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Analogic Corporation (NASDAQ:ALOG)

F3Q08 Earnings Call

June 5, 2008 11:00 am ET

Executives

James W. Green – President and Chief Executive Officer

John J. Fry – Vice President, General Counsel and Corporation Secretary

John J. Millerick – Senior Vice President, Chief Financial Officer and Treasurer

Dr. Edmund F. Becker, Jr. – Executive Vice President and Chief Operating Officer

Analysts

Larry Solow - CJS Securities

Steve Levenson - Stifel Nicolaus

Dalton Chandler – Needham

Michael Caster - SIO Capital

Ed Fowler - The Small Cap Report

Josephine Millward - Stanford Group

Glenn Schneider - SG Capital Management

[Andy Carroll - Capital Management]

Operator

Welcome to Analogic Corporation’s third quarter investor conference call. The following corporate officers are present: Mr. Jim Green, President and CEO; Dr. Ed Becker, Executive Vice President and COO; Mr. John Millerick, Senior Vice President, CFO and Treasurer; and, Mr. John Fry, Vice President, General Counsel and Corporate Secretary.

I’d like to remind everyone that a supplementary financial presentation will be used during today’s call. If you have not already downloaded that presentation, you can do so at any time at www.analogic.com. That presentation will remain available until midnight, June 26, 2008.

Mr. Green will open the call.

James W. Green

Welcome and thank you for taking the time to participate in the call today. We’ll begin by asking our Vice President and General Counsel, John Fry to read the Safe Harbor statement. John Millerick and I will then review the third quarter and recent events using the supplementary financial presentation available on our website, following which we will take your questions.

John J. Fry

Any statements in this presentation about future expectations, plans and prospects for the company, including statements about orders for the company’s products, statements about shipments and installation of the company’s products and other statements containing the words “believes”, “anticipates”, “plans”, “expects” and similar expression constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including risks relating to technology development and commercialization; risks in product development; limited demand for the company’s products; risks associated with competition; uncertainties associated with regulatory agency approvals; competitive pricing pressures; downturns in the economy; the risk of potential intellectual property litigation and other factors discussed in our most recently quarterly report filed with the SEC.

In addition, the forward-looking statements included in this presentation represent the company’s views as of June 5, 2008. The company anticipates that subsequent events and developments will cause the company’s views to change. However, while the company may elect to update these forward-looking statements at some point in the future, the company specifically disclaims any obligation to do so. These forward-looking statements should not be relied upon as representing the company’s views as of any date subsequent to today.

James W. Green

John Millerick and I will now review the quarter and recent events.

Let’s start with Slide 5. Our revenues of $102.8 million were up $19 million or 23% over Q3 of last year and up $4 million or 4% from our last quarter and include an incremental $3.2 million attributable to the Copley acquisition. Income from operations of $7.7 million was 25% over Q3 prior year. Net income was $6.7 million, down 5% versus prior year driven by lower interest rates and a higher tax rate.

Earnings per share on a GAAP basis were flat to Q3 prior year at $0.50 and on a non-GAAP basis were up 9% from Q3 prior year at $0.59. Versus prior year, GAAP and non-GAAP EPS calculations include a negative impact of approximately $0.05 due to much lower interest rates and approximately $0.06 due to higher tax rate.

Our Medical Technology segment demonstrated continued revenue growth, our Security Technology segment continued modest profit growth. We completed the acquisition of Copley Controls Corporation. And, after the close of the quarter, we received a $6.9 million contract from L-3 to ready the XLB for production.

Let’s move onto Slide 6. Our revenues continue to grow. The Copley acquisition will add incremental revenues and provide the basis for further accelerated growth in the future. At $0.59, non-GAAP earnings held steady from last quarter in spite of the $0.04 unfavorable impact of lower interest rates in the current quarter.

I’ll now ask John Millerick, our CFO to review our GAAP and non-GAAP performance this quarter.

John J. Millerick

I will now provide details on the company’s financial performance during Q3 and for the first three quarters of fiscal year 2008. I will begin with a discussion of our GAAP performance in the quarter.

On Slide 7, you will see that Q3 revenues grew 22% over the prior year, combination of strong growth in our Medical Technology product segment partially offset by a slight decline in the Security Technology product segment. Contributing to the increase in Medical Technology product revenues were $3.2 million of Copley revenues for the period from April 14 to April 30, 2008. Excluding Copley, our revenue growth for the quarter was 19%.

Revenues of a $102.8 million were the highest since Q2 2006 and they have been steadily increasing over the last five quarters. On a GAAP basis, operating margins were 7.5% and 7.3% of revenues in Q3 2008 and in Q3 fiscal year 2007 respectively. Negatively impacting operating margins was the impact of early period amortization of acquisition accounting adjustments related to the Copley’s Control acquisition. Excluding Copley, operating margins were 7.9%.

Diluted earnings per share were $0.50 for both quarters. However, it should be noted that lower interest income and higher tax rates had an adverse impact on the current quarter’s diluted earnings per share.

On the next slide, we show GAAP performance in the first nine months of the year. Net revenues have increased nearly 20% or $48.6 million in the first nine months of 2008 as compared to the first nine months of 2007. Security Technology products experienced the largest percentage growth with an increase of 21% versus the prior year while Medical Technology products grew 20%.

For the nine months ended 2008, operating margins were 7.4% of revenue as compared to 0% of revenue in the prior year-to-date period. In the first quarter of 2007, the company recorded an asset impairment charge of $9.7 million related to digital radiography of which $8.6 million was recorded in cost of sales and $1.1 million in operating expenses. Diluted earnings per share in the first nine months of 2008 was $1.52 as compared to $0.50 in the first nine months of 2007.

In the next three slides, we show our non-GAAP operating results. Our non-GAAP adjustments include stock-based compensation, asset impairment charges, executive transition and restructuring expenses, acquisition-related expenses and gains and losses on sale of assets and investments. I encourage you to review the non-GAAP reconciliation table and notes in the press release and in the appendix to this presentation for the detail of our adjustments.

On a non-GAAP basis, operating income increased 37% from $6.9 million in Q3 fiscal year ‘07 to $9.4 million in Q3 fiscal year ‘08. As a percent of revenues, operating income was 9.1% of net revenues in Q3 fiscal year 2008, as compared to 8.2% of net revenues in the prior year. Non-GAAP diluted earnings per share was $0.59 in Q3 fiscal year 2008 as compared to $0.54 in the prior year.

On the next slide you will see our first nine months of non-GAAP results. Operating income was 8.9% of revenues in the first nine months of 2008, as compared to 4.8% in the same period last year. Our diluted earnings per share is $1.71 in fiscal year 2008, an increase of 52% as compared to $1.12 in the first nine months of fiscal year 2007.

Turning to the balance sheet on Chart 12, cash flow from operations was $7.9 million in Q3 fiscal year 2008 as compared to $13.5 million in the prior year, a 42% decrease. Year-to-date, cash from operations was $32.3 million in fiscal year ‘08 versus $23.7 million last year.

Capital spending in the quarter was $3.3 million as compared to $1.9 million last year at this time. In spite of the positive cash flows, our cash and investment balances of $176 million were approximately $98 million lower than a year ago. This is primarily attributable to our $60 million share repurchase program, which was completed in the fourth quarter of fiscal 2007 and the acquisition of Copley Controls during Q3 of fiscal year 2008. Working capital has decreased $27 million since the end of fiscal 2007, primarily as a result of lower cash balances.

So to summarize, the company had a strong quarter in both sales and earnings and continues to maintain a strong balance sheet and liquidity position. With respect to the Company’s Form 10-Q for the quarter ended April 30, 2008, the company will file this report on Monday, June 9.

With that, let me turn the call back over to Jim to discuss quarterly business highlights.

James W. Green

Now looking to Slide 13, starting on the Medical Technology side, medical imaging grew almost $12 million or 25% from the same quarter prior year. However, in Q3 we started feeling the effect of the Deficit Reduction Act on the U.S. CT market.

Over the last year the end customer U.S. market experienced a slow down in demand of the higher technology 64-slice systems and to a lesser extent the 16-slice systems. This pressure on our OEM customers resulted in a softening of demand this quarter for some of our DAS systems.

However, this lower demand was offset by the introduction of a new family of 16-slice DMS Systems or an OEM. Early production inefficiencies of this new DMS System kept the profit line from contributing at typical rates. You should also note that two weeks of Copley revenue contributed to $3.2 million, though at a small loss due to acquisition related accounting adjustments. All said our medical imaging pre-tax earnings results were flat versus Q3 of the prior year.

For digital radiography, which is now primarily our Anrad selenium-based direct digital mammography business continues to see strong adoption more than doubling from the same quarter of the prior year and up 40% quarter-over-quarter. On a pre-tax basis, we remain on track to have the Anrad business breaking even on a run rate basis as we exit this year.

Our B-K Medical ultrasound business grew nearly 17% from the same quarter prior year, a third was organic growth and two-thirds were positive currency effects. On a pre-tax basis, B-K income was up 5% over the same quarter prior year.

Moving on to Security, security revenues were down slightly over $1 million from the same quarter last year. However on a pre-tax basis, security income was up $250,000. On the corporate and other line, you can see the dramatic effect of lower interest on our invested cash.

Let’s move to Slide 14. I want to take a minute and start with a word about the end customer CT and MR markets. We believe the end user U.S. CT market has now seen the worst of the Deficit Reduction Act impact. Calendar year 2007 stabilized at roughly 2005 levels, a reduction of nearly 20% from the 2006 all time high.

During 2007, CT procedures continued to grow at a high single-digit rate, so we expect to see end user demand moving back to modest single-digit growth rates later this calendar year. With a much shorter depth, the end user U.S. MR market stabilized in calendar year 2007 at roughly the calendar year 2006 level with 2008 starting to pickup now on an orders basis.

So looking at our medical imaging highlights, we began production of our new 320-slice CT data acquisition system for a major OEM and production of a new 16-slice DMS for an OEM. From our Copley group, we are starting production ramp of our next family, our new family of 1.5T and very-high-field 3T gradient amplifiers for a major OEM.

We are ramping production of a new family of precision 3T RF amplifiers for two major OEM customers. In digital radiography, production ramp for the mammography flat plate-panel detector systems is progressing and Toshiba has announced their new generation full field direct digital mammography system that incorporates our selenium detector.

Moving to Slide 15, starting with the COBRA Checkpoint systems, the final configuration system has been submitted to TSA’s test lab for qualification test runs, scheduled to begin later this month. On the checked baggage side, we received a $6.9 million contract to complete production field hardening for the XLB, which will be sold through L-3 and branded as the eXaminer XLB. Initial production shipments are planned for fall of 2009.

Our KING COBRA is planned to be branded the eXaminer SX and it’s now being submitted to TSA’s lab for certification test runs scheduled for later this month. The completion of certification allows us to start receiving orders.

Moving on to Slide 16, we are very excited to have Dr. Sophie Vandebroek, Chief Technology Officer for Xerox elected to our Board of Directors effective August 1. I want to personally thank John Tarello for the support and advice he has given me and for the many years of service he has given to the company. John has resigned effective July 31. As for Board actions, the Board will present a director majority voting plan for shareholder approval for consideration at the January shareholders meeting.

On to Slide 17, in summary, we are resolving the last of our loss businesses. We are on plan for successful integration of Copley, we are focusing on growth and profitability of our businesses and we are investing in the future.

We can now open up the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Larry Solow - CJS Securities.

Larry Solow - CJS Securities

Can you just maybe talk a little bit more about just the medical imaging market in general? I know the slowdown at the OEM level seems to be pretty considerable and is there potentially like a lag between when you would see a slowdown at that level before it slows down to the component level, so you may actually still see a couple of quarters of volatility there?

James W. Green

The way it works for us is as the units are shipping from the OEM, they pull from us almost on a real-time basis. So, as they’ve been slowing down, we believe that they’ve reached a new level; I would say a new market level. So, we are now seeing that lower level today. So, what we look at then is what’s going on at the market for the overall market both in the U.S. and outside.

And we are starting to see orders start to pickup on the MR side. We expect to see orders start to pickup again from this lower level on the CT side, so we would expect it to be operating at similar levels over the next probably two to three quarters. And then, as orders start to pick up, if you look at the order shipment time, CT is roughly, you would say five to six months MR maybe a little longer.

So, at this point, we think things have pretty well stabilized, of course, what was nice for us is by introducing a new system incremental into a new OEM that actually helped us offset some of that initial downturn in the quarter.

Larry Solow - CJS Securities

Do you expect any impact from the slowdown and timing-related shipment of tomotherapy, to impact you at all?

James W. Green

Well, again as tomotherapy, as their end customer demand continues to grow, we continue to grow with them, as that moves, we move directly with them. So you have access to what they would say.

Larry Solow - CJS Securities

And then just looking at the DR segment, I know it’s time related it is hard to quantify exactly, but first of all, Toshiba obviously is a third customer in the detection, do you have any time line for when they are going to be launching their product?

James W. Green

No, I can’t really comment on that. You would have to look at their information as to their launch plans and right timing and date. We are just excited that, we have now picked up another major OEM for this product line.

Larry Solow - CJS Securities

And then, when you talk about Anrad being breakeven at a run rate by next quarter, can I basically equate Anrad to the DR segment in total?

James W. Green

Almost in total, virtually all of that segment is Anrad as of this time.

Larry Solow - CJS Securities

So essentially the $1.3 loss this quarter in operating profit should essentially be close to zero next quarter.

James W. Green

We expect to get pretty close to it. What I’d said probably three quarters ago was that as we start the first quarter of next year, we would be at breakeven. We expect to get pretty close to it next quarter.

Larry Solow - CJS Securities

You had great growth and I know it’s obviously the land of small numbers but this $8 million number, would I expect that to grow off of that or could there still be some volatility on the revenue side of DR?

James W. Green

Well, as the DR systems become adopted and as our OEM customers start to, right now we are really just seeing this primarily outside the U.S. As they start to introduce in the U.S. and start to get to the market shares that we would expect them to get to, we see a lot of upside in that business.

Larry Solow - CJS Securities

On B-K Medical, it seems like you had like a 10% or 15% rise year-over-year on revenues, yet operating profit was at the same level, is there any one factor, outlying factor, for that reason?

James W. Green

Well, we are investing in that business. We’ve been hiring additional folks in the channel. We are positioning for growth. Some of that revenue growth that you see though was also currency-related. So in that respect, you wouldn’t necessarily see a drop down dollar-for-dollar on that.

Operator

Your next question comes from Steve Levenson - Stifel Nicolaus.

Steve Levenson - Stifel Nicolaus

On the XLB, are you surprised at the amount of time it’s going to take before you can start shipping these?

James W. Green

Actually, no. Right now, we are testing in the lab for making sure that the algorithms are right and that it’s going to be certified, but to launch a system in volume in the environment that these go into, there is a number of things that we had always planned would have to be done to make that system highly reliable as it ships.

There is also at the same time, a lot of these large systems like an XLB, they go into airports that have an integrated baggage system, so that it takes time for the airport to be ready for these systems to be incorporated. So the two come together, the time it takes for us to verify the hardening and verify the reliability in the field and the time for the airports to be ready to accept a system like this.

Steve Levenson - Stifel Nicolaus

Do you see them replacing systems out there one-for-one or they are going to reconfigure things that maybe they can replace three with two?

James W. Green

With the growth that we are seeing in airports and with the traffic and these larger and larger airplanes coming through, they have got to add capacity. So, if you look at the systems that are out there today and the amount of throughput, it’s not going to be a one-for-one.

We would expect to see the replacement markets start to kick in for the existing systems and we would expect to see some incremental newer big systems going in to cover these larger airports that have these larger airplanes showing up. We also see that in Europe, with planes flying to the U.S. and higher volume there, they are going have to deal with higher volume, higher throughput for checked bags too.

Steve Levenson - Stifel Nicolaus

And, is there anybody you see as a competitor? Does anybody have anything close to the speed or capability that you are aware of?

James W. Green

Not that we are aware of, but we are sure that the one major competitor we have in that area we assume that they are looking at trying to offer something in that same rate.

Steve Levenson - Stifel Nicolaus

But they are certainly behind you based on the time you would expect, or lack of news there.

James W. Green

Again, I can’t comment on it.

Steve Levenson - Stifel Nicolaus

On the 320-slice scanner, is that an item for special applications? Do you see that replacing 64s and maybe you could give us an idea of the size of the markets you are projecting?

James W. Green

We would expect that initially when a new technology like that comes out in CT, you would expect it to first go into unique areas where you need that coverage. So we would expect it to start-off in specialized areas, in areas in neural imaging, potentially cardiac imaging, because with that coverage, you can do real-time perfusion studies, you can do real-time stroke assessments.

So, it starts off as a fairly specialized niche application. In time, we would just have to see as far as the general adoption to that. Most people believe that the 64-slice covers most all of what radiology, high-end radiology needs today and that these larger cover systems will at least start in very high technology niche applications.

Steve Levenson - Stifel Nicolaus

You still have a fair amount of cash and of course, the stock price has recovered. Any plans for deploying that whether it’s in acquisitions or whatever else you might suggest?

James W. Green

Well, I think we’ve said, in the past that part of our strategy includes taking a hard look at good fit acquisitions and that’s certainly something that I am very interested in. With the acquisition of Copley, we feel very good about that and we are looking for more acquisitions like that. We are also looking at acquisitions in areas of new technologies that may not be immediately accretive to earnings, but that would position us for good sustained technology advantages in the future.

Operator

Your next question comes from Dalton Chandler - Needham.

Dalton Chandler - Needham

I wanted to ask a bit more about the medical imaging revenue and I think a lot of us have been trying to understand for a few quarters now how you are continuing to put out these great growth numbers when a lot of your customers have been experiencing slowdowns. But, it seems like you are saying most of it is attributable to new products. So, can you give us a sense of what percentage of revenue was from say products introduced in the last 12 months versus the existing products?

James W. Green

I don’t really have that at my fingertips, but I would tell you that in general we replenish most of our product line in the medical side about every three to four years. So, if you take that as a rough average and you divide it up, you could count that each year you could pretty well count on up to 25% of the revenue being on products that are quite new.

John J. Millerick

A little lower, but that’s.

Dalton Chandler - Needham

I am inferring from your previous comments that the older products may have actually had declining revenue in the quarter and you more than made up for that with new products. Is that a fair way to think?

James W. Green

I think that’s a fair statement that typically the older products will experience the price erosion, the newer products you will get better pricing on it. And, as we add new products to new customers, that also becomes incremental and can additionally offset if there is some price erosion or some volume that starts to fall-off somewhat in a particular segment.

Dalton Chandler - Needham

I notice on the balance sheet it looked like the days sales were up and the turns were down. Is there anything in particular driving that?

John J. Millerick

I think the DSO I think it goes back. I think we are, what, 45 last quarter and I think we are in the low-50s this quarter. I think a piece of it has to do with timing of cash receipts and also we’ve now taken Copley into the balance sheet. So, we are experiencing some of that impact.

In terms of turns, I think the inventory turns on a gross basis have pretty much what they were in Q2, is about four. And, it’s been a little on a net basis, it has dropped about 0.3 from 5.1 to 4.8. It’s essentially the turns are about the same even with the bringing Copley into the balance sheet.

Dalton Chandler - Needham

You mentioned Toshiba you added as a customer for digital mammography. But, I assume they are not approved in the U.S. yet. Is that correct?

James W. Green

I think that would be true. But, you have to look to Toshiba to see at what point they have their regulatory clearances.

Dalton Chandler - Needham

You had mentioned later this month you are going to start the testing for the final qualification on the COBRA. How long do you expect that to take and what does that mean for the potential approval date?

James W. Green

It turns out we actually have both the COBRA and the KING COBRA now called the eXaminer, in effect both systems are now at the test lab and going through their various certification and qualification testing. We expect those since we believe we are on the final configuration of the hardware and software, we don’t see a reason for it to take very long.

It really is up to the TSA if they start to delay for some reason if they adjust their priorities or whatever. But, we would expect to get to both of these very, very quickly. And, I hate to go on a limb, but certainly in an order of weeks we would expect to have these certifications complete.

Operator

Your next question comes from Michael Caster - SIO Capital.

Michael Caster - SIO Capital

As I look at the future, I was just hoping to get a little color on how tax rate looks. If you can help me out over the next couple of years?

John J. Millerick

I think if we look at this year, I think we are looking at it to be about 32% to 32.5% for this year. And, on a go-forward basis, I would expect that it would probably be in the same range as we go-forward.

Michael Caster - SIO Capital

What of some of the benefits that you use to bring down the corporate tax rate?

James W. Green

We get an R&D credit manufacturing, R&D credit, those take, sometimes it’s hard to predict when you’re going to get them because they take an act of Congress and typically every two years they approve it, sometimes it takes them a little while to do it and it ends up becoming retroactive. So, it causes some noise in the tax rate there.

John Millerick

And, there are some various puts and takes. We start-off the statutory rate of around 35% and it drops down. But, the primary swing factor for us has been the R&D tax credit.

Michael Caster - SIO Capital

The 32% includes the R&D tax credits?

John J. Millerick

Yes. It does.

James W. Green

I would also mention that highlight that we are being taxed now much more on income from operations which is at a higher rate than often in the past there was a lot of income from interest which is typically taxed at a lower rate.

John J. Millerick

Yes. When we look at the current rate versus the rate that we had in the prior year, a lot of the rate has to do with the amount of income we generate. The more income we generate from operations, the higher the rate versus the income where it’s more derived from interest income. The tax rates are substantially different.

Operator

Your next question comes from Ed Fowler - The Small Cap Report.

Ed Fowler - The Small Cap Report

With regard to the COBRA, have you started shipping a couple COBRAs or making them and shipping them for the first 12 units?

James W. Green

Those first 12 units are production units. So, they require that we complete the qualification testing for those units. So, we can’t ship or revenue those until we complete the qualification.

Ed Fowler - The Small Cap Report

I see. You need full certification then?

James W. Green

We need qualification on the COBRAs and then for the checked baggage unit, the eXaminer, what we are now calling eXaminer SX, or what we used to call KING COBRAs that requires the full certification for EDS. Both of those are now in starting testing this month at the TSA.

Ed Fowler - The Small Cap Report

So, you are waiting momentarily for the full certification for one of them anyway?

James W. Green

We are waiting with bated breath, yes.

Ed Fowler - The Small Cap Report

What you’re thinking is the XLB will be the replacement machine not just for new airports, but for replacement of the eXaminers that are out there now?

James W. Green

If you look at the offering now that we have now with L-3, we now have the ability to offer the full range of product portfolios. You have the top-end with the 1,100 bags an hour for XLB. We still expect there to a continued demand for this, more mid-tier existing systems that we sell, the eXaminer 6000s.

And, then, the lower tier for smaller airports with the KING COBRA or eXaminer SX. So, there is going to be demand for all of them. The existing systems that are out there are going to go through; there will be a replacement cycle that we expect to see starting to kick in the next couple years. Some of those will be very difficult to upgrade to a new unit. So, they will want to just replace it in kind. Some of those will want to upgrade to a newer faster unit.

It’s going to depend on the needs of the airport, how fast they are growing, what the traffic looks like. But we feel like we are in pretty good position now, now that we have a full portfolio to cover all of the applications for checked bags.

Ed Fowler - The Small Cap Report

Do you see with the eXaminers that are out there now any failures on any of them of normally they run on what a five to seven year cycle?

James W. Green

Typically you can expect a CT type of system like this to have a life at somewhere around five, six, seven years. And if you look at when they originally started shipping in volume back in around 2003, we are not too far off from that cycle starting to kick-in.

But as far as failures in the field, we track that all the time. If a system starts to become unreliable, there does become a point where it needs, where you really don’t want to continue to maintain it and upgrade it, you want to replace it. But that’s just the ongoing nature of that business.

John J. Millerick

We haven’t really hit that depth.

James W. Green

But we haven’t seen large-scale problems there, but again there is a lot of data that tells us about where we expect to start needing to replace those.

Ed Fowler - The Small Cap Report

Jim, I wonder if you could comment on the size of this selenium plate market. Do you expect to be making 500 to 1,000 of these plates?

James W. Green

That’s a tough question. What I tell people is look at the typical market share of our group of OEM customers and then look at the total market for direct digital mammography. I don’t have the numbers in front of me, but I believe if you look at last year there were somewhere in the neighborhood of 2,500 units shipped in the world total. So if you look at what percentage that group might get of that and how fast that market is growing that might give you some feel for what the top expectations might be.

Ed Fowler - The Small Cap Report

Regards to Copley, what margins you expect their revenue to stay on track, but what margins are they running?

John J. Millerick

If we put a pro forma around 30%-ish I think in the current standalone mode.

Ed Fowler - The Small Cap Report

And there is other opportunities with Copley in the motion control area, right?

James W. Green

There is. Yes, the motion business, its profitable business, it’s a growing business, it’s new for us, it’s incremental, it fits the needs of technology orientation, growth and profitability.

Operator

Your next question comes from Josephine Millward - Stanford Group.

Josephine Millward - Stanford Group

Jim, did digital radiography include shipment to both Siemens and Philips or just your initial shipment to Siemens? Your sales in digital radiography, did that include sales to both Siemens and Philips or just one OEM?

James W. Green

Well, right now it’s primarily the combination of the two, but though it’s really primarily Siemens at this point.

Dr. Edmund F. Becker, Jr.

It includes a number of other customers as well. Remember we had a baseline set of customers prior to this growth in the mammo, so that there are other customers behind this.

James W. Green

Yes, we expect the growth to be primarily Siemens and then Philips and Toshiba.

Josephine Millward - Stanford Group

When do you expect Philips and Toshiba to kick in, in the next couple of quarters?

James W. Green

I really probably shouldn’t comment on that because that might be giving away some information that they would want to keep to themselves as far as their launch dates and times and expectations, so.

Josephine Millward - Stanford Group

Now, you had problems with manufacturing yield in the selenium plates if I remember correctly. Has that been resolved?

James W. Green

Well, it’s never resolved to our satisfaction. There is always room for improvement, but it is definitely improving and it’s improving dramatically. We feel good with the improvements that we’ve seen. We are continuing to invest in not only more efficiencies and better yields, but also investing in additional capacity because we expect good growth in that area.

Josephine Millward - Stanford Group

Going forward it seems like you expect the overall MR market to grow faster than CT, is that right especially with your acquisition of Copley, you are really looking at MR as a growth driver?

James W. Green

Yes, absolutely, MR had a much shorter impact from DRAs. It didn’t have as deep of an impact and it didn’t seem to have lasted as quite as long. And if you look at what’s going on in the market and listen to the customers and see that the data, it seems to be starting to recover sooner, and for us with the acquisition of Copley it places MR firmly in our sights as a nice strong growth market for us.

Josephine Millward - Stanford Group

And what was the $3.2 million from Copley this quarter, was that better than you expected, because I have $6 million?

James W. Green

Well, we only had Copley in for a couple of weeks. This quarter and next quarter you really have to watch out for the noise of the acquisition-related accounting stuff that goes on. It didn’t contribute and in fact it was slightly negative at the bottom-line because of accounting requirements in the quarter. Next quarter is also going to be a lot of noise in next quarter too and we don’t expect profit in next quarter from that, but we do expect of course to see that nice revenue starting to pop in.

Josephine Millward - Stanford Group

Do you expect this amortizations on the acquisition to, so you expect this to continue next quarter and would it be finished after that?

James W. Green

Yes, we would expect to see next quarter is not going to contribute because of all the again the acquisition-related accounting. But as we get into the first quarter of next fiscal year, that’s where we start to see the nice improvements on the profit line with it.

Josephine Millward - Stanford Group

And on the security side, just to confirm your backlogs for EXACT, you have about 30 units in your backlog, is that right?

James Green

Yes, 35 units in the backlog.

Josephine Millward - Stanford Group

It is my understanding that Congress has finally approved a TSA spending plan for the year after a very long time. Do you think we might see a spending flush later on this year?

James W. Green

I hate to predict what the government is going to do, but certainly we are optimistic that there could be some additional upside for us there.

Operator

Your next question comes from Glenn Schneider - SG Capital Management.

Glenn Schneider - SG Capital Management

Can you just talk a little bit about the KING COBRA? Can you talk assuming you get certification about the overall market opportunity for KING COBRA, if you anticipate there being some pent-up demand for the product?

And then finally do you think you’ll be able to secure a minimum order type of level from L-3 as you have with EXACT to keep production costs down and probably from a pricing perspective to them? Can you talk a little about how that might shake out?

James W. Green

Well, just starting with the first part of your question, what’s great about this eXaminer SX system, the KING COBRA, is that it is designed for smaller airports and it’s also designed to be able to pop into areas where you don’t have an integrated baggage handling system. So demand in those areas can develop very quickly with, because you don’t have to go through a lot of construction at the airports.

There is a ton of small airports in the U.S. that need to have EDS or something like EDS, where they don’t have anything now except for the trace detection, which is manually and manual-intensive and so on. So, we do think we are going to see some nice demand developing there.

And also outside the U.S., there are airports that again don’t have large inline systems. So, this system is perfect for them. We are working with L-3 to help get the word out to market this product to develop the demand.

And then as far as your question on minimum quantities, L-3 and Analogic they have a great working relationship. They understand the necessity for having a continuous flow in the production line and not having fits and starts and stops. So, I expect that they’ll work with us as they have in the past to help develop a smooth demand flow there.

Operator

Your next question is a follow-up from Ed Fowler - The Small Cap Report.

Ed Fowler - The Small Cap Report

With regard to the pricing on the COBRA, can you tell us a little bit about the pricing that you are thinking in the COBRA, KING COBRA and XLB pricing levels?

James W. Green

I don’t think I can. I think that starts to get to be what would probably be considered confidential information for L-3. I can just tell you that it’s a good business with good margins just like the rest of our security side.

Ed Fowler - The Small Cap Report

Would 350 to 400 be a good number for the KING COBRA?

James W. Green

Yes, honestly, I probably can’t really comment on that.

Ed Fowler - The Small Cap Report

Anyway, the PowerLink agreement, I love this PowerLink product with the XLB, could you comment as to where you see this going or a more specific question, have you signed any PowerLink agreements in the medical field to develop new systems?

James W. Green

We have a signed purchase order with one of our OEMs for working with them now on a design to incorporate into their CTs. We are working with a couple of other OEMs that we expect we have high hopes that we are going to see a pretty stronger adoption with this.

And we are expecting that in time, this technology is going to spread across all these, all of CT and other applications that require transmission of high power where you want some kind of an air gap where maybe it is to a rotating piece of gear or to just any place, anything that you really need to separate electronically. So, but for us it’s is a concentration in CT and I think so the answer to your question is yes, we already have one OEM working with us and we expect to get more.

Operator

Your next question is a follow-up from Larry Solow - CJS Securities.

Larry Solow - CJS Securities

The Copley, if I’ve not mistaken I thought the margins were running, the operating margin was about 10%, you said 30%?

James W. Green

We said gross margin.

Larry Solow - CJS Securities

With Copley, in the amortization expense, isn’t that smoothed out over a 15-year period so that’s only a lot more upfront, is that how it works?

James W. Green

Well, there is a typical fairly large chunk upfront and then it smoothes out over like you say probably the next 15 fifteen years after that.

Larry Solow - CJS Securities

Is there anyway to better quantifying, so you are just saying from of the sound of majority of it was upfront so that and one-time in nature?

James W. Green

What we are expecting is majority of it will flush out in this next quarter, in Q4 of our fiscal year and then you’ll see a smooth run rate from there on.

Larry Solow - CJS Securities

On the severance, the transition expenses, I can fully appreciate in the long run it should save you money and maybe it is just based on transition. But do you have any idea when should it be winding down, because you retooled your management team and you think it could start winding down and it’s been happening now for like each three quarters, so in theory it is not one-time?

James W. Green

It’s a good question, but I certainly would not expect us to see executive transitions extending out through long periods of time.

Operator

Your last question comes from [Andy Carroll - Capital Management].

[Andy Carroll - Capital Management]

Surrounding the Copley, before you acquired the business on margin perspective, is the Copley business higher margin or low margin of the company average?

James W. Green

I think if you look at it on a standalone basis, it was slightly lower gross margin, higher operating margin and then as we integrate it we expect improvements and we also expect that since it adds to our product portfolio, we see some nice upside synergies too on the top-line with being able to offer those products through more than just the customers that they were limited to in the past.

[Andy Carroll - Capital Management]

So, over time it should be a higher gross margin and operating margin?

James W. Green

Yes.

Operator

There are no further questions at this time.

James W. Green

Thank you for joining us today. We invite you to join us for our fourth quarter and year end investor call in September. Thank you.

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Source: Analogic Corporation F3Q08 (Qtr End 04/30/2008) Earnings Call Transcript
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