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spk06: Thank you for standing by and welcome to the OSI Systems first quarter 2024 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 this session, you'll need to press star 1-1 on your telephone. If you'd like to remove yourself from the queue, simply press star 1-1 again. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Ellen Edrick. Chief Financial Officer. Please go ahead, sir.
spk03: 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, OSI's President and CEO. Welcome to the OSI Systems Fiscal 2024 First Quarter Conference Call. We are pleased that you can join us as we review our financial and operational results. Earlier today, we issued a press release announcing our 2024 fiscal year first quarter financial results. And before we discuss our results, however, I'd 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 in 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 both to GAAP and non-GAAP financial measures when describing the company's results. For further information regarding non-GAAP measures and comparable 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 high-level summary of our financial performance for the first quarter of fiscal 24 and then turn the call over to Deepak for a discussion of our business and operational performance. We will then finish with more detail regarding our financial results and a discussion of our outlook for fiscal year 24. Our first quarter financial results were generally solid with the security division again generating double digit revenue growth and significant year over year operating margin expansion. and the Opto Division performing very well, while the Healthcare Division experienced a challenging quarter. We are enthusiastic about the overall significant revenue and earnings growth anticipated for the balance of Fiscal 24. Let's start with a high-level summary of our Q1 results. First, we reported Q1 revenues of $279 million, representing a year-over-year increase of 4%, driven by revenue growth of 14% in our Security Division, and 2 percent in the opto division, which were partially offset by a 13 percent decrease in revenue in the healthcare division. Second, we reported Q1 non-GAAP adjusted earnings per share of 91 cents, up 5 percent from Q1 of the prior fiscal year, as strong operating results overcame the impact of approximately 11 cents per share of additional interest expense associated with higher interest rates in our borrowings. We ended the quarter with a backlog of nearly 1.8 billion. The strong backlog provides outstanding visibility for the full fiscal year. Before diving more deeply into our financial results and discussing the fiscal 2024 outlook, I will turn the call over to Deepak.
spk01: Thank you very much, Alan. Good morning to everyone. I'm pleased to report that our fiscal 2024 first quarter performance aligned with our expectations. we achieved 4% revenue growth with increased margins. With a strong backlog coupled with a significant recent awards and high visibility into the opportunity pipeline, we expect significant revenue and adjusting earnings per share growth through fiscal 24 and beyond. So let's dive into the performance and highlights of each division during the quarter and begin with the security division which saw an increase of 14% in Q1 revenues and operating margin expansion. The division had bookings of $174 million during the quarter, resulting in a book-to-bill ratio of 1.1. During the quarter, we made considerable progress on the ramp-ups for our recently awarded port and border security initiatives with Mexico's defense agency, Sedena, and the other international customer. We anticipate that both programs will contribute substantial revenues in this fiscal year. During Q1, we successfully captured several port and border security customer opportunities in the US and internationally. On the international front, we announced an award for $14 million from a Latin America-based customer to provide multiple units of our Eagle P60 high-energy drive-through cargo and vehicle inspection system. Also, the VM250 radiation portal monitors and the Mini-Zs, handheld backscatter devices, along with our proprietary search scan integration installation software and training and maintenance service and support. In addition, we also announced a $10 million contract from an international customs agency to provide dual energy X-ray cargo and vehicle inspection solution, including multi-year maintenance service and support. In the U.S., we announced a $14 million award from an existing U.S. customer to provide civil works and installation support for our cargo and vehicle inspection systems. And wrapping it up in the ports and borders, shortly after the quarter end, we announced an award that we received in Q1 of a 10 year contract to provide a turnkey screening solution to Uruguay's Ministry of Economics and Finance. The Eagle T60 high energy trailer mounted vehicle inspection system will be used to perform security screening and remote image analysis utilizing the proprietary CertScan integration platform. We will also provide on-site operator training, ongoing maintenance, service and support. I just want to talk a little bit more about our CertScan software, which is our proprietary software solution that helps manage inspection image data, traffic and vehicle identification at checkpoints. Along with search scans utilization as a critical piece in a turnkey solution, we utilize search scan frequently on traditional hardware installations as customers increasingly integrate screening systems with existing data and communication centers. Furthermore, when new data managed infrastructure is required for specific program initiatives, we are often involved in supporting the planning and construction of these facilities. The Uruguay program will join our long-standing successful turnkey projects like Puro Rico, Albania, etc., where we have demonstrated our experience and capabilities in handling large-scale programs for customs and border protection agencies. We have an extensive presence with the U.S. Customs and Border Protection, CBP, in the United States, where we are actively supporting recent border security efforts through equipment and service orders received to date for about 200 million. The CBP has room under two active indefinite delivery indefinite quantity that have IDIQs that have a combined total potential award value of about 870 million. Although the U.S. government is currently operating under a continuing resolution, We are hopeful that additional orders could be issued once the U.S. government's 24 budget is passed and signed into law. Our checkpoint security products and related services team continues to support its customer base in airports, transportation, government facilities, and other critical infrastructures. Our latest explosive trace detection system, ETD, the Itemizer 5X, is now approved by the european union for use at european airports qualified by tsa acstl for air cargo and certified by the china aviation authority or cac for use at airports the itemizer 5x has some of the most advanced software algorithms and optimized detection libraries making it an ideal tool for identifying explosives narcotics and other harmful compounds. We have been diligently collaborating with international airports regarding potential passenger and baggage screening enhancements to align with the latest technology regulatory standards. We remain optimistic about the continued expansion in the aviation CT checkpoint and checked baggage area together with the itemizer 5X projects and have a good healthy backlog. Overall, the Security Division had a great start for Fiscal 24, and with a strong backlog, we expect it will do significantly better in the remainder of Fiscal 24. Moving to the Opto Electronics and Manufacturing Division. Opto delivered impressive results during the first quarter with another all-time quarterly revenue record, achieving $96 million in revenue, including intercompany and generating strong profitability. In addition to being a vital supplier to our security and healthcare divisions, Apto continues to serve its diverse OEM customer base that provides various solutions in aerospace, defense electronics, test and measurement, medical devices, automotive, and consumer electronics. With a strong global presence manufacturing covering the US, England, India, Indonesia, and Malaysia, Combined with a continued trend of customers seeking robust manufacturing alternates to China manufacturing, we look forward to capturing new opportunities with our existing customer base and with new customers. Finally, on to the healthcare division, where Q1 was a tough quarter as sales went down 13% year over year due to challenging marketing conditions, especially in the U.S., where hospital profitability has been hampered. which in turn has caused delays in capital expenditures. The silver lining was growth in the European region backed by recently launched cardiology products and services. The capital constraints and hospitals are actually helping to drive market adoption of a new business model that we have talked before also that reduce the need for significant capital outlays. This division continues to develop innovative new business models and solutions, such as leasing and subscription programs. The Rothman Index-based predictive analytics software and safe and sound patient alarm management software are good examples of tools that can help hospitals increase the efficiency of their existing patient monitoring infrastructure. We continue to invest significantly in R&D and new product innovations. Although healthcare didn't start well in first quarter, we expect its performance to improve during the rest of the year 24. In summary, with significant backlog in security and opto, we are confident about our prospects in these divisions. We also expect more robust performance from healthcare as we look forward to the rest of the fiscal 24. With that, I will turn the call back over to Alan Edrick to talk in more detail about our financial performance before opening the call for questions. Thank you.
spk03: Well, thank you, Deepak. Now I will review in greater detail the financial results for our fiscal 24 first quarter. Again, our Q1 revenues were up 4% compared with that of the first quarter in the prior fiscal year. Q1 security division revenues were up 14%, largely due to the growth in our cargo and vehicle inspection products and related service revenue. This included modest shipments from the $200 million-plus cargo contract announced in January. Aviation-related revenues increased as well. The book-to-bill ratio in the security division for Q1 was 1.1, leading to a record backlog in this division. Opto sales increased 2 percent year over year, driven primarily by strong intercompany sales to support anticipated security division growth, which was partially offset by reduced third-party revenues as certain Opto customers are right-sizing inventory levels or had programs delayed. The healthcare division, as Deepak mentioned, had a challenging first quarter with year-over-year revenues down 13%, driven primarily by reduced patient monitoring product sales. The fiscal 24 Q1 gross margin of 35.4 percent was up significantly over the 32.6 percent gross margin in Q1 last year, despite the reduction in sales in healthcare, which is the division with the highest gross margin among our three divisions. The gross margin expansion was led by the security division, which experienced a favorable mix of sales, along with the execution of certain operational improvements. Our gross margin will generally fluctuate from period to period based on revenue mix and volume, inflation, and impacts of changes in supply chain costs, among other factors. Moving to operating expenses, we continue to work diligently across each of our divisions to improve efficiency and to prudently manage our SG&A cost structure. Q1 SG&A expenses were 59.8 million, representing a 12 percent increase over the prior year, driven by less favorable effects and a lower level of bad debt recoveries in Q1 of fiscal 24 compared to the prior year. We do expect to leverage our SG&A for the full year fiscal 24, where such expenses are expected to decline as a percentage of sales on an annual basis. Research and development expenses in Q1 of fiscal 24 were $15.9 million, up from $14.5 million in the same prior year quarter. 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 vital to the long-term success of our businesses. In Q1 of fiscal 24, we recorded 0.5 million of impairment restructuring and other charges, compared to 1.2 million of such charges in the comparable quarter of the prior fiscal year. Moving to interest and taxes. Net interest and other expenses in Q1 increased from $3.4 million in fiscal 23 to $5.7 million in fiscal 24, primarily due to increased interest rates in our borrowings. We executed an interest rate swap during Q1 of fiscal 23 to fix a portion of our floating rate bank debt. On the tax side, the reported effective tax rate under GAAP was 23.4% in Q1 of fiscal 24 compared to 24.4 percent in Q1 of fiscal 23. In Q1 of this year, we recognized a discrete tax benefit of 0.4 million compared to 0.1 million in Q1 of the last fiscal year. Excluding the impact of discrete tax items, our normalized effective tax rate in Q1 of fiscal 24 was 25.8 percent compared to a normalized effective tax rate of 25.1 percent in Q1 of fiscal 23. I will now turn to a discussion of our non-GAAP adjusted operating margin. Overall, our non-GAAP adjusted operating margin in the first quarter of fiscal 24 increased to 9.6 percent from 8.7 percent in Q1 of fiscal 23, driven by strength in the security and opto divisions. The non-GAAP adjusted operating margin in the security division expanded to 14.3 percent in Q1 of this year from 12.8% in Q1 of last year, primarily due to the mix of sales and operational improvements. The operating margin in our opto division was again solid, increasing to 12.8% in the first quarter of fiscal 24 from 12.7% in last year's Q1. And with a reduction in sales in the healthcare division, this segment's adjusted operating margin was negligible. Moving to cash flow. Cash provided by operations was $17 million in Q1 of fiscal 24, which was comparable to the prior year first quarter, despite the significant build of inventory that we mentioned on the last earnings call would occur in preparation for program deliveries under the two large security division contracts announced in fiscal 23. CapEx in the 2024 fiscal first quarter was $5.2 million, while depreciation and amortization in Q1 was $9.6 million. Our balance sheet is solid, with modest net leverage of under 1.4 and significant capacity for investments, acquisitions, and stock buybacks. Aside from $7.5 million of annual required principal repayments under our bank term loan, the bulk of our debt matures in fiscal 27. And finally, turning to guidance. We are reiterating our fiscal 24 revenues and we are increasing our non-GAAP diluted EPS guidance. We continue to expect our fiscal 24 revenues to increase more than 18 percent over revenues in fiscal 23. We expect our fiscal 24 non-GAAP diluted EPS to grow more than 27 percent over our non-GAAP diluted EPS in fiscal 23. This fiscal 24 non-GAAP diluted EPS guidance 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 and other non-recurring items. We currently believe this guidance reflects reasonable estimates. The actual impact on the company's financial results of timing changes on expected revenues, disruptions, An increased cost in the supply chain and inflation and interest rates is difficult to predict and could vary significantly from the anticipated impact currently reflected in our estimates and guidance. Actual revenues and non-GAAP earnings per diluted share could also vary from the guidance anticipated above due to other risks and uncertainties discussed in our SEC filings. We continue to remain focused on the growth of our businesses and proactive management of our cost structure. We believe our efforts will enable Loisai to continue providing innovative products and solutions. We would like to take this opportunity to thank the global Loisai Systems team for its continued dedication in supporting our customers and partners. And at this time, we would like to open the call to questions.
spk06: Certainly. And as a reminder, ladies and gentlemen, if you do have a question at this time, please press star 11 on your telephone. One moment for our first question. Our first question comes from the line of Josh Nichols from B Reilly. Your question, please.
spk00: Yeah, thanks for taking my question. And it's really good to see the company with the new turnkey security award here in Uruguay. A couple questions there. These have been historically high margin awards for the company. One, how long do you expect for this to ramp up in any context you could give us in terms of the potential size of the award? Thanks.
spk01: Good morning, this is Deepak here. This is not a very large contract. And it'll take us about six, eight months to get it going. And basically, it's in the similar kind of sizes as the other contracts that we have. And we're very, very excited about it. Because one of the things that we are very proud about it when we get these kind of turnkey contracts in different areas, they become like centerpiece for the rest of the area to look at it. And all these turnkey contracts, basically we are making it a point to say this helps the trade between Uruguay and, for example, North America or Europe. So we continue to look at it that these kind of thing, big successes of going forward. Alan, you want to add something to it?
spk03: No, I think that was good. And Josh, while we don't talk about margins on specific deals, Generally speaking, the margins on our turnkey contracts are nicely north of our overall corporate average.
spk00: Well, thanks for confirming that. The company has really been building out its security portfolio. You've been granted approval for ETD with the TSA now, too. How should we think about the timing and opportunities specifically for ETD over the next 12 to 18 months and how that could ramp up?
spk01: Again, we are very proud about the certification. We think it's a great product. And we do definitely know that in air cargo, there's a big revamp going on for new technology. And we are very well poised for it. In the international sector, we think that the growth will come even faster. So we are very excited about it. And as we go back and look at the performance of these units compared to the present existing products there, we think that we'll continue to get a lot of success in this.
spk00: Thanks, Deepak and Alan. I'll jump back in the queue.
spk06: Thank you. One moment for our next question. And our next question. comes from the line of Jeff Martin from Roth Capital Partners. Your question, please.
spk02: Thanks. Hi, Deepak. Hi, Alan. Wanted to get a sense in terms of the timing on these two large orders that are going to be ramping up here pretty significantly. How much has your visibility on timing improved over the last, well, since the Q4 call? And also wanted to ask in terms of supply chain, if you are able to get components that you need. I know you're ordering significantly more than normal. Just an update there on both those timelines and experiences would be helpful.
spk03: Hey, Jeff, this is Alan. I'll take the first part of that question. Our visibility continues to improve as we go month by month on these two large contracts. There are, as you would imagine on large contracts, often evolving changes, but we're really excited about it. We do anticipate starting to see a a real ramp up in revenues on these contracts beginning now in this quarter in Q2, which is really going to generate some significant revenue growth, we believe, over the balance of fiscal 24. So we expect that. There will always be some changes to the timing and the schedule. That's the nature of the beast in this industry. But the visibility continues to improve, and the ramp up is happening as we speak.
spk01: Just to add on to this, Deepak here, Basically, in the supply chain issue, we are handling it well. And again, I've said in the last conference call too, we are well positioned compared to other competitors because we have intercompany resources also. But definitely, we cannot ignore the fact that when you ramp up so significantly so fast, that there are definitely challenges in the supply chain. We are addressing it. And as Alan has mentioned, that... we will start seeing big growth from both these contracts in Q2 almost into Q3 and Q4.
spk02: Great. And then my other question is with the unrest in the Middle East, does that create potential opportunities for you? Are you seeing increased inquiries from countries in the surrounding area for stepping up their port and border equipment inspection capabilities or other areas?
spk01: Well, first I would like to say that we are very saddened with what's happened there. We continue to pray for everybody's well-being. I haven't seen any changes on this Middle East thing because obviously this is something new. But on the Ukraine project and stuff, definitely as things mature in that area, common sense is that countries around that area are all going to need more security equipment. And we continue to look at opportunities. We're working with it. At the same time, funding is very important. And as you know, that the U.S. has been in a tough situation with what's happening in Washington. As that opens up, both for the Middle East challenges and in Ukraine-Russia challenges, we are very well positioned for any equipment to be procured.
spk04: Thank you.
spk06: Thank you. One moment for our next question. And our next question comes from the line of Larry Soto from CJS Securities. Your question, please.
spk05: Great. Thanks, guys. Just, I guess, a follow-up to the last question just on how the contracts are ramping. Just specifically, Alan, just in terms of the increase in guidance, I know you don't guide to the sectors or the segments, but I guess it's sort of the increase in I feel like is that coming from security? Is that just increased confidence there? Or what specifically drives you to increase your EPS, Alex, this year?
spk03: Yeah, great question, Larry. And your hunch is correct. The growth in the EPS guidance is coming from our security business. You saw in our Q1 that we just reported, we saw some nice operating margin expansion, which led to some stronger earnings there. And as we look out through the balance of the year and some of the strength in that business, that is really what's driven us to increase the overall EPS guidance. You know, we expect Opto to continue to perform well in addition to that, but it's security that's leading to the growth in the EPS guidance.
spk05: Okay. And I don't know if you gave a – you quantified the book to bill for security, but if you have that, that would be great, but just also just kind of qualitatively, obviously, the world's not getting to be a safer place. But, you know, opportunities, you know, in terms of your queue, you know, opportunities, your funnel of opportunities, I think you usually like to refer to that, both within vehicle inspection at borders and outside of that and other areas. You know, how are those trending? And if you had the book to build for a quarter, that would be great.
spk03: Yeah. So, Larry, this is Alan. The book to build on security was 1.1. positioning us in a record backlog, so our highest backlog of all time for our security division. The visibility is strong. The funnel of opportunities is real strong and robust really throughout the world and the nature of our product lines. Maybe, Deepak, you want to add to that?
spk01: Yeah, just want to emphasize onto it that the opportunities are growing, both in the border area, air cargo, and also in the aviation sector. That had been on pretty much hold during the COVID time, and as it's coming out, the traffic is increasing. And there is a lot of interest to upgrade to new products in technology, both in the itemizer and the RTT checkpoint and checked baggage area. And we continue to look at it, and we are very optimistic about the funnel.
spk05: Okay. And just lastly, just shifting gears real fast, on the healthcare, slower start to the year than I think you had expected. I guess two questions. And again, I don't know if you can share with us your thoughts, but maybe I know you had thought this segment would be up on both the revenue and operating profit basis on a full year basis. Do you still feel like that's attainable? And then second part of that question is you mentioned sort of a shift to more of a leasing versus upfront sale of the equipment. Is that like in its infancy? Is that still pretty small today? And does that kind of coincide at all with your Perhaps I think you're planning on a next generation product coming out soon over the next couple of years. Is that those two kind of correlate with one another? That'd be great for any caller on that front.
spk01: Well, good question. Good analysis you've done. On the equipment side, definitely we were disappointed, especially in the U.S., with the equipment sale. As you I'm sure know, the hospitals are going through a tough time. There are two other things that what you asked one, we continue to do the R&D investment to develop a new platform of the patient monitoring. At the same time, this new model that is an infancy that we have started the subscription and the software models, the SAS model, it's a little different model. But interestingly, the thing is, this is catching on, there's a lot of interest, though, it's something in the infancy new that we are doing. But just think of it, we've been doing this thing in the security side. So now to do that in the healthcare side, we at least know the building blocks. Now the question is how to educate the customers and how to be able to prove to them. But I think longer term, we are quite excited about this new model of ongoing revenue, what we call like the turnkey model that we have in the security side. Alan, do you want to add something?
spk03: Sure. And to your questions, Larry, yes, those new models are in their infancy, and we think they're going to be growing nicely over the coming years. And You know, our expectation, you know, the team's expectation is that the healthcare division will grow for the full fiscal year in 24, both on the top line and the bottom line.
spk05: Great.
spk06: Excellent.
spk05: I appreciate the call. Thanks, guys.
spk06: Thank you. And as a reminder, ladies and gentlemen, if you do have a question at this time, please press star 11 on your telephone. One moment for our next question. Our next question comes from the line of Christopher Glenn from Oppenheimer. Your question, please.
spk04: Thanks. Yeah, a lot's been asked. One follow-up. I think you said you expect on health care some nice improvements starting sequentially, really, for the balance of the year relative to the first quarter. It sounds like you were caught off guard a little bit in the first quarter, you know, after some fourth quarter strength. So wondering how you'd describe the visibility to the expected pickup there.
spk01: Well, yes, we are disappointed in the first quarter. But keep in mind that over the years, firstly, it's a single-digit growth area and it's book and ship. There's not a backlog driven. So some orders came in in Q4. In Q1, we were expecting some. It didn't happen. So it is a little bit disappointing. But the team feels very much focused onto it that the remainder of the year will get better. and the innovation that we are doing both in the software SaaS model and our continued development of a new product portfolio, that's not going to have what I would call a significant impact in 2024. It's for longer years. Focus right now is to be able to capture the accounts that we have and be able to work with the hospitals of alternates to them of making them more efficient. Alan?
spk03: Yeah, I think that describes it well.
spk04: Okay. And it was nice to see positive free cash flow in the first quarter. It's often a challenging seasonal quarter, and in particular, you know, this year, just ahead of significant ramps in security. So wondering if you could give some color on what sort of levels, range, metrics around free cash flow we should be looking for this year.
spk03: Chris, this is Alan. Good question. So while we don't provide free cash flow guidance, we would – We would agree with your statement, you know, in light of growing our inventory by 80 million to support, you know, the large security contracts still generating, you know, 17 million or so of operating cash flow was quite strong in Q1. As we look out, you know, there'll be some continued buildup in inventory for these contracts. We think where the real, real significant free cash flow could be driven is in fiscal 25, fiscal 26 and beyond. I mean, we've historically been a very strong generator of free cash flow. We think that strength will only increase, you know, as we move beyond this fiscal year. We do expect to generate nice free cash flow this year, but the real strength in the free cash flow will begin in the subsequent fiscal year is our current expectation.
spk04: Okay. And then just one on opto and manufacturing. Really, looking very sturdy you know a lot of short cycle volatility out there um from oems and distribution impacting a lot of names and um just so curious if you could describe a little bit about what's giving you know that stability particularly how externals performed and you know if you're seeing a regular cadence of um you know wallet share additions with your global customers as they try to de-risk supply chains?
spk01: Well, again, a very good question. It's a different marketplace. Basically, in some cases, it's a very predictable customer base. We work with the OEMs, and we continue to look at it. But they're also going through, basically, inventory increase, stop it, go longer term, So it's a continuing evolving matter. The thing that really makes us very, very good compared to our competitors, one is we have a very broad customer base from aerospace, defense, to automotive, medical, consumer, name it. We're in all spaces. So as a group, all those areas, some are weak, some are strong. And the second thing that we keep saying it, and I've said it before and I'll say it again, our global presence of manufacturing is a big advantage and lately you've heard it everywhere that there's a lot of talk about alternate to china and we have the ability both in asia and in u.s and in europe uh to manufacture products from our customers so we look at this business as a a very well thought of business predictable business uh But like I said, this is a focus of the business depending on our customer base.
spk04: Alan?
spk03: I think that says it well.
spk04: Agree. Thank you.
spk06: Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to management for any further remarks.
spk01: Well, thank you very much. And we again want to thank all the employees of the company and all the customers and everybody else, including the stockholders, and not to forget the analysts. We are very excited about the rest of the year. Backlog is there to support it. And we are looking at a lot of other opportunities. And we think that the balance of the year, starting in Q2 into Q3, Q4, will be very strong. Thank you very much. Talk to you in January.
spk06: Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.
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