Deepak Chopra - Chairman, President and CEO Alan Edrick - EVP and CFO.

Brian Ruttenbur - Drexel Hamilton Greg Konrad - Jefferies Larry Solow - CJS Securities Josh Nichols - B. Riley & Company Jeff Martin - ROTH Capital.

Good day, ladies and gentlemen, and welcome to the OSI Systems Fourth Quarter and Fiscal Year 2018 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference is being recorded.

I would now like to introduce your host for today’s conference, Mr. Alan Edrick, Chief Financial Officer. Sir, you may begin..

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 fourth quarter and fiscal year end 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 2018 fourth quarter and full fiscal year 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 actually results could differ materially from any 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 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 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 company’s general business and operations, I’ll provide a high-level financial overview of the fourth quarter. First, we reported fourth quarter revenues of 287 million, a 14% year-over-year increase.

This increase was driven primarily by our Security division for which we reported record Q4 revenues of 185 million, up 26% from revenues in Q4 of fiscal '17, including 17.5 million of revenues from our explosive trace detection business acquired in July 2017. Excluding such revenues, Security division revenues increased by 14%.

Our Opto division reported 9% revenue growth with strength in multiple channels, including intercompany sales. The Security and Opto division revenue growth was partially offset by decreased revenues in our Healthcare division.

Second, we reported Q4 GAAP diluted earnings per share of $0.27 compared to diluted earnings per share of $0.08 in the prior year. On a non-GAAP basis, Q4 EPS was $1.02 per diluted share consistent with Q4 of the prior year.

Q4 non-GAAP EPS excluded the impact of impairment and restructuring and other charges including certain legal costs, amortization of acquired intangible assets and non-cash interest expense, all net of related tax effects. It also excludes discrete tax items.

Third, operating cash flow is 17.3 million for the quarter and a record 133 million for the full fiscal year, while capital expenditures were 6.8 million for the quarter and 43.2 million for fiscal 2018. And finally, our Q4 2018 book-to-bill ratio for equipment and related services, non-turnkey, was a strong 1.3x.

Our backlog as of June 30, '18 was approximately 976 million, an increase of 32% over the prior year with the strong book-to-bill ratio in all three divisions. Before diving more deeply into our financial results and discussing our fiscal 2019 guidance, let me turn the call over to Deepak..

Thank you, Alan, and again welcome to the OSI Systems earnings conference call. We had a good quarter achieving record revenues and for the first time in our company’s history, we are excited to announce that we have surpassed the $1 billion revenue milestone for the full fiscal year.

Our Security and Opto divisions contributed solidly all year long and Q4 was no exception, while the Healthcare division struggled for the second consecutive quarter. As you may remember on the previous call, we made a leadership change in the Healthcare division midway through the quarter that’s already making an impact.

We will discuss a few of the changes which are underway to improve this business when I discuss the various business units. Let’s go into the detail about each division starting with the Security where Q4 revenues were up 26% year-over-year and reached 690 million for the full fiscal year.

Q4 Security bookings are also very strong coming in at 198 million and an impressive 863 million for the year, which represents a non-turnkey book-to-bill ratio of 1.3 for the quarter and 1.2 for the year, respectively. The revenue increase in Security resulted from a nice balance of growth organically and through acquisitions.

Organically, our cargo equipment sales were robust coupled with strong checkpoint sales. With a larger installed base, our service revenues also increased nicely.

The trace detection acquisition completed in July 2017 was a great addition as it delivered strong revenues and profits and from a strategic perspective, trace detection strengthened our aviation security portfolio, while enhancing our recurring service and consumables revenue streams.

Along with improving our position at airports, the trace detection business also brought new customer relationships in non-aviation and critical infrastructure where customers typically don’t have the same regulatory constraints imposed upon the airport customers.

We are excited about the potential of integrating the various technologies to develop inspection platforms that utilize multiple detection methods to make passenger and cargo checkpoints more efficient. A few of the highlights from Q4 for the Security division.

In the cargo product line, we had an excellent finish to the fiscal year receiving a notable award during the quarter of a $63 million contract from an international customer to provide multiple cargo and inspection systems to help secure their critical infrastructure.

As many oil economies continue to recover, we are seeing increased demand from the international regions that have benefitted from this trend and thus have more capital resources to improve their overall security infrastructure. In the U.S., the Customs and Border Protection agency, CBP, continues to rely on our cargo installed base.

Shortly after the quarter end, we announced a multiyear $140 million IDIQ along with a $25 million initial delivery order to support and maintain the existing cargo vehicle and parcel inspection systems fleet in service. This was a great win with CBP who happens to be one of our largest customers.

In integrated services, also referred as turnkey services, are current programs in Albania, Mexico and Puerto Rico continued to perform well.

Our turnkey service business S2 Global has been working closely with the cargo equipment team where we can leverage its integrated service offering of large-scale program management, operator training and command center network designed for larger more comprehensive tenders.

The S2 team is also marketing its capabilities to sports and entertainment venues worldwide as we believe these potential customers can greatly benefit from enhanced security and integrated services that S2 can provide.

In March 2018, we provided security and were also a sponsor for the Rapiscan Classic, a Champions PGA Senior Tour staff in Biloxi, Mississippi. This event was a big success as it brought increased awareness of S2’s capabilities. We will continue to expand our footprint globally in this space.

On the checked baggage front, we remain focused on growing the international market as we announced two $10 million contracts during the quarter for an air cargo customer and an international airport customer. European airports continue to be active in adopting the ECAC Standard 3 technology to meet the upcoming deadline.

In the U.S., we are in certification protocol with the TSA for the RTT 110. In the international airport checkpoint market, we received Standard C3 approval by the ECAC for our latest computed tomography CT solution at the checkpoint Rapiscan 920CT.

Last year, we realigned our Security division so that the cargo and solutions group can focus on cargo and vehicle inspection and integrated services while the detection group can focus on checkpoint security systems, explosive detection systems in aviation and instruments including trace and radiation detection products.

I believe that the realignment contributed to the strong results as it allowed each team to provide greater emphasis on their opportunity base. Heading into physical 2019, we are excited about the strength of our security backlog and pipeline of opportunities across numerous platforms.

Moving to the Optoelectronics group in the fourth quarter, the optoelectronics group and Manufacturing division generated total revenues, including intercompany sales, of 65 million which was a 9% increase from the same period in the prior year.

The Opto team is doing a great job of selecting profitable opportunities and also benefitting from growth with flex circuit customers. As we mentioned in the press release, we did have a business in this division that incurred an operating loss and we have addressed the underlying issues.

Shortly after the fiscal year end, we completed a tuck-in acquisition of an Optoelectronics solution business. This acquisition is expected to add about $13 million in revenues and fits really well with our existing optical sensor business. This acquisition brings new technology and capabilities that we can offer to our existing customer base.

As Opto ended fiscal 2018 with record quarter ending backlog, we believe that the division is well positioned for growth in 2019. Moving to Healthcare. Spacelabs sales were 48 million in Q4 or about 11% lower year-over-year. The performance of Spacelabs was disappointing in Q4 but changes are underway under the newly appointed President, Jim Green.

The Healthcare management team is increasing its focus on the core markets of patient monitoring and cardiology and related supplies and accessories business while deemphasizing the anesthesia and ventilation products.

These actions allowed greater attention and focus to the areas of strength for us and together with further talent added to this organization this past month, we expect the Healthcare to improve its performance in fiscal 2019. Overall, I’m pleased with the Q4 and fiscal 2018.

As we look ahead, we will continue to focus on making strategic investments in technology and people to enhance our competitive position.

Fiscal 2019 is expected to be a strong year, albeit with a challenging Q1 due to unfavorable comparisons associated with the reduced revenue of the Mexico turnkey contract and due to the timing of the rollout of our backlog which is very strong, which is weighted much more to Q2 and beyond for both Security and Healthcare.

I am very proud of what we have accomplished in fiscal 2018 and look forward to an exciting 2019. With that, I’m going to hand the call back over to Alan to talk in more detail about our financial performance and guidance before opening the call for questions. Thank you..

Thank you, Deepak. Now I will review results for the fourth fiscal quarter in greater detail. As previously mentioned, our revenues in Q4 of fiscal '18 increased by 14% year-over-year.

Q4 revenues in the Security division increased by 26% driven by strong performance across much of our product portfolio, most notably in the cargo and vehicle inspection product line and our acquired ETD product line. In addition, as our installed base has grown, the field service revenues in Security have increased as well.

The 9% year-over-year growth reported for our Opto division was driven by strong intercompany sales to our security division and the impact of the flex circuit business that was acquired in January 2018, which contributed approximately 5 million to Q4 sales.

As Deepak mentioned, we experienced continued challenges in the Healthcare division as revenues decreased 11% in Q4 in comparison to the same prior year period. Our Q4 gross margin was 35.2% compared to 34.4% in Q4 of last year.

This improvement was primarily driven by strength in our Security division which continues to experience favorable product and channel mixes, along with the benefits often associated with growing economies of scale resulting from higher revenues and operational efficiencies.

The higher companywide gross margin was particularly notable given the weakness in our Healthcare division which typically generates the highest gross margin among the three divisions. 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 Q4 of fiscal '18, SG&A was up 16 million over the same period last year in order to support the growth of the Security division including costs associated with the acquisitions of the trace business in July of '17 as well as an Optoelectronics and Manufacturing division acquisition in January of '18.

All of our divisions continue to focus on improving efficiencies and prudently managing the overall cost structure. R&D expenses in Q4 were 15.1 million, up from 11.1 million in Q4 of the prior year due primarily to efforts to enhance our Security division’s product portfolio and inclusion of R&D costs from acquisitions.

We remain focused on innovative product development which we view as vital to the long-term success of our business. Impairment, restructuring and other charges net were 11.5 million in Q4 of '18 as compared to 24.8 million in Q4 of fiscal '17.

This included 8.2 million of charges in our Healthcare division stemming from one of our anesthesia products.

Other charges included asset impairment, acquisition-related costs, facility closure costs, employee severance costs and other legal and settlement costs net of a reduction in accrual following the resolution of a GSA compliance matter inherited from the acquisition of AS&E. Moving to taxes.

Excluding discrete items and the impact of the Tax Cuts and Jobs Act which was enacted in December of '17, the company’s effective tax rate on a full year basis was 26.8% in fiscal '18 compared to 27.6% in fiscal '17.

The slight reduction in the overall fiscal '18’s rate from that forecasted as of the end of Q3 led to a Q4 rate of about 20% excluding items mentioned above. Let’s now turn to a discussion of our non-GAAP adjusted operating margin, which excludes the items mentioned earlier in the call.

The company’s non-GAAP adjusted operating margin was 9.3% in Q4 of fiscal '18 compared to 9.7% in the third quarter.

The sequential change was driven in part by the full quarter impact of the new Mexico contract which is at a lower level run rate and thus reduces margins and a decrease in Opto’s operating margins which was due in part to losses incurred in our North America contract manufacturing business. Moving to cash flow.

In Q4 of fiscal '18, cash flow from operations was 17.3 million, capital expenditures in the quarter were 6.8 million while depreciation and amortization was 14.4 million. Days sales outstanding or DSO was 67 days representing a seven-day improvement as compared to the prior year level of 74.

Days inventory increased year-over-year to 153 to support the growth in backlog. Our balance sheet remains strong. We repatriated cash of approximately 140 million in Q4 which was primarily used to reduce the revolving credit line. As such, the reported cash in bank lines of credit at June 30 decreased from the prior quarter.

We ended the year with net leverage as defined under our revolving credit facility of approximately 1.7. Finally, turning to guidance. For fiscal year '19, we anticipate net revenues of 1.125 billion to 1.165 billion and non-GAAP earnings per diluted share of $3.80 to $4.00.

This non-GAAP diluted EPS range excludes impairment, restructuring and other charges and amortization of acquired intangible assets and non-cash interest expense and their associated tax effects.

As Deepak mentioned, we enter fiscal 2019 with a strong backlog which is weighted more heavily to Q2 and beyond and therefore as we anticipated we expect reduced year-over-year sales and non-GAAP EPS in Q1 with nice top line and non-GAAP EPS growth beginning in Q2 and for the remainder of the year.

We continue to evaluate the impact of tax reform on the effective tax rate including the new taxes associated with the computations for the global intangible low tax income and foreign derived intangible income. Each of these provisions is complex.

Our current non-GAAP EPS guidance is based upon a fiscal year '19 effective tax rate which is a little higher than that of fiscal '18. However, this amount is subject to significant volatility and will be updated as more analysis and information is available. We currently believe the sales and earnings guidance reflects reasonable estimates.

Actual sales and earnings, however, could vary from the anticipated ranges due to the risks and uncertainties specifically affecting our business, including taxes and generally affecting industries in which we operate.

These risks and uncertainties include items beyond our control such as site readiness or product installations, evolving government trade policies, customer acceptance and the timing of orders in each division as well as other risks and uncertainties discussed in our SEC filings.

We have continued to grow our business while generating significant cash flows and investing in product development and making selective strategic acquisitions. Our products and acquisition investments enable OSI to continue our leadership role with innovative products and solutions across our various industries.

Thank you for participating on this conference call. And at this time, we’d like to open the call to questions..

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

Great. Thank you very much and great quarter and year. Can we talk a little bit about the Security bookings? Are the overall bookings book-to-bill 1.3? And then Deepak also mentioned after the quarter you had even more bookings from customs and border patrol.

So can you talk about what you see in this quarter and the year on the bookings side?.

Yes, Brian, this is Deepak here. I mentioned on my presentation that our bookings in Security have been on a broader platform. Both the cargo side of the business and the detection side of the business have all had strong bookings. Also we mentioned both in the international sector and in the U.S.

sector it has been strong and they are across the board whether it’s cargo products, whether it’s checkpoint, whether it’s trace, so we are feeling very good about it and entering the next year with a strong bookings in the Security.

We also said with that same sentence that some of the bookings that we have, they result into shipping – shipments and revenue are more skewed towards Q2 and onwards from the Security side..

Okay. So you believe that that kind of growth is sustainable on the Security’s side is the summary. And then answer that and then I want to ask if you’re impacted by any of the tariffs, because I know that you have some manufacturing outside the U.S. in Asia..

To answer to your first thing is yes, we are going in and we’ve said it – going into 2019 with a strong backlog. Our funnel activity is quite strong.

And overall, I’ve also said with the oil economies improving and some of the stuff that for some years maybe were delayed in some parts of the world, they’re coming back to increase their security awareness in a broad product line which I’m proud to say we have the broadest product line gives us much more opportunity to go after these customers.

Regarding your second question, we’re watching carefully. We don’t see any impact as yet. And fortunately for us we are a very broad base even geographically and we’re watching carefully..

Okay. And then I have a couple of questions for Alan in terms of the guidance that you gave.

Can you give us what tax rate and share count that you’re assuming in that $3.80 to $4.00? Are we talking 25% tax rate, a flat share count? Maybe give us some kind of ballpark or some kind of ranges?.

Sure, Brian. So we’re expecting our tax rate to be probably just north of where we finished this year. We finished this year at 26.85%.

So we’re expecting to be probably just a little bit higher than that with the caveat that we’re going through calculations right now related to tax reform and the so-called FDII and GILTI provisions which could add some variability to that. But our assumptions include a tax rate pretty comparable to the year that we just finished.

On a share basis, we’ve finished our fourth quarter with about 18.7 million diluted shares and we’re just assuming some small increases from quarter-to-quarter on that balance right now..

Okay. And then in terms of revenue breakdown and costs, was there any reclassification in the period? It seems like gross margins were a little bit stronger and SG&A was a little bit higher than what I was looking for as with R&D. But that could just be my modeling.

I’m just trying to understand if there were any reclassifications?.

There were some reclassifications associated with certain commissions in preparation for new ASC 606 which would increase revenues a little bit and would increase SG&A a little bit as well. That’s correct..

Okay.

And then just final question, just kind of going forward on your guidance, can you give us any kind of general terms about where you see Security – maybe just tell me is it going to continue growing at its current rate, is Healthcare going to be flat, is Opto going to be experiencing growth like it has historically? I know that you don’t generally break down and say, hey, we’re going to grow Security 12% and Opto 11.5%.

I’m just trying to get some kind of guidance from you guys?.

Sure, Brian, I’ll take that and you’re right. Our overall guidance is on OSI Systems as a company. Our general practice is not to provide guidance by division. That being said, our guidance does imply probably stronger growth in Security.

I would say we’ve factored in some conservatism in the Healthcare division given the softness we experienced in the second half of fiscal '18.

It factors in a little bit of the headwind that we have from the reduced revenues associated with the Mexico contract in our Security business, but overall we’re looking for our Security to be driving a nice share of our overall growth..

Okay. Thank you..

Our next question comes from the line of Greg Konrad from Jefferies. Your line is now open..

Good evening. Just wanted to follow up on just the last question really quickly on the medical side. You mentioned deemphasizing anesthesia products.

How much of a headwind is that in '19?.

Greg, I’ll take that question. So the revenues that we did for our anesthesia business in fiscal '18 were just shy of $8 million and we had about a $3 million loss on those revenues. So that will give you a little indication of the impact going forward..

Thank you. That’s helpful. And then you’ve done two deals now recently in Opto.

How much of this is a vertical integration play versus more on the external sales? And is this a market that maybe there’s further opportunities to consolidate?.

This is Deepak here. Very good question. The tuck-in acquisition that we talked about is in photonics.

It’s a complementary to the business we already have and it just broadens our reach to the customer base, gives us more technology and more products that we can offer both to the customers of this company that we bought, product line, and to our present customer base.

So if we look at it in this gap, it’s very similar to what we did in the Security side. Our total focus has always been to broaden our reach to our customers. And as we look at these kind of tuck-in acquisitions even in the Optoelectronics product line, it always tends to be that we are looking at what more we can bring to the customer..

Thank you. And then just one more from me. You had good operating cash flow in 2018. Is there any way to think about conversions for '19? And then a lot of companies have kind of reinvested some of the tax savings in CapEx.

How should we think about that trending this year?.

Greg, this is Alan. Yes, our operating cash flow was extremely strong in fiscal 2018. We do target a free cash flow conversion of – we try to target to be north of 100%.

There may be different working capital requirements or CapEx requirements that could alter that from time-to-time, but we think we’re well positioned for cash flow going forward as well..

Thank you.

And then just on CapEx, should we expect that to be down, flat, up in '19?.

It’s a good question. Our fiscal '18 included a purchase of our headquarters for our cargo operations in Billerica for about 20 million. So our CapEx we would say was a little bit elevated in fiscal '18. Our fiscal '19 CapEx not including potential CapEx associated with new turnkey projects we would expect to be lower than that of fiscal '18..

Thank you..

Our next question comes from the line of Larry Solow from CJS Securities. Your line is now open..

Thanks. Good evening. Just a few follow ups. On the Healthcare side first real quick, you mentioned – it sounds like there’s some several initiatives underway under Jim Green, obviously deemphasizing of the anesthesia business, it sounds like something that will immediately improve your profitability.

Can you maybe just give us a little more – broadly some more color on the weakness the last couple of quarters and your outlook just in the monitor side of the business and going forward? Just in – go ahead, I’m sorry..

No, go ahead. Complete your question..

No, I was just saying just maybe a little more color on maybe what is the issues impacting you guys? And secondly, what other initiatives can you maybe try to at least reaccelerate growth a little bit there?.

Good question. This is Deepak here. Basically it’s focus, focus and focus.

So under Jim Green’s leadership, the management has analyzed the various product lines, looked at what the margins are, what the future looks like, what new things have to be done and it looked like that the anesthesia is a business which is not core to us, it doesn’t have the same growth potential and profitability.

We are known in the industry, we are known to our customers as an excellence in patient monitoring. So the focus of the group is to look at the business and our strengths where we are and to capitalize on it. And that business is monitoring and cardiology which inherently have lot higher margins also. So our focus is do what we are good at.

There’s no point of trying to just keep doing things that don’t make any sense. And the other thing that we said in our speech that supplies and accessories is another focus that is a good business for us, it’s a good pull through, it puts us in front of customers after the sale even and it’s a profitable business. We want to grow that business.

And we’ve added some more leadership to go after that supplies and accessories business. So that’s the focus, focus and focus..

Okay, great. On the Security side, obviously some – I think the book-to-bill for the year is a nice solid number, that 1.2.

That does include the ETD business, right, the acquisition of that? So it will probably 1.1 or something ish ex that? Correct?.

If you’re talking about in the booked and bill, then you do the book-to-bill, it includes the ETD business..

Okay, that’s fair. Okay.

And 1.3 for the quarter, I imagine some of those stuff were – you mentioned a couple, you highlighted some but some longer-term deals that in sort of multiyear deals that skewed that number a little bit?.

Well, I won’t use the last word you said, skewed into it. We look at it and yes, the bookings in all the various product lines had been very solid all through the year and Q4 especially. And going into the next year we have a very healthy backlog though we have said it again, emphasized that it’s more skewed towards Q2 and beyond..

Right. And on the backlog question a little more just specifically on – you had announced that contract – sort of the hybrid turnkey contract I think the headline number was a $40 million contract.

And if I’m not mistaken that was supposed to ramp during this year, is that fair and is that any one of the reasons skewing your backlog more towards the latter part of the year?.

The answer is yes..

Okay.

Any other turnkey deals, obviously discussions, any update there or color you can provide?.

Well, what we have said is overall the world economy is improving and we believe that we continue to be aggressively pursuing it and it’s all over the globe. We also have said in my call that that side of the business has also opened up in new – what I call a new opportunity that we are going after sporting events and entertainment area.

We are known for all the Olympics, we are known for those big ones.

We are now going after what I call short, faster fields, football stadiums, concert halls, wherever we can find and we believe long term that after what’s happened in the world, there’s more awareness that the security needs to improve in these places and we very well positioned to help improve the security..

Right, okay. Thank you very much..

Our next question comes from the line of Josh Nichols from B. Riley. Your line is now open..

Hi. Thanks for taking the question.

Ongoing strong performance in the Security and the Opto business we’ve seen for a bit now and I was wondering how high do you think these operating margins could go? And do you have any longer-term targets that you’re trying to achieve for the three different segments?.

Josh, this is Alan. I’ll take that. Of course, we have internal targets on all three of our segments and even subdivide below that as well. But as a historical practice we have not provided that sort of guidance. We have limited to our sales and EPS guidance on an annual basis..

And then for Healthcare, you have a new President put in not too long ago.

Any idea that you could help frame as far as how long it may take to get the segment to at least to a point where it’s kind of like breakeven on a revenue level on a year-over-year basis?.

Well, we can’t tell what the internal thing is. Just to add onto it, maybe we didn’t make it clear. Our backlog going into the year for all three businesses are good, strong, including Healthcare compared to a year ago, we’re going a year into with a better backlog which is more skewed towards Q2, Q3 and Q4.

So we believe that in 2019 relatively compared with the deemphasizes of anesthesia, both for margin and we think because putting more focus on the businesses that monitoring and cardiology and supplies and accessories, that we would stabilize the business and become better..

Thanks.

And then could you – any data points of high-level info you could provide us regarding where we are in this replacement cycle regarding Europe as a transition to checked baggage scanners? And then also do you expect much of a tailwind from the new National Defense Authorization Act or is that more of a longer-term opportunity?.

The answer to the latter question, longer-term opportunity. Regarding your first former question about the European, we guesstimate about 40% is done. So there is still a lot of opportunity out there. We are very much focused on that.

And beyond that, we have said that and we have seen it that as the economies improve, we have said it it’s not just Europe, the rest of the world is also opening up to upgrade their technology to the next level..

And then last question for me. So the company has bought back a lot of stock here, right, at some pretty attractive levels and you also have some debt reduction as well.

And given the strong tailwinds you’re seeing with the backlog here, what’s your capital allocation strategy when we think of the split between stock buybacks and debt pay downs for the --?.

Sure. This is Alan. So really from a capital allocation perspective what we’re going to do with our free cash flow, first and foremost we love to win new turnkeys which take upfront CapEx. We also as you know are pretty active in M&A and we accomplished one of those earlier this quarter.

Residual cash we have we look at it opportunistically on the stock buyback program as well as to offset dilution. And any extra cash we have we would use to pay down debt..

Thanks, guys..

[Operator Instructions]. Our next question comes from the line of Jeff Martin from ROTH Capital. Your line is now open..

Thanks. Hi, Deepak. Hi, Alan.

How are you?.

Hi, Jeff..

Fine, thank you..

Deepak, could you expand a little bit on the oil sensitive countries? It sounds like it’s starting to open back up.

And also refresh our memory on what that has been in terms of Security revenue historically? I believe it’s been about a two-year hiatus since those markets kind of turned against you?.

Well, in a general comment Middle East is quite active. Obviously for competitive reasons we don’t break down any further than that. But all I can say is that over the last couple of years, we are seeing 2018 was very good.

We are entering 2019 with a good funnel and opportunity and a good name to ourselves in a product line which is very well received. And Middle East is a very active sector and we are very much focused on it..

Okay.

And then in terms of the Healthcare turnaround, if you were to break it down in terms of where the biggest work is to be done, is it on the product side, is it on the people or process? I know you mentioned focus, focus, focus is what you’re working on but if you can kind of break it down in those three buckets, I think that would be insightful..

Good question. You’re right. Focus, focus, focus is what exactly do we mean? I think one of the things that we are saying is that majority of our revenue comes from patient monitoring, majority of our revenue comes from U.S.

So that as we focus the leadership on it, this is one area we are well regarded, we have a good customer base, we want to capitalize on it and focus and make our customers a happy experience. And that business is what we want to focus on. Second thing is that the previous management put a lot of emphasis over the last couple of years on anesthesia.

It’s a good area to be in but with competition and some of the other changes, it looked like that it’s not a core for us. We would rather divert our resources on other product lines, cardiology, which is a high margin business, we want to put more focus on it. And I mentioned the words supplies and accessories.

Whenever you sell these products after a sale is completed, there’s a tail with it besides the service. By the way, Healthcare also has a service sale but the service people are calling on the customer or servicing the equipment, they can also sell supplies and accessories. So we want to focus on that.

We’ve brought in a new leader for supplies and accessories working for Jim Green and the focus is let’s go after the business that we know and has the margin and we can grow that business. And that’s what we are doing. That’s the focus..

Okay. I think your results speak for themselves in light of what’s been a really challenging year or second half in Healthcare. It sounds like you had a short-term issue on the contract manufacturing side of the Optoelectronics division.

Was curious if that’s resolved or if there’s still a little bit of work left to do?.

Majority of it is resolved, plus it’s an area in North America. It’s an area of product line in contract manufacturing as a combination of some efficiency improvement, some better productivity and also there was some drag in delay of new business.

We are focused on it very much and on a bigger picture, again, one of the things that we consider ourselves we are very strong and focused and Alan and his group give us the input, we basically look at all our product lines. And time to time we look at our product line, look at the focus, ask the management what the future looks like.

And if it looks like it’s not got the future opportunity, we are not shy to turn the tap off..

Okay. And then last question on the ITT side of the business. The non-European international markets, could you expand a little bit on how that is progressing in terms of the uptake? I know that you had an initial large order in Asia a couple of quarters ago.

But to follow up on that, kind of what you’re seeing in the non-European markets over the last four, five months?.

I just want to make sure of the question. You said the word ITT.

It’s RTT, right?.

Yes, RTT..

Okay. Yes, I mentioned besides Europe which is only 40% penetrated there’s a lot of opportunity. Rest of the world definitely is interested and is look at it.

One of the other things that we have been focused on it and it’s done well for us that this product is also very well suited for the air cargo business, which has been a great opportunity and we are focusing on with the team looking at not just at the airports for passengers and the whole baggage screening, but we also are now focusing on the air cargo market which worldwide has the commerce stream increases, the productivity, the speed and some of the requirements that are coming in for checking things going in the packages is a great business for us and we’ve had a great success and we're focusing on RTT, customizing it to go after the air cargo market.

And this is global, not just in any one place, it’s global because there is commerce interconnectivity to the whole world..

That’s helpful. Thanks very much..

We have a follow up from the line of Brian Ruttenbur. Your line is now open..

Yes. Thank you very much. A couple of housekeeping.

First of all on adjusted EBITDA in the quarter or EBITDA in the quarter, can you give us that for the fourth quarter and for the year?.

Sure, Brian. The adjusted EBITDA for the fourth quarter was 42.6 million and for the year was 184.5 million..

Okay.

And then as a follow up on the RTT Europe, can you give us a rough estimate where we are given that 2020 is around the corner? Are we 20% done on the product side actually delivering or getting orders, are we 30%, 40%? And how much of that service revenue has started kicking in for you guys?.

Brian, it’s good questions but you also know that we don’t – for competitive reasons we don’t break any further than down. All we want to say is that we are getting a fair share and there’s still a lot of opportunity left and most of the stuff is still new.

And as they’re coming out of the warranty period, definitely very astute question from you that it does increase the service revenue. And we are very much focused on it and want to keep emphasizing it is not just Europe, it’s the rest of the world too non-U.S. for us right now..

Okay. And then final question on certification with the TSA. That’s been something that’s been dragging. Do you feel like you’re at the 10-yard line or are we close to certification on the RTT in the U.S. with the TSA? Maybe you can give us some kind of update there..

I know it’s a tough thing. I think if I can go back to a couple of years, we keep talking the same thing. What we can say is that definitely the positive news is we are now in active certification mode with the TSA. Beyond that, I can’t give you a commitment when. We feel good..

All right, thank you..

At this time, I’m showing no further questions..

I would like to thank everyone for joining our call. I want to summarize and end. We are very happy and satisfied with our Q4 results and the year end with the strong backlog. We are looking forward to 2019. I want to thank all the stockholders, all the analysts and thank all my employees for a job well done.

And we are on to talking to you the first quarter in October. Thank you..

Thank you very much..

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