Good day, ladies and gentlemen, and welcome to the third quarter 2014 OSI Systems earnings conference call. My name is Gwen, and I'll be your operator for today. (Operator Instructions) I would now like to turn the call over to your host for today, Mr. Alan Edrick, Chief Financial Officer. Please proceed.

Good morning, and thank you for joining us. I am Alan Edrick, Executive Vice President and CFO of OSI Systems. And I'm here today with Deepak Chopra, our President and CEO. Welcome to the OSI Systems third quarter fiscal 2014 conference call. We'd 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 is expected to remain on our website, located at www.osi-systems.com for approximately two weeks. Earlier today, we issued a press release announcing our third quarter fiscal '14 financial results. Before we discuss 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 during this call that may be deemed to be forward-looking statements under the act. Forward-looking statements relate to the company's current expectations, beliefs, projections and similar expressions and are not guarantees of future performance or outcomes. Forward-looking statements involve uncertainties, risks, assumptions and contingencies, many of which are outside the company's control that may cause actual results or outcomes to differ materially from those described in or implied by any forward-looking statement. Such statements include without limitation, information provided regarding as expected revenues and earnings in fiscal '14 and statements regarding the expected overall financial and operational performance to the company and its operating divisions. Numerous factors could cause actual results to differ materially from these forward-looking statements. For example, the company could be exposed to a variety of negative consequences, as a result of matters that the subject of some or all of the company's ongoing investigations and compliance reviews and ongoing reviews by government agencies,…

Thank you, Alan. And again, good morning, and welcome to the OSI Systems earnings conference call for the third quarter of fiscal 2014. Through three quarters, OSI achieved year-to-date revenue growth of 13% and adjusted EBITDA growth of 37%. Given the strong near-term sales pipeline and several sales in the Rapiscan growth, contemplated for the third quarter slipped to the fourth, we are reiterating our full year revenue guidance, as our fourth quarter is shaping up very nicely. In Q3, our revenues were $204 million, 3% higher than prior year and we delivered an operating margin of 10%, excluding the impact of restructuring and other charges. In a macroeconomic environment that at times has been challenging, we continue to grow by innovating solutions for our core markets, launching new products and driving various improvement initiatives in our organization. Reviewing the highlights for the quarter for each division, starting with our Security division, Rapiscan, Q3 sales were about 5% lower than the prior year, primarily due to approximately $10 million of international cargo shipments that were delayed by certain processes, such as obtaining the appropriate export and import licenses and letters of credit. Other few highlights in the quarter. We successfully participated at the Sochi Olympic Winter Games, deploying our security equipment to perform inspections for not only the Olympic venues, but also for the supporting infrastructure such as Sochi Airport, numerous railway stations and main roads, leading to the city of Sochi. The execution was very successful just like our execution at the Summer London Olympics. In March, we received a very important booking, to provide RTT Hold Baggage Screening Systems and related support services for Norway's Oslo Airport, a major European airport, marking another significant airport win, and our first in Western Europe, consisting of multiple units of our…

Thank you, Deepak. We continue to focus on driving our growth initiatives, which in recent periods have resulted in meaningful revenue growth. I'll speak to our fiscal '14 guidance shortly, but first let me review in more detail the financial results for the third quarter of this fiscal year. Our net revenues in the third quarter of fiscal '14 increased 3% over Q3 last year. Leading the way was our Opto division, as strong topline momentum continued with 21% year-over-year sales growth. Approximately one-third of this increase was derived from organic growth and the remainder came by way of acquisitions. As Deepak described, sales in our Security division decreased 5% over the same quarter last year, while our Healthcare division saw modest sales growth of 2%. Our third quarter gross margin of 34.6% is below last year's Q3 margin of 36.2%, which was driven by the fact that the sales growth in the quarter was driven largely by the Opto division, our lowest margin division, which places pressure on the consolidated gross margin. In addition, increased depreciation from our turnkey operations impacted the margin. On a sequential basis, however, we saw gross margin expansion. As I have mentioned on previous calls, the margin will fluctuate from period-to-period based on the revenue mix. Moving to OpEx. We continue to work to manage our cost carefully. SG&A as a percentage of sales was up slightly over the prior year due to support the growth of the company and included additional legal and professional fees. Our goals to hold the SG&A growth rate below the rate of sales growth, though individual quarters may vary from this. We remain committed in all of our divisions, increasing efficiencies and managing our cost structure. We continue to invest significant resources in R&D to enhance our Security…

(Operator Instructions) Our first question comes from the line of Brian Ruttenbur with CRT Capital.

Couple of questions. First of all, the cash flows were very strong so far this year. Is that primarily due to Mexico ramping up or is there something else going on?

Brian, this is Alan. Yes, we've been very pleased with our cash flow this year. Our operating cash flow this year is $124 million. Our free cash flow is about $75 million to $76 million. The primary reasons for that -- you're right, Mexico has played a big part of that. As you may recall, they were little delinquent in paying us at the end June 30, at the end of our last fiscal year. They've caught up and are paying us currently in each month. So that has been a big driver. The rest of our business has done a nice job as well in terms of collections and reducing DSO overall. The enhanced profitability helps. Countering that a little bit is our increase in inventory as we're getting ready for what we believe might be a very strong Q4. But yes, we're very pleased with our cash flow for the year.

So assuming that Mexico was, I believe you stated at the end of the last fiscal year was around 70% year, we're now 90%-plus ramped, the cash flow should be increasing for '15 versus '14 as a step-up just off of that.

Well, intuitively that may sound right. You may recall that at the end of last year, they were about $30 million behind in payments to us, which was reflected in our unbilled receivables. That amount has since been collected, so that was kind of $30 million, above if you will to fiscal '14. So it will change from time-to-time, but you're right a lot of the CapEx that we did in ramping up for Mexico in fiscal '14 is largely behind us.

Next question I have is about a statement Deepak made about best cargo pipeline ever. What percentage of that or number of opportunities are turnkey out of that cargo pipeline? Is it a handful, is it less than a handful or is that cargo pipeline excluding turnkey?

Brian, this is Deepak here. Good question, because we have said in the past that it's a mixture of cargo sales and also services. Services can go down at the end to be a sale. What we meant was, this just specifically is, it's the cargo sales pipeline. We have a very robust pipeline on multi-million sale internationally, not to discounted, that we are not trying to also work on a very aggressive pipeline in the services business. But to just specifically say, that our cargo pipeline at this point, which we are optimistically hoping for equipment that we can close the next 90 to 120 days has never been as strong as we see right now. Obviously, timing is important and internationally these things can move around. But we are very optimistic and it's a very healthy pipeline and they are large, large multi-million dollar orders we are looking at.

And then one other question about FMS orders, potentially with Iraq. Can you give us anymore specifics on that? Are you negotiating directly with the Iraqi government, what's the status with all of this?

Brian, as you know in the past, we have been very cautious, anything that's in active, we don't like to talk much about it. All we can say it is we are very optimistic and we are well-positioned.

Our next question comes from the line of Tim Quillin with Stephens Incorporated.

How much visibility do you have on your fourth quarter guidance? I think even at the low end, it would be a record quarter both in terms of revenue and earnings and you mentioned that you had factored in some large cargo orders I guess that have not yet been received into that guidance. What portion of the guidance still is dependent on future orders?

Tim, good question. This is Alan. Every time we give guidance, it's based on a couple of different aspects of it. One, we have a relative degree of certainty for those shipments that are already in our backlog that we expect to ship in the current quarter or in a current period that we're referring to. The other aspect that is always involved in every single quarter is book and ship, those items that we're going to book the order in the same quarter and ship it. And that's just a regular routine part of our business, particularly in the Healthcare business as you well know. As we look at our Q4, it's a combination of both of those elements. We certainly have a healthy backlog going into the quarter that's very, very helpful. The licenses we're looking to obtain right now would certainly help. The cargo is really a big, big part of it. As Deepak mentioned, many of those are near-term opportunities for us. So I would say, we have a good visibility allowing us to provide the overall guidance we gave, which we provide for a very, very strong Q4 as you pointed out.

And it sounds like there's a fairly broad range of possibilities. Is the low end of the guidance more probable than the high end and what would swing it to the high end, if anything?

Tim, this is Deepak here. With a very strong potential pipeline that we think had been 90 days to 120 days in cargo. And as you know, cargo has little bit more time to make import export licenses, LCs and stuff. So depending between the low-end of the guidance and the high-end of the guidance it all depends on the timing on some of these orders that we will get, that we are anticipating of getting.

And situations where you're awaiting export licenses, is that selling into a country that you haven't sold before or is there some complicating factor in getting the licenses?

Tim, any time you have a high energy cargo product, you need to get an export license. And in some places, some of the customers also require an import license. Nothing to do with a new country sale or any complications, it's just time, because it just takes time to get. It's a standard policy for the high energy cargo that you need these licenses. And secondly, we are very conservative when we do business on these large cargo deals or an LC or some kind of a comfort feeling of getting cash upfront is very important.

Alan, do you have a more precise backlog number other than just $0.8 billion?

Tim, it really was $0.8 billion, I think it was within $5 million of being at that $800 million level.

And do you have a bookings number, maybe an overall bookings number and a bookings number for the Security business?

Our book-to-bill ratio, Tim, in our Security business excluding turnkey as we've done in the past was 1.1. So it was a pretty good book-to-bill overall. For OSI, it would have been just south of 1 overall.

And then in terms of the Mexico ramp up, how much growth should we expect in FY '15 versus FY '14 just because of that ramp up? Would you expect significantly more revenue under that contract in FY '15 versus FY '14 because of the ramp?

So Tim, we intend to provide our fiscal 2015 guidance on our next call in August. So I don't want to prematurely say anything. The revenues that we have been reporting on to the Mexico contract have been significant all year long. So while there will be a certain amount of potential increase in revenues in the fiscal 2015, I think we're better off deferring that until we give our fiscal 2015 guidance.

And then just two quick questions and I'll pass it over. But question one, is do you expect to be cash flow positive in the fourth quarter? And then what would you expect the tax rate to be for the fourth quarter?

So while cash flow has been extremely strong in the first nine months, as you can imagine with the strong Q4 that we're anticipating, that you're astutely point out at the revenue level. That will be a user of working capital in the Q4. So we're not anticipating any significant free cash flow in Q4, it might even be a little bit negative in Q4, which following that with the collections from strong Q4 shipments, what could lead to very strong free cash flow in Q1. From tax rate perspective, our effective tax rate on a year-to-date basis, I believe it's a 27.7%, so that would be a pretty good indicator for Q4.

Our next question comes from the line of Josephine Millward with Benchmark.

Can you tell us what Security bookings were or give us a number for Security funded backlog?

Josephine, it's Alan, I'll take that question. Our book-to-bill ratio for Security excluding turnkey was 1.1. We don't breakdown our revenues precisely between turnkey and non-turnkey, as a matter of course, but a 1.1 book-to-bill ratio. And our backlog in non-turnkey for Security actually went up a little bit from Q2.

Can you breakout turnkey for us, so I can back into Security bookings? Are we talking $30 million, $35 million during the quarter?

Significantly higher than that, Josephine. We don't breakout our turnkey revenues, but I think you have a pretty good idea of the range of what our turnkey revenues are, but we don't break that out separately. But our Security bookings will be significantly higher than the number you just mentioned.

No, no, the $30 million, $35 million, was that your turnkey contribution during the quarter, so I'm trying to break that out because it's very hard to back into funded backlog, if I don't have a precise number for your turnkey -- what was recognized, the portion of turnkey in your reported revenue, and I'm just trying to get there.

I'm sorry, I misunderstood your question. I thought you said bookings. Yes, that is in the approximate range, yes.

So it sounds like, Security bookings was fairly good. Can you talk about what drove the growth in what product area, geographic area, where you're seeing strength? And lastly, talk about Albania, if you expect Albania to contribute in Q4 or its more fiscal year '15?

Josephine, this is Deepak here. Regarding the strength in the security bookings, I'd like to answer that more broadly including the Q4, because we're already one month into it. It's primarily driven international. And there is no one region, though I would say that Middle East is a very strong area for us. Regarding the products, obviously, the big gorilla, 100-pound gorilla is cargo in the equipment bookings, but RTT was very good. We announced the multiple unit order in Oslo. We made some other bookings. We continue to look at other new prospects into it. So the two areas non-services related is cargo primarily and RTT and it's all driven international. Regarding Albania, we are making progress and we are on track, but I don't think so there would be any contribution in revenue in Q4, but we are moving on target, we're working diligently with it and looking forward to 2015.

Deepak, just to follow-up on that, do you still expect to receive TSA certification some time this calendar year for RTT?

I know we've been talking about it. I am sure that you are very astute. You've talked to other people. It's a blind test, people go through multiple times. We are in test actively, and I know I've said it before, end of the calendar fiscal year, we are optimistic. Every time that you get into data with them, it's helpful and people take multiple rounds. And we are quite optimistic that our technology fundamentally is going to get certified. I mean we got certified in Europe. So it's a matter of time.

Our next question comes from the line of Yair Reiner with Oppenheimer.

Just one more question on the guidance. If I take the middle-end of your revenue range, it looks like getting to the middle or even the bottom-end of your EPS range requires you to have operating margin of about 13%, which is quite elevated on a historical basis. Is that math right? And if so, what's driving that in your pipeline, in terms of product mix that would give you confidence around those kind of margins?

I think your math is probably in the ballpark. What would drive operating margin improvement would certainly relate to just economy as a scale. When you take a look at the implied revenues versus prior periods, it is a big indicator of what can happen in the margins. As you also know, our biggest quarter in our Healthcare business tends to be Q4, which is highly leveragable and scalable on the revenue basis to lead to operating margin improvement. So that is fundamentally what's driving it. Economies of scale associated with higher revenues across all three of our businesses.

Which I guess leads me to a question about healthcare. You've been speaking I think maybe a little bit less about the anesthesia delivery product. Can you maybe talk about the reception you're seeing, maybe what have been some of the impediments to gaining share? And then maybe update us on what you think is a reasonable target for you in terms of market share going forward over the next call it year or two?

It's a new launch. We have talked about it, you're right. Last quarter Alan did mention, we have started ramping up production. And there are no stoppages kind of thing, but you're entering a market, which is dominated by two large players. And we are very optimistic about it. Every place we have shown it, it's been very well received. We have started shipping product. And our target obviously is optimistic. We think that fully rolled-in in 2015, 2016, 2017. There is no reason with the product line we have and our focus and our penetration that we should not be looking at about 15%, 20% of the market. So we are very positive about it. It's a little slow start than we would have liked to see. But it's a product that everybody is very cautious about it, people look at it and we are going in against some big guys Dräger and Data [indiscernible], but we are very confident to capture, what I call, a significant growth in the coming years.

And then, one more question for you Alan. On the CapEx, it seemed to have been down significantly quarter-over-quarter. Can you update us on why that was? And then what your target is for the full year?

Q1 and Q2 included quite a bit of CapEx still associated with Mexico, the continued ramp up there as well as Albania. With those two things coming down in terms of size and scope, the overall CapEx levels have evened out a little bit more. So we continue to believe that our CapEx will be somewhere in the neighborhood of the $60 million for the full fiscal year plus or minus. I also wanted to mention in context to your last question, Yair, about questioning, about the 13% operating margins. Just as a reference point, our Q4 of last year was 12.8% on a non-GAAP basis. So it gives a pretty good reference point.

There are no more questions at this time.

Thank you very much, ladies and gentlemen. I want to thank everybody. And look forward to a strong finish for Q4. And hope to talk to you soon. We are very excited about what progress we are making in the product line, especially in RTT and cargo and services and on Healthcare new product introductions. Thank you.

Ladies and gentlemen, thank you for your participation in today's call. This concludes the presentation. You may now disconnect. Have a wonderful day.