressively looking at our cost structure and would anticipate that you will see further charges in Q2.

Okay.

Just to add on to it, definitely there will be an impairment charge, because we are addressing, as we mentioned, and we are executing the structure and the infrastructure rationalization in the Healthcare group, especially North America.

Okay. My last question goes back to the $6 million TSA award that you announced this morning. Does the receipt of this validation and this financial support from such an important customer, does this allow you to perhaps accelerate your timeline for bringing a final qualified product to the market? Does it help you out there at all?

I am sure the divisions would like to do that. Ajay's group would like to do that. We have to overall look at the total company, and I think we will do the right thing to adjust it. Some things can be accelerated, some things you have physical limitations to do it.

We have a pretty well-defined program that we are working on, and this definitely gives us more flexibility and we plan to capitalize on it. But also we want to be very conservative and do the right things. Because after all, this is not a $6 million development that we have been doing. This is a multi - multimillion dollar, multiyear program, so this fits into the puzzle but it's not all-inclusive.

Understood.

Our timeline has not changed to what we have said in the previous conference call. We will start showcasing this product in this fiscal year.

Very good. Thank you very much.

Your next question comes from the line of Josephine Millward with Stanford Financial Group. Please proceed.

Good morning.

Good morning.

Deepak, I just wanted to congratulate you on the very important TSA win.

Thank you.

Now, if everything goes well, when do you expect the TSA to actually move forward with this deployment? I know you have been talking about showcasing the technology before your fiscal year ends, but realistically, if you can give us your sense of the timing with TSA in terms of upgrading the existing tech baggage EDS in the US?

Josephine, I really don't even - not that I'm going to avoid your question, I don't even know. This is, as you know --

I don't think the TSA knows.

Well, that is their prerogative. I think as you talk to Analogic and other people, there are many hurdles. You used the words certification and deployment to replace units, that is a very - that is the ultimate goal, but prior to that, I think it's very important to us to be very careful to what we give you the feeling. The showcasing in an airport environment does not mean that the unit is certified. It goes through various steps. It goes to steps of collecting data to take out some of the logistics of working, the optimization of performance, and then at a certain stage goes into certification mode and, you know, some people take multiple attempts to do it.

We believe that we know a lot but we are also very, very realistic. I don't think so that as prudent analysts that you should look at this is going to have revenue conversion in 2009. It's not going to happen. It's a 2010 kind of thing. But this market is a huge market, as you know, and this market is not going to disappear. And the sooner the product gets there, the sooner the benefits will happen and, at the same time, there are other technologies that they're going to -- the other competitors are trying to increase the performance of their present machines. We - as we mentioned to you before, we have quantum leap forward, taken a pioneering view of a new technology which inherently some people were disbelievers ,and we feel very, very good of the validation by the TSA of this new technology.

Great, that is very helpful. Thank you. Can you provide more color on the scope of this medical equipment downturn? Do you expect Healthcare sales to be down from last year? And if you can talk about how this is going to impact your margins? And this is maybe a question for Alan. If you can talk about how much costs you think you can take out of Healthcare. I think last year you took out about $10 million. Thank you.

I think - I would like to make an all-inclusive statement. We don't know. Frankly if we knew, then obviously we wouldn't have taken the guidance off. We want to wait a couple of months for this confusion to settle down, and I think we think we will have a better chance after December is over, but - for the next conference call.

On the second part of your question is, I don't want to put a number yet because it's a bit too early, but we can definitely share with you that it will be in the same ranges as what you mentioned last year. We are very aggressively looking at the infrastructure cost. So it's not the $800,000 number that somebody asked us in the impairment charge in September. We're going to look at it in a very different mode, and we're going to go take a look at it. We don't know the exact number but it's going to be a pretty big number.

Do you expect to have impairment charges throughout the fiscal year or just in Q2?

Well, I think a big chunk of that, Alan, is that right, a big chunk of that will be in Q2. Obviously, we'll keep looking at it. It's a policy of the company the last year that we will be looking at every division, every area of the business, internationally, domestically. But the big chunk of the impairment charge or cost restructuring will be in this quarter.

And will it mostly be in SG&A or, you know, are you consolidating facilities? If you can give us a little more color in terms of how you plan to cut back on costs?

Don't know yet.

Okay.

All I can say all of the above.

Deepak, traditionally Q2 has been your strongest quarter in Healthcare, and I know you don't have a lot of clarity and visibility right now, based on what you have seen, do you think, you know, Q2 will be relatively flat from last year or is it going be down? In Healthcare?

Josephine, I don't know. By the way, Q2 is not the strongest. It's one of the strongest. Q4 is the other strong quarter, and we had a pretty strong quarter. I don't know where Q2 will be with respect to the previous year. We do expect it to be normally stronger than Q1 and, secondly, I think the top-line is not that - I'm not saying it's not important, but we also are very much focused into it. Whatever is going to happen is going to happen. We're aggressively looking at the cost structure.

Can you talk about the introduction about your lighter patient monitors and how - if you still think that is going to be a growth driver for the year?

Number one, it will be a growth driver for the year. Two, it's directed for the emerging markets, and we also had some launches in Western Europe. We think it will be a growth driver for us. It might not put too much revenue on the table because it's a low-cost monitoring product line, but then in - as far as numbers go and far as the progress goes the next year, the product line and the derivative of the product line will be a significant dollar contributor, both in revenue and margin in coming years.

Great. Thank you very much.

Your next question comes from the line of Tim Quillin with Stephens, Inc. Please proceed.

Good morning.

Good morning.

You know, I guess I can understand from your perspective why you would want to withdrawal guidance, but analysts have to come up with numbers and it seems like you might hopefully have a better sense of things than we do, and withdrawing guidance kind of makes it seem like you don't understand what the worse case scenario might be. So can you at least help us understand what the worse-case scenario might be in the patient monitoring business?

Tim, this has been a tough decision, I understand it. Frankly every time we're talking about this discussion, your face came in front of me because I understand where you're coming from, and the frustration you might have. The best way that we have been able to rationalize, and if we can give you some indication, is Security is going to have a great quarter. Security, hopefully, we think, with the backlog and what we are seeing will have a good year.

Opto will have a good quarter. And Opto has a good visibility, especially with what we have seen with the ITT, winning the next award.

Healthcare international business is doing very well. We have introduced new products. We're very satisfied with the internal estimates.

North America is an enigma to us. It happened very fast and, you know, we could have waited for some more time, both in our cost rationalization and the guidance, but we felt it prudent, because we don't know. If we knew of a delay or loss of orders, one can rationalize it. When you go to a customer and the customer says I have th purchase order for you, but I don't know -- but my CFO is saying wait, because we can't get access to capital, or we'll be drawing our bond, or we're going to redo it after the first of the year. It puts a light to it because we can't say anything.

Obviously, we have analysis inside, and that is one of the reasons why Alan and his group, together with the division, is on an aggressive mode since last - since this month, it's the first month of the quarter. We are looking at a cost rationalization. So obviously, we're doing some internal analysis.

All we can tell you is, we're going to make sure that Healthcare for the year will be profitable, irrespective where the revenue falls. We're very focused on that and we're going to do that.

You can maybe just give us a sense of the revenue split, maybe within North America, maybe you don't want to give specific numbers, that is fine. But as far as products goes, how much is consumables? How much is not going to be a worry with the credit crunch? Is everything a big purchase order that relies on credit? Is everything kind of a big-ticket box purchase or do you have some kind of base of business you can rely on?

Tim, number one, none of it is big-box business, like the CT scanners or the MRIs or the ultrasounds that the GEs and the Siemens and the Philips's sell. These are connectivity boxes that go into a pediatric ward or an OR or something. What you're faced with is, if it's due for replacement, they going to replace the whole ward. They're not going to replace half of it. So if they want to delay it, they'll delay the procurement by a couple of months until they have to. So it's difficult to go back and, what I would call, pick a number, how much are the big-ticket items on that. But we do have service revenue, we do have supplies and accessories. And there are many hospitals who might have this problem short-term because of the clarity needed.

On the other hand, the other hospitals, they don't have this problem. In many cases, it's funded already. The money's already dropped into it. I don't want to call it doomsday. You can see the handwriting from what Philips is announcing, what GE's talking about Healthcare, other companies. Definitely there is concern out there, but nobody is predicting that nobody's going to buy anything. Those are necessity items for patients' lives.

We're basically saying we're going to take this opportunity to get the company stronger, and to look at the leveraging and the cost rationalization in North America, especially, and any other place where we can look at. That is what Alan's group is looking at.

In terms of the outlook for the current quarter, so you're a month into this, do things look like they're getting worse versus what you saw at the end of September? Could you have a situation where Healthcare revenue is down quarter-to-quarter?

Too early to say. This quarter -- Healthcare business runs in where the last month is very strong, the first two months are weak to begin with, and it's too early.

So - and this may be a difficult question but, you know, if I put my model down 20% or down 30% or down 40%, I mean how much is too big of a cut for Healthcare this year?

I don't think so - we're predicting those kind of draconian reductions in revenue.

Okay. And then in - just in terms of the response to the cost side to this, can you give us a sense of the type of things you might be planning to do and are those things that you might have done in the future that are getting pulled forward, and do you have any sense of what size of restructuring charge that you might be talking about?

Again, I want to emphasize that we can't pin a number down. Josephine already sort of got an indication of the kinds of things we're talking about.

Yes. And you may have answered this as well, but can SG&A costs just come down in dollar terms? You know -- I know you have been, you have had restructuring charges for the past couple of years. But SG&A costs have actually gone up in dollar terms over the past couple of years. Can they come down now?

Yes, I think if you looked at SG&A, Tim, last year, it was quite flat overall compared to '07, despite 18% sales growth as an overall company. As we continue to look forward with some of the cost restructuring initiatives we're doing, we're certainly seeing greater leverage where SG&A as a percentage of sales has come down quite significantly, and we're certainly looking at can it come down in absolute dollar terms as well at certain divisions?

Okay. And on cash flows, Alan, what do you - where do you expect depreciation and amortization to end up for the fiscal year?

I would estimate that it would be fairly comparable to what we saw in the first quarter, and the first quarter our depreciation and amortization was $4.3 million. So if you annualize that, we're talking about $17 million, $18 million.

Okay. And then CapEx?

CapEx, we historically as a company run at about a $15 million to $17 million run rate. We're a little bit lower than that in the first quarter, and anticipate continuing to be prudent in our spending throughout the rest of the year.

Could it be lower than - so more like $10 million, kind of a run rate off of 1Q?

I would say that Q1 was lighter than the typical run rate will be. I would say use the 15 to 17 that we historically have been at as a better proxy, and we will look to keep it lower than that, though, throughout the year.

And I know you have advanced payments in the first quarter. How should we just think about generally working capital uses for the company? Are you getting close to the point where you should be working capital neutral for a while, or should we expect working capital to be a drain on cash flow over the next three quarters? Thanks.

Lots of puts and takes overall. I think there is still greater opportunity for us from a working capital perspective to drive down our DSOs, with some tremendous growth in our Security backlog. There will be times where there will be additional inventory requirements in order to support that that put a drain on our working capital. So a lot of puts and takes go into that. But overall, I would say there is more opportunity to continue to improve our working capital as we go forward through the next two or three quarters, as you asked.

Thank you.

With no further questions in the queue, I would like to turn the call back over to management for closing remarks.

Thank you very much. In summary, we feel very good about the Q1. It's been a great quarter, especially a great, strong performance from Security and Opto. We are 3% down in the Healthcare. The whole industry is going through it. I think I feel very proud about it that we have reacted fast. We're going to look at the cost structures and we - we will come out of it stronger. We are investing wisely. We are vindicated with the TSA award. Air cargo is a great opportunity. Internationally, the business looks very good in Security. It looks very good in Healthcare.

We believe that as prudent managers, we're watching the top-line and watching our bottom line, and we hope that we will have better visibility, just like the rest of the industry in North America will have a better visibility, with whatever happens to the credit policies in the next 30, 60 days, and we hope to be able to get back into a guidance by this time when we report the second quarter.

Thank you, very much.

Thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect, and have a great day.