OSI Systems, Inc. (OSIS) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the OSI Systems First Quarter 2018 Conference Call. At this time all participants are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Alan Edrick, Chief Financial Officer. Please 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 the OSI Systems First Quarter Fiscal 2018 Conference Call. We would like to extend a warm welcome to anyone who is a first-time participant on our conference calls. Earlier today, we issued a press release announcing our first quarter fiscal year 2018 financial results. Before we discuss our 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 securities laws. 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 actual results could differ materially from our forward-looking statements due to numerous factors, including factors 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 day 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 first quarter 2018 results, which has been furnished to the SEC as an exhibit to a current report on Form 8-K. Before turning the call over to Deepak to discuss the general business and operations, I will provide a high-level financial overview of the first fiscal quarter. First, we reported Q1 net revenues of $257 million, a 16% year-over-year increase, which was a first-quarter record for OSI. This increase was driven primarily by our Security division, which reported record Q1 revenues of $162 million, up 31% from the prior year and included a robust $22 million of revenues from our newly acquired explosive trace detection business, which we acquired early in the first quarter of fiscal '18. Our Healthcare division revenues were comparable to Q1 of last year; though these revenues were up 10% from the same prior year period on an organic basis, excluding the impact of the prior year Q3 divestiture of a noncore business; total revenues in our Opto division were up by 3%. Second, we reported Q1 GAAP diluted earnings per share of $0.52 compared to $0.03 in the prior year. On a non-GAAP basis, Q1 EPS came in at $0.79, up 80% from Q1 of last year. Non-GAAP EPS excludes the impact of impairment, restructuring and other charges, amortization of acquired intangible assets, noncash interest expense, all net of related tax effects. It also excludes net discrete tax expense of 0.7 million. Excluding the impact of this discrete item, our effective tax rate for Q1 of fiscal '18 was 28.3%. Each of our three divisions once again reported operating margin expansion, excluding the applicable items just mentioned. Third, operating cash flow was $35 million for the quarter and capital expenditures were 24 million. These capital expenditures included the real estate purchase of the AS&E facility in September for just under 20 million. Fourth, our non-turnkey Q1 book-to-bill ratio was 1.6. Our total backlog, including turnkey as of September 30, 2017, was approximately 846 million, up 15% from the backlog figure as of June 30. In addition, in July 2017, as mentioned earlier, we completed the acquisition from Smiths Group of the former Morpho explosive trace detection business. This acquired business contributed nicely to our Q1 financial results. And we believe the business is an excellent complement to our Security division's already broad product portfolio. Before diving into the numbers and discussing our updated fiscal 2018 guidance, let me turn the call over to Deepak.

Thank you, Alan, and again, good afternoon. Welcome to everybody. We are off to a good start in fiscal 2018 as we generated record revenues and earnings in the first quarter. Each division, as Alan has mentioned, contributed to this strong performance. During the quarter, our Security division completed the acquisition of a strategic trace detection business and focused on integration activities while delivering strong bookings and revenue. Healthcare continued its turnaround, delivering its third straight quarter of year-over-year organic revenue growth. And the Optoelectronics and Manufacturing division returned to growth in revenues while achieving operating margin expansion. Going into the details for each division, starting with the Security division, where we reported revenues of approximately 162 million, including the recently acquired trace detection product line, an increase of 31% over the prior year period. Excluding this ETD acquisition, revenue increased 14% when compared to Q1 of last year. Security bookings were 234 million in the quarter, which generated a non-key book-to-bill ratio of 1.8 for this division. A few of the other highlights for Q1 in Security. On July 7, we completed the trace detection product line acquisition from Smiths, ex-Morpho trace detection and got off to a strong start as revenues were 22 million in Q1 from this product line. The bookings were also strong during the quarter as we announced new trace detection orders valued at $16 million to support airlines that are boosting their overseas security infrastructure to comply with the Department of Homeland Security directive that requires enhanced screening on U.S.-bound passenger flights. We are focused on enhancing the leadership team and administrative support functions and are working diligently toward a successful integration of this product line. This acquisition nicely complements our existing product portfolio, increasing our offering at checkpoints for both aviation and non-aviation customers. And also expands our technology base that we can further leverage to develop more integrated checkpoint solutions in the future. The Department of Homeland Security mandate has created strong demand right off the gate, which is expected to provide a boost to revenues, especially in the first half of the current fiscal year. Our high-speed check baggage CT inspection system, RTT 110, continues to gain traction in the marketplace. During the quarter, we announced a $6 million order from an international air and logistics cargo company, an existing customer that is expanding its RTT fleet internationally. Shortly after the end of the quarter, we also announced our first RTT win in Latin America with an airport customer in Panama for approximately $16 million that includes RTT and other checkpoint X-ray inspection systems. On the U.S. certification front, our RTT 110 platform continues to be evaluated by the TSA and we look forward to achieving certification in future, although we cannot be specific of the timing. The cargo product line also performed well in Q1 as we saw an overall increase in tender activity and captured several key wins, a few of which I would like to highlight here. We announced a service and search order valued at $9 million to support customers' existing Z Backscatter cargo and vehicle inspection systems installed base and announced another order from a customer for $9 million for new ZBVs and related service and support. Our cargo sales team is becoming more effective as it now has a complete range of cargo solutions that can be utilized to meet customers' needs. Moreover, the cargo and S2 solutions team are also working closely on customs and border opportunities, where both can contribute. As an example, during the quarter, we announced an international customer contract initially valued at approximately $40 million, to implement a countrywide security scanning program that includes high-energy cargo and vehicle scanning systems, where S2 will also provide the design and construction of the inspection sites and the command and control center. Our turnkey solutions contracts in Mexico, Puerto Rico and Albania continue to perform well. During the quarter, the hurricanes in the Caribbean adversely affected cargo traffic in the region. We expect near-term revenues from Puerto Rico turnkey program to be impacted. As mentioned in our recent calls, we continue to work on the renewal in Mexico on the multi-year MSAT contract. The 2018 guidance for revenues includes this renewal, which, as we have mentioned before, is expected to be at a reduced revenue rate and with minimal capital expenditures. During the quarter, we bought AS&E's Billerica, Massachusetts facility for approximately $20 million. We view this as a key facility and the financial terms were very attractive. Going forward, our strong backlog and overall divisions' performance positions us well for continued growth. Moving to the Healthcare division, where Q1 organic sales, excluding the impact of a noncore divestiture completed in fiscal 2017, grew by 10% from the first quarter of the prior year, representing the third straight quarter of year-over-year organic sales growth. We have also seen increased revenues in the U.S., our largest region for healthcare, for 3 straight quarters. During the quarter, we announced a $4 million order for patient monitoring solutions from a U.S. hospital. And shortly after ending Q1, we announced a $9 million order for another U.S. hospital for patient monitoring and related accessories. U.S. demand has shown growth, while internationally, as we have mentioned before, the environment is still challenging. Our revitalized healthcare management team has done well in working with the product rollout challenges and made significant operational improvements. Going forward, we believe that the division can continue to maintain its steady progress. Moving to the Optoelectronics and Manufacturing division, where revenues were about $59 million or 3% higher than the prior year. Much of the revenue growth, including intercompany sales, leaned towards a more favorable product mix that resulted in improved operating margin. It's great to see this division return to top line growth. We have a seasoned management team that has been hands-on in reshaping and implementing this business strategy of smart growth that delivers higher margins relative to the industry. So overall, we're quite pleased with the strong start in Q1. The Security division has a strong equipment backlog and opportunity pipeline. We believe that the Healthcare division will continue to get stronger and Opto is in a good position to deliver growth. I'd like to take a moment to thank all of our employees for their efforts during the quarter. I'm excited about our future and look forward to the coming quarters. With that, I'm going to hand the call back to Alan to talk in detail about our financial performance, before opening the call for questions. Thank you.

Well, thank you, Deepak. So now let's review the financial results for the first fiscal quarter in greater detail. As mentioned previously, our revenues in Q1 of fiscal '18 increased by 16% on a year-over-year basis. Revenues in the Security division increased by 31% year-over-year, driven by acquisitions and strong performance in both our checkpoint and cargo products and related services. Revenues in the Healthcare division increased 10% on an organic basis, led by stronger performance in our patient monitoring and our cardiology businesses, primarily in the U.S. market. This increase excludes the impact of the AED product line that we divested in February 2017. And as Deepak mentioned, this marks the third consecutive quarter of year-over-year organic growth for the Healthcare division. Overall, the Opto division sales were up 3% as intercompany sales to support the growth of each of the other two divisions significantly increased. External revenues in the Opto division were down 4%, primarily as a result of a decrease in our contract manufacturing business within North America. The Q1 fiscal '18 gross margin was 35.5%, up from 30.8% reported in Q1 of the prior year. The gross margin primarily increased due to the impact of the product mix within our Security division as gross margins from the acquired businesses are generally higher than margins from product sales and related services in the rest of the Security division. In addition, the Opto division contributed to this increase as a result of the favorable product mix driven by growth in our commercial Optoelectronics business, which typically generates higher gross margins than our contract manufacturing business. As mentioned on previous calls, our gross margin will fluctuate from period to period based on product mix among other factors. Moving to OpEx. In Q1 of fiscal '18, SG&A as a percentage of sales increased to 21.6% compared to 19.7% in Q1 of fiscal '17. In absolute dollars, SG&A spending was $55.6 million, which was up by about $12 million over the same prior year period. The increase was primarily in our Security division, resulting from the timing of acquisitions and to support the higher level of sales in this division. The Security division SG&A increase was partially offset by reduced SG&A expenses in our Healthcare division. 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 Q1 were $15.1 million compared to $12.5 million in the prior year. As a percentage of sales, such expenses were 5.9% in Q1 of fiscal '18 compared to 5.6% in the same prior year period. The year-over-year increase in expenses was due primarily to the Security division acquisitions as well as increased investment to enhance our product portfolio. We remain focused on growth platforms and innovative products development, which we view as vital to the long-term success of our business. Impairment, restructuring and other charges were $1.1 million in Q1 compared to $10 million last year. The $1.1 million included about $800,000 of acquisition-related costs, primarily associated with the acquisition of the trace business. The remainder was due to restructuring activities, including employee termination and facility closure costs. The company's effective tax rate for the first fiscal quarter was 28.3% compared to 28.0% in the prior-year quarter. This rate excludes about $700,000 of net discrete tax expense. 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 selections, equity vesting and exercises and valuation allowances among other items. So now let's turn to a discussion of the 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 non-GAAP operating margin improved in Q1 fiscal '18 on a year-over-year basis, coming in at 9.4% compared to 6% in the prior year period. Due to the solid revenue growth in the Security division, coupled with gross margin expansion, the adjusted operating margin was again strong in Security, improving both year-over-year to 16.1% from 13.2% in Q1 of last year as well as sequentially. The Opto division also saw adjusted operating margin improvement with an increase in Q1 of fiscal '18 to 9.4% from the prior year Q1 level of 8.9%. Lastly, the operating margin in the Healthcare division dramatically improved, albeit lower than we would like, as Q1 is historically the softest sales quarter for the Healthcare division. The contribution margin of the Healthcare division is the highest among the three divisions and is sensitive to the top line. Moving to cash flow. In Q1 of fiscal '18, cash flow from operations was 35.1 million. Capital expenditures in the quarter were 23.7 million and included the property purchase previously discussed, while depreciation and amortization were 20.4 million. Days sales outstanding, or DSO, was 72 days for the first quarter of fiscal '18, down from the 74 days at the end of last quarter and in line with the 73 days in Q1 of fiscal '17. Days inventory for Q1 of fiscal '18 came in at 149, which was down by 24 days in comparison to the 173 days reported in Q1 of last year. Our balance sheet remains strong. We ended the quarter with net leverage of approximately 1.7 as defined under our revolving credit facility for pricing purposes. Finally turning to guidance. We have updated our guidance, increasing guidance both on revenues and on non-GAAP EPS. We anticipate 9% to 13% growth in fiscal '18 sales as compared to fiscal '17 to a range of $1,045,000,000 to $1,085,000,000. In addition, we anticipate 14% to 22% growth to $3.40 to $3.65 in non-GAAP earnings per diluted share, which excludes impairment, restructuring other charges and amortization of acquired intangible assets and noncash interest expense all net of related tax effects and discrete tax items. 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 in each division. Over time, we have demonstrated a strong track record of sales and earnings growth with strong cash flow generation, while simultaneously investing in product development and innovation for the future and making strategic acquisitions that 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 different industries. Thank you for participating in this conference call. And at this time, we'd like to open the call to questions.

[Operator Instructions] The first question is from Brian Ruttenbur of Drexel Hamilton.

So strong bookings in the security side of the business in the last couple of quarters. 1.4x, I believe, last quarter and 1.6x on a book-to-bill basis. What is driving this? Is this large cargo? Or is it because of the mandated security increase with U.S. flights? Is this coming through trace detection, which I can't imagine and can't -- since trace is so inexpensive, it can't be coming all through that. Is this RTT? Maybe you can just elaborate what is driving these extreme strong bookings into market share gains, maybe elaborate a little bit.

Brian, I'm very impressed you already answered everything that you said. All those items that you said have been strong bookings.

Is there anything that you can point to that is really driving it more than anything else? Like large cargo, we've got a big Middle Eastern order or is it RTT is really kicking in?

Brian, the cargo -- large cargo has been very good and RTT bookings have been very good, strong. We announced some. Trace has been also very good. But generally speaking, both domestically, as also you all know September is the government fiscal year in U.S., it's a strong quarter for security. But internationally, there has been a lot of demand and there is a lot of awareness all over the world. And as we approach more towards 2020, '21, the necessity for meeting the deadline in Europe at airports becomes a necessity. But we've also seen some interest in growth coming from Asian airports as they try to revamp to get to the latest standards. So all-in-all, security bookings in all those categories have been very healthy.

Great. Another question along those security lines. The upgrade process going on in the EU. Have you got any of your deployments that you -- of the RTT that has rolled off into maintenance contracts? And what have you seen in terms of profitability, if so, on those?

Well, as we have mentioned before, all these contracts that are for the airports, especially for RTT, they have a very long tail for service and maintenance. Some of the -- most of the products are still in warranty. But as they are coming out of warranty, the service tail will start. And that's given -- and on your second question on the profitability, maybe Alan, you can comment on it. We've said for many years that as we were ramping up very fast, we had inefficiencies in our manufacturing, which we have put in behind us and the latest product has healthier margins. Alan?

Yes, Brian, a good question. So sort of two aspects of where we're seeing improved margins going forward on RTT. One, on the basic equipment. So as we ramp up, it has become a -- we have greater economies of scale and we have some reduced manufacturing costs. We have seen our overall equipment margins increasing going forward. And the second, as you astutely pointed out, as these warranties begin to roll off and we get service contracts and we're starting to see that just now, the service margins are generally higher than the equipment margins. So you get that nice recurring revenue at higher margins. So we're just in the early stages of that with respect to the RTT product line. So we're very excited about that.

Okay. And then just two other quick ones. In terms of Mexico, are you a sole-source negotiator down there? Or is there any competition that you see for getting this contract renewed?

Brian, we are very sensitive about it. All we are saying is that we are in negotiations with the Mexican government. I would feel uncomfortable elaborating anything beyond that.

Okay, understood. And then last question on the Healthcare side. Can you -- as I calculate the operating margins, it was on 1.6%, 1.8%. I can't find my notes now. But you are unprofitable last year. Do you expect profitability to be up on the year versus last fiscal year in Healthcare?

Yes, Brian, this is Alan. We certainly do. So yes, we were up significantly from a negative margin last year. Q1 is historically our softest quarter on the top line in Healthcare from a seasonality perspective. And our expectation for fiscal '18 is absolutely to have a much higher operating margin than we reported in the previous fiscal year.

The next question is from Sheila Kahyaoglu of Jefferies.

On Security, I think ETD contributed more than what I had expected. It seems sort of a $65 million run rate based on the antitrust filings. Is that -- can you explain what's driving some of the strong performance? Should that be an assumed run rate of $22 million going forward?

This is Deepak here, Sheila. The -- your numbers are right. We have said in my script that the first half is stronger than the second half. It's driven primarily with the DHS requirements that all inbound flights coming from some places into U.S. require extra screening. We are seeing a lot of that action still and we continue to think that it's going to continue, though we believe conservatively that the first half is a stronger than the second half.

With respect to the traces.

Yes.

Understood. And is that what's partially driving the revenue boost for the full year?

Sheila, this is Alan. Really, I'd say the revenue boost for the full year is a sort of an amalgamation of the entire business. We had anticipated -- when we went into our guidance in August, we had anticipated this boost in the first half of the fiscal year for the DHS initiative because we have already seen a lot of those orders starting to come in. So we would say the revenue boost is really the general strength of our overall business and the increasing visibility as opposed to related to the trace business.

Okay. And then two more quick ones. In terms of Puerto Rico, you said some cargo impact. Is there any CapEx impact for the full year? And how should we think about CapEx for the full year in general?

Sheila, this is Alan. So with respect to Puerto Rico, as Deepak mentioned, there may be some near-term revenue impact, though Puerto Rico is not overly significant for us. But from a CapEx perspective, we're not anticipating any impact for Puerto Rico. For CapEx in general, excluding the property purchase -- the Billerica property purchase, we look at CapEx in the range of $30 million, plus or minus, and then you would add the $20 million that we did for the real estate purchase, but somewhere in that ballpark based on the timing of different expenditures.

And my -- just my last question. One of your peers today mentioned its ClearScan product expanding in airports. Just wanted to get your thoughts on how you think about that product line? And is it a potential extension area for OSI?

Would you repeat that? I did not understand.

The ClearScan product at airports...

Did you say ClearScan?

Yes. I know it's not a product you have. I just thought about it as an adjacent market, how you think about that?

Sheila, I'm not sure about that. But if it's biometric-related product, we are not in that space. But if it's ClearScan, which is the trade name for the L3's checkpoint CT, we are also in that space.

Thank you. The next question is from Andrew D'Silva of B. Riley. Your line is open.

Just a couple of questions. Most of mine have been answered already. Do you know what your adjusted EBITDA was actually for the quarter? If you could start off with that?

Our adjusted EBITDA was $46.4 million.

And when we start thinking about the trace business, should we expect that it's a higher-margin business? And in the first half of the year, gross margins should improve as they did sequentially in the first quarter? Or is there another component right now that drove the gross margin increase?

So really, it was a very strong gross margin quarter for us and we see a number of things that factor into that. All of our divisions did quite well. Trace contributed to incremental gross margins into our gross margin increasing as it carries a higher gross margin than OSI has overall. But then again you have to factor in the relative contribution of trace to the overall OSI, so it helps. But it was really the main businesses that were really driving that as well. The AS&E business we bought last year continues to generate very, very strong margins. The increase in the Healthcare business, which carries the highest contribution margins in the company, helped to improve that and took on a little bit more weight. The Opto business had a more favorable product mix and improved margins. And our basic checkpoint solutions products were also stronger. So the entire business did well. You're right. It will fluctuate for a little bit period-to-period and we'll get a little bit more benefit from trace in first half of the year than the second half of the year, but we are very pleased with that margin expansion.

That's great to hear that's coming across the whole company. Should we expect that gross margins in general for fiscal '18 should be better than they were in fiscal '17?

Yes. Our historical practice is that we provide guidance on sales and earnings per share, but we don't provide guidance on other individual P&L line items.

And then just moving over to the backlog. First of all, just refresh my memory. Healthcare typically doesn't fall into the backlog. That's just a place ordered -- ordered essentially, correct? So that's not really a backlog item. And then I was wondering if you could elaborate if trace falls into the backlog, or if it is similar to Healthcare in general?

So yes, trace does fall into the backlog. And our backlog, as you saw, was significantly up. Trace contributed about $14 million overall to our backlog. So it's really our core business that was generating the very sizable increase in our overall backlog. You're right on Healthcare. It's generally a book-and-ship business. There's not a large backlog. But there is always some backlog. And the nice thing is we're heading into our Q2 with one of the stronger backlogs that we've had in Healthcare in quite some time. So really happy with the bookings the Healthcare team was able to generate.

Great. And the last question, what was AS&E's revenue for this quarter compared to last quarter? And I know you made the acquisition part way through, so if you could give like an apples-to-apples full year, full quarter comparisons that would be useful.

This is Deepak here. We have integrated the cargo product line completely together with AS&E and Rapiscan. So it's very difficult to break that separation into it. The service is together, the products are intermixed into it, the model numbers are still there, but it's very difficult to break that down. But we can say overall that the cargo business had a very strong quarter. Alan, you want to add on to it?

That's a good summary.

The next question is from Joan Tong of Sidoti. Your line is open.

Most of my questions have been answered. But I want to ask you about Healthcare. It seems like you guys are back to a more healthy state in the Healthcare business. But yet, you still talk about the international portion of it is still pretty weak. Can you just like remind us like what you're seeing in the International business? What are the customers talking, telling you in terms of maybe is a budgetary concern? And then I have a bunch of follow-ups.

Well, we've always maintained it and we have said it that the majority of our business is U.S. based, yes, U.S. centric. That has been very good growth, good bookings. Internationally for the last six to eight quarters has been very challenging. Just look at the economies in Latin America, where we used to do well. Now they don't have any money. Economies are in tough shape. Same goes for Asia, same goes for Europe. So we look at it with a very cautious look at it. And I said it, that we have seen, though some improvement, but it's still very challenging and we're very cautious.

Okay, okay. And in terms of like health care over a longer term and can you just remind us what's your strategy there? Any new product development? Any specific markets that you would like to go after and maybe spend a little bit more just because we're kind of back to like more like a normal state? And organically how fast it can grow like in a normal environment?

Well, we said it. We're centric to North America. We're centric to patient monitoring. That's our core business. We are focused on that and we're considered on the high-end side of what is called the connectivity story for a hospital. And as there is more consolidation going on in U.S., more and more customers want integration connectivity to all their hospitals. So we are focused on spending and investing in that part of the technology. Together we are investing more money and focus into the cardiology side of the business. But primarily I would be very focused to say it's a monitoring game. We are a monitoring company.

Okay, okay. That's fair. And then in terms of capital structure, Alan, you said 1.7 times leverage. And what's really an ideal, like, optimized balance sheet for you in your opinion? And in terms of like maybe more M&A going forward and maybe lever off the balance sheet even a little bit more?

Sure. So good question and we certainly increased our leverage a bit with the two larger acquisitions we've done over the past 12 or 13 Months. But the leverage that we have is a very comfortable leverage. And we have ample dry powder within our credit facility and access to the capital markets to continue to be able to execute on strategic opportunities and increase that leverage level. So while we don't have a target leverage to be at, we certainly have great opportunity and great capacity in order to lever up a bit further should the need arise to be able to act quickly on an opportunity.

The next question is from Larry Solow of CJS Securities. Your line is open.

Just a few follow-ups. Just on the -- in terms of Security, obviously, very favorable macro. I think that's certainly benefiting you guys. Is it fair to say you are also taking market share and perhaps the acquisition of AS&E? I see a lot of these several deals you seem to be mixed between their cargo products and your cargo products? The acquisition may be opening up avenues for you, revenue synergies where --, so that's maybe helping growth too above and beyond, with the one plus one, equals more than two, if you will?

Good question. We've said it when we did the acquisition for AS&E. Our product line, we would confidently say is the broadest product line compared to any of our competitors, both in the cargo space and also into what we call the aviation and checkpoint space and with the trace acquisition. Definitely the logic is one plus one makes more than two. It opens up more doors. We can be more flexible. We can offer more services. And one of the things that we have said it is we also have a turnkey business. And when you have a turnkey business, wherever you are providing a service, now that we have a broader product line, we can offer more optimum products to what the customer needs than to have a narrower product portfolio like some of our competitors. That's a big advantage and definitely, we are seeing traction with that.

Okay. And sticking with the Security division. Obviously, you seem to be certainly running, if not all, some of those pretty close to it. With the operating margin, nice sequential increase, and pretty substantial year-over-year increase, how should we view that, that low 16% number? I mean, obviously, historically, I think this is your peak. But you've also done a lot of restructuring over the last few years. So I know you were in the 15% range going back a couple of years for I think two or three years straight. You've done some restructuring since then. So you have made some accretive acquisitions probably on both the margin too. So how should we view this number? And I know you don't guide to the quarter -- to the segment per se, but is this a sustainable number? Was there anything unusual in this quarter?

Larry, this is Alan. Good question. And you are right we don't really guide to operating margins, specifically. To your question, was there anything unusual this quarter in the security? Nothing of a substantial nature at all. So it was a pretty routine quarter for us. There will always be puts and takes that drive our operating margin in the mix in business in terms of the geographical mix, in terms of the product and service offering a mix, will lead us to have some sometimes higher margin and sometimes a little bit lower. But there was nothing particularly unusual in this quarter.

Okay. And then health...

Well, just to add on to it, obviously, we have said it clearly that this quarter has a new product line, which was out there before. But that was planned for and forecasted and we want to capitalize that.

Right. And will there be any synergies on the (inaudible) acquisition, on the cost side, or not too many? Is that mostly a revenue opportunity?

Well, we said it in the last conference call. And Alan...

Yes, okay. That was some, right? Yes, yes. Okay.

But we want to emphasize, AS&E was specifically bought and we made a very big focus on the synergies. This acquisition of the trace business is not synergy dependent. It's more a portfolio needed to broaden our portfolio. And what you said before, 1 plus 1 to be more than 2, it's not synergy based. But then at the same time, there is definitely some synergies long-term because some of the back-office functions, the IT, the HR and some of the sales and marketing and stuff, that's common. But we don't look at that in this particular transaction that, that's going to be the primary reason. It's the product line and to be able to enhance and sell more X-ray machines when we are selling trace and selling more trace when we're selling X-ray machines.

Okay. And you mentioned a lot of your product lines are growing. Or it sounds like the majority, if not all of them, on the Security side. And certainly, a favorable macro and with this acquisition of AS&E and now the ETD purchase, certainly you have more stuff in your bag if you will. Are you -- is this -- obviously, it hasn't turned related into any turnkey deals yet. But I realize that it's a multiyear type process. Is it fair to say that at least the Q and the interest level has risen, along with what seems to be a very favorable macro?

Well, the answer is yes. But I mean, I just want to correct you. We did announce a $40 million deal.

That would serve a quasi-turnkey deal, yes. Right.

Yes. So we look at it the turnkey and the cargo especially are integrated into it. And they're going to be training in controlled rooms and stuff. It's all going to become sort of a semi-quasi turnkey, or a semi-quasi up-selling into the equipment market.

Okay, great. And then just last question some on the Opto, nice year-over-year improvement. The sequential drop in operating margin, is that anything that -- is that just seasonality, or is there anything else behind that?

This is Alan, Larry. As we mentioned following the Q4, we had just an incredibly favorable mix in our fourth quarter. So when you're looking sequentially, we're coming off a very high operating margins in that fourth quarter. So nice to have the year-over-year and improvements, and the team in Opto is really doing a great job.

The next question is from Jeff Martin of Roth Capital Partners.

If I'm not mistaken, this is the first quarter you've broken out services revenue. I was wondering if you could just kind of walk through the components that -- it was up 36% versus an 8% increase in products. You didn't necessarily mention it in your prepared remarks, but I thought it'd be helpful to get a little detail behind that.

Sure, Jeff. This is Alan. I'll take that. So we broke out our service revenue for several years in our 10-Q. But you're right, they're now showing up in the earnings releases as well. The strong growth in our services revenue is a function of a few things. One, it would be the trace acquisition and the AS&E acquisition, where we got a full quarter of benefit as well. So both of those 2 things had a considerable impact. And as our installed base in our security business overall has continued to increase nicely, the related services coming with that has also increased. So the service business has been performing very, very nicely for the company overall.

And then the margin difference is about 220 basis points year-over-year for services. Is that mainly pickup in margin from the mix due to trace and AS&E?

It's the combination of enhancements to the margin from the acquisitions, but also a pickup in our margin of just our pure security core business, where the team has really done a nice job in improving the gross margins in our regular service offerings.

And then on the RTT side of security. Just curious to get some understanding around the significance of your first order in Latin America and kind of the Asia markets. Do you feel those markets are starting to become a little higher in demand? Are you seeing more opportunities there? Or are these more just situational type opportunities?

Definitely, especially the Latin America one. It's -- we look at it as a very significant win because there has not been much investment made in the Latin America over the last couple of years. But then there is so much economic interaction between North America and Latin America. And those airports have started spending money for enhancing their security. And with a win like this in Panama, it becomes a showcase. And then on the Asia side, definitely there is more awareness. But I would make a statement that what we've been saying for some time, the 2020, '21 is a deadline for Europe. But everything is being directed towards that time period where everybody in the world is more aware and they are going to take this opportunity to enhance their security.

There are no further questions in the queue at this time.

Thank you very much for attending the call. We are -- I'm very happy on the start of the year with a strong Q1, with a strong backlog going into Q2, and we're looking forward to talking to you in January. Thank you.

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day, everyone.