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spk02: Ladies and gentlemen, thank you for standing by, and welcome to the OSI Systems, Inc. Second Quarter 2021 Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question at that time, please press star then 1 on your telephone. As a reminder, today's conference call is being recorded. I will now turn the conference over to the host, Mr. Alan Edrick, Chief Financial Officer. So you may begin.
spk04: Thank you. Good morning. 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 21 Second Quarter Conference Call. We are pleased that you can join us as we review our financial and operational results and discuss our updated outlook for Fiscal 21. Before we discuss our Q2 results, I would like to remind everyone that today's discussion will include forward-looking statements and the company wishes to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to such forward-looking statements. All forward-looking statements made on this call are based on currently available information and the company undertakes no obligation to update any forward-looking statement based on subsequent events or new information or otherwise. During today's call, we refer to both GAAP and non-GAAP financial measures when describing the company's results. For information regarding non-GAAP measures and GAAP measures of the company's results and a quantitative reconciliation of those figures, please refer to today's earnings release. I will begin with a summary of our financial performance for the second quarter of fiscal 21 and then turn the call over to Deepak for an overview of the business. I'll then finish with more detail regarding our financial performance and a discussion of our updated outlook for fiscal 21. As the COVID-19 pandemic continues to impact the global economy, our priority at OSI remains the delivery on commitments to our customers and to our partners while ensuring the continued safety of our employees. Now we will jump into some highlights. First, we achieved record non-gap fiscal Q2 earnings per share of $1.35, up 6% from Q2 of fiscal 2020, despite the adverse impact on security division revenues of the ongoing pandemic. Second, we reported a record Q2 adjusted operating margin of 13.0%, a 140 basis point increase from 11.6% in the same period last year. Third, Bookings were solid in the second quarter, continuing our momentum from the previous quarter. Our book-to-bill ratio was 1.1 in fiscal Q2 and 1.3 for the first half of fiscal 21, leading to a 20% increase in backlog since the start of the fiscal year. And finally, cash flow conversion was again strong. Q2 operating cash flow was $36 million, and operating cash flow in the first half of the fiscal year was a record, Before diving more deeply into our financials, let me turn the call over to Deepak.
spk01: Thank you, Alan, and thanks to everyone joining us on today's call. During the second quarter of fiscal 21, as Alan has mentioned, we achieved record-adjusted earnings and had strong cash flow. and we ended the quarter with a backlog in excess of $1 billion. With a healthy backlog and a solid overall first half performance, we enter the second half of fiscal 21 with confidence. Let's take a look at each division's performance in the quarter, starting with the security division. Security bookings in the quarter were $164 million representing an approximate 1.1 book-to-bill ratio. As we have mentioned on the earlier call, we expected Q2 revenues in the security division to continue to be impacted by the pandemic, and this was indeed the case. Although the bookings have been strong in each of quarter one and quarter two, there has been difficulty in converting revenues some of the backlog to revenue given the travel restrictions which impede installations and certain factory and site acceptance tests. Our security team has remained focused on customer service, capturing new opportunities, and strong operational execution. We believe revenues will accelerate in the second half of the fiscal year. We booked several opportunities in cargo screening and aviation detection in the second quarter. For ports and borders during the quarter, we announced a $39 million order from an international customer to help protect its critical infrastructure along with ongoing maintenance. We also announced a $12 million international order to provide multiple units of the ZPortal, a high throughput drive-through inspection system, and the widely used ZBB mobile inspection systems, which can be rapidly deployed to provide flexibility in relocating security checkpoints. This order also includes follow-on maintenance service and product support. We secured another order for $10 million for ZBVs and related maintenance service and support. We continue to see a strong international pipeline for ports and borders, especially in the Middle East and Asia. We believe that the US spending for border security, especially on the southern border, will also be reinvigorated with the election cycle behind us and continued bipartisan support for security and technology. Global air passenger traffic is rebounding a little bit slowly. While some airports have pushed out deliveries, airports in certain regions continue to push for infrastructure upgrades to meet the latest security screening requirements. For aviation detection products, We announced a couple of our wins during the quarter. We received a $13 million order to provide airport screening products, including our 920 checkpoint CT baggage scanner, ODEON baggage scanners, and METOR 900M walkthrough metal detectors for a Scandinavian airport. We also were awarded a $6 million order to upgrade aviation checkpoint inspection systems for another customer. Earlier in quarter two, we announced contracts that were received at the end of quarter one from an international government customer for approximately $93 million to provide various x-ray cargo and vehicle inspection systems, baggage and partial inspection systems, trace detection systems, and follow-on maintenance and support. In security, Our approach to offer a broad portfolio of solutions to our customers has really helped us differentiate in the marketplace. In the first half, global logistics providers were very actively seeking our BPI and RTT solutions for air cargo as they continue to expand and upgrade security infrastructure to handle increasing e-commerce demand, thereby increasing our opportunity pipeline. For turnkey services, our Albania and Puerto Rico operations continue to do well, and the newest project in Guatemala at the Port of Santo Tomas commenced operations a few months ago, with scanning volume currently ramping up. Our security division also continues to work on development of new security solutions, especially in the areas of checkpoint security, cargo and vehicle scanning, enhanced detection software, and AI-based automated threat detection solutions. Overall, we believe the performance of the security division in the second half of fiscal 21 will be stronger than the first half performance, as we see a growing pipeline of opportunities and have a significant backlog. Moving to our optoelectronics division that continues to deliver strong results, Q2 revenues of $88 million represented a new record and a 20% increase over the same period in the prior year. During the first half of fiscal 2021, The team managed through the pandemic-induced operational disruptions at various regional sites to meet customer needs and help grow the top and the bottom line. Opto continues to grow business with both new and existing customers, particularly in Asia and the US. As an example of a notable win with a new customer, Opto received an order for approximately $6 million to manufacture LED lighting electronic components for a leading OEM. Opto's bookings were solid and we ended Q2 with a record backlog in the division that was 16% higher than the Opto backlog at the end of fiscal 20 and up sequentially over the 2021 first quarter. The team will continue to focus on opportunities to leverage our existing channels and manufacturing infrastructure in the US, Europe and the UK and Southeast Asia. We anticipate that this division will continue our strong momentum through the second half of the fiscal year. Moving on to the healthcare division, which reported revenue of $55 million or a 31% higher than the same period a year ago. We have been working over the past year to improve operations and bring in new sales and marketing talent in the healthcare division, and both initiatives were crucial in driving the division's Q2 performance as the team ramped up sales efforts, order fulfillment, and service to handle increased volume. During the fiscal 2021 first half, demand for patient monitoring was boosted by the tailwinds from the pandemic. But we simultaneously also encountered some headwinds in our cardiology business as customers focused more on COVID-related treatments and procedures. As more of the population receives COVID vaccinations, We believe that the diagnostic cardiology product line could benefit based on pent-up demand. Furthermore, we have plans for several new cardiology product introductions in the near term and we continue to develop the next generation of patient monitoring platform. We are proud of the accomplishments of the entire healthcare team and its continued support of the hospital customer base facing the unprecedented pandemic challenges. Overall, we are pleased with our company's fiscal 2021 first half performance. While the security division faced revenue headwinds as we anticipated, the team has done an outstanding job booking new business, driving new product innovation, and positioning itself for a stronger second half. The Opto division continues to deliver strong performance as it benefits from a blue-chip customer base of leading OEMs in diversified industries such as aerospace, defense, automotive, industrial, and healthcare. And the healthcare division's focus on customer and operational execution is paying off with the ability to profitably handle significant increases in demand. Looking ahead, We intend to maintain our focus on meeting our customers' needs while protecting the safety and health of our employees. I am truly proud of our OSI team, and I look forward to the second half of a fiscal year. I will now turn the call back over to Alan to further discuss our financial performance before we open the call for questions. Thank you.
spk04: Thank you, Deepak. So let's review the Q2 financial results in some greater detail. Our revenues in Q2 of fiscal 21 were $276 million, as compared to $305 million in the prior year Q2. Similar to Q1, we reported strong sales growth in the healthcare and opto divisions, but a reduction in revenues in security due in part to the effects of the pandemic. Let's dive deeper, starting with the healthcare division, whereas Deepak mentioned revenues increased 31% year-over-year with strength in many major geographic sales channels across our portfolio, including patient monitoring, supplies and accessories, and service. Opto sales were again strong, with Q2 third-party sales up 25% year-over-year due primarily to organic growth and supplemented by incremental revenues from a small acquisition completed in the second half of fiscal 20, which accounted for approximately 4% of the 25% opto growth. And as expected, we saw a reduction in revenues in the security division, with sales down 28% year over year, largely due to the continued impact of the pandemic on certain aviation and cargo customers. Security bookings were solid, with a book to bill of 1.1 for the second fiscal quarter and 1.5 for the first half of the 2021 fiscal year, leading to further growth and backlog. The Q2 gross margin of 37 percent was 70 basis points higher than the Q2 fiscal 20 margin of 36.3 percent. Driven by margin expansion in each of our healthcare division, which generally carries a greater gross margin than our other two divisions, and our security division, partially offset by the impact of the strong relative growth in revenues in the optoelectronics and manufacturing division, which historically tends to carry a lower gross margin than the other two divisions. The increase in the healthcare gross margin was primarily due to economies of scale associated with the strong Q2 revenue increase. The gross margin in improvement in security was driven by a favorable revenue mix and the continued focus on operational execution overcoming lower sales. As mentioned on previous calls, our gross margin will fluctuate from period to period based on revenue mix and volume, among other factors. Moving to operating expenses. In response to the pandemic, the company adjusted its cost structure toward the end of fiscal 20 and has continued to make such cost adjustments in fiscal 21. This has contributed to a 12 percent decrease in Q2 SG&A expenses year-over-year. We work diligently across each of our divisions to improve efficiencies and to prudently manage our cost structure. R&D expenses in Q2 were 13.8 million, representing a year-over-year decrease of 7 percent. We continue to dedicate considerable resources to R&D, particularly in security and healthcare, as we remain focused on innovative product development, which we view as important to the long-term success of our business. Moving to interest and taxes. Net interest and other expense in Q2 of 21 decreased to $4.2 million from $4.8 million in the same prior year period as a result of reduced borrowings in light of our strong cash flow and a declining interest rate environment since last year. On the tax side, Excluding the impact of discrete tax items, our effective tax rate in Q2 of fiscal 21 was 27.5% compared to 27.7% in Q2 of fiscal 20. We recognized discrete tax expenses of $0.3 million in Q2 of fiscal 21 compared to a $0.7 million discrete tax benefit in the comparable prior year. As a result, we reported a tax provision under GAAP of 28.8% in Q2 of fiscal 21 compared to 25.3% in Q2 of fiscal 20. So now let's turn to a discussion of our non-GAAP adjusted operating margin. For a reconciliation to the GAAP figures, please see our press release. Overall, our adjusted operating margin increased from 11.6% in Q2 of fiscal 20 to 13% in Q2 of fiscal 21. We were very pleased with the significant margin expansion, especially in the face of overall top-line headwinds. In fact, the 13 percent adjusted operating margin is a second fiscal quarter record for OSI. The non-GAAP adjusted operating margin in our security division came in at 15.7 percent in the latest quarter, right in line with the prior year's second quarter, driven by a favorable mix of revenues, sound operational execution, and cost control actions. Our healthcare division reported significant expansion of the non-GAAP adjusted operating margin from 3.1% in Q2 of last year to 17.4% in Q2 of fiscal 21, due in part to leveraging the fixed cost structure with improved sales and sound operational execution. The increases in the security and healthcare margins were partially offset by a reduction in the adjusted operating margin in our opto division which decreased from 13.5 percent in Q2 of the last fiscal year to 12.8 percent in Q2 of fiscal 21, primarily driven by a less favorable mix of customer revenues. Moving to cash flow, we continue to generate significant cash as Q2 operating cash flow of 35 million brought the total for the first half of fiscal 21 to a record 89 million. This was achieved as we invested in an increased inventory in preparation for sales growth while also experiencing elevated DSO due to timing of collections. The receipt of significant customer advances, primarily associated with new international security wins, helped offset the investment in inventory and change in DSO. CapEx in the second fiscal quarter of 21 was $4.7 million, while depreciation and amortization for the quarter was $11.2 million. our cash flow conversion continues to be quite solid. Our balance sheet is strong with modest net leverage and no significant debt maturities until fiscal 2023. Finally, turning to guidance. We are increasing revenue guidance for fiscal 2021 to the range of $1.11 billion to $1.145 billion from $1.1 billion to $1.142 billion previously. Similarly, we are increasing our non-GAAP earnings per diluted share guidance to the range of $5 to $5.35 per share from $4.65 to $5.10 per share previously. The non-GAAP diluted EPS range excludes potential impairment, restructuring, and other charges, amortization of acquired intangible assets, and non-cash interest expense and their associated tax effects as well as discrete tax items. We currently believe this revenue and non-GAAP earnings guidance reflect reasonable estimates, and we have included the anticipated impact of the COVID-19 pandemic in our guidance. Given uncertainties as to the duration and scope of the pandemic, as well as other variables, however, the extent to which COVID-19 may impact the company's financial results is difficult to predict and could vary materially from the anticipated impact thereof currently reflected in our estimates and guidance. Actual revenues and non-GAAP earnings per diluted share could also vary from the anticipated ranges due to other risks and uncertainties discussed in our SEC filings. In the face of challenging times, we remain steadfastly focused on the growth of our business through investment and product development and strategic acquisitions while also managing our cost structure. We believe these efforts should enable OSI to continue our leadership in providing innovative products and solutions. Finally, and importantly, as Deepak mentioned, we'd like to take this opportunity to thank the global OSI Systems team for its dedication in supporting our customers and contributing to the creation of value for our stakeholders while maintaining a commitment to safety in the face of uncertainty. At this time, we're happy to open the call to questions.
spk02: Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star then 1 on your text phone telephone. To ask a question, please press star then 1. One moment, please. Our first question comes from Jeff Martin of Ross Capital Martins. Your line is open.
spk08: Thanks. Good morning, Deepak. Good morning, Alan. Good morning, Jeff. Good morning. I was curious if you could... Give us some additional insight into what you're seeing in the security segment in the second half relative to the first half. What are the key swing factors that give you confidence that you'll see an acceleration in the second half?
spk01: Good question, Jeff. This is Deepak here. One of the things is, as I mentioned and Alan has mentioned, we're entering the second half with a very strong backlog. Bookings have been very strong in Q1 and Q2 in security. and we expect that we will start shipping some of that stuff that has been challenged in the first half. Number two, all our indications are our pipeline continues to be strong, both internationally and domestically. And I also mentioned that with the change of administration in Washington, some of the bipartisan support is coming to reallocate some of the funding from the border wall into technology and non-intrusive equipment, which we are very well placed with and have a great relationship with DHS. Right.
spk08: And along those lines, could you give us some relative perspective as to how much, say, in the last 12 months or last year, the Customs and Border Inspection in the U.S. contributed? I mean, are we talking about going from very little to potentially a significant amount over the next 12 to 18 months and perspective that would be helpful.
spk01: Jeff, you know we don't break it down, but we have said in the previous conference calls, already last year even, DHS CBP, their budgets had gone up quite a lot, and we think continued strength will remain in that place to upgrade technology and to bring more technology-based platforms at the border for inspection.
spk08: Okay. And then my second question is on the healthcare segment. Could you give us some relative perspective on what your expectation is for the second half of fiscal 21 in healthcare relative to the first half? Obviously, patient monitoring has been a nice contributor in the first half, and that may not be as strong in the second half, but cardio may pick up. Could you just help frame for us whether you expect it to be flat up or down relative to first half?
spk04: Hey, Jeff, this is Alan. Sure, I'll take that question. Of course, we provide guidance overall for the overall company of OSI Systems as opposed to division, but kind of giving you a little color, we expect to see continued strength in the healthcare business here in our third quarter. There's so much uncertainty at the time, given COVID and the pandemic, that, you know, looking out beyond that is difficult to say. But overall, we're seeing continued strength in our healthcare business, and we think that will continue. We're really pleased with the improvements made by our leadership team at Space Labs, and we expect that to reap dividends for us for the future.
spk08: Okay, great. And then last question in terms of capital structure. You paid down roughly $30 million of debt in a quarter. Cash was only down minimally. Just curious if we should anticipate continued debt reduction. How are you looking at capital allocation because you're generating significant free cash flow?
spk04: Sure, Jeff. This is Alan. You're absolutely right. The cash flow has been excellent. Our capital allocation strategy is multifold. We look at acquisitions. We look at new turnkey projects. We look at stock buyback and we look at any residual paying down our debt. And the nice thing for us is we don't necessarily think they're mutually exclusive. In this past quarter, it was more on the debt pay down side. In the previous quarter, there was a small acquisition coupled with significant stock buyback. We expect to continue to be a nice cash flow generator and be able to play in all of those areas that I just mentioned.
spk08: Great. Thanks for taking my questions, and congratulations on a nice earnings quarter. Thank you.
spk02: Thank you. Our next question comes from Larry Solo of BJS Securities. Your line is open.
spk06: Hi. Good afternoon, or good morning to you guys. Congrats on a good quarter. First question I have is on the security piece. I know you mentioned a little better mixed benefit this quarter, and I You have mentioned cost cut in the last couple quarters. Just trying to get my hands around the revenue declined about 30%, and you were, as mentioned, able to keep your operating margin flat year over year, which is pretty remarkable. As revenue comes back, without giving us actual numbers, I suppose we should see operating margin continue to rise and reach perhaps significantly above where we are today. Is that fair to say?
spk04: Larry, this is Alan. Good observation and good question. Absolutely. Our team has done an excellent job maintaining margins with the change in revenue. And you're right. As sales move up, we would expect margin expansion is our goal as well. And we think there's significant opportunity to do that. um you know of course some of the changes that we made are more structural in nature and are permanent reductions while others uh like most companies there's some temporary benefit for you know maybe some reduced travel savings and uh and some things like that but but absolutely we do believe there's opportunity for uh operating margin expansion in our security business and and we're we're planning on that okay um and you mentioned um
spk06: I know you had several contract wins recently. Have any of these contracts, have any of these newer business wins contributed in the quarter or not? No, on the security side.
spk04: So the larger announcements that we made and that Deepak referred to will really be more in our second half and even somewhat into fiscal 2022. So this past quarter was principally for wins that we had before besides the smaller book and ship business.
spk06: Got it. And you mentioned Guatemala started to ramp. Is that, you know, any way to sort of characterize that? Is that, have you sort of laid out costs ahead of the revenue? Should we start to see, you know, more rising contributions for that, especially on the bottom line over the next several quarters?
spk04: Yes, that's a correct statement. So we have been ramping up on our revenues for Guatemala and expect to be at, you know, near a full run rate before the end of the fiscal year. And you are right, some of the costs that you put in are relatively of the fixed nature, so they come in in advance of being at peak revenues. So, yes, margins should increase relative to that project for us as volumes ramp up.
spk06: And the drop in service revenue this quarter, you know, sort of picked up a little bit relative to Q1. I think service revenues were down mid-teens and overall private revenue was only down in the high singles. Is that, I assume, mostly from the security segment and I know partially related maybe to Mexico, but is that just utilization stuff and service stuff? Should we expect some of that to start to rebound as we look out?
spk04: Yeah, good question again, Larry. The drop in service revenue is almost entirely related to Mexico. So that contract will lap in June. So as we move into fiscal 22, yeah, we would expect to see a rise in our service revenues year over year. But we'll have another quarter or two of that same scenario relative to service revenues.
spk06: Okay. And you mentioned, you know, pretty significant growth in healthcare, the 30% number. And, you know, I think Q2 normally is a seasonally stronger quarter than Any way to sort of parse out the benefits from COVID? It sounds like it seems to be outweighing the cardio, you know, the slow-down cardio, but maybe not. Just trying to parse that out, and maybe you can help us. How much does cardiology roughly, can you tell us, represent in terms of your segment revenues?
spk04: So, Larry, this is Alan. So, cardiology, including some of the ancillary services, is about a quarter of our revenue of healthcare business overall.
spk06: Okay. And on the COVID benefits, do you see those continuing? Or is that something that may, you know, even with COVID continuing, I don't know, hospitals, are they continuing to purchase monitors or will it become a point where You know, they only have so many bags for monitors, right?
spk01: Larry, this is Deepak here. You know, as Alan has mentioned, it's very difficult to predict it. Right. We've had a very strong couple of quarters. And Alan has also mentioned Q3 continues to show strength. Difficult to read Q4. But all in all, we think that this is ongoing. And it's not just in U.S., It's in Canada. It's in other parts of the world. And cardiology, we think, will pick up. So all in all, we think that the healthcare will continue to do well. But definitely, we are not saying in any shape or form that it can continue with the 30% growth that we've seen. But on the other side, security, we think is going to do better in the second half. And the optoelectronics, Alan has mentioned, continues to show very, very good performance.
spk06: Specifically at healthcare, you don't think we're approaching any type of a, not a cliff, but where you might see a significant pullback from maybe perhaps customers on the hospital side don't buy for a few quarters. Is that something that you think is a risk or not necessarily?
spk01: We don't see any major pullbacks and stuff like that. At the same time, remember, we're also spending a lot of R&D money to develop new products. And those products will start being implemented in cardiology specifically in the second half. And as we go into the next years, the new platform that we're working on in monitoring should start seeing some big traction.
spk06: Okay, great. Got it. Okay, great. Thank you very much. I appreciate it.
spk02: Thank you. Our next question comes from Christopher Glenn of Oppenheimer. Your line is open.
spk07: Yeah, thanks. Good morning. So I was curious about the, you know, cardiology commercialization process with the new products coming. I think there's a focus in North America. I'm wondering how the kind of channel conditioning is going, what your – Why the site is on converting the commercial aspect, you know, independent, isolating out the pandemic timing type dynamics.
spk04: Hey, Chris, this is Alan. Really good question. Yeah, we're really excited about the opportunities in cardiology. We brought on a new commercial team for North America, for the United States specifically, as you're referring to. So we have a new vice president of cardiology sales who came on board and he's recruited some new members to his team, and the timing couldn't be more perfect. So as these new products begin to come out here, predominantly in our fourth quarter, fourth fiscal quarter and beyond, it's just a perfect time to start ramping up for cardiology. As Deepak mentioned, we expect some increasing levels of demand for some of the existing products as we come out of the pandemic, as well as coupled with the new products. We expect this to lead to some significant growth, in cardiology sales, particularly in the U.S., but really on a worldwide basis. And one of the nice things about that is cardiology represents our highest margin product in healthcare. Frankly, it's our highest margin products in all of OSI systems. So as cardiology sales ramp, there's a real nice pull through to the bottom line, both for the division and the company overall.
spk01: Just to add on to what Alan said, another thing, there's a change happening in the marketplace that most people are looking at remote monitoring, home monitoring, tele-services. Our new products and stuff are based on cloud computing, and we are very much focused onto this new trend that's coming in there. People don't wanna visit hospitals. People don't wanna go there. So if they can do the monitoring from home, the doctors can go back and forth, we are very much engaged in that.
spk07: Thanks for that follow-on. I had a question on inflation. Curious how you manage that, whether through hedges or pass-through, and how backlog that's already booked fares when we have an inflation ramp in the economy.
spk04: Yeah, Chris, this is Alan. So we have not tended to see any material impact from inflation. When there can be some inflation, our supply chain also does a a good job managing cost reductions in other areas. So overall, we do not view inflation as really a significant impact to our company overall. Great. Thanks for that.
spk02: Thank you. Our next question comes from Josh Nichols of B Raleigh. Your line is open.
spk05: Yeah. Thanks for taking my question. A commendable job specifically on the operating margin side, guys. Looking here, I did want to ask some of the questions I had have already been addressed. But looking at how strong the opto division has been, we've been hearing a lot of things about shortages and high demand out of that area. Is there any elaboration that you could provide about specific areas of strength, whether it's like specific products and demand, and where is that feeding into from like a geographic region?
spk01: Good question. Definitely, yes, you're right. You're reading right. There's a lot of people that are having shortages and stuff. We don't see much about it. We are very fortunate that we are a vertically integrated company. The demand that we are seeing is on a very broad industrial platform. Obviously, the number one platform that's showing a significant demand is from our healthcare. We are very much into the healthcare OEM products and other areas that we supply to other people. Aerospace, defense, and the answer to your question is, in this particular case, it's pretty much global. There's a lot of demand from the U.S. There's a lot of demand in Asia, even in Europe. Yes, there are some challenges out there, but our product, our customer base, one of the big strengths we've always had in that Opto product line, we have a very broad customer base. And one of the other areas which are doing very well is in the automotive industry.
spk04: And, Josh, just to add on, our biggest strength has been out of our Asian operations, and the greatest growth is what Deepak just mentioned in automotive as well as in some of the defense business. So the broad-based nature of what we do has been extremely helpful for us.
spk05: Thanks, guys. That's some helpful detail on that front. I'm glad to hear that you guys are well-situated as a critically integrated player in that space. Is it fair to say now that you've had a couple of these turnkeys roll out also, right, and you're ramping up now that, that the services revenue is probably kind of bottomed in 2Q and probably going to start ramping up a little bit more as we move through the following back half of this year.
spk04: Josh, this is Alan. Yeah, that's generally a correct comment. I think what we're going to see, where you'll see the growth in service tend to occur probably as we enter our fiscal 22 here in about six months. as we'll continue to have those tough year-over-year comps and service for Q3 and Q4. So we would expect the growth to begin starting in fiscal 22. Thanks.
spk05: And then the last question for me, I mean, I think you guys are according to my model at least, like it looks like you're going to be under a one-time net debt lever right by the end of the year. So clearly a lot of opportunities for you guys, whether that's share purchases or looking at some strategic M&A as well. One of the things I think that people would like to see or have been wondering about is what needs to happen or how could the company kind of potentially accelerate the top-line growth thinking more about next year from whenever you're past those year-over-year comps kind of to like a low double-digit revenue and get out of the mid-high single-digit growth category and what's the opportunity to improve on that front?
spk01: Good question. I'm going to answer it in a broader sense and then maybe Alan can jump in. Basically, our focus is, our backlog is very strong, our pipeline is very strong, especially in security. And as the pandemic settles down, as the vaccination comes into place, more travel is started, we will start seeing some big infrastructure investment from airports and ports and stuff, especially United States. So we think that that's going to be the growth carrier in security. Opto will continue to do well as it's a very broad product line. And healthcare, as Alan has mentioned, though definitely that kind of growth in patient monitoring might slow down, but cardiology is there. And the most important thing is that as a company, we've also been very acquisitive. We look at acquisitions and we continue to look at it with a strong balance sheet. Alan?
spk04: Yeah, I would echo what Deepak said, we have a strong funnel of opportunities ahead of us to drive good, solid organic growth. But sort of leveraging on your comment, Josh, we do have a very strong balance sheet with low net leverage. M&A acquisitions have played a big part of our strategy over the last 10 or 15 years. And we'd like to bolster or supplement that organic growth with some acquisitions as well. So I think the combination of those two can get us to a more accelerated revenue growth, as you were suggesting.
spk05: Thanks, guys. I'll be back in a few.
spk02: Thank you. Our next question comes from Greg Conrad of Jeffers. Your line is open.
spk00: Good morning. Good morning. We've talked a lot about new product development on the healthcare side. Is there any way to think about, as these new programs roll out, how much is kind of replacement versus incremental opportunities and kind of expanding your total addressable market versus replacement products?
spk01: Again, good question. This is Deepak here. You know, on both, on the cardiology side, it's add-on products, it's cloud computing, it's teleproducts related, and those are going to start getting executed in the next couple of months. Regarding the patient monitoring side, we are investing largely for our new platform, and that's going to take some time. And that will go into both combination of replacement, and we also say where we call them conversions. where because of the good connectivity story, good partnership, better price to performance, we think that we will get some replacement conversions also. So that will be the growth path.
spk00: That's helpful. And then, I mean, you've always talked about health care being the highest contribution margin of the business and I think 50%, 60% is the number that you guys have thrown out, and you've kind of seen that play out the last three quarters. Any reason to think that trend changes in terms of drop-throughs, or is that level kind of sustainable as we go forward?
spk04: Greg, this is Alan. We believe that the contribution margins that you've seen in health care are indeed sustainable. It always depends upon the mix of revenues, but as you mentioned at the outset, it is our highest contribution margin business. so the incrementals are significant for us.
spk00: And then just last one, I mean, you talked a little bit up front about the changes in administration and some of the benefits, but we also saw the fiscal year 21 budget finally pass at the end of the calendar year. Any benefit or funding maybe that gets freed up by that bill passing?
spk01: Well, I specifically can't answer that, but as we have said before, both bipartisan and administration, they all are looking at more technology, more technology which will make it more efficient. We are very well placed, have a great relationship with DHS, DOD, CBP. Lots of our equipment is at the southern border. And we continue to think that all the things that are happening and what we are hearing will be positive for us.
spk00: Thank you.
spk02: Thank you. Again, if you'd like to ask a question, please press star then one on your text phone telephone. Our next question comes from David Marazzi of Barenburg. Your line is open.
spk03: Hi there. You mentioned on the last call that you expect roughly half of the billion-dollar backlog to be converted into sales through the remainder of this fiscal year. Just given the difficulties you have in actually converting the backlog into sales, how has that changed for you guys so far?
spk04: David, yeah, good question. This is Alan. You know, as we look at the remainder of the year, we continue to expect a little bit less than half of our current backlog to be converted into revenue through the rest of the fiscal year. We have pretty good visibility in working with our customers in terms of the timing of installations and the like. So we have a pretty high degree of confidence that it'll be, you know, just a little south of half of our current backlog.
spk03: Great. Okay. And then can you just give us a brief update on how the safe and sound acquisition is going? Because I know that you're focusing on the remote patient monitoring market. And you mentioned a few calls ago that would be roughly integrated in the next 12 months or so. So how is that progressing?
spk01: Good question. Well, and it's very much incremental, butted into our development of the next platform. And we continue to move forward. It's very much part of the total R&D that we are doing to develop the next generation, especially remote monitoring, cloud computing and stuff. Safe and Sound is very much part of that integral development.
spk04: And in addition to that, as part of our new development, when we look at our current commercialization efforts, it's been instrumental in winning a certain new business. So it's been very helpful for our sales and commercial team to sell Safe and Sound along with our existing patient monitoring programs products as a nice differentiator for us. So it's really been a big win for us.
spk03: Great. Thanks. Appreciate it.
spk02: Thank you. I'm showing no further questions at this time. I'm just going to call back over to management.
spk01: Ladies and gentlemen, thanks once again for participating in our conference call. We look forward to speaking with you at your next earnings call. I wish everybody a healthy, safe, time and again want to thank once again our total global employees of OSI Systems for a job well done. Very proud of them. Thank you.
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