OSI Systems, Inc. (OSIS) Q4 2017 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and welcome to the OSI Systems Inc. Fourth Quarter and Fiscal Year 2017 Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference call, Mr. Alan Edrick, Chief Financial Officer. Sir, you may begin.

Thank you. Good afternoon, and thank you for joining us. I'm Alan Edrick, Executive Vice President and CFO of OSI Systems and I'm here today with Deepak Chopra, our President and CEO. Welcome to OSI Systems fourth quarter and fiscal year end 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 this presentation is being webcast and 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 fourth quarter and fiscal year 2017 financial results. Before we discuss the results, I would like to remind everyone that today's discussion contains 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. These forward-looking statements are based on management's current expectations and are subject to uncertainties, risks, assumptions and contingencies, many of which are outside the Company's control. Such statements include without limitation, information regarding expected revenues, earnings and growth, and statements regarding the expected 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 are described in the Company's periodic reports filed with the SEC from time to time. All forward-looking statements made on this call are based on currently available information and speak only as of the date of this call, and the company undertakes no obligation to update any forward-looking statement that becomes untrue because of subsequent events or new information or otherwise. 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 information regarding non-GAAP measures and comparable GAAP measures and a quantitative reconciliation of those figures, please refer to today's press release regarding our fourth quarter and fiscal year end '17 results which has been furnished to the SEC as an exhibit to our current report on Form 8-K. Before turning the call over to Deepak to discuss the general business and operations, I'm going to provide a high-level financial overview of the fourth quarter and fiscal year. First, we reported fourth quarter revenues of $252 million, a 14% year-over-year increase. This increase was primarily driven by our Security Division which reported record Q4 revenues of $147 million, up 33% from revenues in Q4 of fiscal '16 and it included $23 million of revenues from the operations of American Science & Engineering, which we acquired in the first quarter of fiscal '17. Excluding AS&E revenues, our Security Division revenues were up by 12%. Our Healthcare Division revenues were up 7% on an organic basis which excludes the impact of the Q3 divestiture of a non-core business. Total revenues in our Opto division were down 5% which is relatively in line with our expectations. Second, we reported Q4 GAAP diluted earnings per share of $0.08. On a non-GAAP basis, Q4 EPS was $1.02, up 76% from Q4 of last year. Non-GAAP EPS excludes the impact of impairment restructuring and other charges, amortization of acquired intangible assets, non-cash interest expense, and the gain from the sale of a business; all net of related tax effects. It also excludes the $2.4 million tax benefit from the initial adoption of our new accounting standard, ASU2016-09 related to employee share-based payment accounting. Each of our three divisions reported operating margin expansion excluding the applicable items just mentioned. Third, operating cash flow is $11 million for the quarter and $63 million for the full fiscal year and capital expenditures were $5 million for the quarter and $17 million for fiscal '17. Fourth, our non-turnkey Q4 book-to-bill ratio was 1.4, our total backlog including turnkey as of June 30, 2017 was approximately $738 million, up 18% from the backlog figure at the beginning of the fiscal year. Lastly, on July 10, 2017 which was subsequent to our fiscal year end, we announced the completion of the acquisition of the former Morpho explosive trace detection business from Smiths Group. This business is an excellent strategic fit and is expected to further enhance our already broad security product portfolio and product development capabilities for fiscal 2018 and beyond. Before diving into the numbers and discussing fiscal 2018 guidance in more detail, let me turn the call over to Deepak.

Thank you, Alan. And again, welcome to the OSI Systems earnings conference call for Q4 and year end. During fourth quarter and throughout fiscal 2017, the team worked to make changes to create sustainable advantages in the marketplace. We were proactive in growing market share in the security division, strengthening the core of our healthcare division and in Opto division continuing to execute on a strategy to create a strong profitable business. Talking in more detail about each division starting with the Security Division where revenues were $555 million for the full fiscal year, 35% higher than the same period year before. Revenues in the division in Q4 were up 33% from the prior year. Security Division bookings were $198 million for the quarter and $554 million for the year which represents a non-turnkey book-to-bill ratio of 1.7 and 1.2 respectively. Obviously these numbers include AS&E acquisition. The revenue growth resulted from a mix of organic growth and the acquisition activity. The AS&E acquisition which was completed in September 2016 benefited us through most of the fiscal year in both, revenues and profits. Alan will discuss little bit in more detail the AS&E impact on both, revenue and profits. From a strategic perspective, we are very pleased with the acquisition as we are able to now go to market with a broader cargo scanning solution base and provide more options to meet our customers specific needs. We can proudly say that in our peer group in the security business we have the broadest product portfolio in this space. We also strengthened our aviation security portfolio with our acquisition of the former Morpho explosive trace detection ETD business from Smiths. This acquisition enhances our position with airports and critical infrastructure customers around the globe that seek safety from the explosive threats. Some of the highlights for Q4 for the security division; on the checked baggage front, our efforts to improve our product efficiencies for the Real Time Tomography, RTT, our high-speed CT have resulted in lower costs and improved margins. During the fourth quarter we announced an RTT order valued at approximately $23 million from a major European airport group, a great success for us. European airports are increasingly active as we have said in the past in adopting ECAC Standard 3 Technology to meet the 2020 deadline. Numerous major international airports also, in Asia, are similarly upgrading their security inspection systems to follow the overall global trend towards standardizing around CT-based checked baggage solutions meeting the new standards. The U.S. market which is preparing for the next major replacement cycle, we continue to remain on-track for the RTT 110 TSA Certification. As the U.S. replacement cycle approaches and European airports strive to meet the 2020 deadline for ECAC Standard 3; we expect to see new opportunities to expand our RTT footprint and install base. The airport checkpoint market also remains active, during the quarter we announced a multi-year contract valued at approximately $7 million to provide Rapiscan baggage and parcel inspection systems including follow-on maintenance and support services to a prominent international airport authority. Going into the cargo inspection side of the business, we won several U.S. and international strategic wins during the quarter. We have experienced a growing opportunity pipeline in this space as we announced approximately $63 million of awards for cargo products during the quarter. The continued growth of the installed base of our products is also leading to continued growth in opportunities for maintenance and services. During the quarter we announced a foreign military sale contract from the U.S. Department of Defense for approximately $23 million to provide training, service and logistic support for Rapiscan cargo and vehicle inspection systems and an additional $20 million order to provide spare parts to support AS&E, Z-Backscatter cargo and vehicle inspection systems. Overall, it was a strong booking quarter for cargo products. Turning to turnkey services; our current programs in Albania, Mexico and Puerto Rico continue to perform well. As we have mentioned in the past, the potential customers that are seeking to buy cargo product or turnkey service model options are increasingly overall and we continue to look at moving from one to the other. We have been spending a fair amount of time demonstrating the strengths of various hybrid options. To that end, earlier this month we announced an international customer contract valued at approximately $40 million to implement a countrywide security scanning program that includes high energy cargo and vehicle scanning systems. Our turnkey screening service business, S2 Global, will provide the design and construction of the inspection sites in a command and controlled center utilizing its global integration platform, Search Scan, and training operations personal as well as providing a comprehensive maintenance and service support program. We are actively working with the Mexican authorities on a multi-year renewal of our MSAT contract. Our fiscal 2018 guidance includes a multi-year contract for Mexico at a lower rate of revenue. The capital expenditures required for this renewal are expected to be minimal as the present installed equipment will continue to be deployed in its current state. As you can appreciate, we cannot comment any further on this. We also used our strong balance sheet to continue to make strategic acquisitions, especially in the security group. During Q4 we announced our intent to acquire the global explosive trace detection, ETD business of Morpho Detection for approximately $80 million in cash, subject to certain adjustments and announced the completion of this transition shortly after the fiscal year end. The acquired ETD business is now part of Rapiscan systems and is expected to be accretive to fiscal 2018 EPS on a non-GAAP basis which excludes amortization of acquired intangible assets and any restructuring or other charges. This acquired business is a leader in trace detection with a current worldwide installed base of approximately 10,000 units. We are very excited about this acquisition for a couple of key reasons; it allows us to leverage the acquired ETD business, existing customer base and product pipeline and gives us an opportunity to offer a full suite of products to aviation and non-aviation checkpoints alike. For aviation checkpoints, we believe the trend is towards an integrated checkpoint where screening machines for carryon baggage and people, trace equipment for explosive detections and automated tray return systems will work in a cohesive manner creating a more efficient and pleasant passenger experience. The acquisition of the trace business and the prior acquisition of a tray returns systems company in October 2016 further strengthens our checkpoint offering for airports and allow us to develop innovative hardware and software solutions, thereby moving us further along the integrated checkpoint path. Looking ahead, we are excited about our growth opportunity in the security business. The recent acquisitions, both AS&E and the trace business in the security space have created growth catalysts for ports, borders, airport and critical infrastructure protection. I'm very proud of the teams achievements to-date but I also realize that we need to continually review our organization and make the necessary changes to keep the business on its extended path. We recently realigned our security division so that the cargo and solutions group focuses on cargo and vehicle inspection and the detection group on checkpoint security systems and security detection instruments. Earlier this month we appointed a new President of the Detection Group, Mal Maginnis. Mal comes to us with 35 years of experience and is well regarded in the defense safety, security and technology industries. We welcome Mal to the team and are looking forward to his contributions. Ajay Mehra continues to lead the Cargo and Solutions Group, that has been a leading innovator in that space. Both of these groups together make us a broad integrated product company in a growing global security market. Moving to Healthcare; Spacelab sales were $54 million in Q4 or about 7% higher year-over-year after adjusting for the AED divesture. Q4 also showed the profitable trend of almost 9.6% of operating income that is business escapable off [ph]. Fiscal 2017 was a difficult year for Spacelabs but we began to see positive momentum in the second half which we expect to carry into fiscal 2018. Our management team work to improve operations to better serve our customers and provide a first rate customer experience in transitioning to our newer higher performance technology key product portfolio. In the second half we upgraded the operations, supply chain and engineering leadership and have begun experiencing benefits from these changes. The new healthcare division leadership team has built a foundation in the division on which we can return to revenue growth and improved profitability in fiscal 2018. Moving to the Opto division; in the fourth quarter the Optoelectronics and Manufacturing Division generated total revenues of $60 million which was a 5% decrease from the same period in the previous year. We have been very selective in growing this division with a more favorable product mix. To that end, the non-GAAP operating margins improved to 14.1% for the fourth quarter, a record, compared to 9.9% in Q4 of the prior year. Looking ahead to fiscal 2019, we believe we can grow the topline of the Opto division, particularly for the second half of the fiscal year in a similarly strategic manner. It has been an excellent year by many pleasures [ph], we have made strategic decisions on acquisitions, investments, customer interaction and personal; each of those decisions requires a willingness to focus on the Company's long-term objectives. Overall, I'm very proud of the employees and the group, what we have accomplished in fiscal 2017 and look forward to a strong performance in fiscal 2018. With that, I'm going to hand the call back over to Alan to talk more in detail about our financial performance and guidance before opening the call for questions. Thank you.

Thank you, Deepak. So now let's review the financial results for the fourth quarter in a little bit greater detail. As mentioned previously, our revenues in Q4 of fiscal '17 increased by 14% on a year-over-year basis. Revenues in the Security Division increased by 33% year-over-year, primarily as a result of $23 million of revenues generated by AS&E, growth in our conventional equipment sales and an increase in service revenues. Revenues in the Healthcare Division increased 7% on an organic basis, led by stronger performance in our patient monitoring business, primarily in the North American market. This 7% increase excludes the impact of the AED product line that we divested in February of 2017. This marks the second consecutive quarter of return to organic growth for our healthcare division. Opto external revenues were down by 7% as compared to the prior year, while intercompany Opto sales were up 15% due to increases in sales to each of the other two divisions. The Q4 gross margin was 34.4%, up from 240 basis points from the 32%, this was primarily due to increased margins in our Opto division as a result of a favorable product mix and improved operating efficiencies, improved margins in our healthcare division due to the product and channel mix and gross margin expansion in our security division which leveraged economies of scale and the inclusion of AS&E which was accretive to the overall gross margin. As mentioned on previous calls, our gross margin will fluctuate from period to period based on product mix among other factors. Moving to operating expenses; in Q4 of fiscal '17, SG&A as a percentage of sales decreased to 19.0% compared to 19.8% in Q4 of fiscal '16. In absolute dollars, SG&A spending was $48 million, which was up by $4.1 million over the same prior year period. This increase was primarily driven by the inclusion of AS&E, a company that we acquired in September. As noted on previous calls, we remain focused in all of our divisions on increasing efficiencies and prudently managing our cost structure. R&D expenses in Q4 were $11.1 million compared to $11.9 million in the prior year. This year-over-year decrease in expenses was mainly due to lower R&D cost in our healthcare division though we continue to make significant investments in research and development in our Healthcare division, as well as in our Security division to enhance our product portfolios. We remain focused on growth platforms and innovative product development which we view as vital to the long-term success of our business. With the inclusion of the trace business, we anticipate R&D as a percentage of sales in fiscal '18 will be roughly comparable to fiscal '17. We previously announced a goal of $18 million of cost synergies related to the AS&E acquisition over a two-year timeframe. We aggressively, but prudently, pursue such cost reductions and are pleased to say we have reached the annualized target ahead of the original schedule. Our estimated benefit from these efforts is approximately $11 million for the 2017 fiscal year. Impairment, restructuring and other charges were nearly $25 million in Q4, which includes approximately $17.5 million for the impairment of assets related to our Mexican turnkey program which I will expand on further. $4 million of impairment related to the embedment [ph] of product lines within our security business which were made redundant as a result of the AS&E acquisition and $3 million of cost related to facility consolidations, employee severance and transaction costs related to our recent acquisition activity. As it relates to the Mexico charge, we relocated and we reopened certain sites during Q4 due to changes in customer operational requirements. Approximately $11 million of the impairment relates to infrastructure cost that could not be relocated; the remaining $6 million or so related to capital assets for sites in Mexico which we believe are permanently impaired and have not produced any revenue. The company's effective tax rate was 27.6% on a full year basis compared to 26.3% in fiscal '16. This rate does not include the $2.4 million tax benefit from adopting ASU2016-09 in the current quarter. As a reminder, this benefit from the additional adoption was excluded from our non-GAAP earnings. Our provision for income taxes is based upon the mix of income from U.S. and foreign jurisdictions and tax rate differences among countries, as well as the impact of permanent taxable differences, tax elections, equity investing and exercises and valuation allowances amongst other items. So let's now turn to a discussion of our non-GAAP operating margin which excludes the items mentioned earlier in the call. As would be expected with an increase in sales and profitability, the Company's adjusted operating margin improved in Q4 of '17 on a year-over-year basis coming in at 11.9% compared to 7.1% in the prior year period. Due to the solid revenue growth in Security and the impact of the profitability from AS&E sales and related synergies, the adjusted operating margin was again strong in the Security division, improving both year-over-year to 15.2% from 9.8% in Q4 of last year and sequentially. Our Opto division also saw significant adjusted operating margin expansion with an increase to 14.1% from the prior year Q4 level of 9.9%. The Opto operating margin in the fourth quarter was the highest that has been in this decade demonstrating the continued success this division has had in capturing operating efficiencies as it relates to product and customer mix. We also saw noteworthy year-over-year fourth quarter improvement in our Healthcare division climbing to near double-digit operating margin at 9.6% from 6.9% for the prior year period as costs were well managed and the product mix tilted [ph] to growth in patient monitoring sales in North America which generally features relatively high margins. Moving to cash flow; in Q4 of fiscal '17 our cash flow from operations was $10.6 million, capital expenditures were $5.1 million in the quarter, while depreciation and amortization was $19.2 million. Days sales outstanding, or DSO, was 74 days for the fourth quarter of fiscal '17 as compared to 58 days last year. The increase was a result of strong June sales and some slower customer payments that were collected subsequent to fiscal year end. Continuing the trend from Q3 of fiscal '17, our days inventory for Q4 came in at 137, down by 16 days sequentially from the third quarter of fiscal '17 and down by 28 days from Q4 fiscal '16 level of 165 days. In absolute dollars, inventory decreased approximately $19 million on a sequential basis from the end of Q3. Our balance sheet remains strong. We ended the quarter with net leverage of approximately 1.4 as defined under our revolving credit facility for pricing purposes. And finally, turning to guidance; we anticipate 8% to 12% growth in fiscal '18 with sales approximating $1.40 million to $1.80 billion. In addition, we anticipate 12% to 20% growth in non-GAAP earnings per diluted share to $335 to $360 which excludes impairment restructuring and other charges and amortization of acquired intangible assets, as well as non-cash interest expense. We currently believe the sales and earnings guidance reflects reasonable estimates, actual sales and earnings, however, could vary from this range because of the risks and uncertainties that affect our business and industries generally, including items not within our control such as site readiness or product installations, customer acceptance and the timing of orders of each division. Over the long-term we have a track record of producing sales and earnings growth with strong cash flow generation, while simultaneously investing in product development and innovation for the future in conjunction with strategic acquisitions. We believe these efforts have served us well. Our investments have enabled us to continue our leadership role in the turnkey screening solutions market space and have allowed us to introduce innovative products and solutions to the market across our industries. Thank you for participating on this conference call. And at this time, we would like to open the call to questions.

[Operator Instructions] Our first question comes from Brian Ruttenbur from Drexel Hamilton. Your line is now open.

Thank you very much. Let me just start off with some basics; first of all on your cash and debt, you have roughly $169 million in cash and debt at $344 million. I assume that does not include the Morpho of roughly $80 million and will that come out of cash or be addition to debt?

Brian, this is Alan, good question. You're correct, that does not include Morpho which was -- the Morpho trace business which was acquired subsequent to year end. That $80 million predominantly came out of our line of credit as most of the cash that we have is offshore.

Okay. So if I take the $344 million and add $80 million plus whatever cash you're going to generate, that's how I should look at your debt. Correct?

That's correct.

Okay, that was easy. Next question is on Mexico; okay, so we know that you've been generating roughly $120 million in the ballpark from Mexico. What is it that you're assuming in your projections going forward and are you assuming a similar profit number or profit margin with Mexico in your guidance that you're giving us?

Brian this is Deepak here. I have said that very specifically that we are not going to talk more about this as we are in the final stages of negotiations which we feel very confident it will result into a multi-year -- reduced revenue multi-year contract. And since the capital expenditure will be minimal, obviously the revenue will be much lower. Alan, you want to add anymore thing more to it?

No, I think that captures it well. And the guidance we gave for fiscal '18 incorporates our thoughts on what that renewal will look like but we can't comment further on it while these discussions are taking place.

Okay, understood. And then the impairment that you talked related to Mexico, how do you catch them all; I apologize but I'm travelling, so Mexico impairment there is $11 million, can you run down through those real quick what was related to Mexico and your impairment charges?

Sure. The customer at Mexico asked us to relocate certain sites towards the end of our fiscal year. And as we relocated those sites, we were able to move the equipment into a new location but the similar works that were associated with the past sites those of course don't have any value really ascribed to many further. So the majority of that impairment related to the write-offs so to speak, the civil works of those sites that were relocated. The relocated sites are often producing revenue for the Company.

Okay. And how much was that in total?

The impairment was about $17 million.

$17 million. Were there other components or was it just a straight $17 million? I don't know if I heard something else in the conversation.

Yes, related to Mexico where the impairment and restructuring charges overall?

No, just related to Mexico. So out of the $24 million charge, $17 million was related to Mexico, is that correct?

Yes, that's correct. So about $11 million was what I just described and the remaining part were for certain sites that never got going and never producing revenue that we invested in the cash and as a result for those sites, those were written-off; so they were never a part of that $120 million in revenue that you refer to.

Okay, that's helpful, thank you. And then in terms of the turnkey project, are you referring to it as the turnkey project because it's not a provisional turnkey project; so the one that you announced that's $40 million. Can you give us a little bit more color on this, what you're doing that's different in this type of project than you were or are in Mexico or Puerto Rico?

Brian, this is Deepak here. I think the last words are very accurately described. The project is somewhere similar between Puerto Rico, Albania, Mexico, all mixed in together; some of them have training, some of them will have more of command control center, some of them had image processing, so those goal what we call it in a total solution. And as we move forward, these turnkey businesses can result into what we call the Mexico style or the Puerto Rico style or Albania style but they are all sale of equipment or leasing of the equipment plus maintenance plus training plus image analysis.

Okay. When does this start -- this project?

I would say by the later part of this year. Alan, you want to comment on it?

Yes, it could get up and running in our fourth quarter of this fiscal year that you could see some revenues but you probably see more of a beginning in the following fiscal year.

Okay. So we're talking next summer this will be up and operational. And can you tell us this is Eastern Europe or is this Middle East and you are South America and you narrow down the region of the world?

You've named all the regions. So for confidentiality it's one of these regions but Brian I also want to emphasize that the minute we do these kind of programs which has maintenance, training, command control center, this can lead into a longer term relationship with the customer for multi-years.

Okay. I'll just wrap it up with -- can you give us some kind of vision for 2018, the revenue by division, what do you expect? You gave a total revenue but do you expect Opto to grow at 3% and Security to grow at 10%; can you give us some kind of numbers or should we be looking at historical numbers and looking for that same kind of growth going forward [indiscernible]?

Brian, this is Alan. So our Company practice has always been to provide guidance just on overall OSI Systems level. That being said, our guidance does suggest that all three of our divisions will grow in fiscal '18 on the top line with the greatest growth occurring within our Security division.

Okay. And the Security division will obviously have growth because of the acquisition; and how much is more if you can add roughly $75 million, is that correct?

Yes, we aren't necessarily describing these incremental [ph] revenues for any particular deal or acquisition, what we can say is we're sizing the trace business to be riding on -- call it $60 million plus annual revenue run rate.

Perfect. I'll get off the line. Thank you very much.

Thank you. And our next question comes from Andrew D'Silva from B. Riley & Company. Your line is now open.

Good afternoon, thanks for taking my questions. Just a couple of additional here. For just a start-off, I mean we can focus on the healthcare segment. I was actually surprised with how you did there, in a good way, because of everything that was going on with the Affordable Care Act, do you guys feel like once that's cleared or at least hospitals are figuring out what's going on there that that should benefit you in a way or do you get any sense of what's going on from a CapEx standpoint within healthcare as there is a lot of turmoil right now?

This is Deepak here. Definitely there is turmoil but we look at the Affordable Care Act. The focus is our business has done well in North America and we continue to look very optimistic going forward and the pipeline looks strong, customer satisfaction is well received. Our challenge is and we have said it before, Alan has said it, I've said it; Latin America, Asia, Middle East, all of that is pretty challenging and we see some signs of improvement but our focused North America will do well next year.

Okay, great. And then as we look at the U.S. cycle that's coming up in 2020; is there anything in particular that we should be focused on as that could be headwinds as in near-term TSA budget changing year-over-year or do you feel like as long as that guidance for them to change over the next systems as in place here in pretty good shape as we head into next few years?

The answer is yes. Their procurement cycle for replacement is in 2020-2022 on the TSA side. We are much focused on the European side, we've had a great success and we just announced -- we said that another major order for $23 million to one airport group in Europe, there is lot more activity there because they are working towards the deadline much faster. Some of the international Asian airports have also started looking at it. So we believe that over the next couple of years the checkpoint TSA style definitely will start getting growth but major action for the next couple of years as I would say is Europe.

Okay, great. Thank you for the color on that. And just two more quick questions. Just first off on turnkey, are you seeing opportunities to add some of the AS&E and trace detection technology that you acquired into some of those bundled packages with either existing or new customers? Is that kind of the strategy right there in turnkey or is it kind of more legacy as it's in prior years?

Well, obviously we have a broader product line so that we could cater to customer specific needs in a better sense, both in a sale and a turnkey. Primarily the turnkey tends to be more cargo related and yes, AS&E is a big asset because they are very strong and have a great brand for what I call the low energy, the Backscatter, Rapiscan, they are very strong trade name for the high energy but in many applications in a turnkey or a broader security thing, you need all of them. Regarding your question about the trace sites, the trace business is going to be a very integrated part of a checkpoint solution together with our X-ray machines, together with our tray return systems, together with our metal gauge [ph]; so as you combine all those technologies, what we are saying is a happy experience in an airport is if you can integrate all these and that's what we did the strategic acquisition for but it gives us a total solution to be able to provide to the customer.

Okay, great. Last question, just staying with trace -- Smiths originally before they were forced after divested business, it had some pretty big operating efficiency numbers they thought they could obtain through the acquisition was around $10 million. But obviously they had a fairly similar business line, is there any sort of operating efficiencies that you guys are expecting through this acquisition and any other types of synergies that you could expand, that would be great as well.

Well, I can make two prompt question; I'll give you some of the high level and Alan can tell you a bit more detail. Basically, this was a strategic acquisition not based on synergies, not like AS&E; AS&E was a synergistic way that we did business and it has done very well for us. This was a strategic business, we needed, we had a product gap, this fills up our product back, so we don't look at as a strategic for a synergies thing but you can call it as synergistic, we have same sales pipeline, we have the same HR, we have the same IT structure, we have the same supply chain, manufacturing; yes, there will be some synergies but we are counting on this as a strategic to pull more revenue for our X-ray machines by trace customers happy that we can bundle it together. Alan, you want to add some?

Yes, I would just add really on the -- kind of on the medium and the long-term perspective, we think that the real type of cost synergies we could see would really be supply chain driven, really on the material cost and leveraging our supply chain. So that -- those aren't things that happen overnight but those are the things that definitely can happen in the medium and long-term which we think can have a nice impact for us.

I wasn't sure if you guys would say anything else, great. Thank you very much and good luck going forward throughout the rest of fiscal '18.

Thank you.

Thank you. And our next question comes from Larry Solow of CJS Securities. Year line is now open.

Hi, good afternoon. I just had a couple of quick follow-ups, just sticking with -- on the trace detection side, I know you don't want to give specific guidance for units or perhaps acquisitions but fair to assume that's immediately accretive?

Larry, this is Alan. I would say that it is fair to say that it's immediately accretive on a non-GAAP basis.

Okay. And anymore color -- is it similar margin profile to you guys, any thoughts on accretion on that front?

Yes. Larry this was a carve out in nature and while we continue to get our arms around it, it is a deal that we think will be margin accretive to us overall so we're excited about it. We'd hesitate on giving too much color around it just yet until we get a little bit more experience under our belt.

Okay. But so margins are at least similar to yours if not better in the long run?

Yes, we believe so. And…

And then just -- go ahead, I'm sorry.

Just to add on to the -- just how the question is, basically we [indiscernible] present now just couple of months. And because of all the changes in the regulations and there is more focus on the laptop thing that's happening at airports, I'm sure you've heard about it. There has been a very strong demand for the trace product line products, especially at the international airports where the flights have to leave from and we are very well capable of catering to that and we are very much focused. So the trace business has started on a very strong footing.

Yes, that was sort of my -- my next question was sort of the bump up in the ETD requirements. So in theory maybe that $60 million run rate in sales could be higher in the short-term, is that without -- is that a fair assessment?

I think at this stage I would say Alan's numbers are right. We can't look at it just as a bump in the road, we look at longer term view. We think this is a good product line and like I emphasized, it's part of our strategy for bundling the total at the checkpoint without X-ray machines that are on tray return systems.

Okay, great. And then just lastly, just one more on Mexico; would -- I know you don't want to get into details but I guess can we assume that -- assuming it does renew, I know you had -- there was a capital expenditure for both, the equipment side which you were depreciating and then the upfront cost for infrastructure cost and what not which I guess will not repeat itself. So fair to assume there will be no depreciation as well?

Larry the two sides of the equation, the subtle works you're referring to -- you're correct, it will be predominantly fully depreciated as of the end of the initial contract term. The equipment side had a life longer than the initial six year contract, so there will be continuing depreciation associated with the equipment. But your overarching question, will depreciation go significantly down related to this contract, the answer would be yes.

Okay, great, excellent. Thanks guys, I appreciate it.

Thank you. And our next question comes from Jon Tong [ph] of Sidoti & Company. Your line is now open.

Good afternoon. I understand that you guys don't provide the quarterly guidance but if you can just give us some sort of -- like color and direction of how should we think about like you know, 2018, maybe the first half versus the back half, taking into consideration of -- like you know, the Mexico renewals could be -- I believe is in the third quarter?

This is Alan. We certainly appreciate your question. It has been our practice really over the past decade that we really only just provide annual guidance without giving specific color on a quarterly basis. But you could clearly suggest that the first half we should be coming out of the gate very strong and -- while the second half we're anticipating a nice second half too. The Mexico renewal takes place at that point in time, so there will be some impact there.

Okay, got it. And then in terms of RTT -- like you know, you guys mentioned Asia, Middle East and other parts outside the EU and U.S. and you're looking at some of the stuff there at different airport; I assume that those are mostly replacements versus new buys. So can you just give us a little bit in terms of the market size like replacements will visit new airport and perhaps talk about the timing like how soon that you can see those turning into bookings and revenue growth?

Good question. The answer to your first question is, it's not a true statement as there is only replacement. There is a lot of activity from growth in Asia especially, in some places they are putting new airports, in some cases it's a replacement of older technology which is not CT based, what is called the multi-view -- the older units; as they come out they get replaced by a newer technology, more expensive CT systems. The answer to your second question; timing wise, basically there is no such requirement like in Europe of a certain standard and a timing but as the more trade goes in, more passengers go in as a threat which is universal for these things, I think the bigger airports all over the world, especially Asia Pacific, they are very progressive so they want to put the best technology upfront, so that as they are going to replace it for the next 10 year cycle, they look at the best technology even though their standards might not require it. So we believe that over the next five years, there will be continued growth for these kind of equipment in all over the world.

Okay, got it. And then Deepak you mentioned like -- you know, the operating productivity, improvement, the cost reduction initiatives on the RTT side, it's benefiting you guys in terms of margin expansion; are we going to see more incremental margins, like opportunity in 2000, going into 2018? And is there a way to sort of -- like quantify it?

This is Alan. Yes, very good question. Yes, the team has worked hard to really improve the margin profile of RTT and they -- we've been doing that throughout fiscal '17. Really the bigger impact of that will indeed the current fiscal '18 because many of the units that we sold in '17 and installed were earlier units that were made under the higher cost structure. So yes, we do believe that there is nice margin expansion opportunity in fiscal '18 and potentially beyond for RTT. And while we haven't said what those margins are in RTT, the delta is pretty significant, so we're excited about that.

And I think you mentioned about over $60 million -- not with inspection this particular quarter; and obviously, you know, when -- the last couple of months there are lot of budget news and especially, if I can may, the proposed 2018 budget for our different agencies, we all know who they are, they look pretty good. So I'm just wondering like -- all the strings that you are seeing in the cargo side and just by talking to our customers, the elevated interest level; is this the sample [ph] like going into next year also into the back half of 2018?

Again, very astute question. Yes, the budgets look quite positive from our product line, especially on the cargo side and we have announced some very big wins. We continue to monitor it, we think that over the next -- 2018 definitely, the cargo products and the aviation products will continue to be in demand.

Okay. Finally, I wanted to talk a little bit healthcare; very strong margin edging back almost to the double-digit rate. I know that this is like a division that is very leveraged to volume but is there anything on the product mix side that stood out this particular quarter and I just want to engage the sustainability going forward. Thank you.

This is Alan. The mix was highly focused on patient monitoring and in particular, the U.S. patient monitoring which tends to carry some of the higher contribution margins for our overall healthcare business. So that coupled with the cost structure that's been put in place led to significant operating margin expansion. And you're right, with healthcare being the highest contribution margins in the overall OSI portfolio, as revenues increase going forward there is really nice opportunity to further expand on those margins and profitability profile.

Okay. So there is no -- there was no sort of one-time or anything that -- in terms of product mix that stood out, it might not be sustainable going forward?

No, it was very regular run rate type of business.

Good. All right, thank you so much.

Thank you. And our last question comes from Greg Konrad of Jefferies. Your line is now open.

Good afternoon, just a couple of questions. I think most of my questions have been asked but -- just let me think about the recent acquisitions, you know, to bring up revenue synergies; are there certain customers maybe that you weren't able to have conversations left that the bigger portfolio you find it easier to kind of getting in and have conversations about maybe future business?

The answer is yes. When you're dealing with government in other parts of the world, the bigger you are, the bigger product line that you have, more credibility you get; and that does benefit. But I would say that most of the players in our space are like two, three, four, they are all in the frame size now -- so, I mean we would say that we have narrowed down the gap, we consider ourselves maybe at number two as far as the revenue of the security products are and compared to our competitors. So it does give you some benefit but I think more important than the size is the breadth of the product line, so we have now a very broad product line. So we could go to an airport; if the airport is needing X-ray machines but they also need trace, we have both; if they need also an integrated tray return system, we have that too; they need metal gates, we have that. If we go to cargo; if they need integrated product line, low energy, medium energy, high energy, integration, training, we have all that; so definitely it helps.

I mean when you kind of lift out all those capabilities, I mean where it stands today; are there any gaps that maybe you can fill through internal R&D or another fashions?

There is always gaps to be filled by both internal development and what all we can strategically acquire, we continue to look at it. But at this stage we are quite content with the product lines that we've got but we continue to look at it, we have been very focused to grow that business.

Thanks. And then just last on the Opto business, I mean, should we expect an ongoing shift where maybe more of that capacity is used internally? You mentioned that the eliminations were up quite a bit in the quarter versus kind of external sales.

This is Alan. That will fluctuate, so clearly as the healthcare business grows and the security business grows, the intercompany sales at Opto has -- can grow along with it, it's balanced on time despite inventory reduction initiatives by certain divisions but it wouldn't be a diversion of capacity away from selling the third-party customers, we have plenty of capacity to fulfill both, our internal requirements and our third-party requirements. So we're actively looking to grow both.

Thank you.

All right. I see no further questions in the queue at this time. I'd like to turn it back to the speakers for closing remarks.

Thank you very much. I again want to thank you for taking the time to listen to. We are very, very happy with our 2017 and we are excited about it, we are entering the 2018 with a strong backlog, we have given a very strong guidance upwards and we believe that this business will be great for us. Thank you. We'll talk to you soon. Bye.

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