Good day, ladies and gentlemen. Welcome to the OSI Systems Incorporated First Quarter 2019 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 call maybe recorded. I would now like to introduce your host for today’s conference, Alan Edrick, Chief Financial Officer. Please go ahead, sir.

Well, 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 fiscal 2019 first quarter 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 fiscal 2019 first quarter financial results. Before we discuss our results, I’d 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 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 the expected financial and operational performance of the company and its operating divisions; the company’s expected revenues, earnings and growth; and expectations regarding the effects of recently enacted tax legislation. Undue reliance should not be placed on forward-looking statements as 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 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 results.…

Thank you, Alan, and again good afternoon to all of you. Fiscal '19 started on a nice trajectory as we generated record revenues and Non-GAAP EPS for the first quarter. The security division performed very well, while bolstering its backlog with strong bookings during the quarter also. The Optoelectronics and Manufacturing division delivered strong double digit revenue growth and operating margins, and completed a small strategic acquisition. The Healthcare division had a disappointing quarter, but we are optimistic that the division's financial performance will improve in the second half. Way into each division's performance, starting with the Security division, where we reported revenue of approximately $170 million, an increase of 5% over the prior year period. We are very pleased with the growth, especially given the tough comp in the prior year due to the reduced economics of the MSAT contract in Mexico, which we have disclosed on previous calls, and the prior year demand experienced for the explosive trace detection products stemming from the Department of Homeland Security trace last point of departure program. Security bookings were over $200 million in the quarter, which generated a non-turnkey book-to-bill ratio of 1.5 for this division. Bookings were strong in both the U.S. and international and across much of a product portfolio as border security and airport infrastructure efforts in Europe and Asia continue to expand. A few of the highlights for the Security division. Breaking down the bookings performance further, Security had strong bookings from of over $100 million for the U.S. government agencies. Shortly after the quarter end, we announced a few of the larger transactions. For example, a delivery order for $61 million from the Customs and Border for Z-Portalcargoand vehicle screening systems. A $21 million service and maintenance contract from another government agency to support our installed…

Thank you, Deepak. Now let's review the financial results for the first fiscal quarter in greater detail. As mentioned previously, our revenues in Q1 of fiscal '19 increased by 4% year-over-year. Q1 revenues in the Security division increased by 5% from Q1 of fiscal '18, driven by strong growth in cargo and vehicle inspection equipment sales. In addition, as our installed base has grown, Security division field service revenues have also increased. The 20% year-over-year revenue growth reported for our Opto division was driven by revenues from the flex circuit businesses acquired in January '18, and from our optical sensor and higher level assemblies business acquired in July '18, as well as ongoing strength in both organic external sales and intercompany sales, primarily to our Security division. As Deepak mentioned, we experienced continued challenges in the Healthcare divisions as revenues fell 16% compared to Q1 of the same prior year period. Our Q1 gross margin was 36.0% compared to 35.5% in Q1 of last year. This improvement was driven by improvements in our Opto division as a result of favorable product mix and improved operating efficiencies as well as improvement in the gross margin in our Healthcare division, as decreased sales were countered by our focus on more profitable product lines. Again, the 36% gross margin was the highest in the first fiscal quarter in eight years. As mentioned on previous calls, our gross margin will fluctuate from period-to-period based on revenue mix among other factors. Moving to operating expenses. In Q1 of fiscal '19, SG&A expenses were up $6 million, primarily due support the Security and Opto division growth as well as due to the added expenses from the two Opto division acquisitions mentioned previously. We continue to focus in all of our divisions on improving efficiencies and prudently…

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

Thank you very much. Very good quarter. Couple of quick housekeeping questions to start off with tax rate, first of all was very low in the first quarter. What should we expect for the year, and what’s included in your guidance -- in your earnings guidance?

Sure, Brian. This is Alan. Yes, so the low effective tax rate you're looking at on a GAAP basis includes about $1.5 million benefit from a discrete item. If we exclude the discrete items, our effective tax rate was 28.1%, which was pretty comparable to last year, which was 28.3%. So our guidance assumes that annual effective tax rate more or less.

Okay. So roughly 28% is what we should assume for the rest of the year? Or should we see this kind of tax rate continue in this quarter that we back out then?

Yes. That was a onetime benefit that occurred. There may be further discrete items throughout the year. But the largest of those tends to occur in Q1, related to that particular item. So using the 28% rate, we believe it will be appropriate. We continue to evaluate tax planning opportunities to lower that effective tax rate. But we do think that would be appropriate to use at this point in time.

Okay. And then another housekeeping on the R&D side. The amount was down year-over-year. And it -- is this related to anything with RTT certification? Is this related to Healthcare, a less investment there? Can you give us some kind of -- or it just could be seasonal? I have no idea.

Sure, Brian. This is Alan. I'll take that one as well. It's really related to two things. One, like you mentioned in Healthcare, as you recall from last year, we talked about deemphasizing our anesthesia product line. And then so doing some of the R&D that we were spending on anesthesia at this point last year, no longer continued. So we would see our R&D in healthcare come down a bit. The second would be post acquisition of the trace detection business. We saw opportunities to further consolidate and gather some synergies, and we took advantage of those opportunities. So that drove down a little bit of our R&D on the Security side. Both of those type of things were very helpful for us.

Okay. And then just a couple of other questions on housekeeping. On the Healthcare side, it continues to be weak. You made the same growth. When do you expect to see those changes actually start showing up in the revenue line?

I said, Brian, this is Deepak here. We feel good about some of the changes that we said also, and focused on the product line like the monitoring and in cardiology and the supplies and accessories. I said in my speech that second half should be positive.

And we certainly expect even before the second half, on the sequential basis, we would anticipate Q2 being much stronger than Q1.

Okay. Then on the year, in your guidance, do you anticipate Healthcare to be up or down on a year-over-year basis? Or it's going to recover in 2020 as what you're anticipating is still going to be down in 2019? Is that fair?

Yes. So we only provide guidance on an overall company basis. But we are anticipating much stronger performance out of the Healthcare division than that, which we saw in the first quarter.

Okay. And then just couple of other quick questions, and I'll stop. Middle East exposure, there has been a lot of questions about companies exposure in Saudi Arabia and folks like that. I know that Middle East is a lot of fire of your products. Can you talk a little bit about a kind of issues that you're seeing or any slowdown that you're seeing in the Middle East, maybe specifically to Saudi [indiscernible].

Brian, this is Deepak here. We haven't seen anything. In that part of the world, there is a lot of activity. But if you look at it from a global perspective, our product line and our geographic reach is so broad. We look at the total world. And there is always some turmoil in some places. Some places are great opportunities. We don't see anything today at all to move into Saudi.

Okay. And then, final question on field services, Alan. I think that you mentioned that's really growing fast. Can you give us some kind of number on our percentage or something that we can get our hand around that how fast field services stride?

Sure, Brian. Yes, it's been -- it's really been a nice source for us of growth. Our install base has been increasing significantly over the past several years. And as a result, as products come off warranty, our service revenues increase with that. So with that point and the specific numbers, we really did see significant growth in our field service revenues throughout our different security product lines.

Would that relate to RTT in Europe also?

RTT in Europe was certainly a part of that. We also saw it in the cargo area, in the trace area.

Okay, thank you.

And our next question comes from Sheila Kahyaoglu with Jefferies. Your line is now open.

Hi, good afternoon, and thank you for the time. Alan, I guess you to elaborate a little bit on security and mix and what’s driving such strengths there, if you could talk about that a bit more, on the profitability.

Sure, Sheila. On the profitability, or on the sales?

On the profitability side.

Yes. So I guess and it'll probably the sales and profitability might go hand in hand a little bit. But, the security management team has done an outstanding job growing the pipeline of opportunities resulting in the bookings and the realization of sales. And we've seen it both on the equipment side and on the service side. And we're really pleased with that performance in light of the difficult comps, especially related to Mexico, from a year over year perspective to have top line growth in the security and having comparable type of profits to last year -- is really a notable achievement. The cargo team has done really an outstanding job, driving the cargo equipment revenues both in the U.S. and internationally, and the related service that comes with that. Similarly on the other side of the business for our baggage and parcels inspection products and our explosive detection systems and trace products, our teams have really done a nice job growing that. At the same time, everybody has been focused on improving efficiencies, looking at supply chain and other opportunities to continue to improve the profits in that regard. So I think, all those things factor together, really helped drive a nice bottom line to your question.

And in terms of, sequentially on an adjusted basis, your margins are still up 300 bps post Mexico. So is that just coupled with your growth services that you’re seeing? Or it -- I am putting ways near amount they're quantifying it. But is that what’s really driving it?

You're absolutely, partially right. The basic service revenue, non-turnkey service revenue growth, which generally carries a higher gross margin and therefore operating margin and equipment sale, has absolutely contributed to that. So you’re absolutely right.

And then just on the free cash flow, can we talk about the cadence of growth from here, what improves if it's just timing, if you could extend on that a little bit more?

Sure. So coming off of a very strong free cash flow here in fiscal '18, Q1 was a little bit light. And the reason for that was multifaceted. A big part of that was the increase in inventories. So our inventories increased quite substantially, and that's really all geared to the buildup to sell the large backlog that we have as we head into Q2, Q3 and Q4. So that was all anticipated. We saw a little bit slower customer collections. So we had a bit higher DSO. Going forward, we think there's great opportunity for free cash flow because some of that build up in inventory will be burned down. So we’ll improve our day's inventory, we’ll improve our DSO on some faster collections, and then we generally have higher profitability in Q2, Q4, than we do in Q1. So we would anticipate that our cash flow will really gear up to. In addition, we had some residual taxes that we had to pay in Q1, from some of the repatriation initiatives that we executed in fiscal 2018 that we're going to beneficial to the company, but there was just a lag effect on the timing of those payments.

And then, and so just one last one, if I can. In terms of bookings that $200 million within securities that you booked in the quarter. You mentioned I think the $100 million from U.S. agencies. What's driving -- is that a pickup from the U.S. agencies? Is that budget driven? If you could expand on that.

Well this is Deepak. These are customers that we've had for a long time. And, some of them are additional products, some of them are service, and some of them new initiatives as the total world is more focused on to the security. And definitely September end is the budget year-end for the U.S. government, so that does help. But we are very, very happy and proud to say that this has been a good year for us, for U.S. government related bookings, not to mention also international.

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

Great, thanks. Just a couple of clarifications. On the EPS, Alan, for the quarter, you actually, on the Non-GAAP adjustment, you take out the benefit, right, on tax rates. So you're using that 28% unchanged effective rate is that correct?

That's correct Larry. We're not using the 14%. We're using the 28%.

Okay. And then that the DSOs went up a little bit, as you mentioned a little bit more on the collection. What gives you sort of the one thing in particular, extraordinary, what gives you sort of confidence that that will improve?

Yes, we just saw some slowdowns during the summer, particularly some of the international customers, which is not necessarily typical in certain periods during the vacations of August and September. We've already seen a pickup in collections in October. And based upon some of the discussions that we've been having, we anticipate that will continue in November and December. So we believe we will see an improvement in our DSO.

Okay. And I know the geopolitical risks were, question was brought up in Saudi doesn't [indiscernible] risk in the short term. Is there any particular area that you guys have been impacted at all? Why any of this sort of perception there rising sort of headwind outside of the U.S.?

This is Deepak here, Larry. Again, my answer is that we look at it very focused on it all if globally there is something happens somewhere. But our business is so broad. Our customer base is so broad. Our global reach is so broad that I don't think that there is any alarm for us.

And Security, Deepak, obviously, it seems like the last few quarters, bookings have been strong and the strength seems pretty broad base. Any one particular area that is really been the leader or conversely any area that's sort of lagging on the security side?

U.S. has been very good both in the cargo space and the trace kind of thing. But on the international side, it's the RTT, it's standard products, it's cargo. There is no one reason. If there is one area that we know, it's weak, that has been for some time. Latin America has been weak over the last couple of years. The rest of the world, I believe, that with all the stuff that you have in the news, including what you have over the last couple of days. Security is going to continue to be in the focal point for everybody to increase. Now that's a sad thing to say, but that's a fact.

Absolutely. You mentioned that, I think, you said two contracts are going live that will require the integrated services. Just one of them was this $40 million so called hybrid contract you announced in August of last year. Is that correct? And then could you tell us what the other one is?

That is true what you just mentioned. And the other one is a small contract International. That is going live, and that's also integrated services contract for which, Alan mentioned that we’ll also put some CapEx this year -- this quarter.

Okay. On the Opto side, really good operating margin there. It looks like it circled back over the last few years, and one of the highest - not the highest, I guess, second highest quarterly result. I realize there's a little bit of quarterly volatility, but is this number sustainable? Has it been helped sort of by some of these acquisitions. Or, any color on that?

Yes, Larry this is Alan. Good question. You're right. It's very strong operating margins. And we continue to believe that the business can continue to put up very strong operating margin numbers. We’ll always see some volatility associated with the mix. But some of the acquisitions that have been done recently have absolutely contributed to expanding operating margin business, higher quality type of sales with higher margins leading to higher gross margins. So the business has done a really nice job, shifting away from what we had a few years ago of some of the lower margin business to higher margin business, and continuing to grow the top-line, and leveraging that growth in the top-line to operating margin expansion.

Okay. Just lastly on the Healthcare piece. I think, directionally no surprise there, perhaps a little bit -- a little bit worse than we had thought. But have you -- has the exit of the anesthesia businesses that are almost complete? What sort of gives you some of the confidence that you'll -- parts here, what gives you sort of the confidence that will see a rebound in the back half? Can you maybe discuss the macro? Or what sort of efforts or gives you that confidence of visibility? Thanks.

Larry, this Deepak here. Bottom-line is that we have been delighted in anesthesia, but it's not been a success. And so we decided that we got to focus on it and we said this on in last conference call because we’re known in the industry for the patient monitoring. And basically, we want to focus, focus, focus, and put more emphasize on that. And also, I think, Alan has mentioned before in the call that anesthesia not only -- was not growing, but it also a loss making. So we decided that we need to exit that, to redirect ourselves, and we believe that the redirection and the focus we have all that we should get more business. As you know, on the other hand, Healthcare is a single digit growth anyway. So we want to just focus on it and see what we can capture both in domestically and internationally. And we have brought some new talents into both at the top. At the same time, we believe that supplies and accessories, which is a good business. It puts us in front of the customers most of times even after the sale. So we brought in some new leadership there, and want to focus and grow that side of the business because that’s a very predictable long-term business that continues to make you in front of the customers.

And our next question comes from Jeff Martin with Roth Capital Partners. Your line is now open.

Just want to verify the service and maintenance contracts that you're bringing on board. Those are non-CapEx requiring contracts, is that right?

One of the contracts, Jeff, this is Alan. One of the contracts does require CapEx, again to the turnkey contract, so some of the CapEx that you saw here in Q1 was associated with that.

Okay. And that CapEx has been expense at this front?

That CapEx is part of our -- yes, it's been incurred, yes.

And then, could you touch on or elaborate on the event security opportunity? I know you’ve been talking about that for a couple of quarters now. But it seems like you're gaining some tractions, specifically this year. And how larger the market do you think that continues for you on an annual basis overtime, you don't put a timeframe on, but maybe over the long run, what do you see it getting to potentially?

Yes. Number one is, I don't -- obviously we have internal targets kind of the things, but it's a new market. It's very difficult to put a number on it. But I think that, even for us that is we were always in like this Olympics. So we were focusing on it and looking at it that there these, what I would called, smaller, predictable, long-term repeatable sporting events, concerts and stuff, which is requiring more and more security, what I would call it upgraded securities, not just a simple guard service upgraded. So we decided. We're going to went up. We're going to try our hands. So we did the sponsorship for the PGA Senior Golf Tournament. It was very well received, because it just gets the name out there. And a lot of people in this industry allowing whether it's tennis or whether it's basketball, whether it's football or cruise lines or whatever or concert, they all get together. So we are able to show our name there. And we believe that -- with that showing our name out there and our ability to grow the technology platform to make security more safer and more predictable. We think that will make some headroom. It's not going to become a -- what I would call a $100 million business. I think it will -- it's too early to say, but we believe that if we can take it into the 10s, 20s, it will be a great business for us.

Okay, that's helpful. Could you touch on your acquisition strategy? Are there opportunities looking at in all three segments and perhaps not Healthcare as much? But, and you've made acquisitions enough. So I just kind of what you're thinking from a bigger picture standpoint will be helpful.

Well, one of the things we're not going to speak -- we’re not going to share much what we are doing. But, I think, you will see us in the Opto manufacturing business to do strategic, synergistic technology broadening acquisitions. And we’re going to -- they tend to be smaller, but they tend to be what I would call a product line that we can add on synergistically offer more services to our customers that could be already have or their customers where we can take some of the stuff we have to put it in their side. In the Security side, we are a little bit more focused on a broader picture globally and with the product line expansion. The two acquisitions that we have done have been very good for us. Are we looking at more? The answer is, we always do. We're not going to say anything more than that. And then, as we broaden our reach, whether it's in turnkey, whether it's in sporting events, whether it's in cargo inspection or the turnkey, we continue to look at our opportunities.

Okay. And then my last question is on the Harris L3 merger. How do you view that from a competitive standpoint and also on an opportunistic standpoint?

Well, a lot of people have asked us that. We don't see anything of any consequence one way the other. L3 is a big guy to begin with. So they got bigger. Harris don't have much [indiscernible] at all or if any in the Security side. So don't bring any synergy on that side. So we look at it business as usual. On the other hand, if their focus -- when they get together finally and they consolidate it, and thus this becomes a less important, we will always look at it.

Okay. And then, were there any stock repurchases in the quarter?

Yes, there were. We repurchased approximately 100,000 shares of stock during the quarter.

And our next question comes from Josh Nichols with B. Riley. Your line is now open.

Yes, thanks for taking my question. I was curious. Really strong quarter, especially, you see with the bookings for U.S. government, especially, as year end. But I was going to ask like some of these -- the bookings numbers can layer into revenue over multiple years. Any kind of color you could give us on how much of that backlog? Do you expect to kind of fall into fiscal 2019 roughly?

This is Deepak here. I can’t break it on specifics. Some of -- most of the orders that we have announced is for the equipment. And equipment orders depending upon some plus minuses, they all will get shipped in the next couple of quarters. Alan, if you want to add. Some of them are maybe at multi-years on add-on service contracts and they happen all the time. But I won’t think that that most of the stuff, $100 million is service ready, is mostly equipment related. Alan?

Sure, Josh. Yes, a nice portion of our bookings, both in the U.S. and abroad will ship in the fiscal '19 period, though there's certainly aspects of it that will ship beyond that as well based on customer requirements. In addition, some of the service contracts can be multi-year in nature. So those will be a combination of fiscal '19 and beyond.

Thanks. I was going to ask so - I know it's only been a quarter since you announced some of the changes that going on in the Healthcare business. Any specifics you could provide on that action plan as far as what's been done to date? Or what are some of the checklist items to do and kind of the timeline in for some of those things?

Yes, this is Deepak here. That’s been about - it's been more than a quarter approximately. Again want to - I don’t want to something like a broken record. Focus, focus, focus is what we are added. We are deemphasizing anesthesia. We’re trying to make the product stability. And as of whatever else growth needs to happen, new things have to be added on to the monitoring line. And the cardiology line, which is at higher margin business. We want to expand that. Supplies and accessories is another area, which I have said that we want to focus on it. We got some leadership in there. And basically better than faster and more predictable delivery, supply chain, a happy experience and features that the customers want, and what they know about us, we want to make sure we provide that service to our partners and to our customers.

Thanks. And then, I know, historically, as other people mentioned you have a really diverse business that you do to work in the Middle East. I know rise in oil prices is kind of generally been a favorable tailwind for the company. Is that a materially impactful thing that you have noticed in the security business? Or is it more, a small incremental benefit as far as the security business that you’re seeing for the bookings?

Well, if you are referring to it, oil prices related to the thing, just in the Middle East area, couple of years ago, when the oil wasn’t 20 to 25 is obviously everything stopped. But over the last couple of years, the economies in all these places have been good. And I've always maintained it what I said before, it's important because that generates their liquidity, that generates the dollars and whatever of the currency. But superiority is a primary important thing for all these countries. And I said all the time, even if you have to protect your assets of oil just like you protect your house. So you want to get it. So we believe that long-term, our goal is to provide a solution that can be the right solution for what the customer wants for securing their assets and looking after them.

And then, last question for me kind of two parts really, but related to kind of check that there is screening really. So now you're seeing your first shipment for the first order for 920CT that's been approved in Europe. One, how material of impact do you think that that could have on European sales? And then also, you way down approval from the TSA for the RTT110. Anything you tell us about what that process looks like or how long can that process takes to get approval from the TSA?

Well, you asked two sided questions. On the first one, on the RTT, and not on the CT checkpoint. We continue to watch. Basically this is an evolving new trial demos most customers are looking at, trying to put to see how much benefit they get. We are watching on it. We have a product even successful. We are deploying it. We're doing demos in other parts of the world. And, but it's a wait and see game, how it works. Everybody wants to take a very careful view to how it grows and we just want to be there. The good news is we are owning that socket anyway to that customer. So we can be there, add on the new product, help with them and see where it goes. If that is the RTT110 certification, we are in the final doors of the certification in TSA, but we can't commit to when. I think that we have to go. We've been saying it for many years. I think this fiscal year; we'll definitely get the certification.

[Operator Instructions] And we do have a follow-up with Brian Ruttenbur with Drexel Hamilton. Your line is now open.

Yes. Just one quick follow-up. Can you repeat the amount of bookings that you have post the quarter? It was $200 million that you had in additional bookings. Is that the number?

I think what Deepak was referring to was announcements that were made subsequent to quarter-end for bookings that occurred during Q1, Brian. So the total bookings were about $230 million in Q1.

Okay. How things progressed post the end of the quarter? Are bookings continued to be strong?

Yes.

Okay. Any elaboration on that?

You know, I'm not going to say it.

And I'm not showing any further questions. That does conclude today's question-and-answer session.

Well, thank you. I would like to thank everyone for joining our call. We are very happy in the Q1, the beginning of the fiscal 2019. And look forward to speaking with you again on our next call. Thank you very much to all of you.

Ladies and gentlemen thank you for participating in today's conference. This does conclude today's program. You may all disconnect. And everyone have a great day.