OSI Systems Inc (OSIS) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2013 OSI Systems earnings conference call. My name is Derek, and I will be your operator for today. At this time, all participants are in a listen-only mode. We shall facilitate a question and answer session at the end of the conference.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Alan Edrick, Chief Financial Officer of OSI Systems. Please proceed.

Thank you very much. Good morning and thank you for joining us. I'm Alan Edrick, Executive Vice President and CFO of OSI Systems, and 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 second quarter fiscal 2013 conference call. We'd like to extend a special welcome to anyone who is a first-time participant in our conference calls. Please note that this presentation is being webcast and will remain on our website for approximately two weeks.

Earlier today we issued a press release announcing our second quarter fiscal 2013 financial results. Before we discuss financial and operational highlights, I'd like to read the following statement. In connection with this conference call, the Company wishes to take advantage of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 with respect to statements that may be deemed to be forward-looking statements under the Act. Such forward-looking statements could include general or specific comments by Company officers on this call about future Company performance as well as certain responses by Company officers to questions posed about future operating matters. The Company wishes to caution participants on this call that numerous factors could cause actual results to differ materially from any forward-looking statements made by the Company or its officers. These factors include the risk factors set forth in the Company's last annual report on Form 10-K and other 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, subsequent events, future results or otherwise.

During today's call, we may refer to both GAAP and non-GAAP financial measures of the Company's operating and financial results. For information regarding non-GAAP measures and comparable GAAP measures in a quantitative reconciliation of those figures, please refer to today's press release which has been furnished to the SEC as an exhibit to a current report on Form 8-K.

Before turning the call over to Deepak to discuss the business in more detail, including our recent agreement with the TSA, I will provide a high level overview of our financial performance. We will again touch on several themes that we discussed during past conference calls. Highlights for the our second quarter of fiscal '13 are as follows. First, we achieved record second-quarter revenues of $194 million. Despite turbulent times, this represents our ninth straight quarter of top-line growth. Leading the way was our Opto division which grew third party revenues by 16% followed by our Security division. After three strong quarters our Healthcare division struggled, posting a 5% decrease in revenues due to soft international sales despite continued growth in the United States.

Second, our strong EPS momentum continued as Q2 diluted earnings per share, excluding the impact of restructuring and other charges, increased 15% over the comparable period in the prior-year to $0.70 per share. This marks the 14th consecutive quarter in which we have generated double-digit year-over-year pro forma EPS growth. In fact, our Q2 operating margin of 11%, excluding impairment and other charges, was a new record since we acquired Spacelabs back in 2004.

Third, our backlog of over $1 billion remains significant. And, fourth, we generated $20 million of operating cash flow, a number that is 8 times higher than last year's Q2. This strong operating cash flow was used to continue to fund the significant CapEx associated with our Mexico turnkey program. And speaking of our Mexico turnkey program, we were very excited to announce earlier this week that our initial scanning locations were certified as operational under our multi-year agreement in Mexico.

We are pleased to report another strong quarter of earnings and we remain very enthusiastic about our future. I will provide additional financial details and will discuss our fiscal 2013 guidance, but first let me turn the call over to Deepak.

Thank you, Alan. Again, good morning and welcome to the OSI Systems earnings conference call for the second quarter of fiscal 2013. We are now halfway through our fiscal year and are pleased with the strong results thus far. For the first half, we achieved revenue growth of 8% and leveraged this top-line growth to strong earnings per share. We also made substantial progress on our Mexico turnkey program and continue to implement key operational initiatives in each division. In Q2, our revenues were $194 million, a new Company record for the second quarter. We also delivered an operating margin of 11%, excluding the impact of restructuring and other charges.

Before discussing highlights for the quarter, I would like to update you on the status of our involvement in the TSA's AIT ATR program. First, as you know, Rapiscan Systems received a show cause letter from the TSA in November. We believe we have clarified all of the questions in the show cause letter to TSA. The final resolution of the show cause letter is subject to final disposition by the Department of Homeland Security and the Company is currently working diligently to complete that process.

We also recently reported that we have reached agreement with the TSA on the AIT ATR contract. Rapiscan determined that the Secure 1000 Single Pose would not be ready to meet the next level of automatic threat recognition software ATR required by the congressionally mandated June 2013 deadline. Therefore, we agreed to work with the TSA to redeploy these systems to other government agencies that already rely on the Secure 1000 product line. As part of the agreement, the ATR development contract was terminated, which allows us to stop the R&D spending on this program for which we saw a limited future beyond the TSA. We have had a close relationship with TSA and its predecessor agencies for the better part of two decades, during which we have together pioneered many of the transportation security technologies in use today.

So, I want to spend a few moments to provide some additional details about the AIT program and our initial role in this program. Before the attempted bombing of the US bound commercial flight on Christmas Day 2009, TSA had tested and approved Rapiscan's Secure 1000 Single Pose product and deemed its imaging technology capable of detecting the emerging threat of passenger-borne explosives. As such, TSA and Rapiscan were already implementing countermeasures to stop underwear bomber-type attacks. After the December 2009 attempted bombing, Rapiscan worked with TSA to quickly deploy more Secure 1000 Single Pose systems to provide better passenger screening at more US airports. Rapiscan was the first and for months the only company able to provide an inspection system that met TSA's strict new requirements for detecting explosives on passengers. Rapiscan worked with TSA to quickly deploy these new systems on a fast track in order to address the emerging threat to our country's security. We are truly proud of the role we played in bringing a dramatic improvement in commercial aviation security in the US. We also continue to work very closely with TSA and Department of Homeland Security on multiple other programs demonstrating our unique capabilities and wide-ranging know how in the security inspection system. Beyond aviation, we have sold numerous secure AIT systems and continue to sell to customers where image accuracy supersedes perceived privacy concerns.

Now, let's review the highlights for the quarter. I will start with Rapiscan. Our broad portfolio of inspection solutions in people screening, baggage and parcel and cargo screening services continues to help us develop a robust pipeline of opportunities in aviation and non-aviation markets. In air transportation, we have made progress with potential customers for a high-speed RTT Hold Baggage Screening system which has been approved for airports that follow the European ECAC standard. The RTT continues to be evaluated by the TSA and we are very confident that we will get TSA certification for our RTT product in this calendar year. I know that we have said that on the previous conference calls and, yes, we are late, but it is an evolving process. We are working confidently with TSA and we feel that the product has very good possibility and opportunity of getting certified this year, and in the European sector where we have already got certification, we definitely will have bookings for the RTT product in our fiscal year. It might not result in any shipments, but we will have bookings. The pipeline for the RTT product line internationally continues to grow. It is very healthy. It's in multiple hundred million dollars and although there are headwinds in Europe as you all read about it, we are very confident that we will be a big player in that market.

Regarding US business, it is a fact that US business has had an impact on Rapiscan's bookings in Q2. As you all know, Washington is going through a challenging time to pass the budget. Until it is passed, the defense bookings will remain unclear. We are very fortunate, compared to our competitors, that we have a broad product line and a very healthy international pipeline, not to mention the two new products, namely the RTT and Trace, which will result into new bookings for these new two product lines. We can assure you that we have not lost any US business except for the de-booking of the $5 million of the RTT -- on the body scanner AIT program. We are confident that the RTT certification that I mentioned before will happen this calendar year in US.

Regarding the turnkey businesses, we've said in the last conference call we are in active discussions with multiple potential customers internationally, but this is a long cycle. The other thing is, as we go and improve and deliver successfully and complete the full installation and execution of Mexico, it will generate much more interest by other customers to come and look at it.

Let's move to the Healthcare division. After several quarters of double-digit revenue growth for this division, revenues declined 5% in the second quarter to $56 million, yet through smart cost management controls the division managed to generate an operating margin exceeding 12%. Much of the dip was the result of the non-US economic environment, especially Europe. With the election cycles behind us in US and the continued progress in the stabilization of Europe, we expect to return to growth in the healthcare industry and are projecting second half to be stronger than last year. Namely, UK has a March ending year, we have new launches of products. We have launched the Arkon anesthesia workstation and to our leverage and relationship with growth purchasing organizations or GPOs, we expect second half to show growth. As Alan mentioned, US had an increase even in this Q2 quarter, but we believe that because of the elections in November in US, the second half US can even show more growth. In summary, Spacelabs had a challenging revenue quarter but still delivered double-digit margins. We expect Spacelabs to have a stronger second half, particularly in the international markets and with newly introduced product offerings and continued growth in the US market.

Moving to our Optoelectronics division, which among our operating divisions had the strongest growth of the quarter, external revenues were 16% higher than the prior period and the operating margins approached 10%. Although Opto is impacted by the same general macroeconomic forces that affected the other two divisions, Opto has broad exposure from OEMs in various industries, including medical, defense, test measurement and industrial and did a fantastic job. There's also a general trend of consolidation of the OEM supply base in a few of these industries. Thus, we are in a great position to capture new accounts and in fact did so as demonstrated this quarter with new customers in critical communications, secure access control and tracking, automotive sensors and electronics gaming. With our local to offshore design and manufacturing capabilities, Opto is well positioned as a valuable manufacturing partner that can help our customers manage high-efficiency manufacturing.

So, in Q2 the OSI team performed admirably under a scenario but everything did not go as exactly as planned. We grew the Company's top line and delivered double digit operating margins, and I'm confident of our Company's abilities as we maintain an unwavering focus to continue to improve our processes, our product offerings, and overall customer satisfaction. I would like to thank our employees, customers, and shareholders for their continuing support. We look forward to a strong second half of the fiscal year. With that, I'm going to hand the call back to Alan to talk in detail about our financial performance before opening the call for questions. Thank you.

Thank you, Deepak. Our focus on growth initiatives and operating improvements throughout the Company has succeeded in delivering significant earnings growth. Our $1 billion backlog and the ongoing progress of our multi-year turnkey screening services agreement in Mexico position us will for further growth and margin expansion. I will speak to our 2013 guidance shortly, but first let me review in more detail the financial results for the second quarter.

Net revenues in Q2 of fiscal '13 were up 3% over Q2 last year on an overall basis. Revenues from our Security division grew 3% in the second quarter. Heavy focus on the Mexico program, as well as delayed customer acceptance from December to January, led to the push out of certain deliveries from Q2 to our second half. Our Opto division continued the double-digit revenue growth momentum from the first quarter by delivering 16% external sales growth as a result of our continued success in broadening our customer profile. In our Healthcare division, though revenues dipped 5% in Q2, we continued to deliver double digit operating margins. As Deepak mentioned, we believe we will see stronger Healthcare revenues in the future.

The Q2 overall gross margin for the Company was 36.1%, up by 110 basis points for the same quarter last year. This increase was mainly attributable to increased revenue from turnkey screening services provided by our Security division, which generally provide higher margins than product sales. This improvement more than offset the impact of reduced revenues in Healthcare, which historically generates the highest gross margin across our three divisions, as well as the impact of the double-digit revenue growth in Opto which typically carries the lowest gross margins among our divisions. We anticipate our margins will continue to improve as our revenue mix changes with increased turnkey revenues from our Security division.

Moving to OpEx. Q2 SG&A expenses as a percentage of revenue were flat at 19%. In absolute dollars, SG&A expenses were up year-over-year about $800,000, or 2%, in support of the 3% revenue growth. We continue to invest significant resources in R&D to enhance both our security and our Healthcare product offerings. To this end, our R&D spending increased 3% of the second quarter of fiscal '13 to $11.9 million with such incremental investment primarily focused on our Security business. As a percentage of revenues, R&D expenses were 6.1% in the second quarter of fiscal 2013 which was comparable to the same quarter last year. We believe our efforts will enable us to capture major opportunities in our core markets in the future. We continue to see the results of these efforts in the significant number of new products that are being released. Our effective tax rate for Q2 was 28.2% and approximately 29% for the first half of '13. Our provision for income taxes is dependent on the mix of income from US and foreign locations due to tax rate differences among countries as well as the impact of permanent taxable differences in valuation allowances among other items.

Top-line growth coupled with gross margin expansion and solid cost management led to Q2 non-GAAP EPS of $0.70 per diluted share as compared to $0.61 per diluted share for the comparable prior-year period. The Company recorded an impairment structuring and other charge of approximately $2.7 million associated with the TSA agreement that Deepak alluded to, which reduced GAAP EPS to $0.60 per diluted share. For the first half of fiscal '13, excluding the impact of impairment restructuring and other charges, our non-GAAP EPS increased 19%.

Moving to cash flow. As we mentioned on previous -- on our previous few calls, we expect to see significant volatility in cash flow in fiscal '13 largely as a result of the Mexico program. We generated a noteworthy $20.4 million of operating cash flow in Q2 and nearly $63 million for the first half of fiscal '13. This cash flow was used to partially fund our capital expenditures which totaled $117 million in the first half of fiscal '13, which as expected, was significantly higher than historical norms in support of our Mexico program. In addition, we repurchased approximately $3 million in stock bringing our first half purchases to approximately $12 million inclusive of net settlements. Depreciation and amortization was $5.9 million in Q2. Although we expect to experience greater than usual variability around free cash flow over the coming quarters, again due primarily to the Mexico project, we remain well positioned to meet future requirements with our cash on hand, cash flow from our ongoing operations and our $425 million credit facility.

Finally, turning to an update of our fiscal 2013 guidance. We are adjusting our sales guidance to be between $850 million and $875 million. While this modifying range reflects solid 7% to 10% annual growth, the new range reflects some softness we saw in healthcare international sales, the de-booking of $5 million of orders related to the TSA agreement, and a few other customer orders now expected to booked later in fiscal '13 and shipped in fiscal '14. On the other hand, with the significant progress being made in our Mexico project and continued anticipated margin expansion, we are reiterating our non-GAAP EPS guidance, including the impact of restructuring and other charges, of between $2.77 and $3 per diluted share, which represents an increase of 21% to 31% over fiscal '12.

During the past few years we transformed OSI into a Company that generates good top-line growth and has an organizational framework that positions us for continued EPS growth. We believe we are well-positioned for continued operating margin expansion in the coming years and we look forward to sharing our progress on upcoming calls. Thank you for listening to this conference call. At this time, we'd like to open the call to questions.

(Operator Instructions)

Tim Quillin from Stephens Inc.

Alan, would you happen to have detailed backlog numbers in front of you, both for the overall Company and for the Security Business?

I do have it, Tim, from an overall Company perspective. Our overall backlog is important. The backlog is about $1 billion. Last quarter, from a rounding perspective, it rounded up to $1.1 billion. And this quarter, from a rounding perspective, it rounds to about $1 billion. As you know, our businesses is shifting more towards security turnkey revenues. So, looking at changes in the backlog in the same way as in the past becomes a little bit less meaningful as we are building up long-term backlog and then we deliver against those long-term awards. Further, as you know, certain of our contracts, like Puerto Rico, never even enter the backlog.

Right. I think that last -- in the first quarter backlog at the end of the first quarter was $1.053 billion. What was it at the end of December?

It was -- we had a book-to-bill ratio of a little bit less than one. So, it's still over $1 billion. While I don't have the precise number in front of me, it rounds down to $1 billion. As you said, the $1.053 billion was just over $1.050 billion, so it rounded up to $1.1 billion; now it's a little bit under that, so it rounds down to $1.0 billion.

Okay. And on the Security backlog, I thought we had discussed that last quarter. I thought the Security backlog, including Mexico, was something like $943 million at the end of September. Do you happen to know what that number is? Or what the book-to-bill was on the Securities side?

Yes. Tim, it's slightly down for the reasons that Deepak mentioned. Our book-to-bill in Security was a little bit under 1, as would be expected in this environment. So, it's a little bit down, not meaningfully down.

So, at this point, what do you see in the pipeline right now? Deepak, you had mentioned potential orders for RTT, for instance. But what other things do you see in the pipeline that might suggest that those security bookings could pick up in the back half of your fiscal year?

Tim, as I mentioned, there is ongoing growing pipeline in the Security business, especially internationally. As I mentioned, the three areas which are very strong are cargo -- the cargo pipeline continues to show very robust demand. Definitely there are some push outs left and right. If you've seen what's happened in the Middle East; you've seen what's happened in Europe. There's definitely a little bit of what I would call a little uncertainty, but the pipeline is super strong. That's cargo.

Then, you look at the RTT product line. As you know, that the machines in Europe are getting pretty old. There is a huge demand for replacement, but we've said it before that, again, because of the turmoil in the European sector, there have been some push outs. Airports are trying to push as much as they can to the future, but it's a requirement. We are well placed into it.

That pipeline, I mentioned in my speech, it's more than a couple of hundred million dollars. And we think that it's a great prospect for us. And we are focused onto it. We are working with multiple airports. And we are quite confident that we are going to book -- we'll book. We might not be able to ship it, but we will book before our fiscal year is over.

The third area, which we find it very exciting, though it has a longer cycle, is the turnkey business, which primarily goes hand in hand with cargo customers, but there are other opportunities even the non-cargo area we are looking at. We are in active discussions. We have even taken some customers to our present sites. We are talking, but these kind of turnkey businesses may come in not in a straight line. And it takes some time to get them. We are very positive and boisterous about that growth business. Frankly, that's one of the reasons we have accelerated our Mexico launch.

Right. And so you sound very confident in terms of getting orders in Europe for RTT. You didn't -- within the fiscal year, you didn't really set a timeline on additional turnkey opportunities and mentioned a long sales cycle. Is the timing of conversion of some of those discussions just still very uncertain right now?

Well, the thing is, it's not a question of uncertain. As we have said to you, this business takes a longer cycle. And we have also said any cargo potential sale of any significant amount can also turn into a turnkey business. So, it's not a question of is it the timing of this quarter or next quarter. We continue to work on it. We work parallel. It's a concurrent parallel sales effort between a sale and a turnkey business.

And then the fourth item that we have said, and we have said it, definitely that you have seen from your other companies you follow, US, until the budget is passed, is continuing to have that thing, but we are actively talking to people in that pipeline, too. So, we have a very broad area in which we participate in.

Right. Okay. And just one last question and I will turn it over to others.

But, on the Mexico contract, is there anything you can -- you started revenue, you are pretty far along on this. Can you give us some sense of what the overall capital expenditures are going to be? And then, what is the level of expense going to be? How many employees are going to be working on the contract? What is -- now that you have a kind of better sense that you are further into it, what is this contract going to look like?

Tim, this is Alan. I will take that question.

From a CapEx perspective, what we said in the past is that we are anticipating it to be somewhere in that $175 million-ish range, plus or minus, and we still expect to be in that general range. For confidential purposes, just like in Puerto Rico, we are unable to say the number of employees. Suffice it to say, it will be a significant number of employees. But as we move forward, we expect the Mexico program to generate significant revenue for us both in Q3 and Q4 and at a profit for each quarter.

Okay. Thank you.

Brian Ruttenbur, CRT Capital.

Thank you very much.

First of all, DNA. How much was depreciation and amortization in the quarter?

Brian, it was about $5.9 million.

$5.9 million, perfect. Healthcare. What percentage of your Healthcare is international? I think I recall it being around 20%, is that right?

Brian, it's a little bit higher than that. Generally speaking, it's about -- two-thirds tends to be US, one-third international, broadly speaking.

Okay. So, was it all just Western Europe that the slowdown was in the quarter?

Most -- this is Deepak here.

The majority of that was in Western Europe.

Okay. Is that because the economy? Is that because your product offering? Can you get any more specific? Did everybody see a slowdown in the industry? Your competitors?

It's definitely not the product line. It's the turmoil in Europe. We think that it's going to get better. As a matter of fact, we have seen signs it is going to get better the second half. UK, for example, has a year-end and their spending is going to go up. We're looking at the second half Healthcare to have a growth compared to a year ago.

Okay. What kind of growth are you looking for in the second half in Healthcare?

Brian, we don't provide guidance by division.

Okay.

We are in the single-digit growth in Healthcare in the second half of the year.

Okay. Great. And then on the RTT certification, you've already been certified for a while now in Europe. Can you talk about any potential sales that you are getting, or hints for sales on the RTT?

Brian, as you know, things that we are working on for competitive reasons we never talk, frankly, until we book. Suffice to say, there are many airports, both big numbers and onesies and twosies, half a dozens all over Europe, and in the Middle East and in the CIS countries. So, the pipeline continues to be strong. Like I said, there is a replacement cycle coming due. It's like pushing from one quarter to the other, it's going to happen. Everybody -- if you ask our competitors they will tell you the same thing. They have to replace the machines. There are about 1500 machines just in Europe.

Okay. So, do you expect an award sometime this year from Europe, this calendar year?

We are counting on it. Our sales funnel shows that we will book -- not be able to maybe ship, but book -- in second half in RTT.

Okay. Good. Then last question.

On the slowdown in the US Security business, was that related to anything with the TSA? Or was that related to Border Patrol? Where was the slowdown? Was there a specific agency that you saw the slowdown?

Number one, we can categorically say there is no impact on the US business except for the AITD booking. But we believe that it's just -- there's just how everybody is sort of playing too close to the chest in the US until the budget is done. It's all over that area. No specific agency or so, but we are very much focused into it. As you know, we have complete office in Washington. We are up to speed on everything that is going on in Washington in our product line.

Okay. Thank you very much.

Josephine Millward, The Benchmark Company.

Deepak and Alan, you had very strong growth in the second half of last year from the big Army order. Now -- and this year you have Puerto Rico and Mexico ramping up. Do you still think we can see double-digit growth in Security in the second half? And how do you get comfortable, based on what we -- because you have a very tough comp in the second half?

Josephine, this is Alan. I will take that.

Our guidance for fiscal 2013 in the second half, and the comparisons year-over-year, of course embed the fact that we do a very difficult comps associated with the Army orders from last year. You are exactly right, in that Mexico and Puerto Rico are both coming on strong; and, of course, are at a higher operating margin than we saw with the Army order. We don't give guidance on a divisional perspective, so we won't talk about the growth rates for each division. But overall, our overall guidance factored in the difficult comps related to the Army orders. We feel very good about our guidance.

That's helpful. Thank you.

Can you give us a sense of, in terms of percentage of completion on Mexico by the end of, say, margin year end? And if you anticipate the project to be fully operational sometime in fiscal year '14?

Josephine, it's Alan.

Yes. We are making substantial progress in our Mexico program. We expect to see significant revenues in the second half of fiscal '13. We do expect that, if not fully operational, very nearly fully operational in fiscal '14 as you suggest. So, we are heading down the right path.

Okay, Alan, but do you think you guys will be 30% to 40% complete in terms of operational by the end of your fiscal year? Or can you give us a rough sense -- or 15% -- just so we have a feel of how this project is progressing?

Yes, our customer is very sensitive to the information we provide overall in the program, but just to give you a greater comfort feeling, by the end of our fiscal year we do think we will have made significant progress which allows us to make significant revenues in fiscal '13. And as we head into fiscal '14 we will be in very strong shape.

Okay. I have a follow-up on RTT.

What has changed for -- you seem to have higher confidence in getting RTT certified in the US. What's changed? Because I know TSA doesn't give you much feedback during the certification process. Is there anything new that's -- I think the tone hasn't really changed on getting certified this year, which is certainly very good news. I would just like to get more color.

Josephine, basically, as you know, that program is an evolving [desk] protocol. As we learn more, we get more confident. And obviously, with our success in certification in Europe, we feel more positive about the technology. And we've been going through this process for some time, as I mentioned before. We are late, but it happens. Some people have taken eight and nine attempts. But you are absolutely right. Our tone has changed to be more positive that we will get the certification in this calendar year.

Great. And in Europe, can you remind us of your current market share for checked baggage multi-view x-ray? Because I seem to remember it's about 5%. You have some pretty well-entrenched competitors there. Why do you think -- remind us why you think you are well positioned in Europe?

Josephine, number one is the RTT to our present installed base is two different products.

I understand that. It's certainly going to replace the x-ray products in Europe. So, if you can give us a sense of your existing market -- your footprint in Europe right now.

Well, we don't have a footprint in the checked baggage as you said, but it's a different product.

Right.

Answer to your question about why do we feel confident -- we still maintain that we have the best price to performance and ownership of any product that exists there with our RTT solution in the checked baggage mode. So, we feel very confident that as the airports, as the customers start looking at, especially price versus service cost over the years, we think that we have the best solution. And I think what's going to happen is that, when they make the decision in side-by-side comparison, we will come out on top and we continue to believe that we will get a significant share of that market.

And on the other, Rapiscan has a great reputation for service and support because we happen to be at the airport with the checkpoint machines anyway. So, even though we are not the incumbents, it's a new technology. It's a new product. Ultimately, it's going to be the ownership cost.

By the way, Deepak, I see Rapiscan machines everywhere in France. It's very impressive, because it's very difficult to sell to the French.

Thank you.

Thank you very much.

Jeff Martin, ROTH Capital Partners.

Alan, could you quantify the magnitude of the delayed customer acceptance for Rapiscan in the quarter?

Sure, Jeff. It was on the magnitude of around $10 million -- that push from Q2 to Q3 associated with that.

Okay. And has that product been shipped at this point?

It has.

Okay. And then could you characterize the budget-driven delays in the US, assuming we get a budget defined here pretty soon? How does that all of a sudden open up the market again?

Well, there's no -- this is Deepak here.

There are no specific numbers, but just a general feeling in Washington. Until the budget gets decided, everybody just play close to the chest of whatever they want to buy. So, I'm sure when you talk to your other companies you follow, you get the same answer. So, it's a watch and see game.

Okay. And then shifting to Puerto Rico -- did you see quite a ramp in transaction revenue there, since it is a per scan model? Did you see volumes pick up much there? And where is that in terms of running at capacity today?

Jeff, it's Alan.

Yes, we did see some nice year-over-year growth in Puerto Rico, which was partially attributable to the gross margin expansion that you saw overall for the Company. We continue to be nearly fully operational there with one more site to go. So, we are running at, let's call it, 85% or so of our projected run rate.

Okay. So, the increase in volume is year-over-year, apples to apples?

It is. As you may recall, we didn't have all the sites up and operational besides the one in Q2 of last year. So, we have more sites operating this year compared to Q2 last year.

Okay. Am I interpreting your commentary around gross margins that you expect gross margins to continue to expand from here? Or are we at a level to use for modeling for the next couple of quarters in Q2?

Our expectation is that there's always changes in the revenue mix that can impact it; but overall with turnkey becoming a bigger portion of it, both Puerto Rico and Mexico, that we would anticipate margins can continue to make some further progress.

And then with Healthcare, if Healthcare comes back a bit, that should help as well, right?

Yes. Healthcare has the strongest gross margins in our Company. So, as Healthcare sales move up stronger, it helps the overall margins.

Okay. And then last question.

What's your remaining stock repurchase authorization at this point?

Today, we still have about 550,000 shares authorized under our stock buyback program.

Okay. Thanks guys. Good luck.

Yair Reiner from Oppenheimer.

Thank you.

I just want to revisit the question about Healthcare. If the third of the Business is in Europe, it looks like that Business may have been off 25%, maybe 30% in the quarter. I guess my question is, what happened to change that market all of the sudden in the December quarter? Obviously, Europe has been a challenging market for some time.

This is Deepak here.

The first thing is what Alan said was, one-third is our international business, not Europe. Just to clarify. Europe business is less than one-third, because we do have business in Latin America, we do have business in Asia PAC.

Regarding the question, what happened was there is definitely a turmoil and there is a credit crunch in Europe. So that if the hospitals want to buy new replacement monitors or whatever, they can delay it. And that's what happened in some of the countries. In UK, we are very positive that with the elections normally, just like in the US, at the year end they have more money left to buy. So, we think that January, February, March, UK will start buying more. And with relative -- I won't say that is stable -- with relative stability in Europe than it was in October, November, December, our pipeline and our forecast is that Europe will bounce back.

I think we are aware of the credit crunch in Europe. We understand the economy is weak, but if you think about it sequentially, I don't think any of us got the sense that Europe all of the sudden tumbled off a cliff in the last three months. If anything, things seem to have stabilized. So, what again changed in the last calendar quarter of 2012 to change the trajectory of the Business?

Well, number one, we've always said in our conference calls that Europe has been challenging. But if you really look at it -- the other thing I said was, though US was up for the quarter, we think the US could have been up even more if the elections were not there; if this was not an unusual year even in the US, because, during October, November, December even in US, some customers froze to wait for the elections. So, though it is up, it could have been up more. So, if you combine that with what we are forecasting and some of the pushback in Europe, it had an impact on Europe.

On the other hand, if you really look at it, we talk about Europe -- Middle East has had a lot of turmoil, too. So, if you really look at it, the best way to look at it is, our 33%, one-third of the business Alan mentioned, definitely had some push, but that push has nothing to do with competitiveness, has nothing to do with our product. We believe in the second half it will bounce back.

Okay. And then just one quick question on RTT.

In your original guidance, you didn't anticipate booking any revenue from that during this fiscal year, is that correct?

That's true.

Okay. Thank you.

Tim Quillin from Stephens.

Thank you for taking my follow-ups. First, did you book any revenue from the Mexico contract in the second quarter?

Tim, we did book some revenue in the second quarter. We also booked some revenue in the first quarter as well.

Right. I saw that. What is the nature of the revenue that you booked in the first and second quarter?

It is just related to our overall screening services program. As you know, we generally don't go into breaking out the type of revenues by program.

Okay. I mean, was it a site that it was already up and generating revenue? Or just compensation for the buildout of the program?

There were multiple factors that contributed to the overall revenue recognition related to the program and the nice progress that we are making.

Okay. Second question is -- and I know this varies quite a bit from quarter to quarter -- but what percent of the securities segment revenue comes from the US government?

Good question, Tim. You are right, it does change from quarter to quarter. There will be certain quarters where it's a significant percentage. There will be certain quarters where it's a very insignificant percentage. It really varies based on the type of orders that we have in the backlog and what we are shipping at that point in time. The second quarter for fiscal '13 had a low percentage of revenues from US government customers.

Okay. But in terms of your future planning and thinking about growth, would you assume that 20% of revenue would come from the US government?

We look at it on a program by program basis and over different periods of time. So, we can't quantify and assign different percentages, because it really does vary from a quarter to quarter and year to year basis.

Okay. And then in terms of Arkon, the anesthesia delivery product, do you have a sense now of when you might start to see first revenues there?

Tim, it's Alan again.

Yes, we began marketing that product this month, actually. So, our expectation is we'll see revenues for it in the second half of this fiscal year. It could be this quarter, next quarter. As Deepak alluded to earlier, we expect the revenue contribution in fiscal '13 to be modest, but going forward, we have very high hopes for the product for fiscal '14 and '15. And the reason we expect it to be more modest in fiscal '13 is that, as hospitals begin buying this product, they usually trial it out. They will buy one or two and test it out for a few months and then come the bulk purchases thereafter. So, we are really excited about their product. We think it is great, great potential for us.

Okay. And then just lastly, and maybe a little bit philosophically, but you've been growing earnings 20% plus; I guess really 25% plus over the last several years. You've got this major contract with Mexico that's starting to ramp up and should be significantly bigger in fiscal '14 than fiscal '13. Would you think about a continuation, that contract supporting a continuation of 25% earnings growth? Or being additive to that type of earnings growth rate? Thank you.

Tim, it's Alan again.

As you know, we provide earnings guidance for our current fiscal year but not on a long-term basis. Our plan is to continue to grow both the top line and the bottom line on a significant basis. We look to leverage our top-line growth to a much faster earnings growth. And, as you mentioned, we have been successful in doing that over the past many years here.

The Mexico program is a very nice program for us, both from a top-line perspective, and, as we've said before, it is a higher operating margin contribution than our corporate averages, which will help us sustain even a faster earnings growth rate than our sales rate and a significant delta. So, we are very excited about that program and think from a long-term perspective we will be able to continue to grow our earnings at a very healthy rate.

Thank you.

At this time, I'm showing no further questions in the queue. I would like to turn the call over to Mr. Deepak Chopra for any closing remarks.

Ladies and gentlemen, thanks once again for attending our conference call. We are looking forward to a terrific second half of the year and speaking with you all once again next quarter. Thank you.

Ladies and gentlemen, that concludes today's conference. We thank you for your participation. You may now disconnect. Have a great day.