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Executives

Deepak Chopra – Chairman, President and CEO

Alan Edrick – EVP and CFO

Ajay Mehra – EVP and President of Security Division

Victor Sze – EVP, General Counsel and Secretary

Analysts

Brian Ruttenbur – Morgan Keegan

Michael Kim – Imperial Capital

Beth Lilly – Gabelli

John Croke – Jefferies & Company

Josephine Millward – Stanford Group

Tim Quillin – Stephens Inc.

OSI Systems, Inc. (OSIS) F1Q09 (Qtr End 09/30/08) Earnings Call Transcript October 30, 2008 ET

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2009 OSI Systems earnings conference call. My name is Stacy, and I will be your conference moderator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to the presentation over to your host for today’s call, Mr. Alan Edrick, Chief Financial Officer. Please proceed.

Alan Edrick

Thank you. Good morning, and thank you for joining us. I am here today with Deepak Chopra, our President and CEO; Ajay Mehra, President of our Security Division; Victor Sze, our General Counsel; and, Jeremy Norton, our Vice President of Investor Relations.

Welcome to the OSI Systems fiscal 2009 first quarter conference call. We’d 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 Web site for approximately two weeks. Before discussing our 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 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 first quarter results. The press release will also be filed with the SEC as part of our Form-8K.

The company wishes to caution participants on this call that numerous factors could cause actual results to differ materially from any forward-looking statements made by the company. These factors include the risk factors set forth in the company's SEC filings. Any forward-looking statements made on this call speak only as of the date of this call, and the company undertakes no obligation to revise or to update any forward-looking statements, whether as a result of new information, future results, or otherwise.

With that disclaimer out of the way, and before turning the call over to Deepak, I will provide a high level overview of our performance during the first quarter and our recent accomplishments. And following this, Deepak and I will discuss the market outlook in security and in healthcare, and in particular, the uncertainty in the near term healthcare capital for (inaudible) and the aggressive steps we are undertaking. So now, let’s take a broader look at the quarter.

We are successfully executing a strategy that we announced sometime ago to improve our profitability and our cash flow. We have highlighted this game plan on our prior conference calls over the past year, and we continue to see positive results. Our fiscal year 2008 financial performance demonstrated significant improvement and provided compelling evidence of the changes we first started implementing at fiscal 2007, and which we continue to build upon leading to improved earnings. You can see the benefits in our results again this quarter.

Our progress was reflected in Q1 2009, with highlights as follows. First, we achieved a 13% increase in first quarter sales, strong sales in our security, and our Opto divisions drove our revenue growth and overcame some weakness experienced in our healthcare business. Second, excluding non-recurring charges, we delivered earnings per share of $0.04 for the first quarter of 2009, compared to a loss of $0.12 last year. We set a goal to be in the black for the first quarter, which is historically our weakest. And we achieved this objective. Increased sales coupled with our improved, more efficient cost structure led to this positive bottom line performance. Third, we shattered our previous cash flow records as we generated nearly $15 million of operating cash flow and $13 million of free cash flow for the quarter. This follows the $9 million of operating cash flow generated in last year’s fourth quarter. Fourth, our security bookings also set a new record for the quarter at $91 million, leading to a strong quarter and a record backlog in our security division and the total backlog for the company of $231 million.

Equally important, we announced several strategic awards in Air Cargo and CT Baggage Systems, which represent significant future growth opportunities.

I will be updating you further on the financial performance of the company and steps we will take to address the softness in the healthcare sales. But first, let me turn the call over to Deepak.

Deepak Chopra

Thank you, Alan. Again, good morning, and welcome to the OSI Systems first quarter fiscal 2009 earnings conference call. As Alan mentioned, we have begun the year on a positive note achieving a profit in the first quarter for the first time since fiscal 2005. Inherently, this quarter has been the weakest quarter for us.

As Alan mentioned, our year-on-year revenue for the quarter increased 13% to $148.2 million. While excluding the impact of impairment, restructuring, and other one time charges, operating income improved by approximately $3.7 million to an operating profit of $1.9 million, and earnings per share improved by $0.16 to $0.04 from a loss a year ago, on a normalized basis from the same period of last year.

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

Healthcare division faced some challenges in the first quarter. It’s also a weak quarter for the healthcare group. This was a direct result of the credit crisis occurring, especially in North America. As a result, sales for the first quarter declined by approximately 3% when compared to the first quarter of the prior fiscal year. Our customers in North America primarily tend to be hospitals. They are typically dependent on the credit markets to finance purchases of capital equipment. As you have seen and read about, this has been a very tough challenging couple of months, and led to our healthcare customers North America delaying the planned orders. As to the extent of how long this situation will last and to the impact this may have on our international business, is uncertain at this time. But we remain confident we have not lost any orders to any competitors. This is a result of our customers inability to give us any visibility of when they’re structure will improve to be able to access the credit markets.

We are monitoring the markets very closely. But as prudent managers, we have moved very quickly to address the challenges we faced due to this credit crisis. As announced, we are in the process of implementing proactive measures to address our overall cost structure in our healthcare group, especially North America. This, though, was not a surprise, but it happened very fast at the end of the quarter, and the 3% revenue loss that we had was due to the push. And after doing the analysis and talking to the customers, the company, as prudent managers, immediately implemented a cost structure review of our healthcare group. We are in the process of implementing that as we speak.

On a positive note, the international business of the healthcare division performed above or well to our internal estimates budget. We do not see any weakness to date, but we are very cautious to make sure that this pay lower to that part of the business. We’ve also, in this quarter, launched our new ultra lightweight patient monitoring product line under the trade name elance. It is a first product designed by our global development team in our new facility in Suzhou, China. Its compact design is suited to a broad range of international markets providing connectivity and high performance in the (inaudible) care environment.

During the quarter, we also had launching meetings in many international countries. And I’m very proud to announce that it’s been a great success. And we’ve also started getting good (inaudible) on our bookings from our customers.

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

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

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

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

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

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

Alan Edrick

Thank you, Deepak. We remain highly focused on driving earnings and cash flow improvement. Our management has systematically executed our strategy to attain these goals, and this focused effort is paying off. I’ll speak more about it shortly. But first, let me review the financial results of the quarter.

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

Our bottom line for the first quarter in 2009 markedly improved. As we reported, net income of $100,000 or $0.01 per diluted share, compared to a loss of $2.1 million or $0.12 per diluted share for the same period of fiscal 2008. Excluding impairment, restructuring, and other charges, net income for the first quarter of fiscal ’09 would have been approximately $0.7 million or $0.04 per diluted share. This result is especially important given that we achieved it in the seasonally challenging first quarter.

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

During the first quarter, we realized further operating efficiencies continuing the momentum evident at fiscal 2008. Our SG&A expenses as a percentage of sales decreased by 20 basis points for the first quarter to 25.4% from 27.6% in fiscal 2008, and by 410-basis point improvement from 31.5% fiscal 2007. Research and development expenses were $10.2 million or 6.9% of sales, compared to 7.4% of sales in the same period last year. In absolute dollars, such costs increased $0.5 million from that in the prior year.

We continue to invest significant resources and technologies that will add value to our security and our healthcare product offerings. As a result of these programs, we believe that the company is well positioned to capture major opportunities throughout the global marketplace in the future.

Our effective tax rate for the quarter was 34.5%, compared to 35.1% in Q1 last year. Our provision for income taxes is dependent on the mix of income from US and foreign locations due to tax rate differences among countries as well as due to the impact of permanent taxable differences.

As we move to cash flow, during the quarter, we’ve generated operating cash flow of $14.7 million, driven by improved profitability and our ongoing focus on working capital management, including the receipt of significant customer advances. Capital expenditures were $2.2 million. And depreciation and amortization was $41.4 million. Generating strong and continuous cash flow will continue to be a top priority in fiscal 2009.

Finally, based upon the economic climate impacting our healthcare division, as Deepak discussed, we are unable to provide guidance until the outlook becomes clear. We are taking proactive steps to aggressively right size our cost structure in healthcare in light of the softness experienced in Q1 and the anticipated continued softness in Q2. During fiscal 2008, we transformed our company into a sustainable organization and a consistent performer. With the economy notwithstanding, we also built a strong foundation for significant future earnings power. We realized the benefits of these efforts in Q1. And we continue to implement the strategy aimed at driving further improvement.

Thank you for listening in on this conference call. And at this time, I’d like to open the call to questions.

Question-and-Answer Session

Operator

(Operator instructions) And please stand by for your first question. Your first question comes from the line of Brian Ruttenbur with Morgan Keegan. Please proceed.

Brian Ruttenbur – Morgan Keegan

Great. Thank you. Can you give us an update on litigation with L-3, where that stands?

Victor Sze

Hi, Brian. It’s Victor Sze.

Brian Ruttenbur – Morgan Keegan

Hey, Victor.

Victor Sze

Where it stands right now is it’s on remand to the district court in New York. As of yesterday, I know that nothing has been calendared by the district court. So it’s just a question right now of standing in queue at the district court for the next date.

Brian Ruttenbur – Morgan Keegan

Okay. So what does that mean? Speaking eighth grade, normal English, going to remand in district court, that means the district court will review it? Is that right?

Vincent Sze

Yes. That means that the appellate court has said that some errors were made at the trial. And therefore, they want a, essentially, what is a do-over.

Brian Ruttenbur – Morgan Keegan

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

Vincent Sze

Not as the entire proceeding. It’s really more of the trial, the discovery of – which really took the bulk of the time the first time around. The facts are the facts. And so, the discovery is not really repeatable. I suppose that it’s possible that there maybe additional discovery performed, but that will not be “redone”. So really it’s the trial.

Brian Ruttenbur – Morgan Keegan

Okay. So how much do you anticipate spending on the – it wouldn’t be as expensive as the first trial, is that correct, because of the discovery, you and I have to redo that?

Vincent Sze

Yes. That’s a pretty safe bet.

Brian Ruttenbur – Morgan Keegan

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

Alan Edrick

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

Brian Ruttenbur – Morgan Keegan

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

Alan Edrick

We had some significant customer advances that we received in the quarter, which significantly favorably impacted our cash flow given that Q1 is, as you pointed out, typically our seasonally weakest quarter to generally collect the sales from Q1 and Q2. So there’s always a – there’s always that lag effect. So I wouldn’t necessarily say that Q1 is indicative of all quarters. But I would say that the positive trend that we’re seeing in Q1 is something to be looked at because we clearly have – we’ve clearly have made a difference in our working capital improvement initiatives as well as the overall profitability of the company, which has significantly positively impacted our ability to generate cash flow on a more consistent basis.

Brian Ruttenbur – Morgan Keegan

Okay. Do you happen to know tangible book right now, where your tangible book value is?

Alan Edrick

I’ll be happy to get back to you after the call on that.

Brian Ruttenbur – Morgan Keegan

Okay. And then, last question, when you expect – or do you expect backlogs will drop in the December period if things like – things are going well? But seasonally, backlogs sometimes drop in the December period or the March period. Do you anticipate that to be consistent this year?

Deepak Chopra

Well, Brian, keep in mind that the different divisions, the healthcare division doesn’t rely too much on backlog because it’s booked and shipped at the same time. And this is relatively a stronger quarter than with Q1. Security had a fantastic bookings. There are enough in the pipeline. There’s enough audition activity that if the stars line up, it could also be a very strong booking quarter for security. And on the optical side, there is in print that IT&T has got a follow on order from the DOD, which we are quite confident that we would participate into. So I don’t know where the backlog will ultimately be, but we are expecting that Q2 will also be a pretty strong booking quarter for us, for the company.

Brian Ruttenbur – Morgan Keegan

Okay. Thank you very much.

Operator

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

Michael Kim – Imperial Capital

Hi. Good morning, guys.

Deepak Chopra

Good morning.

Michael Kim – Imperial Capital

A couple of questions, first, if you could provide a break out on the security business between cargo and vehicle equipment versus somewhat the more conventional baggage systems parcel for people screening systems. I don’t know if you’ve got the break out or the mix between–?

Alan Edrick

Sure, sure. In terms of the particular quarter, our conventional sales and security were $38 million, while our cargo sales were about $21 million. And representing in the quarter, our conventional growth was outstanding at 31%, and our cargo growth was 5%.

Michael Kim – Imperial Capital

Great. And what was the international mix in security? How much of that came from international customers versus domestic?

Victor Sze

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

Ajay Mehra

I mean if you look at the security side of it, I don’t know exactly what the breakdown is. But we’ve seen continued growth and strength not just domestically, but internationally as well. And as we continue to introduce new products going to new markets internationally, we’ve seen – we’re seeing some very strong growth there.

Michael Kim – Imperial Capital

Okay. Great. And on air cargo, I don’t know if you could provide a little bit more detail on how the equipment purchased there are being funded. I think TSA’s been pushing this down to air freight forwarders. And I’m curious how – where they – are they relying on some type of equipment financing, which they may see the same type of impact that hospital customers have had in your healthcare business? Or if there’s some government support? Any detail would be helpful.

Alan Edrick

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

Deepak Chopra

Just to add on to it, this is Deepak here. I think the – what they’re just saying is, initially, I think that certain freight forwarders who are participating in TSA’s pilot program, some funding or a portion of the funding comes from the TSA to these freight forwarders. There are certain amount of equipment of various vendors that had been on an approved list by the TSA, from which the freight forwarders can independently go and make a decision which one they want to buy.

And ultimately, this is going to be a little different than the capital equipment market and the healthcare because in the healthcare market, it’s not a requirement for them to come up with a new tower of construction, or to replace them, or to delay their replacement. Whereas in this particular case, there’s a mandate by the TSA that 50% of all the freight getting onto a passenger plane must be inspected by February 2009, which is less than four months away. And 100% getting onto the passenger planes must be inspected by all carriers if they want to put the packages onto a passenger plane by August 2010. So it’s a requirement that they all will have to do it. Not that one person can do and the people don’t. Everybody has to buy something to do it.

Michael Kim – Imperial Capital

Okay. Great. And then, just on the solid state CT machine. I think, in the past, you’ve talked about some international opportunities from airports that maybe an opportunity for you. Can you talk about any more details or any update on that front?

Deepak Chopra

Well, the way to answer that question is that we’ve been developing this with our own money for a broad marketplace, which, as I mentioned by Frost & Sullivan, is about $600 million plus per year growing well into the next five years. So it’s not that directed at a single airport or a single customer. This is a product, which today, the people who are supplying this product are the L-3s and the GEs of this world. There are approximately a thousand machines out there, both domestically and internationally.

We have a very close relationship with Manchester airport. I think it’s a given that the product showcase will be there. By this order that we got from TSA validates that we have a product, which the government likes, and this money will go – quite good for us to go accelerate our development. And we are going to plan to deliver these products through certification and to start showcasing in the near future.

So it’s a broad product line, and the market is huge. So we believe and very excited that this is not directed at one or two specific customers. It’s a new marketplace that Rapiscan has the access of it. And we always said that if it’s a 2009, 2010 game, we want to be and we will be a player to compete with the L-3s and GEs of this world with our product. And we believe that it’s a quantum leap to in technology and performance, and gives – definite some great advantages to the customer, especially in the cost-to-own, in service, installation, and since it has no moving parts. So this is a great milestone for the company to get the validation from the likes of TSA, which will definitely more interest and focus from the rest of the world.

Michael Kim – Imperial Capital

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

Deepak Chopra

Both, both. It has been a – it’s a downtime where because of lack of the right performance machines, the customers have delayed replacement of their seven to ten-year old machines. At the same time, new installations are not taking place because there is no technology that’s available. So we believe that a faster machine with better throughput, less installation cost, better threat detection will rejuvenate the market to start looking at replacements a little bit faster because it pays itself up. At the same time, new systems instead of putting them stand alone in concourses, they would go into the inline system because of the ease of installation.

Michael Kim – Imperial Capital

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

Deepak Chopra

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

Michael Kim – Imperial Capital

Wonderful! Terrific! Well thank you very much.

Operator

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

Beth Lilly – Gabelli

Hi. It’s Beth Lilly with Gabelli.

Alan Edrick

Hi, Beth.

Beth Lilly – Gabelli

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

Deepak Chopra

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

Alan Edrick

I think just – we’re going to work very closely with TSA, and really going into – at this time, we’re really not at liberty to go into more specifics than that.

Deepak Chopra

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

Beth Lilly – Gabelli

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

Deepak Chopra

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

Beth Lilly – Gabelli

Other companies have gotten money from the TSA and you haven’t?

Deepak Chopra

We now have it.

Beth Lilly – Gabelli

Interesting. Okay, okay. The next thing I want to ask you about is I want to get clarification on the cargo market in the sense of – did I hear you correctly that the TSA is funding – is paying for the funding for the cargo market? Or is it the airline?

Deepak Chopra

They have pilot programs in existence of TSA that they have given some assistance, whether it’s fully covered or not fully covered, to some freight forwarders who are participating in these pilot programs. And we’ve got an order from the freight folk.

Beth Lilly – Gabelli

Yes. So right now the money is coming through the TSA, but at some point – I mean, if there has to be compliance by the second quarter of ’09, is that what you’ve said?

Deepak Chopra

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

Beth Lilly – Gabelli

Okay. So to get that kind of compliance, they’re going to have to start spending money, either the TSA’s going to have to send the money to the cargo companies as well.

Deepak Chopra

Well either that or they get passed over to the guy who’s putting the package through.

Beth Lilly – Gabelli

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

Deepak Chopra

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

Definitely, US, there is a lot of, what I call, lack of visibility from hospitals because of the credit crunch. And that prompted us of taking the guidance off. And I think that everybody’s prediction in the next couple of months, when things settle down, I think by the next conference call, we’ll have a clearer picture. But we’re not waiting. We are addressing our core structure in healthcare right away. And we plan to be there stronger and better as we come out of this. And again, it’s not on the way of our company, we feel very strongly that we are doing everything right, but we just can’t wait. So we have taken the right actions.

Beth Lilly – Gabelli

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

Deepak Chopra

We don’t plan to let that happen.

Beth Lilly – Gabelli

Yes, because you’ve taken out a lot of cost out of your healthcare business over the last couple of years.

Deepak Chopra

We have also said in today’s conference call that we are actively involved in taking more cost out of our healthcare group as we speak.

Beth Lilly – Gabelli

Yes. Okay. So you think by the end – by next quarter you’ll have a better sense?

Deepak Chopra

Definitely, we are hoping that we’ll have a better visibility.

Beth Lilly – Gabelli

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

Alan Edrick

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

Beth Lilly – Gabelli

Okay.

Deepak Chopra

That’s to say that – we have – Alan would you say that in a general term, let’s say US based company Spacelab, that a big chunk of the revenue is fairly dependent upon US?

Alan Edrick

That is correct, the majority.

Deepak Chopra

And that’s just to give another – put in the next perspective, the first quarter they’re only down by 3% in the healthcare. And primarily it’s directed to the North American. The rest of the business did well.

Beth Lilly – Gabelli

Okay. Those are all my questions. Thank you.

Operator

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

John Croke – Jefferies & Company

Good morning.

Deepak Chopra

Good morning.

John Croke – Jefferies & Company

Your commentary this morning with respect to the pressures you’re seeing in the healthcare business, and then primarily centered on what’s happening in the credit markets, I was wondering if you could step back for a second, kind of put that aside for the moment, and just think about the bigger macro economic pressures that we’re seeing and some of the fiscal pressures that are being experienced at the federal and state level. How do you see these trends playing out in your healthcare business putting aside what we’re seeing in the credit market?

Deepak Chopra

Well that’s a $100 question. And you have to also put in to the elections going on. I mean, we don’t know what’s going to happen after November 4th going into next year. Democrats, Republicans, they both have different healthcare plans. They both look at this in a different environment. And that definitely will have impact on everybody’s healthcare strategy. That’s to say that our capital equipment is bought by a hospital, either for a replacement of their old technology or in many cases to reduce the pens and paper to do better connectivity either a new tower opens or a new wards opens. And the more beds they can work into, what I call the high-tech connectivity, the better revenue and profitability the hospital gets.

So monitoring is almost a lifeline. I mean if you want a patient, you got to have our monitors. So it’s difficult to predict overall what’s going to happen to the market from the federal – what’s happening and what the election is going to do. But we believe that if you ignore the credit crunch – and that’s why this happened. We said at the last couple of days of the quarter when things started getting pushed, and our ability to react fast to look at our core structure. Once this thing gets settled down, there is enough visibility, both domestically and internationally of where the orders are and the customer’s ability to buy. These are non-million dollar items, we’ve got $15,000, $20,000 monitors. So we are not like the CT scan or the ultrasounds of multi-million dollar items.

John Croke – Jefferies & Company

Understood. That’s very helpful. You’ve mentioned that there hasn’t been any cancellations of orders in the healthcare business. How are your receivables quality ahead? Have you guys been stretched out at all there? Or are things still performing pretty normally?

Alan Edrick

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

John Croke – Jefferies & Company

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

Alan Edrick

The $800,000, I’m sorry, Q1 related to the prior projects as you’ve mentioned. We are aggressively looking at our cost structure. And we’d anticipate you’ll see further charges in Q2.

John Croke – Jefferies & Company

Okay.

Deepak Chopra

Just to add onto it. Definitely there will be an impairment charge because we are aggressing, as we’ve mentioned, and we’re executing the structure and the infrastructure rationalization in the healthcare group, especially in North America.

John Croke – Jefferies & Company

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

Deepak Chopra

Well I’m sure the divisions would like to do that. Ajay’s group would love to do that. We have to, overall, look at the total company. And I think we’ll do the right thing to adjust it. Some things can be accelerated. Some things you have physical limitations to do it.

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

John Croke – Jefferies & Company

Understood.

Deepak Chopra

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

John Croke – Jefferies & Company

Very good. Thank you very much.

Operator

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

Josephine Millward – Stanford Group

Good morning.

Deepak Chopra

Good morning.

Josephine Millward – Stanford Group

Deepak, I just want to say congratulations on the very important TSA win.

Deepak Chopra

Thank you.

Josephine Millward – Stanford Group

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

Deepak Chopra

Josephine, I really don’t even – not that I’m going to avoid your question. I don’t even know. This is as you know, you’ve got to–

Josephine Millward – Stanford Group

I don’t think that TSA knows also.

Deepak Chopra

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

We believe that we know a lot, but we are also very realistic. So I don’t think so that, as prudent analysts, that you should look – that this going to have revenue conversion in 2009. It’s not going to happen. It’s a 2010 kind of thing, but this market is a huge market, as you know. And this market is not – is not going to disappear. And the sooner the product gets there, the sooner the benefits will happen. And at the same time, there are other technologies that they’re going to – the other competitors are trying to increase the performance of their present machines.

As we have mentioned to you before, we have quantum leapt forward, taken a final review of a new technology, which inherently some people were just believers. And we feel very, very good about the validation by TSA of this new technology.

Josephine Millward – Stanford Group

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

Deepak Chopra

I think that – I would like to – maybe Alan can close the statement. We don’t know. Frankly, if we knew then obviously we wouldn’t have taken the guidance off. We want to wait for a couple of months for this (inaudible) to settle down. And I think – we think we’ll have a better chance after December is over, but for the next conference call. On the second part of your question is, I don’t want to put a number yet because it’s a bit too early. But we can definitely share with you that it’ll be in the same ranges as what you’ve mentioned the last year. We are very aggressively looking at the infrastructure cost. So it’s not of the $800,000 number that somebody asked us in the impairment charge in September. We are going to look at it in a very different mode, and we’re going to take a look at it. And we don’t know the exact number, but it’s going to be a pretty big number.

Josephine Millward – Stanford Group

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

Deepak Chopra

Well I think the big chunk of that will be – Alan, is it right? The big chunk of that will be in Q2. Obviously, we keep looking at it. It’s the policy of the company for the last couple of – for the last year that we have been looking at every division, every area of the business internationally, domestically. But the big chunk of the impairment charge or cost restructuring will be in this quarter.

Josephine Millward – Stanford Group

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

Deepak Chopra

Don’t know yet.

Josephine Millward – Stanford Group

Okay.

Deepak Chopra

Or I can say, all of the above.

Josephine Millward – Stanford Group

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

Deepak Chopra

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

Josephine Millward – Stanford Group

Can you talk about the introduction of your lighter patient monitors? And how if you still think that’s going to be a growth driver for the year?

Deepak Chopra

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

Josephine Millward – Stanford Group

Great. Thank you very much.

Operator

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

Tim Quillin – Stephens Inc.

Good morning.

Deepak Chopra

Good morning.

Tim Quillin – Stephens Inc.

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

Deepak Chopra

Tim, this has been a tough decision. I understand, it and frankly, every time we were talking about this discussion, your face came in front of me because I understand where you’re coming from and the frustration you might have. The best way that we have been able to rationalize and we can give you some indication is security have gone up a great quarter. Security, hopefully we think, with the backlog and what we are seeing will have a good year. Opto will have a good quarter, and opto has a good visibility, especially with what we’ve seen with the ITT winning the next award. Healthcare international businesses are doing very well. We’ve introduced new products. We are very satisfied to the internal estimates.

North America is an enigma to us. It happened very fast. And we could have waited for some more time, both in our cost rationalization and the guidance, but we felt it’s prudent because we don’t know. If we knew of a delay or a loss of orders, one can rationalize it. When you go to a customer and the customer says, “I have the purchase order for you, but I don’t know – but my CFO is saying wait because we can’t get access to capital. Or are we be drilling our mind, or are we going to redo it after the first of the year.” It puts a different light to it because suddenly we can’t come say anything.

Obviously, we have analysis inside. And that’s one of the reasons why Alan and his group together with the division is on an aggressive mode since last – since this month, it’s the first month of the quarter. We are looking at a cost rationalization so obviously we are doing some internal analysis. All we can tell you is, we are going to make sure that healthcare for the year will be profitable irrespective where the revenue falls. We are very focused on that. And we’re going to do that.

Tim Quillin – Stephens Inc.

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

Deepak Chopra

Well Tim, number one, non of it is big box business like the CT scanners or the MRIs or the ultrasounds that the GEs and the Siemens and the Philips sells. These are connectivity boxes that go into a pediatric ward or an OR, or something. What your faced with it is, if it’s due for replacement, they’re going to replace the whole ward. They’re not going to replace half of it. So if they want to delay it. They’ll delay the procurement by a couple of months until they have to.

So it’s difficult to go back and, what I would call pick a number how much is big ticket items or not, but we do have service revenue. We do have supplies and accessories. And there are many hospitals who might have this problem short term because of the clarity needed. On the other hand, there are other hospitals that don’t have this problem. Many cases it’s funded already. The money’s already dropped into it. So I don’t want to call it doomsday.

You can see the handwriting from what Philips is announcing, what GE is talking about healthcare, other companies. Definitely there is concern out there, but nobody is predicting that nobody’s going to buy anything. These are necessity items for patient’s lives. We are basically saying that we are going to take this opportunity to get the company stronger. And to look at leveraging and the cost rationalization in North America, especially, and any other place we can look at it. And that’s what Alan’s group is looking at.

Tim Quillin – Stephens Inc.

And in terms of the outlook for the current quarter, so your month ended this. Did things look like they’re getting worst versus what you saw at the end of September? Could you have a situation where healthcare revenue is down quarter-to-quarter?

Deepak Chopra

Too early to say. Healthcare business runs in where the last month is very strong. The first two months are weak to begin with. And it’s too early.

Tim Quillin – Stephens Inc.

This maybe a difficult question, but if I put my model down 20% or down 30% or down 40%, how much is too big of a cut for healthcare this year?

Deepak Chopra

I don’t think so we are predicting those kinds of draconian deductions in revenue.

Tim Quillin – Stephens Inc.

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

Deepak Chopra

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

Tim Quillin – Stephens Inc.

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

Alan Edrick

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

Tim Quillin – Stephens Inc.

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

Alan Edrick

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

Tim Quillin – Stephens Inc.

Okay. And then CapEx?

Alan Edrick

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

Tim Quillin – Stephens Inc.

Could it be lower than $15 million? So more like $10 million kind of a run rate off of from 1Q?

Alan Edrick

I would say that Q1 was lighter than the typical run rate will be. I would say use the $15 million to $17 million that wee historically are – have been added as a bit of proxy. And we will look to keep it lower than that though throughout the year.

Tim Quillin – Stephens Inc.

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

Alan Edrick

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

Tim Quillin – Stephens Inc.

Thank you.

Operator

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

Deepak Chopra

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

We believe that as prudent managers, we are watching the top line. We are watching our bottom line. And we hope that we’ll have better visibility just like the rest of the industries in North America, we’ll have a better visibility and whatever happens to the credit policies in the next 30, 60 days. And we hope to be able to get back into a guidance by this time that we report the second quarter. Thank you very much.

Operator

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

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