Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

OSI Systems Inc. (NASDAQ:OSIS)

F2Q09 Earnings Call

January 29, 2009; 12:00 pm ET

Executives

Alan Edrick - Executive Vice President & Chief Financial Officer

Deepak Chopra - President & Chief Executive Officer

Ajay Mehra - President Security Division, Rapiscan Systems

Victor Sze - General Counsel

Jeremy Norton - Vice President of Investor Relations

Analysts

Brian Ruttenbur - Morgan Keegan

Rick Haas - Roth Capital Partners

Josephine Millward - Stanford Group

Steve Emerson - Emerson Investment Group

Tim Quillin - Stephens Incorporated

Michael Kim - Imperial Capital

Beth Lilly - Gabelli

Operator

Good day, ladies and gentlemen and welcome to the Q2, 2009 OSI Systems Earnings Call. May name is Shane and I’ll be your operator for today. At this time, all participants are in a listen-only mode.

We will be holding a question-and-answer session towards the end of this conference. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Alan Edrick, Chief Financial Officer. Please proceed sir.

Alan Edrick

Thank you. Good morning and thank you for joining us. I’m Alan Edrick, Executive Vice President and CFO of OSI Systems. I’m here today with Deepak Chopra, our President and CEO, Ajay Mehra, President of our Security Division, Rapiscan Systems, Victor Sze our General Counsel and Jeremy Norton, our Vice President of Investor Relations.

Welcome to the 2009 Second Quarter OSI Systems Conference Call. We would like to extend a special welcome to anyone who is a first time participant on our conference calls. Please note that this presentation is being webcast and will remain on our website for approximately two weeks.

Before discussing our financial and operational highlights, I’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 reconciliation of those figures, please refer to today’s press release regarding our second quarter results. The press release will also be filed with the SEC as part of a Form 8-K.

The Company wishes to caution participants on this call that numerous factors could cause actual results to differ materially from any forward-looking statements made by the Company. These factors include the risk factors set forth in the Company’s SEC filings. Any forward-looking statements made on this call speak only as of the day 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 our second quarter and our recent accomplishments. Despite the very challenging economic environment, particularly with respect to the U.S hospital market, we continue to successfully execute a strategy that we announced some time ago to improve both our profitability and our cash flow.

We have highlighted this game plan on our prior conference calls, and the results this quarter clearly demonstrate the power of this plan. Our fiscal 2009 second quarter highlights are as follows.

First, we achieved a 26% increase in earnings per share including or excluding the impact of restructuring charges. Greatly improved operating efficiencies, coupled with cost containment initiatives, drove this solid increase in the face of a challenging North American Healthcare market.

Second, following our record Q1 free cash flow we again delivered very strong quarterly operating cash flow and free cash flow of $18 million and $15 million respectively. This brings our free cash flow for the first six months fiscal ‘09 to $28 million, compared to negative $20 million in the prior year. We used a portion of this strong cash flow to buy back approximately 600,000 shares of our common stock on the open market for $7.2 million.

Third, our bookings were again quite solid, leading to a record backlog of $239 million at December 31, ‘08. Equally important, we announced several strategic awards in air cargo and CT checked baggage systems, which represent a significant future growth opportunities. While clearly our top line momentum has been impacted by the economic environment, most notably in our Healthcare division, it is gratifying to be able to continue to demonstrate to you significant increases, significant increases in our year-over-year earnings and cash flow.

I’ll be updating you further on the financial performance of the Company and steps that we have taken to address the softness in Healthcare sales. But first, let me turn the call over to Deepak.

Deepak Chopra

Thank you, Alan and again, good morning and welcome to the OSI Systems second quarter and first half of fiscal 2009 earnings conference call. When we last addressed our shareholders during our first quarter earnings call in late October, we spoke of the challenging economic environment that our Healthcare division was facing in North America, due to tightening credit markets.

At that time, looking, revenue was down by approximately 3%, but we prudently looked at the forward, what might happen, and took some steps that we announced at that time our intention to move proactively and aggressively to address our overall cost structure within that division.

In line with the program that Alan has mentioned on every conference call for the last two years that we have undertaken to implement organizational changes all over the Company to reduce our cost structure and improve our overall operating efficiencies.

We took the right steps in November and we did announce approximately the size of it, which was about $10 million. I’m pleased to announce we implemented that and it’s executed and the full impact of that will be felt in the second half of fiscal 2009. This proactive and aggressive measure, along with the continued commitment and dedication of our employees, has enabled us to achieve the following accomplishments during the second quarter and first half of fiscal 2009.

I want to tell you a little bit about the accomplishments, but before that I want to make a comment that in this challenging time, we as a Company are very proud of the total team working together of what we have achieved. We significantly improved our diluted earnings per share for the second quarter and first half of fiscal 2009.

Second quarter non-GAAP EPS of $0.34 versus a year ago of $0.27. We achieved record operating cash flow; Alan is going to go more into detail. I would just like to mention that in the first half, the difference in the cash flow is $47.7 million from a minus to a positive.

We repurchased approximately 604,128 shares of common stock during the second quarter, which equates to approximately 3.5% of the shares outstanding. We have an active share buyback program in place and plan to look at opportunities to keep going forward from time-to-time, because we think that at these kinds of prices it was the most prudent thing to do.

Obviously, we are cautious to watch our head room on credit line, so that as opportunities come our way, we are not caught short. Our balance sheet and liquidity position remains strong and we believe going forward, the Company is well-placed to capitalize on the leveraging and the infrastructure improvement that we have done.

Buoyed by our security division, which achieved record breaking $141 million for the first six months of bookings, an improvement of 33% when compared to the prior comparable period.

The Company was able to achieve a record backlog of $239 million as of December 31, 2008. Our backlog level has increased by approximately 13% from $212 million at the beginning of the fiscal year.

Today, we republished our guidance for fiscal 2009. I know that some of you were not very happy when we took the guidance off from the last conference call, but we felt at that time that we didn’t know enough about what’s happening in the marketplace, especially in the Healthcare, because we think that what happened in late October, was almost like a tidal wave.

The good news is, we see better visibility and with that we are reaffirming our new guidance, which we expect that the revenue will be pretty comparable to 2008 top line, but the EPS will improve 10% to 25% when compared to fiscal 2008.

Let’s talk about the divisions. Healthcare; sales in our Healthcare division declined by approximately 12% and 8% for the second quarter and the first half respectively when compared to the prior fiscal year. This was primarily due to the market conditions in North America.

Our international operation continues to perform well. As highlighted, our customers in North America, which are predominantly hospitals, are facing unprecedented economic conditions including lack of credit availability. Given this, certain US customers have delayed planned purchases.

To-date, we can confidently say, we have not lost any significant orders to our competitors, or received any order cancellations. I would add to it that with the aggressive stance we have taken and the service being number one, we have also succeeded I would say during this time to make some conversions from our competitors to space labs.

Additionally, internal estimates show we have maintained our market share as all our competitors are also facing the similar challenges. But cautiously, we continue to closely monitor the market conditions. As previously mentioned in the second quarter, we proactively implemented measures to address our cost structure within this division. Identifying and implementing approximately $10 million of annualized cost savings.

The full benefit of these cost savings will be evident in our full year operating results. However, I must highlight that despite a 12% decline in revenue for the Healthcare division, we achieved operating income of approximately 8%, when excluding the impact of restructuring charges.

Our Healthcare division continues to perform well internationally, especially in the emerging markets. Last year, we opened a facility in China. The goal of the facility was to focus R&D development on the emerging markets, develop a dedicated product offering for this market segment, which this year we launched, the Elance product line and added number of showings in the international community and to improve our supply chain efficiencies throughout the division.

The China factory anniversary was in February and we have already started seeing some improvement to our gross margin and as more production moves to China. Coming back to the security division, it’s been a great star; it has continued to be positive booking momentum in the second quarter. Year-to-date, bookings have increased by 33% to $141 million, compared to $106 million for the first six months of the prior fiscal year. Backlog for the division was $131 million as of December 31, 2008, an increase of 12% year-to-date, which gives us great visibility going forward.

While security bookings continue to grow, we are extremely proud of the significant operating improvements the division has achieved this fiscal year. When excluding the impact of restructuring and other one-time charges, operating income improved by 86% in the second quarter and 285% in the first half of fiscal 2009 when compared to the prior comparable period.

As we have said in many conference calls before, one of the big changes that have happened is that we had spent and invested over the last couple of years in our cargo product line and we had a lot of engineering going on, one-off production products. We are happy to say that we have got good recognition of our products and as we ship more, as the quantity increases, the margin improves tremendously. The security market, domestically and internationally, remains robust. Quotation levels across all of our product lines have never been this strong.

In the US, we are seeing market growth from the air cargo segment, due to TSA mandate for 100% of air cargo carried on passenger planes to be inspected by August 2010. We are well-positioned to participate in this market, due to our broad product offerings.

Currently, we have more products qualified by TSA for the inspection of air cargo than any of our competitors. We have the ability to offer our customers a variety of choices in order to meet the screening regulations and also as you know, we are the only vertically integrated Company in the screening space and can rapidly respond to our customers’ needs for products.

Last quarter, we announced a receipt of approximately $10 million in Research and Development grants from the US Government. To name a few, we received $6 million from the Transportation And Security Administration for the development of our next generation high speed in line certified CT all baggage screening system, the RTD. We also have a new milestone.

We have told you before that sometime during this fiscal year; we will put our high speed CT in an airport environment to start collecting data. We are happy to announce that as we speak, that installation is taking place in an international airport.

We received two grants totaling $3.6 million from the US Domestic Nuclear Detection Office for the development of Advanced Cargo and Vehicle Inspection Systems, capable of automatically detecting devices or dirty bombs.

Though these are challenging times, we are looking at our costs. Our commitment to R&D in both Security and Healthcare divisions remain strong. We have invested $8.6 million approximately $19 million in R&D in the second quarter and first half respectively.

Though the number looks a little down, it’s not because our commitment is different. We are focusing on the products and we have also launched a couple of products already. Our product development pipeline is full and we expect to announce some new exciting product introductions this calendar year in both Security and Healthcare divisions.

Our Optoelectronics and manufacturing division continue to perform well in a challenging environment. Year-to-date, revenues have improved by approximately 11% while operating income has improved by 58%. With that, I’m going to hand the call back to Alan Edrick to talk in 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 as you’ve seen. Our management has systematically executed our strategy to attain these goals since I joined the Company. These focused efforts are paying off. I’ll speak more about this shortly. But first, let me review the financial results of the second quarter.

Overall, net sales for Q2 decreased 3% to $159 million in fiscal 2009. For the first half of the fiscal year, net sales increased 4% to $307 million. As the dollar has strengthened significantly, our top line has been adversely impacted. Excluding the impact of foreign exchange, sales would have increased approximately 1% in Q2 and 6% for the six months ended December 31, ‘08.

On a divisional basis, our Security group reported another solid quarter with 5% sales growth it would be 12% excluding the impact of FX with a strong backlog providing excellent visibility for the near future. This was particularly impressive, as this was a difficult comparative quarter for our Security division, which posted a record Q2 in the previous fiscal year.

Once again, our Opto group had a solid quarter in a challenging economic environment reporting essentially flat third party sales year-over-year as expected. However, the sales growth in these two divisions was offset by our Healthcare division, which reported a 12% sales decline driven by weak US sales as certain hospitals have delayed CapEx spending as they face an extremely difficult economic and credit environment.

Based on our latest market data, we anticipate that the Healthcare markets will continue to be challenged for the remainder of our fiscal year. As a result, and as we mentioned on our last conference call, during Q2 we aggressively moved to reduce our costs in this division. With these changes, we anticipate that fiscal 2009 pre-restructuring operating income in our Healthcare division will be in the general vicinity of that of fiscal 2008.

Our bottom line for the second quarter in fiscal 2009 markedly improved, as we reported net income of $4.2 million or $0.24 per diluted share, compared to $3.5 million or $0.20 per diluted share for the same period of fiscal ‘08.

As mentioned earlier, excluding restructuring and other charges, net income for the second quarter of fiscal ‘09 would have been approximately $6 million or $0.34 per diluted share, representing a 26% increase from Q2 in the prior year.

For the first half of the fiscal year, our EPS increased from $0.16 last year, to $0.38 this year, excluding restructuring charges. Our gross margin of 34.2% decreased 1.7% from the prior year, due primarily to the sales mix, driven by the reduction in sales from our Healthcare business, which carried the highest gross margins in the Company.

While our gross margin will vary from quarter-to-quarter as a result of a number of factors including the product mix and unit volumes, pricing, foreign exchange, inventory reserves and capacity utilization, we do expect to see overall improvements in the future.

During Q2, we realized further operating efficiencies, continuing the momentum evident over the past three years. Our SG&A expenses, as a percentage of sales, decreased by 140 basis points to 22.4% in Q2, from 23.8% in fiscal 2008, and by 550 basis points from 27.9% in fiscal ‘07.

R&D expenses were $8.6 million, or 5.4% of sales, compared to 7.1% of sales in the same period last year. As Deepak mentioned, as certain projects have come to completion, coupled with increased government funding and cost containment initiatives in our Healthcare division, we saw an overall reduction in R&D spending.

We continue to invest significant resources and technologies that will add value to our Security and Healthcare product offerings. As a result of these programs, we believe that the Company is well-positioned to capture major opportunities throughout the global marketplace in the future. Our net interest declined to $0.9 million in Q2, compared to $1.2 million in the prior year. As a result of both the reduction in our net debt, and the overall interest rate declines. Given the low interest rate environment, earlier this month we entered into an interest rate swap to lock in a portion of our debt balance that what we believe to be a favorable interest rate for the next three years.

Our effective tax rate for the quarter was 34.4%, compared to 35.2% in Q2 last year. Our provision for income taxes is dependent on the mix of income from US and foreign locations, due to tax rate differences among such countries as well as due to the impact of permanent taxable differences. Moving to cash flow, during the quarter, we generated operating cash flow of $18 million, driven by both improved profitability, and our ongoing focus on working capital management, which led to a 10-day improvement in DSO.

Capital expenditures were $3 million depreciation and amortization was $4.3 million. For the first half of the year, as Deepak mentioned, we improved our free cash flow by $47 million compared to last year and even after factoring in a rise in accounts payable of $10 million due to timing issues, this change we believe to be very impressive.

As mentioned on our last conference call, generating strong operating cash flow will continue to be a top priority in fiscal ‘09 and beyond and we are very pleased with the significant progress we have made in this effort.

Finally, as mentioned on our last conference call, the economic climate impacting our Healthcare division at that time was too fluid and unpredictable to provide financial guidance. Over the past few months, we have gained further insight into the direction of the market and as a result took decisive action in Q2 to right-size our business in response to the expected slowdown.

The results of these actions were partially manifested in the very strong Q2 earnings performance. Based upon our current outlook, we anticipate comparable sales in fiscal 2009 in the face of the FX headwind and economic environment that of fiscal ‘08. However, as Deepak mentioned, given the strong improvement in operating efficiencies and restructure activities, we do anticipate that our EPS excluding the impact of restructuring and other charges, will increase at a healthy 10 to 25%.

During fiscal 2008, we transformed our Company into a sustainable organization and a consistent performer. The impact of the economic issues notwithstanding, we also built a strong foundation for significant future earnings power. We realized the benefits of these efforts in the second quarter and year-to-date 2009 results. And we continue to implement a strategy aimed at driving further improvement. Thank you for listening in on this conference call and at this time we would like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Brian Ruttenbur - Morgan Keegan.

Brian Ruttenbur - Morgan Keegan

Can you talk about your cuts in Healthcare and what else you can cut going forward? Have you done all the cuts that you can in the near term?

Deepak Chopra

Well, as we have been saying, that North America was the area where the biggest changes happened in this environment. So, when we looked at it, we looked at across, frankly, the whole Healthcare group and also across the whole Company, including corporate.

Most of the cuts primarily the cuts that took place were combining some regions. We did not touch any of our sales and marketing. We looked into manufacturing efficiency as we accelerated moving from Seattle and UK into China. We looked at some of the back office functions. We looked at how we do R&D and we looked at some service. We looked at some internal, not much in the sales and marketing, because obviously at this time, we are very sensitive to that issue.

We also looked at some of the international areas, though they were doing quite well, Brian, but we looked at reorganizing that and if there was a place where we could combine and take some efficiency, we did. Frankly, we also looked at Security. We also looked at Optoelectronics. We old looked at corporate. So, basically it was a combined combination of where all we can get some synergy and leverage and make the organization stronger.

Brian Ruttenbur - Morgan Keegan

About your share repurchases, what are the plans going forward for share repurchase? What’s authorized? What’s been done so far? What are the plans?

Deepak Chopra

One thing I can definitely tell you, that we’re not going to tell you our plan. Basically, it’s the opportunistic way. We thought that at the $10, $11, $12 region it made sense. We looked at our cash flow need. Alan did an analysis with all the Group Presidents’ of what the next year looked like and we decided to opportunistically take a look at it, what we want to buy from going forward, we have enough head room in the plan, maybe Victor can comment on what it is, but we plan to look at it from time-to-time. Alan, you want to add something?

Alan Edrick

No, I think that addresses it nicely. We do have 1.3 million shares available to us of which we had used 600,000, so there are additional 700,000 or so available under the current plan.

Brian Ruttenbur - Morgan Keegan

And then how did the currency exchange impact earnings? You talked about what had impacted revenue. What did it do to earnings in the quarter?

Victor Sze

Yeah, Brian, as the dollar strengthens, clearly it impacts the top line adversely, but because we have quite a significant amount of costs in foreign jurisdictions such as the UK, throughout Europe, India and Malaysia, we actually receive a slight benefit on the bottom line. So while it negatively impacts our top line and therefore partly our margin, we do have a slight positive impact to the bottom line.

Brian Ruttenbur - Morgan Keegan

Can you tell us what your goal is in terms of operating or net margins or anything goal is in terms of operating or net margins or anything like that over the next 12 to 24 months?

Ajay Mehra

I think in this current environment, while we’ve given guidance for the rest of fiscal 2009 that we feel very confident in, I think it would be a little bit premature to provide longer-term guidance until we get a little bit more clarity over the next couple of quarters.

Operator

Your next question comes from [Rick Haas] - Roth Capital Partners.

Rick Haas - Roth Capital Partners

R&D spend was way down. Should we expect a healthy ramp in the second half of the year? It sounds like you still have the commitment to the R&D programs, just looking at such a drastic reduction, looking at your thoughts for the second half of the year.

Deepak Chopra

Well, two things. One is obviously we’ve been very successful in getting very good, healthy grant money and we expect second half to also get a lot of government grant money. The other thing is that definitely in the second half, there would be a little bit increase in the R&D, but I would think that for the remainder of the year, if you had to model it, maybe Alan you can talk about, maybe a million or two here and there as an increase but it’s not any major difference.

Rick Haas - Roth Capital Partners

So there’s no segment impact based on the R&D level for this quarter, it’s not like you’re starving one segment or another to get to the earnings?

Alan Edrick

No, we’re really not. The benefit in the R&D line is the result of some products that have already come out through our R&D pipeline so as a result less expenditures, from foreign exchange, we do some of our R&D overseas. So, with the strengthening dollar, it results in reduced R&D costs. That’s really the main part, as well as some grants that we received as Deepak was talking about relative to the Security division that helped offset some of the R&D spending. On an absolute relative dollar basis compared to last year, our R&D spending is actually comparable to last year.

Deepak Chopra

Just to add on to one more thing into it. The total number of people working in R&D has not gone down because we’re moving a lot more aggressively to R&D in both China, for our Healthcare, and in the areas of other groups, we have always had presence, a portion of R&D in India and UK.

Rick Haas - Roth Capital Partners

Second question, restructuring charges, looks like 2.8 for the quarter. I think as of maybe the last call, we had discussed maybe a few more restructuring charges in the third quarter. Is that still the outlook for the fourth quarter, looks clean?

Alan Edrick

We are continuing to anticipate some further restructuring charges in Q3 as we optimize some of our efficiencies and Q4, we don’t currently have anything planned for Q4, but we’ll see as we continue to look for ways to become more efficient.

Rick Haas - Roth Capital Partners

The hospital segment, the anecdotal information out there is pointing to a fairly large decline. I’ve heard anywhere from 20% to 30%. Is that what you’re seeing in the domestic market?

Deepak Chopra

Firstly, our products are not the same dollar ticket item as the CT scanners and MRIs and ultrasounds, so it’s a little different marketplace, though it is capital cope and buying. We are not seeing that kind of fall. More of what we are seeing is a little bit of uncertainty. Though I can tell you right now, from what we saw in late October and November, which was just a complete shutdown, the people are now sort of looking at again to get their life started and we are seeing some regions of the US are a little bit more hit than some areas.

For example, we think that in the East, especially in the Midwest, Southeast, it’s a little bit better. California as you have seen everywhere, there’s a lot of talk about the hospitals running out of and the government is running out of money. But we believe that it’s sporadic. It’s not across the board. There’s certain hospitals who already have their funding in place are doing well and some that are waiting for it, they’re basically pushing it. They’re just delaying the decision.

Rick Haas - Roth Capital Partners

So the delay of the decision implies that at some point, assuming capital becomes available, that these orders would come back and then you sort of have an elastic effect where not only would you have these orders that were delayed, but then would you have obviously the orders that were required in the current cycle.

Deepak Chopra

Absolutely and I think this is the point I want to emphasize that no cancellations. We have not seen a single cancellation. People have pushed it to say this quarter, give it next quarter. All people have said look I have an order for you, but I can’t give it to you yet until I can find out where I am going to get the money from.

I think that one of the things we want to emphasize on the Healthcare group, we are so focused into it that as and when the market turns and there is capital available, I think confidently we can say, we will look stronger than we were. We are building towards that.

Operator

Your next question comes from Josephine Millward - Stanford Group.

Josephine Millward - Stanford Group

Deepak since you seem to have better visibility in Healthcare and have right sized your business accordingly, can you just talk about how much do you expect Healthcare to be down for fiscal year ‘09 and when do you anticipate a recovery?

Alan Edrick

Josephine, this is Alan. As I mentioned in my opening comments, we’re anticipating that the operating income for Healthcare in fiscal 2009 will still be in the general vicinity of that 2008, despite the reductions on the top line, based upon all the significant changes that we have made in the organization.

Josephine Millward - Stanford Group

I’m trying to get a sense of how much do you expect top line to be down, because you must have a base case in terms of what kind of downturn you’re anticipating to right-size the bottom of your business. I’m just trying to figure out what’s baked into your assumption and if you could also provide that outlook for your other business division as well, that would be very helpful.

Deepak Chopra

Number one, I can tell you that if I could predict that much forward with specificity, I should work for the government. I can’t.

Josephine Millward - Stanford Group

I know. I’m just trying to get a better sense of your assumption.

Deepak Chopra

Josephine, after saying that, I think it’s a fluent thing. One of the things that we pride ourselves and frankly you’re the one who asked the question the last conference call, that we were only down 3% and we said that we are looking at sizing our operation properly. We were looking at if there’s going to be headwinds. We predicted right. If I’m not mistaken, you asked the kind of cuts you’re looking for is in 800,000 region or more like the last one of about 10 million and we used the word latter. So, to answer your question, we are predicting, we have some internal plans that for competitive reasons we’re not going to share, but we are going to watch it cautiously. We are looking at every week, what the funnel activity looks like. And we see positives in some areas.

We see some caution in the other area. But all I can say that to you is we will be ready and we are looking at it and we are very much focused onto it. The rest of the businesses, Security is doing very well. I think that the business internationally and domestically looks very good. Maybe Ajay can add on to it. At the same time we’re watching very carefully the stimulus going through the house and the Senate. There are a lot of opportunities. Air cargo is a great opportunity for us. We are well-positioned in the cargo, in the contract manufacturing, electronics Opto.

Obviously there are some sectors, defense which is doing good, medical is a little down, some of the international areas are looking fine. So it’s a mixture and that’s the reason we gave you the guidance that we think that Healthcare will be down for the year, Security is going to be up and Alan has said that we expect the top line revenue to be comparable to 2008.

Josephine Millward - Stanford Group

Okay. That’s helpful, Deepak. So you expect growth in Security, Healthcare is going to be down. Do you think Opto is going to be relatively flat?

Deepak Chopra

I think that’s a correct assumption.

Josephine Millward - Stanford Group

Okay. And can you just help us quantify the full year EPS impact from your restructuring and one-time charges?

Alan Edrick

The restructuring and one-time charges for the full year impact are an ongoing process, so with respect to Healthcare you can do the math from the approximately $10 million of annualized reductions, but we’re continuing that process so it will continue to be a significant contributor to the bottom line.

Josephine Millward - Stanford Group

Okay, no, I was talking about your restructuring costs. I guess do you have a sense of what Q3 restructuring might look like to get to your full year EPS adjusted EPS guidance.

Ajay Mehra

Well, the full year adjusted EPS guidance that we provide is excluding restructuring charges. So it wouldn’t be relevant.

Josephine Millward - Stanford Group

Okay. For Q3, should we expect the same level of restructuring charges that we saw in Q2? Maybe it’s another way of asking my question.

Ajay Mehra

As we mentioned to the prior analyst who said, we expect Q3 restructuring charges to be lower than Q2 and we are not expecting significant Q4 restructuring charges at this point.

Josephine Millward - Stanford Group

Okay. That’s very helpful. Thank you. And Alan, you’ve done a great job managing the balance sheet and generating free cash flow. Do you think that the reduction in DSO is there more room to lower DSO? And do you have a target free cash flow for the year?

Alan Edrick

With respect to DSO, there certainly is room to continue to improve it. Though I would caution in this environment, in this economic climate, there are many companies who are looking to extend the payments to their vendors, which in this case would be us and others. So I think over the long term, there are opportunities to continue to improve the DSO. On the short term basis, we’ll see just how that manifests itself. From a free cash flow perspective, we expect to be positive in the second half of the year.

We had a bit of a run up in AP at the end of the year as mentioned. So that contributed to some of the rate free cash flow that we have reported in the first half of the year. But overall, we expect to have a very, very strong free cash flow year as evidenced by the first six months, second six months probably won’t be as strong as the first half of the year but still strong.

Josephine Millward - Stanford Group

Going back to Deepak, you mentioned economic stimulus package. I know there’s several hundreds of millions for cargo inspection in airport Security. How soon do you foresee that money coming down the pike for OSI?

Deepak Chopra

Well, I don’t know. If you can tell me when you predict it will get passed then the money will start flowing. I don’t know. All we can tell you is that in the line items, both in the cargo and in the TSA, that is right up our alley and we are watching it very closely.

Operator

Your next question comes from Steve Emerson - Emerson Investment Group.

Steve Emerson - Emerson Investment Group

First of all, congratulations for your incredible performance in a very tough environment. To follow up on the possible implications of the House bill, this billion two line item, can you put that into context? How much is in the budget for these items now and to what extent does it sound like an increase and which areas? Obviously, we all know that the Senate bill has not passed conference committee but what does at least the House bill imply?

Deepak Chopra

Well, firstly, the number is going to be somewhere, people are talking about between $500 billion to $1.2 billion so it’s still going through. I presume you’re still talking about TSA. It’s to do with EDS.

Alan Edrick

It’s basically the entire money basically is not there for aviation and what they’re looking at is obviously the checkpoint, which we participate in. They’re looking at possibly going at 100% of replacement of all the checkpoint machines.

Steve Emerson - Emerson Investment Group

How much would that be? What I’m trying to figure out is of this money, what’s currently in the budget without this bill? What is the cash requirement to accomplish the task? I’m trying to put this in context based on the limited information we all have.

Deepak Chopra

Steve, I think there’s too many moving parts right now into it. But if you want to put it in the right context, I’m going by memory. After 9/11, the number was $1 and this looks like, if 1.2 passes, bigger than post 9/11. I’m going by memory Steve. I think the important thing to look at it is that the government is pushing very hard that there’s very few if I remember, only 20 airports in America have all the checked baggage screening equipment. In all the terminals, 34 of the airports only have it in some terminals and this money will not get to the total, but it will get started to go back and line up the top airports and put a checkpoint area.

The way we look at it is that A; there is enough money in there for the checkpoint upgrade in which we will participate and we are very well-positioned as you know. In the checked baggage area, we don’t have any presence yet, but we have $6 million, approximately, that we got, was a great validation of our technology and I mentioned on my presentation that we are very happy to announce the milestone that we’ve been saying that in this fiscal year, that we will have the unit out there, collecting data.

And we are happy to announce it is happening as we speak. So that starts getting more possibility and opportunity for what we call, for us is ground zero, for checked baggage participation. And that number could be very big. And we think that and we are hoping for that our technology is validated and we get to play in that market. Ajay.

Ajay Mehra

I think you put it very well. At the end of the day, I think it’s a very fluid situation. It’s a positive situation, obviously, from what we think in terms of what money’s getting spent. But there will be more clarity over the next 60 to 90 days.

Deepak Chopra

Steve, just want to add onto it, we think this is a very good opportunity for new technology. There is a lot of focus on in the checked baggage arena to look at new technology and that’s what we are excited about.

Steve Emerson - Emerson Investment Group

Sounds excellent. What is the market for all checked gates, if some of this money goes to the program you’re already supplying, the new gate scanning equipment that you and Smith provide?

Ajay Mehra

I’m not sure the exact number of machines out there, but it’s probably in the 2,000 plus or minus range.

Steve Emerson - Emerson Investment Group

Okay. And that was what 60 grand a machine?

Ajay Mehra

I don’t know the exact numbers but they vary between us and Smith’s.

Steve Emerson - Emerson Investment Group

Okay. Thank you and happy hunting with TSA.

Operator

Your next question comes from Tim Quillin – Stephens Incorporated.

Tim Quillin – Stephens Incorporated

Great quarter and in a lot of different ways. Remind me if there was any restructuring charges in the Healthcare business in fiscal ‘08?

Alan Edrick

Yes, there were, Tim.

Tim Quillin – Stephens Incorporated

Do you happen to know how much of the restructuring charge from fiscal ‘08 related to the Healthcare business? I’m just trying to get to the pro forma profit guidance that you talked about.

Alan Edrick

Very little actually, in the first six months it was roughly $200,000, though that number was higher in the last six months of the year. I don’t have that number handy Tim, but I’d be happy to get it to you offline.

Tim Quillin – Stephens Incorporated

And then in terms of just to kind of recap the AT x-ray opportunity specifically, are you shipping AT x-rays right now? What kind of revenue are you seeing right now for that product line?

Ajay Mehra

You know, we’re shipping AT x-rays as we speak. In terms of specifically what kind of revenues we’re seeing, I really don’t want to go into that for competitive reasons, what our pricing, et cetera, is, but we are shipping as we speak, yes.

Deepak Mehra

And just want to add on to it what Ajay was saying. One thing maybe Ajay you want to clarify that AT revenue in today’s terms and forward expectations is not in the overall picture, is not a big number in the Rapiscan. Is that a true statement?

Ajay Mehra

It’s not overly significant, no.

Deepak Chopra

That’s the beauty of our broad product line.

Tim Quillin – Stephens Incorporated

No, absolutely. How about on the RTT, did I hear you right saying that you’re going to start testing a unit at an international airport and if so, do you need to test one in a US airport as well?

Deepak Chopra

The answer to the first one is yes, it is in the international arena and the answer to the second question is yes, ultimately it will be in the US airport too.

Tim Quillin – Stephens Incorporated

Are you going to be able to get that done before this potential wave of funding comes?

Deepak Chopra

Well, we are hoping for it.

Tim Quillin – Stephens Incorporated

I guess is there any near term prospects of getting a field test started?

Alan Edrick

I think we said enough and I don’t mean to be coy there, but obviously we want to keep it pretty cheese to what we’re doing from a competitive standpoint.

Deepak Chopra

I think one of the things that I want to add on to it, without A; we are very cautious and this is a new thing for us. But I think if you really have to read it, what we are saying, we always said that we would start the trials and the testing in an international airport before this fiscal year ends. And that ending is June. So if we are saying end of January that we are putting a unit out there, obviously we want to get there as fast as possible.

Tim Quillin – Stephens Incorporated

And the Opto business, I think you’re still shipping a significant chunk of components for your bomb jammer customer. How should we think about fiscal ‘10? Do you still have opportunities in the pipeline that can offset any lost revenue there and we can think about a flat or up year in fiscal ‘10?

Deepak Chopra

Firstly, you’re very astute. We are shipping. Definitely, 2010 the shipment to the jammer program will be less than this year. Do we have opportunities of filling that gap with other alternates, absolutely and at the same time, 2010 hopefully everybody’s predicting as the economy improves, keep in mind that our other business, Opto business, is tied up to a lot of different industrial codes. So that more than adequately can offset it and those products tend to have a higher gross margin than the jammer program.

Tim Quillin – Stephens Incorporated

Okay. The cash flows over the past several quarters have been just fabulous. Alan, you talked about free cash flow for the rest of the year being good. I guess that implies that you’ll continue to have positive free cash flow for the next couple quarters?

Alan Edrick

Yeah, we certainly expect to have positive free cash flow for the second half of the year. A little bit more difficult to go from a quarter-to-quarter perspective. But we do expect to have positive cash flow for the second half of the year and end the year for fiscal ‘09 with a very significant free cash flow number.

Deepak Chopra

I just want to caution you with that, it’s a double edged sword. On the other hand, we are actively aggressively pursuing a lot more US Government business in the Security area and if we land a lot of business in especially US Government, Cargo and CBP and other things, it’s going to consume some cash.

Tim Quillin – Stephens Incorporated

Yeah, that’s a good problem, though. And you have a pretty big cash balance right now and is there any thought to paying down debt and what kind of interest are you getting, interest rate are you getting, paying now on your debt?

Alan Edrick

Sure, Tim. We’re paying LIBOR plus 2%, so very attractive and a portion of that we’ve locked up into some long-term rates as well. The $34 million in cash that we reported at quarter-end is a bit of an anomaly. We don’t normally maintain that level of cash. It’s really a point in time, when we have excess cash; we clearly pay down our lines of credit. As you see, as we report the end of March, you probably wouldn’t see that same level of cash. It was just a bunch of cash that came in right at the last few days of the calendar year.

Operator

Your next question comes from Michael Kim - Imperial Capital.

Michael Kim - Imperial Capital

Just touching on the Security side, can you provide a little more detail on the mix of revenues in the quarter, specifically what the contribution was from cargo? Is it something like about a third versus two-thirds?

Alan Edrick

Sure, be happy to. If we’re looking at cargo for the quarter, it represented about a third of our sales and what we call our conventional business represented about two-thirds of our sales that changes from time-to-time from a quarter-to-quarter perspective really based upon the timing.

Clearly, if you looked at the first quarter, cargo was more significant, compared to conventional. As we look out, at the way our backlog is, cargo is continuing to grow at a very robust rate.

Michael Kim - Imperial Capital

Just touching on that side, I think you mentioned that quotation activity was pretty strong. Was that mostly on the cargo side or also in conventional?

Ajay Mehra

Quotation activity remains strong on all ends, on all product lines, not just in cargo, on the conventional side as well, both domestically and internationally.

Michael Kim - Imperial Capital

Okay. I think just on the international side, are you seeing similar levels as in the US or is it on the cargo side or where are you seeing any particular hot spots for you?

Deepak Chopra

All of the above, for competitive reasons, it is very difficult to break it down, the next level down.

Michael Kim - Imperial Capital

Okay. Fair enough. And then just on the operating margin side, I think you talked a little bit about some continued improvements. What are your goals for your operating margins? Are you looking at somewhere in the upper single-digit range, double-digit range? Maybe if you could provide some framework to think about.

Deepak Chopra

Especially my good friend Tim Quillin, I’m sure you would like us to say that and I’ve said it before. I mean, every Company’s goal is long-term, to get to that 9%, 10% operating income level and we have that goal too. But in these challenging times, it’s difficult to pin down a goal that far out. All I can tell you is that if you look at the results, both in the Security and the emphasis is, if it’s a 12% reduction in the top line in Healthcare, not bad. It depends a lot on the top line for the second half and what happens in 2010, but I think I can say it very confidently, with the changes we have made and the way we are running the operation, when the economy does bounce back in 2010, those kind of high single digit and 10% is not out of line to model.

Michael Kim - Imperial Capital

Okay. Fair enough. Just going back to the R&D line, I want to just confirm that the product pipeline or the development pipeline is intact and to the extent you can, can you talk a little about the road map that you have in that pipeline?

Deepak Chopra

Well, we can assure you, we’re a high tech Company. And again, I would “Tim that for a long time, we spent a lot of money in R&D, we are a very high-tech company, we look at products and we have a great, robust pipeline”. The important thing is, one of the reasons we broke down this time, we booked $10 million in grant money in the Security area in this first half.

And that’s very positive and we expect more. So our commitment to new products is very strong. We have a whole slew of product introductions going through and more than that I don’t know what else to tell you.

Michael Kim - Imperial Capital

Operator

Your next question comes from Beth Lilly - Gabelli.

Beth Lilly - Gabelli

I wanted to just talk a little bit about the cargo business in the sense of there’s some new regulations that have been put in place that 50% of cargo needs to be inspected before loading the plane. Is that correct? Is that February or March?

Ajay Mehra

By February of this year, I think the real mark is by August of 2010, 100% of air cargo has to be screened going onto passenger jets.

Deepak Chopra

Just to add up to what Ajay said, you’re absolutely right, there are some new regulations and what Ajay said is February 2009, which is maybe end of that is 20 days, 28 days from us, but that regulation, though important, has some [inaudible] how it can be inspected, the real deadline, the [foreign] deadline that everybody is trying to get to is the 100% inspection by 2010 and the answer to that question is one thing we are very excited about it is that we have developed a whole broad product portfolio of cost versus tunnel size versus price performance and we are on the buying list, approved by the TSA Ajay?

Ajay Mehra

Right. And we’re seeing a lot of activity in that area and as we speak, that activity keeps on going. Because obviously deadlines have to be met and really 2010, August is not that far off.

Deepak Chopra

And that’s a good growth projection for the second half and 2010 for us. We are well-placed and like I said, we have the broadest product line with model numbers of different sizes and price range compared to any of our competitors in that market.

Beth Lilly - Gabelli

And so the February 2009 I mean, it probably, what, put that regulation in place in order to do phasing and now people are really, you don’t have to adhere to it; correct?

Deepak Chopra

No, no, you have to adhere to it, but there’s different ways you can do it. It’s 50%.

Ajay Mehra

I think it’s being adhered to. Obviously that’s something the TSA and other people are looking at. I think as you look at it over the next year, year and-a-half as you go to 100%, hopefully we’ll be able to get more efficient solutions and longer term solutions and that’s what the hope is to do over the next year and-a-half.

Deepak Chopra

Just to add to what Ajay was saying, there are pilot programs, funded by TSA, for various carriers in that and in which we are participating quite well and what we meant was that 50% inspection is just a start. The real run to the end race is going to happen between now and the 2010 deadline and the pilot programs, which is funded by the TSA will expand on the other hand, pilot programs are such that it’s just a trial kind of a thing and after that the various carriers have to have their own equipment and find their own financial models, how they want to buy and how they want to pass the buck over to the shippers.

Beth Lilly - Gabelli

And the other issue is what, who’s going to pay for it; right?

Deepak Chopra

That’s true. Ultimately, it’s going to get down to the cost of shipping it, some of the rest of the world, especially Heathrow already has it. You see a package coming from that side or from Spain and it will have a £5, £6, £8, £12 charge, depending on the size of it of x-ray inspection.

Operator

I would now like to turn the call over to Mr. Deepak Chopra for closing remarks.

Deepak Chopra

Thank you very much for your time today. In closing, I would just like to reiterate the positive results we were able to achieve in the second quarter and first half of the fiscal year. One thing, before I just end the discussion up and give you the four closing points, I want to thank all the employees.

This has been a challenging time and we as a group have worked very well together. The four bullets I want you to look at, after you close the phone down, second quarter and first half we have significantly improved our earnings per share. We continue to improve our operating cash flows. December 31, 2008, our backlog is at a record level of $239 million.

Quotation activity levels for Security products has never been stronger. And we are well-sized and looking very cautiously and as the economy improves in Healthcare, we would come out of it even stronger than what we were. Thank you very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: OSI Systems F2Q09 (Qtr End 12/31/08) Earnings Call Transcript
This Transcript
All Transcripts