OSI Systems Inc (OSIS) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2009 OSI Systems earnings conference call. will be your coordinator for today. At this time, all participants are in listen-only mode. We'll be facilitating a question-and-answer session toward the end of today's conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference, Mr. Alan Edrick, CFO. Please proceed.

Good morning and thank you for joining us. I'm Alan Edrick, CFO of OSI Systems; I'm here today with Deepak Chopra, our President and CEO; Ajay Mehra, President of our security division, Rapiscan Systems; and Victor Sze, our General Counsel.

Welcome to the OSI Systems fiscal 2009 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 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 the 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 quantitative reconciliation of those figures, please refer to today's press release regarding our third quarter results. The press release will also be filed with the SEC as part of a 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 update any forward-looking statements. Whether as a result of new information, future results or otherwise.

Before turning the call over to Deepak, I will provide a high level overview of our financial performance during our third quarter. We will touch on several themes that we discussed during last quarter's conference call. Specifically, despite the challenging economic environment, we continue to successfully execute a strategy to improve our profitability and our cash flow. We have discussed this previously and the results this quarter again demonstrate the power of this plan.

Our third quarter 2009 highlights are as follows. First, we achieved a 20% increase in earnings per share, excluding the impact of nonrecurring charges in last year's one-time tax benefit. Improved operating efficiencies coupled with cost containment initiatives drove the solid increase in the face of a tough sales environment particularly within our healthcare business.

Second, following our strong first half cash flow, we again generated positive Q3 operating cash flow and free cash flow of $7 million and $3 million respectively. This brings our free cash flow for the first nine months of fiscal '09 to $31 million compared to negative $18 million in the prior year.

Third, our bookings were again quite solid leading to a backlog of $231 million at the end of the third quarter. While our top line momentum has been impacted by the economic environment, most notably, within the North American market of our healthcare division, we are pleased to continue to demonstrate significant increases in our year-over-year earnings and cash flow. I'll be updating you further on the financial performance of the Company and additional steps we've taken to address the ongoing softness in healthcare sales but first, let me turn the call over to Deepak.

Thank you, Alan. Again, good morning. Welcome to the OSI Systems earnings conference call for the third quarter and nine months ending March 31, 2009.

We continue to deliver positive results for our shareholders despite the challenging business environment. As previously discussed sometime in the October time frame, we moved quickly in November 2008 to further address our cost structure, identifying and eliminating approximately $10 million of annualized cost savings in line with the program we had undertaken to implement the organizational changes to reduce our cost structure and improve our overall operating efficiencies. We have completed that on top of that as we had announced last time, we have undertaken this ongoing program and continued looking at areas where we can get more efficient and cut additional costs.

This program along with the continued commitment and dedication of employees has enabled us to achieve the following accomplishments for the third quarter and nine months ending March 31, 2009. As Alan mentioned, he's going to go into more detail in the financial. I will just touch the highlights once again.

Non-GAAP EPS excluding the impact of restructuring and other one-time charges for the quarter improved 20% versus the prior year. Operating cash flow for the nine months ending March 31, 2009, was $40.1 million, an improvement of approximately $50 million when compared to the prior fiscal year. We continued to repurchase our common stock, in the quarter we purchased approximately 26,000 shares. Year-to-date, we have purchased approximately 630,000 shares. Our balance sheet and liquidity position remains strong. Something Alan will discuss in greater detail during his commentary. We still have an active share buyback program in place and we'll continue to look at the opportunities, particularly how to move forward.

Backlog remains strong. Year-to-date, our backlog has increased by approximately $19 million to $231 million an improvement of 9%. Today, we increased our EPS guidance for fiscal 2009. We expect fiscal 2009 EPS to be between $0.85 to $0.93 per diluted shares. Let me tell you a little bit about the three divisions.

Sales in our healthcare division declined by approximately 20% and 12% for the third quarter and nine months respectively when compared to the prior fiscal year. As previously discussed, the decline is primarily associated to market conditions in the North American hospital market. Our customers in North America as highlighted are predominantly hospitals are facing unprecedented economic conditions including lack of credit availability. Given this certain U.S. customers have delayed planned purchases. To date, we have not lost any significant orders to our competitors, or received any order cancellations. Additionally, internal estimates continue to show we have maintained our market share as all of our competitors are facing similar challenges. We've continued to closely monitor the conditions globally. Compared to U.S. the emerging markets and the European sector and Middle East continues to do well. Obviously we watch it very carefully from month to month and day ta day.

I must highlight, however, that despite the approximate 20% decline in sales in the third quarter, the division achieved an operating profit comparable to last year of about $2.2 million. In line with the operating profit from the prior comparable period. We expect the healthcare market to improve in fiscal 2010. And given our lower cost basis in this division, once sales improve, we expect to benefit in profitability, significantly.

While our monitoring sales are under pressure in North America, we have looked at alternatives to grow the revenue. To this end, during the third quarter, we entered into a distribution agreement with Ascom, an Australian based manufacturers of ultrasonic cardiac output monitors. Initial response from our sales channel have been positive.

We also continue to look at R&D, though we have sized it, we have moved some of the R&D functions to the lower cost areas like India and China and we have accelerated our development of the Alliance product line which we had announced before and have got very positive results and looking at that to be in the more focused into the sweet spot of the emerging markets, Asia Pacific and the European sector. Both development on the high end and on the low end continues and we believe that as the market bounces back, we would have a stronger, broader and a better product portfolio to compete and gather market share from our competitors. Cost is a focal point on it and we're very, very proud to announce that for the health of the management and the employees, we have been able to size the operation and most importantly, remained ahead of the curve as the challenges in the healthcare business in North America continue to challenge us.

Security division continues to perform very well. Year-to-date sales for the business has increased by approximately 10%. When compared to the prior comparable period. The business as of March 31, 2009, has a backlog of $126 million, which gives us tremendous visibility. More importantly, however, the business has achieved significant improvement in its operating results. Operating income for the nine months ending March 31, 2009, has improved by $9.5 million to an operating profit of $11.1 million.

Quotation activity remains strong especially domestically for air cargo and cargo and vehicle inspection products. Internationally, our cargo business continues to grow. Just touching on the growth drivers for this business, our three segments in which we participate continue to be growth drivers for us. Fortunately our strength and our bread and butter is in the checkpoint, conventional X-ray, as we have announced before. We continue to work with TSA at the U.S. airports for the next replacement cycle, rest of the world, we're doing quite well. And our business continues to be robust and the activity is very strong.

In the cargo sector, as we had mentioned before, is the biggest growth opportunity for us. Besides the vehicle and border inspection products, air cargo is a big plus for us as we announced in our last conference call that we have started seeing orders coming from the freight forwarders in U.S. who are trying to get to meet the deadline of 100% inspection for air cargo going on passenger planes by August 2010. As mentioned before, we have the broadest product line approved by TSA for that use. We are working with the air freight forwarders and just to give you an idea of how big the market is, there are 4,600 freight forwarders in the United States alone. In the checked baggage arena, we continue to make progress on our real time tomography CT scanner. We have collected more than 6,000 bags data at Manchester airport. We have also installed the machine at Manchester in a checkpoint just recently where we continue to collect more data in the checkpoint area also. We are talking to TSA and we have shown the unit to various International organizations. And look very promising.

Subsequent to the end of the quarter, we announced a significant multiyear contract award from U.K. customs authority for Rapiscan Eagle cargo and vehicle inspection system. The award follows a competitive International tender process which included all of our major competitors. The systems are to be installed at various locations throughout the U.K. replacing the incumbent systems made by our competitors. This is a huge win for us and that demonstrates our product quality and the performance advantages that we have compared to our competitors .

Opto product line, as we had mentioned previously, that the sales are going to decline because of that product line is quite dependent upon the economy. Slow down the economy was planned by looking -- that we looked at it. We did announce this quarter a $27 million order which is the additional order by the U.S. Department of Defense, expected to ship in fiscal 2010. Despite lower revenues, again, cost containment has been a focus of the Company, the operating income is slightly up from last year.

With that, I'm going to hand over the call to Alan to go into greater detail of the financial performance before opening the call for

Thank you, Deepak. As mentioned on each of our conference calls over the past two years, we remain highly focused on driving earnings and cash flow improvement. This effort is paying off. I'll speak more about this shortly but first, let me review the financial results of the third quarter.

Overall, net sales for Q3 decreased 8% to $144 million in fiscal 2009. For the first nine months of the fiscal year, net sales of $451 million were equivalent to the prior year. As the dollar has strengthened significantly, our top line has been adversely impacted. Excluding the impact of foreign exchange, sales would have been -- sales would have decreased approximately 4% in Q3 and would have increased by approximately 3% on a year-to-date basis for our first nine months.

On a divisional basis, our security group reported another solid quarter with 10% sales growth and this would have been 50% if we excluded the impact of foreign exchange rates and continues with a strong backlog providing good visibility for the near future. However, the sales growth in security was more than offset by our healthcare division which reported a 21% sales decline driven by weak U.S. sales as certain hospitals have delayed CapEx spending as they face an extremely challenging economic and credit environment as Deepak had mentioned. Based on our latest market data, we anticipate that the healthcare markets will continue to be challenged in our fourth quarter. As a result, and as mentioned on our last conference call, during Q3, we continued our proactive initiative to reduce our costs in this division.

Finally, as we communicated, since the outset of the fiscal year, as Deepak just mentioned, we'd expected our Opto group to report approximately flat third party sales for fiscal 2009. As revenues from a significant contract in '08 were not anticipated to reach the same levels in this year as well as the economic slowdown.

During the third quarter, Opto revenues were down 11% to third parties while for the first nine months, sales have increased 4%. Thus, Q4 opto sales are expected to remain in a range consistent with our annual expectations. For the third quarter of fiscal '09, our net income was $2.6 million or $0.15 per diluted share compared to $6.9 million or $0.39 per diluted share for the same period of fiscal '08 but excluding restructuring charges, other nonrecurring charges as well as the significant nonrecurring tax benefit in the prior year, our net income for the third quarter of fiscal '09 would have been approximately $4.2 million or $0.24 per diluted share as compared to $3.7 million or $0.20 per diluted share for Q3 in the prior year. For the first nine months of fiscal 2009, our normalized EPS increased from $0.37 last year to $0.61 this year.

Our gross margin of 34.6% decreased 1.4% from the prior year due primarily to lower sales of medical products which tend to carry the highest gross margins in the Company. Partially offsetting this was continued improvement in our security division gross margin. Our gross margin will vary from quarter to quarter as a result of a number of factors including product mix, unit volumes, pricing, foreign exchange, inventory reserves and capacity utilization.

During the third quarter, we realized additional operating efficiencies. Continuing the momentum evident over the past two years. With the strong cost controls in place, our Q3 SG&A expenses decreased 9% from the prior year, reflecting the full impact of the actions we undertook in Q2. Changes we implemented in Q3 will be fully realized in Q4. Research and development expenses were $8.5 million which represented 5.9% of sales compared to 7.7% of sales in the same period last year. As certain projects have been completed, coupled with increased government funding and cost containment initiatives in our healthcare division, as well as the movement of some of our resources in R&D offshore, we saw an overall reduction in R&D spending. We continue to invest significant resources in technologies to add value to our security and healthcare product offerings. As a result of these programs, we believe that the Company is well-positioned to capture major opportunities throughout the global market place in the future.

Our net interest expense was down 50% compared to the prior year. Primarily as a result of lower weighted average interest rates and reduced average borrowings during the quarter as a result of our strong fiscal 2009 cash flow. As mentioned on our last conference call, given the low interest rate environment, we entered into an interest rate swap to lock in a portion of our debt balance for the next three years. Our effective tax rate for the water was 33.3%. After excluding -- which compares to 31.7% last year after excluding the impact of last year's nonrecurring tax benefit. Our provision for income taxes is dependent on the mix of income from U.S. and foreign locations due to tax rate differences amongst such countries as well as the impact of permanent taxable differences.

Moving to cash flow. We generated operating cash flow of $7 million during Q3 driven by our continued focus on working capital management and improved profitability. Capital expenditures of $4.2 million were higher than previous quarters this year as two new previously planned facilities in our security and Opto divisions came online. Depreciation and amortization was also $4.2 million. For the first tine months of fiscal '09, we improved our operating cash flow by an impressive $50 million as compared to last year. As mentioned in previous conference calls, generating strong cash flow will continue to be a top priority. We're very pleased with the significant, sustained progress we've made in this effort.

Finally, turning to our guidance for the remainder of fiscal '09, as our healthcare sales demonstrate, market challenges have accelerated each quarter and the outlook for our fourth quarter indicates continued challenges. We have undertaken decisive and meaningful actions to right size our business in response to the expected slowdown. The results of these actions were manifested in the very strong Q3 earnings performance. Based upon our current outlook, we anticipate a challenging Q4 sales landscape in the face of the FX headwind and economic environment. However, given the strong improvement in operational efficiencies and restructuring activities, we anticipate that our EPS, excluding the impact of restructuring and other charges, as well as last year's one-time tax benefit, will increase at a healthy 15% to 25% in fiscal 2009 compared to fiscal 2008. We anticipate providing fiscal 2010 guidance on our next conference call.

During fiscal 2008, we transformed our Company into a sustainable organization and a consistent performer. The impact of the economic issues notwithstanding, we also built a strong foundation for significant future earnings power. Given the operational improvements over the past two years, coupled with the restructuring activities that have reduced our cost structure, we believe we are well-positioned for significant operating margin expansion in the coming years. Thank you for listening to this conference call. At this time, I would like to open the call to questions.

(Operator Instructions). Your first question comes from the line of Tim Quillin of Stephens, Inc.

Nice quarter again in a difficult environment. Can you help us forecasting the security revenue in the fourth quarter, especially with regards to the timing of large cargo shipments, should we expect 4Q to be higher than 3Q or lower than 3Q based on that anticipated timing?

Tim, it is always hard to figure out the timing, especially on the large cargo orders. And whether it happens in Q4 or Q1, it is something that we -- that we know better as the quarter -- as the quarter goes along. So, it is really difficult for me to give you specifics on that at this point.

Okay.

Alan, you want to add something to it?

Tim, we're certainly anticipating that sales will be roughly comparable to Q3 on a sequential basis in Q4.

Okay. That's helpful. And in terms of Opto, I think you alluded to the fact that you still expect to be down for the full year. Year-to-date, you've been up 4% I think is what you said. Meaningfully down in the fourth quarter, you have this relatively large order for ID jammer components, the $27 million order that will hit fiscal '10. How should we think about fiscal 10 right now given the economic sensitivity, maybe even down overall in ID jammer business. Should we be thinking about that business down in fiscal '10 versus fiscal '09?

Well, Tim, on that specifically, I think it is a fair statement that 2010 will be down compared to 2009 for that specific order. But I think there are more things in the hopper and it is a little bit too premature for us to look at 2010. But we have a lot of other opportunities that looking at it and as Alan mentioned, sometime by July, August, we'll have a little better indication and obviously it would depend on the group -- that group also depends on the general economy. And because the other side of the business is capital equipment. Optoelectronic devices that we sell into medical equipment in medical and semiconductors and construction.

So, on that specific program, definitely, the total revenue would be less than what was in 2009. But the $27 million, definitely gives us a lot of visibility and there might be still some follow-o and keep in mind there are lots of development going on for the next generation, ultra light vehicle for terrain which is different than the present battlefield in Iraq.

Right. And how about on the healthcare side? I guess you probably have limited visibility there. But is there any light at the end of the tunnel or any anticipation on your part that you'll start to see flat or growing revenue as you start to face easier comparisons year over year?

Tim, you're absolutely right. It has been a very challenging time and obviously we're linked on, heavily to the hospital market. And I'm sure you're hearing about it that most of the hospitals are not -- they're playing very close to their chest but ultimately with whatever is happening with the healthcare changes being talked about in Washington, D.C. with potentially 44 million uninsured people entering into the insurance, healthcare insurance program and every indication of every report is that this is just a push. It is not going to go away. We're getting the same indication from our customers. We're getting the same kind of feeling from what we hear from our competitors. So all in all, it is a very challenging area. The last three quarters. It is a pretty open knowledge that each quarter we have gone down in revenue. But the rest of the world, especially where there is national health is doing quite well. Our product portfolio that we are developing in accelerated mode basically is more suitable for some of the emerging markets where there is still money being poured into healthcare, where there is still a lot of infrastructure investment going on and we believe that 2010 -- I mean I don't want to use the word definitely but our anticipation is 2010 would be better than this nightmare we're going through in 2009.

Sounds good. And I think in the -- you probably said in prepared comments as well, but in the press release, you referred to the $2 million legal charge. What was that for? And was that embedded in the SG&A line item?

Yes, Tim, this is Victor Sze. I'll let Alan answer the question about the SG&A but yes, that item is really a holdover item from the point where we had our jury verdict against all three overturned on appeal. At that point, all three as a prevailing party on appeal applied to the Court to have their expenses relating to their appeal bond reimbursed. And the Court has just recently issued the resulting order. So, that's what that item is.

Tim, this is Alan. That item is included in a separate line called impairment restructuring and other charges.

Okay. So, it is part of the $2.4 million?

It is. Of the $2.4 million, $2 million is this charge that Victor just referred to. And $400,000 represents restructuring activities.

Okay. Do you expect any further restructuring activities in 4Q?

We're continuing to look to see how we can make our business more efficient. We think we've done much of the heavy lifting already. At this point, we don't have pro formad out any significant restructuring charges.

Tim, just to add on to that L3 -- I want to make it very clear that it has nothing to do with us paying their legal fees or anything else. It is pretty straightforward that for that large verdict that they got against them, they had to post a bond and the cost of the bond when the thing got reversed completely, the cost of the bond specifically is this item and it is a pretty standard that since the bond was posted, and it got reversed, the cost of the bond, not any legal expense or anything else is what this $2 million is.

Okay, good. Just a couple more questions if I may. One is you talked about, Alan, I think you mentioned that SG&A -- you might look even better in 4Q. I wasn't sure how to read that. Are you looking for having it down in absolute dollar terms quarter to quarter or just down as a percent of revenue? And then if you could talk about anticipated tax rate in 4Q as well? Thank you.

Sure, Tim. We believe that there's opportunity for us to actually take the SG&A down in absolute dollar terms in the fourth quarter in comparison to Q3 so that's a fair statement. In terms of -- in terms of the tax rate, we think it will be in line with what we're showing on a year-to-date basis through the first nine months of this year. We think we're going to be still comparable.

Great, thank you.

Your next question comes from the line of Brian Ruttenbur of Morgan Keegan.

Thank you very much. Question I have on Spacelabs, Tim already hit some of the questions. Have we seen the bottom here? Are you starting to see things level out? Or is there still a downward path?

Well, it is difficult to set up -- be specific because we've taken three quarters down. What we are planning for it is we have sized the operation to look at what the present situation is. And I think everybody's talking about it, that the second half of this calendar year would be better. We are very cautiously watching it, very conservatively. We have sized the operation. All we can say is that if there is any bounceback, we will be ready to capitalize on it. On the other hand, if things remain in the present situation, we are quite comfortable with what we have sized in that we will be in a very good shape.

So I guess in other words, you're not necessarily calling the bottom at this point? Can you see that we're coming to a bottom?

It is very difficult to call out when the bottom is but all I can tell you is that the curve at the bottom is definitely slowing down. So that we think that the trough we're all in might be -- might extend longer but pretty much, it is flattening out.

Okay. And then my one other question is on the $27 million that you're doing with MRAP, and you're talking about you have other business coming in that will replace that. Will it be that -- a replacement or should we see down? Is it going to be a total replacement or not?

Well, again, you're asking a very black and white question. All I meant to say was that to Tim's question, definitely, the 2010 shipments on this program, the $27 million in the new order would be lesser than the 2009. But we have other programs working. At the end of the day, that's not the only program we work on. So we got other programs plus we're also working on the next generation product line in the same kind of products. So there's all kinds of activity going on not to mention as the economy improves in 2010, it automatically has a benefit into this whole product line because it is tied up to the economy. So, there is no one-to-one replacement of anything else but I think we have enough in the pipeline to replace a big chunk of this business that we will lose from this. On the other hand, we continue to get orders and we have a good visibility it was $27 million for the next couple of quarters.

Great. Thank you very much.

Next question comes from the line of Rick Hoss of Roth Capital Partners.

Three questions for you this morning. First, if you could provide a revenue breakout within Rapiscan, so that would be people parcel screening versus cargo vehicle, can you do that?

Well, we have started last conference call, also we said that for competitive reason, we don't want to break it down because then it starts showing up the various groups. Also, frankly, some of the things are getting mingled up. For example, air cargo is a good example. There is lots of overlap between the products that are in cargo and the products that are in the conventional product line. So it's a little bit more fuzzy to break down between the cargo and the other product lines and we said that in the last conference call.

Okay. Second question, as far as the Spacelab's weakness, on the top line, would you describe the major roadblock for securing additional orders for hospitals to order the product as purely credit?

Would you repeat that again?

I'm looking for the major driver to the hesitancy on behalf of hospitals for ordering the patient monitors. And assuming that it is as credit related, the assumption would be that if you see a loosening of credit, the availability of credit, then you would expect to see orders start to come in for the patient monitors. And this feeds into your statement about not losing orders, the orders are still there. They've just been delayed.

Primarily, it is credit related. We have talked to a lot of people but on the other hand, the hospital's present intake of patients has gone down so their cash flow is impacted. So, their whole capital spending habits or their requirements, they're watching it as prudent people very carefully. All we want to make a comment is that we are not losing any market share. In this business. And all of the accounts we have talked to have basically either in a frozen mode or wait and see and everybody is just looking at it -- and the other variable that has gone in is that what is happening in Washington, hospitals are also watching which way the administration is going to go forward with what to do to the overall healthcare system. But I would say that if magically tomorrow, it loosens out, it will definitely have a positive impact instantly.

Okay. Third question, as far as R&D goes, we've had a substantial ramp down on R&D spend. Is it to the point of where you would have an impact to new product development or slowing the development of additional products, follow on products, second generations, et cetera?

Absolutely not. We carefully looked at it as I mentioned and Alan mentioned. Some of the products have probably been completed. But we have also made a conscious effort to move some of the functions to our lower cost operations. Also, in the security area, we have got intake of some grant money from the various government agencies. So in all product lines, both in healthcare and in security, there has been no compromise made. As a matter of fact, I mentioned in my presentation that we have accelerated of the Alliance product platform, which is more suitable to the emerging markets and to the lower cost anesthesia product line. So, I wouldn't say at all. We basically have focused it more and we think that as these products come online and the market improves, we should be in a much better position with a broader portfolio of products and covering a better price spectrum to be attracted to the customer from a higher end, medium end to the low end.

Could we make the assumption that R&D spend would maintain itself in the high 30s on an annual basis?

I think that's -- Alan, that's okay. If I can give plus or minus a couple million.

Sure, high 30s, low 40s.

Okay. So, in other words, 8.5 or 8.6 we saw this quarter is probably on the low end of what we would see on a quarterly basis?

Well, that's true but I think if you have to do a Q4 modeling, it will be pretty much in line.

Okay. Perfect. Thanks a lot for answering my questions.

Your next question comes from the line of Steve Emerson of Emerson Investment Group.

Hello?

Yes, Steve Emerson here.

Hi, Steve.

Am I--?

You're on the speaker for a question.

My apologies. I had to take another call. You mentioned this English Great Britain order. Can you perhaps put a magnitude around the initial order and the potential? You mentioned you were replacing incumbent systems.

Steve, the answer is we can't. It is a multiyear contract. And we can't, for competitive reasons, either tell you what the current order is and what the total order is. All we want to say is that it is a significant win both in prestige and displacing the incumbent which, as you know, is very difficult unless you have a better proposition. And over the total contract, it is significant amount of money.

Can you possibly indicate how big an installed base or anything that gives magnitude of what's there at all?

I think the best way to look at it, obviously, we said it is for U.K. customs. It is for various different ports coming through, specifically the amounts -- I'm really not comfortable talking about that. But obviously it is something over the next three years and we have the exclusive relationship going forward.

Excellent. Thank you very much.

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

Hi, good morning, guys. Just a couple of questions. First, can you talk a little bit about what you're seeing in terms of stimulus-related opportunities for Rapiscan. I think we've all seen some sizable allocations but do you have any visibility on when the timing might come through the pipeline? And then specific on some opportunities on the stimulus package, can you -- along those lines, can you talk about RTT's opportunities and the status with TSA? Thanks.

I think specifically, when you look at the stimulus and everybody is talking about what's gone to the TSA which is approximately $1 billion, bear in mind that's for equipment, that's for installation, airport constructions, all kinds of things but obviously we are participant in there, the money that goes toward checkpoints, specifically or AT or WBI or other programs, we have -- we have participants in there. We've already sold several hundred AT systems to the TSA. We're an incumbent as far as that's concerned. On the customs side, there is about $100 million that's gone towards purchasing large cargo equipment. Specifically, what the details are going to be, I think it is something that's getting worked out between the agency whether it is customs or TSA and Congress and hopefully within the next two to three months, we'll know what their intentions are.

Just to add on to it. You ask about the RTD. RTD is not certified yet. So, it is a fact that definitely we are look at and we will get some portion in it but I wouldn't tell anybody to model it as a significant beneficiary of a product that's not certified yet.

What's your sense of how long it would take to get certified at this point?

Again, it is a tough question to answer. I think--.

I think I can answer that. Really from we're working with the TSA. We're going through it, trying to give you a specific time. I'm not comfortable with it. Primarily because of competitive reasons. But it is a process that you go through and it is not going to happen overnight. But it is something that we are talking to the TSA. We are looking at it internally. But specifically, I'm not comfortable giving you a time frame on that.

Just to add on to it, we're not sort of dodging your question. We don't know. It is one of those things where previously, every company that has tried to go through certification, it has taken multiple attempts so it is a process that is going to take its time but there is no specific set of time line that we can. Both TSA and us obviously are very anxious but that doesn't -- there can be no guarantee. I don't want to sound as if we're dodging the question.

No, not at all. Maybe from 100,000 foot level, would it be a little aggressive to expect that to happen in this calendar year or is it just probably more conservative to think about this is the next calendar year event?

I think we should leave it at that.

Fair enough.

Whatever we say, if it doesn't happen, we'll again be in the situation. This is one of those things where it is going to take its time. We'll do the best we can. But I'm not going to commit anything. I don't know.

Okay. That's fair enough. Now, just turning on air cargo. A lot has been made about 100% inspection by August of 2010. At this point what's your view on meeting that deadline? I think there's been certainly a lot of commentary on that recently and specifically, what you see as some of the impediments for the freight forwarders to really embrace this?

Well, number one, obviously that is passed. It's a law. They want to do it by 2010, August. I think they did it the right way. 50% by February of 2009. That was to get everybody in line that we need to start looking at it. But there have been pilot programs by TSA to some of the great forwarders. We've participated into it. There is a lot of logistics learning that's going on. What product. What kind of cargo. What's the inspection? How to move the cargo efficiently through the freight forwarders places? So this is a learning game. It started and I have no clue what happens whether 2010 August is a sure shot but once it is there, that deadline is there and whether it gets met or it gets pushed, it is definitely going to happen.

I think just to add a couple of things on there, we obviously are seeing very strong activity in that area on air cargo, on the equipment that we have qualified with the TSA. As far as we're concerned, that's the -- that's to date and that's what we are moving forward to.

Okay, great. Then just one of the earlier comments you guys mentioned was quote activity picking up. Can you frame that in terms of a magnitude? Is that incrementally higher over last year or sequentially or are you looking at a more robust double digit type quote activity improvements?

Well, I think what the best way to answer that is that over the last couple of quarters, as the economy has gone down, recession, whatever words you want to use since October, we have not seen any drag down in the connection activity in a global picture in security. And that's primarily on international quotations versus what you're seeing on the domestic side? U.S. domestic, International, keep in mind air cargo just started in the last couple of months. That's a brand new area. That's all domestic. Internationally, has always been very strong. And everybody is working towards what does 2010 August does for everybody's mindset is the sooner or later, all cargo moving all over the world is going to have to have some kind of an inspection. That's just a given. That generates everybody's forward thinking to look at. Something has to be done about it. Everybody is dealing with their plans, some officially, some unofficially. Some driven by the government. Some driven by just freight. (Inaudible).

All right. Great. Thank you very much.

(Operator Instructions). Next question comes from the line of Beth Lilly of Woodland Partners.

Good morning.

Good morning.

I wanted to ask a couple of questions. The first question is I wanted to just get a little more clarity on the R&D side. If you look on it on a year-over-year basis as a percentage of sales it's down significantly, also on an absolute basis. Alan talked about it earlier in the call. I just wanted to gain a little bit more insight into it, because I know you've been doing a lot of R&D on the security side and also on the healthcare side. So can you just give a little more granularity into why there was the drop-off and I'm not questioning whether or not you're not spending on product development but just what is your thinking on that and is that more of a cost containment issue or is that maybe there weren't products in development that you wanted to spend on? Just a little more insight would be helpful.

I'm going to again give you a little higher level perspective because obviously I don't want to get a little deeper into it for the competitive reason. But I think what we did, obviously, it is a given. Over the last couple of quarters, as we have started looking at sizing the Spacelabs healthcare area, we looked at every place. Alan's group did a complete analysis with the management of Spacelabs to look at every aspect where we can get more efficient and where we have to do some sizing. Definitely R&D was looked at, too. At that time, we made a decision that we have facilities in India and in China and as we looked at the various alternates in the sizing of the operation, especially as we mentioned on this conference call, that we have accelerated the last product line which was primarily developed in China. More R&D work is being pushed both in software and hardware design from the Seattle area and as we have downside U.K. a couple of quarters ago, instead of pushing that into U.S. we pushed it and accelerated more to go into the lower cost facilities we already have.

So I think it would be wrong for us to take such a black and white view to say there's no introduction to people. Definitely a reduction of people but also addition of people. We have increased the staffing in both places and we still have a lot of openings we're filling up that part of the world.

In the security side, our intake, I said in the last conference call, we had some pretty good successes in the government grant arena for various developments especially ones that complement what we already want to develop. So that that has gone toward s the plus point and even in that area, we have moved some of the functions in various places in the U.K. and here and some of the mundane work of mechanical design and stuff in other parts of the world. All in all, we are quite comfortable with saying that our R&D is not sacrificed in our total plan. Definitely the number of bodies and the sum of the work being done state side has been moved overseas.

Okay. And as we look at it as a percentage of sales, is it going to run at 6% going forward or do you think it is more along the lines of the historical 7% plus level?

Well, it is short term, we can tell you it is the same. We said Q4 should be similar to Q3. But keep in mind, as a percent of sales the other thing which is a little bit of a misnomer is there is a third product line, the contract manufacturer and electronics group. That doesn't require any R&D. So as the mix changes of the sales also, it will have an impact on the percentage of revenue. I think that for the near future, Alan, if you want to add some color to it, I think it is going to remain somewhere close to where the Q3 or Q4 is going to fall.

Yes. I would say, Beth, that's a pretty accurate statement. If you're looking from a long-term perspective, as I think part of your question was alluding to I think you're correct in that we'll look at it as a percentage of sales probably in the 6 and change range going forward over the next several years.

Okay, great. Okay. Second question is on the healthcare side. Which, if you look at your results, and the 20% plus drop in revenues and the fact that you you're able to maintain your operating margins is a real credit to all of the tough steps you're taking. I want to congratulate you on that.

Thank you.

Yes. As you -- and Deepak, you mentioned something that I wanted to gain a little more insight into. You said as the market comes back, let's say it is 2010, the margins are the real big opportunity because of the costs that you've now taken out. Can you provide a little more insight into -- where do you think your operating margins then can go? Because I think in the past, you've talked about them maybe getting to high single digit, low double digits now with the second phase of cost takeouts, do you think that maybe even further into the double digit level is realistic?

Really, it is a little premature because it comes down to 2010, how fast and what revenue level comes down to it. I think is a fair statement to say that with the changes we have made, again, some sizing it. Some moving the manufacturing faster to the low cost areas, the new product has been designed with local components. I think it is a fair statement to say that manufacturing gross margins, we would like very much to get into the mid-50s as fast as we can. Obviously revenue line has a lot to do with it. But as there is an uptick in revenue, as manufacturing gross margins go into that sweet spot, definitely we will not plan to increase our SG&A on below line cost at the same rate. So that it will start improving the operating income level quite rapidly. But I would hate to put a number down with the timing into it because this is a very challenging times. We've been watching it very carefully.

Beth, this is Alan. Sort of following on that, I think consistent with what you're saying looking out over several years with our new cost structure in place, it really gives us a real opportunity to draw significant operating margin improvement to the levels you mentioned in your question. As we go out a few years. We have a new cost structure and a new paradigm. As sales rebound, real opportunity is to bring home some real improved operating margin in the business.

Just to add on that, I think the other important thing that we want to say that is with the developments being focused into the various geographic areas where we think the GDP is going to continue to grow, where national healthcare is going to come to spend more money, we're now looking at it, we're focusing product lines more suitable to the area. But doesn't mean that they are lower margin product. They're designed for that area with the ASP structure to what they paid on the market place and the gross margin and absolute percentages might be higher than our present product line so that it will change the paradigm and as we come out of this in 2010, we think that as the economy improves locally as the rest of the economies continue to spend money in healthcare infrastructure like China, India, Brazil, and the rest of the Latin American countries, we think that our product line will be better suited and the manufacturing margins would improve because that's the way the products are being designed and developed.

Okay. Okay. Okay, good. And then just -- I have one other question. That is I don't know if I missed this or you talked about it. But in Opto, again, margins expanded there. You've got down revenues but expanding margins. Can you provide a little more granularity there and also just talk about what you think about 2010?

Well, firstly, to answer the first question about the margins. We said it previously, there are two sides of that product line. One is what we call the general purpose Optoelectronic custom assemblies that we make for other OEM customers. They inherently tend to have higher margin because they're unique products. Paid for, designed and developed for moneys paid by the customer to us. That's why there is no R&D associated with it. They tend to a higher margin. Second part of the business is like the[JDAN] contract manufacturing DC Board assemblies that we do for the medical industry, the defense industry, those tend to have a lower margin. As the mix changes between those two areas, the margin changes in that area. How 2010 is going to shape up is a lot going to depend upon the economy because as the economy bounces back, it requires more custom assemblies which inherently, historically, carries a higher margin.

On the other hand, if we continue to go back and get more repeat business in the contract manufacturing and the mix remains into it, that inherently has a lower margin. That part of the business also will increase as the economy improves and the customers get more confidence of their products. So it is very difficult to plan what the gross margins or the margins are going to be in their product line but historically, that's been a pretty narrow range in which it has been and we think that 2010 could be a similar line as 2006, 2007, 2008. Alan, you want to add on something?

Yes, I think what Deepak is saying makes a lot of sense. We've continued to optimize, make more efficient. We've gotten out of some businesses over the past couple of years within Opto. And while the top line will be dependent upon the economy in a large part, there is a continuing opportunity there to improve the operating margins as we have this year. Even in the face of essentially flat sales which we're predicting for the full year. So I would anticipate as we move into next year, depending upon the nature of what the top line impact is, positive or negative, we could see further operating margin improvement.

Okay. Great. Terrific job. Thanks so much.

You have no further questions. I will now turn the conference back over to the CEO, Deepak Chopra for closing remarks.

Thank you very much for your time today. In closing, I would just like to reiterate that we look at this as a very positive result quarter. Again, to summarize the highlights, third quarter, we improved our non-GAAP EPS by approximately 20% when compared to the prior fiscal year. Operating cash flows for the year has improved significantly. At March 31, the Company's overall backlog stands at about $231 million. Security bookings and operating income continue to grow.

In closing, I would like to thank our employees again, as last quarter. It has been a very challenging quarter but we, as a Company, are structured proper sizewise and we believe that as the economy bounces back in 2010, we would come out even stronger than when we entered in this period. So, with that, I would like to end -- to say that as a Company, we are very, very proud of the results of the Company and continue to increase stockholder value. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.