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spk02: Good day, and thank you for standing by. Welcome to the OSI Systems Inc. 3rd Quarter 2022 Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star and then 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star and then 0. I would now like to hand the conference over to your speaker today, Alan Edrick, Chief Financial Officer, please go ahead.
spk05: 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 22 Third Quarter Conference Call. We are pleased that you can join us as we review our financial and operational highlights. Earlier today, We issued a press release announcing our third quarter fiscal year 22 financial results. Before we discuss our Q3 results, however, 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 will 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 discussion of our financial performance for the third quarter of fiscal 22 and then turn the call over to Deepak for an overview of our business performance. I will then finish with more detail regarding our financial results and a discussion of our outlook for the full year of fiscal 22. We are pleased with our results this quarter. Despite global marketplace challenges, including increasing supply chain delays and logistics costs, and geopolitical events. As we work through this environment, we continue to prioritize delivering on commitments to our customers and to our partners, positioning the company for long-term success, and ensuring the safety of our employees. Now we will go through a high-level summary of our financial results. Q3 revenues of $290 million represent a 2% year-over-year increase, driven by growth in security and opto sales which were partially offset by an expected small reduction in year-over-year healthcare division sales. Q3 non-GAAP earnings per share were $1.43, up 4% from Q3 of fiscal 21, driven by a lower tax rate and smaller share count, which outweighed increased R&D, higher supply chain costs, and a less favorable product mix. Bookings were solid, with a Q3 book-to-bill ratio of 1.1, We ended the quarter with a near record backlog of over $1.2 billion, representing a 14% increase since the end of the last fiscal year. Operating cash flow for the third quarter was strong, as we generated approximately $38 million, while CapEx was approximately $3 million. Finally, we were active with strategic transactions this past quarter, as we acquired two small security companies, and unlock significant value in certain corporate-owned real estate through a sale-leaseback transaction. We also spent approximately $51 million in our share repurchase program. Before diving more deeply into our financial results, I will turn the call over to Deepak.
spk03: Thank you, Alan. And again, good afternoon and welcome to the OSI Systems Earnings Call for the third quarter of fiscal 2022. We are pleased with our third quarter results where we achieved solid profitability and strong cash flow on slightly higher revenues from the prior year. The overall bookings continue to be robust and strong as we ended Q3 with a backlog of $1.2 million approximately. Going into our third quarter highlights in each division, and then I'll turn it back over to Alan to provide further detail on our deep financial performance. starting with security where revenues grew 5% from the prior year, despite facing the challenges that Alan mentioned from the global supply chain and logistics and travel constraints that continue as we speak even today. During the quarter, we continued to strengthen our offerings to the marketplace as we made two small strategic acquisitions which are consistent with our focus on increasing the service and software portion of our recurring revenue base. We acquired a longstanding international distributor in a key European region that we believe has many growth opportunities for our solutions, including establishing a direct local sales service and support footprint. We took a similar approach in another region a few years ago, in which we have seen a marked increase in sales since their acquisition. We also acquired a US-based company called Gatekeeper, which provides intelligent optical inspection and recognition solutions to identify threats and provide real-time actionable intelligence. These solutions are utilized for border crossings and checkpoints at critical infrastructure worldwide. The Gatekeeper acquisition expands our hardware offering, while its proprietary software used for the integration of third-party solutions, for example, in vehicle identification, facial recognition, and container tracking, complements the capabilities of our CertScan software platform. our integration software for cargo and vehicle inspection at checkpoints and border crossings. As we have mentioned before, we are excited about the traction we are gaining with our search scan software as a service or SAS model with potential customers. Over the last few years, we have made a concerted effort to grow our revenues from systems integration, software, and ongoing service and support. These complimentary offerings are included in many of our proposals and provide a more steady stream of revenues over the life of the program as compared to a traditional standalone inspection hardware sale. Moreover, higher recurring revenue contribution from software such as search scan operator and maintenance training modules and automated image analysis logarithms has the potential to significantly enhance the overall margins in this division. In addition to making acquisitions like Gatekeeper, which brings new vehicle and passenger ID checkpoint software, we are making significant R&D investments to further enhance our overall software solution offering and security. During the quarter, We made progress on our ongoing major programs, including the one with US Customs and Border Protection, CBP, where we are in various stages of supporting the enhancement of the US border security infrastructure utilizing our cargo and vehicle scanning platforms with X-ray based technologies. In addition to the hardware, search scan and the offerings from gatekeeper are included in the solution for some of these efforts at CBP. We believe that this will continue to grow as CBP continues to expand this approach at various border crossings on the southern border with Mexico. As you might have heard, there are ongoing discussions in Washington DC to get to 100% inspection at the southern border with Mexico. As you might have heard, as an example of the importance of our solutions in helping protect borders and preventing the movement of illegal drugs and contraband, CBP recently announced a significant drug seizure at a border crossing near Laredo, Texas. Multiple screening methods and technologies were used to find the meths hidden inside a truck's trailer that was also carrying food packages. We are truly proud of our contribution in helping secure U.S. borders. Our turnkey programs in Albania, Puerto Rico, and Guatemala have been running as expected and are invaluable in demonstrating our large program experience and capabilities to customers as we bid on major projects worldwide. Most of these programs also have already integrated CertScan into their software. The aviation passenger traffic domestically is returning closer to pre-COVID levels, while international traffic is returning at a slower pace. Since we have exposure to both US and international airports, we expect our aviation business worldwide to grow as these customers will require the latest technology, inspection systems, service, and support to handle the growth in an efficient manner. During March, we hosted the Rapiscan Systems Golf Classic FPGA Tour event that was held in Biloxi, Mississippi. We want to congratulate the winner, Steve Elker, and thank all others that helped make it a successful event. Many of our employees, industry partners, and customers, both domestic and international, had the opportunity to attend and interact at the Classic. The event also raised $1.6 million to support local charities in coastal Mississippi. Over the last couple of years, the Security Division has successfully managed to work through the COVID-related challenges in the marketplace and meet customer demand. Going forward, we anticipate higher demand at ports borders and airports, and a greater willingness from these customers to initiate major projects that were delayed during the pandemic. We have a strong backlog and a pipeline of significant global opportunities across our product portfolio. The recent acquisitions during the quarter also bring new customer relationships that we can leverage to provide other products and services from our existing offerings. With a strong backlog, We are poised for a significant sequential increase in sales and profits in this division. We believe that our ability to offer leading technology and innovative solutions positions us well into fiscal 23 and beyond. Moving to our optoelectronics and manufacturing division. In Q3, revenues were solid while bookings were exceptional, leading to a record backlog for the division. The opto division continues to work through global supply chain and logistics challenges to successfully serve its large OEM base that also includes our other divisions, security and healthcare. Opto saw growth across certain product groups, especially optical components and assemblies for healthcare and technology OEMs. We announced a couple of notable wins, a multi-year order for approximately $35 million to provide electronic assemblies for use in patient care applications, and an order for approximately 5 million to provide electronic components to a leading x-ray imaging OEM manufacturer. During the quarter, APTO division also continues its efforts to make its new Indian facility fully operational, which expands our footprint in the region to handle the anticipated future growth, especially for healthcare products. Moving to the healthcare division, Space Labs, where we had a strong core. Although revenues were down about 3% than the prior year's Q3, which was expected as last year's Q3 contained patient monitoring revenues from COVID-related tailwinds, the division achieved nice operating margin expansion driven by higher gross margins from a favorable product mix. During the quarter, we saw strength in the U.S. channels. Our cardiology products continued to do well in the quarter with double-digit revenue growth. During the quarter, we also continued to make significant investments in research and development for new products. As we did with the safe and sound technology acquisition, we will continue to explore opportunities to add technology to enhance our core product portfolio of patient monitoring and cardiology. Overall, the healthcare division has performed well as the market activity has shifted from COVID-centric demand to more normal historical demand patterns. Throughout this year, I've been impressed with the commitment of our employees to manage the unique challenges in the marketplace and relentlessly serve our customer base. We look forward to finishing the year strong and further enhancing our value to our customers that are critical in promoting health and safety worldwide. As always, I would like to thank our employees, customers, and stockholders for their continued support. With that, I'm going to turn the call over back to Alan to talk more in detail about our financial results and guidance before we open the call for questions. Thank you.
spk05: Well, thank you, Deepak. Now I will review the financial results for our fiscal third quarter in a little greater detail. As mentioned earlier, fiscal Q3 revenues were up 2% compared with that of the prior year. Security division revenues were up 5% with increases in both product and service sales mainly driven by our cargo and vehicle inspection products. Although aviation-related sales were down year-over-year, we are currently seeing an uptick in activity in this arena. Opto sales, including intercompany sales, increased 2% year-over-year with continued momentum in this sector. The growth in security and opto sales were partially offset by a 3% reduction in year-over-year revenues in the healthcare division, given the elevated demand for patient monitoring products, as Deepak described earlier, creating difficult comps for this division in fiscal 22. While patient monitoring sales decreased, cardiology-related sales increased significantly for the third consecutive quarter. The Q3 gross margin was 35.4%. compared to 36.7% reported in Q3 of fiscal 21. The mix of sales within the security division were less favorable than in the prior year's comparable quarter, and revenues in our healthcare division, which carries a higher gross margin than our other two divisions, were down slightly, each of which has a downward impact on the consolidated margin. Like many companies, we experienced increases in certain component and freight costs in each division, which impacted the gross margin overall. Our gross margin will fluctuate from period to period based on revenue mix and volume, among other factors. Moving operating expenses. We continue to work diligently across each of our divisions to improve efficiencies and to prudently manage our SG&A cost structure. This quarter's results again demonstrate the success of these efforts. Q3 SG&A expenses were $58 million, comparable to last year, or 19.9% of sales compared to 20.4% of sales in the prior year Q3. R&D expenses in Q3 of fiscal 22 were $15.1 million, representing a year-over-year increase of 9%. We continue to dedicate considerable resources to R&D, particularly in security and healthcare. We remain focused on innovative product development which we view as vital to the long-term success of our businesses. In Q3 of fiscal 22, we recorded a $1.5 million restructuring and other charge as compared to a benefit of 0.3 million in Q3 of the prior fiscal year. As previously mentioned, we successfully executed the sale leaseback of our Hawthorne, California facilities at an attractive sale price of 32 million. This resulted in a pre-tax gain of approximately $27 million, which has been recorded in other income and excluded from our non-GAAP earnings. Moving to interest and taxes. Net interest and other expense in Q3 of fiscal 22 decreased to $2.3 million from $4.2 million in the same prior year period, primarily due to the adoption of the new accounting standard, ASU 2020-06, which eliminated the non-cash interest expense associated with our convertible debt. We note that adoption of the accounting standard also resulted in increased debt on the balance sheet by eliminating the unamortized discount of approximately 10 million. On the tax side, our reported effective tax rate under a gap was 20.1% in Q3 fiscal 22 compared to 33.7% in Q3 of fiscal 21. In Q3 of this year, we recognized a discrete tax benefit of $0.2 million as compared to a $2.2 million discrete tax expense in Q3 of last year. I will now turn to a discussion of our non-GAAP adjusted operating margin. Overall, our non-GAAP adjusted operating margin was 11.4% in Q3 of fiscal 22 as compared to 12.6% in Q3 of last year. The change was primarily driven by the previously discussed factors related to gross margin and increased investment in research and development. We were pleased with the increase in the adjusted operating margin in our opto division, which expanded to 12.9 percent in Q3 this year as compared to 12.5 percent in the prior year third quarter. We were also pleased that the adjusted operating margin in our healthcare division expanded to 14.7 percent in Q3 of fiscal 22 compared to 13.9% in Q3 last year. This increase was driven by a stronger gross margin due to a favorable product mix, including strong high margin cardiology sales. The security division's adjusted operating margin decreased to 14.9% in Q3 of this year from 17.9% in Q3 of the last fiscal year, which more than offset the improvements in the other two divisions, primarily due to a less favorable mix of customer revenues, rising costs in the supply chain, higher marketing expenses for promotional activities that were specific to Q3, and increased R&D to support new product development. Let's move to cash flow. Cash provided by operations was $38.4 million in Q3. CapEx in the third quarter was $2.9 million, while depreciation and amortization expense in Q3 was $9.8 million. As previously mentioned, we paid cash of approximately $14 million for the two acquisitions, but received $32 million on the property sale in the sale-leaseback transaction. We were quite active in our stock buyback program. During Q3 of fiscal 22, we spent approximately $51.5 million to repurchase over 600,000 shares, leaving approximately 1.4 million shares available to repurchase under the current program. Our balance sheet is solid. with net leverage under 1.5 and significant capacity for acquisitions and additional stock buybacks. We have multiple alternatives to satisfy our obligations under the convertible notes, which mature in September. And finally, turning to guidance. As Deepak described, we are anticipating strong sequential growth in Q4 supported by the backlog and sales pipeline. We are reiterating our previous fiscal 22 sales guidance of a range of 1.16 billion to 1.195 billion, as well as the non-GAAP EPS guidance of a range of 575 to 602 per diluted share. We currently believe this revenue and non-GAAP earnings guidance reflect reasonable estimates, and we have taken into account the anticipated impacts of the COVID-19 pandemic and supply chain challenges in our guidance. Given uncertainties as to the duration and scope of the pandemic, and supply chain disruptions, as well as other variables, however, the extent of the impact on the company's financial results is difficult to predict and could vary significantly from the anticipated impacts 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 these challenging times, we continue to remain focused on the growth of our businesses, and continued management of our cost structure. We believe our efforts in these areas will enable LoaSci to continue our leadership in providing innovative products and solutions. We delivered solid results during the first nine months of fiscal 22 in a dynamic, changing environment and continued to navigate effectively through uncertainty while gaining traction in key strategic growth areas and positioning the company to capitalize on improving end markets. We would like to take this opportunity to thank the global OSI team for its continued dedication in supporting our customers and contributing to the creation of value for our stakeholders. And at this time, we'd like to open the call to questions.
spk02: Thank you. As a reminder, to ask a question, you will need to press star and then one on your telephone. To withdraw your question, please press the pound key. And our first question comes from Brian Ruttenberg from Imperial Capital. Your line is open.
spk04: Yes, thank you very much. So, first of all, I wanted to dig down on the two acquisitions you made. Can you give us some kind of scale on size and how much you paid for those? Ballpark, you know, is it bigger than bread box? Anything that you can give us in terms of what these two acquisitions would add to revenue and how much you paid?
spk05: Sure. Brian, this is Alan. Good questions. The acquisition prices were a total of about $14 million plus some contingent earn out. In terms of the scale, they're not large. What we would anticipate for our fourth quarter would be something about around $3 million revenue contribution. We bought these later in February, so for the Q3 contributed about $1 million in revenues, but no particular profit in such a short time. Great, thank you.
spk03: Yeah, go ahead. Brian, just to add on, as I mentioned, these acquisitions basically are made especially gatekeeper for a longer-term view of adding on to our product portfolio and security and on the software enhancement, and we think that it will have good impact in fiscal 23 and beyond.
spk04: Great. Maybe since we're down that road talking about Gatekeeper and CertScan, you can give us an update on kind of traction where you are on CertScan, if there's been any new wins, what the pipeline's looking like for CertScan.
spk03: Well, you know, we're very excited about it. As we mentioned in the previous call for the Q2, part of the $200 million order that we got from CBP, It had a portion of it for the software search scan. We are implementing it. And I mentioned just now in my presentation, we believe that there is a lot of talk going on in Washington to start getting onto 100% inspection at the southern border, not just at the ports, but at the border crossings. And to get there, CBP needs to be more efficient. They need to have more software integration, to be able to have control centers, all that is right up the alley of CertScan. We are working with our customer. At the same time, I mentioned all our other turnkey systems already have CertScan. We are enhancing it. And any place that we are offering in international sector, we continue to offer CertScan as a model. And at the same time, The good thing about this model is that it's agnostic for equipment and some of our competitor units are also getting integrated into the software platform of CertScan. So, Gatekeeper on the other hand, it has other products which complement the RapidScan products. We believe that facial recognition, manifest, to be able to see the plate readers and stuff, all that software enhances our capability of offering a solution. And most important thing in this thing that we have to continue to say that, Brian, we believe that this software model has now got traction, it's working, and it's basically going to enhance the margin of the division and has the ability to have what is called licensing fees, upgrade ability, so that we'll have multiple years of enhancement with a very good margin as we go forward.
spk04: And then just last question. Thank you very much, Deepak, for that color. On the repurchasing front, you repurchased a lot of shares in the period and have a lot more outstanding shares. Is the plan to continue repurchasing at this kind of aggressive rate, or was the quarter, this last quarter, an aberration because you had all the cash come in from the sale laceback?
spk05: Yeah, Brian, good question. So we certainly utilize some of the cash that came in from the sale lease back, but we went well beyond that in terms of what we repurchased. We look at our overall capital allocation and believe that stock buyback is an attractive element for us. With 1.4 million shares available to repurchase, it continues to represent a very attractive option for us. But as you know, we don't comment on specifically what we may or may not buy.
spk04: Right. Thank you very much.
spk02: Thank you. Our next question comes from Larry Solo from CJS Security. Your line is open. Great. Thanks, guys.
spk06: Good afternoon. Question's a couple on the supply chain and logistics area. Have you seen, you know, supply chain and the costs and as well as just supply in general? Things gotten better, worse? Can you kind of just give us a feel of, you know, what you guys are seeing specifically?
spk03: Well, you know, we can't predict. In some areas, it's gone better. In some areas, it's the same. We don't think it's going to get worse. But freight is a big challenge. It changes. And supply chain, especially in the electronic components, is definitely a big challenge, not only for supply of the product, but also what is called end of life. Some vendors are basically stopping production. So Basically, it's there. It's not going away. But we as a company, we feel we are stronger than our competitors because we are vertically integrated and we have divisions and manufacturing in various parts of the world. So we are capable of handling it better and we have looked at the supply chain in a very focused manner and we are very much addressing it.
spk06: Okay. Fair enough. And now, can you just Give us a little more color. The book to Bill, I think you said it was 1-1, and I assume that's mostly security and health care? Any, you know, variance between security and health care? I mean, security and Opto, not health care. Health care is mostly not a bad business. So can you just give us a little more color there? It sounds like Opto might have been, you know, leading the way there. Is that correct?
spk05: Yeah, Larry, this is Alan. Good question. Yeah, Opto had terrific booking. Security was solid as well. And you're right, it's security and Opto that really sort of lead the way to the 1.1. I would say it was a little bit more tilted towards Opto in this particular quarter, but strong overall.
spk06: And you guys, just in terms of the supplies, just getting, touching back on that, are you guys, is it limiting you or, you know, are there actual areas where you're not able to sell things and you're leaving revenue on the table because of lack of supply or other reasons?
spk03: Well, we're not going any place where we say we're not going to supply. And the customers understand it. Basically, it just pushes to the right. And customers are patient. They understand the issues. And in some cases, especially in the opto side, their customer base is the OEM large business. manufacturers, they also come to help and assist after division to procure the material.
spk06: Okay. Okay. Gotcha. Okay. Just last question. Just, um, just in terms of the guidance, um, sometimes you guys would narrow it by the fourth quarter, pretty wide range for the, for the last quarter of the year. Is that just because, you know, uncertain times or, you know, and you just rather just leave it alone or any color to that?
spk05: Yeah, Larry, this is Alan, you're right, typically would narrow it in the fourth quarter. We do believe these times are sort of unprecedented over the last couple of years. Absolutely lately. So with all that uncertainty out there, we felt it most prudent to leave the range as it is. Fair enough. That makes sense. Okay, great. Thanks, guys. I appreciate it.
spk02: Thank you. Our next question comes from Josh Nichols from the Riley, your line is open.
spk00: Yeah, thanks for taking my question. I think you mentioned that you were going to start delivering on those big IDIQ with CBP, I think, in the fiscal fourth quarter. Is that still the case? So, like, any clarity you can provide on how quickly those might ramp up? And is that going to be like a 12- to 18-month delivery timeframe and what the expectation there is?
spk05: Josh, this is Alan. Yeah, good question. We do expect to get some revenues from that in Q4, though somewhat modest. We expect it to really be a big contributor to our revenues in each of fiscal 23 and 24, and then some of the service component for many years after that. But fiscal 23 and 24 will be the big revenue components from those contracts.
spk00: And then I'm glad to hear the company, right, focusing more and targeting some of these uh software opportunities specifically like cert scan that you mentioned um but i'm trying to think about the size of the opportunity as far as like the software piece of the business if this were to expand beyond just doing like the ports and things like that but but more towards like the southern border for scanning like any way you could help frame that type of opportunity when we think about like next fiscal year for, for search scan, if some of these do things, some of these opportunities do come to fruition.
spk03: Well, obviously we don't want to break it down, but what we can say is as we move forward, the content of software will continue in absolute dollars to keep going up because as there are more sites installed, as there are more customers who accept it as, and as we have said, that software as a fast software is also agnostic to the equipment. So just think about it, that all, whether the equipment is rapid scan equipment or it's made by rapid scans competitors, If the customer is gonna go back and standardize it to make one central station to do integration, the software will be needed and that not only as a first installation software, but also licensing fees and as what we call number of chairs increase as they get more people trained to be on the software, it will continue to increase. So we can't give you the exact size, but we believe that going forward as a percentage of revenue, SearchScan, Gatekeeper, and some of the other integrated software will continue to go up. And it has a higher margin.
spk00: Thanks. And then just last question, I guess a two-part question kind of, but it's related. So, one, given the vertical integration and your global presence, you probably have better visibility than a lot of companies. One, any indication of when the supply chain may – start to ease or is that too hard to say and then the second part is like acknowledging there's a tough environment to grow in given that these headwinds are there like with the supply chain at least in the near term what are kind of the one or two biggest opportunities on the horizon that you think could accelerate the company's growth right more from this mid single digit to low double digit level over the next year or so if these supply chain concerns start to ease
spk03: Good question. Difficult to predict. All we can say is with our broad customer base, with our broad, what I call, vertical integration, there is not a customer out there who, as they need product, won't approach us or we won't approach them. So as the supply chain gets a little bit better, as there is more travel, as we are able to travel and see the customers more face-to-face, That's all growth everywhere. Domestic growth is definitely there. CBP has made it very clear. And like I mentioned in my presentation, Washington DC, Congress has been talking about 100% inspection at the borders. That's a major, major increase. And as that goes and the interaction with other partners of doing business, other countries, This will continue to grow, and supply chain, sooner or later, will get better.
spk00: Thanks. That's all for me.
spk02: Thank you. Our next question comes from Sheila Kyoglu from Jeffrey. Your line is open.
spk01: Hey, good afternoon, Deepak, Alan. Thank you. Maybe just on the topic of the DOD, how much of your security business comes from the Department of Defense? And when we think about the budget just released, what line items, where should we be looking for OSI's direct benefit?
spk03: Well, number one, DOD is also a good customer for us. We do business with them, especially there's a lot of interest right now in the international sector to help with all this conflict that's going on. We can't break it down specifically, but if you want to go look into it, just look into it. Non-intrusive equipment for bases protection or borders or for places where there is a high risk of bad things coming across the border. And those are the kind of places where DOD all over internationally, they use that equipment. For example, at one time, we had a lot of equipment in Afghanistan. And that was a great thing. And in the same way, there are other places in the world where DOD is very much interested, especially with what's happening in the world.
spk01: And then on, you know, when we think about the end markets that you service within security, do you mind re-quantifying it? I might have missed some, but I think you said aviation was downstream. So can you go around the different end markets and maybe give us sort of the trends you're seeing?
spk03: Well, what we said was that at the borders and at the ports, the business continues to be very robust. Air cargo continues to be very robust as there is more air freight going over. Definitely aviation, passenger business, airports have been down for the last couple of years, but it's coming back. You can just see it everywhere now. Airlines are increasing their flights. They're increasing their cost structure. They want more people into it because summer is coming and there's more travel. And as that happens globally, the airports need to ramp up. So we think that that's a little bit behind the other businesses, but it's coming back.
spk01: Okay. So we should think about as they receive funds, they'll deploy them for security equipment. That's the way to sort of think about that. And then Did you quantify the supply chain impact for profitability? You know, how do we think about security margins not only in Q4 ramping back up but into fiscal 23?
spk05: Hi, Sheila. This is Alan. We would anticipate that we'll see a nice sequential improvement in the operating margins for security in the Q4. So we feel quite confident about that at this point in time. We don't quantify the supply chain issues. We'll expect the supply chain issues and challenges will continue to be there for, you know, probably the balance of this calendar year. But nonetheless, we expect some expansion of our operating margins.
spk01: Okay. Thank you.
spk02: Thank you. And as a reminder, to ask a question, please press star and then one. And our next question comes from Jeff Martin from Roth Capital Partners. Your line is open.
spk07: Thanks. Good afternoon, Deepak and Alan. Deepak, I was intrigued by your comment with respect to customers are increasingly willing to initiate projects delayed in the pandemic. Is that with respect to orders that have been pushed to the right? Are you referring to taking on new projects?
spk03: Alan, you want to take that? Can you repeat that again? I did not understand very well, Jeff. Can you repeat it?
spk07: Oh, yeah, I was referring to your comment and your prepared remarks regarding customer willingness to initiate projects that were delayed in the pandemic. I was curious if those were existing orders or if those are potential new orders. And anything you could provide, you know, some color around that, maybe an example would be helpful.
spk03: Well, I would say it's both ways. Some of the orders we already have. And now that it's getting a little bit easier to travel and installation and stuff, customers are encouraging to get that started. But most of the stuff is new business, especially in aviation. As Alan and I both mentioned, aviation has been a little bit hurt. I would say significantly hurt the last couple of years. It's coming back. And as that happens, that's the area that we think that there's going to be much more demand. The other businesses... Most of them are longer lead items. Either we already have the products or it's already in a pipeline. It's just a question of supply chain and be able to get and install and sign up from the customers.
spk07: Okay, great. And then with respect to border protection, we've talked a lot about the U.S. opportunity. Are you seeing increased opportunities in international markets as well?
spk03: The answer is yes. That's one area that every country wants to do it the right way. Think of it this way, I'm sure you've heard about it, that all the ports at every place, there is such a big waiting list. So if one is able to expedite the freight by inspection from the source where the ship left and to come to US or Europe, it doesn't need duplicate inspections. So everybody's working that way and And we have got a very successful model already working between Guadalajara and the Biloxi port. It's a wonderful system that's working very well, which has increased the efficiency by almost 30% of the cargo coming from there to U.S.
spk07: Okay, great. And then last question for me. You mentioned the significant margin expansion opportunity within security relating to software and the SAS model. I'm curious if you could maybe look into crystal ball here and give us a sense of where you think security margins could go over the long term. Is it feasible to get north of 20% on the operating margin side for security?
spk05: Jeff, this is Alan. I would say in particular quarters we could certainly get north of 20%. In terms of being there on a long-term sustainable basis, it's absolutely a goal. It's a question of how fast SearchScan and some of our other, proprietary software products are adopted because those do approach typical SaaS-like margins. So certainly a goal to have nice margin expansion in the security business.
spk07: Great. Thanks for your time, and good luck with a strong fourth quarter, and we'll close the year out strong here.
spk02: Thank you. Thank you. And our last question comes from Brian Ruttenberg from Imperial Capital. Your line is open.
spk04: Yes, just as a follow-up, guys, real quick. You talked several times about the 100% inspection potentially for, I assume, cargo and port and border inspection coming into the United States. Where are we now? The last numbers I've heard is we're at sub-10%. And what I'm trying to get to is what does this mean in terms of, you know, potential equipment sales and trying to understand where we are now and where it could potentially go?
spk03: Well, Brian, very good question. And we won't comment on it because, you know, the numbers are all over the place. All I can say to you is that's why we are saying there's a significant growth opportunity for and one cannot go efficiently to that high number of inspection without getting what I call software integration and to be able to be more efficient with collection of the data, the images, bussing the trucks fast, so that we think that that's a golden opportunity. There's a lot of potential and all I can say that is that on the southern border at certain places, Between us and the customer, we have actually demonstrated at one or two crossings that we can do 100% inspection.
spk04: Okay. And what is the timing potentially of that 100% inspection that they're talking about? You know, is it five years? Are they talking that it could be done quicker?
spk03: I guess your guess is as good as mine. I come back to it is that positive thing is it's working towards that. Again, it has to be the efficiency and the ability for Congress to have money available. And we think that that's a golden opportunity, and it will continue to grow. And we are in a well position, but I can't say when it will happen, how fast it will happen. All I can say is that as you look at the forecast and the talk, there is growth opportunity over the next couple of years.
spk04: Great. Thank you very much.
spk02: Thank you. And I am showing no further questions from our phone line.
spk03: Well, thank you very much. And again, I want to thank all the employees and also the patience of our customers and the support of the stockholders. You're not saying it's not been a challenging time. We're going to go continue through this, but we are well positioned. We are addressing all the issues, supply chain, logistics, freight, R&D, new products, Employee safety, customer satisfaction, that's all in our blood, and we'll continue to do the best we can. And we are feeling very good about it, that we'll have a strong year end, and looking forward to that, plus continued years of growth in the business. Thank you.
spk02: This concludes today's conference call. Thank you for your participation, and you may now disconnect. Everyone, have a wonderful day.
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