OSI Systems, Inc.

Hello, and thank you for standing by. Welcome to OSI Systems, Inc. Fourth Quarter and Fiscal Year 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 the question during this session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. I would now like to turn the call over to Alan Edrick, Executive Vice President and Chief Financial Officer of OSI. Sir, you may begin.

Well, 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, OSI's President and CEO. Welcome to the OSI Systems Fiscal 24 Fourth Quarter and Year End Conference Call. We are pleased that you can join us as we review both our financial and our operational results. Earlier today, we issued a press release announcing our fiscal 24 fourth quarter and full year financial results. Before we discuss these 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 upon 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 further information regarding non-GAAP measures, and comparable gap measures of the company's results and a quantitative reconciliation of those figures, please refer to today's earnings press release. I will begin with a high-level summary of our financial performance for the fourth quarter of fiscal 24 and then turn the call over to Deepak for a discussion of our business and operational highlights. We will then finish with more detail regarding our financial results and a discussion of our outlook for fiscal year 2025. Following record revenues and non-GAAP EPS in each of Q2 and Q3, we again saw record financial results in the fourth quarter, led by the Security Division, resulting in outstanding revenue growth and a significant increase in year-over-year operating income. We are encouraged by the momentum in our business. Let's start with a high-level summary of our fiscal 2024 Q4 and full-year results. First, revenues increased 17% year-over-year to a Q4 record of $481 million, driven by the performance in our security division, where Q4 revenues were up 27% year-over-year. For the full year, fiscal 24 revenues were a record $1.54 billion, a 20% increase over fiscal 23. Second, the significant revenue growth led to record Q4 non-GAAP adjusted earnings per share of $2.84. For the full year, fiscal 24 non-GAAP adjusted EPS was a record $8.13, a 31% increase over the prior fiscal year. Third, bookings were again solid, and we ended the quarter with a backlog of approximately $1.7 billion. Our healthy backlog and robust pipeline of opportunities provide good visibility as we enter fiscal year 2025. Before diving more deeply into our financial results and discussing the fiscal 25 outlook, I will turn the call over to Deepak.

Thank you, Alan. Good morning, everyone. Thank you for joining us today as we discuss OSI Systems' strong performance for the 2024 fourth quarter and the full fiscal year. As Alan mentioned, I'm proud to say our revenues grew year over year by 17% in Q4 and 20% for the full fiscal year, resulting in record revenues for both of these periods. We ended the fiscal year with a significant backlog of approximately $1.7 billion, which combined with the strength of our very robust pipeline gives us tremendous confidence for fiscal 2025 and beyond. Diving into the highlights, the Security Division again delivered fantastic results with year-over-year revenues increasing 27% in Q4 and 37% for the full fiscal year. This growth was spread across many of our offerings in geographic regions, but was particularly notable in Latin America, Middle East, and Asia-Pac regions. During Q4, We continue to successfully execute on our major program with Mexico's Department of National Defense, known as SEDANA, which is expected to generate more than $500 million in total revenue over the length of the contract. For SEDANA, we provide a range of inspection systems, including the Eagle high-energy and low-energy cargo inspection portals, the Carview Vehicle Inspection System, and the CertScan Multisite Integration Platform for inspecting trucks, buses, and cars at Mexico's northern and southern border checkpoints. We also continue to successfully deliver on another major cargo program, the $200 million contract with an international customer. We are performing well with these programs and they are expected to be nice contributors again in fiscal 25. The additional program we won from Sedana valued at over 100 million is well underway also with revenues expected to commence in mid fiscal 2025. Our turnkey projects in Albania, Puerto Rico, Guatemala, and a European airport continue to perform seamlessly providing strong recurring revenues and serving as great reference points on further opportunities. Our latest cargo turnkey project in Uruguay is expected to commence operations before the end of the calendar year. These successful projects, each with their unique security requirements, demonstrate our ability to deliver highly customized solutions to meet our customers' needs. Many of our turnkey and hardware projects also utilize CertScan, our multi-site integration platform that is increasingly adopted by port and border customs agencies worldwide. CertScan sets us apart from competitors enhancing the value of our offerings beside our broad product portfolio. We were active throughout fiscal 2024 with aviation customers also as passenger traffic continued to increase. We expect this general trend to continue as our aviation-related bookings were particularly strong in the second half of fiscal 2024. To that end, during Q4, we announced orders totaling approximately 52 million from two international airports to furnish a comprehensive array of security solutions, including the RTT-110 for whole baggage screening and the Orion 920CT for checkpoint security, with extensive service and support commitments and recurring revenue. For ports and border security applications in Q4, We announced two awards from international customers totaling about $20 million for the Eagle M60 mobile cargo and vehicle inspection systems, including follow-on maintenance and support. These M60 platforms enable efficient and flexible relocation of security checkpoints to optimize security for borders and critical infrastructure. We also announced an award from an international border security customer of approximately $11 million for radiation monitoring solutions and related services and support. This has been a breakthrough year for the Security Division. In addition to robust revenue and profit growth, our continued success in securing major projects in ports, borders, and aviation security reinforces our confidence in our strategy of offering a comprehensive range of products and services in order to provide our customers with the flexibility to meet their specific security needs effectively and efficiently. This approach ensures that we deliver solutions that offer the best value, further solidifying our position as a leader in the industry. With a strong backlog, and strong pipeline, we are enthusiastic about the division's long-term growth prospects in fiscal 2025 and beyond. Moving on to the opto group, the optoelectronics manufacturing division achieved a significant milestone with record Q4 revenues, including intercompany sales of 102 million. Throughout fiscal 2024, including the fourth quarter, We continue to work with our customers to adjust to their demand forecast, and we believe we have made progress in right-sizing to this demand, putting this activity behind us in the coming months. We announced a couple of nice wins during the quarter. We announced a $7 million repeat order from a leading healthcare OEM customer for portable device assemblies. We also received another $7 million order to provide electronic subassemblies to an advanced engineering solutions OEM. In fiscal 2025, we believe that our recent expansion into Mexico, the Tecate operation, will benefit us for nearshoring customer activity along with our favorable position globally in South Asia PAC region, and in UK as large OEMs are seeking to establish or expand their supply chain to de-risk their exposure to China-centric supply chains. Based on the ability of our Opto division to effectively adjust to market trends and changes in customer demand, we believe Opto will continue to achieve profitable growth. Now let's turn our attention to the healthcare division. where Q4 revenues were the strongest for the fiscal year 2024, though down year over year on a tough comparison. Fiscal 2024 brought significant challenges for patient monitoring in the U.S., primarily as hospitals continued to defer capital purchases. Despite these hurdles, during the quarter, we secured a $6 million award from a U.S.-based hospital to provide patient monitoring solutions and related accessories, including exhibit, central stations, expression, patient monitors, and cue patient monitors. Additionally, our Rothman Index predictive and analytic solution is seeing increased success. Our clinical services offerings also continue to be well received by our clients. We are committed to advancing our next generation patient monitoring solutions enhancing the innovative features of our products to help doctors and clinicians deliver improved healthcare treatment. We adjusted the healthcare division cost structure in the quarter also, the benefits of which are expected to primarily start realizing in fiscal 2025. To sum it up, we are confident about our company's future and excited to build on our stellar fiscal 2024 performance. We are extremely excited and confident about fiscal 25 and beyond. I will close this portion of the discussion by thanking all our employees, customers, and stakeholders who have played a part in OSI system success. With that, I will turn the call back over to Alan to discuss our financial results and fiscal 2025 guidance in more detail before we open the call to questions. Thank you very much.

Well, thank you, Deepak. So let's review in greater detail the financial results for our fiscal 24 fourth quarter. Again, our Q4 revenues were up 17% compared with revenues in the fourth quarter of the prior fiscal year. This was primarily driven by our largest division, security. The 27% year-over-year increase in Q4 security division revenues was led by strong growth in our cargo and vehicle inspection product sales as well as solid growth in our aviation and checkpoint product sales. Q4 revenues included continued shipments from the $200 million-plus cargo contract announced in January 23 and from the $500 million-plus cargo contract announced in March 23. Third-party opto sales bounced back nicely as sales increased 6% year-over-year. We continue to see certain opto customers adjusting inventory levels and or ordering patterns, which we anticipate through the balance of calendar 24. Although the healthcare division's Q4 sales were the strongest of the fiscal year, as Deepak mentioned, revenues were 15% lower than Q4 of the prior year due to a particularly challenging comparison period along with a challenging hospital spending environment. The fiscal 24 Q4 gross margin of 32.1 percent was down from the 34.7 percent gross margin in Q4 of last fiscal year. This was largely due to the mix of revenues, as Q4 growth was driven by a significant increase in security product revenues, which typically carry a less favorable margin than security service revenues, as well as a less favorable mix of security service revenues in the quarter. The year-over-year decrease in revenues in the healthcare division which inherently carries the highest gross margin of all three divisions, also contributed to the lower gross margin. Our gross margin will generally fluctuate from period to period based on revenue mix and volume, impacts of changes in supply chain costs, and inflation generally, among other factors. Moving to operating expenses. We continue to work diligently across each of our divisions to improve efficiency and to manage our SG&A cost structure. Q4 SG&A expenses were $71.7 million, or 14.9% of sales, compared to $67.1 million, or 16.3% of sales in Q4 of the prior year. The year-over-year dollar increase in cost was driven by higher compensation costs, including incentive compensation linked to our significant sales growth, increased professional fees, and unfavorable foreign exchange rates, among other items. Research and development expenses in Q4 of fiscal 24 were $15.9 million compared to $15.5 million in the same prior year quarter. We continue to dedicate considerable resources to R&D, and we anticipate further increases in such investment in fiscal 25, particularly in our security division, as we remain focused on innovative product development, which we view as vital to the long-term success of our businesses. We recorded $3.9 million of restructuring and other charges in Q4 of fiscal 24 compared to $3.2 million in the same quarter of the prior year. Moving to interest and taxes. Net interest and other expenses in Q4 increased to $8.2 million in fiscal year 24 from $5.7 million in fiscal year 23, primarily due to increased interest rates on a higher level of borrowings. Subsequent to fiscal year end, we completed a convertible notes financing, which is expected to reduce our future interest expense, which I'll talk more about shortly. Our reported effective tax rate under GAAP was 18.3% in Q4 of fiscal 24, compared to 17.6% in Q4 of fiscal 23. Excluding the impact of discrete items, our normalized effective tax rate in Q4 of 24 was 21.2%, compared to a normalized effective tax rate of 21.9% in Q4 of fiscal 23. For the year, the normalized effective tax rate in fiscal 24 was 23.4%, compared to 22.8% in the prior fiscal year. I will now turn to a discussion of our non-GAAP adjusted operating margin. Overall, our adjusted operating margin in the fourth quarter of fiscal 24 was 14.8%, compared to 15.6 percent in Q3 of fiscal 24, driven by the top-line reductions in healthcare and a less favorable mix of sales in the security division. The adjusted operating margin in the security division was 18.5 percent in Q4 of fiscal 24, which was roughly in line with that of Q3, but down from 19.3 percent in Q4 of fiscal 23, given the less favorable revenue mix in the division. the adjusted operating margin in our opto division increased to 13.9% in the fourth quarter of fiscal 24 from 13.8% in last year's Q4. The healthcare division reported its strongest quarter of adjusted operating margin for the fiscal year, though it decreased to 9.3% in Q4 of fiscal 24 compared to 12.1% in the prior year on lower year-over-year revenues. Moving to cash flow. In Q4 of fiscal 24, we invested significant amounts in working capital and supported the company's growth. Cash used in operations in the quarter was $29 million, primarily due to increases in accounts receivable associated with the security division revenue growth. CapEx in the 2024 fiscal fourth quarter was $8.5 million, while depreciation and amortization expense in Q4 was $11.7 million. Our balance sheet is solid. with modest net leverage of 1.6. Aside from $7.5 million of annual required principal payments under our bank term loan, the bulk of our bank debt matures in fiscal 27. As mentioned earlier, subsequent to fiscal year end, we issued $350 million of convertible notes with a coupon of 2.25 percent due in fiscal 2030 and an initial conversion price of approximately $192. The proceeds were used to pay down our bank revolver and repurchase approximately 550,000 shares of common stock as well as cover transaction costs. This transaction provides enhanced liquidity to capitalize on future strategic initiatives while simultaneously being immediately accretive given a significant reduction in interest cost and a reduction in the share count. In combination with the interest rate swap entered into approximately two years ago, well over three-quarters of our existing debt is now fixed versus floating. Finally, turning to guidance. We are introducing our fiscal 25 sales and non-GAAP adjusted diluted EPS guidance. For fiscal year 25, we anticipate revenues in the range of $1.62 billion to $1.65 billion in non-GAAP adjusted earnings per diluted share in the range of $8.80 to $9.15. This fiscal 25 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 the expected conversion of backlog to revenues, disruptions 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 guidance. Actual revenues and non-GAAP earnings per diluted share could also vary from the guidance indicated above due to other risks and uncertainties discussed in our SEC filings. We continue to remain focused on the growth of our businesses. We believe our efforts will enable OSI to continue providing innovative products and solutions. At this time, we would like to open the call to questions.

Thank you. Ladies and gentlemen, as a reminder to ask the question, please press star 11 on your telephone and then wait to hear your name announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Josh Nichols with B Raleigh. Your line is open.

Yeah, thanks for taking my question. I guess, first of all, Deepak, congratulations on the retirement, although I know you're going to be staying on the board to oversee things. Clearly, the company has been having a great run and it looks like set for another year, right, in fiscal year 25 as well, too. If I want to dive into a questionnaire, I guess good to see that the growth for this coming year north of 6%, right, coming in better than what we had thought. I'm just kind of curious, given that we're already kind of close to two months through the first quarter. I know the September quarter is a little bit seasonally slower just because there's not much activity in Europe. Could you just provide a little bit of color about how you expect the cadence of that growth rate to kind of play out as we go through the first quarter and kind of build from there?

Josh, this is Alan. I'll take that question. So really good question. Yes, typically we see that Q1 is our slowest quarter of the year given the summer and some of the holidays in various countries that you're discussing and suggesting. That being said, given our strong backlog, we do anticipate robust growth even in Q1, certainly down sequentially from where we were. But on a year-over-year basis, we would anticipate – you know, a strong q1 on a year over year basis. And then our revenues kind of building into q2 and into q3.

Great, just thanks. Just want to make sure I got the cadence right now. I want to just kind of touch on gross margin and free cash flow. Clearly, the company has been investing a lot in things like inventory this past year. And I'm wondering, like what the expectations are for gross margins and how that will impact free cash flow for fiscal year. 25, as you get behind some of these large, like more product-heavy deliveries and services, revenue starts to become a bigger component of the mix, or do you think with the backlog as large as it is today that the gross margins are likely to remain where they are given the order cadence that we're seeing that's been persistently high?

Yeah, Josh, this is Alan again. Again, really good question. You know, on the gross margins, they will fluctuate from period to period based upon a number of factors, some of which I had described earlier in the comments. You know, sort of that being said, on an annual basis, you know, I think we see an opportunity to expand the gross margins, particularly as service becomes a bigger component, which inherently carries a higher margin than our products, generally speaking. So I think there's some opportunity for gross margin expansion this year and as we move into future years. From a cash flow perspective, this was a year of significant investment in working capital. We concluded the year with a big investment in receivables as we had such strong sales growth. So that being said, we do expect that to effectively flip. So the higher DSO and higher days inventory that we have associated with the growth when we grew 20% or so last year with kind of the guidance that we're providing this year for social growth, is we do see an opportunity to generate very meaningful free cash flow in fiscal 25 and beyond. So it's an exciting period for us.

Thanks. And then last question for me. I know there's been a lot of skepticism over the last year, year and a half, about like how sustainable all these award wins that the company has been securing and When you look at the backlog today, right, despite the record quarter that you guys had still near record levels of 1.7 billion, I think people are starting to come around to the fact that this is a durable growth story. And with that, you start seeing the share price continue to grind higher over time. When you look out for this next fiscal year, I'm just kind of curious, like, how much do you think of that current backlog is likely to be recognized? Also, equally as importantly, what do you think is the potential large opportunity wins that you still have in the pipeline today so that you're going to be able to replenish that backlog as you have recently with other large opportunities that come to market?

Good question. This is Deepak here. Obviously, we can't break it down how much of the current backlog gets shipped out. Also, Alan has mentioned to you many times, that it varies from quarter to quarter depending on the readiness of the customer, the supply chain and stuff. Regarding the opportunities, like I said in my message, we are very confident about it. Our pipeline is very strong and we've been saying for some time, as we get larger and larger and get bigger customers and get a good reputation, we distinguish ourselves from our competitors and their customers all over the globe are looking at it, and the reference checks out. We are very confident that their pipeline is very strong, and there are significant large opportunities that are there internationally. At the same time, the aviation sector is coming back. That's another positive for us, air cargo. And keep in mind that U.S. business, especially CBP, was not a big contributor in 2024. And as it comes into 2025 and beyond, we are quite confident that we'll be a big participant in the business. So all in all, we feel very good about it. And it's been a very, very positive move into the next year, 2025 and beyond, that we're sitting on a strong backlog, great reputation. And maybe I want to add it onto it, maybe not trying to show off, But we crossed the billion-dollar mark in our security division and can proudly say that we are now maybe number one size-wise in our space in security worldwide.

Appreciate the color. Thanks.

Thank you. Please stand by for our next question. Our next question comes from the line of Jeff Martin with Roth Capital Partners. Your line is open.

Thanks. Good morning, Deepak and Owen. Congratulations on a fantastic fiscal 24. Deepak, kind of segueing off your answer to the last question there with USCBP, just curious what you're hearing out there in terms of potential timing of follow-on orders. I think everybody feels pretty confident that you're well positioned to win a good portion of a potential follow-on order there.

Well, Basically, can't comment on specifically, but we are very well positioned, as you said. CBP, we are very happy with our performance. There are some IDIQs that are presently still have some room left onto it. There is more being talked about. The budgets are being looked at it, and we think there is strong possibility of growth in CBP business, and we should get a good share of it. More than that, I can't comment on.

Yep, that's fair. With respect to the Sedana and the $200 million international order, I was just curious if you could give some perspective on what percent complete those two contracts are.

Jeff, this is Alan. So while we don't go into specifics on individual programs, I would offer that we are further along on the $200 million international order, given that we received that order a few months prior to the previous order. So significant shipments on that occurred in fiscal 24, which as you might remember, we started shipping that actually in Q4 fiscal 23. We did make significant shipments on the Sedana $500 million plus order as well, but a lot more shipments to come on that project. And, of course, we also got the follow-on order with Sedana for another $100 million order that we're gearing up here in fiscal 25.

Yep, thanks for the reminder on that. And then, Deepak, you mentioned significant R&D spending and security. I was just curious if you have any planned submissions for approvals on products and maybe what end markets those might be geared towards?

Well, you know, a good question in a way, but they are two little separate things. We continue to look at certification of various of our products and technology. But in the R&D spend, one of the success stories that we have, and we are very proud about it, we have the broadest product portfolio compared to any of our competitors. so that we continue to innovate and spend investment to continue to broaden it, to put more AI into it, to be more efficient into it, and to work with our customers for their custom needs, especially doing the search scan integration into the product line customized to our customers' needs. And that's the kind of innovation we are doing. But we want to continue to remain ahead of the market compared to our competitors with a product breadth. And that way we can continue to grow. That's very important and that's in our DNA.

Thank you.

Thank you. Please stand by for our next question.

next question comes from the line of larry solo with cjs securities your line is open great thank you uh good afternoon oh good morning uh i guess first question um i know you guys don't provide um specific segment guidance but just curious any color you know sort of in that five to seven percent growth it sounds like all your segments your company are probably improving. Maybe all will grow year over year. Obviously, security grew, you know, mid-30s last year, so we expect that to slow down. Is it fair to just use, like, that mid-single digit as a starting point for all the segments? Does security maybe grow a little bit slower than that? What's like bookings are kind of, you had a great, you know, last couple of years and they've kept up with that, but, you know, in order to grow faster, do we need, you know, acceleration of bookings or is that service component going to kind of kick up kick in and drive that sort of mid-signal digital growth? I guess that would be the first question.

Larry, this is Alan. So good question, and you're correct. We generally don't provide guidance by division, but that being said, to give you some direction, we would anticipate the strongest growth to occur in our security division. We're again anticipating a good year, probably followed by Opto, as I mentioned in the comments, more weighted to the second half than the first half of as more right-sizing of inventories occurring, but we'd expect, you know, solid growth in opto for the fiscal year. And then healthcare, you know, maybe just some small modest growth.

Gotcha. And just in terms of the service piece, I know you mentioned mixed down year over year. It looks like service revenue was basically flat, you know, year over year, and it grew a lot. I know it came forward last year. What's sort of the outlook? I guess does the service component sort of kick in over the next few quarters as your installed base obviously has grown significantly in the last year? I assume there's some kind of warranty period or period where you don't actually get more service revenue. Is there any more call you can give us on that and remind us sort of the difference in gross margin between product and service in a general direction?

Sure, Larry, this is Alan. So you've sort of hit the nail on the head. As we've gotten a larger and larger installed base of our security products and as they roll off of warranty, the service revenues begin to keck in. So we would anticipate some nice growth in our service revenues throughout fiscal 25. And as you correctly point out as well, the margin profile of service revenues is generally superior to that of product revenues on a on a kind of a consolidated basis. And there's a meaningful difference between the two. So all of that can lead to some enhanced margins for us, not just this year, but as we move into future years as well. So we look at these service revenues, which are good recurring revenues, as vital for us. Gotcha.

And just a question, just a follow-up on the CBP question. I know you can't answer timing and whatnot, but I guess I know there's another particular There's still a piece of the IDIQ outstanding. So hopefully that will happen in the next year or so, whenever. But I guess my question here is, are there other U.S. agencies? It looks like a lot of your growth has been international. Are there other U.S. agencies besides CBP where they're sort of in that funnel of opportunity to see you guys?

Good question. And the answer is yes, yes, and yes. One is on the CBP side, as we are sitting here, They're getting their budgets approved into it, and it looks like it's a pretty strong, significant budget for CBP going into the next year. On top of that, the other question, yes, there are other agencies. DOD is a big customer for us. That continues to do look at it. There's Air Cargo, in a way. There's also the Department of Defense, and all these especially one of the things that we all talk about it, which is a little bit awkward to say, that as the world goes through this unrest in the Middle East or in Ukraine and stuff, ultimately all that area, as it settles down, requires more security around that area, and that continues to grow for us. Department of State is a big customer of us, so we look at other agencies besides CBP, and right now there's a lot of interest

Gotcha. I guess just last question. Deepak, I expect and hope you'll remain active. So I expect you will as the chairman when we find a replacement for you. I imagine that that search is probably a slow process, probably not that easy to find someone like yourself. But any timeline, any sense of a timeline on that? Is it like before year end, you think you'll have someone in place? Or what are your thoughts there? Thanks.

Well, that's the plan. I mean, per our announcement before, that by January 1, we should have the new person on board. And as you mentioned, I'll still be there as executive chairman. But that's our plan right now. And we are quite deeply involved in it right now of the selection.

Gotcha. Great. Thanks for all the color.

Thank you. As for ladies and gentlemen, that's star 11 to ask the question. I'm showing no further questions in the queue.

Well, thank you very much once again for attending our conference call. I again, once for all, want to thank our employees, customers, and stakeholders, and looking forward to the October call after the first quarter. Thank you very much, and thanks for your support. Cheers.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.