Good day, ladies and gentlemen, and welcome to the OSI Systems Second Quarter 2017 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today’s conference, Alan Edrick, Chief Financial Officer. Sir, you may begin.

Good afternoon 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 second quarter fiscal 2017 conference call. We would like to extend a warm welcome to anyone who is a first-time participant on our conference calls. Please note that this presentation is being webcast, and it is expected to remain on our website located at www.osi-systems.com for at least two weeks. Earlier today, we issued a press release announcing our second quarter fiscal year 2017 financial results. Before we discuss our results, I'd like to remind everyone that today’s discussion contains forward-looking statements. I will now read the company’s cautionary notice regarding forward-looking statements. 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. 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 expected revenues and earnings and growth, and statements regarding the expected overall financial and operational performance of the company and its operating divisions. The company wishes to caution participants on this call that numerous factors could cause actual results to differ materially from these forward-looking statements. These factors include the risk factors set forth in the company’s last annual report on Form 10-K for…

Thank you, Alan, and again, good afternoon and welcome to the OSI Systems' earnings conference call for the second quarter of fiscal 2017. We had a good quarter achieving $243 million in revenue, driven primarily by the Security and the Optoelectronics Division. Reviewing Q2 performance for each division, beginning the Security. During the quarter, revenues in Security were $140 million, 49% higher from the prior year. This was the first full quarter of impact from the AS&E acquisition and as Alan mentioned, it contributed in a meaningful way. Excluding AS&E, the Security Division grew by about 18%, driven by strength in multiple product areas including RTT, our HBS system. Security bookings in Q2 were $110 million for non-key turnkey book-to-bill ratio of approximately 1.0 and for the first half year bookings were $225 million. In the aviation checked baggage market, we continue to gain traction with our Rapiscan RTT Whole baggage Screening System. As the regulatory requirements compel the European Union airports to upgrade the checked baggage infrastructure, we have been able to capitalize on opportunities in the marketplace with our innovative technology. We announced an order valued at approximately $7 million from a European airport customer to provide our RTT110 Whole Baggage Screening System. This order was in addition to other smaller awards during the quarter. Going forward, we continue to be -- to foresee increasing activity for our checked baggage HBS Systems, especially in the European Union as their regulatory deadline approaches towards the 2020. In the United States, we are now in the testing phase for TSS Notification for our RTT110 product and are targeting completing the testing phase in this calendar year. At U.S. airports, we are also working with the TSA and the airports on their innovation lane program and making progress with our integrated…

Thank you, Deepak. So, let's review the financial results for the second fiscal quarter in some greater detail. As mentioned previously, revenues in Q2 increased by 23% on a year-over-year basis. Revenues in the Security Division increased by 49%, primarily as a result of the inclusion of $29 million of revenues from the AS&E acquisition, a significant increase in sales of our RTT Checked Baggage Systems international customers, and an increase in turnkey screening services revenue as a result of the program in Albania, which ramped up in fiscal 2016. Were pleased that the Opto Division returned to external revenue growth, posting an 8% year-over-year increase. Intercompany Opto sales were down due to right-sizing of inventory in the other two divisions along with lower sales in Health Care which as Deepak mentioned continue to be challenged by the marketplace and some product issues. The Q2 gross margin was 34.1%, down from 34.5% in prior year, due primarily to decreased sales in our Health Care Division, which generates the highest gross margin of our three divisions as well as the impact of increased international sales of RTT, which currently generate lower gross margins than those of our business generally. As mentioned on previous calls, the gross margin will fluctuate from period-to-period based on product mix amongst other factors. Moving to operating expenses. In Q2 of fiscal 2017, selling, general, and administrative expenses as a percentage of sales decreased to 21.2% compared to 21.9% in Q2 of fiscal 2016. In absolute dollars, SG&A spending was $51.5 million, which was up by $8.3 million over the prior year. The increase was primarily driven by the impact of acquisitions as well as increased cost to support the strong growth in our Security Division. Partially offsetting this growth was a decrease in SG&A in our…

Thank you. [Operator Instructions] And our first question comes from Brian Ruttenbur from Drexel Hamilton. Your line is open.

Yes. Thank you very much. Very good quarter. Couple of questions. In terms of the strong quarter, you were talking about why you didn't raise and that's because of your cautiousness; let me say on Health Care going forward, can you elaborate a little bit on that? And do you anticipate remaining profitable in the Health Care Division moving forward?

Yes. Brian this is Alan. As Deepak described, we do believe that the second half of our Health Care will be stronger than our first half and given that we just end Q2 in a profitable position for Health Care, we do remain -- we do believe that we will be profitable in each of Q3 and Q4 and we're looking to grow the business. After experiencing the challenges in Health Care business, really over the past five quarters, although we think we're on the right track, we thought it most prudent at this time to give ourselves another quarter to see what goes long before changing the guidance.

Okay. And then what was depreciation and amortization and your adjusted EBITDA in the quarter?

Sure. One second.

I'm sure that will come out in a day or two, just

Yes. So, Brian the adjusted EBITDA was $33.4 million and depreciation and amortization was approximately $14 .5 million.

Okay. And then -- just couple other housekeeping AS&E, it is largely integrated, we're a couple more quarters away, what's the status and can you talk about where the factory stands and how production is in our these new orders that you got from DHS going through the Massachusetts facility or when you’re other facilities.

This is Deepak here, Brian. Answer to all your questions yes, yes, and yes. It is integrate as Alan mentioned with two-thirds of the synergies that we had planned for it. Our annualized basis, we've already achieved. The teams are working very well together. Answer to your second question, the factory in Billerica is doing well and the CBP orders that we had announced all that AS&E products will continue to be filled in the and Billerica facility.

And Brian this is Alan, I just to want to update those numbers I gave you a second ago. I was reading off of wrong page. The EBITDA is about -- adjusted EBITDA is $40.6 million and depreciation and amortization is $16.8 million.

Okay. Thank you very much for that. And then last question was on backlogs. Europe 11% year-over-year, is that correct and how much are you up sequentially and is that largely because of Security or something else?

So, Brian on a sequential basis, we're down a little bit as the normal turnkey backlog amortizes down, but on a year-over-year basis, you're correct.

Okay. So you're up 11% to over $600 million, is that correct?

That's correct. We're $691 million at the end of a September -- at the end of a December.

Perfect. Thank you very much.

And our next question comes from Larry Solow from CJS Securities. Your line is open.

Great. Thanks. Good afternoon. Just a few follow-ups to Brian's questions. On AS&E, it sounds like you're a little bit ahead of schedule at least on some of the integration. Is it fair to say that you might achieve this $80 million in synergies, which I think was close to a two-year target sooner than originally expected and could you maybe exceed that number?

Well, thing is when you look at and you've not stepped into the company, you were looking outside, and you get some time that you wanted integrated the two company, the two cultures. As Alan has mentioned, yes we are ahead. Regarding the absolute number, it's too early for us to look at it because keep in mind, synergies is one thing, but we also want to combine the two companies and make one plus one better than two in a cultural way and the product way and the R&D way. So, right now there's no plan in that we have something on a bigger target.

Okay, fair enough. Just a few more -- just on the legacy side, obviously the RTT110 is driving a significant portion of your growth, can you just remind us in Europe, I know, I think the regulatory change is supposed to be done by 2020 or 2021, I think, maybe in some select countries. We're still pretty early in the amount of airports that have actually adopted it, right. So, I mean, I think less than 25% penetrated right. So, the opportunity going forward is still significant and you assuming you retain this proportion of wins should be a lot higher, is that fair to say?

Well, the answer to your first question is yes, the 2020 is the deadline. Yes, some airports, something countries have asked for an exception 2021 or 2022. Most of the requirements are known to us and our competitors. We're all looking at it and it's not too early, because keep in mind, a typical large airport, the cycle is may be as much as six, nine months or a year by the time we've complete all the construction and everything else. So, they are all active and out we feel good about it, our product has been well received, we're ramping up production, our costs are coming in line, and we continue to aggressively go after and the tender activity or the funnel activities very strong.

Okay. And I know you mentioned you have seen some improvement on the manufacturing side, it's still weighing a little bit on the -- I guess on the overall gross margin. Do you think -- it sounds like you did say that we're -- by 2018, you should realize the full benefit. Did it weigh significantly on the results this quarter or is it sort of getting towards more of a neutral territory?

Yes. So, Larry this is Alan, so the revenue that we recognize from RTT this quarter was predominantly from RTT Systems that we manufactured two or three quarters ago when we had a higher pressure. So, yes, it would weigh down the margins in the second quarter that we just reported. It will dissipate a little bit through the second half of the year and as move into the fiscal 2018, it will -- it should really nicely improve.

Just to add on to it Larry that -- definitely we have said that that as we learn more, as we get more into it, our manufacturing cost is getting better. A lot of it has to do with their -- with the volume. But more important thing is that we go forward. Each airport has different requirements. So that as you look at each airport, it's not like a constant margin, you look at airport-to-airport whether you're displacing an incumbent or suppression new terminal. So, it changes from that, but overall, our manufacturing efficiency is getting better.

Okay. Just switching gears to Health Care and I appreciate those answers. Obviously, there was -- you guys are still working on execution issues and whatnot. Could you maybe just give us a little better color on A; some of the things you have done or I don't know if you can qualitatively discuss or what gives you the confidence in the improvement and the results year-to-date, is there some macro factors still weighing in on your performance and is international markets maybe not quite as good. Have you seen any last question not that or anecdotally any talk of hospitals may be delaying decisions or due to some uncertainty what happens with Obama Care?

That is a long -- couple of questions in your question. The first one is what signals we are seeing is the new leadership is doing better. Alan and I very much focused onto it. And the fact that we've seen some growth in the quarter, in the North America side makes us feel that we're on the right track. We're in constant touch with some of the clinical staff, we're addressing the issues properly, the new leadership is out there in the open, and we are getting a good -- a better feeling that the customers are happy with the progress we're making. Regarding the Asia and EMEA, we've said it before that market is really -- is a very challenging market, but it's nothing to do with the -- what I call the technology issue, it's just that they don't have the money. They are in a turmoil. Regarding your latter question about Obama Care to early. The ACA, whatever is going to happen neither the -- neither Washington knows yet what really is the facts, nor guy like us. We're all watching, but we have a pretty focused platform that we think will do well during this stage.

Okay, fair enough. Thank you very much. Appreciate it.

[Operator Instructions] And our next question comes from Andrew D'Silva from B. Riley. Your line is open.

Hey guys. Thanks for taking my call. Good job this quarter. The first question just kind of following up on the last question from the previous caller, as it relates to Health Care, when you're in there negotiating with the decision makers within the respective healthcare systems that you're working with, this is that -- your products are typically a capital expenditure, right, it's a budget that's usually set a year or two in advance, am I correct there?

That's true.

So, do you -- based on conversations that you're having right now, have any sense of how that's trending calendar 2016 versus calendar 2017, or is it too early to tell at this point?

Well, I think the first question, yes, it's capital equipment. Two, yes, the hospitals have to plan ahead a year, year and a half, two years even of the spending of the capital expenditures. Many times, it stayed up unless it’s a replacement of the product is tied up to the construction of the new wing of a hospital or whatever else. So, if there -- the answer to your question is what are we signing about it. One of the challenges that the marketplace has is there's a tremendous amount of consolidation going on in the hospital area. So, that that whole thing -- and we've said in last couple of conference calls, where you were dealing with a hospital for an order for $0.5 million or something, that hospital now is part of the bigger group, GPO or IDN and that way, it becomes a little bit more difficult to plan the timing of it. But all of this capital equipment is a must-have for the hospitals. They have to have it, without that, they can't put a patient in there.

Okay, got it. Understand it. And then, if you can, I know this is maybe a little bit of a stretch of an ask from you guys. But we're a little bit less than a month into the third quarter and this would probably help on the modeling from a quarter-over-quarter basis for us at least when we're think about growth third into the fourth. Are you seeing progress in the first couple of weeks here of the first quarter or the third quarter versus the second and the first quarter or is it pretty much steady state to this point?

Hey Andrew, this is Alan. We don't provide any sort of interim information within quarters, so it's just not something we've historically done.

Okay, fair enough. I figured -- I'm trying. And then, my last question really just relates to AS&E, you've had time at this point to integrate as you mentioned. Have you seen any low hanging fruit opportunities from the combined entity now that weren't present when AS&E was maybe a standalone entity? And is that -- any increase to maybe opportunities from legacy businesses in the Middle East that they were generating a meaningful portion of the revenue from in 2013 and 2014. Is that coming back in any way or is that still maybe something we should not think about at this point in time?

Well, I won't call it low hanging fruit. AS&E's business model was different from our business model. They are more into sole source specific products with lot of the investment made with their customers. Those customers we have talked to, they are very happy, they are all supportive of it to be -- AS&E to be part of the bigger product portfolio and we can offer a more broader product portfolio, high energy, middle energy, low energy, backscatter, transmissive. So, we think that one plus one makes more than two and we have been well received, the organization and the customers are quite happy. And many of the customers that they had, Rapiscan also had. So, together it makes more synergistic way to go forward.

Great color there. Thank you. And last part of that question I just thought of it was, is there an opportunity to plug any of AS&E's products into maybe a Turnkey Services business model or is that not something that's realistic based on the offering that they have?

Absolutely. Yes, and I think I did say it in my thing that we have more broader product portfolio to offer to the customer in the Turnkey Solutions, and we are definitely capitalizing on it.

Fantastic. Great. Thank you very much and good luck going forward for the rest of year.

Thank you.

And our next question comes from Jeff Martin from ROTH Capital Partners. Your line is open.

Thanks. Good afternoon Alan, Deepak. How are you?

Thank you.

Hey, Jeff.

Deepak, could you expand on your comments on the Innovation Lane Program with TSA, hadn't heard of that before. Curious how that came about and what you think the opportunity there is?

Yes, you might have travelled off lately. If you're travelling in U.S., you'll see that some of the airports even at Los Angeles Airport, I think its Terminal 7, Atlanta and some of other places, they have started doing some innovation Tray Return Systems to increase the throughput. And this basically is quite prevalent in Europe where you got to like U.K. Airport or Paris Airport. So, this is a new innovation to bring more through -- some of automation at the checkpoint. It's called the Innovation Lanes and it's a combination off a Tray Return System where people put their bags -- efficiently three or four people can stand together, put their bags in and it goes faster through and the other side gets less crowded. So, we are involved in talking to TSA and the airports to look at it since we acquired a small product line in U.K. couple of quarters ago and we're working diligently with that and also in European airports and in Middle East and in Asia on these Tray Return Systems together with X-Ray machines. So, it’s the new way of what I call not a box sale, but integrated checkpoint and it does improve the throughput and is very well received.

Okay. And that dovetails into my next question is, what's your visibility in terms of the next replacement cycle with the checkpoint screening equipment in the U.S.?

Well, I mean I can't comment what's going to happen with the new government administration, but the most of these X-Ray equipments that are out there at the checkpoint, ours and Smith's, they are not in their replacement cycle, there's no replacement as such. And frankly speaking they are more looking at how to automate and be better and upgrade them. So, I don't think so there's a replacement cycle that I know of at the checkpoint today

Okay. And then Alan, could you give us a sense of what your total company manufacturing footprint looks like on a global basis? And the reason I asked the question is, if free trade gets turned on its head what could happen there?

Sure Jeff. We do -- we manufacture throughout the world. We do quite a bit of manufacturing here in the U.S. We do manufacturing in low-cost jurisdictions such as Malaysia, Indonesia, India. We manufacture in the U.K. Those are really our principal areas of manufacturing, and we have some smaller locations elsewhere. We're in the process of doing some modeling for some what-if analysis in the event that some of the things that have been raised by the new government were to take place. We think we're in a good position overall with sort of flexible manufacturing environment that we might be able to take advantage of certain changes that take place. But at this point, a little bit premature until we know what those changes might be.

Right. Okay. Thanks for taking the questions.

And at this time, I'm showing no further questions.

I would like to thank everybody, ladies and gentlemen, for participating in our conference call. Wishing you all a Happy New Year and look forward to talking to you in April for the third quarter. Thank you very much. Good day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone have a great day.